eMagin Corporation

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Good morning and welcome to Imagine Corporation's second quarter 2022 earnings conference call. Please note this event is being recorded. After management's prepared remarks, there will be a question and answer session. To ask a question during this session, you will need to press star 1 1. I will now turn the conference over to Mark Koch, Imagine CFO. Please go ahead.

Thank you and good morning, everyone. Welcome to Imagine's second quarter 2022 earnings conference call. Before we begin, I would like to remind you that in the following prepared remarks and in our Q&A session, we will make statements about expected future results that may be forward-looking statements for the purposes of federal securities laws. These statements relate to our current expectations, estimates, and projections and are not guarantees of future performance. They involve risks, uncertainties, and assumptions that are difficult to predict and may prove not to be accurate, especially in light of the effects of the ongoing pandemic. Actual results may vary materially from those expressed or implied by these forward-looking statements, and we undertake no obligation to update these disclosures. These forward-looking statements should be considered only in conjunction with the detailed information contained in our SEC filings including the risk factors described in our 2021 Annual Report on Form 10-K and current Form 10-Q. During this call, we will also refer to adjusted EBITDA, a non-GAAP financial measure, to provide additional information to investors. A reconciliation of adjusted EBITDA to net income, which is the most directly comparable GAAP financial measure, is provided in the press release that we issued this morning. Non-GAAP financial measures such as adjusted EBITDA are not meant to be considered in isolation or as a substitute for our GAAP financial measures and financial statements. With that, I will turn the call over to our CEO, Andrew Sculley.

Thank you, Mark, and hello, everyone. Thank you for joining us today. On today's call, I'll provide some key takeaways from our quarterly results and discuss our technological advances and equipment schedule. Mark will then discuss our consolidated results in greater detail. Our second quarter included a number of highlights, including higher revenue, improved gross margin, new business wins, and progress on our AS9100 ISO certification. Our total revenues rose 14% to $7.2 million year over year, while our gross margin improved to 22% from 9% a year ago. The gain in gross margin was driven in part by increased yields and a favorable sales mix, along with the impact of higher manufacturing volumes. This is the third consecutive quarter in which we realized year-over-year increases in throughput. The improved yields and increased throughput resulted from the impact of the new government-funded equipment in our production facility and improvements in our manufacturing operations. We achieved continued growth in display revenue from the ENVGB program and other military programs, along with increased veterinary and surgical revenues. We also strengthened our relationship with a major prime contractor by advancing our capabilities for higher level assembly and ship displays to a customer providing heads-up displays for optical surgery. As of the end of the second quarter, Our total backlog of open orders remains strong at $14.3 million, with $12.8 million shippable over the next 12 months. This reflects demand for our displays for use in thermal weapon sites, military night vision goggles, and medical applications. Additionally, the U.S. Army's Program Executive Office for Simulation Training and Instrumentation awarded us a $2.5 million two-year development contract in Q2. Their goal is to secure a U.S. source for high-performance microdisplay that provides high brightness and visual acuity even in bright daylight conditions. We will design a backplane that will allow for significantly higher luminance of our DPD displays and ultimately leverage the full potential of the equipment we are acquiring under our Title III and IBAS funding grants. Furthermore, we anticipate that our government-funded DPD tool will be available to satisfy this demand for high luminance displays, as well as demand from both existing and new military customers. At the same time, we are continuing our proof-of-concept display work for a Tier 1 AR VR customer and are anticipating this September arrival of an advanced DPD chamber for R&D usage, which we will use to complete the remaining OLED deposition phase of this contract. This new R&D chamber will enable us to fabricate additional high-brightness prototypes. Moreover, it should accelerate progress with our product roadmap as we await qualification of a government-funded DPD tool early in the second half of 2023. That will be capable of serving our military and commercial markets. As previously announced in May, we received the People's Choice Award for Best New Display Technology at Display Week 2022, where we showcased our direct pattern, single stack color OLED micro display, which is capable of over 10,000 candela per square meter of maximum luminance. We continue to display our technological leadership at industry conferences, including an upcoming paper presentation by our chief operating officer, Dr. Amal Ghosh, on OLED micro displays for AR VR applications at IMID 2022, the international meeting on information display later this month in Busan, Korea. Lastly, we have completed a preliminary audit and expect to obtain an AS9100 ISO 9001 certification in the third quarter of this year. We expect our quality control efforts will be additive to the yield and throughput improvements anticipated from the new equipment provided under our Title III and IBAS programs. Furthermore, we expect that this certification will elevate our profile as the supplier of choice for OLED micro displays for various markets that we serve. With that, I'll turn the call over to Mark, who will discuss our financials.

