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To: Sector Investor who wrote (1337)7/23/2002 10:24:50 AM
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Part 3 - final.

16:35 Q&A

Greg Weaver, Kern Capital

Q. Hi. Just a follow-up on that last question. On the smart bomb thing, are you competing with a quartz or a silicon gyro there?
A. No. The current technology is based on Ring-Laser Gyros. The Quartz and silicon technologies are really in a lower performance class than what's required for this particular application.

Q. So, how much of a ASP reduction is required to make this feasible relative to normal fiber optic gyro pricing?
A. That's a good question. I think that our technology is inherently less expensive, so we are talking about system sales which are approximately in the same ballpark as our current products, so it's not something where we have to design a product for half the price from where we are today.

Q. So the Ring-Laser costs about the same then?
A. Ring-Laser is more expensive than our current technology.

Q. Umm. OK. Just a series of other questions. Just in a general sense, on the revenue guidance, if I'm doing the math right, you're implying that your revenue will be sequentially down from this quarter. Is that correct?
A. Yeah. The third quarter is historically less than Q2, you know, when we give guidance we are talking about growth over last year, so the guidance we gave for 30%-40% growth was for the Year over year figure, not 40% growth sequentially quarter to quarter.

Q. Oh, no, no, I understand, but I just did the math for the whole year. I didn't realize you were saying by quarter. I figured you were saying for the whole year right? I mean you did $33 [million] last year? Multiply that by 35% right?
A. Right.

Q. So that's gets you about $45 [million], so I backed into the last two quarters and that is about $11 million a quarter, assuming they were equivalent?
A. I think that's a reasonable assumption. I think that what we are trying to say is that we are not forecasting 61% growth going forward indefinitely.

Q. All right. I guess what I'm after then is where is it falling off?
A. We have a normal third quarter seasonal dip, and then it should pick up again in the fourth quarter, and we're giving you a range, when we discuss the forecasts, and we could certainly exceed that range. There are a lot of very positive things out there right now that could allow us to do that.

Q. OK. And a little more color. You had a great number on the satellite side. What is it, you are up about a third sequentially here. What portion of that satellite sales from Q1 to Q2 is attributable to that OEM deals, and is there any kind of channel fill going on there?
A. No there isn't. We watch that very closely, and actually a very small percentage, uh, we just, in the month of June we just began on the OEM products, so I would say it is less than 5%-10%.

Q. Of the total satellite revenue?
A. Correct. Less than 5 [percent] I would guess. The real importance there, uh, we had a question earlier on backlog, and for the first time we've got a fairly substantial backlog, and it's all attributable to that OEM business. So we see real momentum there, and a source for some real growth. When you combine that with the positive impact that those volumes have on our overhead, - I had mentioned a 4-point swing year to date in bringing that overhead down. In the quarter it was actually 5% improvement, and that was strictly due to volume. So it has a very positive impact on us going forward.

Q. So, if you just did what you have in backlog, - I assume that satellite backlog from the OEMs is shippable in the current quarter, right?
A. Well some of that's - we also get some visibility out quarter, because it is based on annual production rates. But those aren't always commitments for a specific delivery. Some of that is we are committing to do just-in-time deliveries as they build vehicles.

Q. So that 15% of your $7.4 million backlog attributable to those guys isn't necessarily third quarter stuff?
A. I would say that's true, but I have to check that with Dick. In other words, we might have backlog that's in there that would be for out quarters as well. The point is that that's unusual. Normally we don't get any visibility on satellite sales, until the order comes in and it gets shipped that day. About 10% is attributable to the current quarter.

Q. Two thirds of it?
A. Correct.

Q. OK. So that applies, you know, you are doubling or so sequentially, - I mean, that makes sense if you've only been shipping for one month and you get three months now, at the same production rate? You should at least double? So, something else has fallen off there on the satellite side?
A. Well traditionally, the Marine market is seasonal. If you look at the company's historic revenue numbers, and typically Q3 is one of the lowest, is somewhat lower than Q1 for example or Q4, so, but it's not dramatic, the Marine market isn't a huge percentage of the total revenue. Obviously defense isn't seasonal, so …

Q. What's it, the satellite between the Marine and land?
A. The majority of the units are on the land, although the Marine products tend to be more expensive, so my guess is that approximately that 30%-40% of the revenue number is coming from Marine, and that's the component that is seasonal, uh, Q3 being slower.

Q. OK. Gotcha. What's your plans for Capex for the rest of the year in terms of dollars?
A. About $1.2 million.

Q. And what's that being spent on mainly?
A. New product tooling. We have some building improvements, but those are really the two large categories.

