Vuzix Corporation (VUZI) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Vuzix Fourth Quarter 2017 Financial Results and Business Update Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this call is being recorded. Now, I'd like to turn the call over to Andrew Haag, Managing Partner at IRTH Communications. Mr. Haag, you may begin.

Greetings, everyone and welcome again to the Vuzix's fourth quarter and full year 2017 financial results and business update conference call. With us today are Vuzix's CEO, Paul Travers; and CFO, Grant Russell. Before I turn the call over to Paul Travers, 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 not limited to general economic and business conditions, competitive factors, changes in the 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 represents management's estimates as of today, March 19, 2018. Vuzix assumes no obligation to update these projections in the future as market conditions may change. Yesterday afternoon, the company issued a press release containing its financial results and the company filed its 10-Q with the SEC. So, participants in this call who may not have already done so, may wish to look at those documents as the company will provide a summary of the results discussed on today’s call. After the market closed on Friday, March 16, 2018, the company issued a press release announcing it's financial results and filed it's 10-K with the SEC. So participants in this call, who may not have already done so, may wish to look at those documents as the Company will provide a summary of the results we discussed on today's call. Today's call may include non-GAAP financial measures. When required, reconciliations to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found in the Company's Form 10-K, annual filings at www.sec.gov, which is also available at www.vuzix.com. I will now turn the call over to Paul Travers, who will give an overview of the Company's fourth quarter 2017 financial results and business outlook for 2018. Paul Travers will then turn the call over to Grant Russell, Vuzix's CFO, who will provide an overview of the Company's fourth quarter and annual operating results. Paul Travers will follow Grant Russell and provide closing remarks. And we will open up the call up for Q&A after managements update. Paul?

