Novanta Inc (NOVT) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to the GSI Group third quarter 2005 earnings results conference call. This call is being recorded. at this time, I would like to turn the call over to your moderator, Mr. Ray Ruddy. Please go ahead, sir.

Thank you, operator. Good morning and thank you for attending our third quarter conference call. This call is being broadcast live over the Internet in listen-only mode, www.gsig.com. Charles Winston, CEO, and Tom Swain, Chief Financial Officer, join us this morning. Before proceeding, certain remarks made during this conference call may constitute forward-looking statements. These statements are based on management's beliefs, assumptions and current information and as such are subject to risks and uncertainties and changes. Our Safe Harbor statement can be found in our financial press releases, available also on our website and applies to this call as well. First, let me begin by quickly reviewing GSI's positioning, for any new listeners.

Our 14 leading brands can be categorized into three major product segments that we report on. There are Precision Motion, Lasers and Laser Systems. Our Precision Motion segment sells control and positioning products anywhere high mechanical accuracy is required, like in robotic surgery. Our lasers are used in medical and electronic applications. Lastly, our laser systems are critical in the production of memory chips. Now I will turn the call over to our CEO, Charles Winston.

Thanks, Ray. Good morning. Listeners today can find our press release on the wire from last night. Today Tom and I will provide insight into the results and then answer your questions. Per our guidance last quarter, revenue for the quarter was $62.6 million, down approximately 6% from the second quarter. This was due mainly to lower sales in our systems segment as the semiconductor industry reached, what we believe, is the bottom of the cycle. The third quarter results indicate incremental operating performance improvement, particularly in our ability to maintain strong gross margins at 39% on lower revenue base. This is down 2% from the prior quarter, as indicated in our last conference call. Compare our results to those a year ago at the peak, when our revenue was $91 million in a quarter and the gross margins were at 41%.

We expect the progress made in improving our operating leverage over the past year to continue to pay off as revenues increase. Further, our goal continues to be to generate cash. In this third quarter, cash and investments increased by $15 million. Now looking at each business segment. Our Precision Motion segment sells high quality motion control products that enable our customers to make the systems used in the manufacturing of such products as printed circuit boards and disk drives. In this segment, third quarter revenue was $36.5 million, up from 34.2 million in the prior quarter. Gross margin at 41% was down slightly from the last quarter due to product mix, while operating profits increased by approximately $0.5 million to 5.5 million. Most of the quarter on quarter revenue improvement came from increased demand for our high-end air bearing motors that are used in the production of printed circuit boards.

Demand for densely populated boards remains strong. It's hard to say whether this is a seasonal fluctuation or a cyclical recovery. However, the PCB industry analysts expect that the number of holes to be drilled in printed circuit boards will double over the next three years due to the increased demand from mobile communications and entertainment products. Revenue from other product lines and markets in Precision Motion were mixed, some slightly up, some slightly down, with no major shifts. Our second segment, Lasers, which enable high quality repeatable cutting, welding, drilling in most light industrial and some medical applications. Quarterly sales were down 12% from 11.4 million to $10 million, we believe mostly due to seasonality. Gross margins fell slightly from 36% to 34% on the volume. This segment was slightly above breakeven in operating income for the quarter. Our third segment, Laser Systems, supplies capital equipment to the semiconductor industry.

As we guided last quarter, Laser Systems sales decreased quarter on quarter. This was due to several reasons. Some shipments were pulled in to Q2 and seasonal and cyclical effects, also. We believe that the third quarter was the bottom of the cycle, as we reached a low level equal to that in the first quarter of 2003, which was the bottom of the last cycle for us. System sales are mainly driven by three product lines, WaferMark, WaferTrim, and WaferRepair. Our WaferMark systems are used to write ID codes on wafers for tracking. Demand remains strong with the continuing transition to 300 millimeter wafer size. The strength of our sales indicates that chipmakers are releasing purchase orders to customers. It appears they are increasing the future silicon supply for a more robust chip market in 2006. Our WaferTrim systems are used to produce A to D and D to A chips for applications such as power management in electronics. Revenues were unchanged from prior quarter, remaining at a very low level.

