Onto Innovation Inc (ONTO) 2007 Q3 法說會逐字稿

Good morning, and welcome to Nanometrics' Third Quarter 2007 Financial Results Conference Call.

The speakers today include Tim Stultz, President and CEO, and Quentin Wright, Chief Financial Officer of Nanometrics.

The Q and A session will held at the end of the call. Until that time, all participants will be in a listen-only mode.

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 discussion 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 Dr. Tim Stultz. You may proceed, sir.

Thank you.

Good afternoon, everyone. I appreciate your calling in today.

With me on this call is our CFO, Quentin Wright, who will go through the details of our results at the end of my prepared remarks.

This is my first earnings conference call as the CEO of Nanometrics. I've been on board for just over two months, and I'm very pleased to be sharing some positive financial results with the investment community.

Q3 was another record revenue quarter for us, and our third consecutive quarter of revenue growth. Q3 was also our third straight quarter of improving gross margin, and we achieved our first service gross profit in six quarters.

This period marks our third straight quarter of reducing our operating expense, both as a percentage of revenue and in absolute dollars spent.

We again achieved an operating profit and an operating margin improvement of close to 4 percentage points versus Q2.

These improvements resulted in our first net profit in 10 quarters, a major milestone in our turnaround effort.

Finally, this is our third straight quarter of improving tangible book value per share.

A couple of quarters ago, Nanometrics was a turnaround story. In April of this year, Bruce Rhine assumed the role of interim CEO and was instrumental in leading the team's turnaround of the company. Our Q3 results are proof that that turnaround is now complete. The merger integration which Bruce stated last quarter was 75% done is also now essentially complete.

Going forward we will continue to drive Nanometrics in the areas of profitability, cash flow and predictability, the key metrics of our turnaround strategy. But today I would also like to speak briefly about our strategy to achieve efficient growth based on profitability, competitiveness and customer satisfaction.

First, we will continue to run the business to reach an operating model which will make a profit, generate cash, and be responsive to changes in our markets and the general financial climate.

Second, we are working to better align our product and applications development efforts with our customers' technology and product roadmaps.

And third, we are increasing our focus and directing resources to improve quality and customer satisfaction.

These steps should result in a better, more nimble company which is responsive, competitive and capable of delivering continued profitable growth.

Now I'd like to provide several updates on business objectives which have been discussed in previous reviews.

First, an update on our merger integration. Our goal in acquiring Accent was to expand our footprint in the metrology space while also realizing a post-merger annual cost savings of $8 to $9 million. After stumbling in the first six months of the integration, the team made the changes necessary to recover and realize these savings. Specifically, net of intangible asset amortization, we have reduced OpEx by about $3 million a quarter from $17 million in Q1 to $14 million in Q3. This is an annual OpEx reduction of $12 million, which is evidence that we have achieved our merger integration cost savings goal in addition to other efficiencies. Part of our success in improving our business model post-acquisition is evidenced by our revenue per employee, which in Q3 was $295,000 on an annualized basis, a 25% improvement relative to the initial phase of integration.

My second update is on the consolidation of our manufacturing facilities and our outsourcing initiatives. During the quarter, we completed the shutdown of the IVS facility in Concord, Massachusetts, and integrated the manufacturing into our Korea operations. We also transferred 100% of the systems manufacturing from our York facility to our manufacturing site in Korea. We sold our Japan building, which formerly housed our flat panel business, and we have taken substantial steps to unwind our previous vertical integration strategy, including shutting down our machine shop and plating shops in Milpitas and outsourcing systems manufacturing to third-party turnkey suppliers. So essentially, we went from four underutilized factories with virtually no outsourcing to two factories with nearly 20% of our products outsourced at the systems level.

Finally, I would like to update you on our target business model. For two years, Nanometrics has maintained a gross margin target of 53% on a GAAP basis. This is still our goal. Though our quarter-on-quarter gross margins performance is definitely improving, we still need to gain a better understanding of our true costs and expense structures to improve the businesses processes in order to take the next appropriate actions to further grow our GAAP gross margin to our model level.

Our OpEx percentages have come down to approach our goal model, however we expect to shift the mix somewhat in 2008 with an increases in R&D spending, mostly offset by reduced G&A expenses.

We have also maintained for several quarters that our target cash breakeven is $25 million in quarterly revenues. With our current revenue run rate and gross margins, and excluding non-cash charges such as stock-based comp, depreciation and amortization, right now our breakeven level is about $28 million. This means relative to where we were six months ago, we are three quarters of the way to meeting that target.

We are not, however, forecasting significant sequential drops in our OpEx at our current level of revenues. If, however, business conditions deteriorate to the sub-$30 million level per quarter, we are confident that the steps we have taken to reduce our fixed costs and shift to a more variable cost structure will enable us to get our OpEx to the $12 to $13 million range within a quarter of notice.

