Onto Innovation Inc (ONTO) 2006 Q4 法說會逐字稿

Good afternoon, and welcome to Nanometrics Fourth Quarter and Fiscal Year 2006 Financial Results conference call. The speakers for today's call include John Heaton, President and Chief Executive Officer, and Doug McCutcheon, Executive Vice President and Chief Financial Officer of Nanometrics. The Q&A session for today's call will be held at the end of the call. [OPERATOR INSTRUCTIONS]

Before we begin today's conference, the host company has asked me to make the following statement. The following discussion may include forward-looking statements regarding, among other things, Nanometrics' future financial results, business performance, and market conditions. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Factors that could cause such differences include, but are not limited to, changes in demand for the Company's products, changes in the Company's ability to ship its products in a timely manner, changes in business or economic conditions, and the additional risks and uncertainties set forth in the related press release and in the Management's Discussion and Analysis section of the Company's latest annual report on Form 10-K filed with the Securities and Exchange Commission. As a reminder, this call today is being recorded for replay purposes.

I will now turn the call over to Mr. John Heaton. Sir, you may proceed.

Great. Thanks, Bill, and thank you all for joining the call today. Before I get started, I just want to give everyone a moment here. I know we had a little bit of delay getting the announcement out and numbers out to the community. I apologize for that. We did try to start the call a little bit late here to try to accommodate everyone looking over the numbers before we started getting into details.

But just kind of as an introduction to what we're going to talk about today, I wanted to start by giving you, really, two perspectives on the Company. The first one is positive. We address a market that is growing and our position within that market continues to improve.

The second perspective and one that is not as pleasant is that the merger strategy we embarked on produced some unfavorable financial results in 2006. Q4 results and our guidance today will demonstrate both of these perspectives and enumerate how challenging these transition periods can be. We will address all the financial results in detail and I'll have Doug do that after I finish my comments.

We also wanted to make you aware that we did recently do a presentation at an investor conference in San Francisco, which carefully outlined our thoughts on the industry and our future opportunities. As they were trying to summarize that presentation, I encourage all of our investors to visit our homepage at www.nanometrics.com, download the slides and look into the presentation. I think it does a good job of capturing what we believe the market looks like, where our opportunities are, and how our products fit into that.

Now, looking at the numbers specifically, we had a significant net loss in Q4, and I should like to shed some of the light on the three key financial metrics. As I said, Doug's going to go into the details, but from my perspective, revenues, gross margin and cash are the three areas I want to highlight today.

Note that included in this release is a reconciliation of GAAP to adjusted non-GAAP financial results, which we internally -- use internally to help look at our business. And we don't necessarily refer to them as non-GAAP numbers; we refer to them as adjusted.

So, from a revenue standpoint, we had guided flat to down 10%, and we came in at down 14%. This was due to our expectation that we would receive acceptances during the quarter that did not materialize. It's a very straight-forward and simple problem. We expected during the quarter to get acceptances and we did not achieve those. It was not caused by pushouts or order cancellations.

Number two, the product gross margin was down almost 12% as adjusted, to 37%. So, our over all gross margin down 11%, as adjusted to 29%. This is an area where the merger integration took its greatest toll. The primary driver of poor product margin was primarily manufacturing under-absorption. I'll look at it kind of four areas here.

We are in the middle of a multi-core consolidation of our manufacturing facilities, and I've outlined this before in some of my conversations at these conferences. We are currently in the process of ramping up our Korean operation and winding down our manufacturing operation in York, England.

At the same time, the old facilities are still producing tools, so as we've talked about, again, during our presentation at investor conferences and in conversations with investors over time, that because of the complexity of the design and manufacture of these tools, it was a requirement for us, and because we're moving to production offshore, that we should have two simultaneous production facilities running at one time.

Of course, when you have double the number of people producing the same number of products, you end up with a significant under-absorption problem.

This combined with a 14% decrease in revenues had a material impact on gross margin. It is not a trend. We know how to bring our gross margin back into historically high levels and we are implementing the necessary steps to achieve that.

Next, we had another high quarter of warranty expenses and excess material, labor and inventory expenses involved with controlling the inflow and outflow of parts while we consolidated our manufacturing. So, it's pretty easy to understand, we have two different facilities, we have to buy material for both. Significant inventory is part of that. We're also going through processes as we move these operations around to consolidate and look at the viability of some of these inventory charges. So, at the end of the day you look at all of these things, there ends up being quite a bit of cleanup as you go through two different operations.

