Intevac Inc (IVAC) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Intevac's 2007 second quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Please note that this conference call is being recorded today, July 30, 2007. Kevin Fairburn, Intevac's President and Executive Officer, is hosting the call today. I would now like to turn the conference over to Mr. Fairburn. Please go ahead, sir.

Good afternoon and thank you for joining us today. With me are Charley Eddy, our Chief Financial Officer, Joe Pietras, our Vice President and General Manager of our Imaging Division and Jeff Andreson, our Executive Vice President of Finance. Luke Marusiak, our Chief Operating Officer, is currently on business in Asia. After Charley reads the Safe Harbor statement, I will give a progress report on our second quarter activities and then Charley will work you through second results and talk about our expectations for 2007. We then open up the call for questions. Charley?

During the course of this conference call, we will comment on future events and make projections about the future financial performance of Intevac, including statements related to projected orders, production rates, shipments of our products, revenue, gross margin, operating expense, other income, profitability, tax rate, earnings per share, cash flow, capital expenditures, depreciation and stock-based compensation expense. We will discuss projected demand for hard drives, our 200 Lean system and upgrades. We will discuss the impact of upgrading legacy tools, the transition to perpendicular recording and product development plans. We will discuss our new Lean Etch semiconductor manufacturing product, its projected available market, its competitive advantages and why we believe Intevac can successfully enter this market. We will discuss our plans for military and commercial low-light imaging products, the expected market sizes for these products, projected applications and anticipated orders and shipments 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 develop 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 me way fail to achieve expected cost reductions, tax rates 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 July 30 call include time-sensitive forward-looking statements that represent our projections as of the date of the call. We undertake obligation to update the forward-looking statements made during this conference call. Any redistribution of the call without our express consent is strictly prohibited. Kevin?

We are pleased to report our second quarter results which were at the midpoint of our revenue guidance with gross margin and net income exceeding guidance. Revenues totaled $72 million as delivered 12 200 Leans. We achieved GAAP net income of $11.6 million, or $0.52 per diluted share. Results included $1.3 million of stock option expense, equivalent to $0.05.

Two major milestones have occurred since our last conference call. On July 17 at SEMICON West, we formally launched our high productivity technology enabling Lean Etch system for semiconductor manufacturing. We believe entry into this market can help us achieve significant future growth.

Secondly, we achieved export approval from the U.S. government to ship our digital night vision modules to Sagem our NATO customer. Sagem is under contract to deliver night vision systems for headmounted and rifle site applications to the French Army as part of the FELIN Advanced Combat Suite Program. We expect over $50 million of revenue from this program over the next seven years.

Over the last three years, we have grown our hard drive equipment business revenues by over 600% as customers added capacity to meet the increasing demand for disk drives and transition to perpendicular media technology. The first half of 2007 has been quite strong, however, in the last few weeks our outlook for the remainder of 2007 has been negatively impacted by two factors. First, the recent announced acquisition of Komag by Western Digital had caused one of our customers to delay orders until the impact on the OEM media market is fully understood.

Second, another customer decided to use the [limpid] set of their legacy tools for producing first generation perpendicular media, which also results in a delay of expected 200 Lean orders. I will talk in more detail later on the market dynamics as we see them today.

Last quarter, I indicated that given the uncertainties in the hard drive market, that we were driving the business with one foot on the accelerator and one on the brake. We will see later in Charley's financial update that we are stepping on the brake and bringing our expenses down in order to adjust the order push-outs we're seeing in the near term.

Our new Lean Etch semiconductor manufacturing system was well-received at SEMICON West. It addresses the pressing need of semiconductor manufacturers do significantly lower their production costs while providing leading-edge process performance. The initial application focus is 45 nanometer dilectric etch and beyond, but Lean Etch can also be used for larger features. Lean Etch was designed with the same lean thinking principles we utilized in the 200 Lean to lower our customers' cost of manufacturing hard drive media. The six-chamber Lean Etch system can process up to 200 wafers per hour which provides a 200% increase in throughput relative to cluster pools in the market today. This results in a 45% improvement in expensive clean room space utilization.

Lean Etch also has universal etch capability extendable from dielectric etch today to silicon and metal etch in the future for both critical and noncritical applications. The served available market for etch is estimated to be about $3.2 billion per year. The Lean Etch system's mainframe can also be used to address those types in the deposition market with the development of a deposition chamber. The (inaudible) deposition market is estimated to be $4.8 billion which increases the size of the market addressable by the lean mainframe to $8 billion per year.

