Dorothy Cipolla - VP and Executive Director of Compliance, Treasury and Tax Jim Gaynor - President and CEO Donald Retreage - CFO

Matt Koranda - Roth Capital Partners Zack Turcotte - Dougherty & Company LLC Gene Inger - IngerLetter.com Marc Wiesenberger - B. Riley FBR

Good day everyone and welcome to the LightPath Fiscal 2018 Fourth Quarter Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] And please note, that today's event is being recorded. I would now like to turn the conference over to Dorothy Cipolla, please go ahead.

Thank you. Before we get started, I would like to remind you that during the course of this conference call, the company will be making a number of forward-looking statements that are based on current expectations and involve various risks and uncertainties that are discussed in its periodic SEC filings. Although the company believes 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. In addition, references may be made to certain non-Generally Accepted Accounting Principles, or non-GAAP measures, for which you should refer to the appropriate disclaimers and reconciliations in our SEC filings and press releases. Following management discussions, there will be a formal Q&A session open to participants on the call. I would now like to turn the conference call over to Jim Gaynor, LightPath's President and Chief Executive Officer.

Thank you and good afternoon. And I apologize upfront for my scratchy voice. I'm suffering a little bit from some kind of cold or allergy infection. So -- but I'd like to welcome you to LightPath Technologies fiscal 2018 fourth quarter financial results conference call. Our financial results press release was issued after the market closed today and posted to our corporate website. Following my remarks, our CFO will provide a more comprehensive review of the numbers and then we'll turn and conduct a question-and-answer session. So, now onto my remarks. Fiscal 2018 marked a year of unprecedented change that has set the stage for our company's future. This followed the transformational acquisition of ISP Optics in fiscal 2017 to accelerate our path to becoming a leading global provider of infrared optics, while also possessing an impressive family of products for visible light. With the ISP acquisition, we gained the cornerstone of what we believe will be our primary long-term growth engine. During 2018, we commenced with a number of initiatives intended to strengthen our infrared business as well as our entire organization. Our year-end financial results demonstrate the significant progress we made and provide indications of the opportunities ahead for both top and bottom-line growth in fiscal 2019 and beyond. The highlight of our efforts in fiscal 2018 was the strong order bookings which gained momentum throughout the year. Our booking substantially increased despite the telecommunications sector into which we sell our higher margin precision molded optics products, reaching what appears to be the trough of its downward cycle, which adversely affected our unit volume by approximately 35% for this sector. Given that the segment of PMO market that LightPath serves, the laser diode segment, typically grows at 5% to 7% annually, we were not able to offset this business loss with gains in other PMO market segments. Therefore, we focused on IR and other growth markets to deliver an increase of 38% in our 12-month backlog as of June 30, 2018, as compared to the backlog at the end of the prior year. With our infrared business having lower average gross margins than our PMO business and the IR products now contributing the majority of our revenues, we put in place a strategy to improve our gross margins. To improve margins, we are making investments at our manufacturing facilities in Zhenjiang, China; Riga, Latvia; and Orlando, Florida, intended to lower the cost of production for infrared products, which also give us redundancies to handle the anticipated growth as we look forward. In the third quarter, we leased an additional 12,000 square feet of space in Orlando, where we will be able to expand our staff and engineering needs. From 2014 through 2016, we successfully increased gross margins for our PMO products, which remained in excess of 50% today, while expanding production capacities and volumes for that platform. Now, we are addressing the margins and production capacity of our infrared products, where margins had historically be in the 30% to 40% range. The need for our strategy to elevate gross margins was compounded in fiscal 2018 as the primary raw material that makes up approximately 40% of the cost of an infrared lens increased by nearly 28% this year. At the same time, the IR market is growing rapidly and we are making considerable headway in taking market share. Since acquiring ISP in December of 2017, we took a business that had over $12 million in revenues in calendar year 2015 and grew it to just under $15 million in revenues for fiscal 2018. In addition, demand for IR products accelerated as the year progressed, which impacted other aspects of our business. First, we reached the production capacity for our diamond turned IR products at a time we were implementing gross margin improvement initiatives to maximize the margin contributions of our infrared business. The production capacity constraints resulted in the deferral of some IR shipments during the fourth quarter which impacted our revenues. Without these production capacity constraints, we believe that the growth in our infrared business could have been higher. Currently, we are increasing our global IR production capacity which will enable us to nearly double our IR revenues and do so at higher level of profitability. In terms of the margin improvement initiatives, we are in the process of relocating the manufacturing operations of ISP's facility in Irvington, New York to our facilities in Orlando, Florida and Riga, Latvia and with some production also moving to our facility in Zhenjiang, China. All of these other facilities have lower cost and better labor pool to accommodate our topline and margin improvement goals for the IR business. The transition of the ISP manufacturing operations should be complete by the end of fiscal 2019. As we previously discussed, the substantial growth of our IR business has been in a faster pace than we anticipated and was further accelerated by high germanium prices which generated even more interest from our customers to convert to our chalcogenide BD6 germanium-free glass material system. We developed the BD6 material in fiscal 2018 as an alternative to germanium for which volatile costs are negatively impacting our IR margins. The increase in germanium prices is believed to be partly attributable to China essentially controlling the