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Edited Transcript of VUZI earnings conference call or presentation 15-Mar-19 1:00pm GMT

Q4 2018 Vuzix Corp Earnings Call

Rochester Mar 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Vuzix Corp earnings conference call or presentation Friday, March 15, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ed McGregor

Vuzix Corporation - Director of Institutional IR

* Grant Neil Russell

Vuzix Corporation - CFO, Executive VP, Treasurer & Director

* Paul J. Travers

Vuzix Corporation - Founder, Chairman, CEO & President

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Conference Call Participants

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* Brian David Kinstlinger

Alliance Global Partners, Research Division - Head of TMT Research, MD & Senior Technology Analyst

* James Patrick McIlree

Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology

* Nehal Sushil Chokshi

Maxim Group LLC, Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the Vuzix Fourth Quarter and Full Year 2018 Financial Results and Business Update Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to turn the conference over to Mr. Ed McGregor, Director of Investor Relations at Vuzix. Thank you. You may begin.

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Ed McGregor, Vuzix Corporation - Director of Institutional IR [2]

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Good morning, everyone. Welcome to the Vuzix Fourth Quarter and Full Year 2018 Financial Results and Business Update Conference Call. With us today are Vuzix CEO, Paul Travers; and CFO, Grant Russell.

Before I turn the call over to Paul, I would 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, March 15, 2019. Vuzix assumes no obligation to update these projections in the future as market conditions change.

This morning, the company issued a press release announcing its financial results and filed its 10-K with the SEC. So participants in this call, who may not have already done so, may wish to look at those documents as the company will provide a summary of the results discussed on today's call.

Today's call may include non-GAAP financial measures. When required, reconciliations to the most directly comparable financial measure calculated and presented in accordance with GAAP, can be found in the company's Form 10-K annual 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 fourth quarter and full year 2018 financial results and business outlook for 2019. Paul will then turn the call over to Grant, who will provide more detail on the company's financial. Paul will follow Grant and provide closing remarks. We will then open the call for Q&A after management's update. Paul?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [3]

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Thank you, Ed. Hello, everyone. 2018 was a solid year of growth for Vuzix in terms of revenue, which increased 46% over 2017, our second consecutive year of robust growth, growing customer acquisitions and growth and expansion of strategic partnerships.

And as strong as 2018 was, we expect 2019 should be far better. Demand for our products continues to build, and our 2019 pipeline is increasingly positioning us to achieve full year revenue that has the potential to significantly outperform 2018's numbers. That said, Q4 revenue came in lighter than we had originally anticipated, primarily due to the Blade manufacturing challenges. And our current expectation is that this level of business will persist for 1 more quarter as Blade production ramps and M300 deployments pick up steam. Recently announced developments we expect will advance our growth curve materially this year as well as business already in the pipeline that continues to mature.

During 2018, we greatly expanded our addressable market for our technology and products, which now includes significant opportunities across enterprise B2B with our M-Series Smart Glasses; enterprise B2B and B2C with the Blade Smart Glasses; major defense suppliers, primarily on the waveguide-based systems for hubs and aircraft to Humvees; first responders, homeland security and police and the prosumer with our Blade Smart Glasses; and finally, OEM waveguide-based opportunities in white labels.

We believe we will win our fair share of business in more of these segments by bringing the most functional wearable products and applications to market, and we'll keep pushing the solution envelope.

At Mobile World Congress this February, for example, we announced and demonstrated the M400 smart glasses with the new XR1 microprocessor from Qualcomm inside. This is one of the first products made commercially available using this new platform, and it was proudly part of Qualcomm's CEO press conference at Mobile World Congress. Running Android 8.1, offering USB-C connectivity and having a host of hardware improvements covering nearly every major feature. The M400 will be, by far, the most innovative and powerful set of enterprise smart glasses on the market when it rolls out this summer.

For Vuzix, Qualcomm represents not just a design partner and supplier, but a key enabler for us to build and deliver the latest technology for AR Smart Glasses, not only the enterprise but in the consumer space as well. Qualcomm is investing significant resources into AR Smart Glasses to fuel the ecosystem and bring together world-class partners to help accelerate the smart glasses business. It's been great working with Qualcomm for the past year on several new smart glasses products from Vuzix, and we look forward to the continued collaboration with them.

