MicroVision Inc (MVIS) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2005 Microvision financial results conference call. My name is Gregory, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. If at any time during the call you require assistance, please press star followed by 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 call, Mr. Brian Heagler, Director of Investor Relations. Please proceed, sir.

Thank you. I would like to welcome everyone to Microvision's second quarter 2005 financial results conference call. Participants on today's call are Rick Rutkowski, Chief Executive Officer; Alexander Tokman, President and Chief Operating Officer; Steve Willey, President of Consumer Solutions; Richard Raisig, Chief Financial Officer; Andrew Lee, Vice President of Sales; and Tom Sanko, Vice President of Marketing.

The information in today's conference call includes forward-looking statements regarding projections and 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 "believes," "estimates," "expects," "anticipates," "target," "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 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 security 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.

Thank you, Brian. Thank you, everyone, for joining us this afternoon. We're going to try and keep the call to an hour, including the Q&A. So I'll proceed forthwith with the review of the financial report and then a discussion of the outlook going forward and highlight a couple of themes. We'll introduce our new President and Chief Operating Officer, Alec Tokman, to you, and he can comment on some of the initiatives that he has undertaken and some of those that he has planned over the next 30, 60 and 90 days, in particular.

We're, obviously, pleased to report record revenue for the quarter, 4.7 million is a record for us. It's a little below our most recent estimates. If you recall in the last guidance we issued, we mentioned that there might be some variability due to what we called a completion analysis on our project in particular. What this means is that as we look-- we recognize revenue on our contracts on a percentage of the work completed against the budget, and then periodically we actually re-baseline the budget. So that can cause some variability and in particular, in the case with the Ethicon contract where we had not only the project revenue, but running in parallel with the $2 million stream of license revenue that's being recognized along with that, you do get a little bit of variability.

So not a substantial difference from where we wanted to be. Excellent performance year-over-year, quarter-over-quarter. A bit of a spike here in terms of contract revenue because of the schedule for delivery of the Ethicon deliverable's and we'll, again, see some of that taper coming into third quarter and I'll comment on that, as well. Generally, what is very positive here, though, is that we do see product sales accelerating, helped by some additional upside in military sales, with respect to our order from General Dynamics. That's going to help us both in the second and the third quarter and we'll speak to that, as well. Company reported revenue for the three months ended June 30 of 4.7 million. That is a record for the Company. It's an increase of 124% over the 2.1 million reported in the same quarter last year.

For the six months, we reported revenue of 8.7 million compared to 4.8 million for the same period in 2004, again, a really very strong increase versus year ago results. And we expect that comparison to continue through the third quarter and indeed for the rest of the year. We're on track to have a much, much stronger 2005 than 2004. Contract revenue increased 142% to 3.7 million in the second quarter versus a million and a half a year ago, and more than doubled for the first half of the year to just over 7 million versus 3.5 million last year.

Product revenue for the second quarter also showed strong growth and increased 78% from last year, to just top 1 million in product sales. The second quarter, the product revenue was comprised of $669,000 from sales of Nomad System and $374,000 from sales of the Flic bar code scanner. Product revenue for the first six months of 2005 was 1.6 million, a 30% improvement from the same period last year and was comprised of $878,000 in Nomad sales, and $765,000 from sales of the Flic scanner. As of June 30, backlog totaled 6.8 million, an increase from last year's 4.5, and that's comprised of 5.9 million in development contract bookings, and 900,000 for the Nomad system and Flic scanner. So that sets the stage for continued growth in product revenue for the third quarter.

We're targeting an increase quarter-to-quarter in the neighborhood of 30%, and we think there's some additional upside, potentially, to that as well, and I'll talk, speak to how we get there with those estimates and the actions that we're taking to drive product revenue in particular. I'll also speak to what the contract picture looks like for the third quarter in terms of contract billings, and try to put that backlog in context ,as well, versus other activities that we're engaged in.

We did reduce our operating loss for both the second quarter and the six months, reporting a loss of 5.8 million for the second quarter, 11.4 million for the first six months. Those are improvements of 2.6 and 3.5 million, respectively, from the same periods last year. That improvement in operating loss was principally due to increase in both revenue and gross profitability and, in particular, contract gross margin improved pretty dramatically versus last year.

We reported consolidated results that include a net operating loss from Lumera. That number is on the order of $900,000. There's some other items in the consolidation that are worth looking at. We reported, our consolidated net loss was available for common shareholders was 5 million, or $0.23 a share for the second quarter, compared to 8.5 million, or $0.40 a share in the same period last year. The six-month period, we reported a consolidated net loss available for common shareholders of 12 million, or $0.57 a share for the six months of '05, compared to 15.2 million or $0.71per share in the same period last year.

