Intevac Inc (IVAC) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Intevac's second quarter 2006 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. At that time, we will provide instructions for those interested in entering the queue for the Q&A. Please note that this conference call is being recorded today, August 1st, 2006.

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, and Verle Aebi, President of our Photonics Technology Division.

After Charlie reads the Safe Harbor statement, I will give a progress report on our second quarter activities and then Charlie will walk you through our second results and talk about our expectations for the third quarter and 2006. We'll 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 projected production rates, system shipments, revenue, gross margin, operating expense, other income, profitability, tax rate, earnings per share, cash flow, capital expenditures, depreciation and non-cash stock-based compensation expense. We will discuss projected demand for disk drive media, our operational plans in Singapore, the impact of upgrading legacy tools, the transition to perpendicular recording, the advantages of the 200 Lean and other factors that affect demand for the 200 Lean and projected evaluation unit shipment dates for our new equipment product line.

We will discuss our plans for military and commercial low-light imaging products and the projected applications and market sizes for these products. These forward-looking statements are based upon our current expectations and actual results could differ materially as a result of various risks and uncertainties, including, without limitation, the possibility that markets for our products may not be as large or develop as quickly as projected.

We may not be able to develop and deliver new products and technologies as planned, that orders and backlog may be cancelled, delayed or rescheduled, that we fail to achieve expected cost reductions or financial results and other risk factors discussed in documents filed by us with the Securities and Exchange Commission, including our annual report on From 10-K and quarterly reports on Form 10-Q.

The contents of this August 1st call include time-sensitive forward-looking statements that represent our projections as of the date of this call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of this call without our expressed written consent is strictly prohibited.

Kevin?

We are pleased to report excellent second quarter results, well above our prior guidance on revenue and net income. Record revenues of $59.5 million were achieved as we delivered 11 200 Leans, all configured for perpendicular media production and multiple disk lubrication systems.

Orders for spares and upgrades continued strong and contributed to the revenue upside. We achieve GAAP net income of $9.3 million, or $0.42 per diluted share. Pro forma net income, after excluding non-cash stock-based compensation expense, was $0.45 per diluted share. This was significantly better than our pro forma guidance of $0.30 to $0.40.

Orders for the 200 Lean continued on strong. Our backlog at the end of Q2 totaled $96 million and included 20 200 Leans. Since then, we have received orders for 12 more 200 Leans, which [weighted] our total backlog for 32 systems.

A portion of these 32 systems are scheduled for delivery in 2007. In equipment, our operations team again did a great job accelerating system deliveries and not system orders to achieve our revenue upside. We also continued to improve our build and test processes to reduce cycle times, include high build quality and smoother installations. These operational improvements are key to enabling us to increase our build rates beyond a system a week, which is likely to be required later this year, as the fourth quarter is shaping up to be very large for us.

Our initiative to reduce costs and improve our responsiveness to Asian customers by moving part of our manufacturing to Asia is on track. Our Chief Operating Officer, Luke Marusiak, is currently in Singapore, formally opening our new manufacturing and logistics center. We have started manufacturing sputter sources in Singapore, and we'll move other sub-elements of 200 Lean production there over time. While we intend to continue manufacturing in Santa Clara, particularly early production of new products, our strategy is to expand our operations in Asia and defer expansion in our more expensive Silicon Valley headquarters as long as possible.

The ongoing demand for more digital storage continues, as the transition to digital from analog in the business and consumer spaces shows no sign of abating. The latest long-range forecast from Trend Focus projects even higher demand for hard disk drive media compared to their previous forecasts.

This is a key indicator for our business, as growing demand will require additional new systems. The transition to perpendicular media is gaining momentum. Hitachi Data Storage Systems announced in May that it's introducing its first perpendicular media hard drive this summer. This perpendicular drive is 160 gigabytes, compared to 100 gigabytes for the old longitudinal technology.

