Dorothy Cipolla - Chief Financial Officer and Corporate Vice President Jim Gaynor - President, Chief Executive Officer, Director

John Nobile - Taglich Brothers

Good afternoon and welcome to the LightPath Technologies quarterly financial results 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 that this event is being recorded. I would now like to turn the conference over to Ms. Dorothy Cipolla, Chief Financial Officer and Corporate Vice President. Please go ahead.

Thank you and good afternoon. Welcome to the LightPath Technologies' fiscal 2015 second quarter financial results conference call. Our call today will be hosted by Mr. Jim Gaynor, President and Chief Executive Officer. Following our discussion, there will be a formal Q&A session open to participants on the call. Before we get started, I would like to remind you that during the course of this conference call, we will be making a number of forward-looking statements that are based on our current expectations and involve various risks and uncertainties that are discussed in our periodic SEC filings. Although, we believe that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate and there can be no assurance that the results will be realized. With that out of the way, it's now my pleasure to introduce Mr. Jim Gaynor, President and CEO of LightPath.

Thank you, Dorothy and welcome to everyone who has joined us on the call today. We appreciate your interest in LightPath. I will open with an overview of operational results, highlights and recent developments and then we will turn the call over to Dorothy for a more in-depth review of our financials. After some closing remarks, we will open the call to your questions. In the second quarter, we made significant progress in the growth of our business and also spent considerable time for longer term and more profitable growth planning. The highlight of our second quarter growth is order bookings, which continued to improve broadly across our business. Backlog for our products was up 8% in the second quarter of fiscal 2015, compared to the second quarter of last year and up 5% quarter-to-quarter. Some of these bookings contributed to our growth in second quarter revenues. Revenue for the second quarter of fiscal 2015 increased 15% to approximately $3.4 million compared to approximately $2.9 million for the second quarter of fiscal 2014 and up 29% as compared to the first quarter of fiscal 2015. The balance of our second quarter bookings with added to our 12-month backlog, which increased approximately 5% to $5.6 million at December 31, 2014, in just the last three months. This backlog, in large part, applies to our aspheric lenses. However, we are now seeing material contributions from our infrared product line. This growth in our infrared product is very exciting measure of our success. Infrared revenues increased by more than 180% year-over-year. Bookings also increased significantly, up 563% in the second quarter of fiscal 2015, compared to the second quarter of last year and up 31% from the first quarter of 2015. These results reflect the ongoing momentum that commenced from the first quarter of the year. Along with the strategic growth initiatives we announced earlier this week for our aspheric lens and infrared lens businesses, the higher growth contributions from our infrared business and our anticipated margin improvements, we are well positioned for substantial improvements in our profitability and cash flow generation as we move forward. I would like now to review our recently announced strategic growth initiatives. These initiatives leverage our past investments in manufacturing and product development. Moreover, they set the stage for enhanced sales and marketing activities as well as operational efficiencies to drive more profitable growth. Under these plans, the company will be better positioned to accelerate its revenue growth beyond what we have already achieved and elevate our profitability principally by the transition to a technical sales process that leverages the success of our existing demand creation model. To align the organization for specific goals and accountability under this plan, an executive structure has been created with three direct reporting lines, operations, our China operations and finance. During the past five years, we have invested to expand our high-speed manufacturing capacity, enhance our manufacturing, coding and finishing processes and implemented a demand creation model that leverages our low-cost high volume superior quality production capabilities to not only take market share but more importantly to create new market opportunities. Our order backlog and revenue growth reflect the initial success of these efforts. Our compounded topline growth over the past five years for precision molded optics has averaged about 10% per year, nearly double the market rate. Our bookings in background figures have reached record levels. Our production capacity has increased by nearly 400% during this period, while our gross margin has increased from 18% back in 2006 through 2008 to 42% in 2012 through 2014. In the past two quarters, as we moved into a lower cost manufacturing facility in China and endured certain to duplicative expenses until the transition has been completed, our gross margins are below our target range for the low to mid 40s. However, in our second-quarter results, when you eliminate the nonrecurring cost to make these changes, the gross margin