MicroVision Inc (MVIS) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Fourth Quarter 2004 Microvision Earnings Conference Call. My name is Michelle and I will be your coordinator for today.

At this time all participants are in a listen-only mode. We will be facilitating a question-answer session towards the end of today's conference. If at any time during the call, you require assistance, press star zero and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference Mr. Brian Heagler, Director of Investor Relations. Please proceed, sir.

Thank you. I would like to welcome everyone to Microvision's fourth quarter and fiscal year 2004 financial results conference call. The information in today's conference call includes forward-looking statements regarding projections of future revenues, plans for product development and production, future contracts and commercial arrangements, growth and demand, future product benefits and future operations, potential future benefits of our equity interest in Lumera, as well as statements containing words like believe, estimate, expects, anticipates, targets, plans, will, could, would and other similar expressions. These statements are not guarantees of future performance. Actual results could differ materially from the future results implied or expressed in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are included in our most recent annual report on form 10-K filed with the Securities and Exchange Commission in Item One under the heading "Risk Factors Relating to the Company's Business" and our other reports filed with the Commission from time to time.

Except as expressly required by the Federal Securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changes in circumstances, or any other reason.

I would now like to turn the call over to Rick Rutkowski.

Thanks, Brian and thanks everyone for joining us on the call today. I'm going to structure my comments as follows. I'd like to move through the numbers. There is some additional complexity to a couple of different categories in the numbers today so I want to make sure we get that before moving on to the discussion of 2005 prospects, Q1 and Q2 in particular. So hopefully you will bear with me on that front, and if you do have questions additional questions on the numbers we will be happy to take them later in the call.

Consolidated revenue for the 12 months ended December 31st was $11.4 million compared to $14.7 million for the same period in '03. For the fourth quarter, revenue was $3.3 million compared to $4 million for the same period in 2003, that represented a sequential increase over the $2.7 million reported for the third quarter of this year. That was in keeping with our getting contract revenue back on track theme that we are articulated mid-year. We did point to that we would see the sequential improvements.

The $3.3 million was a little under what we had targeted. We did have a sub contractor not book sufficient revenue in the fourth quarter. I think that was about a $200,000 push-out, so it is a little below but nonetheless a good increase over third quarter. Importantly, that trend is really accelerating here into the first quarter and continues to look strong and potentially even very strong in the second quarter, so that’s all very positive news.

In terms of revenue composition, '04 revenue was comprised of $2.6 million in product revenue, $8.8 million in contract revenue, so the decline was, of course, in the contract area product revenue more than doubled versus 1.1 million in 2003. Contract revenue declined from $13.5 million to $8.8 million, and excluding Lumera declined by about $3.7 million. We did have an unusually large and profitable commercial contract in late 2004. We also, as we mentioned in the past, had a military contract that we expected, which was delayed which we should see later this year. So those were the principal causes of that decline in contract revenue and we experienced most of that impact in the first half of the year. As I said, we saw improvements in the third and fourth quarter.

Product revenue for year 2004 was predominantly Flic bar code scanners, Nomad was introduced late in the year and accounted for about 864,000 of the 2.6 million. The balance of that was $1.7 million in sales of the Flic bar code scanner. I'll talk a little bit about some weakness that we saw there in fourth quarter and also a more positive outlook for first quarter with respect to Flic.

Consolidated revenue for the fourth quarter included $763,000 in product revenue, $2.6 million in contract revenue, compared to $812,000 in product revenue and $3.2 million in contract revenue for the same period last year. Of that product revenue last year you'll probably recall that $600,000 was due to delivering 100 Nomads to Iraq for the Striker Brigade, and we did not have a Striker comparison in the same quarter of this year.

That contract revenue, that $3.2 million also included $284,000 attributable to Lumera in the second half of '04. We are no longer consolidating Lumera revenue with Microvision revenues, so that is an important footnote there in terms of comparing revenue for the periods as well. And we used what is called the one line equity method which will also impact some of the below the line accounting as well that we will talk about.

We did report a record year end backlog of $7.1 million. That is our highest ever year end. It's our highest quarterly backlog in over three years, I think to be precise, it's about 13 quarters. That is really important because this has been an ongoing effort of ours in terms of stabilizing the contract business to a sustainable level making resources more fungible, getting a little more smoothing going there, so those are all good things that I think are going to come out of that backlog. And as a result of that backlog we have also announced some additional contract bookings since the first of the year. We have some others coming up probably in the next several weeks.

In sales of product we do now expect our first quarter revenue to exceed $4.2 million, that will be a record first quarter for the company. Not quite a record quarter but a record first quarter and will represent an increase of more than 27 percent over fourth quarter of last year and more than 55 percent over the first quarter of 2004. That is when we exclude the $316,000 from Lumera, so comparing Microvision to Microvision on those first quarter results we're up about 55 percent at that $4.2 million mark. There is a little upside to that number as well, we think.

