Intevac Inc. (NASDAQ:IVAC)
Q4 2008 Earnings Call
February 03, 2009; 04:30 pm ET
Kevin Fairbairn - President & Chief Executive Officer
Jeff Andreson - Chief Financial Officer
Joe Pietras - Vice President & General Manager of Intevac Photonics
Hongyu Cai - Goldman Sachs
Rich Kugele - Needham
Welcome to Intevac’s 2008 fourth quarter and full year results conference call. All lines have been placed on mute to prevent any background noise (Operator Instructions).
Kevin Fairbairn, Intevac’s President and Chief Executive Officer is hosting the call today. I would now like to turn the conference over to Mr. Fairbairn. Please go ahead sir.
Good afternoon and thank you for joining us today. With me are Jeff 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 updates in our business and drivers of future growth. Joe, will provide an updates on Intevac Photonics and then Jeff, will discuss our financial results and outlook. We’ll then open up the call for questions. Jeff.
During the course of this conference call, we will comment upon future events and make projections about the future financial performance of Intevac, including statements related to projected cash flow, orders, revenue, gross margin, operating expense, other income, profitability, taxes, earnings per share and stock based compensation expense.
We will discuss projected demand for hard drives, our 200 Lean Systems and upgrades. The impact of upgrading legacy tools, the transition to pattern media recoding, the status of our Lean Etch semiconductor manufacturing product and our alliance with TES. We will discuss our plans for the Photonics business, projected applications and the status of our products and programs.
These forward-looking statements are based upon our current expectations and actual results could differ materially as a result of various risks and uncertainties related to these comments 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 February, 3rd call include time sensitive, forward-looking statements that represent our projections as of the date of the call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of this call without our express written consent is strictly prohibited. Kevin.
Thanks, today we report our results for the fourth quarter; with revenues exceeding guidance and operating expenses lower than guidance. Revenues totaled $16.4 million, with one 200 Lean shipment in the quarter. Our net loss was $12.6 million or $0.58 per share and included $10.5 million of goodwill and intangible asset impairment charges, equivalent to $0.34 per share and equity based compensation expense equivalent to $0.04 per share. Excluding the impairment, our net loss came in slightly below the low end of guidance, primarily as a result of our tax provision, as Jeff will discuss in more detail later.
We will not be providing 2009 annual guidance today, given the limited visibility from our hard drive customers who are in the midst of restructuring their businesses to cope with the dramatic changes in their end markers. Jeff will provide our Q1 guidance later in the call.
In the absence of annual guidance, I will explain where we see revenue opportunities for 2009 and how we have cited our cost structure accordingly to manage the business in these uncertain times.
Let me start with the resizing of the business. We acted quickly to the rapid economic deterioration in the fourth quarter and in November announced and executed a global cost reduction plan that reduces our cost structure and minimizes our cash burn, while still enabling us to invest in products that will drive future growth. With our current cost structure, we expect to breakeven on a cash basis with revenues of approximately $150 million.
I will now explain where we see revenue opportunities to support this breakeven point. We believe that our Photonics business revenues will continue to expand chiefly driven by government spending on development and deployment of digital night vision technology. Our goal is to achieve at least $30 million in revenue and Joe, will provide more detail later.
In our equipment business, we did not expect any capacity buys in 2009. We do expect ongoing spending on non-system orders such as spares, service and technology upgrades to our large installed base. This is expected to be in the range of $30 million, at least the balance of revenue coming from system cells driven by technology needs.
We expect spending to be backend loaded until our ACD customers complete their business restructuring, we did not expect any significant bookings. While nobody at this point can actually predict hard drive demand in the short term or when the market will begin to recover, but one thing that remains constant is the driving force of more digital storage.
Once the economy recovers, we expect to see a significant snap-backing demand for hard drives. We do not believe people will be cutting back in the number of videos, photos or music based store during the downturn. We were also encouraged by the dramatic reductions in notebook prices and emergence of ultra-cheap and portable notebooks which will spur greater sales of hard drives. We have the shortest delivery times for new systems as compared to our competition and can help our customers respond to their eventual up-turn.
