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Operator
Good afternoon and welcome to the LightPath FY16 fourth-quarter financial results conference call.
(Operator Instructions)
Please note this event is being recorded. I would now like to turn the conference over to Mr. Dorothy Cipolla, CFO. Please go ahead.
- CFO
Thank you, and good afternoon. Welcome to LightPath Technologies' FY16 fourth-quarter and full-year financial results conference call. The call today will be hosted by Mr. Jim Gaynor, President and CEO. Following management's discussion, there will be a formal Q&A session open to all participants on the call.
Before we get started, I would like to remind you that during the course of this conference call, we will be making a number of forward-looking statements that are based on our current expectations, and involve various risks and uncertainties that are discussed in our periodic SEC filings. Although we believe that the assumptions underlying these statements are reasonable, any of them can prove to be inaccurate, and there can be no assurance that the results will be realized. With that out of the way, it is now my pleasure to introduce Mr. Jim Gaynor, President and CEO of LightPath.
- President & CEO
Thank you Dorothy, and welcome to everyone who has joined us on the call today. We appreciate your interest in LightPath. I will open with an overview of operational results, highlights, and recent developments, and then turn the call over to Dorothy for a more in-depth review of our financials. After some closing remarks, we will open the call to your questions.
Now onto my remarks. What a year it has been. There are so many exciting things to talk about, if I had to summarize the year and our outlook, it is best defined as accelerating growth. The fourth quarter of FY16 marks our sixth consecutive quarter of strong fundamental performance since we implemented a series of new growth initiatives in early 2015.
Our solid performance in the fourth quarter completed a year in which we achieved substantial growth in route to setting numerous financial performance records over recent years. Here are some of the highlights from FY16 financial results: Revenue increased 26% to a record $17.3 million in FY16, from $13.7 million in FY15.
Gross margin as a percent of revenue reaches record annual levels of 54%, up from 44% in 2015. Operating income of $2 million improved, as compared to an operating loss of approximately $259,000 in the prior year. Net income of $1.4 million increased from a net loss of $715,000 in the prior year.
EBITDA for FY16 was approximately $2.5 million, compared to a loss of approximately $144,000 in FY15. Adjusted EBITDA, which excludes the non-cash income or expense related to the change in fair value of the Company's warrant liability, was $2.6 million, up over 700% as compared with $320,000 in the prior fiscal year. And our operating cash flow increased by 700% to a record $1.5 million in FY16, up from $179,000 in 2015.
Early in the fiscal year, we publicly disclosed certain operating performance objectives that we felt would set the stage for LightPath to solidify the prominent industry-leading position. In terms of revenue growth, we intended to exceed the industry growth rate, which at the time was less than 10%. For FY16, I am pleased that we nearly tripled the industry growth rate, with the Company reporting revenues of over $17 million, or a 26% increase from the prior year.
Strategic revenue, a subset of consolidated revenue, was up 93% year-over-year, well in excess of our goal to exceed 30% growth. LightPath has continued to execute on its business plan to drive growth. In fact, our revenue growth has been accelerating, improving from under 1% growth from 2013 to 2014, to 16% growth from 2014 to 2015, to 26% growth from 2015 to 2016.
Another of our operating performance objectives was to deliver an adjusted EBITDA margin in excess of 13%. Adjusted EBITDA for FY16 was a record $2.6 million. Our adjusted EBITDA margin of 15% for the year was well above our goal, and increased from 2.3% in the prior year.
Finally, we set an objective for weighted return on assets of ROA of 12% to 15%, adjusted to exclude the effects of warrant calculation evaluations. Asset changes in the past year included a cash position that increased by 77%, an increase in receivables from higher sales in the year, and an increase in inventories, in anticipation of continued revenue growth from a more diversified worldwide customer base.
