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Edited Transcript of IVAC earnings conference call or presentation 28-Oct-19 8:30pm GMT

Q3 2019 Intevac Inc Earnings Call

SANTA CLARA Oct 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Intevac Inc earnings conference call or presentation Monday, October 28, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Claire McAdams

Intevac, Inc. - IR Counsel

* James P. Moniz

Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer

* Wendell T. Blonigan

Intevac, Inc. - President, CEO & Director

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Conference Call Participants

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* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* Dan Weston;WestCap Management;Analyst

* Mark S. Miller

The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst

* Nehal Sushil Chokshi

Maxim Group LLC, Research Division - MD

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Presentation

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Operator [1]

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Good day, and welcome to Intevac's Third Quarter 2019 Financial Results Conference Call. (Operator Instructions) Please note that this conference call is being recorded today, October 28, 2019. At this time, I'd like to turn the call over to Claire McAdams, Intevac's Investor Relations Counsel. Please go ahead.

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Claire McAdams, Intevac, Inc. - IR Counsel [2]

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Thank you, and good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the third quarter of 2019, which ended on September 28. In addition to discussing the company's recent results, we will provide financial guidance for the remainder of 2019. 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, and then Jim will review third 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 risk 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 28 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.

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [3]

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Thanks, Claire, and good afternoon. Today, we reported Q3 results above the high end of guidance. Revenues of $26.3 million were above expectations, due primarily to stronger-than-expected levels of hard drive upgrades during the quarter. Favorable gross margin in Photonics helped to drive a smaller net loss than forecast at $0.02 per share. In the third quarter, we continued to gain momentum, driving our strategies for revenue growth and profitability. Last quarter, we discussed the multiple critical milestones we achieved in the first half of the year, laying the groundwork for our future growth trajectory.

In Photonics, the new record order announced in July drove backlog to an also record level of $76 million at quarter-end. We continue to see quarter-on-quarter revenue growth and increasing operating profitability for the Photonics business in 2019, and our order momentum through the third quarter signals another year of strong growth as expected for Photonics in 2020.

In our Thin-Film Equipment, or TFE business in the third quarter, in response to our customers' request to accelerate their installations, we delivered the remaining 5 ENERGi systems in backlog. We successfully completed the installation and qualification of our first VERTEX Spectra evaluation system with a leading display cover glass manufacturer, which signed off and began running demos full-time in August.

Additionally, we continued to see cell phone manufacturer pull, driving the agreement finalization for a second VERTEX evaluation system to ensure dual sourcing capacity in the supply chain.

Finally, in the third quarter, we neared completion of the build and test of our first MATRIX PVD evaluation system for advanced semiconductor packaging, which is on track to be delivered and installed this year. As we move into the fourth quarter of 2019, we continue to manage a number of moving pieces in our business, particularly in our Thin-Film Equipment group. These pieces can be positively or negatively impacted not only by current industry climate but by the global trade and macroeconomic environment as well. Since our last call, however, our confidence levels have strengthened for year-over-year revenue growth in both Photonics and equipment, which raises our expectation for return to profitability for fiscal 2019.

Looking ahead to 2020, we continue to drive for revenue and profitability growth. In Photonics, our backlog and order momentum to date indicates another significant year of growth. For our equipment business, our visibility for 2020 is limited, and as I've mentioned, has many moving pieces at this moment.

We continue to assess how the business environments are unfolding and are building our 2020 outlook as we finish up 2019. We do, however, see the 2020 revenue profile, as with 2018 and now 2019, to be significantly back-half loaded.

Now for an update of our business segments, starting with Photonics. Our results to date and expectations for a strong Q4 are driving growth for this fiscal year of over 35%, with operating profitability in line with our long-term model of 10% to 15%. We recorded significant revenues from the IVAS program during Q3 and announced the expansion of the program's scope in the associated increase in contract revenue. This now $31.5 million contract is for the development and delivery of the initial lot of digital night vision cameras for the IVAS system-level development and qualifications. Through the end of 2020, the IVAS camera modules we are delivering will leverage the successful accomplishments of our state-of-the-art digital night vision cameras developed over the past year along with our next-generation ISIE 19 sensor development activities.

