Intevac, Inc.

Thank you and good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the fourth quarter and full year 2011, which ended on December 31.

In addition to outlining the company's financial results, we will provide guidance for the first quarter and talk about our current outlook for 2012.

On today's call are Kevin Fairbairn, President and Chief Executive Officer; Jeff Andreson, Chief Financial Officer; and Drew Brugal, Executive Vice President and General Manager of Intevac Photonics.

Before turning the call over to Kevin, 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 and year, which remains subject to adjustment in connection with the preparation of our Form 10-K for fiscal 2011, 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 January 31 call include time-sensitive, forward-looking statements that represent our projections as of the date of this call. We undertake no obligation to update the forward-looking statements made during this conference call.

I'll now turn the conference call over to Kevin Fairbairn. Kevin?

Thank you. Good afternoon, and thank you for joining us today.

Our fourth quarter revenues were $18.6 million within our guidance and a net loss of $0.27 per share that met the high end of our guidance. For the full year, revenues totaled $83 million and we lost $0.96 per share.

Today, I will provide an overview of the company's key strategic business initiatives, a recap of 2011 and our prospects for the coming year. Jeff will then discuss our financial results and outlook.

maintain our leadership position, providing leading-edge manufacturing systems for the production of magnetic media in the hard drive industry; diversify and significantly grow our Equipment business by addressing the critical need of solar cell manufacturers to produce high conversion efficiency cells, while lowering their manufacturing cost; and finally, grow a significant Photonics business based upon our technology leadership with digital low-light sensors.

We saw positive progress in each of these initiatives in 2011.

I will now discuss the highlights in low lights for the past year and our outlook going into 2012.

First, the low lights. 2011 was clearly a disappointing year for Intevac.

Our hard drive business was negatively impacted by the pending industry consolidations and the historic flooding in Thailand, which together resulted in the near standstill in capital investments for the magnetic media capacity.

In our Photonics business, we suffered our first down revenue year since 2005 due to the congressional budget approval delays. Several programs that we initially expected to start in early 2011 were not fully funded until the fourth quarter.

No programs were canceled, they were simply delayed.

The good news is that we are projecting revenue growth in each of our business segments for 2012.

In 2011, we made positive progress in our hard drive business, developing and delivering enhanced deposition technology sources. These sources increased the efficiency of target materials sputtered onto the disk.

This is a rapid payback for our customers, given the high costs of these purchased materials, such as platinum. We have shipped over 200 of these sources as upgrades in 2011 and expect this upgrade business to continue in 2012.

We also developed a new source technology to advance the state-of-the-art diamond-like carbon coating used to provide the protective overcoats on disks. This new source is currently in qualification with multiple customers.

Now turning to our outlook for the Hard Drive business. The basic drive of the hard drive market, digital storage growth, continues to be very strong.

The proliferation of digital content creation has been driven by devices such as smartphones and tablets, the increasing use of social media and ever-increasing pixel counts. Digital storage, as measured by bytes shipped, has been growing slightly by 50% a year for the past 5 years.

Demand for storage appears to be in different economic conditions as people continue to create contents, in both good and bad times alike.

With 50% of storage growth per year, historic magnetic media areal density technology improvements of 40% a year, resulting in about a 10% net annual growth per disk. However, the rates of areal density technology improvements are slowing to about 30% and possibly lower.

Therefore, if digital storage growth continues at the same rate, we would expect absolute growth to increase above 10% per year. This bodes well for the future of our hard drive business as disk production growth is the major driver for our system cells.

Turning to 2012. We are starting the year at charted territory.

The industry supplies constraints of significance and are just now beginning to improve. The supply of hard drive is predicted to fall short the demand for the remainder of the year with full catch-up, and the inventory is not expected until early 2013.

Given this, it is widely understood that Q4 will be the peak shipment quarter for drives this quarter, when the availability of component supply will enable the industry to serve normal seasonal demand, as well as pent-up demand and inventory replacement.

As for these numbers in perspective, total unconstrained demand in Q4 2011 was estimated to be 180 million drives. Recent reports indicate that the industry was able to ship approximately 120 million drives this quarter.

So unmet demand is currently at least 60 million drives, a figure that will likely grow until the industry restores its supply base and begins to catch up through the back end of 2012 and into 2013.

We have previously said that media capacity would be near full utilization, around 180 million drives for the quarter. Based on some initial industry and analyst projections and our own estimates, it appears that the industry's Q4 2012 shipments will likely exceed that level and be potentially as high as 200 million to 210 million drives.

