Vuzix Corp Q1 FY2022 Earnings Call

Greetings, and welcome to the Vuzix First Quarter ending March 31, 2022 Financial Results and Business Update Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this call is being recorded. Now I would like to turn the call over to Ed McGregor, Director of Investor Relations at Vuzix. Mr. McGregor, you may begin.

Good afternoon, everyone, and welcome to the Vuzix' first quarter of 2022 ending March 31 financial results and business update conference call. With us today are Vuzix CEO, Paul Travers; and our CFO, Grant Russell. Before I turn the call over to Paul, I'd like to remind you that on this call, management's prepared remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements during the question-and-answer session. Therefore, the company claims the protection of the safe harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by any forward-looking statements as a result of certain factors, including but not limited to, general economic and business conditions, competitive factors, changes in business strategy or development plans, the ability to attract and retain qualified personnel as well as changes in legal and regulatory requirements. In addition, any projections as to the company's future performance represent management's estimates as of today, May 10, 2022. Vuzix assumes no obligation to update these projections in the future as market conditions change. Today's call may include certain non-GAAP financial measures. When required, reconciliation to the most direct comparable financial measure calculated and presented in 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 operating results and business outlook. Paul will then hand the call over to Grant Russell, Vuzix' CFO, who will provide an overview of the company's first quarter financial results. Paul will then return to provide some closing remarks. After which we will move on to the Q&A session. Paul?

