Novanta Inc (NOVTU) 2005 Q1 法說會逐字稿

Welcome to the first quarter 2005 GSI Lumonics earnings conference call. My name is Bill and I'll be your conference coordinator for today.

At this time, all participants are in a listen only mode. However, we will be facilitating a question and answer session towards the end of today's conference.

(OPERATOR INSTRUCTIONS)

As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today's presentation, Mr. Charles Winston, President and Chief Executive Officer. Please proceed, sir.

Thank you, operator. Good evening and thank you for attending our first quarter conference call. This call is being broadcast live over the Internet in listen only mode at www.firstcallevents.com on a specific url detailed in our press release. As usual Tom Swain, our Vice President and Chief Financial Officer, joins me this evening from the United Kingdom where we are sitting.

Before proceeding, I must mention that 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 on any of our financial press releases, available also on our website, applies to this call as well.

You have all read the earnings report that went on the newswires about an hour ago and, clearly, we wish we could have achieved stronger performance for the first quarter of 2005. But rather than recite the numbers, Tom and I will try to provide our insights into the dynamics of the current market situation and then answer your questions following our remarks.

Let's begin by putting the situation into a proper macro perspective. Most of you have been following the Company for some time and are familiar with the transformation of GSI Lumonics during the past 4 years through divestitures, restructuring, and acquisitions. We have reduced our Systems Business segment from approximately 60% of revenues 4 years ago to about 34% at the present time.

With 66% now in lasers and precision motion components, the Systems Business segment is mostly dedicated to the semiconductor market whereas laser and precision motion components mostly serve non semiconductor markets in electronics, medical, industrial and other applications. This diversification program has provided less dependency on semiconductor capital equipment. While we are concerned with the downturn in the semiconductor sector, today we are in a much better position to get through this cycle.

Expansion of our Laser and Components segments, combined with a restructuring of the Systems Business segment, provides a cushion in the semiconductor downturn cycle, while leveraging the upturn in semi.

Now semi clearly has a lot of leverage but with system sales down approximately 35% year-over-year, same quarter, we do not see anywhere near the losses we experienced in 2002. In fact, we anticipate remaining profitable. Further, we have a strong debt-free balance sheet with approximately $87 million in cash and marketable securities or roughly $2 a share, must of which is available to further diversify the business through additional acquisitions. So we are in a good position to focus on improving our margins and generating future growth opportunities as we go on through the year.

Now let's take a more detailed analysis of the business. Approximately 37% of our revenues in this quarter we derived from sales into the semiconductor market, most of which was capital equipment into niche market segments of memory repair, wafer trim, and silicon wafer marking. While there are sales of wafers and motion components into the semi market, these are relatively minor compared with systems. About 23% of our revenues came from the electronics market, where we supplied mainly lasers and precision motion components. While there are other niches within electronics, the dominant ones are PCB production and data storage. And here, again, there are sales of some systems with circuit trim and inspection of printed circuit boards into this electronics niche. However, these are relatively small compared with the components sales.

Light industrial market at about 18% and medical at about 12% of revenues, respectively, are comprised entirely of precision motion and laser sales. The same is true for the remaining 10% which is comprised of Aerospace, Scientific, and other market niches.

Looking more closely at semiconductors, we believe we are near the bottom of the semiconductor trough at this time. Whether we have actually achieved bottom at this particular moment remains to be seen, but it feels quite near to the bottom, based on our dialogue with our customers on a weekly basis. We believe the cycle will be less deep and shorter in duration than the last one, due to the inventory buildup in the industry not being as severe and the business environment being a much more controlled and monitored one.

Wafer trim is a process in the production of mixed signal, power management, and analog-to-digital conversion devices. These are used in PCs, mobile electronics, appliances, and automotive. Sales into this niche declined significantly and we have remained dormant since mid last year, as the producers continue to operate at below capacity in concert with the inventory overhang created during the last half of 2004.

According to April forecast updates from a number of industry sources, the industry excess inventory situation should be corrected during the second quarter timeframe. So we do not expect a full recovery until late this year or possibly into 2006 when the capacity purchased last year is fully online.

