Good day, and welcome to Intevac's First Quarter 2014 Financial Results Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, April 28, 2014..

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 first quarter of 2014, which ended on March 29. In addition to outlining the company's financial results, we will provide guidance for the second quarter and full year 2014..

On today's call are Wendell Blonigan, President and Chief Executive Officer; and Jeff Andreson, Chief Financial Officer. Wendell will start with an update on our businesses and then Jeff will review the first quarter results and then provide our guidance and outlook before turning the call over to Q&A..

Before turning the call over to Wendell, 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 about 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 28th 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..

Additionally, we will not be taking any questions related to the proxy contest initiated on April 10th as the intent of this call is to provide our stockholders with an update on our businesses and the results of the first quarter and our outlook for the year..

I will now turn the call over to Wendell.

Wendell?.

Thanks, Claire. Before I begin, I'd like to take this opportunity to thank the employees of Intevac for their hard work and dedication, not only in executing the quarter, but doing so while embracing the changes we are driving through the organization..

On the call today, I'll discuss the actions we are taking to navigate through the current business environment, provide you with an update on each of our business segments and explain the changes I have made in our Equipment growth strategy..

Our outlook for 2014 remains relatively unchanged from our expectations entering the year. Jeff will discuss the details of our outlook a bit later. We continue to be focused on reducing cash burn and positioning the company for profitability as we enter 2015..

During the first quarter, we implemented additional cost reductions, including a reduction in force in our Equipment group that will result in approximately $2 million in annual savings, much of which we will see this year.

In addition to making these cost reductions, we have implemented initiatives, some of which are multiyear in nature across the organization, aimed at consolidating our organizational structure and facility footprint. We are also working on increasing the variability of our cost structure in all of our business segments..

Now I'll turn to a more detailed update of each of our businesses in the markets we serve, beginning with our Equipment business. I'll start with our hard drive equipment business. In 2014, we continue to expect to ship a few systems this year in our service and spares business holding flat versus last year.

A modest decline is expected in our upgrade business. Over the past several years, we've had significant amount of revenue generated from high-efficiency sputtering source upgrades. The upgrade of the installed base is nearly complete and the focus now is on upgrades that will increase yields or reduce defects on the media..

We have multiple programs underway with our customers, which, if successful, can result in approximately $100 million of upgrade sales over the next 3 years. The qualification process for these types of upgrades can take 6 to 9 months, so this is the reason for the softness we are seeing this year..

We recently completed an update of our media growth projections through 2017 with the latest and best information available. Our model incorporates a number of key variables, including estimates for exabyte growth, areal density improvement and product mix.

Our previous projections published 6 months ago resulted in a range of Intevac system shipments required for media capacity additions of between 25 and 100 tools over the next 4 years. Our range of expectations for data growth and exabyte shipped on hard drives is largely unchanged.

Areal density improvement, however, has been far slower to materialize than earlier thought and in fact, has been lower than 10% per year. This is good for our business..

On the flip side, product mix has shifted more towards 3.5-inch disks with continued softness in the PC market and reduced expectations in particular for mobile PCs utilizing 2.5-inch disks.

With more of the storage expected to be shipped on higher capacity 3.5-inch disks, the latest estimates in our model now generate a range of 20 to 80 of our tools needed for media capacity additions through 2017. We see this as a narrowing of our prior estimate but is still a strong forecast for our hard drive equipment business..

We continue to keep a close watch on all the key variables that drive our hard drive equipment business. Expectations have continued to improve for capital investments in the buildout of cloud infrastructure and PC conditions appear to be stabilizing.

We will drive our strategy to maintain technology leadership, pursue opportunities to gain share and focus on the significant upgrade opportunity within our installed base, which I said earlier, could generate around $100 million of revenue for us through 2016..

In the near term, we're maintaining our outlook of a relatively flat year at the high end of our guidance for our hard drive business in 2014, with capacity orders commencing in 2015. These orders, combined with executing on our update business pipeline, indicate an improving environment for our hard drive equipment business next year..