The major revenue opportunity for us lies in the actual fielding of IVAS systems to the dismounted soldiers after the qualification and selection processes are complete. Until July, the IVAS award was the single largest order ever booked in Photonics and continues to represent the largest future revenue opportunity for this business. If successful, the projected volume of digital night vision camera modules beyond the initial development contract to be fielded to the dismounted soldiers would be in the hundreds of thousands of units. The success of the IVAS program over the next 5 years is a primary component of our potential to double the level of revenues in the Photonics business compared to the last 5 years, and beyond 2023, continue to drive the largest revenue opportunity component comprising our $1.4 billion revenue opportunity pipeline.

Also supporting our growth outlook was the latest record booking for Photonics announced last quarter, a $40 million multiyear contract award to supply digital night vision cameras in support of the U.S. government. Together, these 2 major orders have contributed to our all-time record level of Photonics backlog, building a strong foundation for future growth and increasing our confidence in another year of growth for Photonics in 2020. We have multiyear visibility for our manufacturing options and continued validation of our digital night vision technology.

With regards to our ongoing technology advancement efforts, we have now completed the initial ISIE 19 sensor design and performance qualifications. We are currently building the ISIE 19's sensors in small quantities in support of several new programs that will be the launch vehicles for the ISIE 19. Supported by the government, we now have successfully met the design specifications required to take digital night vision to its next level of performance, including enhanced frame rate capability and higher dynamic range. We'll ship our first camera system based on the ISIE 19 in late Q4 and expect to field a significant quantity next year for multiple programs, including IVAS.

Moving now to our equipment business. In Thin-Film Equipment, as I mentioned earlier, we were pleased to report continued progress in our growth initiatives outside the HDD market and, in particular, our effort to expand our current footprint in the display cover glass industry. In our TFE growth initiatives, we made important progress engaging with handset makers, which provided the customer pool to install our first VERTEX evaluation system with a leading display cover glass manufacturer. This VERTEX was quickly qualified and signed off in August for decorative back cover glass applications. The tool has been dedicated to running decorative patterning applications, and demos have been requested by most major handset makers in China. The interest level for this capability is very encouraging.

This evaluation system provides quick turn regional accessibility to Intevac's newest technologies and enables new differentiated and fully integrated film stack configurations that expand the freedom and options available for the design of next-generation smartphones. Customer pull with a top 5 handset maker is also driving the activity to place a second VERTEX evaluation system with another display cover glass manufacturer also in China. At our last call, we were very close to finalizing the agreement with the initial manufacturing partner. However, during Q3, we and the handset manufacturer together selected an ultimate display cover glass company to work with on this project. Currently, our business team in -- is in China finalizing the new agreement, and we continue to plan on the second tool shipping and being operational before the end of the year at a second display cover glass company.

The strategy with both these evaluation agreements is to generate production demand with a major handset maker and enable these tools to convert to revenue in 2020 while driving additional growth through follow-on orders. We also continue to work with both top-tier and boutique cover glass manufacturers, who are also candidates for additional revenue systems.

From my earlier comments, eval tool revenue timing and follow-on orders are some of the moving pieces in our equipment forecast. Regardless, we are driving for year-over-year growth in our TFE business in 2020, and such growth would likely be driven, in part, by multiple VERTEX systems converting to revenue next year.