Our enterprise pipeline comprised of Vuzix's integration partners or VIP accounts, value-added resellers and direct customer engagements is now our largest in Vuzix's history. As we continue to strengthen our relationship with key customers and partners, our efforts remain focused on closely supporting them as we move them through the process to full deployments. We are receiving clear indications from our direct customer base that smart glasses programs are set to expand in both size and number for 2019. This same theme regarding expanding adoption is being echoed by most of our largest partners. For example, UVmax, a key Vuzix partner and European-based company, continues to invest in AR and has expanded its operations over the last several months and now has an established presence in the United States as well.

While some enterprise smart glasses providers are no longer competing in the market due in part to having less competitive designs, Vuzix, on the other hand, is increasing its footprint in continuing to forge new business relationships with numerous key partners like the one with Verizon that we disclosed earlier this week.

As stated in our 8-K filing this week, Vuzix has entered into a 3-year Master reseller agreement with Verizon. Verizon, their affiliates and sub-resellers will now resell Vuzix M300 Excel Smart Glasses and M-Series related accessories, Vuzix's Blade Smart Glasses and Vuzix Basics Video. We expect them to target their 3,000 largest B2B enterprise customers with these products, particularly those engaged in the manufacturing, logistics, and transportation sectors.

The Verizon reseller relationship represents a major shift in the markets for smart glasses and that we are now in a position to offer off-the-shelf solutions that are ready to go to work out-of-the-box. No longer are pilots required as solutions for Vuzix smart glasses being developed and tested over the past several years and are now ready for prime time.

We're working closely with Verizon and their enterprise sales force to bring Vuzix's hands-free smart glasses solutions to their huge customer base. Examples of this include: Sales team training; development of collateral sale tools; and sales engineering support. We believe this relationship will result in significant business on the enterprise side of the house for us, with initial orders expected in Q2 of 2019.

This relationship will also help accelerate our enterprise footprint across the United States as well as announcing to the rest of the world that Vuzix is a leading ready-for-business player in the AR wearable space. For Verizon, Vuzix brings cutting-edge AR hardware that has the potential to lay across and take advantage of the 5G initiatives that they have recently announced.

At the same time, Verizon has also started using Vuzix smart glasses internally for training and onboarding new employees to support their technicians in the fields. The business opportunity to outfit internal Verizon technicians with smart glasses is above and beyond the reseller agreement, and could represent thousands of units on its own. We see our business relationship with Verizon having the potential to expand across other vertical markets as well, including first responders, education, 5G, B2C and more. I could give you examples for each one of these verticals, but let's think about first responders on an ambulance and how minutes or even seconds could determine a life or death situation. The idea of connecting a first responder to a medical expert remotely through a "see what I see" application over Verizon's network becomes a very powerful solution with extremely broad appeal.

We're also engaged with Verizon 5G partnerships, 5G Labs and [XR edge] team to drive innovation and showcase smart glasses technology for business, communities and consumers. Even though 5G is just getting started, and it will take some time before the technology is available for everyday users, we are currently exploring past to commercialize and maximize the Verizon 5G experience on Vuzix smart glasses. Although not specifically designed for 5G, pairing 5G connectivity to a pair of smart glasses like the Blade can drive new experiences and connect consumers in so many ways. The ability to push compute to the cloud and edge while using Vuzix glasses as an augmented reality information display to receive and transmit real-time connected information will drive next-generation use cases.

For example, using smart glasses connected to the edge, users can simply look at the shelf and receive product information in a retail store about food choices. [Oversee wait] finder instructions to help navigate an indoor/outdoor space or consume real-time language translation visually or with voice. These are all functionalities that could be used by millions and as you can imagine, are just the tip of the iceberg.

On our third quarter conference call, we mentioned that we had received a 15,000-unit RFQ for enterprise smart glasses. Vuzix remains actively engaged with our end customer and software partner related to this opportunity with regards to the preparation and platform development to ensure that the introduction of the new technology is smooth and successful.

