Claire McAdams - IR Wendell Blonigan - President and CEO James Moniz - EVP, CFO and Treasurer.

Peter Peng - B. Riley FBR Nehal Chokshi - Maxim Group Mark Miller - Benchmark Company Ben Klieve - Noble Capital Markets.

Good day and welcome to Intevac's Second Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be provided at that time. [Operator Instructions] Please note that this conference call is being recorded today, July 30, 2018.

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 second quarter of 2018, which ended on June 30th. In addition to discussing the company's recent results, we will provide financial guidance for the third 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 second 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 July 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..

Thanks, Claire, and good afternoon. Today we reported Q2 results that were higher than forecast. Revenues were just over the top end of the guidance, due to a strong performance in our hard disk drive business.

Gross margins also came in above forecast, for both equipment and Photonics, and with tight control of operating expenses, our loss was much smaller than forecast, at $0.01 per share. We continue to focus on managing cash and ended the quarter with $39 million on the books.

Bookings were up sequentially in both equipment and Photonics, with total new orders of $24 million, up 14% from Q1.

During the quarter, we continue to make progress in the expansion of our Thin-film Equipment business, as well as a development of our new ISIE-19 digital night vision sensor, to support the capture of our photonics opportunity pipeline.

On our last call, as we recap 2017, I highlighted that we had delivered three consecutive years of growth, in both 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.

We also communicated our expectation for a pause in our growth trajectory in 2018, due to a number of developments that transpired earlier this year.

Since then our outlook is fundamentally unchanged, so today I'd like to give you an update on the status of each of our businesses and our business initiatives, driving our outlook for the rest of the year. I'll begin with an update on our Thin-film Equipment business.

The biggest growth opportunity for our Equipment business continues to be our VERTEX tool and the deposition of protective, decorative and end reflective coatings on display and back side cell phone cover glass.

During the second quarter, we made several strategic moves, targeted to accelerate and improve our capture rate for applications for the VERTEX system.

We added regional sales manpower to the VERTEX program, increasing our sales and marketing efforts directly with handset and electronic manufacturers, in an effort to raise awareness not only of our capability, the traction we are seeing in the marketplace.

This effort in the second quarter resulted in demo engagements with seven handset makers and one new cover glass manufacturer. Included in the work were demos of our decorative coating capability protected with our oDLC film.

Clearly the activity we announced in March with Truly, protecting decorative films on backside cover glass peaked interest in this application. We expect to finish these demos and see initial results during the third quarter.

We also continue to drive the strategy to place seed VERTEX assets with key cover glass makers and generate end customer demand, which after reaching a threshold and volume would be purchased. We have had discussions with three separate large cover glass manufacturers in the last quarter to take delivery of our VERTEX under this initiative.

We have made progress in our discussions and have proposals in place with each of them. During the second quarter however these cover glass makers were ramping production for new phones that will release in the fall and getting closure on this initiative from the key decision makers proved challenging.

I am personally spending time in Asia to drive progress with this initiative, and we'll be back this quarter to continue the effort. A key to adoption that we are addressing with these strategies, is to generate pull in the market with the handset makers directly and minimize the risk for the cover glass makers' capital investments.

In March we issued a joint press release with our first oDLC customer, Truly Opto Electronics, announcing the launch by the 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. It is our understanding that the production run has been completed for this model at Truly at this time.

We continue to closely monitor this application on back covers for additional orders and adoptions. Truly has four VERTEX systems installed, and along with this application is applying oDLC for front cover glass, wearables, point-of-sales, interfaces and vending machines among others.

We announced in January the upcoming availability of our new deposition source technology for VERTEX that deposits high durability anti-reflected or AR films as well as high durability decorative coatings, similar to the films that we are currently protecting with oDLC only much harder.

Using this new deposition technology, we have been working to improve our oDLC to protect against sharp point impacts, as the current formulation is tuned to protect against abrasion and provide extended lifetime for the anti-smudge coatings. We now have engineered a new under layer for our DLC film that greatly improves point impact resistance.

We call it oDLC 2.0 and we're optimistic that applications that we have not yet captured with our original oDLC will be enriched with the new technology. The production versions of this new deposition source are now in house for initial builds, integration and qualification.

We still expect this technology to be available on new orders or as upgrades in the back half of the year. Beyond this, we've already received a patent on our oDLC deposition source, and we filed our provisional patents for a novel ultra-high durability film stack for AR and decorative coatings.

We've also developed a hybrid concept for VERTEX that would enable this novel film stack to be produced at high-volume and low cost.

We continue to expect new orders for VERTEX this year, but given we just recently began engaging end customers with sampling of our new offerings, we need to see how that plays out over the year as the new technology becomes available.

