Intevac Inc (IVAC) 2010 Q3 法說會逐字稿

Good day and welcome to Intevac's third quarter 2010 financial results conference call.

(Operator Instructions)

Please note that this conference call is being recorded today, November 1, 2010. At this time, I would like to turn the call over to Claire McAdams, Intevac's Investor Relations Counsel. Please go ahead.

Thank you, and good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the third fiscal quarter of 2010 which ended on October 2. In addition to outlining the Company's financial results for the quarter, we will provide guidance for the fourth quarter and full year 2010. On today's call are Kevin Fairbairn, President & Chief Executive Officer; Jeff Andreson, Chief Financial Officer; and Joe Pietras, Vice President & General Manager of Intevac Photonics.

Before turning the call over to Kevin, I'd like to remind everyone that information provided in today's conference call contains forward-looking statements. During the course of this conference call we will comment upon future events and make projections about the future financial performance of Intevac. These forward-looking statements are based upon our current expectations and actual results could differ materially as a result of various risks and uncertainties relating to these comments 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 November 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.

I'll now turn the conference call over to Kevin Fairbairn. Kevin?

Thank you. Good afternoon, and thank you for joining us today.

We are pleased to report continued strong operational execution and financial performance in the third quarter. Revenues of $64.6 million met the high end of our guidance. We achieved a record high operating margin of 24% and exceeded our earnings guidance with $0.58 of net income per share for the quarter. We recognized revenue on eight 200 Lean systems with a ninth system expected in Q3 now scheduled for the fourth quarter. Contributing to the strong financial performance was a greater than expected mix of high margin technology upgrades, offsetting the rescheduling of one system and continued control of manufacturing costs and operating expenses. Today, I will provide an update on our hard drive equipment business and discuss the continued traction being achieved in our new equipment markets. Joe will provide an update on our photonics business and Jeff will discuss our financial results and guidance.

Firstly, in spite of the moderated hard drive forecast for the second half of 2010, we remain on track to deliver full year revenue and earnings in line with previous guidance. Recently there's been some debate concerning the long-term demand for hard drives driven by the initial success of the iPad as well as the advent of cloud computing. The situation is reminiscent of when iPod and other MP3 music players started using flash in 2005 and that this heralded the demise of the hard drive industry. Hard drive unit shipments grew 75% over the following five years, well dispelling that notion.

Our view is that while the world's hunger for digital storage continues to outpace growth in aerial density, there will be an ongoing growth in demand for magnetic media for mass storage. The growth in magnetic media can be affected on a short-term basis by economic conditions, however over the medium and long-term, magnetic media shipments continued to return to steady double-digit growth as digital content creation continues to be somewhat immune to economic realities. We expect video to accelerate the growth of digital storage whether it is shared personal video generated by smart phones, ever increasing pixel count digital cameras, movie streaming, video conferencing, or security cameras, video is exploding in its use. As for the cloud, we expect for most storage to increase the need for digital storage. Always available, always secure, always safe is going to require redundant storage, and mass storage will continue to be dominated by the most cost efficient solution which is hard drives.

Another positive for our business is the rate of improvement in aerial density is forecast to slow down from the 40% level over the last few years to close to 30%. This will drive up the average number of disks per hard drive as you have seen this year. We have already witnessed high capacity drive shipping, there's more [plateaus] over the last few months. This growth is the principle driver for capacity selling of our 200 Lean Media Deposition System. A 30% improvement in aerial density will require the industry to invest in new media manufacturing technologies.

There are two new media technologies expected to go into production in the foreseeable future, thermal assisted magnetic media recording and patent media. Both technologies will drive increased business for Intevac. We have already developed a deposition and edging product to support these new media technologies, and are working with our customers to optimize these applications for their eventual production deployment. Some of the system magnetic media recording will require major upgrades of our existing installed base as well as accelerate the retirement of legacy systems. Patent media will double our served market size as an Etch system will be incrementally required for each media deposition system.

