Intevac Inc (IVAC) 2008 Q2 法說會逐字稿

Welcome to the Intevac's 2008 second quarter results conference call. (OPERATOR INSTRUCTIONS) 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 Jeff Andreson, our Chief Financial Officer; Luke Marusiak, our Chief Operating Officer and Joe Pietras, our Vice President and General Manager of Intevac Photonics. After Jeff reads the Safe Harbor statement, I will give an update on our recent activities with Joe providing additional details on our progress in Intevac photonics. And Jeff will discuss the second quarter results and provide our guidance for the third quarter and full year 2008. We'll then open up the call for questions. Jeff?

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 orders, projection rates, shipments of our products, revenue, gross margin, operating expense, other income, profitability, tax rate, earnings per share, cash flow, capital expenditures, depreciation, 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 bit pattern media recording and product development plans. We will discuss the status of our Lean Etch semiconductor manufacturing product and other new product development programs. We will discuss our plans for our photonics business, projected applications and anticipated orders and shipments.

These forward-looking statements are based upon our current expectations and actual results could differ materially as the result of various risks and uncertainties, including without limitation, the possibility that markets for our products may not be as largely developed as quickly as projected and that we may not be able to develop and deliver new products and technologies as planned; that orders and backlogs may be cancelled, delayed or rescheduled; that we may fail to achieve expected cost reductions, tax rates or financial results; that the auction rates security market recovery is delayed 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 28th call include time sensitive, forward-looking statements that represent our projections as of the date of this call. We undertake no obligation to update the forward-looking statements made during this conference call. Any redistribution of this call without our express written consent is strictly prohibited. Kevin?

Thank you, Jeff. We are pleased to report better than expected results for the second quarter. Revenues totaled $32 million with four 200 Lean shipments in the quarter. Our net loss was $937,000 or $0.04 per share, which was $0.10 better than the high end of our guidance. Our results include stock-option expenses of $1.6 million or $0.05 per share.

Our highlights for the second quarter include our first 200 Lean Gen II revenue as an evaluation system, shipped during the first quarter, was accepted earlier than we had forecasted. We also shipped a second Gen II evaluation system in the quarter, which means we have now placed Gen II evaluation systems with two of our three major customers. We announced the acquisition of Oerlikon Group's magnetic media deposition business, which we have now closed. As Joe will expand upon later, our imaging instrumentation business has been renamed Intevac Photonics, which saw another record revenue quarter for Q2 and made significant progress on new products for ongoing business growth.

So far in the third quarter, we have received a purchase order from a new customer for a Gen II system that will ship in early 2009. And, finally, this morning we announced that hard drive industry veteran Dr. Mike Russak has joined our management team responsible for equipment business development.

Mike was the president and CTO of Komag for seven years. His career extends more than 30 years and we're delighted to have Mike on board.

Let me update you on the fundamentals of the hard drive industry and explain its impact on our business outlook. The world's need for affordable data storage continues to grow rapidly. iSuppli is reporting a 21% year-to-year growth in hard drive unit shipments for Q2 and projecting a 17% increase for 2008 over last year.

This is impressive considering the current economic headwinds. The industry has a long history of double digit growth, even in difficult times with the exception of 2001, when the tech bubble burst.

Growth in hard drives is a key driver for our business, as the industry these days invests just in time for capacity. Given the seasonal nature of hard drive shipments, customers ideally want new capacity installed in the first half of the year to support peak production rates in the second half, which causes lumpiness in our revenues.

Instruction of new technologies can cause changes to this ordering pattern and accounting rules such as SAB101 can impact quarters in which revenue is recognized. As we expected, 2008's been a slow year for new system capacity additions in the hard drive market, in spite of the significant growth in hard drives year-over-year.

The primary reason for this has been the upgrade and reuse of approximately 20 of our legacy tools, which at this time last year had been sitting in storage. These upgrades of legacy tools have substantially met the incremental capacity requirements of one of our largest customers.

You may remember that during the second half of 2007 and the first quarter of 2008, we had record levels of revenue from upgrades. While the upgrade business delayed the purchase of new systems in the short-term, over the longer term these upgrades will result in more revenue for Intevac.