The second quarter net loss includes a $1.3 million, or $0.06 per share gain, and a net non-cash, net non-cash gain relating to the embedded derivative feature and warrants of the 10 million convertible exchangeable notes, and a $1.6 million, or $0.07 per share gain on the sale of Lumera shares. As I mentioned, the share of Lumera's net loss in our second quarter was about $0.04 a share, or $934,000.

We ended the second quarter with 2.3 million in cash, cash equivalents, and investment securities. Earlier today we did announce that we have raised an additional 5 million in new equity capital, and also converted 5 million preferred stock into common equity. So we're emerging from this transaction with a balance sheet that we think is improved in two ways, increased equity, reduced debt, and that puts us, we think, in a stronger position going forward.

So with that summary of the financial highlights for the quarter, I would like to offer just some remarks to frame the activities going forward. We think these are outstanding year-over-year results. We're very satisfied with the overall direction of the business. As we go through each of the categories, our OEM development activities and our product sales, we're clearly happier with some of those results than other areas and we're focusing our attention acutely on the areas that we think can really benefit dramatically from improvements.

In particular, one of the things things that we have seen in the second quarter and expect to see more of in the third quarter is product sales accelerating. This has been a key focus of ours. In this case, the bright spot is our work with the military and equipping the Stryker Brigades with the Nomad ND 2500 unit. We think there's substantially more opportunity there. Our commercial sales of Flic appear to be going very much according to plan. We're looking for good solid growth in Q3. If you'll recall what we said in our last couple of reports to you, that we expected the first half of the year to be a couple of flat quarters. That's what we've seen, but that we did expect to see some acceleration in that activity in the third and fourth quarter.

And I think that has to do with the fact that we have made some organizational changes and are really focused on improving operating effectiveness there and, in particular, focused on channel development through a strategy of leveraging our existing resources by growing their account base of resellers and systems integrators with respect to Flic.

The challenge of marketing the commercial Nomad continues to be our greatest challenge and, again, I think I would characterize that by saying that in order for us to really effectively maximize the potential of this product, we've got to leverage our presence into distribution channels that include systems integrators, applications, developers, and other solutions providers. We are starting to see ourselves be effective in that regard. We have had one deal, in particular, that has been in discussion stage for a long period of time. We believe that will soon come to fruition with respect to the automotive space.

I think, Andrew, you also mentioned that we expect to have a deal with an overseas distributor for Nomad, as well, very soon. Another key aspect of this, with respect to channel development and applications development, is the recent announcement by both Microvision and Hunter Engineering. In this case, what Hunter Engineering has done is produced a version of their WinAlign software that will support the Nomad interface. What that enables is the use of the Nomad display as a user interface to a wheel alignment system. It's a very powerful application. It's one where we can measure discreetly the productivity benefit and quantify it. It's a known dilemma in terms of the familiarity with the, this piece of equipment and some of the constraints that exist in using it in its current form and so we think user acceptance can be quite high.

There's a very, very large installed base, I think, unofficially. What we hear back channel in the industry is that there are roughly 65,000 locations today that house Hunter wheel alignment systems. Our strategy here is going to be very focused. We're going to begin in the southeast, so, Andrew, maybe you could offer a few words on what we're doing there, as well as some of the further segmentation we've done in terms of targeting truck maintenance, and some of the activities we're seeing there and even with some of our fleet customers. Sure, thank you. Well, we have moved, or will be moving later this week four teams into the southeast to be working with Hunter Wheel Alignment, independent reps, and we're dividing up territories by zip code in a very methodical process to go after and take advantage of this new WinAlign software revision that allows Nomad to work and work very well. We're seeing as much as 25% to 30% increases in productivity from some of our trial efforts. We want to go out and share that with the market. So in terms of the truck space, we're seeing tremendous acceleration not only in interest, but in activity. We recently signed a nine-store deal, which is a secondary deployment with a major truck dealer down in-- Volvo truck dealer down in Texas, and results are just coming in now and they also tend to indicate a great promise with truck and heavy equipment. So we're excited and look forward to seeing some growth in the truck and heavy equipment area this quarter. I think, again, what you're hearing from us is that we continue to refine our focus on how to effectively sell and market the product into this segment, and I think I want to turn it over to the Alec Tokman for a moment to talk, generally, about his approach to both Flic and Nomad and what he views his near-term mandates are in terms of driving product sales.