There are a number of reasons why we think we can succeed in the semiconductor equipment market against the existing competitors. Major customers typically have a multi-etch supplier strategy as there can be 250 to 350 etch systems in a large fab. They look to create competition amongst their suppliers to advance the state-of-the-art for technology and lower their cost of manufacturing. The Lean Etch addresses the customers' critical needs to reduce production costs while providing leading-edge process performance. Our engineering and technology team have developed many of today's successful semiconductor products in their prior careers at companies such as (inaudible). They've created more than 200 patents at these prior companies. They are proven innovators who know how to address customer's needs.

Our operations and business development teams also have extensive experience in the semiconductor equipment industry. We know the large potential customers and how to support them. We've proven over the last few years that we can ramp manufacturing of a complex product and support large customers. We're building on a sound business foundation developed supporting our hard drive customers and are well capitalized with a strong balance sheet to pursue this opportunity.

Our product qualification activities continue with leading memory customers. In the last conference call, I mentioned that we were making modifications to our process chamber to enable improved future etch process [extendability]. These changes came as a result of our development activities for the leading semiconductor manufacturer. We're in the process of requalifying the modified chamber design through demos with the customer. We will complete process (inaudible) to ensure the chamber system and is stable for our customers' manufacturing environment. We expect to complete these activities through the remainder of this quarter and possibly into early Q4. We will then be in a position to ship the first beta tools for customer qualifications. This slated, and we first project that -- however, our system is now more technology competitive as a result of these process chamber modifications. We expect first revenue recognition for the Lean Etch in the second half of 2008 and have set an aggressive goal of up to $50 million in shipments.

Now I will turn back to the hard drive market. The mood of the hard drive market has improved compared to this time last quarter. Recent quarterly reports from Seagate and Western Digital have been more upbeat. The latest reported growth of almost 13% year-on-year for PCs was higher than expected. Macro trends for increased consumption of hard drives have not changed. Digital video recording, Vista-related PC sales, expansion of emerging country markets, high-definition TV, backup and archiving of personal content and other growing consumer-related applications are all growth drivers for hard drives.

This growth in hard drives in turn drives our equipment business today. The migration to perpendicular magnetic media continues to be a factor driving our growth. Assuming that we maintain our existing market share and that the legacy tools are all retired, we estimate that the market will need to purchase approximately 125 our 200 Leans from 2008 through 2010. Some customers are extending the life of their legacy tools by using it for first generation perpendicular media production. The impact to Intevac of these legacy upgrades is additional upgrade revenue in the short-term and a lengthening of the upgrade cycle for new equipment. In aggregate, this leads to more revenue for Intevac as the upgrades cost as much as $1 million per system. This activity has driven the increase in nonsystems orders for this year.

Indications from some of our customers are that the extensions of life of the legacy tools will be limited to one generation, or about 12 to 18 months. A situation is now occurring in the industry that may accelerate the retirement of the legacy tools. In Q2, Samsung announced the highest density hard drives in the market for desktop and mobile using media manufactured on 200 Leans. A 200 Lean should always be able to manufacture better media than the legacy tools because it does not have to compromise any film specs to maintain productivity. Samsung's action will prompt others to improve their technology to remain competitive.

A further factor that may hasten the retirement of legacy tools is that the hard drive industry has to continue to rapidly improve their performance to cost ratio to slow the encroachment of Flash memory into their market.

The Komag acquisition is causing short-term uncertainties for other merchant media suppliers. Komag's business at Seagate, Hitachi and Samsung is up for grabs, assuming these customers continue to outsource some or all of their media needs. Our merchant media 200 Lean customer appears to us to be in a good position to pick up market share as they have comparatively less Western Digital business to lose than they stand to gain as a result of Komag's exit from the merchant media market. They also have the same advanced media deposition 200 Lean systems as their potential customers. In addition, they have the highest entity media currently announced in the market. Clearly increased market share for our customer is good for our business.

So while the short-term uncertainties brought on by the industry consolidation are slowing all the momentum in 2007, the long-term impact can be a net positive for Intevac.

Switching to Imaging. In our Imaging Instrumentation business, we continue to transition from a contract R&D-based business to a product-centric business. Revenue from product sales totaled 30% of our first half 2007 revenue compared to 17% during the first half of 2006. We continue on track double our business year-over-year.

The approval we received to export night vision camera modules Sagem, our NATO customer, was at an increased performance level, similar to currently exportable U.S. night vision and analog sensors. We started delivering modules at this increased performance level and expect to complete the delivery of a total of 700 preproduction units by the first quarter of 2008. Production deliveries are expected to begin in 2008. We expect to deliver over 30,000 camera modules over seven years to this customer as a value in excess of $50 million.