Prior to our call today, we issued a press release updating our product line offerings for our VERTEX tool as well as our latest diamond-like carbon protective coating, trademarked DiamondClad. Over the last several quarters, I have discussed our internal development programs to push the performance envelope of our protective coating to approach that of sapphire and also reduced the cost of depositing the coatings on cover glass. DiamondClad is a proprietary multistep process that improves upon our original single-layer film solution, oDLC 1.0. Developed in-house, utilizing the ion beam source technology released last year, DiamondClad now performs similar to sapphire and scratch testing at the Mohs 8 standard and is far superior to the industry standard glass with anti-fingerprint, or AF coatings, which scratch at a Mohs 5 level. DiamondClad coating outperforms standard cover glass by a factor of 4 in Taber wear testing and by a factor of 4x to 6x in use case AF durability testing with sand, denim and perspiration. We've begun some initial sampling to select customers today and are now officially rolling out the product. We have trademarked the name, and we'll be driving a marketing campaign to raise awareness in early 2020. Beyond the improvements that we've made in our protective film's performance, we've also been working to reduce the cost of applying the film. The adoption of protective coatings for cover glass has shown a clear cost performance trade-off, and we have been aggressively working both sides of that equation. As we move from a single-layer DLC film to a multilayer approach of DiamondClad, the film costs on our standard in line VERTEX system went up, which was in the wrong direction.

Today, we introduced a new platform architecture for our technology, the VERTEX Marathon. This new system utilizes the core source technology we developed and released last year on a high-throughput platform optimized for multiyear coating. By moving the DiamondClad process to the Marathon platform, we have enabled the most advanced oDLC technology at less than half of the cost of oDLC 1.0, our first version, deposited on previous generations of VERTEX. Our first Marathon tool has been built and is moving in to our clean room now to prepare for demo activities for all the film stacks VERTEX addresses, specifically DiamondClad protective coating as well as antireflective, decorative and unique pattern applications. For more information, please see our website at www.intevac.com.

We are eager to see how the 2 eval system projects progress and are excited to introduce DiamondClad and the VERTEX Marathon into the market. VERTEX remains a key program in the company, and I will continue to update you on our VERTEX business activities each quarter.

Now I'll talk about progress beyond our efforts in display cover panel. We've made steady progress in the build and test of our first MATRIX PVD evaluation system for advanced semiconductor packaging, which is scheduled for a Q4 delivery to a leading OSAT, or Outsourced Semiconductor Assembly and Test provider. The MATRIX PVD system will go into evaluation and qualification at the R&D facility and is designed to lower the cost of advanced semiconductor packaging architectures. These architectures enable smaller-package footprints for mobile devices as well as improved thermal and electrical performance as compared to conventional packages.

As for the ENERGi platform, in our solar cell ion implant business, we continue to have confidence in the future potential for the ENERGi product line. Last quarter, our customer accelerated their delivery schedule for the 5 tools remaining in backlog, which have shipped and are reflected in our third quarter revenues. We continue to discuss additional tools for 2020 in support of a multi-gigawatt capacity expansion in China, which would utilize ion beam building as well. Just as in other areas of our equipment business, these additional tools are also moving pieces, and we will need the new expansion in China to launch in order to regrow our ENERGi backlog. We believe, however, we do have the potential to see another good year of ENERGi revenue in 2020 based on current discussions with our customers.

And finally, an update on our HDD business. Recent HDD channel information indicates hard drive units came in a bit better than expected in the third quarter, even after adjusting for the inconsistency among suppliers of 14 versus 13-week quarters. Expectations for strong near line drive demand in the second half continued to drive the majority of growth for media as we exit 2019.

Capacity utilization rates by our customers are currently very high, and even with the 2 200 Lean shipping in Q4 and 2 more in 2020, we continue to believe the hard drive industry could exhaust its media capacity by the end of 2020. Beyond that, long-term forecast currently model media demand growth of 8% annually through 2023 in support of the 25% growth rate expected for Exabyte shipped on hard drives.

Meanwhile, after tempering our expectation for HDD upgrades in the second half due to very high tool utilization rates and the associated lack of tool availability for upgrades, our customers continue to push forward with strategic technology upgrades regardless. The result for Q3 was some upside in our HDD upgrade revenues, and for the full year, our revenue forecast has improved modestly since our last call with an even stronger upgrade quarter forecast for Q4.

