Greetings and welcome to the Vuzix Third Quarter 2020 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] As a reminder, this call is being recorded. Now I would like to turn the call over to Ed McGregor, Director of Investor Relations at Vuzix. Mr. McGregor, you may begin.

Good afternoon, everyone, and welcome to the Vuzix third quarter 2020 financial results and business update conference call. With us today are Vuzix CEO, Paul Travers; and CFO, Grant Russell. Before I turn the call over to Paul, I would like to remind you that on this call management's prepared remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements during the question-and-answer session. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those contemplated by any forward-looking statements as a result of certain factors including, but not limited to, general economic and business conditions, competitive factors, changes in business strategy or development plans, the ability to attract and retain qualified personnel, as well as changes in legal and regulatory requirements. In addition, any projections as to the company's future performance represent management's estimates as of today, November 9, 2020. Vuzix assumes no obligation to update these projections in the future as market conditions change. This afternoon the company issued a press release announcing its financial results and filed its 10-Q with the SEC. So participants in this call who may not have already done so, may wish to look at those documents, as the company will provide a summary of the results discussed on today's call. Today's call may include non-GAAP financial measures. When required, reconciliation to the most directly comparable financial measures calculated and presented in accordance with GAAP can be found in the company's Form 10-Q filing at sec.gov, which is also available at www.vuzix.com. I will now turn the call over to Vuzix' CEO, Paul Travers, who will give an overview of the company's operating results and business outlook. Paul will then turn the call over to Grant Russell, Vuzix' CFO, who will provide an overview of the company's third quarter financial results. We will then move on to the Q&A session, after which Paul will provide some closing remarks. Paul?

Thank you, Ed. Hello, everyone, and welcome to the Vuzix Q3 2020 conference call. Vuzix is entering one of the strongest and most promising periods in our history in terms of Smart Glasses demand, product line strength, OEM developments and the significant advancements being made on our next-generation technology. We are executing on many fronts and we have a healthy balance sheet to support our efforts. The increase in Smart Glasses demand, which began in this spring, strengthened further in Q3, as our Smart Glasses sales were the highest we've yet achieved as an enterprise wearable computer supplier, exceeding our previous record set in Q2 of this year. Our Q3 sales of Smart Glasses totaled $2.7 million, up 15% sequentially and 156% on a year-over-year comparable basis. And these record sales were achieved in a quarter that included the summer months, which is often a slower period for many enterprise customers in the U.S. and Europe due to planned vacations. We are pleased to see our products being used across our expanding client base to assist customers in solving the complex issues associated with today's business environment. Demand for our products has been and continues to be broad-based across numerous market verticals and around the globe, most notably in healthcare, field service, manufacturing and logistics. And the momentum behind our core enterprise Smart Glasses business has not slowed. During the month of October, Vuzix recognized a single-month record for Smart Glasses revenue, outpacing our previous record. We're seeing replenishment orders from resellers, follow-on orders from direct customers and a continued stream of inbound sales from new customers, as our core Smart Glasses business continues to accelerate across the globe. As a result, we believe we should be in a position to deliver yet another record quarter of Smart Glasses product…

Thank you, Paul. As Ed mentioned, the 10-Q we filed this afternoon with the SEC offers a detailed explanation of our quarterly financials. So I'm just going to provide you with a bit of color on some of the numbers. Our third quarter revenue rose 140% year-over-year to $2.8 million, largely due to increased sales of smart glasses which increased 156% to $2.7 million in the quarter. Sales of our M400 smart glasses accounted for the majority of this increase, a product that was not yet in full volume production in the comparable 2019 period. There was an overall gross profit of $0.3 million for the three months ended September 30, 2020, as compared to a gross loss of $0.2 million for the same period in 2019. Subtracting from our Q3 2020 gross profit figure was a $0.2 million inventory obsolescence reserve taken for unique smart glass component inventories that are no longer expected to be utilized. On a product cost of sales basis only, product direct cost declined to 53% of sales in the 2020 period as compared to 64% in the prior year's period. The change is primarily the result of higher margins turned on the M400 versus the M300 series in the prior year's period which had begun to be discounted with the pending arrival of the newer M400 model. Manufacturing overhead costs, while increasing in absolute dollars by 8% for the three months ended September 30, 2020 over the 2019 period decreased as a percent of total product sales to 17% from 40% in the same period of 2019. Clearly, as we continue to see growth in our sales, these costs as a percentage of product sales should decrease further. R&D expense was $1.9 million for the three months ended September 30, 2020, compared to $2.3…

Thanks, Grant. Our fourth quarter is off to a strong start in terms of Smart Glasses revenue through October. This momentum, along with the recent introduction of our new products is expected to continue and ramp further. We're in a position to not only deliver yet another quarter of growth in our Smart Glasses revenue but also set a new full year Smart Glasses sales record. It is encouraging to see that the growth of our business in 2020 is broad-based and has not been tied to any single large customer. We like the trend we are seeing here across our customer base and the ROIs they are achieving, and believe enterprise behaviors appear to be changing permanently and for the better as a result of the pandemic. What we are finally witnessing firsthand is the birth of a new industry sector within technology one that Vuzix has pioneered from the beginning and invested heavily in to build a valuable IP portfolio that positions Vuzix to win big over the long haul. Vuzix is and will continue to be a leader in a market that is expected to grow into a multibillion-dollar industry over the coming years. With that said, I'd like to now turn the call back to the operator for Q&A.