Wafer mark business was very strong in the first quarter, consistent with completion of 300 mm fab and silicon supplier expansions. However, changes in the forecast and some order pushouts indicate slowing business conditions ahead in this segment. This is being driven by a lower utilization rate in the fabs, currently believed to be running at approximately 84 to 85%. The memory repair niche has also been relatively steady, due to the transition to 300 mm wafers and 90 nm dimensions. However, at the end of March, we did experience unexpected order delays for three systems. This caused the decline in revenues in the Systems segment to be greater than we had anticipated.

Again, this reflects corrections and capacity utilization. Visibility for the balance of 2005 still remains quite limited, so we anticipate approximately the same level of sales for memory in the second quarter with a slight improvement in the second half, due to expected increase in integrated circuit fab utilization rates and the need for further increases in 300 mm wafer production. In demand here is being largely driven at this time by PC and server market needs.

Based on recent data from industry research sources, DRAM makers -- where we have not yet been qualified -- appear to have considerably higher market shares at this time than we previously believed. This is good news since it could lead to increased sales, despite the slower market conditions.

Our second largest market -- Electronics -- is primarily driven by PCB production and data storage niche applications. PCB productions served mainly by our Westwind air bearing spindles group declined in line with expectations, due to seasonal demand for PCs, laptops, communications equipment, and consumer entertainment devices. We had some pushouts toward the end of the quarter believed to be an inventory correction. We expect further reduction in orders of approximately 5% for the next one to two quarters, with improvement in the fourth quarter as we near the bottom of this correction.

There is very little unsold stock in the supply chain due to very close control in the marketplace. We believe capacity utilization rates are in the 80% range in PCB production at the present time. Growth is expected to be driven mainly by demand in Asia for the backside of the year.

Data storage is also experiencing seasonal adjustment with the last two quarters, the fourth quarter of last year, and the first quarter of this year being typically slower periods for consumer entertainment and PC sales. We anticipate gradual improvement through the year. Further, we believe the industry is in a transition year in the high density disk drive technology, moving towards spiral right technology -- which is more efficient and higher throughput. This offers us an opportunity to upgrade an installed base. Future growth in this area is in the sub 1 inch micro drives -- .85 to 1 inch diameter -- that compete with flash memory below 1 gig for the consumer entertainment and mobile communications applications.

Light industrial niches are served by lasers and precision motion components. Lasers are used for microwelding and marking. Lower volumes of laser sales in the first quarter was due to combined impact of seasonality and the acceleration of deliveries in the fourth quarter of last year, demanded by our customers. However, strong demand has pushed backlog up to its highest level in the past 12 months for lasers. So we anticipate the second quarter of shipments will exceed first quarter performance. Increasingly, the Asia-Pacific marketplace is becoming a key area for sales expansion of lasers.

Outlook continues to be limited to approximately one quarter but currently we see continuing improvement in the order book toward the middle of this year.

Sales in Medical are steady with indications of some improvement in both the component and laser product groups. We continue to strengthen our presence in the Asia-Pacific, opening new sales offices in Shanghai and Beijing in the most recent quarter, and appointing a new regional sales manager for the northern China area and hiring some additional salespeople in other parts of China.

Manufacturing of air bearing spindles will begin at our China facility during the summer months as a key element for improving our gross margins and components. The controlled rollout of increased service and application strength into this region is planned as our sales volume grows in the area.

Now over to Tom for some detail on the financials.

Thank you, Charles. Sales for the first quarter were down 19% from Q4 of 2004 and 13% from Q1 of 2004 last year. The predominant driver in the revenue falloff was from the Systems growth. It was down 38% from last quarter as the result of pushouts and a shortfall in expected orders for memory products.