Amidst these changes to our assets and our record-setting adjusted net income of $1.5 million for the year, which is up from an adjusted net loss of $251,000 in the prior year, our ROA of 15% was at the high end of our target range. Among other operating performance measure, we increased our 12-month backlog to a record $6.6 million. This improvement is highly understated, given our successful efforts to maximize manufacturing efficiencies and production capacity.
During the past two years, we have invested in the development of new technologies and machinery, as well as moving to a larger facility in Zhenjiang, China to increase manufacturing volumes and improve production yields. In FY16, we benefited from favorable trends, which resulted from the successful implementation of our organic growth strategy. Throughout the year, we experienced improvements in our sales mix, and were able to increase prices as demands for our product grew, attesting to our product differentiation and technological leadership.
The volume of our precision molded optic lenses produced in FY16 increased by 17% from the prior year. Our financial performance further benefited from an increase in the average price per precision molded unit of 2%. We expect continued growth in sales to be derived primarily from our specialty products and our precision molded optics product line, particularly our high volume precision molded optics or HV PMOs, sold in Asia, and our infrared product line based on recent quote activity and market trends. I believe we have made a lot of progress improving our product line, manufacturing capabilities, market position, sales funnel, and outlook for growth.
In the wake of this impressive performance, we are extremely excited with the pending acquisition of ISP Optics. I'd like to discuss this acquisition. We have known ISP Optics for several years. The more we were intrigued with the growth potential for our infrared products and the very large markets they address, the more we wanted to place greater emphasis on this part of our business.
We have spent a great deal of time talking with ISP's leadership to determine the optimal ways to penetrate the market and perhaps collaborate. We've taken a huge leap forward by moving to acquire ISP Optics.
Here are some of the details which have already been publicly disclosed: We announced on August 8 a definitive agreement to acquire ISP Optics for $18 million, of which $12 million will be payable in cash, with the balance in the form of a note issued to the sellers. ISP is headquartered in New York State, and has major manufacturing operations in Latvia, thus giving us a strong presence in Europe, which complements our existing strengths in the US and Asia.
The Company is a premier manufacturer of advanced infrared optical components, coatings, and optical subsystems, substantially accelerating our market share and suite of products in the infrared side of our business. Upon the closing, ISP will become a wholly-owned subsidiary of LightPath.
The sell owners that have agreed to the acquisition and will stay on for -- onboard for a period of time to assist with the successful transition and integration, as well as to ensure that our collective growth plans are intact. In 2015, ISP generated on a consolidated basis $12.1 million of revenue, $1.5 million of net income, and $3.3 million of adjusted earnings before interest, taxes, depreciation, and amortization, or EBITDA.
On our last conference call, we talked about the leverage in our model. We have benefits from some pricing power, as well as ongoing manufacturing efficiencies in the fourth quarter. When coupled with our efforts to drive margins higher, we believe the ISP acquisition provides for additional leverage opportunities. This leverage is grounded on ISP's Latvian facility, and a our low overhead costs and lower manufacturing facility in China, which is roughly 35% cheaper than our former facility in that country.
The new facility is running at under 60% of its capacity right now, so we have ample room for continued top line growth, as well as contribution margin expansion. From a sales and manufacturing perspective, we gain leverage, but there are also the shared public Company costs over a larger base of business that will further drive our profitability and cash flow generation.
More importantly, however, it is that the combination of LightPath and ISP Optics combines two fast-growing high-technology infrared and optical product pioneers, to establish a premier global leading-edge industrial technology Company. We'll have complementary product and manufacturing, with LightPath's high-volume molding technology, and ISP's high-value diamond printing, coatings, and polishing capabilities.
ISP's primary vertical markets are infrared lenses for sensors, military electro optical products, and infrared imaging cameras, which are all areas of focus, as we continue to implement our growth strategy. The ISP business broadens LightPath's global customer base significantly, with nominal overlap, and expands our market reach to include a major operations in Asia, North America, and now Europe, with ISP's Latvian operation.
