eMagin's (EMAN) CEO Andrew Sculley on Q1 2014 Results - Earnings Call Transcript

May.13.14 | About: eMagin Corporation (EMAN)

eMagin (NYSEMKT:EMAN)

Q1 2014 Results Earnings Conference Call

May 13, 2014, 4:45 p.m. ET

Executives

Andrew Sculley – Chief Executive Officer and President

Paul Campbell – Chief Financial Officer

Analysts

Dennis Van Zelfden - Brazos Research

Aram Fuchs - Fertilemind Capital

Jack Morebeck - First Washington Corporation

Tom Rath - Davidson Investment Advisors

Operator

Good afternoon and welcome to the first quarter 2014 eMagin Corporation earnings conference call. [Operator instructions.] I would now like to turn the conference call over to Mr. Paul Campbell, chief financial officer. Sir, please go ahead.

Paul Campbell

Thanks very much, operator, and welcome everyone. Thanks for joining us on the call today. We are here in Bellevue, Washington, where it is actually sunny and warm today. Unfortunately, we don’t know that by our own firsthand experience.

As usual, before we begin, please note that we will be referring to numbers that are part of our quarterly report on Form 10-Q for the fiscal first quarter ended March 31, 2014. During today’s call, we may make forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are based on the company's current expectations, projections, beliefs, and estimates, which are subject to a number of risks and uncertainties. Such statements include references to projections of future revenues, plans for product development and production, the company's ability to ramp up production at its manufacturing facilities, future contracts and commercial arrangements, future product benefits, future operations, liquidity, capital resources, as well as statements containing words like believe, expect, estimate, plan, target, will, intend, could, and other similar expressions.

We have risk factors, which are included in the our Form 10-K for 2013, which is on file with the Securities and Exchange Commission. Except where required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, and changes in circumstances or any other reasons.

With that said, I'd like to turn it over to Andrew Sculley, eMagin’s president and CEO.

Andrew Sculley

Thanks, Paul, and thank you, everyone, for being on the call today. I’ll begin with some corporate highlights, and then Paul will discuss our financial results. Following Paul’s remarks, I’ll update you on recent developments, and we’ll open the call up for questions.

As we announced during the first quarter, we received notifications to stop shipments from three customers pending a review of possible interconnect problems. Our investigation says that the three customers have a similar issue, but each resulted from different mechanisms. One customer had a few failures over many thousands of displays shipped. This was our largest display volume, largest runner.

Even though this was likely a low-risk variation, we’ve taken steps to implement improvements in our processes. These improvements involve new equipment for more accurate material placement and new materials. We have resumed shipments to this customer.

Shipments to the second customer are expected to resume in late June. We’re working on the qualification of the new processes that I mentioned for this customer. The third customer has a very high environmental requirement that goes beyond our maximum rating. However, the customer is very interested in using OLED.

We’re implementing the improvements I mentioned before, and are working to make the interconnect fit this demanding environmental profile. We expect to meet these needs in late July. Please note that this very difficult environmental requirement has not been a problem for our OLED and OLED seal system, which confirms our confidence in these systems.

I’ll mention here that we’re implementing our improved seal system. This seal system has passed the test of 85 degrees Centigrade - that’s about 180 degrees Fahrenheit - and 85% relative humidity, for 1,000 hours. We’re aware of one well-known OLED company that has stated that a test of 60 degrees Centigrade, or 140 degrees Fahrenheit, and 90% relative humidity for 100 hours, results in a 9-year life.

Of course, our test is much more severe and lasts 10 times longer. Hence, we feel confident in harsh military environments that are displays are subject to and the sometimes difficult conditions found in all mobile applications, when, for example, one leaves the mobile device in a hot car during summer.

Now I’d like to update you on our display production. You’ll recall we had uptime and yield issues on the SNU machine since we started production. We had a breakthrough last year, when we redesigned a chamber in the tool.

Since implementation of this in 2013 and significant time spent during the fourth quarter on both tuning the tool and optimizing the tool, and running production at the same time, the performance during Q1 has been much better. The tool can now run at its rated speed. The yield has improved versus the fourth quarter and our yield teams are continuing the improvements in Q2.

The advantage of this tool versus our R&D tool is apparent. When we run the R&D tool, that’s the Satella, you’ll probably recall, we run a test wafer and then make adjustments and continue running. After the adjustments, the tool drifts toward a control limit. By drifting, I mean things like the color coordinate or the white point, drift toward one of the control extremes.