Thank you, Andrew. Hello everyone, and thank you all for joining our call today to discuss the Company's fourth quarter financial results and business outlook for 2018. I have a lot to share during the call and will start with our activities around our Waveguide Optics and the Vuzix Blade. This is a technology that we feel ultimately will drive much of the future of what we do with Vuzix. After Grant discusses the fourth quarter and year-end results, I will then provide an update on our efforts in the enterprise space and outlook for 2018. CES 2018 marked the beginnings of one of the more significant events in our Company's history for a number of reasons; so I'd like to start the overview here. Vuzix Blade; we asked folks the blade does as a matter of fact truly support Amazon Alexa was showcased to over 4,000 industry professionals at CES 2018 and the related Pepcom President there. And, then in late February it was shown publicly again at Mobile World Congress in Barcelona, Spain with the Pepcom and Showstoppers President in recently at South By Southwest. In mostly all cases that was received by almost everyone with general amazement, as folks felt they were truly "viewing the future." The Vuzix Blade is differentiated from anything in the market and that delivers a highly useful Smart Glasses experience and a form factor that people would actually want to wear; by most measures Vuzix's Witness Blade offering has done what no other company has been able to achieve thus far. These events drew much attention to Vuzix, that by way of example grew Vuzix's product article page views at January 2019 to 4.1 million views versus 400,000 in January 2017, that's a 900% increase in industry media exposure, all of our external communications firms in Europe and the U.S. did an excellent job at helping to get the message out and coordinated great meetings with the press. The Vuzix's Blade effectively went viral in the press due to the exposure and clearly how well it was received. The headlines were very favorable with just a few examples like from The Verge, they spent almost an hour at the booth the Pepcom by the way, they were just all over the Blade. Anyway "Vuzix played AR Glasses are the next-generation Google Glass we've all been waiting for." And from the quote of Mac; "If I were Tim Cook, I'd take a long hard look through the lenses of Vuzix's Blade. I think you can see the future through them." And then finally, from Gizmodo, "Holy crap, actual working AR Glasses that aren't completely…" We also received a pile of best of AR Awards at these shows with folks like Tech Radar, The Headline from a piece they wrote said; "Vuzix Blade glasses will undoubtedly blaze the trail towards logical, approachable AR for everyone" with Amazon's Alexa digital assistant steering the wheel. The Vuzix's Blade Edge Developer Program was also kicked off in January to great success, and we have already made some early shipments of Blade products to participants in this program. We have started our second engineering production batch and sooner after our first 1,000 piece production bill will commence, and we're expecting we'll go to developers and other key customers whose early adoption we can further leverage once the blades more formal release begins by summer and into broader distribution and availability throughout our markets. Our message has been consistent over the past several years which is in order for the mass market to start adopting AR Smart Glasses in a meaningful way, the technology must effectively disappear and the Vuzix's Blade demonstrates that it can be accomplished right now. And as good as we believe the Vuzix's Blade is, we're just getting started with AR Smart Glasses. Many folks on the call may be aware of the term Moore's Law and it's promise of the doubling of semiconductor chip performance every 18 months while reducing the size and power by a factor of 2. Well, Moore's Law does not apply to optics, and on top of that much of the conventional optics being used by others in the AR industry today have been around for hundreds of years; optics in the physics of light and it's transmission is extremely complex. Using this overtech [ph], we believe can be near impossible to be a near impossible challenge in limiter for the design of any AR glasses that don't end up looking like a science project. Some of the world's leading companies despise this point. For example; where outcrashed [ph] a partner, Optical Architect at Microsoft Hollow Lens said, "unlike electronics, optics do not follow Moore's Law, and is proven to be one of the hardest challenges to solve in AR/VR hardware." Tim Cook, CEO of Apple in an interview with The Independent in October 2017 said the following about augmented reality and optical displays; but today I can tell you the technology itself doesn't exist to do that in a quality way, the display technology required, as well as putting in a stuff around your face, there are huge challenges with that; the field of view, the quality of display itself, it's not there yet. Clearly, some folks still haven't seen the Vuzix's Blade yet. Around the Blade and our waveguides Vuzix's has built an extensive patent portfolio in excess of 100 patents and patents pending in areas of optics, head mounted displays in smart glasses. In addition to developing an extensive patent portfolio, the Company has practically invested north of $100 million to advance, develop and bring the Company's proprietary waveguide optics technology to market. Along the way, we have gained years of manufacturing know-how and developed proprietary processes, trade secret materials, some of our "secret sauce and custom equipment" to allow us to design and manufacture some of the world's highest performance waveguides available. We believe our waveguides are world's best-in-class. A common question from Vuzix's has sometimes been, how will the Company compete against the largest consumer electronic titans in the world when it comes to AR Glasses? I can confidently say to you, that in the enterprise space, we do a fine job of just that today. And