Intevac Inc (IVAC) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Intevac's first-quarter 2006 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. At that time, we will provide instructions for those interested in entering the queue for the Q&A. Please note that this conference call is being recorded today, May 1, 2006.

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.

Thank you. Good afternoon and thank you for joining us today. With me are Charley Eddy, our Chief Financial Officer; Luke Marusiak, our Chief Operating Officer; and Verle Aebi, President of our Photonics Technology Division.

After Charley reads the Safe Harbor statement, I will give a progress report on our first-quarter activities, and then Charley will walk you through first-quarter results and talk about our expectations for the second quarter and 2006. We'll then open up the call for questions. Charley?

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 production rates, system shipments, revenue, gross margin, operating expense, other income, profitability, tax rate, earnings per share, cash flow, capital expenditures, depreciation and non-cash stock-based compensation expense.

We will discuss projected demand for disk drives and disk drive media, industry media manufacturing capacity, perpendicular recording, the advantages of the 200 Lean and other factors that affect demand for the 200 Lean. We will discuss our plans for military and commercial low light imaging products and projected applications and market sizes for these products.

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 developed as quickly as projected; that we may not be able to develop and deliver new products and technologies as planned; that orders and backlog may be canceled, delayed or rescheduled; that we fail to achieve cost reductions or financial results; 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 May 1 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?

We are pleased to report excellent first-quarter results, well above our prior guidance for revenue and net income. Revenues were $49.6 million as we delivered nine 200 Leans and three disk lubrication systems for three customers in the U.S. and Asia. Every system was configured for perpendicular media production. Orders for spares and upgrades were unusually strong and also contributed to the revenue upside.

GAAP net income was $7 million or $0.32 per diluted share, significantly better than our guidance of $0.16 to $0.24. Pro forma net income after excluding non-cash stock-based compensation expense was $0.34.

We set a new record for quarterly bookings, as orders for the 200 Lean continued on strong. Our backlog is now $125 million, compared to $84 million at the beginning of the quarter. The $125 million includes two 200 Leans that are scheduled for 2007 delivery.

In equipment, our operations team did a great job accelerating system delivery and non-system orders to achieve our revenue upside. We also strengthened our build and test processes, which led to reduced cycle times, higher build quality and smoother installations. These cycle times and process improvements are key to enabling an increase in our build rate beyond a system a week, which may be required later in the year.

We made great progress year to year on increasing gross margins by 16 percentage points, but our work is not finished. Our initiative to reduce costs by moving part of our manufacturing to Asia is on track. We have leased a larger facility in Singapore and expect to start manufacturing sputter sources there in Q3. We plan to transfer production of an increasing proportion of the 200 Leans to Singapore over time. While we intend to continue manufacturing in Santa Clara, our strategy is to expand our operations in Asia and defer expansion at our more expensive Silicon Valley headquarters as long as possible.

The demand for digital storage continues to grow at the transition from analog to digital in the business and consumer spaces shows no signs of abating. While there may be the occasional business hiccup that impacts the storage market, such as delays on Microsoft's new operating system impacting PC demand or a particular new games console using a hard drive, the underlying theme is the same -- more digital data and more hard drives.

The transition to perpendicular media continues with more hard drive use -- utilizing this technology announced this quarter. Perpendicular media enables higher memory densities relative to the longitudinal technology that the industry has used for years. Analysts project the transition to perpendicular to occur over the next three to five years. This is an important transition for Intevac because the large installed base of our legacy 250B media manufacturing systems is not well-suited to economically manufacture this new media technology.

Our latest product, the 200 Lean, is specifically designed to address the technology and economic requirements for perpendicular media manufacturing.

Our legacy 250Bs are limited to a maximum of 12 process steps, which is adequate for most longitudinal media. Efficient perpendicular media manufacturing can require as many as 20 process steps. The 200 Lean's modular architecture can support as many process steps as necessary for efficient perpendicular media manufacturing.