We believe we will be able to generate significant synergies through cross-selling of products, the expanded product offering, and our greater production and assembly capabilities, as well as material processing capabilities. ISP effectively expands LightPath's served available market to $1.7 billion from $800 million today. By all measures, this is expected to be a transformative acquisition, that will create a global infrared and optical industrial technology leader, with even more enhanced growth opportunities than we've had in the past.
Among other changes to LightPath, I'd like to acknowledge Dr. Xudong Zhu, who has resigned from our Board of Directors effective September 6, 2016. Dr. Zhu is President of Pudong Science and Technology Investment, a LightPath shareholder. Dr. Zhu began serving on the Board on April 28, 2015, following Pudong's direct investment into the Company. Pudong currently owns just under 15% of our outstanding common stock.
Dr. Zhu has determined that he needs to devote more time to his primary business responsibilities for Pudong and his other business ventures. We appreciate both his contributions at the Board level and his continued support of LightPath, as we implement our growth strategy. Upon Dr. Zhu's resignation, the Board will have seven directors, six of whom are independent as defined by NASDAQ listing rules.
For the results we achieved in FY16, and on behalf of our executive management and Board of Directors, I would like to acknowledge the tremendous efforts and dedication of our growing team around the world. I will now turn the call over to our CFO, Dorothy Cipolla, to provide additional detail on our fourth-quarter and full-year results.
- CFO
Thank you, Tim. First, I'd like to mention that much of the information we are discussing during this call is also included in the press release issued earlier today, and on Form 10-K, which we will be filing shortly. I encourage you to visit our website at LightPath.com, and specifically the section entitled Investor Relations. I will now review financial performance and operating detail from our FY16 fourth quarter and full year, which ended on June 30.
I'll begin with a review of the fourth quarter. Revenue for the fourth quarter was $4.7 million, an increase of 5% from $4.5 million last year, which is nearly up by 15% from the third quarter. Although we have increasingly diversified our revenue base, which Jim has addressed in his remarks on today's call, and which we expect further diversification from the ISP acquisition, it is best to view our performance on a year-over-year periodic basis, rather than on a sequential quarter basis.
The FY16 fourth quarter growth is attributable to a 63% increase in sales of our high-volume precision molded optics or HV PMO lenses, an increase of more than 70% for sales of our infrared lenses, and infrared non-recurring engineering products, or NREs, which was offset by decreases in our low volume precision molded optics, or LV PMOs, and specialty products. Total precision molded optics revenues increased by 19% in the fourth quarter compared to last year. This marks the fifth consecutive quarter we have experienced year-over-year increases in sales in both our precision molded optics line and for our infrared products.
In addition to these product groups, there's also the fifth sequential quarter in which our non-recurring engineering revenues showed marked improvement. It's important to note that for our non-recurring engineering work, or NRE, it is essentially revenue generated from engineering and technical R&D, which would otherwise be expensed. So when you look at our R&D and product development expenses of about $1 million to $2 million per year, the NRE work further adds to our technological leadership.
Moving to our geographic revenue mix, 41% was from the US, 33% was from Asia, 21% was from Europe, and 5% was from rest of world. Our geographic mix has moved from 55% to 59% international sales from the third quarter last year.
Adding to the transparency of our financial reporting, I'll provide vertical market sales figures, which are further demonstrating our diversification. In the fourth quarter of FY16, vertical market sales include 9% from telecom and wireless, 9% from medical, 35% from industrial, and 14% from government and defense sectors, and 33% from our catalog and distribution customers.
The gross margin as a percentage of revenue in the fourth quarter was 52%, compared to 47% last year. The improvement in gross margin as a percentage of sales on a quarter-over-quarter basis was driven by the increased revenue, with a favorable product mix resulting in higher sales prices, leverage of our sales volume against our manufacturing overhead costs, the realization of the full benefit of our Zhenjiang facility's lower cost structure, and better yield for infrared products. As previously disclosed, with the lower cost base in Zhenjiang as compared to Shanghai, we have approached a range of gross margins of high 40% to mid 50%, which we believe is a normalized base.
