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IVAC > SEC Filings for IVAC > Form 10-K on 20-Feb-2014All Recent SEC Filings

Show all filings for INTEVAC INC

Form 10-K for INTEVAC INC


20-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis (MD&A) is intended to facilitate an understanding of Intevac's business and results of operations. This MD&A should be read in conjunction with Intevac's Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this Form 10- K. The following discussion contains forward-looking statements and should also be read in conjunction with the cautionary statement set forth at the beginning of this Form 10-K. MD&A includes the following sections:

Overview: a summary of Intevac's business, measurements and opportunities.

Results of Operations: a discussion of operating results.

Liquidity and Capital Resources: an analysis of cash flows, sources and uses of cash, contractual obligations and financial position.

Critical Accounting Policies: a discussion of critical accounting policies that require the exercise of judgments and estimates.

Overview

Intevac provides process manufacturing equipment solutions to the hard disk drive industry and high-productivity process manufacturing equipment to the PV industry. Intevac also provides sensors, cameras and systems for government applications such as night vision and long-range target identification. Intevac's customers include manufacturers of hard disk drives and PV cells as well as the U.S. government and its agencies and contractors. Intevac reports two segments: Equipment and Photonics.

Product development and manufacturing activities occur in North America and Asia. Intevac has field offices in Asia to support its equipment customers. Intevac's equipment and service products are highly technical and are sold primarily through Intevac's direct sales force. Intevac also sells its products through distributors in Japan and China.

Intevac's results are driven by worldwide demand for hard disk drives, which in turn depends on the growth in digital data creation and storage, the rate of areal density improvements, the end-user demand for personal computers, enterprise data storage, including on-line, cloud storage and near-line applications, personal audio and video players and video game platforms that include such drives. Demand for Intevac's equipment is impacted by Intevac's customers' relative market share positions and production capacity needs. Intevac continues to execute its strategy of equipment diversification into new markets by introducing products for PV solar cell manufacturing. Intevac believes that expansion into this market, which is significantly larger than the hard disk drive deposition equipment market, will result in incremental equipment revenues for Intevac and decrease Intevac's dependence on the hard disk drive industry. Intevac's equipment business is subject to cyclical industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for hard disk drives and PV cells, as well as other factors such as global economic conditions and technological advances in fabrication processes.

                                                                                       Change                Change
Fiscal Year                       2013             2012             2011           2013 vs. 2012          2012 vs. 2011
                                                (in thousands, except percentages and per share amounts)
Net revenues                    $  69,632        $  83,424        $  82,974        $      (13,792 )      $           450
Gross profit                       21,973           34,158           30,431               (12,185 )                3,727
Gross margin percent                 31.6 %           40.9 %           36.7 %        (9.3) points             4.2 points
Net loss                          (15,696 )        (55,319 )        (21,975 )              39,623                (33,344 )
Loss per diluted share          $   (0.66 )      $   (2.37 )      $   (0.96 )      $         1.71        $         (1.41 )

Fiscal 2011 financial results reflected a challenging environment that resulted from consolidations in the hard drive industry, a natural disaster (flood) in Thailand, and the impact of U.S. government defense budget delays. Net revenues during fiscal 2011 reflected lower equipment sales to hard drive manufacturers and lower


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Photonics' contract research and development ("R&D") offset in part by higher Photonics military product sales. Intevac sold fewer 200 Lean systems in fiscal 2011 than in fiscal 2010, as Intevac's hard drive customers delayed equipment purchases during the extended regulatory approval process for the two acquisitions by Seagate and Western Digital. Also Intevac's hard drive customers had invested heavily in increased production capacity in the previous year, which met some of their 2011 capacity needs. Finally, floods in Thailand resulted in supply chain disruptions for Intevac's hard drive customers. During fiscal 2011, Intevac recognized the first revenue on its PV products. For fiscal 2011, Photonics product revenue from low-light sensors and cameras increased; however, contract R&D revenue declined as certain R&D contracts had been completed in the prior year and contract funding for several large programs was impacted due to delays in U.S. government defense budget approvals. The fiscal 2011 net loss reflected lower net revenues and increased operating expenses from the inclusion of SIT which was acquired in the fourth quarter of fiscal 2010, offset in-part by reduced variable compensation expenses and recognition of an income tax benefit. During fiscal 2011, the Company did not record compensation expense in association with its profit sharing and executive incentive variable compensation programs as a result of being in a loss position.

