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Edited Transcript of EMAN earnings conference call or presentation 28-Mar-17 1:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 eMagin Corp Earnings Call

Bellevue Mar 28, 2017 (Thomson StreetEvents) -- Edited Transcript of eMagin Corp earnings conference call or presentation Tuesday, March 28, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew G. Sculley

eMagin Corporation - CEO, President and Director

* Jeffrey P. Lucas

eMagin Corporation - CFO

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Conference Call Participants

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* Andrew Paul Uerkwitz

Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst

* Dennis Van Zelfden

* Michael Fawzy Malouf

Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the eMagin Fourth Quarter and Full Year 2016 Earnings Conference Call. (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, sir.

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Jeffrey P. Lucas, eMagin Corporation - CFO [2]

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Thanks. Good morning, everyone. We are very glad to have you join us today for our fourth quarter 2016 earnings conference call.

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, et cetera.

Our risk factors are included in the company's Form 10-K for 2016 to be filed with the Securities and Exchange Commission by Friday, March 31, 2017. 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'd like to turn the call over to eMagin's Chief Executive Officer, Andrew Sculley. Andrew?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [3]

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Thank you, Jeff, and good morning, everyone.

It's been a busy year and we're very encouraged by the progress we're making in our commercial efforts. As we mentioned in today's press release, we recently signed a multi-million dollar agreement with another major Tier 1 consumer electronics company. This is our third success in 15 months. And while I'm not at liberty to disclose any names, I'm comfortable telling you that you would easily recognize them all. In addition, we have interest from other parties, and we'll opportunistically continue our dialogues with all of them.

It is interesting to note that while some of them are relatively new to us, there are others with whom we have had discussions in the past. Apparently, they went out and researched what they believed to be competing technologies. Recently, they've come back to us only to tell us that our technology is far and beyond anything else available in the marketplace today. So we are actively reengaging with them as well. In addition, we have signed nondisclosure agreements and are in active discussions with several interested parties on high-volume production capabilities in order to meet the commercial market demand.

From a revenue perspective, we expect to see improvement in 2017. In the first quarter, we will be recognizing approximately $1.5 million related to these commercial activities. Starting in quarter 2, we will begin to recognize revenues related to our recent signed agreement, and this will continue for at least the next 12 months. When you combine that with our military business, where we expect to have increasing reincurring revenue over the next few years, you can get a clear picture of where we're headed and appreciate that commercial is becoming a more important part of our revenue and one that will continue to grow.

While others are attempting to do microdisplays with OLED for AR and VR, we believe that our proprietary direct patterning technology gives us an unbeatable advantage in the very high level of brightness needed to satisfy several pending military programs as well as surpass current consumer HMD threshold requirements. We have made recent enhancements to direct patterning equipment as well as process improvements that are enabling us to reach these high brightness levels, improved display performance, and increase our throughput.

As we've said in the past, our expertise, knowhow and legacy, building low-power, high-brightness, high-resolution microdisplays for the military and industrial markets would enable us to develop best-in-class microdisplays for the rapidly evolving consumer electronics market. Currently, we have shipped limited quantities of our enhanced direct pattern displays to key strategic partners, potential partners and defense prime contractors. For us to meet expected commercial demand, we must be able to mass produce our proprietary direct pattern next-generation microdisplays. As I noted, we're in discussions with several interested parties to evaluate options and recognize that this is another important step for commercialization of our technology.

Aside from our achievements with direct patterning, we have continued to develop market-leading products for military and commercial applications. We've produced samples of a 2K x 2K full color RGB microdisplay to a consumer company at year-end, and product should be available for customers during the second quarter. This is currently our largest microdisplay design and expands our product offerings for the consumer and commercial marketplaces.

As well, we completed the prototyping of a new 0.48-inch diagonal full color XGA format microdisplay targeted at industrial and commercial customers. These are cost-effective medium-resolution displays, which we plan to have available in the second quarter. In the industrial market, we delivered an HD-plus resolution WUXGA display to a major medical device company for use in their next-generation surgical equipment.