When the drifting approaches a limit, we need to, again, stop production and adjust the tool, then monitor it again, etc. With the SNU, after an adjustment when you first start up the machine, the measurements stay at essentially the same spot and don’t drift. That, plus the speed, has been very helpful building depleted inventory that we had at the end of the year.

As I mentioned above, our yield was better in Q1. However, we require more work before we hit our goals. And we expect the yield team to keep on going over this rest of the year, and we’re comfortable that we’ll see other significant improvements.

We expect additional improvements in manufacturing over the entire 2014 on both not on yield, that I mentioned, but also uptime. Our new manufacturing vice president is implementing statistical process control, and Lean manufacturing. He’s started a pull system for production planning, and these improvements are going to allow us to produce the volumes needed for future growth. It’s very good to have this discipline being put in the manufacturing environment.

And now, I’ll turn the call over to Paul to take you through our first quarter financial results.

Paul Campbell

Okay, I’d like to start with the income statement. Revenues for the first quarter of 2014 were $6.3 million compared to $8.5 million in the first quarter last year, and $6.1 million for last quarter.

The decrease in year over year revenues was mainly due to the stop order, which Andrew just mentioned, also, due to lower R&D contract revenues and lower average prices due to our product and customer mix.

The stop order reduced the Q1 revenue as we had many displays in process for the three companies involved. We stopped work on those displays and we were able to change our production schedule somewhat to produce and ship displays to other customers who wouldn’t otherwise have received shipments in Q1. This mitigated to some extent the loss of revenue.

Our effective average selling price per display shipped decreased about 9% from the same quarter last year, which also had a decreased effect on the revenues. However, our average selling price increased about 17% from last quarter. So 17% up from last quarter, but 9% down from same quarter last year.

And this average price is a function of the mix of customers, volume discounts that we give, and the mix of the type of products shipped. But essentially, in Q1, we shipped more higher-priced displays than we did last quarter. And part of this is due to the stop order, where those customers get some of our lower-priced displays.

R&D contract revenue for the first quarter was just $19,000, and this is compared to $374,000 for the same quarter last year. Typically, most of our R&D contract revenues are comprised of U.S. government related spending, which has been impacted over the past year or so by budget issues and sequestration.

For years prior to 2014, our R&D contract revenue ranged from about 15% to 22% of total revenues. Last quarter, we recorded just 1% for R&D contract revenue. But we are encouraged by what we have working now, and we expect R&D revenues to increase going forward, moving more toward the historical levels for the balance of 2014.

Moving on to gross margin, first quarter was $1.9 million, 31% of revenue, compared with gross margin of $3.8 million, or 44% of revenue first quarter last year. So the decrease in the gross margin was due primarily to lower revenue, which has a big impact, higher production costs, and a decrease in the selling price that we just went over. The increase in gross margin from last quarter, from Q4 to Q1, margins increased nicely, actually, and this was due to a higher average selling price and slightly higher revenue and yield.

Operating expenses are comprised of internal nonfunded R&D expense and selling, general, and administrative expenses. R&D expense for the first quarter increased $236,000 to a total of $1.4 million or 23% of revenue, and this compares to $1.2 million, or 14% of revenue, in the first quarter last year.

We did incur some increases in personnel related costs and other expenses to support the R&D activities that we have going on, such as the ultrahigh brightness project, but a portion of the increase is also due to having fewer funded R&D contracts. But we were not able to utilize as much of our internal R&D resources against funded contracts. For the funded contract, we record the R&D funds as revenue, and R&D expenses associated with those contracts are recorded in cost of goods.

Moving on to the SG&A, the selling, general, and administrative expenses for the first quarter were $2.1 million versus $2.2 million for the first quarter last year. So they actually decreased. And this was due to lower bonus and stock compensation expenses, and this was partially offset by a small increase in legal expenses.

Once again, we’ve been pretty effective in keeping the operating expenses under control, but we always do that without sacrificing the R&D spending we believe is necessary to further our leadership in OLED microdisplay technology.

We incurred an operating loss for the first quarter of $1.6 million, continue to operating income of $322,000 for the first quarter last year. Adjusted EBITDA for the first quarter was a loss of $700,000 continue to adjusted EBITDA gain of $1.2 million in the first quarter last year.

Taking a look at the balance sheet, at March 31, we had cash, cash equivalents, CDs, and corporate bonds, which we include as a liquid asset, so I sort of include them in our cash number, totaling $8.3 million, continue to $11 million at the end of 2013.

