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Intevac (NASDAQ:IVAC)

Q4 2013 Earnings Call

January 29, 2014 4:30 pm ET

Executives

Claire McAdams

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

Wendell T. Blonigan - Chief Executive Officer and President

Analysts

David Rold - Needham & Company, LLC, Research Division

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

Nehal Sushil Chokshi - Technology Insights Research LLC

Operator

Good day, and welcome to Intevac's Fourth Quarter 2013 Financial Results Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, January 29, 2014.

At this time, I would like to turn the call over to Claire McAdams, Intevac's Investor Relations Council. 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 fourth quarter of 2013, which ended on December 31. In addition to outlining the company's financial results, we will provide guidance for the first quarter of 2014 and our current outlook for the full year. On today's call are Wendell Blonigan, President and Chief Executive Officer; and Jeff Andreson, Chief Financial Officer. Jeff will start with a review of the fourth 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 the company's most recently completed fiscal quarter, which remains subject to adjustment in connection with the preparation of our Form 10-K, 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 reports on Form 10-Q. The contents of this January 29 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 fourth quarter. Jeff?

Jeffrey Andreson

Thanks, Claire. Consolidated fourth quarter revenues totaled $20.6 million, slightly above our guidance. Equipment revenue was $12.8 million and included 1 200 Lean system. Photonics sales of $7.7 million included $3.5 million of contract research and development revenues. Equipment gross margin was 38.1%, which was above our expectation but was down slightly from the third quarter, primarily due to the mix of lower-margin upgrades.

In our Photonics business, gross margin was 36.8%, an increase from the third quarter, due to improved yields and lower manufacturing variances. Consolidated gross margin was 37.6%. Q4 operating expense was $6.6 million, which included a reversal of a contingent consideration accrual of $3.7 million. In our 2010 acquisition of Solar Implant Technologies, the agreement included a revenue earnout on future revenues. Our current revenue expectations are reduced from prior estimates to -- mainly due to the delay in the transition of the technology.

Total R&D and SG&A expenses were $10.3 million, up slightly from the third quarter due to a lower-level, customer-funded nonrecurring engineering in our Equipment business in the fourth quarter.

Our Q4 net income on a GAAP basis was $1.7 million or $0.07 per share. Our Q4 net loss on a non-GAAP basis excludes the reversal of the revenue earnout accrual and was $2 million or $0.08 per share, as compared to our guidance of a loss of $0.13 to $0.15 per share.

Our backlog was $15.9 million at quarter end -- $59.9 million at quarter end. Equipment backlog of $13.6 million included 1 200 Lean system and 1 solar system. Backlog in our Photonics business was $46.3 million. We ended the quarter with cash and investments of $81.4 million, equivalent to approximately $3.43 per share based on 23.8 million shares at quarter end. Cash and investments decreased by $4.3 million, principally due to the operating loss and stock repurchases.

During the quarter, we initiated a $30 million stock repurchase program and bought back 241,000 shares for $1.7 million. Capital expenditures were $844,000 and depreciation and amortization was $1.2 million for the quarter. For the full year, we exceeded our goal of reducing our cash burn by 50% from 2012.

I'll now turn the call over to Wendell.

Wendell T. Blonigan

Thanks, Jeff. Entering 2013, the company expected the year to be a challenge in our Equipment business, given the limited capital investment planned in both hard drive media and solar cell manufacturing equipment. In 2013, the company implemented a series of cost reduction activities that reduced our operating expenses by over 25% and reduced the cash burn by over 50% from the 2012 level.

We also underwent a thorough review of our businesses and financial projections, including cash needs, as part of our strategic planning process. Given the current outlook for our businesses over the next few years, we concluded that this was an appropriate time to return capital to our stockholders. At our November board meeting, we authorized a $30 million stock repurchase plan that returns capital of our stockholders while retaining the company's flexibility to effectively manage and grow the business. We began actively buying immediately after announcing the plan, and we will continue to update you on our progress each quarter.

Now I'll turn to a more detailed update of each of our businesses and the markets we serve, beginning with our Equipment business. The primary driver of our hard drive equipment business is a demand for the number of disks or media units. The industry has gone through a significant transformation since 2010, the last time we installed a significant amount of media capacity. This transformation is best characterized as a transition from PC or client-based storage to more efficient centralized or cloud-based storage. This has resulted in 3 straight years of flat to down media units shipments. That is expected to change this year, as exabyte demand is forecast to overtake storage efficiency gains realized by the transition to the cloud.

