Intevac Inc (IVAC) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Intevac's 2005 first quarter results teleconference. (OPERATOR INSTRUCTIONS). Please note that this conference is being recorded today, Monday, May 2nd, 2005. Kevin Fairbairn, Intevac's President and Chief Executive Officer, is hosting the call today. I would now like to turn the conference over to Mr. Fairbairn. Please go ahead, sir.

Good afternoon, and thank you for joining us today. With me are Charlie Eddy, our Chief Financial Officer; Luke Marusaik, our Chief Operating Officer; and Verle Aebi, President of our Photonics Technology Division.

After Charlie reads the Safe Harbor statement, I will give a progress report on our first quarter activities. And then Charlie walk you through first quarter results and talk about our updated expectations for 2005. We will then open up the call for questions. Charlie?

During the course of this conference call, we will comment upon future events and make projections about the future financial performance of Intevac, including statements related to our expected orders and order backlog, number of systems shipped, expected delivery schedules and customer acceptance, revenue, product cost, gross margins, operating expenses, depreciation, other income and expense, profitability, earnings per share, cash flow and capital expenditures.

We will discuss the growth in the hard disk drive market, our 3 to 5 year outlook in the equipment business, and our market share and production capacity in the equipment business. We will discuss the performance of our low-light camera products, the projected applications, projected size of the markets they address, and when we believe pre-production and production deliveries will commence.

We wish to caution you that these are forward-looking statements that are based upon our current expectations, and that actual results could differ materially as a result of various risks and uncertainties, including, without limitation, the following -- failure to achieve expected financial results; inability to develop and deliver new products and technologies as planned; the possibility that markets for our products may not be as large or develop as quickly as projected; possibility that orders and backlog may be canceled, delayed or rescheduled; difficulties and delays in delivering, installing and obtaining acceptance for our products, which could result in additional cost, lower gross margins, delays in revenue recognition or penalties; and other risk factors discussed in documents filed by us with the Securities and Exchange Commission, including our annual report on Form 10-K and quarterly reports on Form 10-Q.

The contents of this May 2nd call include time-sensitive forward-looking statements and represent our projections as of the date of the call. We undertake no obligation to update the forward-looking statements made during this call. Any redistribution of this call without our express written consent is strictly prohibited. Kevin?

Q1 was an exciting quarter as we achieved record bookings, gained additional customers for the 200 Lean, and made excellent progress on our next generation head mounted night vision systems.

As a result of record bookings in our equipment business, we increased our backlog to 66 million at the end of Q1. This backlog is all scheduled for 2005 delivery, and positions us for strong growth in revenues compared to 2004. More importantly, our material cost reduction activities have been successful, and we expect the combination of higher volume and higher gross margins to improve our financial performance relative to 2004 and lead to significant profits in 2005. We continue to the busy with quotation activity and hope to further increase orders for delivery in 2005.

During the first quarter, we received orders for twelve 200 Leans from a total of 3 customers. Our first 200 Lean customer ordered multiple 200 Leans which we will begin delivering in the second quarter. Our second large customer, after completing an exhaustive nine-month evaluation of the 200 Lean versus our competition's system, selected the 200 Lean. This led to the purchase of their qualification (ph) 200 Lean system, which we recognized for revenue in Q1. Follow-on orders for production systems are expected this quarter for delivery later this year. We're now in the process of opening a second field office in Asia to provide installations, service and parts support for this customer.

A third customer also ordered a 200 Lean for fall delivery. This tool will be used for perpendicular development. Subsequent production system orders are expected to be in 2006.

Subsequent to the end of Q1, we reached agreement to ship a 200 Lean to a fourth customer for production qualification. Successful qualification, which is not expected until early 2006, coupled with successful commercial negotiations could lead to production orders for delivery in 2006.

In Q1 we also received orders for four of our legacy MDP-250 media manufacturing systems for production capacity expansions cut of already qualified products. All four systems are scheduled to ship in the second half. As a result of all these orders, we expect to end the year with increased market share.