market price of germanium. Comprehensive production capabilities and global availability for a new line of infrared lenses made the chalcogenide compound -- made of chalcogenide compound was announced during the second quarter. This compound is developed and grown internally by LightPath to produce black diamond glass and marketed as BD6. In addition to molding BD6, material -- the BD6 material can be fabricated into optical elements via precision diamond turning. A number of optical coating options are available and suitable for various customer requirements. BD6 chalcogenide glass lenses are light weight, passively athermal over a broad temperature range and are economically practical. LightPath’s advanced precision glass molding expertise and proprietary tooling technique enables a highly repeatable process that is scalable to high volume production. Beyond the performance qualities this product offers to our customers, we have improved control of the supply chain, since we are the supply chain. And may now better regulate the primary cost of materials used in our largest segment of consolidated revenues. LightPath now has significant capacity to make enough high quality BD6 glass to meet our forecast demand for precision molded IR lenses. Our glass manufacturing and molding capabilities were augmented in the second quarter as part of our vertical integration and differentiation, which has been driven by the market's increasing requirements for low-cost infrared optics applications. The new material for IR products and the enhanced sales strategy developed in fiscal 2018 following the addition of new leadership for our global sales operations have been delivering the intended results. Instead of singular purchase orders, we are creating stronger relationships with existing and new customers where we have contractual long-term supply agreements. I'd like to briefly call out a few of our recent orders, which are for IR and PMO lenses. In June, we announced an award of $550,000 purchase order for a large quantity of our new 19-millimeter EFL thermal imaging assemblies from a well-known commercial infrared optics OEM in the United States for use in a consumer product. Later in June, we announced to receive an order valued at over $600,000 for one of the world's largest commercial video surveillance manufacturers based in Asia. This was a new customer for us. Finally, we were rewarded a $1 million purchase contract for two custom designed infrared imaging lenses by a major American thermal imaging camera manufacturer. This contract is with a new customers as well for LightPath, which is active in the commercial, firefighting, law enforcement, and outdoor sports market. In August, we announced our selection by Renishaw, a London Stock Exchange listed world leader in metrology technology and products to continue our partnership as the designated supplier of two types of glass molded lenses for Renishaw's resolute optical encoder products. This substantial contract allows Renishaw to secure its high volume requirements from LightPath for the next three years. The contracts that I have discussed in this call and others that we have not disclosed give us improved revenue visibility for several quarters into the future, while enabling us to better manage our future production requirements and related capital investments. Bookings have continued from the fourth quarter of 2018 into fiscal 2019 at a strong rate. At the same time, there are indications that the telecommunications market will recover, particularly as the access networks around the world are being upgraded to accommodate the conversion to 5G applications. And as that happens, we will have the opportunity to grow our high margin PMO business. In fiscal 2018, we worked on 35 non-recurring engineering projects related to 5G technologies for some of the largest telecommunication OEMs in of the world, which is in addition to the nine NRE projects from the prior year. NRE projects are a leading indicator demand for high-volume production requirements. As these orders come in, LightPath will be ready. On the 5G front, we have done quite a bit of work with Huawei. During the year, we were engaged to work on at least six new lens designs for them, and we have more in discussion. With Lumentum, we've got 5 new lenses in development and a few with NeoPhotonics that may be applicable to 5G. The strategic initiatives and investments being made to expand our customer base and product lines grow our revenues and improve our margins, aligned with our long-standing objective of maintaining a strong financial condition and this starts with our leadership. We further bolstered our finance team by appointing Donald O. Retreage, Jr., our new Chief Financial Officer. Our former CFO, Dorothy Cipolla, now heads our Compliance, Treasury and Tax areas, which have becoming increasingly complex as we diversify and grow internationally, face currency fluctuations, and deal with trade and taxation matters. Don, our new CFO is a corporate leader with vast experience of nearly 25 years in international finance and accounting, a financial management expert with a proven track record of accelerating revenue growth and adept at strategic decision-making resulting directly in maximized workforce productivity and business profitability. Collectively, we have a far greater depth in the department to support our ongoing growth and profitability goals. Both Don and Dorothy are on the call with me today and will be available to answer your questions during the question-and-answer segment. Prior to that, Don will participate, for the first time, by providing a more detailed review of our financial performance for the fourth quarter and fiscal year. While I'm not trying to steal his thunder, I'm pleased that through the course of fiscal 2018, we were able to reduce the company's total debt by 35% to $7.4 million, while maintaining a healthy cash position. Cash was $6.5 million at the end of the year, following a reduction in debt and spending $2.5 million for capital equipment. We have continued to take a balanced approach towards improving our financial condition and paving the way for long-term growth in all aspects of our business. In the long-term, our overall objectives remain constant in delivering global diversified growth and solid cash flow generation. To this end, both the near-term and long-term outlooks are aligned. As we look into fiscal 2019, we are energized with a strong global team, growth opportunities in both of our main businesses lines, and the many steps being taken to improve our profitability. I'll now turn the call over to our CFO, Don Retreage, to provide additional detail on our financial results for the fiscal 2018 fourth quarter and full year.