generated by the business is in the low 40%. Given the success we have achieved over the last several years, the new growth initiatives and the organizational modifications are intended to return us to the target gross margin level and benefit from higher sales and leveraging our operating expenses to drive improved earnings. We will be in a better position to further enhance our incremental organic growth for our core aspheric lenses business, prime our operations for the anticipated high-growth of our new infrared products and allow for the integration of strategic acquisitions. Another benefit of the changes is an estimated annual reduction of operating expenses of 5% to 10% or savings of approximately $200,000 to $375,000 per year once we complete the implementation. An integral component to our new plan, LightPath is aligning it sales and marketing efforts to elevated demand creation model to an even more technically based approach as its addressable markets have proven to be increasingly receptive to the company's product lines. Technical and engineering staff will be more fully integrated with the company's sales force. Two new sales positions have been created. The first is an Executive Director of Sales and Marketing, which combines the responsibility for all sales and marketing under Glenn Breeze. The second is a marketing manager under Kimberly Clifton. Organization supporting aspheric visible lens products and the company's new line of infrared products will be combined. Sales, marketing, engineering and quality will report to Alan Symmons, who assumes the newly created position of Executive Vice President of Operations. Alan Symmons, who was previously Vice President of Corporate Engineering has been a valued part of LightPath's leadership since 2006. Glenn Breeze, our new Executive Director of Sales and Marketing with over 40 years of industry experience was previously our Director of Infrared Sales and joined LightPath in 2013 from Ophir optics, a competitor to LightPath. Kimberly Clifton with 20 years of sales and marketing experience also joined LightPath in 2013 and was hired to lead the inside sales and marketing communications function. A second reporting line as defined in our new plan will be led by our CFO, Dorothy Cipolla, who will handle our finance related areas and will also assume the newly created position of Chief Administrative Officer. The areas reporting to Ms. Cipolla will include functions relating to finance, controller, human resources, purchasing, facilities and internal control systems and IT. The third reporting line of our new plan is responsible for our business in China. This will continue to be led by General Manager, Hui Yue. Mr. Yue has been with LightPath since 2007, serving as General Manager for the company's activities in China for the last three years. Earlier at LightPath, he had been Deputy General Manager for the Shanghai operations for over five years. Under his leadership, LightPath has doubled its lens manufacturing capability, including the recently opened facility in Zhenjiang province. Speaking of our presence in China and our leadership enhancements, we are pleased to announce the appointment of Dr. Xudong Zhu to our Board of Directors. With the addition of Dr. Zhu to the company's Board, we will expand from six to seven directors, six of whom are independent as defined by the NASDAQ. Dr. Xudong Zhu is President of Shanghai Pudong Science and Technology Investment Co, which we refer to as Pudong, which is a Shanghai-based investment management company with a leading professional management team, diversified business lines, strong financial position and rich strategic resources. Pudong beneficially owns 14.9% of the company's outstanding shares of common stock, which includes 930,790 shares we issued in a private placement on January 20, 2015 to its subsidiary, Pudong Science & Technology Investment Company of the Cayman Islands. The balance was acquired through open market purchases as originally disclosed in a Schedule 13G filed with the Securities and Exchange Commission on August 15, 2013 and amended on February 14, 2014 and January 27, 2015. The appointment to our Board of Directors underscores Dr. Zhu's commitment to the company after conducting considerable due diligence and leading successive investments to become one of our larger shareholders. Beyond the sizable ownership of our stock, his respected position in China, where we have significant manufacturing and marketing operations and his experience as a technology investor will be beneficial to his contributions to LightPath's leadership. As we disclosed, the proceeds from the sale of common stock to Pudong are intended to provide working capital to support our continued growth through global expansion, which will include organic initiatives as well as strategic acquisitions. The combination of these changes will allow us to take full advantage of the substantial increase in revenue generating opportunities we are seeing and generate broader market applications. As a result of our recent investments in technologies that decreased our lens production cost and expanded our production capacity, as well as our new capital and optimized go-to-market and management initiatives, we believe we can further improve on our track record of growth and do so far more profitably. I will now turn the call over to CFO, Dorothy Cipolla, who will provide additional detail on our second quarter results.