See end market results from our current decorative coating protection project with Truly and progress with our new penetration initiatives. Of note, new configurations at VERTEX that enable oDLC 2.0, AR and decorative coatings will require new film qualification cycles and also require customer acceptance prior to the revenue recognition.

We'll update you on our progress as we announce orders as well as our quarterly conference call. As for the balance of our Thin-film Equipment business, our prior expectations of revenue for the HDD segment as well as for our solar products remain consistent from last quarter. Our hard drive business continued to be strong in the second quarter.

Revenues included two 200 Lean Systems and continued strong levels of upgrades, spares and field service. We also announced multiple new orders for a total of three 200 Leans, one shipping later this year and two in backlog for 2019 revenue.

Industry hard drive units again surprised to the upside in Q2 and given the continued strength in Nearline, we expect media units grew quarter-over-quarter as well. Even PC units increased year-over-year for the first time in six years.

Nearline high capacity drives continue to be the growth segment for the hard drive market, which is positive for our business giving the significant number of disks in each Nearline drive. The new 14-terrabyte Nearline drives currently rolling out have a record 10 disks in them.

The most recent estimates in our industry show strong growth in extra bytes shipped on both hard drives and solid state drives through 2022, with hard drives still representing at least 90% of total extra byte shipped during that period.

While excess disk manufacturing capacity still remains today, capacity utilization has increased above the 80% level. The capacity crossover point is currently forecast to occur in 2020, after which our hard drive customers would need to add more 200 Lean Systems to meet the growing demand for high-capacity Nearline drives.

These forecast change as we all know, but the overall sentiment in the HDD market remains as positive as it's been in many years. In the meantime, the multi-year technology upgrade programs underway have resulted in strong demand for both systems and upgrades.

We now have four 200 Leans in the plan for 2018 revenues and are forecasting another strong year in our HDD business, similar to 2017 with the business more weighted towards upgrades rather than tools.

In our activities in the solar market, I'm pleased to report that we've begun the installation process on the first three energy ion implant tools of the 12 systems currently in backlog. This is a positive step as the facility for the manufacturing line has now been completed and tool sets are starting to move in.

While the schedule and timing of the remaining nine tools remain fluid. At this time we continue to expect three more tools we'll ship this year with six in revenue for 2018, the other six in 2019.

In addition to the implant tool, we continue to progress in capturing booking opportunities for the MATRIX PVD tool targeted for existing manufacturing line upgrades. Earlier this year, we talked about our launch into the advanced packaging market with our MATRIX PVD platform.

This is a market where our advantages of high productivity Thin-film processing solutions provide a compelling advantage over current ones. In particular, our solution reduces the cost of the redistribution seed layer by two-thirds compared to existing process technologies.

The MATRIX presents a cost reduction path for industry OSATs as they move from wafer to panel level processing. As the same MATRIX platform can be configured for today's 200 and 300 millimeter wafers or panels up to 890 millimeters wide.

Consistent with our product development process, we engaged with Tier 1 OSATs and have ongoing activity for both wafer level and panel level demonstrations and evaluations.

We continue to participate in all the relevant industry conferences and we will install the demonstration tool in our clean room when it's completed this fall to validate operational particle performance. At this point, we are seeing delays in panel level factory plans and do not expect the revenue in the MATRIX systems for the market this year.

We delayed some development activity but our objective remains to book the first tool from a foundation OSATs customer before year-end.

Now moving on to Photonics, last quarter, we discussed how our Photonics business is weighted toward funded development contracts versus products this year, and has been affected by delays with the release of the government's budget.

We were waiting for funding to flow down from the government and we have now seen that start to happen across several programs. Also, we're pleased to hear the announcement that there's a handshake deal in place between Lockheed and the government for the F-35 Joint Strike Fighter LRIP 11.

This should get the contracting flowing through the supply chain and pave the way for LRIP 12 through 14 negotiations. There is still some channel inventory we're working through this year but we expect sensor volumes will come up from current monthly levels beginning next year.

One highlight of the second quarter was that we received our next tranche of government funding towards development of our new digital night vision sensor, the ISIE-19. This has allowed us to continue the development schedule with only a minor delay.

We were expecting the next funding - we expect the next funding release to occur prior to the end of the government's current fiscal year.

Our ISIE-19 sensor is the core technology for all of our new night vision products, including our pursuit of dismounted soldier digital night vision, and it is the technology upgrade path for all current production programs we have and are currently delivering.

Intevac Digital Night Vision Systems continue to be the technology of choice for the premier fighting platforms of United States military. The Striker II Helmet is a significant program in our pipeline and includes the future night vision system for the Euro Fighter, as well as targeted for several other airframes.