A large deployment by a leading Fortune 100 company clearly represents that the industry adoption of AR and smart glasses is maturing and this one is getting very close. We also continue to work closely with a wide range of other established customers such as SATS, a major player in ground handling operations across Asia, operating in 62 cities and 60 airports worldwide. SATS is currently, working on expanded use cases for our smart glasses, and has begun discussions with other airlines and airports. We expect to see SATS continue to roll out their program throughout many of the airports they operate in, in 2019 and 2020. Stay tuned here as we look forward to bringing you further news on these enterprise customers as well as on a host of others as 2019 progresses.

The Vuzix Blade and its ecosystem of applications and software continues to evolve and grow. Over the last several months, we successfully launched the commercial edge program for enterprise, and feel we have just scratched the surface on potential applications and features for developers and the tech enthusiasts. The Blade can now be paired to the phone wirelessly to receive messages and alerts while pictures and videos taken with the Blade can now be almost instantly accessed through the Blade companion app on the phone and shared socially.

Over the next week or so, we will be turning on the GPS API in the Blade using location data from the Bluetooth-connected smartphone. Alongside this update, we'll also be releasing a series of new applications, including news, AccuWeather, sports scores and newsfeeds and location-based services like Yelp. All of these applications run locally on the Blade and will deliver significant value and content without users having to take out and hold their phones. The Vuzix Blade platform, we feel, is unique and differentiated from other smart glasses available in the market today. The Blade is untethered from the phone and can operate independently with Wi-Fi, but it can also still connect to wearer's phone via Bluetooth to receive messages, e-mails, incoming phone calls and other alerts. What's even more exciting about the Blade platform is that the device supports voice assistants such as Amazon Alexa and Google Assistant as well as a running native Android applications. This is all supported by an ever-growing developer community. The Blade software is updated and refreshed via OTA, or over the air, so the user experience and platform is always iterative and being enhanced.

The team at Vuzix has been focused on quality and ensuring that every customer has the best first impression out-of-the-box with the Blade. As a result, our production teams continue to make the best quality optics and smart glasses we have ever made and our volumes continue to rise.

If you had a chance to attend Mobile World Congress in Barcelona or follow the conference from afar, you saw that the most important takeaways were related to connected workers, connected cities, connected people and 5G, as Qualcomm's President highlighted in his press conference at Mobile World Congress, the march towards 5G and the concept that connected cities and communities and connected workers represent a tremendous amount of opportunity for smart glasses manufacturers like Vuzix.

The 5G initiatives, just beginning this year, will have multi-year rollout and Vuzix is well positioned to ride this large wave. One of our partners, 1000 realities, showcased a connected work area with the Vuzix Blade while tied into the network of SK Telecom at Mobile World Congress. By combining cloud computing and the Vuzix Blade, users were able to see real-time data and information overlaid onto the real world and tracked in real time as the wearer looked around and continued through their tasks. For example, a user could walk up to a water valve and simply by looking at it, see how much open it was or closed. Turn the valve and the data would update in real time. This demo showed off the versatility of the see-through optics of the Vuzix Blade, but also provided a glimpse of what the future will look like with connected activities using Smart Glasses on 5G networks.

As 5G approaches, our current wireless carrier engagements are expanding. We are clearly now dealing with major providers and that are based in the United States, as is evidenced by our recent disclosure relationship with Verizon as well as other relationships that are maturing in Europe, Korea, Japan and Australia. This group includes, among others, 4 of the top 10 revenue-producing carriers in the word covering an estimated 1 billion wireless subscribers through the networks. We expect that there will be tremendous synergies and value that can be generated by partnering with some of the world's largest carriers in their respective regions.

The business opportunity for Vuzix with wireless carriers is multi-pronged and significant. If you think about wireless carriers, they often deliver broadband service and television as wireless connectivity to subscribers.

One the B2B side, the opportunity is several fold. There's an extensive workforce of technicians that work remotely to service towers, customer lines and legacy and new optics lines. Wireless carriers not only work directly with consumers, but also support very large enterprise customer bases. Wireless carrier support public safety, smart cities, first responders and education by providing network connectivity and enabling smart solutions. And wireless carriers are currently hungry for innovation and new offerings, including AR Smart Glasses for both consumers and enterprise. Many of them are now taking a deep dive to evaluate and determine how smart glasses will fit into their hardware roadmaps.

