Intevac Inc (IVAC) 2005 Q2 法說會逐字稿

Welcome to Intevac's 2005 second-quarter results teleconference. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). Please note that this conference call is being recorded today, Monday, August 1, 2005. Kevin Fairbairn, Intevac's President and Chief Executive Officer, is hosting the call today. I would now like to turn the conference over to Mr. Fairbairn. Please go ahead sir.

Good afternoon and thank you for joining us today. With me are Charlie Eddy, our Chief Financial Officer, Luke Marusiak, our Chief Operating Officer, and Verle Aebi, President of our Photonics Technology division. After Charlie reads the Safe Harbor Statement, I will give a progress report on our second-quarter activities and then Charlie will walk you through second-quarter results and talk about our updated expectations for 2005. We will then open up the call for questions. Charlie?

During the course of this conference call we will comment upon future events and make projections about the future financial performance of Intevac, including statements related to projected revenue, gross margin, operating expense, other income, profitability, earnings per share, cash flow, capital expenditures and depreciation. We will discuss the impact of perpendicular reporting and small form factor disks on demand for our equipment. We will discuss our low light imaging products, their projected applications and market size, and when we believe production deliveries will commence. These forward-looking statements are based upon our current expectations and actual results could differ materially as a result of various risks and uncertainties, including without limitation the possibility that markets for our products may not be as large or develop as quickly as projected, that we may not be able to develop and deliver new products and technologies as planned, that orders in backlog may be cancelled, delayed or rescheduled, that we may fail to achieve expected financial results, and other risk factors discussed in documents filed by us with the SEC, including our Form 10-K and Form 10-Q. The contents of this August 1st call include time-sensitive forward-looking statements that represent our projections as of the date of the call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of the call without our express written consent is strictly prohibited. Kevin?

Thank you, Charlie. We are pleased to report excellent second-quarter results. Revenues increased to 30 million from 11 million in the previous quarter. To achieve this, we significantly increased 200 Lean production and were able to deliver one more system than originally planned. We delivered a much higher level of stairs and upgrades than forecast. And more importantly, we achieved reduced 200 Lean costs relative to last year. These excellent operational accomplishments, along with the sale of the technology license related to our flat-panel equipment, resulted in 3.9 million of net income, or $0.19 per share, which significantly exceeded our beginning-of-quarter expectations.

Orders for the 200 Lean continued strong. We exited the quarter with 65 million in backlog. And since then we have received additional orders for six more 200 Leans. Our factory is now producing at the rate of one system per week and is almost fully booked through the end of the year. The majority of this backlog is scheduled for 2005 delivery and positions us for significant growth in revenues compared to 2004.

More importantly, in Q2 we demonstrated that we had been successful on our material and labor cost reduction activities, which have lead to higher gross margins and will enable us to significantly improve our financial performance relative to 2004.

Since the beginning of Q2, follow-on orders have been received from each of our four 200 Lean customers. We also received orders for two more of our legacy MDP-250 (indiscernible) media manufacturing systems for production capacity expansions of already qualified products. These systems are scheduled to ship in the second half.

We also sell disk lubrication systems which deposit a thin lubricant layer onto the disk following processing by the 200 Lean. These systems sell for about $250,000 each. In Q2 orders were received for five of these systems for delivery in 2005.

Demand for hard drives continues to be robust with emerging consumer applications continuing to grow rapidly. Hard drive companies continue to report positive outlooks for their businesses. We continue to see orderly (ph) investments in additional capacity. Our first customer to take delivery of 200 Lean systems in 2004 continues to lead in 2005 in terms of number of systems ordered. Our other three 200 Lean customers are in the early stages of deployment. Based upon their plans, we expect they will buy more systems in 2006 relative to 2005, and will lead to an ongoing growth in our equipment revenue. The transition to perpendicular technology will be the key driver for new business in 2006.

The majority of capacity buys to date are configured with 20 available stations, consistent with the needs of perpendicular media technology, but (indiscernible) enough of those stations are populated with the process hardware necessary to support legacy longitudinal media manufacturing.