Thank you, Ed. Hello, everyone, and welcome to the Vuzix Q1 2022 Conference Call. On this call, we're going to review our results and recent developments and then give you some perspective on where we see things headed. The first quarter of 2022 was a challenging one for Vuzix, our customer suppliers and partners due to the obvious combination of macro conditions related to COVID and geopolitical tensions in Europe. These issues generally and their impact on timing related to certain anticipated customer orders resulted in our Q1 revenue falling short of expectations. Revenue growth and profitability are important objectives for Vuzix. That said, the AR industry is at its early beginnings, and as such, it is difficult to predict month-to-month and even quarter-to-quarter frankly. But the underlying trends in communications from our key accounts reflect indications of growth that the industry expects. We remain focused on delivering value-added hardware and solutions to our customer base and expanding our global sales channel and sales teams in select high-growth regions to support our core product offerings. At the same time, we continue to prepare the company for our growth by investing in our core technologies, including waveguides and display engines as well as our manufacturing capacity. These investments will enable us to better address and support the expected broad industry growth, including in and around the metaverse that is projected to ultimately span the enterprise, defense, and consumer markets. For the reasons just stated, total first quarter revenue was $2.5 million, a decline of 36% compared to the prior year. Historically, Q1 for Vuzix has been our slowest quarter of our typical fiscal year, with the exception of 2021 when Q1 represented record product sales for Vuzix. We consider these results to be anomalous and largely associated with timing delays of customer rollouts and the general world market conditions mentioned above. By way of example, if just two key accounts were not pushed out, our first quarter numbers would have met or exceeded consensus Street expectations. Further, from a customer engagement perspective, the first quarter was encouraging across our core smart glasses business, with the M400 continuing to be our flagship offering. During the quarter, we continued to expand our international sales channels and work diligently with our key independent software vendors to support the needs of our collective customers as they work through final optimizations ahead of expected enterprise-wide rollouts. On the OEM side of the business, upon which I'll expand shortly, there is growing momentum with existing and new customers, none of which was reflected in our first quarter revenue number. We feel that visibility into our smart glasses customer base and their commitment to product rollouts is improving. Despite the numerous current headwinds, we still expect our core smart glasses revenue in 2022 to grow over 2021, driven primarily by larger deployments within logistics and warehousing, but also by steady expansion within health care. We have a growing number of customers in the warehousing and logistics space well along in their implementations. Feedback from our largest customers in this space remains very positive, and additional units continue to be ordered, deployed, and software fine-tuned in preparation for company-wide rollouts. These rollouts are, in some cases, within critical infrastructure areas for many of these companies. And with the global challenges stressing their businesses, both from supply and labor force challenges, they are being extremely cautious to make sure there are no glitches that might impact their business as the rollouts commence. All of our major health care ISVs continue to expand the availability of their Vuzix powered surgical solutions. Last month, Medacta launched their next AR shoulder augmented reality surgical platform in both Europe and the U.S. In March, Pixee Medical announced the commercial launch of its Knee+ AR computer-assisted orthopedic solution in the U.S. This solution was launched commercially in January 2022 in both Europe and Australia. Rods & Cones is now active in more than 600 hospitals across more than 30 countries. Ohana One with TeleVU are also expanding their network. And over the last months, they joined Vuzix in donating their solution, both time and remote software with our donation of M400s to Ukraine hospitals to help support the needs for medical assistance. Beyond these firms, we continue to see our glasses showing up almost daily across social media and in more hospitals around the world. Most recently, René, University Hospital in France, and Osaka Saiseikai Izuo Hospital in Japan. We anticipate health care in 2022 will be another solid growth contributor for Vuzix. Overall, our sales pipeline for 2022 remains healthy, and our biggest challenge is managing and understanding customers' expectations around the timing of deployments from these key accounts, movement of which can have a material impact on our quarterly sales. Again, despite Q1, we expect our full year smart glasses revenue for 2022 to grow significantly over 2021, especially as we move through the back half of the year. During the first quarter, we also remained very active in terms of pursuing numerous strategic and key initiatives that should drive the transformation of Vuzix. On the acquisition and investment front, Vuzix continues to be engaged with several companies that could broaden our service offerings across key market segments and broaden our technical capabilities and know-how. As a result of internally driven initiatives and potential acquisitions, we expect Vuzix to shift from being primarily an enterprise smart glasses supplier to a more diversified supplier of smart glasses, SaaS-based solutions and OEM components and products for the broader markets. On this front, we are planning to hold a conference call early next week to provide an update on developments in this area. It will be open to everyone. So, please set aside some time to join the call and learn more. To support the number of inbound requests for access to Vuzix technology and to proactively offer it to third parties, primarily in the broader markets, we created a standardized OEM platform. This new platform announced last week meets the increasing market demand for our technology and the coming need for high-volume waveguide manufacturing capabilities to support these broader markets. As a U.S.-based manufacturing company, Vuzix has a competitive advantage in the core technology to offer solutions to the U.S. Military and allied foreign defense markets. We continue to make significant improvements in our waveguide manufacturing quality and our ability to produce at scale at what we believe could be the industry's lowest cost and highest-performing solutions available. The total addressable market for waveguides is expected to be in the billions of units annually within five years. Vuzix, with our OEM platform and high-volume manufacturing, is preparing to deliver to this broader market opportunity through large defense, consumer and industry third-party partners. In this regard, we are now seeing ever-growing customer interest and orders from aviation and defense customers for head-worn waveguides and display engines. At this juncture, Vuzix has expanding relationships with five major defense contractors, and we are receiving RFPs from new and existing customers alike. There has been a lot shared in the public domain regarding the U.S. Army's IVAS program and some of the challenges the program has faced. The U.S. Army is clearly committed to wearable displays but has publicly made the point that they are rethinking the best path to success. We believe this rethink has been helping Vuzix to foster business relationships with key defense contractors in order to explore new solutions. The ultimate goal for Vuzix from these defense-related OEM programs is qualification and selection into volume programs, which typically range anywhere from hundreds to even hundreds of thousands of units over the course of the widely deployed program, which are typically spread out over three to five years and can take several years to be qualified. Vuzix is well underway with several of these programs and is expecting initial volume deployment as early as this year. As a reminder, in five weeks, the expiration of our non-compete related to the defense markets will expire. This will allow Vuzix to directly engage with U.S. or allied defense and homeland defense forces around the world. This should make a big change for how Vuzix will be able to conduct its business in the defense markets going forward. Leading consumer customers are also approaching Vuzix driven by new interest in the level of performance we have achieved with our Shield next-generation smart glasses. To reiterate from the experts at Yelp, the Shield was by far my most convincing visual experience of any type of AR glasses so far. Besides being comfortable to wear, with the good weight balance, the image was crystal clear with no haze nor artifacts between the display, the waveguide optics, and the projection module. Vuzix has done a remarkable job of optimizing performance and quality. Our strong IP portfolio and the ability to produce these components efficiently in volume with price points significantly lower than other competitors is opening these new doors. The consumer smart glasses market requires products that can meet specific price points and volumes. In the end, competing companies can make hero devices or one-off prototypes. However, producing them in high volume and at price points that fit the broader markets is very difficult, and we feel that Vuzix has the best recipe. Vuzix has the waveguide production capacity now to meet the level of volumes required for both internal and current external programs. To deliver against expected future demand, we are expanding our facilities to address the ability to manufacture the millions of units of waveguides associated with the business we see coming. This is an effort that has been underway for some time now at Vuzix, with our newest production line well underway. We will be sharing more on this in the coming few months. In summary, business activities, announcements and ultimately, revenue from our OEM business group is expanding, and we expect it to grow significantly over the course of 2022 and beyond. Vuzix has three next-generation products to be released over the next several months. Supply chain and staffing resource challenges in 2022 have negatively impacted the timeline related to the introduction of these new products. But despite these challenges, our teams are managing our delivery and project schedules accordingly, and we expect the three new products to enter production just a few months behind schedule. Vuzix Shield is far advanced versus the competition, and its form and functionality have garnered significant early interest from enterprise customers that require a more traditional eyeglass form factor and capabilities afforded to them by the Shield to solve operational challenges. Commercial production of the first Shield model is now expected to commence in the third quarter of this year, with enhanced versions being introduced when components are available, including ultimately full color. The Vuzix M400C, which is effectively on schedule, is our second-generation USB-C-based Windows PC and phone compatible smart glasses. They take full advantage of the robust design and camera afforded by the Vuzix M400, including IP67 ruggedness. We have shipped a limited number of initial production units of the M400C to a Windows mobile computer manufacturer, and we anticipate their first volume production orders will be received by the end of the second quarter of 2022. We expect to introduce the M400C to our standard channels also in this quarter. Vuzix is also working on a new follow-on waveguide-based smart glasses product that will feature our latest advanced waveguide optics, a larger field of view and have the ability to run Android 11 out of the box. We believe this new product will answer the call for many of our enterprise customers that love the Blades form factor but require an upgraded OS to support their application architecture. We expect to formally announce and commence volume production of this follow-on based waveguide product in Q3 of this fiscal year, barring any last-minute supply chain issues. Finally, we have been diligently working on our first Vuzix developed SaaS-based solution built on the Microsoft Azure platform. We expect we'll begin beta testing for the first customer feedback over the summer. We will share more on this when we formally release this solution to the markets. I'd like to now pass the call over to Grant for his financial review. Grant?

