Intevac, Inc.

Thank you, and good afternoon, everyone. Thank you for joining us today to discuss Intevac's financial results for the third quarter of 2012, which ended on September 29.

In addition to outlining the company's financial results, we will provide guidance for the fourth quarter.

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's 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, 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 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 31 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'll now turn the call over to Kevin Fairbairn. Kevin?

Good afternoon, and thank you for joining us today. I'd first like to express our concerns and best wishes for those that have been impacted by the recent hurricane on the East Coast.

Our third quarter results included revenues of $16.8 million, which exceeded the upper end of our guidance and a net loss per share of $0.34, which included a bad debt write-off equivalent to $0.08 per share. In our Photonics business, we achieved record revenues of $9.4 million and a profit for the quarter.

Today, I will update you on our progress in our Equipment business. Drew will discuss the Photonics business, followed by Jeff who will discuss our financial results and outlook.

Third quarter results for our Equipment business were disappointing, and while we made good progress during the quarter on improving our revenues through higher technology upgrade sales and lowering our operating expenses, we unfortunately received news at the end of the quarter that our early CIGS customer was ceasing operations. This resulted in us taking a bad debt write-off, thus negating our operational improvements within the quarter.

Several years ago, we've made the decision to hedge our risk in the thin film CIGS market by working with a strategic customer who would bear the cost of developing and deploying of technology on a modified 200 Lean system. The customer's business plan included the licensing of the technology to other cell manufacturing companies.

We expected to generate sales of systems to additional customers as a result of this business relationship. Unfortunately, the significant fall in silicon-based solar cell pricing undermined the economics of thin film CIGS technology cells.

Capital equipment markets are depressed right now for semiconductors, flat panels, LEDs and our served markets of hard drive media and solar cells, with the primary cause being the difficult global economic conditions. Given the current situation, and our belief that our Equipment business is focused on the markets that we expect will drive future growth, our game plan is to continue to provide technology upgrades to the large installed base of hard drive media systems, execute to our commitments, earn our customers' ongoing trust and win the majority of new systems business in the future, focus our efforts in the solar cell market on technology, not capacity, that is providing competitive process equipment solutions that improve the conversion efficiencies of silicon solar cells and thus, lower manufacturing costs.

Our short-term focus is to ensure the successful qualification of our new products and capture additional customers so that we can get qualified for production system orders and deliveries in 2013 and beyond and finally, prudently manage short-term spending with our long-term opportunities.

Since our last call, forecast for the hard drive markets have been reduced, and unit demand is now expected to remain relatively flat for the fourth quarter. About 4 [ph] reasons have been cited for this fall-off in demand ranging from macroeconomic headwinds, reducing PC demand, inventory corrections by the OEMs, delayed purchases in advance of Windows 8 and the impact of tablets and smartphones, but has not stopped growing the data generation.

We continue to believe that the proliferation of digital devices and the growth in big data have intensified data generation, driving continued growth in storage. As an example, people are taking high-definition photos and videos at an amazing rate on their phones, consuming their local flash memory.

At some point, all of this data will end up on a hard disk.

It seems right now that we are experiencing something like the downturn of late 2008 through mid-2009, and the hard drive shipment's growth stalled for nearly a year before recovery. People can postpone buying PCs and storage due to the difficult economic times, but at some point, they're going to need new storage.

Unlike in the past, consumers now have more choices as to where they store their data, with the emergence of multiple cloud storage providers. Some might think that cloud storage would be more efficient than PC storage.

It probably is in terms of the fill rate of data per disk. However, given the redundancy requirements to ensure data is never lost and always available, it is likely that it will require even more storage when compared to individual PC storage.

Our storage drives contain between 3 and 5 disks each, and given the higher forecasted growth of cloud storage relative to PCs and notebooks, we continue to expect the total number of disks to grow faster than drives. Slowing in aerial [ph] density growth relative to overall growth in data will further increase the need for hard drive disk.

This growth is the key driver for our systems business. Therefore, we remain confident that the combination of data growth and slowing aerial [ph] density will result in growth for hard drive media over the longer term.

In the near term, specifically 2013, ahead of the need for the industry to add capacity in aggregate, we expect that there will be opportunities to ship a limited number of systems to fill gaps at a few customer sites.

In addition, we will continue to develop and sell technology upgrades that help our customers lower their production costs and enable future media technology improvements. We are pushing hard and are beginning to win more service and spare business and should see growth in that area as well.

This enables us to better manage our support infrastructure so we are ready to support the industry's expansion when growth resumes.

Now I'd like to review the solar market and the progress we have made on our new product penetrations with leading customers in the industry. The situation in the solar industry continues to be difficult due to too much production capacity added over the last few years.

Demand is growing as the economics of solar at today's current pricing has become very compelling in many markets. There's still a commitment in many countries to make solar an essential part of their energy policy and future electricity production.

industry consolidation, with those companies having the best technology combining the scale and access to capital being the survivors.