Q. So that implies you are doing positive $700K of operating cash flow for the rest of the year?
A. Pretty good.

Q. Yeah. OK. And on the Gross Margin front, what's the model or target gross margin? I guess, you know, in a year or two?
A. I think longer term we can see our way through to about 45% on the Gross Margin line. It could be much higher, but you know, we are selling consumer electronics, and you don't get the same kind of pricing with those products as you do with some other kinds of products.

Q. OK. And on the Defense side, you talk about new funding right, but, I mean my sense is that there is a long lead-time on a lot of this stuff? So, is this just …
A. Well that's what I was trying to point out with the uh, you know the fact that the growth we've seen in defense now, most of those orders, all of those sales, and most of the actual orders were booked prior to 9/11, so , right, because of the long lead time you don't get the rapid buildup that you would expect, so, that doesn't mean it doesn't happen. So, what we are saying is that starting, really now and going into the next two quarters and going into next year, we should start to see the type of buildup that you would expect to see for the types of products that we make, which, as I pointed out are exactly the type of products they need. And these products are being used right now for the Counter terrorism activities that the military is being funded to do.

Q. So, seeing an order increase in the back half of the year isn't surprising, but I guess maybe I'm more surprised by - unless I misinterpreted your comments you expect the back half of the year for revenues to improve for defense. Is that correct?
A. Yeah, and one of the uh, if you look at our cash position and our orders that we are expecting, we've ordered some long lead materials in advance of the orders, and we did that really to help out our military customers, and US military with their requirements. But we've taken some careful steps, but never the less we incurred some risk in buying this inventory, but we are confident that we are going to ship this order in the second half of the year.

Q. OK. And I guess this lastly relative to the models on the street, um, on your Op-ex side of your income statement, the numbers came in higher than expected. I mean, that's something you guys can't control, - most companies are struggling with a good top line, so I guess I'm trying to understand, why do you suppose that is the case? Is there some surprise, or is it just some mis-communication with the street, or …
A. Well, I think we have to be careful in talking about the street, we only have currently one analyst, so I don't want to speak specifically to a specific model, but I think that Dick has addressed, you know, we had some one time expenses we had visibility on, and perhaps people who are not inside the company didn't have as good visibility. Dick, you may want to talk just a little bit about the magnitude of, you know, expenses that were incurred in Q2 that we don't expect to recur.
Right. In my call, in some of the sections, I talked about one-time expenses. If you were to sum those together, they made up about $640,000. Now, because they were one time expenses that were unusual in nature, certainly not recurring, Pierre Maccagno really didn't have any visibility to those, but if we were to net that out of our net loss, we'd be looking at something on the order of $200,000, - just about a penny, so we had about 6 cents of non recurring items, between commissions and recruiting fees and things like that, that will help us going forward. Without those things, we came very close to breaking even for the quarter.

Q. So, it is safe to assume then that your Opex is declining by at least $650,000 sequentially? I mean because you are talking about other cuts too.
A. Well, I think that's a reasonable estimate. You know our goal is to reduce our spending and get closer to breaking even, and I think that's about as much guidance as we are willing to give at this stage.


David Lorens?, Advantis? Capital

Q. Good morning. When can we expect the roll out of the low profile antenna?
A. What we've talked about is we are probably launching that product in the back half of this year, and we don't have any significant revenues in the plan for it this year. But it will be a marketing launch based around trade shows, and when the right time is to introduce the product. But it will be this year.

Q. OK. And, in regards to the DOD certification process, where are you in regards to that?
A. Uh, certification for what?

Q. DSP-5000 - ongoing discussions with the department of Defense.
A. The DSP-5000 is a non-military product, so it's already good to go as far as that product is concerned.

Q. Then that - there was a certification process in regards to, uh, For your FOG.
A. Right. You might be talking about the Smart bomb effort?

Q. Yes.
A. And that would be something that our prime would be tasked with. In other words we make a sub-component, and they would qualify the entire sub-system. And then the Prime would be responsible for qualifying the entire program. I'm not sure if that answers the question.

Q. Are there any of your products in process for that type of certification currently?
A. No. All the products that we manufacture now are already quality approved for their intended use.

Q. OK.
A. Everything we are making today is ready to be sold, and all our defense products are not awaiting any certification that would impact revenues in Q3 or Q4. If that answers your question?

Q. Yes. And in regards to back log going forward you said $7.4 billion [sic] at Q2 end? Has that increased since then?
A. It was million, not billion. No, the backlog is where it is. We are only a few weeks away from the quarter end. We certainly hope it grows, and we have every expectation that it will.
Q. Great. Thank you

James Pugh? Dolphin(?) Asset management

Q. I'm still a little bit confusing on the revenue breakdown. The commercial revenue is $7.9 [million], fiber optic is $900,000, and Defense is $2.6-$2.7. There is a million missing here.
A. What you have there is we generally group our products in that fashion, but we have other products that are legacy kinds of products, OEM products, Marine products, things like that, and we group all that into a category we describe as Navigation.