Turning to the military. As we mentioned in the release today, we are selected to participate in the U.S. Army's Enhanced Night Vision Goggle III or ENVG III program, and the Family of Weapon Sight-Individual, FWS-I program. Both programs are now in low-rate production phases. It is anticipated that these programs will accelerate during 2017 and production will continue to 2020 with potential follow-on orders through 2031.

We have completed or are on schedule for a number of government-funded programs, including the Mantech program from the department of the secure Secretary of Defense. On the product front, we signed a multiyear agreement with a major European defense company with expected sales to exceed $3.5 million through 2018. We are also discussing a new display design to meet future defense system requirements. We delivered displays under a major U.S. Marine Corps contract for a laser range finder program. This contract extends into 2020 and replaces currently fielded equipment.

We worked with the U.S. Army and a defense aviation prime contractor for a potentially higher-volume major aircraft helmet modernization program. Finally, the company supplied displays for Trijicon, which has a leading line of thermal weapon sights and thermal monoculars. We continue to work closely with them to offer higher-resolution displays for future products.

As you know, we recently launched a new consumer product line with 2 night-vision products for the consumer and commercial markets, BlazeSpark and BlazeTorch. We are in production with these products and have distributed demo units to prospective customers. We are seeing broader applications for these products than we originally anticipated, which may take a little longer and require expanded marketing and promotional efforts.

While 2016 was a challenging year for our financial performance, we made great strides in many areas of the business that will serve us well into the future. Our military business will be growing again as new programs begin to ramp up and we work to develop new products for advanced applications. Our direct-patterning technology has positioned us as the leading OLED microdisplay company, able to achieve brightness levels that surpass the threshold required for virtual and augmented reality as well as the complex cutting edge requirements for several pending military programs.

While we will continue to work with our strategic partners on product designs for commercial prototype displays, we'll also be evaluating alternatives with them for mass production to meet future demand. We believe that 2017 will be an important and productive year for us and look forward to updating you on our progress.

With that, I'll hand it over to Jeff for a more detailed look at our quarterly financials.

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Jeffrey P. Lucas, eMagin Corporation - CFO [4]

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Thank you, Andrew. I will start with the income statement. Revenue for the full year 2016 was $21.4 million, $3.7 million or 15% lower than the prior year revenue. The fourth quarter contributed to this decline with revenue of $4.6 million, down about 33% from the fourth quarter 2015. This decline was mainly due to anticipated lower volumes in some of our maturing U.S. military programs. This is consistent with what we'd mentioned last quarter. It was a driver behind the decline of product revenues in the quarter just ended.

We are already benefiting from production ramps from new U.S. military programs. We are seeing this impact in the first quarter and expect to see it throughout 2017. We have positioned ourselves as a pivotal technology partner for many defense contractors in some of the largest markets in the U.S. night vision and VR-enabled training systems. Additionally, we are witnessing a solid demand for our displays for 4 military defense contractors. And very importantly, as Andrew mentioned, we've also signed 3 agreements with major consumer technology companies that we're very excited about. We will start seeing revenue from our development work on these agreements starting in the first quarter of 2017.

Focusing on our revenues. Product revenue was $3.7 million in the quarter, down 37% compared to last year but $117,000 higher than the third quarter this year. The year-over-year decline reflects the maturing of all the defense programs, as I had just mentioned.

R&D contract revenues totaled approximately $905,000, down slightly from the same quarter in 2015 but up 18% sequentially from this year's third quarter as efforts intensified on our key contracts, including the Mantech contract on which we've been working since 2015. Gross profit for the fourth quarter was $490,000 compared to $904,000 in the fourth quarter last year, reflecting lower revenues. Gross margins were 10.8% compared to 13% in the same quarter last year.