Total cost of sales was approximately $2.3 million for the fourth quarter, a decrease of approximately $111,000 compared to the same period last year. Total cost and expenses increased by approximately $254,000 compared to last year. The increase was primarily due to a $252,000 increase in professional fees and legal expenses related to the ISP acquisition.
Despite the higher expenses to provide for continued and accelerated growth, total operating income for the fourth quarter of FY16 was $523,000 compared to $449,000 last year. The increase in revenues and improved gross margin were partly offset by an increase in total cost and expenses. Total operating interest for the fourth quarter of 2016 was $523,000, which was a 16% increase as compared to $449,000 for last year.
In the fourth quarter, we recognized non-cash expense of approximately $27,000 related to the change in the fair value of warrant liabilities, which was issued in connection with our June 2012 private placement. The warrant liability has an inverted correlation to the change in price of our common shares, and the assumptions on when the warrant shares will be exercised. In the prior-year period, we recognized non-cash expense of approximately $839,000 related to the change of these warrants.
Net income for the fourth quarter was approximately $331,000, and this includes the $27,000 non-cash expense for the change in the fair value of the warrant liabilities, or earnings per share of $0.02 per basic and diluted share. This compares to a net loss of $367,000, which includes the $839,000 non-cash expense for the change in the fair value of the warrants, or a loss per share of $0.02 per basic and diluted common share last year.
We had foreign currency exchange losses in the fourth quarter of FY16 due to the changes in the value of the Chinese yuan, in the amount of approximately $149,000, which had a $0.01 impact on basic and diluted earnings per share. This compares to a foreign currency exchange gain of $26,000 last year. Adjusted net income, which is adjusted for the effects of the non-cash change in the fair value of the warrant liability and other non-cash items, was approximately $359,000 in the fourth quarter, as compared to approximately $472,000 last year.
Moving on, our adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, for the fourth quarter, and this also eliminates the change in the fair value of the warrant liability was $673,000, as compared to an adjusted EBITDA of $623,000 last year. Weighted average basic shares outstanding increased to $15.6 million, compared to $15 million last year, primarily due to the shares of common stock issued under our 2014 employee stock purchase plan, and exercises of stock options and warrants.
I'll briefly review financial performance and operating details for the fiscal year, which ended June 30. Revenue for FY16 was $17.3 million, an increase of 26% from $13.7 million last year, where the growth is attributable to increases in all of our product groups. The gross margin as a percentage of revenue in FY16 was 54%, this compared to 44% last year. The improvement in gross margin is primarily attributable to favorable product mix, resulting in higher sales prices, and the leverage of the sales volume against our manufacturing overhead costs.
Due to the significantly higher revenues in the year, total costs and expenses increased by approximately $1.1 million compared to last year. The increase was primarily due to a few reasons, one being the $412,000 accrual increase for FY16 management bonuses given the current operating performance; the $100,000 payment for an early termination fee of the sales agreement; $60,000 increase for fees related to our annual stockholders meeting and related proxy solicitation; a $334,000 increase in professional services and fees related to the annual meeting and the ISP acquisition; and the $139,000 increase in other expenses.
Total operating income for FY16 was $2 million, an improvement as compared to the operating loss of approximately $259,000 last year. For all of FY16, we recognized non-cash expense of approximately $52,000 related to the change in the fair value of the warrant liability, issued in connection with the June 2012 private placement. In the prior-year period, we recognized a non-cash expense of approximately $464,000 related to the change of these warrants.
Net income for FY16 $1.4 million or $0.09 per basic and $0.08 per diluted common share, which includes $52,000 non-cash or $0.01 per share income related to the change in the fair value of the warrant liabilities. This compares to a net loss of $715,000 or $0.05 per basic and diluted share, which includes the $464,000 or $0.05 per share impact of the change in the value of the fair warrant for last year.
