Intevac Inc. Q3 2009 Earnings Call Transcript

Oct.26.09 | About: Intevac, Inc. (IVAC)

Intevac Inc. (NASDAQ:IVAC)

Q3 2009 Earnings Call

October 26, 2009; 4:30 pm ET

Executives

Kevin Fairbairn - President & Chief Executive Officer

Jeff Andreson - Chief Financial Officer

Joe Pietras - Vice President & General Manager of Intevac Photonics

Analysts

Bill Ong - Merriman

Rich Kugele - Needham & Company

Aaron Rakers - Stifel Nicolaus

Michael Needleman - Preservation Asset Management

Operator

Good day, and welcome to the Intevac’s third quarter financial results conference call. Please note that this conference call is being recorded today, October 26, 2009. At this time, I would like to turn the call over to over to Claire Adams, Intevac’s Investor Relations Counsel. Please go ahead ma’am.

Claire McAdams

Thank you and good afternoon everyone. Thank you for joining us today to discuss Intevac’s financial results for the third quarter of fiscal 2009, which ended September 26. In addition to outlining the company’s financial results for the quarter, we will provide guidance for the fourth quarter and full year of fiscal 2009.

On today’s call are Kevin Fairbairn, President & Chief Executive Officer; Jeff Andreson, Chief Financial Officer and Joe Pietras, Vice President and General Manager of Intevac Photonics.

Before turning the call over to Kevin, I’d like to remind everyone that information provided in today’s conference call contains forward-looking statements. During the course of this conference call, we will comment upon future events and make projections about the future financial performance of Intevac.

These forward-looking statements are based upon our current expectations, and actual results could differ materially as a result of various risks and uncertainties relating 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 10K and quarterly reports on Form 10Q.

The contents of this October 26 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.

I will now turn the call over to Kevin Fairbairn. Kevin.

Kevin Fairbairn

Good afternoon and thank you for joining us today. Our results for the third quarter exceeded our guidance in revenue gross margin and earnings per share. Revenues totaled $19.2 million, which included one 200 Lean System. Net loss was $1.8 million or $0.08 per share and included equity based compensation expense equivalent to $0.03 per share.

Our results exceeded guidance for a number of reasons. In addition to recognizing revenue on our first 200 Lean for patent media, we saw a significant amount of upgrade business during the quarter driven by customer’s growing need to convert a portion of their existing media capacity from 3.5 inch to 2.5 inch.

These conversions required upgrades to the 200 Lean Systems already in the sale with additional features such as rotation stations that enabled processing of media on draft substrates. These upgrades along with improved factory efficiencies on a growing Photonics business also helped us to exceed gross margin guidance by 330 basis points above the high end of the range.

These achievements coupled with our lower operating expenses simply improved our bottom line with our loss per share $0.05 better than the high end of our guidance. We are very encouraged by the numerous positive signs of recovery in the hard drive market. Demand for the hard drives surpass expectations going into 2009, an example of this recovery in demand is our recently announced order for two 200 Lean Systems that represent the first capacity driven orders of the year.

Still everyone listening to our call today would like to know when the industry would need to add more capacity and how quickly our revenues will ramp during this recovery. We are not yet in a position to answer that question. While our customers are beginning to talk about capacity additions in 2010, they’ve also stated they continue to caution pending validation of their recovery sustained through December. As a result it is likely that our customers will hold off until the first quarter of 2010 before placing new orders for capacity.

So our disability on new orders remains limited. Yet we are seeing a number of positive market dynamics, which in the near term include year-over-year hard drive unit growth turning positive, the PC market proving to be elastic as the lower prices of computers in particularly netbooks are driving PC unit growth even in these challenging economic times.

Constraints in 2.5 inch disk manufacturing capacity for advanced mobile applications, retirements of legacy media manufacturing systems with several customers, a corporate refresh cycle on the horizon expected to feature by Windows 7, and of course the ongoing proliferation of Digital Content in the consumer world. All of these signs indicate that capacity needs the 2.5 inch should require additional media capacity systems like the 200 Lean 2010.