During the first quarter, we invested $300,000 in additional manufacturing equipment, and we did increase the inventory on the balance sheet. Some of that increase in the inventory was due to the stop shipment, as we had these displays in process that we didn’t finish, and we ordered other product, got that product working on some different displays.

Continuing on the balance sheet, we had no debt. We continue to have no debt, and we’ve been self-funding for more than five years. We haven’t done any equity raises or suffered any of the associated dilution in the stock in the last five years. We have a strong balance sheet, and our financial position remains solid, despite our loss in the first quarter.

We believe the strength will help us to capitalize on expected growth opportunities going forward, such as the ultrahigh brightness OLED microdisplay market and the emerging personal head-mounted display market.

So our outlook for the balance of 2014 is that we anticipate higher average revenue per quarter during each of the remaining three quarters of 2014.

With that, I’ll turn it back over to Andrew for some further comments on our industry leading technology.

Andrew Sculley

Thanks, Paul. As a reminder for those of you who are new to imagine, our active matrix OLED microdisplay technology - and sometimes you see that written in the industry as AMOLED - this technology leads the industry in a number of important areas. First, we offered the highest brightness in both monochrome green and also yellow, I should mention, and color. These displays have very high contrast, even at the extreme end of the luminance.

These high luminance displays have the advantage of lower power for normal luminance and longer life times. That is, a 5x improvement in power and a 13x improvement in lifetime for the monochrome displays running at a normal luminance.

As we have mentioned before, we are working on an ultrahigh brightness color display. For reference, the highest high-brightness color display we have today, called the XLS, is rated at 1,000 candelas per meter squared, or [nits]. And just as a reminder, your television is probably 350 nits, or if it’s a very bright one, maybe 450.

The new technology, this ultrahigh brightness color, will be above 5,000 nits. Today, we are working on a low resolution demonstration that we expect during this half of the year. Next will be high-resolution prototypes that we expect to be available in the second half of the year.

We’ve already demonstrated our technique of patterning for two colors, so we feel confident that this is a successful path forward. We are very excited about this. Our progression for our technology is illustrated by these new technologies. Often, we produce new products for military use. Today, fighter jets and helicopter pilot helmets use monochrome green displays. Our displays will work very well here, because of the high contrast.

Today, the fighter pilots use LCOS displays, which is liquid crystal on silicon, and they’ve complained about the LCOS displays that are in the helmets today. They’ve asked the military to eliminate the green glow when the display is turned up bright. This screen glow is the result of relatively low contrast, and by that I mean very simply, when the display is running brightly, you can’t turn off precisely all the other pixels, so everything appears a little greenish.

And that’s because the contrast ratio of an LCOS display is about 1,000:1 at best. Our monochrome green display has a 50,000:1 contrast ratio. That is, you can turn off the pixels, even when it’s running at 17,000 nits and above. And it also has about 100,000:1 contrast ratio at normal luminance. Again, these fighter pilots want to see these very bright icons during the day, and they want to see night vision at night, so you have to have a full range with these displays.

To our knowledge, this performance beats any display in use today. The companies working on avionic helmets have also asked us for color, hence our ultra brightness color displays will work for these avionics applications. But here, we need to continue to extend the brightness range for color beyond 10,000 nits. You’ll recall earlier I said our first displays will be 5,000 nits and above.

Outside the military, there are many companies working on augmented reality near-eye applications. You may have heard at least of one company, if you follow microdisplays. At CES earlier this year, we saw about 30 companies discussing their augmented reality near-eye headsets. Our color displays of 5,000-plus nits will work well here.

Many of the current headsets use LCOS displays, and for consumer applications, they will experience the same issue that the fighter pilots do, caused by low contrast, hence our color displays with their outstanding contrast, low power, and great environmental stability will have a great advantage here too.

I should mention that as far as we know, no other OLED companies can produce ultrahigh brightness color displays of 5,000-plus nits, and at our very small pixel sizes. To the best of our knowledge, the other microdisplay companies do not have a viable direct patterning technique for OLED, and the companies producing cellphone or TV sized OLED displays cannot pattern the OLED at our small pixel sizes. We are uniquely qualified to advance in this market for ultrahigh brightness displays.

Now, I’d like to update you on our other progress. We have a digital SVGA display that we’re discussing with customers. This display will provide our customers with all of the advantages of the latest technology we have built into our digital displays, including things like automatic correction over luminance and temperature for color, full dynamic range for low luminance, and the virtual elimination of motion artifacts.