We are in a position, we think, to offer just a touch of preliminary guidance for the second quarter. We think we can see our way to a 15-20 percent increase over the $4.2 million quarter to quarter, going into the second quarter, and just the fact that we have a little more visibility itself is very encouraging and I'll get into why we think that is in just a few moments.

With respect to the net loss for the 12 months ended December 31, '04, Microvision reported a net loss available for common shareholders of $33.5 million or $1.56 per share compared to a net loss available for common shareholders of $26.2 million or $1.46 per share for the same period in 2003. For the three months ended December 31, '04 we reported a consolidated net loss available to common shareholders of $8.2 million, $0.38 a share compared to a net loss available to common shareholders of $5.2 million or $0.26 per share for the same period in 2003.

Now, let me sort of put that together for you because what I want to do is show you how this is largely attributable to the decline in revenue and some inventory write-offs though our operating expenses remain more or less flat year to year. We did see some reallocation of those moving with an emphasis towards sales and marketing, but the gross numbers were largely flat year to year. So what you are seeing here is there is about a $2 million chunk of that difference that is a non-cash piece associated with how we now account for Lumera. That is that one line equity method. And so that is an increase of about accounts for an increase of about $2 million. The decline in revenue we described earlier just on the contract side was about $3.7 million so call it $2.5 million or so net of the increase in product sales. And then you have inventory write-offs. The number there is about 1.3.

The inventory write-offs were associated with both products, in the case of Nomad, it was really getting the product into production. We do normally expect to have some reasonably high scrap levels, finished goods yields low on the front end of the process. We also transitioned some important components. A notable example of this is the replacement of the scanner assembly.

From a return on investment perspective the payback for these inventory write-offs are that we have products that are less expensive to produce and more reliable and we think both of those things make good sense to make investments in. So those inventory write-offs I think total about 1.3 for the year. And if we have other questions on that we can as I said come back to that as well. So I think I have covered this.

The remaining portion of the increased loss in the fourth quarter was due largely combined effect of lower revenue, reduced margins I didn't mention. Our contract mix was less favorable generally. And especially in the fourth quarter because of the items I mentioned earlier, that sort of extraordinarily high contract -- highly profitable contract in the fourth quarter of last year and if you remember back that far, we talked about some of the timing differences that entered into that recognition as well.

Operating expenses as we said did not increase '03 to '04. Resources were shifted from R&D to sales and marketing. As I mentioned earlier in the call, another key point here is that the weakness that we saw in the first half of the year saw steady improvement through year end with a sequential increase of 22 percent in the latest period and that is consistent with our theme of certainly getting that contract revenue back on track.

Record backlog, key point for us as I said and continuing to stay ahead of that with new bookings. We're very encouraged by the bookings picture for the end of this month and early part of next quarter and for the second half of this year as well. That puts us, as I said, in a position where we are targeting a record first quarter with revenue of $4.2 million and we have some early visibility on Q2.

So what is all that about? The two key objectives for us in '05 are to restore and sustain the contract bookings and billings to historic levels, that is sort of in that 12 million plus range and to aggressively grow product revenue. And we think we're in a very strong position relative to the first of these goals having booked our largest contract award ever at the end of the year, and I'll talk a little bit more about that contract and what it -- what we think its full value and full potential are.

With respect to product revenue, we are also encouraged, we are really focusing at this point on developing channels and increasing channel presence as we said, I think, in our most recent call for both the Nomad Expert Technician System and the Flic bar code scanner. We're having good success with both products in the market just in terms of fundamental customer validation of the value premise, so we have spent the last couple of months really identifying channel partners that can help us leverage and repeat that success and scale it. That is what we really think growing the numbers on that front is really all about.

I'll touch on and then come back to the fact that we are also encouraged by the outlook for increased sales of the ND2500 system which is for both the military and industrial use. That is the system that was ready to go to Iraq. And if you remember, we have a solicitation pending or notice of a pending solicitation out there for purchase of up to 250 units so that is in the offing as well.

So let's talk about this issue of channel development. One of the reasons that we are very bullish on Q2 and for the balance of this year is that we see some channel partners and also some co-marketing agreements that we can enter into in the very near term here. We think we are talking about at least one very important distribution agreement and two very important co-marketing agreements that relate to the automotive vertical. The ROI case continues to get fleshed out and be very compelling. So word of mouth will support that.

One of the important aspects that I think we mentioned in the press release as well, is adding value to the Nomad by integrating into other systems in those automotive service shops as well, and in particular if we can identify a connectivity solution that relates to a large installed base and has compelling value, we think that can be a real catalyst for growth. It is what we would refer to as a beachhead application. One that gets us into a lot of different places.

We are seeing repeat sales at some of our earliest installations. We actually have technicians now coming and asking to get a Nomad instead of a notebook computer, so lots of positive indications. But as we said the key right now is really about channel footprint and channel presence and we think there is some very good news pending there in terms of the kinds of relationships that we will enter into. That will impact us beginning in the second quarter and through the balance of the year with reference to this vertical.

