Good day, and welcome to Intevac's Third Quarter 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference call is being recorded today, October 26, 2020.

And at this time, I would like to turn the call over to Claire McAdams, Investor Relations for Intevac. Ms. McAdams, the floor is yours..

Thank you, and good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the third quarter of 2020, which ended on September 26. In addition to discussing the company's recent results, we will discuss our outlook looking forward.

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 our business and our current outlook, then, Jim will review third quarter results and provide guidance for the fourth quarter 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 October 26 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. Thank you all for joining our Q3 2020 earnings call. I hope that you and your loved ones remain healthy and safe during this challenging time we are navigating.

Today, we reported third quarter revenue in line with expectations, slightly above the midpoint of guidance, and with strong gross margin performance and tight control of operating expenses operating profitability and net income came in favorable to our forecast at roughly the breakeven level.

In Q3, we recorded the strongest bookings quarter for Thin-Film Equipment or TFE in 18 months, driven by strong demand for upgrades in our Hard Disk Drive or HDD business. Photonics revenue remained at record high levels coming in at over $12 million due primarily to continued strength in the IVAS development program for the U.S. Army.

A key highlight in the third quarter was our positive free cash flow, which further strengthened our balance sheet, increasing total cash and investments to just under $50 million. Year-to-date, we've increased cash by over $6 million despite the incredibly challenging environment we're operating in 2020.

Regardless of the impact incurred in our operations due to COVID-19, we continue to deliver solid results in the third quarter, supporting our expectation for profitable results, positive free cash flow, and an increase in our cash position for the full-year.

The most significant challenges we continue to face in 2020 are pandemic-related delays and constraints in our TFE business.

Nearly all of our equipment business is Asia-based, which means we have little to no ability to engage a customer sites on development work, nor facilitate high-level regional meetings, given travel restrictions and bans, onerous quarantine requirements, as well as a general reluctance to meet face-to-face during the pandemic.

We try to facilitate these activities remotely. This has proved to be very challenging, particularly in China. Given our HDD customers are U.S. headquartered companies with Asia-based manufacturing, these constraints have been manageable.

We continue to deliver strong levels of technology upgrades in Q3, positioning 2020 to be a near record in HDD upgrade revenue, with both near term and longer term forecasts for our HDD business continuing to strengthen.

That being said, the ability to travel internationally and directly interact with customers is an important component of our business, and the ongoing pandemic continues to be a hindrance in our TFE system evaluation programs, each of which require timely and close collaborations.

These programs unfortunately continue to elongate as the pandemic continues on. As an example, we haven't been able to travel to China since January, effectively eliminating our ability to roll out DiamondClad to the key cell phone design engineers and executives there.

For our installed evaluation VERTEX system, we needed to extend the evaluation timeframe to compensate for two quarters of operations lost due to our customer's facility shutdown in quarantine.

So, while a fresh frustrating aspect of 2020 has been the push out of VERTEX revenue previously forecasted for the year, we continue to make progress on multiple fronts with encouraging results. I will share several examples with you.

First, our VERTEX evaluation activity in China for patterning now includes projects with the majority of the largest handset manufacturers in the region. While the first back covered glass design we discussed last quarter was unfortunately not selected by the end customer for release this fall.

They're continuing the effort with six new designs, plus we're currently working with two additional China-based handset makers for rear glass decorative padding development. Given this continued engagement in multiple projects and process, we remain encouraged that our prospects to win a significant program in China with this technology.

Second, our demo activity in the U.S. for DiamondClad applications has never been busier. In addition to the initial development work for the latest cell phone front cover glass, we have demos underway with major screen protector companies, as well as U.S. companies targeting various consumer product applications.

Adding to that, we're also performing initial demos for automotive mounted camera and sensor lens protection.

So, as we near the end of a very challenging year, we clearly have experienced frustrating pandemic-related setbacks in our VERTEX initiatives, but there has also been encouraging progress that continues to fuel our optimism as we move forward.

Looking ahead to next year, given the fact we have developed the systems and hardware needed to enable DiamondClad decorative patterning, we'll continue to focus our efforts on sales and marketing, including our branding initiatives via DIAMOND DOG screen protectors, and in film development, emphasizing further improvements in covered glass breakage performance.

In solar cell implant, since about this time last year, discussions with our ENERGi implant customers have consistently been focused on their plans targeting a multi gigawatt expansion in China. This expansion, which was initially planned for 2020, has continued to delay.

While it is still possible the expansion will happen in 2021, which could result in meaningful business for us. At this point, our confidence that we'll see purchase orders within the next quarter or two is waning.

This customer has been focused on transferring ownership of their solar business, and it will be up to the new management team to decide if and when this expansion will happen when ownership transfer eventually occurs.

