Intevac Inc (IVAC) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Intevac's third 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, October 30, 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. Fairburn. Please go ahead, sir.

Thank you. Good afternoon and thank you for joining us today. With me are Charley Eddie, our Chief Financial Officer; Luke Marusiak, our Chief Operating Officer; and Joe Pietras, our Vice President and General Manager of our Imaging Division.

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

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, shipments of our products, revenue, gross margin, operating expense, other income, profitability, tax rates, earnings per share, cash flow, capital expenditures, depreciation and stock-based compensation expense.

We will discuss projected demands for disk drive media, media deposition equipment, our operational plans in Singapore, the impact of upgrading legacy tools, the transition to perpendicular recording, advantages of the 200 Lean and other factors that affect demand for the 200 Lean. We will discuss projected market size for our new semiconductor equipment product line, when we expect [to deliver data] shipments and commence revenue recognition.

We will discuss our plans for military and commercial low light imaging products and the projected applications and market sizes for those 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; that we may not be able to develop and deliver new products and technologies as planned; that orders and backlog may be canceled, delayed or rescheduled; that we may 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 Form 10-K and quarterly reports on Form 10-Q.

Contents of this October 30th call include time sensitive forward-looking statements that represent our projections as of the date of the call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of the call without our express written consent is strictly prohibited. Kevin?

We are pleased to report excellent third quarter results, well above our prior guidance of revenue and net income. Revenues of $55 million were achieved as we delivered nine 200 Leans. Orders for spares and perpendicular upgrades searched within the quarter contributed to the revenue upside. We achieved GAAP net income of $9 million or $0.41 per diluted share. Pro forma net income after excluding stock-based compensation expense was $0.45 per diluted share. This was significantly better than our pro forma guidance of $0.11 to $0.19.

In equipment, our operations team demonstrated excellent execution by accelerating system delivery of advance system orders to achieve our revenue and income upside. The team is already executing to schedule on our Q4 revenue plan which requires us to produce systems at a record build rate. We also expect to deliver a significant amount of nonsystems business [in the quarter.]

Our initiative to reduce costs and improve our responsiveness to Asian customers by moving half of our manufacturing to Asia was tested in Q3. Our Singapore manufacturing facility, which became operational in Q3, played a key role in helping us achieve the large pull-in of nonsystem orders. We will continue to expand manufacturing of our Singapore facility as we transition our Santa Clara facility for the [build] of our new product line systems.

Our hard drive related business was principally driven by the year-on-year growth in hard drives and to a lesser extent the migration rates of perpendicular magnetic media. Other factors are our customers relative marketshares relative to other magnetic media suppliers who produced media for market testing systems and the average number of disks for hard drive. In recent times, marketshare shifts have been mutual to positive for us and the ratio of disks and hard drives has been relatively flat.

The ongoing demand for more digital storage continues as the transition to digital demand log in the business of consumer spaces shows no signs of abating. The latest long-range forecast [in terms of] focus project even higher demand for hard disk drive media compared to their previous forecast. Forecasters continue to predict that the world's demand for digital data storage will continue to grow faster than the growth of aerial density indicating ongoing growth in hard drives and [head the need] for more media deposition systems like our 200 Lean.

The transition to perpendicular magnetic media continues in multiple new perpendicular based hard drives announced during the quarter. All Q3 shipments were configured for perpendicular. Part of the increase in nonsystem's business was related to perpendicular upgrades for systems already in production.

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, again, increasing our revenue guidance for 2006. We are also encouraged by initial visibility into the first half of 2007 which indicates more system shipments and higher revenues than the first half of 2006. Some of our customers have indicated to us that next year they will begin to replace their installed legacy systems with 200 Lean systems to produce perpendicular media.

We will provide our 2007 guidance during our next conference call. Some of our customers would like to extend the use of their [legacy builds] perpendicular production as we continue to develop new capability enhancements for the 200 Lean, we believe the (indiscernible). We believe the perpendicular production will reduce the productivity of the legacy (indiscernible) and actually shrink available capacity.

