LightPath Technologies Inc (LPTH) 2019 Q1 法說會逐字稿

Good day, and welcome to the LightPath Technologies Fiscal 2019 First Quarter Financial Results Conference Call.

(Operator Instructions)

Please note, this event is being recorded.

I'd now like to turn the conference over to Don Retreage, CFO.

Please go ahead.

Good afternoon.

Before we get started, I would like to remind you that during the course of this conference call, the company will be making a number of forward-looking statements that are based on current expectations and involve various risks and uncertainties that are discussed in the periodic SEC filings.

Although the company believes 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.

In addition, references may be made to certain non-Generally Accepted Accounting Principles, or non-GAAP measures, for which you should refer to the appropriate disclaimers and reconciliations in the company's SEC filings and press releases.

Following management's discussion, there will be a formal Q&A session open to participants on the call.

I would now like to turn the conference over to Jim Gaynor, LightPath President and Chief Executive Officer.

Please go ahead, Jim.

Thank you, and good afternoon.

Welcome to LightPath Technologies Fiscal 2019 First Quarter Financial Results Conference Call.

The financial results press release was issued after the mark closed -- market closed today and posted to our corporate website.

Following my remarks, our CFO, Donald Retreage, will provide more comprehensive review of the numbers, and then we'll conduct a Q&A session.

We feel really good about LightPath's progress in the first quarter of 2019.

It was a very busy 3 months, and here are some of the highlights.

On the financial results front, revenue increased nearly $1 million or 13% to $8.5 million in comparison to the first quarter of last fiscal year.

Booking grew in dollar terms by twice as much as the increase in revenues, moving higher by $2 million or 30% to $8.7 million in comparison to the first quarter of last fiscal year.

Our 12-month backlog was approximately $14 million at September 30, 2018, representing an increase of over $1 million from both the $12.8 million at June 30, 2018, and the $12.9 million a year ago.

Backlog at the end of fiscal 2019 stood at a record level for the company.

On the research and product development front, the most important achievement, in the quarter, surrounds our new line of infrared products.

In mid-June, we announced comprehensive production capabilities and global availability for a new line of infrared lenses made from chalcogenide compound.

This compound is developed and grown internally by LightPath to produce Black Diamond glass, which has been trademarked and marked as -- marketed as BD6.

I'll talk more about this product further on in my remarks.

But in terms of progress in the first quarter, we added several more lenses to our portfolio and secured a number of large and important contracts.

On the corporate development and management front in the first quarter, we streamlined our operations to maximize more profitable growth, which included a consolidation of our product groups down from 5 to 3 and organized our target markets by industry.

Under the guidance of our strength and management team, which included bolstering of our finance and sales leadership, with the start of fiscal 2019, we organized our business with the goals of improving our time to market, maximizing sales opportunity and reducing redundant costs.

On the -- our business has been consolidated from 5 product groups into 3: Infrared, or IR optical products; precision-molded, or PMO products, which now includes both used what we used to refer to as low-volume and high-volume precision-molded optics; and specialty products, which now includes nonrecurring engineering, or NRE projects.

For sales and marketing purposes, our major markets include our catalog business and distributors, commercial, defense, industrial, medical and telecommunications and network.

Followers of LightPath may have read some of our press releases in the past month or so, in which we detailed new orders in terms of our industrial classification.

We believe this will help facilitate customer acquisition and enhanced understanding of the practical applications of our increasing product lines.

Customers in each of these markets may now select the best optical technologies that suit their needs from the LightPath's entire suite of products.

This strategy is availing us to more cross-selling opportunities, particularly where we can leverage our knowledge base of technical requirements against our expanding design library.

We believe that we are seeing success from this strategy as evidenced by our increasing backlog of orders.

At the center of this streamlining, among other initiatives, is our intent to elevate our gross margin to a sustainably higher level.

It is important for investors to understand where we believe our gross margin should be.

Before our transformational thrust into the infrared business, our gross margins had gone from 36% in fiscal 2012 to 54% in fiscal 2016, as revenues went from $11.3 million to $17.3 million in the same time span.

Today, our PMO gross margins are still at the level -- at that level depending on the product mix.

With the PMO business during the last few quarters being impacted by lower volumes from the higher-margin telecommunication sector, our gross margins for all PMO revenue in these periods were a bit lower.

The good news here is we have seen a marked increase in new orders for our telecommunication product, up 58% in Q1 from -- Q1 2019 from Q4 of 2018.

With the inclusion of the IR product revenues, our consolidated gross margin was naturally reduced since IR products have a higher material cost and longer processing time.