Our customers have commented publicly that they will continue to invest in technology. The hard drive industry is very competitive and nobody can afford to fall behind in technology. We have witnessed how market shares and profitability can be significantly impacted for hard drive companies that do not stay competitive. We expect two types of hard drive technology system investments to be made in 2009, those for pattern media and those for legacy tool replacements.
We continue to make progress in our new 200 Lean Etch process modules, which will support the low cost production requirements of pattern media and we expect that the major drive manufacturers will begin to transition their R&D efforts into pilot production which requires production type Etch equipment in the second half of 2009.
Pattern media manufacturing effectively doubles the size of our market, because each 200 Lean deposition tool in production will require one 200 Lean Etch tool running at similar throughputs. To date, the R&D efforts on pattern media utilized equipment from the head handle the semiconductor industry with throughputs. So, 50 to 100 wafers per hour at best compared to the 1,000 disk per hour productivity level demanded by the media manufacturing environments.
With our leading market position in media deposition, as well as our internal expertise on Etch process technology, we have a strong position entering this market and we expect initial orders will be placed during 2009. The second type of capital investment for technology change is legacy tool retirement. Today most hard drives use either 2.5 inch disks that where used in notebook computers or 3.5 inch disks that where used in desktop PC’s.
In 2008, we saw a 2.5 inch disk production exceed 3.5 inch for the first time. The extent of legacy tool replacements or retirements during 2009 will be driven by the increasing mix shift towards notebook computers and 2.5 inch disks. Notebook computers with the notebook segment expected to show strong growth are expected to outnumber desktop computers by a substantial margin in 2009.
The legacy tools currently producing 3.5 inch media struggle and in some cases cannot produce the most advanced 2.5 inch media technology. Therefore, while the industry has plenty of excess capacity right now, the majority of excess capacity exists for the declining 3.5 inch market and investments will be needed to be made by our customers in order to protect or grow their share of the notebook markets
In our Lean Etch business, we are encouraged by initial progress with our working relationship with TES, our Korean alliance partner. We shipped our first Lean Etch to TES in the fourth quarter are making good progress in both replacement to over the customer achieving qualification in 2009. We are currently in the midst of a deep recession in the semiconductor industry. So, the business is not expected to contribute revenue this year, however our alliance provides us with a strong market position to benefit in this future, when spending does resume.
I have outlined our revenue opportunities and cost structure for 2009 and before I turn over the call to Joe, I’ll summarize the drivers for significant future growth in 2010 and beyond. The underlying drivers of demand for increased storage capacity are intact and even expanding. As the economy recovers, we expect hard drive unit growth will resume and more system capacity buys will be needed.
New media technologies, such as pattern media will expand the amount of capital investment and our own production equipment required to produce this media resulting in a doubling of the total available market in the next three to five years. We have taken a groundbreaking approach towards penetrating the semiconductor industry and our alliance with TES and are encouraged by the growth prospects for our Lean Etch products.
We are introducing a number of new Photonics products that are seeing strong demand today and which together encompass a multi-hundred million dollar market opportunity within the next several years.
I’ll now turn the call over to Joe, and then Jeff will comment on our financial results and outlook. Joe.
Thank you, Kevin. Intevac Photonics achieved revenues of $4.5 million in Q4 down approximately 20% from our Q3 revenues of $5.7 million. This was primarily due to the completion of current phases of several contracts and also reflected lower product sales as a result of the current economic climate.
Despite the worsening economy, 2008 was a growth year for Photonics, achieving revenues of nearly $23 million, a 19% increase over 2007 sales. Notably, product sales grew 60% in 2008 to more than $8 million and comprised 37% of total Photonics revenues for the year. Today, we are well positioned to continue growing our Photonics business through increased product sales, which we expect will contribute at least half of Photonics revenues in 2009.