In 2006, we expect to ship systems mainly configured in perpendicular format. This will result in higher average selling prices per system. Some upgrade business is also expected to convert 200 Leans in the field from longitudinal to perpendicular formats.

Building the field engineering capability to support this large growth in business continues. We are busy establishing new field offices in China and Japan, plus expanding our existing operations in Singapore. We will continue to expand the capability of the 200 Lean with the addition of automated loading of small form factor disks such as are used in products like the iPod. The market for small form factor disks is forecast to grow quite rapidly and could increase our served market by as much as 25% over the next three to five years. This new small form factor disk module will be available in 2006 and will further increase our average selling price.

Positive progress continues on gaining market share through concentrating on the largest vertically-integrated customers and achieving penetration of follow-on orders from them for our 200 Lean systems. When we have won business, it always follows a head-to-head competition with our competitors' system, which we have won on each occasion to date.

We reported in the last conference call that we have an active program to sell the IP associated with our D-Star flat panel sputtering equipment product line, which we no longer market. We are pleased to report that we sold our first non-exclusive license which positively impacted our Q2 results. Work continues on the sale of further IP licenses with active negotiations in progress with a second potential licensee.

There is one remaining D-Star flat-panel deposition that was delivered to an R&D customer in 2003 and is still pending customer acceptance. We are closer to achieving customer sign-off but are reluctant to forecast this long-awaited event until we have the customer acceptance and final payment in hand. This system will not contribute any gross profit upon revenue recognition and is excluded from our revenue guidance for 2005.

In imaging, progress continues on development of our next generation low light video cameras for head-mounted night vision systems. This market segment has continued to grow in size with significant recent buys by the U.S. Army of legacy and interim night vision products. The estimated size of the U.S. Army night vision business is over $400 million per year for today's legacy night vision goggles, and is representative of the market size to be expected when the transition to video-based night vision is made.

Last quarter we reported completion of the development of a custom CMOS imaging chip to enable significantly-enhanced performance relative to our previous low light sensor that used a standard commercial CMOS image chip. This new sensor is targeted at the military head-mounted night vision market. Prototype cameras using this new sensor have been demonstrated to the Army and to our NATO customers with initial results confirming the significant performance improvements. We are on schedule to deliver preproduction cameras with this new sensor to our customers in Q3 and begin low-rate production shipments in mid 2006.

We also devised the NightVista 2 camera for non-military activities using a less exotic version of the sensor. The NightVista 2 is a 1.3 megapixel digital video camera with significantly better low light performance than the first-generation NightVista product. A beta version of the NightVista 2 camera has been delivered to a commercial customer and is now under evaluation. NightVista 2 product release is planned for this quarter with product shipments beginning later in the year.

We were very pleased to receive international recognition for our extreme low light sensors at the Soldier Technology Conference held in Brussels in June. A panel of program managers of the major soldier modernization programs in the U.S., UK, France and other NATO members recognized Intevac's EBAPS low light level sensor as the most innovative product of the year for its combination of extreme low light performance, small size, light weight, and low power consumption, which are key to enabling next-generation digital head-mounted night vision systems.

Good progress was also achieved in Q2 on our near infrared physical science camera product. This product continues our strategy of leveraging our military imaging technology for significant commercial applications. This camera uses a version of our LIVAR sensor customized to meet the needs of the scientific imaging market. A prototype camera was completed in Q2. We expect to complete product and manufacturing regiment testing in Q4 and start initial deliveries of this product by year-end. We estimate a $30 million potential yearly market for this product and its derivative products.

Charlie Eddy will now discuss the financial results. Charlie?

Thank you, Kevin. As I talk through the highlights of the second quarter, I'll also comment on expected third-quarter financial results and our expectations for 2005.