Analysts project the transition to perpendicular to occur over the next three to four years. Our latest product, the 200 Lean, was specifically designed to address the technology and economics required for perpendicular media manufacturing. Our outlook continues to be positive, and we are increasing our revenue guidance for 2006 by about 20%. The prime drivers for growing our business continued to be the increased capacity needs and the transition to perpendicular technology.

We are also pleased to have already received some orders for 2007 delivery. At this time last year, we did not yet have any orders for deliver in 2006. Some of our customers would like to extend the use of their legacy tools to perpendicular production.

As we continue to develop new capability and enhancements for the 200 Lean, we believe the desire to upgrade legacy tools will reduce. We believe that perpendicular production will reduce the productivity of the legacy tools and actually shrink available capacity. While upgrading legacy systems can extend their use for a while, it does not eliminate their eventual replacement.

The impact to Intevac of these legacy upgrades will be unplanned upgrade revenue in the short term and a lengthening of the upgrade cycle for new equipment. In aggregate, this should lead to more revenue for Intevac as the upgrades can cost as much as $1 million per system.

During the quarter, we initiated a lawsuit against Unaxis for patent infringement of our 200 Lean by their new system. We are seeking damages and an injunction to prevent the shipment of any infringing products. We compete in the marketplace based upon innovation, performance, reliability and support of our products and cannot allow our valuable intellectual property, which we created through our long-term investment in research and development to be unfairly used against us.

Our progress on developing an equipment product line to address a new market for Intevac continues on track. We expect beta shipments for customer qualification activities to start in Q1 of 2007. Our operating expenses will increase in the second half of this year, as we expense the engineering, part and test materials for our internal qualification of this new product and establish the business development and support teams to work with a new set of customers.

However, we continue to be efficient with our spending, as we have held year to date operating expenses to 20% of revenue while we continued to develop new capabilities for our hard drive business, as well as create this new product line.

In imaging, we continued to transition from a technology development focus to a product-centric operation. In Q2, we announced that Intevac and DRS Technologies are developing a digitally fused, head-mounted night-vision goggle for the U.S. Army. The program is on schedule, with first [site] deliveries targeted for year end.

The goggle will include a low-light imaging sensor provided by Intevac and a thermal imaging sensor provided by DRS. The imagery from the thermal, infrared and the low-light night-vision sensors will be digitally fused and displayed on a miniature, high-resolution display in front of the soldier's eyes.

Integrating these two technologies in a compact, digital, head-mounted system delivers the benefits of both technologies simultaneously in single image, as well as offering the ability to present data from other sources in the same display. This combination of capabilities offers significantly enhanced situational awareness to the soldier.

The current market for military head-mounted night-vision goggles is in excess of $0.5 billion per year and is expected to remain a high priority for the Army for many years. Momentum has continued to build for our low-light level sensor technology. Six defense contractors have now selected Intevac's technology for digital head-mounted night-vision systems. This quarter, we started a program with the Air Force to investigate unmanned aerial vehicle applications and a program with a defense contractor for a vehicle-mounted application.

These design wins are consistent with our strategy to position the Intevac sensor as the solution of choice for digital low-light level camera applications. Our key short-term operational objective in imaging is to eliminate the operating loss. This requires moving into volume production for both our military head-mounted night-vision cameras for our NATO customer, and our commercial MOSIR camera.

The single-largest single term obstacle to establishing high-volume production for these two product lines is obtaining export approval for them. Shipments of our cameras to our NATO customer is wholly dependent on export approval by the U.S. government.

During Q2, we worked closely with the Departments of Defense and State on this matter and now expect to reach a decision on export in Q3. Provided we receive export approval, we expect volume shipments to begin during the fourth quarter of 2006. Revenue for this program is not included in our guidance.

MOSIR is an extreme low-light, near-infrared camera targeted at the scientific market. Customer interest in this market is high and we shipped additional domestic beta units during Q2. Despite having been designed specifically for scientific imaging applications, there is a concern in one of the export groups in the Department of Defense that a more restrictive military product classification may be needed.