This increase will be driven by both the growth in the hard drive unit demand and some eventual replacement. Still, given the speed of which the industry conditions are changing, without being cautious by full-year guidance and likely number of hard drive system shipments at this time, as Jeff will discuss in his comments.

Now turning to our new equipment products. Faster progress was made in 2011 on our equipment diversification strategy, where we are leveraging our leading expertise in developing and manufacturing systems for focus, more on substrate vacuum processing at very high throughput.

This expertise was developed and honed at the hard drive industry, and we are now applying this to the solar cell market.

To succeed in this technology-based commodity market, solar companies have to continuously lower their costs and improve the capability of their products. The key performance metric is cost per watt, the cell conversion efficiency being the biggest lever.

The industry to date has lowered their cost per watt, principally through increasing volume leverage, incremental process and yield improvements at a lower silicon cost. The industry is currently going through the period of excess supply versus demand, which has resulted in significant price erosion of solar modules.

In the long term, this is good news. The industry must attain grid parity pricing in order to compete and prosper without government assistance.

We're beginning to see consolidation in the industry, with several companies exiting the business. We expect the large, well-capitalized integrated companies, as well as the technology-leading companies, to survive in the long term.

These other companies that we are focusing our sales efforts on as we penetrate the market with our new products that provide the technology solutions to increase cell conversion efficiency at a lower cost per watt. We are not counting on new greenfield sites for business.

We expect business to come primarily from retrofitting our systems into existing manufacturing lines.

In the last quarter, our flagship Lean Solar platform, configured with multiple deposition stations, completed the sign off at its first silicon cell customer.

Using this common Lean Solar platform, we developed a new process module for the texturing of the surface of silicon wafers using plasma etching. We are very pleased to report that the first phase of systems shipped in the fourth quarter to a leading solar cell manufacturer in China.

We continue to make progress with our Solar Implant Technology for precise silicon doping, which is now integrated onto the Lean Solar platform in our demo lab, with the first phase of shipments expected in the first half of 2012.

We expect to have multiple customers qualified in our Lean Solar, Texture Etch and ion implant products in 2012 for the goal of achieving repeat orders in the second half. We may see additional repeat business from our first Lean Solar deposition system, depending on our customers' investment timing.

In all, we expect to see significant traction and growth in new revenues in 2012 with meaningful sales from any repeat order commencing in 2013.

Turning to the Photonics business. We achieved a number of key milestones in 2011 that indicates a return to growth this year.

We made significant progress on ramping 2 production programs for our NATO low-light camera customer and our LIVAR cameras, building our pipeline of new programs and advancing the capability of our core sensor technology.

In Q4, we shipped a record number of cameras and modules. Initial funding was received through to ready our manufacturing to support the build of over 1,000 cameras for the Apache helicopter and other future Night vision programs.

Additionally, we were awarded 2 new near-eye display multi-year production programs for training simulators.

We also have a new leader for our Photonics business. I would like to introduce Drew Brugal, who joined us a few weeks ago.

Drew has a long and distinguished career in the U.S. Navy, where he initially served as a fighter pilot and retired with the rank of Captain in 2005.

Drew has made a successful transition into the business world, where he most recently was the President and CEO of Vision Systems International, the leading provider of advanced helmet systems for military avionics. Given that Drew has only been with us for a few weeks, I am covering the Photonics business today, with Drew available to answer questions.

We expect 2012 will be a return to growth in Photonics, with solid product revenues and an increase in contract development revenues. Our focus this year is getting this business profitable while continuing to deliver on our program or product amendments.

We had expected to achieve this important milestone in 2011, but the delays in the military budget approval pushed our revenues below our breakeven. We did improve our yields for lowered -- at low-cost sensor costs, resulting in a 500 basis point improvement in our gross margins over 2010.

We expect to see initial qualification of head-mounted night vision systems in a range of applications, ranging from avionic helmets and goggles, to goggles with digitally fused light, from our low light camera and our thermal camera. These fused systems will be used by special forces and will likely be the first, following the deployment of head-mounted digital night vision.

Our unique long-range camera system, known as LIVAR, is expected to deploy in the qualified and additional platforms. Today, we have a production program with Northrop Grumman for a fixed-wing aircraft application using our LIVAR camera.