Fiscal 2012 financial results reflected a challenging environment as the global economic slowdown resulted in lower sales of personal computers and consumer electronic applications and lower hard drive unit shipments by hard drive manufacturers. Personal computer sales were also negatively impacted by changing consumer trends toward higher usage of mobile and tablet devices. The transition to "cloud" storage also resulted in lower hard drive shipments. With hard drive unit shipments down over 2011, the Company shipped only two 200 Lean systems for capacity during 2012. In fiscal 2012, Intevac completed a customer qualification on its PV etch manufacturing product as well as delivered two beta ion implant evaluation systems that underwent qualification. During the first quarter of 2012, Intevac discontinued offering products to the semiconductor industry and sold certain assets which comprised its semiconductor mainframe technology. In fiscal 2012, Photonics business levels grew driven primarily by the recovery of the contract R&D business, as several key U.S. defense programs received budgetary funding in late 2011 and Intevac was awarded a major development contract with the U.S. Army. The fiscal 2012 net loss reflected slightly higher net revenues, improved gross margins, increased operating expenses from the inclusion of an $18.4 million goodwill and intangibles impairment charge and a $3.0 million write-off of a promissory note receivable and higher income tax expenses from the establishment of a $23.4 million deferred tax valuation allowance. During fiscal 2012, the Company did not record compensation expense in association with its profit sharing and executive incentive variable compensation programs as a result of being in a loss position.

Fiscal 2013 financial results reflected a continued challenging environment as the hard drive business continued to be negatively impacted by the effects of the proliferation of tablets, the transition to centralized or "cloud" storage, and the effects of uncertain macro-economic environment conditions on demand for personal computers from consumers and corporations. The Company shipped only two 200 Lean systems for capacity during 2013. In fiscal 2013, Intevac completed a customer qualification on its solar implant ENERGi system. In fiscal 2013, Photonics business levels reflected the continued proliferation of Intevac's technology into major military programs. The U.S. Army awarded Photonics a multi-year contract to manufacture pilot night-vision systems for the Apache helicopter. During the first quarter of 2013, Intevac sold certain assets comprising its Raman spectroscopy instruments product line, also known as DeltaNu.

The fiscal 2013 net loss reflected lower net revenues, lower gross margins, lower operating expenses and a small income tax benefit. Fiscal 2013 operating expenses reflected savings from the global cost reduction program which was implemented in the first half of fiscal 2013. During fiscal 2013 the Company recorded a decrease in the liability for contingent consideration related to the SIT acquisition resulting in a gain of $3.7 million recognized in operating expenses. The adjustment in the liability was due to a change in the estimate of future product revenues in the earnout period. During fiscal 2013, the Company resumed its executive incentive variable compensation programs and recorded variable compensation expense. During fiscal 2013, the Company did not recognize an income tax benefit on the U.S. net operating loss.


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In fiscal 2014, Intevac expects that the continued proliferation of tablets, the increase in centralized storage, and the effect of macro-economic environment conditions on demand for personal computers from consumers and corporations will continue to negatively impact the hard drive equipment business. The Company therefore expects that capacity shipments of Intevac equipment to hard disk drive manufacturers will be approximately at the same levels as 2013. In 2014, Intevac expects higher sales of PV equipment products as solar cell manufacturers begin to adopt new vacuum technologies in the manufacturing of solar cells for both existing and new production lines. For fiscal 2014, Intevac expects that Photonics business levels will increase from 2013 as Photonics delivers production shipments of the pilot night vision systems for the Apache helicopter.