For the MATRIX PVD system in advanced packaging, just as we're seeing delays in China the MATRIX evaluation system which is located in Europe is also being affected by global travel restrictions and quarantines. The tool continues to make solid progress in its evaluation, albeit at a slower pace than originally planned.

This tool's revenue remains in our 2021 plan, and we believe that this evaluation and qualification process will continue at its current pace, given that the introduction of mainstream advanced panel level packaging technology is still a ways out in the future.

Turning now to our HDD Media business, which has continued to strengthen in 2020, as a result of the acceleration of datacenter investments that reflect the changes in the way we work, learn and communicate as a result of the pandemic.

Heightened demand for mass capacity nearline drives for cloud based storage, and the datacenters are driving upside in media unit growth rates. Expectation for growth in nearline drive exabyte shipments, both in the short-term and long-term have increased for three straight quarters now.

The rising expectation of 34% annual growth in nearline HDDs over the next five years will require the industry to produce and ship far more discs, which in turn drives demand for our systems.

For Intevac, the enablers of increasing demand for mass capacity drives and more discs for drive will benefit our TFE revenue growth trajectory, and our confidence in the fundamental drivers of our HDD business has continued to increase since our last earnings call.

At this point in 2020, the industry is running at or near historically high media capacity utilization rates and we estimate rates to be over the 90% level periodically.

While the growth in exabytes shipments will continue to be supported in part by our customer's ongoing technology upgrade initiatives, the discussions to significantly expand the industry's media manufacturing capacity, beyond the incremental capacity we've added in the last two years, for the first time in a decade has begun.

Today, the most recent media demand expectations have indicated installed capacity crossover in the mid to late 2022. However, with this accelerating growth and planning underway, we believe we'll see an increase in 200 Lean shipments in supportive media capacity expansion, beginning in 2021.

We would also expect to see initial tool bookings no later than the end of Q1 2021 to support any capacity expansions that would materialize in that timeframe.

Adding to our confidence in strengthening short and longer term forecasts for our HDD business is taking into account our current application case understanding, it's our expectation that we will participate in a significant way in support of all media capacity expansions that address the growth in mass capacity drives, with our industry leading 200 Lean.

At the same time, technology upgrades continue at near record levels, with upgrade bookings increasing significantly in Q3 ahead of what will likely be our largest ever quarter for HDD upgrades revenue in Q4. With current visibility, we also expect 2021 will be another strong year for upgrades as well.

The takeaway here is that while COVID has clearly presented challenges and delays in achieving the expected progress in our TFE growth initiatives this year, we're incrementally more positive about the growth trajectory for our hard drive business.

In the short-term, we now expect HDD revenues to approach approximately $15 million in 2020 with a slightly stronger second-half, driven by upgrades.

In the medium and longer term, we expect upside to our prior growth expectations due to both a pull-in capacity crossover point as well as favorable shifts in market share as mass capacity becomes a dominant component of the HDD unit demand, which now brings me to an update on our Photonics business.

Expectations for a strong growth year for Photonics in 2020 have further solidified since our July call. We continue to see a modest sequential downtick in revenues in Q4 due to the completion of our latest program for the Apache helicopter. We have multiple programs underway that continue to support our forecast for strong growth and profitability.

While the IVAS program continues to be a major revenue contributor in the second-half of 2020, our forecast is also supported by the tenure deliveries against programs for Joint Strike Fighter, the Delta-I coalition goggle development, as well as the next generation IVAS camera development.

We also expect to be on contracts to the enhanced visual acuity or EVA program within the current quarter. The second-half revenue is expected to be at least equal to the first-half. The implied 2020 year-over-year growth is over 30% for our Photonics business.

As we look to 2021, our growth expectations for Photonics will be directly dependent upon production order selection, timing and initial volumes of cameras for the IVAS program.

For a plan, we expect our night vision sensors to be fully integrated into the IVAS program and begin initial qualifications in December, and undergo field evaluations at soldier touchpoint 4 in the first quarter of 2021.

The overall program scheduled to equip the first fighting units with IVAS Systems in the fourth quarter of 2021 is remaining on track. In Q3, we commenced the initial shipments of our IVAS night vision cameras, and the initial startup and characterization work is nearing completion.

Currently, we are working on system level integration in image optimization specifically leveraging Intevac's digital night vision acumen in high dynamic range operation, which allows low-to-high light level transpositions without washing out the imagery, and automatic contrast on rhythms that provide differentiated fidelity and acuity in night vision performance.

We anticipate several iterations of firmware enhancements will occur during the qualification, optimization, and field testing to leverage our know-how and maximize performance..