We are developing a LIVAR camera compatible with gimbals that are used on helicopters and UAVs. Long-range surveillance is expected to continue to be a priority for the military.

On the technology side, we will continue to advance the state-of-the-art and the development and initial qualification of our 4-megapixel sensor and to improve the sensitivity of our sensors through funds in development programs.

Before turning the call over to Jeff, I will sum up by saying that all 3 of our key strategic business initiatives have significant growth opportunities. Each one is technology leading and serves critical needs in its respective industry.

Our future success both have a solid foundation we have created through our innovation, hard work and customer relationships. We are very excited about our future and look forward to providing you with updates on our progress each quarter.

Jeff?

Thank you, Kevin. Consolidated fourth quarter revenues totaled $18.6 million, within our guidance of $16 million to $20 million.

Equipment revenue totaled $12.5 million, which included one Lean Solar system and no 200 Lean Systems recognized in the quarter. Photonic sales of $6.1 million consists of $4.3 million of product shipments and $1.8 million of contract research and development.

Q4 consolidated gross margin of 34.3% was slightly above our guidance. Equipment gross margin of 36.4% was lower than the third quarter, due primarily to the impact of the lower margin on our first crystalline silicon solar deposition system recognized in the quarter, as well as the lower mix of upgrades in spares.

Photonics gross margin of 30% improved from the third quarter, reflecting the improved cost of our night vision sensors.

Q4 operating expenses were $14.9 million versus our guidance of $15.2 million to $15.5 million. Our Q4 net loss of $6.2 million or $0.27 per share, meeting the upper end of our guidance.

Net income included $969,000 of stock-based compensation expense, equivalent to $0.03 per share. Our backlog was $32.9 million at quarter end, and included no 200 Leans and one Lean Solar system.

We ended the quarter with cash and investments of $114.8 million, equivalent to approximately $5 per share. Capital expenditures totaled to $838,000, and depreciation and amortization totaled $1.3 million for the quarter.

For the full year, revenues were $83 million, including $28 million from Photonics and $5.5 million from new equipment products. Gross margin was 37%.

Operating expenses totaled $61 million. And our net loss per share was $0.96.

Also recently, we made the decision to sell the linear mainframe technology for the semiconductor equipment market to Brooks Automation, as during the year, it became clear that ongoing development activities would be required on Continuum to support our customers' 450-millimeter programs, further delaying our expected revenue growth. Brooks is the leader in selling mainframes to the semiconductor industry and a natural fit to exploit the unique IP we developed.

The decision also enabled the company to focus its resources on a large solar opportunity. The transaction closed early in the first quarter.

I will now provide our guidance for the first quarter and the company's current outlook and primary assumptions for 2012.

We're projecting consolidated Q1 revenues of $16 million to $18 million, which includes no 200 Leans and one Solar system recognized at the high end of guidance. We expect first quarter gross margins to be approximately 35%, reflecting the lower factory absorption expected at these revenue levels.

Operating expenses are expected to be in the range of $15.5 million to $15.7 million. The increase from the fourth quarter is related to the statement of the limited amount of variable compensation and the normal seasonality of employee taxes in the first half of the year.

Other income and expense will be approximately $2.2 million, which includes approximately $2 million gain associated with the sale of the Continuum mainframe technology and excludes any impact associated with changes from the valuation of our investments or foreign exchange.

For Q1, we are projecting a net loss in the range of $0.23 to $0.26 per share, which includes an approximate $0.05 favorable impact from the sale of the Continuum mainframe, and an estimated $900,000 of pre-tax stock-based compensation expense equivalent to $0.03 per share.

I'll now turn to providing our current outlook for 2012. Based on our view of the expected Q4 hard drive shipments, as well as recent quoting activity, we have reasonably good visibility today for at least 10 system orders by mid-year.

We continue to expect the year to be back-end loaded, with these systems all shipping on the second half. We also have some visibility regarding additional orders beyond that, but our initial estimate of upside orders to be 4 to 6 hard drive systems for the year.

As these initial estimates are subject to the rapidly changing industry conditions Kevin mentioned, and are therefore subject to revision, we will not be providing full-year guidance on this call. As we gain additional visibility as to the amount of that order upside, we will probably be in a position to provide full-year guidance for our hard drive business.

That being said, we currently expect the sales of upgrades in service to the hard drive industry in 2012 to be similar to that of this year. For Photonics, it is reasonable to estimate that business will grow by 10% to 15% year-over-year.