Thank you, Andrew, and hello, everyone. Starting with the top line, total revenues for the second quarter of 2022 increased 14% to $7.2 million, compared with $6.3 million reported in the prior year period. Total revenue consists of both product revenue and contract revenue. Product revenues for the second quarter of 2022 were $7.0 million, an increase of $1.3 million from product revenues of $5.7 million reported in the prior year period. The year-over-year increase in display revenue was due to strength in military markets, including shipments of displays used for the ENBGB program, and higher revenue contributions from medical customers. Contract revenues were $0.1 million compared with $0.5 million reported in the prior year, reflecting an anticipated decrease in second quarter development work associated with a proof-of-concept project. As Andrew mentioned, we anticipate increased development activities with this tier one consumer company following the expected september 2022 delivery of the r d deposition chamber additionally in q2 we began to recognize revenue under the new u.s army development contract total gross margin for q2 was 22 resulting in a gross profit of 1.6 million compared with a gross margin of 9%, which resulted in a gross profit of $0.6 million in the prior year period. The gross margin improvement reflects increased product revenues, higher yields, and the impact of higher average selling prices in the current year's period due to a favorable sales mix, combined with the impact of higher manufacturing volumes. Operating expenses for Q2, including R&D expenses, were $3.4 million compared with $3.5 million in the prior year period. Operating expenses as a percentage of sales were 47% compared with 55% in the prior year period. Operating loss for Q2 narrowed to $1.8 million compared with an operating loss of $2.9 million in the prior year period. primarily reflecting the increased gross profit as noted above. We anticipate improved performance over the subsequent quarters due to operational improvements and significant upgrades to our capital equipment and manufacturing processes provided by the IBAS and Title III government programs. Net loss for the second quarter was $1.4 million, or two cents per share, compared with a loss of $0.3 million or zero per share in the prior year period. After adjusting for change in the fair value of the warrant liability, net loss for the second quarter of 2022 was $1.7 million or three cents per share on a fully diluted basis. Excluding the impact of the $2.6 million change in the fair value of the warrant liability for the prior year period, Net loss for the second quarter of 2021 was 2.9 million or 4 cents per share. Adjusted EBITDA for Q2 improved to negative 0.3 million compared with negative 2.0 million in the prior year period. As of June 30th, 2022, the company had cash and cash equivalents of 4.3 million and working capital of 12.3 million. During the second quarter, the company repaid $0.6 million under its asset-based lending facility. Borrowings and availability under the ABL facility were $2.1 million and $0.7 million, respectively, as of June 30, 2022. Additionally, the company realized $1.6 million in net proceeds from sales of common shares under its ATM program. With that, we will open the call for questions. Operator, please go ahead.

Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, you will need to press star 1 1. Again, that's star 1 1 to ask a question.

Please stand by while we compile the Q&A roster. Now, first question coming from HCW.

Your line is open.

Good morning, Andrew and Mark. How are you?

Good morning, Kevin. How are you? We're good.

Good, good. Thanks for having me on the call. Just help me understand the timeline. and maybe a little bit more on the new Army development contract, understand that you need that deposition tool to come in, I guess, next month. How long will it take for you to get that thing in place and online operating properly in order to perform what the Army is asking you to do?

