Novanta Inc (NOVTU) 2006 Q3 法說會逐字稿

Good morning, my name is Phyllis and I will be your conference operator today. At this time, I would like to welcome everyone to the GSI Group third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. [Operator Instructions]

At this time I would like to turn the call over to Mr. Ray Ruddy. You may begin your conference.

Thank you, Operator. Good morning. Thanks for attending our third quarter 2006 conference call. Our call today is being broadcast live on the Internet in listen-only mode at our website gsig.com. Dr. Sergio Edelstein, President and CEO and Bob Bowen, Vice-President and Chief Financial Officer join us this morning.

The following presentation will include forward looking statements within the meaning of the federal securities laws, including statements about the Company's expected sales performance, operating results, financial condition, and business strategy. These statements are subject to a number of risks and uncertainties, including those detailed in the Company's press release issued yesterday and in its 10K and other filings with the Securities and Exchange Commission that could cause actual results and outcomes to differ materially from those projected in the forward-looking statements. Assumptions may change over time.

Please remember that these statements speak only as of today's date, and that you should not place undue reliance on them. You are encouraged to review the written risk factors set forth in GSI's SEC filings carefully before making any investment decisions. In addition, please note that this call is being recorded by GSI and is copyrighted material. It cannot be re-recorded or re-broadcast without the Company's express permission, and your participation implies consent to our taping. GSI will not be updating the recording of this call.

First, let me begin by quickly reviewing GSI's product positioning for any new listeners. Our precision technology segment, which generates approximately 60% of our revenue sells to equipment manufacturers and markets like electronics, medical, and industrial manufacturing. This segment is highly diversified. It is made up of six product lines. Those are encoders, scanners, printed circuit boards drill heads, lasers, medical printers, and optics.

The second segment, our semi-conductor systems segment, generates about 40% of our revenue and manufactures end-user capital equipment for production of memory and high-performance analog devices. It is composed of three main product lines -- WaferRepair; WaferTrim; and WaferMark.

With those comments, I would now like to turn the call over to our CEO, Dr. Sergio Edelstein.

Thank you, Ray. I am pleased with the revenue and operating results for Q3. Total Company revenue is up 30% from a year ago. Operating profits increased 162% during that period. Earnings per share was $0.14 versus $0.05 last year. And we generated earnings per share of $0.41 this year. Compared to Q3 of '05, precision technology revenue grew 12% while gross margins grew 15%. Semiconductor revenue grew 84% and gross margins increased 100%. In the past nine months we have generated $35 million in cash or approximately $0.83 per share.

Our bookings for the quarter were lower than last quarter due to a combination of the timing of individual customer orders and unusually strong bookings in the second quarter.

Moving forward, we will continue to increase our focus on growth. Our precision technology products continue to gain ground with customers in the medical, printed circuit board, electronics, and aerospace industries. We are beginning to secure design-wins with two new products in particular, the [mercury two] encoders, and the new lightening scanners.

In semiconductor systems, our memory customers have been announcing aggressive capital spending plans. We recently launched the M450T memory repair system and have placed six machines at customer sites. We have steadily improved our position in this segment and expect that this trend will continue.

In the WaferTrim segment, our newly released M350 system is being well received. We plan to continue to accelerate our new product introductions, leveraging our combination of technologies and key applications, such as printed circuit board drilling, where we are in a position to bring unique value to our customers.

With that, I'd like to turn the call over to Bob.

Thank you Sergio. Total Company revenue of 81.6 million was up 7% from 76.4 million sequentially. Precision technology revenue of 52.1 million increased 5.6 million or 12% year-over-year. Revenue grew at four of our six product lines in this segment -- encoders, printed circuit board drills, optics, and scanners.

Semiconductor systems revenue of 33 million increased 15.1 million or 84% year-over-year. WaferRepair, WaferTrim, and WaferMark contributed equally to the revenue gains. Third quarter bookings were 65.1 million, above the level of a year ago, but below the Q2 2006 levels. In precision technology the trends in these businesses are unchanged, but the lower bookings level in Q3 are likely to influence our Q4 revenue levels. Precision technology is a design-win based business and we believe our existing and new products will continue to drive growth in 2007 and beyond.