Thank you. [Operator Instructions] And our first question is from the line of Christian Schwab with Craig-Hallum Capital Group. Please proceed with your question.

Hey, good afternoon, guys. Can you talk about OEM and engineering services? Would you expect a recovery in that in Q4? Or -- and do you have a visibility on when you would expect that to be more material again?

Yes. Christian, hello. The Q4 numbers we've already got a reasonable chunk of business that's pretty similar to what was in Q2 in the hopper. But we expect the bulk of it should deliver here in Q4.

Okay. Great. And then just from a big picture I appreciate the slide and kind of walking through some of the bigger things that you guys have talked about as well as talking about Verizon. How should investors bracket the opportunity from a revenue perspective? Not next quarter or the quarter after that, but in the next two to three years should you be modestly successful, can you give us a range of potential outcomes and what it could mean to the top line?

Yes. First, how it might unfold. I think you'll see like imminently even more and more coming out of our friends over Verizon has this program starts to unfold for them. They've got a lot of work done already. Their 5G network is already around. And their efforts around what they're doing with Vuzix and there's I think six total companies in the cohort program that's like really moving nicely. It's right on track. I think you'll see knock on wood if it's unfolds if it looks at Q1 will be the beginnings of a real sort of rollout of these efforts and the numbers could be in the thousands to tens of thousands of pieces kinds of thing over that period of time you discussed.

Okay. Great. And then taking for the Verizon color. If we just kind of talk about the couple of defense contract opportunities that you have -- I think there's three separate ones that you highlighted. Can you give us an idea is that thousands or tens of thousands over the same type of timeframe as well?

It should be in the tens of thousands over the next two to three years. Two of them each comes in the same bucket.

Fantastic. Great. I don’t have any other questions. Thank you, guys. Good quarter.

Thanks, Christian.

And our next question comes from the line of Jack Vander Arde with Maxim Group. Please proceed with your question.

Great. Thanks, guys. Hi. Thanks for taking my questions. Paul, you mentioned record-high revenue of smart glass product sales in October. And I think you alluded to it's comparable to like a full quarter's worth of $1.2 million or so of revenue. That gives me a good sense as to what you mean by the October level record. And then I also noted that you mentioned M400 represent the bulk of the third quarter product sales revenue. So what I'm wondering is can you provide any color around which smart glasses represent the bulk of this October product sales record specifically?

Well, we do have some 4,000 in the mix and the Blade in the mix. That said, right now the M400 is designed into so many programs. You saw the medical slide. I mean there's so many companies that are using that thing, but there's a nice demand for it. People really like the 4,000, but we're just getting started with it Jack. So I think if you for competitive reasons we don't like to share too much of how this mix works. I mean our next-generation optical systems we think give us a big edge. And I think you'll see over time, the 4,000 start to become a significant contributor. That would be the Blade in pharma in those kinds of places. But in October, it's still right now the 400 is the lead dog in the race I guess is a way of putting it.

Okay. And that makes sense. That's helpful. And then if I could just maybe dig in a little bit for the remainder of 2020 here and then looking into 2021. Given all these the M4000 upgraded void just began shipping at the very, very end of September. I guess what would you expect for maybe like a normal seasonality now as you look, I mean there is no normal seasonality per se. But looking into the first half of 2021 even if I can get ahead of myself with these new product introductions that have higher ASPs and more applications with them and you've also expanded your geographical reach would you expect maybe a similar seasonal pattern? Or would you expect a stronger first half than typical because of these new products?

So we - first of all with the way the world is right now Vuzix is not really seeding the seasonal thing. I mean I don't know what to expect here for Christmas. And there's always those holiday things that happen. But the fact of the matter is the world is trying to figure out how to go back to work. And at the moment COVID is winning. And so we're not seeing the seasonalness as much as how do I solve these problems. And the optical see-through systems that we have offer certain advantages, in some cases much lower error rates when you're using them because you see the real-world and the virtual information at the same time. That said those advanced capabilities take a bit more time to implement. On the flip side of the coin that waveguide right now has a -- it's a double the field of view of the M400. All that said, we're designed in on all these programs on the 400. I think what you'll see is the 4000 would be -- it will continue to grow. There's an interesting upfront demand for it already. And as people are using it the feedback we're getting is it's awesome, but it is not necessarily looking to replace the 400 at this point just yet. It has its own sort of places that it's being successful in. I think in the long run optical see-through systems are going to be the best way to do this. And so as 2021 unfolds you might start to see the 4000 coming more and more online and catching up a bit to the 400, but I think both of these products have a long ways to go. It's just getting started. Sorry I know that's kind of a roundabout but --

No, fair enough. It's helpful. Understood. And then just the last question is, I'm wondering if you can maybe further fine-tune or be more measured as we talk about the engineering services revenue just because that can cause any quarter to be up or down relative to estimates or outlook. So with -- I think you have about $700,000 of contracted revenue from these OEM engagements and you think the bulk of it is going to hit the fourth quarter. What does that mean? I mean let's say, it's $500,000 or something in the fourth quarter. What does that mean in terms of the four quarters in 2021? Is there a replenishment though? Does it just depend on as you reach a new phase with the other contracts? Or is it actually $700,000 is the entire contract for these five arrangements?