in the consumer space, Vuzix's will have it's own offerings but also we expect to capitalize on the tremendous opportunity to supply and work with a select group of some of the world's largest tech giants as AR Glasses become ubiquitous and replace the smartphone over the next 5 to 10 years. In some cases, like our recent relationship with Toshiba, we are being asked to supply a finished smart glasses product; with others, our venture relationship would be more focused around Vuzix's being a key supplier of our waveguide and associated optics and display engines. The value proposition, an advantage of Vuzix's optics compared to the competition is rooted much deeper than the surface of a couple of millimeter thick waveguide that are nearly indistinguishable from regular eyeglasses. Our waveguide optics and display engines, and the revolutionary technology path we're on beyond today offer a number of significant advantages over other wearable display optics solutions; including high contrast, true see-through capabilities, a critical spec when the display isn't on which I'll describe a bit more in a minute, less weight, more compact size, and high brightness images for use indoors or outdoors. This gives Vuzix we a substantial advantage over other competitors because it allows us to produce optics that are fully transparent even when they are off; think about it, how many folks put their sunglasses on and take them off and are constantly cleaning them because they don't like the smudge they have to look through. Many of our competitors with the display turned off places stuff in front of you that blocks the view, that makes it look like you're looking through a haze, etcetera etcetera. When our waveguide are off they are absolutely clear, and when they are on they are absolutely beautiful. High brightness -- they produce the high brightness required for AR and for enterprise Smart Glasses applications, so on and off these babies function perfectly. Put together, our waveguides and optics engines provide what we believe are the smallest packaged solutions available today and provide the most degrees of freedom around the industrial design of a finished pair of AR smart glasses. It's important when you're doing a design that these things don't look like the digital glasses that are 3D shutter glasses that's flat across the front, they really look odd, we can tilt and angle and Chevron -- there is a lot of tech that goes into making that work. In Vuzix, again, it's wrapped around the axle of all of this technology we've built over the years. But even more important than what I've laid above, Vuzix has technology, equipment and processes in place to manufacture our waveguides in volume and at price points that should enable the mass market today. There is currently not much competition with see-through and optics; some are able to make a handful of devices in an R&D lab demo but lack the ability to scale a manufacturing process consistently and economically to produce hundreds of thousands, if not millions of waveguides. This appears to be a major hurdle for most of Vuzix's competitors on the waveguide front. Our facility in Rochester, New York is already equipped with waveguide automation and replication equipment capable of producing upwards of 400,000 waveguides annually. Our existing facility can profitably accommodate the installation of 6 more production cells which should push our annual capacity to well over 3 million waveguides. In terms of manufacturing readiness, we believe we can qualify and install an additional 2 million waveguides worth of capacity in less than 6 months. We're prepared and on a path to be able to deliver over a million waveguides in the AR smart glasses space by the end of 2018. Our ability to reliably and cost effectively produce waveguide optics and volume has garnered the attention of many of the industries key players. As a result, Vuzix is seeing a dynamic business opportunity growing around our waveguide optics technology with several distinct go-to-market pass. This is not only as a leading supplier of smart glasses such as the Blade, but also as the go-to-market supplier of high volume waveguide optic systems for a select number of OEM partners. The amount of interest from major industry leaders in what we are doing here at Vuzix has kept us rather busy since the CES. We believe our ongoing meetings with some of the largest companies in the world is not only validating our unique ability and expertise but it's convincing us to accelerate our waveguide optics go-to-market commercial roadmap and strategy. Unfortunately, the bulk of these efforts have to be kept highly secret and confidential because most of these players want their product deployment planning kept secret for competitive reasons. The little I can say is that we are now in discussions with over a dozen potential OEM partners, with several of these companies engaged in technology and supplier due diligence related to our waveguide optics and display engines for their AR hardware product roadmaps. We believe Vuzix waveguide technology will help refine our commercial plans around Vuzix as a critical supplier and are optimistic that we'll have multiple new collaboration agreements related to our waveguide optics in 2018. The capital raises in December and January solidified our balance sheet and provides Vuzix the financial strength to better negotiate and respond to potential large scale customer needs as we scale our waveguide optics manufacturing capacities. This is very opportune for us as it seems company after company is clamoring to devise a product roadmap and participate in the next wave of computing in the form of AR smart glasses. It's truly a horse race of consumer electronics thorough brands that are winning up at gate to create and offer AR solutions. As you can see, this is our exciting stuff for Vuzix and the combination of years of development efforts by our teams. I'd like to now turn the call over to Grant, and again, I will then follow-up with a review of our enterprise business and future outlook. Grant?

