Onto Innovation Inc (ONTO) 2010 Q2 法說會逐字稿

Good afternoon and welcome to Nanometrics' second quarter 2010 financial results conference call. A Q&A session will be held at the end of the call. Until that time, all participants are in a listen-only mode. Please note that this conference is being recorded August 5, 2010. At this time I would like to turn the call over to Claire McAdams, Investor Relations Counsel for Nanometrics. Please go ahead.

Thank you and good afternoon everyone. Welcome to the Nanometrics second quarter 2010 financial results conference call. On today's call are Dr. Timothy Stultz, President and Chief Executive Officer and Jim Moniz, Chief Financial Officer.

Before we get started, I would like to call your attention to the following Safe Harbor statement. This conference call contains certain forward-looking statements including, but not limited to, statements regarding Nanometrics' expected results for its most recently completed fiscal year, which remain subject to adjustment in connection with the preparation of its financial statement and periodic report on Form 10-Q for the quarter ended July 3, 2010, the continued adoption and competitiveness of its products, the expansion of the Company's served markets and future revenue growth, profitability and cash flow.

Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of risks, including slower than anticipated market adoption, a contraction in current levels of industry spending, and the additional risk factors and cautionary statements set forth in the Company's Form 10-K for fiscal year 2009, as well as other periodic reports filed with the SEC from time to time. Nanometrics disclaims any obligation to update information contained in any forward-looking statement.

I will now turn the call over to Tim Stultz. Tim?

Thank you Claire. Good afternoon everyone and thank you for joining us today. In my remarks today, I will discuss the financial and business highlights for the quarter, our view of the current and near-term industry environment and give some perspective on our business outlook for the next few quarters. Jim Moniz will provide a closer review of our financial results following my prepared remarks.

By any measure, the second quarter of 2010 was the best quarter in Nanometrics' 35-year history. During the quarter we posted record revenues of over $50 million, had our fifth sequential quarter of product margin improvement and delivered record high, industry-leading operating profitability.

Financial highlights for the quarter include revenues of $51 million, a 37% growth over the previous quarter and 250% growth year-over-year; gross margin of 55%; operating margin of 25%; earnings of $0.51 per share; and $14 million in cash generation from our P&L which increased our cash balance by $9 million after investments and working capital.

The IC industry is experiencing huge bit growth in chip demand, largely driven by worldwide consumer spending and the world's leading chip companies are aggressively investing to address this market demand. Although we are clearly benefiting from an overall increase in semiconductor capital spending. The real driving force behind our above average performance is the growing importance and investment in process control metrology and increasing adoption of Nanometrics' leading edge tools that serve the critical growth markets of optical critical dimension or OCD, overlay, wafer scale packaging and high-brightness LEDs. Our growth in each of these served areas is a direct result of our marketing and engineering teams working closely with our customers to define and develop differentiated products and technologies that solve tough technical challenges and enable those leading companies to meet their business objectives. The success of those collaborative efforts is reflected in our numerous Tool of Record designations, strong performance and sales pipeline.

Going back to our quarterly results, I would like to highlight some important trends that have begun to emerge, strengthening the overall health and outlook for our business. The second quarter was notable as to the level of revenue, but it was also distinguished by the quality and diversity of our revenue base. Over the last few quarters we have commented on our growing business within the memory and logic sectors of the semiconductor industry. As reported, we have had a high concentration of revenues with two major customers; Intel and Samsung and from two geographic regions; North America and South Korea.

Whereas that business continues to be strong for us, this quarter we reported a third customer that contributed more than 10% to our revenues which was Hynix. In addition we added three countries; Japan, Taiwan and China as regions that each generated at least 10% of our business in the second quarter. These results reflect a growing adoption of our products by a broader customer base over expanded geographic regions and a healthy reduction in revenue concentration.

Keeping with the quality of revenue theme, I would also like to speak to our product mix. Our flagship product to the semiconductor industry is the Atlas thin film OCD system which achieved revenue growth of nearly 30% quarter-on-quarter, however many of our other products either met or exceeded that level of growth, including our overlay, integrated metrology and materials characterization products. Of particular note, our materials characterization business grew more than 50% this quarter, about two-thirds of its revenue coming from the LED industry and our Unifier product has continued to gain traction in the advanced wafer scale packaging and data storage markets.

These growing contributions to our overall business by product, customer, geography and markets served are meaningful indicators of the breadth of our competitive progress and the success we are beginning to realize in expanding our business base.