Fortunately, our service gross margin improved for the second quarter in a row, and it has to be one of the highlights of the quarter, and I congratulate our service organization for that.

The third area is the cash. While our cash balance suffered due to our net losses, we see cash balances increasing and additionally we have secured a bank line. We do not see the need to raise dilutive equity capital for the foreseeable future, but we are certainly implementing some processes within the Company to more closely watch where we are on a cash basis on a more regular calendar schedule.

So, in the past, Nanometrics has been in an excellent position from a cash perspective, had tens of millions of dollars. Through the integration of the two companies, we were put into a situation where we had to reduce some of the debt that was brought in as part of the integration of the two companies. That combined with ongoing operating losses resulted in now kind of a precarious position, and through the guidance of management and our outside directors, we decided that securing a bank loan was a prudent approach for the Company to reduce any sort of issue going forward.

So, let's look at some of the more details. Why were the Q4 results so disappointing? At the most fundamental level, we have too many entities, 22, to really effectively track on a financial basis. Many moving parts and overlap in manufacturing, as I mentioned before, is an ongoing issue and one that will play out over the next quarter or two. And it's something that could be expected as two things occur.

The Company is resolving product lines and trying to optimize the profitability based on manufacturing that was in place. So, as Nanometrics looked at consolidating with other companies, one of the strengths that Nanometrics brought to the merger consolidation was that we had low-cost manufacturing sites available to us. And obviously as part of the Accent manufacturing being based on the pound currency, moving that manufacturing and moving the manufacturing closer to the customers made sense to us. But these things have cost, and that's really the perspective that we're trying to bring to people.

Another important part of looking at these different entities and the complexity of shutting down the different territories throughout the world is that we had different IT systems. As part of SOX compliance and an ongoing strategy for the Company to better get visibility into the numbers, we have been embarking on a process of retiring systems that were in place in previous manufacturing sites and bringing up new systems, and the cost of doing that and the complexity in understanding and training associated with making the significant IT change has been something that has not been easy for the Company to fully grasp.

So, going forward, what are we going to do? Well, there are two, really, areas that I want to talk about today. Short-term, it's very clear that we need to drive faster adoption of new financial systems to get better visibility to the numbers. So, the idea that we can more fully understand exactly what's happening throughout all the different entities within the Company is a key driver for me now in the Company. Implementing better budgeting and control for our business. What means to me is that we will be establishing and improving the ability to get visibility into the numbers, and also being able to judge how well our different organizations throughout the world are performing relative to those numbers.

Another really important issue we have on the short-term is completing consolidation. It's never become more evident that closing these other facilities has taken on much greater emphasis now that we've let this thing go for some period of time. Again, I wanted to emphasize why that took so long. As you all can fully appreciate, both companies had customers and expectations and orders in place, and we were obligated to continue the manufacturing in those facilities until we were able to accommodate those customers' requirements.

Now that we've completed many of those shipments and four or five months have passed, now we can see the end of the tunnel as regard to the outsource manufacturing for some of the products, and then bringing those manufacturing into the Korean operation at the end of the tunnel here.

Another important aspect on the short-term is going to be because our revenues do seem to be increasing, and I will go into that as the guidance goes forward here in this conference call, greater absorption is going to have a huge lever on the Company's ability to improve results. So, what does that mean if we look at, again, the results in Q4?

One of the issues was that we had a lot of manufacturing facilities online and many of the people were under-absorbed. As the revenues and shipments increase, that under-absorption is absorbed over a larger base of products and therefore that number goes down to a very small number, much more in line with historical trends within the Company. We see that happening now in the next quarter or two.

Lastly, on the short-term, addressing headcount and realigning resources, obviously, no company can continue to operate in a substantial loss mode like we are today, and that greater emphasis now has to be given to the ability of the Company to really meet the customer's expectations while also addressing our customers -- excuse me -- our investors' concerns over profitability, and that is going to now result in an acceleration in headcount and realigning of the resources within the Company.