For those of you who don't know the numbers with respect to the automotive opportunity, the market for tools and equipment in the service and maintenance segment is about $8 billion. There are 22,000 automotive dealerships in the U.S., another 50,000 plus service locations, third-party service locations which would include Sears and Midas Mufflers and places like that. So this is a very, very large market just in North America. We're seeing penetration within the dealerships.

Another aspect of our strategy is to target some of the larger enterprise accounts. Those are the Auto Nations, the Lithias, the Sonics where you have 200 plus dealerships owned under a single ownership entity. Hendricks is another example of that. As well as some of the OEM accounts. We have talked about Honda in the past. BMW, Volvo trucks are others that we are making good inroads with. Porsche training, and then also fleet accounts. Probably the most significant company doing work with regard to fleet maintenance is Frito-Lay and we are moving through a very well defined process in most of these instances. So we are very encouraged by the picture going forward here for the automotive service vertical.

In terms of the second half of the year we think we will get some additional help from new verticals which include principally manufacturing, two applications in the manufacturing domain. One is plant maintenance, by increasing up-time by very small marginal percents I can impact and reduce capital expense overall. We're working today with probably four different large global entities in various stages of trial and evaluation for plant maintenance.

The other category for inside the factory is process control. In this case I have automated equipment for assembly of complex things. Trucks, cars, what have you, and by providing the workers with more information, I can reduce total capital cost. We have a major global manufacturer in an advanced stage of a very well and rigorously defined trial. They have done the work on paper to compare the ROI of using Nomad against the ROI of having to go to a next generation of capital equipment and the numbers are quite compelling. So we think if we are successful there is significant opportunity. This is obviously a very easy stretch.

We're seeing the referenceability of the automotive market already take hold. Most of these opportunities that I have described, plant maintenance and process control are really things that came to us and we have been supporting them opportunistically. Our more proactive stance going forward here and especially as we shift to a partnered distribution model in the automotive service domain will be to focus our resources on refining that business case and becoming more proactive about marketing into those parallel verticals.

Military maintenance is one that is obviously very close to maintenance for commercial automobiles. We have had some good early success with the Army Reserve deploying 37 units. We do expect in the second half of the year, possibly in the second quarter but in the second half of the year to see some follow on. There is really pretty strong interest developing there.

The other area where we are seeing a very similar kind of interest is in the Air Force. The Air Force actually has a fairly advanced e-tools program through the air mobility command. That program has historically emphasized the use of laptops, notebooks, PDAs and things of that nature for flightline and back of shop maintenance. In trials that we have done these are some of the people that quickly recognize the marginal advantage of Nomad because they understand the limitation of using handheld devices in those environments. So I would say in the second half of the year we could look for some sales coming online there as well and there is quite a bit of buzz actually going around in that community right now.

With respect to the ND2500 which is an industrial and military version of the Nomad, this is the one that the Striker Brigade is looking at. It's an advancement over the system that we deployed a year ago last October. We're still calling this upside potential, now we're calling it upside potential for Q2. We think you can look for us to be teamed with a major defense contractor who is prime on multiple programs that would be key to commercialization of this type of tool. Their programs are aimed at personal systems for soldiers and they are in the middle of really all of the important programs.

So there is -- there is potentially some very positive strategic news here in the offing with respect to the ND2500. We have been contacted, as you know the Brigade that is currently in Iraq, the first of 125th, is still requesting units. We have also had a request from an additional Striker Brigade who is exploring the potential to acquire additional units. The ND2500 carries about a $7,000 average selling price when the multi-function switch is included with it and in most cases that is the default requirement.

We have also had some success getting support for continued development and product qualification. One of the things that the Army is talking to us about is taking the product through a more formal qualification process so that it can be given a catalog number for procurement that will streamline future procurement and position the product very well for some of the key programs that are coming online in 2006. So this is something we are really quite excited about and we think has really increased in visibility pretty substantially in the last month or so.

With respect to Flic, I mentioned that we had a little bit of weakness in the fourth quarter. We are expecting the product to do better this quarter. We did have some changes in personnel. In particular the sales director has been replaced. We have a new guy named John Bogger running this. And he is doing just a really terrific job. His initial focus was on getting out and trying to restore productivity to the existing channel because we have actually got a pretty good channel of independent software vendors, ASP providers, and a couple of OEMs getting started on the product, but we wanted to make sure we were doing all we could with them and things sort of tailed off in the last part of the year here with respect to that. We are quite pleased with where we are with respect to first quarter on that.

We expect I think right now second quarter to be flat, maybe up slightly versus first quarter and then more traction in the second half of the year. The catalyst for that traction again, or really the game here is really about channel development. With respect to OEMs we are really placing an emphasis on office products, providers like Smead and the related channel i.e. Office Depot, Office Max. That involves bundling the solution with software or with what is called an ASP web-based application that can be accessed in this way. We are working with some sort of commercial versions of ASP providers now.