As far as what we're seeing for our HDD business in 2020, at this point, it's too early to say. Our planned upgrade activity is very strong at year-end, and our visibility for the level of upgrades in 2020, whether they're similar, higher or lower than this year is quite limited. We also have little visibility for additional 200 Lean orders beyond the 2 in backlog, but as the demand picture starts to solidify for the media required in the second half of 2020, our customer would likely start making those plans then. Just like other parts of our equipment business, the HDD media business can be lumpy quarter-to-quarter and year-to-year. Of note, over the last few years, our HDD customers have started each calendar year with relatively conservative views of capital investment. And yet, we have exited each year with a stronger and more profitable HDD business than we had expected in January.

The overall takeaway from the long-term outlook of hard drive media is that our HDD business is reasonably stable at current levels, and given the need for capacity additions to support the forecast demand of hard drive storage for the cloud, we continue to expect the business to contribute at least as much revenue over the next 5 years as it has over the past 5, with modest upside depending on media capacity needs to support near line drive growth.

So in summary, we've achieved critical milestones for the primary objectives of our 2019 corporate growth initiatives, and with the introduction of our VERTEX Marathon system and DiamondClad protective coatings, we're very excited about our future business opportunities. And while it's premature to provide our outlook for 2020 on today's call, I've explained some of the drivers and moving pieces that surround our push for another year of growth.

First, in Photonics and military digital night vision, we have the backlog and a multiyear visibility to forecast strong growth ahead for 2020. Second, in hard drive media, which we expect to continue to be stable and profitable, we are working to gain visibility in the upgrades and tool orders required to drive growth next year. Third, in display cover panel, we're driving for growth in 2020. We're excited about our new DiamondClad protective coatings and in the coming months, we look forward to achieving market adoption of the higher-performance and lower-cost coating enabled by the VERTEX Marathon platform. Fourth, in solar, we're encouraged by discussions with our customers so far that 2020 could be another good year of shipments. And fifth, the newest market for us which is the advanced semiconductor packaging, could begin to contribute to revenue in 2020, but is certainly a market we feel could be a meaningful contributor in the years to come.

And in conclusion, to sum up our final outlook for fiscal 2019, we expect strong year-over-year growth in Photonics exceeding 35% and modest growth for the equipment business. With this improved revenue and operational outlook, we can now guide with increased confidence for a return to profitability for the full year. I'll now turn the call over to Jim to discuss the details of our recent financial results, Q4 and our full year outlook. Jim?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [4]

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Thank you, Wendell. Consolidated third quarter revenues totaled $26.3 million, about 3% above the high end of the guidance range. Thin-Film Equipment revenues totaled $17.1 million and included 5 ENERGi systems along with upgrades, spares and service. Photonics revenue of $9.2 million included $4 million of product revenue and $5.2 million of contract, research and development revenues. Q3 consolidated gross margin was $8.8 million or 33.4% and slightly above guidance of 32% to 33% but down from Q2 due to the mix of 5 lower-margin ENERGi tools in the quarter and no 200 Leans in Q3.

Q3 operating expenses were $9.2 million, down slightly from Q2 and at the midpoint of our guidance, primarily due to a more focused emphasis on selected programs in R&D. This resulted in a net loss of $480,000 or $0.02 per share, a smaller loss than our guidance. Our backlog was $115.4 million at quarter end. Thin-film Equipment backlog of $39.3 million included 4 200 Lean HDD systems and non-systems HDD backlog. The backlog in our Photonics business was $76.1 million. We ended the quarter with cash and investments, including restricted cash, of $37.1 million, equivalent to approximately $1.60 per share based on 23.2 million shares at quarter end. Cash came in below our $40 million objective due to delays in customer payments. We ended the quarter with an accounts receivable balance of $24.9 million, which was higher than we expected. Customers delayed payments that were due end of quarter until the first week of the current quarter. We received almost $8.5 million in collections in the first week of Q4 alone.

Cash flow used by operations was $2.1 million during Q3. Q3 capital expenditures were $1.9 million and depreciation and amortization were $858,000 for the quarter. The company continues to manage the cash very closely to maintain a minimum balance of approximately $40 million. As a result, stock buybacks during the quarter were limited.

We purchased 14,737 shares of common stock for a total of $69,000 during the third quarter. As of October 28, 2019, the company has repurchased 5 million shares for $29.2 million out of the $40 million plan.