In the short-term, the industry is being buffeted by the prevailing economic winds and has suggested it's scheduled for deploying additional manufacturing capacity. If you recall on the last conference call, we estimated the industry was adding approximately 10% incremental capacity in 2010 or roughly in line with peak to peak growth expectations for the year at that time. Based on commentary from recent conference calls by hard drive and PC companies, peak to peak growth for 2010 is now expected to be less than 10%. Our customers have responded to this reduced growth by rescheduling system installations to keep their factories at high utilization.

In the last conference call we communicated the two systems originally scheduled for 2010 delivery were rescheduled to 2011. Since then, some 2010 deliveries have been shifted from the third to the fourth quarter, which further reduces the amount of capacity on line for this year. Our customers have expressed capacity utilization rates of around 95%. Expectations for 2011, continue to call for low, double-digit year-over-year growth in hard drives. More importantly for Intevac, we expect the growth in actual (inaudible) to actually exceed that growth. We will need to wait until our customers complete their calendar fourth quarter builds to have some understanding of first quarter volumes and make their predictions for year-to-year peak growth before we can provide estimates for the systems valve in 2011. We do expect some ongoing retirement to legacy systems coupled with new technology buys beyond capacity needs.

Now moving from the hard drive segment, I am very excited to be talking about our traction in the new equipment markets for Intevac. Let me start with solar, where we see tremendous opportunity as the perspective market is much larger than the magnetic media market. I want to start by giving some perspectives on this market. Solar is not new. In fact, the origins of today's photovoltaic cells technology of manufactured equipment goes back to the '70s and early '80s when the first oil prices hit and there was a rush to develop alternative forms of electricity generation. From the early '70s through the mid-2000s, the industry has used essentially the same technologies, processes, and equipment to manufacture solar cells and was not able to achieve a cost competitive alternative prior to the surge in demand created by the generous feed-in tariffs in Europe. While prices for solar fell during this period, they did not fall to the point where the industry can survive without government subsidies.

Grid parity requires solar to hit $1 per watt at the module level. Today, the lowest manufacturing cost is about $1.20. We are now, in our opinion, entering a new wave where cell manufacturers are looking for cost efficient vacuum equipment technology solutions to improve cell efficiencies thereby driving down the cost per watt in order to achieve grid parity. This will enable a growing, healthy industry that does not require subsidies. This is Intevac's opportunity as we apply our process technology and high productivity platform expertise to help the solar industry achieve grid parity. Today's $1.20 per watt is comprised of $0.60 for the silicon, $0.20 to process the silicone, and $0.35 to modularize the cells. A 25% increase in conversion efficiency, assuming today's absolute costs do not increase would lower the cost per watt to below the $1 grid parity target.

We have two products aimed at improving cell efficiencies for this market, a vacuum processing system called Lean Solar, and a cell inspection system called NanoVista. The majority of cells produced today utilize equipment concepts from the '70s and currently only one vacuum processing step is utilized in manufacturing a typical silicon cell. Based upon the cell efficiency improvement road maps, we believe there are some significant future vacuum process opportunities that play to our strength developed in the hard drive industry for high productivity into greater process solutions. To date we have sold two thin film multi layer Lean Solar deposition systems, one for an [Six] application and the latest order announced in August for an advanced crystalline silicon application. Through 2011, we expect to expand our process solution offerings of the Lean Solar platform. The Lean Solar six system we shipped in Q2 has been installed and has met the first phase of qualification. As thin film solutions in the solar market continue to mature, these applications will become a larger portion of the multi-billion equipment market each year. Today, crystalline silicon cells represent 9% of the market. So it was a major milestone to penetrate this market by winning this order over a large, well-established equipment manufacturer. This first system is capable of depositing both metal and transparent conductive oxide films on thin film solar cells. We expect to ship this tool in Q1 of 2011.

Our NanoVista inspection system continues to receive a lot of interest for its capability to measure crystal efficiency related cell parameters that high productivity that can help cell manufacturers improve the quality and consistency of their product. We shipped our first NanoVista solar inspection system in the third quarter to a large US solar cell manufacturer. NanoVista uses a low light camera specially developed in our Photonics business for this solar application. We are currently in the process of painting a commercial classification that will allow Intevac to ship NanoVista outside the United States. We believe we are in the final stages of the process and hope to complete this in the next three months. In the semiconductor market, we sold our first five Continuum mainframes to be used at large memory manufacturers, one of which was delivered in October. This innovative, high productivity linear mainframe was developed as part of our previous Etch development program.

