Intermolecular's (IMI) CEO Dave Lazovsky on Q2 2014 Results - Earnings Call Transcript

| About: Intermolecular, Inc. (IMI)

Intermolecular, Inc. (NASDAQ:IMI)

Q2 2014 Results Earnings Conference Call

August 1, 2014 8:30 AM ET

Executives

Rick Neely - Senior Vice President and CFO

Dave Lazovsky - President and CEO

Analysts

Harlan Sur - JPMorgan

Edwin Mok - Needham & Company

Operator

Good day, ladies and gentlemen. And welcome to Intermolecular, Inc. Second Quarter 2014 Earnings Conference Call. All participants will be in a listen-only mode. Please note this call is being recorded. My name is Stephanie, and I’ll be your operator for today.

I would now like to turn the conference over to your host for today, Mr. Rick Neely, Senior Vice President and Chief Financial Officer. Please proceed, sir.

Rick Neely

Thank you, Stephanie. Good morning. And welcome to Intermolecular’s second quarter 2014 earnings conference call. We announced results before the market open today and you’ll find a copy of the press release on our website at www.intermolecular.com. On the call with me today is Dave Lazovsky, President and Chief Executive Officer.

Today’s conference call contains forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections and future market conditions is a forward-looking statement.

Actual results may differ materially from those expressed in these forward-looking statements. Intermolecular assumes no obligation to update these forward-looking statements, which speak only as of today.

For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the press release we issued today, as well as the risks described in our Form 10-K for fiscal 2013 and our subsequent quarterly reports on Form 10-Q as filed with the SEC, particularly in the sections titled Risk Factors.

Before we begin, please note that during this call, we will discuss non-GAAP financial measures as defined by the SEC and Regulation G. We believe non-GAAP financial measures provide useful supplemental information to both management and investors, but note that these measurements are not a substitute for GAAP and should only be used to evaluate the company’s results of operations in conjunction with corresponding GAAP measures. All non-GAAP measures are reconciled to the most directly comparable GAAP financial measures in our press release issued today.

With that, I will now turn over the call to Dave.

Dave Lazovsky

Thanks, Rick. Good morning, everyone. And thank you for joining us on today’s call and webcast. Our Q2 revenue results were above our guidance range at $9.9 million as we received some additional revenue that was not in our quarter beginning backlog.

For the second quarter, our overall financial results reflect two major factors in our recent business. On the topline, the reduce revenue levels from previously -- from quarterly results stem from the completion of the SanDisk and Toshiba collaborative development program, suspension of the GLOBALFOUNDRIES program and the transition of the ATMI program to production volume-based royalties. This move a quarterly revenue run rate from the $15 million to $17 million range that we delivered in 2013 to the level we reported today.

The second major factors on the expense line, where we have reduced our headcount and the associated expenses to adjust for the change in our program workload, while maintaining the core skill sets and capabilities we need to re-grow the topline.

From our peak headcount of approximately 250 at the end of fiscal year 2013, we are now running lean as significantly lower headcount. In terms of total dollar spending combining our costs of goods and operating expenses, we have cut our total quarterly spend from a peak of $19.3 million in Q4 2013 to $16.3 million in the second quarter, a $12 million reduction on an annualized basis, excluding restructuring charges and product build costs.

Though painful, these changes were necessary to preserve the strength of our balance sheet to ensure that we can make the necessary investments in new technology capabilities and new customers to again grow our business.

We are making investments with new customers to grow the business in the number of micro CDPs. The impact of these new customer initiatives can be seen in the lower Q2 gross margin than we have run historically.

These two factors resulted in reporting a non-GAAP net loss of $5.3 million for the quarter, excluding approximately $300,000 in restructuring charges. Our balance sheet remains in good shape as total cash and investments were $70 million at the end of the quarter.

As we have discussed on our prior call, we believe our completed CDP with SanDisk and Toshiba has resulted in the creation a very valuable technology and IP. We have collaboratively developed and patented critical technologies, which we believe to be necessary to the commercialization of next-generation non-volatile memory products.

We believe our IP position in ReRAM is significant and that there are near and long-term markets to support ReRAM’s commercial adoption. We have high confidence that there exit markets for ReRAM today, such as the low power mobile storage applications and storage class memory for the high-performance enterprise storage market.

We believe these markets will support the commercialization of ReRAM technology and IP, and that economic viability and scalability of ReRAM does not depend upon other factors such as the availability of EUV Lithography in the near-term.

We believe our expectations regarding the value of this IP was supported earlier this quarter, when SanDisk and Toshiba elected the exclusive license option that was in their contract, for which they will be paying us licensing fees to maintain exclusivity in the field of memory chips until they go into the production phase at which time, we would receive volume-based royalties.

In business segment outside of our semiconductor programs, we recently signed a new collaborative development program and IP licensing agreement with the technology and market leader in the display industry, who has chosen to remain confidential.

