Onto Innovation Inc (ONTO) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Nanometrics' Second Quarter 2007 Financial Results Conference Call. The speakers for today's call include Bruce Rhine, CEO, and Quentin Wright, Chief Financial Officer of Nanometrics. The Q&A session will be held at the end of today's call. (OPERATOR INSTRUCTIONS)

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 discussions and analysis section of the Company's latest Annual Report on Form 10-K filed with the Securities and Exchange Commission.

I will now turn the call over to Mr. Bruce Rhine. Please proceed, sir.

Thank you, operator. Good morning, everyone. I appreciate your calling in today. With me today is our CFO, Quentin Wright, who will go through the details of the results at the end of my prepared remarks.

On our Q1 conference call three months ago, I talked about what our team would do to address profitability, cash flow and predictability. We spoke about our ten-week plan and commitment to our business model.

Because of the nature of our cost structure, we could not get all the work done in 90 days and we still have a ways to go to achieve our target model, but I would like to use this call to personally thank our management team and employees for their efforts to bring about such improved financial results in the second quarter.

While our revenues were up just slightly compared to Q1, we improved overall profitability by, first, improving gross margins, significantly improving our service gross margins and then substantially decreasing our operating expenses. We increased our-- we improved our cash position by generating an operating profit for the first time in two years, reducing our levels of receivables and inventories and selling non-strategic assets. And we improved our predictability by empowering managers to act on their initiative, implementing weekly review of key indicators for frequent corrective action, faster closing of monthly books and identifying any revenue recognition issues early in the quarter in order to resolve them within the quarter.

The net result is that we delivered the first quarterly operating profit for Nanometrics in nine quarters and we increased our cash balance by 67%. We are committed to continuing this trajectory of improved results and, therefore, announce that the Board has approved a stock repurchase of up to $4 million.

Next, I'd like to go into a bit more detail about what we did during the quarter relating to our profitability, cash flow and predictability and then to conclude with some thoughts about our position in the market. In terms of profitability, we made a focused effort to understand our cost structure and drive to an operating model, including weekly staff meetings and basic fundamental blocking and tackling to find areas to drive down our costs.

We did eliminate 26 heads, mostly middle and executive management. We eliminated a centralized decision-making process and enabled line managers to cut costs at their discretion. We eliminated three major consulting contracts. We made progress on our merger integration and I would estimate that we moved from about one-quarter complete to about three-quarters complete during the course of the quarter.

We improved our overall cost structure, shutting down the former IBS plant and working to get all of our York, U.K., manufacturing outsourced or transferred.

For cash management, we had weekly reviews of receivable collections. In fact, at the beginning of the quarter, our oldest accounts receivable was over 800 days aged, a total of $142,000, and we worked on it and collected it last week. Operations did an excellent job of linear shipments and building tools to plan and we resolved a lot of reliability problems that allowed us to collect cash.

Regarding those reliability problems, which affected our results and our integrated metrology market share during 2006, what we did in Q2 was eliminate any obstacles our engineers were facing so they could complete their efforts to improve reliability. The team did a wonderful job turning around a protracted adverse customer satisfaction situation, resulting in a key integrated metrology design win with a flash memory customer in Japan.

Also, we have been conducting a thorough CEO search process. In our call last quarter, I stated that I would be surprised if we hired the CEO in our second quarter and disappointed if we had not hired that individual by that fourth quarter and that's still the case. That being said, we will absolutely continue to be focused in driving towards our target model, generating cash and enhancing our position in the marketplace as we complete the search and as the new CEO comes on board.

In the market, we are seeing that our thin film and OCD products are competitive. I'm encouraged for demand for our integrated and stand-alone products, but that demand is clearly inelastic and, therefore, can result in revenue variances from quarter to quarter.

We believe the steep decline in flash memory prices is very positive and will drive increased flash unit demand. This should eventually make flash a preferred substitute for magnetic media. This steep decline puts pressure on our customers' margins. To compensate and lower per-unit cost, flash customers must implement smaller geometry more aggressively. This, in turn, drives the need for more metrology products.

We also believe that we benefit from consumer demand for advanced cell phones, high-definition TV, wireless applications and digital music, photos and videos. These products typically have a shorter life span than the traditional PC and drive consumption of more silicon area.

Lastly, while the industry has begun initial discussions about a larger wafer size, 450 millimeter, we believe this transition will occur well into the next decade, pushing out wafer size productivity gains.

For the future in Nanometrics, expect operating expenses to continue to trend down, although not as fast on a percentage basis as we complete the remainder of our integration. Expect fixed manufacturing costs to decline as we unwind our vertical integration and expect further shifts of fixed costs to variable costs, lowering our break-even point.