To meet the strong demand for our systems, we have put capacity in place necessary to achieve a production rate of one system per week. As I speak, we are creating the first 200 Lean system for shipment. This system is being shipped on schedule with a manufacturing cost significantly lower than the systems we shipped in 2004. We remain focused on hitting our cost goals and expect to achieve higher gross margins on 2005 system builds compared to 2004.

We also sell disk lubrication systems which deposit a thin lubricant layer onto the disk following media deposition. The systems sell for about $0.25 million each. To date, we have received orders for nine of these systems for delivery in 2005.

Demand for hard drives is robust, with emerging consumer applications continuing to grow rapidly. Recently there have been multiple announcements from hard drive public companies reporting positive outlooks for their businesses. There is a concern being expressed that media capacity may be a limit to business growth short-term. Capacity shortfall indicators are a positive for Intevac, as they are predictive of the need for more disk manufacturing systems.

Trend Focus, the hard drive industry association, recently made the following statement. "Media vendors have been slow to invest in new capacity, and disk availability continues to tighten. We're not exactly ready to call it a shortage, but there could be some limiting effect on hard drive shipments later in the year." Clearly, those customers who cannot meet demand risk losing market share.

Over the next three to five years, we continue to forecast a $1 billion system market to support increased capacity for the growing hard drive market, as well as the deployment of perpendicular media technology into mainstream production. We expect that the majority of capacity (technical difficulty) buys (ph) will be configured with twenty available stations, consistent with the needs of perpendicular media technology, but initially with only enough of the stations populated with the process hardware necessary to support legacy and longitudinal media manufacturing. We continue to believe that perpendicular will be introduced in 2005.

We also expect to see additional systems sales to support the rapid growth in small form factor drives that use drives -- that use disks that are one inch in diameter or smaller. These small drives are used in iPod-like products and mobile phones, to name a few of the rapidly growing uses. We estimate the small form factor growth could increase the $1 billion served market by as much as 25%.

Our customers currently load four to five small form factor disks onto the carrier that is processed like a 3.5 inch disk in our equipment. For reasons of both quality and efficiency, this manual process needs to be automated. In Q1 we commenced an engineering program to design an automatic interface module to our disk factoring systems. We do not expect to see revenue from this new module until 2006, although the majority of the development spending will occur in 2005.

We have one remaining D-Star flat-panel deposition system that was delivered to an R&D customer in 2003 and has been customer acceptance limbo. We finally reached agreement with this customer on how to achieve signoff. As a result, we are designing and installing some additional modifications to this system. The cost of these modifications significantly impacted our reported gross margin in Q1. Charlie will provide more of the details on this topic.

We have an active program underway with the goal of realizing some value (ph) (technical difficulty) from this productline. As part of the process of selling D-Star IP, we thought it was important to close out this last major outstanding item. Overall we expect D-Star activities to be positive for 2005.

In our imaging business, we're making excellent progress on our Next Generation low-light military head mounted night vision systems. The eventual market for these cameras is large. The market for legacy night vision goggles today is over $350 million a year.

In the first quarter we delivered prototypes of head mounted cameras to our NATO customer, the U.S. Army, and a commercial customer and received favorable feedback from field tests of these prototypes. These prototypes cameras, which use the version of our low-light sensor based on the commercially available CMOS imaging chip, have demonstrated significantly better low-light performance that our current NightVista camera.

During Q1 we will completed development of a custom CMOS imaging chip to replace the commercially available chip used in the prototypes. This new imaging chip offers much enhanced performance over its predecessor, and will be used in the production version of our camera -- the head mounted night vision systems. We're now integrating these new imaging chips into our low-light sensors, and expect to have pre-production cameras completed by Q3.

Our overall head mounted night vision camera development program is on schedule and supports the beginning of production shipments in mid-2006. This imaging sensor with a new custom CMOS imaging chip is also expected to be incorporated into a range of camera products for commercial applications later in 2005.

LIVAR continues as a key part of our long-term product strategy. We have substantially completed product development and have entered a phase where revenue growth of our model 400 LIVAR product will be determined by the rollout schedule of end-user systems under development by our customers.