Our WaferRepair systems are critical to the production of both NAND flash and DRAM memory chips. While it is not possible to predict the cycle, we feel this quarter was the bottom. It was our weakest quarter for WaferRepair systems in two years. Further, the market drivers are strong. According to VLSI, back-end IC fab utilization has now reached 98% in September. Historically, these levels drove capital investment. Customers are maintaining a tight chip supply and, as a result, we are seeing short lead times for orders. We are also seeing the RFQs for increased numbers of systems at this time. For our overall business, including WaferRepair, we provided $7.6 million in quotes in September and we just generated $28 million in quotes so far through October. Also, as demand for NAND flash chips increases, the chips being produced with more storage capacity. This means that the next generation ICs will require more fuse links and, therefore, more systems. This increases potential overall market for us.

Additionally, we believe the potential exists in 2006 to grow market share by becoming a supplier to the remaining available market. We estimate that currently we share half the business at customers who make up 40% of the market or we have about 20% of the total market requirement. Our prospective customers were in various stages of qualification testing. We feel we will continue to be successful here. In addition, customers are now evaluating our new green laser technology. This system capitalizes on the physical properties with the pulse laser light to focus an effectively small spot size for blowing fuse links that is more narrow than the wave length of the green light itself. In fact, this system is now in production at a large customer. In another large prospect, our system has been qualified at 110 nanometers. And this customer has also asked us to submit bids with our green pulse laser, even as we are being qualified at 90 nanometers in the red.

Lastly, at two other smaller fabs, one qualification will end in November and another one in December. Once qualified, we will then be able to compete for new business. If successful, competitive wins should ramp up during the fourth quarter of this year and through next year, because we will simply have the ability to compete for these transactions. Now that we have updated you on our operations to date, on to some guidance. For the corporation we expect revenue for the fourth quarter to be somewhere between $65 to $70 million, mainly due to improvements in the semiconductor market for capital equipment. Gross margins should fall one point as systems volume improvements offset against anticipated unfavorable changes in product mix in Precision Motion. We anticipate earnings per share to be in the range of $0.05 to $0.07. There are a few more matters for comment. We continue to be focused on incrementally improving expenses. You can see in this fact that we have designed parts of our business to remain profitable during cycle fluctuations, as all of our segments were.

Across the board, fixed expenses were lower this quarter in R&D, SG&A, and the cost of goods sold. We will continue to incrementally improve earnings by moving more manufacturing to China for certain components and laser products. As part of our cost management efforts, GSI will be delisting from the Toronto stock exchange. There are several reasons for this action. First, we will save approximately $100,000 a year in exchange, legal, and transfer agent fees. Second, we have gotten feedback from investors that an impediment to investment is share volume by combining the exchange volumes onto the NASDAQ, this will increase our trading volume on NASDAQ by approximately 50%. Third, we no longer have significant operations in Canada. Fourth, after extensive research, we're unable to quantify corporate or stock benefits of a dual listing. We expect the delisting process will be effective November 1st, after that GSI will cease to trade on the Toronto Stock Exchange and be available only on the NASDAQ market. I now open the call to questions and answers from Tom and myself.

And if you have a question today, you may signal by pressing the star key followed by the digit one on your touchtone phone. Do keep in mind that if you have been using a speakerphone, please make sure your mute function has been turned off to allow your signal to reach our equipment. Once again, that is star, one if you have a question. We'll pause for just a moment to assemble our roster. And we'll take our first question from Jim Ricchiuti from Needham & Company.

Thank you, good morning.

Morning, Jim.

Chuck, I wonder if you would just give us a little bit more color on what's happening with margins. It's down sequentially, it looks like, if each of the three units. Is it mostly volume driven, and you're also talking, I think, about a little bit of a dip in Q4 as well.