Before I turn the call over to Quentin, I would like to thank the employees and management team of Nanometrics for their hard work this quarter. I would like to personally thank our COO, Bruce Crawford, for an absolutely outstanding job well done. I would also like to thank the Board of Directors for their confidence in my leadership capabilities.

We have turned Nanometrics around in terms of profitability, cash flow and predictability. There is a lot more work to do as we turn our attention to new product offerings and continuous improvement of our operating results, but the train is back on track and steaming forward.

I'll now turn it over to Quentin Wright, our CFO.

Thank you, Bruce. Last night we released our second quarter 2007 financial results. If you have not received them yet, you may find them on our website at nanometrics.com.

I will now address some financial aspects of the quarterly announcement. Total revenues were up slightly in Q2, representing another record revenue quarter for Nanometrics. In particular, the mix of revenues changed between Q1 and Q2. Q1 was a record quarter for stand-alone metrology shipments and Q2 was a record quarter for integrated metrology revenues, with stand-alone seeing its second-highest revenue quarter ever.

While strong revenues in the first quarter were primarily a reflection of a ramp-up in manufacturing capacity for our memory customers in Korea, Q2 was particularly strong for our memory customers in Japan, a region where we recently announced a multi-platform order that will result in significant future integrated metrology sales.

For the first quarter, revenues were divided by channel as follows -- stand-alone metrology, $20.3 million or 54%; integrated metrology, $12.4 million or 33%; and service revenues, $4.6 million or 12%.

Revenues were divided geographically as follows -- North America, $8.3 million or 22%; Japan, $13.1 million or 35%; Taiwan, $4.5 million or 12%; Korea, $6.4 million or 17%; Europe, $2.2 million or 6%; and other, $2.8 million or 8%.

Now regarding our gross margins, before I provide quarter-to-quarter comparisons, I should point out that we have changed our presentation for the amortization of acquired intangible assets. Previously, intangible asset amortization was included in product costs and in selling expenses. Going forward, we have indicated amortization of acquired intangible assets as a separate line item under operating expenses, which is more reflective of industry practice.

Our product gross margin for Q2 was 50%. Our service gross margin was a negative 5% and our overall gross margin was 43%.

Our reported gross margin in Q1 was 36%, but for comparison purposes, given the change in the presentation of intangible asset amortization, it was 37%, meaning that we improved our overall gross profit-- or gross margin by 6 percentage points on an apples-to-apples basis. The improvement came from both product gross margin, which improved by 4 percentage points, as well as service gross margin, which, while still negative, represents a significant improvement over Q1's negative margin of 27%.

Our gross margins and operating expenses were both helped by an overall belt-tightening, reduced headcount and focus on cost control, as well as a hastened effort to complete the integration of last year's acquisition.

Regarding our operating expenses, excluding amortization of intangible assets, total operating expenses decreased from $16.9 million in Q1 to $14.2 million in Q2. The $2.7 million decrease was due largely to decreased legal expenses of approximately $1 million, decreased stock-based compensation, severance payments and salaries of about $1 million, and overall decrease in selling and general expenditures.

When we exclude non-cash charges such as amortization of acquired intangibles and stock-based compensation, our operating expenses were $13.7 million or 36.6% of revenues, nearing our model of 35%.

Our operating profit was $292,000 on a GAAP basis, including non-cash charges of $2.3 million, broken down as follows. Amortization of intangible assets of $1.7 million included in operating expenses, including approximately $350,000 of intangible assets written off in conjunction with the sale of our DiVA product line. Stock-based compensation expense was down sharply to $642,000, of which $37,000 was in cost of product, $87,000 was in cost of service, $310,000 was in R&D expenses, $158,000 was in billing expense and $50,000 was in G&A.

Our headcount decreased by 26 people from 555 at March 31 to 529 at June 30th.

A few quick aspects of the balance sheet are as follows. Cash at June 30 was $15.4 million, an increase of $6.2 million versus our $9.2 million balance at the end of Q1. Accounts receivable stand at $27.1 million, down $1 million from last quarter end. Our DSOs were reduced again to 65 days, compared to 68 days in Q1 and the Q4 level of 90 days.

Inventory decreased again to $33.1 million from $39.1 million last quarter. I should note that we capitalized approximately $5 million of evaluation and demo equipment during the quarter as we felt this equipment was more appropriately reflected as fixed assets. Accordingly, our inventory turns were 2.6 times for the quarter.