Consolidated Q2 revenues totaled 30.4 million. Equipment sales of 20.3 million included six 200 Lean systems and three disc lubrication systems. The 28 million of equipment sales was higher than our beginning-of-quarter guidance as a result of delivering one more 200 Lean for revenue than anticipated, higher than forecast turns business of upgrade spares and service, and the flat panel equipment IP license. The 2.1 million of imaging revenues was as expected at the beginning of the quarter, largely derived from R&D contracts.

As of the first six months of 2005, we have recognized seven 200 Leans for revenue and our order backlog of 66 million at the end of Q2 includes orders for 15 systems. Subsequent to the end of Q2, we received orders for six more systems. 27 of these 28 systems currently in backlog are scheduled for delivery and revenue recognition in 2005. These 27 systems include 21 200 Leans and six MDP-250s.

For the third quarter we're projecting consolidated revenues of 35 to 39 million. Our projected revenue includes eight to nine disc manufacturing systems, seven disc lubrication systems, and imaging revenue about 10% higher than Q2. The range of eight to nine systems is due to one of the nine systems being scheduled for delivery on the last day of the quarter, which creates some risk of slippage into early Q4.

For the full year, we expect consolidated revenues in the range of 124 to 130 million. This range corresponds to shipping between 27 and 28 systems for revenue and includes 9 to 11 million of imaging revenue. It does not assume any additional sales of technology licenses or include the flat panel system that Kevin discussed earlier.

Q2 consolidated margins were 31.8%, which included a 33.4% gross margin in equipment and a 9.2% margin in imaging. Equipment gross margin of 33.4% was positively impacted by the sale of the flat panel technology license along with the higher than anticipated level of revenue. We expect consolidated gross margin to improve in the third and fourth quarters to the 33 to 35% range.

First-quarter operating expenses of 6.1 million were also lower than our beginning-of-quarter expectations of 6.9 million. Lower prototype expense and engineering and a slower pace of hiring than forecast were the primary reasons for the lower FX. We expect operating expense of approximately 7.5 to 8 million in Q3 as a result of higher spending for equipment, research and development, field operations and projected provisions for employee profit sharing and bonus plans, which are tied directly to our profitability. We expect full-year operating expense to be in the 28 to $29 million range. Growth in OpEx is being driven by the establishment of new field offices in China and Japan, expansion of our existing field operations in Singapore, development of our new equipment product line, and provisions for employee profit sharing and bonus programs.

Our Q2 net profit of 3.9 million, or $0.19 per share, was better than our beginning-of-the-quarter expectations of zero to $0.03 per share and was driven by the higher revenues, gross margin and lower expenses that we discussed earlier. The 3.9 million net profit consisted of a 4.6 million operating profit in equipment, a 1.3 million operating loss in imaging, a 113,000 operating profit in corporate, and 423,000 of other income, plus $3000 for taxes.

For Q3 we're projecting a further increase in net income and are projecting earnings per share in the range of $0.21 to $0.29 per share. Our net operating loss carryforward, which totaled 30 million at the beginning of the year, will shelter us from any significant income tax expense this year. Accordingly, we are planning on a 2005 tax rate of 2.5% of net income.

For the full year 2005, we are projecting capital spending of 4 to 5 million and depreciation of 2.5 to 3 million. We closed the quarter with 42 million in cash and liquid investments compared to 43 million at the beginning of the quarter. We expect that cash and investments will continue at about this level during Q3, again, increasing in Q4.

Accounts receivable of 22 million was unchanged from the beginning of the quarter. Overall our receivables are in excellent shape and turning over in a timely fashion. With this cash flow on no debt we remain well capitalized to execute our business plan for 2005.

Our headcount at the end of the quarter totaled 318 employees, up from 273 employees at the beginning of the quarter. The majority of the increase was in operations. 101 of the 318 employees are contractors. The majority of these contractors work in operations as part of our strategy to maintain a flexible workforce that can respond to rapid changes in demand.

This completes the formal part of our operation and, Miles, we're ready for questions.

(OPERATOR INSTRUCTIONS). Rich Kugele, Needham & Co.

Excellent quarter. Can you give us a little bit of color on the actual amount of the licensing fee on the flat panel side?