We are currently addressing this concern, as approximately half of the $30 million a year available scientific market is outside of the U.S.

Charlie Eddy will now discuss the financial results. Charlie.

Thank you, Kevin. As I talked through the highlights of the second quarter, I will also comment on expected third-quarter financial results and our expectations for 2006. Our expectations will include projections on both a GAAP basis and on a pro forma basis that excludes projected non-cash stock-based compensation expense related to our employee stock option and stock purchase plans.

Consolidated Q2 revenues totaled 59.5 million, and included 11 200 Leans and seven disk lubrication systems. This was above our beginning of quarter guidance as a result of stronger than anticipated sales of upgrades and spare parts.

Imaging sales of 3.1 million consisted of 2.7 million of contract research and development and 378,000 of product shipments. Product shipments included a LIVAR system, MOSIR cameras and NightVista Free extreme low-light cameras.

Second quarter consolidated gross margin of 36% was at the upper ed of our beginning of quarter guidance. Cost of sales included 93,000 of non-cash stock-based compensation expense, which had a minimal effect on gross margins. Second quarter operating expense of 11.3 million included 602,000 of non-cash stock compensation and was marginally lower than our beginning of quarter expectations.

GAAP net income for the first quarter totaled 9.3 million, or $0.42 a share, 695,000 of stock-based compensation expense is included in these GAAP results. Pro forma net income, after excluding stock-based compensation expense, was 10 million, or $0.45 per diluted share. This compares favorably with our beginning of quarter guidance of $0.30 to $0.40, which also assumed a lower tax rate. The 9.3 million GAAP net income consists of 11 million operating profit in equipment, a 1.3 million operating loss in imagine, a $153,000 operating profit in corporate, 729,000 of other income, plus 1.4 million for income taxes.

We increased our projected tax rate for 2006 to 8.8% from 3% that we used in the first quarter. The Q2 results include the effect of bringing our year to date tax provision up to the 8.8% rate. The increase in the tax rate was the result of projecting a significantly higher level of income for 2006 than we projected at the end of the first quarter. The increase in projected income was driven by the strong 200 Lean orders.

In 2007, after we have earned our way out of the tax valuation allowances accumulated in prior years, we expect a tax rate of approximately 35%. The 35% rate is subject to a number of variables and will likely change as we see how much of our tax valuation reserve is revised during 2006 and gain better visibility into our 2007 operating results.

For the third quarter, we were projecting consolidated revenues of 40 to 45 million, which assumes recognition of eight 200 Leans for revenue. We're projecting third-quarter pro forma gross margin of 35 to 37%. GAAP gross margin will be about a half a point lower.

We're projecting second quarter, third quarter, pro forma operating expense of approximately 12 to 13 million. GAAP operating expense is projected to be approximately 1.1 million higher. Operating expenses are growing as a result of product design and business development costs related to our new equipment product line.

We expect other income to increase to approximately 900,000 as a result of interest earned on our increasing cash balances. For Q3, we're projecting pro forma earnings of $0.11 to $0.19 pre diluted share. GAAP earnings, including a projected 1.2 million of stock-based compensation expense, should be about $0.05 lower, or $0.06 to $0.14 per diluted share.

For the full year, we're raising our revenue guidance range from 180 to 205 million to 220 to 240 million. This range assumes recognition of between 43 and 47 200 Leans for revenue and provides some latitude for our customers to fine-tune their delivery schedules between now and year end. Given our current backlog and depending how many systems we ship in 2006, we now have between five and nine 200 Leans in backlog for 2007 delivery.

We expect Q4 to be the strongest quarter of the year and have made plans to produce and install systems at a rate that exceeds one system per weak. We do not expect to be capacity constrained and we will ship for our customers scheduled requirements. Q4 is a good example of the large fluctuations that our revenues can experience from quarter to quarter.

This is the nature of our business and we want to encourage investors not to base their valuations on either the high-revenue quarters or the low-revenue quarters, but step back a bit and base your valuations on a longer-term, more integrated view of our results.