We are also seeing additional positive indicators for the longer terms such as the corporate mix shift towards mobile PCs, which should lead to shorter refresh cycles and hence increased hard drive demand over time. The increasing benefits of 2.5 inch drives such as reduced space and power leading to a mix shift away from 3.5 to the desktop enterprise and consumer electronics markets, significantly reduced expectations for the penetration of solid-state drives into hard drive market.

Growing G3 wireless coverage especially in the large emerging markets combined with aggressive progressional plans from widest carriers will drive further mobile unit growth. A significant number of the legacy tools in the field that will have to be replaced over the next few years and the fact that patent media is on every hard drive company’s technology roadmap, with initial deployments of production systems to begin as early as 2012.

As we look back upon the year, 2009 has been a challenging year for all equipment companies. Still we are pleased with our progress this year, our goals during this downturn, with a significantly lower break even points to protect our strong balance sheet in the event of a protracted downturn continue to improve our operational effectiveness and lastly to ensure we strengthened our product portfolio so that we emerge with better prospects for revenue and earnings growth than any time in our past.

We have reduced our operating expenses by 20% over the last year, and we believe we have sustained our gross margins better than many other public capital equipment companies, doing large part to our continued focus on Lean business practices. And the hard drive market we developed and shipped the first high productivity patent media system in Q2, achieving sign off in Q3.

Our second patent media system was shipped in early Q4. We expect additional orders of patent media R&D tools from our new and existing customers in 2010. We will also be shipping an R&D media deposition system with new enabling capabilities this quarter. We believe these new systems represents significant opportunities for us in the future when these technologies rap into production.

We have continued to fine tune our Lean semiconductor product with alliance partner test as they demo the systems to local large customer in the South Korean market. While this semiconductor equipment market decline to a record low levels in 2009, we are hopeful that in conjunction with test becomes a benefit from the semiconductor market recovery.

Lastly we have developed during the process of developing new manufacturing solutions to the further market derived from our 200 Lean as well as our semiconductor high productivity mainframe. We have been approached by a number of cellular companies who are aware of our reputation in the hard drive industry for providing high productivity, precise and uniform film deposition capability at a very low cost.

One such customer XonX recently announced their partnership with Intevac where we will work together to develop a new breed of Thin-Film photovoltaic manufacturing techniques to produce six solar cells. For our other PV customer, we have removed from backlog our initial order for a 200 Lean tool as we do not have a defined delivery date for this system.

At the end of the day the solar market is a cost driven business. Various technologies can be employed to improve efficiency of the solution that provides the lowest possible cost per watt of reasonable efficiencies will be successful. Initial customers results from our lab tools show positive results and efficiencies and projective cost.

I will now turn the call over to Joe Pietras to talk about another growth quarter for our Photonics business. Joe.

Joe Pietras

Thank you Kevin. Intevac Photonics revenues were $6.9 million in the third quarter, growing 10% quarter over quarter and 20% year-over-year. We received a record amount of orders and exited the third quarter with a record level of backlog. This growth is being driven primarily by our Military Digital Night Vision business, our Military Long Range Target Identification or LIVAR camera business, and continued momentum in our hand held Raman instruments business.

In our Military Digital Night Vision business, we reported receiving export approval for our digital camera module and higher levels of performance to satisfy the requirements of Sagem, our NATO customer. As a result, we executed plans on the third quarter to increase production capacity and are on target to begin higher volume shipments in the fourth quarter with increased shipment rates continuing into 2010.

In the domestic Military Night Vision market, we experienced a number of important developments related to both our core Digital Sensor Technology and our Night Vision System products. As we announced last week, we received a sub-contract award of $7 million to develop a new large format Night Vision Sensor based on Intevac’s patented Digital Sensor design. This new sensor, which we expect to be available on 2011 will expand our family of Digital Night Vision Sensors into large field of view applications for both Avionics and ground use.

