Intevac, Inc. Q3 2008 Earnings Call Transcript

Nov. 5.08 | About: Intevac, Inc. (IVAC)

Intevac, Inc. (NASDAQ:IVAC)

Q3 2008 Earnings Call Transcript

October 27, 2008, 4:30 pm ET

Executives

Kevin Fairbairn – President and CEO

Jeff Andreson – CFO, Treasurer and Secretary

Joe Pietras – VP & General Manager, Intevac Photonics

Analysts

Bill Ong – American Technology Research

Hongyu Cai – Goldman Sachs

Rich Kugele – Needham & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Intevac 2008 Third Quarter Results Conference Call. Please note that this conference call is being recorded today October 27, 2008. Kevin Fairbairn, Intevac’s President and Chief Executive Officer, assisting the call today.

I would now like to turn the conference over to Mr. Fairbairn. Please go ahead sir.

Kevin Fairbairn

Good afternoon and thank you for joining us today. With me are Jeffrey Andreson, our Chief Financial Officer, and Joe Pietras, our Vice President and General Manager of Intevac Photonics. After Jeff reads the Safe Harbor Statement, I will give an update on our recent activities. Joe will provide an update on Intevac Photonics and then Jeff will discuss the third quarter results and will provide our guidance for the fourth quarter and full year 2008. We’ll then open up the call for questions. Jeff?

Jeff Andreson

During the course of this conference call, we will comment upon future events to make projections about the future financial performance of Intevac including statements related to projected orders, production rates, shipments of our products, revenue, cross margin, operating expense, other income, tax rate, earnings per share, cash flow, capital expenditures, depreciation and stock-based compensation expense. We will discuss projected demand for hard drives, our 200 Lean Systems and upgrades.

The impact of upgrade in legacy tools, the transition to bit pattern media, the status of our Lean Etch semiconductor manufacturing product and our alliance with TES. We will discuss our plans for our Photonics business, projected applications and the status of our products and programs.

These forward-looking statements are based upon our current expectations and actual result could differ materially as the results of various risks and uncertainties, including without limitation, the possibility that markets for our products may not be as largely developed as quickly as projected that we may not be able to develop and deliver new products and technologies as planned. That orders and backlogs maybe cancelled, delayed or rescheduled; that we may fail to achieve expected cost reductions, tax rates or financial results; that the auction rates securities market recovery is delayed and other risk factors discussed in documents filed by us with the Securities and Exchange Commission including our annual report on form 10-K and quarterly reports on form 10-Q. The contents of this July 28 call include time sensitive, forward-looking statements that representative our projections as of the date of the call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of this call without our express written consent is strictly prohibited. Kevin?

Kevin Fairbairn

We are pleased to report better than expected results for the third quarter. Revenues totaled $28.6 million with four 200 Lean shipments in the quarter. Our net loss was $3.4 million or $0.15 per share, which was $0.05 better than our high end of our guidance. Our results include stock option expenses of $1.8 million or $0.05 per share.

Our highlights for the third quarter include entering to an alliance with the Korean Equipment Company, TES and completes in the acquisition of the Oerlikon Group's Magnetic Media deposition business.

Our first 200 Len Gen II revenue as an evaluation system shipped during the quarter was accepted earlier than we had forecasted. We also shipped a second Gen II evaluation system in the quarter which means that we have placed Gen II evaluation systems with two of our three major customers. Our alliance with TES covers product development, manufacturing and sales of Intevac Lean Etch in Korea and China, and TES’ CVD semiconductor equipment product in the rest of the world.

During the quarter, we also shipped two 200 Lean Gen II system as well as our first LIVAR prime evaluation system for pattern media. And as Joe will expand upon later, despite the sequentially corporally revenue decline, Intevac Photonics made significant progress on new products for ongoing business growth. These highlights for the quarter standout again for backdrop or weakening outlook for the hard drive industry. Overall sentiment for the drive sector rose significantly towards the end of the third quarter and has declined further in the past few weeks. The negative bias has also been reflected in worsening projections for drive company revenues and CapEx budgets for 2009.

Industry reports the worldwide hard drive shipments are 10% to 15% year-over-year for the third quarter 2008 with fourth quarter expectations of a flat to up 5% range, versus normal seasonality of 6% to 9%.

The earnings reports last week from leading hard drive companies rebuilt the opportunities as well as the challenges facing our industry. On one hand, ACD storage remains one of the few markets demonstrating significant year-over-year growth in a weakened economy. On the other hand, the hard drive companies are moderating their capacity expansion plans in response to the uncertain demand environment.

