Greetings and welcome to the Vuzix Second Quarter 2020 Financial Results and Business Update Conference Call. [Operator Instructions]. Now I would like to turn the call over to Ed McGregor, Director of Investor Relations at Vuzix. Mr. McGregor, you may begin.

Thank you, operator, and good afternoon, everyone. Welcome to the Vuzix Second Quarter 2020 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, August 10, 2020. Vuzix assumes no obligation to update these projections in the future as market conditions change. This afternoon, the company issued a press release announcing its financial results and filed its 10-Q with the SEC. So participants on this call who may not 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, reconciliation to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found in the company's Form 10-Q filed at the 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's CFO, who'll provide an overview of the company's second quarter financial results. We'll then move on to the Q&A session, after which Paul will provide some closing remarks. Paul?

Thank you, Ed. Hello, everyone, and welcome to the Vuzix Q2 2020 Conference Call. Q2 sales and gross profits were the highest we've achieved as an enterprise product supplier. We're pleased to see our products being used across our client base to assist customers in solving the complex issues associated with today's business environment. Our sequential revenue growth in Q2 for product sales was nearly double, 98% to be exact, as compared to Q1 driven by a record $2.3 million worth of Vuzix Smart Glasses revenues in the quarter, representing a quarterly year-over-year increase of 183% compared to Q2 of 2019. Our second quarter Smart Glasses sales were driven by new customer acquisitions and follow-on purchase orders from existing customers. COVID-19 has changed the way business is getting done by most organizations. And as a result, we are seeing our business growth become part of the new normal. Our third quarter is off to a strong start with revenues continuing to show further growth. As a result, we believe we're in a position to deliver continued growth in this quarter and over the remainder of 2020. We're now 6 months into the COVID pandemic, and the business activities to support enterprise customers and business continuity continues to accelerate, precipitating for many, a shift in terms of urgency and interest to deploy smart glasses. The global pandemic is currently showing no signs of letting up, and all indications are that we have entered a new normal for business to operate regionally and globally. This has and continues to accelerate adoption for most of our key business verticals, most notably field service, telehealth and health care. There are also similar needs for customers operating in manufacturing, warehousing and logistics and retail, both online and in-store pickup, all of which were negatively impacted…

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. For the 3 months ended June 30, 2020, total revenues increased $0.8 million to $3 million versus the same comparable period in 2019. The increase was driven by higher sales of our non-OEM smart glass products, which rose 183% year-over-year. Sales of OEM products were nil for the 3 months ended June 30, 2020, as compared to just under $1 million in the 2019 period. We do not currently contemplate further orders of that OEM smart glasses model. Engineering services revenues for the quarter was $0.7 million versus $0.4 million in the prior year's period. There was an overall gross profit of $0.8 million for the 3 months ended June 30, 2020, as compared to a gross profit of $0.2 million for the same period in 2019 driven by improved product gross margins and stronger gross margins earned on our engineering services program. Product gross margin before overheads and other items was 50% of this -- for the 3 months ended June 30, 2020, as compared to 24% in the prior year's period with the improvement primarily the result of higher margins earned on the M400 versus the M300 series in the prior year's period when the M400 was not yet available for sale. Manufacturing overhead costs for the 3 months ended June 30, 2020, as a percentage of total product sales decreased to 16% from 20% in the same period in 2019 with the majority of the decrease being attributable to higher levels of sales versus the previous year's comparable quarter. In addition to its normal reserve for obsolescence…

Thanks, Grant. Our third quarter is off to a strong start in terms of smart glasses revenue through the first week of August and is currently outpacing our second quarter sales rate. This bolsters our belief that we are in a position to deliver continued growth in the third quarter and over the remainder of the 2020 year. 2020 is proving to be a transitional year for Vuzix. And it is encouraging to see that the growth in our business to date is broad-based, but not dependent on any single project or customer. We're also seeing growth across multiple market sectors. And with the world changing as a result of the pandemic, we see that growth continuing into the foreseeable future. Again, why send the person when you can send the pair of glasses? They're faster, cheaper, safer and more. What Vuzix delivers in relation to COVID is going to be part of the new normal. And when people finally get back to work at scale, adoption of smart glasses and many other use cases, as we have discussed in the past, should expand our business even further. Augmented reality and smart glasses in general are the computing platform of the future, and Vuzix is positioned well to be a winner in the space. With that said, I'd like to now turn the call back over to the operator for Q&A.