With regard to our Night Vision System products, we are seeing strong business traction around our recently released Night Port product. Night Port is fully digital monocular that provides night vision viewing and recording capabilities utilizing our expertise in digital sensors and micro display viewers. Night Port has the potential to replace tradition analogue night vision goggles, which represents a $400 million market annually.

You may recall that during the second quarter, we completed a number of successful demonstrations of our Night Port product to keep military customers. These demonstrations lead to funding of two important development programs launched in third quarter for separate binocular type products based on the Night Port design for ground and avionic US military applications. The production opportunity for these two products, which we expect will develop over the next few years, represents approximately $45 million over 10 years.

In our LIVAR camera business we continue to see increased momentum delivering in the third quarter a record number of LIVAR cameras against a multimillion dollar production order for an airborne application. We expect to receive follow on orders, which would provide backlog throughout 2010. The opportunity represented by this airborne application alone is estimated at approximately $37 million over the next 10 years.

In our Raman instruments business where our focus is on handheld portable instruments for materials identification, the order pipeline continues to grow within our target markets. During third quarter we were awarded a US government contract in excess of $1 million to develop a portable standoff Raman technology for remote detection of chemical, biological hazards.

To sum up, in our military business we continue to make significant progress in winning orders that demonstrate penetration of our digital night vision products and LIVAR cameras on major military platforms that have significant growth potential. In our commercial business we continue to see growth with our handheld Raman instruments in our target markets.

I will now turn it over Jeff to discuss our financial results for the third quarter and our outlook for the fourth quarter and full year 2009. Jeff.

Jeff Andreson

Thank you Joe. Consolidated third quarter revenues totaled $19.2 million exceeding our guidance of $13 to $18 million. Equipment revenue totaled $12.3 million with one 200 Lean system recognized in the quarter. Photonics sales of $6.9 consisted of $4.5 million of contract research and development, and $2.3 million in product shipments.

Consolidated gross margins of 45% exceeded the high end of our guidance with 42%. Equipment gross margins improved from 39% to 48% sequentially due to a higher mix of technology upgrades and spares as well as improved factory utilization to support our fourth quarter revenues.

Photonics gross margins improved to 40% from 34% in the second quarter due to a higher margin development contracts and lower product manufacturing cost. Q3 operating expenses declined from Q2 to $12.4 million, and we are slightly below our guidance. Overall operating expenses for the third quarter represented a 22% decrease since Q3, 2008, the quarter prior to the implementation of a global cost reduction plan.

We recognize the tax benefit for the quarter of $1.8 million. Our Q3 net loss was $ 1.8 million or $0.08 per share compared to our guidance of a loss of $0.13 to $0.22 per share. The net loss included $1million of pre-tax stock based compensation expense, equivalent to $0.03 per share.

Our backlog was $52 million in quarter end, an increase of $8 million compared to $44 million at the end of Q2, and included a total of five 200 Lean systems. As Kevin explained we have deployed one 200 Lean for a PV application as we do not have a defined delivery date from the customer.

Now I’ll discuss the balance sheet. We ended the quarter with cash and investments of $97.7 million or approximately $4.43 per share, which included evaluation allowance of $4.4 million associated with our Auction Rate Security Investments. Excluding the impact of this adjustment, cash and investments increased by $1.3 million from Q2 and included a $2.5 million tax refund related to a carry back of our 2008 losses. We continue to closely manage our cash flow in line with the current business environment.

Our investment portfolio at the end of Q3 included $66 million in student loan back to Auction Rate Securities. In Q3 $500,00 of the securities were called apart. We continue to have liquidity access to these assets for our existing line of credit, and do not anticipate borrowing as we have adequate cash to support the business. In the third quarter capital expenditures totaled $556,000, and depreciation and amortization totaled $1.4 million.