Our customers are typically major defense contractors who are integrating our LIVAR cameras into complex weapons systems. Their development cycles can be lengthy, and we do not expect significant contributions to revenue this year. We're continuing to market model 400 cameras to integrate as targeting new programs.

We're continuing to develop enabling technology for new markets that can lead to products for Intevac in the future. Over the last year, we received increased government funding for the development intensified photodiodes, or IPDs. IPDs can detect single photons at GHz data rates. This activity has targeted both high-performance laser/radar applications for missile defense and for high data rate communication links for future of Mars land missions for NASA.

Charlie Eddy will now discuss the financial results. Charlie?

As I talk through the highlights of the first quarter, I will also comment on expected second quarter financial results and our expectations for 2005. Please remember these projections are forward-looking statements subject to the cautionary words made at the beginning of the call.

Consolidated Q1 revenues totaled 10.6 million. Equipment sales of 8.5 million included one 200 Lean system and equipment-related upgrades, spares and consumables. The 200 Lean system included in revenue was for the acceptance of a system that we delivered in mid-2004.

Revenues were higher than our guidance for the first quarter due to higher-than-expected sales of 200 Lean upgrades. The 2.1 million of imaging revenues were largely derived from R&D contracts. Order backlog increased to 66 million from 10 million at the end of 2004, with the increase resulting from orders for twelve 200 Lean systems and four legacy MDP-250 systems.

For the second quarter, we're projecting consolidated revenues of 23 to 25 million. Our projected revenue includes five 200 Lean systems, two disk lubrication systems, and imaging revenue comparable to the first quarter. For the full year, based on our current backlog and recent quotation activity, we expect that consolidated revenues will fall somewhere in the range of 105 to 130 million, which includes and 9 to 12 million at of imaging revenue.

We are quite comfortable with the lower and end of this range. The upper end of the range is consistent with our current understanding of what our equipment customers want this year, and is an indication of what is reasonably possible provided those current desires turn into orders during the second and third quarter.

Q1 consolidated gross margin was 19% compared to our beginning of quarter guidance of 25%. The largest impact to gross margin related to the D-Star system that Kevin discussed earlier. We provided for 510,000 of additional costs related to obtaining acceptance for the system. We expect that this system will be accepted by the customer later this year, but do not expect it to contribute any gross profit. It is not included in the revenue guidance that I just gave you.

Q1 equipment gross margin of 21% was significantly impacted by the D-Star reserve. It was also negatively affected by the 200 Lean system accepted by our system this quarter, which represented one of the remaining two high-cost units that we built early in 2004. This system realized gross margin in the low teens, comparable to the gross margins we achieved on the other 200 Lean systems built in early 2004.

We expect second quarter equipment gross margins, which are dominated by deliveries to our first 200 Lean customer, in the 30% to 32% range. We expect second half equipment gross margins to improve to the 33% to 35% range as we add more customers, our volume builds and we come further down the production learning curve.

Imaging gross margin increased from 2% in Q4 to 15% in Q1. The improvement resulted from a lower portion of revenue coming from cost-sharing programs. We expect Q2 imaging gross margin to be roughly comparable to Q1.

First quarter operating expenses of 6.3 million was slightly better than our beginning quarter guidance of 6.5 million. We expect operating expense of approximately 6.9 million in Q2, with higher research and development spending driving the increase relative to Q1.

The development activities associated with development of an automated (indiscernible) for small form factor disks, and development of imaging sensors and cameras, account for the majority of the increased spending.

The Q1 net loss of 2.9 million or $0.19 a share was slightly better than our expectations at the beginning of the quarter, and consisted of a 2.7 million operating loss in equipment, 1.2 million operating loss in imaging, 469,000 operating loss in corporate and 431,000 of other income. The 431,000 of net other income consisted primarily of interest income, dividend income and early payment discounts. We expect net other income of approximately 450,000 in the second quarter.

Q2 we're projecting net income in the range of $0.00 to $0.03 per share. This represents the net of increasing profitability in our memory equipment business, which is being partially offset by investments we're making in the imaging business, and our new equipment productline.