The takeaway is that we are making every effort to run the business to make a profit and generate cash with reduced sensitivity to revenue level.

Lastly, an update on our cash balance. Our cash balance declined modestly in Q3 after a significant increase in Q2. The primary reason for the decrease is that our shipments were very backend loaded. The timing of shipments was driven more by demand than supply in that our customers were being conservative in placing orders, probably due to uncertainties in the financial and consumer markets. We observed similar behavior through our OEM partners.

We also repurchased about 26,500 shares of stock, and our overall working capital increased during the quarter.

To conclude my first call as CEO of Nanometrics, I would say the following. We are running the business to a model to make a profit and generate cash as best we can, given the inelastic demand for our products. We feel good about the demand for our products, especially given the disruptive additive growth of flash memory, which is being driven by the consumer's need for low power, large capacity media memory. The integration and consolidation's behind us, and we are now transitioning from turnaround to profitable growth. And finally, we are confident about our product roadmap and competitive position and our ability to improve our business performance.

I would like now to turn the call over to Quentin to discuss more details regarding our Q3 results.

Thank you, Tim.

Earlier today we released our third quarter 2007 financial results. If you have not yet received them, 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 3.5% in Q3, representing another record revenue quarter for Nanometrics. Revenues were up 33% over the third quarter of 2006, which was the quarter in which the Accent acquisition closed and which included close to a full quarter of Accent results.

Our operating profit in Q3 was $1.7 million, an operating margin of 4.5%. This compares to our Q2 operating profit of $.3 million and an operating loss of $5.8 million in the third quarter of 2006.

Net income in Q3 was $2 million compared to a net loss of $130,000 in Q2 and $6.6 million in the third quarter of 2006.

Similar to Q2, Q3 again showed strength with our memory customers in Japan, with continued strength among customers in Korea and the U.S. and increased penetration into China. Samsung and Toshiba were our only customers representing greater than 10% of Q3 revenues.

For the third quarter, revenues were divided by channel as follows: standalone metrology, $25.8 million or 67%, integrated metrology, $7.5 million or 19%, service revenues, $5.3 million or 14%.

Revenues were divided geographically as follows: Japan, $13.0 million or 34%, North America, $9.4 million or 24%, China, $5.8 million or 15%, Korea, $5.5 million or 14%, and the rest of the world was $5.0 million or 13%.

Regarding our gross margins, our product gross margins for Q3 were 50%, roughly flat compared to Q2. Our service gross margin was 10%, up from a negative 5% margin in Q2. Our blended gross margin was 44%, an overall improvement of 1% versus Q2.

Our service gross margin improved for a few reasons. First, we enjoyed an especially high level of upgrade activity in the quarter, which tends to be fairly profitable. Second, our installed base is growing. And third, we have focused on reducing our overall service-related expenses.

Regarding our operating expenses, total GAAP OpEx of $15.4 million represented a decrease of $.5 million compared to Q2. As expected, during Q3 we reported a gain on the sale of real estate in Japan and Milpitas, as well as the sale of other non-strategic assets and a restructuring charge related to the shutdown of our machine shop and plating facility. Both the gain and the charge were about $2.1 million, so they roughly netted each other on the total OpEx line.

Excluding amortization and intangible assets, the restructuring charge and the gain on sale of assets, total operating expenses decreased to $14 million in Q3 from $14.2 million in Q2. Our combined R&D and SG&A expenses continued to decrease as a percentage of revenue from 38% in Q2 to 36% in Q3.

Our GAAP operating profit was $1.7 million. That includes non-cash charges of $2.2 million, broken down as follows: amortization of intangible assets of $1.3 million, stock-based compensation expenses of $873,000, of which $206,000 was in cost of net revenues, $231,000 was in R&D expense, $140,000 was in selling expense, and $296,000 was in G&A expense. Therefore, while our GAAP operating income was $1.7 million, when we exclude non-cash charges for stock-based compensation, depreciation and amortization, our operations generated approximately $5 million of cash flow reflected in our working capital.

Our headcount decreased from 529 at June 30, 2007 to 519 at September 29.

A few quick aspects of the balance sheet are as follows.

Cash at September 29 was $14.9 million, a decrease of $.5 million from June 30. As Tim remarked, this is primarily the result of backend loaded shipments. This is evidenced by the increase in accounts receivable, which stand at $34.2 million, up $7.1 million from the last quarter, therefore resulting in higher DSOs of 80 days versus the Q2 level of 65 days.

Inventory levels were flat at $33.1 million, with inventory turns at 2.6 times for the quarter.

Our working capital increased by about $7.5 million, with our current ratio going from 2.5 in Q2 to 2.9 in Q3.

We also used $.2 million in cash for share repurchases, which included 26,500 shares in Q3.