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

Thank you very much, sir. (OPERATOR INSTRUCTIONS) Gary Hsueh, CIBC World Markets.

Hey, thanks for taking my question and congratulations to the Company for a very well executed quarter.

I just wanted to start asking some questions here on margins, in particular gross margin. So if I were to bake in that amortization in cost of goods sold, kind of a flattish sort of gross margin, Q-on-Q, but understanding that, and this might be wrong, that the integrated metrology product has lower gross margin and that's actually at record high kind of revenue levels as a percentage of mix in Q2, what-- what is sort of a gross margin expectation at these kinds of revenue levels at a more normalized mix?

So, Gary, I'll take a stab at it and then I'll let Quentin take a stab at it. So I think the next couple of quarters we have quite a few moving pieces in the gross margin because in addition to the relative cost of sales, unit cost of sales, we're also taking out a significant portion of the cost of sales that is fixed expense by doing two things.

We have a general outsourcing strategy where we're moving our products that were manufactured into York. We're moving most of those to outsource vendors.

The other thing that we plan to do in Q3 is eliminate our machine shop and plating shop in the Milpitas facility. So we don't think that that will have any direct impact, except that it will convert a fixed cost to a variable cost. However, we just have that modeled. We don't have the actual data on that.

So there's a lot of moving pieces, I think, 'til-- 'til we get to move to some kind of a steady state. The one factor, though, that we do have is that when running reliably -- and that's a key issue, because our warranty reserve is an important part of the gross margin -- the integrated products actually tend to be accretive to the overall gross margin.

And maybe I'll flip it over to Quentin, then, to see if he has anything else to address.

No, I think Bruce answered it pretty well. Yes, I think our integrated products get as good or better margins as our stand-alone and as we continue to work on our reliability issues we expect to see accretive numbers coming to our gross margin line item.

Okay. And I kind of got rushed here at the end of the prepared remarks, but no guidance again here for Q3? Is that--?

That's right, Gary, we're--

Why not?

Well, because I'm an interim CEO and I think it would be more appropriate for a full-time, permanent CEO to put those numbers together. We see the normal-- I don't think we see anything different in the marketplace than anyone else that's reporting.

I think we're comfortable giving some guidance on operating expenses. We think that they'll continue to trend down into the second quarter. And I think that our-- I think we'll take some fixed cost component out of our gross margins that will-- that will have an opportunity, given if the revenues stay where they are, to impact gross margins.

And I think we talked about-- on the last call, we talked about our breakeven point and our goal of getting that to around $25 million a quarter cash breakeven point and achieving that goal by the first quarter. And I think where we're at right now, by our calculations, we're at about a $29 million breakeven point and we're confident that we'll improve upon that, going into the third quarter and we're confident that we'll get our commitment of having that breakeven point down to $25 million by the first quarter of 2008.

Okay. But if I operate under the assumption that there is somewhat of a digestion period in terms of semiconductor capital equipment orders and shipment in Q3 and there should be some re-normalization here in your integrated metrology products in terms of revenue in Q3, that means, directionally, Q3 revenues should be down, right?

Yes, we're just not providing any guidance, Gary. We're not comfortable providing any guidance at this point in time.

Okay. Great job, nonetheless. Thanks.

Thank you.

[Michael Amari], [Amerigo, Inc.]

Congratulations, guys, for a great quarter. As a shareholder, I'm gratified that we have new management here that are very dynamic.

My question is, in one of the meetings in the past Bruce Rhine has indicated that Nano is spending a lot of energy on its partnership with ASM-- ASML, but wasn't ready to publicly talk about it. Are you ready to talk about it now? (inaudible) for ASML.

We-- we're not, at this point, comfortable in expanding on that relationship beyond what we've said in the past.

Anyway, congratulations for a great quarter.

Okay. Thank you very much.

(OPERATOR INSTRUCTIONS) Weston Twigg, Pacific Crest.

Okay, great. Thanks. Hi, guys. I actually have a quite few questions, so why don't I just ask a couple and then I'll log off and I'll log back on if there's another opportunity later.

I wanted to see if maybe you could just remind us, remind everyone, of what the long-term margin targets are on a GAAP basis here? And then maybe like key milestones to look for on your expected progression?

Right. So our-- let's see here. Our model is a gross margin, blended gross margin, of 53% and an operating margin of 14% and at our revenue number right now, we're probably just a little bit behind R&D spending and a little bit ahead of GS&A spending of where we want it to be.

Okay. And then in terms of cost reductions that we talked about in the past, I think there was a number around $6 million to $9 million in cost synergy from acquisitions. I'm wondering how you are in terms of-- are you on track for that or do you think you're going to beat that number this year?