The upgraded legacy tools produced about 40% fewer discs per year compared to our 200 Lean Gen II and are incapable of producing the world's most advanced highest capacity discs. We believe these systems will need to be replaced in the next two to three years.

While the second half of 2008 is soft, we believe 2009 will be significantly better than 2008. Our customers are experiencing increasing pricing pressure in the market as they compete for market share. This typically has little impact on the media unit volumes provided the underlying demand remains intact. In fact, lower prices can lead to higher volumes.

I do look forward to 2009. Industry analysts estimate media demand is over 1.2 billion discs or 17% growth over 2008. Intevac customers manufacture about 65% of the world's media and in order to meet this incremental demand, we believe our customers will need to add a significant number of 200 Lean Gen II systems in the first half of next year.

Further, one of our customers recently announced closure of their California media manufacturing facility. Replacing this capacity will require about eight Gen IIs.

We have another customer who this year started the process of replacing their legacy tools with 200 Leans and has indicated they will continue to replace tools in 2009. Therefore, we're optimistic about the growth of our hard drive business in 2009. Beyond 2009, growing capacity needs and the ramp in patterned media are expected to further drive growth.

Let me explain about this upcoming media technology change. Media technology changes are a positive for our business. The change to perpendicular media technology in 2007 drove a significant ramp in our business in 2006.

We have another major change coming called patterned media, which will require new manufacturing steps. There will still be the magnetic media deposition steps on our existing 200 Lean products; however, this step will now be followed by two new steps.

The first step is lithography to put down resist track patterns on the discs. We've developed a new system called litho prime to deposit a priming film on the disc before it goes to a third party lithography tool. We will ship our first litho prime evaluation system in Q3.

The next step is the etching and planarization of the resist patterned hard disc. This will be done on a second 200 Lean system that will incorporate etch, resist, strip and planarization sources to support this new process step. We expect patterned media will begin ramping in the 2010 to 2011 time scale.

The good news is that this technology can potentially double the market for 200 Lean systems as it requires discs to be processed through two 200 Lean equivalent systems compared to one system today. Our goal is to start shipping 200 Lean etch-capable systems for R&D and pilot use in 2009.

Earlier this month, we closed the acquisition of Oerlikon's magnetic media deposition business, which we believe is a beneficial transaction for the hard drive industry. Oerlikon developed some compelling source in sputtering cathode technologies.

We are currently working to integrate their knowledge and IP in order to enhance the capabilities of our own systems. We will make available Oerlikon developed sources for our large and installed base of legacy and 200 Lean systems, as well as new systems. We're supporting all of Oerlikon's media installed base worldwide.

Under the terms of the acquisition, we disposed of the litigation that would have cost an estimated $5 million to bring to conclusion. We have yet to include the incremental revenue due to this acquisition in our 2008 forecast as we are in the initial phase of integration.

Regarding our Lean Etch program, sharply falling memory chip prices have put our prospective Lean Etch customers into a state of turmoil. This has made our progress in shipping our first Lean Etch evaluation system frustratingly slow. We remain optimistic about our prospects in the semiconductor etch market and continue to make progress with the world's leading memory companies.

We have a tremendously talented etch team here at Intevac and we continue to move some of these resources over to patterned media etch development, thus reducing our spending on the lead etch program. There is still a possibility that we'll ship a Lean Etch tool before the end of the year although with higher uncertainty due to the significant reduction in memory chip capital spending we are currently witnessing.

Finally, earlier this month we announced a 200 Lean Gen II order that will ship in early 2009 and we are very pleased to report that this tool will go to a new Intevac customer for their R&D use. I will now turn the call over to Joe to comment on the second quarter progress of our Intevac Photonics business.

Thank you, Kevin. In June, we renamed our imaging instrumentation business to Intevac Photonics. Over the past two years, we've broadened our product lines to address a wide range of applications in the photonics industry.

