Intevac, Inc.
Q1 2018 Earnings Call Transcript

Published: 1 May 2018

[Operator:]

Good day and welcome to Intevac's First Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] Please note that this conference call is being recorded today, April 30, 2018. At this time, I'd like to turn the call over to Claire McAdams, Intevac's Investor Relations Counsel. Please go ahead.

[Claire McAdams:]

Thank you, good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the first quarter of 2018, which ended on March 31. In addition to discussing the Company's recent results, we will provide financial guidance for the second quarter of 2018 and our current outlook for the full-year. Joining me on today's call are Wendell Blonigan, President and Chief Executive Officer; and Jim Moniz, Chief Financial Officer. Wendell will start with a review of each of our businesses and our outlook going forward then Jim will review first quarter results and discuss our financial outlook before turning the call over to Q&A. I'd like to remind everyone that today's conference call contains certain forward-looking statements including, but not limited to statements regarding financial results for the Company's most recently completed fiscal quarter, which remains subject to adjustment in connection with the preparation of our Form 10-Q, as well as comments regarding future events and 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 April 30 call include time-sensitive forward-looking statements that represent our projections as of today. We undertake no obligation to update the forward-looking statements made during this conference call. I will now turn the call over to Wendell.

[Wendell Blonigan:]

Thanks, Claire, and good afternoon. Today we reported Q1 results in line with guidance, with revenues of $18 million and a loss of $0.23 per share. Revenue showed relative strength in our hard drive equipment business and lower than forecasted Photonics sales. The results in our Photonics business negatively impacted gross margin, but with close control of operating expenses, bottom line results were within the range. On our last call, as we recap 2017, I highlighted that we had delivered three consecutive years of growth, both in revenue as well as bookings and last year we achieved our objective to return to profitability without relying on capacity additions in the hard disk drive industry. Also during the call, we communicated our expectation for the continuation of growth and profitability in 2018. Since then, there have been several developments that transpired in both Photonics and Thin-film Equipment that have caused our outlook for 2018 to moderate since our last forecast. I will walk you through these development details in the business-specific portions of the call. In Photonics, we experienced delays in certain funded R&D releases as well as a temporary production slowdown in the Joint Strike Fighter program. In Thin-film Equipment, our near-term VERTEX system revenue outlook has decreased for the year as the initial application for our second customer that has been under testing and evaluation over the last year will require an approved version of oDLC which we are now addressing with our 2.0 version film. Our expectations for revenues from the hard drive and solar markets remain consistent from last quarter and in total, we now see 2018 as a pause in our revenue growth trajectory as we position our VERTEX oDLC 2.0 in our new ISIE-19 Photonics sensor to drive the resumption of growth in 2019. Given the developments in the first quarter, we took significant actions across the company to reprioritize engineering programs and reduce operational expenses, all while ensuring that we can continue to drive our growth initiatives on VERTEX and ISIE-19 without impact. In Equipment, we suspended all work in solar products except the support installation of the tools currently in backlog, put on hold projects in concept and feasibility and extended the development timeline of our MATRIX PVD system for advanced packaging. Our equipment operations in Asia are now and will continue to be fully utilized, manufacturing hard drive systems and upgrades and providing installation and service support. In our Santa Clara equipment operations, we reduced headcount by 12%, primarily in engineering and administration. In Photonics, we reorganized to increase focus on engineering program capture and execution, installing longtime Intevac veteran Tim Justin into the role of General Manager. In Photonics, we reduced headcount by 8%, primarily in manufacturing and administration as the engineering staff via funded development programs are generating a significant portion of the revenue stream this year. In addition, Vice Presidents and above have reduce their salaries by 10% for the year, which was has allowed the company to retain key technical positions deemed critical to drive our VERTEX and ISIE-19 initiatives. While this change in our short-term outlook is disappointing, taking a longer and bigger picture view, significant progress continues to be made in our expansion of our Thin-film Equipment business and the development of our ISIE-19 Photonics sensor to capture our opportunity pipeline. So now I'd like to give you more detailed description of our business environment and the progress we're making starting with Thin-film Equipment. The biggest growth opportunity for our equipment business continues to be our VERTEX tool and the deposition of protective coatings on display and backside cover glass for cell phones. During the first quarter, we made several strategic moves targeted to accelerate and improve our capture rate of customers for the VERTEX systems. Over the last year, while we've made progress with our current VERTEX customers, it became clear that we had a chicken and egg problem in penetrating additional cover glass suppliers. End customers need verified capacity to commit projects and cover glass makers needed end customers to commit to the capital. We are now driving a strategy to play seed VERTEX assets with key cover glass makers and generate end customer demand which after reaching a threshold and volume will be purchased. We've also added regional sales manpower to the VERTEX program and increased our sales and marketing efforts directly with handset and electronics manufacturers in an effort to raise awareness not only of our capability, but the traction we are seeing in the marketplace. We added two new Board Members Kevin Barber and Mark Popovich, both of which have deep experience and knowledge in the cell phone and/or advanced packaging markets. They now provider our Board with up-to-date information in activity and trends in key target markets and will act in a technical advisory role for management as we drive our equipment growth initiatives forward. So let's talk about recent traction. In March, we issued a joint press release with our first oDLC customer truly out to electronics announcing the launch by a top three handset manufacturer of new phone models incorporating our film for backside cover glass protection. The VERTEX is depositing oDLC on a portion of their recently launched flagship handsets protecting the vibrant and striking decorative color coatings deposited on the outside of the back cover glass. We'll be keeping a close eye on success of this application in the marketplace, which if successful commercially should lead to demand for additional VERTEX capacity systems, which could come from truly other cover glass makers or both. Truly we currently have four VERTEX systems installed along with this application is also applying oDLC for front cover glass, variables and point of sales applications among others. In addition to cover glass applications, we've been working with truly on a new application involving different substrate materials. The plan at the time of our last call was to install two additional VERTEX tools in a new production line with two system shipping by the end of Q2. Unfortunately after Lunar New Year, we were informed that the new line was put on hold and those 2018 opportunities have pushed. We have suspended work on this application, but intend to resume the program when the overall business environment improves, as we believe it could drive significant cost savings if successful. On the strategic front in a move to increase the visibility and applications of our coating solutions, we are finalizing an agreement with the top three cover glass manufacturer to install a VERTEX system by midyear and