In our military digital night-vision business, productization of our digital sensor technology is continuing at a risk space. In Q4, we’ve received approval by the U.S. export agencies and resumed production deliveries of higher performance digital camera modules to Sagem, our NATO customer. Domestically, we are pleased to report that we received our first production order for U.S. military application of our digital camera module and began low rate production deliveries in the fourth quarter.
Revenues for this U.S. Avionics application, is estimated at over $25 million for the next seven years. We are also nearly complete with the development of a next-generation digital night-vision sensor, which has been funded by multiple branches of the U.S. military. During Q4, field tests of this sensor with the U.S. Army demonstrated that the sensor is successfully meeting the performance requirements of the U.S. military.
As evidenced of the U.S. military’s interest in fielding this next-generation sensor, we received a development contract in Q4 to provide a digital camera module for an existing Avionics application, which represents an opportunity of about $20 million in sales over the next six to seven years.
Additionally, we’ve received an invitation by the department of defense to participate with our next-generation sensor and the defense acquisition challenge. This is the DoD program intended to accelerate fielding of new technologies. Given our current programs to deliver digital camera modules to a growing number of ground and Avionic, night vision applications, we estimate our total revenue opportunity to be in excess of $150 million over the next 10 years.
In Q4, we also made good progress in the development of head-mounted night-vision system products. With our partner DRS technologies, we are on track to deliver to the U.S. Army in Q1, enhanced performance prototypes of our digital enhanced night-vision goggle or DENVG, which digitally combines night-vision and thermal imaging. The U.S. Army is currently evaluating DENVG prototypes from two other competitors. One of which incorporates our own digital night-vision sensor.
We expect that by 2012, the army will award one of these three potential suppliers with initial production contracts, which will likely be evaluated at over $150 million over three years. We are also completing first units for customer deliveries of our new night port product. Night port is a compact monocular system that provides full digital night-vision viewing and recording capabilities. Night port is designed as a direct replacement for legacy, night-vision goggles, the market for which is an excess of $400 million annually.
Our LIVAR camera business is also making a significant transition from contract R&D to product demands. We received an order from a major defense contractor for low level production with deliveries to began in early Q1. We expect to receive follow on orders for this application ranging from $2 million to $3 million during 2009.
In addition over the past several months, we have received small quantity orders from nine additional customers, who are evaluating our LIVAR camera in their applications. We continue to estimate the LIVAR business opportunities to be around $100 million over the next 10 years. In our commercial business we’ve reported last quarter that we are refocusing our sales efforts toward product opportunities with volume-based end-user or OEM applications in target markets.
Leading our growth in this area if our DeltaNu handheld Raman instruments, which provides portable real-time materials identification. In 2008, revenues from our handheld Raman instruments increased nearly four fold over 2007. Through our focus on law enforcement, industrial inspection and military markets, we believe revenues from our handheld Raman instruments could increase another two-fold in 2009.
I will now turn it over to Jeff, to discuss our financial results for the fourth quarter and full year 2008 and our outlook for the first quarter of 2009. Jeff.
Thank you, Joe. Consolidated fourth quarter revenues totaled $16.4 million and included one 200 Lean system. Photonics sales were $4.5 million and that consisted of $2.9 million of contract, research and development and $1.6 million in product shipments. Fourth quarter consolidated gross margin of 35% was slightly below the beginning of quarter guidance.
Equipment gross margins increased to 42% as compared to 32% in the prior quarter due to the higher mix of upgrades and spares, as well as savings from our global cost reduction plan. Gross margin was down compared to 47% in the year ago period, due to the lower volume of upgrade business in the fourth quarter. Photonics gross margins decreased to 19% from 32% in the third quarter and from 47% in the year ago period, as a result of the lower level of product revenues, lower factory utilization and higher warranty expense.
Q4 operating expenses were $25.6 million and included goodwill and intangible assets, impairment charges of $10.5 million to write-off the carrying amount of the goodwill on our equipment segment and write-down certain intangible assets. The company’s market capitalization was adversely impacted by the current macroeconomic business environment, which triggered impairment test on its goodwill and intangible assets. This test resulted in impairment charges totaling 9.7 million for goodwill and 800,000 for intangible assets.