Some industry observers are predicting that 6% of existing solar suppliers will exit the industry over the next several years, resulting in a balancing of supply. The second part of the equation is investing in technology that will improve their profitability by lowering their cost for a while to support the pricing levels required to drive profitable growth.

Our value proposition to the solar cell manufacturers is simple. We provide equipment that will improve their cell conversion efficiencies and lower their costs on a dollar-per-watt basis.

The largest opportunity we are pursuing is ion implant for silicon doping, which the industry recognizes as one of the most promising new technologies that enables higher cell compression efficiencies. We shipped our first ion implant systems for the 2 large customers near the beginning of the last quarter, and the startups have proceeded well, with the process results exceeding our near-term goals for the cell efficiency improvement.

Our focus now is demonstrating production readiness, achieving product qualifications and obtaining production orders. We are working with a large number of other large solar cell manufacturers, are in various stages of the sales demonstration process.

As expected in these market conditions, the cell manufacturers understand the need to invest in technology. However, they have limited to no budgets right now to invest, which has delayed our ability to place additional tools in the market.

Our goal remains to place additional tools into the market by year-end. The second largest opportunity we are pursuing is texture etch.

Our vacuum process application modifies the silicon cell to absorb more light than the current wet etch process allows. The first system we shipped has been used for R&D at a leading Asian cell manufacturer and will be upgraded to a pilot light system configuration for production qualification.

Success is expected to lead to production orders. In summary, in 2012, we have made progress in penetrating the solar market with 2 competitive evaluation tools, such as our ion implant as well as shipping our first NanoTexture Etch tool.

In spite of the very difficult industry environment, we are in a good position to receive our first production orders beginning as early as the fourth quarter and certainly, into 2013. We are confident that the success of these initial customers will translate to adoption by other leading cell producers, and we continue to believe that the solar market represents a very large long-term opportunity for us.

I'll now turn the call over to Drew Brugal to provide an update on our Photonics business. Drew?

Thank you, Kevin. The Photonics business achieved record revenue of $9.4 million, as Kevin said earlier, as well as exited the quarter with a near-record backlog of $24 million.

We expect we will end the year with revenue between $30.5 million to $31 million. So we will see revenues decline sequentially in the fourth quarter as we completed several large program deliverables in the third quarter.

As we announced earlier this year, we received a $10 million order for the U.S. Army's Apache helicopter program for the qualification and manufacturing transition phase, which includes the initial lot of low-rate production cameras.

We have now completed several key program milestones and are on track to begin the initial low-rate camera deliveries in late 2013.

Simultaneously with this order, we now expect to enter a quoting phase for the initial full-rate production order in late Q4, the completion of the final negotiation expected to be by midyear 2013. This next order will ensure continuous production deliveries through 2015.

The full Apache program has production requirements that run through 2017 at a value in excess of $50 million for U.S. helicopters alone.

Once initial upgrades are completed for the U.S. Army, foreign military sales for additional Apache helicopters will begin further increasing the opportunity.

In our long-range airborne identification systems or LIVAR, we have recently received the next production order release for $4 million to support the ongoing production requirements for our partner Northrop Grumman, which is part of the 5-year indefinite-delivery, indefinite-quantity procurement agreement we completed with Northrop Grumman earlier in the year.

As we stated on the last call, we continue to receive funding to advance the state-of-the-art of our most advanced 4 megapixel sensor and to improve the sensitivity of our 2 megapixel sensor as part of our multiyear contracts for improvement and performance and manufacturability. The 4 megapixel activity is being funded through 2 branches of the U.S.

military. The 2 megapixel activity is part of a 3-year program with the U.S.

Army, and we have just completed the first year.

We are closely monitoring the potential budget impacts of our existing and future programs by the impending continuing resolution and possible sequestration by the U.S. government.

We believe our current major production programs, Apache and LIVAR, will not be adversely impacted in 2013 and 2014. These programs have what is called multiyear funding.

For both 2013 and '14, funding has been secured. Additionally, our funding for digital night vision systems for the U.S.

Special Forces or SOCOM is also secured through 2015. Risk to Intevac will be associated primarily with new programs, and we'll continue to closely monitor this.

Regarding our NATO program, this is not expected to be directly affected by the U.S. government funding actions.

We expect no reduction in this program. We are well positioned to continue our revenue and profit growth.

I will now turn the call over to Jeff to discuss our financial results and outlook. Jeff?

E

Thanks, Drew. Consolidated third quarter revenues totaled $16.8 million, exceeding the high end of our guidance of $15 million to $16 million, primarily because of the 40% sequential increase in Photonics revenues.

Equipment revenue totaled $7.4 million, which did not include any 200 Leans or our LEAN SOLAR systems recognized in the quarter. Photonics sales of $9.4 million included $5.2 million of contract research and development.

Q3 consolidated gross margin of 34.1% met the high end of our guidance. Equipment gross margin of 35.6% was lower than the second quarter due primarily to lower revenues and lower factory utilization.

Photonics gross margin of 32.8% declined from the second quarter, driven primarily by the higher mix of contract R&D and near-eye display products, but was the second-highest Photonics gross margin reported in the last 3 years.