Margins for the quarter were down 3.5 points from last quarter and 4.3 points from the same quarter last year. The falloff in margins is mostly attributed to the decline of revenues with 2.5 points of the margin decline from last quarter coming from the reduction in volume, and 2.1 points from the same quarter last year. Margins were also unfavorably impacted in the quarter by severance costs, a customs issue, and higher than anticipated inventory net obsolescence provisions -- all totaling approximately 1.4 million.

It also should be noted that there was a benefit of .7/10 million in the last quarter and .6/10 million in the same quarter last year from the sale of inventory that had been previously written down. We do not anticipate any significant further recoveries from inventory obsolescence this year and continue to focus strategically on margin improvement.

The decline in the laser segment margins from last quarter and the same period last year are primarily attributed to the provision of .4 million for a customs issue and .2/10 million for severance costs, with partial offsets by other factors. The component segment margins increased from the last quarter, as a result of the shift in product mix to higher margin products. And the increase from the same quarter last year is the result of the higher margin products from the Micro E acquisition. Gross margins for the systems segment declined 7.5 points from the last quarter, with 4.4 points of this decline being attributed to volume. The balance of the decline is in a combination of the difference in obsolete inventory provisions and an offset by a shift in product mix.

Margin declined from the same quarter last year by 10% with 3 points of decline attributed to lower volume. An additional 3 points of the decline are attributed to the difference in inventory obsolescence provisions, with a balance due to product mix changes.

Going forward, we expect to get margin improvement from cost reduction efforts and small volume increases. Our target remains to achieve 40% plus gross margin rates by the fourth quarter of this fiscal year. R&D costs were up only slightly from the last quarter and are up significantly from the same quarter last year, primarily from the added development cost from the Micro E acquisition. The increase in SG&A expenses, compared to last quarter, is primarily attributed to a net benefit from a bad debt recovery in the last quarter of .5/10 million, higher fringe benefit costs of approximately .4/10 million and higher pension cost of .3/10 million.

Cash flow from operations was a usage of 1.2 million. This resulted, mostly, from payments for Accounts Payable accrued payroll costs and taxes payable of 9.9 million, combined with additions to inventories of 3.1 million that were partially offset by a 6.3 million reduction in receivables. We expect cash flow to be positive for the balance of fiscal year with the primary drivers being operating profits, excluding depreciation and amortization.

Inventory turnover was down from 3.2 to 2.7 from last quarter, as a result of higher inventory levels in the Systems division and lower revenues. Day sales outstanding increased from 69 days in the last quarter to 75 days in Q1, primarily as a result of longer collection cycles in the Systems segment.

Charles, I turn it back over to you.

At this time, Tom and I are available to answer your questions. Operator, would you please proceed?

(OPERATOR INSTRUCTIONS) Susan Streeter of Sprott Securities.

I'm just wondering if you can elaborate in terms of the businesses, the components and the laser segments. Specifically, as those account for an increasing amount of revenue, you mentioned that the production of the air bearing spindles in China should help margins. What else is planned to boost those margins because, clearly, we've seen some declines over the last couple of quarters. And I'm just wondering how you plan to turn that around?

You mean specifically in components or in general?

In both components and lasers. And I do understand that, obviously, on the Systems side there's a big volume component there that is difficult to control. But the component in the revenue is fairly strong in the component group but you're still seeing some margin pressure. I'm just trying to get a better understanding of that.

The components piece, obviously, the Westwind move will shift to a lower production source. We are also planning for the end of the year to bring into production in that facility in China, some of the laser -- not all of the laser itself -- but parts of laser to be either made at our plant or procured in local sources in China. In addition, laser is -- the laser business segment is introducing several new models of laser at the laser show in Munich in June. And these are all designed for lower price point and lower costs of manufacture with higher margin. So that's a big part of it as well as changing the venue of manufacture.

Also in the Systems group we have a dedicated effort there to source from lower cost producers in Asia-Pacific -- Taiwan, Korea, and China -- to source parts that we were getting locally in the U.S., but to go for a lower cost with equivalent performance.

So we have several dedicated activities going on in each group focused -- and these were initiated almost a year ago in the design phase and also now into the procurement phase and production phases. These are all designed to help improve the margins as we go through this year quarter by quarter.

