Onto Innovation Inc (ONTO) 2007 Q4 法說會逐字稿

Good morning and welcome to Nanometrics' fourth-quarter and fiscal year 2007 financial results conference call. The speakers today include Tim Stultz, President and CEO, and Gary Schaefer, Chief Financial Officer of Nanometrics. The Q&A session will be held at the end of the call. Until that time, all participants will be in a listen-only mode.

Before we get started I would like to call your attention to the Safe Harbor statement. This conference call contains certain forward-looking statements within the meaning of Federal Securities laws. These statements are based on management's current expectations and involve risks and uncertainties that may cause actual results to differ materially from those described in the forward-looking 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 risk factors and cautionary statements set forth in the Company's Form 10-K for the year ending December 30, 2006, and in the other reports which the Company files with the Securities and Exchange Commission and incorporate by reference.

I will now turn over the call to Dr. Tim Stultz. Please proceed, Sir.

Thank you and good afternoon to everyone.

I appreciate your calling in today. With me is our Chief Financial Officer Gary Schaefer, who will go through the details of our financial results at the end of my prepared remarks.

First of all I'm very pleased to be announcing a record revenue year for Nanometrics. In 2007, our Company went from being a relatively small process control company to being one of the major providers of metrology equipment to the global semiconductor industry. This was accomplished through a combination of organic growth and strategic acquisitions.

In 2007, we also made significant progress towards our stated goals of improved profitability, predictability and cash flow. We achieved above industry revenue growth, gross margin improvement and profitability from operations. That being said, the last quarter of 2007 was challenging as many of our customers faced price erosion for their products, primarily in the memory sector.

We in turn experienced some late quarter pushouts of planned shipments which resulted in sequential decline in our quarterly revenues in the fourth quarter. We fully expect to recognize those revenues in the first half of 2008.

In spite of this decline in revenues, however, we improved our product gross margin and generated $2 million in cash basis operating income and we continue to make progress towards our business model. A few highlights from our fourth quarter include a 2% improvement in product gross margin compared to the third quarter; our second consecutive quarter of positive gross margin in service; and our third consecutive quarter of generating operating profit on a cash basis. Also a highlight of the quarter was a significant strategic customer win in the data storage sector (inaudible) in head-to-head competition against our competitor.

On a year-to-year basis, revenues increased 52% to $146 million. Gross margins improved by 5% (inaudible) from 37% to 42%. Operating expenses decreased from 55% of revenues to 41%; and our cash grew about 87% from $8 million to $14.9 million.

While we still see plenty of room for improvement we are clearly a stronger and healthier company compared to a year ago. And importantly we are on the right trajectory.

Now I'd like to speak to some of the specifics surrounding our continued focus on achieving efficient growth based on profitability, competitiveness and customer satisfaction. As we have stated before, we serve a market where the demand is [interlastic] and our customers' capital expenditure timing cannot be precisely forecast. We are confident however about the increasing demand for our process control metrology products, which is driven by increased consumption of silicon for chip production, increased complexity in chip manufacturing, and tighter process control requirements driven by shrinking device geometries.

We also feel confident in our market position. We have over 6,000 systems in place and over 350 fabs around the world and strong relationships with key customers in memory, logic and [foundry] parts of the business. With an inability to directly drive the timing of orders in revenue recognition, our commercial focus is on strengthening our position within our served markets in order to benefit from incremental or increased spending by our customers when it does occur.

We will do this by working closely with our customers on applications development, offering competitive products -- each performance is properly aligned to their own product and technology road maps, and by working to strengthen our relationships with quality and responsiveness in all aspects of our products and services. To this end, we have stepped up our strategic account management activity and reorganized around stand-alone, integrative metrology and materials' characterization for business units.

This allows us to work more closely with our customers in product road map matching, applications development, and other collaborative efforts. These efforts have already resulted in improved clarity to our own product road maps and better alignment with regard to our customers' performance and timing requirements.

As a result, our product development pipeline is more robust than ever with several new products; and addressing each of our core markets scheduled to be released within the next two quarters.

Just last month, we announced a major addition to our product lines -- the NanoCD Suite. The CD Suite is principally a software solution set which works with our stand-alone [atlas] and integrated OCD product offerings to enhance performance, increased productivity and provide seamless interconnectivity between multiple platforms.

In addition to new OCD product sales the Nano CD Suite is compatible with much of our installed base, and provides the opportunity for incremental revenues from upgrades. In addition to experiencing growing demand for our thin film, OCD and overlay products we are also seeing increased interest and demand for our materials characterization products, particularly from our high brightness LED customers and more recently from customers in the slower photovoltaics business industry.