We also have a couple of them at the other end of the spectrum in Tele-innovations and Delicious Monster that are targeted directly at consumers and this is really representative of our vision for the market. We see bar code scanning becoming something that is moving from traditional supply chain management into areas like file management, soft inventory management, even personal inventory management and so the channels that can access those very, very large unit volume numbers are key to us. We have a couple of very significant single sales opportunities there that we are working but it is really blocking and tackling.

The -- we have upgraded our software developers kit so we are able to get a much faster turn from independent software vendors in terms of integrating the product and Tele-innovations was able to bring the product online very quickly for their application and Infinite Peripherals successfully integrated the Flic with the Blackberry Rim -- the Rim's Blackberry product for use initially in a field for sales tracking application. Sales and maintenance. So that is going to be we think a growth area as well. Primary focus again, channel development, channel development, channel development.

The other part of our business that, you know, we are certainly really pleased about with respect to the Ethicon contract deal is the OEM category. As you will recall the strategic way we view the company strategically is that we manifest our technology in two ways. One is finished goods products. The Flic bar code scanner, the Nomad system. We also manifest them as OEM solutions that support and enable product designs by OEMs.

The Ethicon deal is a significant deal in a few different respects. One of which is the size of it. It's the largest deal that we have ever done by a stretch. It contains a committed initial piece of 6.2 million, that has actually gone up a bit since we booked it. And it contains an option to continue with development for another additional $5.5 million. The likelihood would be that that would be triggered following an evaluation period so you're probably looking at either very late this year or early next year for that to occur. Further to that, though, it contains beyond that, a supply agreement so in this case Microvision has the preferred position of being the exclusive supplier of the product if we so elect to do.

Now, one of the things I apologize for, I can't sit here and say this is the product, this is the market opportunity and I was wrestling with this just a few days ago with someone who says -- well, how do we understand that. I think there are some datapoints that you can sort of impute to calibrate what might be going on here. And one of those is if you look at Ethicon, this is a $2 billion a year company, so clearly they are not looking to add small franchises to their business. They are typically looking at things that are going to increase revenue by some meaningful percentage.

Another way to look at that and you're sort of triangulating to the same place really, here, is to say, well, gosh, if they're investing 12 million with Microvision and then there's an internal staff supporting this whole thing, what do those numbers look like? What is their cost of capital and hurdle rate required over a period of time? And you're going to see that you can't support really an insignificant investment and an insignificant product franchise with those numbers so I apologize that I can't give you more than that, but it is meaningful to at least reflect on it in those terms and as we go I think it becomes more exciting.

I will tell you, it is a product that we are tremendously excited about. We think it has the potential to be highly disruptive and we don't -- we think we are partnered with about the best company that we could hope to partner with for pursuing this opportunity. So, we think it is significant.

So let me extrapolate from that a little bit and tell you why we believe this is further significant. We believe it is a milestone for us in terms of executing on our strategy. In that this is the first contract development program that has been structured all the way through to actual volume manufacturer and supply.

That is our objective with every one of these OEM activities and what we have done is nurtured the activities through a series of proof of principle and proof of concept or more advanced prototypes with the objective of converting in each case to these sorts of design wins.

The others that we would highlight are work in the automotive head up display domain. We will try to do more here in the next month or two in terms of just sharing visually where we are. It's quite impressive, because what you're looking at today in terms of the prototypes that are being delivered to Audi and BMW and other customers are something that really resembles very much a product. There is additional engineering to do but the progress has been just enormous over the last year. We take great pride in what we have accomplished here in that we believe that the laser head up display is very well positioned as a viable if not a preferred solution among some of the leading automotive OEMs in the world right now and we think that is a pretty major accomplishment. Our partner -- Tier 1 partner is one of the largest Tier 1 suppliers globally today.

So we continue to make excellent progress. This is a very highly structured sequence of events. The last prototype was the first time that the specifications both package and performance specifications were provided. The first time that they were provided by the automotive OEM for insertion into a car and that has been a very successful effort and discussions are on going with respect to our Tier 1 partner. So the effort again is to convert this into a similar kind of deal with Ethicon, as we have with Ethicon where our go to market OEM partner would likely be a Tier 1 provider that would be supplying these to the OEMs.

I have mentioned this before, but I'm going to keep mentioning it because I think it is important and germane. We think we are entering this market at a very opportune time. Opportune in two respects. Early in the growth curve, very aggressive forecasts going forward. Display Search in October estimated that 2004 production of head up displays for automobiles was on the order of 100,000 units. They are estimating an annual growth rate of about 84 percent plus through 2010 resulting in about 4 million units a year in 2010. We believe that that growth curve still has plenty of room to grow to accelerate further because at 4 million units a year, you are at roughly 6 percent of automobiles. About 67 million automobiles produced annually at that point.

So, we think this is very exciting franchise. We are entering at the right point on the growth curve. We are also entering at a point where and really this is a way of elaborating on the same theme. The OEMs are seeing and buying into that growth curve because customers are responding and drivers are responding enthusiastically to the functionality of a head up display but what OEMs are really struggling with is systems based on currently available technology, LCD projection technology. So as I said, I know I have made this statement before, but to us this business case just becomes more compelling all the time and our effort is to enter into a strategic relationship to go to market with the product and we're very encouraged by what we see there.