In semiconductor systems, order rates were 9% higher quarter-over-quarter, but down since the second quarter of 2006. Wafer repair was slow because large customer buying patterns, which were well above the trend line early in the year, were below trend line in Q3. Gross margins at 41% were up 1.8 points from last year due to increased volume and improved productivity, but lower than we expected. We had inventory adjustments in semiconductor systems and our UK-based printed circuit board drilling factory experienced some manufacturing difficulties they are working through.

R&D expenditures of 7.6 million were up 24% quarter-over-quarter driven by our investments in several new products including the mercury encoders, lightening scanners, and new WaferRepair and Trim systems. We expect our investment in new product development to remain around 10% of sales for the balance of the year. SG&A grew 19% quarter-over-quarter mainly as a result of personnel-related costs. We expect SG&A costs will be up approximately 8% for the year.

Operating profits at 7.5 million, or 9.2% of revenue, were up 162% quarter-over-quarter. The tax rate was 29% and fully diluted earnings per share for the quarter were $0.14, $0.15 excluding stock-based compensation within our guided range of $0.13 to $0.17. We finished the quarter with 131 million of cash and cash equivalents, up 16 million sequentially, largely to earnings and strong collections. Since the beginning of 2006, the Company's cash balances are up 35 million or approximately $0.83 per share.

Our expectation for the fourth quarter is that revenue will be between 68 million and 78 million. We plan to bring to close a significant amount of work in the tax area in the fourth quarter. At present it is too early to say what effect these projects might have on the 4Q tax rate, but we may experience either favorable or unfavorable movements. Our fully diluted earnings per share guidance for Q4 of $0.04 to $0.10 assumes a tax rate of 30%.

With that, we'd like to open the call for questions. Operator.

(OPERATOR INSTRUCTIONS) Jim Ricchiuti with Needham & Company.

Good morning. I want to delve a little further into the gross margins for the quarter and the numbers that you cited in the weaker gross margin -- weaker than expected. You talked about an inventory adjustment in the semiconductor business. Can you elaborate on that, please.

Yes. The adjustment largely is related to our excess and obsolete reserve requirements in the business. We've discontinued some products over the past years. We have a detailed calculation. Some of the inventory on hand fell into the category of requiring reserve adjustments. That was primarily the driver behind the inventory adjustments in the semiconductor business. The rates also were somewhat lower than we expected in part as a result of the mix of products, which I believe you know our [primary] repair products have the strongest margin rates. Just as a percent of those sales in the overall total, they were not as strong as they had been in Q2 '06.

Sergio, on the obsolete products, were they -- what product class? This wasn't memory repair, I take it.

No. These were older WaferMark products.

And then on the -- is that behind you, do you believe, at this point?

It is a calculation that we go through on a quarterly basis. So I can't say that it would never occur again. I mean it's -- but, we are current through the end of Q3 '06.

Okay. And on the precision technology front, was this -- this was an issue that you had in manufacturer in the UK on the PCB areas?

Yes. This related to one of the newer product lines in the printed circuit board drilling segment. They ran into some manufacturing problems that they have largely worked their way through now. They did impact the second quarter results.

On the bookings front, can you say what the bookings were down in the semiconductor business sequentially? You are coming off a very strong Q[2]. What kind of magnitude of decline did you see?

They were down about 50%.

Okay. Just as you -- early -- it's still early in Q4. But it sounds like overall the industry tone is [inaudible] positive. How do you see that correlating to [inaudible] bookings?

The change in bookings from the prior quarter to this quarter is more pronounced that any trends we see from our customers. So I think they are particular to us and have to do with the particular customers who happened to buy in the prior quarter compared to the customers who bought this quarter. This is, as we mentioned several times before, this is a market segment where things do change from quarter-to-quarter depending on mix and the particular customers who buy. This is a segment in which we're coming in from behind and we've been gaining share. As we work our way up, things do change from quarter-to-quarter. That is what we've seen happen this particular quarter.