The impact to Intevac of these legacy upgrades would be [unplanned] upgrade revenues in the short-term and the lengthening of the upgrade cycles for new equipment. In aggregate, this would lead to more revenue for Intevac as the upgrades can cost as much as $1 million per system. The success of our 200 Lean system in the hard drive market has allowed us to grow annual revenues by nearly 600% since 2003. While there is an opportunity for further growth, we need to enter new markets to achieve ongoing long-term growth.

We want to provide some more visibility to our investors on the opportunity we are pursuing with our new [product development] on why we believe we can be successful. We are targeting the semiconductor applications where we have unique expertise. The target application markets are estimated by analysts to be $8 billion per year. We plan to start market penetration in 2007 with revenue generation starting in 2008. We will continue to add applications to our unique system architecture over the next few years to address more of this targeted application markets.

Our goal is profitable revenue growth. This is more important to us than market share. (indiscernible) our future success was based upon having the right people. During the last few years, we have been building a much stronger team at Intevac, not just at the executive level, but at all levels and across the functions of product development, marketing and sales, manufacturing operations, and field service to complement the talents already at Intevac.

The majority of our hires have been from the leading semiconductor equipment companies. Our operations team has demonstrated their ability to execute [as witnessed by our] demonstrated results in the 200 Lean over the past few years. I believe our technical team is one of the strongest in the semiconductor equipment industry when it comes to conceiving and bringing to market winning products. In their prior careers, they have been responsible for many of the successful products currently generating billions of dollars per year for the major semiconductor equipment companies.

In 2005, we estimate the products created by their leadership and inventions generated revenues of over $4 [billion] for their prior companies. Our team, while working for these other large equipment companies in the past has generated over 200 patents related to semiconductor equipment design and semiconductor processing. Our future success will require innovative and differentiated Intevac product solutions to address the semiconductor challenges of technology and cost.

Our experience from the incredibly cost competitive hard drive industry combined with our experience in the semiconductor industry has helped us to conceive new equipment solutions that we believe will be very competitive. We do not underestimate the challenge of the semiconductor industry. Our team is very experienced with the challenges of selling to and supporting these large customers.

Our progress on developing this new product line continues on track. We expect (indiscernible) shipments for customer qualification activities to start in Q1, 2007. I will not at this point be getting into specifics of the product under development or any benefit of potential competitors.

Our first product target from application market in excess of $1 billion. We [are not] anticipating announcing our new product line before Q2 2007.

In imaging, we are continuing our transition from a technology development focus to a product centric business. In August, Joe Pietras joined the Intevac Imaging Division as Vice President and General Manager. Joe has over 25 years experience in the imaging and optical sensors industries, holding executive management positions, most recently at Sarnoff Imaging Systems and Roper Industries Digital Imaging businesses.

Joe has appointed Verle Aebi as Chief Technical Officer of the Imaging Division. We are excited to have Verle in this strategically important role as we look forward towards future growth of the imaging business from new areas of imaging technology and markets. We also thank Verle for his many technical contributions which now serve as the basis of building a product centric business.

Several years we have forecasted that 2006 would be a point of positive inflection for the imaging business. Significant events occurred during Q3 that have reinforced our conviction. We received the first production order for our LIVAR 400 camera product, which provides long-range pocket identification in the short-wave infrared.

This order, received from a defense contractor, is valued at $1.6 million and will be delivered from May 2006 to the end of 2007. Progress also continues in our headmounted night vision systems market. A joint program with DRS Technologies to develop a headmounted night vision goggle for the U.S. Army, which digitally fuses the images from a lowlight night vision center from Intevac through a thermal imaging center in DRS continues to be on schedule. Prototypes will be delivered to the U.S. Army in the first quarter of 2007 for field tests.

We also made significant progress in advancing our headmounted night vision camera business with our NATO customers. We recently entered into a purchase agreement with our NATO customers that outlines our intent to purchase tens of thousands of production camera modules over the next seven years, valued in excess of $55 million.

We are working closely with the Department of Defense and State to gain export approval by the U.S. government. We expect a decision will be reached soon. The initial production phase would start this quarter and run through mid-2007.

High-volume phases would start in 2008. We also continue to receive strong market response for our first commercial camera product, the MOSIR 950 specifically designed for [spectropically] applications. Additional prototypes were shipped during Q3 within the scientific instrumentation market. We expect the transition of MOSIR product production [rates in] late 2006. Charley Eddy will now discuss the financial results. Charley?