Intevac Photonics groups together our three business units of cameras and sensors in Santa Clara; DeltaNu Raman Instruments in Laramie, Wyoming; and Intevac Vision Systems, formerly Creative Display Systems, in Carlsbad, California. Through Intevac Photonics, we will increase our branding of products that serve the multibillion dollar defense and commercial imaging and instrumentation markets.

I am pleased to report that Intevac Photonics achieved record revenues of $6.4 million in Q2 with product revenues at a record $2.4 million, or nearly 40% of our revenue. In the first half of 2008, our product revenues have doubled over the same period last year as we continue to grow our photonics business through increasing product sales and strategic acquisitions.

Our military digital, night-vision business continues to strengthen. In Q2 we continued delivering production levels of our digital night-vision camera module to Sagem, our NATO customer and expect to double our delivery rate by the end of 2008. We are also delivering a notable number of camera modules to US military customers for development of several ground and avionics digital night vision applications. We expect to receive our first low rate production order for two US military applications in the second half of 2008.

During Q2, we completed successful demonstrations of our next generation digital night vision sensor to multiple branches of the US military that are funding its development. We expect this advanced sensor to be applicable in a wide range of US military applications.

In addition, we continue our efforts to expand our digital night vision business into value-added goggle products. Our development of the digital enhanced night vision goggle or DENVG continues with our partner, DRS Technologies. We're on track to deliver prototypes of an enhanced performance DENVG design to the US Army for field testing in the second half of 2008.

We expect to continue advancing our design to support the US Army in deploying DENVG, which will have a sizeable initial production award valued at $150 million over three years. Using our core technology at Intevac Vision Systems, we're also developing an advanced digital night vision goggle product, which we expect to market in late 2008 as a complete night vision systems solution to multiple opportunities in ground and avionic applications.

In our commercial business, we are increasing our focus on product opportunities with volume-based applications, especially those involving DeltaNu Raman instruments. In Q2, we successfully delivered and demonstrated prototypes of a compact Raman reader to a major medical products company for use in a specific diagnostic application, an opportunity expected to contribute up to 20 to $25 million in revenue over the next several years.

We are also developing a hand-held Raman system for a major company involved in the remote detection of chemicals for security applications, an opportunity we estimate can grow to 5 to $10 million per year by 2010. Our strategy to expand our commercial products business is key to our growth.

In the near term, however, it is the commercial side of the business that is being affected by the current economic slowdown. So our growth in 2008 won't be quite as strong as we had estimated at the beginning of the year.

However, we are making significant progress in our photonics business and pursuing opportunities totaling about $250 million over the next four to five years. I will now turn the call over to Jeff to discuss our financial results for the second quarter and our outlook for the third quarter and full year 2008.

Thank you, Joe. Consolidated second quarter revenues totaled $32.1 million and included four 200 Lean systems. Photonics sales were $6.4 million and consisted of $4 million of contract R&D and $2.4 million in product shipments.

Q2 consolidated gross margin of 41% was within the beginning of quarter guidance. Equipment gross margins decreased to 42% as compared to 47% in the prior quarter as the mix of upgrades was far lower in quarter two. Gross margin was down compared to 43% in the year-ago period due to the lower number of 200 Leans sold during the quarter.

Photonics gross margins decreased to 35% from 42% in the first quarter and from 39% in the year-ago period as a result of the lower factory utilization in our Vvision Systems business, formerly Creative Display Systems, as we continue to ramp this recently acquired business. Q2 operating expenses of $15.8 million came in better than guidance and 9% lower than the year ago period.

We continue to tightly manage our expenses in response to the current business environment while ensuring we don't impact the future growth opportunities. Our 2008 tax rate is forecasted to result in a net tax benefit for the year and this quarter resulted in a net tax benefit of $955,000. Q2 net loss totaled $937,000 or $0.04 per share. The net loss included $1.6 million of pre-tax, stock-based compensation expense equivalent to $0.05 per share.

Our backlog decreased to $27.7 million at quarter end, down from $43.5 million at the end of quarter one. Backlog included four 200 lean systems as of our quarter end and includes five tools as of this call. Now I will discuss the balance sheet.