But in terms of characterizing the level of activity over the next one to two quarters [inaudible] outlook.

In the memory sector the message we are receiving from our customers is overall positive. Some of them have made public announcements with very robust investment plans.

And in the other areas too of the equipment business it's generally healthy?

I think overall most of our customers are communicating intentions to sustain spending in the near future.

Okay. Thank you.

Stuart Muter with RBC Capital Markets.

Thanks. Good morning. A couple of questions, I guess first for Bob. Excluding the inventory reserve adjustment, what would your gross margins have been in the semi business in Q3?

They would have been up at least a point -- or maybe one to two points.

In precision motion, the manufacturing problems, you said they are largely worked through. Will they impact the fourth quarter as well?

We expect the margin rates in that product line to improve in the fourth quarter. The last word we had a couple days ago was that they believe they've worked through the manufacturing difficulties. There may be some impact as a result of September activity, but we are expecting our margin rates in the segment to improve in Q4 versus Q3.

That's helpful, Bob. Sergio, could you talk a little bit about business trends from the analog semi manufacturers. Have you seen that soften with the softening environment that they are seeing? Could you talk a little bit about that, please.

Yes. Short-term our analog customers are not signaling any changes in their buying patterns short-term. They have been placing orders at a steady rate. At least in the short-term, we are not getting any indications from them that that is going to change. They are not signaling any dramatic changes in investments.

Okay, that's helpful. Last question. Could you talk a little bit about, looking forward, opportunities in PCB.

Yes. I think this is an area where we can create an increased level of value for our customers moving forward. When we look at particularly the PCB drilling system manufacturers, they use technologies that range from lasers to drilling heads and encoders. We are truly the only company that has all of these technologies. We have been working with a lot of them as some of our key customers. We are starting some new projects with a new product we're releasing where we think we're going to be able to do quite a bit more in that market in the future.

That would mean moving up the value chain. Is that fair to say?

Yes. I think we're starting to see that, for example, now with our newly released lightening-2 digital scanner. We have integrated the technologies from our traditional scanners with the encoders into a new product that provides advanced performance. This will have unique value for our PCB customers.

Great. Thanks a lot.

Chuck Murphy with Sidoti & Company.

Good morning. I think Stuart just hit on my question about the new products for precision, so I will just switch to my other question. Any thoughts on uses of cash going forward? You have a rather large balance.

Yes. We are continuously looking for opportunities. We're stepping up the effort to investigate any opportunities to put that cash to good use. My primary consideration will be the strategic fit with the businesses we have and how any potential ventures that we might engage in can help strengthen our market positions. I think we're in some very good markets and we have room to grow. We would be looking at using that cash to strengthen the position in these market. So strategic fit will be the primary consideration. We are -- as you know, it's very hard to plan or schedule very specifically how that would happen. I will, of course, keep all of your apprised as we have news to report on that front. We're very well aware of the potential advantage that that cash can give us.

Thank you.

Jed Dorsheimer with Canaccord Adams.

Thanks. A couple questions. Bob, first off on the SG&A. The 8% growth, is that quarter-over-quarter or year-over-year?

Year-over-year.

Did you did give -- I missed the R&D. Could you repeat that.

About 10% of revenues.

Alright, thank you. Sergio, on the systems side, I think that you were trying to prepare a product for penetration into Hynix. Could you elaborate on your positioning and whether or not your current products are specifically suited to try and capture that account at this point. Could you give some further color as we look into 2007 as far as additional new key accounts that you might be able to penetrate. Thanks.

Without giving specifics on any one particular customer, in general we are placing memory repair tools at every major memory manufacturer. Moving forward, we have a number of technologies that we are starting to implement on new products, particularly for throughput enhancements where I think we have -- we can gain some advantage -- some competitive advantage. As I mentioned before, we incorporated some of that in the M450T, but we are doing more work for the next generation product, which we're working on, that I think will make a difference for some of the customers in which we still have some more opportunity to gain ground. So that is going to be a major focus for us moving forward in 2007.