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

Consolidated Q3 revenues totaled $55 million and included nine 200 Leans. This was well above our beginning of quarter guidance as a result of shipment of one more 200 Lean than expected and stronger than anticipated sales of upgrades in spare parts within the quarter.

Imaging sales of $3.2 million consisted of $2.7 million of contract research and development (technical difficulty) through (technical difficulty) in product shipments. Product shipments included LIVAR, NightVista, MOSIR cameras and camera kits to our NATO customer.

Revenues for the first nine months of 2006 totaled $164 million, up 94% from the year ago period. Second quarter consolidated gross margin of 42.5% was an all-time record and well above our beginning of quarter guidance. Equipment gross margins increased to 42.5% from 32% in the year-ago period. Our cost reduction programs increased volume and product mix all contributed to higher gross margins and equipment.

In imaging, gross margins grew to 41% from 14% in the year-ago period. The imaging gross margins benefited from $296,000 of favorable rate adjustments related to completion of prior year government rate audits. Imaging margins also benefited from product shipments and a reduced level of cost share development contracts.

Consolidated cost of sales included $70,000 of stock-based compensation expense which had a minimal effect on gross margins. Third quarter operating expense of $14.1 million increased by 84% from the year-ago period and included $808,000 of stock-based compensation. The increase in operating expense is mainly due to increased spending for new products and market development and equipment; increased provisions for employee and tenant plans; and the inclusion of stock-based compensation expense in the 2006 results.

GAAP net income for the first quarter totaled $9 million or $0.41 per share. Pro forma net income after excluding stock-based compensation expense was $9.8 million or $0.45 per diluted share, an increase of 55% from the prior-year period.

Net income for the first nine months of 2006 totaled $25.4 million or $1.16 per share. Pro forma net income after excluding $2 million of stock-based compensation expense was $27.2 million or $1.24 per diluted share, a 328% increase over the prior-year period.

We increased our projected tax rate for 2006 to 10% from the 8.8% we reported in the prior quarter. The Q3 results include the effect of bringing our year-to-date tax provision up to the 10% rate. This is the second time this year we have increased our projected tax rate and it is a result of allocating a relatively fixed level of 2006 tax benefits to an increasingly higher level of projected 2006 income.

Our order backlog grew to a record $130 million. It includes orders for twenty-four 200 Lean systems. We have received orders for two more systems so far in the fourth quarter, bringing our total backlog of systems as of today's call to twenty-six 200 Leans. We expect to ship 14 to 16 systems for revenue during the fourth quarter, which leaves us with 10 to 12 systems in backlog for 2007 delivery.

For the fourth quarter, we are projecting consolidated revenues of $82 to $90 million. This results in projected full-year revenues of $246 million to $254 million or year-over-year growth of approximately 80%. We are projecting fourth quarter pro forma gross margin of 38% to 40%, cap gross margin will be about .25% lower. We are projecting fourth quarter pro forma operating expense of $16 million to $17 million.

GAAP operating expense is expected to be approximately $1.2 million higher. Operating expenses are growing as a result of product design and business development costs related to our new equipment product line, and our bonus and profit-sharing programs for employees that are tied directly to GAAP profitability.

Q4, we expect a particularly higher level of engineering material spending related to development and testing of our new semiconductor equipment product line. We expect other income of approximately $1.1 million in Q4. In Q4 we are projecting pro forma earnings of $0.65 to $0.80 per diluted share. GAAP earnings including a projected $1.4 million of stock based compensation expense should be about $0.06 lower or $0.59 to $0.74 per diluted share.

For the full-year, this leads to pro forma earnings per share of $1.89 to $2.04, a year-over-year increase of approximately 150%. GAAP earnings, including a projected $3.5 million of stock-based compensation expense, should be about $0.16 per diluted share.

Inventory grew from $34 to $41 million during the quarter. The majority of the increase related to three 200 Leans we built to finished goods for delivery in Q4. Year-to-date capital spending and depreciation totaled $5.5 million and $1.7 million respectively. For 2006, we are projecting capital spending of approximately $11 million and depreciation of approximately $3 million.

Cash and investments increased to $90 million from $66 million at the beginning of the quarter. The growth resulted from our profits in combination with a reduced Accounts Receivable and increased customer deposits related to our record level of backlog.