Q. And that's roughly a million?
A. Yes.

Q. OK. So that's a fourth category, or is just commercial?
A. We don't want to break it out as a fourth category. Most of the revenues for those products are in the Marine area - our older Marine navigation products, so generally we don't break it out

Q. What has been the trend in the past few quarters for this particular line of product?
A. They're declining. They are legacy products. If it's under a million a year we generally don't break it out as a separate category.

Q. Well, it's a million a quarter, right?
A. I was talking about the Marine navigation products, which are on the order of a million dollars per year, not per quarter. We also have some OEM products which are digital compass based and they are on the order of $500,000 per quarter. We have funded engineering work, which is also a revenue item.

Q. OK. So we can expect about a million going forward on this particular category, where you can't really credit to any of those three categories?
A. Yes. Right.

Q. That's about the number? A million a quarter?
A. Right. And what we do is we typically will aggregate the sales into one of the other categories, when we consolidate, in terms of when we give a breakdown, like in our 10-Q, all the revenue will be aggregated into one of the larger categories. So we've actually given you more detail here. Which is the sub component that's just satellite sales. And the reason we do that is that these are the new products, and this is really the part of the company that's been the engine for growth, and that's the part of our business that's been growing so rapidly. So not only is it the majority of our sales, it's also the part of our business that's growing the fastest.

Q. OK. And also, I know you haven't broken down the Gross Margins for different products? I mean, commercial, defense, fiber optic? Can you talk about that? The rough range of margins?
A. We generally don't do that for competitive reasons, but I will say that the highest gross margins tend to be military and fiber optic products themselves are large gross margin products, but we have a dedicated factory, which is currently underutilized, and the net margin on those products is low. On our communications products, the average margin is sort of in the middle between those

Q. OK. So going forward the margin improvement which you anticipated, will largely come from fiber optic and defense?
A. Well, I think that, yes, increasing the margin on the fiber optic gyro business is related primarily to increasing the volume, so that the fixed overhead is spread. The military margins are very stable and don't change, and the satellite products, the margin is improving in terms of the cost, but offsetting that you've got some new OEM customers that have some pricing that's not very different from retail pricing. So again it's difficult to make general statement about the margins when each category has a host of different products within it that have a pretty wide margin range.

Q. The contract with the three major OEM customers, uh, I understand that you are delivering it now and next quarter.
A. Yes.

Q. Do you expect any sort of ?egalization on the retail side because of these contracts?
A. No we don't, because these are replacing competitive products so in other words these vehicles were already, uh, a lot of them had optional equipment that was installed which wasn't ours in the past so

Q. Oh I see.
A. So, these are new sales for us and sales losses for our competitors, and in the case of some of these vehicles we are really reaching down into a class of vehicle that currently was not our primary target customer. So, while conceivably what you are suggesting is possible, we've looked at it very carefully and we don't think that's going to happen at all.

Q. Ok. The other question is what is the initial order size like and also what should we expect in terms of the timeline going forward in terms of the increasing volumes from these OEM customers?
A. Well, the increase in sales will be starting in Q3, and it will help drive the growth of the land mobile communications satellite line. I don't have an exact number for you in terms of what that will represent in dollars, but we are hoping that this will help continue - you know, we recorded 50% growth in the communications line in Q2. These types of awards are necessary to keep that kind of growth rate going and going forward.

Q. OK One more question on the R&D side. You expect R&D to go down the next two quarters. Do you have a better picture in terms of how low they could go in the next two quarters, and what will be the sustaining level going into "03?
A. We generally don't forecast that kind of information, but we do see a decrease in the two factors that contribute to that. One, we have in our backlog right now, orders that will fund some of the engineering activities. So that we will be transferring costs from internal costs to customer-funded costs. At the same time Martin talked about how we are managing our PhotonicFiber project, and also talked about the nearness to completion on the low profile antenna. Those two events will tend to push back on spending, so, we'll see a convergence of reduced new product initiative spending, coupled with customer funding and that should give us some decreases over the next two quarters.

Q. OK. The backlog was $7.8 million?
A. $7.4 million.

Q. OK. So what was the backlog last quarter?
A. $8.2 [million].

Q. OK. So why the decline?
A. We shipped this quarter $2.2 million in military revenues, and as I discussed earlier, that's the majority of that backlog.

Q. OK. All right. Well, thank you.
A. You're welcome. Thank you.

Closing remarks.

Very good. I understand there was a problem with our web cast which may delay it being available, but it should be back online shortly, so, if you have anybody who had a problem, let them know. Other than that we'll talk to you soon. Thanks.

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