I'll now turn the call over to Joe Pietras to talk about the strong momentum in our Photonics business. Joe?

Thank you, Kevin.

Intevac Photonics reported its seventh consecutive quarter of revenue growth with third quarter sales of $8.8 million. Revenues were up 2% from second quarter and 28% compared to third quarter 2009, and are expected to increase again next quarter to reach approximately $35 million for the year and 30% over 2009. In our digital night vision business, we delivered a first production lot of camera modules to our NATO customer who in turn deployed the modules to their military customer for field use. This marks the first, high-volume deployment of digital night vision to military ground forces in the market today. The customer feedback has been very positive and we received a third major order release against the $18 million open purchase order we received in 2009. This new order release, combined with our existing backlog, provides for volume production shipments into the fourth quarter of 2011. In third quarter, our manufacturing costs stabilized and improved versus the prior quarter as we continue to focus on lowering our costs. In the US night vision market, we now believe that special operations requirements will lead to deployment of digital night vision for ground soldier use in advance of the US Army ENVG (D) program which is currently undergoing replanning.

In the third quarter, a field demonstration of two Night Port based products was held before a large US military audience which included personnel from special operations. Feedback was very positive as our products performed favorably as compared to the leading conventional analog goggles. Development and low rate procurement phases for special operations applications are scheduled to occur over the next few years. Earlier this year, we were awarded a multi-year contract for funding up to $7 million to develop various types of digital night vision goggles for these applications. High volume deployment is expected to begin in 2014 and will represent an opportunity of approximately $25 million in annual revenue.

In our Lve Wire camera business, we began to ramp delivery of Live Wire cameras during third quarter to our two volume based customers against their production orders. We expect to continue increasing production shipments in fourth quarter to levels double that in previous quarters in order to meet this growing demand. Our current backlog of orders carries us through mid-2011 with follow-on orders expected early in 2011 for these applications. We estimate our existing line of our business to represent a $45 million opportunity over the next ten years, with the potential to add several new customers as LIBOR applications expand in both avionic and ground use.

In our handheld Raman Instruments business, we continue to see the near term opportunity centered on chemical, biological, and explosives detection. Our explosive detection units are being deployed abroad and we have received estimates from our customer that near-term demand exists that can represent an opportunity for several hundred units estimated at over $4 million. In third quarter, we also received our first volume order for our handheld stand-off Raman Instruments from a major defense contractor. This single application represents an opportunity of $3 million during the next few years and not surprisingly, there is growing market interest in stand-off detection for explosive, chemical, and biological threats. As a reminder, our stand-off Raman products are capable today of identifying materials from a safe distance of up to three to four meters and we are only one of a few companies that have this capability.

I will now turn it over to Jeff to discuss our financial results for the third quarter and our outlook for the fourth quarter and full year 2010. Jeff?

Thank you, Joe.

Consolidated third quarter revenues totaled $64.6 million and met the high end of our guidance of $60 million to $65 million. Equipment revenue totaled $55.9 million and included eight 200 Lean systems recognized in the quarter. Photonics sales of $8.8 million consisted of $5.2 million of contract research and development and $3.6 million in product shipments. Q3 consolidated gross margin of 45.8% exceeded our guidance of 41% to 42%. Equipment gross margins of 48.8% were higher than the second quarter due to the higher mix of technology upgrades and spares. Equipment -- or Photonics gross margins were slightly higher than the second quarter at 26.4%, reflecting improvements in the cost for our high volume NATO customer. Q3 operating expenses were $14.2 million and were slightly below the low end of our guidance of $14.3 million to $14.8 million. That sequential decline is primarily due to reduced legal costs related to to our successfully resolved auction rate securities arbitration which concluded in July.

Our Q3 net income was $13.2 million or $0.58 per share, exceeding the upper end of our guidance by $0.11 per share. Net income included $830,000 of stock-based compensation expense equivalent to $0.02 per share. Our backlog was $64.9 million at quarter end and included six 200 Lean systems. Backlog will continue to climb until our hard drive customers determine their spending plans for 2011, which we expect will happen once the fourth quarter is complete.