Q3 operating expenses were $16.7 million versus our guidance of $14.5 million to $15 million and included a $3 million bad debt charge. Excluding the bad debt charge, operating expenses declined $1.2 million or 8% from Q2 primarily from lower development expenses for both our new equipment and night vision products.

Our Q3 net loss is $8 million or $0.34 per share, which included the bad debt expense equivalent to $0.08 per share and $943,000 of stock-based compensation expense equivalent $0.03 per share. Our backlog was $40 million at quarter end and did not include any 200 Leans or LEAN SOLAR systems.

In addition to the reported backlog, the company has 2 evaluation systems that will be recognized as revenue once accepted by each customer.

We ended the quarter with cash and investments of $98.8 million, equivalent to approximately $4.21 per share. Our free cash flow was a net use of cash for the quarter of $4.5 million and included capital expenditures of $447,000, depreciation and amortization of $1.1 million for the quarter.

I'll now provide our guidance for the fourth quarter. We are projecting consolidated Q4 revenues of $17 million to $20 million, which includes no hard drive and 1 solar system recognized at the high end of the range.

We expect fourth quarter gross margins to be in the range of 36% to 37.5% Operating expenses are expected to be in the range of $13.5 million to $14 million.

Other income and expense will be approximately $0 as we have sold the last of our auction rate securities recently that will offset our expected interest expected income for the quarter. Also, this excludes any impact associated with changes to the valuation of our intangibles and other assets or any foreign exchange impacts.

For Q4, we're projecting a net loss in the range of $0.20 to $0.22 per share, which includes an estimated $900,000 of pretax stock-based compensation expense, equivalent to $0.03 per share.

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

Just a couple of questions for me. I guess, first, when -- Kevin, when you were talking about, I think, next year that there could be a couple of systems on the hard drive side that could go into factories just, I guess, to round out facility capabilities, was that based on conversations that you've had with the customers?

Or is that your own industry perception of the conditions?

Rich, this is Kevin here. No, it's based on conversations with individual customers, and none of this is related to increasing capacity.

It's more related to some technology gaps and possible product changes

Okay. And then when it comes to the operating expense, Jeff, when you look at OpEx, if industry conditions on the drive side and solar side for that matter continue through next year, do you see any room in the OpEx side to further cut back or do you think you've got the business as lean as it can be?

Well obviously, you've seen what we did in prior years. We never really added a lot back since 2008, 2009.

Most of the increase is around new products. So the answer is we've taken some short-term actions already.

You've seen some of that flow through already and in the fourth quarter. But I would say year-over-year, we do have a few levers to pull to bring it down.

But we're trying to balance getting our products done, out there, and qualify with our spending.

So if you look back from 2008 to 2012, Intevac has lost money for the past 5 fiscal years and probably could lose money next year just given the weak visibility. We know that the hard disk drive industry and the solar industry is going to be highly cyclical despite the long-term growth that we're projecting.

So the question is, how will Intevac manage the type of heavy cyclicality, which is actually even worse than cyclical industry of semiconductor industry?

Bill, this is Kevin here. Just one correction, we actually made good money in 2010.

So after the cutbacks in spending in '08 and '09, the disk industry did bounce back quite sharply. For the solar, I agree that the overall market size is not going to be what it has been for the last 3 years, but we're certainly seeing a lot of demand for technology improvements.

One of the problems the industry has right now is that there's a demand for the product at the current pricing, but people can't make money at that pricing. A way to do that is to lower their costs on a cost-per-watt basis, and we offer one of the few parts to doing that.

So even though it's a downturn overall for the solar industry, I do believe there will be opportunities for us through '13 and '14 before there's any resumption of the need for more capacity.

Okay. That's helpful.

And then my last question is given that you got record revenues in the Photonics business, the operating margin is at about 7.6%. So maybe walk us through what type of operating margins can we get from the Photonics business on high revenues.

Bill, it's Jeff. Yes, this quarter, we did particularly well.

Some of that was driven by mix. I'd say that we've said breakeven is about $8.5 million a quarter.

And so you've seen we've surpassed that and we got up to about 7%. But I'd say at that range, it fluctuates between 5% and maybe about where we're at now.

And then as it crosses to about 40, I think it can sustain that level consistently going forward. There's probably a level of somewhere between 10% and 15% that the business might tap out at in the near end, only because of the way you'd have to be -- go through government procurement.

There's some limitation to what we can and can't do in pricing.

That's helpful. And then since you've mentioned about breakeven, any color you can give us in terms of breakeven in terms of the disk drive business, so we can perhaps model that for the new year?

We've said that Photonics breaks even at $8.5 million. We said the company breaks even at about $135 million on a cash basis, so you should be able to kind of back into that.

Equipment can breakeven in and around $100 million. I mean the hard drive business itself has a very low kind of OpEx appetite, and so it breaks even at a lower number than that, much lower so...

I would like to thank you for joining us today, and we look forward to updating you in our next call on our fourth quarter and year-end results. Goodbye.