VUZI - NASDAQ

Greetings, and welcome to the Vuzix Second Quarter ending June 30, 2022 Financial Results and Business Update Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Ed McGregor, Director of Investor Relations at Vuzix. Mr. McGregor, you may begin.

Good afternoon, everyone, and welcome to the Vuzix' second quarter of 2022 ending June 30 financial results and business update conference call. With us today are Vuzix CEO, Paul Travers; and our CFO, Grant Russell. Before I turn the call over to Paul, I'd like to remind you that on this call, management's prepared remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements during the question-and-answer session. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by any forward-looking statements, as a result of certain factors, including but not limited to, general economic and business conditions, competitive factors, changes in business strategy or development plans, the ability to attract and retain qualified personnel, as well as changes in legal and regulatory requirements. In addition, any projections as to the company's future performance represent management's estimates as of today, August 9, 2022. Vuzix assumes no obligation to update these projections in the future as market conditions change. Today's call may include certain non-GAAP financial measures. When required, reconciliation to the most direct comparable financial measure calculated and presented in according with GAAP can be found in the company's Form 10-Q filing at sec.gov, which is also available at www.vuzix.com. I will now turn the call over to Vuzix' CEO, Paul Travers, who will give an overview of the company's operating results and business outlook. Paul will then turn the call over to Grant Russell, Vuzix' CFO, who will provide an overview of the company's second quarter financial results. Paul will return to provide some closing remarks. After which we will move on to the Q&A session. Paul?