We were also impacted by foreign currency exchange losses in FY16, due to the recent devaluing of the Chinese yuan in the amount of approximately $370,000, which had a $0.02 per share impact on basic and earnings-per-share. This compares to a foreign-exchange income of $24,000 in the prior year. Adjusted net income, which is adjusted for the effect of the non-cash change in the fair value of the warrant liabilities, and other non-cash items, was approximately $1.5 million in FY16, compared to a loss of approximately $251,000 in FY15, an improvement of over $1.7 million.
Moving on, our adjusted EBITDA for 2016, which eliminates the change in the fair value, was $2.6 million as compared to adjusted EBITDA of $320,000 last year. Weighted average basic shares outstanding increased to 15.4 million in FY16, compared to 14.7 million last year, due to the issuance of shares related to issuances under the 2014 employee stock purchase plan, the private placement in January 2015 with Pudong Investment, and shares issued with exercises of stock options and warrants.
Cash and cash equivalents totaled approximately $2.9 million as of June 30, an increase of 77% from $1.6 million as of June 30 last year. Cash flow provided by operations was approximately $1.5 million for FY16, as compared to $82,000 for FY15. During the 12 months of FY15, we expended approximately $1.1 million for capital equipment, while growing our cash balance by $1.3 million. As of June 30, the Company's 12-month backlog was $6.6 million compared to $6.5 million as of June 30 last year.
With this review of our financial highlights concluded, I'll turn the call back to the operator, so we may begin the question-and-answer session.
Operator
(Operator Instructions)
Joe Maxa, Dougherty & Company.
- Analyst
Thank you, and congratulations on a nice quarter. I wonder if you could expand a little more on the key drivers you're seeing, perhaps by vertical, the strength in the quarter, and then the outlook, if that's expected to be maintained in 2017, on your core business, I'm talking.
- President & CEO
I think there's a few catalysts that are driving our business right now. The telecom sector, which is a sweet spot for us, is doing very nicely, and it's being driven, I think, by three factors that we think will continue for the foreseeable future, over the next several years.
Those are the Chinese investment in its infrastructure, and in particularly in his networks and that kind of thing is driving, some construction projects that they've reinstituted, such as the expansion of their high-speed rail, is driving our industrial tool volume, and that's a very nice thing. In the telecom sector you have, again, the Chinese, but you also have the data center interconnect driving volume in these networks, and the upgrade of the Metro core, the short haul high-speed data transmission.
So I think those things are driving that telecom sector, and we are seeing very nice growth in our customers, and those catalysts are, from our perspective, verified by the orders we see from our customers who build type of equipment, or put components into those types of networks. I think that those are very strong drivers of our existing business, and then on the infrared side, we see continued adoption of commercial type applications in the infrared sector, and technology developments that are continuing to drive and open that market up, and we think that will continue for the foreseeable future.
Things like the autonomous car and LIDAR-type systems, there are sensor systems, fire fighting and safety equipment are all things from a commercial perspective that are driving that market. So those factors, I think, are what we see driving our markets for the foreseeable future, and yes, I think they're going to continue for the next several years.
- Analyst
That's helpful. And Jim, on your -- the acquisition, potential acquisition with ISP, are they seeing the similar type growth rate you are? You have a pretty nice 26% growth rate. Maybe give a little color on if you think that can continue for you, but also curious on how ISP is doing, and what is driving their business?
- President & CEO
I think ISP's business is strong, as well. They are -- it's a different kind of business, a little bit different than ours, although it's very complementary. They are much more project-based in their business model, so they do -- the majority of their business is driven by custom optics, or particular programs and designs for specific applications and relatively high-end type product.
So I think their growth rate is in that -- historically, it's been running 8% to 9%. We think that will continue. They've had some very nice pops in recent years that are more like, what was it Dorothy? 15%-plus growth, so we're seeing nice growth, and from what we see in the forecast and stuff, we expect that to continue.