Thank you, Rick. As both Rick and Andrew mentioned, some of our near-term, to mid-term priorities include basically driving growth and profitability on the existing products, specifically on Nomad and Flic, and to do so, we basically break down these efforts into several phases, looking at improving our marketing effectiveness through improved market segmentation, and strategic segment prequalification, improving our customer prequalification within the segment, as well as paying more attention to the product turnover training and turnover process, specifically, how do we train the customers, how do we manage the acceptance period and how do we baseline the actual quantitative gains that we can use then to attract new segments. In doing so, we put together several Tiger teams that are addressing these issues as we speak. Once the tactical issues get addressed and we have reasonable belief that we can improve our penetration into the existing and new segments, which we already discussing at this moment, we'll focus on development of multi-year strategic road map and multi-generational product plans, followed by basically developing a solid and sound 2006 operating plan that we can communicate to you early in January of next year. That's about it from me. This is the third week on the job. I'm learning a lot. The team is great here. Everybody wants Microvision to succeed and I'm going through the major learning curve. You need to understand the products, technology, what customers like, what customers don't like, we are looking at assessing the current strategies and goals and baselining them, as well as looking at the operational effectiveness through various functions, marketing, sales, R&D, and manufacturing.

Thank you, Alec. I think it's important that one of the things we're able to do now with Alec on board is to be rigorously analytical about what we're doing in the market as we are doing it and then increasing cycle time so that we can effectively position and reposition.

One of the things that I would amplify that Alec mentioned is in the process of turning over the product to customers, one thing that we have agreed that we need to do more of is going in and ensuring that the customer's recognizing the full potential benefit of, realizing and recognizing the full potential benefit of the product and then documenting it because we will then be able to leverage those results. That sort of proof of ROI ends up being very significant and especially in this particular segment.

I think in parallel, we've got some ideas about additional segments that we will qualify with respect to strategic accounts, in particular, where we have field services, a good example, where we have a large field force that may be currently already using computers in the maintenance process. You know, certainly many organizations have this. We have a fleet trial ongoing right now with a major consumer package goods company that is going exceedingly well with respect to truck maintenance. One of the things that, again, correlates to both Alec's and Andrew's comments, Alec mentioned insuring that we segment within the segment and further refine the segmentation as we look at the market.

I think the, looking at trucks and heavy equipment as an example of this within the automotive maintenance domain is a very good, useful, and constructive example. The reason that we are targeting that as another beachhead opportunity is that the average repair order for a truck is substantially higher in terms of economic value than the average repair order for an automobile. So the ability to leverage both labor and time, obviously, correlates to that cost component, as well, there is a compounding economic return in that you're not just leveraging the labor input. You're actually leveraging the capital equipment that you are maintaining and that you're focused on uptime, or wheels on the road time.

So for fleet maintenance and truck maintenance, this tends to be a great sensitivity to that and that of course applies to a whole array of capital equipment. One of the things that we've mentioned in the past, also, is that this is where our relationship with Microsoft, we think, can really begin to bear fruit.

Again, we think the path into these markets is through both selectively targeting strategic accounts where we might have a large user base that is captive to a large Fortune 100, or Fortune 500 organization, or alternatively, working with a, one or more systems integrators and of course Microsoft has helped us and will continue to help us promote awareness in both of those constituencies. I think, in short, we feel as much conviction as ever, if not even a greater and more informed conviction than we felt with respect to the long-term prospects for the product. We think that there is some steps to execution that we can take this quarter and the next quarter that can help us see dramatically improved results, potentially pretty quickly. Alec I think wanted to add--

Just wanted to add one comment to ditto what Rick has said. We're going to focus our efforts on the Fortune 500 companies, specifically, manufacturers of various equipment, the medical, or other industries, and the reason it's simple, because one of the intangibles in getting further penetration of Nomad products, specifically, is to be part of a top-down organization when we're operational leaders and measured on productivity goals every year, and this is-- we feel will be one of the success factors because we strongly believe, and we already have quantitative information stating that there are double-digit savings and benefits from using Nomad for various applications.

Okay. So just to summarize on the discussion of commercial Nomad activities, we think organizational alignment is going to be a component of this. We've completed some of that during the last quarter. We did have some turnover within the sales force. We feel that we have substantially upgraded that force. If we look at the composition of that force, with respect to automotive, we have several decades of experience. That company is like Reynolds and Reynolds and ADP that comprises our current sales team, including the new sales leadership for the product, a fellow named Bob Spitler [ph], has about 23 years in the automotive segment.

So we have made some organizational changes and there's more work to do in terms of alignment and improvement effectiveness, quality of execution effectiveness is another initiative. Leveraging partners, including both strategic accounts, as well as integrator distribution and channel partners, and then also in parallel, qualifying new segments and our initial entry into those new segments will be some combination of integrators. We have some in the queue that have been introduced to us by Microsoft, as well as strategic accounts.

One thing I would like to just pass along to the shareholders is with the interest in heavy equipment and trucks in the commercial side where commercial organizations are looking at enhancing their productivity, as Alec mentioned, we're also seeing the military also embracing the commercial variant of Nomad in a way that we hadn't fully appreciated at the start of this quarter, or the start of last quarter. So we're seeing acceleration in the military side for usage of Nomad. These are installations that service and repair heavy equipment and they have seen in the last six months to a year a great drawdown of their personnel and their staff in light of the current condition in Iraq and other places. So I think that's a good leading indicator, commercial variant being sold into the military market as another topdown example as Alec mentioned.