The other area of primary focus continues to be in the consumer electronics domain. I think we will be able to talk very shortly about some technology breakthroughs that are very germane to this space. Just to put some context around it, memory and storage are becoming probably much more important than wireless bandwidth in terms of portable media products.

Just ask Apple. The iPOD is essentially a very high density hard drive.

We're going to see that storage curve continue to go to staggering kinds of numbers. So whether it is hard drives, compact flash, thumb drives, and other types of storage, we're moving very quickly to a point where movies and games can be in very, very compact form and, of course, that is really incompatible with the compact form.

Steve, maybe you can comment on some of what we are seeing in the last six months or so from players in the consumer electronics domain and what they are they're really looking for in terms of display functionality.

Well, that probably harks back to a press release in August of last year, where we described a scalable architecture, and we've continued to refine that, and in parallel investigate markets that would benefit from the sort of wider field of view and higher resolution that we described would be available, and that primarily as Rick described personal entertainment and gaming markets. So that has been a recent focus and certainly with respect to electronic gaming, we now believe that this market could be very receptive to a next generation of HMD-based solutions whereby the wide field of view, the immersive effect, would be put to good effect.

We have also been looking at continuing to evaluate opportunities for a wearable multimedia gateway which would support the emerging cellular handset services, television, et cetera, which currently are bottle-necked by the very small display. So we really have been bifurcating our efforts, market opportunities and emerging market evaluation and scaling the architecture, and as Rick described we will have more to say about that soon.

One of the things we are hearing is a real emphasis on a cinematic experience, a very wide field of view. So in the consumer electronics domain, people are saying well, let's sort of go from the ridiculous to the sublime, i.e., the 2-inch display that is very limiting, not just to a 14-inch display but to a 60 or 80-inch display or larger.

We believe we have got some fundamental intellectual property that represents a pretty profound breakthrough in that regard and we will be able to talk about that in pretty short order. We have got some patent filings to complete. We do have a priority date by virtue of a provisional filing that we did very early in the process. So we think there is some really fundamental landmark patent sort of opportunity here.

In summary, I guess I would like to say we are very pleased with where we are coming out of 2004, which was certainly in the first half a difficult year where we struggled with getting product into production. We now have that well behind us. We did see -- have success ramping the contract revenue in the second half of the year and as I said with the Ethicon contract and additional bookings coming in, we are in a very strong position going into the new year. We think the prognosis for the longer term looks good as well. Real emphasis with respect to product revenue and in that -- in that vein with respect to channel development in particular. So if I were suggesting what you ought to be looking out for, you ought to be looking out for distribution agreements, co-marketing agreements, that we think can help us ramp the product.

We do have a website dedicated to Nomad and one dedicated to Flic, increasingly on the Nomad website you will see customer testimonials. This I think is at the end of the day the most powerful evidence of all, because these are the people who are using the product and able to articulate its functional and economic benefits and they do so very persuasively. As I said I think one of the other things to look out for with respect to Nomad, and that ties to sort of co-marketing arrangements, is applications where you are potentially tying to a large installed base of existing systems. We think those are the catalysts for growth and we have good progress to report on all of those fronts. So we are -- we are quite enthused from where we sit today. So I think that probably gets us to the Q&A portion here, and we're happy to turn it over for questions and answers.

Thank you, sir. Ladies and gentlemen, if you wish to ask a question key star followed by 1 on your touch-tone telephone. If your question has been answered and you wish to withdraw your question press star 2. Once again, that is star 1 to ask a question. Our first question comes from the line of Alan Robinson of Delafield Hambrecht. Please proceed.

Good afternoon, Rick. A couple of items. Firstly on the results you reported today. They were a little bit out of line compared to my expectation. It seems that your accounts receivable ramped up significantly in the fourth quarter. Can you just give us an idea of what is going on there? Whether any customers are more reluctant to pay up or what is actually going on there? And secondly, in terms of the operating expenses what would be, given your shift from R&D spending to sales and marketing, what is a reasonable run rate for your operating expenses this year?

Alan, on the receivables, the increase at the end of the year -- or for the year was predominantly due to Ethicon. Ethicon was almost $3.5 million in that number.

Okay.

And in terms of the operating expenses --

Let me add to that because you're going to see kind of another aberration in Q1 cash flow and it had to do with the timing of that. The Ethicon contract was booked before the end of the year. The $3.5 million was actually paid very soon after. So, and the reason it is a large receivable is the terms of the contract indicated that that $3.5 million would be paid up front. Now, we are recognizing that as revenue over a longer period of time. Over a couple of quarters, but from a cash flow perspective you're going to see cash flow in Q1 be unusually high, the loss -- the outflow be unusually low as a consequence of that coming in. That is worth noting as well with respect to that particular receivable. Go ahead Richard on the operating expense.