I'll now discuss the balance sheet. We ended the quarter with cash and investments of $29.2 million or approximately $5.75 per share. The increase of $40.8 million as compared to Q2 was the result of reduced working capital levels from the collections of accounts receivable and a reduction in inventory levels. As a result of the favorable arbitration award, Citigroup repurchased at par $54.8 million of outstanding auction rate security investments in July. In the third quarter, the Company recorded a $3.3 million reversal in the temporary impairment charges associated with these investments. This reversal affected only the balance sheet valuation of the investments. Capital expenditures totaled $3.1 million and depreciation and amortization totaled $1.5 million for the quarter.

I'll now provide our guidance for the fourth quarter and the Company's current expectations for full year 2010. We are projecting consolidated Q4 revenues of $36 million to $37.5 million, which includes four 200 Lean systems and assumes no further rescheduling by our customers. We expect fourth quarter gross margins to be approximately 40%. Operating expenses are expected to be in the range of $14.3 million to $14.5 million. Other income and expense will be approximately $100,000 and excludes any impact associated with changes to the valuation of our investments or foreign exchange. For Q4, we are projecting net income in the range of break-even to $0.03 per share which includes an estimated $900,000 of pretax stock-based compensation expense, equivalent to $0.03 per share.

I'll now provide the current -- Company's current expectations and guidance for the full year 2010. We expect to ship a total of 26 200 Lean systems in 2010. Our consolidated revenues are forecast to be in the range of $202 million to $204 million. Intevac Photonics will be approximately $35 million. As we look at the rest of the P&L for the full year, we expect gross margins of approximately 43% and operating expenses to be in the range of $56.2 million to $56.4 million. We expect other income to be approximately $400,000 and our tax rate to be approximately 15%. We are projecting our full year net income to be between $1.17 and $1.20 per share.

Capital expenditures for the full year will be in the range of $8 million to $9 million as we are completing our 2010 incremental capacity investments in our Photonics business. Depreciation and amortization will be approximately $6 million. We expect our cash and investment balance at year end to be approximately $135 million or nearly $6 per share. This represents an increase of $45 million over the cash and investments balance at year end 2009.

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

(Operator Instructions)

Our first question comes from Mark Miller with Noble Financial.

Just like to talk about the heat assisted magnetic recording. I've heard reports that this is getting pushed up faster than people thought six months ago. I'm just wondering what your perspective is and how that enables you -- gives you a greater opportunity in terms of your Lean tools and other tools.

Hi, Mark. This is Kevin here. You probably have better information than we have. Obviously, there's always a lot of rumors in the hard drive industry as to when things are going to happen. From our perspective, we developed the deposition technology to support the -- some assisted media, and we expect this will result in systems with additional stations, so instead of shipping 20 stations, there will be typically 24, and for an install base, that would require a retrofit of a module. So, that would be about a $1 million upgrade per tool and a corresponding increase on new tools.

Okay. So there is a significant upgrade opportunity once we go to hammer?

Yes, it uses a different type of deposition technology.

all right. Just wondering about the -- what are your projections for dropping, in terms of the solar, to about a dollar per watt? Is that going to occur over the next six months, a year, two years? What projections are you seeing for that?

We've seen people project that this will be achieved by 2013. So, in addition to improving efficiency, there are various projects out there to reduce the thickness of the silicon. So, the platform we've developed will support the much thinner silicon that they will want to use in the future. So 2012, 2013 is what we see as the time perspective.

So, we should see a 20% decrease in the cost of the panels or will it be more or less?

That's what we would expect. Now, companies like First Solar that use thin film are already below $1, but the efficiencies of their panels are much lower than that of silicon panels.

Thank you.

Our next question comes from Kevin Hunt with Hapoalim Securities.

Thanks, guys. I had a couple of quick questions. First, in terms of the backlog that you talked about, so you're saying six systems in there now, four in the fourth quarter. So I want to just clarify, does that six include the Solar Lean tool or is that just purely disk drive and then what's -- maybe you can help us understand what's been pushed out into next year?