[James Moniz:]

Thank you, Wendell. Consolidated first quarter revenues totaled $18 million at the high end of our guidance range as filed in our HDD business more than offset the decline in Photonics. Thin-film Equipment revenue totaled $12.8 million and included one 200 lean system along with upgrades in spares and service. Photonics revenues of $5.2 million included $2.7 million of product revenues and $2.5 million of contract, research and development revenues. Q1 consolidated gross margin was $4.9 million or 27.1% and lower than our guidance of 29% to 31%, driven by a significant decline in Photonics gross margin on the lower revenue volume. Q1 R&D and SG&A expenses were $10 million up from Q4 due to normal seasonal increases, but below our guidance due to tight control of development spending in response to the revenue forecast. This resulted in a net loss of $5.1 million or $0.23 per share within our guidance range. Our backlog was $66.9 million at quarter end. Thin-film equipment backlog of $55.6 million included two 200 lean hard drive systems, 12 energy solar ion implant systems and non-systems HDD backlog, three energy tools are awaiting installation at our customer's factories at quarter end and are awaiting customer acceptance. The backlog in our Photonics business was $11.3 million. We ended the quarter with cash and investments including restricted cash of $40.7 million, equivalent to approximately $1.82 per share, based on 22.4 million shares at quarter end. Cash flow used by operations was $4 million during the first quarter. Q1 capital expenditures were $592,000 and depreciation and amortization was $1 million for the quarter. Now turning to the full year outlook for 2018. Given the factors Wendell discussed related to VERTEX revenue recognition in Photonics program funding delays, we now expect our Thin-film Equipment revenues will be down about 5% to 10% from 2017 and Photonics revenues will be down around 20% from 2017. This will reduce overall revenues by around 10% to 12% from the 2017 levels. At this overall revenue level and given the mixed impact, we would expect gross margins of around 33%. Last quarter we were forecasting operating expenses of between $40 million to $41 million for the year. With the reduction of forecasted revenue, we took actions to reduce our operating expense to below $38 million. We also reevaluated a couple of projects and will incur small write-offs this quarter that are expected to bring our total operating expenses to between $38 million and $39 million for the year. Below the operating line, we expect to see interest income of about $400,000 and net taxes of about $900,000 for the full year. For Q2 specifically, we are projecting consolidated Q2 revenues to be between $24 million and $26 million. We expect second quarter gross margins to increase from the first quarter and to be between 30% and 32%. Q2 operating expenses are expected to be between $10 million and $10.5 million inclusive of the write-offs mentioned earlier. We expect interest income of about $100,000 and net taxes of about $300,000 in the quarter. For Q2, we are projecting a net loss in the range of $0.11 to $0.13 per share on an estimate of 22.5 million shares. This completes the formal part of our presentation. Valerie, we are ready for question.