Great. During the quarter, was the memory repair business, was the downside in bookings driven by any one particular customer?

You know that the memory customers that place large orders are few. They [noise] -- I am sorry, we seem to have some noise on the line. The timing of the orders -- and in some cases, we are not the single supplier. So the way they plan for their purchases, in the cases where they have multiple suppliers, can make a difference for us because these orders are large. Depending on who is buying in any particular quarter, our numbers can change from quarter to quarter. That is what we are seeing. We are confident that overall our trends are all moving in the right direction.

Great. I'll pass it on. Thank you.

Susan Streeter with Sprott Securities.

Good morning. Can you talk a little bit about the broader range in guidance you've provided versus prior quarters. Is that reflective of the fact that the bookings were down as much as they were?

I think that's probably partially it. We've had in past years, customers come back in the fourth quarter and ask for shipments in the quarter. That does not always occur in the first three quarters of the year. I think it may be just an indication that we could end up on either end of the segment -- either end of the range.

With respect to backlog, did you mention that number?

No, we did not mention the backlog. Backlog coming into the quarter is about 75 million.

About 75. Thank you. Lastly, just another housekeeping item. The stock-based compensation expense of roughly 500,000, is that primarily in SG&A? Or is it split between SG&A and R&D?

It is all in SG&A.

All in SG&A. Can we expect that level going forward, just as an estimate?

Yes.

Okay. Thank you.

Todd Coupland with CIBC World Markets.

Good morning everyone. Are you able to split the decline in bookings, the exaggeration, as a result of your share gains? What do you think the market did in your area in the quarter? So memory, mixed signal, what have you.

I think in the semiconductor business, we've indicated in the past that the orders from quarter to quarter are lumpy. Even at specific customers, there are some orders where we will get, in a given quarter, the lion's share. There are other orders where we will not. We believe, I think, that the trend line of our share, particularly related to -- we've got very strong positions in both WaferTrim and WaferMark. In Memory, we believe the trend line of our performance from a market share standpoint, is up. It's probably the case that Q3 was not as strong in that respect as Q2. But that is something that moves up and down from quarter-to-quarter. We believe firmly that most of these customers are going to a two-vendor strategy and that over time, the market is going to split around 50/50.

Okay. Is that about where the market is now?

No.

Would this adjustment in Q3 and the trends that you see, are we about ----

I think we've got -- I think we would say right now based on activity year-to-date, we're around 30%, maybe a little bit higher. Maybe about a third of the market.

So there is a little bit more share you can pick up. And then at that point, your trend is lumpy from quarter-to-quarter, but should be somewhat reflective of then market demand.

Yes.

The second question I have is, what do you think is an appropriate gross margin for the Company, or a target for the Company over the next year or so? Or what is the target model for the Company?

In the short-term we certainly strive to maintain our margin consistently above 40%. I think in the long run, we will focus on improving our profitability as we strengthen our positions in the markets and we continue to improve our efficiency and drive our cost reduction initiatives aggressively. We have ambitions to improve our profitability over time. Short-time, that would be the number that we would target for the next few quarters.

Okay. Is there any reason -- just one last question. Is there any reason a tax rate of around 30% -- should that number change at all over the next few quarters? Is that a good number to use?

I think that is a good number to use.

Okay, great. Thanks a lot everyone.

Richard Sung with Genuity Markets.

Good morning. Just a couple questions. I think you mentioned the manufacturing difficulties impacting gross margin as seen in the quarter. Did that show up in precision motion gross margin?

In the precision technology segment.

How should we be thinking about the gross margin in precision technology going forward? Do you see that improving over the coming quarter or two?

I believe there is some room for upside improvement. We have a number of different products. So there is a mix impact. We did have the manufacturing difficulties I spoke of. We certainly expect those to ameliorate in the fourth quarter, which should provide some potential upside.