Yes, this is Tom. The issue on margins is we have a combination of volume impact, which was certainly a factor in the Systems Group, and then it also is a combination of mix issues, also. Generally we're getting fluctuations on mix of -- in the range of one to two points and then volume can be another one or two points.

We don't see anything, Jim, that causes us concern. We don't see any trend developing. It's just as Tom said. I think volume improvements over the next couple of quarters will cure most of it.

Yes, maybe you should look at the trends in lasers and PMD, both of those over the past several quarters have been gradually trending up. Systems is more consistent except for more of a volume fluctuation and they can have a mix variation, too.

I'm not looking for specific guidance on the different groups, so I was just wondering, are there any of the three groups do you see margins stable to possibly improving in any of the groups in Q4, or -- ?

I think overall they'll be about where they're at now, and that will be more of a mix variation, mix will offset volume.

Okay.

I think as we move forward over the next two to three quarters, we should see some improvement in the Precision Motion, which will be due to the more product coming out of the factory in China, as well as, again, some mix shift issues that are going on within the components business. Lasers also should show some improvement with some better volume. And, of course, the biggest one will be some systems improvements with volume.

Chuck, can I just get a little clarification on the comment you made about RFQs? I think you said 20 million through October. Is that a four month period, so from the June quarter in addition to October?

No, I may have confused the issue. We actually generated RFQs valued at $28 million in the month of October alone, that was up significantly from September, which was about 7 million. So what we are seeing is requests from RFQs that have larger volumes in multiple unit orders, which is very encouraging, because these customers would not be asking for large quotes like that unless they were serious. When someone walks in and asks for an RFQ for one system, you wonder whether it's ever going to generate an order. But when they are asking for multiple units quotations, then they are pretty seriously in the planning process.

Now, is that being led by wafer market, because that typically is a bit of a leading indicator for you, isn't it?

Well, I think it was overall, but the big ones were repair, more of the repair business, and right behind that, the wafer marking. We have not really seen any indication of buying coming back in the mix signal area yet.

Okay. And lastly, and then I'll just turn it over to somebody else, any flavor for the composition of your bookings, where you saw strength, and perhaps just a little color on the bookings?

Looking at the quarter, we had some weakness in the CPG in the components group, which is more of a seasonal thing, so they dropped off. Systems was a little bit -- just a little bit up from last quarter overall. And the biggest shift, I think, was really, and I call it more seasonal, in the overall Precision component segment.

We also should point out that in the quarter before, we had had stronger orders came in in Q2 from the data storage area and these tend to be lumpy. You get a fairly good size order and then you run that off for a couple of quarters. So we saw good size in the data storage business in Q2, which didn't repeat in Q3, but some other orders came in but not at the same level. So overall, it can go up and down quarter to quarter, but it doesn't worry us over the long term, the trend is up.

Okay, great. Thanks a lot.

We'll now move to Jed Dorsheimer with Adams Harkness.

Hi, guys, thank you. A couple of questions. Chuck, and maybe Tom, I was wondering if you could just help me here. As I look at the model and I look at the last year, where the systems business looks as if it had peaked in 2004. Am I reading this correct that while the Systems business only represented about 45% of revenues, the margin contribution was actually greater than 50% to total from wide profitability?

Yes, that's correct.

And so therefore, maybe asking Jim's question a different way, when we look at the quote activity over the past month, would those quotes typically result in next quarter turns business, or next quarter bookings, which would then result in first quarter leverage?

It would more likely generate order bookings during the fourth quarter and lead to shipments in the first quarter. There would be some shipments that would take place in the fourth quarter, toward the end of the quarter, but we are outlooking an improvement in the systems business for Q4, compared to the Q3 just completed. But we're expecting the larger impact will take place early next year.

Great. So I -- so it looks as if as far as the gross margin, the real impact should be in the first quarter, correct?

That would be correct, because we have more leverage on the upside for margins built into the Systems business, because of the restructuring we've done over the past year.