Our direct engagement with both Microsoft and night vision labs on the IVAS program has been continuous, as we continue to work through initial delivery, integration and longer term program planning. Initial IVAS production feedback could be possible as early as year-end 2020, which will give us greater visibility into the growth forecast for 2021.

The key takeaway for Photonics is that we continue to expect Intevac will be a meaningful supplier for this critical all digital IVAS platform for our groundsoldier, as it moves into production sometime next year. Success in this program will be a significant driver of continued revenue growth for Photonics for many years to come.

So, to sum up, our overall outlook as of today, our forecast for 2020 has improved for two straight quarters now after taking a conservative approach in April and pushing TFE growth initiative revenue in 2021. The expectations for our hard drive in Photonics businesses and the critical role that Intevac plays in them continue to strengthen.

While in total, we expect our revenue to be down 11% to 12% in 2020 due to the year-over-year decline in solar implant revenue. Gross margins will be higher, operating expenses are being held flat and we expect to be profitable at both the operating and net income lines for the full-year.

With positive cash flow from operations and continue prudence and capital spending, we are generating a significant net increase in total cash and investments year-over-year in 2020.

Looking beyond 2020, we now have a scenario where both our core businesses, HDD and Photonics are becoming meaningful growth drivers on their own, and we continue to be encouraged by our progress in our TFE growth initiatives, and that they too will contribute to our longer term growth story in spite of the ongoing COVID related impact we continue to experience.

As for 2021, in both our core businesses, we expect important questions to be answered over the next few months with respect to HDD media capacity expansion plans, as well as production rollout plans for IVAS. This will help clarify and drive our outlook for the next year.

We also expect the progress in our TFE initiatives to accelerate from the current pace once business interactions with the U.S. and other countries start to normalize in this prolonged pandemic environment. All-in-all, we currently feel that we are on a solid path to sustainable profitable revenue growth for the years to come.

I'll now turn the call over to Jim to discuss the details of our recent financial results.

Jim?.

Thank you, Wendell. Consolidated third quarter revenues totaled $21.6 million within our guidance range of $21 million to $23 million. Thin-Film Equipment revenue totaled $9.4 million and included upgrades, spares, and service.

Photonics revenue of $12.2 million included $5.7 million of product revenues, and $6.5 million of contracts research and development revenue. Q3 consolidated gross margin was 43.1% and above the guidance range of 40% to 41% as a result of favorable mix for both businesses.

Q3 operating expenses were $9.4 million, up slightly from Q2, but just under our guidance primarily due to a more focused emphasis on selective programs in R&D. This resulted in a net loss of $357,000 or $0.02 per share a smaller loss in our guidance. Non-GAAP net loss excluded restructuring charges and was $0.01 per share.

Our backlog was $63.3 million a quarter-end and consisted of $45.2 million of Photonics backlog and $18.1 million of non-systems and HDD backlog in our Thin-Film equipment business. Now turning to the balance sheet, cash flow generated by operations was $4.2 million during Q3.

Q3 capital expenditures were $492,000 and depreciation and amortization were $848,000 for the quarter. We ended the quarter with cash and investments including restricted cash of $49.4 million equivalent to approximately $2.07 per share based on $23.9 million shares at quarter-end.

The company continues to manage cash very closely with increasing confidence that we will significantly grow our cash balance year-over-year. For Q4, we are projecting consolidated revenues to be around $27 million plus and minus $500,000. We expect fourth quarter gross margin to be around 41%.

Q4 operating expenses are expected to be between $9.5 million and $10 million higher than Q3 driven by an increase in R&D expenditures in Photonics as well as the impact of a 14th week included in this fiscal quarter. We expect interest income of about $100,000 and GAAP income tax expense of about $700,000 in the quarter.

As I mentioned previously, our cash taxes will be lower. For Q4, we are projecting net income in the range of $0.02 to $0.04 per share assuming approximately $24.4 million shares. Given the midpoint of our Q4 guidance, we expect full-year revenues to be just under $96 million.

At this revenue level and expected product mix, we expect gross margins to be approximately 41% with operating expenses of around $37.8 million for the year using the midpoint of our Q4 guidance. We expect interest income of about $300,000 and GAAP income tax expense of about $1.8 million for the year, of which more than half will be non-cash.

We are projecting full-year profitability of around $0.02 to $0.04 per share. This concludes the formal part of our presentation. Omar, we are ready for questions. We're ready for questions..

I'm sorry, guys. Your first question comes from Mark Miller with The Benchmark Company..

Hi, Mark..

Good afternoon. You've had some strong orders for Photonics, and the backlog is still decent, and do you expect -- you indicated several opportunities next year in the shipping and volume for the IVAS ground soldier.