We had anticipated a development funding release for this program around the August timeframe and we're working on bridge funding on a month-by-month basis with our customer BAE.

Unfortunately this program has slipped to the right and is now on hold with resumption expected towards the end of this year, when our customer gets on contract and then full development activities will commence into 2019.

Our wireless head mounted displays for the family of Weapon Sight Crew Served are now in initial field evaluations and projected product quality requirements are going up as the user base is expanding. We also believe that overtime this head mounted display can have applications outside of the military.

And finally we're making progress on the DELTA-I coalition warfare digitally fused goggle program, but there has been some delay programming the funding from all of the coalition partners. As a prime on this program, we are currently in process of selecting a partner to do binocular integration.

We'll talk more about DELTA-I as things progress in the back half of the year. So in summary, we still expect 2018 will be a pause in our revenue growth trajectory after three straight years of growth. Our outlook is unchanged with total revenues expected to be right around $100 million mark.

As we move now to the back half of the year, we still have several moving pieces bookings to secure and sign offs to complete and we continue to progress on all fronts. As events develop during the first quarter, we took decisive action in lining our spending in strategies, while ensuring we did not disable our growth initiatives.

As Jim will detail in his remarks we've made good progress reducing our expenses as well as managing our cash, while still investing in our growth initiatives. We entered 2018 with $43.5 million in cash and equivalents and given our current outlook we expect to exit the year with a net increase in our cash position.

Our growth story remains very much intact and we are steadfast in our focus to return to growth and profitability in 2019 as we continue to build momentum in our growth initiatives this year. I'll now turn the call over to Jim to discuss our Q2 results, our Q3 outlook and some additional commentary on 2018.

Jim?.

Thank you Wendell. Consolidated second quarter revenues totaled $26.1 million slightly above guidance. Thin-film Equipment revenue totaled $20.8 million and included 200 Lean Systems along with upgrades of spares and service.

Photonics revenues of $5.3 million included $2.5 million of product revenues and $2.8 million of contract research and development revenues. Q2 consolidated gross margin was $9.8 million or 37.4% and exceeded the high-end of our guidance.

Customer request to pull in higher margin upgrade revenue in the second quarter allowed for increased incremental margin in Thin-film Equipment. The strong orders in Thin-film Equipment also allowed for increased material receipts, which resulted in higher absorption than forecast.

In Photonics, we maintained favorable yields, controlled expenses and managed program cost gross to a minimum, which all resulted in improved margins. Q2 operating expenses were $9.7 million down from Q1 and lower than our guidance primarily due to a more focused emphasis on selected programs in R&D and cost containment efforts implemented in Q1.

Q2 operating expenses also included a small write-off of fixed assets. This resulted in a net loss of $167,000 or $0.01 per share exceeding our guidance. Our backlog was $64.6 million at quarter end. Thin-film Equipment backlog of $54.2 million included three 200 Lean HDD Systems, 12 energy solar ion implant systems and non-systems HTD backlog.

The backlog in our Photonics business was $10.3 million. We ended the quarter with cash and investments including restricted cash of $39.1 million equivalent to approximately $1.73 per share based on $22.6 million shares at quarter end. It is our objective to manage our cash and investments to stay above the $40 million level.

We were just below that at the end of Q2, but given the high amount of accounts receivable at the end of Q2, we believe we will end Q3 with cash above $40 million. Cash flow used by operations was $489,000 during Q2. Q2 capital expenditure were $581,000 and depreciation and amortization was $1.5 million for the quarter.

Now turning to the full year outlook for 2018, we continue to expect overall revenues to be down by about 10% to 12% from the 2017 levels. At this overall revenue level and given the mix impact we would expect gross margins of around 33%. We expect our total operating expenses to be 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 Q3 specifically we're projecting consolidated Q3 revenues to be between $18 million and $19 million. We expect third quarter gross margin to be between 35% and 36%.

Q3 operating expenses are expected to be between $9 million and $9.5 million. We expect interest income of about $100,000 and net taxes of about $200,000 in the quarter. For Q3, we are projecting a net loss in the range of $0.11 to $0.13 per share assuming approximately 22.7 million shares. This completes the formal part of our presentation.

James we are ready for questions..

Yes sir. [Operator Instructions] Our first question comes from Craig Ellis with B. Riley. Your line is now open..

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

Good afternoon..

So just on the guide, can you give some of the gives and takes? Are you expecting any revenue recognition for any systems in your Equipment and maybe some expectations for the Photonics segment?.