IR revenues went from less than 10% of total revenues to approximately 50% due to our ability to grow this business and the acquisition of ISP Optics in December of 2016.

In fact, first quarter fiscal IR revenues of $5 million represented 58% of total revenues.

Today, the majority of this new business has been based in the standard materials for infrared: germanium, zinc selenide, et cetera.

These materials have volatile prices, which has impacted our manufacturing costs.

As we convert many of these products to our BD6 material and add a molded component, we will see significant improvement in our margins.

We intend to make this IR business more profitable in much the same way we improved our PMO profitability.

The ongoing relocation of our New York operation, which was acquired with ISP, to our other facilities in Orlando, Florida and Riga, Latvia is another key step in margin improvement.

This relocation was even more necessary as volume production requirements had increased with accelerating adoption of our expanding line of proprietary infrared lenses.

As anyone might expect in this process, we are incurring redundant costs for overhead and personnel, have had to invest in additional equipment and have seen a temporary volume efficiency decline given the obvious productivity-level challenges when jobs are being moved.

By our estimates, approximately half of the increase in cost of goods sold in the first quarter can be attributed to these type of issues associated with the relocation of the New York operation.

We expect we will continue to have some higher costs for the next 6 months, as we complete this relocation.

Accordingly, as we saw significant improvement in the gross margin between Q4 2018 and Q1 2019, we expect we will continue to see improvements as we work through the relocation.

Whether it is our IR products or our PMO products, LightPath industrial-leading value proposition is resonating with new and existing customers alike, which in large part, has led to the many recent announcements for near-term and long-term supply agreements.

One of them was a contract relating to 5G telecommunications requirement that was announced after the end of the first quarter.

So this adds to our excitement and the progress being made in fiscal 2019.

I'll now turn the call over to CFO, Don Retreage, to provide additional details on our financial results for fiscal 2019 first quarter.

Thank you, Jim.

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 in our quarterly report on Form 1040-Q (sic) [Form 10-Q] filed with the SEC.

I encourage you to visit our website at LightPath and specifically the section titled Investors Relations.

Now on to my remarks pertaining to the first quarter of fiscal 2019.

Revenue for the first quarter of fiscal 2019 was $8.5 million, an increase of nearly $1 million or 13% in comparison to the first quarter of the last fiscal year and 6% over the last quarter.

The revenue increase is primarily driven by an increase in infrared volume and higher PMO average prices.

In each of the past 5 quarters, infrared product revenue has surpassed PMO revenues, solidifying its position as our largest product category.

Breaking the revenue down by product group, we see the following trends.

IR products.

The industrial market is where we are currently seeing the most growth for our infrared products, both molded and turned.

In first quarter, revenue for the infrared product group grew 38% with unit volume up 78%.

Within the infrared product group, the molded product experienced its fastest growth rate, albeit from a small number.

IR revenues were 58% of revenue compared of 47% last year.

In our PMO product.

Demand from telecom and catalog distribution, which includes a number of end markets, contributed to our PMO revenues in the first quarter.

Total PMO product revenue was 36% of revenue compared of 43% in the first quarter of the prior year.

However, the average selling price for PMO products sold in Q1 was up 46% compared to Q1 2018, driven by the mix.

I would also note that we saw a significant increase in orders in Q1 for our telecom products with a 58% increase over Q1 2018.

This is an encouraging sign looking forward.

Specialty, NRE products.

Revenue for the specialty products, which now includes nonrecurring engineering projects, was 6% of revenue in the first quarter, down from 10% last year.

The decline is a result of timing for NRE products.

While we have a solid pipeline of customers for this relatively smaller product segment, the timing is wholly dependent on customers and their project activities.

Each contract can distort performance in a quarter, depending on the timing.

The first quarter of fiscal 2018 included a large NRE project, which was not repeated in the first quarter of fiscal 2019.

Moving to our geographic revenue mix.

36% was from the U.S., 18% from Asia, 43% from Europe and 3% from the rest of the world.

Our overall graphic mix has shifted away from Asia and towards Europe, with the increase in our infrared sales with our regional operations in Riga, Latvia.

Sales to customers in Europe were 43% of sales for the first quarter compared to 23% in the first quarter of the prior year and 31% in the fourth quarter of fiscal 2018.

Our diversified revenue with contributions from multiple country operations is an integral to our overall growth strategies that does come with some currency risk and taxation issues, which I'll address later in my remarks.

Further, in the terms of trade business that are concern to investors, we have not experienced meaningful impact and uncertain if we will.