Great. Just a couple more questions on the Systems. You had mentioned -- I mean that quote activity is quite impressive, from 9 million to 28 million. Is this being -- I know you mentioned, Chuck, that this was being driven by higher volume type of activity. Is it being driven with a broad base set of customers, or is it primarily either market share gains at one or two, or to just an uptick in activity at one and two? And then maybe if you could comment if that was primarily NAND or DRAM in that quote activity? Thanks.

That's primarily a few customers, would be the first answer. And the second one is it's both, because the industry is using the same lines to produce both, but they're trying to ramp more in the NAND flash area. They all see that as being a much more profitability piece of business.

Lastly, in the Systems business, when you look at the geographical mix from an activity perspective, could you give a little bit of color on a country or region basis, as far as where you're seeing the most activity, is there any softness that you are seeing, or maybe to word it a different way instead of softness, are you seeing just a lack of activity in any one particular region? Thanks.

Could you rephrase that question? I got lost in the -- ?

Sure. So when we look at -- when we're looking at the order activity, geographically-speaking, could you give us some color on where you're -- is that strength coming from any particular region or country? And just any color on that. Thanks.

Jed, are you referring in the Systems, or overall?

Systems.

Okay. Systems is obviously going to be more from Asia. I won't be any more specific than that.

Well, that's what I was hoping for, maybe between Korea, Taiwan, China, and Japan.

Well, you made the trip, so I think you know better.

And last question, Chuck, just the PCS business, in the past we've gotten inventory issues have snuck up a little bit. Just wondered if you could give a little color on visibility and how clean the channel is, particularly in the air bearings? And then the one area in the PCS that I didn't hear you talk about was the MicroE. Was wondering if you could give a little update there, too. Thanks.

Yes, in the printed circuit board area the supply on spindles is pretty tightly managed now. There's only a handful of customers. They're large customers and they've been really very, very disciplined in their approach to taking on inventory. So we check with them on a regular basis, weekly for the most part, and we haven't seen any buildup that exceeds beyond what we would consider a normal range that they should have on hand to run their business successfully. So we're not seeing a lot of inventory build there. And that remains a nice area and we've seen some strength in the orders there, as I mentioned, because printed circuit board manufacturing has improved in a number of areas. But the data storage business, we had some good orders came in the second quarter, slowed down a little in the third quarter, but it's lumpy. We don't seeing anything that would say it would continue to decline at this point. It may be coming back again in the fourth quarter, I don't know yet. But we have no reason to believe that things are going to be anything other than historically a little lumpiness here and there. And those are really the two main drivers. And we've also seen some pickup in the semiconductor part of the MicroE business.

Thanks. I'll pass it on.

And Stuart Muter with RBC Capital Markets has the next question.

Yes, thanks. Good morning. A couple of questions for Charles. First, on the Systems business, with the rapid ramp in NAND flash that the industry is going through, do you see the potential to pickup some new customers in the NAND flash segment?

Good morning, Stewart. Thank you for participating in the coverage that's coming. But, yes, we expect to to see the business being driven more and more going forward by the NAND flash production. But again, this equipment is used dually to make NAND or DRAM. And that's the nice part about it, the versatility of these line that they can get an order for one or the other and still use the same equipment. But we think going forward NAND will be the bigger driver because the targets being set by our customers are to increase their NAND capability more and more.

Okay. And do you think that you can gain some new customers over the next six, nine months in NAND flash?

We do. We believe our equipment is very capable there, very competitive, and we're getting good test results on both DRAM and NAND flash. So we feel very good about the fact that there will be more requirements and we are going to be able to participate at more accounts for business. I believe we should be picking up some good orders over the next several quarters.

Great. And when do you think the wafer trimming business from the analog mixed signal guys will pick up? I think it tends to be pretty lumpy, but do you have any visibility on when you think that will improve?

We don't see anything, really, in the next two to three quarters. If anything, it would be mid-year before we would see any upturn from them based on the discussions we have about their future plans.