Yes, on the guidance we gave for the Q3 revenue, there are no systems. There continues to be strong upgrades in non-systems business and hard drive. And I think as Wendell has said, we still expect six energy tools for the back half of the year but those are not in Q3.

And we do expect growth mostly from what we've seen in bookings and backlog in the photonics business in Q3 over the first two quarters which averaged a little over $5.2 million per quarter in Q1 and Q2 that will grow in Q3..

Okay. And just kind of back into the full year comment, this is seem like the fourth quarter as you know contain six energy systems, two VERTEX system and one lean system.

Is that the assumption there?.

That is a correct assumption, yes..

Okay.

And the upgrades in software, just given the second quarter, are you kind of expecting a more normalized level around $10 million per quarter for the upgrade in software?.

That's also a good mathematical computed number, yes..

We expect it to be strong. It's much stronger in 2018 than it was in 2017. And as Wendell in his prepared remarks, we expect hard drive revenue to be strong. The mix will change a little bit, where we had six systems in 2017. There will be four systems, but that loss of systems revenue will be offset by higher upgrades in spares and maintenance..

Okay.

And maybe you can talk about the cash and how comfortable you are if receiving a large VERTEX order, and with the cash that you have right now?.

Yes, I can answer that question. We ended Q2 with just under $40 million. And we're confident that we will be above $40 million at the end of Q3. As you know we do have a VERTEX system fully built, and we did procure some long lead items for multiple VERTEX systems.

So depending on the orders and certainly the two systems we have in revenue, we don't expect any impact of cash. I'm not sure I understood your question fully on the cash impact with VERTEX..

Just, it seems like you're engaged with a few customers.

And if these orders come in, how comfortable with the cash balance that you have right now, or do you need to potentially raise some cash in order to fulfill some big orders that might come your way?.

Now we're in good shape with our cash position. And this is about the level we want to run. We're a little bit under the $40 million just because of the timing of some of the ARs. But as Jim said, as we move through this quarter we expect the balance to go back up over $40 million..

Great. And one more question before hop back into the queue. Just given that there is a few systems in the fourth quarter.

Are these in the inventory, or are these going to be built end of the third quarter for shipment?.

So the one hard drive systems been built as we speak, that was part of the three system order we got in Q2. And I believe in the press release, we said one would go in Q4 and the other two would go in the first half of 2019. On the six energy systems, three are already there and in fact they're currently going as we speak into installations.

And then we have roughly four more built that are in inventory ready to ship when the customer is ready to get those. We expect that to happen sometime in the back half of the year and those will revenue as well. So those are all in inventory. And as we talked about earlier, there is one VERTEX system already fully built in inventory..

And just as a note on top of that with the energy tools that we expect those to revenue at shipment, we believe that we will be through the revenue recognition, customer sign-off cycle with the first three and we should - if they don't revenue at shipment, they will revenue once the sign-off occurs, if they have shipped previously..

Great, thank you guys..

Welcome..

Thank you. Your next question comes from the Nehal Chokshi with Maxim. Your line is now open..

Thanks. So you mentioned that, the Smartphone OEM, that's the top three smartphone has now been in the market with your coating.

I believe that they have multiple skews with a few skews that utilize your coating, do you have any color as far as how has been demand for the skews with and without the coating?.

At this point certainly the end customer is very close to the best on what's going on with the sales of the different models and the different colors. We got to gauging it by additional orders and or adoptions on other phones. So I think we're still in the digestions phase of that rollout at this point. So we don't have a lot of clear information..

Okay.

And how has utilization the four systems that Truly trended over the past quarter?.

Kind of not our place to see that, but I can see that they still have some capacity, but they are also been able to leverage this program as well to generate additional interest..

Okay, good. And then finally on the tool orders that you guys received, the three tool orders for Lean 200.

Just wanted to understand, why is the timing for the first one 4Q 2018 as oppose to earlier doesn't add not really help them with respect meeting demand requirements, or is this for advance technology?.

You're talking about the tool that's actually in the 2018 forecast..

Correct..

That our customer really doesn't necessarily tells exactly what they are going to use that for. But I think in general, the environment, the capacity has been - the environment has been positive, the capacity has been reasonably tight.

But I think they are carefully watching the demand curves and they will look at the capacity needs probably a little bit later on..

So what do you say with the capacity utilization for media now?.

We're calculating it mid-80s at this point..

Okay.

And what do you think it was one year ago?.

I think I have that right in front of me. One year ago was, yes, - just at 80, that's up about 5% compared to low 70s in 2016, so you can kind of see how that capacity has ramped a little last 12 months..

Great. Okay, great. Thank you very much..

Thanks, Nehal..