Thank you, Paul. Before I begin, I'd like to encourage interested listeners to review our 10-K that we filed late Friday with the SEC for more detailed explanation on some of the annual year-over-year variances as I will be highlighting just a few. And as everybody knows, we do file our financial reports in dollars but I'm going to comment on the operating results in millions this time. For the three months ended December 31, 2017 Vuzix reported $1.6 million in total revenues as compared to $0.6 million for the same period in 2016, an increase of 168% year-over-year. Quarterly sales have now increased 7 consecutive quarter stating back to Q2 2016. The year ended December 31, 2017 Vuzix reported $5.5 million in total revenue as compared to $2.1 million for the prior year, an increase of 160% year-over-year. Overall, quarterly and annual revenues were up primarily as a result of much stronger M300 smart glasses sales, sales of engineering services related to the work we did for Toshiba, and finally a much stronger waveguide component revenues due to increased development activities with our existing OEM engagements. We reduced our gross loss from sales in 2017 to $0.7 million versus a gross loss of $1.2 million in 2016. The improvement was primarily a result of higher revenues to absorb the overheads and improve the direct product margins which actually improved 5%, and that's even with the fact that we're selling our eye-wear at zero margin currently due to prior rate downs. Overall, research and development expenses for the 2017 year decreased to $6.7 million as compared to $6.9 million for the 2016 period. This decrease was mainly due to the reclass of internal salary costs from R&D operating costs to engineering services cost of sales related to the Toshiba engineering project, and decreased M300 development cost as compared to 2016. It should be noted that such reduction in R&D expense is not contemplated for the 2018 period and we currently expect R&D expenses for the year to increase but we won't be reclassing internal wages to cost to sales. Our operating expenses related to sales and marketing increased 5% due to the commercial launch of the M300 and additional staff. G&A expenses for 2017 were $6.1 million as compared to $5.1 million in 2016, with the increase primarily being due to the hiring of new staff during 2017 offset by a reduction of $0.4 million in the R&D and shareholders communications costs. For the full year, the net loss for 2017 after the provision for accrued preferred stock dividends was $21.3 million or $1.02 per share as compared to $20.9 million or a loss of $1.23 per share for the full year of 2016. Now for some balance sheet highlights; our pro forma cash position as of December 31, 2017 was $43 million and that's inclusive of our common stock offering that closed on January 29, 2018. The company now has clearly enough capital to operate and execute on it's business plan for at least the next 12 months. Cash used in operations including changes in the working capitals operating analysis totaled $16.5 million in 2017 as compared to $14.4 million in 2016. Cash for investing activities was $2.7 million versus $2.2 million. The increase was for IP and related license purchases along with $0.4 million in capitalized software development costs related to the new Vuzix's basic Smart Glass application suite. To close up my comments with the growing demand for the shipments of the M300, as well as the introduction of our Toshiba and Blade Smart Glasses to the market, we expect to see cash flows improve as our revenues expand in 2018. With that, I'd like to turn it over to Paul Travers. Paul?