The question is regarding the synergy as-- compared to the pre-acquisition numbers?

Yes.

That-- I think that-- the acquisition occurred over a year ago, so we haven't really been footing back to pre-acquisition numbers so much as looking at the individual tasks that need to be done and I think at this point, the channel, sales and marketing is virtually complete. The engineering is largely complete and the operations side of the business.

This quarter we'll-- we'll get out of our lease. Last quarter we got out of the manufacturing of the product at our IBS location in the Boston area and this quarter we'll get out of the lease. The lease is over in September.

This quarter we transferred a fair amount of the manufacturing out of our York facility, except for some critical sub-assemblies, and we'll start to take some-- some headcount out of York manufacturing, but it'll-- it'll take us a little bit of time, probably into the fourth quarter, 'til we restructure the fixed costs associated with the facility there and we expect that to be complete in the-- in the first quarter.

So we haven't really been footing back to sort of pre-acquisition synergy numbers. We've been more or less focused on the project plan and the list of items that we have to get done to get-- to get everything integrated operationally.

Okay, great. And then if I could jump over just to the service side, you talked about improving margin there. I'm just kind of wondering, maybe you could give us a feel for customer feedback on the service side and how the progress is coming along in terms of cross-training your FSEs, lowering the install costs, lowering the end cost of warranty services?

Well, I think the biggest areas in the-- is in the reliability improvement that we've made, understanding the specific issues that we had with the integrated product and addressing kits that will deal with that reliability problem and that is taking-- the implementation of that has taken a lot of pressure off of the inefficiencies associated with having to just sort of disruptively fly people and parts around the world to sort of offer stopgap solutions to reliability problems. Most of that's settled down during the quarter.

I think the customer feedback, the clearest indication would be the press release that we issued about six weeks ago. I think that was a direct cause and effect where we had a better-- better implementation of reliability fixes caused the customer to gain enough confidence that they-- that we were able to win business.

Okay, great. I'll hop off here, but I'm going to log back in for more questions.

Okay.

(OPERATOR INSTRUCTIONS) Gary Hsueh, CIBC World Markets.

Yes, just a quick question here on the share buyback. Is that under a 10b5 or is that completely at management's discretion here?

Well, it's at Board discretion more than management's discretion, but it is at the discretion.

And it's not under a 10b5 program where there's a certain threshold in terms of a stock price where you buy back stock?

No. There's a subcommittee of the Board that's been formed to make those decisions on a case-by-case basis.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Weston Twigg, Pacific Crest.

Okay. A couple more questions. This is more housekeeping. If-- on the amortization charges for the quarter, I'm wondering if you remove those what would your tax rate have been and how should we look at the tax rate moving forward? What would be the ongoing tax rate?

Wes, could you speak up just a little bit, please?

Oh, sure, yes. My question was on the tax rate. If we remove the amortization charges for the quarter, what would the tax rate have been and how should we look at the tax rate moving forward? What should we assume the ongoing rate is?

Yes, our tax rate is composed of a lot of different entities involved in that. We have-- we have entities scattered across the globe and so our tax rate is a function of a lot of the various foreign jurisdictions, as well as the U.S. jurisdiction. So the tax rate-- we are able, at the moment, to continue to benefit losses that we have incurred in our U.K. entity and we're generating some credits out of that.

Our tax rate, going forward, ought to be pretty low. I don't know that we'll continue to record credits going forward in the future, but the tax rate-- I don't have an actual tax rate for you, because we book our taxes on a discrete basis and it's going to stay at a pretty low tax rate going forward.

We're-- we manage our various entities around the world such that the taxes that are generated by the foreign locations are not significant.

Okay.

And in the U.S., of course, we have some NOL carry-forwards and various credits that will serve to offset income into the future in the U.S.

Okay. And then also, I guess more housekeeping, can you tell me what CapEx and depreciation and amortization was for the quarter?

Depreciation was about $700,000 for the quarter and CapEx was about $200,000.

Okay. And just-- I wanted to go back, maybe, just on the cost piece. I'm wondering on the common hardware platform for the stand-alone products, do you have a progress update there?

Well, we're-- right, so we do have-- we haven't announced the product formally yet, but we're tracking as part of our integration plan. There's a product plan that runs in parallel to where we will be mapping the products from the Accent-- former Accent portfolio into a common platform, along with the road map that we have on our scatterometry and thin film products from the Nanometric portfolio.