This display will ultimately take the place of our SVGA Plus display, which is our largest seller today. It is in qualification testing and we expect to release it for production this quarter. We already have delivered prototypes to a number of customers who are looking at the display for their next-generation equipment.

The SXGA096 is a 9.6 micron SXGA, hence it is smaller than our current SXGA. Its size is about the same as our SVGA Plus. Again, that’s our current major selling display. This means that ultimately it will be similar in cost, but at a higher resolution. We have samples that we are evaluating. Our customers are also interested in looking at these.

On the last earnings call, I mentioned that we have delayed the SXGA096 to capture a contract to build a custom display, and we, fourth quarter, successfully built this custom display. It’s in the hands of the customer for evaluation with an ultrahigh brightness OLED structure and the customer’s evaluations are going well. We anticipate the customer and we taking the next steps on this display.

Our color OLED XLS technology provides the highest brightness for color OLED microdisplay available in the marketplace today. It provides, as I mentioned earlier, 1,000 nits in full color, and is capable of a contrast ratio of 100,000:1. This allows our customers to use our display in see-through, augmented reality applications for military such as training and simulation, as well as commercial apps such as gaming, wearables, etc.

We have made some recent improvements in this structure. We never rest here. We’ve made these improvements that extend its lifetime. The full qualification of these displays with the new lifetime chemistry products remains on track for completion in the third quarter. We see very strong interest in this display from customers.

As a reminder, this OLED stack technology is available to all of our resolutions, from the VGA all the way up to the WUSGA. One other very important customer need for this very high brightness display is we have some customers that have outstanding optics in every facet, except they’re inefficient, and therefore the very high brightness OLED takes care of that inefficiency.

Not only is it high brightness, but it’s also power efficient, so it matches well with an inefficient optic. Of course, it matches well with an efficient optic.

We continued deliveries of microdisplay products to more than 85 domestic and international customers. These include display shipments for the FELIN soldier modernization program in France, BAE’s OASYS FLIR in Sweden for three industrial thermal camera electronic viewfinders, and BCF’s technology in Scotland, for ultrasound goggles for a large animal veterinarian.

We continue to see strong demand for OLED microdisplays in our key market segments over the next few years. We anticipate higher average revenue for quarters going forward in 2014 than we saw this quarter, based on successful implementation and resolution of the stop ship orders, and continued improvements in manufacturing processes, and also the new products we’re introducing.

Last week, we presented at the Sidoti Microcap Conference. We saw interest in the investment community in our ultrahigh brightness display potential for augmented reality applications and other applications. Those applications can obviously both be for not only augmented reality in the military, but consumer applications, and also avionics.

Lastly, I would like to mention that during the first quarter we entered into a settlement agreement with Global OLED Technology LLC, related to the patent license agreement. This final resolution extinguishes any current financial or legal uncertainty that may have arisen under the agreement. Furthermore, it allows us to continue to execute on our core business strategies without any contractual loyalty obligations on the sale of eMagin’s current product offerings, which do not incorporate any GOT intellectual property.

This completes our formal remarks, so we’d like to open up the call to your questions.

Question-and-Answer Session

Operator

[Operator instructions.] And our first question comes from Dennis Van Zelfden from Brazos Research.

Dennis Van Zelfden - Brazos Research

Andrew, I was wondering, I know that optimizing the new SNU machine is a continual process, but can you tell us, say on a scale of zero to 100%, where we are in the process? Are we halfway there? 75% of the way there?

Andrew Sculley

As you talk to our group, we have a target yield that’s very high. I’d say that our first step goal is to be where the Satella R&D tool used to be in its heyday, which was actually the beginning of 2010, and that’s when, if we had a problem, we would stop it for a week and tweak it, and then start it up again.

So we’re close to that scenario, but we really need to go beyond that. So the two pieces of optimization are uptime - I’m comfortable where we are today in that, we’re at where we expect to be. Of course I’m sure that over time we still want to improve that. We’ll never stop.

And on the yield, step number one, we’re getting much closer to where the step number one is, and that is, again, where the Satella was back in early 2010. And then we need to go beyond that.

Dennis Van Zelfden - Brazos Research

Given your industry-leading technology, and quite frankly you’ve been describing all these good things for many quarters in a number of areas, I’m just curious, how come, do you think, you’re not a $50 million to $100 million company by now? Why aren’t companies beating a path to your door with this demonstrably better technology that you’ve got? Could it be that you just can’t break out of the military market? Or do you think last year’s manufacturing issues have deterred some companies from seeking you out? Just big picture, what do you think the problem is?