Longer term, and longer term to me means six months to twelve months out, the outsourcing strategy we've been talking about on some of our conference calls here recently is taking on greater initiative. We're making some good progress on that. As I mentioned earlier, we talked about this, also, in our industrial presentations. Our outsourcing strategy is going quite well. Achieving a common platform is another part of the initiative. If we think in terms of how do we get real production leverage over the systems that we have, a common hardware platform is one of the key indicators and the key ways of driving profitability into the gross margin. We see that now going forward and a clear path to making that happen within the calendar year.

Lastly, the reduced legal and accounting and consulting in the G&A. Anybody that looks at that P&L statement has to be shocked by the relative level of G&A spending to the -- especially to the R&D number. Clearly, we're in the second year of SOX compliance. We have a lot of entities within the Company, we have a lot of manual systems that have required quite a bit of accounting, consulting and auditing. And as we now go into 2007, we can see a clear path to that number going down and being much more in line with historical trends. In fact, it's a key initiative for me now within the Company.

So, based on all that information and what we intend to do about the results, my role and focus in the Company is going to now change dramatically. I am going to have a greater emphasis on operations and financial systems for the foreseeable future. My focus is going to be on driving simplicity into the numbers and make them easier to track and predict. I'm going to have a key initiative within the Company to drive the synergies and manufacturing, and that means the consolidation of the manufacturing sites as well as the outsourcing. And, of course, delivering the top line growth and market share gains that we believe we can achieve in the coming year.

So, from my perspective, the future looks very bright. The market dynamics are very favorable. Memory spending is strong, and we are heavily leveraged on the memory spenders. We see good growth opportunities in each of our four core markets. Overlay metrology now is very clear a growth opportunity for our Company. Optical CD, thin film being traditional opportunities for our Company at Nanometrics, as well as integrated metrology.

Consolidation is resulting in better pricing environment and opportunity for market share gain. So, we definitely see the wind at our back when it comes to the ongoing consolidation that is going on within our industry and within some of our peers and competitors.

We think we have new products and greater scale worldwide, which would benefit our investors. We see 2007 as a great year for our Company and one with significant growth that will translate into profitability.

With that, I'm going to turn it over to Doug McCutcheon, our CFO.

Thank you, John. I'm going to recover a little ground that John has covered, but go into a little more detail and description of some of these areas. The results for the Company for the fourth quarter include the results for Accent Optical Technologies results for the full quarter for the first time.

As noted in our November 2 call, in the first few periods following an acquisition, there are some unusual accounting ramifications which may have quite significant short-term effects, but their impact declines as the new combined company reaches a steady state equilibrium with only the amortization of the long lived assets.

We noted that such would be the case for our fourth quarter, and the purchase accounting impacts for the quarter were in line with expectations.

We have this time also included a reconciliation P&L statement in our press release, which helps you identify those items. The reconciliation provides the adjustment between the reported GAAP figures and the effect of [a] the purchase accounting adjustments for the acquisition of Soluris and Accent Optical, and [b] the equity-based compensation expense required under FAS 123[R]. I remind you that both of these adjustments are non-cash items.

As on the schedule in the press release, I will refer to the figures with the effect of these items removed as the adjusted results, which are not GAAP.

Revenues for the quarter were 24.9 million. This was down 14% from the revenues of 25.1 million in the third quarter, which was the midpoint of our guidance, which was "flat from Q3 plus or minus 10%."

So, the fourth quarter revenues were below the lower end of the guidance by 4%. This deviation, as John mentioned, can be entirely attributed to our inability to complete the acceptance process for several new product units and a single customer. I have obtained the customer's acceptance certificate.

The negative impact of the top line was $2.9 million. This amount remains in deferred revenue to be recognized in an upcoming period. The irony of this is that the machines have been fully paid. Simply doing the math, had those units been recognized, revenues in the fourth quarter would have been 27.8 million, or just 4% before the Q3 level.

When we spoke to you in November, we indicated that we could see some possible softening of business in the fourth quarter and had we been able to close on those acceptances, it would have indeed been modest. At the same time we indicated that early Q1 business looked strong. It remains to look that way and we will describe this in more detail when we get to our guidance for the first quarter. But the outlook remains consistent.

Now, some details on the revenue. For the fourth quarter, the revenues were divided by our channel of stand-alone metrology was 15.8 million, or 63.3%. Integrated metrology, 4 million, or 16%, with service revenues of 5.2 million, or 20.7%.