Thank you, Paul. As Ed mentioned, the 10-Q we filed this afternoon with the SEC offers a detailed explanation of our quarterly financials. So I'm just going to provide you with a bit of color on some of the numbers now. Our first quarter total revenues for the three months ended March 31, 2022, decreased 36% over the prior year's period to $2.5 million. The decrease was primarily the result of a reduction in smart glasses sales versus Q1 of 2021, a quarter, which was our strongest first quarter to date from selling smart glasses and a period, which is typically the slowest quarter revenue-wise of our fiscal year. Sales of waveguides and display engines totaled $0.1 million in the quarter versus none in the previous year's period. Conversely, we had no engineering services revenues in the quarter versus $0.1 million in the prior year's period. There was an overall gross profit of $0.6 million or 26% for the three months ended March 31, 2022, as compared to a gross profit of $1.1 million or 28% for the same period in 2021. A portion of the decrease in gross profitability is due to the absence of any high-margin engineering services in the current 2022 quarter versus $0.1 million earned in the prior year's first quarter period. Our relatively fixed manufacturing overhead costs, while down in absolute dollars by 27%, climbed as a percentage of total product revenues to 16% or by 2 percentage points. R&D expense was $3.1 million for the three months ended March 31, 2022, compared to $2.2 million for the comparable 2021 period, an increase of approximately 41%. The higher R&D expense was primarily due to increases in external development expenses related to our Shield smart glasses and increased salary and benefit expenses due to headcount increases. Sales and marketing expense for the three months ended March 31, 2022, was $2 million as compared to $1.3 million in the 2021 period, a 55% increase over the prior year period, due primarily to increases in salary expenses from new hires and a $0.3 million increase in trade show expenses, which rose as a result of our return to attending trade show events in person post the broad COVID lockdowns of 2021. General and administrative expenses for the three months ended March 31, 2022, were $5.5 million as compared to $6 million for the 2021 period, a decrease of 10% versus $6 million in the prior year's period. This decline was largely due to a $0.6 million decrease in non-cash stock-based compensation, which was significantly higher in the first quarter of 2021 due to the vesting of an equity market capitalization milestone under our LTIP or long-term incentive plan. The net loss for the three months ended March 31, 2022, was $10.5 million or $0.16 per share versus a net loss of $9.2 million or $0.17 per share for the same period in 2021. Now for some balance sheet highlights. Our balance sheet remains strong with cash and cash equivalents position of $113.3 million as of March 31 and a net working capital position of $126.6 million. Cash used in operations, after adding back noncash operating expenses, which primarily consists of stock compensation expenses, but excluding changes in our working capital, totaled $5.7 million for the first quarter of 2022 as compared to $3.8 million in the 2021 period. Cash used for investing activities for the first quarter of 2022 was $0.2 million as compared to $0.7 million in the prior year's period. During our first quarter of 2022, the company repurchased 36,685 shares of our common stock at an average cost of $6.84 under the $25 million common stock repurchase plan approved by our Board of Directors on March 2 of this year. As of March 31, 2022, the shares were held in treasury. As of March 31, 2022, the company continues to have no current or long-term debt obligations outstanding. Looking forward to the balance of 2022, we are confident we have the resources to execute on our business plan and invest further in our future.