- Analyst
Then margins, your business, do you think you can maintain that, say, mid-50%, low to mid-50% range? And should we assume based on comments you made on ISP for that to be a little bit higher gross margin?
- President & CEO
Well I think, actually LightPath's margins are currently a little bit higher than ISP's. I think it has more to do with material costs, and we have some very low-cost operations in China, and very efficient. So I think our gross margins are currently a little bit higher than theirs, and I think that's probably what we will see in the immediate future.
As we said, we really expect our margins to run in the high 40%s to low 50%s. We think that's a normalized rate, and we certainly expect that to continue. ISP's margins are in the high 30%s to low 40%s, which is also a very good margin for the type of work that they do, and the amount of development work, et cetera, that's associated with their products.
- Analyst
Okay, thank you. That is very helpful.
Operator
John Nobile, Taglich Brothers.
- Analyst
Good afternoon, Jim and Dorothy, and thanks for taking my questions. In regard to ISP, I just wanted to get a better understanding of your acquisition here. Correct me if I'm wrong; isn't your molded optics method, isn't that in direct competition to ISP's diamond turning method?
- President & CEO
It depends on the product you're talking about John, but no, I would say not. I think they're totally complementary. There's a business of molded optics that has a lower cost structure, that is generated more towards commercial, with slightly higher volumes, where their product, and there's also a need for turned and polished lenses, as well. And the way we look at it is, it's completely complementary. It now expands our capabilities to do those types of things, and expand that business.
We think it's an additive, a scope-enhancing type thing. Moving forward, we are very excited about that. I really want to focus on our results this quarter, and we will be talking more about the acquisition as we move forward here. But today's call really needs to be focused on the performance that we had in our 2016 and our fourth-quarter, in which we think we're just -- we had a phenomenal year.
- Analyst
No doubt about that. Actually in regard to the quarter, the fourth quarter was very strong, looking at it compared to Q1, Q2, Q3. And I look back at last year, the fourth quarter was much stronger also. So it raises the question of seasonality. Is there a seasonality that we can expect in the fourth quarter? This is two years in a row where it was a nice jump up in the fourth quarter, and if there isn't, is this a level that we should expect going forward, a revenue run rate?
- President & CEO
I think if you look at what happened in 2016, I don't think we had a quarter below $4 million, $4.1 million for the year. And so we have continued to increase the volume in our business year over year, and quarter over quarter. So I think we're reaching higher levels of business overall, and I think that those types of levels, and levels that we're at, early in the year, we put out some metrics that said we would continue to grow 12% to 15%, 12% to 16% a year for the next several years, and we fully expect that level of growth to continue. We exceeded it this year.
But as I said, we went from 1% to 15% to 26%, so we're having a nice run. The catalysts in the business that I talked about earlier are driving that, and we continue to see those types of opportunities. And the other exciting part is, Dorothy talked about the level of NREs and stuff that we had this year, and that's all future stuff. That's engineering work, designing products for newer applications and custom type stuff that will play out in the future. Some in the immediate future, some longer-term, but that increase and that type of work is a good bellwether of what you can expect going forward.
- Analyst
Okay, and as far as seasonality, should I say that there really wasn't any?
- President & CEO
I think you see the slight increase in our quarter. Generally our Q3, because it has the Chinese holidays and the US holiday impact in it, tends to be a little weaker, so you get a little bump in the fourth quarter as a result of that. It is probably some carryover from some slowdown in the third quarter.
But given the strong year, you've got the third quarter was still pretty good, even though we did see some slowing. So I think you see a little carryover based on the holidays and those kinds of things. We lose a couple of weeks of focus in China in that October time period, when they have their big holiday, and so that -- the whole country slows down there, and we see some impact from that.