Our deferred tax asset, which is fully expensed, now totals 21.3 million. Accordingly, we're planning on a 2005 tax rate of approximately 4% of net income. For the remainder of 2005, we're projecting capital spending of 4 to 5 million, depreciation and amortization of approximately 3 million.

We closed the quarter with 43 million in cash and short-term investments, up from 42 million at the beginning of the quarter. We expect that cash and short-term investments will decline to the 30 to 35 million at midyear, and then build back to current levels by the end of the year.

Accounts receivable grew to 22 million from 5 million at the beginning of the quarter. The growth was driven by customer advances related to the high level of bookings. Overall, our receivables are in good shape and turning over in a timely fashion. With this cash level and no debt, we remain well capitalized to continue to execute our business plan for 2005.

Our headcount at the end of the quarter totaled 273 employees, up from 191 employees at the beginning of the quarter. The majority of the increase was in manufacturing and field operations, and is related to ramping up capacity in the equipment business. About two-thirds of the increase was accomplished with contract labor.

Operator, this completes the formal part of our presentation and we're now ready for questions.

(OPERATOR INSTRUCTIONS). Rich Kugele, Needham & Company.

I guess just firstly, regarding the additional Lean customers that you have successfully added during the year, do you expect their stations to be higher in the initial configurations then perhaps your first original customer, basically coming from the premise that -- has the industry realized that they need more and they are not ordering a lower number to begin with?

I believe all the systems that we have orders for have the same number of stations.

Have you seen any customers order any additional stations yet?

Are you talking about the total number of available process stations on the call (ph)?

Yes.

No, we're still seeing the same number, which is 20.

In terms of the fourth customer that has just recently been thinking about buying or getting an R&D system delivered in early '06, do you have a sense on what the ultimate magnitude of production systems to them could possibly be?

Those would be -- that would be in '06 and we would expect that to be in excess of a dozen machines if it is going to be a media factory.

And that system is going to be delivered this year. We didn't think it would get to revenue until '06.

And can you give us a sense on what type of relative mix you expect the total year guidance to be? Do you expect additional 250B orders over the course of the year? Or do you think you're at the point where everything incremental from this point would be still 200 Lean?

I think most of it will be 200. You might see a few odds and ends of 250 bees.

Jesse Pichel, Piper Jaffray.

Good job on guidance. How many more Lean will you have to book for '05 to reach the top of year guidance at 130 million?

I haven't got that number right with me. Not that many more. You can look at -- equipment did 8 million of revenue in Q1. We guided you to another 22 to 24. That gets us to about 30. We have backlog of 60, which is mostly -- the majority of that is equipment. So there is not that much more to book to get to 105 million in revenue.

So the bottom of year guidance includes the 12 and a couple few more and you are at 130?

We have still got to do some more bookings from things that we expect are coming to get to the bottom of the range. The bottom of the range to us a fairly conservative estimate of what we can do. The top of the range is based on what our customers are telling us, kind of what we will expect they will do. But it is an industry where things change quickly, so you kind of need to wait and see them happen before you really count on it.

Did you give the corresponding net income for that revenue range?

No, we didn't.

Any reason why?

No, our policy as we only really give the precise guidance for the next quarter.

You say that you've just made the announcement today that you have a fourth Lean customer, is that correct, for '06 delivery?

We talked about it in this call.

Why the conservative revenue recognition? Here you have recognized revenues with two other customers on the identical machine, why not just recognize it now?

This is very much like the second customer where we have to qualify in order due to get revenue.

Charlie, the disk lubers and the one inch auto loader, will they be in Service going forward or Equipment?

They will be part of our Equipment revenue.

Right, but are they going to be in Service or --?

They are all part of systems revenue. I think the lubers we tend think of as kind of -- since they are quite a bit less than the big systems, we tend to think of them as that flow of all the other revenue other than systems.

I don't know if it Verle is there, but I'm wondering a question for him or for Kevin, the new custom CMOS image sensor, is that part of the NATO ally program or is that still the old image sensor?

No, we are targeting the new custom CMOS image sensor for all of our head mounted products, and that includes the NATO program.