A return to media unit growth is forecast for 2014, driven primarily by the continuing growth of data, exabyte demand and strong spending to expand the cloud storage infrastructure. We believe the industry currently has an installed capacity of approximately 300 million disks per quarter. With the current level of media shipments, capacity utilization is around 80%. The question for our business is, when will the disk demand begin to cross over the installed capacity and trigger our customers to resume capacity additions? Some industry estimates have pointed to a crossover point sometime in late 2014. Based on these estimates, or what we would consider a high-growth scenario, projecting that growth rate through 2017, we would expect about 100 new capacity systems for Intevac. In a slower-growth scenario that would show a crossover point in late 2015, our hard drive equipment business would still be much improved from 2013 levels, with about 25 capacity systems being installed during the same time frame. Incremental to these would be tools for R&D or any legacy tool retirements.

In 2014, we are expecting a similar year for our hard drive business as compared to 2013, with limited system sales as the industry continues to work through the excess capacity. We are focusing our near-term activities to drive our businesses and upgrade service and spares for an installed base of over 200 production systems. We continue to keep a close eye on the key media drivers -- exabyte demand, aerial density and the mix shift toward high-capacity drives for the cloud -- in order to understand the implications for our business and a return to capacity system orders. We believe that once we get past this transition period, the hard drive business will be quite healthy for us. It has been profitable with just a few systems shipped per year and has averaged greater than 20% operating profitability over the last 10 years.

The investments that we've been making in our Equipment business have been to diversify into large, complementary markets where high-productivity tools such as our 200 Lean system are required. In recent years, that investment and focus has been in the solar cell manufacturing market. In 2010 and 2011, we introduced products in ion implant, PVD deposition and etch to address higher-efficiency cell structures and to lower cost-per-watt manufacturing.

Since that time, the market for solar capital equipment deteriorated significantly, and our results to diversify into this market have been disappointing. The manufacturing capacity that was procured and installed from 2008 through 2011 put the industry into significant overcapacity, drove solar prices down, pushed cell manufacturers' business in red and constrained their access to capital.

The good news is that conditions for solar cell manufacturers are improving. Tier 1 companies are generating cash and beginning to plan capacity additions. The overcapacity in the industry is expected to be consumed sometime in 2015, when demand exceeds approximately 50 gigawatts. Looking forward, we are focused on generating returns on our diversification investments.

During my first 2 quarters with the company, we extensively reevaluated the market, our products' competitive position and our customers' technology roadmaps and capacity plans in order to determine the revenue growth potential of each of our products targeted at the solar market. We have processes in place to manage the investments to grow our businesses. We are monitoring key industry and product performance metrics and adjusting our ongoing investments to a level that is aligned to the revenue opportunities as conditions change over time. As our current products are at or beyond their beta qualification phase, our investment levels have been significantly reduced. In 2013, we reduced our cash burn by half, and we will be reducing it further in 2014 as the market continues to digest the current installed capacity.

The solar market is a dynamic market that we have seen change significantly over the last 10 years, and that we believe has significant opportunities. Our Equipment business's core competency is high-volume, thin-film PVD systems for hard drive media manufacturing. This competency can be leveraged to other thin-film markets, and the recent solar PVD win is a good example. This product has significant follow-on potential starting in 2015 and the platform and source technology hold the possibility to serve additional adjacent markets in the future.

We believe the opportunity for solar implant is large when the industry transitions to advanced cell structures and N-type wafers. The challenge is rationalizing our expenditures in the near term while cultivating the opportunities in advance of anticipated technology transitions. For our SOLAR etch product, we have scaled our investment in this product down to a minimal amount in light of the near-term opportunities we see. The view is, we believe we have a significant opportunity serving the solar industry. We will carefully manage our level of investments in this space based on the opportunities we see and what is affordable for the company while closely monitoring the industry dynamics. For the year, we expect revenues to improve over 2013, albeit modestly. We entered the year with one tool in backlog.

Now I'll turn to Photonics. In our Photonics business, we ended the year with our sixth consecutive profitable quarter and a backlog of over $46 million. This business is well positioned to grow around 25% in 2014, with additional opportunities above this level. The $27 million Apache camera award will be the primary growth driver for this business in 2014. As the prime contractor for the U.S. Army, this represents a key milestone in the growth of our Photonics business. Additionally, it marks a transition from a sensor manufacturer and subcontractor to a high-volume integrated systems provider. In the fourth quarter, we shipped our first Apache production cameras. Our camera shipments will ramp slowly in the first quarter and reach the required monthly production volumes by the end of the second quarter.

In 2014, are Photonics organization will be focused on executing the production ramp for the Apache camera, as well as continuing to work on the next 2 major drivers in revenue: our digitally fused goggles for the Special Forces and the Joint Strike Fighter night-vision cameras. We believe that our position as a prime on Apache and as a high-volume integrated system provider significantly enhances our ability to capture new programs and expand our business going forward.