Cash and equivalents decreased to $116 million or approximately $5.35 per share from $125 million at the beginning of the quarter primarily as a result of our growth in working capital. Our investment portfolio at the end of Q2 included $78 million in student loan backed auction rate securities.

All of our investments continue to be rated AAA. In early June, we had a $3 million security called at par and continue to see refinancing securing in the marketplace. In quarter one we determined and reported that a temporary impairment exists and recorded a charge to "Other Comprehensive Income" of $1.6 million or 2%. No additional impairment was recorded in quarter two.

Our expectation is that the market will correct over the next 18 months and as such have concluded this is a temporary impairment. We established a line of credit to borrow against these securities if needed, but currently do not anticipate borrowing as we have adequate cash to support the business.

Capital spending totaled $933,000 in quarter two. Depreciation and amortization including DeltaNu and CVS purchase accounting amortization totaled $1.2 million in quarter two. Our headcount, at the end of the quarter, totaled 490 employees with 8% being temporary employees.

I will now provide our guidance for the third quarter and full year 2008. We are projecting consolidated Q3 revenues of 24 to $28 million, which includes four 200 Lean revenue shipments. We expect second quarter gross margins in the range of 30% to 33%.

The reduction in gross margin is a result of a higher mix of systems versus technology upgrades, and low factory utilization in the remainder of the quarter. Operating expenses are expected to remain in the range of $15.5 million to $16.5 million. Other income and expense will be approximately $800.000, reflecting lower interest rates. For Q3, we are projecting losses in the range of $0.20 to $0.25 per share, which includes an estimated $1.8 million of pretax, stock-based compensation expense equivalent to $0.05 per share as well as an anticipated net tax benefit.

For the full year, we're lowering the range of our 200 Lean system shipments from 12 to 16 down to 11 to 12 as one of our major hard disc customers has elected to delay capacity additions to 2009. Our industry lead times enable our customers to add capacity closer to the peak production period.

We now expect Intevac Photonics revenue to be in the range of 25 to $30 million for 2008, which is less than our beginning-of-year guidance but will still result in year-over-year growth in the range of 30% to 60%, which represents strong performance in light of the current economic conditions.

Our projected full year consolidated revenue guidance is $115 million to $125 million, which brings down the low end of our beginning-of-year guidance of $120 million to $150 million. We expect gross margins to average 41% to 42% for the full year remaining in the same range as previously guided.

We are guiding operating expenses lower in the range of $63 million to $65 million and other income primarily interest income on our cash of approximately $4 million. Our forecasted 2008 tax rate will result in a net tax benefit for the year.

The net tax benefit for the year will be in the range of $4.5 million, at the high end of our guidance to approximately $5.5 million at the low end of our guidance. For the full year we expect a loss in the range of $0.15 to $0.30 per share, which includes an estimated $6.6 million of stock-based compensation expense, equivalent to $0.18 per share.

Our acquisition of Oerlikon's magnetic media business closed in July and the financial impact has not been included in our guidance as we'll be completing the acquisition accounting as well as business integration occurring during the quarter. This completes the formal part of our presentation. Operator, we're ready for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from Bill Ong.

Good afternoon, gentlemen. I have a question on the Oerlikon magnetic acquisition. Can you just talk about the incremental market opportunity by acquiring this business as you already have a pretty substantial market share on your Lean tools? And also maybe prior to the acquisition, how many tools did they plan to ship this year for evaluation? And just get some insight on the business in '08 with this acquired business.

Hi, Bill, this is Kevin here. We see the incremental opportunity coming from some source technology, which they had developed and we were still in the process of developing. Those sources can be put on the 200 Lean as well as the 250B.

In particular, they have one source, which is used for R&D development, that we've had requests over the years to develop. Now we can make that source immediately available.

In terms of incremental system sales, we don't see any benefit from the acquisition. They had placed two eval systems but the customers were looking at them more from a point of view of understanding the capabilities of the tool rather than incremental sales. We expect those tools -- we'll be bringing those back.

As a follow-up, since using them as a sourcing opportunity for your Lean systems, does that give you some R&D cost savings maybe down the road?