On the OEM front, Vuzix remains actively engaged with Foxconn-owned Toshiba Client Solutions, who continues to aggressively market their Windows-based Dynabook product line with AR100 Smart Glasses built and powered by Vuzix. It's taken some time, but it's great to receive another purchase order from Toshiba, and we expect this program to continue to expand. We're excited to roll out with them to their customers and to continue to support their efforts as their enterprise business and customer deployments continue to expand.

We have also delivered the initial HUD system to our first commercial aviation partner in the fourth quarter, and we are in the process of quoting phase 2 efforts with this company. We have also quoted follow-on development programs with this partner. We recently received RFPs for custom heads up display projects from 2 other companies in this space, and we received a third RFP for a custom H&D system for commercial aviation cockpit from a leading logistics company.

It's a busy time for Vuzix in this vertical, and we continue to see meaningful inbound requests from custom OEM waveguide programs within the aviation and defense markets.

I'd like to now pass the call over to Grant so he can walk through our fourth quarter and full year financial results. Grant?

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [4]

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Thank you, Paul. Before I begin, I would like to encourage interested listeners to review our 10-K that we filed this a.m. with the SEC for a more detailed explanation on some of the annual year-over-year variances because I will be highlighting just a few.

For the full year ended December 31, 2018, Vuzix reported $8.1 million in total revenues as compared to $5.5 million for the prior year, an increase of 46% year-over-year. Overall, quarterly and annual revenues were up primarily as a result of stronger smart glass sales and to a lesser degree, sales to our OEM partner. For the full year, total sales with smart glasses, inclusive of our M-Series and Blade, increased 55% over the prior year's results. For the 3 months ended December 31, 2018, Vuzix reported $2 million in total revenues as compared to $1.6 million for the same period in 2017, an increase of 25% year-over-year. Quarterly sales has now increased for 9 consecutive quarters, dating back to 2016.

Our overall annual gross profit from sales in 2018 improved to $1.8 million versus a gross loss of $0.7 million in 2017. This $2.5 million improvement in gross profit for 2018 over 2017 reflects improved average selling prices of our smart glasses, the elimination of the lower margin iWear product line, lower inventory write-offs and higher total overall revenues, on which to absorb the generally fixed manufacturing overhead costs.

Research and development cost for the 2018 year increased to $10.4 million as compared to $6.7 million for the 2017 period. The increase in R&D expense was primarily driven by additional R&D staff hiring, development costs for the M400 Smart Glasses and an increase in external software development cost for the Blade.

Sales and marketing costs for all of 2018 increased to $4.8 million from $3.7 million in 2017, with the increase primarily due to higher app store and website related costs, increased tradeshow costs, increased marketing agency fees and employee-related expenses. Of note, our Q4 2018 sales and marketing expenses were down by $0.2 million over the same period in 2017, reflecting the impact of our revised sales and marketing activities. They are now focused primarily on supporting existing customers and less toward activities targeting new customer acquisitions, which are more costly.

General and administrative expenses for the 2018 year were $7 million as compared to $6.1 million for the 2017 period. Within this overall 14% increase were higher salary, separation and stock compensation costs, increased legal costs, which were all offset by a $0.7 million reduction in IR and shareholder cost. I would like to point out that G&A expenses for the 3 months ended December 31, 2018, were $1.3 million versus $2 million in the prior year's period, the reduction of approximately $0.7 million. This reflects the recent impact of some of our spending reductions.

For the full year, the net loss after provision for approved preferred stock dividends was $23.7 million or $0.88 per share as compared to a $21.3 million or a loss of $1.02 per share for the full year in 2017.

Regarding our balance sheet. Our cash position as of December 31, 2018, was $17.3 million, and we had a net working capital position of $22.7 million. Cash used in operations, excluding changes in our working capital, totaled $18 million in 2018 as compared to $15.3 million in 2017.

As compared to December 31, 2017, our inventory levels rose in 2018 by $3.4 million, largely due to increases in component materials caused by production bottlenecks from the new Blade product as well as increased work-in-progress inventory for our M-Series Smart Glasses. We expect our inventory levels in 2019 to decrease through the year as we sell through this inventory.