Yes, this is another area where I think organizational improvements are going to help us. We've had some-- we've let some space open up by attrition in the organization over the last six months in anticipation of Alec's joining the Company, and in anticipation that we might want to engage in some more targeted realignment of resources, but we do have some activities, in particular, one area that we would really like to pay attention to in addition to trucks, in addition to the Hunter application is the military segment. We've had with very limited resources applied to this very, very good success so far and in fact, have closed business with at least one, if not more additional regional readiness centers.

Actually, a total of three.

Total of three readiness centers for the National Guard. It's a huge market, there are about 800,000 maintainers in the military. The U.S. military spends about $56 billion a year on maintenance. So, again, I would like to-- then as I mentioned, with respect to automotive, we would expect a partnership to be executed very soon that can help us to address that market, as well.

With respect to the Flic scanner, I think I've articulated this before, but what we are really focused on right now is process, simply moving new accounts through the prospect qualification funnel and scaling what we're doing now. We believe that the existing sales force, which is really quite small, still has substantial capacity to manage additional reseller and systems integrator accounts, and so we've got a heavy focus on qualifying those accounts.

Part of that, as well, has been driving the infrastructure that surrounds the product in creating, again, an ecosystem of application developers around the product, as well as supporting product compatibility with multiple platforms, particularly emphasizing the handhelds and, Tom, maybe you can give us some data points that speak to the progress there.

Sure. It appears that there is a definite need for something like a Flic, a bar code scanner for all different sorts of mobile field forces, whether they are service or sales or delivery, lots of things, and so we've had a concerted effort in that area, and Flic scanners can be connected either by Bluetooth, the wireless means, or by a cable to a variety of mobile devices running palm operating systems, pocket PC, BlackBerry, we actually have certified 18 palm devices, 27 pocket PC devices, and 4 BlackBerry devices, and we're now working with mobile operators, the actual carriers to identify the next generation devices they intend to support. So we're actually ahead of the game and when they come out, they are sort of already certified for Flic connectivity.

Beyond that, another interesting thing is we have a software developer's kit for Flic and over the last year, year and a half, it's really matured to the point where the developer's kit actually enables application developers to seamlessly integrate the Flic into their offering. So up until we had this kit, you would need to run a little separate piece of software called Flicware in order to connect everything together, and now it's really just a matter of plug and play and so we've gone from a few, a handful of these integrated applications a year ago, to dozens at present, and it's growing every day. So it's a very powerful way to sell the product because now it becomes a solution instead of just a piece of hardware that's sort of bolted on, and we're looking forward to that, expanding into the future.

I think some of you can track this progress on the website, the customer facing website for Flic, flicscanner.com, you will see the connectivity matrix and compatibility matrix grow. You'll also see this evolve into a clearing house or a forum for applications developers, so that I can come to that with a platform centric solution that I'm looking for, gee, I'm looking for a bar code scanner that will work with this model smart phone, or this model PDA, or handheld, or alternatively, an application centric view. I'm really looking for something that's going to help me do asset tracking, or inventory management.

This hasn't really been done and there is a very significant ecosystem of developers of these applications and applets that can comprise this sort of offering. What we can then do is put this together with the channel and one of the more robust channels to access here would be those wireless network operators themselves. By that we mean Sprint, Verizon, Cingular, T-mobile. I was going to say Nextel, but that's now Sprint, so we covered that.

And the motivation there is that data capture, if we automate data capture, as opposed to having field forces rely on punching data in on a keyboard, we increase the data stream, which is billed by the bit. So we do-- we have seen substantial interest in bar code peripherals from these providers, and from a hardware perspective, the emphasis is on simplicity and affordability and, with respect to the peripheral. It needs to be compatible and of a common-- viewed in the context of the price points of these sorts of smart phones and handheld devices.

So a several hundred dollar bar code scanner is not a good solution for them. So we look forward to more of that activity later in the year. As I mentioned, we think we're going to see solid growth in Q3 for both product categories, so we're generally very pleased with that.

I did promise earlier that I would comment as I began the discussion on our OEM contract activities on the issue of contract revenue, potentially coming down a little bit in the third quarter versus second quarter, and we attempted to speak to this in the press release. In short, one of the reasons we have the range that we do is there is about $300,000 or $400,000 of variability in contract revenue that really relates to how soon we get under way with one or more particular development contracts, and I think the point we wanted to emphasize is that increasingly what we are seeing is that our development contracts are becoming more comprehensive as is the case with Ethicon, in that we entered into and negotiated in that case not simply a development contract with a three or six-month term, but something that had a multi-year term, many millions of dollars associated with it, and a back end supply and royalty arrangement.