Results of Operations

Net revenues

                          Years Ended December 31,
                                                                Change               Change
                       2013         2012         2011        2013 vs. 2012        2012 vs. 2011
                                                   (in thousands)
Equipment            $ 39,135     $ 52,538     $ 54,878     $       (13,403 )    $        (2,340 )
Photonics
Contract R&D           14,444       15,755        7,124              (1,311 )              8,631
Products               16,053       15,131       20,972                 922               (5,841 )

                       30,497       30,886       28,096                (389 )              2,790

Total net revenues   $ 69,632     $ 83,424     $ 82,974     $       (13,792 )    $           450

Net revenues consist primarily of sales of equipment used to manufacture hard drive disks and PV cells and related equipment and system components; revenue from contract R&D related to the development of electro-optical sensors, cameras and systems; and sales of low-light imaging products.

The decrease in Equipment revenues in 2013 versus 2012 was due primarily to a decrease in revenue recognized on disk lubrication systems, technology upgrades and spare parts. The decrease in Equipment revenues in 2012 versus 2011 was due primarily to one fewer 200 Lean system sold to hard disk drive manufacturers, offset in part by increased revenue from disk lubrication systems, technology upgrades and spare parts. Intevac delivered two 200 Lean systems in both 2013 and 2012 compared to three 200 Lean systems in 2011. Revenues from disk equipment technology upgrades and spare parts increased in 2012 versus 2011 as Intevac's customers invested in upgrades for 200 Lean systems which increase the efficiency of target material sputtered onto disks.

During fiscal 2013 Intevac recognized revenue on its first solar implant ENERGi system. During fiscal 2012 Intevac recognized revenue on its first NanoTexture etch system for PV applications. During fiscal 2011, Intevac recognized revenue on the first PV deposition systems. During the first quarter of 2012, Intevac discontinued offering products to the semiconductor industry and sold certain assets which comprised its semiconductor mainframe technology.

Equipment revenues in 2014 are expected to increase slightly from 2013 levels due to increased revenue from Intevac's new PV equipment products. Intevac expects that capacity shipments of Intevac equipment to hard disk drive manufacturers will be approximately at the same levels as 2013 as the hard drive industry is expected to remain in an over-supply condition through 2014 and not require incremental manufacturing capacity. Increases in PV equipment products will be driven primarily by the adoption of new vacuum technologies in the manufacturing of solar cells for both existing and new production lines.

Photonics revenues decreased by 1.3% to $30.5 million in 2013 versus 2012 and increased by 9.9% to $30.9 million in 2012 versus 2011. Contract R&D revenue in 2013 decreased as a result of a lower volume of contracts as Intevac completed its major contract with the U.S. Army to develop a pilot night vision system for


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the Apache helicopter. Contract R&D revenue in 2012 increased as a result of a higher volume of contracts related to two large U.S. government defense programs and due to the continued expansion of Intevac's low-light camera and sensor products in military applications.

Photonics product revenue increased in 2013 as a result of higher sales levels of low-light camera modules. Photonics product revenue decreased in 2012 as a result of lower sales of low-light camera modules and a lower level of shipment volumes for long-range imaging products. Product revenues in 2011 reflected higher sales of low-light sensors and cameras used in military night vision and long-range imaging as well as commercial applications such as Intevac's near-eye display products.

Fiscal 2013, 2012 and 2011 product revenues reflected lower sales of Raman spectroscopy products. On March 29, 2013, Intevac sold certain assets comprising its Raman spectroscopy instruments product line, also known as DeltaNu, and no longer offers Raman spectroscopy products. In 2014, Photonics revenue is expected to increase from 2013 levels. Substantial growth in future Photonics revenues is dependent on the proliferation of Intevac's technology into major military programs, continued defense spending, the ability to obtain export licenses for foreign customers, obtaining production subcontracts for these programs, and Intevac's development and market acceptance of commercial products.

Backlog



                                   December 31,       December 31,
                                       2013               2012
                                           (in thousands)
                  Equipment       $       13,565     $        8,902
                  Photonics               46,319             26,282

                  Total backlog   $       59,884     $       35,184

Equipment backlog at December 31, 2013 includes one 200 Lean system and one PV deposition system. Equipment backlog at December 31, 2012 did not include any 200 Lean systems or systems for PV applications. Photonics backlog at December 31, 2013 includes $17.9 million in revenue that will be earned beyond 2014.