Thank you very much, Grant. Our enterprise business continues to grow at Vuzix, M300 sales continue to increase in Q4 and we expect the level of business activities around the M300 spend to expand throughout 2018 and beyond delivering enterprise-class smart glasses to businesses increasing their efficiencies, knowledge, capture and service levels. Between Q4 in this call, the underlying market for Vuzix smart glasses has picked up steam and it is represented by an increase with some of our key sales metrics and activities which is a strong indicator for future sales growth. We made further investments in our enterprise business in Q4 including adding top level sales talent and adding to our CRM and marketing tools and enhancing our ERP and supply chain software system, as well as investing in pre-sales and technical support. We invested in and launched the Vuzix's basics application platform to help accelerate the customer pilot phase and to reach the previous [indiscernible] small business market who couldn't afford a custom solution just yet. We increased our active pilot programs by approximately 150 pilots since the last conference call, an increase of about 40%. We have increased our VIP partner network by 35% and furthered our global reseller network. We have also qualified more sales leads in the last 4 months than we did in all of 2017. Our Top Tier VIPs have been ordering with a significantly higher frequency and in larger quantities. Orders directly between Vuzix and large enterprise organizations are also increasing including a large order that we delivered to a Top 5 life sciences company for a global deployment. We are in final stages with a large aviation services company for what we expect will be Vuzix's largest deployment of M300's to-date. And our inbound RFPs have also accelerated in 2018 with line of sight to multiple first half deployments that we expect to start deploying in the second quarter; these activities we believe should lead to significant enterprise ales growth in 2018, especially in the second half of the year as the M300 platform continues to be the smart glasses hardware of choice for the enterprise market. We're also seeing a fair number of companies that may have initially chosen glass or ODG hardware coming back to Vuzix as their company readies itself for larger global deployment of smart glasses. For example, smart glasses hardware has to work for 100% of the workers, we have a large aviation partner leading glasses for the Vuzix's M300 for their large scale deployment because our hardware works for left and right eye users. Diverse wearable platform that the M300 delivers also was pivotal for a large pharma company realizing that Vuzix M300 could support being the one smart glasses device they needed to deploy to 16 different used cases; we were not talking about just one here folks, these guys are using in a lot of different areas and again, with all of the accessories and the way our system is designed, it's so flexible that it seems to fit just about every used case out there. Another company is coming back to Vuzix with a planned 700 unit roll out at half the price of their ODG pilot hardware shrinking their expected ROI payback period in half. These are just a few of the reason opportunities that exemplify that Vuzix is the first choice in terms of hardware platform and enablement of true large-scale deployments. On top of this growing success, we're very encouraged with the launch of Vuzix's basics application platform. The first of these applications Vuzix's basics video was launched in Q4 and is the first application in the platform. Vuzix Basics video out-of-the-box allow it's companies to click, connect and collaborate using our M300. We worked with several large enterprise clients including to GE Aviation, ATV, Lifecycle Engineering and Vibco [ph] to trial the application in their real-life operations. With their feedback and success in Q1 2018 Vuzix made this offering downloadable from our Vuzix App Store as an add-on SaaS solution offering that has annual subscription fees. Vuzix Basics video sales continue to gain steam, as evidenced by our increases in pilot programs since Q4. Vuzix Basics video is enabling pilot and POCs in large enterprises and opens the door to small businesses that are buying this application directly from Vuzix. This is important that small businesses make up a large part of the industrial and field service space from a headcount perspective, and these organizations see immediate value in the Vuzix M300 with Vuzix Basics video solution. This sector we believe is an untapped market for smart glasses, primarily because of the significant efforts to get a quick win with smart glasses, and Vuzix Basics video solves the problem. This is also opens the door for our VIPs as the ability to deliver a smart glasses PLC in hours, days at the very most and the large enterprise gets that quick win on the books much sooner leading the desire to expand to more structured enterprise appointments that the VIPs will drive. Vuzix plans to add more of Vuzix Basics applications over the course of 2018 to expand these business offerings and based on the initial success of VDV begin to more aggressively market to small businesses, similar to the strong interest we received from the largest consumer companies in the world related to our waveguide optics technology, Vuzix has also witnessed an influx of inbound requests for collaboration from some of the largest organizations in the world that want to deploy the Vuzix's Blade and it's waveguide optics technologies in their organization to drive their industry 4.0 initiatives and comprehensive digital transformations. Companies are putting a focus on how to leverage augmented reality in their products and services in the overwhelming media attention from both CES and Mobile Congress regarding the Blade has opened a whole new series of opportunities for Vuzix and enterprise. Having a comprehensive wearable computing and AR solutions platform will allow a company to enable important parts of their entire value chain, all ideally supported with Vuzix's AR smart glasses devices across the board. Since the launch of our developer program and CES, we have witnessed a jump in requests for NDAs, non-disclosure agreements, as well as master service agreements, MSAs in enterprise. What we are hearing from these organizations is that a lightweight consumer-friendly stylist pair of AR smart glasses like the Vuzix Blade can be embedded into critical, differentiating and proprietary used cases for the businesses. These large organizations see the Vuzix Blade as an ideal part of their solution and this spans a range of used cases that is amazingly diverse. I wish I could say even more but even described in the used cases is violating any agreements we have in place. Again, there is so much more I'd love to be able to share but what I can say is, we're being told by a large number of customers and prospects that Vuzix solutions have the potential to transform their business and deliver competitive advantage and they are in a race to prove our solutions and afford them across their businesses. Finally, last week Vuzix announced that we are now producing our M300 type C smart glasses for Toshiba in volume. We coincided with the receipt of the first initial purchase order from Toshiba for just under $1.1 million. This cobranded pair of smart glasses is the first Windows-based smart glasses solution in the market, and we believe this product will be received well by our customers and theirs. The initial purchase order from Toshiba is the first of several orders we expect from Toshiba to satisfy the $5 million purchase order minimum for this products specific exclusivity. Our partner at Toshiba are very excited to start selling the device in volume and we are looking forward to meeting their needs in our beginning discussions on further new collaboration between companies on different products at the same time. In summation; as you can gather from management's comments there is a tremendous amount of awareness of Vuzix from enterprise customers and strategic partners alike. We feel 2017's tech team established Vuzix as a leader in the enterprise space on many fronts. Vuzix set new records for revenue, added several new OEM partners, chips added significant strength to the Vuzix's team through the addition of talented new employees and broadened our intellectual patent portfolio of 100 patents and patents spending; also importantly, Vuzix now has the financial resources to execute on it's plans for the next 2 to 3 years and greatly grow it's business. 2018 should be fueled by increased M300 enterprise deployments, revenue contributions from the Toshiba M300C, Vuzix Basics video and Vuzix Blade which will enter the market in a big way along with new and growing strategic partnerships, all of which we expect will position the company for stronger growth in 2018 and beyond as Vuzix continues to pace the way in a multi-billion dollar, hundred plus billion industry and that's the leader. Now let me pass the meaning to Andrew to begin the Q&A session. Andrew?