Well, there's a couple of things to think about. One is the tool comes in. This is an upgraded R&D tool, and that comes in in September. And then we, you know, it's just an upgrade of the old R&D tool with some good, very good upgrades. So it'll take some time to get up. But the other thing to realize is the U.S. Army program for $2.5 million is that that requires a backplane redesign, and we're doing that. And so that backplane design will take us to the end of the year, and then the R&D tool will be up and running. And that's a two-year program, Kevin? Yeah, it is two years. And the other thing is we don't expect the R&D tool to take an enormous amount of time, and it's important because the Tier 1 project we're working on we need to do additional deposition, and we want to use that new tool, so that should start shortly after September.

I see. Okay. The press.

I'm sorry, Kevin. Can I say one other thing? The other important thing, and we said this during the prepared remarks, the other important thing is the new Title III tool, we'll be able to produce this very high brightness color display in volume. And I'm talking about our volume type. So that's going to be an extremely positive.

Right, right. So that's kind of where I was going, because I tried to do some rough math based on the press. And it seems there's a total of seven tools that are part of the upgrade process three you have and four are coming do i understand that correctly and then i think there's one big deposition tool is that the one that you're referring to yes yeah and that's uh that that's correct you're counting well and the large deposition tool is the one that we'll be able to do our direct patterning or dpd in uh production

and that's mass production for us it will also be able to do any display we make today could be done on that tool and it will also be able to do this very high brightness with the new project by the army okay can can you yeah andrew would you mind just sort of taking me through the timeline on that i mean i understand that's supposed to be in by the end of the year but

It could take a while to get it dialed in. We shouldn't really expect it to be up and running until maybe the third quarter next year.

Oh, what we said, yes, the big tool. We said that it would be in, and then we would qualify it in the second half, early second half of next year, and therefore we'll be able to run things on it. Okay.

Okay.

Take some time to qualify all our products on it if we want to do DPD on every one of our products today.

Okay. Now, my understanding is that you're going to run what you currently have in parallel, right? So that'll give you a little more redundancy?

Oh, yes. Yeah, the current larger tool, and this current large tool is small compared to the new one. But the current large tool will be continuing to run and we'll be able to run both tools in parallel. And that's one of the ideas is that the single use failure now will have two very good tools. One capable, of course, in mass production of the direct pattern displays and also the new display that we're designing for very high brightness, full color mass production. And here what I mean by very high brightness, we already got over 10,000 candela per meter squared. And now this next effort, we can estimate that it's going to be 1.8 to 2 times what that is.

Is that going to be a dual-stack configuration, or will you be able to do that just on a single?

Well, the dual-stack or tandem architecture is one of the things that we're working on as well, sure. By the way, doing a tandem architecture, and that's the common language from the inventors, but the tandem architecture is much easier to do with red, green, and blue singly than a tandem white. So we have an advantage over everyone. And the other great thing is when you do a tandem architecture, we don't have the color filters, which throw away 80% of the light. So very big advantage here. And as you know, you've heard things like a tandem architecture or actually heard a three stack at the display week 2022. One company had maximum of 7,000 nits, although from my eyes, they were only running it at 2,000. So 7,000 nits, white with color filter, three stack tandem. And here we've got one stack with direct patterning. at over 10,000, and when we do this next program, it's going to go to more something like 20,000. What an advantage we have.

Yes. No, thank you, Andrew, for that extra color. Could you just walk us through where you are on the consumer development side? Obviously, you spoke to one program, but my understanding is there are others. and lots of development that you've done in the past, and I'm just hoping you could speak to where your current programs are and how much interest you're seeing.

