eMagin Corporation
Q3 2015 Earnings Call Transcript

Published: 13 Nov 2015

[Operator:]

Good afternoon and welcome to the eMagin Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jeffrey Lucas, Chief Financial Officer. Please go ahead.

[Jeffrey Lucas:]

Thanks, Cate. Welcome everyone. We are glad to have you join us this afternoon for our third quarter 2015 earnings conference call. As always, before we begin, please note that we will be referring to numbers that are part of our quarterly Form 10-Q for our third fiscal quarter ended September 30, 2015. During today’s call, we may make forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the company’s current expectations, projections and beliefs and are subject to a number of risks and uncertainties. Such statements include references to projections of future revenues, plans for product development and production, the company’s ability to ramp up production, future contracts, product benefits, operations, liquidity and capital resources as well as statements containing words like believe, expect, plan, target, etcetera. Our risk factors are included in the company’s Form 10-K for 2014 on file with the Securities and Exchange Commission. Except where required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements for any reason. With that, I would like to turn the call over to eMagin’s Chief Executive Officer, Andrew Sculley. Andrew?

[Andrew Sculley:]

Thanks, Jeff and thank you everyone for being on the call today. I will begin with some corporate highlights then Jeff will discuss our financial results. Following Jeff’s remarks I will summarize a few additional items and then we will open the call up for your questions. During the third quarter, we spent significant effort on our new products and new technology. These efforts were in support of customer programs and the U.S. government-funded programs. The significant effort can be seen in the quarterly R&D costs and these are a critical need for our future programs. We finished qualification of a higher brightness color OLED architecture that we are calling XLS on an SXGA resolution display with 9.6-micron pixels. The combination has SXGA096 XLS. We qualified both the OLED architecture and the new resolution at the same time. These efforts are extremely important for key new programs. This new OLED architecture and the SXGA096 display is important for number of customers. The OLED is white with color filters, which can run at 800 nits maximum, and as you probably recall, nits are candela per meter square. And that 800 nits is close to twice as bright as your smartphone. The display typically runs at 700 nits. That’s what our customers typically use it for. And our largest running color OLED product typically runs at 150 nits. So, this 800 is much, much brighter. And just to note that the 800 nit display is not direct patterning, so this is OLED with – white OLED with a color filter, but it is a qualified production part today. This is something we had to get done. A 9.6-micron pixel SXGA is smaller than our other SXGA display and therefore has lower manufacturing costs for the same OLED architecture. We also put significant effort into our direct patterning. The results were better, full color WUXGA and that’s 1920x1200 displays, which also have 9.6-micron pixel pitch. And we made samples of a direct pattern to color display for aviation. The two-color display ran at 8,000 nits. The customers of this product were the night vision lab. They are funding this effort with the Army and aviation customer. They sold the display. They were every impressed. And the aviation customer took a couple of them home. So, we are hoping that they will be flying. Although these R&D efforts generate expenses and take time away from display production, they are critical for our current customers. They need these displays for the upcoming programs and are also critical for the long-term. In order to continue with the new product development and technology development and expand our display production, we have increased our efforts on capacity expansion. This will allow us to increase both display production and development efforts. The capacity expansion uses capital and engineering efforts to improve both equipment efficiency and yield. The capital expenditures are mostly small, like $50,000 per tool to improve our advanced yield system output. The only – there is only one larger item and that’s a tool to improve capacity in an early step. It’s a very old tool we need to replace it, but it’s not an OLED deposition tool. I don’t want to frighten you. One of the areas requiring our R&D effort is augmented reality, or AR. Higher brightness is required for some application. And here, the easiest one to understand immediately that we are involved with is the display in an aircraft that – aircraft helmet that reflects off a visor in front of the pilot’s eyes. And again, as you probably remember, this is I have got to see icons on the screen, so I don’t have to take my eyes off the outside world and I have to compete against sunlight. And in night, it has to do full night vision. And this is for both military and commercial aviation. And I will remind you that there is a company, one of the four top companies working on commercial. But think for a minute about a consumer application. If that same image can be reflected off a pair of sunglasses, it wouldn’t need to be as bright and you and I could have augmented reality on our glasses, our sunglasses and this is where the 800 nit color OLED architecture could be important for these AR applications and also for applications in the industrial segment like inside a warehouse, etcetera. So