Operator, we will now open the call for question-and-answers, and if you can remind everyone how to prompt for questions, that would be great.

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

Can you give us an idea of a multi-year timeframe -- what you're kind of thinking in the thousands of units that you anticipate being able to sell in the Blade versus the M300 and categorize which one of those two you think would be bigger than the other?

Grant, you want to take the numbers part of that one to start?

Sure. At this stage, I mean -- we're not -- let's go in providing unit sales guidance but I can tell you that we do have the supply chain running to build M300 and 1,000 to 2,000 per month range and we have our planning all the way out for the next 25,000 pieces and that will take -- either take -- could take a year or could take two years. And then for the Blade, we -- our current production plan is for a minimum of 10,000 pieces in 2018 and hopefully that could be a multiple but component lead times for some of the new tactics in these things that can be fairly long. So in the short-term, clearly, we believe the M300 is going to be the leader and but the Blade should rise and the indications as Paul mentioned. Enterprise to the consumer side is looking pretty solid, so we could be pleasantly surprised and see that match or maybe even exceed the M300.

And my last question has to do with the waveguide optics and potentially selling those to others. Can you give us an idea in a multi-year timeframe with greater than already a dozen partners -- the opportunity of that product?

When we first say that Vuzix to be clear is going to be in this business selling finished products. There are select partners that we're talking with right now that would be very synergistic with what Vuzix does and it would be good for Vuzix to be in their products and in those cases, these guys are -- some of them have been in development for a bit now and some of them has sounded consciously, publicly, but odds are this is going to be a 2019 kind of deployment for most of these guys, a lot of them are just getting started although I have to say some of them are really pushing fast into their development programs. And the kinds of numbers, I mean this is -- the guys that we would enable are in sectors of the consumer electronic market that could represent millions of units for Vuzix. So I would suggest that you hear about development efforts more or so in 2018 from an OEM perspective, and then deployments in 2019.

Our next question comes from the line of Brian Kinstlinger with Maxim Group. Please proceed with your question.

With 1Q almost done, Grant, can you tell us how many pieces have shipped thus far in the first quarter excluding Toshiba?

Brian as I said, we don't disclose or unit sales currently at this time. So we're tracking ahead of last year's quarter, I can tell you that.

I would hope so, right.

I mean, I really am not prepared to answer that.

How about the Toshiba relationship -- you've made an announcement on that one, can you talk about how you expect that to ramp through this year?

Well, they like I see -- there is going to be sometime between first deliveries to a customer and rollout deployments with their Windows-based product. They are targeting some very large enterprises; so the speed of that -- I mean, we will see but I mean it should be a nice steady increase this year and we -- I can't share forecast with you but it could be a pleasant surprise, we did indicate in the contract there is the $5 million of required purchases for them to maintain their one-year exclusive. We expect that will be achieved and they've shown us indications of multiples of that but time will tell.

And do you recognize revenue from Toshiba when you shipped them product or when they ship their product to users?

When we ship to them because they've brought it and taken title of the product.

So will there be revenue in this first quarter?

It's going to be tight, we picked up production and it can take 2 to 4 weeks to get the product flowing off at the end of the line; if they can do it in a shorter period than yes, otherwise that will be Q2.

And then we saw -- as you discussed, negative gross margins, it decreased obviously this year but can you talk about when you'll see a normalized margin? And then, can you talk about how much fixed cost is in gross margin versus the product margin?

If you refer to the Q, there's -- I mean the K, on -- there is a table we have quarterly and annual tables regarding our composition of cost of goods and you'll see there some of the fixed items are clearly, the manufacturing overhead freight are fairly variable, we have warranty and we've had been having amortization of software development costs and royalties. The amortization of software development cost that was completed at the end of September and that related to the original smart glass OS; now we're investing in software development costs related to Vuzix Basics, so that will start flowing back through cost to sales when we feel all that software is completed. But as I briefly mentioned, the eye wear is currently being sold at cost because we've written that till sums down. We've got about another $120,000 worth of cost of goods for that -- the flow through the income statement but thereafter then, we should be getting to more normal -- on more normalized basis but the first $1.5 million of gross margin pretty well gets eaten up by our fixed overhead costs. Then after that we have the contribution from the product sales and that's strictly a matter of volume. We would expect -- clearly in 2018 to start going back to a positive overall gross margin.

And that's in the first quarter?

No, I said in 2018, it's not going to be in the first quarter.

And then in terms of the M300, can you talk about how many -- what the product margin is? You said it's gone up and then I didn't take a look at the K. And then, can you talk about how many were shipped in the first quarter? I mean, sorry in the fourth quarter, sorry about that.

As I said previously, we don't really see unit sales; I mean, our average sales price, we've disclosed some of the revenue numbers, you can work back from that. I mean we're still not shipping clearly thousands per quarter but the average selling price is around $1,100 so you can do some math backwards. The margins are improving; as I stated in for the year, they improved by 5%, even with the eyewear. We're expecting those numbers should grow into the mid-50's with our -- once the eyewear is out of the game, so I hope from a product standpoint we still feel we'll be achieving in the mid-50's on the actual smart glass sales.

And is that timeframe and by mid-2018 to mid-50s or is that…

Yes, we should be there by mid-2018 for sure.

And then, can you talk about the priorities with the increased capital -- what are your top couple of priorities? And then with that money, how many shares now outstanding and then, options and warrants in addition?