We expect-- that is very much our goal to do more of those kinds of deals. We expect at this point to see more of those kinds of deals. The numbers in some cases are very, very large volume projections, especially as we start to focus on the consumer electronics categories. One can imagine the kinds of numbers that would be associated with portable media players and electronic gaming and some of the other consumer applications for wearable displays.

So to the extent that we're negotiating those deals, we're trying not to drive them along a time line that will allow us to bill that contract revenue in a particular quarter, but around a time line that will allow us to introduce the right product to the market in a timely fashion, and to maximize our economic potential on the back end of those deals, and unfortunately, I, I probably can't say too much more than that, but we are anticipating that we may see some of those activities soon.

Part of the reason for that is-- and we did make an aside in our, the latter portion of our press release today, is that the technical breakthrough that we have made in our optical systems design relating to wearable displays is profound in that it uniquely will enable a consumer solution, a very wide field of view consumer solution. So let me clearly delineate that for you.

If I want to create the effect in a wearable display of looking at a very high resolution HDTV, or better resolution image, over a wide field of view, think 100-inch diagonal display, heck, think 200-inch diagonal display if you want. This is orders of magnitude beyond what our competitors are in the market with. If I am capable of achieving that, the consequences from a market share perspective can be profound, in particular, if this is something that's absolutely unique. We believe that this optical system can only be enabled by a scanning display architecture, and really shows some of the power of this architecture. I guess without, again, going too far, right now we are not the only people who believe that.

We have managed to attract the strong attention and interest of multiple perspective partners who immediately, I think, in many cases, understand the implications optically of what we're talking about. Today, obviously, very close hold under nondisclosure agreements. So again, I apologize for some of the secrecy, but we want you to be very tuned into the way in which we're viewing this. We're looking at very high volume opportunities, and I'm going to let Steve comment on that in just a moment. Before we do that, I wanted to comment on one other significant, two other significant technological mile stones. The first is that we have achieved our first full color images with a laser micro camera. By micro camera, we're talking about a diameter of the entire camera of about 5mm. We are getting outstanding image quality with respect to, especially this stage of development. These are the very first images. Resolution, spectral quality, looking very, very strong, and we're also getting a field of view here that is stupendous, it's 140-degree diagonal field of view, so this is a major achievement, in terms of combining resolution, depth of focus, overall image quality and package size, and we think the market potential of this will become evident as we go forward.

We do continue to optimize the camera's performance and we fully expect to be able to report more developments in this vein as we go forward. As you can imagine, we will be promoting both of these architectures to our customer base and prospective customer base, especially as we get into the latter part of this year, and so we're very pleased about it. Again, this is the theme of really showing R&D productivity and progress through the pipeline, moving toward commercialization in each case.

Another key development in this domain relates to a whole range of products, very significantly right now to our commercialization, and the feasibility of commercialization, of our head-up display product, which is aimed for high volume applications at automotive manufacturers, as a built-in accessory to automobiles. I should mention that Audi has very recently, in the past several weeks, made very public statements to the German media about their intention to use a laser scanning head-up display in their automobiles. As a policy, Audi does not name suppliers, but I think many of you know we've been working with Audi for two years and we also have a pretty formidable intellectual property portfolio in this domain.

I think we will be able to say more as the summer progresses about the go-to-market strategy, including identifying one or more perspective partners, Tier 1 automotive suppliers that can help us get there, which leads me back to this last piece.

One of the remaining outstanding items relating to time to market and commercial feasibility has been the availability of a green laser. The go-to-market strategy that we have discussed with our customers and partners is to go to market if we can with a two-color display. That would essentially match what's available in the market today, red and green will give us amber, yellow, and a variety of different shades of red and green, among other color gradations.

A green laser that can be modulated at video rates and can achieve a particular price point is critical to that effort. One of the key challenges in sourcing that laser is that we not only had to have a laser of particular noise signature. We had to have a laser that could modulate at high speed, and this is a requirement that is really unique to laser scanning display, so most of what was available on the marketplace was not really optimized to perform this function.

I think the best possible case is what we're looking at today in that we have developed a proprietary method for directly modulating these lasers to the required rates. We have demonstrated a proof of principal of this, and, in effect, it opens that supply constraint potentially, and, therefore, reduces the risk, a key risk item in bringing that product to market so. We think that's a very significant milestone and, again, I think we look forward to reporting more on our go-to-market strategy, including potential partnering arrangements, as we progress through the summer and into the early part of the fall. Steve, you might want to talk a little bit more about where we are with respect to consumer electronics activities, including the new architecture and also some of the work that we've done with the edge emitting LED approach, as well.