Any timing there on when the U.S. Army is going to make some type of decision?

That is in process over the next 12 months, but I think the decision as to exactly which way they're going to go is a next year decision for the Army.

That the (indiscernible) we do expect they will be putting out some additional programs in '05.

That's right.

As part of that activity.

Mark Miller, Hoefer and Arnett.

Congratulations on the strong bookings. Just wanted to understand something. You said you are currently -- factory was operating roughly -- you expected to be shipping one system per week. Is that correct?

Yes.

I would interpret that you would, with the total backlog, have shipped through all this backlog before the fourth quarter. Does that make sense?

We have the capacity for one week. We're not necessarily going to ship one a week for the next 30 or 40 or whatever weeks there are left in the year. But we've got the capability to do it. We will try and smooth our production out so that we make good use of those people.

Some of this backlog could actually go out -- realizes revenue in the fourth quarter, is that correct?

All of the backlog we have is scheduled to revenue this year. We still have a number of slots open where we can get a lot more orders and still ship this year. We could receive orders --clearly, orders we get in Q2 should still be shippable this year, and probably some of the orders we get in Q3 will also be shippable for revenue this year.

From what you said you got four Lean customers right now, and it sounds like you could get -- the orders that have not received yet for the Lean tools will come from the first two customers, is that correct, that will be included in the revenues for this year? They will be the primary ones for the additional bookings that haven't been made to this point?

I think the additional 200 Lean bookings will come from people -- will come from those first four.

From the first four? Because it that you said the perpendicular -- the system was bought for the one for perpendicular research. They would not order until the fourth -- until '06 (multiple speakers).

They will come from among the first four, not necessarily from all the first four.

Yes, we have made the -- some people order in '05 for '06. It is really going to depend on their end markets.

Thank you.

Kevin Hunt with Thomas Weisel Partners.

I wanted to delve into this quarter revenue a little bit. You had you see the 8.5 million in equipment revenue from basically one Lean. Can you help us understand a little more what we should be thinking of per Lean, essentially, as they ship, on what -- in terms of revenue? And then that was my first question. The second question is on the one inch attachment that you're talking about there, Kevin. What can we expect on that in terms of revenue?

I will comment on the small form factor module and Charlie can comment on the 200 Leans. For the small form factor module, that is the extension of the machine. And that is not just disk loading, also adds process capability as well. So it is very configurable. So the average selling price could be anywhere from $1 to $2 million, depending on how many process modules get added to it.

That would be on top of what we paid for the Lean?

Correct.

So in terms of the ASP, the ASPs are all over the map. But I would say they can be -- depending on how fully configured a system is, if it was really stripped out, maybe just -- it might be as low as 3.5 million. And if it was really loaded up with all the bells and whistles and maybe the customer only had bought the first one, it might be as high as 5 million.

And can I follow up on something Rich was asking, which I think was you of implied that possibly people weren't using all 20 stations. Does that mean there is incremental revenue from even like the ones you sold last year or how should we think about that?

Think of it is perpendicular -- the system that people are buying may have run for 20 process stations. That is a 20-station configuration. As people start doing longitudinal, they might only populate 12 or 14 or however many stations they need to transfer their longitudinal recipe. As they start moving into the perpendicular as recipes or even advanced longitudinal, they may start adding more and more, fully populating the system.

So as we go on in time, I think the orders are coming in with more and more of the system being configured with process stations. And a good chunk of the nonsystem revenue we got are people ordering typically more process stations for the installed base.

Process module or process hardware to go on this (multiple speakers) stations.

Yes.

Actually one last thing. On that 250Bs -- you have four of those on backlog, I think, are those the second half of the year shipment?

Yes.

Brian Horey, Equity Growth Management.

Can you give us any color on how you expect OpEx to play out beyond Q2? Is that a level that you expect to sustain going forward, or might it increase from there, or just some sense as to what the vector for that looks like?

Probably a fair but not totally precise way to think of it is just kind of a straight line, what we gave you and Q2 forward to the end of the year. And I will do that with a couple of caveats. There is a couple of things that are kind of unusual expenses in Q2 that are pushing things up a little bit.