Cash used for investing activities in 2018 was $3.1 million versus $2.7 million in the prior year. Included in the 2018 amount was $1.5 million to reacquire a certain sales and marketing right that were subject to a noncompete agreement, which we amended in October 2018, and $0.5 million for strategic investments in 2 private companies.

Given our current cash position and our previous cash burn rate, I'd like to spend a few minutes discussing our cash expectations for 2019, the slower than hoped broad adoption of AR Smart Glasses by industry to date is something that management realizes must be closely monitored and addressed. As a result, we have been proactively implementing further plans to reduce our operating costs. Our goal is to reduce our overall operating cost by at least $4 million in 2019 as compared to 2018, notwithstanding from what we expect to be a sizable increase in our revenues and gross profit. These cost reductions should reduce the level of revenues required for cash positive operations, and should help bring us to or near our goal of achieving cash flow breakeven by the final months of 2019.

The expected cost reductions will be achieved through multiple activities, including rightsizing across all areas of the company both with headcounts and departmental spending, continuing with implementing changes to our sales and marketing efforts that were announced last June, this will result in lower cost and our focus on supporting existing customers rather than expensive new customer acquisition efforts. Lowering trade show participation, including our booth sizes and sponsorships. Lowering our spending with external PR firms and marketing agencies. Reducing our use of outside contractors to maintain and develop our website and app store. Reducing our R&D department's use of outside software contractors. Seeking partners or engineering service projects to share and reduce the overall R&D burden. Fostering more developers to provide apps for our products for resell on our app store where Vuzix shares in 30% of the purchase price on monthly subscription. And all the new products we finally introduced in 2019, other than the M400, will be derivatives of our existing models, but with improved performance and hopefully, lower cost of production. The overall results will be a more modest CapEx program in 2019. Successful execution of these actions achieved in tandem with another solid year of revenue growth should help facilitate our goal of advancing towards being a cash flow generating company by the end of 2019.

With that, I would like to turn the call back over to Paul.

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [5]

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Thanks, Grant. In summation, the seeds for the next wave of enterprise growth in adoption of smart glasses have been successfully planted in the industry and by Vuzix, and Vuzix has established itself as one of the leaders in this market.

With new relationships with industry leaders like Verizon, Qualcomm and others, and our growing customer base in general, we remain confident that we are well positioned to deliver accelerated growth and technology leadership in 2019. We are in an innovation race in the space and our product development efforts are focused as we continue to develop next generation products for existing and new markets with our partners like Qualcomm, Plessey, and others.

The M400 is positioned to be the most powerful monocular AR glasses for enterprise announced to date, and we expect to be in production by mid-summer. Our base enterprise business is poised for significant growth and with the addition of new B2B sales channels from what the likes of Verizon, it should accelerate in 2019 even faster. Vuzix Blade sales will continue to expand at potential OEM waveguide-based programs and will make it clear that Vuzix an established leader in the rapidly growing AR space.

On a final note, I would like to commend the entire Vuzix team for achieving ISO 9000:2015 certification this month for our Rochester-based manufacturing operations. This was a milestone step for Vuzix and a critical one as we further engage with it and begins to supply waveguides and finished AR Smart Glasses products to a growing number of companies around the world, including Vuzix's own needs. Tier 1 consumer electronics firms, in particular, require ISO certification in order for companies to become an established supplier to them. Customers worldwide know and understand what achievement of the certification means in terms of improved quality and service, on-time delivery, positive customer attitudes and fewer product returns and complaints. We have always taken great pride in our commitment to quality and customer satisfaction and having the systems in place at Vuzix to qualify for ISO 9000, certainly supports our goal to provide the highest value to our employees, partners and customers.

Now let me pass the meeting over to the operator to begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Brian Kinstlinger from Alliance Global Partners.

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Brian David Kinstlinger, Alliance Global Partners, Research Division - Head of TMT Research, MD & Senior Technology Analyst [2]

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If I use the base price of $1,000, it looks like you sold around 1,300 smart glasses in the December quarter compared to, I think 1,700 in the third quarter, and 1,800 in the second quarter, using the Ks and the Qs. Can you reconcile these trends, the solid demand trends and the exciting opportunities you're talking about? Is it slower adoption and enterprises having been ready to take on this technology? Is it production? Just maybe go through the trends versus some of the anecdotal evidence you've been talking about.