We continue to generate healthy cash flow while we remain debt-free and are making major investments in our equipment and imaging businesses. Our headcount at the end of the quarter totaled 474 employees, up from 417 at the beginning of the quarter. 22% of our employees are currently based in Asia. 118 of the 474 employees are contractors. The majority of these contractors work in Operations as part of our strategy to maintain a flexible work force that can respond to rapid changes in demand.

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

(OPERATOR INSTRUCTIONS). Jesse Pichel, Piper Jaffray.

Good afternoon. Fantastic quarter and execution. Regarding the new tool, how many beta customers do you have and you mentioned an $8 billion TAM. Does that exist today or was that a future market? And then I have a follow-up question.

We anticipate having upwards of four beta customers. They're not all signed up today. And the TAM is today's TAM, not future. The future's projected to grow.

And could you talk a little bit about the imaging business? It seems like we're reaching a tipping point there with a number of decisions both on your NATO customer and achieving an export license. And two, with winning a -- competing with defense companies in the U.S. offering. Is this strategic to IVAC or do you envision a possible spin-off of this division over time? If you could just let us know of your current thinking there.

This is Kevin here, I'll let Joe make a few comments in a second. I would say the imaging is playing out as we said it would. I think three years ago I started telling investors that 2006 would be at the point where we saw the hottest (indiscernible) collection in our revenues and that would be product driven. So I'm glad to see that's coming to fruition. Joe, would you like to make a comment?

Yes. With the opportunities that are in front of us now with our NATO customer and the LIVAR order, which we just received, as well as the market traction we have with our MOSIR camera, we are in a position to be able to double our revenues in 2007 because our business would be on the order of about 40% product based.

So on the subject of spin-out, we've always said that we believe that in the long-term, that once imaging got to the critical mass, it would make sense for our investors to realize that value by spinning off the business.

Chris Cook, Zazove Associates.

It looks like you guys are targeting about $5.5 million of CapEx spending in the fourth quarter which is a decent amount above what it has been running per quarter. I was just curious if you expected that to be the continuing run rate or if this is a onetime occurrence.

It's a onetime occurrence.

And would you then revert back to historical levels of CapEx you think in 2007?

Well, we said it would be about 11 this year. I would say it would probably be -- we haven't given any guidance for next year. I would be surprised if it's much different than 11 next year. It could possibly be less.

Rich Kugele, Needham & Co.

A few questions. Charley, spares and upgrades versus the loop systems, can you give us a sense what those were in the third quarter?

It was only a few louvers in the third quarter. Most of the big upside in revenue other than the one system was a lot more spares than upgrades. I would say probably for the full-year, we'll have something on the order of $50 million of nonsystems business.

And then in terms of the imaging business, can you describe -- you give a little sense of some of the orders there, but how do the orders actually come in? Are they all going to be multi-year orders that you kind of have the customers pull from, or will they be one-off with little to no backlog? Any color on how we should see those going forward?

With our NATO-based customer purchasing agreement, those will be on purchase order releases over the next seven years. In the MOSIR camera business, we're working with several instrument manufacturers and so we expect to see a small volume OEM type orders over 2007.

Perhaps, Joe, you might want to explain about the LIVAR order, about how that initial production order compared to maybe later production orders.

Yes, the LIVAR order is an important opportunity for us in that it's going into multiple platforms and we are also working with other defense contractors. And so this could represent over the next several years, actually hundreds of millions of dollars of business for us.

In actual product sales or will you be licensing it out?

In product sales.

And then, in terms of the 200 Lean side, I know it's early to be looking at '07, but at least just directionally given what you're seeing in the market and general industry expectations for unit growth, should we expect flat, down, or up equipment sales?

Well, we've already stated in the conference call that our initial visibility in the first half of 2007 is higher than that of 2006. Our tops down analysis for the industry suggested numbers higher than I've seen some of the analysts projecting. And we have discussed that with some of our customers, that the fear is based on what we've heard from different customers that maybe there's not enough systems to meet the needs of the industry. We'll see how it plays out.

Just to jog your memory, in the first half of last year, we shipped 2,200 million. So we're looking for the first half of 2007 to be something north of that.