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

Certainly, sir. [OPERATOR INSTRUCTIONS]

And your first question comes from the line of Gary Hsueh of CIBC World Markets.

Yeah, hi. Thanks for taking my question. Timothy, welcome on board. I've got a few questions here so just let me start.

I notice you guys are not giving guidance again. I was wondering if you could help me out with some of the outlook, particularly against a backdrop of peers who have basically reported orders down in Q3, revenues down in Q4, but orders maybe popping up slightly in Q4, boding, I guess, well for sort of revenue stabilization here in Q1.

So is that the same case for Nano?

Gary, thank you.

You know, I think we have to remind ourselves that we are basically a small company in a very large market, and we have a very small market share. We do have a broad portfolio of products, and we have a balanced geographical stream. And we really have the ability to grow independent of some of those trends that are reported on a more global basis.

Okay. That helps certainly.

And, you know, if you look at the industry here facing an '08 CAPEX that is declining, particularly in the memory segment, how do you feel comfortable with your current cost structure? Why not continue to push the metal to the pedal here and reduce OpEx even further.

The OpEx work that we're putting in place is really to make sure that we shifted, as you know, from the fixed to variable costs and to track our OpEx with our revenue stream. We have the ability to adjust it if our market outlook changes, but we don't think it's terribly out of balance with the current revenue.

And Timothy, if you could just help me remember or recollect here, what's kind of your general sort of product mix here in terms of memory, logic and foundry customers.

I know it's a little off with the integrated side but, you know, if you could help me outside of the integrated market, what would the mix of standalone and your other products be?

Well, if we look at the product line, the thin film and the OCD products represent about 45% of our business. The integrated metrology is roughly 20%. Our overlay is around 10%. And what we call our materials characterization is roughly 25%.

If we look at it by the end use, the memory represents about 50% of our markets, with a heavier weighting on the flash versus the DRAM. We're seeing about 25% to 30% in foundry and logic, and between 20% and 25% in other areas.

Okay. So about the industry kind of average product mix from a customer standpoint and use standpoint?

Yeah, I think so.

Okay. And Quentin, I have a question here for you. If I just look at the balance sheet, one thing that kind of sticks out is just how low we've drawn down on this deferred revenue account for the last three quarters. Can you tell me what's going on there in terms of deferred revenue going down so much?

Yeah. You know, the big -- the larger numbers in previous quarters had to do with deferred revenue of tool shipments, and, you know, that's something that we have to live with in today's world where, you know, there are certain revenue recognition criteria that we have to accomplish before we can recognize revenue.

We had a lot of machines in deferred revenue in previous quarters. We worked very hard the last few quarters on getting all the machines accepted or whatever hurdle we had to get over to get the revenue recognized.

And currently we've got I think pretty much all the tool revenue out of that number. I think that number pretty much just refers to deferred service contracts, deferred service revenues. But that's not to say that we can't run into the problems with specified, you know, customers or specified tool shipments in the future that we may end up having to defer those tools.

But yeah, we've worked very hard on getting those numbers down and getting over the hurdles on the revenue recognition for those tool shipments, and I think we've been very successful in doing.

Okay. So that's helpful.

So it's an indication that you've worked down the cycle time for customer acceptance on a tool. It's not an indication that, you know, there's less cushion for revenue kind of numbers in Q4, Q1? That's not the right reason?

Well, we don't really have a cushion for revenues. I mean, we take the revenue, of course, when we accomplish those revenue recognition criteria. But yeah, we've been focused very hard on getting over the hurdle with our customers to get the rev rec accomplished.

Okay. Perfect. Thank you, guys.

Okay.

And your next question comes from the line of [Steve Lambert] of Nanometrics.

Oh, no, my apologies. I'm from WaMu Investments, guys. But great quarter. Thank you very much for that quarter.

Can you briefly comment on the share repurchase, 26,500 shares. Is there an average price per share there, and do you plan on continuing to buy those shares again? Is there a maximum dollar amount you'll pay per share?

Yeah, well, we repurchased, what, 26,500 shares at about $200,000, so I think that the average price was about $7.47.

The board's authorized the company to go up to $4 million, and I think we're just going to look at that share repurchase on a more opportunistic basis. And so we still have authorization to buy those shares, but at the moment we have not been buying shares lately and we'll just continue as we'll take a look at that as the share -- we'll watch the share price and decide whether we want to continue with that or not.

Great. Thanks a bunch. Timothy, welcome aboard and great quarter again, guys.

Thank you.

And your next question comes from the line of [Phillip Zarah] of the Algorithm Group.

Yes. Good afternoon.

Hello.

Congratulations on the great quarter.

Thank you.

I just have a few quick questions. Besides Samsung, what was that other customer that was over 10%?

That was Toshiba.

Toshiba. And how does that compare, our concentration, say to 2006?

I will try to find that. I'm not sure I have that data at my fingertips here. Just a moment.