Okay. If I could touch on the outlook -- you indicated that you thought Systems would sort of be potentially around similar levels in the second quarter. Your expectation -- would you expect to see the components expand from the Q1 levels?

We think components have the opportunity to improve somewhat from the -- there's some softness obviously in the PCB spindles part of our component business. But we see other parts of the component business regaining some traction, particularly -- for example -- in our scanner business line which was hurt by our own quality performance last year. We now have fixed all those problems during the fourth quarter of last year. And we are getting very good response from our customers about the quality of the product, the on-time delivery, and we are seeing orders picking up there in the component segment. We are also seeing some other encouraging signs in other parts of our components business. Medical printers, for example, looks like it's getting a little bit stronger and the data storage piece, as you know, was very strong in the middle of last year when we acquired Micro E and then it got softer in the fourth quarter which is very seasonal and it stayed about the same level in Q1. We believe the data storage market will start to pick up again toward the middle of this year; so we are encouraged by what we are hearing in terms of some strengthening there.

So the signs overall for the components business are positive in terms of potentially increasing the volumes as we go through the year. We are not talking about huge increases but nice increases. And then, the laser business, as I said, should improve in the second quarter -- for two reasons. One, we had acceleration of shipments from Q1. People wanted them in Q4 so we shipped them and that took away some of the business in Q1. And we also had some pushouts into Q2 of orders, which are now fully in hand, and for shipments in Q2. So we have a good order book in lasers as built up. And so Q2 is looking like it will be stronger than Q1 and backup probably in levels that we saw at the tail end of last year.

Thank you. And the last question I had related to the SG&A. Tom, you mentioned there were a couple of charges relating to higher -- or costs relating to higher pension and benefits. Are those onetime in nature or are those something that we will see on a go-forward basis as well?

The pension costs of about 3/10 of a million -- that is something that we will see all year. That's a pension plan that's been frozen and it's a cost that we are incurring basically because it's underfunded. That obligation that shows in our balance sheet, we've been working that issue and that will be a catch-up that we will make this year. That will go forward all year. Then next year we will have to see what we have. Hopefully it will come down. But we will be carrying that all year long.

The higher fringe benefits costs are a combination of two factors. We normally expect this in the first quarter, but what we had this quarter was unusual. It was higher cost in our hospitalization which could be in some of our other fringe benefit costs. That will probably drop back a little bit -- in other words, if we don't see that continuing at that level and it's because the payroll taxes bunch up in the first quarter and we just had higher experience in our hospitalization. It's a semi self-funded plan and occasionally come through with higher cost on it.

Jed Dorsheimer of Adams Harkness.

I may have missed it. What is the revenue guidance for next quarter?

We basically said relatively flat.

Relatively flat? All right. Then just maybe just follow up some of Susan's question -- if we look at the components business, I thought I heard you say that you expected that to be relatively flat but in the scripted portion, you had mentioned that Westwind may be slowing a little bit. So, should we look at those other businesses as offsetting so that net, net it is flat?

Within components we are seeing some slowing -- continued slowing, I should say -- in the Westwind, not dramatically down from first quarter but slightly down. And we are seeing some improvement in other sectors of the components business and no further deterioration expected in the data storage piece. So we believe that the components piece will be flat to slightly up. The laser piece, we believe, will be roughly flat from where was -- the Laser Systems piece rather. And the laser piece, we expect to be a little bit up from where it was prior quarter. So, overall, relatively flat for the whole Company to slightly up.

When we look at the Westwind and the Micro E, is that about 60% of the components business?

We don't separate out the two individual components -- of components. We basically have three key groups in there. Micro E, which you got the information from the acquisition that was put out -- you can get some good ideas on what it does. And Westwind, which was also a separate acquisition and then the base operations in Billerica.

I was just adding the 17 to 18 range plus 8.5 to get that. It just seems like it -- so it would seem as if these other businesses that were hit by the quality issues really dropped down in the past quarter. And now what you're saying is, with the continued slowness in the disk drives in the Westwind, you are sort of going -- you are getting that offset because those took a big drop-down last quarter?