We're projecting full-year pro forma gross margin of approximately 35%. GAAP gross margin will be about 0.25% less. We are projecting full-year pro forma operating expense of approximately 48 million. GAAP operating expenses are projected to be approximately 3.3 million higher.

We expect other income of approximately 3.2 million for the full year. Total non-cash stock-based compensation expense is projected to total 3.9 million in 2006, equivalent to approximately $0.16 per share. Year to date capital spending and depreciation totaled 2.2 million and 1.2 million respectively. For 2006, we are projecting total capital spending of approximately 9 million and depreciation of approximately 3.3 million.

The majority of capital spending is in the equipment business and for IT infrastructure. Cash and investments increased to 66 million, from 46 million at the beginning of the quarter. Accounts receivable dropped from 42 million from 58 million at the beginning of the quarter and was the primary contributor to our strong cash flow. We continue to be completely debt free and are generating cash as we grow the business and make major new investments in developing new products in equipment and imaging.

Our headcount at the end of the quarter totals 417 employees, up from 401 at the beginning of the quarter. About 15% of our employees are currently based in Asia. We expect that to grow to approximately 25% by year end as we ramp manufacturing, logistics and customer support operations in Singapore. Ninety-eight of our 417 employees are contractors and the majority of these contractors work in operations as part of our strategy to maintain a flexible workforce and respond to rapid changes in demand.

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

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Rich Kugele with Needham & Company.

Thank you. A few questions, if I could. First, in terms of general media availability in 2007, I know you have the five to nine orders there, depending on how demand pulls in for Q4, but do you see enough media constraints in 2007 to require a similar amount of total shipments of your systems that you had in '06? Or you think that things could be tighter, or any comments on what you're seeing relative to total shipment potential for 2007 over 2006.

Well, Rich, this is Kevin here. We normally give guidance for 2007 until much later in the year. We don't see any slack in any of our customers' factories and they all have plans to add more capacity at a steady pace. So we'll get a clearer picture around year end. But, as I said in my script, at this time last year we had no orders for 2006 and we already have orders in hand for 2007, so we consider this a much better start to 2007 than we saw for this year, which is on course to be a record year for us.

And, Charlie, you mentioned comments about the upgrades. I'm just interested if - what do you think is going to be driving force behind whether you see a lot of the upgrade business or whether those upgrades are only a portion of the potential systems that could be upgraded and they turn into full systems. Are you expecting to have to upgrade all of the legacy that are kind of in question?

Rich, if you look at our non-systems business and everything other than shipping brand-new systems, that level is roughly double what it was last year. It's grown from around 15 million to around 30 million a year. We don't really have included in our guidance right now any significant guidance from upgrading legacy tools, other than kind of the normal we had a feature every once in a while.

So if a customer were to go and be conducting a lot of upgrades of legacy tools in 2007, that would be then a further adder to your business model?

Yes, I think if you took an old 250B and you wanted to bring it up and use it for perpendicular production, it would depend on the state it was in, but it wouldn't be hard to spend $1 million to do it. So that would all be incremental revenue to us, at least over the whole cycle.

And in general terms, who do the gross margins compare on those upgrades versus your 200 Lean sales?

It's more like our upgrade business than our system business. It's reasonable margin.

Okay, and then just lastly, Kevin, on your semiconductor capital equipment product, which I guess we'll hear more about in Q1. Once we get into Q1 and it has shipped for some customer evaluation, how do you expect that level of R&D and SG&A to kind of progress? Is most of the increase here in Q4, or do you think you'll need to have more costs to support that business?

Well, I think you'll see where we're spending the money will change. Will probably see some reduction in R&D with some increase in business development and support costs. But we're trying to run the business per the business model, and so we've kind of held back from spending when our revenues were lower in order to keep to our model.

And you're still confident in the size of the market for that potential product?

Yes, we're very confident in the size of the market.

Okay, I'll cede the floor. Thank you.

Your next question comes from the line of Mark Miller with Brean Murray.