The U.S. Army has funded Intevac to continue the development of our technology for the digital enhanced night vision goggle [DENVG] program. Intevac received funding (inaudible) the higher frame rate, increased resolution and longer range sensor. Additionally, we expect to receive orders for our sensor modules from other [DNVG] development teams. We still expect the U.S. Army to initiate DNVG preproduction in 2010.

We received funding from a major defense contract to develop our next generation LIVAR 500 long-range target identification camera. Delivery of prototypes are scheduled for early 2008 with preproduction deliveries expected later in the year. This program can expand into multiple platforms representing an opportunity in the tens of millions of dollars per year.

Orders for our commercial products were strong, including a record number of MOSIR near infrared cameras, as well as our DeltaNu Raman instruments products. We expect continued growth in our commercial business as we expand our distribution capabilities by adding a U.S. direct sales team. In addition, this quarter, we expect to begin delivering a high performance Raman instrument, the Advantage 1064, which uses our proprietary near infrared sensor technology. The Advantage 1064 will provide new capabilities and materials identification to various scientific and industrial markets.

As a result of ramping production for our NATO customer, increasing sales of our commercial products and continuing contract R&D work, we expect rapid revenue growth and profitable operations for our Imaging business during the second half.

Before turning the call over to Charley, I want to take a moment to thank him for his exceptional contribution to this Company. Charlie has been with Intevac for 16 years, ever since the buyout from [Varian], and he has been instrumental in building our strong financial foundation and relationship with the investment community. In May, we announced Charley's retirement plans and this will be Charley's last earnings conference call with Intevac as he retires in two weeks.

Six weeks ago, Jeff Andreson joined Intevac to succeed Charley as CFO and we are delighted to have him on board. Over the last 12 years, Jeff has held a number of senior finance positions within applied materials where I first worked with him as did a number of my staff. We're confident that he has the background and industry experience to provide sound financial leadership through this next phase of Intevac's growth. Charley and Jeff have been working closely together to ensure a seamless transition of the CFO role. In fact Charley, will continue to work with Intevac on a part-time basis after he retires.

With that, I hope you will join us in welcoming Jeff in his new role and expect to hear his voice in our Q3 results conference call. I will now turn it over to Charley to discuss our financial results for the second quarter.

Thank you, Kevin. Consolidated Q2 revenues totaled $72 million, included 12 200 Lean systems. Imaging sales of $3.6 million consisted of $2.5 million of contract research and development and $1.1 million of product shipments. Second quarter consolidated gross margin of 43% was above our beginning of quarter guidance. Equipment gross margins increased to 43% from 36% in the year ago period. Increased volume, product mix, cost reduction programs all contributed to the increase.

In Imaging, gross margins grew to 39% from 25% in the year ago period. Imaging gross margins benefited from higher margins and R&D contracts and an increasing mix of product sales. The second quarter operating expense of $17.5 million was significantly less than our guidance and 11% less than the prior quarter. We expect to make further progress reducing operating expenses in the second half.

We reduced our 2007 estimated tax rate to 26.9% from our initial estimate of 31.6%. Given that we get a relatively fixed benefit from our R&D tax credits, the tax rate has dropped consistent with our lowered expectations for 2007. We made a year-to-date adjustment in the rate, so our Q2 results include a $676,000 credit to Q1 tax expense, equivalent to $0.03 per diluted share.

Net income for the second quarter totaled $11.6 million, or $0.52 per diluted share, included $1.3 million of stock-based compensation expense equal to $0.05 a share. Our order backlog totaled $57.5 million at quarter end and includes four 200 Lean systems. Partially offsetting the week bookings for 200 Leans were record bookings in Imaging and strong orders for spares and upgrades in Equipment.

During the third quarter, we expect to ship the four 200 Leans currently in backlog and a record level of spares and upgrades. We also expect Imaging to achieve record revenues and significantly reduce their quarterly loss. [Quarter] (inaudible) we're projecting consolidated Q3 revenues of $48 million to $52 million. We expect third quarter gross margin of 43% to 45%, operating expense of $16.5 million to $17.5 million and other income of approximately $1.5 million.

In Q3, we're projecting earnings of $0.18 to $0.24 per diluted share, which includes an estimated $1.6 million of stock-based compensation expense equivalent to $0.06 per share. For the full year, we're projecting revenues of $210 million to $220 million, and shipment of 29 200 Leans. Imaging revenues of $20 million to $22 million are included in the above projection.

We expect gross margins to average 42% to 43% for the full year, we expect operating expenses of $68 million to $70 million. We expect other income, primarily interest income on our cash, of approximately $6 million. For the full year of 2007, we expect between $0.85 and $0.95 of GAAP earnings per share which includes an estimated $6 million of stock-based compensation expense equivalent to $0.20 per share.