we still have ways to take this 800 nit color display and make it significantly brighter and that’s an easy thing for us to do. For the extreme brightness applications like those military aircraft, etcetera, our direct pattern technology is critical. No other company has produced color displays that are as bright as our color OLED direct pattern displays. And to remind you, we have demonstrated 6,500 nit color. Our continued R&D effort will bring these direct pattern displays to production readiness. We continue to supply samples over our displays to Tier 1 companies working on VR and AR applications. We have been asked for proposals for large volumes of displays for future product generations by these Tier 1s and we are also supporting a project with a Tier 1 company on a new design for VR applications. For VR, the Tier 1s tell us they need OLED for speed and that’s of course you remember reading all about the prior Oculus efforts. They were using LCD and people got sick. So, the speed is needed to deploy sickness. But also one high contrast, which OLED gives and the reason you would need the high contrast is you want the person wearing it to feel like he is in the picture and that’s high contrast is needed. We also need higher resolution than an OLED cell phone. The key here is that the pixel pitch has to be high or PPI, it’s called. Our higher pixel density displays are about 3,000 PPIs. The best AM OLED display that I could find is about 540 or so PPI. And I did find a higher PPI cell phone display, which was about 800, but it’s an LCD, which I remind you the Tier 1 companies tells us is unacceptable. Given our pixels bridge, we can make an extremely high resolution display for an HMD that is much higher than the resolution a cell phone can deliver for similar HMD, either now or in the future. Ours is much higher, hard to beat 3,000. The project I mentioned above on – working on a higher resolution will result in higher resolution display. We are talking to a potential – to potential foundry partners with the help of one of these Tier 1 companies for very high volume manufacturing. I know our hope you have done your homework on these markets and looked at the size of them. One research firm is often quoted. They say AR and VR markets will grow to $120 billion and $30 billion respectively by 2020. Now the displays are only a component of this, but it’s a very important component. So another research company estimated a number of headsets for VR in 2020 and they say the headsets in 2020 will be 100 million sold. Now some of those displays for those 100 million headsets will be pairs of OLED microdisplays and some will be cell phone displays. And depending upon how you split that and we assume the OLED split will be significant. This will be an enormous addition to the microdisplay market that we see today. Again, our OLED microdisplays have the pixel densities required by these applications, the speed and contrast. For the AR market the research says it will be bigger, but develop later than VR, so everyone is thinking VR is going to be here soon, if not now. Here, microdisplays are essential. You can’t put it on a cell phone display and on an augmented reality device, it’s just too big. And brighter displays are important. And that’s why the XLS OLED architecture at 800 nits will be good for many applications. Recall that this is the architecture I mentioned above and we just qualified it. Future AR applications that require very high brightness will lead our direct patterning technology. There are few companies that are interested in our 2K by 2K HMD, and this is very exciting for us. The HMD group is also developing another unique headset, which if all if all goes well will be out next year. We have increased our efforts here. As you know, we hired Dan Cui who has significant experience and contacts in the HMD market. He has done outstanding workforce now, hooking us up with many companies for customers, etcetera. We have also hired Kip Kokinakis as the President of our Immersive HMD group. Here, Kip comes to us with many years of experience in HMD development, design and assembly and he has run companies in the past. He is using his experience for outsourced development and assembly of HMDs for our products. Successive these HMDs will mean more volume for our OLED displays because we plan on putting our OLED displays in them, for the obvious reasons that they are the best displays for these headsets. Now the expansion of capacity I mentioned above will not handle the volumes this year once tell us they will need. But it is a needed step for our current customers and these are both display customers and development customers and it’s also needed for the HMD group. It is a first step in preparation, however for the Tier 1s demand. Improving our current efforts will allow the better design of next generation equipment for implementation with the foundry partner. With this in mind, we are discussing these markets with a number of potential partners. We are also searching for a new VP of manufacturing with a background in scaling up processes similar to our OLED display processes. We have hired a new CFO, Jeff and very happy to have him with us and he comes to us with great manufacturing experience, including scale of efforts. These efforts today are needed for our future success in AR and VR markets. And they are clearly needed for our success today and in the near-term next year. On the military side, we submitted significant proposals to multiple prime contractors for U.S. Army’s Family of Weapon Sites and that’s called FWS. Specifically, we have done this for the Crew Served and the FWS sniper programs. For the