Yes, their increase is offsetting, basically, the shortfall that we are seeing developing from Westwind.

I just wanted to make sure I had that right.

Then, just maybe moving over to the laser business. Sounds like bookings are pretty strong -- but when we look at this particular quarter, the gross margins dropped off considerably in that business. Is that all volume-driven?

No, there are two key factors there. They had a -- we accrued for an issue we had with Customs. They have -- we haven't actually had a judgment, but we are being conservative in saying we may have one and it's an issue of about $400,000. And we accrued that and it's in the margins because it's related to the movement of parts in and out of the country and the UK.

We've provided for that. Then an additional factor was, there was about 200,000 in severance costs when they restructured some of the service operations in Munich. So they have got those two hits which are quite significant. And if they didn't have those, obviously, the margins would have been quite a bit better.

Going forward, though, those are going to be in that business?

No. Neither of those should be costs that go forward. The point is, if we didn't have them, they would have actually shown some margin improvement.

Got you. I guess, Tom, I am just a little confused. It's just a one quarter issue that the government is (MULTIPLE SPEAKERS)

Yes, this is a one-time thing. It's -- we have made an estimate of the exposure that we have and we have accrued the possible expense. It might get settled out the other way but we just want to cover it (MULTIPLE SPEAKERS)

Fundamentally what happened, Jed, was we have been following all of the British Customs documentation rules and using their forms and so forth and the European Community has come back and told the British government that they want all the exports from Britain to be using their documentation furnished by the EU. And anyone who wasn't using them they want to assess a penalty. So the British government turned around to all the British companies of which we are one -- and there are about 150 companies involved -- and everybody has spoken up and said, "This is unfair. You can't go back and penalize us for doing what you told us to do just because you're having a trade dispute with the EU."

I got it, I just wanted to make sure (MULTIPLE SPEAKERS)

Yes. So we took the charge to be conservative, as Tom said, rather than wait until it gets settled, which might be two years for now. We just took the charge knowing that it's an issue.

And then -- .

Its one time, though.

I see. Then, looking at the bookings in that business, it sounds as if those would be -- could be better than your laser business could be better than the fourth quarter. Did I get that right?

That's correct. It could be but we are saying it's going to be better than the first quarter. That's for sure. We believe it will be better than the first quarter and we are hoping it can be even better.

I guess another way to ask the question is, do your bookings justify the fourth quarter revenue levels that you currently have on the books at this point?

No comment on that one.

All right. Then moving over to your Systems business, the order delays that you saw in the three systems -- are those going to hit this quarter?

I thought one was pushed out, I think, to the fourth quarter and one or two to the second quarter. So there -- we expect we will ship them in their memory systems so they are in the higher margins part of the Systems business. That's why they had a lot of impact on the quarter when they moved out.

Those should offset the slowing wafer marks? Is that the right way to look at that?

Yes. We were thinking there would be a little bit of a pickup in the memory and wafer mark will slow down a little bit.

And the trim business -- you know, it's plagued us a couple of quarters. It's sort of been the scapegoat. I'm curious, is that -- are those completely out of your forecast at this point?

They are. We're not seeing any serious activity for the next couple of quarters. I can't speak for the fourth quarter but, certainly, Q1 and Q2 and Q3, there's not any activity planned.

No single unit sales. No significant volume.

Given the somewhat abrupt slowdown in your business, things have sort of gone the other way for you. I'm curious. As you look at a year out, with three quarters ago, where you increased your long-term targets and I'm curious that, given the environment's changed a little bit here, have your expectations changed at all with the, 1, the timing and, 2, the level of your gross margins, your SG&A? You know -- your target models.

That's a good question. We've always pegged that to the fact that we had to be running at or above the $320 to $330 million run rate on sales in order to have the volume behind us that would allow us to make the improvements. So right now, we are running clearly below that and we have to get back up to that. And that can happen through, of course, a good turnaround in the fortunes of the market for semiconductor. That would be a big plus. So that could happen next year and, also, some additional acquisitions will help.