[Operator:]

Thank you. [Operator Instructions] Your first question comes from Nehal Chokshi of Maxim Group. Your line is open.

[Nehal Chokshi:]

Thank you. So how long have you guys been working on this oDL 2.0, oDLC 2.0?

[Wendell Blonigan:]

Well, Nehal this is Wendell and thanks for the question. As I said in this script, we've been actually working on a high durability anti-reflective coating that was a complete separate project from the DLC and as we moved through the different processes with different customers and had solidified some of the films that we were putting down for AR, we identified that that could be -- those -- that activity could be translated on to the 2.0 version that has a thicker under layer and provides better protection for sharp point impact. So it's been -- the actual activity and the source development has been going on for well over a year, but that was specifically related to antireflective coating development versus DLC and we transition that over to the DLC program around the end of last year and start some development there.

[Nehal Chokshi:]

Okay. And when you, to put that into context of you've been working on the AR for about a year which you brought into the oDLC program, the 2.0 program, I guess when you originally developed oDLC, how long did that take?

[Wendell Blonigan:]

The original oDLC was probably done over about a three year time span, which includes the source development in the platform.

[Nehal Chokshi:]

Right. So the obvious question then becomes is was the -- this seems like a compressed timeline for bringing oDLC to market faster than original oDLC and what's the confidence around being able to do that?

[Wendell Blonigan:]

Well, I think one way to look at it is fundamental platform VERTEX is already present. We have to make some modifications at how it operates, but realistically that's more software motion profiling and things like this. The sources have been worked on for well over a year in the AR program and the actual DLC process, which is the carbon process is the same as DLC 1.0 it's the under layer between nut and the glass, which is being changed in 2.0. We wanted to keep all of the functionality that we had with the current DLC and provide that along with a better protection against point scratching and that required a thicker layer. And maybe that's too complicated as an answer, but we believe that the 2.0 implementation is not a three year implementation.

[Nehal Chokshi:]

Right. Okay. Just to be clear, the original oDLC did have an under-layer or it did not and now you're implementing an under-layer and then you come back and realize what we need a thicker under-layer in order to be able to withstand the short point contacts.

[Wendell Blonigan:]

Yes the original oDLC has an under-layer but it's very thin. It's made very think for its optical characteristics.

[Nehal Chokshi:]

I see. Okay. Got it. Understood. And then as a result, essentially there is no new chemistry that you need to develop for source technology it's really just tweaking the thickness of the various layers.

[Wendell Blonigan:]

The answer to that question is yes, we have a core set of films that we developed for AR, bit we are also working on some different ones and it's really about controlling a refractive index versus the hardness of the film and without making it too complicated, when you put these hard films down on thickly on a piece of glass, the hard films tend to have higher refractive index. So you really need an antireflective function on that under-layer in order to eliminate that and that's how we were able to port our AR work over to DLC.

[Nehal Chokshi:]

I see. Okay. All right. And then two years ago when Truly had accepted their first system from your guys earlier than expected, it sound like you guys had a pretty high degree of confidence that this was going to get adopted, but this is still early in this cycle right. You hadn’t secured that second customer yet and I guess is this sort of where we are with the oDLC 2.0 in terms of level of confidence and you hope that will grow as you get further into your program or you think we're further along in terms of the confidence level there was?