Our outlook for this year and beyond continues to be positive, and we are upping our guidance for 2006. All of our 200 Lean customers are executing on their plans to add additional perpendicular-capable capacity in 2006. The transition to perpendicular technology and the increased capacity needs are the prime drivers for growing our business. Today, we have a backlog of 25 more 200 Leans for delivery in the balance of 2006 and expect further orders for systems to be delivered in the second half of 2006.

We continue to refine our internal modeling on demand for our systems over the next three to five years as the end market for hard drives continues to grow and the industry transitions to perpendicular media technology. We expect the first legacy system replacements will begin in the second half of 2006. Our modeling indicates that legacy system replacement will accelerate in 2007 and continue through 2008 and 2009.

However, it is possible that our customers may continue to use their legacy tools at reduced productivity for perpendicular production, which would strain available capacity. It is still too early to accurately predict likely 2007 shipments. This will depend on factors such as overall end market growth, the number of new factories constructed, reuse or retooling of the installed base, market share changes for our 200 Lean customers, and their outsourcing strategies for media.

Seagate's acquisition of Maxtor is expected to close this month. Our assessment is still that the merger will have a neutral to positive benefit to Intevac as both companies use our systems.

Work continues on the sale of further flat-panel equipment to IP licensors, with active negotiations continuing with a second potential licensee. Potential proceeds in this activity are excluded from our 2006 guidance.

We are accelerating our efforts to develop new products and upgrades for our customers to enable ongoing revenue growth beyond 200 Lean system sales. We substantially enhanced our engineering and technology team through significant key hires in the first quarter. Our increase in operating expense reflects this investment. No significant revenues are expected in 2006 from these developments.

Progress continues in imaging on development of products for both commercial and military markets. Last quarter, we reported the start of a one-year program for the U.S. Army to develop a fused digital head-mounted night vision system for the soldier. This program is well underway, with successful completion of initial design milestones.

In this system, Intevac low-light imagery will be fused with imagery from our partner's thermal camera and displayed in front of the soldiers' eyes using their micro display. Prototype deliveries are scheduled for late 2006.

We also reported last quarter that two other major defense contractors had selected Intevac's low-light-level sensors for their digital head-mounted night vision products. Three additional defense contractors have now selected Intevac technologies for their digital head-mounted night vision products. These design wins are consistent with our strategy to position the Intevac sensor as the solution of choice for digital head-mounted night vision products in this over 400 million per year market segment.

First deliveries of our MOSIR camera were made in Q1. MOSIR is an extreme low-light near-infrared camera targeted at the scientific imaging and spectroscopy markets, which we estimate to be a 30 million per year market.

Work was also started on a development program for a major customer using our intensified photodiode technology. Our intensified photodiodes can detect single photons at very high data rates, which can enable applications such as space communications, spectroscopy and laser radar.

Charley Eddy will now discuss the financial results. Charley?

Thank you, Kevin. As I talk through the highlights of the first quarter, I will also comment on expected second-quarter financial results and our expectations for 2006. Our expectations will include projections on both a GAAP basis and on a pro forma basis that excludes projected non-cash stock-based compensation expense related to our employee stock option and stock purchase plans.

Consolidated Q1 revenues totaled 49.6 million, included nine 200 Leans and three disk lubrication systems. This was substantially above our beginning-of-quarter guidance as a result of recognizing one more 200 Lean for revenue than originally anticipated and stronger-than-anticipated sales of upgrades and spare parts.

Imaging sales of 2 million consisted of 1.5 million of contract research and development and 500,000 of product shipments. The product shipments included intensified photodiodes, our first MOSIR camera shipments, LIVAR cameras for target identification and night vision cameras for night vision applications.

First-quarter gross margin was 35% and consistent with our beginning-of-quarter guidance. Cost of sales included 46,000 of non-cash stock-based compensation expense, which had a minimal effect on reported gross margin.

First-quarter operating expense of 10.7 million included 382,000 of non-cash stock-based compensation expense, and was higher than our beginning-of-quarter expectations. The overage resulted from higher-than-planned prototype expenses related to the development of our new equipment product line.