Jim Ricchiuti from Needham & Company.

Chuck or Tom, if you take a look at the gross margin and make the adjustments there, you could be -- depending on the mix, of course -- somewhere between 37 1/2% gross margin, potentially, depending on mix. Is that a fair estimation?

Yes, the issue is taking out the volume piece that pulled us down and then we got some of the unusual items. And when you -- if we operate att the current volume level, should take out the unusual items, that's about where you're at.

And, as you look at the mix of business, it shouldn't be any -- that much of a variation based on the different segments that they tell me you have given with respect to those segments. I wonder if you could also -- Tom, one of the things I'm still struggling with is on the SG&A line. And maybe I'm not just not quite grasping it. But it was clearly higher than I was looking for and just as I looked back to Q3 of '04, you are running a little higher in SG&A off a revenue base of 91 million. Is there any opportunity to bring the SG&A down as you're clearly operating at a much lower revenue number?

It may come down but I don't expect anything dramatic. It could come down a little bit. Certainly, the timing -- one of the things that happens, within this quarter, we saw about 400,000 higher than the same quarter last year and -- also -- looking at last quarter and the fringe benefits. That's kind of an unusual item. Those things tend to average out over time so that was probably a high point.

Another thing that happened that made the fourth quarter unusually lower in the G&A is, there was about a $600,000 recovery of net debt. So that (MULTIPLE SPEAKERS).

Actually looking out to the third quarter of last year -- but it looks like for the SG&A there is not a whole lot of leeway in terms of where that ago even with (MULTIPLE SPEAKERS) --

There's not an awful lot of variation in it. But we do get these things -- you know, you have legal expenses and other things that come and go. But there's nothing that we anticipate that's really unusual. We had a few things this quarter. The one thing we have this year that we didn't have last year is the pension cost. And that's going to be about 300,000 a quarter. So that's a definite increase.

Chuck, I wonder if you could comment on where you are in the memory repair business? You talked about where there's still perhaps some decent activity is among those DRAM manufacturers with the higher marketshares and -- some of those, you are not yet qualified. Can you talk a little bit about where you are with some of those?

We are in several of them now, undergoing qualification testing. And it becomes a question of two things. 1, how long a test cycle takes. It can go anywhere from a couple of months to the better part of a year, depending on how they want to go about the testing and how much data they want to generate before they give us a technical certification. And the second part of it turns out to really hang on when they will place new orders for expansion. So there are 2 factors there. 1, get qualified in the shortest time possible and, 2, hit the right timing window of when they're going to place their next orders. So we're working on that now which is something we weren't doing earlier for a number of reasons -- mostly, the constraints of manpower last year because our sales, as you know, ramped up from $20 million to $40 million in the quarter for quarter run rate during the year for the Systems business. So we had very little manpower to throw at getting more qualifications. But now with business slowdown, we have that resource available. We have the equipment available and we are in process, right now, at several accounts of going for the qualifications and, again, trying to catch the timing window on the purchases.

And we're talking about maybe 2 to 3?

Yes. We are actively pursuing it in Q2, Q3, and we're hoping to get some business before the end of the year. But, certainly, a main goal is to have secured positions at these other accounts as their buying picks up.

Speaker: How many accounts are we talking about, where you feel or -- let's put it another way -- where you feel you have a better chance of being qualified as you look out to the second half of this year?

In total, there's five or six accounts that we're talking about. And we are actively pursuing two or three right now and, again, trying not to spread ourselves too thin -- but we are going after the ones that really have a higher volume of production of bits.

Brian Piccioni of CMO Nesbitt Burns.

Not to belabor the point about the outlook for Q2, but the sense that I get is that we are looking about 23 1/2% year over year decline second quarter. And now it works out to being about 19% first half of this year vs. first half of last year, despite the acquisition. Do you think you could still meet the objective? I think you had given us, at last conference call, that sales will drop about 10 to 15% this year. I mean, is the second half going to be that good?