President’s 2015 budget, these programs are projected to have more than 20,000 units delivered between them. And you may have remembered, as I mentioned before the 20,000 units over a couple of years is a big volume for a military program. During the quarter, we delivered SXGA096 high brightness displays with low power color XLS architecture to key government programs. These were the ones that we just qualified in the same quarter. More than 15 customers ordered for testing purposes, small quantities of our new products that’s digital SVGA and the SXGA096, that’s an addition to the key customer above. And either on these displays put our high brightness OLED XLS, that’s the color 8,000 nits or XLT. And just to remind you, XLT is very high brightness monochrome. The monochrome green can go well above 20,000 nits to about 24,000 nits. And that I haven’t seen from anyone else. And I will just mention one other thing that even at that very high brightness, our display has a contrast ratio of 50,000 to 1, and that’s why, by the way that navy pilots wanted to go to an OLED display because of that high contrast. And if you look at our only competitor in this market for OLED displays, they have shown at a military conference their display went from – between 8,000 nits and 10,000 nits, that’s versus our 24,000 nits and at that high luminance, they are 8,000 to 10,000, it 5,000 to 1 contrast ratio, and it’s in comparison to our 50,000 to 1. So we are way ahead of our competition here. And this demonstrates the appeal of the capability of these displays and also the pricing that we have got a large number of customers, 15 is a big number and the markets for these military, that’s the one who have tried them first. So we also improved and qualified our SXGA120, that’s 12 micron pixel pitch high brightness green monochrome display during the third quarter. They work for a lead customer. And obviously, the high brightness, one of the places that they are used this is in the aviation. The improvements in this display were reduced motion artifacts of the military pilots, no matter where they are in the world don’t want to see any motion artifacts at all. And they also – we enhanced that the uniformity in a high brightness level. That was something that the very high brightness pilots need. Obviously, any other use of this, those two factors will come in handy as well. We are successfully satisfying customers who are building AR HMDs for the military, and ultimately commercial aviation. We designed a new display for one company and improved the current display that was actually the SXGA120 for another company and they are aviation related. These displays used High Brightness Green OLEDs. And I should mention that 20,000 nits over 20,000 nits is 40 times brighter than your smartphone, I would just like to give you a grounding. In the future, the military and commercial aviation customers will want color displays. They told us this, the U.S. government told us this and that’s where our direct patterned displays come in. And plus, we are adding to that direct patterning a more efficient OLED architecture that we are inventing and working on and also adding a new backplane design. The backplane will give 30% lower power. This is going to give the aviators what they need. Full color displays, very high brightness, very high contrast and also in the future, obviously the AR market. We had a successful review a couple of weeks ago with the sponsors of the three programs funding, development of very high brightness display. Those programs will give us those full color displays and these are color and they are at 10,000 nits, that’s the brightness goal or above and that’s 20 times brighter than your smartphone, plus a backplane that takes 30% less power. The power consumption of these displays will be significantly better than our current displays when run at the same luminance, even without the new backplane. So throw the new backplane in and they will be outstanding. So you remember, I will just remind you that Google augmented reality device. That lasted for about two hours when it was run. That’s tested by one our folks on Alps Ski trip. So obviously, they need better power consumption and that’s where something like this will come in. This was a very good meeting we had with the sponsors. The sponsors were very happy and impressed with the technology that we – the advancement that we have been going through. And this is the funding that’s important to us because it will help us develop the displays much more quickly. So as I mentioned before, the sponsors were very happy with the progress and one of the customers took a few of those two color displays shortly thereafter. In the third quarter, we have also been awarded a two new development programs, subcontracts. These are important because they usually turn into something more important and they are likely to continue into 2016. The first program is a Small Business Technology Transfer program of the Air Force Research Laboratory and the second, a Small Business Innovation Research program with the United States Special Operations Command, that’s SOCOM. Both programs are investigating improved OLED micro-display design and performance. The Phase 2 follow-on programs are likely at the conclusion of these. And from past work, we know that SOCOM is a very important customer. With leading-edge equipment, it has often been adopted by the broader army. And we take programs like this, because we see a great advantage for us. So, it goes for both helps us in the future and it helps the people we are developing it for. With that, I will turn it over to Jeff to talk about the financial highlights.