Also as a reflection of the new Nanometrics and similarly with the third quarter, our geographic distribution has shifted to be less concentrated in several regions and indeed very global. North American revenue, 9.9 million, or 39.8%. Europe and other non-classified areas, 6.8 million, or 27.4%. Japan was 4.2 million, or 16.8%. Taiwan and China were 2.5 million, or 10%, and Korea was 1.5 million, or 6%.

Now onto the gross margins. Our reported product gross margin was 5.3 million, or 26.6%. Our reported services gross margin was essentially break-even of -0.1 million, or -2%. Our reported overall gross margin was 5.1 million, or 20.6%.

These figures as previously noted include acquisition related charges and stock-based compensation expense. But even without those charges, the product margin and therefore the overall margin were markedly lower than the prior quarter and below our expectations.

Let me begin with the product gross margin. As noted in the pro forma or adjustment reconciliation, also included in the GAAP numbers are acquisition-related charges of 1.8 million, and stock-based compensation of 0.1 million. Before the effect of these roughly 2 million of non-cash expenses, adjusted product gross margin was 7.2 million, or 36.5% of revenues. As John mentioned, the largest single contributor to the lower product gross margin was a significant under-utilization of our manufacturing capability in terms of absorption.

Although not manifest so much in the revenue figures because of the complex interplay of deferred revenues and prior manufacturing activity, in our principal Milpitas manufacturing facility, we managed to earn only about 50% of the manufacturing labor and overhead in the fourth quarter as we did in the third quarter. Part of this is due to the holiday season, but that's only a very small contributor.

We also experienced some under-absorption to a much lesser extent in our manufacturing locations in New York and Concord, Mass. The good news is that our factory loading in Milpitas for the first quarter is back up to very strong levels and we expect to experience normal levels of absorption.

As John mentioned, also, during the fourth quarter and continuing for the first half of 2007, we also have the overlap effect of transitioning from York manufacturing to South Korea and Asian contract manufacturers. This will continue through the second quarter and then be behind us.

Warranty expenses which had been extremely high in prior quarters have been reduced, although they still represent a significant expense and the focus of continued management attention.

Service gross margins, as shown in the pro forma results, include a modest non-cash charge for stock-based compensation. The adjusted service gross margin in the fourth quarter was essentially break-even compared to -0.4 million, or 8.7% of revenue in the third quarter. Quarter-on-quarter revenues, service revenues increased 0.8 million, or 19%. The cost increased only 0.4 million, or 10%. The cost increase was due to the Accent service operations being in the financials for the full quarter and resulted in the notably better gross margin.

So, adjusted total gross margin was $7.2 million, or 29%.

On to operating expenses. They were up quarter-on-quarter as expected due to the inclusion of the Accent Optical expenses for the full quarter as compared to the partial third quarter. Total reported GAAP operating expenses were 17.2 million, up from 15.5 million in the prior quarter. Adjusted operating expenses in the fourth quarter were 15.0 million as compared to 13.5 million in the third quarter.

Looking at each individual operating expense lines. R&D expenses were 4.5 million, or 18% of revenue. This was about 6% above the spending level in the prior quarter, again due to the Accent effect.

Sales and marketing expenses were reported at 5.7 million, or 22.9% of revenue. Adjusted sales and marketing spending was 4.6 million, or 18.6% of revenue, down slightly from the third quarter.

As John mentioned, G&A expense was high. It was reported at 7.0 million, or 28% of revenue. Adjusted G&A was 6.3 million, or 25.4% of revenue. This is an increase of 1.5 million from the adjusted figure for the third quarter.

This increase was caused principally by four factors, each contributing about 200,000 to 300,000 each to the increase. First, year-end adjustment to audit fees to include the newly acquired companies. Second, increased litigation expense. Third, hired temporary labor expense to complete the accounting for the Accent acquisition. And fourth, increased IT spending in order to merge the Company's networks.

Litigation expense alone was approximately $700,000. We do expect litigation expense to remain high until after the scheduled trial date, which is May 29. The remainder of the increase was the effect of the full quarter of Accent.

Of the higher costs in Q4, we view 500,000 to 700,000 of them to be one time and not recurring in the first quarter.

Our reported operating loss was 12.7 million. Our adjusted operating loss was 8.5 million. We had a foreign exchange translation loss of approximately 700,000 in the quarter.