Given our geographic diversity of manufacturing, all our orders for China can be made in China or in Riga, Latvia.

So there is not an expected pressure there.

For demand from American customers, we do some manufacturing in China for those programs, but thus far, the impact of tariffs have been minimal.

Now on to our vertical market sales review for the first quarter.

As compared with the first quarter of last year, sales to catalog distributors were 18% of revenues versus 22% last year.

Defense was 14% of revenue versus 11% last year.

Industrial, 42% versus 38% last year.

Medical was 4% of the revenue versus 5% last year.

And telecom was 11% of revenue versus 10% last year.

Jim reviewed bookings in his remarks, so I will move on to backlog.

In terms of backlog at September 30, 2018, the PMO group represented 32% and IR was 61% of backlog.

These levels are consistent with the backlog at the ending of the fourth quarter.

As of September 30, LightPath 12-month backlog increased 9% to $14 million as compared to $12.8 million as of June 30, 2018.

Gross margin in the first quarter of fiscal 2019 was approximately $3 million or 36% of revenue as compared to $3.3 million in a quarter -- in the same quarter for the prior year or 43% of revenue.

As we discussed, IR revenues now represent a majority of our consolidated revenues and because of the higher material costs and the longer process times, they have the lower margins than the PMO products.

Total operating costs and expenses were approximately $3.3 million, an increase of approximately $213,000 compared to the same period of the prior fiscal year.

Management expects elevated SG&A costs through the end of fiscal 2019 as part of the New York facility relocation.

Moving down, the income statement.

Some important factors include lowering net interest expense due to the full satisfaction of the Sellers Note for the ISP acquisition during the third quarter of last year.

Income tax benefits of approximately $179,000 compared to income tax expense of approximately $58,000 for the period of the prior fiscal year.

This is based on a mix of taxable income and lapses in our various tax jurisdictions.

While we have a large NOL carryback -- while we have a large NOL carryback benefits to shield corporate earnings in the U.S., we will still pay foreign subsidiary income taxes.

FX exchange losses in the first quarter of fiscal 2019 was approximately $338,000, which had a $0.01 unfavorable impact on our basic and diluted earnings per share compared to a gain of $246,000 is the first quarter of fiscal 2018, which had a $0.01 favorable impact on a basic and diluted earnings per share.

The company reported a net loss for the first quarter of fiscal 2019 of approximately $583,000 or $0.02 basic and diluted shares per share -- diluted loss per share compared to the net income of approximately $218,000 or $0.01 basic and diluted earnings per share for the first quarter of fiscal 2018.

Included in the net loss was expenses for inefficiencies related to the relocation of the New York facilities and the impact of the $338,000 for FX.

Cash and cash equivalent totaled $5.5 million at September 30, 2018, down from $6.5 million at the ending of fiscal year.

During the quarter ended September 30, 2018, the company expended approximately $670,000 for capital equipment as compared to $1.4 million in the same period for prior fiscal year.

With this review of our financial highlights concluded, I will turn the call back to the operator, so we can begin with questions and answer sessions.

(Operator Instructions) Our first question will come from Zack Turcotte of Dougherty.

Zack on for Catharine Trebnick.

First, just a housekeeping one.

If you have the number for contribution from ISP in the quarter?

Well, the IR number was about $5 million compared of the $8.5 million and the vast majority, I think -- What did we do in molded?

Was $0.5 million?

Roughly $0.5 million, Zack, I think was precision-molded IR stuff.

Right.

Okay, perfect, thanks.

And then -- all right.

So on the gross margins, I know you said, obviously, the reasoning for it is higher mix of infrared products, which had lower margins.

So even though you're working to increase the infrared margins, and you are getting some strength in PMO now from the telecom sector, could we expect to see margins remaining sort of in this area as IR continues to shift into a heavier mix?

Well, Zack, I think we'll see margins continue to improve a little.

I mean, if you look at where we were in the fourth quarter compared to the first quarter, I think our gross margin was around 30% in Q4, and it was 36% in Q1.

So that's a pretty nice improvement as we transition both through this increasing mix of infrared product and the additional costs that we incurred for some of them -- and unanticipated, some of them, for the relocation of New York.

Just a little more -- I mean, we had -- for example, during the quarter, we had a major water line break in the factory in New York, which flooded the factory, and it damaged 2 of our coding -- 2 of our coders in that operation.

The good news there is one of those, we were planning to decommission and obsolete.

So that hurried that along.

The second one has since been repaired and has just come back online.

So we are -- we didn't expect that to happen.

So we had a lot higher repair costs associated with that.

