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Intevac (NASDAQ:IVAC)

Q3 2013 Earnings Call

October 28, 2013 4:30 pm ET

Executives

Claire McAdams

Jeffrey Andreson - Chief Financial Officer, Principal Accounting Officer, Executive Vice President of Finance & Administration, Secretary and Treasurer

Wendell T. Blonigan - Chief Executive Officer and President

Analysts

Richard Kugele - Needham & Company, LLC, Research Division

Mark S. Miller - Noble Financial Group, Inc., Research Division

Operator

Good day, and welcome to the Intevac's Third Quarter 2013 Financial Results Conference Call. Please note that this conference call is being recorded today, October 28, 2013.

At this time, I would like to turn the call over to Claire McAdams, Intevac's Investor Relations Counsel. Please, go ahead.

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 2013, which ended on September 28. In addition to outlining the company's financial results, we will provide guidance for the fourth quarter of 2013.

On today's call are Wendell Blonigan, President and Chief Executive Officer; Jeff Andreson, Chief Financial Officer; Mike Russack, General Manager of Hard Drive Equipment; and Drew Brugal, General Manager of Photonics. Jeff will start with a review of the third quarter results, and then Wendell will provide an update on our businesses. Jeff will then provide guidance before turning the call over to Q&A.

Before turning the call over to Jeff, I'd like to remind everyone that today's conference call contains certain forward-looking statements, including but not limited to, statements regarding financial results for this company's most recently completed fiscal quarter, which remains subject to adjustment in connection with the preparation of our Form 10-Q, as well as comments regarding future events and 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 10-K and quarterly report on Form 10-Q.

The contents of this October 28 call include time-sensitive forward-looking statements that represent our projections as of today. We undertake no obligation to update the forward-looking statements made during this conference call.

I will now turn the call over to Jeff to discuss our financial results for the third quarter. Jeff?

Jeffrey Andreson

Thanks, Claire. Consolidated third quarter revenues totaled $19.1 million, within our guidance range of $18.5 million to $19.5 million.

Equipment revenue totaled $11.8 million and included one 200 Lean system. Photonics sales of $7.4 million included $3.1 million of contract, research and development revenues.

Equipment gross margin of 39.7%, which improved from the second quarter primarily due to the higher margin 200 Lean system versus the initial Solar Implant system recognized in Q2. We also came in above the guidance range because of better-than-expected margins on upgrades and spares during the quarter. In our Photonics business, gross margins were 30.3%.

Q3 operating expense of $9.9 million declined 9% from the second quarter. This decline reflects the savings from our cost reduction actions and also included some customer funded nonrecurring engineering in our Equipment business during the quarter. The normalized expense level is in the range of $10 million to $10.5 million, as I'll discuss in the guidance.

Our Q3 net loss was $2.7 million or $0.11 per share. Our backlog was $70.7 million at quarter end. Equipment backlog of $19.8 million included two 200 Lean systems and no solar systems. Since the end of the quarter, we now have 1 additional PVD solar system in backlog. Backlog in our Photonics business was $51 million.

We ended the quarter with cash and investments of $85.7 million, equivalent to approximately $3.57 per share based on 24 million shares at quarter end. Cash and investments decreased by $2.6 million, principally due to the operating loss. And for the full year, we remain on track to reduce our cash burn by half compared to 2012 and the end of the year -- and end the year with approximately $80 million in cash and investments. Capital expenditures were $1.6 million, and depreciation and amortization was $1.2 million for the quarter.

I'll now turn the call over to Wendell to provide his initial thoughts since joining the company as well as updates on our businesses. Wendell?

Wendell T. Blonigan

Thank you, Jeff. First off, it's great to have this opportunity to speak to all of you on my first call since becoming President and CEO of Intevac. I've been with the company now for just over 90 days and would like to say I'm very excited to be here and look forward to updating you going forward.

I've spent the majority of my time reviewing the statuses of each of our businesses, our market position and product capabilities, our organizational capabilities, and our efforts to date in equipment diversification. I've also had the opportunity to meet with and listen to the majority of our employees and major customers around the world as well as talk with our largest shareholders.

Today I'd like to give you my initial thoughts about the company, our products and the markets we serve. With respect to the company, Intevac has a strong balance sheet; a market-leading system for hard drive media manufacturing; a growing Photonics business; new products that have been sold into additional markets; and most importantly, a talented global workforce that is aligned and motivated to address the business challenges we face and drive continuous improvement in everything we do. I've been impressed with both the technical breadth and the capability of the company, as well as the professionalism and skill of the management team. As I said earlier, I'm very excited to have joined Intevac and look forward to being part of the team in the next chapter of the company.

In our hard drive activities, we have outstanding relationships with our customers. We have the industry-leading product, and appear to be leading our competitor in developing solutions for next-generation media technologies, such as HAMR, or thermal assisted magnetic recording. I'll discuss the dynamics we are seeing in that market in a minute.