Our headcount at the end of the year was 522, which was an increase of just 12 people, or 2% from September.

Now, turning to the balance sheet. As John mentioned, cash at December 30 was 8 million, down 7.1 million from the 15.1 million level at September 30. This usage, of course, stems from the pro forma loss in the quarter. Given the positive outlook we have for the first quarter and beyond, we expect cash to not decline significantly further. However, to ensure that the Company always has access to adequate cash reserves, we have recently completed the arranging of a $15 million multi-year revolving credit facility with a major bank. There are currently no drawings outstanding under that facility, but it is available for our use should we need to do so.

Accounts receivable stands at 24.9 million, a decrease of 2.6 million from the prior quarter. DSOs increased from 85 to 90 days. Inventory levels for the combined companies stand at 47.8 million, flat from the previous quarter. Again, with the positive outlook for the first quarter, we expect to start driving down our inventory levels this quarter.

Now, to that positive outlook. Our guidance for the first quarter is that revenues are expected to increase from the Q4 level by between 25% and 35%. With the nearly full absorption of factory costs, gross margin should return to historical levels, although high litigation expenses will continue to impact operating expenses negatively. The other year-end costs should be behind us.

That concludes our prepared remarks, so, operator, you may now poll for questions.

Thank you very much, sir. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Gary Hsueh of CIBC World Markets. Please proceed.

Hey, guys. A lot of questions here that I could possibly ask, but let me just start by asking a question about the top line. You talked about missing customer acceptance now for two quarters in a row, and that kind of drove downside to your organic core Nano business. Can you talk a little bit about it? I think for two quarters in a row, I think we probably deserve a little bit better explanation here on which products, and whether or not that's a systemic problem with this new product.

Well, the simple answer is the one for the Q4 was a new product, so when many of these new Fabs come online they ask for specials. We made some accommodation to accommodate multiple front-opening unified pods in the front, so our traditional system has been a two-FOUP system. The system that we modified for the customer ended up being a three-wide system.

So, if you look at the details of that particular order, it was a reconfiguration of a historical system and it just takes a little more time to get the factory automation parts of the system accepted. And that's really the detail that you need for Q4. That was the one order.

Okay. And was this push -- was this delay in customer acceptance, was this the same thing that you experienced in Q3?

No, it wasn't. So, I think Q3 mostly revolved around the number of -- trying to bring the Accent people and the new sales organization onto the SAB 101 type rules. So, again, it was an education to begin with on the sales organization. Half of the worldwide organization for us was not SAB 101 compliant, and there were issues relative to customer POs and commitments relative to the revenues that was recognized in previous quarters. And additionally, the process that we have, as we call it [certificate], so we actually have to get a customer to actually sign off on an acceptance certificate now, which is a new process for many of the folks. So, that was really more as part of the merging of the two companies in Q3.

Okay. Then let me ask you a question here in terms of your Q1 guidance. How much of Q1 guidance is being supported by customer acceptance of the miss here in Q4?

We are anticipating to conclude on that acceptance, but it's not -- the guidance is wide enough that we can get most of that.

Okay. And when you say we should be getting back with more normalized kind of absorption levels at the $30 million range, do you mean we should be modeling product kind of gross margins back to the 50% kind of range? Is that --

Again, historical has had a product gross margin range that has typically been, say, from 47% to mid-50s percent.

But I wouldn't be that aggressive in saying, because we still have a facility --

We still have the facility.

-- regardless of the shipment levels, which was the biggest part of our under-absorption. Again, the sheer number of systems being shipped, that went way up, but we still are extremely inefficient because we still have two manufacturing lines running. So, that's an important point for you and I would not expect until we get the York manufacturing shut down that we will fully get back to where we expect to be, which is in that mid-50% range for gross margins.

Okay. So, let me try and understand your cost structure here. It brings up a good point. So, you expect the duplicate cost structure, I think you said to start tailing off after Q2, right, or start tailing in Q2, but really be behind you here in Q3, right?

Yeah, that's right.

That's correct.

On the cost of goods side. And then on the OpEx, on the R&D, G&A kind of sales and marketing side, it basically looks like the catalyst here for that number to start coming down, besides the kind of step-down by roughly 500,000, 700,000K in Q1 is basically this Nova Measuring case in May. And after the case in May, then the litigation expenses should really let up, and that should really be able to let you drive down to kind of a more normalized OpEx number, and that also happens in Q3. Is that right?