Cash and investments increased to $117 million from $114 million at the beginning of the quarter, the result of strong profits and a reduction in inventory, partially offset by an increase in receivables. Our receivables are in current and good shape from a collections perspective.

First half capital spending totaled $3.4 million. First quarter depreciation, including DeltaNu purchase accounting amortization, totaled $2.2 million -- sorry -- first half amortization. For 2007, we have reduced our projected capital spending from $14 million to approximately $10 million. We expect full-year depreciation and amortization of approximately $4.5 million.

Our headcount at the end of the quarter totaled 466 employees, down 11% from the 525 employees at the beginning of the quarter. 30% of our employees are now based in Asia. [About] 12% of our employees are contractors who primarily work in operations.

This completes the formal part of our presentation. Operator, now we're ready for questions.

(OPERATOR INSTRUCTIONS). David Bailey, Goldman, Sachs.

This is Min Park calling on behalf of David. Just a couple questions please. Beginning with your Lean 200 orders, apart from the four orders in backlog, can you tell us what the pipeline looks like maybe in December or as we turn the corner for the new year?

In the hard drive industry, Q3 and Q4 are the kind of peak quarters for outputs, and typically we find our customers [wait for the] understand what that demand is, and they projections as to what it's likely to be in the following year. They start making their plans for systems. So whilst we have all our customers with internal plans which are shared with us indicating they're going to be wanting systems early '08, until we get orders, they're just plans. I don't know of that helps.

Okay, and you said you expect to see some stalling on orders mainly because of what your general staff position of Komag. When do you expect Seagate and Hitachi to start accelerating orders again? I mean, obviously it's still early in the game, but have they given you any qualitative expectations?

My comment about the delay caused by the Komag acquisition didn't relate to those two [firstly] integrated customers, it really related to our customer who is a merchant media supplier who currently has business with Western Digital. And obviously until they understand how the market's going to shape up after the acquisition, they are not sure how many systems they're going to need. So that was the push-out there.

Do you expect Seagate or Hitachi to accelerate their orders then, now that they have become more vertically integrated?

Well, I think that's what everyone is waiting to find out how this all finally settles out, because as Seagate and Hitachi continue to outsource the same percentage of their business, and then it's obviously going to be competition between [Sheradenko] and Fuji for that business. Or, they could decide to go more vertically integrated, which would obviously be positive for us, assuming they continue to buy the same tools as they currently use in production, which is 200 Lean.

One last question. I think you said for, 2007 you're looking for full-year revenue around 210 to 220. Is that correct?

That is correct.

So looking at the midpoint of your September quarter target, that is around -- your target is around $15 million to $20 million for December?

Yes. If you do the math, you've got a number in that range.

Why do you -- we understand the push-outs in the 200 Leans, but with the tools and the spares being sold, why do you expect the revenues to decline so dramatically in that quarter?

It's primarily the absence of any system shipments.

Great, thank you very much.

Richard Kugele, Needham & Co.

Thank you. A few questions. If orders come in before the end of the year, how quickly can you ship? Are you in process with any of these systems that have been pushed out, and they're similar on your balance sheet, or any comments there?

We only order materials for tools as we get orders. We're continuing to stay in very close contact with our customers in case there is any last-minute ordering as people maybe underestimate what they need for the year. So, we still have time to ship systems, we just don't have any orders right now.

I do believe that the customer you're referring to was in the process of actually replacing equipment to go and upgrade to the Lean versus their older tool set. Do you know how far they had gotten through that?

They were still on track to do that. My understanding these new tools were required for some perpendicular products which they got qualified on. Now there's some uncertainty whether they will -- that product will be required by Western Digital.

Okay. Any comments on where you think the industry is in its transition to perpendicular, how far along we are?

Rich, you probably know better than I do because you listen to everybody's conference calls. But it seems like -- from our perspective, it seems to be accelerating. You have probably gathered from when you do your calculations that we have a lot of non-system order business, and that's principally upgrades for perpendicular.

Okay. Just lastly on the semi-cap product, obviously the main area of focus for investors today. The original expectation was you would probably ship to one major guy for evaluations first and then to the others. In this delayed time frame, are you now planning on shipping to multiple at the same time for eval?

We always plan to ship to at least three major customers around the same time frame, maybe separate them by a month or two.

So the first two or three will get it before the year end?

That is still our goal.

Because did the other guys also ask for these changes, or are you just going to offer that to them as the fully changed product?

We will offer that with this product to everybody, and I think everybody will appreciate the improvements we've made.