[Operator Instructions]. Our first question comes from the line of Christian Schwab with Craig-Hallum Capital Group.

Great. Congratulations on a very strong quarter. I was just looking for the growth commentary. Is that a comment regarding year-over-year growth in '19 to '20? Or is that a comment regarding sequential growth from the just finished June quarter?

Yes. The answer is yes to both of those, Christian.

Okay. Perfect. When the avionics opportunity that we've already been qualified in, can you give us any potential range of outcomes over the course of the next few years between zero and obviously something else, so we could kind of gauge the opportunity there and what would be a fair ASP, if you're willing to share, plus or minus that we should be thinking about?

I don't know. Gee, this is really difficult without -- let me say this. If you follow the defense space in -- when it comes to smart glasses and things like the HoloLens being employed, et cetera, there's a lot of big defense suppliers that aren't part of that HoloLens effort, and they are already delivering wearable technology today. And if you take a look at what our friends were doing over on that side of the house, it's a significant piece of potential business here. I mean there's a lot of defense guys out there and gals that need to have access to equipment like this. And it's going to be in programs, we believe, at least what we're being told, upgrades to stuff that's in the field and brand-new programs. So you'll see these things in a lot of different places. They have to be qualified to defense-level performance. And so it's not as inexpensive as purchasing a enterprise-level solution just because it has to meet all these other sort of specifications. So you look at even a finished product at Vuzix, these subcomponents are probably going to be more expensive than that. Hard to give you a hard number on that, again. But it's greater than $1,500 to $2,000 kind of numbers. And the volume could be significant. And we mentioned a couple of players in this regard. The technology, the future is all wearable, and see-through optics is a critical part of it. And the cool thing is Vuzix manufactures these things in the United States. And if you pay attention at all to world politics, you know that, that could be a very important edge.

Great. Thank you, Ed. I'll just ask one more quick question and get back in the queue. We have a vast expansion of opportunities that we kind of talked through, so I will let you regurgitate that. But what I was thinking about is a couple of the other opportunities that kind of stood out, I thought, which was the Verizon opportunity on a couple of fronts as well as marching through NRE engineering with a U.S. defense contractor. Would you expect or be disappointed if there wasn't some sort of potential material volume from both of these customers in 2021?

Oh, we definitely should see significant contributions to revenues not just there, Christian. Think about knee surgeries. There's over 600,000 knee surgeries done a year in North America. I mean there's a lot of places where the technology Vuzix makes should have nice contributions to the revenue side of things. And in the Verizon side, we have high expectations. And in some of our OEM programs, we have high expectations. And 2021 will not be a bad year for them, knock on wood.

Our next question comes from the line of Jim McIlree with Bradley Woods & Company.

Paul, you mentioned in your commentary two nondefense engineering programs. And to the extent that you can elaborate on that, are those four see-through optics as well? And we haven't seen the engineering part of that yet, correct?

That's correct.

And if we haven't, when is a reasonable time to think that they would? That -- when's the reasonable time to think that you could start working on those projects?

Well, we're in development on them now. So I would anticipate you'll see some contribution to the pile here from an engineering -- nonrecurring engineering OEM perspective, even in this quarter, for Q3, on some of them, Jim. And there's smart glasses and optically see-through-related programs -- optically see-through optics. It's just, I wish I could share more. I'm hopeful that..

No. I understand.

Shortly here, we'll have a bit more color we can put on those for everybody.

Okay. You also mentioned in your comments -- I was just going to say...

Some of it is related to next-generation display systems that I think people will find pretty cool.

In your commentary, you also mentioned increases in sales to international customers. I was hoping you could give us some indication about how much of sales was deployed in, let's just go broadly, Asia, Europe, North America. Not necessarily where the sale was made, it might be made to a North American customer that deploys it internationally. But the end deployment, do you have an indication about how that would divide up in those three geographies?