On the operating expenses, I thought you mentioned in the letter, we are looking at combined operations expenses in the current years of being maintained near what they were in '04 on a net basis. And as Rick indicated we have -- in '04 we kind of reallocated some expenses, did less research and development and did more sales and marketing.

Right. I think on balance in rough numbers, Alan, you have got sort of $3 million going in each direction, sales and marketing versus R&D.

Okay.

Right. So increase of $3 million in sales and marketing, reduction of $3 million to R&D.

Okay. So are we still looking at a break even revenue rate in terms of cash flow break even of around about $14 million? You have referenced that in the past?

Um-h'm.

And just give us an update on how that is likely to pan out this year?

Well, we haven't -- we think we will make good progress towards that this year, particularly in the second half of the year. The objective continues to be targeting first half of next year to kind of achieve that run rate and, of course, the real high variability component there is Nomad. We believe we can ramp it across the segments that I described to you in that time frame to account for a large chunk of that quarterly requirement. We are seeing good evidence, you know, certainly in current and second quarter with these new distribution agreements coming online, so that is going to be key to achieving that goal but that number is still a reasonably good number.

I think it is important one of the things we saw in -- in 2004 was the sensitivity of our model to contract revenue. So that obviously presumes a certain mix, you know, along the lines of what we would call historical lines of 12-$14 million in contract revenue. If that is below that, the contract revenue is below that sort of number that break even hurdle goes up. If the contract revenue varies favorably than that number can come down a little bit because the contract has a leveraged contribution to cash flow.

Right.

Because we are allocating costs IR&D costs up to cost of goods.

Okay. Let's talk about the financing for a second. It seems that it came a little later than I had expected. Can you talk about any problems you were experiencing with negotiating the financing and how you see changes in the landscape of financing through this year? Clearly we assumed that you will be requiring to tap the market again before you get to cash flow break even. Can you talk about that at all?

I don't think the timing reflects any difficulty that we had. We did get as we mentioned with respect to the Ethicon deal kind of an extraordinary infusion of cash which might have been inconsistent with expectations a little bit, the $3.5 million that we described. The other piece is really purely mechanical and had to do with the seniority of the instrument and when we could put that into place. We had some covenants in place that restricted us from putting a senior instrument in place prior to a certain date.

How does this impact your likely -- tap your fund raising in the future? Is it going to become more difficult?

No, I don't think so at all. We think it's actually an instrument that gives us a lot of flexibility, in that that we are able to demonstrate that we partially monetize the Lumera asset. What we were in able to in effect issue Microvision equity at a significant premium, especially if you adjust that premium for the potential of conversion into Lumera. So it's counter dilutive in a couple of different respects and we are paying a coupon rate in exchange for that but no, we don't think it impedes anything we would likely do in the future. I don't want to say too much about what our future plans are but we have got plenty of room to do other kinds of financings so I don't think we are impaired in any --

And we have only secured the note with 1.7 of Lumera stock which leaves 3.7 million completely free and available to the company as one alternative financing source.

That's an excellent point. So, 3.7 million shares of Lumera are completely unencumbered.

It Looks like the current value, that's about $17 million worth. Is that going to be enough, do you think?

Enough for?

To finance you through consistent long term profitability?

I think it is probably a bit north of that, what the remaining requirement would be, but and it is not clear to me that we would draw solely on that asset in any case. But it does give us a lot more flexibility, both with respect to that asset and with respect to other forms of financing that we can use. So we are actually pretty pleased with the structure. We think it was -- it was a great success in that regard. And we think, you know, going forward can be quite favorable.

Thanks. I'll let someone else take a turn.

Our next question comes from the line of James McIlree of Unterberg, Towbin, please proceed.

Hi, it's actually Kristine Day calling in for Jim. A quick question on that inventory charge. How much of that fell in Q4?

About 750,000.

And all of it was in the last two quarters, wasn’t it?

I was going to say the balance of it was in Q2 and 3. Predominantly Q3.

It is back-end loaded, Kristine, and part of the reason for that is that, you know, Nomad really didn't get into production until we -- original schedule had been earlier in the year March. We really didn't get into it until the middle of the summer and we really didn't start ramping it and make the change to the new scanner system until August/September.

Okay. As far as guidance, do you -- can you give second half revenue projections at all?

We are not in a position to do it yet. We think as we -- as we get into these distribution agreements, that's going to extend the horizon that we can project out over. Part of it as you can imagine the nature of these agreements is discussing and coming to mutual agreement with respect to forecasts and binding forecasts and things of that nature. So once we are there we are -- we think that is going to be -- that is another positive of those is we think it is going to give us a little bit longer forecasting horizon.

I missed a bit of your answer regarding the Op Ex progression. How is that panning out for the year? Is the current -- is Q4 a good base level going forward and the split?