Thank you, Ed. Hello, everyone, and welcome to the Vuzix Q2 2022 conference call. On this call, we're going to review our results and recent developments and then give you some perspective on where we see things headed. The overall business environment in the second quarter of 2022 remain challenging for most companies, due to macroeconomic headwinds causing delayed decision-making and the resurgence of COVID, particularly in parts of Asia. Despite these issues, our Q2 revenue of $3 million, which exceeded the consensus expectation, represented a 20% increase versus Q1 2022, and a 3% gain year-over-year. From a customer engagement perspective, the second quarter was very encouraging across our core smart glasses business. Most notably, we expanded our international sales channel with the addition of westbase.io to support our business in Northern Europe, a firm with a 30-year pedigree and one of the most experienced connected worker device distributors in Europe with solutions from cellular to XR Technology, and connecting tens of thousands of frontline workers and businesses. We're bolstering our local sales and support team in Europe, with additional boots on the ground that came online in early Q3 to support our key accounts and drive additional sales growth in the EMEA region. Also in Europe, we will be opening a Vuzix sales office in Germany later this quarter, which will provide a new central operational and support hub for our European business. As always, we continue to work closely with our key independent software vendors to support the needs of our collective customers as they roll out their solutions and work through any further optimizations ahead of expected enterprise-wide rollouts. On the OEM side of the business, upon which I will expand shortly, there is a growing momentum with both existing and new customers, and we expect our OEM business activities and revenue to accelerate in the back half of 2022. We continue to invest in our core technologies, including waveguides and display engines along with our significant investment and commitments in Q2 regarding our MicroLED and backplane announcement with Atomistic Additionally, we are also investing in the expansion of our high-volume, cost-effective waveguide manufacturing capacity. Our smart glasses core customer base continues to expand, and our customers' commitments to scaling up is also increasing. One market vertical that has continued to expand over the last 12 months is warehousing and logistics. After a period of starts, pauses and stops primarily due to COVID and other headwinds we discussed earlier, we're now starting to see volume multiyear rollouts for smart glasses being actively planned by some of the largest companies in the world. One Fortune 100 customer that we referenced in the July press release has already placed multiple orders for initial rollouts and is well into scheduling a multiyear rollout of our smart glasses. The smart glasses project at this retailer has a currently slated will represent one of the largest deployments of smart glasses in the world to-date. And it's great to see that Vuzix smart glasses were selected to support this customer. The benefits afforded by this smart glasses and software solutions will help deliver critical efficiencies and powerful ROIs to the logistics arm of this customer without any material implementation disruptions to their operations. They are just one of four Fortune 100 retailers that are preparing to actively deploy much larger numbers of our products. Feedback from our other large customers regarding warehousing and logistics, including Amazon remains very positive. As per their own social media, Vuzix smart glasses have been deployed across various Amazon warehouses, and we expect this project to roll out should continue to expand over the second half of 2022 and beyond. Amazon even has their own custom M400 Smart Glasses SKU from Vuzix. At other large customers in this space, our smart glasses are being deployed within their distribution centers and the integrated software solution in some instances is still being fine-tuned in preparation for wider rollouts and which we anticipate should begin during the second half of 2022. In healthcare, our major ISVs continue to expand the availability of the Vuzix-powered surgical solutions. Medacta continues to expand its next AR surgical platform solution, which now has hundreds of units and performed over 1,000 surgeries to-date. They had a full market release of their shoulder surgery solution in May and in June received their solutions approval in Japan for knee, shoulder and spine surgeries. In late July, Pixee Medical received FDA 510(k) clearance for its FX SPS, a total shoulder arthroplasty online 3D planning software, which will create even more sales opportunity in North America for their smart glasses based surgical solutions for both knee and now shoulder replacements. Rods & Cones business also continued to expand and they're now active in more than 600 hospitals and have supported well over 25,000 surgeries in 75 countries worldwide, that's a current run rate of as many as 60 surgeries a day. Around the world, we are seeing more and more healthcare-related white papers being written and POCs taking place, as well as a steady stream of incoming inquiries from doctors and medical facilities. Overall, our core Smart Glasses outlook and expected sales pipeline for the remainder of 2022 remains healthy. However, one of our biggest challenges in our forecasting continues to be managing and understanding customers' needs and expectations around the timing of deployments from these key accounts, which can have a material impact on our quarterly sales. Regardless, we expect our core Smart Glasses revenue over the second half of 2022 to grow compared to the second half of 2021. As announced in mid-May, Vuzix signed a series of agreements with Atomistic, a France-based technologies firm with a novel material science approach related to the development of next-generation micro light-emitting diodes or micro-LEDs. The combination of Atomistic Display and Vuzix see through waveguides will deliver full color high-resolution HD solutions, a level of form and functionality that represents what we believe to be the Holy Grail for the broader AR wearable markets, markets expected to ultimately become as large as the current smartphone market itself. We're making great progress. And if you would like to learn more about Vuzix's micro-LED efforts and this transaction, please review the conference call that Vuzix hosted on May 18 of this year. You can find it on our website. Elsewhere on the M&A front, Vuzix continues to engage in due-diligence and hold discussions with multiple vertical market solution companies that could broaden our SaaS-based service offerings across key market segments. We look forward to bringing you news about these developments if and when they are successfully completed. As promising as the smart glasses market opportunity looks to us going forward, we are equally excited about what we are seeing on the OEM side of our business. Our standardized OEM platform that was announced during the second quarter is, now being proactively offered to third parties. This new platform will offer customers one-stop shopping for their advanced