Thank you, Jim. First, I'd like thank Jim, the rest of the executive team and LightPath's Board of Directors for entrusting me with taking all the role of CFO at LightPath Technologies. Since joining the company, in June, I have been thoroughly impressed with the integrity, professionalism, and dedication of the entire organization, as well as the collection of technologies and market opportunities. Next, getting on to the business of today's event, I would like to mention that much of this information we are discussing during this call is also included in the press release issued earlier today and in our annual report on Form 10-K to be filed with the SEC. I encourage you to visit our website at lightpath.com and specifically the section titled Investors Relationship. Now, onto the results for the fourth quarter of fiscal 2018. Our revenue for the fourth quarter was $8.1 million, down 10% from $9 million last year. Revenues generated by infrared or IR products were approximately $4.1 million in each of the four quarters for fiscal 2018 and 2017. In each of the past four quarters, infrared product revenue has surpassed PMO revenues, solidifying its position as our largest product category. Industrial applications, firefighting, cameras, and other public safety purposes are the primary drivers for the increased demand for IR products. Revenues and production volume will vary depending on the mix of the business. In the fourth quarter, we sold 46,000 IR lenses, a record for the company and up 12% from the third quarter of fiscal 2018 and 8% from the fourth quarter of last year. Total PMO product revenue was $3.4 million for the fourth quarter, down from $4.2 million in the fourth quarter of prior year. Revenues from the sales of low volume PMO products, generally lower quantities at higher selling prices, decreased by approximately $481,000 or 10% to $1.8 million in the fourth quarter from $2.2 million in the prior year period, primarily attributable to low sales to customers in the telecommunication, defense, and industrial sectors. Sales of high volume PMO, generally higher quantities at lower selling price, were $1.6 million in the fourth quarter, a decline of $335,000 or 22% from $1.9 million in the prior year period, primarily attributable again to the continued soft demand from the telecommunications industry. Specialty products revenue was $596,000 in the fourth quarter, down 6% or $37,000, from the fourth quarter the prior year due to timing of customers' orders. We have a solid pipeline of customers for this relatively smaller product segment, where each contract can distort performance in the quarter depending on the timing of when the orders were received and shipped and where revenues recognized. Investment in this product category is picking up for our LIDAR sensing and [indiscernible] safety technology. This is a relatively new area of focus for LightPath and we expect these projects to deliver a future stream of larger production quantities. Finally for NRE projects, we reported revenues of $66,000 in the fourth quarter of fiscal 2018, up 8% or $5,000 from $61,000 in the prior year period. Moving to our geographic revenue mix. For the fourth quarter of fiscal 2018, 37% of sales were from the U.S., with 23% from Asia, 31% from Europe, and 8% from the rest of the world. Our overall geographic mix remains fairly consistent with approximately 62% international sales for fourth quarter compared to 63% in the fourth quarter of the prior year and 57% in the third quarter of fiscal 2018. Our diversified revenue with contributions from multiple country operations is integral to our overall growth strategies that does come with some currency risk and taxation issues, which I'll later address in my remarks. In terms of sales demand -- sales channels, 17% of sales were from distribution and catalog customers, while 8% resulted from direct sales efforts. This compares to 16% from distribution and catalog and 84% from direct sales for the fourth quarter of last year. Now, for our vertical market sales review. In the first -- fourth quarter, as I mentioned, 17% of our sales was from our distribution and catalog customers, which are generated from a variety of end markets. 42% of our sales was generated from customers in the industrial market; 11% from government and defense; 12% from telecom and wireless; 5% from medical; and 13% from instrumentation and other. Quarter-over-quarter, the most notable shift for the increase in industrial from 38% to 42% of sales, offset by a decrease in telecom from 16% to 12% of sales. In comparison, the third quarter of fiscal 2018, our vertical market orientation is fairly consistent. In terms of bookings, as Jim mentioned, we took in orders during the fourth quarter of fiscal 2018 valued at $9.9 million, an increase of 43% as compared to $6.9 million in the prior year period, with similar amounts and growth percentage for our third quarter of fiscal 2018 on a year-over-year basis. While we do not disclose bookings by vertical market, some interesting insights can be offered when looking at the results from select markets in the fourth quarter as compared to prior periods. We have been executing the larger contracts renewal that commence shipments in the second quarter. In terms of backlog, at June 30th, 2018, the primary product category of PMO represented 32 of backlog -- 32% of backlog and IR was 62% of backlog. These levels are consistent with the backlog at the ending of the third quarter. As of June 30th, LightPath 12-month backlog increased 38% to $12.8 million as compared to $9.3 million as of June 30th, 2017 and was fairly consistent as compared to $12.9 million as of March 31st, 2018. The year-over-year increase reflects strong bookings for most of the company's product lines and the bookings of a large infrared annual contract during the second quarter. Previously, we were explaining the substantial declines of our backlogs as we shipped against a large contract. But now we're seeing a relatively consistent if not increasing backlog as we ship against a large contract for the two recent -- the two most recent sequential quarters. And as Jim noted, we are also building a backlog of orders beyond the next 12 months. Gross margin in the first -- in the fourth quarter was approximately $2.4 million, a decrease of 44% as compared to approximately $4.4 million in the same quarter last year. Gross margin as a percentage of revenue was 30% for the first quarter -- the fourth quarter of fiscal 2018 compared to 48% for the fourth quarter of prior year. The change in gross margin as a percentage of revenue is primarily attributable to the four factors; IR revenues now represent the majority of our consolidated revenues, with IR product sales having an average gross margin that is about 20% points lower than the blended average of our other product lines; lower telecommunications-related revenues within our PMO product groups, which historically has been a higher-margin area with PMO revenues. And