For Q4, we are projecting consolidated revenues to be between $34 million and $35 million. We expect fourth quarter gross margin to be between 42% and 44%, up from Q3 as mix improves with 2 200 Leans and a higher amount of HDD upgrades in the Q4 revenue forecast.

Q4 operating expenses are expected to be between $9.2 million and $9.4 million. We expect interest income of about $100,000 and GAAP income tax expense of about $1 million in the quarter. As I had mentioned previously, our cash taxes will be lower.

For Q4, we are projecting net income in the range of $0.18 to $0.22 per share, assuming approximately 23.4 million shares. Given our Q4 guidance, we expect full year revenues to grow 13% to 14% over 2018 to about $108 million. At this revenue level and expected product mix, we expect gross margins to be approximately 36%, with operating expenses of around $37 million for the year.

We expect interest income of about $500,000 and GAAP income tax expense of about $2.1 million for the year, of which, more than half will be noncash. At the midpoint of our Q4 guidance ranges, for the year, we are projecting full year profitability of around $0.02 to $0.03 per share. We are also projecting to end the year with a total balance of cash and investments over $40 million and reporting net increase compared to the end of fiscal 2018. This completes the formal part of our presentation. Operator, we are ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Craig Ellis with B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [2]

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Congratulations on returning to profitability. Jim, I just wanted to follow up to start with a clarification on the gross margin guidance for the fourth quarter. Nice to see the 42% to 44% range. Is that all driven by the mix that's occurring in the thin-film side of the business? Or are you seeing margin improvement in Photonics as well?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [3]

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I think percentage-wise, it's going to be driven mostly by the Thin-Film Equipment mix. Although if you listened to Wendell's part of the conversation, we believe that the Photonics business could grow at least 35%. And so if it does, then the revenue in Q4 of Photonics will also increase, which will contribute more margin dollars in Q4 than it did in Q3. But the percentage is going to be heavily weighted towards not having the 5 ENERGi tools and having 2 200 Leans in Q4 in the equipment business.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [4]

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Got it. And then moving on to a couple questions for Wendell. Wendell, you started the fourth quarter with a very strong backlog position in Photonics. Can you just talk a little bit more about what you're seeing there? And is that backlog position something that we should think the company will sustain? Or as the company drives growth in revenue, will we be seeing that backlog position come down as you work through successful orders that have already been achieved?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [5]

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Well, we think, just looking over the next -- the duration of the IVAS program, we think those revenue levels are pretty much at their run rates. And then, of course, we also announced a larger program, the $40 million in booking that we had. That's all in backlog. That goes over several years. But what I can say is that we certainly have a pipeline of programs that we are engaged with, particularly ones that are going to launch the ISIE 19 sensor into the market that are still on our plate to go get. So there's -- we're not out of opportunities to build Photonics backlog at this point.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [6]

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Good. And then a couple on the thin-film side. First, the MATRIX PVD tool that's got advanced packaging potential, it sounds like that's going into R&D. One, is that so? Two, can you talk about the potential to drive that into other customers? And then thirdly, if this tool were to go into production, can you give us a sense for what the opportunity would be if you transition from R&D into production?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [7]

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Yes. Okay. So we have to be very careful because the customer very much does not want us to disclose what they're doing. But it is going into the factory that will initially start out R&D but then would convert to volume manufacturing. We expect that to occur in the -- in 2020 depending on how quickly they progress in their qualification of the entire suite of tools for their line. In this one -- when that would occur, we would do an upgrade of that tool that would put the, what I would call, the material handling right now, it's mostly manual. And then we put the (inaudible) and other things on the tool once they did that conversion. And we think there's an opportunity, just in that particular line for at least 2 more systems beyond the upgrade on the eval. As far as additional customers, I think this was really important for us because we were in a position -- yes, we -- where the customers say, yes, we love the tool, we know it works in the so and so industry, but we want to see proof that it's working in volume production in the advanced packaging industry. And we'll have that data as we get towards the end of the year, which will make the doors open easier for us in other opportunities.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [8]