Grant, do you want to try to take that one? I think I could pick it up here.

Sure. I mean the U.S. is still the prime market, Europe #2, and then -- but Asia, particularly Japan, really grew in the last couple of quarters. So it's a bigger percentage. So I mean, historically, it's Asia, Japan as being 10%, 12%. And I think it's probably a recent crested the 20% level. So it's coming on. So international sales are rapidly going to become the -- probably greater than domestic, excluding the engineering services programs in 2020.

Okay. Grant, while I have you, it looked like cost of sales on the variable side is getting close to where you want it to be. Or are there still a lot of -- is there still substantial room for improvement as a percent of sales?

Well, we think there's still some room for improvement. Obviously, the higher the volume, the more we can spread some of our close to more fixed overhead costs. I mean, we still had a fairly large reserve for obsolescence regarding the Blade as we transition to the next generation of it. So those are always pull downs. And hope -- we don't like to have to take those provisions, but it's -- we were kind of forced to the way everything worked out. So -- but I think we're getting there. And our goal is still ultimately try to get to a gross profit number of 40% or greater with -- provided we got the total revenues up top to amortize those costs.

Understood. Okay. And then just finally on the Blade. I'm assuming that your security customer is still -- I don't know how to characterize it. So this might be unfair, but let's call it behind schedule. Is that what's happening? Or is there something else going on that we should be aware of?

From the perspective of COVID, unfortunately, for those guys, not a lot of people are going on cruise ships. Not a lot of people are going to the baseball game. Not a lot of people are -- just think about a lot of what they were making was to address markets that are in a pretty tough spot right now, even baseball, no people in the stands and organizations are coming up with 19-plus of their players -- so they got a -- with COVID, so they got to close down. So unfortunately, for them, that's challenged. They do have another product that they're coming out with. I guess. That's related to temperatures and those kinds of things. But their focus on the security side, unfortunately, it's got a bit of a hiccup in it right now.

Okay. Is the upgraded Blade or the new version of the Blade with the autofocus and the stereo, is that going to address a different customer set? I'm just trying to understand what happens with Blade going forward.

It's across the board a much better solution, Jim. I mean, if you think about the way it was previously, there was no audio built in. So if you're an enterprise customer, what you had to do is put earbuds in your ears, and that made for safety issues, extra cables, extra things to take care of. Now you just put these guys on and you've got a full communication system just like the M400 does and with the auto focus, another important part when you're doing remote support and those kinds of things. So this is going to be for those folks that need to have remote support kinds of things and the likes but they can't have that sort of out there look of an M400, it's a great option. And security is part of that market still. That said, it doesn't have the performance of an M400. It just doesn't have the camera support. It doesn't -- it only runs in -- on the 2.4 gigahertz WiFi, but there's lots of folks that like it. Right now, Blades are picking up pace. We reduced the price to $499. And yes, they're selling, I think, pretty well at the moment. And we think that people will really like the upgraded Blade here coming up.

And will the upgraded Blade priced at the $499 mor closer to the $800 to $1,000 that you had previously?

We got enough margin in it that when we made this price change, the Blade really seemed to kick in the overdrive a bit, and there's enough margin in it, especially on a direct sale basis, which we do a lot of. We are considering a price less than the $999 number, but I'm not sure Grant is in a position to where we'd like to share that just yet because we're still thinking it through.

And we're selling down the existing Blade stock, but it won't be more than the Blade was when we reduced its price. So -- and that was $799. So that will be the high side, I believe. And also, all new Blades are going to have safety glass lenses in them. Before, that used to be a premium option and now all Blade upgraded models are going to have that included. So just a nice feature, and hopefully going to be more attractive to some enterprise customers.

Right. And I'm sorry, but just one more, if I might. So Paul, you talked about Q3 so far exceeding, I forget the words you used, the pace or the rate of Q2. Are you saying that if you took the Q2 sales and divided it by the number of days and did the same thing with Q3 to date, the number in Q3 is bigger? Is that another way to look at it?