What we can say about this program is that it leverages our core competencies in material science and engineering and is focused on a high-value mobile display application. While we would like to share more information about our customer agreements with investors as we’ve stated in the past.

Our business objective is to add CDP services and IP licensing agreements with Tier 1 customers in large and growing markets, on projects that are on the critical path of their product roadmap. These customers are technology leaders in their respective industries. As leaders, the majority of our customers have strict confidentiality provisions associated with our technology development activities and our product roadmaps.

That being said, we’re starting to see various development efforts moving to CDPs and some of those impacts are reflected in the incremental increase to our third quarter revenue guidance. We look forward to providing with update as these opportunities grow into the next stages of development.

Now before I hand the call back over to Rick, I would like to thank the Intermolecular teams for the significant contributions to advancing our business, expanding the capabilities of our HPC innovation platform and for producing the technical results that we’re delivering to our customers.

Our priority remains execution with the existing CDPs to help our customers which would become two collaborative partners, accelerate their innovation and bring better products to market faster.

I look forward to the team's dedication and continued commitment as we grow the business through both new customer engagements in semiconductors and clean energy as well as building increasing licensing and royalty streams resulting from the commercialization of technologies developed in our existing customer collaborative development programs.

With that, I’ll turn the call back over to Rick. Rick?

Rick Neely

Thanks Dave. Now I will briefly summarize select financial results for the second quarter. Revenue for the second quarter of 2014 was $9.9 million which was down sequentially from the first quarter of 2014 and down 40 % versus the second quarter of 2013.

CDP revenue represented 69% of total revenue in the second quarter and licensing and royalty revenue 31%. As we discussed in our last conference call, we recognized a significant amount of one-time license and royalty fees from GLOBALFOUNDRIES in Q1 that accounted for a large part of the quarter-over-quarter revenue decline.

We have three customers which were greater than 10% of total revenue during the first quarter. Together these three customers represented approximately 72% of total revenue in the second quarter.

Net loss in the second quarter of 2014 on a GAAP basis was $6.9 million or a loss of $0.15 per basic share which includes $300,000 of restructuring related costs. This compares to a net loss of $3.9 million or a loss of $0.08 per basic share of common stock in the previous quarter. In the same period a year ago, we reported a net loss of $0.7 million or a loss of $0.02 per basic share.

I would like to remind you to please review today’s earnings press release for both GAAP and non-GAAP measures and a reconciliation between those results. The key difference from GAAP to non-GAAP measures is the exclusion of employee severance and related restructuring charges and stock-based compensation expense.

On this basis, we reported a non-GAAP net loss for the second quarter of 2014 in the amount of $5.3 million or a loss of $0.11 per basic share. This compares to a non-GAAP net loss of $1.3 million or a loss $0.03 per basic share in the first quarter of this year and a non-GAAP net profit of $0.6 million or $0.01 per fully diluted share in the year-ago period.

Gross margin in the quarter was 43%, lower than the 59% recorded in the prior quarter and below the 57% in the second quarter of 2013. The difference in gross margin compared to the first quarter of this year was predominantly driven by the accelerated payment received from GLOBALFOUNDRIES in Q1 as well as increased inventory reserves taken in the second quarter.

As we mentioned in our last conference call, even with the recent reductions in headcount and other cost-saving measures, gross margin tied to CDP revenue will likely remain below our target range of 40% to 45%. Until revenues increased further, it will be challenging to achieve consistent total gross margins at our recent historical levels.

Total operating expense in the second quarter was $11 million and this includes $0.3 million in restructuring tied to the reductions in headcount during the quarter. Excluding restructuring charges in all comparisons, operating expenses were $10.7 million for the quarter compared to $11.9 million in the first quarter of the year and $10.1 million in the same period a year ago.

This 10% sequential reduction in operating expense is a reflection of headcount reductions and other cost-saving measures undertaken at both the first and second quarter of this year. As Dave mentioned at the beginning of this call, we have taken substantial costs out of our P&L in the past six months, reducing our annualized expense run rate by approximately $12 million when comparing this quarter to peak spending quarter of Q4 of 2013.

We will continue to manage the delicate balance of both controlling costs while at the same time enabling Intermolecular to invest in the new areas that will put us back on the revenue growth path. Other net expense during the quarter of $174,000 primarily reflects our quarterly net interest expense related to a three-year term loan at 3.25% interest rate.

As of June 30, 2014, our balance sheet included cash and total investments of $70 million, which is down slightly from the combined total of $72.3 million at the end of the first quarter of 2014. Our second quarter ending cash position benefited from the timely payments from several customers as well as lower capital spending that we have done historically.