GAAP net income for the first quarter totaled 7 million or $0.32 per share. This compares favorably to our beginning-of-quarter guidance of $0.16 to $0.24. 428,000 of non-cash stock-based compensation expense is included in these GAAP results.

Pro forma net income after excluding non-cash stock-based compensation expense was 7.4 million or $0.34 per share. 7 million of GAAP net income consisted of 8.5 million operating profit and equipment, a 1.9 million operating loss in imaging, $20,000 operating profit in corporate, 589,000 of other income, less 218,000 for income taxes.

Our projected tax rate for 2006 is 3%. The low rate results from utilization of net operating loss carryforwards and tax valuation allowances.

In 2007, we expect to be back to a fully taxed rate of approximately 35%. 35% rate is subject to a number of variables and may change as we obtain better visibility in 2007.

For the second quarter, we are projecting consolidated revenues of 50 to 55 million, which assumes recognition of 10 to 11 200 Leans for revenue. We are projecting second-quarter pro forma gross margin of 34 to 36%. GAAP gross margin will be about a half-point lower.

We are projecting second-quarter pro forma operating expense of approximately 11 million. GAAP operating expense will be approximately 700,000 higher. We expect other income to increase to approximately 700,000 as a result of interest earned on our increasing cash balances.

For Q2, we are projecting pro forma earnings of $0.30 to $0.40 per diluted share. GAAP earnings, including a projected 800,000 of non-cash stock-based compensation expense, should be about $0.04 lower or $0.26 to $0.36 per diluted share.

For the full year, we are raising our revenue guidance range from 160 to 180 million to 180 to 205 million, which assumes recognition of 34 to 39 200 Leans for revenue. The lower end of the guidance makes the conservative assumption that we receive no more orders for 200 Leans during the year.

We are projecting full-year pro forma gross margin of 34 to 36%. GAAP gross margin will again be about a half point lower. We are projecting full-year pro forma operating expense of 42 to 45 million. GAAP operating expenses will be approximately 3.6 million higher. We expect other income of 3 to 3.2 million for the full year.

Total non-cash stock-based compensation expense is projected to total 4.5 million in 2006, equivalent to approximately $0.19 per share. Capital spending and depreciation for the quarter totaled 1.2 million and 601,000, respectively. For 2006, we are projecting capital spending of approximately 9 million and depreciation of approximately 3.3 million. The majority of capital spending is in the equipment business and for IT infrastructure.

Cash and investments decreased to 46 million from 50 million at the beginning of the year. For the full year, we expect to generate enough cash from operations to fund all of our capital acquisitions and increase our cash position without resorting to debt or equity financing.

Accounts receivable grew to 58 million from 43 million at the beginning of the year. The growth relates primarily to customer advances from new orders that were invoiced late in the quarter. Cash balances have increased significantly during the early part of the second quarter as we've collected a lot of these receivables.

Our headcount at the end of the quarter totaled 401 employees, up from 362 at the beginning of the quarter. 93 of the 401 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 presentation. And, operator, we are now ready for questions.

(OPERATOR INSTRUCTIONS). Rich Kugele, Needham.

Needham & Co., thank you. First, can you just update us on what timing you can speak about regarding the semiconductor equipment product?

We have been quite consistent there that the earliest we will be shipping the product will be in the end of the year, and we're still not clarifying exactly what [marked out of them is wicker]-based.

Sure. Okay. And secondly, regarding the ASPs, Charley, were these mainly just to more highly configured systems going out the door, more stations? Or was it just a straight ASP increase because of your own ability to do so, or any color there?

Are you saying because of the revenue upside?

In the press release, you mentioned that ASPs were higher. I'm just interested about that.

Yes, I would say the ASPs are on the order of $4 million. And they are tending to trend up as the systems become more feature-rich. If you go back to when we first started shipping the 200 Leans, the ASPs were probably closer to 3.5 million. So there has been a progression with time. That seems to be continuing.

And then lastly, IDC recently raised their drive forecast for 2007, now looking for about 16% growth. Based on what you see in your conversations with your customers, do you think that having -- being short here on media probably exiting 2006, by most analysts' estimates, do you think that we can catch up enough to even be able to grow 16% in 2007?