These customers are not directly impacted by the same market dynamics as traditional semiconductor manufacturers and as such provide us with product revenue opportunities somewhat insulated from the market swings and pricing dynamics of (inaudible) device makers.

Finally, we are continuing to improve quality and customer satisfaction through tracking, training and disciplined follow through. We are already seeing benefits from these activities as measured by install and acceptance time and positive customer feedback. In the near term these efforts will result in reduced service and warranty expense, and in the longer term, increased probability of follow-on orders.

With regard to driving to our business model and improving profitability, we are continuing our efforts to reduce our fixed to variable cost ratio through expense control, outsourcing products at the systems level, and improved channel efficiency.

In the third quarter of 2007, we announced that we shut down our machine shop (inaudible) facility. I'm pleased to report that the entire operation has been taken over by a third party business group to whom we outsourced the subassemblies previously manufactured by us in that same facility. We transferred responsibilities for [seamless] and importantly we have had no interruption with supply of our products nor any decrease in quality in the manufactured components.

Bottom line is that we now have a fully qualified cost-effective source for precision machine parts without the burden of the overhead of fixed cost structure. We expect nearly a $1 million benefit to our gross margin in 2008 as a result of this transfer.

In January we announced a 7% reduction in our worldwide work force. This combined with other expense control measures will bring us to our model target of $25 million cashflow breakeven. Research and charges will be taken in Q1 and Q2 will reflect the benefits of our reduced cost structure.

Last week, we announced that our Japanese partners Toho Technology Corp. had assumed the distribution rights for our materials characterization products in Japan. This will [improve] our channel efficiency by expanding our sales footprint in that region for those products, while supporting an increased focus on direct key account management and systems sales of our flagship products by our direct to Japanese sales teams.

Our performance in 2007 clearly represented a major improvement over 2006. Much of that improvement took place in just the last three quarters. Comparing our Q4 results to our first quarter of 2007, we have accomplished the reduction of about $3 million in a recurring quarterly operating expense; a 62% increase in our cash balance; and a 7 percentage point improvement in gross margin.

At the same time we monetized the number of nonstrategic assets, reduced our manufacturing centers from five to two and significantly increased our outsourcing of products at the system level.

In summary to conclude my comments, I would like to say the following. We are focused on continuing to improve our business performance through gains in predictability, profitability and cash flow. We are making important strides in improving product and service quality, customer satisfaction and competitiveness. Demand for our core products remains strong with increasing interest in our materials characterization product offerings.

We are fully committed to achieving our business model of 53% gross margin and 13% operating margin on a GAAP basis in 2008. And we have a reenergized organization with a clear vision of our goals, and a solid commitment to achieving them.

Before turning the call over to Gary, I want to take a moment to recognize the terrific dedication and hard work of our employees in helping to make Nanometrics a real turnaround story in 2007. I will now turn the call over to Gary to discuss in more detail our Q4 and fiscal year 2007 results.

Thank you, Tim.

Earlier today we released our fourth-quarter and full year 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 announcement.

For the full year 2007, we achieved record revenue of $146 million, an increase of 52% over the prior year of $96 million achieved in 2006. For the fourth quarter total revenues of $33.2 million represented a 14% decrease from our record third quarter and a 33% increase over the fourth quarter of 2006, which was the first full quarter reflecting the combined results of both the Accent Optical and Soluris acquisitions.

Revenues for the quarter declined sequentially, primarily as a result of our customers' cautious outlook on the macroeconomic climate as we witnessed our customers actually underspending their 2007 budgets, deferring some Q4 shipments into 2008. Despite the lower revenue volume, our product gross margins increased to 51.6% versus 49.6% in the third quarter and 36.2% in the fourth quarter of 2006.

Product gross margins improved primarily as a result of our completing the integration of our mergers, which included the consolidation of our manufacturing facility as well as our shift to a less vertical manufacturing model which further reduced our fixed costs. Our service gross profit declined by $100,000 in the fourth quarter, equating to a service gross margin of 7.9% compared to the 10.3% margin achieved in the third quarter of 2007.

We remain confident in our efforts to improve our service gross margin as the fourth quarter represented more than a 10% improvement versus our -2.4% service gross margin in the year-ago period. Our service gross margins have improved year-over-year primarily as a result of our focus on reducing service-related expenses through quality improvement and personnel training, higher revenue from upgrades, and a growing installed base.