Okay. That's helpful. And final question on wafer marking. Could you talk, Charles, a little bit about how has the trend been in wafer marking through the course of this year? Has it been pretty much flat or is it slowly rising? If you could talk about the trend there, that would help.

It has been strong consistently quarter to quarter for the past three or four quarters. In fact going back into last year, it has been one of the good main stays for our business. The transition to 300 millimeter has been a pretty constant change over quarter to quarter, and that's where we've been benefiting. We expect that to continue for the next several quarters.

Great. Thanks a lot.

Thank you, Stewart.

Now move to Todd Coupland with CIBC World Markets.

Hi, good morning, everyone.

Good morning, Todd.

With respect to your TSE delisting plans, do you have any plans to re-domicile GSI Group as a U.S. corporation?

No, we don't have any discussions going on. We went through that drill a few years ago. This is just purely and simply a cost cutting move. When I sit here and I look at my business and the SG&A expenses, I have some choices. I can lay off two or three engineers. They have wives, families, kids, and they produce new products for us. So I can get rid of a few engineer. Or I can delist on an exchange. There's no choice in my mind there. I need those engineers. Their families need to eat. Delisting on an exchange doesn't cost anybody any pain in terms of their life.

I guess, just to play devil's advocate for that on a moment. It seem likes $100,000 relative to the size of the corporation is quite small when you think about the bulk of your shareholder base and today, anyway, the bulk of the coverage of the Company. So, sitting here, it doesn't seem like it's -- the benefit is all that great. I mean, I understand what your response is, but that's more of an editorial comment than anything else.

Todd, we could sit here and discuss it for a long time, but when it gets down to it I'll paraphrase a long time ago senator in the United States Senate, Everett Dirksen from Illinois, who said, a few billion here, a few billion there, you're talking about real money after a while. And the same thing here. It's $200,000 here, $200,000 there, but when you sit down with the budgets and you're looking at $13 million and you want to reduce it to $12 million to improve $1 million on the bottom-line for your shareholders, you have to start making cuts and those cuts come in the $100,000 category. When I look at them I see faces of people in front of me that I've known for many years, who are designing and building equipment for us and I need those people and their families need to eat. And you may think I'm being a bleeding heart, but that's what life is about, that's what this business is about, it's about people. We're not a capital intensive business, we're not a bank, we live on the intellectual property that comes from our people. And being listed on two exchanges to me was an extravagance.

Okay. Thank you for that. If I could just move on to a couple of business-related questions. So when you think about the DRAM repair bookings that you have seen in the month of October, how long is it going to take to convert -- or I guest it's not bookings, but it's people asking for quotes. How long is it going to take to convert that into revenue?

Typically it takes from one to two quarters. Right now we're see the order activity, which is a request for quotations, we're filling those. We're negotiating with customers. We've been through trials and tests on the equipment, so they're asking now for quotations. Some of them were wrapping up evaluation tests, others we've already completed. So we expect that the RFQs will turn into actual orders sometime in Q4, but we can't predict exactly the timing on this. It could roll over into Q1, it could be in Q4, some shipments could actually start in Q4. Most likely the shipments would actually generate revenues would be in Q1.

This question was asked a little bit earlier. So would you -- with this kind of quote activity, would you expect a lot less seasonality in 2006 as a result of this product?

Well, you're basically asking me to predict a recovery in the cycle and I wish I could. I would love to say yes to that, but I can't. I don't have any better insight than most of you do. What we are seeing, as I said, is the order -- the requests for the quotations, which is preorder activity, has improved substantially. It's a handful of customers basically looking for larger buys, multiple unit buys, that would be spread out over multiple quarters, can't have them take it all in one quarter. But the good news is we are outlooking an improvement in our sales for Q4 compared with Q3 in the Systems business. And we believe that represents a sustainable trend for the next several quarters, as best we can see.

Okay. And with your order pipeline, would you, in this segment, would you see the quote activity accelerating from what you saw in the month of October?