I think -- and then in the decision as we're moving operations, we -- as I've said, the last time, we got some redundant wages in terms of we're carrying a couple of extra people while we make this transition.

And then we just had some more inefficiency in that operation than we would have liked, and that contributed significantly.

So if you were to adjust, for example, our EBITDA, that was about 6% or 6 points of margin that we gave up there for those kinds of things.

So I think we're on the track of our margins improving, and we expect to see that kind of thing.

I think we'll get them back to where they should be, which is in the -- probably in the low 40s as we move through this thing a little bit at a time.

And I think from this point forward, we'll continue to see some improvement as we work our way through that relocation project.

Great.

And then you talked about consolidating the product groups from 5 down to 3 as well as naming some target industries by products, like obviously, infrared driving strength in industrial and telecom in -- PMO for the telecom sector.

What kind of cross-selling opportunities do you see between these as far as, for an example, current infrared customer and -- an industrial customer with infrared products potentially having a use case for PMO or vice versa?

Well, I think we see that because we tend to deal with a lot of the larger companies in China and the U.S. And they have multiple projects.

So the -- both of those, the visible and the infrared, are applicable in some instances.

But what I was really trying to say in that statement was the fact that as we put these press releases out for these particular wins, we're trying to associate them with the industry group that, that customer and that product application falls into, so the investors get an idea of where the applications are occurring.

We had a major contract that we signed with a major telecommunication customer in the quarter.

We did some very good, nice infrared ones as well that -- so we're building.

So there were 2 parts to that.

One is we see the business growing across multiple market sectors as well as we're seeing longer -- we are winning larger contracts that are going over a longer period of time, and we're starting to build that backlog so we get more visibility in the business and we're not as dependent on short-term orders and, what we call, turns, which are orders that we book and ship within the quarter.

So I think both of those things are happening.

And what we're trying to do is give that sense to the public of how this business is growing and the opportunities that we have and the infrared is growing quite rapidly, particularly with the chalcogenide material as a substitution for germanium.

And as we are able to put some of the molded applications or molded product into some of these applications, the interesting thing: Even though it's a pretty small number, the molded products are growing quite rapidly as the fastest-growing segment that it still has a way to go before it becomes what we'll consider significant.

But I don't think that's too far off in the future.

Okay, and then maybe just one more, talking about that telco order in the quarter related to 5G components.

How big of an opportunity do you see in 5G this year and next year?

There's obviously a lot of talk about it, but everything we've heard seems to be that it's in super early stage.

So just an idea what you see on that?

Well, we attended a key supplier conference with Huawei during the quarter.

And that was all they wanted to talk about was 5G.

That's where their focus is.

And they expect it to see that ongoing over the next 5 years.

So that was very encouraging.

And then we got a really nice order from them for this type of products.

So I think -- and we've done a lot of work, as we pointed out in the past, on the new-design lenses for that type of application.

So we're starting to see that stuff build.

The other thing I would say to that is as the component or as a component supplier into the back office -- backbone networks of these types of devices, we should see it early on because that stuff has to be put in place as they begin to roll out these networks.

So we'll be on the front edge of that slow growth, but there is a tremendous amount of work to do it because you got to put up an awful lot of towers for these short-range applications that 5G represents.

And that's the good news and the bad news, I guess.

There's a lot of work to do in infrastructure to make it, and which is why I think you're hearing from these guys that it's going to take a while to do.

The next question will come from Matt Koranda with Roth Capital.

Just wanted to start with the implied order flow.

Some pretty good growth year-over-year for you guys.

So just wanted to see is there anything large or onetime in there that wouldn't necessarily repeat as that business runs out?

Or is that all sort of normal course of business bookings that you got this quarter?

The kinds of bookings that we're seeing are not super-huge, onetime deals.

These would be things that would have a reoccurring element to them as we go through time.

But they are longer term -- a lot of them are longer term because of their magnitude.

So we are seeing that.

But what we see and what we have disclosed is the growth in our, what we call, disclosure backlog, which is orders that are shippable in the next 12 months.

So they're not -- they're going to be -- we'll start to see these type of shipments over the next several quarters.

And so they're pretty immediate in that type of impact.

Okay, got it.

And the orders that, I guess, were press released since the end of the quarter, so in October, I assume those were not included in the existing backlog that you guys reported?

Correct.

Yes, we're just talking about the backlog as of the end of September.

Okay, got it.

And then maybe could you talk a little bit about sort of the mix that you saw in terms of bookings?

Has that kind of trended?

I mean, I would assume it's trending toward the IR side just given the mix that you've got in revenue.