Yes. That's another way of looking at it.

Yes. Average weekly sales for the Q2 were running at a faster pace so far in Q3.

Fantastic. That's great to hear. Congratulations, nice numbers. And we'll talk again later.

Our next question comes from the line of Jack Aarde with Maxim Group.

Congrats on the solid results this quarter. So Paul, I want to follow up on the -- I know some other analysts have asked about it, too. But I want to follow up on the announcement regarding the Tier 1 aerospace customer that completed the Phase 4 of the program. Just so I understand, has anything changed in terms of the status of this relationship or just progress or since the July 16 announcement?

Not that -- yes. As anything can change. It's just -- the program is just moving down the road. I mean..

Well, we are now negotiating a supply agreement product for volume production, which just started during the midway through Phase 4. So they obviously seem to be pleased with what we're doing and want to move on to the next stage, namely production. But that's not signed at this stage.

Got it. Yes. And it's no doubt, a clear positive in my mind as well. I'm just trying to understand. This is kind of -- I guess this is one of the major ones that timing made its way to the end now. So I'm just trying to understand, is -- do you have a sense as to how long it would take to get to production? Or is this -- are we kind of just creating the rules as we go here until you guys strike that negotiation that makes both sides happy?

What we've delivered to them so far is practically speaking, production. There's still a few minor adjustments. But I think you will see before this year is up, a contribution to the production side of this. So you should see that.

Got it. Okay. And then let's say, hypothetically, you guys -- you reach an agreement, volume production begins. Just so I understand the reality or the potential reality, what must you expect, say, it's -- everything goes into volume production in Q3, could Q4's revenue or just units in total generate enough revenue that would, say, exceed all of last year's product revenue? Or would it be a linear ramping each quarter? How much revenue could possibly be generated like best-case scenario? And would it ramp over time? Or would it be a linear thing?

It's going to ramp over time. And the volumes to start with, it just takes time to fill a TAM and with the -- get it worked into programs and those kinds of things. But these are components that should get used in multiple programs. And as those programs start to unfold for our customer, our volumes will ramp up alongside it. So it's not going to be instantly boom, there's thousands of units a quarter being sent, but it should be a nice contribution in 2021 to our business. I will say that if you look at sales in general, it's broad-based. Last year, in 2019 in our second quarter, we had 1 customer take 1,000-plus smart glasses from us. It's not the characterization of what we're selling today. We have customers that are buying 50s and hundreds kinds of numbers. And so it's spread out. And we, at the same time, with some of those customers, are in the process of quoting much larger volume production rollout. So yes, it's very true that this defense customer is going to be an exciting 2021, but I think you're going to also see the standard smart glasses product lines Vuzix have start to have some companies that buy in larger volumes.

Understood. Okay. That's helpful.

The broad-based stuff will be there, I believe, and it's -- you've heard how Q3 is going already. It looks like it's nicely picking up speed. But we're very hopeful at the same time that you'll see some contributions from some of these folks we're selling to that are bigger.

Got it. Okay. And then if I turn away from product revenue and looking at engineering revenues, just so I understand, it's clearly you expect product revenue to be increasing each quarter. But what about the engineering services? I believe you mentioned you have two new but maybe not formally announced OEM projects. So will these contribute to engineering revenue lines during the second half of '20? Or would you expect it to decline given this aerospace customer has exited the Phase 4? What would I expect for engineering services?

I think you're going to see there -- engineering revenues had been lumpy at Vuzix. There'll be some quarters where there's a lot of stuff going on than at the other quarters, where it's more at a lull because we delivered on stuff and you're going through the next phase. We've got 2 new programs that we've discussed a little bit about and there's others in the queue. So maybe when we get more happening here at Vuzix, it will be a little less lumpy. But when you have less numbers of programs like that, there's times where you're busier with them and there's time that you're less. So that one's harder to peg, Jack.