Thank you, Jim. First, I would like to mention much of the information we are discussing during this call is also included in the press release issued earlier today and on Form 10-Q, which was filed today. I encourage you to visit our website at lightpath.com and specifically the section entitled Investor Relations where we have included the preparations that we have made at recent investor conferences and our annual shareholders meetings. I will now review financial performance and operational detail for our fiscal 2015 second quarter which December 31. Revenue for the second quarter totaled approximately $3.4 million which is an increase of $445,000 or 51% as compared to the same period last year. The increase from the second quarter of last year is attributable to increase in sales of precision molded lenses and an increase of sales of infrared products which Jim addressed earlier in the call. The gross margin as a percentage of revenue in the second quarter was 38% compared to 43% in the second quarter last year. Total manufacturing costs of $2.1 million increased by approximately $415,000 in the second quarter compared to the last year, primarily given the higher revenue level. We also incurred additional cost due to higher wages associated with the overlapping manufacturing workforces during the transition of production between the company's two facilities in China, including seven of our terminated Shanghai staff as the production was moved to Zhenjiang. As we noted in prior calls, the addition of a second manufacturing facility in China increased our global occupancy by 67%, with commensurate increases in rents, electricity and overhead expenses. Beginning in n the first quarter, we felt the impact of the newly added manufacturing personnel. While we are transitioning work to the new facility, margins have been temporarily pressured. Gross margin for the second quarter was 38% impacted by severance cost incurred as we accelerated the transition from our Shanghai factory to our new facility in Zhenjiang. We are ahead of schedule in terms of transferring our manufacturing operations and expect this to be completed before the end of our fiscal 2015. Over the course of the last two quarter, we have reduced our headcount in Shanghai from 121 to 29. Remaining in Shanghai will be our sales, development, engineering and some administrative functions including purchasing and customer support. Essentially all manufacturing operations are now moved to Zhenjiang. On an adjusted basis, to reflect a normalize non-redundant cost basis, without severance charges and other related expenses, the gross margin in the second quarter would have been 21%. We expect our margin to improve to this level or higher as to take advantage of leverage in our model with increased revenues applied against a normalized cost base. During the second quarter, total cost and expenses increased by approximately $249,000 compared to last year. The increase is due to the addition of approximately $277,000 for special service fees in support of strategic growth initiatives, $23,000 of severance to terminated employees offset by ongoing management of our expenses. Total operating loss for the second quarter of fiscal 2015 was approximately $405,000 compared to an operating loss of approximately $186,000 last year. Adjusting for the aforementioned overlapping expenses in cost and charges which are one time in nature, total cost expenses in the second quarter would have been $1.38 million as compared with over $1.43 million last year. Operating income on an adjusted basis for the second quarter would have been $11,000 as compared to an operating loss of $186,000 in the prior year. In the second quarter of fiscal 2015, we recognize non-cash income of approximately $535,000 related to the change in the fair value of warrant liability issued in connection with the June 2012 private placement. In the second quarter of last year, we recognized a non-cash expense of approximately $35,000 related to the change in the fair value of rewards. The warrants have a five year life and its fair value will be remeasured each reporting period until the warrants are exercised or expired. Net income for the second quarter was approximately $141,000 and this includes the $535,000 non-cash income for the change in the value of the warrants or $0.04 per basic and diluted common share, compared with a net loss of $15,000, which includes $35,000 non-cash expense for the change in value of the warrant or $0.01 per basic and common share for the same period last year. Weighted average basic shares outstanding increased to 14.3 million in the second quarter compared to 13.9 million last year, primarily due to the issuance of share with our employee stock purchase plan. Adjusted EBITDA for the second quarter was approximately $220,000 compared to approximately $39,000 last year. the negative adjusted EBITDA in the fiscal 2015 period reflects the elimination of non-cash income relating to the warrant liability. Please refer to our SEC filings and website for EBITDA reconciliations. Now on to the financial results for the firs half of fiscal 2015 which ended December 31, 2014. Revenue for the first half totaled approximately $6 million, an increase of $237,000 or 4% as compared to the same period last year. The increase from the first half of last year was attributable to an increase in sales of precision molded lenses and 158% increase in sales of infrared products. The gross margin percentage in the first half was 38% compared to 45% last year. Total manufacturing cost of $3.7 million increased by approximately $549,000 in the first half this year compared to last year, given the higher revenue level. We also incurred additional cost due to higher wages associated with the ramp up of infrared production, the overlapping manufacturing during the transition of production between the China facilities and severance for terminated Shanghai staff as production was moved to Zhenjiang. During the first half of 2015, total cost and expenses increased by approximately $356,000 compared to last year. The increase was primarily due to an increase of $258,000 in professional services fees in support of strategic growth initiative, $173,000 in wages and partially offset by $88,000 in lower stock compensation expense. Total operating loss for the first half was approximately $915,000 compared to an operating loss of approximately $248,000 for the same period last year. In the first half of 2015, the company recognized non-cash income of approximately $481,000 related to the change in the fair value of the warrants and last year we recognized another cash expense of approximately $54,000 related to the change in the fair value of these warrants. And as I mentioned, these have a five year life and they are remeasured each accounting period. Net loss for the first half of 2015 was approximately $438,000 which included the $481,000 non-cash income from the change in the value of the warrants or $0.03 per basic and diluted common share, compared with a net loss of $282,000 which included the $54,000 non-cash expense for the change in the warrant value or $0.02 per basic and diluted common share last year. Weighted average basic shares outstanding increased to $14.3 million in the first half the compared to $13.7 million last year, primarily due to the issuance of shares which were issued according to our employee stock purchase plan. Cash and cash equivalents totaled approximately $795,000 as of December 31 and this cash and equivalent amount at year-end do not include the gross proceeds of approximately $1.3 million which we received from the Pudong investment which closed in January 2015. As of December 31, company's total backlog was $5.6 million which compared to $4.3 million as of June 30, a 31% increase and the backlog was $5.3 million at September and that's a sequential increase of approximately 5%. With this review of our financial highlights concluded, I will turn the call back to the operator so we may begin the question-and-answer session.