[Jeffrey Lucas:]

Well, thank you, Andrew. I am afraid my comments can be a little bit more mundane in the exciting developments about which Andrew spoke. And I will now speak to the company’s financial performance for the quarter beginning with the income statement. Revenues for the third quarter of 2015 was $5.4 million, $294,000 lower than the third quarter of 2014 and $1.6 million lower than the second quarter, which was one of the highest revenue quarters in over two years. Breaking it down a little further, product revenue for the quarter was $4.6 million, which was about $530,000 lower than the third quarter of last year. Our average display price was about the same, but we shipped around 5% fewer displays during the quarter than a year ago. These fewer units shipped and produced are largely attributable to lower production time due to scheduled maintenance, which there was none in the second quarter and less in the third quarter of last year and also very importantly, the commitment of production resources to R&D to both qualify new products and to expand our throughput volumes. R&D revenues for the quarter were $772,000, that’s about $245,000 higher than the third quarter last year and about $835,000 lower than the second quarter of 2015. Note that the second quarter’s revenue reflected an unusually high level of activity with the Mantech project about which I will speak in a moment, as well as about $300,000 for a few smaller one-off projects that were completed during the quarter. R&D revenue during the quarter was derived from one new project in six continuing projects. The largest revenue contribution was from the multiyear ManTech contract awarded last year to develop and produce an ultra-high brightness, high resolution, high contrast full-color OLED micro-display at a lower unit cost. We have several perspective projects in high brightness and the works which we anticipate will offset the revenues foregone from the projects recently completed. As you probably know, most of our contract revenues are comprised of U.S. government-related spending, which has been impacted by fiscal budgetary issues and sequestration. As a result, quarterly R&D project revenues have varied significantly over the past few years from a low of about $19,000 in the first quarter of 2014 to a high of $1.6 million in the second quarter of this year. We expect R&D revenues for the next few quarters to be comparable to this past quarter and well within its historical range. Gross margin for the third quarter decreased to 21% of sales from 30% in the third quarter of last year. The company experienced lower margins in both product sales and in R&D revenues. Gross profit from product sales was $900,000, $625,000 lower than the third quarter 2014. The lower margin was due to higher unit costs, reflecting the absorption of the company’s fixed manufacturing costs over fewer units produced. As you probably know, our fixed costs are a substantial portion of our total manufacturing costs. So, fewer units of production over which to allocate those costs can have an impact on the unit cost and on turn on our product margins. The R&D gross profit contribution in the third quarter was about $205,000, or 27% of our contract revenues, that’s down from $716,000 or 44% of contract revenues in the second quarter. The prior quarter’s gross profit reflected stable revenue catch-ups from earlier quarters and approximately $75,000 of gross profit contribution from several non-recurring projects. During the third quarter, R&D gross profit was affected by the absence of these smaller projects completed during the second quarter and by the impact under percentage of completion accounting of projected higher material costs for one of these projects. Turning to operating expenses, operating expenses in total increased by about $600,000 to $3.3 million from $2.7 million in the third quarter last year. Operating expenses are comprised of internal, non-funded R&D expenses and selling, general and administrative or SG&A expenses. R&D expenses increased by $200,000 to $1.2 million in the third quarter from $1 million in the year early period due larger to a decrease in funded R&D, which resulted in higher R&D expense through eMagin and expand the development activities to qualify new products and very importantly here to increase manufacturing volumes to greater throughput and higher yields as we prepare for the higher volumes required by our commercial customers. And I did devote – you require substantial amount of our time. SG&A expenses increased by about $40,000 to $2.2 million from $1.8 million in the year earlier period reflecting most of these severance and other non-recurring charges, which offset the comparative savings from the lower administrative cost structure we have been putting in place over the past year. These expense reductions, however, were offset somewhat by personal expense increases in our HMD, or head-mounted device, reflecting Dan Cui and then also as Andrew noted, the addition of Kip Kokinakis during the quarter. Operating loss for the quarter was $2.2 million, $1.2 million greater than the loss in the corresponding quarter of the prior year. EBITDA for the quarter, excluding non-cash stock compensation charges and the non-recurring items noted above was a negative $1.2 million in comparison to a negative $363,000 in the prior year period. I think it would be a worthwhile to briefly take a measure of where we are for the year-to-date in comparison to last year. Through the third quarter, we achieved revenues of $18.4 million, $575,000 or 3% lower than prior year revenues of $19 million. Gross margins for the nine months ended September 2015 were 32% compared to 31% in the prior year. Gross profit for 2015 year-to-date through September was about $5.9 million versus approximately $5.8 million in the prior year. Operating expenses are $7.8 million in 2015 or $1.7 million lower than the prior year. And of this amount, $900,000 pertains to lower R&D expenses and $800,000 pertains to lower SG&A. Operating profit for the year-to-date through September 2015 was about $2 million, $1.7 million less than for the year-to-date through September 2014. Looking at the balance sheet, our cash balance, including investments, was about $5.1 million at September 30, down from $5.4 million at June 30. The negative EBITDA was offset by an approximate $2 million reduction in working capital, primarily attributable to a reduction in accounts receivable, which offset an increase in inventory during the period. Capital expenditures during the quarter were $625,000 primarily for manufacturing equipment. In reference to our financing activities during the quarter, we continue to have no debt. We launched an at-the-market or ATM equity raise in September. Through the end of the quarter, the company raised by $19,000 through their efforts. I will note that this is the company’s first equity raise in over 6.5 years. And finally, regarding our guidance for 2015, based on our current backlog and expected orders from the balance of the year, along with our existing production capacity, we have lowered our guidance and expect to achieve revenues north of $24 million for the year in total. And with that, I will turn it back over to Andrew for some further comments.

[Andrew Sculley:]

Thanks, Jeff. I just want to summarize a few points. We successfully qualified products and demonstrated technology for customers, mostly military-related today, but the future they will be both commercial aviation and the AR/VR applications. We have enhanced our capacity to handle the continuing increasing demand for displays in development and prepare for their future. This work in enhancement we have started in or put more effort into the third quarter and we will continue that. The AR/VR Tier 1 companies have sampled our displays and are discussing future requirements with us. And the HMD group is working on opportunities for the 2Kx2K HMD and developing a new HMD that we expect to be out next year. So now with that, I will open the call up for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Dennis Van Zelfden of Brazos Research. Please go ahead.