third, production capacity constraints were encountered by -- for our IR business as experience increased orders in parallel with the beginning of transmission of our operations at New York to our other regions. IR margin challenges were further complicated by higher germanium prices, which Jim spoke to earlier in his remarks. The fourth reason, foreign exchange currency issues as most of our sales are in U.S. and a majority of our products are manufactured overseas. Foreign exchange rates, as the dollar fluctuates, may impact our manufacturing cost on a reported basis. While the majority of the gross margin decline was due to lower PMO volumes, gross margin was also unfavorably impact by currency fluctuation on the rising cost of germanium. Total cost of sales was approximately $5.7 million for the fourth quarter of fiscal 2018 and increased approximately $1 million from $4.6 million for the same period last year. Total operating costs and expenses for the fourth quarter was approximately $2.9 million, a decrease of $304,000 compared to $3.2 million in the same period last year and about $150,000 lower than the third quarter of this year. This includes new product development cost of $440,000, which increased by approximately $58,000 compared to the same period last year. SG&A expenses were under $2.2 million in the fourth quarter of 2018, down from nearly $2.5 million in the prior year period. Total operating cost and expense also include the amortization of intangibles related to the acquisition of ISP. Moving down the income statement, our financial results were impacted by a few other items. Net interest expense, which includes interest on debt cost, was approximately $135,000 in the fourth quarter of this year compared to approximately $207,000 in the fourth quarter of last year. This decrease is primarily due to the full satisfaction of the sellers note during the third quarter of this year. Other expense below the operating income includes foreign exchange losses of $714,000 compared to foreign exchange gains of $333,000 in the fourth quarter last year, a swing of approximately $1 million. Also in the fourth quarter this year, we recorded an income tax benefit of approximately $508,000 compared to an income benefit of $5.1 million for the fourth quarter last year. The benefit recorded in the fourth quarter in last year was primarily attributable to an adjustment to the valuation allowance for the company's deferred taxes related to deferred tax liabilities recognized in conjunction with the ISP acquisition. The tax benefit in the fourth quarter of fiscal 2018 is primarily attributable to further adjustments to the evaluation allowance against our net deferred tax assets. All other changes in the tax expense and effective income tax rates were attributable to the mix of taxable income and losses generated in various tax jurisdictions. We are subject to certain taxes depending on the profitability of our operation in various countries. Please see our press release or SEC filings for a more thorough discussion of these matters. At June 30th, 2018, we had a net operating loss carryforward of approximately $75 million to offset net income as reported on a consolidated basis in the U.S. Again, further discussion on these tax issues are in our press release and SEC filings. Net loss for the fourth quarter 2018 was approximately $1 million or $0.03 basic and diluted earnings per share compared to net income approximately $6.4 million or $0.26 basic and $0.24 diluted earnings per share for the fourth quarter last year. The decrease of net income is primary due to the approximately $5.1 million tax benefit for the fourth quarter of fiscal 2017 compared to a tax benefit of approximately $508,000 for the fourth quarter of fiscal 2018. The remaining decrease in the net income from fourth quarter of fiscal 2018 to the fourth quarter of fiscal 2017 was driven by the aforementioned decrease in the revenue and gross margin, partially offset by lower operating expenses and a $1 million of favorable swing in foreign currency exchange gains and losses. Weighted average basic and diluted common shares outstanding increased to 25.7 million and 27.5 million respectively in the fourth quarter this year, from 24.2 million and 26.2 million, respectively, in the fourth quarter last year. The increase was primarily due to 967,208 shares of Class A common stock issued in connection with the satisfaction of the sellers note, shares of Class A stock -- common stock issued under the 2014 Employee Stock Purchase Option Plan -- Stock Purchase Plan and shares of Class A common stock issued as a result of the exercises of stock options and warrants. EBITDA for the fourth quarter of fiscal 2018 was a loss at $269,000 compared to earnings of $2.3 million in the fourth quarter of fiscal 2017. Adjusted EBITDA, which eliminates the non-cash income or expense related to the change in fair values of the June 2012 warrant liability, was approximately the same as EBITDA. The warranty liability was eliminated in December 2017 as the warrants expired. Finally, I'd like to discuss some balance sheet items and cash flow. Cash and cash equivalents and restricted cash totaled approximately $6.5 million at June 30th, 2018, down from $8.1 million at the beginning of the fiscal year. For the fiscal year, cash flow from operation was $2.6 million in 2018 compared to $5 million in last year. Total debt was reduced by $456,000 or 4% in the fourth quarter. First, for all of fiscal 2018, including elimination of a portion of the finance incurred in connection with the ISP acquisition and exchange for shares for our common stock and cash total debt was reduced by 35% to $7.4 million as of June 30th, 2018 from $11.4 million at the beginning of the fiscal year. During the fourth quarter, we expended $36,000 for capital equipment. For the year, we expended approximately $2.5 million for capital equipment as compared to $2.2 million in fiscal 2017. In addition to capital equipment purchases, the company also entered into capital leases of $460,000 for equipment, which resulted in lease payments of $287,000 in fiscal 2018, up from $193,000 in prior year. The increased levels of capital equipment purchased on leases reflect the actions taken to increase production amid capacity constraints for its IR business. The current ratios of June 30th, 2018, and 2017 was 3.4 to 1 for both periods. The total stockholders' equity as of June 30th, 2018, was approximately $35.3 million, a 19% increase compared to approximately $29.7 million as of June 30th, 2017. The increase is highly due to the Class A common stock equal to approximately $2.2 million issued in conjunction with the satisfaction of the sellers note along with other small issuance related to stock-based compensation, partially offset by net income for fiscal 2018. With this review, our financial highlights are concluded. I will turn back to the operator so that we may begin with the question-and-answer session. Thank you.