But does it differ in any material way from sort of the current revenue mix that you've got now so that we can kind of think about how mix trends over the next year or so?

Didn't we give some percentages on where that backlog was in bookings?

Yes, I think it is weighted towards the infrared side.

But the caveat that I would put on that, Matt, is that we're starting to see a pretty nice pickup in some of the visible stuff, particularly in telecom.

61% of the backlog is IR.

Yes, we said 61% of the backlog is infrared.

So I think -- just to give you -- we said there was a 58% increase in telecom orders that we took in Q1 compared to Q4, which is pretty significant.

And that represents a dollar value that equal to magnitude to the kind of quarterly telecom orders that we were booking in 2017, which was the peak telecom year for us and significantly higher than the average that we saw in 2018.

So if that's -- that's one quarter, so even if it continues, and it looks like it will, that's a pretty encouraging sign for the visible side of the business as well.

Yes, certainly is.

And then just, I guess, one more in terms of a mixed question.

But on the verticals that you shared, I noticed that, I guess, catalog and distribution was down a bit year-over-year.

Well, pretty much everything else seemed like it was up or flat.

Any sense for what's driving that in your distribution channel?

Is there just some de-stocking that needs to happen?

What are you hearing?

No, I think it has more to do with telecom.

And the reason I say that is previously, we had a major distributor in Singapore that was feeding Fabrinet, who was doing the contract manufacturing for a couple of our major telecom operations.

And that was previously included as a distributor, and now that's moved into the the telecommunication sector.

So that business has kind of shifted.

So that's kind of skewing the change in those 2 categories.

Okay, got it.

So you moved that -- you've re-categorized that particular customer into the...

Right, because we -- what's the word?

Direct, noun.

Is it?

Yes, we took that business direct.

It's no longer going through the distributor.

And because he wasn't doing a very good job, we fired him.

Got it, okay.

And -- I mean, do you envision that sort of -- is that a general trend that we should be considering over the next year or so in terms of going more direct?

Or any more actions to come on that front?

I think that's just going to be -- I would hope that, that's a one-off-type thing.

It's not -- it's just -- that's on a case-by-case basis.

If we see somebody is not doing what we would like them to do, keeping their finger on the business, and things are changing and we're getting surprised, then we'll take action.

And so that -- I mean, I wouldn't consider that a strategy or a trend of ours.

But we just we're going to try and manage the business the best way we see fit so that we know what the hell is going on.

Okay, got it.

And then just in terms of gross margins.

I guess, if I look at the improvement that you guys made on a quarter-over-quarter basis, it looks like you're getting quite a bit of pull-through in terms of gross profit dollars for the incremental revenue that you've gotten quarter-over-quarter.

Is that kind of -- is that rate kind of how we should be thinking about the improvement throughout the rest of the year as revenue ramps?

I mean, it's sort of -- it's north of 100% in incremental pull-through.

But just wanted to hear your comments on that.

Well, I mean, that has been our model in the past, where we leveraged those overheads.

But think about what we've done is we took an operation that was probably the highest-cost operation we had in the corporation, and particularly some of the coding operations, and we moved almost half of it to our Chinese operation.

So we got a -- and that benefit is now flowing through.

And now we have moved the diamond-turning operation that was in our New York operation.

It has been totally relocated to -- the majority of it went to Riga, our other low-cost operation, and then the balance came here to Orlando.

And that isn't totally done from a -- the way we want the facility set up, but it is totally done from running the product through the machines.

We've got -- we're almost done installing the last pieces of equipment, and we've covered those with substitution of equipment that we had in Orlando.

So we're not down from a capacity or a throughput point of view, we just haven't quite finished all the dotting the i's crossing the t's in terms of how we're running diamond turning.

So we're starting to see those improvements flow through in that margin.

And I think we'll see more of that in Q2.

The -- then that leaves us with the coding operation, and that's the one that we're starting to work through now.

So there's going to be some changes in this quarter and in the next quarter as we do that.

So the thing we've been waiting for is the facility expansion in Orlando to be finished so that we can actually install our equipment.

And that will start happening very soon.

Okay.

Last one from me, I guess.

I don't know if I caught it.

Maybe you had in the prepared remarks.

Rolled on a little late.

But anything, I guess, onetime in nature in your OpEx that you'd call out?

I think you called out elevated expenses with the move of Irvington.

But I don't know if you guys quantified anything there.

We did.

And it is -- those are -- those expenses that are -- we had that water pipe break, which -- in New York, which shut down 2 of the coders, one of which we've decommissioned and the other just got repaired and has come back online just in the last few days.