[Dennis Van Zelfden:]

Good afternoon Andrew.

[Andrew Sculley:]

Hi, Dennis.

[Dennis Van Zelfden:]

Andrew I was wondering if you could reconcile last quarter’s comments and I don’t have them in front of me but last quarter’s comments regarding record booked orders and the fact that revenue I guess in my opinion, is kind of poor this quarter. And again, not in front of me, but it looks like next quarter’s revenue is nothing going to be – is not going to anything good or bad either?

[Andrew Sculley:]

Yes, I don’t have it in front of me either. But if it was a record book quarters, remember that’s all the POs and those POs go over for more than one quarter. Some of them might be out – well a number of them might be out in next year as well. So this quarter, I think we could have done better. And we are improving or enhancing our capabilities so that we can do both the R&D programs and the production and have better future quarters.

[Dennis Van Zelfden:]

Is there a lot of R&D programs booked for the fourth quarter that are going to take away from regular business?

[Andrew Sculley:]

Well, some of them will certainly and we do have some control over that. The ones that will be in this next coming quarter are the three programs for enhanced brightness and they certainly take tool time away from normal product production, because you take the tool and use it for a weaker R&D as opposed to production. With the qualifications of products, which takes running products, those are we probably have one more left. It would be good to do a little work, but it’s not going to be significant. So remember – yes, sorry, go ahead.

[Dennis Van Zelfden:]

I was just going to move on. I guess the last question, in this conference call you talked a lot about setting the stage for higher production in the future and you are doing a lot of things for that higher production. What is the likelihood or can you handicap for us whether these customers that you are talking to will ever actually come through with their commercial orders and kind of timeframe for that?

[Andrew Sculley:]

Yes. I understand. Well, certainly we talked to some that have given us ideas of what’s the next generation project – product. It will be higher volume. And they are not right around the corner for us, because well I will give you one example, if I might. And this is from my past. Here, we put in machines that would be bigger than five times what our wafer size is an area. And if you design the machine and build it and this is for somebody like I will just mention is all [indiscernible] Tokyo the two I like best in Japan. So they will take about nine months to build it. They will put it in your facility in three months. And then you have a ramp time. And that ramp time depends on how advance the machine is, etcetera. But over the next year, you will be ramping. So if somebody came to us today and said we have got a huge volume, we need to take some time to put the equipment in. And in fact, when they talk to us about this, we tell them this is how much it will cost for capital equipment to do that type of volume. And it depends on who it is that we are talking to, some of them blink and some don’t. Some say that’s what I expect. So we will take some time. But I would think that it will become clear that companies are interested in working with us because we will get closer and closer and we will be able to tell you something. Now we can’t. We have strict confidence with anyone we are working with.

[Dennis Van Zelfden:]

Okay. So I guess if I can, but assuming if I am wrong, the announcement or the talk of potentially linking up with some big customer for volume production could come in 2016, but the actual revenue from that would be more like 2017, would that be correct?

[Andrew Sculley:]

That’s actually true. With one exception in caveat and that is that the small volume start can be in 2016 or today, right because they are not going to take a product and then pay for a huge volume piece of equipment, until they pay for samples. And so they are more likely and that’s why we are enhancing our capacity now. Now, they are more likely to ask for a smaller volume upfront and put that smaller volume headset out with the terrific display that only we can make as a prototype or high end version.

[Dennis Van Zelfden:]

Okay, thanks for the clarity.

[Andrew Sculley:]

Yes. No problem. And thanks for the questions. It’s a very difficult thing for such a small company, but people are talking to us about investments in that respect, investment in tools, that’s a good question.

[Dennis Van Zelfden:]

Thanks.

[Operator:]

The next question comes from Kevin Dede of Rodman. Please go ahead.

[Kevin Dede:]

Good afternoon gentlemen.

[Andrew Sculley:]

Hi Kevin.

[Jeffrey Lucas:]

Hi Kevin.

[Kevin Dede:]

Hi. So could you give us the number of R&D contract customers you had and the number of commercial customers just so we could check those numbers versus the prior two quarters?

[Andrew Sculley:]

Number of commercial customers?

[Jeffrey Lucas:]

Well, we actually did business with about 60 customers during the quarter. We did about 75 in the previous quarter. Only but not that there is no diminution of customer base overall. That’s not the fact just in the terms of the business in which you work. And for the contracts, we have six customers, primarily military.

[Kevin Dede:]

Okay, thank you. I am sorry.