I'd like to touch a little more about the upgrades. Has anyone else - Seagate it announced that they were going to be upgrading the Max Media tools. Has anyone else decided to upgrade? It sounded like other people were now considering that possibility, besides just the upgrade on the Max Media tools.

Hi, Mark. It's Kevin here. That's certainly has been publicly discussed by Seagate, but we can't go into any more details than that. We have had feedback from other customers, though, that they intend to take legacy tools out of production in 2007.

Okay, you said basically that the legacy tools will add unexpected revenue, but that does that effectively - you said they will eventually have to be replaced. Does it effectively push out some of your anticipated orders in '07 and '08 by them doing this? I mean, that would seam reasonable.

I'd say right now that's not coming into our forecast in terms of pushing out of orders.

Okay, just wondering, you also said operating expense is going to be rising. Are you still sticking to your guidance? You had a model, at least, you were talking about 22, 23% operating expense next year. Is that still the case?

Mark, we haven't given any guidance for next year. I've given you pretty good direction on where we think operating expenses are going this year. I don't think you'll see them go down from year to year. They'll probably be coming up as we keep entering the new business. I think you'll probably see them go up a little more next year, but that will also be a function of what next year looks like, how much latitude we have there.

If you look at our numbers year to date, the revenues have been growing more quickly than the OpEx and we're running, what Kevin said, about 20% operating expense year to date. That's quite low for an equipment company, and we'll probably have some quarters when we slip ahead, but over time we'll try and seek that model that we've been showing in our presentations.

All right, so you're roughly 20% now and you wouldn't roll out the possibility that those slightly are somewhat higher next year.

Yes, we're 20% now. I think if you took all the ranges of guidance I gave for revenue and OpEx for this year, you get to between 20 and 22% for this year. Over time, we ultimately think that the margins should go up quite a bit and OpEx should probably eventually get to plan at around 25%. But it probably won't be a totally linear path on the way there.

That really requires us to get our gross margins up.

Just finally, on your new tool, I wasn't sure that it's been specified. Has that been the case, or are you still withholding where that tool is going to be positioned at.

We're still withholding where the tool is going and the nature of the tool, other than it's wafer based.

All right. Thank you. Congratulations on a record quarter.

Thank you.

Your next question comes from the line of [Shawn Boyd] with [West Cliff] Capital.

Good afternoon. Congratulations on the quarter.

Hi, Shawn.

Just a couple things here. On the Q3 guidance, can you talk a little bit about the expectation that we're going to see delivery of eight 200 Leans, as opposed to what we've been seeing in the past couple of quarters?

That's how it's scheduled out. I mean, our customers' requirements are pretty heavily concentrated in Q4, so we're delivering systems to the requirements and they just haven't specified as many in Q3. So eight is what we have scheduled for delivery right now.

Got you. So it's primarily a timing issue and then once you ramp to that rate greater than one a week with the Q4, we make them put here.

Yes. Well, actually, we'll start towards the second half of this quarter - we'll start ramping pretty hard to get ready for the big Q4 shipments.

Okay. And I missed the guidance on lubers. How many lubers did you have this quarter?

We delivered seven this quarter, and we haven't typically given any guidance going forward on that. They are about a quarter of a million each, and so they don't have that big an effect on the numbers, nothing like a 200 Lean.

That's good. And just the last thing is in terms of the tax rate picking up a bit, should we just kind of hold that 8% for the back half of the year?

That 8.8% is what we estimated the tax rate would be for the full year. So in the current quarter we caught the accrual up. So if you look at it as a percent in Q2, it looks higher, because we also brought Q1 up to 8.8% in the second quarter.

Got it. Okay, thank you.

Your next question comes from the line of Chris Cook with Zazove.

Yes, I just had a couple of quick questions. Working capital, either needs or cash coming from working capital in the back half of the year, what are your guys' expectations for that?