Largely. I think 2004 versus '03, the answer we gave to Alan was really what you saw in rough terms was, R&D come down by about $3 million and sales and marketing go up by about $3 million so on balance we are the gross number is flat and we are starting that as a baseline, moving off that as a baseline going into 2005. There is -- will probably be some modest reallocation of sales and business development resources coming later in the context of some of these distribution agreements.

For example, in one instance we have talked about migrating personnel over to our distribution partner several quarters into the arrangement. The likelihood, though, is that on balance you're going have a net zero change because we will simply focus internal resources on the other verticals that I mentioned to you. But I don't think there is anything really major that would need to be adjusted other than the sort of the flip-flop that we -- the trade back and forth between R&D and sales and marketing.

Okay. As sales ramp going Q1, Q2 and hopefully by the end of the year, will -- how will the cost of sales ramp? I mean how much of that cost is fixed and how much would be incremental margins? I mean from the added volume?

On the basis of this distribution deal, you're not going to see a lot of increase in unit variable cost. This is actually one of the positive features about this is that we ought to be able to maintain a relatively high ASP. We are talking about a value added arrangement where the primary or significant chunk of the value for the reseller comes from their ability to provide service, support and software solutions. So I think just in terms of tiered pricing that is something that is a little bit further out. With respect to increasing fixed costs associated with sales we don't have any budgeted really. Nothing meaningful.

Part of the issue here and the impact on the margins is the low volumes at both Nomad and Flic. We haven't been realizing economies of scale and -- if I have got it right and we certainly expect that that to improve.

Right.

Going forward.

Is your question, Kristine, more relating to the hurdle rate implied by the absorption, the manufacturing absorption is that what you are after?

It was really -- it was really based on the increased volumes mean lower costs.

Yeah, that is -- That is certainly a benefit. There is actually good news on the cost front independent of volume. We think we have got a very positive picture in terms of cost reduction even at sort of the modest volumes that we have seen historically. So certainly increased volumes would impact product cost favorably.

Can you give the product versus contract split in the Q1 and Q2 guidance at all?

Probably not just yet. Q1 more easily than Q2. Q1 is looking like about 3 -- call it 3.5 plus in contracts. And the balance in product. 3.6, maybe a little bit north of that.

Could be north.

Okay. Thanks. I think that is -- you have answered all of my questions.

Thanks.

Our last question comes from the line of Arthur Daglione of Merrill Lynch. Please proceed.

Hi, Rick. I wanted to actually look a little bit more broadly on -- you had talked about the possibility of some distribution for the auto market, Nomad distribution agreements, and I wanted to find out, number one, generally if you can characterize how this might affect margins, on your sales. And then number two, could you talk about the integration of the software and systems that you mentioned providing the complete solution and then I do have one follow on question after that.

Okay. Great. Margins on sales. I just touched on it briefly there because I thought that was the question Kristine was asking but since you asked it again I'll try to give a better answer.

We think that the good news here and this is often the case with distributing computer hardware, because computer hardware is relatively commonplace, your resellers who are themselves software solutions providers tend to not make a significant mark-up on hardware. It tends to be on the order of 10-15 percent. So the reallowance to this sort of value added channel is pretty low. That being said I think what that translates to is we ought to be able a maintain a reasonably high ASP. Don't hold me to it but $3,500 plus or minus is a reasonable number certainly short term. We will obviously create incentive structures that will provide better pricing as our partners drive volume, potentially including rebates and fairly conventional things of that nature to try and incentivize them to beat (ph) number. So from a margin perspective, pure margin perspective, that all looks pretty good.

With respect to that -- what the nature of that value added and the systems sale, Nomad, of course, in an automotive maintenance environment is a wireless terminal, it is pulling content from a variety of different sources. And one would be the DMS system, the dealer management system which is an integrated system that includes fixed operations and parts and service information as well as sales and F&I, finance and insurance modules. The other is the electronic parts catalog, which actually contains parts diagrams and parts data and increasingly is starting to contain service bulletins and things of that nature. And the third major leg on that stool is the actual OEM service content.

So a technician is going to typically have a session where they will go to a car in the best case, they will grab the VIN number, they might be able to do that in the case of something that we are working on with Honda by connecting the Nomad directly into the car, by querying the car. It goes back and pulls up any relevant service data from the OEM service content and/or the electronics parts catalog, which in turn connects to the dealer management system to check inventory and also to provide an electronic repair order interface so that that technician can log in what repairs have been done, what parts have been requisitioned and or used, et cetera. So it is really that sort of thing, you want someone to go in there and integrate into these existing systems. There's a large installed base of them.

I'm going to stop short of mentioning what the other kind of tool is because we have got a co-marketing arrangement with respect to -- but the other kinds of things that you see in -- in dealer service shops are diagnostic tablets that are sort of PC-based kinds of systems. You see wheel alignment systems that are PC based systems and connecting to all of these things ultimately is where you're going to provide the best value and open up some really interesting doors into the market. So I hope that answered that question.

It did. It sounds like it can be leveraged into a lot of different avenues and we'll wait to see how that plays out.

Yep.

The other question I would have is regarding -- you mentioned in your press release a Nomad trial and evaluation phase with some leading manufacturing companies.