Gross profit on product sales was $304,000 versus $600,000 in the fourth quarter last year. Gross margin on product sales was 8% compared to 10% in the same quarter last year. This decline was mainly due to the decrease in product revenues and the impact of lower volumes on our heavily fixed cost nature of our operations. With our fixed manufacturing costs relatively stable, the fewer units produced can still result in higher fixed cost per unit and lower overall margins. Contract gross profit was $186,000 versus $304,000 in the fourth quarter last year with a gross margin of 21%.

Moving to our expenses. Total operating expenses, which includes R&D and SG&A, were $4.3 million in the quarter, up $1.3 million or 36% from $3 million a year ago. R&D expenses in the quarter totaled $1.9 million or 38% of revenues compared to $1.2 million or 17% of revenues from a year ago. The approximate $700,000 increase is due to a lower allocation of R&D cost to our R&D contracts, our direct patterning development efforts and higher spending on development costs associated with our consumer products.

SG&A expenses for the quarter totaled $2.4 million compared with $1.9 million in the same quarter last year. This year's SG&A included higher noncash stock compensation charges, costs associated with the launch of our consumer products, and nonrecurring costs incurred in the consolidation of our finance and procurement functions to our corporate manufacturing headquarters here in Hopewell Junction from a former satellite location in Bellevue, Washington.

Operating losses for the fourth quarter were $3.8 million versus a $2.1 million operating loss in the fourth quarter last year. Net loss for the fourth quarter was $3.5 million or $0.11 per share compared to $2.1 million or $0.08 per basic share last year.

Largely the result of our operating losses, adjusted earnings before interest, taxes, depreciation, amortization and stock compensation, or adjusted EBITDAS, in the quarter was negative $3.2 million compared to negative $1.6 million in the same quarter of last year. This year's adjusted EBITDA included modestly higher noncash compensation expense to reflect employee option grants during the year. These grants are made to employees for their efforts over the past year and, given the many exciting and the many initiatives ahead of us, particularly in our commercial activities, for the hard work we have ahead.

Turning now to our balance sheet. On December 31, 2016, we had cash and cash equivalents of $5.2 million compared to $9.3 million on December 31, 2015. The decrease in cash was due primarily to operating losses through the lower production volumes, our investment in R&D and the inventory build for our consumer products launch.

In December, we entered into a working capital facility allowing up to $5 million of borrowing availability against our eligible accounts receivable and inventory, of which we have $1.9 million outstanding at December 31, 2016. In March, we also put in place a separate $5 million facility with our largest shareholder to fund our commercialization activities.

We feel that we are in a better position entering 2017 than the prior year and are cautiously optimistic about our outlook. Given the recent developments, most notably signing a third agreement with another major consumer electronics company, is evidence that our strategy is working. Furthermore, we have already experienced a sizable uptick in new military programs that will also contribute to our revenues in 2017.

In closing, I reiterate Andrew's comments that we believe eMagin is the only company with OLED microdisplays that have the brightness and resolution requirements to meet the demand of the market. We are excited about where our positioning is in 2017, our improvements in technology, the evolution of our intellectual capital and the significant interest we're seeing in our products and our company. We look forward to updating the market on our progress of our company initiatives in the coming months and throughout 2017.

So with that, I will turn the call back over to Andrew for final comments before we open the call to questions. Andrew?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [5]

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Thanks, again, Jeff. Before we open the call to questions, I'd like to underscore again that we are committed to achieving material and measurable milestones that can drive shareholder value for eMagin, and we are beginning to deliver on these key milestones. We have significantly expanded our addressable market as we move well beyond our core defense markets with growing traction in commercial industrial and our entry into the consumer market.

We are very focused on the progress and discussions with large strategic partners as well as moving our technology into mass production. Our defense business continues to provide a solid foundation for our business, and we continue to see ample opportunities with existing and future contract vehicles, which will help us fund advanced technology development to power the next generation of high-performance display technologies.