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And then lastly from me before I hop back in the queue. It sounds like there's 2 VERTEX that could rev rec in the fourth quarter if I had that right, and then a couple more next year, hopefully, I'm not getting the tools mixed up. But can you just walk through the engagement activity and some of the rev rec activity on the VERTEX side?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [9]

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Yes. As I said in my -- we've got one tool out there that's installed, signed off and running demos. We expect to get the next one out of here. Within a month, we've just got to finalize up some of the legal terms in the eval contract so that one we expect as well to get out, but they would be evals running into the 2020 time frame. One of those tools turns, the worst-case scenario, it turns on 12 months. It veers to the other one is configured and once it gets x amount of production through it then that triggers the purchase. But our goal here is to get adoption and get some volume production through those tools. So it would make sense to go ahead and rev rec those and get those in full production, and the goal here is to get enough production that will drive follow-ons in 2020. Most all -- most of all those tools need to go through their full cycle, especially if they are on the Marathon platform. That will need to go through a full acceptance cycle before we can rev rec and shipment.

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Operator [10]

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And our next question comes from Mark Miller from The Benchmark.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [11]

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How many people are you in discussion with in terms of your decorative coating tool? It seems like at least 2, but are there others you're in discussions with?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [12]

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I didn't quite understand the question, Mark.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [13]

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Who are you talking to? How many manufacturers cover glass manufacturers are you engaged with for the VERTEX decorative tool?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [14]

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Well, in my remarks -- well, let me say it this way: We're -- everybody has -- all the major handset makers have seen our 1.0 diamond-like carbon. The DiamondClad we just last week started selectively showing some people what we've got, and we'll go across the hand makers, all the top hand makers, to get that in front of them. On the decorative back coatings, as I mentioned, we've got demo requests from mostly the major Chinese handset makers today on the tool it's running. And then I would say there's one that's -- one particular handset maker that I referenced is really driving the second tool in the field, so there's dual sourcing for their products. So we're making good progress there, and we'll continue our visibility on the DiamondClad starting now.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [15]

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Do you expect to get DiamondClad tools revenue next year?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [16]

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That would be the expectation that we'd make that happen next year. We just got out of the field this weekend, and we have a targeted tool that we're going to upgrade in the field with the DiamondClad sources, and we expect to have that done before the end of the year.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [17]

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In terms of your Photonics backlog, how does that compare in terms of margins compared? Will that be an uplift in margins compared to previous Photonics backlog of same margins?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [18]

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I think it's going to be similar to the margins you've been seeing. With a higher volume, we have a higher amount of efficiency. And last quarter, we did 43%. That was a little bit higher than we expected, but I think you're going to be see high 30s, maybe even around 40% as we go look at the backlog that's currently there.

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Operator [19]

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(Operator Instructions) Our next question comes from Nehal Chokshi with Maxim Group.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [20]

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So this VERTEX Marathon seems to, especially the DiamondClad, seems to be a significant upgrade. DiamondClad is only available on VERTEX Marathon. Is that correct?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [21]

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No, it can be done on the Spectra tools that are out there today. And it's just a matter of how much output you can get off of that tool versus the Marathon. And it's just, the throughput is slower. So it can run at least for engineering and development work and run on Spectra, no problem, but I think in large-volume production, it needs to go to the Marathon platform. And we have the ability to take this source, lots of good components off of the -- an installed VERTEX Spectra, and those bolt right onto the Marathon platform. So there's an upgraded path there to get to the higher-volume production.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [22]

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Okay. Are you disclosing the ASP on the Marathon?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [23]

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Not at this time. We're really looking at the overall cost of getting the films down, and they are more complicated film with more layers, and we were able to deliver that multilayer at half the cost of the 1.0 on VERTEX, so that's what we were driving at.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [24]

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I see. Okay. Great. Right. Now the evaluation systems. These 2 cover glass OEMs, are they Spectra? Or are they Marathon at this point?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [25]

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They're Spectra. They would be candidates to convert to the new platform later.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [26]