Thanks, Grant. To close, I would like to reiterate a few important points. The world's adoption of AR and smart glasses is gaining momentum and by most accounts unstoppable. We are seeing no loss of enthusiasm to deploy this new technology throughout enterprise with medical leading the charge and supply chain right behind it. All the while the broader markets are coming to life with some corporations even completely rebranding their organizations around it. Vuzix has been preparing for this for years, and we have developed the IP and manufacturing capabilities to supply to it. For the rest of 2022, you will start to see significant activities happening around the OEM portion of our business as we engage with the broader markets, while our smart glasses begin major deployments throughout enterprise. And to deliver to this growing opportunity, Vuzix has the balance sheet to get it done. With that, I would like to turn the call back over to the operator for Q&A.

Our first question today comes from Christian Schwab of Craig-Hallum.

This is Tyler on behalf of Christian. A couple of questions. So first, Paul, I was wondering, as we're about halfway through Q2 here, any update on COVID impacts you're seeing to customers now in Q2? Are they trending better, maintaining a similar level of impact? Any color there? And then based on that, would you expect Q2 revenue could possibly grow year-over-year?

Q2 revenue is expected to perform better than Q1, and we're feeling optimistic about that. The second quarter is beginning to trend positively. The impact of COVID varies among larger companies, particularly those in the supply chain utilizing our glasses. It's crucial for them to avoid any disruptions that could affect their financial performance, but the deployment process is taking a bit longer. While we are expanding to more facilities, they are proceeding with caution. Therefore, the impact we are experiencing is more of a gradual adjustment, taking months to a quarter. We are confident that Q2 will exceed Q1. The latter half of the year looks promising based on our current pipeline. COVID is still present but its effects are lessening, and things are improving.

All right. That's great color. And then on the OpEx level, I understand you guys are investing some more here for the opportunities you see ahead, but how should we think about OpEx trending from that $11 million we did in Q1? Any help there would be great.

Grant, do you want to take that one?

Well, it shouldn't be growing. A big chunk of that, remember, is non-cash charges related to the LTIP, long-term incentive plan we implemented in 2021. So that's accounting for a large chunk of the increases. In sales and marketing and R&D, we've made many of the hires we expected. We're still looking for some more both on the R&D side and a couple of strategic hires in sales overseas, but it should be moderating. And, of course, there's not going to be any more big increases due to the LTIP in the short term until we earn those milestones, and we're far away right now.

It happens quickly sometimes.