Thank you all for your interest. And with that, we'll open up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Mike Malouf of Craig-Hallum Capital Group.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst [2]

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I'm wondering, now that we have 3 signed, if you -- could you just remind us where you are in the process of each? I think you signed your first one early last year. So I'm wondering if you can just kind of summarize that? And also, give us a sense of the road map of each as you sort of look out over the next year or so?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [3]

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So just a reminder on the one we signed a year ago essentially was an IP agreement for a headset design on IP that we had, so it's different. And also it had display requirements, i.e., that we would supply displays. That's why we did the 2Kx2K design. Other ones are more interested in what we had started out by talking to a lot of different companies and said, look, we're interested in designing the next-generation display for virtual reality and augmented reality. And we proposed a new display to a number of companies, most of which said, we'd like to do it on our own with you, i.e., fund you to do it, and so that's where we are actually in one of these companies, and the other one we're working towards that.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst [4]

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Okay. And on the -- and which agreement encompasses getting product to the market in the second quarter?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [5]

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Well, I think that the -- in the second quarter, we mentioned the 2Kx2K will be available for customers, right. That would be whomever wants a 2Kx2K. And that's, as I mentioned, the one a year ago. The other one's a product design, takes a little while to get there, right.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst [6]

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Okay. So that's what I was confused about. So it's the IP agreement that you signed a year ago, and that has led to a joint venture or some sort of relationship that allows you to produce product for customers.

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [7]

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No. The thing we signed a year ago was for headsets and had a 2Kx2K desire in the agreement. And we will -- we have produced a 2Kx2K, and we will have it available for customers in the second quarter. But that's -- there's no joint venture or anything like that associated with it.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst [8]

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So are those 2 separate statements? Or are they tied in some way?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [9]

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Well, should that -- I can't tell you that customer will or will not buy displays, but should they buy displays, then we have them available, and there are other customers.

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Michael Fawzy Malouf, Craig-Hallum Capital Group LLC, Research Division - Head of Boston Team and Senior Research Analyst [10]

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Okay, great. So when you take a look at some of the chatter in the market, one of the biggest representatives of AMD, Roy Taylor, has talked about working with you in August of last year and again, in September of last year at [Dyson], and has been working with you for 18 months. Obviously, you've only been working with 1 agreement for 18 months. So it's hard to not say that it's not AMD. And on April 12, he's going to give the keynote at the Virtual Reality World Congress and has tweeted that he's about to announce something pretty amazing and surprise people. What do you think of that as an opportunity for you guys?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [11]

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I can't tell you that we're working or not working with Roy. On the other hand, great announcements in the AR/VR space is great for everyone. We really want to see this take off, obviously.

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Jeffrey P. Lucas, eMagin Corporation - CFO [12]

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We're just in a position, Michael, we really can't comment on that.

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Operator [13]

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The next question comes from Andrew Uerkwitz of Oppenheimer & Co.

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Andrew Paul Uerkwitz, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [14]

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On these agreements, are they far enough along where we could see other OpEx requirements -- OpEx increase requirements? Are there capital requirements you guys need to fulfill to move these projects along at all?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [15]

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Well, for capital requirements, at this point -- think of this, if we were working with you about a new display design, the first step is to design the silicon for the display, and that's why we said that we could recognize revenue over 12 months. That's what that is. And -- but in order to mass-produce something like this, we have to be working on the next generation, a low-rate production line at the same time.

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Jeffrey P. Lucas, eMagin Corporation - CFO [16]

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But Andrew, also to supplement that response there, we've been making an investment in OpEx, and very importantly, in our R&D activity for the past year. If you look at our operating expense structure, you see that's gone up, and it's gone up in anticipation and contemplation of this. So we don't envision dramatic increases this year. I think you've seen some pretty sizable ones last year, reflective of our preparation in this area.