In 2006, it looks like the only one that crossed the 10% was Applied Materials, and the other ones were below that margin. Oh, I'm sorry. Let's see. Samsung was 14% [inaudible] and HighMix was 14%.

Okay. Very good.

And my other question was does the or how does the transition from DDR1 to DDR2 or from DDR2 to DDR3 benefit Nanometrics, the DRAM technology?

We continue to have strength in both markets, but the flash has been much stronger for us.

Okay. Thank you very much.

And your next question comes from the line of Jared Cohen of J.M. Cohen and Company.

I was wondering, given how well you're doing, if you can give us some idea why you seem to be able to grab more orders than some of your competition, particularly some of the companies your own size?

Yeah. I'm not sure that I can respond to that.

We really focus on our customers, much more than we do on our competitors. We believe we have a diversified portfolio of products sold primarily to wafer manufacturers and LED makers. We think that they're good products, they're competitive, and, you know, candidly speaking, what we do is we try to close the orders that are in front of us.

Just out of curiosity, if we take a look at your last quarter, how much of your product revenue came from existing customers?

Off the top of my head, I don't think we have any significant business from any new customers.

Okay. Thank you very much.

You bet.

And your next question comes from the line of Weston Twigg of Pacific Crest.

Hi there. Just a couple of questions here.

I wanted to go back to the service gross margin. You know, 10% is a pretty big increase over last quarter. I know you mentioned some of that was from upgrades, but I'm kind of wondering how should we look at an improvement of service gross margin moving forward, and do you still have the 19% goal?

Yeah. You know, one of the luxuries of being in business for a long time is that we have a pretty large installed base out there, and we're focusing on trying to sell more of these upgrades into our installed base. And so I think that trend will continue, you know, into the future here.

You know, we're still -- and as far as your question is the goal, yeah. I mean, we still have that goal out there. I mean, kind of refer you back to, I guess, Tim's earlier comments about the company moving towards a blended 53% gross margin for the company.

And so yeah, we're going to continue to move towards that goal.

Okay.

I guess kind of related to that, then, on the equipment side, on the product margin side, it looks like it actually -- I have 50% in June and then 49.6% in September, even on a little bit higher revenue. Just wondering if you can explain the slight drop in the product gross margin?

Yeah. I think, you know, the biggest piece of that, it was just the mix of the products this quarter versus last quarter. And also, you know, I think Tim referred to our integration being completed. But during Q3, I don't think we have, you know, really recognized or realized the full impact yet of the cost savings that we're going to be getting out of our transition and our integration of the two companies.

So, you know, I think it's just a reflection of those two items in Q3.

Okay. So that should trend upward then in Q4?

Yeah. Again, we're moving towards a goal of 53% as our gross margin, and we're going to continue to move towards that goal.

Okay. Great.

Also wondering on the OCD and overlay markets, you know, we've talked about ASML entering the OCD and overlay markets and I'm wondering if you can comment on how that might impact Nanometrics in the sense of should we expect royalty revenues to kick in, or can you comment on that relationship?

Well, the only comments that we can address right now is we certainly have a well-known IP agreement and we do believe there's commercial value in that agreement, and we are working to realize that.

We have discussions under way, but we're bound by an NDA and so we really can't discuss it in more detail.

Okay. Great. Just a couple other things. Just wondering if you could give me CAPEX and depreciation for the quarter?

Yeah. It was about $1 million.

CAPEX?

Oh, and CAPEX was about $300,000.

Okay. And then going back to the deferred revenue question that Gary asked about, wondering if maybe some of the -- if we should look at it as essentially there being a bump in the revenue this quarter from working out some of that deferred revenue, and would that then imply that maybe we won't -- we might see a down revenue quarter in December, next quarter? Does that makes sense?

Yeah, Wes. Obviously, you know, we do not give specific guidance. I really wouldn't be addressing that one.

Okay. All right. Thank you.

Currently you have no further questions in queue. [OPERATOR INSTRUCTIONS]

And you do have a question from the line of Michael Amari of Amerigo.

Congratulations, guys. A great quarter. You're doing a great effort to turn the company around. I would like to ask -- I know your business is lumpy, but did you give any figure on backlog?

No, we don't.

You don't. Okay.

At one time you attempted a relationship with ASML in photographing. Did this come out to any conclusion?

It has not reached any conclusion. And as I mentioned earlier, we do have an IP agreement with them, and we believe there is some commercial value in the agreement. But we really aren't in a position both to talk about it nor quantify it.

Okay. I thank you very much, and have a good future. Thank you.

Thank you very much.

And that was the last question in queue, so we'll turn it back over to management for closing remarks.

Well, I want to thank everyone for calling in. I personally feel pleased to be in a position that was able to report on the work that was done by a great team of managers, and we're ready to close the meeting.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.