And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner today will be Matt Koranda with Roth Capital. Please go ahead.

Hey guys, good afternoon.

Hey Matt.

Just wanted to start out with the IR lens volumes. Looked like they were up, I think, according to your commentary, like 8% year-on-year, but with revenue kind of flattish I guess, that suggests lower ASPs. What's driving that? And should we anticipate a stable mix relative to this quarter here going forward? Or could there be a shift in mix that sort of drives ASPs back to their more historical levels?

Well, I think, that kind of pricing shift is really just associated with mix more than anything else for the products that we sell, Matt. So, it should, over a longer period of time, be kind of even to where it's been. So, I don't see that as anything other than that.

Got it. And then I guess, is there any way to quantify how much IR growth you guys gave up just given the capacity constraints during the quarter? And just to clarify, I mean, were you alluding to the fact that you were moving some production from Irvington during the quarter and that's why you had capacity constraints? Or you're just mentioning that you were running all out already and you just didn't have the ability within the quarter to kind of add capacity?

Yes, I think it's more that the volume became faster than we anticipated and we were up against the capacity constraint. So, I don't think in the quarter, we really had much as a result of the beginning of the transition impact. As I said, we took over ISP the full year before we acquired them they did about -- just about $12.3 million and the infrared business attributable to the ISP product in this fiscal year was just around $15 million. So, we had just increased that business substantially in a short period of time and we ran up against some capacity constraints. And now it depends on the mix of molded product versus diamond-turned product and those kinds of things where that capacity falls out. And we did have some coating issues. That is where some of the capacity constraints reside. And since then, we've added a big chamber in China that is -- so now we have the ability to coat both glass material systems in China. That moved the substantial load off the New York operation to China, so that increased that capacity and then, as we were transitioning the business during the course of this fiscal year from New York to Orlando and Riga, we have another -- we'll have another new coating device coming online about November 1st. So, that'll be another machine and then we'll be able to move the other machines one at a time. So, that should alleviate that type of capacity constraint. I think we've already alleviated it for the most part with the operation that came online in the beginning of August in China as well as both of those moves will lower the overall cost of coating. Excuse me, my voice is a little rough.

I’ll try not to make you speak too much more here Jim, maybe a couple of more here. I guess you kind of pre-answered what I was going to ask you, which was where exactly is the bottleneck. But are there other any other areas where you feel like there's going to be -- need to be action to expand capacity just in terms of glass production or diamond-turning capacity? Or we feel pretty good about what has been added thus far this year so that we are on track to, I think, in your guys prepared remarks around -- in the release you mentioned sort of the potential to double the revenues out of your infrared lines? So, -- back to that or what else do we need to add to get there?