and customized waveguide and display engine solution needs from design to high-volume, cost-effective production capabilities, a mix that is currently almost impossible to find with the competition. Since this announcement of our expanded OEM initiatives, we have been fielding many RFIs, Request For Inputs and formal RFQs, Request For Quotes for our waveguide-based solutions and in most cases, display engines to go with them. Our IP portfolio continues to strengthen and now consists of 247 patents and patents pending. Our ability to deliver the world's best performing waveguides and display engines and volume with a very cost-competitive solution is just one of several critical technologies needed for the AR products of the future. We are well on our way to expanding our waveguide production facilities to support high-volume, low-cost offerings. We have also made significant waveguide technology strides that include 80% reduced Eye Glow, a tripling of waveguide efficiency for higher brightness and more efficient battery usage and the use of higher index substrates and polymers, supporting single-layer color designs and much larger fields of view to name a few of our advances. To deliver against expected OEM needs in Vuzix's own future demand, we are preparing for an expansion of our waveguide fabrication equipment to address the millions of units of waveguides associated with the potential business we see coming long-term. And our goal is to do the same for full color high-resolution micro LEDs in due course by the atomistic investment. We feel the OEM revenue opportunities for Vuzix are very significant as the waveguides and engines will be an integral part of the computing platform of the future from defense, all the way to literally replacing the smartphone. On the defense side, where our non-compete agreement expired in June, allowing us to directly engage with any US and allied defense organizations around the world, we are well positioned as the only US-based manufacturer of waveguides. We are actively addressing the defense market with plans to attend key defense-related trade show events and outreach to direct government programs. We are also in the process of evaluating new talent and business development that could assist our efforts with bringing on additional defense business. Our goal is qualification and selection of our OEM components into volume programs where production runs can span five years or more and result in four, five and even six figure unit volumes. On the consumer side, we are well positioned to be a flexible, high-volume cost competitive provider of waveguides and related solutions. Most notably, many leading consumer products companies have publicized their intention to offer smart AR glasses for the masses, but are discovering just how challenging it is to build a pair of highly functional cost-effective and fashionable consumer AR smart glasses in volume. The optics and display engines for AR glasses represent integral pieces of any solution and have to be designed from the ground up to work together for their application. So many are now turning to Vuzix as a partner for our waveguides and display engines for this exact reason. On the enterprise side, customers and varied industry verticals are driving a variety of use cases that represent greenfield applications and/or upgrades to older solutions that are already being deployed. I would like to give you some specific customer color on what's going on for us in the OEM space. And as you can see on Slide 8, it's a lot. We are actively engaged with many leaders in their respective spaces, and we are in discussions with many more. Starting with defense, we are currently engaged with seven firms with multiple projects underway with some of them. Most notably, we recently announced an agreement with L3Harris Technologies, a leading defense contractor to develop a new customized waveguide-based head-mounted display engine for use within existing L3Harris programs and new ones in the works. It's exciting that our technology can be used on multiple projects that they may pursue and the multiyear unit potential for us could be quite large given the size of L3Harris's existing product lines and the use cases they target. Projects with other defense firms remain in various stages of development. For instance, the long-term supply agreement we have discussed in the past with another defense partner is still in process with preproduction modules continuing to be delivered. We expect to offer more specifics about some of these over the balance of this year as well as see some move closer to production. On the consumer side, we announced an equally significant development last month when we received a purchase order for custom design waveguides from a Fortune 50 software and hardware technology company. The work for this customer, which is consistent with the consumer-related marks I made previously, is well underway and the waveguides are being built by Vuzix to specifically match this customer's needs and specifications. We are also engaged with other firms of equal caliber, and anticipate that additional programs will be announced as we continue to receive growing customer interest for cost-effective and fashion forward due to waveguide designs to support the broader markets. Overall, we expect our OEM-related revenue growth to accelerate in the second half of this year as more development projects reach the contract stage. In most cases, these will be engineering service sales, and as such, represent just the very beginning in terms of future revenue potential. Vuzix remains on track to release three new AR smart glasses products over the next several months. Our development and production teams should get high marks for successfully managing our delivery and project schedules, with the challenging supply chain issues during shutdowns in China due to COVID. We are nearing completion of a new waveguide-based successor to our Blade Smart Glasses that will feature our latest advanced waveguide optics, a new microprocessor and Android 11 out of the box. We believe this new product will answer the call from many of our enterprise customers that love the Blades form factor, but required an upgraded Android OS and broader WiFi capabilities to support their applications architecture, among other things. We expect to formally announce and commence volume production of this follow-on product within weeks. The Vuzix M400C, our second-generation USB-C-based Windows PC and phone compatible smart glasses, takes full advantage of the robust design and camera afforded by the Vuzix M400C, including IP67. We have shipped a limited number of initial production units of the M400C and we expect to introduce the M400C to our standard channels during the third quarter. Finally, the Vuzix Shield, our next-generation smart glasses is far advanced compared to the competition and its form and functionality have garnered significant early interest from enterprise customers that require a more traditional eyeglass form factor and the capabilities afforded to them by the shield to solve operational challenge. The Shield is on track for introduction well before the end of the second half of this year. I'd like to now pass the call over to Grant for his financial review. Grant?