Well, from an equipment perspective, we can always help our customers there. You'll have to comment on substrate availability.

Kevin Hunt, Thomas Weisel Partners.

A couple of questions. First, on the imaging, it looked like you had much better gross margins, and I'm assuming that's because you're shipping product there now. But can you give me any -- help us understand more the margin dynamics there? And also, on the OpEx lines, is it just you had a lot more hiring, of why some of those R&D and SG&A are going up?

Yes, in imaging, probably two things going on there. There was more revenue from products, which tend to be higher gross margin. And we really didn't have much in the way of programs where we were sharing the development cost. So I think that explains the big increase in imaging gross margin.

In terms of OpEx, we have been adding to the development team. We've been adding to the business development team related to developing the new product. We also, as we build successive versions of this thing, you can get fairly large numbers of material that get charged to the P&L. Probably generally, we forecast and it doesn't happen. And we surprise you favorably in OpEx. I would say this quarter, we probably went over our forecast a little bit. So you saw more of an uptick.

Okay. So is that 11 million-ish type of range -- is that what we should think about kind of going forward?

11 million is the guidance -- the GAAP 11 -- I'm sorry -- on a pro forma basis, the guidance I gave for Q2 is 11 million.

Is that going to be -- I mean, if we look out to the second half of the year, is there any reason to think that is going to change substantially, or--?

For the year, I said 42 to 45 million for OpEx for the full year.

And one last question. On the tax rate, you had mentioned now for next year going to like a fully taxed number? Is that because your net income is going up higher this year? Maybe you can kind of walk us through that tax implication again.

Well, what happens on tax, I think this year we're having a great year. And it will be the second year of making money. So it will be probably pretty hard for us to leave any of our valuation allowance on the books.

So probably the most likely scenario is at the end of this year, we will bring whatever valuation reserve is left back to the P&L and show it as a credit to the tax rate. And then we will just be accruing a normal tax rate going forward. So there might be some extraordinary good news, but we haven't tried to put that in the guidance.

Next year, figuring out the tax rate is pretty challenging, depending on whether you're thinking about it in GAAP or pro forma. And it is now very affected by all the stock option expensing. So 35% is about what our tax rate was historically, when we were accruing taxes. So that is a good starting point for thinking about next year.

Ming Yang, Piper Jaffray.

This is Ming for Jessie -- Jessie Pichel. Congratulations on a great quarter. A few questions now. Can you talk more about your activities you have for your new tool, and is that part of the reason why R&D was up Q over Q?

We'll be very circumspect about these tools that we're developing. But in terms of the higher R&D, yes, it was related to that.

And then -- so you're still expecting the tool to ship I guess toward the end of second half of this year?

That is our goal, to start shipping betas in the latter part of this year.

And then can you talk more about the status of your imaging product and also the size of the Army contract in particular?

I will let Verle comment on that question.

As we mentioned in the call, we have begun to ship our low-light-level imaging chip to a number of other customers. And our development program with the Army has been continuing quite well. Basically, the current plans with the Army are looking at 2009, 2010 timeframe for initial production.

The other factor, of course, will be the status of our shipments to our NATO customer, which is dependent upon achieving export approval from the State Department later this quarter or later this summer.

Then, basically, we would expect to see an uptick in imaging revenue and sales in 2007 based on the products we are developing this year, the MOSIR product and the HMD products.

Great. And then I guess, Charley, you said part of the revenue increase for the quarter was due to the upgrades?

Yes.

Can you kind of quantify that a little bit or let us see how you would move going forward?

We don't break the number out exactly. I can tell you that the historical run rate on upgrades on non-systems business was about 4 million a quarter. We were way ahead of that this quarter.

I think you can attribute that, one, to our installed base is growing. So there's more systems to sell parts into. Some of those dollars were for upgrading previously shipped systems to perpendicular configurations.

And part of it, if you look at kind of how we changed the guidance from last quarter to this quarter, at the high end, we have added -- we increased the number of systems from 36 to 39. We added $25 million to the high end of the revenue. So you can see there's -- we've thrown a lot more non-systems business in there. So I think that business is improving.