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [3]

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Yes. Brian, it's kind of a mix of things. I mean, if you just take into account things like our friends at Toshiba and Foxconn, it's taken them -- first of all, they brought the product out, they got a lot of great responses from people, then they went through an acquisition, it's taken time to get that organized, their business has been growing on this side but that kind of put bumps along the way for getting these guys rolling in their next-gen offers -- or excuse me, next-gen orders from Vuzix. Those kinds of anecdotal things happened across the industry. Those other companies that they're in the queue, they're getting started, they're just taking time to get all of their departments to sign off and get moving. It's just one of these things, it's a brand-new industry. The entire industry has been trying to figure out when it's really going to happen. There's not an analyst out there that doesn't believe that this is going to change the face of manufacturing enterprise business in general, it's just a timing to get it all started and rolling. And because of that, it's lumpy for us. That said, it's backing up. Companies like Verizon are coming on board and they're selling cookie-cutter solutions now. It's no longer needing pilots. For instance, with the case of Verizon, as an example, they're selling a series of products from Vuzix, they're using their [MDM] internal networks in their sales team to sell off-the-shelf applications now. So we're not talking about having to go into a facility and let's test-drive it here for a month or 2, these things just work for people now. You can get streaming video services, tech support, you can get work instructions and are just cookie-cutter now. So it's getting a lot each year. The world is becoming not $250,000 pilot programs, it's becoming just install and go. So it takes time and brand new industries for all that to happen, and that's what Vuzix has been going through.

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Brian David Kinstlinger, Alliance Global Partners, Research Division - Head of TMT Research, MD & Senior Technology Analyst [4]

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And then I think in your prepared remarks, I wasn't quite sure, I thought you said that the first quarter would be another quarter that sounds similar to the recent trends. So does it look more like 2Q? Or is it more like 4Q in deliveries? And then when do you expect it to accelerate?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [5]

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Well, the second quarter for Vuzix is already looking like a pretty strong quarter, I can't get into all the details there but you can imagine those other companies coming online finally again, and we've had some production bottlenecks with our waveguides, quite frankly, that's what's been -- we would've had significantly more Blades shipped by way of example in the fourth quarter if the production waveguide side of the business was happening. So that will be fixed in Q2. I mean, the gear that we have on the plant floor is designed for volume, but we didn't want to ship anything that didn't look perfect. And so our quality standards are quite high for the Blades coming off the line and the waveguides that are using them. That has really pushed the processing set we're using. We've had for adjust them and improve them so that we can get that high quality, but also get the volumes up. We're, at this point in time, I think by the end of Q1, the waveguides will no longer be a bottleneck. And over the next 3 to 6 months, we have second-generation equipment that's coming online, that's going to expand us even further. So Blade will be cranking here in the latter half, certainly, all the rest of this year and all of this other business is starting to come online, partners like Toshiba, again, it's obvious, you can see that they're coming online here in the second quarter also. And so, look, first quarter is going to experience a little bit like what the fourth quarter did last year.

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Brian David Kinstlinger, Alliance Global Partners, Research Division - Head of TMT Research, MD & Senior Technology Analyst [6]

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Great. And then my last question, you mentioned Toshiba went through some changes and obviously they made a nice order in the second quarter. But that's still relatively small to what their commitment is, do you expect that kind of order you'll see others -- several more in the second half of the year? Or will this just ramp a little bit slower than maybe everyone thought even going forward?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [7]

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It's really difficult for me to put a number on that, right? I can tell you that we hear really positive news from that partner. I cannot possibly tell you what the details are because they'd probably string me up. It's a confidential thing as you can imagine. They're optimistic right now, I can tell you that. If you pay attention to what they're doing online, if you've been -- look at the trade shows, they're very, very active in the market.

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Operator [8]

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Our next question is from Jim McIlree from Chardan Capital.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [9]

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Grant, you indicated that you thought inventory levels could decline by year-end, and I'm just confused how that can happen. If you're going to be have a big ramp in sales as the year progresses, how would you be able to reduce inventory levels?