As a result of this increasingly short term pessimism, we expect to come in below our full year 2008 guidance provided from our last conference call, due to the push out of upgrades and some R&D system orders to 2009. While we will not be providing guidance for 2009 and for our next conference call, I’d like to briefly discuss the three drivers of 200 Lean sales in the coming year, which are capacity additions, legacy tools retirements and technology transition.

The projective product mix in 2009 for instance, the mix is 3-1/2 inch aluminum for desktop versus 2-1/2 inch class mobile [ph] also have impacts in our business, as I will explain later. The first driver of our 200 Lean Etch is the addition of media manufacturing capacity. Capacity additions are driven by the overall growth in hard drives and the average number of disk factors [ph] in the drive.

Our share of those capacity editions depends on our market share and our customer’s market share. In 2008, we sold the majority of growth (inaudible) mobile, which on the media basis is projected to increase 25% to 30% over 2007 with desktop growing only a modest amount. The reduced forecast for 2009 brought upon by these difficult times still includes a sizeable as much as 20% year-over-year growth for mobile, even though overall growth is forecast to be in a range of 5% to 10% for all drives fighting its way down for that tops right now possibly out of the emergence of $300 net broke [ph] with hard drives. Time will tell how these low price offerings would impact the growth in the market. We hope positively, especially in the back half of 2009 as macroeconomic conditions begin to recover.

We expect the growth in mobile to have some impact from capacity editions, with even more impact on retirement of legacy systems. Let me explain. Customers had been successful in developing advanced processes with a limited number of stations on legacy tools that work on aluminum substrates for the desktop market. However, for mobile class media, an additional process that is required to make the legacy tools unsuitable, the 200 Lean Etch no such limitation, given the limited growth in desktop media that would likely be an excess capacity on the legacy systems. Example, this legacy capacity would include last month announced shutdown on one of our customer’s U.S. parts.

The other factor impacted on the retirement of the legacy systems is they constrained the output of media parts when space is limited. Throughout 2008, one of our customers has been retiring legacy systems in favor of 200 Leans. A strategy which frees up floor space enables the manufacturing of advanced media, and also played the need to build new factories. We’ve been in active discussion with all of our customers with aggressive proposals to these components on legacy systems and replace them with 200 Leans. We believe legacy tool replacements could be a substantial opportunity for our hard drive business in 2009.

The third major drive demand is technology change. Even in last week’s conference call, you heard that capital budgets will be targeted at technology advancements. Actually, I’ve discussed in our last two conference calls, the transition to pattern media has began to take shape. We delivered our first LIVAR prime evaluation system in the third quarter for use with the (inaudible). We are now developing ads and strip sources for pattern media and are working towards shipping our first 200 Lean Media Patterning Systems in 2009. In the past times, the macroeconomic weakness had been our first learning ground for technology investments. That’s the opportunity for increasing cells of pattern media development systems to become significant in 2009.

While the uncertainty of the end market continues definite expectations for the hard drive market, we see our opportunity in 2009 to be a combination of conservative capacity additions to retirement of legacy systems with 200 Leans to support the continued growth in mobile drives and the first shipment of patter media development systems. Intevac has the shortest delivery lead time in the industry and we remained poised to deliver tools to the industry at the market quickly turns.

Turning to our semiconductor business, in the third quarter we announced the groundbreaking alliance with TES, a Korean equipment company. In our ongoing dialect to catch up at the major Korean semiconductor companies, it became a part of the Korean initiative to passed on both local equipment suppliers was an impediment to penetrating our target customer in that region. These same customers strongly encourage us to establish an equipment path on a shipping career. And in the past few months, we have met some several Korean capital equipment providers.

We chose to partner with TES due to the strength with their relationships, their successful track record in the market, their existing CVD capability and their enthusiasm in marketing and selling our Lean Etch. The slides represent the win for both companies and we will both share development, manufacturing and selling efforts in both the Lean Etch and TES’ CVD product line. TES has exclusive rights to market the Lean Etch in Korea and China, and we have exclusive right s to market their CVD equipment to the rest of the world.

We are getting our first Lean Etch tool ready for shipment to TES after which we expect it to carry out on to the customer side. In the future, TES will be responsible for final 70 in-tests of Lean Etch systems for the Korean and Chinese markets.

We are in the midst of one of the most challenging semiconductor capital equipment sales downturns on record with an analyst forecasting recovery to begin no earlier than the back half of 2009. In the meantime, we are optimistic with this alliance will accelerate the market penetration of our Lean Etch to wallow [ph], so expanding our address for market into CVD, much more quickly than we had planned this by setting us up for business expansion when the market recovers.