[Operator Instructions]. Our first question comes from John Nobile of Taglich Brothers. Please go ahead.

Hi. Good afternoon Jim and Dorothy. Good topline numbers. That was good to see. And actually if I factor out the change in the fair value warrant liability, it was still profitable, I believe, by a little bit, but you still made a profit, which was a nice turnaround. But anyway, I wanted to get to the second quarter sales to China. If you could maybe breakdown what that was specifically? In that area, how does it look in Q3, given all the news I have been seeing about reduced economic growth in that region?

Well, we have done fairly well in China and continue to be. I think our sales directly into the Chinese market, they are running a little bit below our expectations, but they are still growing. We probably booked close to $800,000 which was a pretty decent number, given what's going on over there and we shipped most of that. And I think we see that number growing slightly in this current quarter, even though we are going to experience their Chinese New Year. So everything will be shut down for a week officially and you have the before-and-after affect around that week. So it tends to be one of the slower quarters over there. But I think we see good progress. And I think it has to do with the quality of the customers we have in China which we have a lot of customers like Huawei and people of that nature whose business is expanding and we have done quite a bit of design work. With Huawei, for example, we have probably done somewhere between, I can't remember exactly, but it is between nine and 15 new designs with some of those starting to go into production. We expect to see a full-blown production level with that particular customer going, starting in May. It has actually started now, but we think the volume stuff will pick up and be running full tilt by May. So that continues to be driven by the telecom infrastructure, driven by the bandwidth demand and those themes that are requiring expanding optical networks. So I think that's good news from that standpoint. We expect to see that. The industrial tool stuff, we have some good customers there. We booked some very large orders the previous quarter. We expect to see that stuff start to build in volume. We have seen some of that. We are seeing some other inquiries where the business is starting to grow a little bit for us. In the optical world, John. I think we are fortunate from that standpoint and the kinds of market themes that are out there that are driving that business.

So that's good. So only because, especially in the industrial area, I figured things could be pretty tight there.

Plus, the Chinese government is starting to stimulate again. So we will see what pertains. That's usually a good sign in the short term anyway.

Okay. You had mentioned about upcoming reduction in operating expenses of 5% to 10%. Is that going to be strictly on the SG&A line? Or do you also plan to reduce R&D?

Well that reduction is through the whole P&L. So there is a significant portion of it that's the cost of goods and that relates to this change in workforce that was implemented in China where we have transitioned out of Shanghai and moved the vast majority of our manufacturing to our Zhenjiang plant. Partly because of the slowdown, there is fewer people hired back in Zhenjiang than we had in Shanghai. But more importantly, the cost of the people in the interior of China is significantly less than they were in Shanghai. So we made that transition. And as we said, we went from about 120 people six to nine months ago down to 29 left in Shanghai, who are professional skilled people. They represent our development engineers and some very excellent administrative people in the personnel and customer support and purchasing as well as our sales organization in China. It could be anywhere. So that's what's going to be left in Shanghai. So we will take advantage of that. So most of that change has occurred and the benefit of that is all at the cost of goods. The other changes that we did is where we combine our -- we had initially set up a separate organization in Orlando to set up and start up the infrared development and production. We have accomplished that purpose. And now we have combine those two organizations together and we have been able to reduce some of the overhead costs that were associated with that. And that represents a few hundred thousand dollars of savings that's in the SG&A area.

Okay. So a few hundred thousand in SG&A.

Well, I think net of everything, as we said, is going to be approximately somewhere between $200,000 and $375,000 to $400,000 a year of savings.

Okay. But I was looking to break it down. It looks like it's shared between cost of goods sold and SG&A, not really touching R&D, but with SG&A you figure a few hundred thousand on a yearly basis savings?