Well, I think, on the other side, I mean, I think we're in pretty good shape from a diamond-turn type capacity using the germanium glass on the chalcogenide because of the cost of germanium. There's been a lot more interest, a lot faster than we anticipated in converting a germanium product to chalcogenide product. And as such, we are in the process of expanding our glass manufacturing capacity. So, that hasn't happened yet, but it's underway and we will be adding capacity here in Orlando relatively soon. I think that we'll have another set of furnaces come online here within the next month. And then a little longer term, we're going to add -- we are adding additional capacity for glass melting in Riga. For the chalcogenide material systems, that's a little further down the line, that's a few months out until that comes online. So, for right now, we're approaching our capacity with the demand that we see coming for the BD6, but I think we've got it handled. In the short-term, if we get a little short, we can always buy some material on the open market even though it's more expensive. So that -- and then, along with that, we are expanding our ability to make pre-generation on the germanium side and the BD6 side as well as our polishing capabilities, but I don't see either one of those as a real capacity constraint, but we are expanding those operations.

Okay. And rough, maybe, ballpark figure, what's the cost to sort of getting to the end goal in terms of the total capacity that you're shooting for this year? I mean I know a lot -- I'm just trying to figure out the -- you spent a lot on CapEx this last year, I think, in order to kind of boost capacity and remove some of the bottleneck. So, how much has already been spent and how much is left to spend that'll spill into this fiscal year here?

I think we'll have another couple of million dollars in our capital budget for 2019. The majority of that is targeted towards these kinds of growth operations. So, our capital investment levels are going to be pretty consistent to what they've been for the last couple of years.

Okay. And then just lastly, if I look at gross margins, I know you guys have mentioned sort of that ISP historically kind of ran in the mid-30% range in terms of gross margins. And then core LightPath, looking back over the last couple of years, I know it fluctuated, but you typically were able to generate between 50% to 60% gross margins on most of the core optics products. I'm just trying to get a sense for, sort of, how quickly can we get back to those levels for each of those individual product lines? And what needs to happen to get us there? How many quarters is it going to take to transition during fiscal 2019 to kind of get back to those levels and if that's possible?

Well, I think, the plan is -- I mean, on the precision molded optics side, the visible side of the business, the margins for the products that we're generating are similar to what they've been historically. I mean, they run in the mid-50s to low 60s. They continuing to be there. The problem we had in 2018 was that volume from the telecom business fell off rapidly and the fourth quarter was probably the steepest decline that we saw in the year. So, that's really strictly a volume issue. And the problem is, is when your volume goes down 35% in a quarter in a PMO, in a market segment that grows 5% or 6%, there's no place to go to replace that much business in that kind of timeframe within that market segment. So, what we did is we replaced that with infrared business, which has a different margin structure and so our overall margin suffered in that quarter as a result of that. Now, the problem that we're facing now is, I know for sure and I can say with almost 100% confidence that the telecom business will come back. What I can't tell you is exactly when and I defy anybody else to do that as well because that's the nature of that business. But with all the signs, with a number of new projects and NREs that these guys -- these major equipment manufacturers are spending, and I don't think they're spending their money for things that they don't think are going to -- that aren't needed, that's a pretty good sign that, that business is on its way back. So, as that occurs, I think we'll see that recovery in the margins on that side of the business. The investments and stuff we're making on the infrared side was a two-phase problem. The margins are just different because of the material cost differences and the cost of germanium is about 40% of the cost of the lens. So, when that spikes up 28%, that's a big impact. Now -- and because we had some longer-term contractual obligations, we couldn't recover all of that. On the custom side of the business, we were able to recover some of it. So, I think there's that problem. But the investments that we are making will impact both the germanium operations and the molded operations as we move more of these operations into our lower cost facilities, which is what this transition from New York is all about. As we move coating to China as much as we can, that's a huge savings in that process. It's, I don't know, six to one difference, I think, in terms of what it costs to coat in New York versus what it costs to coat in China. The -- and as well as moving into Orlando was less expensive than New York as well. And then diamond-turning operation that was in New York will be relocated to Riga, primarily. And with the defense side of it being moved to Orlando that will generate additional savings. So, I think what we'll see is a pretty good improvement. Gradually the benefit will roll out during the course of this year. So, having to sum all that up, I think that we can get to margins, which were in the 30s moving towards the 40s pretty quickly for that side of the business. But when you still -- when you blend those businesses together, as we've said, we're going to probably see margins in the mid-40s, with the IR becoming a predominant, or in the more heavily weighted business just based on the volume.

Okay. Got it. That's was very helpful.

That was a mouthful, I know.

Yes. Helpful color very much. So, thanks for the answers and I'll jump back in queue here.

And our next questioner today will be Zack Turcotte with Dougherty. Please go ahead with your question.