Significant portions of Intevac's revenues in any particular period have been attributable to sales to a limited number of customers. The following customers accounted for at least 10 percent of Intevac's consolidated net revenues in 2013, 2012, and/or 2011.

                                         2013       2012       2011
                    Seagate Technology      37 %       51 %       41 %
                    Northrop Grumman        11 %        *          *
                    U.S. Government          *         10 %        *
                    HGST                     *          *         12 %

* Less than 10%

The magnetic disk manufacturing industry consists of a small number of large manufacturers. Sales in 2012 to the U.S. government represent contract R&D under contracts with the U.S. Army and the U.S. Navy.


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Revenue by geographic region

                          Years Ended December 31,
                                                                Change               Change
                       2013         2012         2011        2013 vs. 2012        2012 vs. 2011
                                                   (in thousands)
United States        $ 32,534     $ 30,845     $ 28,907     $         1,689      $         1,938
Asia                   31,907       47,712       47,325             (15,805 )                387
Europe                  5,191        3,795        6,128               1,396               (2,333 )
Rest of world              -         1,072          614              (1,072 )                458

Total net revenues   $ 69,632     $ 83,424     $ 82,974     $       (13,792 )    $           450

The increase in U.S. sales in 2013 versus 2012 was primarily due to higher camera sales to a U.S. customer. The increase in U.S. sales in 2012 versus 2011 was primarily due to higher contract R&D net revenues from Photonics. The decrease in sales to the Asia region in 2013 versus 2012 was primarily due to lower net revenues from disk sputtering systems, disk lubrication systems and technology upgrades. The increase in sales to the Europe region sales in 2013 versus 2012 was primarily due to higher sales of Photonics' digital night-vision cameras to a NATO customer. The decrease in sales to the Europe region sales in 2012 versus 2011 was primarily due to lower sales of Photonics' digital night-vision cameras to a NATO customer.

Gross margin

                                        Years Ended December 31,
                                                                                    Change                 Change
                                  2013            2012            2011           2013 vs. 2012          2012 vs. 2011
                                                          (in thousands, except percentages)
Equipment gross profit          $ 12,116        $ 23,594        $ 22,318        $       (11,478 )      $         1,276
% of Equipment net revenues         31.0 %          44.9 %          40.7 %
Photonics gross profit          $  9,857        $ 10,564        $  8,113        $          (707 )      $         2,451
% of Photonics net revenues         32.3 %          34.2 %          28.9 %
Total gross profit              $ 21,973        $ 34,158        $ 30,431        $       (12,185 )      $         3,727
% of net revenues                   31.6 %          40.9 %          36.7 %

Cost of net revenues consists primarily of purchased materials and costs attributable to contract R&D, and also includes assembly, test and installation labor and overhead, customer-specific engineering costs, warranty costs, royalties, provisions for inventory reserves and scrap.

Equipment gross margin was 31.0% in 2013 compared to 44.9% in 2012 and 40.7% in 2011. Fiscal 2013 gross margins declined over fiscal 2012 due primarily to lower revenues, lower factory utilization and higher provisions for inventory reserves. Fiscal 2012 gross margins improved over fiscal 2011 due primarily to a higher mix of upgrades and spares shipments as well as higher system margins, offset in part by lower factory utilization and higher provisions for inventory reserves. Gross margins in the Equipment business vary depending on a number of factors, including product mix, product cost, system configuration and pricing, factory utilization, and provisions for excess and obsolete inventory.

Photonics gross margin was 32.3% in 2013 compared 34.2% in 2012 and 28.9% in 2011. Fiscal 2013 gross margins declined over fiscal 2012 due primarily to lower margins on contract R&D, offset in part by of higher-margin product sales and cost reductions associated with digital night-vision products and warranty. Fiscal 2012 gross margins improved over fiscal 2011 due primarily from cost reductions associated with digital night-vision products and warranty offset by slightly lower margins on contract R&D. Manufacturing costs for digital night vision products decreased in 2013, 2012 and 2011 as a result of cost reductions and yield improvements.