Well, everyone we talk to, and this is on the AR side or VR side, they don't always tell us what they want. They want a very high resolution, so 4,000 is the key number nowadays. The newer ones didn't want to stitch the backplane. Sorry for the technical jargon, but if you don't stitch the backplane, you have to have something a smaller diagonal. If it's a square, diagonal has to be something like 1.3 inches instead of the 4000 resolution we did was 2.1 inches in diagonal. So people want it smaller nowadays, and we have spoken with a number of companies We've gave them the path forward on how to get to a 1.3-inch diagonal, near as 4,000 as we can get, and there's great excitement. The other thing is I have to say that no one has told us they can withstand less than 10,000 nits. So even those three-stack white that we saw at the display week 2022, that's not good enough. And you asked about the past. So the other thing, this new R&D system that's coming in in September, we need to finish the prototypes for the Tier 1 we're working with now, all of the prototypes with the OLED. And then the next step is we want to also produce more of those 4000 resolution displays that we already have. And we've shown the 4,000 display to a number of companies. And the company who paid us to design that allows that to happen. We don't violate anything, of course. And that creates excitement, too.

Okay. Just want to switch gears a little bit. Mark, it looks like the gross margin was down sequentially. Do I have those numbers correct? And I'm slattish revenues. Could you help me understand why that happened?

Yeah, sure, Kevin. It was slightly lower manufacturing volume in width to absorb costs, you know, about, say, 15% lower volume. And in the first quarter, we had some recoveries of displays that we You know, we had taken a look at the specs and discovered that we were being too tough on ourselves, so it does include some recoveries of displays that we were able to reclaim and put into our inventory, which was a positive adjustment. So we did not have that reoccur in the second quarter.

Okay. And then just last question for me, could you refresh my memory on the accounting or synopsis of actually the accounting of the deferred income on the government award? Because I keep seeing that increase as a liability.

Yeah, certainly. So when we – like we make progress payments to vendors for the equipment, and as we – In advance of the progress payment being due, we bill the government. The government pays us the funds to reimburse the government, so we increase our fixed assets. Then we also increase the deferred revenue liability. And then there's another step that you're starting to see in our other income section. You see there's other income of $350,000 in Q2. So as we depreciate this equipment, the depreciation for the equipment for the new government equipment shows in COGS, but the accounting says as we depreciate it, we actually recognize the benefit or the income from the government grant. So over the course of the program, all of that deferred revenue will eventually be amortized to other income. So all that will decline over the course of the program, commensurate with the amount of depreciation expense each quarter. Rather involved, but I guess if you pull back on the macro level, we've received these over $35 million, $39 million in funds from the government. And the accounting on a macro level is that it's a grant, so it's considered an income in that sense. And we recognize that income over the useful life of the equipment, which is, of course, is basically a proxy for the depreciable life of the equipment.

Okay, and what are you using, like 10 years or longer?

No, for most we're using seven years, which is what we've done for equipment. It, of course, would last longer than that, much longer, but that's been our convention for our major pieces of manufacturing equipment.

Okay. I'm sorry, I'm going to stay on. Just walk me through where you are in government projects. new development one, and the EMDG. But I know that there were a bunch of other things, helicopter helmets, missile targeting displays. What else can you help me with?

There are a number of projects that we're already on and working on, like the helicopter. And forgive me, we can't name who is their actual customer. There's a number that we're also working on, and I'll just mention that, for example, the family of weapons sites, there was another bid that had taken place, and we used our displays with a number of primes, and one of them looks like it's going to get the award. So that's one. We are on a significant aircraft, and we're still supplying displays to an aircraft's helmet. Sorry, I can't mention the name, but that's very good for us. And some of the other programs that we're on, they're not in the U.S. We're providing displays outside the U.S. as well. And there's one of them that is a tank program where the The people in the tank can put on a device and they don't have to stick their head outside and it looks outside of the tank. And they can also see as an AR device inside the tank also. So it's very interesting to us. Okay, one other one. Obviously, we have a long-standing customer, which is a big customer that is for consumer thermal scopes for hunting. And you might think that that's a small volume, but for us it's very big. And they also now work on the government side. So we have a number of programs going very well.