That was expensive.

And then as we've indicated before, we're carrying some redundant labor as we make these transitions.

And then we've just -- we're just suffering with some larger inefficiencies in New York than we had anticipated.

I mean, but it's not -- I guess, it shouldn't be unexpected as when you're moving jobs like that, and you have people that have decided not to move and continue, and they're short term in nature, and they know it.

So it's -- that was a fairly good expense in the quarter.

I think if I made 2 adjustments to EBITDA for Q1: one for FX, which we called out at, what, $338,000, the impact; and the other for those type of inefficiencies and costs, EBITDA would have been 14% versus the 3%.

So that's why I'm pretty encouraged by what we're doing.

I think we're doing the right things.

The next question will come from Chris Vachovsky, a private investor.

So in previous conference calls, you've talked about how you're doing NRE work for telecoms that would result in you having orders for kind of a custom lenses that will be eventually be sold at much higher gross margins than your usual lenses.

And this is a belief for the visible light lenses for telecom.

Is this happening?

And those new orders -- those new telecom orders that you've been talking about, were those, those kind of custom lenses at the much higher gross margins?

Well, I think the short answer is, yes.

We're starting to see -- in this quarter, we saw increase in our telecom revenue but not at the level that we saw the increase telecom quarters.

So we think that's a building trend as that business comes, one, from our perspective would look like some recovery from the depths of the trough that it went into.

And those -- that product line has excellent contribution margin with it.

And so we would expect to see that impact grow as the volume of those new orders starts to go through the production and become shipments.

All right, but would it -- is there a change from -- let's kind of look at things maybe couple of years ago, when you had excellent telecom orders.

Would -- if -- when telecom orders get good again, maybe, hopefully, in a couple quarters, would we have better margins for those from -- as compared to a couple of years ago because now we are doing self-sourced products.

Is that something to hope for?

Or is it going to be the same as it was when times were good back in couple of years ago?

I would say -- I would not say that they would be substantially better than they were a couple of years ago, when they were pretty damn good.

I think, those -- as I said, those products have excellent contribution margin.

And as we go forward with these products that move into some of these access network applications and 5G applications, they will have similar, very excellent margins associated with them as well.

They won't be worse.

All right.

Okay.

And moving onto backlog.

Before, maybe last year, there was kind of a behavior of backlog where it would just kind of go down until the last quarter of the calendar year, your fiscal Q2, when it would go up suddenly.

Now we're seeing much better results.

The backlog is actually increasing before that last calendar quarter.

Does that mean that we won't see as large of an increase in the last calendar quarter?

Or would we still see this kind of bump-up that happens in the end of the year?

Well, I think, the overall business has grown quite nicely through the period.

And you're right, we've generated quite a bit of interest in our chalcogenide products.

And -- but we still expect that we will have success with renewing some of these very large contracts that we had in the previous years that caused those spikes.

I do expect that we're in that time period where we have the opportunity to look at renewing those things.

We have taken some -- from those customers, we've gotten some new orders, and we've also gotten some orders that extend the existing contract while we work on a renewal.

Okay, that's good to hear.

And on gross margin.

You said that there are 2 major things affecting the gross margin: the -- well, 3 major things, and 2 of them are the move from New York and the germanium.

And can we assume that both of those factors would be kind of decreasing over the next couple of quarters as -- if ever, replacement for germanium lenses and the move from New York is kind of going -- proceeding along?

Or would we see the same effect going forward?

Well, I think the short-term impact will be from completing the relocation of New York operations, and so we won't have those extraneous costs after the next 2 quarters or so, when we finish that move up.

And through that period, we should see some gradual improvement in those things.

I think the conversion of our business from our IR on the turned lenses -- the diamond-turned lenses, there's 2 things that are going to happen, which will take a little bit longer than the next 2 quarters to see fully implemented but will be occurring along that time frame: one is the substitution where we can of molded infrared chalcogenide lenses for what today are turned, germanium lenses.

And the second is just replacing turned, germanium lenses with turned chalcogenide lenses.

Those things are occurring.

That's -- for our business, that's where we want to drive it, using less germanium and zinc selenides and those types of materials.

And using more of our chalcogenide glass, which will give us improvement in those margins.

But I think that's a longer-term, slower implementation as people make those changes in their designs and/or new products are designed with those materials to begin with.

So that's going to be a continuing improvement and change that you'll see in our business.

But to say that it's going to happen in the next 3 months or 6 months in a definitive level is very difficult to do.