Yes, I would be pleased to do that. We continue to make strong progress through the wide field of view architecture that Rick touched on, and that we first described earlier this year. It really is promising the combination, and it's that unique combination of features that is so exciting. It's a combination of very wide field of view, so we're all familiar with the 42-inch or 55-inch flat panel that you'd buy at a department store, but at 100-inch plus, you get a new experience, an emersific [ph] experience, and our testing, internally, has indicated this is very compelling. And so that is a benchmark that we've set for this wide field of view display. It's 100-inch diagonal plus.

This display must be able to, must enable HD wide screen resolution has become our expectation as consumers, and for this to be wearable by a consumer, obviously it has to be comfortable and light and otherwise acceptable. So it's that combination that no party yet has achieved and in large part, it's a very novel optics design. There are wide field of view high resolution wearable displays today at $50,000, but they weigh four or five pounds and, again, they are entirely unacceptable. This breakthrough is very significant and we now add it to our portfolio for consumer platforms. Rick touched upon the, an architecture that we developed over the past couple of years based upon edge emitting LEDs and our current focus is the manufacturing and commercialization of that platform working with EELED vendors and, again, we can report some good progress in that area.

A third platform in this consumer group relates to a micro projector, and it's not something that we've talked about a lot, but as we see emerging developments in light sources, and Rick touched upon one from the standpoint, of the green laser, this starts to enable the notion of a highly miniaturized micro projector for consumer markets and we'll be talking more about that as the year goes on. So that's kind of a summary.

Yeah, I think that's an interesting point you make. We've been approached over the years and more recently, very actively, by several consumer electronics companies, both in the United States and, particularly, in Asia. And the emphasis is on a, essentially a handheld projector peripheral that could be driven by a very, very small portable computer to allow for presentations and, in effect a micro, micro computer, if you will. The development in laser modulation is very promising. One of the candidate lasers that we're very close to will afford very, very efficient power consumption as well, which will be a critical requirement for that application area also.

In fact, this category has a name. It's a pico projector. Not a micro projector, even smaller, pico projector, and the computer that it would tie to it is a cell phone. So it's recognition from a standpoint of stored media and bandwidth your cell phone is becoming very powerful, but we're still left with a two-inch screen. So the OEMs and the handset and PDA categories are searching for micro projectors that might uncap the potential of the mobility [ph] device for them.

And, again, I think laser projection uniquely enables this because power efficiency and heat dissipation are going to be key to achieving these requirements. We won't achieve this by using necessarily LED rays and certainly not white light sources. Well, thank you, again, for joining us this afternoon. I think we're ready to turn over to Q&A. Just in summary, I would say, again, very pleased with the year-over-year results. We see that trend continuing in the third quarter. Sequential trend in product sales continuing in the third quarter. A lot of activity focused from an operating and execution standpoint on product sales, execution, strategic accounts and partnering. We expect to see some near-term developments in that domain.

We believe the Hunter arrangement is very positive in terms of providing an application base and a field force to leverage in pursuit of that, and we'll be acting on all of those. In addition to that, we reported today the OEM activities across the board, I think, technological success to point to and, increasingly, I think, we are seeing what we have targeted, which is the move towards more comprehensive deals that take us from development into high volume production, and we hope that we'll be able to report on some of those in short order, as well. Thank you, and I think we can take questions.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch-tone phone. [OPERATOR INSTRUCTIONS] And your first question comes from the line of Jim McIlree of Unterberg.

Thanks and good evening.

I used to know a guy by the name of Jim McIlree at Unterberg.

I'm subbing in for Jim, tonight, so. I hope that's okay. In terms of your Nomad revenues, how much of that came from the Army order and how much from commercial?

I think about half a million was from the Army. A little over half a million was from the Army, Jim. It was predominantly the Army in this quarter.

Right, and so what is left on that-- so there would be about 700,000 left on that, is that correct?

Yes, 6, 6 and change.

6 and change. Is that expected to come primarily in Q3, or is that spread out over the next--

All of the balance will be in Q3. We've delivered the complete order at this point.

Okay, great. Is there any expectation for a follow-on this year?

What we expect first is to see an additional development contract and there is potential for follow-on order. Whether it's this year or early next is a little bit up in the air. Beyond that, there is further potential for a substantial follow-on order, depending upon what sort of funding can be secured. We have the Alaska and the Hawaii brigade this. Would be 2006. The Alaska and the Hawaii brigade standing up next year. So we're hopeful that we can, based on the results that we achieve with this system, leverage that into some more purchases next year, as well. But I think there would be some smaller orders in late fall, government fiscal year is October, and then it would be, I think, what we've seen is first quarter.

Depending on the timing, first and second quarter of next year.

Okay. Great. It looked like the product margins were, product gross margins were negative. Can you walk through that, please?