Okay. Fair enough. And that makes sense. That's reasonable. And then, I guess, just lastly, have you seen any opportunities from -- that were historically announced that may have been put on hold or delayed? I don't know, such as I think Ride-On come to mind to me, for example. Are you seeing anything like that? Any of those arrangements or delayed projects now coming back online?

It's amazing to me how Q1, as the pandemic started to come to the fore, how many programs got put on hold. As it happens, our smart glasses are so good at this remote support problem and business continuity, that the COVID stuff from that perspective, accelerated a bunch of areas and some new areas came in. There's a lot of our business that slowed down. And some of it, the brakes are just on completely. The security effort that Jim was talking about just a few minutes ago, that's one of those ones that's on hold right now. And I don't know, you tell me when a cruise ship's ever going to go out again or when we can go back to the ball game. So yes, we've got stuff that's -- the brakes are on. Some of that stuff is starting to free up, though. I mean, the people are trying to come back to work. They're all trying to figure this out. And it's messy. But to the extent how our products help open the doors, those are the areas where we're starting to see things pick up again and those programs start to come back online.

I look at that as a nice -- the work that we've been doing over the last 4 or 5 years, I have to say a fair amount of it fits into that bucket, which is why we got a bit of time here that's been a challenge today, but...

For sure. Again, congrats on the strong quarter.

Our next question is from Brian Kiplinger with Alliance Global Partners.

This is Jacob on for Brian. First, you've had a number of press releases regarding the use of your smart glasses for remote medical response in hospitals. Can you talk about the progression of these customers? Are they purchasing a few pairs in the beginning and then if it goes well, purchasing more?

I mean, that's how it's kind of been moving. There are, in some spaces, where it's accelerating faster rather than less. There are some areas where they're using our glasses 24/7 today, especially in Asia, more so. I mean, in the States, they're using them, but I think they're on and off in some cases. So it's -- the pandemic's caused challenges, pluses and minuses even for the folks that are on the front lines of all of that. That said, there are some areas in the medical side of our business that are buying reasonably significant numbers of units today.

Okay. And what's your total installed base for health care not working right now?

We don't break it out that way. Or...

Okay.

I mean, from a competitive perspective, I'm sure there's more than one person on this call that competes with Vuzix. And we just don't feel a need to have to tell everybody on the planet where the -- where our business is mostly at right now, from that perspective.

Yes. I understand. Okay. Last quarter, you talked about enterprise delays given plant closures and other COVID challenges. Outside of health care, can you comment on how the procurement process and sales cycle has changed over the last 4 months?

We've had a few items that we've had some challenges with, some special glues and those kinds of things. And -- but I have to say, for the most part, we've not run into significant effort -- issues on the manufacturing front. The plant floor is running well. We've got inventories. When we've had some glitches, we found alternative sources to stuff. Does that sound right, Grant? Did miss anything in that regard?

No. No, that sounds reasonable. It's not really slowing us down. I mean it might have -- too long. Some of the new products we got coming out have been delayed a little more than day-to-day production.

Yes. There's been some cases where stuff would get put delayed because the mandate has been to produce products related to personal protective equipment and those kinds of things. So we have some windows that we get delayed on, those kinds of things because there's these really thin windows that go in the front back of our waveguides, but we've found, like I said, alternative sources and stuff. And so little glitches and delays. But for the most part, it's been manageable.

Okay. And lastly, what was the average price per pair of smart glasses sold during the quarter? And do you expect that to increase or decrease or remain the same over the remainder of the year?

Grant, you want to take one?

Yes. Retail is $17.99 for like an M400. Clearly, we do offer volume discounts. And as volumes increase, the average number will drop down. I mean, I would suggest -- let me see here. Just -- I mean our M4000, that comes up shortly is going to have an even higher selling price, but at best, I mean, I would say we've averaged a 25% discount off our retail. It would be the average selling price of the products.

We have reached the end of our question-and-answer session. I'd like to turn the call back over to Mr. Travers for any closing remarks.

I'd like to thank everyone for your interest in participating on today's call today. We look forward to speaking with you again in the November time frame when we report on our Q3 results. Stay healthy, everybody. And again, thanks for stopping in to listen to the call.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.