Andrew Sculley

I think there’s two things to think about. If you were to go to another company in the microdisplay business - it doesn’t have to be an OLED one - and say what are the biggest markets, a very big market today is military, and the military has been not robust recently. All you have to do is go back to our major competitor, at least in the U.S. market, for military, and that’s our Massachusetts LCD company, and look at their revenues from 2010 until now, significantly.

But if you go outside the military, the great demand that people see in the future is for augmented reality headsets, and these are the ones that are out in the market today, in terms of prototypes, but not any large volume.

So I think really, we are a dominant player in the military, and that’s not just a U.S. statement, because we are about 40% outside the U.S., but we’re dominant in the military today. And tomorrow, we also want to be dominant in the commercial, and that commercial is not high-volume today. And by that, I mean the consumer commercial.

Dennis Van Zelfden - Brazos Research

Paul, a lot of things have negatively impacted gross margin in the past four quarters or so. Now that the machine is running much better, is it possible to get back to the mid-40s gross profit margins? Or has something changed permanently, whether it be cost, mix, volume, etc.?

Paul Campbell

No, I don’t think things have changed permanently. In fact, this quarter was a nice improvement in the gross margin. And as Andrew mentioned, we think we have some room to grow in yield, which will help the margin a lot. The other thing that will help the margin a tremendous amount is just sheer volume.

And you know, we’ve had a couple of lower volume quarters the last couple of quarters, but as soon as we get more volume, gross margin will improve a lot. So no, I don’t think we’re in a place that we can’t grow from. In fact, I expect the gross margins will grow, and fairly significantly, if we get revenue growth and yield improvement.

Operator

Our next question comes from Tom McGuire from [unintelligible].

Tom McGuire

You know, I quickly read the Q while listening to you guys, and I did like the new business section of the Q, where you talk about getting significant interest in your high brightness options, and that you expect I think it was between 2015 and 2020, to realize significant revenues in this area.

So my question is, regarding ultrahigh brightness options for consumer applications or commercial, however you want to define it, I see two limiting factors. One is getting the unit cost down to a level such that a mass market can develop, and two, getting production levels up to a level that you can meet demand and fill orders.

How difficult are those two factors? Just kind of educate me on what you see happening there?

Andrew Sculley

Let me start with the manufacturing costs. If I first start with the avionics, there you have a very expensive helmet, hundreds of thousands of dollars, and they want a special, big, even large pixel, display, so that’s maybe a few thousand dollars for that display.

Then, when we go to the foot soldier, we take that few thousand dollar price down by a factor of ten, and we have a much larger, instead of thousands of displays, you might have an order over a couple of years of 20,000 displays.

And then if you take a step down to the consumer application, now you have a much smaller display. So instead of having 60 displays on a wafer, you have 550 to 600 displays on a wafer, because these are smaller, and the price has to come down by another factor of ten, but then the volume goes up by many, many factors of ten.

So I think that you can envision, you can model, as we have, the manufacturing costs where can get down to where we can sell them to the consumer. On the production side, there are two pieces to that. One is the front end, with OLED. And remember, the front end manufacturing capacity and cost is a function of the wafer itself. So if we have a wafer with 550 to 600 units on it, you can have a much higher volume than if you have a wafer with 100 units on it. So that will help us there as well.

So we believe that with continued yield improvement - and we need continued yield improvement, I don’t want to say anything that’s not true, so we need continued yield improvement - I think we can meet volumes that are of that level, and for some of the high brightness things that we can make today.

The other manufacturing capacity in the back end, we can also get some help externally for that. Although we do the packaging in the U.S. today, for the military etc. on a commercial application back end, or packaging external is a very good idea, and they can help us with the cost and capacity.

Operator

Our next question comes from Aram Fuchs with Fertilemind Capital.

Aram Fuchs - Fertilemind Capital

I noticed in the Q that the delayed shipments started in April, the next comes in June, the resumption started in April, the next comes in June, and the next comes in July. Is there a particular reason inside your production schedule that is occurring? Or is it just customer needs?

Andrew Sculley

If I start with the first customer, the easy one, actually based on our current product, we and the customer convinced the end customer that it was okay to ship now. So as I mentioned, though, we’re still looking, we’re working on process improvements, which will apply to all our customers.

So that customer, we can ship now with no change in the product at all. The other one that we’ll be shipping at the end of June, we need to put those process improvements in place, and they need to have time to qualify them.