Before I turn the call up to Joe, I’d like to comment briefly on Intevac Photonics. The macroeconomics issues we all are currently facing as resulted in the slowdown in the growth of the scientific market. This has affected our revenue growth in the third quarter and we expect the current environment will possess through the end of this year. That being said, our photonics business continues to introduce new products that we will expect to lead a continued growth in our photonics business.

I’ll now turn the call over to Joe to discuss the business in more detail after which Jeff will comment on our financial results for the third quarter and outlook for the fourth quarter and full year 2008. Joe.

Joe Pietras

Thank you Kevin. Intevac Photonics achieved revenues of $5.7 million in Q3 down approximately 10% from our Q2 record revenues of $6.4 million. While our Q3 revenues were down as a result of several programs going to completion, our product revenues remained strong at $2.4million were 42% of our revenues. In the first nine months of 2008, our product revenues have doubled over the same period of last year as we continue to grow our photonics business through increase in product sales.

In our military digital night vision business, we have experienced the delay in production deliveries of our digital camera modules to Sagem, our NATO customer, as a result of their desire for higher performance exportable camera modules. Working with U.S Department of State and Defense, we have now received an initial approval to export our digital night vision camera module at higher levels of performance and expect to resume production deliveries to Sagem by the end of 2009.

We continue deliver our digital camera modules to a growing number of U.S. military customers for the development of various ground in Avionic digital night vision application. We expect to be awarded our first low rate production order for a U.S. military Avionics application in Q4. Revenue for this application is estimated at over $25 million for the next ten years. Judging from the level of customer interest, we believe that our digital night vision camera products are in excellent position to capture a large portion of the U.S. military digital night vision market, which we estimate will grow to $150 million annually within the next five years. We are also making progress in the development of new digital night vision products both at the sensors level and at the systems level goggle.

During Q3, we successfully completed initial prototypes of our next generation digital night vision sensor being funded for use by multiple branches of the U.S. military. We have incorporated the sensor in our digital-enhanced night vision goggle or DENVG, along with the next generation thermal sensor from our partner DRS Technologies, and expect to deliver prototypes with this enhanced performance design to the U.S. army in the early first quarter of 2009. The U.S. army expects to deploy this technology in 2012 with deliveries valued at $150 million over three years.

We are also on track to complete in late 200 the initial prototype of our new night port product from Intevac Visions Systems. Night port is a compact monocular system that provides full digital night vision viewing and recording capabilities which we expect will have broad use in multiple ground and Avionic applications.

Interest in our LIVAR camera products continues to be strong. We just receive funding from a major defense contractor to begin low level production in early 2009. Due to the multiple platform applicability of our camera, we continue to estimate the LIVAR business opportunities to be around $100 million over the next 10 years.

In our commercial business, the majority of our sales of imaging cameras and DeltaNu Raman instruments our made within the scientific research market where sales have been flat during 2008 due to tightening of research funding. We are refocusing our sales strategy on product opportunities with volume-based end user or early-end [ph] customers in target markets. We are developing opportunities within the inspection market, both with our imaging cameras and with our DeltaNu handheld Raman instruments, which provide portable materials identification. We are also pursuing new opportunities with our handheld Raman instruments in law enforcement and military applications including chemical detection at remote distances. We estimate these opportunities will provide at least $3 million in initial year product sale in 2009.

I will now turn it over to Jeff to discuss our financial results for the third quarter and our outlook for the fourth quarter and full year 2008. Jeff?

Jeff Andreson

Thank you Joe. Consolidated third quarter revenues totaled $28.6 million and included four 200 Lean systems. Photonics sales were $5.7 million and consisted of $3.3 million of contract, research and development and $2.4 million in product shipments. Q3 consolidated gross margin of 32% was within the beginning of quarter guidance. Equipment gross margins decreased to 32% as compared to 42% in the prior quarter due to the lower mix of upgrades and spares as well as lower factory utilization.

Gross margin was down compared to 49% in the year ago period, as the mix of upgrade was far lower. Photonics gross margins decreased to 32% from 35% in the second quarter, and 45% in the year ago period as a result of the lower research and development contract revenues. In Q3, margins improved in our vision systems and DeltaNu businesses.

Q3 operating expenses of $16 million were within guidance and 3% lower than the year ago period as we continue to manage our expenses in response to the current business environment. Our 2008 tax rate is forecasted to result in a net tax benefit for the year and for this quarter resulted in a net tax benefit at $2.6 million.