In the second half, depending on how well we're doing, I think our business model for OpEx -- we may get well ahead of our business model in terms of the revenue or ahead of the OpEx. And we're trying to get to where we hit our operating model for the year, which in equipment I think we had targeted for like 12% or 13% pre-tax for the year. So if we're really doing well in revenue, we may loosen up a little bit on OpEx, try and pull some other development activities in. We're not really high on the model. We will probably -- we will try and keep from growing OpEx.

Do you have a target margin for the non-equipment side of the business?

We do. We're still in the development stage, though. So we're really -- your model is looking at beyond this year.

Thank you.

Mark Gomez (ph), Pipeline Data.

Great quarter. Hoping you could give a little bit more color in terms of where we might be in the cycle. Looking at some Gartner forecasts, there is obviously strong growth projected, not just through this year but at least through next year as the HDD market breaks away from its PC dependency, some trends that we really haven't seen since the late '90s. Wondering if that is the way you see things and what the impact of that, as well as the move to perpendicular, could be on your installed base of 250s?

We did a top down analysis just over a year ago, where we made an estimate that we thought that the eventual market for additional capacity required, plus the need (ph) to re-talk (ph) the perpendicular would be about $1 billion. That is to total available market to Intevac and our competitors. We subsequently increased our estimate based on the small form factor, and moved that number to closer to about 1.25 billion.

You ask where we are in the cycle. We think we're not even 20% yet into the cycle. So we're still in the early stages.

What was that first number again that you took to 1.5 billion?

We originally estimated for the larger disk size that that was about $1 billion opportunity, and later on modified it and said we thought the small form factor would add another 25% opportunity.

So in one year you had to modify your forecasts by 25%.

We increased it, yes.

Have you had a look at the Gartner forecasts? I am wondering how much about is incorporated into those forecasts, or if you're going to have to keep revising those up?

Our original forecasts were taken not from Gartner but from someone else, and they were more conservative than the numbers people are saying today. We have chosen to go with the more conservative numbers until there's better data.

Jesse Pichel, Piper Jaffray.

Kevin, could you update us on your R&D initiatives for targeting additional tool markets outside the hard disk drive arena?

Those are continuing to go well. We still -- on track to have potential first customer shipments either the back end of this year or early next year. And we're very pleased with our progress.

When we say first shipments, is that another R&D tool? Is that revenue recognition?

I expect the initial tools will be evaluation systems.

For recognition in '06?

Correct.

And what would be the ASP profile look of these tools? Would be similar to hard disk drives, and then again on the margin?

The ASPs will be less and the gross margins that we're targeting much better.

What is your total available market there in terms of the number of tools for this market?

We have estimated that per application is about 100 tools a year so -- and the three applications we believe we'll be targeting eventually.

Could you talk about your relative positioning in that market and where your competitive advantage lies?

I would not want to go into that much detail at this point. I think we'd just be giving unnecessary information to our competitors.

Could you give us a little more detail on the end market? Is it semiconductors or packaging?

We have said that it is related to semiconductors, but it is not in traditional semiconductor markets.

Finally, has there been any change to your competitive positioning in the perpendicular HDD tool market? And specifically let what is Innova doing there?

Innova is not going to go away. They continue to sell and market aggressively. On our latest estimates, we believe we're outselling them at the rate of over 4 to 1 in systems. So if that continues, that will be very positive for us.

Thanks a lot. Good job.

Mark Miller, Hoefer and Arnett.

Actually, I have two of them. I just wanted to go through -- I apologize -- but the margins you are talking about -- equipment margins for the first -- second quarter would be 30% to 32%, and equipment margins for the second half be 33% to 35%? Is that correct?

That's correct.

Imaging margins would be what for the -- was that 15% or 18%?

They were 15 in the first half. We said they would be on the order of that in Q2. I would expect them to kind of drift up throughout the year.

You mentioned you were outselling your competitor 4 to 1. Does that mean they've had -- I wasn't realizing they have had a win in terms of their -- what is it the 30, 40 system? It is that what Innova calls it? Have they actually gotten into somewhere with that tool?