In solar, I think we have a very competitive product in ion implant, which is an application on most customers' technology roadmaps for silicon-based solar cells. The near-term challenge will be this industry's ability to invest in new technology and the timing of supply and demand recovery.

As implant begins to be adopted on more advanced cell structures, we have seen this to be our largest opportunity in solar to date. Having said this, we recently received an order from a new Tier 1 customer for a PVD thin film deposition system that will also be used for the manufacture of advanced solar cell structures. So we're encouraged by these modest improvements in technology investment and our ability to win new customers and applications.

In Photonics, it's clear we are in a unique position, having the only digital low-light sensor in the industry. The team here is doing a very good job of completing the pre-manufacturing work for the Apache program, as well as advancing the developments of our other large programs. This business is at an inflection point, as I see it, and the focus will be on execution and accelerating the adoption of our products.

On the financial side, Jeff and I have reviewed the cost reduction activities to date and will continue to assess the alignment of our investment versus timing of market recovery in our Equipment businesses. We are just beginning the process of planning for 2014, so I'll have an update on this on the next call.

Now to turn to a more detailed update of each of the businesses and the markets we serve. In our Hard Drive business, the industry transition from a PC-based storage market to a cloud-based storage market has dampened hard drive unit demand for the last 5 quarters. The high growth rate drives for the cloud has been not been able to surpass persistent PC unit declines, as PC still compromise the largest segment of the hard drive market. We've seen a number of positive trends for our business and merger over the same timeframe, including higher capacity drives and increasing ratio of discs per drive and slowing areal density improvements.

The PC headwinds over the last several quarters have left -- has left media capacity underutilized. Having said this, we continue to see exabytes shipped outpacing areal density increases and an increasing disk per drive ratio driven by the increase in high-capacity drives for the cloud. The question, therefore, is not if, but when the positive drivers for the media units will start to push the limits of existing capacity and result in a resumption of new system orders. So far this year, given the exabyte demand and average drive capacity, we have been fairly consistent in seeing those limits being reached and orders being placed sometime in the second half of 2014. However given the fourth quarter hard drive shipments this year are forecasted to be flat versus seasonally up, it is possible that this inflection may shift. There are certainly scenarios being contemplated in which demand recovers into next year, so we'll be watching each of these variables closely and update you on our next call.

Industry forecasters all agree that data storage requirements will continue to grow significantly. While it is very difficult to predict the exact timing of when the industry will begin adding capacity systems, the growth of generated and stored data will drive the need for a significant number of new capacity systems over the next 3 to 5 years. As we go through this cycle, we will continue to focus on extending our technology leadership, developing additional upgrades that support our customers' cost reduction and R&D roadmaps, expanding our service and spares business, and finally gaining market share.

Now moving onto our progress in Equipment diversification. On the last call, we were -- we said we were starting to receive some renewed customer interest for our PVD thin film systems for use in advanced solar cells. Just last week, we received an order from a new Tier 1 customer for a high-throughput thin film deposition system to be used in the manufacture of crystalline silicon solar cells. This system is capable of depositing a variety of metal films required for advanced solar cell architectures. This win is indicative of our company's strength in providing high productivity thin film solutions that meet our customers' needs, and we are pleased that it adds another application and a new Tier 1 customer for our Equipment business.

In the meantime, we remain engaged with several customers for our implant and PVD systems and will continue to prudently manage our level of expenditures. As I said earlier, I believe the industry will adopt new technologies for advanced cell structures that will push cell efficiencies into the 20% range and above. The question is the timing of demand growth that will consume the current installed capacity. The demand for high-efficiency cells is strong and growing, so we continue to believe that our opportunities in the solar market are significant. But we continue to expect market conditions to remain difficult until the industry absorbs installed capacity and improves cash flow.

Now turning to our Photonics business. We continued to build momentum in Photonics during the third quarter. Backlog has now increased to a record $51 million with over $30 million of this being the Apache program for the U.S. Army. We expected to ship the first cameras in the fourth quarter, but we have experienced some delays associated with the government shutdown. These delays have pushed out some milestones of the pre-manufacturing phase, and it will be difficult to achieve initial shipments in Q4. We will, however, continue to work toward delivering our first cameras in the quarter. This is an issue with timing, as there is no impact to the nearly 600 cameras we have in backlog.

During the quarter, we had very successful user demonstrations for our digitally fused goggle program and continue to receive additional funding for this, as well as the Joint Strike Fighter Helmet Mounted Display program. The combination of the Apache program and continued development work on these other 2 programs position this business for strong growth in 2014 and beyond.

We are closely monitoring the potential for any additional impacts the government shutdown has on our business, our backlog remains strong, and we don't see any risk to programs already underway. However new programs could be affected.

I will now turn the call back to Jeff to discuss our guidance for the fourth quarter. Jeff?