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [10]

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The part of it is we'll be manufacturing the Blade and the M400 here. So we'll have the shorter supply chain. I mean, right now, the M300 products are made in Asia. We have to make some bigger supply commitment. As a result, some of our inventories are higher than we would have liked so we'll have the ability to adjust the faucet on how much we build each month and (inaudible) either promise them a minimum quantity per month or you're going to pay a standby fee. So we're anticipating that and plus, just better management. Last year, we implemented and expanded add-on to our SAP, which our operations group is confident it's going to be able to help us reduce our ongoing inventory levels and better vendor delivery performance moderator. So we're hopeful. I mean, there's cash sitting there, I guess, that's part of the statement. I mean, we do have the ability to live off much of our existing inventory right now. So yes, as the business skyrockets, and lasts for a year, probably we'll have to retract and our inventory levels will be less, but that'll be a good thing by then, if that's the case, and that's the reason.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [11]

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And I think last quarter, you indicated how much inventory you had at the M300, I'm looking at my notes, was it $3 million, is that right? Yes, $3 million.

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [12]

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It's...

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [13]

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What's that level now with the M (inaudible)?

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [14]

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That's gone up some. We did introduce a new model in the fall, the XL so we had a little bit of build up there. So as part of Brian's earlier question, the price did drop from $1,500 down to $1,000 but then we have the XL, which sells for $1,500. So frankly, our average selling price dropped a little and there's certainly customers that still like the original M300, and they're buying low. So that was another reason there.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [15]

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And I'd like to understand the statement you made about cash flow breakeven. I think you said in the ending months of 2019, so it sounds like a run rate. If my math is right, and you reduce your OpEx by the $4 million, I mean, it still seems like you would need about a $40 million revenue run rate by the end of the year in order to be cash flow breakeven? I'm assuming cash expenses of $16 or so million and revenue -- and then gross margin of 40% or so.

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [16]

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I did not mean to infer that we're going to be cash flow breakeven through 2019. I said, in the last months. Months...

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [17]

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Yes, that's what I'm doing, too, yes, just the last months.

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [18]

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I mean, to be at a run rate of $40 million at the end of the year, if you annualize November [all sites], that may not be impossible. That's our goal. We still see a tremendous upside.

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James Patrick McIlree, Chardan Capital Markets, LLC, Research Division - Senior Research Analyst of Industrial and Consumer Technology [19]

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Okay. And then lastly, do you have commitments for the Verizon reseller agreement in terms of joint marketing, training, things like that, that's going to require additional personnel or additional spending in order to serve that account?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [20]

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No. We have the personnel we need. They have a team of their own that are on this. And we'll admit it takes some hand-holding, but we do have a sales and marketing team here that are more than capable of dealing with and managing the business. We will not need to add folks for it. At least today, if they really hit it out of the park, this business could get large with Verizon. And so you could see when they're selling enough that we would have special folks that would be just managing that relationship but right now, the team we have now is more than enough.

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [21]

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And part of the service for them is being provided by our outside third-party support to help us, and they have the ability to scale and they're relatively inexpensive. And part of the sign-up process with Verizon, they reviewed their capabilities and performance, and we're satisfied that if the business grows and basically helped it. We'll have the back end to support it.

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Operator [22]

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Our next question is from Nehal Chokshi from Maxim Group.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [23]

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Would you mind detailing what is the precise manufacturing issues that you are dealing with right now on the Blade? And just to be clear, you do expect this to be cleared in the early part of the June quarter?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [24]

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So I can't get into every detail, but let me leave you with this. To manufacture a waveguide requires very, very strict tolerances on flatness, on wedging the plates, on the materials themselves, this is a lot of things that go into a high-performance image and the end result when the waveguide's finished. And there may be 15, 20 steps in this process at least once you're at a point where you can just punch them out. And there's a few of those steps in the process that are particularly sensitive. And if you don't do them just right, you end up with yield problems and the performance of the waveguide's not quite there. If you do them right, which takes a bit longer right now, well, it's actually been improved significantly because we've taken some of our equipment, and we've split the functions without getting into too much detail, again. But by doing that, we've been able to significantly jump the rate at which we can get waveguides out that still need the specs that we need. And so if you saw our plant floor, at the end of last year, you'd see x amount of equipment in it. Now you see x amount plus and that plus bit, it's how we've broken some of those out. With those changes, it's allowed us to significantly improve the ramp. As I said, by the end of this quarter, I think we're in a position to where it's not the bottleneck anymore. And through all of this, we have been working on our next gen of equipment, and that next gen is being built, as we speak, and will come online here over the next 6 months. And with it, it will, yet again, make a big jump in our ability to produce. And so I really can't get into more than that without getting into secret sauce stuff and...