Yes it does. We saw two areas for cost deferment. One was the legal costs which we estimated at $5 million. And then there was a series of engineering projects that we will no longer have to do or things that we expect the customers would have asked us to improve based on what they saw on the race track, which is the Oerlikon system, which we can now just move across without spending engineering money.

That's great, thank you very much.

Your next question comes from the line of Mark Miller.

I would just like to follow up that a little bit more on the Oerlikon purchase. So, it's basically the sputtering cathodes. I'm just wondering if you'd give us a little bit more. Is it they're more efficient? Does this save the customer money? Is there less down time?

There's a series of sources that they have. As I mentioned, they had one source which is used for R&D, not for production, which we've had multiple requests over the past couple of years to make available on our systems.

In terms of their regular source technology, it's not clear yet that they had any advantage in terms of efficiency but they had done some things which made changing targets faster which all of our customers would benefit from. And they had one source that was in qualifiation with one of our customers that we'll be able to pick up that qualification trail and, obviously, if that goes to production, get revenue on that.

Just wondering with the new customer, can you give us any color what caused them to look at you now as opposed to the past. Was it an improvement or dissatisfaction with the old supplier?

None of the above, Mark. It's -- we're covered under an NDA so we can't say who the customer is, unfortunately.

Okay. Thank you.

Your next question comes from Hongyu Cai.

Thank you. A couple of questions please. First of all, could you talk a little bit more about the decline in your gross margin both in the equipment and imaging business, and how you expect them to trend in the next few quarters?

Okay. We'll have Luke talk to the question concerning the equipment and Joe will give you the answer relative to imaging.

I'll address the equipment side of it and just want to talk a bit about our first half margins. They were generally high because of the high mix of technology upgrades and the spare shipments versus the system shipments in the first half.

These are forecasted to decline from the first half levels as we see systems business become a larger percentage of the mix. But it's important to note with the exception of the factory utilization impact we're not seeing any erosion in margins.

On the imaging side, it's really attributed to some low factory utilization in our Vision Systems products. We expect to see that recovery -- some of that delay was due to programs that pushed out about a quarter and we're starting to see some of those orders materialize in Q3. We expect to see some recovery here in Q3.

Okay. Thank you. And then our latest update from CDNWD indicates that both are concentrating their CapEx on tests and assembly, instead of media. Could you share your view on that?

You may have more details than we have. All well can comment upon is that everybody is forecasting significant increase in media growth year-on-year and capacity in our opinion continues to be fairly tightly managed. So we believe there will be significant opportunities for us in 2009 on the media systems.

Okay. And last question. Your guidance for the test credit for the full year increased from $2 million to $4 million to $4.5 million to $5.5 million. Is it just because of higher operating loss you're expecting or is there any other explanation for that?

No it's just the fact we've taken our guidance, tightened it up in the range and we have a higher operating loss in the US.

Thank you very much.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Rich Kugele.

Thank you. Just a few questions. I guess first, can you give us a sense at least directionally or percentage-wise how much more the Gen II costs over the Gen I and whether or not we should be assuming that starting, pick the time frame, that in early '09, that all of the shipments will ship as Gen II?

Hey, Rich, it's Jeff. Specifically your question was how much of the cost change versus our say, Gen I tool. They're up a little bit. The plan is to have ASPs up between 4.5% and 5% for that tool. Gross margins would once we ramp them to volume will be much like the Gen II if not a little bit better. We expect mostly Gen IIs going forward.

Okay. And then should we assume that all of the 20 legacy old Maxtor tools will be fully deployed and utilized by the end of calendar 2008?

That would be a good assumption.

And I was trying to think back to a time when someone could have ordered an R&D system and never ordered a production. Your history goes longer than mine. Is there any precedent for that?

Unfortunately, Rich, we can't add any color to this one. We're under an NDA.

Okay, Just last question on upgrade business; obviously, a pretty big step down for this next quarter. Do you think as new systems get ordered in 2009 that that will offset some of the upgrade business, that they will just be buying new?