I'll now turn to Photonics. Our Photonics business outlook continues to be strong and is on track to grow by at least 25% this year. In the first quarter, revenue was $8 million with an 11% operating margin. The revenue growth over the next several quarters will be driven primarily by our Apache program.

It is always challenging to ramp a new product, but our team has done a great job so far managing the challenges of the transition from a contract R&D operation to a volume systems provider. And they're on track to meet our customer delivery requirements..

Now I'd like to talk about our program opportunity for this business. Today, we have visibility for programs that total approximately $350 million spanning the next 7 years. We're in various stages of engagement with most of these programs. Some are well underway, such as the Apache program, and others are in the early development stage..

Intevac's differentiated digital night vision sensor is single source for nearly all of these programs. As we look at this pipeline, we are designed in with our sensor assembly for the Joint Strike Fighter Pilot Helmet. Our digitally fused goggle program is progressing for the special forces.

We expect these programs to drive the next wave of growth beyond the Apache program. These 2 programs, in addition to Apache, represent over 1/2 the opportunity pipeline..

Our Photonics business, in contrast to prior years, is a significant contributor to corporate performance and provides important diversification for the company in light of the cyclicality of the Equipment business.

It is approaching an inflection to achieve model profitability that we believe can generate significant stockholder value when the business captures its opportunity pipeline and become sizable enough to execute on its strategic alternatives..

Now I'll move to our Equipment growth strategy. We continue our efforts to grow the Equipment business and capitalize on differentiated technologies we have developed for the HDD media manufacturing market. We have redefined our growth strategy in Equipment to become an application-based strategy rather than a market-focused strategy.

We have consolidated our hard disk drive and solar business groups to a more efficient thin film equipment group led by Executive Vice President, Jay Cho. Our core capabilities lie in high throughput small substrate thin film deposition, particularly sputtered metal and dielectric deposition.

We are now focusing our Equipment growth efforts into the vacuum deposition market where we can leverage our core technical capability. Our new product offerings utilize a substrate-independent platform that can address multiple vacuum coating applications in a wide array of markets.

We will execute this strategy within the cost structure we have in place today..

Our first success with this new strategy was the PVD system order for advanced crystalline solar cell manufacturing we received in the fourth quarter of last year, displacing our customers' incumbent supplier. Further validating our new strategy, last week we announced our first development tool sale into the mobility marketplace.

We reengineered our diamond-like carbon thin film technology that was developed for the hard disk drive media market into a scratch-resistant protective transparent coating for cell phone cover glass. Both of these wins have follow-on opportunities expected in the next 12 months..

We have established both a business development organization and a product development process to manage the growth initiatives in all of our businesses. Now in place is a rigorous phase gate process that funds program as development milestones are met and the risk is retired from the program.

Specifically, our process focuses on the retirement of market, technology, adoption and competitive risks..

We believe that our new strategy, coupled with an improved organizational configuration and business processes, significantly increase our potential for success in our growth initiatives..

With regard to our current products focused on the solar market, we have scaled our investment in solar implant to a level that aligns with the opportunities we see for this technology.

We continue to have active engagement with Tier 1 customers, and this product is now under management of the business development organization and has milestones and gates set for its continued funding. Our processes are in place and we continue to work to proliferate this new product for the next generation of high-efficiency device structures..

Our product targeted for etching of multi-crystalline solar cells was unable to meet our milestone engage set in the first quarter of the year and we have discontinued that product..

In closing, I'd like to summarize our key strategies.

In the hard drive media manufacturing equipment business, we are focused on remaining the technology and market share leader through a continuous improvement and enhancement of our HDD media manufacturing tool, with particular focus in the near term on developing and qualifying our upgrade road map..

In Photonics, we will grow this business by leveraging our industry-leading digital night vision sensor and camera technologies to capture the program opportunity pipeline we discussed earlier.