[Wendell Blonigan:]

Well we can certainly see that we have now -- we are now able to retain all of the DLC characteristics and improvements point. At some point, there was a compromise that needed to be made either in how well it protects against abrasion versus how well it protects against a point contact. We think we're by that now and we certainly at the array of testing that we do on these films, whether that SAN Shaker or Taper [ph] or these two-year simulated usage testing, we can certainly see margin improvement in some of these characteristics without losing the original functionality. Now a number of the applications don't require that and you can put down a less-expensive film with oDLC 1.0 because it's only using a very thin layer under-layer and that's completely adequate for some applications including the application we talked to about the top three handset makers, that's oDLC 1.0 and that passes all of the tests that the -- that particular customer wants to have it passed.

[Nehal Chokshi:]

Okay. Very good. I'll seize the floor for now.

[Wendell Blonigan:]

Okay. Thanks Nehal.

[Operator:]

Thank you. Our next question comes from Craig Ellis of B. Riley FBR. Your line is open.

[Peter Peng:]

Hi this is actually Peter Peng calling in for Craig Ellis and thanks for taking our question.

[Wendell Blonigan:]

Hi Peter.

[Peter Peng:]

Hi. Just on the first quarter gross margins variability, it seems like photonics was down, but software went up significantly. So can you just help reconcile the gross margin different? It seems like the net, net that would cancel each other out?

[Wendell Blonigan:]

Yeah what happened in Photonics is we actually have some cost growth in one of the programs and on lower revenue, it gives you a much higher percentage of revenue and so that really the most significant development in Q1 was we had some challenges of the cost and we had to take a forward loss provision and the revenue only being $5 million had a higher impact which is why the gross margin at around 6%.

[Peter Peng:]

Okay. And then on the systems and upgrades I would like to kind of take your equipment backlog and just kind of take out all the equipment tools. It seems like the upgrades went up significantly. It looks like at the high end single-digit kind of millions, given that why aren’t you more positive on that part of the business?

[James Moniz:]

We are positive on it. We are very positive, which is why we had said that we would expect to see a similar level of hard drive revenue, which was very strong last year I think in the mid $50 million, but on less system. So we have more upgrades and we saw a lot of that those orders happen in Q1, we don't expect that same level of high orders every quarter, but that gives us a lot of backlog going into the next three quarters. So we are feeling very comfortable about that.

[Wendell Blonigan:]

Yeah and I think Peter also, this is Wendell that when we look at the latest forecast that are out there and we highlighted in the script as well that we're now seeing a company like Trendfocus forecasting a growth rate that will extinguish the excess capacity out there in a reasonable timeframe to 2020 is where there current forecast shows that crossover point, which is not where we were at a year or two ago. So there's really been a lot of positive sentiment inside the HDD and some good projected growth rates of Exabyte shipments on hard drives.

[Peter Peng:]

Okay. And then kind of just taking your the growth rate for the thin-film and if I kind of back out the expected two more VERTEX in the second half, it seems like you're going to -- you're expecting two more lean shipments in the second half. Is that right two to three lean systems in the second half?

[James Moniz:]

We actually in our guidance for Q2 there's actually two leans in Q2 and we're expecting the third one after that. So really three more, one in the second half and two in the second quarter is what's in our current forecast.

[Peter Peng:]

Okay. Great. All right. And then on the -- question on the VERTEX, it seems like with $24 million capacity truly and then if we add in two more back and adding about six more $8 million. So if the customer wants to adopt for say 20%, 30% of the Smartphone, would you have the ability to ramp up?

[Wendell Blonigan:]

Well, we're having to put another tool in the field as we talked about, that would be the next tool. We would be able to build out one additional, I think we as a management team want to keep one in finished goods, so we can react quickly and then we do have some long lead parts that still remain on order or are in-house actually, so we can react within a three to four month timeframe on the next couple of two to three tools from there. But we'll certainly be monitoring what the capacity is being consumed in the VERTEX and how the programs look coming in, how the acceptance of this decorative coating protection that Truly is doing now, how customer capture is going with this third Tier 1 cover glass maker as well as how Truly is doing with their program. So we feel comfortable we can react.