And Charley, just lastly, on the tax rate, any update what we should assume for '07?

I think we'll have the final guidance on the '07 tax rate in the next call. In prior calls, I said 35%. I'm hoping that that's the worst-case. But we've got to see how this year closes out. We are in transition from a low tax rate to a full year. So we have to see how that plays out. I'll have good guidance in another three months.

Thank you very much and well done.

(OPERATOR INSTRUCTIONS). Mark Miller, Brean Murray, Carret & Co.

Congratulations on a good quarter. I'd like to talk about the increase in the spares revenue. I'm wondering how much is that ongoing and how much is that due to any special retrofitting programs?

We've seen our customers accelerate not only the system orders, but also the PMR upgrades [as demanded that product has] required. Our visibility in the next six to nine months indicates that that acceleration and increased volume will continue. And, again, as Charley mentioned, we did $50 million of nonsystem orders comprised of spares and perpendicular upgrades.

So we expect these upgrades to improve things for the next two or three quarters. That's what you said?

Yes, that's correct.

What about the margins? What effect did they have on your margins, say if you weren't upgrading. What's your margins have improved to? You have an estimate?

Well, we've guided to 38% to 40% and that's a mix of all the things we shipped. I think I'm just going to leave our guidance at that.

That was your pro forma or was that your cap? I'm sorry, I missed your cap guidance.

Our guidance was that for Q4, the margins would be 38% to 40% pro forma. The GAAP is maybe a quarter of a point difference.

I guess that still didn't kind of answer my question. I'm just wondering what boost the refurbishing in terms of the total percentage, you went from 32% to 42.5%. What percent of that increase was mainly attributed just to the retrofit and increased mix?

Well, probably, you're taking it from a year ago. If you go from the last quarter, we were 36.4%. So I don't really think of it -- we have a variety of margins on all the things we shipped and that generally helps us if there's more higher percentage of upgrade.

And just finally, you're talking about exceeding your shipped total of 20 Leans in the first half of next year. You're ending with a backlog of 10 to 12. So should we see higher orders? It looks like, I guess that leaves a question of do you think your orders for the fourth quarter will exceed what you saw in the third be flat or lower?

I don't know. I think we'll -- we have a four-month leadtime and the customers tend to give us orders right as they come up to leadtime. So I think you'll kind of see orders come in consistent with what we need to make those numbers.

Gaurav Kapoor, Weisel.

I was just wondering how much was the option expense in R&D in [SG&N] Airline?

I'll break that out for you after the call.

And about tax rate guidance, I think I missed it. Can you repeat that?

We've set the tax rates for this year to 10% and then in Q3, we booked a catch-up entry. So you see a little higher as a percent of earnings in Q3. That will be 10% by the end of the year.

And then regarding backlog, you have 24 systems in backlog. How many systems are you targeting for December quarter?

We said 14 to 16 in Q4. At the beginning of the quarter we had 24 systems in backlog. We've gotten two more orders since the end of the quarter. So we're at 26 today.

Michael Needleman, Ridgecrest Investment Management, LLC.

Just a couple of quick things. I did not catch how much cash you were ahead on the balance sheet at the end of the quarter.

If you take the cash short-term investment and also the cash that we put out more than 12 months, it's $90 million.

The second question is, just in regards to NATO, because one of the things is you're waiting clearance from the standpoint of the U.S. government. You were expecting, I believe, at the end of last quarter, sometime possibly third quarter approval on this. How does that look now? And clearly there's been delays, but where do you think that is now as far as the approval process?

We're actively in discussions with the export authorities. And we'd hoped to receive a response within the next few weeks and I'd say we're cautiously optimistic.

Do you expect that to be, I guess, permission granted this quarter or your outlook for this approval process is when?

Within the next few weeks.

Just in regards to the shipments that you have for this quarter, because this is going to be a record number of shipments, should the number of actual contract employees actually go down at the end of this quarter? Because I'm assuming you're adding people to get this out this quarter. Is that correct? Or how should we kind of look at that going into next year as far as the volume is concerned?

As Charley mentioned, we had a combination of mix and efficiency in the end of 2003 -- or, excuse me, early into Q4 we expect to maintain our contract headcounts. We also expect a strong Q1 to maintain that as well. And we'll look [at] the future in terms of how to exercise it. We don't really see ramping it up or dramatically decreasing it in the short-term.