Well, we hope it will be sustainable at that level or better. What we're counting is as we finish up qualification tests at a number of accounts, to see more requests for quotations come in. Again, order -- the cycle times on these orders is extremely short. The visibility is less than 90 days on most of this. They'll come in out of the blue and say, without any notification, say we want a request for quotation here. We would like your quotation in the next two weeks. So things are real -- they're real short term compared to even the last cycle.

Okay. And then just lastly, if we think about your target business model for 2006 with some of the operating cost cuts you've made, et cetera, what should we think about in terms of sort of total OpEx and gross margin goals for '06?

Well, we're not going to give you that big guidance, but basically the model is still a valid one. We need to get ourselves up above $80 million a quarter run rate sustainable for several quarters in a row to be able to achieve the margins at about 45% gross and in the mid to high teens in the operating income pretax.

Okay. Great. Thanks a lot.

You're welcome, Todd.

And once again, if you have a question it is star, one. And if you are using your speakerphone, make sure the mute function has been released to allow the signal to reach the equipment. We now move to Susan Streeter with Sprott Securities.

Thanks, good morning.

Good morning, Susan.

I'm just wondering if you could spend just a moment giving us an update in terms of the transfer of some of the Westwind production to China?

That's going very smoothly. We took out a lot of equipment from the UK, automated machine tools, shipped them over to a new factory that we moved into in April. The equipment did get transferred during July-August and is up and running now. Produced first articles in the September-October time frame. And we expect during this fourth quarter period that we'll see a much more steady run of product coming out of there. And as we move forward into the next several quarters, we will ramp up higher and higher. So more of our production will come from there and, therefore, improvements in our components gross margins will take place over the next several quarters to get us up into the mid-40s overall for the Components business. Most of the product being produced there right now is for the Westwind group, but also we're planning and starting production of some other product lines there, as well, on a lower level. So this is a long-term plan. It's been a plan for quite some time and it will take several years to play out overall. But we're very pleased with the way the factories come up. I think our employee account there now is up to somewhere around 60 employees, or 70 employees, I believe, full time, and we're still hire something people. We have a full staff on board. The fellow running it is a British ex-patriot who was a long term employee of Westwind and he is over there as the manager of the plant. And we brought over also some additional British ex-pats to help him run various departments, such as production. We have a financial staff now hired. We have HR people hired. So target is to get up to approximately 100 employees in the factory by the end of the year.

Okay. And can you quantify what level of revenue you think could come out of that facility?

I'm not going to do that at this point.

Okay. And then just secondly, just in terms of the inventory, it was roughly flat with the last quarter, and I recall that you saying that you had four DRAM systems in inventory, looking to ship, sort of, in the back half, maybe the fourth quarter, the first quarter, and also you had some things in inventory as it related to transfer to China. Is that still the case?

That is true. We still have that inventory from -- mostly from Westwind, which represented an additional quarter to quarter and a half worth of inventories, roughly about $3 million, as I recall, and that's a buffer inventory, because we had to take the equipment down, ship it over to China. We will burn that off as we go through Q4 and Q1 of next year. So I would say by the end of Q1, we should be seeing somewhere in the neighborhood of $2.5 to $3 million reduction from components inventory for the Westwind move. And then the Systems business, that -- we still have systems on test, they have not been purchased, but that's all part of the discussion we just had on the RFQs and the order cycle. We believe that once we are awarded some business that these accounts, they will buy the equipment that is on demonstration test now. And that should help to burn down some of the systems inventory over the next two to three quarters. It will probably take into the second quarter of next year to get it all done.

Okay. And then just lastly, with respect to the systems business and the green laser technology, is there any material difference in pricing between sort of the red laser and the green laser systems?

Green is a little bit higher and has good margins. It's a fairly unique product.

Okay. Great. That's it. Thank you.

Thank you, Susan.

With no further questions, that will conclude the question-and-answer session for today. I'll turn it back over to your host for any additional or closing remarks.

Thank you so much. We hope to see you at the end of next quarter.

That will conclude your conference for today. Thank you for your participation. Have a wonderful day.