Jon Lopez, OTA.

Congratulations. I had a couple quick ones, if I could. The first one -- could you just repeat the explicit Q2 guidance that you offered on the line items?

Sure. We said that revenues would be 50 to 55 million, and that that assumed that there would be 10 to 11 200 Leans. We said that gross margin would be 34 to 36%, and that is pro forma gross margin. You take about a half of point off to get to GAAP gross margin.

We said that pro forma operating expense would be about 11 million. If you want to get to the GAAP operating expense, you need to add about $700,000. We said other income would be about 700,000, as compared to 600,000 in the current quarter. We said pro forma earnings would be $0.30 to $0.40 per diluted share. If you make the GAAP adjustment, then you need to take $0.04 a share off that number.

Terrific. My second question is, looking sequentially, if you guys do just sort of the midpoint of the guidance and your revenues are up sort of mid-single digits sequentially, the midpoint of your gross margin implies a modest downtick. And I'm curious if you could just talk through the factors that would -- I just assume with more volume, better utilization, etc., that you would see the gross margin continue to tick up with sales volumes. Why isn't that going to be the case next quarter? Or potentially not the case?

Gross margin is a function of a number of things. It's a function of the mix of systems versus non-system business. We've got a really big boost from it in Q1 on the non-systems business. It is a function of which customer we're shipping to. And margin structures aren't exactly the same. So I think you'll see some things jump around a little bit from quarter to quarter. But for the year, we think it is on the order of 34 to 36%.

Got you. The second question is just on the balance sheet, you had made reference to the receivables growing relative to the customer advances. I was wondering if you could just spend a second on that. It looks to me like your customer advances increased about 26% sequentially, but your receivables grew a little closer to 35.

Yes, we exited the quarter with a lot of receivables. Probably the biggest element in there was, you'll probably recall, we did a press release where we got an order for 11 systems. Later in the quarter, there was a big AR for the advance portion of that. We have since collected that. So I can tell you that the cash balances right now are dramatically up from where they were at the end of the quarter, as are the receivables balances.

So that pretty much explains the call it 5% sequential drop in cash -- most of it is just related to the receivable.

Yes, we have a lot of -- we have a few very large invoices. And the timing of when one hits or another hits can really kind of gyrate the numbers around. But the receivables are all in good shape, and they're all turning over. And I think you'll see us in Q2 with quite a bit more cash.

Got you. The third question is the inventory on customer site numbers decreased pretty meaningfully from December to March. And I was just wondering if you could talk to that dynamic. Why did that decrease so much?

We must've had a -- well, we obviously had a system that had been delivered that we hadn't taken revenue for, and I think we have none of those on the balance sheet right now. So this says everything that has shipped has gone to revenue.

If you have it -- like we had a situation where there was a system that had shipped with a new feature. And the feature was different enough where we didn't feel comfortable taking it for revenue on shipment. We wanted to wait until we got it installed and made sure it all worked. So that was the one that got deferred. It is probably the one you're looking at in the balance sheet.

Got you. And the last question, if you could just talk -- because I know you don't want to give specific numbers -- but as you think about 2007 from a shipments perspective, from your shipments perspective, you obviously have the positive trends that you guys discussed a little in the opening remarks. Offsetting that potentially is a number of your customers are operating at all-time high CapEx dollars and all-time high percentage of revenues devoted to CapEx this calendar year, or this fiscal year.

So I'm curious if you could just talk through some of the dynamics at play as you think about 2007 -- can it be a year of increasing shipments for you? And if so, just what are some of the market dynamics that could get you there?

Well, I think Rich Kugele in the first question highlighted that IDC had indicated a 16% increase in end market growth for hard drives. That always has an impact on our number of capacity tools that have to be purchased. Obviously, 16% is a good number.

The other factor is, as we've talked about, there may be the beginnings of a retooling of our old tools to perpendicular capable tools. That is the one factor that is the hardest to predict. So it is too early for us to give a definitive number on 2007. Obviously, we hope it is a very positive year.