And that’s true with the third customer, and the reason that one’s going to take longer is we have an environmental hurdle to overcome. And that customer wants a part that is much, much higher reliability in very stressful environments, and that goes beyond what our part is meant to do, so we’re actually revising the part for them. That’s why they will take the longest.

Aram Fuchs - Fertilemind Capital

And is that schedule one of the reasons why you can predict increasing revenue throughout 2014?

Paul Campbell

Right, that schedule, along with the demand from our other customers, our forecast shows that yeah, we’ll have increased revenues in the remaining three quarters as opposed to first quarter.

Aram Fuchs - Fertilemind Capital

And then there’s nothing in the capex. Is there anything substantial this year?

Paul Campbell

Well, substantial? We do have a tool that we’re installing that will be able to demonstrate the ultrahigh brightness display. So it’s not terribly expensive, but that’s on the docket this year. And we have some other manufacturing needs, but not as high as in past years. Certainly not anything like when we purchased the new OLED [deposition] tool, which was fairly expensive.

Aram Fuchs - Fertilemind Capital

But if you get revenue going towards $8 million again, that would go into working capital, right? It wouldn’t be going out the door for another purpose most likely?

Paul Campbell

Well, we can’t foresee. We may need some additional equipment. It depends on how quickly we ramp. If we have volume needs that surpass our capacity, then you could see some capital expenditures around that.

Andrew Sculley

I would also add that some of the things that I spoke about were new equipment to accurately place material, but that equipment is maybe $100,000 type of equipment, so it’s much smaller in scale than something like the SNU. So that we are doing, and if we have an issue somewhere else, it may be something like that. We don’t foresee, at this time, except for the tool that Paul was mentioning, anything large.

Operator

And we do have an additional question. This comes from Jack Morebeck from First Washington Corporation.

Jack Morebeck - First Washington Corporation

Where does our backlog stand? Number two, in regards to your guidance to increased revenues, can we have sequentially more each quarter in the remaining three quarters? Three would be, back when you talked about getting the new machine, you were talking about doing ten times the volume that the old machine would do, and I worry about whether or not, if you are successful with the 30 customers that came to your booth, and your consumer application becomes more viable, because to me, given what’s going on with the military, that seems to be winding down, or harder to get new orders there.

But coming back to some of the other questions earlier, about the complexity or we have the wrong machine, or if you were to start over again, you’d never design the machine that you have currently. And are we in line to get any kind of financial relief from the manufacturers? Or was it just a poor design?

And one, the backlog, and two, can we get this machine up to a level where we could get commercial consumer usage, because they’re not going to get many orders until we get some capacity up. I know everybody’s frustrated, but maybe we’d be better off to get a new machine or go in a different direction or something, if all that you’re developing is so good that you just can’t get it out. So I’d like to have some more expansion and listen.

Paul Campbell

Let me try to answer the first couple of those. Regarding the sequential revenue, we thought about what we’d say, because the stop order had sort of an impact on that, because of the schedule that we have now laid out for the resumption of the shipments. It spills into Q3 quite a bit, where we don’t really resume shipments to one of the customers until July and the other one in June.

We didn’t want to make a statement about sequential revenue growth, although that’s certainly possible from Q1 to Q2. We’re only not even halfway through the second quarter yet. But we didn’t want to make a statement there, but we feel comfortable that the rest of the year will average higher than Q1. So we are very comfortable to say that.

Secondly, regarding the backlog, we don’t disclose on a quarterly basis what the backlog is in specific terms. Then we have the question on the machine.

Andrew Sculley

Yeah, on the new machine, there’s a couple of things to think about. One of them is the ten times the volume, that comes about on two reasons. One of them is that the speed of the machine is much faster than the R&D tool. So it’s easy to pump out 2 to 3 times the number of wafers in the same timeframe as the other one. Easy, I’m saying. And we’re not even pushing the machine today. We can do two and three times higher volume than the old machine, in terms of wafers.

The next thing is that the yield will be better, and the reason we estimate the yield will be better is because of the things I’ve mentioned. You can set the tool, and it goes on very well in terms of it doesn’t drift over time. It’s very uniform. So we expect the yield to get better, and we have a ways to go before we’re happy with that.

So those two things will allow us to do much higher volumes than we can do today. And the final thing is, if you’re talking about a consumer product that uses the displays we can make today, well, consumer products that you’re probably thinking about are augmented reality, wearable displays, headsets. They’re much smaller, so again, you have that factor of five in addition to what I just said, because there are 500-some displays per wafer instead of 100, so it’s a factor of five right there.