Now having said that, the Chinese economy is not strong right now, overall. But for us, we've had very good success this year in China, and very good growth, because we've been positioned properly, and because we are picking up some business from some of the weaker players that are dropping out. So while overall, people talk about the weakness in China, it has slowed down quite a bit, but our business has grown in that sector, and we see that continuing. And partially, it's because we have high end customers, and we produce a quality product at a great value, and so we're able to pick that up.
- Analyst
Okay, and a question for Dorothy. I think last quarter, the NOLs in China were depleted. So I'm just wondering what to expect as a tax rate for sales in that region?
- CFO
The tax rate that you should expect is 25%.
- Analyst
Okay, 25% for that region. And just one more question, in regard to the Board with Dr. Zhu's resignation, I'm curious if there's going to be a need to replace him, or is the Board going to stay at the current size?
- President & CEO
We don't have any plans to add any new directors at the moment. So right now, there are no plans to replace him. The Board will be at seven directors, with six of them on the outside, as I said, outside directors, and that's sufficient for what we are doing right now.
We went through where we could add some people, we put some flexibility into the size of the Board there in our annual meeting last year, which we appreciate the shareholders doing that, and we did that so that if the opportunity or the need arises, that we can add those skill levels to the Board, and have that flexibility as we move forward here to grow the Company. But for the immediate timeframe, no, we don't intend to immediately replace him.
- Analyst
All right, well listen. Thanks Jim and Dorothy for taking my questions. That's all I have right now. Thank you.
Operator
[Chris Vachovsky], a private investor.
- Private Investor
Congratulations on the good quarter. So, I have a couple questions. First, am I correct in noticing that the adjusted EBITDA and the adjusted net income are really actually still lacking about -- they haven't adjusted for about $400,000 of the one-time costs, like $250,000 for the professional costs related to the acquisition, and another $150,000 of currency losses; is that correct?
- CFO
No, that is not correct. EBITDA and net income is only being adjusted for the change in the fair value of the warrants.
- Private Investor
All right, so if you want to adjust for one-time costs, then the adjusted EBITDA and the adjusted net income would be about $400,000 higher; is that correct?
- CFO
Yes.
- Private Investor
All right. Okay, so if you are providing adjusted metrics, why don't you adjust all the way? I'm just curious.
- President & CEO
I'll tell you, we try to be as fair as we can to the numbers, and there always seems to be these recurring non-recurring charges, so we try to be fair to what we what we report, and give a relatively conservative base.
- Private Investor
All right. I understand that you want to be conservative. Okay, the backlog, you had a nice increase year over year, but it seems like a small decline sequentially. What is that about?
- President & CEO
I think it's more just timing of how the orders flow, and I think if you really look at -- we grew our backlog, while we significantly increased our shipment volume. Rather than sit on the backlog, we are pushing it out into shipments and revenue.
- Private Investor
Okay. And the relatively large increase of inventories year over year, is that indication of higher revenues for the next quarter?
- President & CEO
I think yes. As well as we are growing our infrared business, and that had some higher material costs associated with it. So as those materials go into raw material and WIP, you get a little bit of an increase there, just because of the value of those materials.
- Private Investor
Okay.
- President & CEO
So like a 70% increase in our infrared volumes in the course of the quarter, so that business is developing, and we will see that type of thing as the working capital requirements increase.
- Private Investor
Okay, so can we be assured that those higher inventories are mostly infrared and the high volume of the optical areas that are growing really fast?
- President & CEO
I think it's quality inventory. It is not -- we're not growing an obsolete inventory here, and our reserves and stuff have not really increased that substantially, nor do they need to.
- Private Investor
Okay. And gross margins also increased nicely year over year, but also slightly lower sequentially. I thought you'd have more benefit from your new Chinese facility this quarter. Can you give us some more detail on that?
- President & CEO
I think that's just -- you are going to see some quarter-to-quarter variation based on product mix. That's just the normal course of things, so I think that's one you have to look at a little longer-term, given the nature of our business and the quarter-to-quarter fluctuations in mix that we have. So that tends to drive that. There really aren't any yield problems or those kinds of issues that are driving, or increased costs that are driving that on a cost of goods basis.