Q3 net loss totaled $3.4 million or $0.15 per share. The net loss included $1.8 million of pretax stock-based compensation expense equivalent to $0.05 per share. Our backlog decreased to $18.5 million at quarter end down from $27.7 million at the end of quarter two. Backlog included one 200 Lean systems as of our quarter end.

Now, I will discuss the balance sheet. Cash and investments are $115 million or approximately $5.28 per share. Cash and equivalents remained flat from Q2 as improvements in working capital offset our cost of acquiring the Oerlikon hard disk business. Our investment portfolio at end of Q3 included $73 million in student loan backed auction rate securities down $3.2 million at Q2, and net of an unrealized loss of $1.5 million. All of our investments continue to be rated AAA. We continue to expect the market will recover over the next 18 months and as such I’ve concluded the impairment is temporary. We have a line of credit in placed to borrow against these securities if needed, but currently do not anticipate borrowing as we have adequate cash to support the business. We continue to have a strong balance sheet with little debt and a cash position that we believe can sustain a prolonged downturn effect should occur. We continue to aggressively manage our cash.

Capital spending totaled $879,000 in quarter three. Depreciation and amortization, including purchase accounting amortization; totaled $1.5 million in Q3. The increase in this amortization associated with the purchase of the Oerlikon hard disk business. I will now provide our guidance for the fourth quarter and full year 2008.

We are projecting consolidated Q4 revenues of $12 million to $16 million, which includes one 200 Lean system. We expect fourth quarter gross margins in the range of 36% to 38%. The increase in gross margin is a result of the higher mix of technology upgrades versus systems as compared to quarter three.

Operating expenses are expected to be approximately flat at $16 for the quarter. Our fourth quarter has four additional days as compared to the prior quarter due to our December 31 year-end. We continue to aggressive manage our expenses while ensuring completion of key programs for our fiscal year 2009 technology-based sales. Other income and expense will be approximately $800,000. For Q4, we are projecting a loss from a range of $0.16 to $0.20 per share, which includes an estimate of $1.3 million of pretax based compensation expense equivalent to $0.04 per share as well as an anticipated net tax benefit.

For the full year we will revenue 11 200 Lean system shipments. We expect in to that photonics revenues to be in the range of $22 million to $24 million for 2008.

Our projected full year consolidated revenue will be in the range of $106 million to $110 million, reflecting the push out of hard disk drive upgrade and R&D system orders to 2009 and the tightening in the scientific research market as mentioned by Kevin and Joe. We expect gross margins to average from 39% to 40% for the full year. We expect operating expenses will be approximately $64 and other income, primarily interest income from our cash to be approximately $4 million.

Our forecasted 2008 tax rate will result in a net tax benefit for the year. The net tax benefit for the year will be approximately $11 million and as has increased from prior guidance with the extension of R&D tax credit by congress. For the full year, we expect a loss in the range of $0.29 to $0.33 per share, which includes an estimated $6.3 million of stock-based compensation expense, equivalent to $0.18 per share. This completes the formal part of our presentation. Operator we are ready for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Bill Ong for the American Tech Research.

Bill Ong – American Technology Research

Yes, good afternoon. I just have two questions. What’s your ending backlog for the quarter? And also, if you can also add some color on 2009, I know you’re not prepared to give any formal guidance but obviously with the weakened CapEx from the Seagate and Western Digital Corp, it looks like they won’t be shipping – their low buying of equipment of maybe one or two machines, but any comments or you’re just trying to make us – what do you think is the spares and system upgrades business is going to be in the first half of ’09 and just in general, color or numbers would be helpful. Thanks.

Kevin Fairbairn

Okay. So I’ll let Jeff comment on the backlog and then I’ll talk to where we see the business in 2009 without giving in to any specific guidance.

Jeff Andreson

Bill, the backlog is $18.5 million and it’s about a third photonics and the rest is equipment.

Kevin Fairbairn

So Bill on the business applications, I try to explain during my presentation here that was – we see that there may be a modest amount of capacity additions. We do see some significant opportunities for legacy tool replacements. This would be taking 250B or the surfaces and replacing them with 200 Leans not from the bidding [ph] net capacity editions, but now these tools will be much able to support their very significant growth in mobile. The other aspect of the business, Bill that could be strong in 2009 is technology, in particular, the systems for pattern media. At this point, no one has R&D pilot line system that could be use in manufacturing – potentially used in manufacturing. We’re working towards developing the Etch modules to develop the 200 Lean to provide that capability, and we know there’s strong customer pool to get pools like them in 2009.

Bill Ong – American Technology Research

Great. Thank you very much.

Operator

Our next question comes from Hongyu Cai with Goldman Sachs.