Thank you, Paul. As Ed mentioned, the 10-Q we filed this afternoon with the SEC offers a detailed explanation of our quarterly financials. So I'm just going to provide you with a bit of color on some of the numbers now. Our second quarter total revenues for the three months ended June 30, 2022, was $3 million as compared to $2.9 million for the prior 2021 period. And while we did see a year-over-year double-digit gain in Smart Glass unit sales in the second quarter of 2022, this was offset by negative foreign exchange impacts and a large volume discount given on a customer order in the quarter. Revenues from engineering services were relatively unchanged in the 2022 quarter versus the 2021 quarter. And I would like to point out – we currently have near $0.7 million in remaining engineering services obligations, which should be completed and recognized in the second half of 2022. There was an overall gross profit of $0.4 million, or 14% for the three months ended June 30, 2022, as compared to a gross profit of $0.6 million or 20% for the same period in 2021. The decrease in gross profitability in the quarter was largely attributable to a rise in product direct cost to 62% of sales versus 47% in the same period of 2021, primarily driven by a higher level of sales discounts on large volume unit order, and the negative impact of foreign exchange in the 2022 period on non-US dollar denominated sales and higher allocations of applied manufacturing overhead costs included directly in product cost of sales. R&D expense was $3 million for the three months ended June 30, 2022, compared to $2.7 million for the comparable 2021 period, an increase of approximately 10%. The higher R&D expense was primarily due to increases in external development expenses related to our Shield smart glasses and increased salary and benefits expense due to headcount increases. Selling and marketing expenses for the three months ended June 30, 2022 was $1.9 million as compared to $1.3 million in the 2021 period, a 37% increase, largely due to a $0.3 million increase in headcount and salary and benefits related expenses and, to a lesser extent increases in travel sales commissions and tradeshow expenses. General and admin expenses for the three months ended June 30, 2022 was $5 million, a decrease of 3% versus $5.2 million in the prior year period. This decline was largely due to a decrease in shareholder and IR-related expenses and, to a lesser degree, a drop in recruitment and hiring expenses. The net loss for the three months ended June 30, 2022, was $10 million, or $0.16 per share versus a net loss of $9.2 million, or $0.15 per share for the same period in 2021. Now for some balance sheet highlights. Our balance sheet remains strong with cash and cash equivalent positions of $100.6 million as of June 30, 2022, and a net working capital position of $109.1 million. Cash used in operations after adding back non-cash operating expenses, which are mainly stock compensation, but excluding changes in our working capital, totaled $5.5 million for the second quarter of 2022 as compared to $4.6 million in the 2021 comparable period. Cash used for investing activities for the second quarter of 2022 was $8.2 million as compared to $0.6 million in the prior year's period. The increase reflects $4.5 million of payments made towards our $15 million technology license fee commitment related to our Atomistic agreements and $3.5 million for investments in manufacturing equipment, product mold tooling and backplane design and tooling fees. As of June 30, 2022, the company continues to have no current or long-term debt obligations outstanding other than our Atomistic outstanding license fee commitment. Looking forward to the balance of 2022, we are confident we have the resources to execute on our business plan and further invest in our future. With that, I'd like to turn the call back over to Paul.