So we feel comfortable that we can do much higher volumes with the tool. And that shouldn’t stop us from thinking of other tools. For example, with some of the products that we’re working on now, we’ll need some additional capability. But that’s the future.

Jack Morebeck - First Washington Corporation

How many different prototype projects are we working on relative to potential orders from various customers that we’re not now producing [unintelligible]? Can you give some idea of demand in the future for the adaptabilities, or their capabilities of your OLED products? You mentioned one that you’re going down the line with, and it looks promising, and so far there haven’t been any setbacks. Are there any other prototype projects that people will come to you and see what we’re working on?

Andrew Sculley

Normally, for prototypes, there are two different types. One is, as we mentioned, we’re producing a digital SVGA. That’s not out in the market yet today. And a smaller XGA, that’s not out in the marketplace yet today. And we have those in the hands of numerous customers. Some of those customers are clearly military.

So those are prototype products today, in these customers’ hands, and to be honest with you, off the top of my head, I can’t tell you how many each of them are with. The other one that I mentioned earlier was literally a customer that paid us money to design a new display. And this new display, that prototype is in their hands. We’re also working on other prototypes where a customer will pay us some money to do a design, and we’re looking at that too.

I probably can’t tell you the number of new displays that are in the hands of new customers. That’s probably a tough thing to do. But we certainly have these new displays. And by the way, we wouldn’t build a new display unless we really saw a need for it, and we had the customers who are interested in it. So at least those two, the digital SVGA and the new SXGA, those are desired by the marketplace.

Jack Morebeck - First Washington Corporation

So given your product mix, and all the work you’ve done, and all of the OLED capabilities that you’ve developed, etc., can you see a point in time that you will be able to move away from the development type company? Or is it just going to be so long for the market to be able to come to this sophisticated level of new products?

Andrew Sculley

Well, no, if I were to look at the market for very high brightness, and that ranges from the very high end military avionics helmets to somebody wearing a small high brightness wearable headset, if I were to look at that and think of those 30 companies we saw at CES, which is the Consumer Electronic Show, who are all working on them in various forms, I think that market will be nearer term. I think you’ll see it in the 2015, 2016, etc. timeframe.

And even on the consumer side, Jack, I don’t know if I’m going to expect to see you wearing a heads-up display next time I see you, but I will bet you that you have read about these same type of displays being used in medical. There are news articles about that, and also industrial. So I think that will also add to it.

I think the commercial side is in the nearer term, next year. And by the way, there are other companies working on this [unintelligible] similar things, but not display companies, necessarily, but headset companies that say it’s coming.

Operator

Our next question comes from Tom Rath from Davidson Investment Advisors.

Tom Rath - Davidson Investment Advisors

Andrew, you commented on your progress in direct patterning, and I just want to make sure I understand what you’re talking about. You said you had the sets at two colors, and I assume the goal is to get to three colors. How much more difficult is it to get to that point?

Andrew Sculley

You’re absolutely right. The idea is three colors. And by direct patterning, just so everyone on the phone understands, today we use a white OLED material, so if you turn it on by itself, it will glow white like lights in your room. And then we put color filters down. Color filters are easy to pattern at the very small structures, 8 micron pixels, which have 3 subpixels in it. It’s easy enough to do that.

On the other hand, what you want to do, because the color filter removes, by design, two-thirds of the light, and really it’s not 100% efficient, so maybe you get 20% or 25% out. So we want to remove those color filters, and therefore, we need to put down little pieces of colored OLED, red, green, and blue.

So we’ve done two colors, and that has been successful. And we’re working on doing three colors. I think it’s plausible, easily. By the end of this second quarter, we plan to have a low-resolution demonstrator, so it will be almost VGA, not quite. And then for the second half of the year, we plan to have a prototype that is 9.6 micron pixel of all three colors.

And it’s not far-fetched. We did convince others like the military, who partially funded this, that it was the right way to go. And I know it’s difficult, and no one else has done it yet, but this is the right path.

Paul Campbell

Yeah, we think we’ll be first.

Andrew Sculley

Absolutely, we think we’ll be first. Now, just so you don’t misunderstand that statement, others, including in my past, when I was a member of a joint venture of Kodak and Sanyo, we directly patterned OLED displays. Samsung does too, today. But their pixels are so much bigger, and ours are very small. It makes it much more difficult.

Paul Campbell

We’d be the first microdisplay.