We will drive opportunities to grow our Equipment business by leveraging our core capabilities in high throughput thin film deposition into adjacent vacuum coating applications, in which we have already had success, first, in the manufacturing of high-efficiency solar cells and recently, in protective coating of cover glass for mobile devices..

We will prudently allocate funding for our growth initiatives based on the expected return on investment and the retirement of product and market risk. We will implement our strategic agenda while continuing to maintain a strong financial foundation and return capital to our stockholders..

I look forward to updating you on our progress next quarter. And we'll now turn the call over to Jeff to discuss our financial results for the first quarter, guidance for the second quarter and our outlook for the year.

Jeff?.

Thanks, Wendell. First quarter revenues totaled $17 million, which was above our guidance. Equipment revenue totaled $9 million and included one 200 Lean system. Photonics sales of $8 million included $3.7 million of contract research and development revenues..

Total consolidated gross margin was 28.3%. Equipment gross margin was 22.2%, flat to the first quarter of last year and down from the fourth quarter due to a lower level of Equipment upgrades and the impact on our factory absorption at the lower revenue level.

In our Photonics business, gross margins were 35.2% down slightly from the fourth quarter of 2013, but up significantly from the first quarter of last year due to higher contract margins..

Q1 operating expense was $9.5 million down from the fourth quarter and our guidance, as we implemented additional cost reductions in the quarter. Our Q1 net loss on a GAAP basis was $4.5 million or $0.19 per share.

Our Q1 net loss on a non-GAAP basis was $4.3 million or $0.18 per share as compared to our guidance of a loss of $0.23 to $0.25 per share..

Our backlog was $51.9 million at quarter end. Equipment backlog of $8.5 million includes 2 PVD systems, one for solar and one for protective coating of cover glass. Backlog in our Photonics business was $43.4 million. We ended the quarter with cash and investments of $75 million, equivalent to $3.14 based on 23.9 million shares at quarter end..

Cash and investments decreased by $6.4 million principally due to the operating loss, capital expenditures and stock repurchases. During the quarter, we bought back 138,000 shares of stock for $1.1 million..

Capital expenditures were $1.4 million and depreciation and amortization was $1.2 million for the quarter..

Now I will provide our guidance for the second quarter and our outlook for the year. We are projecting consolidated Q2 revenues of $12.5 million to $13.5 million. The decrease in revenue from the first quarter is due both to no hard drive systems in the second quarter, as well as lower Equipment upgrade revenue..

Our Photonics revenue is expected to grow from $8 million in the first quarter to over $10 million in the second quarter. This growth is driven by our Apache camera business. We expect second quarter gross margin to be 27% to 27.5%, which is slightly lower than the first quarter due to the lower level of upgrades in our Equipment business..

Operating expenses are expected to be $9.5 million to $10 million. For Q2, we are projecting a net loss in the range of $0.21 to $0.24 per share..

I'll now discuss our outlook for the full year 2014. The outlook for the full year 2014 is largely unchanged since our last conference call. We expect revenues in the range of $73 million to $83 million, with total Equipment revenues up 10% at the high end of our outlook.

In Photonics, revenue is up approximately 25% to 30%, respectively, from 2013 levels..

Gross margin is expected to be 34% to 35%, with operating expenses of approximately $38 million to $39 million for the full year.

While the resulting operating loss is expected to be in the range of $10 million to $13 million on a GAAP basis, the cash burn for the full year is expected to be approximately $5 million excluding any cash used in the company's $30 million repurchase -- stock repurchase program.

The net loss for the year is expected to be between $0.41 and $0.49 per share. This completes the formal part of our presentation. Operator, we are ready for questions. .

[Operator Instructions] Your first question comes from David Rold of Needham & Company. .

David Rold in for Rich Kugele. Well, I just I want to ask a question on the win announced this week on the touchscreen equipment opportunity.

Just any idea of market size, who the incumbent was you displaced, who potential other competitors might be, ASP's net business versus others and what the extent of the modifications necessary for -- to repurpose that Equipment?.