Rich, the license was -- let me first preface it; it was a very restricted license. We sold non-exclusive rights to one of our patents and it added about 1.5 million in revenue and about -- the D-Star activities added about 1.4 million in gross profit.

The total number of potential people that could be licensing this technology; is it significant or is this kind of a few one-offs we'll see over the next few years even?

The potential is maybe one or two more.

Back to the equipment side, do you expect any legacy 250B systems in 2006, or have we pretty much made our point with the 200 Lean and we'll move past that?

We believe that in 2006 there will be 200 Leans.

Lastly here, the current media tightness is well understood and documented. Can you provide some color on when you believe supply constraints may become more in balance, based on your own shipments, backlog and understanding of your competition?

We look at the projected growth in the market, which people are saying about 20%, and we just do a very simple cost (ph) down. We see that the capacity buys for equipment seem to be in line with what is needed by the market.

So some time between now and the end of '06 we should wind up being more in line? Is that what you are suggesting?

I don't think things are that far out of line. I think this industry tends to be fairly tight with its capital expansions, which is good for us in terms of we don't want to see a big overshoot.

Mark Miller, Hoefer & Arnett.

Congratulations on a good quarter. I would like to talk about of your four customers, have any of these customers placed orders with your competitor or they're only buying from you?

I think historically some of them have bought from our competitor.

You said you expect a significant rise next year, and I just want to understand. Did you say three -- you expect three of the four current customers to post larger number of unit orders, or was it all four?

We said that three of those customers this year are just taking a few 200 Leans and that their plans call for a lot more tools next year.

Final question. Last week on a conference call, Maxtor indicated it was still there plans to at least produce the early stages of perpendicular on existing equipment. Is anybody else leaning that way?

I wouldn't be surprised if some people don't do that, and you have to remember if you do perpendicular on the 250B, you're roughly half of throughput. So given that the industry is operating near capacity, that will mean they'll just have to buy more equipment for capacity.

I forgot one other thing. We essentially have this tremendous media shortage. Are you seeing any companies asking to pull in orders?

We had one customer this quarter, but I would say in general we're not seeing a panic buying; it's very orderly.

Is this normal? Because that strikes me as odd for everything we have been hearing about the media shortage. What has been your experience there in similar times?

My prior experience was in the semiconductor world where DRAMs were notorious for undersupply oversupply. But it's very difficult to bring on a complete media package or a media line in a number of months. And that's why I think we're seeing our customers plan out their activities over the next year.

Kevin Hunt, Thomas Weisel Partners.

I had a couple of questions. Can you talk about maybe the breakdown of shipments of the -- I think you still have six 250Bs in there. When are those going to ship Q2 -- Q3 versus Q4? Correct me if I'm wrong, but you shipped three louvers (ph) this past quarter and seven more. That is getting to be a pretty significant number. Maybe you can talk a little bit more about what the potential for shipping more louvers could be going forward.

Let's see. The 250Bs, they are probably split 50-50 between Q3 and Q4, the six remaining ones. The louvers to the extent they need to add capacity, it tends to be more or less, I think, one louver per 200 Lean. And in some cases they have capacity and they don't add. But I think as they've been adding capacity, that's why we have seen more orders.

One other question. You had pretty good numbers in terms of the margin side of things this quarter. It sounds like you are going to be up a little bit on the expense side the next two quarters. Can you talk about maybe like longer-term where you think you can kind of get to on an operating margin, assuming we are at kind of, as you said, a significant increase in revenues for maybe next year and the year after? Could we be 15%, 20%? Some kind of general ballpark of where you think you can operate.

Well, we're currently -- in the second half I think our revenues are probably getting a little bit ahead of our OpEx, so we might even get a little bit ahead of the operating model that we have been telling people about. (indiscernible) the goal we had for this year was to get to 34% gross margin and 20% OpEx. I think we will probably do a little better than that on OpEx this year. We're right in the range it looks like in gross margin. So I think as you go out longer-term and we start transitioning into the new product, and maybe we get a little more experience on the 200s, we would like to keep working the margins up. Over a couple of years we would like to see the margins be another 10 points higher and draw a portion of that to the bottom line.