Yep.

How long of an evaluation period would you foresee? And can you just in general kind of characterize the size of the opportunity that would be under consideration here?

In general, I can. I have got my marketing VP sitting here and he is going to kill me. I'm going to use a word like it's huge. It is an enormous opportunity because you are talking about both machine operators and machine maintainers and virtually any kind of factory.

Now, in terms of what the path into that market looks like, and this is one of the things you find in an established enterprise any sort of Fortune 100 or Fortune 500 global enterprise, they can tell you chapter and verse about where what the relative efficiency or inefficiency of what each step in any process in that factory is. So they're able to -- my point there is they're able to prioritize. Gee, I'm going get my biggest ROI by integrating Nomad into process A, Q and X and therefore that is what we're going to prioritize in terms of how we roll it out. With respect to -- and these are household name companies.

There is two ways that you get to the return on investment. One was articulated to us by a major semiconductor company who has huge fabs spitting out thousands and tens of thousands of chips an hour. And their capital equipment ROI is based on the fact that if I own 50 machines and I increase uptime or reduce downtime by 2 percent that means I don't have to own a 51st machine. It's very simple math for them.

On the process control side it is a little bit more complex. But it involves in the case we're talking about, one of the trials, you have got a very complex as-built matrix for goods moving through the line and the decision that this particular company was faced with was either having to upgrade to a new generation of capital equipment that could keep pace with the increasing complexity of this as-built matrix or to equip the machine operators with more information in the process control loop and perform more tasks manually. They did the math and very quickly concluded that there was just no comparison. So the ROI there is I'm getting to defer, potentially indefinitely, an upgrade of capital equipment and extend the life of existing capital equipment. So that I think in turn gives you a flavor for what we could be talking about here, in terms of market potential, because the return on investment can be so profound when you are leveraging that kind of capital infrastructure.

Every one of the companies we are talking about has capital plants that would be measured in the millions billions of dollars in terms of its total value. So it is a significant opportunity.

With respect to the trial process itself, the one that is best defined and that we have the most visibility on would conclude at the end of May. That would result -- that is a trial that involves I think about a dozen units or so today. I think the next increment would be a couple of hundred units so they -- they would scale up and do an entire plant location on that basis. And then if that works you'll see it scale out to elsewhere in the organization.

Each manufacturing plant we could be looking at a couple of hundred units?

In the case of this particular manufacturer I think somewhere I have actually a note telling me how many plants they had in that case 120.

Okay.

Up to 200 per plant is what it says in my notes. And some of this is market development. They're going to discover, we think and this is what we have seen already, is people are discovering new applications. We had an interesting call from one of the big workstation providers the other day and it goes to this issue of downtime, and you can imagine if I'm a provider of a computer that is responsible for operating a telecommunications network what the cost per minute could be if that network goes down. I think the number that they mentioned was something like $7 million. So again, the value of being able to shave, you know, seconds off of those kinds of things is really profound.

So we are finding that these people -- the mode we are in right now, Art, is that these people are coming to us. We have always envisioned the next phase of business development for Nomad would be pointing to what we are doing in automotive and referencing it into other areas and in particular into other maintenance areas.

You'll see the same kind of objective there in terms of distribution partnering. There's all sorts of electronic tools and information and software solutions providers that address these manufacturing verticals just as the ones that we are talking to address the automotive service vertical, so our objective will be to partner with them as well. So this is in some ways happening faster than we anticipated in terms of these opportunities coming to us and what you are hearing from us right now is actually a fairly unstructured approach to that market. That was really what I meant earlier when I said, you know, the next phase to for us will be doing a more rigorous analysis of that market and I guess what that translates to is next time you ask me what the opportunity is I can give you a more intelligent answer. So, but I -- it is -- it is a very good one and it is a compelling one.

Well, I think I'm beginning to see the picture. I appreciate that, thank you.

Thank you. One thing that I wanted to again emphasize is that we are -- Kristine asked the question about mix during first and second quarter. I guess what I can say, Kristine, if you are still here, is that we would expect the mix to become more favorable towards products in the second quarter as well. Right now the visibility we have would suggest that, you know, contract revenue is going to remain in that sort of 3.5, 3 to $3.5 million range quarter to quarter. That is our objective, that what we would see most of the sequential growth that we are talking about from Q2 would come from product sales and we would expect that -- that mix trend to continue through the balance of the year with these distribution agreements in place.

Thanks very much. We're very excited about where we are looking forward. The prospects for 2005. We look forward to reporting to you in the next several weeks on a number of the things that I've indicated we should be able to discuss and we think it going to be an important year for the company. We are seeing interest in our products come from actually lots of different places. Highlights will be our distribution agreement, co-marketing agreements in the automotive segment. Conclusion of these tests in manufacturing. Additional military procurement partnering with the major defense contractor. And that domain we think it will be a great way to start the year.

Thanks again for joining us today.

Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude the presentation. You may now disconnect. Good day.