What we can say, of course, we announced this because it really aligns to the strategic direction we're going with the company. As far as market size, obviously, the cell phone market is 1.5 billion units per year, something like that. So the opportunity out there could be very large.

I think where we're at in our stage, we have been working with a particular Tier 1 customer on this application. We are in the product development stage of this program, and they do have a customer that's going to purchase cover glass with our films on it. And then we'll have to see how the market adoption goes forward with that.

So it's early stage, a little too early to really decide with that Equipment market looks like until we see some of the initial adoption. But it's very positive with our strategy going forward and a validation of that to some degree. You asked the question on the... .

The competitive landscape in the... .

Yes, competitive landscape, this is an area where you will see some of the European players or in this Von Ardenne is one that plays somewhat in this space. But most of the competitive tools out there are either doing very large sheets of glass or is equipment that did large sheets of glass that have been adapted and palletized.

So we think our solution is pretty novel and we also have pending patents on our carbon source. So we believe we have differentiated technology with our diamond-like carbon that we initially developed for the hard drive.

I'm sure if this becomes a very popular coating that there will be other people that will take a close look at this, but we're encouraged with the progress. .

Okay.

And just the extent of the modifications necessary to repurpose it? Does it end up -- how does it update the margin is I guess the question?.

I think right now, we are working on existing platforms with slightly modified sources. So -- and again, this is a development tool that we've put out in the field. We will address the production version of this particular tool.

We may keep that on a current platform if the market is not taking off as quickly as we'd like, or if we get very good adoption rates, we may look to move that program onto a higher output platform. That's our universal platform that I mentioned in the script. .

[Operator Instructions] And your next question comes from Mark Miller of Noble Financial. .

I just wanted to clarify your response to the previous questions.

This DLC tool, is that essentially the same type process technology you're using for the hard drives? Or is this something completely new in terms of the deposition technology?.

No. This is the source that was developed for the hard drive business that we've done -- worked with the process to make it transparent. The DLC we put on hard drives is opaque. So that's where the development activity and it was really more process development with a little bit of modification to handle the different substrate rather than a hard disk.

.

Is there any thought of going to adding to that a chamber that deposits a hydrophobic coating to prevent fingerprints or suppress fingerprints? Or does anybody offer that in terms of your competitors?.

At this point, those 2 processes are being done in 2 separate pieces of equipment. The finger -- the anti-smudge is done in evaporation chamber. But it's certainly an interesting area that we will look at. .

So it's something you're not offering now but a possibility to expand your universe here?.

That's correct. We're not offering that at this point but we'll look at all the opportunities that we think this can blossom from this particular technology in this industry. .

I'm just wondering, you said you discontinued your Solar etch program.

What's going on in terms of the ion implanters? Are you involved in any quals or evaluations currently?.

Yes. We have several ongoing. I would say they are all major players. One may be a little more further out because it's a very, very advanced application. But we are actively doing demos. I think we just did over 2,000 cell runs for a big customer in Asia, and we're just -- we're seeing that data start to come back this week and next week.

So we still have interest and engagement and that's what we're using to drive our spend levels in that area, as well as how we set our milestones and gates on how we continue to fund this program. .

So if these quals go well for you, it's possible we'll see some additional orders this year for the ion implanters?.

I would say that there is a possibility, yes. .

Just wanted to get back on -- just to finish up some of the cash flow items.

Cash consumed by operations, was that around $5 million or assuming?.

A little bit more. .

Okay.

And then CapEx this quarter?.

It was $1.4 million. .

And depreciation? That's probably on your balance sheet, I can -- depreciation and amortization?.

It was $1.2 million. .

[Operator Instructions] And there are no further questions. I'll now turn the call back over to Mr. Blonigan. .

Thank you. We want to thank you for joining us today and we look forward to updating you in our next call on our second quarter results. Until then, so long. .

Ladies and gentlemen, this concludes today's teleconference. You may now disconnect..