[Andrew Sculley:]

I just mentioned in prior quarters, we had customers for development. They were customers developing for the aircraft. We did a new display for one customer and modified. I mentioned that in here. We modified a display for another customer for military helmets and in the future commercial as well. So there is a couple that don’t fall into the next quarter. Okay?

[Kevin Dede:]

Okay. Andrew, you talk a lot about direct patterning and development of that technology, could you give us a bit more background on that and how that capability might distinguish you from competitors?

[Andrew Sculley:]

Yes. If – well, remember I talked about OLED cell phone displays, the pixels per inch. So there is about 540 pixels, maybe they will go up to 600 pixels per inch and our displays are, best displays are over 3,000. So the companies who do cell phone displays, there is really only one today, doing all that cell phone display, they can directly pattern and do. They use technology called fine metal mask, but they put the pixels down so that there is only 540 pixels, 3 sub-pixels in there in an inch. So our direct patterning puts down 3,000 pixels in the same size. And you can imagine that it’s so much more difficult to do that. In fact, there is no technology in the general market that can do anything like that. So we have the only, so the difficult….

[Kevin Dede:]

Okay. Now, but it seems to me that or perhaps I just misunderstood your discussion, but it seems to me that this I guess, this direct patterning is something that you have developed more recently and I am just kind of wondering how that transition came to be?

[Andrew Sculley:]

Well, you remember the U.S. government night vision light [ph] came to us and said the navy pilots are having a tough time with the contrast of their LCD or LCOS displays. So we developed a very High Brightness Green. And we had a helmet, we put color displays in there. This is one of the jet helmets. We put color displays in there and they liked it so much. They asked us to develop color displays. And the only way to do that is to take the color filters off. The color filters will – you lose four times to five times, maybe 20% of the light comes out because the color filters by design cut out two-thirds, and they are not 100% efficient, so you get maybe 20%, maybe 25% out. So how do you make the OLED so efficient, it can go through that and still be bright, you really can’t. The only way to get the 10,000 nits is to take the color filters away. In order to do that, you have to put little dots I will call them, red, green and blue OLED. And the problem with those dots is they have to be 2 to 3 microns live and then the technology that exists today cannot do that. And I think people have tried very many technologies and the only one that really works today in the industry itself is a fine metal mask. We are doing something different. And so that is a recent development, but we were working on this last year. We got a ManTech award last year. I think, it was September, that’s for 30 months. And here, the task is now nice we have seen you can do it, now make it manufacturability. So, this is an outstanding project for us.

[Kevin Dede:]

Now, I understand that, that three color direct pattern is pretty important for your 2Kx2K. And my understanding is that you are at two color, but not at three. I am kind of wondering if you can give us sort of an update on how that capability is going and whether or not you think it makes the prototype that you hope to demonstrate at CES in January?

[Andrew Sculley:]

Well, here is the current display is a two-color display that we put together and don’t confuse this with the two-color display that I mentioned in when I was doing my run through. So, we have a two-color display that we did for the Navy, but it’s white with color filters, red and green color filter. And now the question is we need a full-color display, so we have done two things. One is we said, hey, we can do this very quickly and use the same technique that other companies like the OLED color, OLED cell phone companies, Samsung, they actually do a PenTile display. So, we asked ourselves could we do that and make three color? And the answer is yes, we do very quickly. We don’t have to re-spin the display or anything. So, that’s in a sense what Samsung does is they do a green and red pixel, then the next pixel is green and blue, then green and red. Here what I mean? So, it’s very shaking a little bit. So, we can do that. We can do that very quickly. In fact, we have already. So, we can put those in the headset and then show it to anybody. And right now, we are showing it to companies that are very interested in it. And frankly, I think that’s much more important than CES, but we can do this today. Then what we want to do is re-spin the display and make it three-color, white with color filters. So, for VR application like this, you don’t really need the high brightness. So, it would be much better for us in terms of capability and capacity to do a three-color, 2Kx2K display, red, green and blue sub-pixels in each pixel and that we could to by next year.

[Kevin Dede:]

Okay. You did mention that you were working on supplemental 2Kx2K that you hope to have ready next year. And I imagine that’s one you are referring to?

[Andrew Sculley:]

Yes. And my point is we really have a full color one today. Okay, it’s a PenTile architecture, but it exists today and actually we let people look at it and they didn’t come back and say anything, because the pixels are small enough, the display looks great enough that that they didn’t see any issue with it at all, but we would like to do a three-color side-by-side as well.

[Kevin Dede:]

Okay. Given the – maybe this is better for Jeff and then I will cut myself off. Otherwise, I will go all afternoon. I am wondering, Jeff, how you are looking at your OpEx going forward? I got to you sort of the top line guidance is now down to 24 for the year. I am just kind of curious about what you are expecting on OpEx given the new hires. And maybe an indication of where you think margins go based on volume expectations you have for the December quarter?