So there's no specific update publicly at this point, other than to say that that-- that consumes-- that is probably the largest single project that we have in engineering and what's changed somewhat from that is the other goal that we've set in the common platform is that we will be able to outsource it. So the additional scope that's been added into that project is more from a manufacturing engineering scope to make that platform easy to outsource.

I think before this quarter it was contemplated that we would actually manufacture that-- that platform ourselves and that's not what we want-- that's not the model that we want to get to. We want to get to a-- more of a return on asset, inventory-light model where we can completely turnkey outsource that common platform.

Okay, great. Also, just a couple questions on product market share. On the thin film side, it seems like you've been making some headway here. I'm wondering, are you taking-- do you think you're taking share from KLA-Tencor here and where do you think your market share might be at the end of the year?

You know what, that's a good question and I don't-- I don't think that I've-- we've analyzed that to the point where we-- maybe we're just oversimplifying it, but we're not so much concerned with the strategic aspects of marketing and where our share is. We're just more focused on-- I don't want to beat a dead horse, but profitability and cash flow and predictability. So we haven't really-- at an executive level, anyway, we're convinced that the demand's out there to drive us above our breakeven point and I'd have to get into that with the sales team and really understand on an account-by-account basis where it's coming from.

So I don't-- I really don't have a good answer for you.

Okay. That's fair. I'm also wondering, do you see customers viewing the NanoNet product as maybe a deciding factor for some of these net com decisions now?

Oh, that's clearly part of the strategy is being able to offer the solution in both integrated and stand-alone and then have a pretty comprehensive communications element where recipes are transferable and, in fact, we have a hot swap strategy where the modules can be moved from an integrated tool into a stand-alone tool. And so I think the way we define it is that we want to-- we want to offer-- we want to offer the information about the thin film or about the topography of the wafer surface in the case of OCD.

We want to be able to offer that independent of whether the customer chooses stand-alone as an AP strategy or integrated and NanoNet's a big component of that and we continue to invest in expanding the features that are available on NanoNet.

Okay and I guess kind of along related lines, I just kind of wonder if you could walk through, I guess, your competitive strategy in terms of the OCD and overlay markets versus KLA-Tencor? There's been some consolidation in both of those markets and now it's primarily KT and Nanometrics. How are you positioning your products there in terms of technology, productivity, throughput? What's your advantage?

Well-- I don't think it's appropriate for us to comment on that in a public forum, but we have-- I mean, we certainly respect all of our competitors and it's a situation where with the growth of flash memory, in particular, and the fact that there's no wafer size increase that allows any of our customers, not just our memory customers, to amortize their fixed cost over a larger wafer area, they all tend to be driven, especially the advanced logic microprocessors and the memory customers, by shrinking. And shrinking leads to more-- in general, more instability. And to combat the more instability of the process, they take more measurements.

So our focus is certainly on offering a good feature/value proposition to the customer, but also making sure that we take advantage of this rising tide in metrology, which benefits the entire market, not just Nanometrics.

Okay, great. I guess one last question. I'm just wondering if maybe you could give us some color on what you see as your outlook for the year in terms of just the overall macro environment, maybe, heading into 2008?

That's a good question. Yes, I think that-- I think there's going to be a little bit of a rebalancing of capacity with more IDMs-- more and more IDMs moving into the foundry business, so-- at very advanced levels of logic. And so I think that'll require foundries that covet that business to be able to offer those capabilities. And so I would look for maybe more investment in that area.

And we've-- we've gone out and said, I think, for the last year that we're very bullish on flash memory. We think that-- we think that with the cost curve that flash memory is on and, more importantly, the overall strategy to price ahead of the curve, we think that there's going to be a faster switch from magnetic media to flash than maybe that's contemplated by reading most of the public information that's out there. We're very bullish on that.

We view-- that's absolutely a substitutional demand, which is incremental to all the other factors that we talk about. As magnetic media shifts into silicon, it drives substantial silicon area and for us there's a multiplicative effect. There's more area, plus this particular area tends to be-- to have very aggressive lithography challenges with dual patterning and with rapid adoption of smaller feature sizes and all that leads to more measurements being taken.

So we think that that's a very long-term secular trend and we think that it-- that that market has achieved a mass now where it's very meaningful relative to overall demand for metrology products.

Okay, great. Thank you very much.

(OPERATOR INSTRUCTIONS) 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 they may have.

Okay, well, thank you very much for participating in the call today. Thank you very much for your interest in Nanometrics and we will continue to work hard here to continue to improve our profitability, cash flow and predictability of results. And thank you for your interest in Nanometrics.

Thank you very much. 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.