No. Some of these programs will evolve into significantly higher engineering services revenues and some of them should start to roll into actual production programs. But in 2021 some of these programs if they come through like we think they will it could be in the millions potentially worth of engineering services efforts through the year.

Terrific. That’s helpful. That’s all of my questions. I will go back in queue.

Thanks Jack. Thank you.

And our next question is from the line of Jim McIlree with Bradley Woods. Please go ahead.

Yes, thanks and good evening. Grant, it seems like engineering services are going to increase this quarter relative to Q3. And if that's the case I'm assuming that some of the research overhead that you have gets allocated to those services and so you could have a decline in R&D this quarter relative to Q3. Is that scenario correct?

Yes, you're correct. I mean it won't be huge because the projects probably no more than -- less than 25%, 30% is internal labor and the rest is out-of-pocket costs.

Got it. Great. And then based on that Slide 5 from the deck, it seems like the engineering services this quarter could be as large as or close to what you did in Q2. Is that -- am I in the ballpark there?

Yes, you are Jim.

Yes.

Okay. Great. Paul you indicated that the M4000 is in part of the October revenues and I'm assuming it's small. But can you talk about production? Just remind us where your bottlenecks might be and/or what potential parts you have to have enough of? Just -- can you just update us on the M4000 product manufacturing scenario?

Jim, we have some inventories if you look. I think we're in pretty good shape. I will say that things like waveguides we make here. But our waveguide production, even though this is a brand-new waveguide, and it uses a brand-new kind of grading structure within the waveguide, we're coming out beautiful. We're yielding nice. So we're not having problems on waveguides. It is true that a brand-new product takes a little bit of time to come up to curve, from a production perspective. So, it's gated a little bit by our learning process, is one. And number two, we are taking extra care on these first units that go out the door. You don't get many first impression. So, I will say when the numbers, if they're cranking up to 10,000 per quarter and those kind of things, Vuzix will have inventory issues that don't need to be getting in the queue. Some of the stuff like CPUs and cameras take more time to get in than others and those kinds of things. But our current run rates and stuff Vuzix is in really good shape on production.

Yes, Jim 90% of the electronic components in the 4000, are common to the 400. So we can literally swing back and forth with whatever we want to build. And the Cobra II display engine that's in the M4000 is -- had its home in the Blade. So we're pretty good at that. The amount of new stuff that hasn't been tested is pretty minimal. So we're pretty confident that we can manage production to meet demand.

That's great. Thank you. And on the $1.2-ish million in October Smart Glass sales, I would love to multiply that times three to get a quarterly number. But, we've got Thanksgiving and Christmas holidays. Do those typically have a big impact on shipments or sales or activity?

There's no doubt that December slows things down a bit and November does a little bit also. I will say that so far November is not doing bad. And sometimes there's year-end dollars that folks like to get in the queue to make sure they get it spent before year-end and the like. So it's really hard to say just yet Jim on.

But I'd like to think now with the two more months for a full quarter of M4000 sales in the Blade upgraded that -- which were in a big contribution in October that maybe that's the numbers you're suggesting could be feasible or better.

Yes. Just to make sure you heard that right. They were not a big contributor in October.

Yes. Sorry if I got that wrong. Yes, definitely not a big contributor.

We didn't grow.

I got that. Yes. And then my last question is the prior question or the first question on Verizon. I know you're optimistic on it, but isn't it reasonable to think that the rollout is going to be measured that is Verizon will find the customer, the customer will try it they'll do it in small volumes and then they'll roll forward? So those big volumes you're thinking of are certainly possible, but more likely in the second half of next year. Is -- again is that a reasonable way to look at it? Or am I being too pessimistic?

No, you're -- no, that's not bad. It's not that. We think that there'll be more like pilots in the first quarter and Q2, Q3 to Q4 and into the year after will be more substantial rollouts Jim.

All right, fantastic.

Okay. Good.

Sorry.

No.

All right. Well, thanks a lot guys, and good luck with everything.

Thank you, Jim.

And we have no further questions in the queue at this time. I will now turn it over to Paul Travers for final remarks.

Thank you very much everybody for joining the conference call. Enjoy your holidays coming up, and we look forward to sharing with everybody how the rest of the year goes on our first reporting next year. Knock on wood, if it keeps going like it is, it should be a very exciting end of the year, quarter for Vuzix and full year frankly, one of the best Vuzix has seen in probably quite some time. Thank you very much.