If you look at our quarterly GAAP loss of $6.9 million on an EBITDA basis, that’s earnings before interest, taxes, depreciation and amortization that loss would drop to $2.4 million, when you remove $2.7 million of depreciation and amortization, $1.3 million of stock-based compensation, restructuring of $0.3 million and $0.2 million of net interest expense.

We will be working hard to maintain the strength of our balance sheet. One key factor for Intermolecular investors to keep in mind is a relatively high non-cash charges we carry resulting from capital depreciation and employee equity incentive programs, neither of which consume operating cash. This factor keeps our cash burn at a manageable level.

Now I would like to go over the financial outlook for the third quarter of 2014. I’d like to remind everyone that the following statements are based on current expectations as of today and include forward-looking statements. Actual results may differ materially.

Our guidance for the third quarter of 2014 is as follows, we project revenue in the range of $10 million to $11 million. This revenue projection includes approximately $9.7 million from backlog at the end of June 2014. Non-GAAP net loss excluding stock-based compensation expense is projected between a non-GAAP net loss of $5 million and $4 million, or between a negative $0.10 per share to negative $0.08 per share on approximately 48 million basic shares outstanding.

Now I would like to return this call to the operator for any questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Harlan Sur with JPMorgan. Your line is open.

Harlan Sur - JPMorgan

Hey, good morning. Thank you for taking my question and congrats on securing the Toshiba, SanDisk exclusivity agreements. Are they paying you in quarterly installments? And is that the reason for the step up in your quarterly revenue run rate reflected in your September quarter guidance?

Dave Lazovsky

Hey, Harlan, this is Dave Lazovsky. Yes, they are paying us currently in quarterly installments and it’s one of the contributors to the step-up, yes.

Harlan Sur - JPMorgan

Okay, great. Thanks for that. And then, on the new CDP engagement with the display customer, did you guys 8-K that as you typically would, because I don’t recall seen it? And if not, does that mean that the CDP revenues at this point are just not that material?

Dave Lazovsky

So we did not issue an 8-K on that agreement, because it did not rise above the 10% threshold, that’s correct.

Harlan Sur - JPMorgan

Okay. And then obviously good to see you increasing at your end market exposure. So given the terms and the progress with this new display customer, I know it could be early days, but what’s your expectation in terms of been able to extract volume based royalties based on the progress, based on the milestones, based on your customer’s roadmaps and timing for ramps?

Dave Lazovsky

Sure. So this customer like many of our customers, they have requested confidentiality not just around the technology application itself, but also around the economic terms, the commercial structure. What we can tell you is that the Tier 1 display manufacturer that’s working on very high volume mobile display application, but beyond that, there is not a lot of detail we can provide.

Harlan Sur - JPMorgan

Okay. That’s fine. I appreciate that. And then, it looks like your non-GAAP OpEx was $9.7 million in the June quarter if I am not mistaken. And I am assuming that that’s the reflection of the restructuring in February and then again in May. On the May restructuring, you said annualized cost savings around $2.5 million, $3 million, how far off the way are you through that and where should we be on the OpEx front in the September quarter and December quarter?

Rick Neely

Yeah, Harlan, this is Rick. We completed all of the restructurings. So those are although as typical, the Q1 is fully reflected in this quarter’s results that the Q2 is not quite there yet. But I think you can take the guidance we just gave on the overall OpEx for Q3 and use that as your guideline, because the -- we need to -- there is two things, one was we had to adjust for changes in our workloads, so we’ve done that. At the same time, we need to re-grow revenues. So we don’t -- I would not anticipate further reductions in expenses, but in fact, we need to grow from this base so we can grow our investment into improving our sales line.

Harlan Sur - JPMorgan

Okay, good. And then just my last question, I will get back into queue. So in addition to the potential for the 20-nanometer fixed royalty payments from Micron, what’s your visibility in confidence level, Dave, on capturing royalties of ATMI, as they go into 20-nanometer, sub 28-nanometer, materials production, what’s your confidence level on royalties from Epistar and Guardian in the second half of this year?

Dave Lazovsky

So we don’t want to speak for our customers, but we do see as we had mentioned on previous calls and we expect on the materials fronts incremental growth in materials royalties associated or correlated to 20-nanometer and sub 28-nanometer wafer starts particularly with the foundries. And our clean energy programs, the technology development activities remain on track. What has been made public is the joint, the press release that was issued with the Epistar last quarter state our intentions of moving the LED technology that we’ve developed with them into production.

Harlan Sur - JPMorgan

Okay. Thanks a lot, guys.

Dave Lazovsky

Yeah. Thanks, Harlan.

Operator

(Operator Instructions) Our next question comes from Edwin Mok with Needham & Company. Your line is open.

Edwin Mok - Needham & Company

Hi, great. Thanks for taking my question. So first question I have is actually, I think you mentioned that there are three customers above the 10%, total is 72% of total revenue. If I recall back order numbers, does that mean that Guardian has actually increased sequentially on the first to second quarter and are they starting to pay royalties via through (indiscernible)?