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Andrew Paul Uerkwitz, Oppenheimer & Co. Inc., Research Division - Executive Director and Senior Analyst [17]

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Great. I appreciate the color. And then, on the military side, should we start to expect a significant ramp or just a ramp throughout 2017 as some of these newer contracts start to get to full production?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [18]

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The military doesn't normally jump up. It would be a ramp in terms of a -- we're supplying for the first display or we're supplying the displays for the first headsets, et cetera, to be put into service, and as that and -- will ramp over time.

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Jeffrey P. Lucas, eMagin Corporation - CFO [19]

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Andrew, we volumes we're seeing here are pretty impressive. The challenge, of course, in military contracts and programs, it happens over a long period of time. We are at low-rate production volumes with a lot of these programs right now. And we're seeing those numbers increase. But these things don't take off too steep of an incline initially, but we are seeing a pretty solid ramp certainly over the next several months.

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [20]

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Pretty exciting.

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Operator [21]

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(Operator Instructions) Our next question comes from Dennis Van Zelfden of Brazos Research.

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Dennis Van Zelfden, [22]

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I was wondering, if the $1.5 million you're going to book in the first quarter from these development contracts, is that something we should see every quarter this year -- the amount?

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Jeffrey P. Lucas, eMagin Corporation - CFO [23]

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Well, we're always very careful in terms of how much we actually share with The Street, but you are going to see revenues associated with the development work for the next several months, actually for several quarters, as Andrew pointed out. There's a lot of effort that goes into actually developing a prototype display and a lot of effort, so there'll be a lot of revenues that will be associated with it. So you will continue to see that, again, for the next several quarters at least.

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Dennis Van Zelfden, [24]

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Okay. I guess what I really mean is, is it kind of at that level? Or is it going to be lumpy?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [25]

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Well, it will not be necessarily at that level for all the quarters.

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Jeffrey P. Lucas, eMagin Corporation - CFO [26]

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But there may be some lumpiness to it. And part of the lumpiness, just to let you know, is that as we're working with these companies, their requirements change and the scope of the work changes. So you will have a little variability as a result of that. Often that variability, of course, is on the upside from what our original expectations may be because of this general growth and the scope of the work that we're doing with them.

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Dennis Van Zelfden, [27]

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Okay. Regarding the potential high-volume manufacturing partner. Are you close to that? Or when do you expect to maybe have something in place?

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [28]

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It requires 2 things: One is because the market is very early, the high-volume manufacturing partner requires a customer. And so we have a little bit of a challenge. Now we do have 3-way NDAs, but we have a challenge to bring the customer and the manufacturing partner together, and we're working with a couple.

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Jeffrey P. Lucas, eMagin Corporation - CFO [29]

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Yes. I think we'll be a little cautious and never saying we're getting close. We've been in discussions with these folks for quite a while. They are large companies, large players with their own level of administrative and bureaucratic complexity. These things don't happen quickly. And even when we think we're getting very close in something, invariably another element can come into play. So we are -- I will say this, we are making solid forward progress with these folks, but we're not in a position nor would we be to say it's going to happen soon or the very near future or the later future, and it could happen relatively quickly. But there's so many variables involved here, that we're just a little cautious here in terms of setting any specific time line expectations.

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Operator [30]

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(Operator Instructions) Seeing no further questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Andrew Sculley for any closing remarks.

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [31]

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I want to thank everyone for joining us on the call and thank you for your support. It is a very exciting time for us, and to get agreements to generate the next-generation display and work with mass-production partners, talk with them who are very interested in taking this to the next level, it's exciting. So I thank you and the eMagin team very much.

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Jeffrey P. Lucas, eMagin Corporation - CFO [32]

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And let me just add that we've been working on this for a long time, and we are now at a very, very exciting juncture, we feel, for the company, overall. We appreciate the patience that you as investors have shown with us, and we are working diligently to certainly earn that. Thank you.

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Andrew G. Sculley, eMagin Corporation - CEO, President and Director [33]

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Thank you all.

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Operator [34]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.