Into back, we markedly required to make any current or future cash expenditures as a result of these impairments. Excluding, the impact of the impairment charges operating expenses were 15.1million or 900,000 below our guidance and 6% lower than Q3 as we began realizing the impact of a global cost reduction plans in the quarter. Our 2008 tax rate resulted in a net tax benefit for the year and this quarter resulted in a net tax benefit of $6.3 million.
Our beginning of quarter guidance assumes the higher level of available R&D tax credits than we were able to utilize, in fact in our EPS by $0.05 per share in the quarter. Q4 net loss totaled $12.6 million or $0.58 per share. The net loss included $1.6 million of pretax stock-based compensation expense equivalent to $0.04 per share and $0.34 per share associated with the goodwill and intangible asset impairment. Our backlog increased to $20.2 million at quarter end up from $18.5 million at the end of Q3. Backlog included one 200 Lean systems as of our quarter end.
Now, I will discuss the balance sheet. Cash and investments, our $106 million or approximately $4.84 per share and includes evaluation allowance of $8 million associated with our auction rate security investments. Cash and investments, excluding the impact of the additional evaluation allowance decreased by $2.6 million from Q3 as we continue to aggressively mange our cash, cash flow in light of our current business environment.
Our investment portfolio at the end of Q4 included $66 million in student loan backed auction rate securities. In Q4, we recorded additional impairment charges of $6.6 million for a total unrealized loss of $8 million. All of our investments continue to be rated AAA. We continue to have liquidity access to these assets through our existing line of credit they can also be expanded if needed.
We 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 if that should occur. Capital spending totaled $1 million in Q4. In Q4 non-cash goodwill and intangible impairment charges were $10.5 million and depreciation and amortization totaled $1.4 million.
I will now provide our guidance for the first quarter of 2009 and discuss the impact of our global cost reduction plan. Our goal for cost reduction plan resized the company to breakeven at approximately $120 million in revenue and approximately $115 million on a cash basis. Besides the company at this revenue level in order to continue to be able to continue to invest in key development programs that will drive revenue growth in the future as Kevin discussed earlier.
We are projecting Q1 consolidated revenues of $9 million to $12 million, which does not include any 200 Lean systems. Our hard drive customers have put on almost non-critical purchases, as they continue to determine their plans for 2009. Our customers have stated that they will continue to invest in technology and areas that affect manufacturing efficiencies and costs.
We anticipate they will begin to place orders for these purposes once their plans are finalized. This lower level of revenue impacts our ability to observe of our fixed factory overheads and as a result, we expect first quarter gross margins in the range of 20% to 25%.
Operating expenses are expected to decline to approximately $14 million for the quarter, reflecting the impact of our Global Cost Reduction Plan. We will continue to aggressively manage expenses while ensuring completion of key programs, which support our fiscal year 2009 and beyond technology-based sales. Other income will be approximately $500,000.
For Q1, we are projecting a loss in the range of $0.30 to $0.35 per share, which includes an estimate of $1.4 million of pretax stock based compensation expense, equivalent to $0.04 per share as well as an anticipated net tax benefit. This completes the formal part of our presentation. Operator, we’re ready for questions.
(Operator Instructions) Your first question comes from Hongyu Cai – Goldman Sachs.
Hongyu Cai – Goldman Sachs
Thank you, just a couple of questions. First, both your contract IDN product sales dropped mostly in your imaging business. Could you please apply some more color about the decline and how long will this trend persist going forward?
This is Joe. During the fourth quarter, we had several contracts which came to completions of current phases and so we are expecting the funding to resume in the first quarter and be back with some of those contracts. Some of the product sales has to do with just economical conditions in some of the scientific research markets, which we were participating in mainly through 2008, but as we mentioned, we are refocusing that business onto OEM businesses in the industrial sector and we expect some rebound of that beginning in first quarter.
Hongyu Cai – Goldman Sachs
Okay, thank you and then second, if we rank the factors that droved the sharp decline of the gross margin in your imaging business, which one will you rank on top among the three factors that you mentioned in your press release?