I will now provide our guidance for the fourth quarter and full year. We are projecting consolidated Q4 revenues of $34 to $36 million, which includes four 200 Lean systems. We expect fourth quarter gross margins in the range of 40% to 41.5%.

The decrease in gross margin percentage from the third quarter is a result of the higher mix of system shipments in the equipment business, and a reduction of Photonics as we begin to deliver the first high-volume Night Vision modules to Sagem. We expect the gross margins for these products to normalize in the second quarter of 2010 as volumes increase and yields improve to expected levels.

Our fourth quarter has an additional four days as compared to the prior quarter due to our December 31 year-end. As a result while we continue to reduce cost, operating expenses are expected to be flat at approximately $12.5 million for the quarter. Other income and expense will be approximately $200,000, excluding any impact associated with changes to the credit ratings of our Auction Rate Securities or foreign exchange.

For Q4 we are projecting net income in the range of breakeven to $0.03 per share, which includes an estimated $1 million of pretax stock based compensation expense equivalent to $0.03 per share as well as an anticipated net tax expense. While the EPS at the low end of guidance is breakeven the company expects pretax profitability at both ends for the revenue guidance.

Income tax expense for the fourth quarter will range from approximately $1.8 to $2.1 million due to the required year to date adjustments of net tax benefits from prior quarters. Our tax rate on a cash basis will be zero for the year.

To summarize guidance for the full year we are projecting consolidated revenues in the range of $78 to $80 million, which includes five 200 Leans. We expect Intevac Photonics revenues to be approximately $27 million for 2009. We expect a loss for the year in the range of $0.52 to $0.55 per share, which includes an estimated $4.5 million of stock based compensation expense equivalent to $0.15 per share.

This completes the formal part of our presentation. Operator, we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bill Ong - Merriman.

Bill Ong - Merriman

So I understand that your visibility is limited to 2010, but can you offer some color on what type of seasonality can we expect in 2010, maybe go through some potential scenarios on the Lean tools as well as Photonics?

Kevin Fairbairn

So let me start with the equipment side. We would expect the majority of orders and deliveries to be in the first half for capacity systems because people typically want to get production in place for the last two quarters. In terms of incremental R&D systems they can occur anytime during the year.

From a Photonics business we continue to see that business growing, so overall we would expect quarter-upon-quarter growth through the year, there maybe occasional flat quarter-to-quarter, but in general will be up into the right.

Bill Ong - Merriman

Then on the solo business, on the high level you have expectation on when you can start recognizing revenues over the next year or two or you can just give us some sense of time periods when you can get some revenue recognition there?

Kevin Fairbairn

We would expect any systems that we ship in 2010 to get revenue recognition within one to two quarters, because the basic tools, 200 Leans or our semi mainframe are well proven., and we would expect whatever specifications we sell them to, to be achieved fairly quickly. Once the customers’ starts using the tool for which it was sold by the R&D production, then our revenue recognition would enable us to recognize that tool as revenue worthy.

Operator

(Operator Instructions) Your next question comes from Rich Kugele - Needham & Company.

Rich Kugele - Needham & Company

A couple of questions; I guess first, when it comes to the upgrade business that you saw on the quarter that really is all 200 Lean, there is no upgrades that are occurring on the 250 Bs anymore, right?

Kevin Fairbairn

In the quarter we sold 200 Leans. In the future we wouldn’t rule out that some of our customers are trying to prolong the use of legacy systems, might not do some upgrades, which can potentially be reused on 200 Leans.

Rich Kugele - Needham & Company

The upgrade could be?

Kevin Fairbairn

Yes, for instance the sources that we used on the 250 Bs can be used on 200 Leans and we continue to do upgrade business where we improve the efficiency of the process and we reduced the cost of saving [Audio Dip]. So they are fairly soft paybacks that people will often buy sources that can be used later on 200 Leans.

Rich Kugele - Needham & Company

Okay, and in terms of the 2.5 inch upgrade specifically, that doesn’t actually improve throughput it just tailors it a little bit more to 2.5 inch.