You're probably talking about will they upgrade to Gen IIs or buy new systems. I think at this point we're not sure exactly the path that each customer is going to take. But usually in the first half of the year is when the customers do do a lot of upgrades beyond the Gen II-type of upgrades. Sources, et cetera.

The other thing, Rich, in 2009 we expect -- seeming we're successful developming these new modules for the 200 Lean, to either sell a significant number of upgrade modules for 200 Leans for patterned media or sell actual systems configured for patterned media. So, that's something that wasn't in the mix for 2008.

We expect to be shipping some of those Oerlikon sources as well which customers are making the requests right now. We're doing the homework to see how we would provide those sources.

Okay. One other question on Oerlikon. Is the plan to talk about the integration revenue costs et cetera on the next earnings call or will you be putting out something along the way?

Hey, Rich, if it's materially, we'll update you but right now I don't think we expect it to be too material at this point at least the next month and a half or so.

Hey, Rich, I wanted to add color to your upgrade question. I just wanted to point out that every Gen I is a potential upgrade opportunity because it can be upgraded to Gen II. And there's a pretty significant installed base out there, as you know.

Okay, that's great. Thank you.

(OPERATOR INSTRUCTION) You have a followup from the line of Mark Miller. Mr. Miller, your line is open.

Yes, I'm just wondering how far -- when you say significant opportunities, do you think -- in relationship to what? You think the first half of next year you'll see a significant pickup in either orders or shipments of your tools over what we saw year-over-year?

That is our belief right now based now in where we see the capacity in the industry and what's needed to support the peak productions in the second half of 2009.

The building -- just want to go through the opportunities or what you mentioned on the call. You're talking about upgrades or systems for patterned media. There was these legacy tools from another shop that need to be upgraded and then the generic growth in the industry. Is there anything else that would lead to significant opportunities?

Clearly, gaining traction with our etch product would lead to additional revenues as well although we're talking equipment right now. On the imaging we believe there's a lot of opportunity for continuing growth as well.

All right, thank you.

Your next question comes from the line of Peter Wright.

I have two questions. One, could you comment on whether the Seagate closure of their California media plant is positive, negative or neutral? And two, would you, going into '09 would you think '09 is more like a calendar '07 in terms of the tools business or more like calendar '08?

Okay, it's a good question. The first question is we definitely think it's positive for our business because our understanding is that Seagate is either going to make up that capacity in the Woodlands, which would be more 200 Lean orders or get it from their media supplier, which is also an Intevac customer. So, we see it as positive. In terms of which year is a closer surrogate for 2009, then we think 2007 is more clearly aligned.

Great, thank you. And any comments on the etch business? Do you have a drop-dead date? Do you have any kind of contingency plan if things don't accomplish your objectives?

We continue to look at this very closely on an ongoing basis. And our assessment is right now it's still a very attractive proposition and we're still very well-positioned.

But as I said in the call, we're all frustrated by the slowness of getting a tool out there. But we understand the memory customers are in a downturn right now and until they sort themselves out we're not going to get a tool in there but that market will recover as it always does. This is not the first time the semiconductor memory market had a big downturn.

Finally could you give an estimate where you think cash might be after the closure of the acquisition, let's say, by the end of September, just approximately?

We don't guide the balance sheet but we don't see it dropping down all that significantly. In fact, we shipped a bunch of tools that were pretty much manufactured in quarter two. That capital or the working capital growth we helped to spin back.

Is the acquisition closed?

The acquisition is closed.

Was it closed by June 30th?

No, it was closed in July.

How much was that?

We're not disclosing that actually. But it was not a material transaction so it is less than 10% of our total assets. That will give you the top end.

You ended up with what, $147 million or something? Cash?

$116 million in cash.

$66 million and $80 million? Including your long-term investments?

No, no, cash and all investments were $116 million, Peter.

$116 million? And you're comfortable it will be above $100 million by the end of the quarter, in most normal business environments?

That's a good assumption.

Okay. Let's call it, hopefully, a conservative assumption.

Yes.

Thank you.

There are no further questions at this time.

Okay, I would like to thank you for joining us today and we look forward to updating you in our next call on our Q3 results. Good-bye.

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