Thank you, Grant. To close, I would like to reiterate a few important points. The world's adoption of AR and smart glasses is gaining momentum and by most accounts will be unstoppable. We are seeing no loss of enthusiasm to deploy this new technology throughout enterprise with medical markets leading the charge and supply chain right behind it. Vuzix has been preparing for this for years, and we have developed the IP and manufacturing capabilities to supply to it and to deliver to this growing opportunity, Vuzix has the balance sheet to get it done. With that, I'd like to turn the call back over to the operator for Q&A.

Thank you. The floor is now open for questions. [Operator Instructions] The first question today is coming from Matt VanVliet of BTIG. Please go ahead.

Hey, good afternoon. Thanks for taking the question. I guess first on – you outlined a number of OEM opportunities here across a number of different market verticals. Curious how a number of those discussions have been progressing just the last several weeks or a month or two as inflation goes up and there's concerns around whether it's the consumer world or just the broader macro, limiting potential total business activity and maybe even enter a technical recession here. Just curious if you've had any of those discussions sort of slowdown or what you consider the pace of those? And then a secondary question on that, if a number of those come through, where would you be from a total capacity and production capability? And how quickly can you continue to invest and expand those capabilities as demand comes in? Thanks.

Yes, hey Matt, really good questions. First of all, the pace. It's quite fast, quite frankly. We opened up, we went to the Biz Show [ph], maybe 3, 4, 5 months ago, something like that. And we announced this new portion of our business. I mean we've always sort of offered that if anybody picked up the phone and called us that we would be willing to do this sort of stuff for select customers. This was officially announced and is part of a program now with Vuzix. And since we've done that, the amount of business that's coming over the transom just keeps growing. And it has not slowed down a bit actually, as it relates to the economic wins, at least from what we can tell, it seems it's less expensive to get good outside help than it is to try to hire a whole bunch of people to do this inside and come up to speed because what we do is play unique, which just opens up doors. I mean we should be seeing this business. It will be very consistent and growing easily every single quarter here through the next foreseeable quarters, frankly. Right now, their engineering programs that are part of building into production programs. And in one case, we're actually preproduction. In 2023, instead of just having these earlier programs, real production programs start to roll out, which is even more exciting quite frankly. And as far as capacity goes, this is part of the reason why we are – we said we were preparing to upgrade our facilities. The facts are, what is probably short on where we're really at. We are well into upgrading our facilities for higher volume capacities. We can already manufacture a reasonable quantity of waveguides. And for the defense customers and the like, we're fine with where we sit. But some of these customers are wanting really significant numbers. And for those folks, we need to have more expanded facilities. They take time. There's no doubt to bring up a new line, take some time, but we'll be well into doing that.

All right. Great. Thanks for that. And then as you look at the logistics and warehousing deals you have coming through and ultimately what the pipeline is there. How would you characterize sort of the volume of these initial orders relative to the overall total opportunity there? Have you captured 5%, 10% of the opportunity or are you may be like 25%, 30%? Just want to get sort of a big picture ballpark of how much more expansion is here, as you talked about already receiving follow-on orders? Thanks.

Yeah. I mean everybody is looking to Vuzix to finally open up that tap with our customer base and see real expanded volume programs. These really are -- they're just getting started in that. I mean, smart glasses are going to change the way work gets done. And at $3 million a quarter, it's pretty modest revenues, frankly, compared to where this business is going to be. So this is the tip of an iceberg. I would characterize it as way less than 1% even. This is just getting started.

All right. Great. Thank you.

Thank you. The next question is coming from Christian Schwab of Craig-Hallum. Please go ahead.

Hey, guys. This is Tyler on behalf of Christian. So I guess, first question, maybe just a follow-up on the OEM front, and it's great to hear that those things are tracking, very well still. I was wondering to the degree you can, Paul, maybe help rank order some of these OEM opportunities. The slide was great with a number of them, but maybe kind of level set where we're at on maybe what ones are furthest along if you're able to, or what ones are potentially could be some of the largest opportunities? Any color there would be great.

Yeah. I'll try to characterize it for you, Tyler. The defense programs are -- they're smaller volume, okay? But the unit cost for a defense smart glass engine, which would be a display and an optic and maybe a pair of them. Those things are in the $4,500 to $7,500 per unit kind of costs or sale price, but the volumes are smaller. I mean I will say, if you get into some of the programs that are part of the bigger side of the US defense markets, they can be tens to 100,000 piece quantities with those kinds of numbers. So the margins are easier to maintain at a much higher level, but the volume is smaller, but it's still a significant business when you add it up. The unit volume and the much bigger businesses in the broader markets and you start talking about potentially replacing a smartphone. And if your technology is in those smartphones and they ship billions a year, it's just a significant business, Tyler. And so we have people that are in the spectrum that go from that smaller, but higher-margin opportunity right on through to we're going to need a boat load of these. And on the boat load side of the business, I would suggest it's 2023 going into 2024-ish kind of thing for volume programs. Some guys are trying to be even more aggressive than that in their discussions with us. On the defense side of the business, like I said, there's one in particular that we've already got preproduction programs we're shipping to. So 2023, you'll definitely see early production -- real production programs on that side of the business.

That's great. That's great color. Thank you. And then second, pivoting maybe to the strategic partnership you announced in the quarter, I think, was very interesting and positive. I was wondering, you said you continue to engage with multiple other opportunities like this. So I also wondering on the strategic or M&A opportunity front, should we expect similar sort of technology tuck-in deals? I know you've mentioned software opportunities in the past, maybe something larger, more transformational. Any color and your thought would be great.