I wasn't referring to the 30, 40 when I gave the ratio of systems. Just like we sold some legacy 250Bs, I would expect that they picked up some capacity buys as well.

Do you expect them within the next three months to announce any major wins with any of the major media manufacturers?

I can't comment on what they will or won't do.

J.D. Abouchar, Specific Edge Investments.

Congratulations on the outlook. I had a question for you on it four customers that we have right now. What is the rough hard drive market share for them?

It is north of 50% -- probably north of 60%, but we would have to go away and do the detailed analysis.

That's good enough. And on the -- switching topics on the custom CMOS sensor, does this push out our development timeline in terms of getting to revenues for the night vision equipment? And also, what type of R&D expenditure and risk does this present to getting to revenues?

In terms of the development timeline, the chip was targeted when we began development early last year to complete in Q1 of '05, and so we have maintained our timeline on the development.

This chip is basically going as scheduled. This has been our plan all along for what was going to go into the camera for the NATO ally.

Right. And for our HMD customers in general.

So it is not really a new development or change in strategy?

No, it is one of the checkboxes you can check off on the way to the NATO program.

Okay. Duly checked off. Thank you.

Mark Gomez, Pipeline Data.

Just forgot to get an answer with regard to the move to perpendicular and what impact that could have on your installed base of 250Bs.

The 250B can only support 12 process steps, and some of our customers in development have put perpendicular onto the 250B. But the result has always been that the throughput is more than halved. So if people want to make competitive hard drive disks, then they need to go to something like the 200 Lean, which gets a high throughput and delivers the technology. So we expect over time that the 250Bs will become obsolete.

So the move to perpendicular should be a major driver for 200 sales going forward?

I would say it is by far the largest factor. If people are going to put capacity in and they have the opportunity to qualify the 200 Lean, then that is the right economic choice.

Do you have an estimate of the installed base of 200 -- 250Bs out there?

Yes, there is about 110.

110 units. And do you have a sense as to what the overall market installed base is for sputtering machines? And can you talk a little bit about your potential opportunity to go in and gain share from the installed base of other potentially obsolete machines?

Because the numbers are changing rapidly, if we go back to 2003 there were probably about 200 total systems out there. Some of the systems have lower throughput, some of them had higher throughput. We think the market is -- just based on projections -- is going to double. Plus, people are saying the small form factor could represent yet another doubling in the market, which remember earlier I said that for small form factor you can do four or five disks at once. So that means you won't need twice as many systems, or by that point (indiscernible) four times as many systems. So that's why you factored it back to just 25% of the market we had estimated.

This is Charlie Eddy. The total market opportunity that Kevin referred to of about 1.25 billion, you could think of that as equivalent to maybe roughly in 300 200 Lean equivalents in terms of the total market (multiple speakers) for us.

Is it correct that he just implied by -- he said double and then double again, which would imply something between -- was it 400 or 800?

Systems?

Yes.

No, no we are looking -- the 1.25 billion is a going to roughly 300 200 Lean systems.

You mentioned the installed base of 200s being 100 approximately, the total installed base being 200, the market opportunity being double that, correct?

Let me try some more of the numbers. Say there is about 110 250Bs out there, there is now also a number of 200 Leans that we have shipped. That stuff probably equates to roughly 60% of the market, or of the capacity for making disks. Then you have all the Innova systems that are out there. And they were maybe -- in the last round they might have been 20% market share or something like that. Then you have tools from a couple of other manufacturers who really aren't participating this time around. And so the total market might have been the equivalent of 200 of our older style machines, but it was a mix of machines from everybody, of which we had about 110.

What I was trying to do -- I understand your conservatism. I'm just trying to figure out what the upside potential is. Sounds like there's a fair amount of it.

Yes. Can I restate? Maybe I wasn't very clear on my description. So the 200 equivalent systems that were out there, what we call the legacy market, they were enough to support roughly 250 million hard drives a year. The analysts are saying the market is going to double. In theory, that would be 400 of our legacy systems. But our new product has a higher throughput, so that is why we de-rated the number of units required. So then our new system also has a higher average selling price. So that was where the $1 billion came from.