We are counting on some improvement in the, obviously, in the semiconductor portion of our business for the second half. We're also counting on lasers continuing their improvement, especially with several new models being introduced by midyear. We think we will be very attractive to the customer base. And we do believe that there have been a lot more business that we could've had in lasers had we had the correct price point, because the performance of our equipment has been relatively good, but we've been on the high end of price. So we believe that's a good opportunity for us to improve. And it will also improve margins. And the last piece is the components stitching it altogether. We believe we will be bottoming out in Q2 and Q3 with spindles for printed circuit board manufacturing. And then we sense there will be some recovery of the back end of the year, certainly in Q4, for that segment and data storage -- very similar. We are expecting to see some improvement in Q3 in that area. And as I said before, the other component pieces are already showing some recovery that's been offsetting some of the downdrift that we've seen during the quarter and the pieces I mentioned.

So in other words, you figure you can still slide in with the 10 to 15% decline then?

For the full year-over-year, that's what we're looking at and, yes, we definitely need to see some improvement in the back end of the year. And I think it will be there.

In terms of starting to do work at particularly the air bearings in China, I mean, I know it's a bit of a messy topic. But what's the concern about intellectual property and the possibility that they might have knockoffs coming out of the market in fairly short order?

That's a good question, Brian, and we have wrung our hands over that for several years on other products before Westwind joined the Company. But we've figured out a way to take the products we're taking and if you take any one of our products, you can separate it out into what we would consider a piece that's not very interesting from an intellectual point of view that pretty much anybody can make. And that is joined up with another piece that has a lot of intellectual property built into it in the form of either mathematical algorithms or very unique mechanical design or electrical design that is very difficult to machine to certain tolerances and you'd have to know what those are. Anything falling in that category of what I would call intellectual property is not going to be made in China. We are going to make it in our local sites in Westwind, in the UK, or in Billerica, or in Wilmington at the local factory. That's the part we will retain for in-house manufacture.

What we're going to make in China even though it's our plant in China making it, we want to be sure that we are not making anything there that -- if it walked out the door -- would harm us. So we are making really the low value content in terms of intellectual property but things that consume a fairly high amount of labor costs.

That's certainly an interesting strategy. I'm going to ask another tech question because the financial questions have been largely asked and answered by now.

If you keep that, Brian, people will find out you're an engineer.

Don't tell anybody, and I won't tell. The small hard disk drives -- as soon as you're getting into size sub 1 GB drive that competes with flash and of course flash being a semiconductor technology is under constant pricing decrease -- we've got to be talking about some pretty low average selling price devices. And, therefore, the components have to be pretty low average selling prices, as well, say in contrast with the hundreds of GB drives that full-size drives that might be found in servers and that sort of stuff. It sounds like a pretty tough business to make money at. What's the strategy there?

It is, Brian, and I really question the sanity of anybody who would want to do it. Probably.

Isn't that what you're doing?

No, actually what we're -- we're not making the drives. If you remember from our Micro E acquisition, Micro E supplies the positioning and motion control technology down to the nm -- sub nm level of accuracy -- that goes into the servo writers and media writers that write the tracks on the hard disk drives. So the real opportunity for us is, if they start making the mini drives for consumption and iPods and cell phones and all kinds of portable devices, rims, and you name it. But if they move that way -- away from flash -- then there will be large volumes required so they will have to produce a lot of them. They will need a lot of servo writers. The more servo writers that are made -- that's where the benefit is for us. And we get a good margin on that business. It's very very good, in fact, because we have the unique technology in terms of its positioning accuracy and the level of performance.

I knew you weren't making the drives. So what you're making is the capital equipment for the drive makers that they will be needing to upgrade because of these new drives?

Actually one step below that. We are making a critical component that goes into the capital equipment. We are not actually making the servo writers. We supply the people who make the servo writers with a key motion control component.

(OPERATOR INSTRUCTIONS) J. D. Obershire (ph) of (indiscernible) Investments.