The blended gross margin for the fourth quarter decreased slightly versus Q3 from 44.2% to 44.1%, which is a result of the higher product gross margin being offset by the greater proportion of service as a percentage of overall revenue. Our blended gross margin improved by nearly 16 percentage points compared to the fourth quarter 2006 gross margin of 28.2%.

Total operating expenses for the fourth quarter totaled $16 million on a GAAP basis compared to $15.4 million in the third quarter and $19.1 million for the same period a year ago. The sequential increase was due primarily to a true-up adjustment of approximately $400,000 towards the estimated pension obligation of the Company's sales office in Taiwan.

The Company had been contributing at the minimal required rates historically. To a lesser degree, other factors contributing to the increase were slightly higher legal and audit fees, an increase in executive salary expense, as well as higher stock-based compensation expense. The decrease in operating expenses versus the year-ago period was due primarily to the consolidation of our facilities around the globe, the completion of the integration of our mergers, and reduced legal and audit expenses.

We experienced some operating loss of $1.3 million in Q4 after generating a GAAP operating profit of $1.7 million in the third quarter 2007 and an operating loss of $12 million in the year-ago period. The fourth-quarter operating loss includes non-cash charges of approximately $1.3 million in amortization of intangibles and $1 million in stock-based compensation. Excluding these charges we generated operating income of $1 million in the quarter.

Our net loss for the fourth quarter was $1.3 million, compared to a net profit of $2 million in the third quarter and a net loss of $12.1 million in the year ago period. For the fourth quarter, revenues were divided by channels as follows. Stand-alone metrology, $16.8 million, 51%; integrated metrology $5.9 million, 18%; materials characterization, $4.8 million, 14%; service revenues, $5.7 million, 17%.

Revenues were divided geographically as follows. North America, $12.6 million, 38%; Japan, $8.9 million, 27%; Korea, $4.5 million, 13%; Taiwan, $3.9 million, 12%; and the rest of the world, $3.2 million, 10%.

We had three customers representing greater than 10% of our revenues during Q4. Toshiba at 15%; Samsung at 14%; and Western Digital at 12%. Stock-based compensation expense for the quarter includes $138,000 in cost of net revenue, $242,000 in R&D expense, $176,000 in selling expense, and $463,000 in G&A expense. Our headcount increased slightly in Q4 from 519 at September 29th to 523 at December 29th, primarily due to the conversion of contract employees to full-time employees. The net increase in headcount as of year-end is before the 7% work reduction announced January 9th of this year. We expect to realize cost savings resulting from the work force reduction in the second quarter of this year.

A few quick aspects of the balance sheet are as follows. Cash at December 29th of $14.9 million, a slight increase compared to our cash balance at September 29th. Our accounts receivables stand at $34.9 million compared to $34.2 million at the end of Q3, therefore resulting in DSOs of 95 days. The higher level of receivables was primarily due to a longer collection period offered to two of our largest Asian customers for shipments in the third quarter of 2007. The balances have been collected in Q1 to date.

Inventory levels were roughly flat at $33.3 million with inventory turns at 2.2 times for the quarter. Inventory levels remained high, relative to our revenue levels as we experienced push-outs from our customers from Q4 into 2008. Our prepaids were partially offset by other current liabilities, due to a consumption tax refund. The net effect was an increase in cash of approximately $400,000. We also used $500,000 of cash for share repurchases which included 65,000 shares in Q4.

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

(OPERATOR INSTRUCTIONS). Gary Hsueh of Oppenheimer.

Quick question here. Exactly how much pushed out from the December quarter in terms of shipments into the second half of '08? Are we talking something like $2 million or $10 million? Can you try and help give us a sense of the magnitude of these push-outs?

The push-outs will go into Q1 and Q2 and I really can't comment exactly as to the amounts at this point in time. But (multiple speakers) push-outs going into Q1 and Q2.

I just noticed that the North America book-to-bill data suggested that bookings were actually up sequentially in the December quarter versus the September quarter by the tune of 5 to 10%. Let's call it 7%.

If that were to apply to you guys, I think that the shipment that you would recognize would be somewhere in the single digit range. I mean just wondering if that's kind of right ballpark or if this number is a lot bigger than I'm thinking?

That's not a bad assumption. I think if you look, we had our businesses in the North America region quarter on quarter which was nominally flat and you'll see that some of the areas in Asia-Pacific where some of the push-outs that we experienced occurred are where the adjustments were in the actual revenues.