Yeah. We -- so technology is always an important part of what Vuzix does. And you could potentially see more stuff happening on that front. On the software front, though, I mean, we said this before, getting a SaaS model, functional at Vuzix, we think, is important. And you'll see, I think, knock on wood, should they come together, some stuff that's on that side of the house. That has the potential, I think, to be significant for Vuzix. But knock on wood it may not be all that expensive to get into game with it. So I'm sorry, I can't offer more than that, Tyler, but – so there's two legs to it as you know, the technology side, like I mentioned, in the SaaS base side of it.

All right. That sounds good. It's all for us. Thanks, guys.

Thank you. The next question is coming from Jim McIlree of Dawson James. Please go ahead.

Thank you, and good afternoon. Paul, I was hoping you could characterize the pace of the rollouts that you're expecting in the logistics business and not necessarily numbers, but well, numbers would be great. But I'm trying to imagine, if a customer has make up a number of 100 warehouses, how you think that might be rolled out, that is 20% in year one, 25% year two something like that, or is it more front-end loaded or back-end loaded? I was just hoping you could kind of characterize what you think the rollout schedule might look at -- might look back?

It really does depend upon the customer where it is in their system. And the other thing that happens, Jim, is once these guys start to roll, they often what we've seen in the past and how these companies operate is with success comes let's have faster success. So the current thinking is, it starts just a little bit slower, but then as it rolls, it gets faster and faster. So that's not a really hard answer for you there. I apologize for that. But the kinds of volumes that we're talking though, you've got a reasonable number of products in the distribution center, and there's 200 distribution centers, it all adds up fairly quickly.

Okay. And the second question, again, regarding that customer set. Are you the sole source smart glass supplier, or are these customers dual sourcing this particular technology?

From what we're seeing, once the decision is made, it's the product of choice. And so many of these retailers – if you look in the health care sector, all of the business that's really happening around smart glasses in health care, in operating rooms, you don't see much competition there. It's – and once it's decided on the systems are built around it, and the software is released, it's almost like you're kind of cemented in the program. It doesn't mean, we don't have competition, with these guys because often, there's this front end where they're trying to make decisions and they got to comp this one against that one. And then of course, there's always the negotiation that maybe we'll use them instead of you kind of saying that happens. But once you're there, Jim, we're not up against multi-unit of this and this and this company's deployments. It's just too difficult for these companies, I think, to even manage that.

All right. And then my last question is, as we start – as you start rolling out, whereas your customers start rolling out the products through their system, what level of resources will you have to commit either in terms of aftermarket support or maintenance or warranty or what is it that you'll have to do in order to support these deployments that you don't have right now?

That we don't have or that we don't have enough of them maybe would probably be a better way to think about that. Look, in many of these cases, we recommend that they buy extra units on-site. So if you need, for instance, 100 to 400 per site, which is -- in some cases, we have partners or the deployments that would have those kinds of numbers. In other cases, there's like 10 to 50 per site kind of a thing. In those cases, we always recommend if it's a smaller number, a few spares. If it's a bigger number, more spares, and we have programs in place with these guys to allow them to return product fast if they need to. I will say our return rates on the M400, which is the -- probably the lead dot in all of this, it's pretty low. We do not get a lot of warranty repair back. They're quite low numbers. It's more work upfront, which is part of the reason why it's taken longer to deploy than we'd like to see it. But once you get over that front end, there's less handholding that's required. I would also say that in almost every case, this is done with an ISV, a partner with Vuzix. And those folks are also supporting these programs with these companies. So there's a level of support to come two companies to help make this happen in almost in most cases.

Got it. Great. Thank you. That's it for me.

Thank you. At this time, I'd like to turn the floor back over to Mr. Travers for closing comments.

Everybody, I'd like to thank you for participating in the call today. I hope everybody is getting a good feel for the excitement that's going on at Vuzix these days. It's a really fun time to be at Vuzix, I have to say. It's great to see the level of interest across the Board and what our product mixes are doing to the world. And we look forward to sharing a lot more with everybody as the next year and actually a couple of years unfold. Exciting times to be Vuzix, and thank you very much for all being shareholders. Have a good evening everybody.