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Okay, okay. All right. About 1.5 years ago, you guys were talking about a smartphone out in the wild, relatively high-volume SKU, with an oDLC coating. Have there been additional smartphone SKUs that have hit the market since then with the oDLCs?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [27]

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Through our work with Truly, they have some cover glass that's going on some phones in the China market only. But it's what we want to take and readdress the market for the protective coatings with the DiamondClad, where we could not perform at sapphire level until now. So we'll be going back out to show that we've got there.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [28]

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Got it. Understood. And then on the hard drive side. I know you addressed this in your prepared remarks, so I apologize. But can you just review what's the expectation on the timing for the 4 Lean 200 systems in backlog right now?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [29]

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Yes, we've clearly said that 2 of those would go in Q4. And at the moment, the other 2 are scheduled. The customer has requested that they go into his fiscal year 2021, which would be our 2020, which would be like July. So we're continuing to work with the customer. That's one of the reasons why Wendell also pointed out that as we look at 2020, it is definitely back-end loaded, and those 2 200 Leans certainly contribute to that being back-ended loaded. But of those 4, 2 will go in this current quarter, Q4 '19, and the other 2 will go next year. Currently, the customer is talking about putting them in the back half of our 2020 calendar year so that it gets into his -- beginning of his 2021 fiscal year.

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Nehal Sushil Chokshi, Maxim Group LLC, Research Division - MD [30]

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Okay. All right. And I think you guys also discussed the expectation that order activity for new Lean 200s could also come through within the next 6 months or within 2020 as well. Is that correct?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [31]

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I think we're right now trying to figure out how the ended the '19 -- calendar '19 is going to play out. Obviously, Q3 was a little bit better. But just seasonally, the front half of the calendar years tend to be light, and that's when we typically see those type of plans formulating. So we probably won't have visibility -- clear visibility on our calendar 2020 plans until partly through the calendar year.

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Operator [32]

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And we have a follow-up from Craig Ellis with B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [33]

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I think we ultimately got there with some of your commentary and response to the last question, Wendell, but I wanted to go back to the comment that 2020 would be a back-end loaded year similar to what we saw in 2018 and 2019. And I think mathematically, 2018 was a little bit more back-end loaded of the 2. But acknowledging the fact that there is a lot of potential business that may not solidify until the first half of next year, can you provide any further color around how the linearity would compare to '18 and '19? Do you expect it to be somewhere in that range? Or would it be even more back-end loaded than what we've seen in the 2 recovery years '18 and '19?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [34]

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Craig, this is Jim. I think from what we're looking at currently today, it's going to be more back-end loaded than either '18 and '19. It won't be as back-end loaded for Photonics because of their high backlog. But if you look at the backlog in Thin-Film Equipment, and you look at a lot of our initiatives that we're out promoting, whether it be VERTEX or whether it be the follow-on order on ENERGi or whether it be the MATRIX evaluation tool, there's a lot of progress being made. But if you look at the timing of when those will convert to revenue, they're going to be focused on the back half. So it's going to be more back-half loaded than 2018 or 2019 were.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [35]

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And then how do you feel about maintaining a $40 million cash position through the first half of next year and into that back half, Jim?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [36]

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I'm going to say at the moment, I still feel really good about it. I think some of the drivers that could influence that is as we get success with the VERTEX tools, we have, in the 5 that we've sold, been successful in getting down payments. We don't know if those will continue as we move forward and that's one of the reasons for keeping the cash is so that we can fund the growth of inventory for those 6 months or so between the time we buy it and convert it to cash. So I feel very comfortable absent of any major business change happening. But if there is a more severe business change being no down payments, we have the cash to be able to fund that and quickly turn that inventory into cash. So I feel really good about that.

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Operator [37]

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And we have a question from Dan Weston with WestCap Management.

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Dan Weston;WestCap Management;Analyst, [38]

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Most have been answered by now. But Jim, on the -- or Wendell, the $40 million contract you guys announced in Photonics last quarter, was there any revenue contribution from that particular contract in Q3?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [39]

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No.

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [40]

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No. There wasn't. We would expect that we wouldn't see revenue on that contract till the very end of Q4 I think.