[Peter Peng:]

Okay. And one more question before I hop back into the queue, the 2.0 these ASP is going to be much higher or are they relatively similar with the 1.0?

[Wendell Blonigan:]

That's a great question. So in the -- for the 2.0 version it's a similar, similar price. We have done some cost reduction on that platform already. It's just the source technology is a bit more expensive than the current under-layer source and then if we move to an integrated tool that does the decorative coating, now that has multiple sources. That will be more expensive tool, but it also is doing the function of two separate tools and in our latest sales and marketing work over the last few weeks in Asia, there's a lot of interest in being able to combine those tools and taking out the handling of the substrates between those tools, that's a big cost reduction and like we said on the script, the tool we plan on having out here and installing with this new cover glass maker, they want it to be configured with the decorative coating.

[Peter Peng:]

Okay. Thank you, guys.

[Wendell Blonigan:]

Thanks Peter.

[Operator:]

Thank you. Our next question comes from Mark Miller of Benchmark. Your line is open.

[Mark Miller:]

Good afternoon. I just wanted to clarify something on the decorative coatings. Is there a unique decorative coating or are you also combining what you call decorative coating with the anti-reflection coating. Is that what you're terming the decorative coating or is that something separate?

[Wendell Blonigan:]

Well that's a great question Mark because it's the same source and it's the same type of films, but when you're doing, so you were doing a front cover with oDLC on it. You would want that to be an anti-reflective type coating, but on the back covers, what you're really looking for is a reflect coating. So you use those same types of layers, but you terminate with a different refractive index. So you're actually reflecting certain colors or transition of colors. So it's the same hardware, fundamentally the same type of films in both applications, just done in a different way to get a different effect.

[Mark Miller:]

Just wondered if you can kind of address the situation sabre rattling about the tariffs between United States and China. What impact if any is it having on the solar market and also if you can talk about the n-type cell market and what's happening there, has that continued to slow down from previous expectations in terms of opportunities?

[Wendell Blonigan:]

Okay. So from a tariff perspective, we're not actually seeing any impact to the business that we're looking at. Certainly we're waiting to see where these exemptions come out because I know there is some US-based companies that are affected that are petitioning to be excluded from that. That could have some impact. I know that there was one particular company that was talking about a certain amount of manufacturing capacity in the U.S. space being impacted if those weren't lifted. There has been dialogue with customers in China. There is some concern about what ultimately happens, but it hasn’t been impacting any deals or moving anything forward there. And could you restate the second part of your question again?

[Mark Miller:]

What's going along with the ramp of n-type cells?

[Wendell Blonigan:]

Okay. So n-type, we're seeing well one of our, the tools that we have out there right now that are waiting for installation is an n-type ramp, so we're seeing that come back to life. We're seeing some tools installed there and we anticipate getting it installed, the first tools in a reasonable period once they move in some other equipment. So we see that moving. Certainly we're not hearing anything formal from the premier n-type guys as far as additional new capacities, they're are usually pretty good about announcing that in their supplementary materials on their conference calls, but we have been in discussions for some cost reduction activities where we do some replacement and upgrades of existing lines to make them more cost-effective. Beyond that, I don't have any current information on the resumption of the China frontrunner on the n-type, but we're expecting that I think relatively short waiting to hear about that coming back into interplay where as if last year most of that money got shifted to PERT cell manufacturing capacity installations.

[Mark Miller:]

And finally any expanding opportunities you see coming out of the new Trump budget for you guys?

[Wendell Blonigan:]

The new Trump budget I think what we see is of course everybody, the sentiment is better. There is money there. The continuing resolution is lifted, so there's the ability now to create new program starts. There is concern that as soon as we get into October, they’ll put a new continuing resolution in place. If they can't get a budget to be agreed upon prior to the end of the fiscal year. Most of the plus-up in the military budget that came at the end, a lot of it was significantly around platform. Some of those platforms which we are involved with including Apache and the joint strike fighter; however on a near-term basis those platforms won't be built for several years. I don't think we've seen a plus-up at this point in LRIP 11. I think that's staying right around 200. I forget the exact number 275% or something like that units, but it's certainly positive, but it doesn't equate for us to any kind of a short-term move in the supply chain for the night vision systems for those platforms.