Okay. And just kind of bigger picture, stock has already kind of traded down to the $5.00 range. Clearly we are already discounting a significant kind of CapEx correction year in '08, so I think we've got that part figured out. What I'm trying to understand here is just your materials characterization business for the full year in '07? And how you think the different buckets within your materials characterization business could grow in '08? Sort of you know bucking the trend in semis.

I'm just wondering, to start off, if we could kind of get materials characters broken out by solar (inaudible) LED and maybe [platters] in '07 and how that might trend in '08?

We don't provide that much granularity on materials characterization. We have experienced a nice increase in the number of inquiries and actually some of the sales, particularly in the solar global (inaudible), but the materials characterization represents somewhere between 20, 25% of our business, and continues to be somewhat insulated as I said against the pricing swings that the chip industry has seen -- particularly in the memory market.

One last question and I might just requeue. In terms of your movement to a distributor in Japan, how will that impact margins in your materials characterization business in '08 compared to '07?

We actually by the time you take into considering the selling costs, our margins should -- will hold well, in particular our net margins that distributors also have been our outsource manufacturer; and so the relationship with them is actually a long and established one that we have.

Weston Twigg. Pacific Crest.

Just wanted to follow up real quickly on the materials characterization piece. Unless I missed it, it sounded like there was only around $4.8 million this quarter or 14% of revenues. Which actually would be down from last quarter. You're talking about it sort of being less cyclical in semis and an area of strength for the Company. Can you --?

Could you speak up a little bit? You're barely coming through.

I just wanted to go back to materials characterization piece. It looks like -- if I heard it correctly -- it was around 14% of revenues this quarter down from around 25% last quarter which would have been around, I guess, $5 million this quarter. Just wondering why the materials characterization is down when you are talking about it being more of a noncyclical or non semi-related business that is showing strength right now?

Just a moment. We are trying to sort out the question. In terms of total revenues for the materials characterization, as a percentage of revenues we went from 25% to 20% in materials characterization.

20%. Maybe I misheard.

Against total product revenues as opposed to the total revenues.

But that would still be down quarter-over-quarter, right?

Yes, I think the point here is two things that occurred. One is that it's still a relatively small number, so one system, one to two systems of our higher end system can cause a pretty significant swings in that number because of the granularity and we actually did have a light supply issue that caused that to shift one of the tools from Q4 into Q1 that was more of our ability to deliver than it was for the customer to take receipt of it.

Looking ahead into Q2, would you expect materials characterization business to be at the same level as Q4? Or come back to maybe more of a Q3 level?

I expect some growth in materials characterization in Q1. Or Q4.

Also I was looking at just the other income. I think maybe you touched on this a little bit, but just -- it was down pretty substantially from last quarter and I was wondering why that was? And maybe how we should look at other income moving forward?

I've got other income ended up at $38,000. In Q3, we had other income at $395,000. And that was down. That was primarily down to -- because of the foreign exchange loss that we saw and foreign exchange gain that was there. And that's now been reduced in Q4.

Okay. Just another question, if there's time here. On the service organization, just trying to reconcile how you can increase your revenue on the service organization, but lower your service margins. What happened during the quarter that would account for a lower service gross margin?

It's more of a story of what happened in Q3. In Q3 -- we have an upgrade part of our business that is attributed to service revenues and we had some nice upgrade business in Q3 which represents very high margin business for us and we [didn't] have quite the same level of upgrade in Q4. And so the margins (inaudible) reflective of direct service -- or strength service as opposed to upgrade supported service.

(OPERATOR INSTRUCTIONS). [Michael Amari] of [M. Amari Co.] Incorporated.

Could you please tell me, could you update me on the buyback? Are you still authorized to buy back and did you buy back anything in the first quarter?

We are authorized to continue buying back stock up to $4 million during open trading windows. We've bought back about $750,000 worth of stock so far and we have not been buying back in Q1 to date because we've been during -- it's been our blackout period.

But, basically, you think the price of the stock is quite low, quite adequate to start buying around $5.50.

I have another comment. On January 10th, you came out with that announcement to cut 7% of the jobs. You left that announcement so vague that because we didn't have any guidance for the fourth quarter, the stock market thought that you're just going to do real bad because of the change in softness that you referred to.

It feels to me it seems like if you were to give a guidance would be a lot better than leave the market uncertain in such a way where the market gets cut and went the stock market (inaudible) cut the stock price in half because of that four line statement saying we -- maybe it is prudent to cut 7% because of the softness. It left us in such a way where we didn't know how bad the situation is.