Andrew Sculley

Absolutely, and the first anybody to do it this small.

Tom Rath - Davidson Investment Advisors

So this is being developed under a contract from the navy? Is that correct?

Andrew Sculley

Well, yeah, it started with a contract from the navy, and now we’re on our own to finish it. And it’s a tough thing to do, but we’re getting really close. Two colors means we’ve proven that we can do it.

Tom Rath - Davidson Investment Advisors

So did you deliver the endpoint to the Navy that they were looking for?

Andrew Sculley

Well, we’ve got a little more work to do, because they really liked that prototype display. We’ll do a prototype for us, on one of our regular displays. The navy wants a special prototype.

Tom Rath - Davidson Investment Advisors

So you just mean you’re through with the funding portion of that?

Andrew Sculley

Yes.

Operator

And our final question for today comes from John Pearson.

John Pearson

I was wondering if you could educate me as far as how should I view the German Fraunhofer and their direct patterning news lately. Should I view that as a competitor to you guys?

Andrew Sculley

Well, Fraunhofer is using a different technique. They’re an institute that does R&D, and then wants to license it to others. We know the gentleman, two of them we know very well. So we’ll keep up to date with them. So I think I would describe it as a competitive technology as opposed to a competitor. We have a friendly bet that we’re going to win.

John Pearson

The direct patterning, I understand that it enables a brighter and more efficient display, but will it also enable a smaller pixel size eventually?

Andrew Sculley

Yeah, I understand what you mean. The limit to the pixel size is not the direct patterning today. The pixel size has multiple things, how much electronics you can stick underneath the one pixel. You have to have so many transistors and capacitors under each pixel and subpixel, so that’s really a limit today. The direct patterning is probably not a terrible concern to us with the pixel size.

John Pearson

And in the past, you’ve told us about your design reference kits, and how well they have sold in the past. Do you have any update this quarter? Is that still something selling strong for your new displays?

Paul Campbell

We did sell a number of design reference kits. I don’t have the exact number. We have talked about that in the past, and we just don’t have it here. I can certainly get that for you. If you want to give me your email address, I can send that information to you.

John Pearson

Okay, I’ll send you an email. My very last question - and if you’ve already talked about it, please just disregard the question - as far as the XGA display, are you finished with that display? And what is the current status of your opportunities with that display?

Andrew Sculley

We didn’t talk about the XGA at all this time. The XGA is, of course, the resolution that one would use for electronic viewfinders. We could sell the display today, if we had a customer that was significant for us. We actually haven’t seen the market develop in very high end electronic viewfinders that we had originally anticipated.

And when I say that, I mean the market itself, and not that we’re just losing that volume to others. There are others like Sony that put their XGA within the Sony high end cameras, but the other companies aren’t doing much of that. For example, Canon has not moved. Their high end cameras all have optical viewfinders and not electronic. We of course expected more customers or companies like Canon, Nikon, etc., to do more of the electronic.

So we can sell the display today. If we wanted to improve it even more, I think there’s some more work we could do on some of the electronics in the display - actually, I know this is going to be cryptic - that would improve the color gamut even more. But we got to the place that we needed to be on the gamut and the display itself.

Operator

Ladies and gentlemen, at this time I am showing no additional questions. I’d like to that this conference call back over to Mr. Sculley for any closing remarks.

Andrew Sculley

Thank you very much, everyone. I just want to also mention the important people, other than Paul and me. Obviously we’re not the most important in the company. The team itself is much more important, and they’ve done an outstanding job getting this machine from where it was to where it is today. We’ve got a yield team that has production technicians on it, on many of the teams, so a shout to Ruben and Mike. I had a review with their team the other day, led by Christine, so thank you very much for your effort in that.

Our new production VP Robert is doing an outstanding job. We have to thank Dr. Amal Ghosh for all of his effort on direct patterning, and Evan for helping him out. It’s an amazing team in New York, and Olivier and the design team in California.

But I’m in Bellevue, Washington today, as Paul mentioned earlier. This group puts out the financial reporting in an amazingly efficient way. They have a very small team, but Paul and the group manage to do an outstanding job. Business development, keeping our customers happy, even though we’ve had some difficulty with stop ship.

So I want to thank the eMagin team very much for everything they’ve done to get us to where we are. And we all know, every one of us, we have a long way to go. And we appreciate very much everyone on the phone call, with your questions. I assure you we will work like mad to get what we said here done, and we are optimistic of the future.

So thank you very much.

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