Sure. Rick, do you want to--

Yes, Jim, for the-- in both the quarter period and the six-month period we had what I call period expenses, inventory reserves, some scrap, and inventory adjustments for lower cost of market. For the quarter, the number was in the area of about 1.3 million, so that went through cost of goods sold. On the six-month period, the number was about at 2.1 million. As you may recall in the first quarter discussion, our margins were below expectation because of some inventory reserves in that quarter, and we had more of the current quarter. Part of it is the lower cost, or market adjustment based on current selling prices, and as you know, the fourth quarter of last year, we started capitalizing overhead into inventory.

Right.

And our current level of production, we've actually got current level of sales, we've got, actually got some excess production capacity, and under the rules we need to write any excess overhead that's in inventory off to cost of goods sold, and so there was an adjustment in the current period for that, as well. So it's basically those items that, again, I call period expenses because they are not expected to recur quart-after-quarter, but we brought our inventory values in line with the market price and so on. So those were the reasons.

And, Jim, I think we can walk you through the details of that independently. The-- what we heard this morning on this, because we were going through it in some detail was that there's also an effect here if we look at the comparison versus the same quarter last year, that is beneficial in the quarter last year in that we, in the transition to the absorption accounting, we gained a benefit by the transition-- right, going from capitalizing to expensing. So, I think, we can quantify that for you. On an apples to apples basis, I think we actually see an improvement.

And let me just add that another component of that is sort of excess and obsolete. As you know, as we continue to develop the product, certain components get obsoleted and so on, as they are replaced by an improved design, and so those things are beneficial longer-term, but there is a cost in getting the product to that point shorter term.

Okay. Let me ask it a different way. If you just looked at the bill of materials and compared it to the price, are you at positive margins? So let's forget about covering the overhead and--

If you just take billing materials and compare it to the average selling price, we are-- we have positive contribution marks.

Okay. So it sounds like it's a function of just getting the volumes up?

Yes, it's basically there are two issues. One is controlling any of these kinds of period costs, and the second is getting volumes up, yes.

Don't forget, there are some other cost components, including installation warranty standards, as well as commissions and other that contribute to the growth margins.

Right, okay. Great. The equity deal that you announced this morning, is that consummated? You have the cash in your hands right now?

Yes. We have received the cash.

And will there be any charges associated with the conversion of the preferred into equity?

Will there be charges associated with the conversion of the preferred into equity?

That's correct.

Well, we haven't really gone through all the accounting yet, but I don't believe so because it's a straight equity transaction. On the conversion-- actually there will-- there will be some adjustments, but I think they are going to be positive. We're not ready to sort of go through the accounting for it yet because we haven't, we just haven't done that, but I don't think there are going to be any charges going through.

Okay.

Well, we'll let you know as soon as-- on the next phone call since it will be on the current quarter.

Okay, great. I'll queue back up.

Just to put a finer point on your question about closing. We're in the midst of formal closing. We understand that the wire transfer has been made. We haven't formally closed the deal and distributed the--

Okay, but it's-- the documents are signed and it's a matter of the wires clearing?

Correct.

Okay. Great. I'll queue back up. Thank you.

And your next question comes from the line of Alan Robinson of Delafield Hambrecht. Please proceed.

Hi, good afternoon.

Good afternoon.

I would just like to follow up on a couple of questions that Jim had there. With the conversion of part of the convertible into common stock, can I assume that your share count's going to be 2 million higher than where it was at the end of the second quarter now, so a million from the common stock issue and another million from the half million from the 500-- from the 5 million conversion, excuse me?

Roughly, roughly. I think it's a shade below that.

Yes, all right. And now with the, with the changing of the structure of the convertible, as I, as I recall you moved the conversion feature, which allowed the holders [ph] conversion to the Lumera stock-- do you still have to keep the 1.75 million shares of Lumera as a security for for that convertible?

The-- I want to be clear. I think you're clear on this, Alan. I want to make sure others listening are clear that you're referring to two different transactions.

Yes.

Right. So in the one case, the question you asked was about the number of new shares associated with the conversion of the preferred and the new equity issuance. The second question is about the effect, the restructuring of the debt, convertible debt deal. The short answer to your question is, yes, the shares remain as collateral, but there is no exchange ability feature. So in effect, the $5.50 call option that we had sold, and I'm-- literally that, but, in effect that, is not a part of that package anymore. What we did in that restructuring, because we weren't going to be able to get that, those Lumera shares registered effectively, and in a timely fashion, was to restructure the deal, and provide additional warrants in exchange for relinquishing the exchange ability feature and the loss of optionality to the investor.

Right. So moving on from that, does that imply that we're no longer going to see one of these below the line items related to the gain on the derivative feature of the note payable?

Well, again, we're still going through the accounting for that. One of the things that could occur would be the reversal.

Yeah, okay. All right. And then just finally, you are showing a backlog of-- realized next year rather than for the balance of this year.