The front of the 10-K has got our number of shares and I think -- what we've got here -- I think we've got $27.3 million is our current share count. There's about warrants that were issued in the last two financings, so I think they're about a little over $2 million, and then stock options about $1.5 million. Clearly, we still have the Intel-preferred shares outstanding which are convertible, and there is about $25 million worth of those and they converted $5 million to shares; so potentially there is another 5 million shares worth of dilution there. What was the balance of that question?

The priorities of your capital; I think you've been capital constrained for a long time now that you're not…

Yes, I mean -- I see, clearly, general working capital but we do not have any direct plans for any acquisitions or major expenditures other than we want to expand the capacity of our waveguide production, we have some new products where -- that are coming along, we want to do a little more and go faster on R&D because we feel we have some new technology we want to capitalize and get the market a little quicker, and make some strategic hires within the organization to complement all that. But I mean, at this stage we don't expect it to keep it on the balance sheet, invest in the short-term money and have it on-hand when we need it.

I'd like to add just a little bit of color on the Toshiba effort. So Toshiba actually has been in the market with select accounts for some time now, they're in very short number of units, maybe like -- I can't tell you the exact numbers but 50 to 150 kinds of numbers where they have been sharing already and letting people use and using their software, and they've gotten a great response from those firms and so there has been some seeding already happening.

Thank you. Our next question comes from the line of Jim McIlree with Chardan Capital. Please proceed with your question.

Can you share with us how many eyewear units you have in inventory; i.e. how much we still have to sell before we get those?

We've got about 1,700 units.

And you think -- if I understood the answer to a previous question correctly, you think you can get rid of them by the middle of the year; did I hear that right or…

That's our intention, yes.

And R&D in Q4, I know there is -- you had some things going on there, $2.3 million, is that a good level going forward or is or that -- they're going to go up or down?

It probably is going to be at least that level going through 2018 or maybe one at couple of $100,000 markets; there still was some modest re-class of some internal labor from -- on the Toshiba project.

And then I was just hoping that I could -- you guys could explain a little more detail on the M300 timeline; pilots -- are they paid pilots, kind of like what the size of these pilots are to-date either -- let's call in terms of units per pilot, just kind of a general number there. And then, what you think the rollouts might look like -- so let's say if a pilot has 10 units, the rollout is going to have -- to make up the number 10x of that. And is there enough experience yet to talk about adoption rates from pilots to production rollouts?

The pilots really vary; some firms are significant numbers, north of 50 pieces actually; some are 2 or 3 just to get the tests drive going. The rollouts in some cases -- we're talking with folks that are in the thousands of pieces; in other cases it's just smaller, 100 to 500 kinds of numbers. And it really depends a lot upon the form whether using it. In some cases, I mentioned on the call that there is as many as 16 different vertical areas within the firm that they're using these glasses, and these firms are massive, they have hundreds of thousands of employees, not every one of them clearly would be using the glasses but they could get deployed in a pretty significant way. There are other firms that have outlets around the world to the tunes of 4,000 or 5,000 outlets they need to have one or two systems. So really is very, very broad -- the number of units a pilot could turn into. Folks here in the sales team have a funnel and they work that funnel backwards and there is [indiscernible] in a bunch of different buckets as to where they could end up.

And it's obviously very encouraging and bullish that you've increased the number of pilots; I'm just trying to translate that into pilots for a month turns into rollouts 6 months down the road, 9 months down the road; do we have experience yet to really have a firm estimate on timing from pilot to rollout?

Again, that also is pretty broad because it depends upon -- again, the smaller pilots with smaller firms have a tendency to be in the work faster, the bigger guys take longer and it can take anywhere from several months to almost [indiscernible] 15 to 20 pieces, the best of size of the business in the small firm and then it's a rollout, right on through the many months, 10 or 12 months, even sometimes a 1.5 year plus kind of numbers.

I'd say 6 to 9 months for the big companies.

And then on the Blade; it sounds to me like -- well, I'm confused as to what your initial focus is going to be; is it going to consumer or enterprise? And on the enterprise market, I'm assuming that you're targeting or your channeled market is similar to M300? But if it's consumer, what channel are you contemplating using?

It's focused first on enterprise, we have very clear requests in business opportunities there. It's in the mix of M300 activities that we already are doing, the developer community already knows Vuzix, we're in the process of building out an ecosystem around the Blade that ultimately the average Joe [ph] is going to love, but it's going to take more time to get there but there is a plenty of business on the consumer or on the enterprise side right now that we're seeing. Again, as I said in the call -- my comments; there are folks now that are saying I want to use this across -- Vuzix's products across our used cases, so there is places where folks are B2C oriented where they've got an outlet -- where -- kind of like in Amazon where they would have brick-and-mortar store, they need folks in that brick-and-mortar store stacking shelves in the light and smart glasses, although were efficient, you look kind of off wearing them and they really like the Blade for those used cases and due to big opportunities on that side of the house in enterprise. So that's where the initial focus is but we do have activities happening on the consumer side, the south where the applications that are running, we're building out an ecosystem that is also pointed at the consumer side of the space.