Hongyu Cai – Goldman Sachs

Hi. Thanks. In your previous call you are very positive on your 2009 demand forecast. With the weakening macro environment, could you talk about how your expectation has change?

Kevin Fairbairn

Right now, we’re in the midst of doing a whole bunch of scenario planning because the drive number could be down. On the other hand, there’s some factors which could increase on those. There’s a significant decline in this selling prices of laptops, so we’ve got emergency networks. This could have a great positive impact on the growth in mobile and therefore we’re immediate for that as – I think given the market situation right now, I’m talking in general, I think until we get passed this very difficult month of October and things begin to settle down. It’s been very difficult to project the – what’s going to happen in’09? If those people are correct, we may begin to see recovering in the latter parts of ’09. That could be positive for us, and that’s why we’re maintaining our ability to respond very quickly to customers in the capacity systems (inaudible) night support the back end.

Hongyu Cai – Goldman Sachs

Thank you. And the follow up if I may, CD cut paybacks by 25% and the WD, although none of your customer so announced the cut of about 8%. How do you do this?

Kevin Fairbairn

Well not surprise given the current situation. But if both customers emphasize the fact that they will continue to invest in the technology and the retirement to legacy tools and replacement to them by 200 Leans is considered a technology upgrade as the pattern media, so there’s still a lot of CapEx follows there to support our business.

Hongyu Cai – Goldman Sachs

Thank you very much.

Operator

Our next question comes from Rich Kugele with Needham.

Rich KugeleNeedham & Company

Thank you. Good afternoon. A couple of questions. Just conceptually as you look at ’09, if we assumed that the budget that had been set by Seagate and others, actually stand at those levels, what is that imply for upgrades? Is there any way to calibrate whether we’re talking about low single digit number or is more of a typical year? Any way of understanding just the upgrade business?

Jeff Andreson

Rich, it’s Jeff. Upgrade business as non-system systems.

Rich KugeleNeedham & Company

Well, I guess that’s a fair point. I’m actually talking about replacement of tools.

Jeff Andreson.

Right. Okay.

Kevin Fairbairn

Thank you. When we look at it as people would replace three legacy tools to 200 Leans, that way the net capacity in the market would be changed now that there a lot more capable producing mobile and next generation technologies. I think there’s still probably close to 100 of our legacy tools out there and there’s probably more than 20 maybe 25 of circuits [ph] tools out there, so there’s a significant opportunity. It’s really going to come down to – some of those tools need to be converted to support this growth in mobile. Plus, what people want to do to lower their – or improve their technology. So we really see 2009 has been a technology driven year and not a capacity driver year.

Rich KugeleNeedham & Company

Okay, that’s helpful ratio. And then, in the past you’ve been working on moving more of your manufacturing to Asia. Can you update us on that progress and how that may have helped or how it can help in the future?

Kevin Fairbairn

Well, in the second half of ’08, we slowed down in that transition because of the limited number of system builds, but as we look at this transition of turning 250B into 200 Leans. It makes sense to do that in Asia. We don’t want to be bringing back these whole tools and stripping them down in the states, so we will look at accelerating our capabilities in Asia to support back the legacy tool replacement.

Rich KugeleNeedham & Company

Okay. Any sense on when you think you can get most of that done? Is that the first half of it?

Kevin Fairbairn

We think it’s going to start on the first half. Certainly, people would want to get these tools back online for the Q3, Q4 next year. But then maybe that some of our customers take a steady approach in general to some of those legacy tool replacements, because it’s part of the logistics in their factories they have to sort through.

Rich KugeleNeedham & Company

Okay. And then lastly as you look at your OpEx, both by division and overall, if we don’t see it, the resurgence and demand or at least some low level of ordering until maybe the second half. Is there any other further actions you think you can take without naming them, that can pull in OpEx or do you think the level that you’re at now is the way we should be thinking about the business until demand returns?

Jeff Andreson

Rich, it’s Jeff. We’re doing a number of scenario plans in light of what we’re hearing from our customer as well, so we’ll develop a number of scenarios in which we’ll have actions associated with them to look at OpEx. We draw our out backs – hold on OpEx even beginning back in 2007, so we’ve seen a 5% or 6% decline from a year ago when you normalized our quarter core, but there’s still some more actions we can do if we see a very long term downturn here.

Rich KugeleNeedham & Company

Okay. Thank you very much.

Operator

There are no further questions at this time.

Kevin Fairbairn

Okay. Well, thank you for joining us today and we look forward to updating you in our next call on our Q4 and 2008 results. Goodbye.

Operator

This concludes today’s teleconference. You may now disconnect.

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