(OPERATOR INSTRUCTIONS). Rich Kugele, Needham.

Just a couple more. What are your leadtimes on the upgrades? How quickly can you turn those around?

Rich, this is Luke. Usually, with most upgrades, we can turn those in a three- to four-month timeframe. So we were very successful, as Kevin mentioned earlier, in Q1 of taking orders and actually turning those and shipping them out within the same quarter. So three to four months is your rule of thumb.

So the upgrades actually have the same amount of leadtime as the equipment?

Generally the type of upgrades that have been requested, yes.

Okay. And any update to what your long-term overall Company gross margin range should be?

Sure, our interim goal for the disk drive equipment is to get our gross margin to 40%. And this is our number one operational objective. We've got numerous programs underway to reduce product costs, including our Singapore manufacturing initiative, the manufacturing and process improvements, and reducing costs to purchase materials. As these programs bear fruit, we will adjust our margin guidance accordingly.

And then just, Charley, last question. How should we think about -- after you subject out the -- in your guidance was, what, 10 to 11 machines for 2Q, the balance -- how should we think about how they could roll out in Q3 and 4?

I would say the current -- what we have is that it is a little stronger in Q4 than Q3. But our customers -- we're constantly doing scenarios with all our customers. And so at this point, I can't tell you that with absolute certainty. Our last forecast had a little more of the second half in Q4 than Q3.

So it is still the case that we should clearly be focused more on the year than the quarter?

We have a cyclical business. I think year over year, we're turning it -- however you look at it, it is going to be a great third year of big growth. But it is lumpy from quarter to quarter.

Michael Needleman, Ridgecrest.

I was wondering whether or not you could possibly just address -- on the imaging side of the business, I think I heard you say for the quarter that 1 million of it was from actual R&D and 500,000 was from production. Is that correct?

1.5 million from R&D and 0.5 million from products.

And how should we expect that line of business to look going forward? I heard about the 2009-2010 possibility as far as full production, but how should we look at that for the remainder of the year?

We have been very consistent that we're looking in the second half of this year to see a significant inflection point relative to product revenues and we expect that to grow through 2007 and beyond. As Verle mentioned, the NATO program for head-mounted -- if we get past export approval for that program, we could see some significant revenues in '07 for that particular --

Is that part of that second-half production ramp? Or is that above and beyond the second-half production ramp that you just mentioned?

It is above.

It is above, okay. And what do you need to do to actually get the export aspect signed off on?

We are working with the Department of Defense and the State Department to do exhaustive data correction on our cameras so that [several] standards can be established for export. And we expect that to happen by the summer.

Kevin Hunt, Thomas Weisel Partners.

A couple of follow-ups. You mentioned some other military projects that you had. Do those also have any kind of export issues that you have to go through?

No. Right now, our focus is on U.S. domestic programs until we resolve the export issues with this one NATO customer. So we're not pursuing other NATO customers right now. There are no issues.

And the other [question] I had was on the upgrade and spares activity. I don't know if you really -- I think you said something about this, Charley, but what was kind of driving that this quarter perhaps compared to some other quarters?

Well, I think there are a couple of things. The installed base of tools has grown. So we have more tools to sell upgrades to and spares. Second, some of the tools that we have previously shipped are getting -- although they were perpendicular-capable, they weren't configured for perpendicular. So we had -- we shipped a fair amount of product to help people convert, to have them be ready to do perpendicular production.

Okay. So that is something that we shouldn't, then, expect to be maybe at a higher level for a little while, anyway, as perpendicular kind of comes into --

Well, I think the whole level of -- you kind of analyze the changes in the number of systems and the changes in our revenue guidance. We have assumed a higher level of non-systems business than we did last quarter, as it's been -- it was very strong in Q1. It looks like it will still be pretty good in Q2.

There are no further questions from the phone lines. Will there be any closing remarks?

Well, thank you for joining us today. We look forward to updating you on our Q2 results during our next conference call. Goodbye.

This concludes today's conference call. You may now disconnect.