Jesse Pichel, Piper Jaffray.

Great quarter. Congratulations. Of the total 200 Leans you have shipped from the very first tool last year, how many are perpendicular equipped? And then, how much is the revenue to bring a 200 Lean up to perpendicular readiness? And three, of the 200 Lean orders in your backlog, how many of those will be perpendicular ready versus perpendicular equipped? I think you know the line of my questioning; if you could just discuss that.

This is really off the top of my head. I would guess three to four systems are perpendicular configured, and then mainly for pilot line R&D. In terms of increase in average selling price, it can be anywhere from 300 to $600,000 depending on how close the configuration was that they used for longitudinal to what they'll need for perpendicular.

Of your backlog, how many systems there will be perpendicular ready -- perpendicular equipped?

Maybe three or four.

Three or four in backlog?

In our current backlog, but that could change.

So three or four in your current backlog, and then three or four to date have shipped with perpendicular readiness?

Right, but those were not for production; those were mainly pilot line R&D type systems.

But they could be moved into production without further equipping; is that right?

All the tools that we've shipped could be switched to perpendicular in one shift; it's just a question of a customer having adequate sources and the correct sources available.

Could you discuss a little bit about for an OEM what their cost per aero density looks like to go perpendicular versus advanced longitudinal?

If you look at just the capital costs it's about $0.25 per disk. And what we did when we went from the 250B to the 200 Lean, even though the average selling price went up -- because for a perpendicular system we increased the throughput so that the net result for our customers is they're going to pay about the same money per disk and from a capital perspective. There be a small increase related to some of the additional material they use in perpendicular, but I don't believe it's a large amount.

And what's your thoughts there on the head technology, or what the incremental costs are there?

I'm not the right person to answer that.

(OPERATOR INSTRUCTIONS). J.D. Abouchar, Pacific Edge Investments.

Congratulations on a great quarter. I guess my first question would be of the four customers, roughly speaking, what market share do they hold of the hard drive market, and what customers are potentially out there that you could still land?

Roughly speaking it is over 60%. And the customers that are still out there are the ones which are -- the ones who later move into perpendicular. We made a decision to focus on the leading customers in terms of where they were in terms of their R&D spending and their capital spending, and then effectively work our way down the list of customers.

And when you talked about the ASPs on the 200 Lean going up for next year as more people order perpendicular-ready systems, is that roughly in the 3 to 600,000 increase that you were talking about earlier?

About that ballpark, yes.

And then shifting to the night vision area. You talked about the IR opportunity in the science camera. And you specified or sort of ballparked a $30 million (indiscernible) there. How did you get such a precise number? Is that something we'd actually see revenues on in '06?

No, that's what we project that market will grow to based on the input we have had back from the OEM that we would be selling to. This is a totally new capability. No one has ever had this level of sensitivity in the near IR. And this would be used in the spectroscopy market.

So that's something that we could actually see production revenues on in '06?

No, we would expect to grow revenues in that area over the next three years.

Should we look at sort of the whole night vision segment as roughly about 2 million plus or minus a quarter? And that's sort of the base R&D revenue run rate. And then products, when and if they come, would add to that?

That's a pretty good way to model it.

Macon Rudasil (ph), Keane Capital Management.

Nice quarter. I just had a question. From time to time you've talked about another product that you have not really wanted to release that's in a different market that you haven't wanted to release. Is there any more evolvement on that front, a little bit more about that type of product, or the industry that that product could potentially target?

We continue to be somewhat quiet about that product line. What we have said is it's a wafer-related application that is not part of mainstream semiconductor production. We really don't want to give heads up to any of our potential competitors that we're developing a product for this emerging market. We would expect to ship tools in the early -- in the first part of 2006, with revenue recognition coming in the second half of 2006. And you know, eventually we hope this application develops into a similar size market to our current served market in the hard drive industry.