[Jeffrey Lucas:]

Sure. First of all, I just want to clarify our guidance is north of 24.

[Kevin Dede:]

Okay.

[Jeffrey Lucas:]

So just keep in mind, but secondly from the standpoint of what we see happen with operating expenses, I pointed out that we had some substantial non-recurring costs severance and things of that sort that were incurred in the quarter. If you were to back those out, you can get a pretty respectful run-rate where it will be going forward. Perhaps, the only additional expense we might incur that’s not reflected for the most part in the September’s numbers would be the fact that we are doing additional investment in the head-mounted device group, some of the product development efforts there. So, we will be incurring some small additional expense there, but outside of that, I don’t see a whole heck of a lot changing. One thing do keep in mind though and I know this has come up in previous earnings calls is that we have had some variability in terms of the bad debt reserve and that’s had a big impact, for example, in the first quarter of this year. So, I am assuming really no dramatic change in the bad debt reserve. That could have – has had a significant bearing in terms of the operating expense overall.

[Kevin Dede:]

Okay, so sorry to catch up. What’s your thinking on what that, if you mentioned it I apologize I missed it, the non-recurring portion of your SG&A costs in this past quarter?

[Jeffrey Lucas:]

It’s about $400,000.

[Kevin Dede:]

Okay.

[Jeffrey Lucas:]

Little north of that, $400,000 or $500,000.

[Kevin Dede:]

Okay, alright. Fair enough. Then what’s your thinking on margins? I mean, they were down both on – even on the contract side sequentially and pretty much lower than where I have seen them trend versus the past, say six quarters, five quarters anyway?

[Jeffrey Lucas:]

Well, let me speak, first of all, in the product side, I think we are going to see some improvement in the margins. We would expect that. And if you take a look at where they have been historically that range, I would be pretty comfortable indicating I would expect them to be the margin percentage for products to be in that range. In terms of the contract, we actually suffered this quarter with our margins on the R&D contract work in large part, because we did have some additional material expenses on some of the projects, which budgeted for the projects overall. And as a result of that, you have sort of this catch up accounting that goes with percentage of completion. So, we have got hit a little more severely this quarter than you otherwise normally would be because of some of those costs. So, I would expect an improvement I think in the contract margins, getting sort of the midrange where we have been historically over the next quarter or two.

[Kevin Dede:]

Okay, fair enough. Thank you, gentlemen.

[Andrew Sculley:]

Kevin, if I didn’t explain things well enough for you on the three color versus two color direct patterning, etcetera you can always come back to me, write me a note or something like that. Okay?

[Kevin Dede:]

Yes, thank you, Andrew for making yourself available. I appreciate that. It’s a little embarrassing, I guess.

[Andrew Sculley:]

No, no. I just want don’t want to give anyone the wrong idea and it sometimes it’s complicated, that’s all.

[Kevin Dede:]

Well, understood. Thank you very much, Andrew.

[Andrew Sculley:]

Okay. Thank you, Kevin.

[Jeffrey Lucas:]

Thanks, Kevin.

[Operator:]

[Operator Instructions] The next question comes from Tom McGuire, a Private Investor. Please go ahead.

[Tom McGuire:]

Good afternoon, gentlemen.

[Andrew Sculley:]

Hi, Tom.

[Tom McGuire:]

My question is I know you are talking with lots of companies and OEMs and you have been for sometime and we shareholders are just waiting for the day we wake up and see a press release that indicates that you got contract or you got a strategic relationship or whatever. So, Andrew, I hope this is not unfair, but why don’t you handicap that happening? What do you think? I mean, you have been in discussions. You have probably gone far with some and all that and where do you think you can get a deal done somehow that’s attractive to shareholders and allows the company to have some cash to increase its production and hopefully become a significant player in these new markets that your development products work?

[Andrew Sculley:]

I think with all the companies that we have talked to and this is on both sides, foundry partners and as well our manufacturing partners and as well the companies who would want these things, the first question you have to ask is augmented reality and virtual reality going to be a significant thing? And I think that you and I would both agree that this is a high probability. It will be a big deal in the future. And we are not alone in guessing that. You could talk – you can listen to many people like Mark Zuckerberg of Facebook, he said that same types of things and the company is talking to us feel it’s going to be a big deal. So, if that’s probable, I think it’s also highly probable that we hook up with one of these or a couple of these companies to make it real, because our display technology is that good that they are talking to us. Let me try one other way to take a look at this. Consider for a minute a large Tier 1 company, why in a world would they come to this little company imagining the military business, why would they do that. They would do it because we have the technology and the know-how to get it done, that’s why they come to us. Otherwise, they also must be going to those big OLED companies, but the big OLED companies don’t make microdisplays. And I am not that they never had, you could read that Samsung had done some work on the microdisplay in 2011 for their digital camera. I am just being open and honest here. And but they don’t make them. And they would have to start from scratch to design the silicon instead of a TFT and design OLED that works and a seal system that I have just mentioned one of the things, forgive me for the technical stuff, but just to show you that it’s different. The seal that companies making cell phones, etcetera use when they are doing that thin film seal is about five times to ten times bigger and thicker than ours. You can’t have that for a microdisplay. So there is a lot of work and effort going into doing that. That’s why we are ahead and that’s why these large Tier 1s talk to us. Otherwise, they wouldn’t give us the time of day.