- Private Investor
Okay. And some questions about particular areas that you pointed out in -- during last conference call. The endoscopes, the one-time use endoscopes, are those growing in mass production? Are those selling?
- President & CEO
That's still a developing opportunity. They haven't really hit the production volumes yet, although we still very excited about that opportunity looking forward. They're having very good results from their test cases, so I think that's still a very good premise for the future.
- Private Investor
So are you still waiting for government approvals on that?
- President & CEO
It is not our product. We are providing some components into that device for our customer, he has that product approved, so now it's a matter of getting it moved into the various doctors and hospital clinics, and those kinds of things, and it just takes some time and some proofs that they are doing. So they are working around the world to develop those, and having good success with it. So we look forward to that being a very nice opportunity in the future.
- Private Investor
Okay, this would be good, speaking as a patient, as well. It's horrible to think you're getting a used endoscope. Anyway, so the HVAC, you said there is new applications for completely optical HVAC systems, that instead of sensing temperature, they look at the temperature of different parts of the room and so on. Are those things happening?
- President & CEO
I think you're seeing the growth in the infrared sensors for those types of products, whether that be lighting control, or air-conditioning control, or occupancy control, heat sensors or safety equipment. That's still, again, a developing area, but I think you're seeing that take off. And the thing we like about those type of sensing operations or applications is they tend to have better volume from a commercial aspect, and they have lower costs as a result of that, and that's where molded infrared optics really can have a good application.
- Private Investor
That's good to hear. I know you don't want to talk about the acquisition, but I would just like to try a couple questions. Have you decided what portion will be debt, what portion will be equity of the new offerings?
- President & CEO
I think what we've said is, we are paying $18 million, of which $12 million will be cash, $6 million will be a note taken back by the sellers. Beyond that, we don't know how that mix will play out, and when we go to market, we'll be able to further define that. And there will be more information coming out about that in the near future, so I'd like to leave it at that.
- Private Investor
Can you at least assure us shareholders that you won't dump $12 million worth of shares by some kind of at the market offering? Because you have a relatively low market cap, if you go -- and relatively low volumes. Can we assume that if you put in an offering, it will be replaced by backing out of the market?
- President & CEO
I can't tell you exactly what's going to happen, but I will tell you that we are sensitive to dilution versus debt, and we're going to try and balance that as best can, and what we think is in the best interest of our shareholders and the Company. So we will do our best to make sure that we do this in the most fair and equitable way that we can accomplish it.
- Private Investor
Okay, and final question about that. You said that it would be -- the deal would be accretive within 12 months. Is that accretive per share including any possible dilution, or do you just mean that it's accretive as to total net income?
- President & CEO
I don't have a good answer to that. We believe you have got two profitable Companies coming together, that should make a profitable Company going forward, with tremendous upside potential. So we believe it's going to provide very good income going forward, and the potential to be very profitable as we move forward. There's a lot of factors that go into that, so it's a tough one, but we believe we are in good shape.
- Private Investor
All right. Thank you, and I look forward from hearing again from you about this deal. Thanks.
- President & CEO
All right. Thank you very much.
Operator
This concludes our question-and-answer session. Our like to turn the conference back over to Jim Gaynor, CEO, for any closing remarks.
- President & CEO
All right, thank you. In conclusion, we appreciate the support of our shareholders and the dedication of our global team at LightPath. This team is expected to significantly increase upon the acquisition of ISP Optics, and with this expanded global presence, which is bolstered in scale and scope, we intend to remain focused on our efforts to drive diversified revenue and growth, and continue to drive benefits from the leverage in our business, as we improve our profitability and generation of cash flow. With the progress that has been made and our plans for continued execution, we look forward to delivering long-term profitable growth, which may deliver meaningful returns for the benefit of our shareholders. Thanks again, and we look forward to speaking with you next quarter. And thanks, operator
Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.