I think that's correct. Yes.

Okay.

It's almost 50/50. If you wanted to split it, John, I would split it 50/50 between cost of goods and SG&A.

Okay. Well, that's good to note and you mentioned a lot of these have happened. I am just curious if there is any reduction in both operating expenses on the cost of goods sold and SG&A. They are going to show up also in Q3. Like are we going to see, well if I factor out SG&A, which I had $1.3 million but you had onetime items in there. So it was about the $1 million or $1.1 million without that onetime nonrecurring item. So at that level, can we expect that to still drop a little bit further going forward?

Yes. I would think so. It's hard to figure that one out, specifically because I will give an example. Our electric cost in Shanghai where we are running all of this, we were spending probably RMB100,000, what was it, a month?

Month.

A month. And running that same level of operation in Zhenjiang now, it's about a third of that. I wasn't expecting electricity to cost so much less by moving in the interior. But it does. So there are some -- the general operating expenses, I think associated with things like that just tend to be cheaper in the new location. So I think we will enjoy some benefits from that perspective. But the major one is the cost of the labor and the professional people that we have hired in Zhenjiang will be a lot lower cost.

And I just want two quick questions I want to throw at you and thank you for taking these questions. In September you received, there was the $1 million aspheric lens order. How many have been shipped in Q2, the quarter you just reported? And what can we expect in Q3 and beyond in regards of that order?

Well, I think that's an order that's still ramping up. I don't have a good breakdown of what we shipped in Q2, but I don't think it was very much. I have to dig into that to give you a decent answer. But we do expect that to start going into production. But it has been minimal up to this point as this is the side of the slowdown in China that we are seeing some impact there.

So that's kind of encouraging to some degree that Q2 didn't really show much of that order but in Q3 and beyond is when we should see it ramping up, selling it to [indiscernible].

Right.

All right. Just one more quick one.

But I will add this John. We had business with that customer prior to that order, a different level of business. When I say different level, it's a higher end type product. We did receive a couple of significant orders for that business going in the several hundred thousand dollars range of business that was growing. So the existing business we had initially is continuing and ongoing and that business, he seems to be doing pretty well with that. This newer business has taken a little longer to get started than he was hoping and again obviously they were hoping. But it's still coming.

Okay. That's great. And just one more quick question in regards to the gross margins and severance costs were a big component of that. Could you safely say that all of those severance cost have been expended or is there a little bit more we can see in Q3? And do you expect, actually in Q3 for gross margins to return to the mid-40% range, low to mid-40% range? Is that a safe bet to say?

I would say, yes. As to the future severance, I don't see it coming on the cost of goods line. I think there might be a little bit more on the SG&A line. But that wouldn't impact the margins.

Okay. That wouldn't impact the margin, but severance could still happen in the SG&A line? To give you that, I know what you were talking about 50/50 mix, probably Jim you had mentioned a few hundred thousand in the outlying, so we can see that reduction going forward in Q3?

John, just so people understand, in China, you pay the severance when you let the people go in total and those people are gone. The only time it doesn't get paid right away is if you get into a dispute. In other words, a person decides he wants a better package than you offered him, which is all defined by their labor laws. So it's kind of a funny situation. But they can go to the labor board and dispute it. And if they don't get a favorable ruling there, they can then take it to the next step, which is a civil court. Out of the roughly 80 people that we let go, we have one person who is in that situation. The labor board has denied his claim. So now whether he is going to go to the next step or not, we don't know. But that's the only one that hasn't been paid out of the Chinese severance, which is all covered.

Okay. So in that region, obviously, it looks like all the severance cost have been expended.

Yes. So the majority of this cost has been recognized and run through the P&L already.

Okay. Great. Well, listen, thanks for taking my questions. That's all I have. I will leave it open for anybody else. Thank you.

Okay. Thank you.

[Operator Instructions]. At this time, it appears that there are no further questions. I would like to turn the conference back over to Jim Gaynor for any closing remarks.

All right. Thank you. In conclusion, I guess we appreciate the support of our shareholders and the dedication of our global team at LightPath. We remain focused our efforts to drive revenues for our product lines and in particular our precision molded optics and our infrared product lines. And ultimately benefit the leverage in our business to improve our profitability. With the progress that has been made and our plans for continued execution, we look forward to delivering long-term profitable growth, which may deliver meaningful returns for the benefit of our shareholders. Thanks again and we look forward to speaking to you with the next quarter report.

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