Yes, Chris, cash really jumped a lot in Q2 from 46 to 66 million. I think in the second half of the year, you probably won't see cash grow - it might grow a little bit, but not too much. Our capital spending is kind of back-end loaded and we'll suck a bunch of cash into working capital for the big build in inventory and then billing all the customers.

And then I think in Q1, as we collect on all those systems we ship in Q4, you'll see another good jump up in cash?

Okay, and then - so you would expect, I guess, that you would end the year with $60-plus million of cash on the balance sheet, but not really much more than that.

We'll have to see. Our cash is being really affected by the one or two collections ...

Sure.

But I think it would be at, maybe a little above that level, and then you see it really start to increase in the first quarter when we get all those collections.

And then what would your guys' use for that cash be as it starts to build up on the balance sheet?

Well, we have plans to grow the company into a much bigger business, and as it gets bigger, it might seem like we have a lot of cash now. As we get bigger, that won't seem like a lot, and so we're just trying to port it for a while.

So we're using it as working capital to grow the business.

So, predominantly, you view a need for working capital as you grow the imaging business, as well as in the equipment tool business, or would be capital spending?

We expect most of it will be working capital and for all of our businesses.

Okay, okay, great.

I mean, Chris, I would much rather make it than borrow it or raise it.

Oh, understood. It's just a question of cash being $3 a share and it appearing to build at some point you may want to think about returning that to the shareholder in some form.

Well, Chris, if we can't grow the business fast, then obviously that would be something we'd look at, but we believe we can give our investors a much better return by using that cash.

Terrific. Thanks.

Okay, thanks, Chris.

Your next question comes from the line of Ming Yang with Piper Jaffrey.

Hi, this is Ming for Jessie Pichel.

Hi, Ming.

Hi, congratulations on a great quarter. Now, you had talked about you believe that '07, '08 will actually be the peak year for your [TARDIS] tool. And I think that your '06 deliveries actually accelerated quite a bit. I mean, do you still believe that? Like, what do you see going forward in terms of a tool delivery?

Well, in the past we said our top-down analysis suggested that '07, '08 will be the peak years. On the other hand, we have people like Kaufman Associates, who recently came out with an analysis suggesting that there won't be a peak, there will just be an ongoing increase in the market size after 2010. In fact, the latest one I've seen showed the equipment market doubling between '06 and 2010, driven by a doubling in the number of disks being produced. So that may be more bullish than our projections, but we certainly see a lot of opportunity out there.

And then in terms of upgrades of 250B, I mean, what percent of the legacy tools do you think might get upgraded, I mean, from what you guys are seeing out there?

I think that's a very hard one to call. We're continuing to develop new capabilities for the 200 Lean, which are going to make it harder and harder decision to extend the legacy tools.

I mean, at $1 million each, I think it's not too bad for you guys, right, if it just pushes out the upgrade cycle?

For $1 million, people may get a two-year extension in life. So I think it really comes for some of our customers in the short-term as an accounting issue. Short-term depreciation and cash spending, and can they defer that for a year or two, but in the next four years, we still think those tools will have to be replaced.

And my last question is about the ASPs for the 200 Leans. It looks like they've increased, so how should we think about that going forward? I think they're up about $0.5 million each, if I'm right.

Yes, Ming. When we started shipping the 200 Leans, we were around 3.5 million and they were generally being shipped in the longitudinal configuration. They're all being shipped in perpendicular configurations, so I would say that ASPs have probably moved up, and in some cases a little through 4 million. It's all a function of the configuration and how many things the customers order with the systems, but there's probably a - they're easily at four now.

Okay. Okay, great. Thanks a lot, guys.

Your next question comes from the line of [John Lopez] with OTA Asset Management.

Hi, thanks. I have three quick ones, if I could. The first one is on the balance sheet, your customer advances, that line item actually declined 12, 13% or so sequentially. I'm just curious if you could describe the dynamics specifically with your backlog generally increasing. I'm surprised that that line decreased, so if you could just describe that a bit?