Following up on that the question on the hard drives. Most of the hard drive manufacturers are having a pretty good year and taking up their CapEx numbers. Is this more a technology shift issue for it being weak? Because some of the other people in that space have seen their bookings really expand over the last six months.

Some of it is technology-driven where they are moving the spiral right and some of it is capacity being consumed because they did buy a lot of stuff last year. They did have a lot of capacity online and it wasn't the full utilization. So that's why we saw some slowdown and it's more -- this is one where it's hard to tell is this cyclical or is it seasonal? Because it takes place in such a short period of time. But typically they ramped up very strongly in the second and third quarter last year, in order to make the demands for the Christmas rush for everything they could make. And then we saw a slowdown in Q4; and Q1 was -- remains slow.

But to your point -- that's where we have some hopes that things will pick up for us.

Does the move to vertical media from horizontal media -- the higher density platters? Does that have an effect on you as well?

Well if there's a transition where they need to have new servo writing equipment or new media writing equipment, then that helps. That's where we benefit because we are, as I mentioned to Brian earlier, we are supplying a critical component that goes into the media writing or servo writers.

Can you disclose who the typical customers would be, other than capital equipment people or is that too sensitive?

It's everybody who's writing on disk or making equipment to write on disk. We are literally designed into everybody.

Following up on the DRAM side -- so what it sounds like is that you're trying to qualify with some other people. That's going to run its course and then when they add capacity, they may or may not buy from you. Typically, if they do that, is it onesie twosie, or do they -- they are going to build a new fab so they're going to allocate X percentage of equipment towards you?

Typically when they -- the customers, when they undertake a qualification they have to dedicate and commit quite a bit of resources to do that. It's not just us shouldering the load. They've got to assign people, they have to put the equipment on their factory floor. They have to bring it into slow volume -- low volume and then increase the volumes in order to get the data they need. So here's a commitment to work 3, 6, 8 months to get this thing certified for production. Once they've done that they wouldn't do that unless they had the intent of starting to give you some reasonable portion of their business -- either somewhere between 30 to 50% of their orders. They start to split the buys. So, they were trying to really qualify a second source and for us it's the same thing. We try to get an understanding upfront that if we are both going to go through the pain of qualification, there's no sense in doing it for one unit.

Can you guesstimate where you think your marketshare is now before these qualification guys are added in?

My guess is, we probably -- we had 50% of the customers we were serving. And we believe that we can increase that number substantially above where we are if we add this unserved customer base, which we believe is almost the size of the customer base we are serving.

So it would be fair to say you think right now, you are serving maybe half the DRAM customer base in terms of bits?

Roughly because this is all -- these are all rough estimates put together by the industry gurus. So yes, it could be that could.

(OPERATOR INSTRUCTIONS) Jed Dorsheimer of Adams Harkness.

Looking at the stock price here in your cash position, I know that you guys have been fairly adverse to buying back stock but I saw at your analyst day, you had mentioned the $8.00 dollar level is sort of a threshold. I'm curious if, given the fact that the shares have declined significantly, you would be reconsidering that proposition?

It's always a possibility but really we are more focused on maintaining our acquisition program.

Sure. It's just that at some point, though, I think that buying back shares actually can increase the shareholders equity. And from a return to your shareholders, I was -- maybe this is a comment more than anything else. It would be nice to see you at least explore that opportunity.

It's something we do explore at these times. And there is discussion of it. But we have no plan in place to proceed on it at this point.

At this time, we have no further questions in queue. I'd like to turn the call back over to our speakers for any closing remarks.

Thank you, operator, and thank you all for attending the conference call. Tom and I appreciate the opportunity to interact with you and look forward to seeing you in person in the near future. And we also have dedicated ourselves, as you know, to improve the situation, improve our margins even under the uncertain conditions on revenue. So, Tom, any further comments?

No. I don't have any.

In that case, thank you very much and good night, everyone.

Thank you very much, Sir, and thank you, ladies and gentlemen, for attending our conference call this evening. We appreciate your participation and you may disconnect.