Well, I think there are two things. The first is the significant 700,000 that was in the Q4 for the Nova lawsuit. We expect that to continue until the May 29 trial date. But beyond that, if you look at where the OpEx spending is, there's a tremendous amount being spent on auditing and in general the financial organization here.

So, as we go through the SOX work and through the consolidation of all of our facilities, as we mentioned, when you have all these IT systems, there's a lot of manual process. And when you have manual process, you have a lot of consultants and auditors, and everyone has to do things by manual, and it just drives the number up.

So, as we get passed this year-end audit and finalization of the SOX compliance, then we can go back and work on the automation and reduce the consulting and overall cost structure relative to our overall finance and accounting in the Company. So, that's the primary objective for -- as I mentioned in my comments earlier, one of my primary objectives.

Okay. Just a few more here. Tax rate guidance here in '07, Doug, is that 5%?

Yeah. Very, very low. We have NOLs in most areas, and so it's only if we -- it will -- there will be tax provisions if we're able to achieve our profit objectives in a few countries.

Okay. And back to you, John. I mean, the one kind of question I was driving at, is this just a temporary kind of one quarter pop in terms of revenue just because you're recognizing some prior customer acceptances that it slipped into a year. If I listen to one of your biggest customer supplied materials, they think that there's some lags here to the order number, at least that's in their guidance and throughout the rest of this year. And so is this really just kind of a one-quarter sort of pop due to delayed customer acceptance that you're finally signing off here in Q1, and it's kind of uncertain in Q2 or Q3, or is your biggest customer kind of sharing some of that visibility and you're a little bit more enthusiastic about what the follow-through could be beyond Q1?

Well, on the one hand you've got to say, of course, we had always expected that 2007 was going to be a gangbuster year because our customers being primarily memory customers have been doing a tremendous amount of expansion. So, if you look at the top five customers spending the world, Intel, Samsung, Toshiba, Hynix, you look at all these profile customers, those are the customers that we have, so we've always been pretty optimistic about 2007. And, of course, when [Emac] came out with their numbers and their guidance, it looks pretty good.

On the other hand, we also do -- listen to the street and there's lots of information always blowing around about capacity and over-capacity and price pressure. We love it when the prices go down because that also drives further adoption of flash. And so from our perspective, I think the customers are going to continue to spend, and so we have an optimistic view overall for the year. So, we don't see this as a one-quarter pop. We see this as the beginning of a good year and the beginning of a successful integration of two companies.

All right, perfect. Thanks, you guys.

Thank you very much, sir. [OPERATOR INSTRUCTIONS] Our next question comes from the line of Raj Seth of Cowen & Co. Please proceed.

Hi, thanks. A lot of moving parts here. I wonder if maybe we can abstract away a little from the detail. Doug, what's the operating break-even? How far do you think that goes down, let's say over the next two quarters, without trying to get too precise, over the next quarter or so?

Yeah. We have previously commented our adjusted base is break-even and currently is about 33 million a quarter. I would have to say that given the current litigation expense and the overlap currently experiencing in the gross margin, that probably is a little bit higher than that right now. It's probably more like 34 million or 35 million break-even. But clearly as we get those expenses out and get the realization of the gross margin numbers, we have a lot of leverage to drive that number first to 30 million and then below that, and that's our goal.

So, 30 million you think is something in the next two quarters?

You know, second half of the year.

Okay. And then, John you talked about, I guess, looking for some opportunities perhaps to reduce headcount. You're at 522 people today. Where do you think -- where does that go? How significant are the kind of reductions that might be available?

Well, again, when you look at where the revenue is, it's totally driven by customer demand on one side, and the other side is -- what I mean by that is, you cannot make significant headcount reductions when you have customer demand going up. So, that's one aspect of it.

Second part of that component, though, is that we do have this double manufacturing strategy going on right now until we get everything moved out. And so until we get that, we're not going to see a significant headcount reduction.