Kevin Fairbairn

Correct, so for those, for the 2.5 inch upgrade that was only on the 200 Lean and you are right, it has no impact on throughputs.

Rich Kugele - Needham & Company

Okay, and then I guess, just lastly when it comes to the composition of the five Leans that are in backlog, can you give us a sense for what types of, so we noted obviously two of those capacity but the composition of the rest and what general timing we should be thinking about the revenue recognition of those?

Jeff Andreson

Well, Rich it’s Jeff. So two are for capacity, two other ones are Gen2 for planner, one we have said is for R&D application, for advanced planner media. And then we have one DTR as well. Obviously there is five in backlog and four in our revenue forecast. So one of those is likely to slip into Q1, so we have guided it as such.

Rich Kugele - Needham & Company

Okay, and one last question. When it comes to the discussions that you are having with and in particular that drive customers, do you get the sense that they are still in the planning stages for capacity additions? Do they recognize the lead times involved now for you to be able to deliver the tools in time?

Kevin Fairbairn

Yes, you are absolutely right there, doing that scenario planning, we are telling them to be careful and that they can’t suddenly turn an equipment industry on, it’s not just impact, it’s all the other sub component suppliers have been turned off by both the semiconductor and ACD and solar industries. They will work to come back on. So I think everyone is aware that they need to move quickly.

Rich Kugele - Needham & Company

Is there any sense that on how your primary competitor has weathered the downturn?

Kevin Fairbairn

Well, it’s hard to tell, they are a subsidiary of a much larger Japanese company, and certainly in the past P&L issues never seem to affect them in the way they would say, public company like Intevac.

Jeff Andreson

Rich, just one other thing to add on. They still have a much longer cycle time than we have from order to delivery. So they, as far as we know they haven’t improved on that.

Operator

Your next question comes from Aaron Rakers - Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

I guess, just to build on that, can you guys explicitly say what your lead times are right now from order to ship?

Kevin Fairbairn

We typically quote 17 weeks, but quite often if a customer is thinking of placing orders then they give us a few weeks warning as they are paid for working place. So that kind of helps us with some of our suppliers.

Aaron Rakers - Stifel Nicolaus

Fair enough, and that’s in line with your historical normal lead times?

Kevin Fairbairn

Correct. I just thought in case people miss Jeff’s point earlier, we continue to believe that our lead time is almost half that of our competitor, which could be important in this next cycle as people need to respond to the great market.

Aaron Rakers - Stifel Nicolaus

And as you add, I think, you just mentioned that you have two systems that come on for capacity in this next quarter or so. Is there any way to think about what, how much capacity that will leave us within the industry in terms of hard drives, is there way that you guys tend to look at that on a drive perspective?

Kevin Fairbairn

Those two systems won’t produce any media in Q4. So they will come online, probably be running production later in Q1.

Aaron Rakers - Stifel Nicolaus

And let’s say that once they come on to production where does that lead the industry from a capacity standpoint in your point of view?

Kevin Fairbairn

Well, it’s a little difficult to say in this particular customer’s case because they have been taking legacy capacity offline. So I am not sure the true, how big the addition is, Jeff.

Jeff Andreson

Yes, I would say that their retire in legacy tools, which probably produce somewhere around 50% to 60% in the same output of the two new tools. So it’s in that one tool added into the marketplace, which is maybe a half a percent of growth, and total media. But, so it’s a very small amount.

Aaron Rakers - Stifel Nicolaus

Okay, fair enough. And then, I think last quarter you guys had mentioned that you had started to see some of the pattern media stuff come into production in 2011, and I think today you said 2012. Have you seen that stretch out a bit when you start to see that stuff come on?

Kevin Fairbairn

Yes, let me talk to customers, I think consensus as to the kind of productions maybe moved out one year, but what will be unclear is the initial introduction will be longer than say perpendicular media because the learning curve is a lot more difficult, so we may well ship early production systems in late 2011. But they may not actually produce any significant amount of this until much later in 2012.