I think it will be occurring over time.

And by the time we get through this fiscal year of '19 and probably halfway through '20, we'll see a pretty substantial mix shift in our business that -- where we'll have the chalcogenide being the majority of those types of products for us.

I think there'll always be a place for germanium and the other infrared materials, but I think, from our perspective, we try to drive it to the material that we -- our material that we manufacture and is moldable.

So can you just say a couple of words about your that -- the -- your intellectual property in that material, I think, or chalcogenide?

Do you have like full IPA rights to have a patent on the material itself?

Or do you have a patent on the process?

Or...

Well, the way we process the material is company trade secrets since we didn't -- we chose not to do any patents around that.

Chalcogenide is a material that is in the marketplace and has been for years and years.

And so there's no -- nobody has a lock on that material I think.

The only thing I would say is we do manufacture it ourselves, and we have tuned to match our processes, particularly on the molding side.

And so that's where we believe we have a pretty good advantage.

And it just inherently is a lower-cost material than germanium and some of the other materials that are common today in the infrared applications just because it has fewer or no rare earth associated with it.

All right, and if there's anyone else -- has anybody else managed to mold optics using chalcogenide?

And if so, do you have advantage over them?

Yes, we have competitors, and they are good, solid competitors in the marketplace.

And so far, overall, we are beating them on cost and price.

Next question comes from Marc Wiesenberger of B.Riley FBR.

Yes.

I think you mentioned that you're seeing some good pricing increases in PMO lenses.

Is that across the entire spectrum or with specific verticals?

And do you see that as a onetime increase or potentially sustainable over multiple quarters?

I think it has a lot to do with the particular mix that we happen to ship in any given quarter more than anything else.

And as the volume picks back up, then it's -- we have a pretty good -- we absorb the overhead better than when that volume is off.

But from a margin point of view, we haven't seen any deterioration in the precision molded optics margins through this whole period.

So they are holding up pretty well from that standpoint, but the price increase we saw -- the average price -- higher average price we saw in Q1, I think, was as much a result of mix as anything else.

Got it.

There was a pretty big shift in terms of geographic sales with 43% in Europe.

Was this coming from a distributor that was fueling that?

And if so -- or do you see that kind of shift going forward?

And would you potentially create or increase your European sales force to accommodate that shift?

Well, I think that shift is really being driven by those -- as we shift, the higher percentage of our business becomes infrared.

And that seems to be where a lot of the applications in Europe, and that's where -- also where our major -- our largest customer is.

And so he is a contributor to that shift.

I think the sales organization that we have through the distribution system that we have in Europe is good and can handle that level of business for us that we have been looking at expanding some of our representation into some of the Scandinavian countries, where we haven't done a lot historically.

So we're adding there to cover that.

But I think it's just -- it's really driven, I think, primarily by just the growth in the infrared business more than anything else put up against the general weakness in China -- in the Chinese economy as well.

So the industrial tools and things that were, look, drivers of the business in Asia -- China's economy is not strong right now.

As a matter of fact, it's weak, and they are suffering.

Our advantage there is we tend to deal with the premier, large companies that are either very large OEMs and Chinese companies or their parents are -- there are assembly operations for companies out of the U.S. and Europe in Asia.

So we tend to get that business, and that business tends to -- those guys can survive because they ship worldwide.

So I think we're seeing that, but most of that shift, I think, occurred for those 2 reasons: just a general weakness of the Chinese economy combined with the strength of -- and then the growing business in infrared for us.

Got it.

And so when you say that there's a decrease in the industrial market, that's primarily China is what you are referring to?

Correct?

Yes, so I mean, those are the industrial tool-type applications, those kinds of things.

So that tends to be the lower-price point products that we do that are pretty high volume, the laser levels and saw guides and pointers and barcode scanners, those type of applications.

Got it.

And then with regards to the time to process and create and ship the IR lenses.

You have this great, new proprietary BD6 material.

Do you foresee being able to shorten the cycle for creating and shipping that to kind of get more throughput in a given quarter?

Well, Marc, that is one of our major objectives is to shorten the cycle from book to ship.

And yes, I think we have a lot of programs that we're working on that will start to benefit over time that are aimed at doing just that-type thing.

And that was one of the reasons we've had such success with our precision molded optics is because we really were able to improve and shorten the cycles in that process.

And the process for the infrared is not -- for particularly the molded infrared is not that dissimilar, but it does have some particular parameter differences just because of the material systems, et cetera, that we deal with.

So yes, we're working on a number of things that will -- that are focused exactly on that point but shorten that lead time.