Would you expect Photonics revenues next year to grow?.

When we're [looking] [ph] we're just starting our planning of our 2021 planning, and as to some of the commentary, the growth trajectory in Photonics is going to have a large lever, which is going to be the success in the IVAS program and beginning our shipments there, and there's still a lot of questions to answer, timing, volumes, selection, that kind of thing.

So for right now, we believe there certainly is the opportunity to do that, but I think as we get through the end of this year, and certainly by the first quarter, we'll be able to speak a lot clearer on what the Photonics trajectory looks like, but the opportunity is definitely there..

Do you have any feeling if there's any change in leadership in the White House, if that would have any impact on any of these programs?.

From our discussions with our business development director that's out in -- on the East Coast, initially I don't believe that there's a feeling that it would change either way, particularly on the IVAS programs, that program has got a lot of momentum behind it.

I think that we need to see the budgets passed, all that hoopla has got to get closed up here in a couple weeks, hopefully, and then we'll see, but right now we're not building anything like alternate forecasts between whoever takes the White House, and the Senate and the House at this time. I think our projections are pretty solid..

You're projecting higher revenues for the fourth quarter, but margins are lower, and you have a strong quarter for upgrades, which are usually higher-margin type sales for you.

I'm just wondering why the margins are coming down from the third quarter?.

We've seen a good contribution this year, specifically in Photonics and specifically on the Apache program. We shipped the backlog of that program in Q3. We did about $1.5 million in revenue in Q3 that will not repeat.

That is going to drive the margin down a little bit, and we do expect the upgrades to be higher in the fourth quarter than they were in the third quarter. We did almost 43% gross margin in the third quarter, and right now we're forecasting somewhere around 41% --.

You see -- okay, my last question, I'll jump back in the queue.

Any thoughts about the Apache program coming back next year, is that done or are there going to be some follow-on programs for Apache?.

We believe there will be continuing follow-on programs for Apache, whether that's applications with the upgrades to new technology -- into our new technology or upgrades of night vision systems for gunners, we think there is opportunity out there.

I don't expect that there is going to be anything, at least in the beginning part of 2021, but we certainly remain in contact and in discussions with the Apache sensors group, and there are programs that are being put together for that. We'll see how that plays out in 2021..

Thank you..

Thanks, Mark..

Thank you, Mark..

Your next question comes from Gus Richard with Northland..

Yes, thanks..

Hi, Gus..

Hi, thanks for taking the question. Just on the hard disk drive side, upgrades are really strong.

Now are those for energy-assisted magnetic recording or are there other upgrades incorporated there?.

I think that there's some of both. I think what we see on the upgrade side on, for the hard drive business, is there's a number of steps to ultimately get to some type of energy-assisted recording, including adding additional functionality to the tool, which is -- and that functionality is also being required for standard PMR.

So we're kind of seeing a little mix of both. Some of it is completely dedicated to advanced technology, some of it is advancing the current technology but is -- would be part of a upgrade for the energy-assisted at a later date..

All right, and are all three drive companies participating or is it limited to one or two?.

There's, without giving too much away, and we have different type of upgrades going to certainly more than one..

Okay, and then your expectation for additional new tools sounds like probably by late 2021, mid-2021, is that a reasonable expectation?.

Yes, I think that if you were to take my comments in the script and say, okay, if it's 2021, if he puts it into Q4 of 2021, be a 2021 shipment, that really means just given the math of lead times, those orders need to be in -- by the end of the first quarter..

Got it, very helpful. Thanks so much..

All right, Gus, thanks..

Our next question is from Mark Miller with The Benchmark Company..

Yes, your quarter-ending backlog, there were no Leans in it.

Are there any implanters in the backlog or is it mainly the upgrades?.

Yes, there are no tools in Thin-Film Equipment that are in backlog, it's pretty much upgrades and then some spares and service..

Thank you..

All right, thank you, Mark..

Thanks..

There are no further questions at this time. I'd like to turn the floor back over to Mr. Wendell Blonigan..

All right, thanks. Before I signoff, I'd like to take a moment to pay respect to our Founder and long-term Chairman, Norman Pond, who passed away in September, after a brief illness. To Norm's family, our thoughts and prayers are with you, and to Norm, rest in peace. I'm sure you're continuing to watch over Intevac, just as you always have.

I want to thank again the dedicated employees of Intevac all around the world for their tremendous effort and dedication in 2020 to date. I also want to thank our customers and our suppliers for their business and appreciated partnerships, and finally, I'd like to thank our stockholders for their continued support of Intevac.

I thank you all for joining us today, and we look forward to updating you again during our Q4 call, in February..

Thank you, and this concludes today's teleconference, you may now disconnect your lines. Thank you..