[Tom McGuire:]

So Andrew, what kind of timeframe do you think is out there in terms of perhaps hearing or seeing some sort of press release or some sort of deal with one of these big companies, is that six months, three months, year, what do you think?

[Andrew Sculley:]

I think that we are trying like mad to get close enough to them. So if they have to do something that requires us to get a press release, to satisfy everyone including ourselves and feel much better, we can say something real then. And I would hope that we can do something during next year. But I don’t want to give you a month.

[Tom McGuire:]

Okay, thanks very much.

[Andrew Sculley:]

Thank you, Tom.

[Operator:]

The next question is from Jack Morbeck of First Washington Corp. Please go ahead.

[Jack Morbeck:]

Andrew, business model going forward, because you are pretty much just a development company, even though we have been hoping that, that wasn’t going to be the case, but you have this technology, do you think is the business model going forward is if someone, one of these companies decides to adopt your technology or is that you are going to be paid a royalty and someone else is going to have to manufacture you will remain more of a development company right along, because when you say you are a year away from anything, perhaps a year away, maybe if someone comes and to adopt it, that’s kind of what the Board or you guys have decided that this is what the future is?

[Andrew Sculley:]

No, we are not going…

[Jack Morbeck:]

We are not going to see. We are hoping at one point, I mean if you look back 5 years ago you would probably get more revenues than you are doing now. I don’t have the figures in front of me. I just know that at one point, we are hoping that we would get to $50 million of revenues or something, but we are still – we are doing all the contracts with the military, etcetera, etcetera, but as a development company. So well, I guess my question is as you look forward the success is going to be paid perhaps a royalty on that, I am interested in what you think the company could look like if you are successful?

[Andrew Sculley:]

I appreciate the question, Jack. Well, there are obviously multiple business models going forward. But we do have manufacturing technology as well. And we would want to be a part of that. So getting to those that $50 million is not out of the question. We are still breaking our necks to hook one of these larger customers and get there. We also however, know that significant capital would have to be built if, as I mentioned in 2020, one of the research companies said there will be 100 million virtual reality headsets. If they were all OLED microdisplays, there would be 200 million displays. And as you can guess that’s many more than we make today, so significant investment would have to be in equipment. And whether that comes from the customers or foundry partners, either one of those makes sense to us. Obviously, it could be an IP play as well, but we are a manufacturing company at heart. And we believe will play a significant role in manufacturing for those displays in the future.

[Operator:]

Mr. Morbeck do you have another question?

[Jack Morbeck:]

No I don’t think so. Thank you.

[Operator:]

Okay, thank you.

[Andrew Sculley:]

Jack anything you would like to talk to us about your thinking here is would be fine, let us know.

[Jack Morbeck:]

Thank you.

[Andrew Sculley:]

No problem. Thank you.

[Operator:]

There are no additional questions at this time. This concludes the question-and-answer session. I would like to turn the conference back over to Andrew Sculley for closing remarks.

[Andrew Sculley:]

I would like to thank our shareholders for being on the call and the questions. I would also like to thank you for ideas that you have given us and things that we should think about. I know it’s a tough technology and a long time for the AR and VR market to develop. And there are a lot of things that we have to put in place to make that happen. We are working very hard on them. So I would like to also to turn my attention to the team that we have in place that we are doing so many things and we are devoting our efforts to getting that capacity by tool efficiency and yield up to where our capacity is higher, so that we can satisfy both sides of the equation and see growth on both development and product revenue. I would like to thank the headset group that Dan and Kip for coming to join us and working like mad to get somewhere significant with this headset idea and we do have a couple of customers, companies who are interested in the headset, so that we are all working very hard. And we are looking forward to success. And next year, we are looking forward to success so that we can satisfy everyone that there is a company very interested in our microdisplays outside of the military for consumer application and that’s what we are looking forward to. So I thank you, everyone for joining the call. And the eMagin team I thank you very much for working hard as you do.

[Jeffrey Lucas:]

Thank you all for joining us this afternoon.

[Operator:]

Your conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.