And just to clarify on the answer you just gave Paul; you're talking about enterprises potentially deploying the M300 and the Blade but in different used cases. So maybe for some particular users, the Blade would be appropriate but for other users in a different part of the organization maybe the M300 would be appropriate. Is that -- did I understand your answer correctly there?

You nailed it, that's exactly correct.

And I just wanted to again to make sure the channel that you're using for the Blade to the enterprise market, it's similar to the channel for the M300; so you're not recreating denovo a new path market?

No, that's correct. Although I have to say there's a lot of end customers come into Vuzix surrounding the Blade; so we do use the VIPs of course and they are excited about it also but there's folks that are in large organizations that -- they're willing to put their own effort in around the Blade because it's sees -- they finally have a way to impact a part of their business with a change that could be significant that they haven't before.

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I just want to make sure I understand correctly; we don't expect any cannibalization of the M300 and enterprise work cases versus the Blade, right? So the Blade -- we're kind of thinking about -- if I'm correct, correct me if I'm wrong; in retail stocking and picking and light hands free mobile applications type of things versus the M300 workload cases which have typically been warehousing and field services; is that correct?

100% correct. They are still -- it kind of works across the organization and in certain areas it makes great sense for an M300 and then there's other areas where the blade is a better choice.

I just wanted to make sure that I understood that correctly. What do you believe would be a fair price to sell the waveguide optics for?

We're still working through that detail. We've heard that alternatives -- waveguide is just a few of them out there quite frankly, but some of them are in the $100 an eye kinds of costs; others I think are even more than that because it's so difficult to produce them. So there's a benchmark there, a baseline out there that says they're fairly expensive, it does not cost Vuzix anywhere near that. That said, this is a value proposition, we're bringing something to the table that you can't get elsewhere. We can produce them in volume, so there is a number -- it's less than $100 a piece because it doesn't -- we just don't need to have it that high and that -- that makes it so you can't sell in mass market products. So it will be a mass market price point for the overall system, Vuzix's contribution is not going to be a trivial piece, to get waveguides, it's not -- it's not about $1 a piece, that's for darn sure; it will be in the -- probably less than $50 but we don't go beyond saying stuff like that, but at the end we're not really settled on the final price yet.

What type of gross margin are we targeting though?

It really is a function of volume by the way, if you -- to get that kind of price points that you need for mass market you got to be buying mass market volumes. And Grant, you want to talk to the margin side of it?

Sure. Well, clearly it will be as much as we can reasonably get but we do understand the sensitivity. The large OEMs, they're going to be pretty demanding; so I would think if we're selling them by the millions to two accounts we would -- we probably wouldn't be achieving 40% margin, so it will be probably closer to mid to high 20s in big, big volumes. That's more of a typical OEM margin, we're not going to get the 40-plus that would normally come from taking a product directly to market, a finished product.

By the way why we're not enabling everybody, it's only selected accounts that will have the opportunity to work with Vuzix.

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Just wanted to ask a question about the 10-K which again mentioned going back to 2016 of November, a loss of a strategic relationship. I know that Grant has said that Intel still has their preferred; was that just a reiteration specific to or can you say whether that was in reference to Intel -- has Intel in anyway shape or form communicated their desire to either convert or otherwise -- and can you made any mention the current ongoing relationship with -- between Vuzix and Intel? Thank you.

The Intel relationship is just like it was a year or two ago. They still own their preferred shares in Vuzix, we haven't slipped any of them into at this point in time. And what can I say, we buy parts from them and we use them in our products and the relationship status quo effectively.

Again, they are still a strategic relationship and that they are still providing parts to Vuzix; and -- so there's no certainly animosity or negative to the relationship. I assume a reiteration of that exact release from November 16.

Yes, it's in our risk factor section and we believe it's prudent to continue on with that. I mean there's other risk factors saying that their preferred shares if converted can't be sold because there's an effective registration statement and so on. It's just making sure that people are potentially aware.

Thank you. This concludes our question-and-answer session. I would like to turn the call back over to Mr. Travers for any closing remarks.