So, what we're going to try to do, as I mentioned earlier, is drive some of the costs, which realistically are not so much headcount related as they are under-absorption and facilities and overhead costs in general. It's not all driven by the people, it's driven by a lot of other material and costs in the Company. So, realistically, on the short-term, in the next week or two, you're not going to see significant reductions. But over a period of time as we consolidate the manufacturing as quarter one goes to quarter two and goes to quarter three, that you'll see not only the manufacturing reduction, but you'll also see the outsourcing start to take effect on the Company.

John, forget about timing for a second. I realize it's hard to predict, but where do you think that can go, let's say, by end of the year?

You know, it's not a number I want to put out there. It's not a number that I really want to discuss.

Okay, that's fair.

Because it also depends on at the end of the year, if we have too few people and we have 2008 looking like gangbusters, then that number is useless to you today. So, we --

Yeah. No, that's fair.

-- we have to -- number one priority for us is to drive efficiency in the Company that we now have, and that's our primary goal. When we get to the end of that process in the next couple of quarters, then we will assess what is the next step and where the market is at, and make appropriate changes therefor.

Okay, two other little ones. Doug, you had an inventory step-up. How much was that excluding the amortization? I guess there are two separate pieces in there?

For the fourth quarter?

Yeah, just in the COGs line.

Give us a second.

Yeah, of the 1.8 million adjustment you see on the reconciliation, about 1.5 million was step-up.

Okay. And my final question, what are your lead times right now? I know it varies probably by product but --

Well, I think they're not significantly different than they ever have been. We do carry a lot of inventory and our strategy in the Company has been to make sure that we have the longer lead time items on hand. As we said, though, as we go into the future, our concept is that a lot of these major subsystems which we carry in inventory will be absorbed by subsuppliers and outsource manufacturers. So, we anticipate two things happening as we go through the year. Reduction in the inventory, because we're going to be outsourcing some of these major subcomponents and, number two, a shorter time to delivery for our customers. But right now it's about the same. You know, it happens we can do and we have been doing turns within the quarter, so some orders we get in the quarter and we ship in the quarter.

Yeah. Sorry, let me sneak one more in just to make sure I got it. Doug, you talked about 700K -- 500K, 700K and spending decrease in Q1. Is that the way to model it, sort of 500K, 700K down sequentially in aggregate, or is there more?

Yes. No, we believe that's the ballpark.

Okay, thanks.

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Mark Bachman of Pacific Crest. Please proceed.

Hi, this is Wes Tweegan for Mark Bachman. A couple of questions. I know this has already been kind of picked at, but I'm just wondering if you can give us any more idea on the double manufacturing and what the timeline is going to be? I heard one to two quarters, but if you could give us sort of, I don't know, maybe a percentage basis over first quarter, second quarter? Could we get any more color on that?

We're currently building our first system in Korea as we speak and anticipate a ship date at the end of the month. So, if you take that in consideration as a build one, if everything goes well, you can see March, April being okay to shut down the other facility. If you look at the products that we're not making in Korea will be outsourced in Asia, those have already been through build one and they're working on build two now. So, those are probably further along because they didn't require the same amount of infrastructure development that we had to do in the Korean operation. So, I think it's realistic to expect that in Q2 that we're done.

Okay, great. I'm also curious on the overlay business. Have you won any significant business from the Nikon exit [inaudible] yet?

So, I think if you look at the digestion by the customer, two things have occurred. So, as we went through the merger last year, late last year, that was the timing when Nikon started to exit the market. Typically, the digestion or the development of a new supplier is on the order of one year. So, all I can say is that there has not been any significant shipments to new customers, but there have been significant engagement with new customers with some of our competitor's tools, and we expect that the evaluations and the development work that we're now embarked on will result in greater market share and new customers as we go through 2007 and 2008.

Okay, great. And then another question. On the common platform, I'm just curious, you mentioned it should be rolled out by the end of the year and I'm curious what does that mean? Does that mean sort of beta tools at that point, or you'll begin [inaudible] production?

No, we expect shipments this year. That's our expectation, yes.

Okay, great. Okay. Thanks.

Yes, thanks, Wes.

Thank you very much, sir. [OPERATOR INSTRUCTIONS] At this time we have no further questions in queue.

Great, then, I'll wrap it up with that. Thank you all very much and we look forward to results next quarter.

Thank you very much, sir, and thank you ladies and gentlemen, for your participation in today's conference call. This concludes your presentation and you may now disconnect. Have a good day.