Jeffrey Andreson

Thanks, Wendell. We're projecting consolidated Q4 revenues of $19 million to $20 million, including one 200 Lean manufacturing system shipping in the quarter. We have previously guided 1 to 2 systems would ship in the fourth quarter, with the second system being a highly configured tool scheduled for a late December delivery. We now expect revenue recognition for this tool to occur in the first quarter of 2014.

We expect fourth quarter gross margin to be 36%. Given the delays in the Photonics business discussed earlier, we expect Photonics revenues will be approximately flat to Q3 levels. At this point, we expect these delays to be limited to the fourth quarter.

Operating expenses are expected to be in the range of $10 million to $10.3 million. Other income and expense will be approximately $100,000. This excludes any impact associated with foreign exchange. Tax expense associated with our foreign operations will be approximately $150,000 to $200,000.

For Q4, we are projecting a net loss in the range of $0.13 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] And our first question comes from Rich Kugele from Needham & Company.

Richard Kugele - Needham & Company, LLC, Research Division

A couple of questions. First when it comes to this new PVD thin film system that you shipped, or you're going to be shipping, is this comparable to the same ASP? Or are there some unique features?

Jeffrey Andreson

Rich, I think we said on the past, one of the first systems we shipped was a PVD solar tool, and this will range between $3.5 million and $4 million.

Richard Kugele - Needham & Company, LLC, Research Division

Okay. And is there anything unusual with the revenue recognition on it? Because of it being a new customer and application?

Jeffrey Andreson

Yes. We'll revenue this on acceptance. It should ship around midyear next year, and revenue will come on sign-up.

Richard Kugele - Needham & Company, LLC, Research Division

Okay. And then in terms of highly configured tool for the drive business, but now, I guess, it's pushed into the first quarter, I'm surprised that there's something new in 200 Lean land. Can you just describe it all as what -- how this one was configured differently than ones in the past?

Jeffrey Andreson

Yes, I think our revenue recognition is if it's exactly the same, then we revenue on shipment. But this, there was some minor modifications. I wouldn't say it's anything significant. We just couldn't get it all done by the end of the quarter.

Richard Kugele - Needham & Company, LLC, Research Division

Okay. And then lastly, Wendell, just to understand a little bit of how you view the strategy at this point. Obviously, the Photonics business is unique, $51 million, pretty impressive backlog but not really consistent with some of the other elements of the business, and it's always been viewed as something that probably needs to be elsewhere, at some point. So can you just update us on your view of the strategic level of this business?

Wendell T. Blonigan

Yes, Rich, I think that there's been discussions along that line. The Photonics business, as I mentioned in the script, is really kind of turning a corner. And it's in a transition from more of a kind of an R&D type activity to moving into volume production. So from a strategic fit, I think right now, we're focused mostly on execution and product adoption for the foreseeable near future anyway.

Richard Kugele - Needham & Company, LLC, Research Division

And Jeff, it's probably still fair to say that were it not for the solar investments, the company would be profitable? Is that still consistent?

Jeffrey Andreson

Or pretty near to profitable. Yes, the losses are still being driven by our investment in the new equipment.

Operator

[Operator Instructions] And your next question comes from Mark Miller from Noble Financial Capital.

Mark S. Miller - Noble Financial Group, Inc., Research Division

Just had a question about the PVD tool. I assume this is for the next generation higher efficiency cells, is that correct?

Wendell T. Blonigan

Yes. This particular tool, this is Wendell, is going to be applied using -- to make some advanced cell technologies.

Mark S. Miller - Noble Financial Group, Inc., Research Division

Okay, and compared -- do you have any feeling in terms of the TAM for that -- the future TAM for that? Especially in comparison to the opportunity for your ion implanter tools. I assume they will be used with the ion implanter tools in the same line?

Wendell T. Blonigan

Yes, I think when we kind of look at that opportunity and we're kind of bundling together those opportunities because they are both targeted at the high-efficiency cell architectures, we see that TAM similar around $200 million in the 2017 timeframe, so having a 25%, 30% of that market, we think that's significant for the company.

Mark S. Miller - Noble Financial Group, Inc., Research Division

Who do you view as your major competitors in that market?

Wendell T. Blonigan

In particular, there's some small companies that are in the space, as well as 1 large player that is in Japan. However looking at our competitive positioning and cost of ownership, and as you know, the solar game is cost per watt, and that's efficiency, it's tool costs, and running costs. We like the way we're positioned in the market right now.

Mark S. Miller - Noble Financial Group, Inc., Research Division

And maybe I missed it, but what was the cash from operations? How did that run this quarter?

Jeffrey Andreson

I didn't actually say that on the call, but we were down $2.6 million quarter-on-quarter, I believe, and that was mostly due to the operating loss.

Operator

[Operator Instructions] And I'm not showing any further questions in queue. I would now like to turn the call back over to Mr. Blonigan.

Wendell T. Blonigan

Thank you. We want to thank you all for joining us today, and we look forward to updating you in our next call on our fourth quarter and year end results. Until then, so long.

Operator

This concludes today's teleconference. You may now disconnect. Thank you.

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