Hey guys, Zack on for Catharine Trebnick. First, just what was the revenue attributable to ISP in Q4?

I think it was $4 million, wasn't it?

$4 million?

Just a second, Zack. Just split it out.

ISP in fourth quarter, yes, $4 million.

$4 million.

$4 million. Okay and then something that Matt mentioned was, you said increasing your global IR production capacity could double IR revenues. Over what time period are we looking at that, like fiscal 2019 over fiscal 2018 doubling or longer time period?

Well, I think, we'll have as the stuff put in place during fiscal 2019, so we'll start to see that surpass the ramp-up during the course of this year. So, by the end of 2019, I would say we'll be pretty close to having it doubled.

Okay. And on the capacity constraint, so it sounds like that was pretty much entirely attributed to chalcogenide products due to the move away from germanium, correct? Because of the rising prices?

No, I think it impacted -- it was primarily a coating problem, which impacted both lines. And primarily given where we are, the germanium side of the business was where the constraint was.

Okay. And another just kind of clarification. So, you're talking about adding further production in a month or a few months and being able to do coating for bulk in China that there won't be an impact of the constraints on Q1 directly?

No, I don't think we'll see that kind of constraint in Q1.

Okay, great. And then kind of more general question on the infrared products. You talked about really shifting toward that [indiscernible] your primary driver as of right now due to telecom weakness. So, what are your biggest market opportunities with the infrared products? What use cases or verticals you're selling into do you think will drive a doubling potentially in revenue in fiscal 2019 for infrared?

Well, I think -- I mean, overall, one of the drivers was to shift from germanium to chalcogenide because of the cost of germanium. So, that drives markets into the product. Then I think, you have -- where we've had good applications is in things like firefighting cameras, what I call aiming lenses, which are things for rifle scopes or pointers, those type of devices. And then there's the whole sensing technology. So, this involves the movement to [indiscernible] buildings, the LIDAR, the autonomous vehicles, all of those things are driving applications in this field. Like, the thing that's happening Zack is the cost of thermal imagers, in general, is coming down. It's coming down because the cooling systems. They now have uncooled sensors in the cameras, so that whole segment is a big driver and where we play predominantly. The size of the sensors has gone from 25 microns down to 12 and is probably moving to 10. So, you get twice as many sensors per wafer, so the cost of those sensors is less. And then with -- the optics become the next biggest item on the bill of material of these things and the shift from germanium to chalcogenide is offering a reduction in that cost. And as the overall cost of these imagers come down, then the applications just explode. So, these spectrograph-type applications, sensing, Internet of Things type things, where all these machines need to talk to each other, all of those things are driving those types of applications.

Great. That’s really helpful. Th.

And the next questioner today will be Gene Inger with IngerLetter. Please go ahead.

Hi guys. It's been an interesting time, and I gather what you're saying, because Matt has mostly asked most of the questions that I had. You seem to have resource management under control or at least you know the direction that you're going in. Your resolved capacity constraint. But I am still confused about China in terms of what happens if you've made this transition away from germanium and now you're providing different materials to your customers, what happens if the commodity market changes? And what happens if there is or is not a major trade accord with China?

Well, those are all good questions Gene and I can't answer the politics, but I will tell you this. We kind of looked at -- so first of all, for lenses, for some reason, which I greatly appreciate, have not been on any tariff list that we are aware of. So, we haven't been impacted at all yet. The other thing that I would say is, that's -- a little over 60% of our overall business is international, either in Europe or Asia. So, that business does not necessarily have to be impacted because it doesn't come back to the U.S. And then as you look at the stuff that does come back to the U.S. and you figure out how you could move it around, some of it doesn't need to. So, if the trade thing were to happen and these tariffs go into effect and they start to impact our business, it would be less than 25% of our overall business would be impacted. And then the other thing that I've said is any other tariff rates that we've been looking at for these types of products, things on the metal or the rubber that gets involved in them, those tariffs tend to be more in the lower percentages, like 10% or less, so it really becomes less significant. I mean we're not talking like the 25% tariffs that have been discussed so broadly in the media. So, I think it's going to be -- I think it's something that we could manage from that standpoint, if it were to happen. Obviously, we hope that it doesn't. But we have our capabilities in the U.S. and Europe that can cover a lot of it in the worst case. So, I think, given our diversification and our global nature, we'll probably be okay.

Jim, I'm just back from Berlin IFA, which was a technology show, and I met with a South Korean Professor, Head of a research institute and saw some interesting discussions about wavelength optical axis technology for 5G. Probably, you know what I'm referring to. Wondering whether the capabilities and the changes in this industry are going to be as dynamic. I think you've touched on that a little bit and you believe you have the capabilities. Maybe that's a topic for another time. But I guess I would ask this. Do you anticipate -- since you're talking about integrating the movement of ISP out of New York over the course of this fiscal year that's going to be an inhibitor or a stimulant to revenue and margins as we go through this new fiscal year? In other words, did you have capacity constraints essentially shoving profitability into the new fiscal year?