Aaron Rakers - Stifel Nicolaus

Okay. And then final question from me. With that said, do you see the industry moving to an increased platters per drive dynamic as kind of the aerial density growth slows and that impacting your business, looking into next year and into 2011?

Kevin Fairbairn

If aerial density slows then suddenly that will maintain if not increase the average number of disk for hard drive, which is good for a business.

Operator

(Operator Instructions) Your next question comes from Michael Needleman - Preservation Asset Management.

Michael Needleman - Preservation Asset Management

Just a couple of questions; I came on late, so maybe I did not hear. Where are you with your new equipment from the standpoint of heading into the semi-cap side of the business, where is that? Just a quick update.

Kevin Fairbairn

We are currently working with our task, which is our alliance partner in Korea who is working with their customers, memory customers there to get the tool, demos and qualify. We have hoped to ship the tool into the customer before the end of the year, but it’s probably going to be early next year now.

Michael Needleman - Preservation Asset Management

So do you actually have one in beta?

Kevin Fairbairn

We have what we call a production configuration tool currently in test, which that tool would eventually go on to a customer side. So you might call that beta but it’s not a actual customer yet.

Michael Needleman - Preservation Asset Management

Okay. So we are delayed there. The second question is just to come back. I think I heard the last individual ask lead times, we are 17 weeks, I thought the lead times for your equipment was a little quicker from the standpoint of purchase to be able to fill, maybe I am thinking back, you were able to sometime ship a product within a quarter? Am I wrong by saying that?

Kevin Fairbairn

No, you are correct. In some cases our customers tell us they are going to be ordering systems, but they are getting their paper work in line. And sometimes they will give us some advance ordering, so we can get long lead items and therefore reduce the overall lead time for the equipment. So you are right, we have delivered equipments within the quarter in the past.

Michael Needleman - Preservation Asset Management

So in other words that 17 weeks if no one has given you any kind of go ahead order, any new equipment, is that correct?

Kevin Fairbairn

That’s correct, I am assuming that the equipment industry in general is in normal times, none of them kind of components sub suppliers lost some of their capacity.

Michael Needleman - Preservation Asset Management

And I am going to switch real quick. The night vision product, where is that? What’s on the government docket there as far as timing and everything else?

Jeff Andreson

We are ramping up our shipments to Sagem our NATO customer. You see that production will continue over the next few years and we are continuing to win other programs where some of our system level products are Night Portal that we came out with recently and started to gain traction and we went to very important binocular style products that have very big revenue potential over the next 10 years, so.

Michael Needleman - Preservation Asset Management

And how about the big product cycle, I believe, was going to be coming up. I don’t know whether or not it was this year or coming into next year, 2010-2011 time frame?

Jeff Andreson

That’s the digitally enhanced night vision goggle and that would be out there in roughly the 2013 time frame.

Michael Needleman - Preservation Asset Management

Okay, and the bidding process is still ongoing for that?

Jeff Andreson

It is still ongoing and the technical development is still ongoing, and so all competitors are working the technical issues. We see other opportunities in avionics and in some special ops applications will come on sooner.

Kevin Fairbairn

Yes, I think it’s fair to say that our technology is being qualified and deployed in practically every advanced night vision application.

Michael Needleman - Preservation Asset Management

Just one last question. I want to be sure, I also heard a question that was asked. A couple of the hard disk drive players have come out and they have stated publicly that they may be raising CapEx one has and one has also stated that they are going to be at least looking at the aspects of raising CapEx. If in fact you are having discussions with them, I will go ahead and ask the questions, have they given you any preliminary POs for that long lead time products?

Kevin Fairbairn

Not to-date.

Operator

There are no further questions at this time.

Kevin Fairbairn

Okay, well, thank you for joining us today. We look forward to updating you in our next call on our Q4 and 2009 results. Good-bye

Operator

Thank you. This concludes today’s teleconference, you may now disconnect.

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