Another question. I guess it's been speculated from time to time that at some point you would like to diverge these businesses between hard drive and military. Is that still -- I mean, it's not said that's exactly what you want to do. But now that these businesses begin to evolve, anymore color on that front?

I think it's premature on the imaging business. I think there's a tremendous latent value there, but I think we need to bring this business closer to maturity before we entertain those thoughts.

Sanjay Puri (ph), Walker Smith (ph) Capital.

Nice job. Can you guys talk about -- could you just talk about kind of on the perpendicular side over the next maybe 12, 24 months where you think buying patterns will be? Meaning, do you think we will experience a significant ramp-up in mid '06 by a lot of the hard disk drive guys, or is it kind of the latter part of '06? I guess I'm just trying to get a handle on how you think about your business evolving on the perpendicular side over the next 12 to 24 months.

We believe that most of the tools we ship next year will be perpendicular configured. And as we have said, we expect a significant increase in our revenue next year, maybe of the order of 20 to 30%. The industry will, obviously, have to eventually completely transition to perpendicular. And that's going to take them three years. So initial start this year; then we have 2006, 2007, 2008.

Greg Weaver, Kern Capital.

Great job on the gross margins. Just curious if I'm doing the math right. So on the equipment side, your gross margins this quarter was about 29%, and you're anticipating it going to 35-plus in the September quarter?

I don't think you're doing the math right. You're asking me to cite a non-GAAP number, which I can't.

But the 1.4 million went in the equipment bucket, right?

It did. Make sure you take it off the equipment margins, not the consolidated margins.

Is there a difference in gross margin between the 250Bs and the 200 Leans now?

Yes, the 250Bs are legacy products, so they are pretty good gross margins.

(OPERATOR INSTRUCTIONS). Mark Miller, Hoefer & Arnett.

I thought your largest customer had accounted for a good percentage of orders and shipments of the Lean tool. In fact, by my calculation, they (indiscernible) come close to buying enough capacity in these tools to where they were at in the end of 2003. Is your feeling that these orders are going to decrease or stay the same over the next couple of years?

We think they're going to stay the same.

Just curious about the other four customers. Have they purchased the competing tool from Anava, all four of them, which would be the 30-40 (ph) tool -- either purchased, installed or ordered these tools?

At least three of them in the past have had Anava tools, and a couple of them may have also had 30-40s, which have -- obviously they have made the decision to go with the 200 Lean, which obviously is very positive for us and shows that they perceive the 200 Lean as better value than the 30-40s they already have.

I am confused now. We have four customers who have purchased 200 Lean. There are four other customers out there of the eight. Right? There's eight or nine total customers? So four customers have purchased 200 Lean. Is that correct?

Correct.

And the other four are possible candidates, or are they going the other way?

The other four are possible candidates. As I said in the conference call, every time we have gone to a direct head-to-head data-driven decision, the 200 Lean has won on each occasion to date. But there are customers out there that have bought our competitor's tool who have yet to seriously evaluate the 200 Lean.

Rich Kugele, Needham & Co.

One quick follow-up. Have you had any traction now that the 200 Leans have been well established for over a year in getting some service revenue on that, anyone signing up for contracts on the service side?

I will let Luke answer that one.

It's Luke. We actually got our first major 200 Lean service contract in Q2. However, no growth in this business requires transitioning the customer from a long history of doing it themselves. But the new clients, the new Greenfield manufacturing sites offer us a good opportunity to grow this part of our business.

Do you have to add additional staffing to support that service business, or do you think you have enough people today?

As we ramp up our global service and logistics in support of the tools going in right now, that will give us the opportunity to leverage that into service. So we plan to take what we are tasked to do for installs, and then transition that.

(OPERATOR INSTRUCTIONS). Gentlemen, I have no further questions on this end. Are there any closing remarks?

Thank you for joining us today. We look forward to updating you on our Q3 activities. Thank you.

Ladies and gentlemen, we appreciate your joining us today. This does conclude our Intevac 2005 second-quarter results teleconference. You may now disconnect.