Just one last question, I believe you said as far as beta, that you expect -- although you don't have customer agreements, to have four customers here in the first quarter?

No, no, I said it will probably be in the first half of 2007.

As far as getting the four?

Yes.

(OPERATOR INSTRUCTIONS). Jesse Pichel, Piper Jaffray.

How many quarters are you expecting service revenue to stay at these levels that you're guiding to in Q4? I mean it looks like -- and correct me if I'm wrong, service revenues are set to nearly double here in Q4. Is that about right?

Yes, I think they've been increasing throughout the year. So I guess I was trying to tell you, we're going to be about $50 million for the year. And I think of $50 million per year as kind of the run rate we're staying now. And our visibility is a couple of quarters out. Beyond that we'll have to see what happens.

Are service revenues doubling into Q4 or is it more than doubling?

Relative to --

Q3.

Relative to Q1, they probably doubled -- probably not relative to. Are you talking service or spares and upgrades?

Total service.

What's your definition of service? We want to make sure we're --

Equipment revenue that's non-200 Leans.

Other than the systems?

Right. Other than the systems.

I'd say it's probably Q4 is maybe double what it was in Q1. And it's been kind of growing Q3 and Q4. for.

And then could you talk about tax rate for 2007?

Yes, we'll have good guidance on the tax rate in the next call. It's really the Company is in transition from having a very low tax rate and a lot of tax things on the balance sheet to being a full-blown tax player. And so the next year's rate is going to be a function of how we come out this year. So in prior calls, I've said in absence of a better number, use 35%. I'm hoping that's worst-case and we'll do a little better, but I need to do a little more work before I can prove that.

Mark Gomes, Pipeline Data.

Great quarter. Just looking at the corner backlog and your outlook for early next year, given what's happening in the marketplace with the Seagate Max [floor] integration, you see a lot of marketshare shifts going on. Are you seeing similar shifts in the customer profile that you have?

It was apparent what's happening. In the last quarter, there was some marketshare shifts to Samsung in the desktop. It's never clear where they get all their media from, so we think it's beneficial to us that one of our customers is providing this, but it's not completely visible to us. Does that help or --?

Yes, that's a little helpful. I'm just trying to think. Samsung is traditionally a Fuji customer and they moved over to Comag. Do you know if Comag will be supplying Samsung with media that will be based on Will dose gene of the Michael resupplying Samsung with media that will be based on, in fact, sputtering systems?

I really can't help you on that particular question. That's one you'll have to take up with Comag.

(OPERATOR INSTRUCTIONS) Chris Cook, Zazove Associates.

I just wanted to get an idea of what you guys thought working capital would do in the fourth quarter. It's been a dramatic provider of cash the last couple of quarters. I would assume that's run its course?

Yes, we've done really well pulling, generating cash in the last two quarters. I think we've added about $45 million in two quarters. I think we'll kind of over the next two or three quarters, we're going to continue to generate cash, but it may be a little lumpy from quarter to quarter. We've got a big ramp going on in Q4, we'll probably carry a lot of receivables into the next year. So, it might be up. It might be down. By the end of this quarter just how some timing works out. But generally the model is good and we're continuing to generate cash over time.

Jon Lopez, OTA Advisors.

Just a couple of quick ones if I could. I just want to make sure I understood one of your earlier comments regarding visibility. I thought you guys exited last year with about 17 total 200 Leans in your backlog and you're going to exit this year with 13 or 14, I believe you said? So I'm just -- I'm sorry, do I have those numbers wrong?

We entered the year with 10 to 12.

You would exit this year with 10 to 12?

Yes.

So just given that your backlog will be --

Can we just clarify that's what we have right now. We still have Q4 to receive additional orders for systems as you go to 2007.

So when you're talking about better visibility into the first half of '07, your assumption would be that you'll be exiting this year with comparable or higher backlog than you exited 2005?

Correct. We get forecasts from our customers of when they anticipate taking systems and they're typically at leadtime they give us orders and then those forecasts into deliverables. And so between the orders we've received plus the forecasts we had, that's where we get our visibility from. But when we talk about backlog at the end of the year, that would be the end of Q4, not the end of this quarter, Q3.