So the customer advances. That's typically when we get an order for a system. We get maybe a third of the order as an advance payment. So we get cash and that shows up as a customer advance. At the time we ship the products, the customer advance gets liquidated and moves up into revenue. So when you have pretty good revenues, that tends to liquidate the customer advances.

If you have a lot of - if your backlog has gone up a lot, then the customer advances tend to grow a bit.

I understand, okay. The second question is, on Q3, your gross margin guidance surprises me a little bit just because of the fairly sharp decline in volume you're expecting. Could you just talk a little bit more about how you're going to sort of maintain gross margin despite 28, 29% lower revenues quarter to quarter?

Yes, the majority of our costs, probably 80% of our costs are material, and then you've got the factory that has to put everything together, and the labor. We're pretty flexible on the labor force. And then the factory, the overhead doesn't have that big an effect on the margins. We also have an - you just have a mix effect where depending on which customer you're shipping to and depending what percentage of the revenue is non-systems business, which tends to be higher margin than the systems. And so when you have a lower quarter, that gives us some good mix effect.

I understand. Okay, and then just thinking about the fourth quarter, I know you didn't give specific guidance on the margin side, at least, but the dollar shipments are going to be like 35 to 40 million higher versus September. You've never shipped that much more incremental revenue in a quarter, and I'm wondering, as you think through the implications on gross margin there, are you running inefficiently because you're shipping so much, or could you just talk through what, if any, guidelines you could offer on the gross margin side?

No, we didn't specifically give guidance for gross margin, but we're not really that sensitive to volume on gross margin like a lot of companies, because we don't have really high fixed cost. Most of the volume comes and goes with each product, either the labor or the material. And the volume has some effect, but not an enormous one. It's more a function and what are we shipping and so ...

So all else equal, there's no appreciable impact on margin either way. It's just going to depend on what you're shipping.

Yes, it won't hurt, but I think our guidance we gave was we were a little lower in the beginning of the year, I think around 35 is about right for the whole year.

Okay, and the last one, could you just give me ballpark, if a customer delivers a tool today, when's the earliest that tool can be delivered.

We close deliveries four months after we get the order.

And that's still the case today despite the fact that obviously you're running much higher backlog than you were like a year ago.

Yes, the customers want the products when they order them, and we figure out how to give them the products when they want them.

Got you. Okay, so four months from order intake to delivery?

Yes.

Okay, thanks a lot. Congratulations.

Thanks.

Your next question comes from [Garov Kapur] with Thomas Weisel.

Thanks, just a clarification on the OpEx number. Your OpEx seems to be going up significantly. I was just wondering, is that the increase in OpEx mainly due to that new Singapore facility that you just announced, or is that you guys are investing heavily on that new [inaudible].

Garov, the Singapore facility has very little effect on us. Most of it ends up in cost of sales. It's a manufacturing and build [through] and support. The increase for OpEx, it's both in engineering and G&A. In engineering, we're building the prototypes. Generally, when we build the first systems in engineering, we just write them off. So there's a lot of cost for building the systems and engineering. There's also a lot of cost for material you'd spend in testing them out and cycling them for a number of cycles.

Then there's also a new set of customers that we'll be selling to, and so we're putting some very senior business development teams in place to support the new set of customers. And so you're seeing the expense for that.

Okay, and then can you update us on this NATO contract that you guys had, how bit a proportion it could be going forward, and then the same with DRS and when can we expect significant shipments with this NATO win and your partnership with DRS?

The NATO shipment is really contingent upon getting export approval for the products Kevin mentioned in the conference call, and we expect to get a decision from the State Department later this quarter. If that decision is positive, we'll begin shipping at the end of this year.

The program with DRS that we announced in the press release is to develop a prototype head-mounted night-vision system that the Army will take delivery on year end and then begin testing on it, and there will be follow-on development programs after that which will lead to production probably three to four years out we expect now. All that's contingent on the Army's evaluation.

Yes, thanks.

Your next question is a follow-up from the line of Mark Miller with Brean Murray.