Kevin, it's Jeff. That's only the 200 Lean hard drive tools.

Okay.

Four tools in the fourth quarter and two in 2011 is what we've said. So, the ones going in the fourth quarter may have little impact, I think, on the capacity edge for the year, obviously.

Okay. So the two that have been pushed out, is that indefinite when they'll take them or is that more like a Q1 or we just don't know at this point. Well, I would say -- we don't want to give any guidance, but our expectation was certainly by mid-year, they would ship. Okay. And the other question I had was in terms of the upgrade activity. What was the reason that was so much more robust than you had sort of guided to and then it implied you're guiding to go significantly down in the fourth quarter? Can you just help us understand that dynamic a little bit better?

This is Kevin here. Our engineers have developed a source with a very good utilization where you could get a very quick return on your investments on some of these expensive targets and the customers took up that new technology upgrade quicker than we had originally expected.

Okay. So, you're saying that's not going to continue into the fourth quarter, is that --?

We would expect to continue to sell technology upgrades to other customers. I can't tell you exactly how much Q4 and how much will be next year, but there's a lot of interest in this new source technology.

Okay. all right. Thanks, guys.

Our next question comes from Rich Kugele with Needham & Company.

Thank you, good afternoon. Just a couple of questions. I guess first on the guidance when it comes to the gross margin, can you bridge us on the September gross margin and what are the puts and takes to get it to the Q4 guide?

Rich, it's Jeff. First, I would say that we're not seeing any margin degradation at the product level. This is mostly driven by mix. So, we're seeing Photonics come up -- expect to see them come up slightly, but we had some pretty richly configured tools in the third quarter versus the fourth quarter, so we're not actually seeing any kind of product level erosion, it's just being driven by mix.

Okay. And then secondly, rather than give guidance, just to remind people of maybe what the sensitivity analysis might be. So, let's say, for example, that units for the drive industry don't grow at all, zero in 2011, but you get the aerial density improvement that you're -- or the lack of an aerial density improvement that you were talking about on the call. What do you think a base level of business would have to be? And then, we'll go maybe the other way and then say, let's say it's a 10% unit growth, how many tools would that be?

Why don't we start with the second scenario, Jeff?

Thanks, Rich. We don't want to give any exact -- but we've done an analysis that says if we have 10% growth, that'll amount to about 15 200 Lean Gen II equivalents and that's without any legacy retirements or R&D tools. And, that's at a level that's slightly above what we saw this year in shipments, because we have to remind you guys that there were some legacy tool retirements, although we can't be specific, it was somewhere below half of our tools, but we also had some Gen Is ship versus Gen IIs which pushed the tool count up as well. And then, to say no capacity added next year, the only thing I would point to is that's what happened in 2009 and going back in history then, the hard drive business still did about $50 million, I think, 52, something like that.

So Rich, I was a little confused by your first half of your question. So, you were saying if there's no increase in drives, but the aerial density slows down, are you saying --?

That you would still need to see platter counts go up, right?

Right. So, I can reiterate that for other people who are listening, that what drives up business is the platter count. So, if the average number of platters goes up per hard drive, that the number of hard drive shipments were to stay constant, they would still drive the need for more capacity tools. And, if the average platter count per hard drive and the hard drives go up, that's doubly good for our business.

Rich, I would add that last year the platter count was like 1.65, 1.62 in there, and the first half of the year it's about 1.75 of this year, so far, and we don't have the Q3 numbers yet.

Okay. Then just the last questions on the timing of orders. When do they have to be ordering in order to make Q3, Q4 type production runs if they were going to be above Q4 levels?

Well, if they wanted to have them in -- our lead times are around 17 weeks, so you can go backwards from there. So, they could hold off as late as the end of the first quarter if they wanted delivery in the early third quarter, but our delivery started earlier than that this year.

Now, there's some players out there like Nidec that are talking about Q1 actually being up. Is that in the scope of what your customers are even thinking today or is this going to be a surprise later?