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Research and development

                                          Years Ended December 31,
                                                                                  Change                Change
                                      2013          2012          2011         2013 vs. 2012         2012 vs. 2011
                                                                    (in thousands)
Research and development expense    $ 21,037      $ 31,762      $ 34,287      $       (10,725 )     $        (2,525 )

Research and development expense consists primarily of salaries and related costs of employees engaged in and prototype materials used in ongoing research, design and development activities for PV cell manufacturing equipment, disk sputtering equipment, semiconductor equipment and Photonics products. During the first quarter of 2012, Intevac sold certain assets comprising its semiconductor mainframe technology and no longer performs research and development activities for semiconductor equipment.

Research and development spending decreased for Equipment during 2013 as compared to 2012 due primarily to lower spending on PV development, costs recovered under a NRE arrangement and savings from the global cost reduction program. Research and development spending decreased for Equipment during 2012 as compared to 2011 due primarily to lower spending on prototype materials for PV development and the discontinuance of semiconductor equipment development.

Research and development spending decreased for Photonics during 2013 as compared to 2012 and during 2012 as compared to 2011 due to a higher volume of billable contract R&D efforts. Research and development expenses do not include costs of $11.3 million, $11.3 million, and $4.9 million, in 2013, 2012, and 2011, respectively, which are related to customer-funded contract R&D programs and therefore included in cost of net revenues.

Selling, general and administrative

                                        Years Ended December 31,
                                                                                  Change                 Change
                                   2013           2012           2011          2013 vs. 2012          2012 vs. 2011
                                                                   (in thousands)
Selling, general and
administrative expense           $ 22,278       $ 25,919       $ 25,597       $        (3,641 )      $           322

Selling, general and administrative expense consists primarily of selling, marketing, customer support, financial and management costs. All domestic sales and the majority of international sales of disk sputtering products in Asia are made through Intevac's direct sales force. Intevac also sells its equipment through distributors in Japan and China. Intevac has offices in Singapore, Malaysia and China to support Intevac's equipment customers in Asia.

Selling, general and administrative expenses decreased in 2013 over the amount spent in 2012 due primarily to lower equity compensation expense and savings from the global cost reduction program, offset in part by increased accruals for variable compensation programs and costs associated with the implementation of the global cost reduction program. Selling, general and administrative expenses in 2012 were virtually flat with 2011 spending.

Acquisition-related expense (benefit), net

                                         Years Ended December 31,
                                                                                 Change                Change
                                      2013          2012         2011         2013 vs. 2012         2012 vs. 2011
                                                                    (in thousands)
Acquisition-related expense
(benefit), net                      $ (3,727 )     $ (219 )     $ 1,247      $        (3,508 )     $        (1,466 )


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Acquisition-related expense (benefit), net, represents the change in the fair value of contingent consideration arrangements related to the SIT acquisition; see Note 7 "Contingent Consideration." Increases in the assessed likelihood of a higher payout under a contingent consideration arrangement contribute to increases in the fair value of the related liability. Conversely, decreases in the assessed likelihood of a higher payout under a contingent consideration arrangement contribute to decreases in the fair value of the related liability.

The benefit recognized during fiscal 2013 is associated with the change in the fair value of the contingent consideration related to the revenue earnout obligation. We recorded liabilities on our consolidated balance sheet of $4.1 million as of the original acquisition date for this contingent consideration arrangement and subsequently remeasured the liability to fair value, with changes in fair value reported in earnings. As a result of this remeasurement, we recorded a net gain of $3.7 million for the year ended December 31, 2013.

The net benefit recognized during fiscal 2012 is associated primarily with the change in the fair value of the contingent consideration related to the milestone obligation. We recorded liabilities on our consolidated balance sheet of $5.6 million as of the original acquisition date for this contingent consideration arrangement and subsequently remeasured the liability to fair value, with changes in fair value reported in earnings. We made payments in total of $5.6 million to the selling shareholders associated with this arrangement. The fourth and final milestone was not achieved on the targeted date outlined in the acquisition agreement and was not paid. The net benefit recognized during fiscal 2012 is primarily related to the reversal of the accrual for the fourth milestone. This liability is settled and is no longer subject to future remeasurement.

Bad debt expense

                                          Years Ended December 31,
                                                                                      Change                Change
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