That would be a good problem. And then last one, just a little bit of a clarification. Maybe Paul, you mentioned five major defense contractors with whom you have expanded your relationships. Are those all new contractors? Does that include some of the contractors you have previously been engaged with that you're now expanding relationships? Just, I guess, some clarity there on those five defense contractors.

All right. We have not lost any. We have gained some, and there are five that we are in active programs with right now. And we've got RFPs and the likes that we're responding to on three other new ones. The whole access to waveguides in the U.S. defense markets is becoming something important. U.S. suppliers. It's a really big problem right now. If you think about most of the folks that make waveguides today are doing it in China. And if you can't have a U.S. supply, that becomes very problematic for the defense markets, and Vuzix is a U.S. manufacturer right here in Rochester, New York. And this IVAS thing is, it's an important program for the U.S. defense markets. And although they're derailed just a little bit because of this first round and some things they want to change, the pedal is to the metal from what we can tell.

That sounds great. All right. That's all for us.

The next question is from Matt VanVliet of BTIG.

I guess looking at the health care market, you announced a few good programs that continue to see a lot of traction. Just wondering if you could maybe dig a little deeper in terms of what order flow looks like, what kind of the pipeline at those organizations are, especially in terms of sort of how much wallet share you feel like you've captured so far relative to the overall opportunity in front of you?

Yes. There are approximately 400,000 hospitals around the world today. Companies like Rods & Cones are currently in only 600 of them. This represents just the early stages of this market and the potential it holds. If we examine the operations carried out by Pixee and Medacta, they perform over 600,000 procedures each year in North America. Additionally, there are several new companies in the medical field starting to purchase from us for various applications. I believe we will continue to see progress and growth in this sector, as we are in the infancy of health care advancements. Extensive research has been conducted on the health care market, illustrating its size and the projected impact of augmented reality and smart glasses, particularly in operating rooms in the next few years.

All right. And then as you look at the shift that you're talking about on becoming a little more of an OEM program going on here. How should we think about any incremental costs that might be associated with getting that up and running? And maybe how much is diverting current resources from other endeavors to be more focused on the OEM opportunity?

From the beginning, if you review our past conference calls, our OEM strategy has always been clear. Our aim in the higher-end broader markets has been to become a supplier. The facility we constructed, along with the processes and equipment, was designed to deliver in volume to those markets over time. However, transitioning from 100,000 to 300,000 waveguides annually to millions will require upgrades to the plant floor, but those will come as the business develops. We are currently in Phase 1, which by the end of summer or early fall should enable us to produce up to a couple of million waveguides annually from the upgrades we're implementing. A couple of million is a solid starting point, but for some of these companies, that's just the beginning, akin to monthly production numbers. Therefore, you can expect us to invest more, enhance the plant floor, and increase our volume as the business evolves.

The next question is from Jack Aarde of Maxim Group.

Great. I appreciate the update. So Paul, regarding the five major defense contractor OEM projects, I have a couple of questions. I'm a bit confused as to why we're not seeing any engineering services revenue from these in the first quarter. To help clarify, are these revenues inconsistent, or are there specific phases within the engineering services revenue agreements with these five OEMs?

This is all a function of development programs and the phases that these companies go through as they go through them. There's a need for demand in a quarter or two quarters based upon how we might develop for something. And then the folks on the other end are consolidating the stuff that we put together with their final programs that they're delivering against. And so it's just like you described, lumpy now; not much showed up in Q1. It's very true, but there's a fair amount of stuff that's already happening here in our second quarter. So it goes from one quarter shelves into the next one. Some of the new programs and folks that we're involved with, it's going to be less lumpy through the year because they're reasonable sized programs that will take the entire year to develop against.

Okay. And then just kind of a follow-up. In the past, you used to talk about and you've outlined in the prior presentations that sort of like the four phases of testing for these OEM projects. Can you maybe just outline where these five projects are in the testing phases or production cycles? Or is that kind of an evolving kind of thematic that's not really true anymore?

Well, these teams go through various development stages, starting with creating prototypes, moving on to qualifications, and finally to deployments. All of them are currently in those stages. Some are very close to completion; we've discussed this before. In particular, we are finalizing a supply agreement, which will be completed soon. These teams will be rolling out their products this fall, so they will be entering production soon.