Yes. I think that would not be a shock to us. I mean we saw it last year. We saw Q4 -- Q1 higher than Q4, and I read the same article as you, but that's something that -- it's the effect of the Chinese New Year and the holiday season continuing through into February.

Okay. Great. Thank you very much.

Our next question comes from Bill Ong with Merriman Capital.

Yes, good afternoon, gentlemen. On the -- solar demand has been quite strong this year. We saw good strength across the board in panels and (Inaudible) and equipment, and that allowed you to ship your first Lean Solar tool. But now there's some concerns about solar demand uncertainty in the middle of 2011. How could that maybe limit your demand for next year and when do you think you can see a break out year in your Lean Solar tools?

Hi Bill, this is Kevin here. So we see 2011 as really a year of qualification and us bringing additional process applications to this platform. As we've modeled the business, so we've concluded that even if the industry wasn't growing there will be a significant opportunity to upgrade existing lines to improve the efficiencies and therefore bring down their costs. So our -- what we're trying to achieve is a product that works both in a growing market and also in the market where the capacity isn't increasing, but the need for higher efficiency is still there.

Can you maybe talk about how many customers are you talking about? Is it like a half a dozen, a dozen? And then, how many have the capital resources to actually buy parts of equipment?

We initially start off by working with some of the local start-up companies in the Valley. Our focus now has moved to the top ten solar companies who have lots of capital and have very big production lines. So, I don't see it's an issue with their ability to afford capital, and we'll focus on both the market leaders as well as the technology leaders.

That's helpful. Thanks.

Our next question comes from [Neil Chusky] with Technology Insight.

So with the lower aerial density rate of increase that you guys are projecting, what do you think can be the rate of cost decline and if it's in the historical 25% to 30% parameter range, how do you think hard drive manufacturers can achieve this with the reduced rate of aerial density? And then I have a couple of other questions that are less abstract.

Okay. So let me first deal with that one. Historically, our customers have been lowering their costs by improving their -- the aerial density, and they've been doing it about 40% a year. It's the industry that's projecting that rate of improvement will slow from 40% to 30%. So, that will mean that they will have to put in more capacity because they won't be able to reduce the number -- the average number of disks per drive as quickly. So, some of these terabyte and two terabyte drives will have to live longer with more [discs], or if they go to the next storage capacity points like three terabyte or four terabyte, they'll have to put more disks in. So, that's how we see that going.

Okay. Just to be clear, what do you see -- do you see the cost per bit decline changing as it becomes more difficult to go onto aerial density curves -- stay on the aerial density curve?

Well, the rate of improvement will slow down.

Okay.

And the ratio of what they've been doing with aerial density, 40% becoming 30%. This is somewhat analogous to the semiconductor industry where again people were forecasting slowdowns there because the technology is getting more difficult to move to smaller geometries.

Right, okay. This new source technology, is that enabling faster throughput by less down time or better yield or is it purely just a better use of the source material?

It enables the production of some unique magnetic alloys that couldn't normally be obtained at normal processing temperatures. So, it's a technology enabler. It doesn't go any faster and it just enables the assisted magnetic media.

So, it is possible for these guys to get a little bit higher throughput with their existing systems utilizing --

No. No, it doesn't affect the throughput is unchanged.

Okay. All right, good.

It enables them to make more advanced films.

Okay, all right. And then, we already talked a little bit about new seasonality from Chinese New Years. A couple of follow-up questions with regard to that. So, have your customers indicated concern that they may be actually capacity constrained into March Q. And then secondly, your guidance implies that you'll have two units left in backlog at the December quarter if you receive no new unit orders. So with that in mind and the seasonality, would you expect to get new orders this quarter or do you think that will be more of a Q1 and Q2 event?

We would expect orders for HDD equipment to materialize in Q1, Q2.

Okay.

We think that, our customers will make do with the capacity they have. The tools that they've slowed down on installation, they can always speed those up. And, the two tools in backlog if people -- if the customers need to pull them in, then they have plenty of time to do that as well.

Okay. all right. Thank you very much.

(Operator Instructions)

I'm not showing any other questions at this time.

Okay. Well, thank you for joining us today. We look forward to updating you on our next call on our year end results. Goodbye.

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