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Dan Weston;WestCap Management;Analyst, [41]

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Okay. Got it. That's helpful. Go ahead, Jim.

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [42]

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That's a multiyear contract I think hasn't released yet.

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Dan Weston;WestCap Management;Analyst, [43]

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Got it. Yes. And once that starts to contribute end of Q4, maybe in more earnest in Q1 next year, do you anticipate that revenue to be, kind of, linear over the life of the contract? Or is there any spikes that you're estimating?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [44]

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I think the customer has not allowed us to tell anybody exactly what that program is. However, we expect from a -- it's a manufacturing -- a volume manufacturing contract, so we expect that to be pretty stable. But we do see it initially ramp from some smaller numbers as far as units per month to a little bit more. But that ramp will be through, I guess, maybe the first quarter of next year, and then it would be very predictable and flat.

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Dan Weston;WestCap Management;Analyst, [45]

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Got it. Okay. That's helpful. And then finally, as that starts to, kind of, layer on to the Photonics revenue stream, do you anticipate that there could be even more operating margin expansion in Photonics than we've already seen?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [46]

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Yes. I'm going to say no. Our model is the mid-30s. And one of the questions earlier, I said it could be the high 30s. I would say as we're looking into 2020, absent of any favorable news we see in yields or efficiencies, this is going to probably be mid-to high 30s throughout the year. It may fluctuate a little bit quarter-over-quarter depending on what's going on with the funded R&D in any given quarter.

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Dan Weston;WestCap Management;Analyst, [47]

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Yes. No. Fair enough, Jim. I was more interested in the operating margin.

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [48]

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Oh, in the operating margin? Is your -- give me your question again, and I'm sorry, I was focused more on the gross margin.

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Dan Weston;WestCap Management;Analyst, [49]

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No, that's quite all right. Yes. That's why I asked because I know there will be some fluctuations on the gross margins line, but you've done an admirable job of getting the operating margins into a level I didn't think you could get that quickly with the layering on of the additional revenues from the additional program. Do you think that operating margin has a chance to increase from here as well?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [50]

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I think it's going to be similar to our model. We talked about our model, and I think Wendell has given the model around 15%. It may fluctuate in any given quarter, not a lot we hope. But I think it will stay around 15%, maybe a little bit above that as we go through next year. I don't expect it to get any higher.

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [51]

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There's a limit to how much the government allows us to make in that business. So.

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Dan Weston;WestCap Management;Analyst, [52]

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Okay. Maybe, I'm a little mistaken, sorry. Weren't you considerably higher than that in Q3? I think you are over 20% in Q3, aren't you?

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James P. Moniz, Intevac, Inc. - Executive VP of Finance & Administration, CFO & Treasurer [53]

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Maybe, I think we might have been 22%. But I think in that particular quarter, we were fortunate to have some manufacturing variances that hit, which kind of reset some things. But I don't expect that level, necessarily, to go quarter-over-quarter. So we do see some programs that may have short durations, slightly higher margins. Some ability to under-spend in the OpEx because we're spending it on the revenue, but we can't delay some of the funded -- some of the internally funded R&D programs. So there's a combination of a number of things. But don't expect 22% to be the new normal and it's going to be like that going forward.

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Dan Weston;WestCap Management;Analyst, [54]

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Okay, okay. That's really helpful, Jim. And then finally, Wendell, can you comment to (inaudible) this last $40 million contract? The -- you indicated that your ISIE 19 will be, kind of, ready at the end of this year. Remind us, was that order specific to the 11? Or will that morph into the 19?

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [55]

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That order is based on the ISIE 11. So -- but every ISIE 11 we ship out is a candidate to replace with ISIE 19 at some point.

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Operator [56]

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And I'll now turn the call back over to Mr. Blonigan.

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Wendell T. Blonigan, Intevac, Inc. - President, CEO & Director [57]

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Thank you. 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. I thank all of you for joining us today, and I look forward to updating you, again, during our Q4 call in January. Until then, so long.

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Operator [58]

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