The products being manufactured out of China right now, is the China manufacturing product set, is that set right now? Or are you moving more products over to that factory?

We have opportunities to do more in that factory. So I think you will continue to see a steady increase in activity in that region on a case-by-case basis.

Great. Thank you.

Jim Ricchiuti with Needham & Company.

Bob, can you quantify the impact of the manufacturing issue on the [inaudible] margins?

I would say it was about a point, maybe -- I would say it was about a point.

Okay, and bookings in the precision technology area were down versus [inaudible]. Can you say how much?

They were down, but it was largely due to -- we've got one of -- the optics product line tends to get large orders, let me call it from time-to-time. It's lumpy from a bookings standpoint. They had very strong orders in Q2. They've got -- they had weak orders in Q3. And Q4 we expect their order -- their bookings levels to be back up to the Q2 level. I think as much as anything that was just timing as to when that optics business receives their large bookings.

Okay. Another question of the precision technology business, [inaudible] where you see the biggest areas of growth in the [inaudible].

I think I mentioned a couple. I think in the scanners. The three major areas are the scanners, the printed circuit board drills, and the encoders. I think we have room to grow both in terms of market share in each one of those segments, as well as in bringing solutions for specific targeted applications such as the printed circuit board drilling application that I mentioned before. I think these are areas of significant opportunities for us in the future.

And just looking out over the next couple quarters, you see good conditions in that market? It is some diverse markets. But in general, how does [inaudible]?

We are focusing on those few areas where I think we can realize gains in a reasonable period of time. The nature of that business is that we sell to OEMs who design in our products into their systems. So in particular for these new products that we just released recently, we will focus on design-wins, particularly during the early part and mid '07, to get these product designs into multiple systems at several dozen different customers in these industries. So that once they start shipping their systems with our products designed into theirs, then our products are going to volume shipments. Then that is when we realize the revenue. That will take a few quarters. But then once we get into the situation, then we have a sustained source of revenue. We're driving those products where we believe we have a very good opportunity to add revenue to the Company with new products.

So you anticipate a higher level of design-win activity over [the next couple of quarters]?

We are planning to secure multiple design-wins with these products in the areas I mentioned over the next few quarters.

If you got those design-wins by, say, Q1, Q2 of next year, would you anticipate most of those beginning to contribute to revenues as early as the second half of next year?

Yes. It's very hard to predict the magnitude. But, yes, we are expecting to -- our plans for next year include new revenue from those new products starting in the second half of the year.

Generally with some of the newer products, they tend to have higher margins. That will be the case?

In general, our approach is to provide high-end unique solutions that command good prices with good margins. Our intention is to create products that provide good profitability. We design the products around that concept.

Thanks a lot.

Jed Dorsheimer with Canaccord Adams.

Just one follow-up question for Bob. I think a previous administration had focused on trying to extract some leverage out of the operating line and focused on a longer-term target model. Looking at SG&A, it looks like it's seeing a pickup. What do you see that getting to over the longer term? Could you outline -- do you see this business as 45% gross margin, 10% R&D. What would the SG&A be? What are the goals in any timeframe? Thanks.

It's tough to put a timeframe on it at the present. I think it's clearly the case that we believe that this business has the capability to deliver better gross margin rates than where we are today. There is a lot of focus on that. We expect the R&D numbers probably to continue to be around 10% of revenues. Our SG&A numbers today are about 21% of revenues or so, which is in line with the comparables that we look at. We are going to be putting a lot of focus on trying to leverage the operating statement and leverage that piece of the cost structure going forward. Obviously a lot of that is going to have to do with the volume levels we achieve. But there is tremendous focus on those numbers at present and will be going forward.

At this time there are no further questions. Are there any closing remarks?

Thank you, Operator. Thanks for attending the call. We will see you both at the Needham conference and Sidoti conference in January. Other than that, we will talk to you next on our call. Thanks so much.

This concludes today's GSI Group third quarter earnings conference call. You may now disconnect.