Hongyu, its Jeff. We had a warranty expense that was larger that normal due to a technical issue that we had discovered and replaced some prior shift sensors and then factory utilization and then products.
Hongyu Cai – Goldman Sachs
Okay and so this warranty expense, would that continuing into next quarter?
No, this is Joe again. We had some early manufactured sensors which we realized had to be replaced, and so we completely executed that in the fourth quarter and are now past that issue.
Hongyu Cai – Goldman Sachs
Okay and given the circumstance of the ACD vendors in their capacity addition, will you consider further restructuring actions going forward?
As I’ve said, we kind of structured for a $150 million break-even on the cash basis. If we were to see further deterioration in the business and we are already planning for no capacity additions, then clearly if there was further deterioration in the outlook we will continue to re-look as our cost structure.
Hongyu Cai – Goldman Sachs
Okay and just one last question, could you provide a bit more update on your Lean Etch qualification and when should we expect to see the first shipments?
Okay, we shipped the first tool to Korea in December, that tool has now being reassembled and setup for doing customer demos in Korea. The plan is, so that system will then ship on to a customer around mid-year for qualification and we will not expect revenue until 2010.
(Operator Instructions)Your next question comes from Rich Kugele - Needham.
Rich Kugele – Needham
Good afternoon gentleman. A few questions, I guess first on the Lean Etch, can you give us a sense of the $14 million OpEx quarterly run rate is actually associated with that now? And if we actually go out of 2010 for additional revenue opportunities to kind of emerge, does the tool require any changes based on whatever technology that could impact that quarterly OpEx run rate?
Rich, it’s Jeff. I’ll take the OpEx question. We are running just below 20% of our OpEx on that. At this particular point in time, I’ll let Kevin answer that technology question.
Yes, that number we probably go lower. Now we shipped the tool to Korea, there has been a request for some fairly very simple modifications and software additions. We expect that quantity of request will go down. In terms of major engineering efforts on the tool, we don’t expect any. We believe the tool is largely done apart from some minor (Inaudible) customers specials.
Rich Kugele – Needham
So as we go, because we’ll probably have to put out a 2010 number and as we go onto 2010, we shouldn’t assume that as you actually, if TS is able to go and sell some that your OpEx goes up as a result. We shouldn’t have to make that correlation?
No, there is no correlation at all.
Rich Kugele – Needham
Perfect and then in terms of the installed base of 250B’s, it’s kind of a tough question and I don’t even know directional what the answer is. How much of the installed based is today being devoted to 2.5 inch. Is there any or is it all on 3.5 inch?
To my best knowledge, and it’s not 100%, but I believe that’s 250B’s are all doing 3.5 inch.
Rich Kugele – Needham
Okay and can you remind us again how many of those tools are out there?
This is around 100, give or take 10.
Rich Kugele – Needham
Okay and then when it comes to, I believe that there was a tool that was shipped as a R&D type tool that you were hoping to recognize revenue on at some point in early ’07. What’s the status of that tool?
Okay, that’s tool we’ll probably ship around mid-year and we don’t have the final deliver date that’s our expectation right now.
Rich Kugele – Needham
But that was not for pattern media that was something that was just 200 Lean plus type.
It’s a tool for a non-media application.
Rich Kugele – Needham
Okay and then as people do look at pattern media. Do you people typically with these next-generation technologies, do they typically by one for R&D or is it two. How many does the average customers type by four next-gen development.
If we go by immediate acquisition, it’s usually two tools and initial one to began that and then nature a second. Devote one tool to more R&D applications and the second tool to more private line reproduction qualification.
Rich Kugele – Needham
And should we assume similar price to your 200 Lean?
The initial tools maybe a little more expensive because of the R&D nature of the tools.
We had no further question at this time.
Okay. Well, thank you for joining us today and we look forward to updating you in our next call on our Q1 results. Goodbye.
Ladies and gentlemen, this does conclude today’s teleconference. You may all disconnect.
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