Then the analysts came along and said in addition to the 500 million hard drives, there's a potential of anywhere from 2 to 500 million small form factor drives. The disks for those drives will be made on equipment which has four to five times the productivity as the equipment used for the larger disk sizes. That is why we said the market will only grow 25% incrementally for that small form factor.

Greg Weaver, Kern Capital.

On the autoloader, it seems like that would help your customers a lot. Just curious why you couldn't get them to pay for some of the development?

That is always a complex question, because if the customer pays they often ask for an exclusive period. And that may not be always in the best interest of the Company.

When did you say that the product would be ready?

We're targeting the Q4 to be in a position to ship the first of the customer products.

Assuming you're developing on your own nickel here, is there any at least some guaranteed orders here?

We feel highly confident there are going to be orders. We wouldn't be doing this if we didn't have extremely strong customer pull. And so we are really in the stage now of nailing down final specifications and pricing.

Any sense of what percent of the potential installed base -- was probably somewhat covered by the last question, the 25% growth -- so that is in terms of what portion of the machines you think at the end of the day might have that additional functionality?

Eventually it will be 25%, but some of this is predicated on just how big a small form factor. The numbers have been going up rapidly recently, and we will have to see where they actually turn out.

On the D-Star mop up here, so are you shopping the intellectual property -- have you got any bites, any additional color there?

As I said, we have offered it to multiple equipment companies and several have expressed positive interest, and we're still in the process of the discussions.

Do you figure this is an '05 event?

That is our plan.

And on the SOx, Sarbanes-Oxley side of things, Charlie, could you maybe break out how much the expenses were there, and how that is ramped for you and where you see that going?

We did almost all the SOx work internally. So the primary adder to expense was the additional audit expense. The way accounting works now is you expense the audit costs in the period when it happens. And the SOx-related costs was I think on the order of 375K in Q1. There won't be much of it in Q2. I think the total SOx audit bill was on the order of -- it was between 5 and $600,000, which shipped (ph) between -- mostly between Q4 and Q1.

But yet your total OpEx it is going up despite the non-375 recurrence?

That's correct.

I think you said there was some one-timers in there?

Some of the R&D things, particularly where we're building new systems -- the first version of systems, you buy the system, you expense it to R&D. And so you get heavy flows of engineering material coursing through the R&D line.

So it won't be in SG&A sequentially if it is all R&D basically?

There's also some growth in SG&A, hand in hand with the surge of orders in the equipment business. We're building out -- increasing the infrastructure around the rope (ph) of customer service and support. So Kevin told you about the customer number two, we're putting an office in close proximity to their facility, so it will probably be a couple of more of them.

How is your efforts going in terms of the aftermarket consumables and support?

As you know, a lot of the legacy tools that have been done -- all the service has been done by the customer today. But as I speak to you now, we're actually closing in on our first 200 Lean service agreement. And we're working on focusing on the assemblies -- selling assemblies and doing high-value service for the customer versus just getting then piece parts. We hope to at least penetrate $1 to $2 million of additional revenue this year, and set the groundwork going forward for a much higher percentage of service and spares business.

I guess just lastly for me, on the vision side of things, do you expect any actual military production orders -- well, I know it won't be in '05 production, but additional orders in '05 from additional military customers?

We're talking to another headman at customer (ph) and I think there's some probability of an order in '05. Again, the production would be -- for that order, if it takes place, would be the latter half of '06 in terms of revenue.

And how about on the life sciences side of things? It has been pretty quiet there. Is that kind of not panning out or just--?

No, we said that we would take this sensor that we have developed for the head mounted, and that later this year we would take that, spin it into a camera for the life science market. There is a case where the development will be done targeting the merchant markets, but spinning off into a commercial application.

You have no further questions at this time.

Thank you for joining us today. We look forward to you joining us next quarter. Thank you.

That concludes today's Intevac 2005 first quarter results teleconference. You may now disconnect.