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [25]

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No worries, I understand. That was helpful. In terms of new equipment to help with the yield issues and effectively splitting up some of the steps that you've talked about here, when was that new equipment brought online?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [26]

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About -- maybe, I got to think this through here a little bit, in the -- yes, it was done in stages, Grant, thank you, and it's been right after the Consumer Electronics Show, as I recall some of it came online and just over the last week or 2, maybe 3, a couple of other pieces came up online. And we're ironing out the rough spots on it and even now if you go out back on the plant floor, there's lots of smiles on people's faces because this new equipment's working really well.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [27]

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Okay. So you are actually seeing that the new equipment has resulted in improved yields, maybe not to the desired yields, but improved yields?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [28]

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Absolutely, yes.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [29]

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Okay, okay. And then backlog for Blade, has that been going up, given that you've been having these production issues?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [30]

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It's kind of a frustrating thing for Vuzix right now, frankly. It's getting better, but we got a lot of folks coming to Vuzix saying, "Well if I place an order for 100 or if I place an order for 250, how long is it going to take to get them?" And at this moment, we don't have good answers for those folks. We will have coming up in the next quarter. So we've been [chiseling] down the backlog but at the same time, that we're -- rates just keep -- they just keep coming on the website, the larger orders are harder to get and close right now because we're unable to give people better answers on timing but that's, like I said, end of this quarter, we'll be in much better shape in that regard.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [31]

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Okay. And then so, Grant, you talked about putting [several] marketing focus on?

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [32]

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No, I'm sorry. I just wanted to mention one other thing. I will tell you that the product that's going out the door, people really like it and our return rates, I realize, we're just getting going here, but the return rates are really, really low, like less than 2% kind of numbers.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [33]

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That's good. That's very good. All right, Grant, so you mentioned that shifting the sales and marketing focus from sourcing new customers to servicing existing customers, I also note that you have increasing number of partnerships, and you also seem to be focusing on large RFQs. So I would take this as a shift in selling motion to where you're looking to have a structurally lower sales and marketing to revenue expense ratio, and I believe you messaged that. However, the corollary is that why would this not result also in a structurally lower gross margin? Because when you're typically dealing with larger customers or larger orders, they're usually looking for bigger price breaks as well?

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [34]

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Clearly, when people start buying Smart Glasses, our products by the thousands, they'll get a better price than if they're only buying 10, 20 or 100. So I mean, we build our models and assumptions on the basis that we're going to have a certain percentage of accounts that get biggest discounts than others. We don't think that will materially hurt us in any way. And again, the total gross margin is what matters, and impacts our cash flow the most. So if that ends up being a little less, I mean, it's a total quantity that you end up with in the end, that's going to prove to be the success for us.

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [35]

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And the more you make, the less the per unit cost is because the overheads that go into all that cost goes down on a per-unit basis. So volume is to our advantage in this regard also.

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Grant Neil Russell, Vuzix Corporation - CFO, Executive VP, Treasurer & Director [36]

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Yes. And first of all, with Verizon, the pricing we've given them, which is well within our current pricing model. So we haven't had to make any great concessions at all to achieve that. So.

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Operator [37]

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This concludes the question-and-answer session. I'd like to turn the floor back to Paul Travers for any closing comments.

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Paul J. Travers, Vuzix Corporation - Founder, Chairman, CEO & President [38]

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Thank you, everybody, for joining our conference call. Again, it's an exciting time at Vuzix. We're looking forward to the future, and I think a pretty exciting 2019. Have a great day, everybody.

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Operator [39]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you, again, for your participation.