At this time, we are estimating revenues from new products to be in the range of $10 million to $20 million. This revenue growth is dependent on the completion of several customer qualifications, as well as the timing of revenue recognition, which require final acceptance on all initial shipments.

We continue to expect 2012 will be a year of qualifying our systems with our initial customers, with backlog ramping in the second half of the year. Given the current outlook, we see gross margins increase into the high 30s, with upside beyond that if we see greater system shipments for the full year, and quarterly operating expenses being flat or slightly down from Q1 levels.

Our tax rate should be approximately 25%, but it's dependent on the mix of U.S.- versus Singapore-based revenue. Other income and expense is expected to be approximately $2.7 million for the year, which includes the $2 million gain in Q1.

This completes the formal part of our presentation. Operator, we are ready for questions.

Just a few questions for me, I guess. In terms of timing, you talked about shipments of the Lean Systems for the hard drive business in the middle of the year.

Does that mean you would need to see the orders in the first half? Or are you talking about shipments -- orders in the midyear for Q4 production?

Well, Rich, it's Jeff. What we said was we would expect orders by midyear.

And as the year would be back-end loaded for the hard drive systems, that they would all ship in the second part of the year -- second half of the year.

Okay. So because of the component constraints, the normal cadence has just pushed out?

Yes. That's how we see it today.

Okay. And then that 10 systems of potential orders, is that based on a -- your existing customer base all ordering?

Or just a subset of them?

This is Kevin here. Which -- only the companies out there have Intevac systems, so I'd just say it's several customers.

Okay. And then, well, I think that it makes sense.

The new products. When you're talking about the new products, revenue of $10 million to $20 million, should we assume that that's all Equipment revenue, or is some of that also alluding to Photonics lens?

That would be all of the new Equipment revenues that we are guiding at right now.

What were your cash from operations last quarter?

Cash from operations last quarter was -- well, we burned some cash quarter-over-quarter, so it was down I think about $3 million.

So do you see it burned for the current quarter?

Current quarter, meaning Q4, or looking in the next quarter?

Well, the quarter we're in right now.

Okay. We will probably see some initial cash burn as we're coming out at the end of the quarter.

But I did have some receivables, well, from quarter-to-quarter, so I don't suspect it will be too big in the quarter, probably inside $5 million.

From what I've been reading about the solar market, people are anticipating to pass the additions or demand around 26 gigawatts this year, and I don't believe until that demand gets over 29 gigawatts or in the high 20s, you'll start to see significant capacity yet. Your tools are more new technology.

I'm just wondering if you can comment on that.

Yes, this is Kevin here. So we don't believe there's going to be much in the way of new greenfield sites in the next couple of years.

This is -- there's a lot of capacity out there, as you said. The watts we are going to see, just like in the hard drive industry, the people who want to win and survive will have to use technology to improve the capability of their products, principally by improving the conversion efficiency of their solar cells.

So that's why we're getting a lot of interest from the Tier 1 customers who are looking to get the edge over everybody else. And that will be our focus, and that will mainly be a retrofit market through existing manufacturing lines.

And finally, on formatted media, is that 2014 and beyond?

That's what it looks like right now.

When you say formatted media, you mean Patterned Media?

Right.

Yes, I'd -- we're going to see firmer system magnetic recording come in before we see Patterned Media.

Actually, I have a follow-up on the -- to clarify with the guidance you gave. So the $10 million to $20 million you said, that's basically the solar revenue and any other new product similar or something like that?

In the Equipment -- yes, on the Equipment side of the business, it's solar.

Okay. And then in terms of -- on a quarter, any -- can you give us out what the ASP was?

Or I mean, what the totals in the solar revenue was in the quarter?

We did about $4.5 million in solar. We did about $1 million in mainframe last year.

So it was probably in the $3 plus million range in quarter 4 [indiscernible].

Okay, so it's $4.5 million of the total in the year, you're saying?

For just solar. Some of our new equipment business was the mainframe.

Okay, so it was -- all right. And then, in terms of the Photonics business, what should we expect for, say, a run rate of the R&D revenue to get to -- for -- in 2012?

Well, we're going to see the R&D revenue probably get up to just shy of half the revenue on the year.

Half of the...

For Photonics, yes. So it's going to bounce way up in this fourth quarter level.

Way up, yes.

Okay. Well, thank you for joining us today.

And we look forward to updating you on our next call when we provide our first quarter results. Thank you.