So it seems like sometimes if you spend a little bit more time in giving guidance or giving an announcement that's clear, that it wouldn't have such a debacle. For people that own the stock that is very hurtful.

We are not talking here about analysts, we're talking about investors that see their stock go from $9 to $5 in a day because of a very vague announcement.

I feel that area should be a little bit addressed.

I understand the comment. We are absolutely focused on doing what we believe is right for the business over the long term and we believe that the steps we took were correct. Because we don't give guidance, we couldn't make that -- change that press release in any way along the lines that you suggested, but I do understand your thoughts. And it is something that we continue to consider as we focus on our operations.

That's great. I appreciate that. But you feel that this coming year you should be better generally? I mean you're not giving guidance, but are you positive for 2008?

I think the way we look at it, we feel very good about our competitive position, our market position. And as we look back to last year, we outperformed our sector, both on a full-year basis as well, first half to second half. And we expect to equal or outperform the sector average revenue guidance that our peers are currently providing.

Well, you actually -- the fourth quarter wasn't bad at all. I mean when you write that announcement that you are experiencing softness, etc., one would have thought that you're going to be having terrific loss. Actually you had a positive cash flow and you did well.

I mean you had 1.3 million loss, but that was non-cash basically. So I don't see why this announcement has killed the stock entirely. I don't know. The impact of that announcement was really very negative. Maybe it's the market, but I'm not sure.

I appreciate if you can think about put more thought before you put announcements like that in the future.

I will take your comments seriously. Thank you.

Weston Twigg. Pacific Crest.

Just wondering if you could break down for me, your end market in terms of DRAM, NAND, logic and foundry customers last quarter?

Yes we had -- our memory business represented about 55% of our total revenues was somewhere between 55 and 60% of that being in the NAND section. Foundry and logic represented about 25% and the balance was in the materials characterization.

Just kind of wondering also if I look at your earnings this quarter, strip out the amortization of intangibles which is how the street treats the same for (inaudible), it looks like you broke even this quarter at around $0.00 EPS. Just wondering once you complete your work force reduction and restructuring where would you expect that new breakeven point to be? I know you said 25 million, but would you expect it to drop right down to 25 million or be somewhere in between you know -- like you had, maybe the next quarter?

We believe we are going to reach the $25 million cash flow breakeven and as you know when you look at the non-cash items, the major ones, we have about $1.3 million in amortization of intangibles. We have about $1 million a quarter in stock-based comp and we have about $1 million of depreciation.

And you talked about -- previously, at one point -- talked about getting little over 50% gross margin, around 53% gross margin and getting to that this year. What type of revenue level do you think you'd need to achieve that gross margin? 53%.

We -- if they are severe, Wes, if there's huge swings in revenue it certainly would impact our ability to hit all of our margins, but if you look at our performance over this quarter, we actually had down revenues and up gross margin. So we are pretty confident we can achieve the goal. Our (inaudible) margin did increase by 2% in the quarter and we did generate the profits from our service business where there's still upside and opportunity to improve those gross margins specifically.

So I think that it's going to take a lot of work. It is not going to be an easy path, but I think we understand how to do that. We are pretty excited about the products that we will be introducing which will have value-based pricing, which will also help us in our margin growth.

Just a couple more quick questions. Your top customers, 3 greater than 10% customers. Do you expect those to remain the same this quarter?

We obviously don't speak specifically of any customers. We feel pretty comfortable with the ones that have been consistently above 10%. With the newest one being in the WD, that's a pretty new win and a new embracing of [this] technology. So we would have to say whether or not there's a long-term trend on that one.

Also just wondering, can you just give us a little bit sort of your view on the current market conditions and how you see it playing out through 2008?

You want my flavor compared to everyone else's?

Yes.

It clearly -- there's -- when we meet with our customers as you do when you do your own channel check, there's a continual demand for more chips. When we meet with the fab managers they are chomping at the bit to expand production. When we meet with the process developers, they are pushing really hard to get into the next technology node which is necessary to increase the chip density on the wafers. And then when we talk to the economists, they are holding the purse strings pretty tight.

So I think that when there's -- my feeling is that when there's a little more comfort in the kind of the global economic environment and a little stabilization on the memory pricing, I think that some of those budgets that weren't spent in 2007 and are being held up to 2008 will start to be released.

That helps. I think that's it for me.

There are no further questions in the queue at this time.

Thank you for joining us today. We look forward to updating you on our Q1 results at our next conference call. Goodbye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.