And now that you have kind of unveiled it at SEMICON West, was there any sense of what the competitive reaction might be to this solution?

We have certainly seen no response so far.

Okay. All right, thank you very much.

Kevin Hunt, Thomas Weisel Partners.

Thanks. A couple of follow-up questions. Actually one was on the R&D numbers came down I think lower than what you kind of guided to and lower than what they had been. What's going on there? You just had enough expense on the semi-cap tool, and now that's kind of tapering off, and should we think about that going forward being sort of steady?

One, we put the brakes on OpEx as best we could and it's total OpEx coming down. But we have not slowed down anyway on the Lean Etch development. We just did the best we could to control expenses.

And in terms of the disk drive equipment, any guess of when timing of when people will be able to sort through what their future plans are, I mean looking at it like at the end of the year before they do that or what --?

I would hope that -- I think Western Digital announced that they hope to conclude this Komag deal by the first of September, so I'm assuming in Q4, people are going to sort themselves out and come back to us with much clearer plans. Because the total end market for hard drives hasn't changed. It's how they're going to be produced and distributed that has really changed from our perspective on the media side.

You guys said $50 million now for the target for next year. How many units does that assume, and when you kind of realize that 100 million, I think you were expecting it to be earlier at that point, but when do you think the 100 million will be a reasonable target, an annual run rate for that?

I would certainly hope to be there the following year. Obviously where there's push-out of a limited number of systems, we can bring in and we can get to revenue recognition in the second half of '08. So that 50 million represents maybe three (inaudible) systems turning and seven to eight systems shipping have been signed off. So in the grand scheme of things relative to the number of Etch tools that are bought per year, it's a small number. But obviously for us, it's a significant number.

Thank you.

Mark Miller, Brean Murray.

Just wanted to confirm your EPS guidance, your GAAP EPS guidance for the year. It is now $0.89 to $0.95 -- is that correct?

$0.85 to $0.95.

Okay. And you're talking about for the full year shipping 29 Leans, which means that you're just going to ship the four remaining and not expect to see any more shipments or any more revenue recognition I should say than what you already have in backlog. Is that correct or incorrect?

That's correct.

All right, thank you.

Mark (inaudible) [Pipeline] Data.

Hi, guys, Charley, congratulations and happy retirement. It has been great working with you.

Thank you, Mark.

Just a quick question on the remaining backlog. If we take out the four Leans, there's still substantial backlog there. Can you give a little color into what that entails and how we can expect that to be recognized over the next two quarters or years?

As I said, we had very strong orders for spares and upgrades, so there's a much more than usual level of that backlog than we typically have at the end of a quarter. And then Imaging also had record bookings. So their number is becoming a little bit bigger portion of backlog than it has been in the past. The rest of it's the systems. You can look at the revenue projection, you can see a majority of that backlog will go to revenue in Q3.

Excellent. Jeff, you've got some big shoes to fill.

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

Charley, you were talking about trying to rein in expenses as much as possible. Where do you think the business has to run in order to support all of the development efforts for the Etch tool and the continuing improvements in the Lean and the Imaging? How far do you think you can go on expense cuts, because that's really how we're going to have to model '08, right?

I'm going to defer to Jeff on this one.

We think we can probably get down in a range of 35 to $40 million in revenue and still maintain spend level that will allow us not to impact our growth.

And, hopefully, we're not talking about this, but do you think in any realistic terms, but what do you think your breakeven than would be?

Somewhere in that range.

All right, thank you.

Mark Miller, Brean Murray.

Did you give us some guidance on the tax rate for the remainder of the year and the third quarter?

Yes, Mark. The tax rate is always the rate we estimate for the full year and we estimate it to be 26.9%.

Okay, for the full year?

Yes.

All right, thank you.

Kevin Hunt, Thomas Weisel Partners.

Actually I had a follow-up on the same thing. Any sense of what the beyond '08-'09 beyond? Are we still talking 35% for your full tax rate, or are you -- we don't know that yet?

I think the best thing to do is probably just if you take the rate we are currently using, the 26.9, I'd just use that going forward.

Okay, and do you a breakdown of the OpEx by -- I'm sorry, not the OpEx, but the stock options by line item?

You mean by whether it's OpEx or sales?

Yes.

It tends to be -- the lion's share of it tends to be in OpEx. There's generally just a little bit in cost of sales.

Okay, thanks, Charley, have fun on your boat.

Thanks.

(OPERATOR INSTRUCTIONS). You have no further questions at the time, Mr. Fairburn.

Okay, thank you for joining us today. We look forward to updating on our next call on our progress. Thank you.

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