The next question will come from Gene Inger of ingerletter.com.

I'm curious, since you mentioned China, maybe I've like 3 questions only.

Let me touch on that real quickly.

I'm curious about a joint venture you referred to in a press release some time ago, in which I think you spoke to a unique technology which can be duplicated by nobody else.

And I think you said in that, that time, the contract will be worked out and it was on track.

I don't know if there's been a delay or you've already covered that or you're referring to that in the industrial fuel category?

And I wondered if you could elaborate.

So I think that had to do with some applications that we're working with a particular Chinese OEM on a development scale.

But if it could've worked out, would've been really great and the potential was there to do a joint venture in the future.

That program has had some setbacks not from our part of it, but from their part of it.

And I think they're retooling their approach.

So it is kind of I would say, been put on pause.

I don't think it's completely dead yet, but it's certainly not active at the moment as far as we're concerned.

However, in that application area, we are working with several other companies and those programs are still very active on a development nature for LIDAR-type applications for autonomous-type vehicles.

I was just going to ask you about LIDAR, because I didn't know if it related to that or simply LIDAR is used in measuring devices and so on in Chinese construction and so on?

I think this was more geared towards vehicles and industrial vehicles like fork trucks and then some applications in automated warehouses and stuff like that.

Well, how do you stand with respect to LIDAR developments in the United States or elsewhere at this point?

Well, I think those are proceeding quite nicely, and we're doing some very unique optical designs for some of those applications that I think put us in a very good position should -- as these things reach -- progress through the development stage.

But they're still in the development stage at this point.

Could I ask you to sort of perhaps sum something up.

It sounds like you're saying that despite a couple stumbling blocks like the water break, relocation expenses and so on, that the bulk of the problems with that are -- behind that are maybe nonrecurring, and now it's sort of just the process of completing it.

So when I look at the increasing revenues and slightly better margins, which I know you and I both hope will be improved even more, I guess, the question is because 1 or 2 of the analysts who have followed you, and there are not many, have suggested that the company is sort of in a neutral stance as far as investors are concerned.

So I wonder if you think that this combination of streamlining operations and relocations and higher sales and slightly better margins proceeding merit an upgrade from the neutral level as far as how one perceives the company?

And indeed, whether the higher sales and margins will be sufficient to offset these unique expenses and short-term losses?

Well, I think we are going through a transition in the business on multiple fronts.

One is from a physical plant point of view, which is always a major undertaking when you relocate a major facility, and we're coming -- that's becoming less and less risky as we go through time and we get these things set up.

We're not done with it.

As we've said, that will be with us through the rest of this fiscal year.

The next 2 quarters, for sure, will be some of the heavier work.

So that's occurring, but once those are, what I would consider, nonrecurring expenses, once we get through them.

But then the other part of it is, Gene, is we're always working to improve the margins on the product line, and we are transitioning our business where infrared is becoming the heavier weight of the total business.

And it has a different cost structure, which we've outlined previously, and so I'd like to emphasize that.

We have a nice core business that we've developed and worked very hard on.

It has excellent margins.

It still has those.

Now we're adding to that this infrared component, and its where the growth in the marketplace is and where we can participate and grow.

And you see that growing element in our numbers already, and it's become the majority.

It was 58% of the business in Q1.

So it's now the biggest thing, but it has -- because of the materials that are used in it and the processing times, it has inherently a different margin structure, which is a little bit lower.

So when you mix, weight those things together, our margins will be a little bit different than they were historically and -- but on a much bigger base.

So -- like I just think that's the right way to run the business.

I would rather have a little bit lower margin on a lot bigger number than a super margin on a smaller number in a market segment that has limited growth.

I mean, the precision molded optics is driven by laser diode-growth markets potentially, which is historically somewhere between 5% and 7%.

The infrared market is just exploding with applications as the cost continue -- on thermal imagers continues to get better and lower.

So that's where the market is growing, and that's where we've invested and are participating.

And I think we'll be quite successful with it.

And this concludes our question-and-answer session.

I would now like to turn the conference back over to Jim Gaynor for any closing remarks.

Thank you.

So in conclusion, we appreciate the support of our shareholders and, as always, the dedication of our global team at LightPath.

With our strengthened presence around the world, we remain focused on our efforts to drive top line, bottom line and cash flow growth, while making improvements in our overall financial condition.

We're very excited about our growth prospects, and we'll be sharing them at the upcoming Roth Capital and LD Micro investor events in December.

Thanks again for participating on today's conference call, and we look forward to speaking with you next quarter.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect your lines.

Have a great day.