For that project, when production begins, it will not impact the product revenue in the income statement or engineering.

I would have to ask Grant. Grant, would you? Probably the waveguides that we would deliver into a defense program once it is out of engineering, how are we going to report that as products or still as...

Waveguide components?

Yes.

I mean, at this stage, if it becomes as we hope a material segment, then we start disclosing OEM components from Vuzix branded product sales.

Yes. But it would be unlikely we would break it into where it went and those kinds of things. It just would be a bottom line number.

Yes.

Okay. Understood. And then just one more follow-up question on the product side. Regarding the smart glasses set, you mentioned that you expect your core smart glasses product revenues to increase year-over-year in 2022. When you refer to core smart glasses, are you talking about the existing smart glasses models currently available, or do you also include the three new products that are scheduled for launch this year?

Yes, our core products, even without the stuff that we're going to launch, will be bigger than 2021. There's going to be more contribution to the newer products as they roll out here towards the second quarter and into the third quarter. Does that make sense?

Yes. So the existing models will grow year-over-year in your plan, and then the new products will be additive to that as well.

That's correct. And I've got to say there's a fair amount of interest in especially the two new waveguide devices. Even though we haven't made a formal announcement on the one that we allude to, there are certain companies that we're working with that have requested that particular product in its feature set. So...

For 2022, the majority of our revenues will still be our 400 smart glasses.

That's correct.

Okay. That's helpful. I appreciate the color, guys. I'll hop back in the queue.

The next question is from Jim McIlree of Dawson James.

The shift or the transition or the increased OEM focus that you're going to announce soon, does that mean that you're going to reduce the amount of resources, personnel or capital that you're putting into the enterprise business? Or is it just you're going to put more resources into OEM while keeping the enterprise business contribution the same?

We intend to take a leading position in the enterprise market for smart glasses. You will notice our improvements. We are actively evaluating various factors, including costs, to enhance Vuzix's performance, while our OEM initiatives are distinct from those efforts. Jim, everything we do in terms of production equipment is directly aligned with the types of waveguides that other companies require. Therefore, Vuzix is not suddenly diverting onto a completely new path to capture that market. Yes, we will need to increase our production capacity, but those are positive challenges that we are ready to tackle.

And we get to leverage a lot of cost. In the case of an OEM that maybe wants something specific, we usually charge NREs accordingly, which covers those incremental costs. But as far as maybe program project managers and others as the business grows, there'll be some resources there, but we think it will be quite additive.

And the increase in capacity that you're contemplating, how much is that going to cost you ballpark?

I really can't get into those kinds of numbers at this juncture, Jim. Sorry.

Okay. Well, I mean, we'll see them soon enough.

But, yes, I mean the equipment is not that expensive actually for us to do this, and it will make waveguides like significant numbers of them. And the increase in capital is $3 million plus.

All right. That's helpful.

Yes, and yes. And maybe I can help with a range. Can you hold on just one second. Okay, Jim. Yes, I mean the equipment is not that expensive actually for us to do this, and it will make waveguides like significant numbers of them. And the increase in capital is $3 million plus.

Okay. That's helpful. Lastly, I'm trying to understand the OEM relationships mentioned in the presentation. I believe you stated there are currently five, and in your comments, you mentioned three more. Are these eight separate companies you are collaborating with, or do they represent eight different programs, possibly involving the same company for multiple programs? Are all eight primarily defense-related?

They are defense aerospace. They are eight distinct companies. And in some cases, there are more than one programs they plan on using our waveguides in. So it's up like ten to twelve programs.

And it sounds like I'm sorry, go ahead.

No. It's okay, Jim.

It sounds like at least one of them is trying to displace the current vendor on IVAS. Is that a reasonable assumption?

I think that it is.

There are no additional questions at this time. I'd like to turn the call back to Paul Travers for closing remarks.

Thanks, everybody, for listening in on our conference call. Looking forward to early next week when we have this follow-up conference call associated with some of the next-generation efforts that we're working on that should be a good call. Stay tuned. I think we'll probably have a press release out on Monday or Tuesday in that regard to tell everybody the coordinates for where the call is. Thank you, everybody, and have a great evening.

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