Alan, you cut out for a good chunk of that question. Could you repeat it, please?

I apologize. Of the 6.8 million backlog, how much that have is for this year and how much for next year?

You mean in terms of what we will bill?

Yes, that's correct.

I haven't really looked in detail which of those projects would carry over, but I, I would expect that we-- right now in the aggregate, but this also assumes some new billings that are not yet in-- based on current bookings, it looks like we're looking at about 4 million of that this year, leaving about-- about 2 million for next year.

Yes. And you're talking about the rest of the current calendar year.

That's right.

Because we typically disclose all of it planned on being performed in the next 12 months.

Yes, got ya, okay. And last question, just on sort of qualitative basis, Rick, clearly you've been engaging a number of new investors with respect to becoming involved in the Microvision story. What have you found to be the biggest sticking point that you need to surmount to try to engage investors in a more financially meaningful way?

Interesting question. I think we've seen, frankly, in our case, I think, one of the key features has to do with the capital market context because we have not been fully capitalized. It's probably entirely appropriate to look at the capital markets environment as reflecting a risk factor related to the Company.

So we have tended to, I think, we already have intrinsically a reasonably high beta volatility relative to market. I think that is somewhat amplified if people believe that the market is bad enough that financing may become difficult, or if we may be in a bad market. So I think independent of that, though, we have tended to want to focus on very long-term investors. We're starting to see more of those come back into the market, you know, certainly if we look at the trend over the last several years, the definition of long-term is now beginning again to approach something that's more consistent with the way that we would think of it, and I think we've seen some new institutional investors come into the fold just in the last couple of quarters that, I think, fit that profile.

So you know, I don't think we've felt that we have been particularly at a loss or rebuffed. You know, clearly capitalization has been something that people have wanted to pay attention to. Obviously, in the -- during 2004, our operating results were, were not strong and were below those of the prior year, so that became a hurdle to overcome. And, I think, there continues to be, and, again, appropriately so, a focus on the Company's ability to effectively make the transition from technology development into technology commercialization. One of the reasons we had been so keen to add the operating strength that Alec brings, Alec Tokman, brings to the equation is exactly that.

We felt that this is an area where we really needed to excel and, in order to fully make that transition in the most effective possible fashion. I think we'll be able to see some of that interest come back. Another aspect, and frankly, you know, as I think about this and I guess my example is a little extemporaneous here, my answer, I apologize, I think there's been a taint on the space, generally speaking. I think Microvision is certainly not the first company to talk about the promise of micro display technology and to fall short of that promise in the time that investors originally might have thought.

So I think there's a bit of a, you know, the baby in the bath water, and an inability to distinguish the two in this regard, in that we've seen micro display field emissive display companies fail. We've seen companies with respect to outpromising liquid crystal on silicon technology fail in the rear projection market. We've seen LCD providers fail to achieve the gains in resolution and performance and price that many have promised, and in fact, you know, recently it was interesting that one of our competitors announced two products, one aimed at gaming and an immersive gaming experience, and the other aimed at portable media devices, portable internet devices and both of those were based on quarter VGA resolution displays. So we have very mixed feeling about that.

On the one hand, we're elated that our competitors do appear to be plateauing in terms of their ability to achieve incremental gains. On the other, we're fearful that, again, they taint the market, both with respect to the customer experience, and with respect to the financial market's view of this. And I, and I say that only to be-- because I do believe that it's a legitimate factor in this. I think this has been a tough space for not just Microvision, but many of the players in it and I think it's been a tough space for investors to really get their arms around, especially without doing quite a bit of work, and then I'll end it by just saying that's understandable in that, historically, and especially in recent history, and by that I mean the last 10 or 15 years, display and imaging technology has been co-opted and dominated by Asian companies.

We've seen that happen to Xerox and Polaroid and Kodak, and so the domain expertise that goes along with that in the financial community has been somewhat lacking in recent years, as well. So I think it's very difficult to find that level of technical expertise in financial analysts and industry analysts that can help investors understand, gee, who's got better technology and, is this real, and to provide that kind of support, as well. So, again, I think that's probably more than you wanted to hear on the subject.

No, I appreciate that. That's useful color. Thank you.

Thank you. Well, we are running to an airplane today. We do have a conference tomorrow in San Francisco, Unterberg, Towbin is hosting their tech fest conference and we will be presenting at that, but we do look forward to hearing from you and to reporting, again, on what we think are, some exciting prospective developments as we go forward. Again, I think, we are enthusiastic to welcome Alec Tokman. He is very much a part of the Microvision team, has immediately immersed himself in not only the actions that he's pursuing and the initiatives he's undertaking, but also in the culture and has become a member of the family, I think, very, very quickly and commanded the respect of those he's worked with. So we're looking forward to good things. Thank you, again.

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