Wonderful. Thank you so much for entertaining all my questions, gentlemen. I really appreciate it. I'll turn the floor over.

Our pleasure. Thank you, Kevin.

Thank you. And our next, our last question coming from the line of Mike, well, your line is open.

Good morning, Andrew and Mark.

Good morning, Michael. One thing I should mention before you start, I forgot to mention ENBGB program to Kevin's question. So my apologies, Kevin, and sorry for interrupting, Michael. But ENBGB, they recently got a big plus up in terms of government funding. Instead of $75 million, they went up to, so it's not going to necessarily reach the number of $300 million for government funding. So it's up to $300 million. But we expect it to be much larger than the $75 million. And also, if you read the press on this, look it up in the Internet, it performs very well. So that's other good news. And that's our biggest program right now. Sorry, Kevin, I forgot it. And Michael, I apologize for interrupting your question.

No problem. So, Andrew, to my knowledge, Imagine is still the only company right now that can do a 4K OLED micro display at over 10,000 nits. I wanted to ask... Go ahead.

Well, that is correct.

Okay.

Okay.

I wanted to ask...

Yeah, let me say one other thing. To our knowledge, we're the only company that has produced an OLED micro display at 10,000 nits and above. To our knowledge. Okay.

Okay.

Okay.

Well, I wanted to ask, and I've asked about this before, just kind of your view of kind of the competitive landscape. You know, as we're kind of coming down the home stretch here, Getting close to the consumer headset, the next generation, I think there's some big guys kind of going after those same sort of targets. I wanted to just kind of check in with you and see if you think that that changes much over the next couple years where maybe one of these guys kind of gets there and says, hey, we can do that too. Or do you feel like you've got to, yeah.

Yeah, we have good patent protection and know-how. That said, you know, one of our goals is potentially to get a mass production partner. We're also interested in the CHIPS Act, but a mass production partner, and there are a few companies with whom we're speaking about this technology.

Okay.

There is interest, and I think The easiest way to get to 10,000 nits is to use direct patterning, and our methodology is very good.

Okay. And I know that you've been thinking about this manufacturing agreement for quite a number of years now. You don't have anything finalized yet, but I just wondered if, if you've kind of settled in your mind on which company that you're going with, or do you think that it would more likely be more than one license that you would provide for maybe a couple different companies to use rather than an exclusive agreement?

It really depends on the end result. An exclusive agreement is more valuable. has a higher price tag than a non-exclusive agreement so that uh that depends on that and uh we are talking to a few which actually is like four companies about this okay all right um and i wanted to ask uh there's a there's a consumer company that holds a license to use your technology going back to 2017 Good memory.

Do you still hear from them at all?

Yes, we do. They're very interested in this new equipment that's coming in.

Okay, good. So are they also interested in you finding a manufacturing partner and maybe willing to kind of help with that process?

Absolutely, yes.

Okay. All right. I think that's all I've got, but that sounds really good. So thank you very much for taking my questions.

Well, you're welcome, Michael. Thank you, Michael. We are very happy with the progress that we are making, and the new R&D chamber will be quite good at making the displays. And I'm not mass production. Yes, go on.

Yeah. Sorry. Do you think that what you're going to do here in September with the R&D chamber, is that kind of the last step to complete the proof of concept? Yes. It's needed. Okay. So after that gets done, then that would be kind of when that consumer company would decide, let's go forward with some, let's go see that manufacturing partner? Yes.

Yes. Yeah, it will take a while to get all those displays done on the tool. But we'll start it after the tool is in and running, which is later this year.

All right. Well, sounds great. Thanks again.

Thank you, Michael. Thanks, Michael.

Thank you. I will now turn the call back over to the company for any closing remarks.

Thank you again for joining us today. This concludes the conference call. Have a nice day. Thank you.

Ladies and gentlemen, that's our conference for today. Thank you for your participation. You may now disconnect.

Good day. shortly to raise your hand during Q&A you can dial star 1 1