The second question, just to clarify again, do you have a number of units on the lubrication side that you shipped this quarter?

No, I don't believe we have many loop systems in backlog.

The third question is, can you just talk a little bit about on the operating expense side, once you have this step in calendar Q4, will operating expenses step back down again entering 2007 or is this a new sort of higher run rate in support of the [semi-] business?

Well, there's a couple of things driving the expense. We have a pretty conservative vent in the engineering accounting, so a lot of the stuff we buy related to the new products we just write off. That probably goes pretty heavy for Q4, probably also extends into Q1. Our employee incentive plans are all tied to GAAP earnings and so Q4 is going to be really strong. So those accruals tend to push things up a bit in Q4.

We'd probably all like to think that expenses will go down a little bit after we get through the initial phase of R&D. We will have the costs of those initial units we ship in the field, which will be on our nickel and we'll partially amortize off to expense. So I wouldn't think it goes -- I think Q4 is somewhat of a deep -- but we'll give clear guidance on that in three months.

Last one, I'm sorry, as you think about your gross margin guidance for the December quarter, can you just talk through some of the factors that are taking that lower? Is it mix or is it unit production volume? Can you just give a couple of the things that are going to take it down a little bit?

Well, I have a little different perspective. We've been running in the mid-30s for a long time. We've had a major operational objective to get to 40. And I think we're almost to -- we're at the point where we're within spitting distance of running at 40%. So we feel like that was a pretty good uptick in our guidance. Q3 was a quarter where just all planets aligned and everything that went well could have gone well.

Congratulations. Thanks.

(OPERATOR INSTRUCTIONS). Mark Miller, Brean Murray, Carret & Co.

Back to your new semiconductor, your beta site testing, how long do you think that will occur? Are we looking at one or two quarters? And any necks sticking out about when we might see first revenues from these tools?

We took the customer evaluation [beta polls] can run from three to four quarters depending on the customer. The goal would be to gain orders from these tools in the second half of 2007. For production units that have (indiscernible) in 2008 plus turning those beta units into revenue.

So either -- it sounds like early '08 before we see any revenues from these.

That's from a conservative perspective, that's our planning.

Since nobody else asked, I think the thing that investors are having a hard time with seems to be a disconnect. We've heard in the last couple of weeks, both Seagate, which is one of your largest customers, significantly lowering their capital outlook. Comag is now going to be servicing Samsung, which has not been typically a customer of yours, and also talk about reduced capacity expansion rates that co-lag. And yet you've been putting forward kind of an upbeat outlook, at least for the first half of next year. I'm just wondering how we can reconcile these differences between what we're hearing from your largest customers, Comag and also the possible shifting of some business from Fuji over to Comag from Samsung?

Okay, Mark, you can probably help me on this one. I thought Seagate said that their CapEx reduction wasn't affecting media. I'm pretty sure I read that so I was hoping you could confirm that.

We'll have to look at that. They did talk about a general 30% decrease from where they were at, but we'll check into that.

And then on the Comag, Samsung, Fuji relationships, again, it's hard for us to comment on that. Obviously, Samsung picked up some marketshare points. The industry is growing, so there's probably business there for Fuji and Comag. But [what will] split this and I don't know.

But Comag also took out its capital expansion plans for this year and also stated recently they're not going to do any capacity expansion, at least in the first half of next year. Too, I know that doesn't impact you the way it would one of your customers, but it's still -- it's hard to reconcile some of the things we're hearing about an upbeat outlook for ships, especially the second half of next year with that action.

Well, Mark, you also need to, in your analysis, include the fact that some of our customers are telling us that they're now replacing their Legacy systems with 200 Leans. So that isn't necessarily a big increase in capacity in the industry. It's just an increase in capability in the industry.

But your bigger tools make far more [distance] than the Leans, I guess they're replacing at a one for one basis. I guess that would be your point, then.

That's my point. Also, whenever you take a tool out of production and bring a new one in, there's always a gap in terms of -- before the new tool comes online to replace the previous tool.

There are no further questions at this time, sir.

Well, thank you very much for joining us today. We look forward to you coming back and us updating you on our Q4 in 2006 results. Thank you.

This does conclude today's conference. You may now disconnect your line.