[Mark Miller:]

Thank you.

[Wendell Blonigan:]

Yeah there was a little bit of military sales in that budget that we've quoted on as well. That's possible.

[James Moniz:]

Four military sales, but we don’t expect that order till late in '18 and they will revenue in '19.

[Mark Miller:]

Thank you.

[Wendell Blonigan:]

Thanks Mark.

[Operator:]

Our next question comes from Ben Klieve from Noble Capital. Your line is open.

[Ben Klieve:]

Thank you. A quick follow-up question here on LRIP 11, my understanding was that, while there is delays in LRIP 11, but there is still a lot of pressure being put on the supply chain to ramp up capacity in advance of kind of 12, 13. What are your customers saying about volume production beyond LRIP 11, beyond the near-term delays that they're seeing from the one, from that one lot?

[Wendell Blonigan:]

We have been quoting on LRIP 12 and 13 correct Jim?

[James Moniz:]

Yeah, we quoted 12 to 14 actually last year.

[Wendell Blonigan:]

So the overall units are in line with the projected number of aircraft to be built. I have that chart, but I didn't bring it with me on 12 and 13, but we don’t see that slowing down, but we have to get past this impasse with LRIP 11 and get the full amount of LRIP 11 aircraft on order, which is not today. Did that answer your question?

[Ben Klieve:]

So the, yeah, yeah it does and so basically the sentiment from your customers is essentially that just they have to work their way through 11, but once they think they have visibility, once we can transition to 12 to 14 here to really ramp that business back up again, it's just over the next few quarters, it's challenges are going to continue due to delays in LRIP 11, is that right?

[Wendell Blonigan:]

Yeah, maybe a better way for me to answer the question is that we in our normal cadence of business would be expecting to be quoting on LRIP 12 and LRIP 13 right now which we are. So we're not seeing that process being delayed by the LRIP 11 deal.

[Ben Klieve:]

Okay. Very good. Thank you. That does it for me. I'll jump back in queue.

[Wendell Blonigan:]

All right. Thanks Ben.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from Nehal Chokshi of Maxim. Your line is open.

[Nehal Chokshi:]

Thanks. So there has been about a month of top three Smartphone really went GA with your coating. Can you just provide some clarity on that? Was it on just one or two or I think there was five colors overall offered or was it on all of the colors?

[Wendell Blonigan:]

It certainly was not on all the colors. They don’t necessarily tell us everything, but certainly there was one particular color that they were using as a test case and then beyond that, we don't have a lot of visibility, but I don't have clearance to actually say, which one of those colors it is.

[Nehal Chokshi:]

Okay. Understood and I guess, you probably don't have an answer to this question then, but do you have any visibility into what's been the demand response for the colors that are utilizing the ODLC?

[Wendell Blonigan:]

It's a little bit early, but our understanding is there is one color that's not too popular and it's definitely not that one that we're on. So I think there's been a reasonable response to most of those colors and I think one of the colors that I believe does the transition, I don't think is available quite yet. So they don’t have any feedback on that.

[Nehal Chokshi:]

The one that has the transition, is that the one that possibly has the ODLC on it or definitely not?

[Wendell Blonigan:]

That I don’t know.

[Nehal Chokshi:]

Okay. All right. Thank you.

[Wendell Blonigan:]

Thanks Nehal.

[Operator:]

Thank you. I am showing no further questions at this time. I'd like to turn the call back over to Mr. Blonigan for any closing remarks.

[Wendell Blonigan:]

Okay. Thank you. Before I sign off, I would like to thank our dedicated employees of Intevac all around the world for their tremendous effort and outcomes in this dynamic environment. Also I want to thank our customers for their continued business and appreciated partnerships. And finally, I'd like to thank our stockholders for their continued support of Intevac during this pause in our growth trajectory. I thank all of you for joining us today and we look forward to updating you again during our Q2 call in July. Until then, so long.

[Operator:]

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