Our next question comes from Mark Miller with Benchmark. Your line is now open..

Just curious, I just wanted to follow on the previous question. So you just reported earlier today that they're starting to be really near full in both media and head production.

I am just wondering, are these tools now that you've gotten orders for recently are they more replacement of the legacy coders that have been there for quite some time, or do you feel these are actually capacity add because mid-80s it sounded like Seagate was higher from what they were saying this morning?.

Yes, I hadn't - I actually hadn't had a chance to listen to that yet. But we have been in a technology upgrade cycle at a system level for a while. Those are not adding capacity into the market, but I think as we move through 2019, we think that that program completes in 2019.

So whether they use I'd say without saying too much, it's - they are getting to the point where they need to use tools for capacity. So, I think again they're looking at that demand curve very carefully and very cautiously and they'll add capacity when they absolutely are convinced that there is no - that the growth rates are going to sustain..

The number of legacy tools currently out there is that fewer than 12?.

Yes..

Okay..

You're talking about 250s, correct?.

MDP-250, right..

Yes..

They've been there for a long time. So, okay I think that's about it for me. Thank you..

Okay, thanks, Mark..

Thank you. [Operator Instructions] Our next question comes from Ben Klieve with Noble Capital Markets. Your line is open..

Alright, thank you.

A couple of questions from me on the Photonics side, can you talk about how the gross margins improved sequentially from the first quarter if you back out the loss provision that you recorded during the first quarter?.

Yes, as you know the first quarter Photonics gross margins came in about 6% and the second quarter they came in at about 20%. I don't have the actual math behind it, but there was a big cost reserve we put in Q1 on a small volume of revenue, which was around $5.2 million which if I had to do the math I'd say that that was probably about 10 points.

So sequentially from there it went from roughly the mid-teens 15 to about 20% and most of that just on the improved yields. And then essentially improved efficiencies in Photonics put a slightly different mix..

And then so given that some of that improvement was driven by effective costs controls internally, I'm curious to what degree do you see further improvement in the gross margins here.

assuming there's no shift in the revenue mix how much more run way do you have on the gross margins just from internal improvements?.

Well we have a combination of two things. We have continued improvements in efficiencies and yield and then also a mix change.

And as you know, we had some lower margin programs in the first half of the year and we do expect to see a little bit of a mix shift in the second half, which is why on the guidance you'll look at the fact that we gave guidance of somewhere between $18 million and $19 million and a loss of between $0.11 and $0.13 a share, in the prior quarter we were $24 million to $26 million at about the same kind of a loss.

So Photonics is contributing to that improved performance in the back half..

Okay, perfect. Thank you.

And on the F35 you touched on that you think revenue could pick back up in 2019, I'm curious to what degree of visibility of that if - like you noted if while 11 production if that contract comes through how much visibility do you have of growth in 2019 from that platform or versus needing lots 12 I guess lots 12 especially to come through?.

We'll still be working through our L-rep 11 [ph] in 2019. We did have a meeting with our customer several weeks ago and there's a lot of work going on in the supply chain channel, there's some inventory that build that's one of the factors on our lower monthly run rate.

And they expect that to correct itself as we move out of this year and we expect our sensor numbers to come up. But I think the - I haven't read of anything about a formal deal yet just a handshake deal.

But that's going to allow the negotiations for 12 to 14, which we've already seen RFQs for and that will - they plan on tripling the production levels over the next several years. So we should see that in the out years, but we definitely think 2019 we're going to see the resumption of higher monthly run rates for the F35..

Perfect, thank you.

And then just one last one for me, given the changes that you guys have made internally here over the last few quarters - seen over the last quarter is the SGA run rate that we had in Q2 is that - we kind of apply that as a run rate going forward or is there any kind of meaningful shift from that $4.7 million that we should look at here in the back half of the year?.

You're talking about just the R&D specifically or are you talking….

I'm sorry, SGA..

It's at $4.7 million, but I think you meant $9.7 million..

No $4.7 million is just SG&A..

Well sorry yes, on the SG&A part I think you would assume that that's kind of a pretty good run rate going forward..

Okay, perfect. That does it for me. Thank you all, I'll jump back in queue..

Thank you..

Thank you. Actually show no further questions at this time, so I'd now like to turn the call back over to Mr. Blonigan..

Thank you. So before I sign off I'd like to thank the dedicated employees of Intevac, all around the world for their tremendous efforts and outcomes in this very dynamic environment. I also 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. Thank all of you for joining us today and we look forward to updating you again during our Q3 call in October. Until then so long..

Thank you. Ladies and gentlemen that does conclude today's conference. Thank you for your participation. You may all disconnect. Have a wonderful day..