To summarize, we remain the market and technology leader in hard drive media deposition. Hard drive media is forecasted to resume its growth in 2014, and the business remains profitable at current levels. In solar, we will manage our expenses carefully and be selective in the opportunities we choose for revenue growth. In Photonics, we have a backlog of over $46 million, and I expect to see around 25% growth in revenue, with operating profits increasing significantly. Largely due to this increased profitability in our Photonics business, coupled with the cost reduction actions we have put in place, we will be able to bring our cash burn down by another 50% compared to 2013 to around the $5 million range.

I will now turn the call back to Jeff to discuss our guidance for the first quarter and outlook for the year. Jeff?

Jeffrey Andreson

Thanks, Wendell. We are projecting consolidated Q1 revenues of $16 million to $16.5 million, including 1 200 Lean manufacturing system. We expect first quarter gross margin to be 26.5% to 28%, which is lower than the fourth quarter, due to a lower level of factory absorption in our Equipment business.

Operating expenses are expected to be approximately flat to the fourth quarter, which had included extended holiday shutdowns for the company. Other income and expense will be approximately $100,000. This excludes any impact associated with foreign exchange. Tax expense will be approximately a $50,000 to $100,000 benefit for the quarter. For Q1, we are projecting a net loss in the range of $0.23 to $0.25 per share.

Turning to our outlook for 2014. As Wendell referenced earlier, we expect the hard drive equipment business to be roughly flat this year, with expectations for media growth beginning to drive capacity needs most likely in 2015. Our Solar Equipment business is starting to show signs of growth, beginning with the initial qualification of our implant tool and the new PVD order for 2014, and we expect year-on-year growth to be modest.

We expect significant growth in our Photonics business in 2014 of around 25%, with some potential to exceed this. Given these ranges of revenue, we expect gross margin in the range of 34% to 35%, with operating expenses running approximately $10 million per quarter. Importantly, at these revenue and investment levels, we expect our cash burn for 2014 to be 50% lower than 2013, or about $5 million, excluding cash deployed for stock repurchases. We will continue to monitor business conditions and will adjust our plans to achieve this goal.

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 the line of Rich Kugele from Needham & Company.

David Rold - Needham & Company, LLC, Research Division

David Rold on for Rich Kugele. So first, I was wondering what lead times are running at for the 200 Leans?

Jeffrey Andreson

They run about 16, 17 weeks to -- from order to delivery from our end, maybe another 5 or 6 weeks for shipment, installation and qualification.

David Rold - Needham & Company, LLC, Research Division

Okay. And in that vein, how comfortable are you with the supply chain for those tools, given how long it's been since material orders?

Jeffrey Andreson

We're not worried about the supply chain. They're in good shape.

Operator

Our next question comes from the line of Mark Miller from Noble Financial.

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

[indiscernible] for the summer quarter?

Wendell T. Blonigan

Mark, we didn't hear you.

Jeffrey Andreson

From the beginning, Mark.

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

What was the cash from operations for the December quarter?

Jeffrey Andreson

Well, we burned about $4.3 million, and we bought back about $1.7 million in stock. So it was down about $3 million, a little under.

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

Okay. You're saying that you're going to reduce your cash burn by 50%. Is that down to $5 million for the whole year?

Jeffrey Andreson

For the year, yes. Excluding any repurchases we do for stock.

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

Right. I missed your sales projection for 2014 for the whole year, sorry.

Jeffrey Andreson

We didn't sum it out for you. And I gave you ranges, yes.

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

I was just wondering, investors kind of reacted negatively to -- I think, one of the points was it would appear to be flat to down sales of enterprise drives by Western Digital and Seagate. I understand that, that's in part due to Toshiba gaining some traction in the enterprise space -- in fact, considerable traction last quarter. Is that what you're hearing, that Toshiba has gained some share versus both of those firms?

Jeffrey Andreson

Well, I mean, I don't know if I'm hearing it, but I think it's easy to imply that through the data that we have.

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

I think the important thing for the industry is that it's not so much an issue of cloud slowing down, but rather some share shifting going on. I guess that was the point I was trying to make.

Wendell T. Blonigan

We hope that is correct.

Operator

[Operator Instructions] Our next question comes from the line of Nehal Chokshi from Technology Insights.

Nehal Sushil Chokshi - Technology Insights Research LLC

How does the pace of transition from sixth-generation PMR to seventh generation PMR affect the maintenance stream? Does it affect it at all, or -- and if it does, I have a follow-up question, then.

Jeffrey Andreson

Not really. I mean, we have -- what they work on and versus what would be a repair service or installed base, it has almost no effect on us.

Nehal Sushil Chokshi - Technology Insights Research LLC

Okay. But I think in the slide deck that you have presented in the time at which excess capacity becomes utilized, that is dependent upon that pace of transition, is that correct?

Jeffrey Andreson

Yes. You would say that the pace of aerial density is pretty slow right now, so that certainly helps get us there.

Operator

There are no further questions at this time. I'll now turn the program back to Mr. Blonigan.

Wendell T. Blonigan

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

Operator

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

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