Well, I think anytime you move a major operation, you try to do it with the least amount of disruption and we've tried to do that. Our plans are such that we don't have that, but I can't say there won't be some part of the disruption. And part of the thing is that we have some duplicate cost going on right now, which showed up in the fourth quarter to some degree, where we have gone ahead and hired a head in the new operation so that we have time to train some of these people so that when the equipment is brought online, it's ready to go immediately. As I said, we bought a new coater and put it in China and that moved a substantial load off of the coating operation in New York such that -- so we don't have to worry about that. So, we've done a number of those things. And then the reason that it's going to take the full year to do it is because we're going to move it a piece at a time. And as we move a machine, we'll get it up and installed and running before we move the next major piece of equipment. And that really relates more to the coating operation than anything else. From a diamond-turning point of view, which is the other major operation, which is in New York, we've already established the process here in Orlando with -- we have now two, it could be three machines dedicated to lens turning, which pretty much covers what is there in New York. And then as we move machines, we are already set up such that we could move the next two machines to Riga and those are basically plug-in. They're -- the facilities are all in place. It's just ready, they get there, they plug them in and spin them up. So, I think that disruption will be minimal. So, I think we've tried to put these kinds of things in place. It's a little expensive upfront, but it pays big dividends on the backend.

I guess, finally, I would just say, coming back from Germany two days ago, there was just an incredible focus on infrared and all kinds of sensors, everything. And a couple of the new cars like the Audi 8 Series, the Audi -- I mean, excuse me, BMW 8 Series, the Audi Q8 have infrared-forward vision. I don't if you're providing the lenses or not. I think they're from [indiscernible]. And these are technologies that you haven't referred to in this discussion. You have in the past. And I wondered if you'd like to comment on how that -- those areas as well as LIDAR and so on are coming along.

Well, I think, we're continuing to work with these companies in the LIDAR field and that's a major technology. It will be used for autonomous vehicles. Some of these guys are struggling with the overall technology of the device still. So, there's still a lot of development work. From the optical side, we feel like we're in pretty good position. We have a nice technology with our collimators that fit into those things very nicely. And so we're ready from that standpoint. We've talked about sensing -- of all kinds of sensing technology, whether that's the assisted driver systems or not. We are in that market and able to provide those type of products. So, where we've had some initial success in the automotive market is more with the laser-assisted headlights. We are either using a super high beam or using a laser on phosphorus to generate the headlight light. So, we're designed into a couple of those systems. So, all those things take a long time to germinate and so those things will be coming in the future, I think, from a production standpoint.

Well, good luck, and hopefully you completed, or are completing the consolidation and turnaround back to better profitability.

Yes, it certainly is a major goal. No question.

Yes. Cheers and good luck.

Thank you, Gene.

Feel better.

Thanks.

And our next questioner today will be Marc Wiesenberger with B. Riley FBR. Please go ahead.

Thank you. With the increased visibility, how should we think about the growth in FY 2019 relative to FY 2018?

Well, I think, on a percentage basis, it should be similar. I mean, the type of growth that we've forecasted typically, we don't give guidance. But we're in that 15% to 20% range. We expect to see that kind of growth organically into 2019.

Great. Thank you. Turning to the Renishaw contract, is this the longest kind of contractual arrangement that you have currently or have had? And also, how does the going through your distributor impact the economics? And then the last part is, how should we think about the cadence of revenues over the three years?

I think it is one of the -- probably the longest contract that we've entered into, I think, from that standpoint. These are lenses that we have been selling to them for the last couple of years. They're very customized lenses. So, I think, the pricing is solid and is indexed. I think -- so that's not a problem. And I think, really what this contract means to us is that business is assured over this period of time both for the customer and for us. So, that point of thing. As I said, it was a custom lens. That gives us a lot of visibility as to what their volumes will be or what their anticipated volumes will be, so that we can do better planning for that type of the business. So, I think it was a win-win for both the customer and us.

And then in terms of the cadence over the three years?

I think it's pretty stable, pretty constant volume to what it's been.

Great. And then, have you made any efforts to better align the revenues and costs kind of in the international contracts?

Well, certainly, in our plans as we negotiate these things in the future that we will be running the revenue in the same currency as the production is done. So, that should smooth out, at least to the gross margin line with those kind of fluctuations. We haven't cut those things in place yet, but those are what we're working on.

Understood. That’s it from me. Thank you very much.

Thank you.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Jim Gaynor for any closing remarks.

Thank you. In conclusion, we appreciate the support of our shareholders and the dedication of our global and expanding team at LightPath. With our strength and presence around the world, we remain focused on our efforts to drive topline, bottom-line, and cash flow growth, while making improvements in our overall financial conditions. We're very excited by our growth prospects. So, thanks again for participating on today's conference call and we look forward to speaking with you next quarter.

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