Just trying to just compare your revenues in this quarter, or the September quarter with the June quarter. Are your imaging revenues going to come back down, or are they going to stay at the level they were in the June quarter in September?

I'd say they'll probably be between the Q1 and Q2 number.

Are you also anticipating somewhat lower spare orders in the September quarter, or is that going to be flat?

I suspect the non-system business won't change too much from quarter to quarter.

So the biggest change is just the reduction in the Lean tool ships.

The primary difference is we're just not delivering as many tools in Q3 and then we're delivering a whole lot in Q4.

Okay, thank you.

Yes.

Your next question is also a follow-up, from the line of Ming Yang with Piper Jaffray.

Hi, just a quick question. What do you expect legal costs to be for this year and next year for the new lawsuits, this and that?

We have built that into our guidance. It depends on what point you are in the suit. We're kind of in the early part of it, so it doesn't cost too much. If we get to the point where we're in court, then it gets to be a little bit more, but I don't think I want to provide guidance for what that's going to be.

But it's within your guidance at this point, right?

Pardon me?

It's within your guidance?

It is.

Okay, and regarding the new tool, is that for a front-end application or a back-end application.

Yes.

Is that front end or back end?

It could be either.

Oh, it could be either. Okay, great, thank you very much, that's it for me. Thanks.

Your next question comes from [Michael Needleman] with [Ridgequest].

Gentlemen, if you did say this, pardon me, because I didn't hear it. I think I heard you said what your revenue guidance was now for the year. Did you give out earnings guidance as well?

No, we didn't.

Okay, and based upon what you said about the expenses, when you talked last quarter about ramping in the expenses for the new product, what has changed, if anything, just on the amount, the timing, anything that's different from the last quarter, when you talked about the possible ramp of expenses and we're starting to see that?

Hello?

Yes, well, we're thinking. I'm trying to calibrate relative to - I don't see what's changed. I think that we have now said that Q1 for deliveries of the evaluation systems. That's probably a little later than we have said before.

Yes, before we were saying either Q4 or Q1, depending on the customer schedule on that.

I'd say the product we're putting out is probably - there's probably more to it than we had before. It addresses more markets than we had before and we're spending a little bit more money because of that. So it's a little broader development in terms of things it can address. We're kind of - as we go along this path, we're adding a lot of critical resources in engineering, and I think that - I'm not sure the ramp of the headcount is that different than what we had envisioned the last time around. It's probably about the same.

I think the thing that's hard to project is the material that the engineers spend is all the parts for testing and parts for designing and we always kind of project it to happen soon and it always takes a little longer. So we keep projecting the expenses to go up and they've started to go up, now.

And, very quickly, on their third quarter, I think you did give earnings projections. Again, I apologize if you did or didn't.

No, Michael, what we do is we always give - we give earnings guidance for the...

Current quarter.

... current quarter that's coming up. And with I gave you, I mean, I gave you revenue range, I gave you gross margin, I gave you expense, I gave you other income. I gave you the tax rate.

Okay.

So you can figure out the range that's implied in the guidance.

Okay, thank you very much.

Okay.

[OPERATOR INSTRUCTIONS] Your next question is a follow-up from Rich Kugele with Needham & Company.

Yes, just one quick follow-up on the third-quarter guidance again. Even when you look at roughly 40, 43 million of revenue on the low end of the gross margin range, what do you think actually gets you to that $0.06 with options? Do you need to have the upper end of your OpEx, or are you really suggesting that if you're growing that slowly in order to support this business, really most results should wind up towards the upper end of this band?

Well, Rich, I gave a range on gross margin, I gave a range on revenue, I gave a range on OpEx. The range of EPS I gave was kind of combining all those things together and trying to figure out what we got for the range. Historically, we've done better than our guidance, but I just don't think you should expect that we'll always hit the high end.

Okay, fair enough. Thank you.

At this time, there are no further questions. I will now turn the call back over to management for any closing remarks.

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

This concludes today's Intevac second quarter 2006 results conference call. You may disconnect at this time.