Dave Lazovsky

Edwin, this is Dave. So the Guardian program has stepped up relative to previous run rates based on the extension or an expansion of the program that we closed in Q1 of this year, but the volume based royalties with Guardian have not yet initiated.

Rick Neely

But they are as you noted, they are one of our largest customers.

Edwin Mok - Needham & Company

I see, okay. That’s helpful. If I look at your royalty cutback, what happened to GLOBALFOUNDRIES, right, royalty revenue actually increased quite a bit sequentially. I was wondering is that because of this and exclusivity agreement that you guys have with them that help contributed to that increase? And is that current new run -- level run rate that we should expect from this customer on a quarterly basis?

Dave Lazovsky

No. As we said before, our GLOBALFOUNDRIES is around over $4 million of license royalty that didn’t reoccur this quarter. So if you drop that out of the March quarter to this quarter, that’s pretty much all that. We actually should see -- as you start to see this quarter, in fact it’s more than all of the quarterly differential. As you start to see this quarter, we’re picking up some additional licensing fees from SanDisk, Toshiba and some others. So I think this is the ratio that you should look at moving forward. Q1 was an aberration with the one-time payment.

Edwin Mok - Needham & Company

Okay. That’s helpful. And then if I kind of look at the margins, I think you guys talk about always you guys are investing for UCP and some of that investment reflects in your gross margin line, right, so that’s why the decline in gross margin. How do you kind of think about that? It seems like the revenue starts improving in the third quarter. Some of these actions started turn into revenue, all right. Should we expect margin to kind of march up and any kind of guidance you can provide around that in terms of how we think about gross margin…

Dave Lazovsky

Well, I think, right, this quarter we were at a low point for a couple of reasons, one was drop in the revenue, but also we had some inventory reserves that we would not expect to be -- that was about three points hit. We wouldn’t expect that to continue, but I would expect to be in the 40s for the next few quarters because we’re in a classic situation where until we refill some of the sales pipeline which we’re starting to do and get more utilization of our equipment, you are just stuck with the very large depreciation and overhead cost.

I mean, we actually -- our depreciation has increased quarter-over-quarter. We went from 2.5 to 2.7 quarter-over-quarter. And year-over-year, it’s almost 400K or 500K per quarter increase. So that’s hitting our margins by three or four points. And until we can give a little more activity, which we’re starting to do on the sell-side, I wouldn’t expect to get above 50s for a while. I said that in the call that it would be challenging to get back to our historical levels until we can improve some of the revenue numbers. I mean, we won’t be too low, but we won’t be also in the 50s for a few quarters.

Edwin Mok - Needham & Company

Okay. That’s good. And then last question I have is on the display customer that you say you signed. Did they contribute any revenue in the second quarter? Or is it mostly driver for the sequential increase in the third quarter?

Dave Lazovsky

Yeah. They did not contribute revenue for the second quarter, it’s a newly signed program.

Edwin Mok - Needham & Company

So the sequential increase from the second to third is mostly come for this display customer with some additional effort or am I getting correctly?

Dave Lazovsky

Yeah. So it’s a contributor to our guidance.

Edwin Mok - Needham & Company

Okay, great. That’s all I have. Thank you.

Edwin Mok - Needham & Company

Yeah. Thanks, Edwin.

Operator

Our next question is a follow-up from Harlan Sur with JPMorgan. Your line is open.

Harlan Sur - JPMorgan

Hey, thanks for taking my follow-up. Just one more question. So as it relates to your partnership with Micron, obviously they are making a lot of inroads. And trying to get their 20-nanometer technology into production, I think this 25-nanometer was like 30% of the mobile DRAM mix in the most recent quarter, so they are making a lot of progress on that front. Can you just give us an update on the development efforts with Micron on its nonvolatile memory efforts?

Dave Lazovsky

Yes. So, Harlan, we’re working very closely with Micron as you know on a variety of advanced memory applications. And they’re very sensitive to the confidentiality associated with disclosure on both the applications and the associated timing -- commercial timing in the product roadmaps. So there has been a lot that we can talk about there. These programs are tracking well and we do anticipate an incremental step-up in the fixed quarterly licensing fees associated with the implementation of next generation DRAM.

Harlan Sur - JPMorgan

Okay, great. Thanks a lot.

Dave Lazovsky

Sure.

Operator

I’m showing no further questions. I will now turn the call back over to management for closing remarks.

Dave Lazovsky

Thank you everyone for attending our conference call. We went in with an early morning approach this time. We will probably go back to the afternoon sessions from West Coast time, but appreciate it and wish everyone a good weekend. Thank you.

Rick Neely

Thank you.

Operator

Thank you. Ladies and gentlemen that does conclude today’s conference. You may all disconnect and everyone have a great day.

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