I would like now to speak briefly to the subject of guidance and in particular our business model. Over the last several years, we have elected not to give quarterly guidance regarding bookings, revenues and profitability. We have repeatedly pointed out that first, we serve in an inelastic market and we have no meaningful ability to control or smooth our customers' capital spending. Second, we are confident in our products and competitiveness and thus our ability to outperform the overall industry. And third, we believe it is fundamental to long-term value creation to be able to run our business without short-term pressures such as pricey concessions or other actions which come at the expense of our business model simply in order to meet or beat guidance.

We have however, been very consistent in providing specific guidance in the form of our business model, which is the internal yardstick whereby we measure ourselves. We do this because we feel our shareholders should know what our goals and expectations are.

In January 2009, we published a revenue volume based business model that illustrated both our breakeven revenue level in the downturn as well as our operating leverage in an upturn. The model defined our product, service and operating margin targets for various revenue levels up to five times or then current quarterly run rate. This model has been continuously available on our website since we introduced it and it includes targets of 54% gross margin and 25% GAAP operating margin on $50 million in revenues.

This quarter we exceeded those performance metrics. We believe this is solid evidence that we understand our business, have a motivated team that competently manages and controls what we can control and that we know how to compete and execute.

Looking forward, we see the business environment remaining favorable. Semiconductor demand remains strong, fueled by growth in sales of all manner of new electronic devices, increased digital content in consumer products and the need to invest in business and industrial IT infrastructure. We see overall business for well positioned capital equipment suppliers in the second half of 2010 to be stronger than in the first half of the year. We also believe, barring offsetting external economic events that semiconductor capital equipment investments will further grow in 2011, driven largely by new fab toolings and capacity ramps.

These trends should be favorable to us and lead to further growth, as we benefit from expected fan-outs of tool-of-record designations over multiple fab sights. Incremental contribution of leading chip companies that haven't started to spend capital in a meaningful way, strengthening contribution of our integrated metrology business, continued growth in our materials characterization and LED business, and growth expected for advanced wafer scale packaging applications.

So our bottom line message today is that with the operating performance we are currently demonstrating, the strength of our competitive position and the growth of our served markets, we believe we are well positioned to continue growing while outperforming the overall industry. We are encouraged with our progress to date. We know we can do even better and we are fully committed to delivering growth and earnings performance consistent with the levels you expect from the industry leaders.

I will now turn the call over to Jim Moniz, who will review our financial results in more detail. Jim.

Thank you Tim and good afternoon everyone. Nanometrics' press release containing second quarter fiscal 2010 results was sent out by Business Wire today, August 5th around 1 p.m. Pacific Time. The press release may also be found on our website at Nanometrics.com. In our release and on our website are reconciliations to non-GAAP operating income, which is management's measure of cash flow generation from the P&L. That being said, all the figures referred to in my comments are GAAP unless otherwise noted.

Second quarter revenues of $50.8 million were up 37% from the previous quarter and were up 250% from the second quarter of fiscal year 2009. Product revenues of $43.4 million increased 52% quarter on quarter and 450% year on year. Service revenues, which include both upgrade and core service revenues, were $7.4 million, down 14% from $8.6 million in the prior quarter, and up 12% from $6.6 million in the second quarter of fiscal year 2009.

As Tim mentioned, we saw stronger demand from customers worldwide. Revenue by geographic region is based upon the shipped-to or first-in-use destination and during the quarter, the breakdown was US at 42%; South Korea at 22%; Japan at 13%; Taiwan at 10%; China at 10%; and the rest of world at 3%. Revenue by product type was automated and integrated metrology at 72%; service and upgrades at 15%; and materials characterization at 13%.

Gross margin in the second quarter was 55.1% compared to 55.3% in the previous quarter and 41.4% in the second quarter of fiscal year 2009. Product gross margin increased to 57.6% compared to 56.3% in the prior quarter. Service gross margin came in at 40.5% in Q2 compared to 51.9% in the prior quarter, reflecting a lower mix of technology upgrades.

Total operating expenses in the second quarter came in at $15.1 million, which was $0.5 million, or 4% above the prior quarter. This increase was driven primarily from the higher sales volume.

Operating income was $12.9 million in Q2 compared with $5.9 million in the prior quarter and an operating loss of $6.5 million in the second quarter of 2009. Our operating margin was 25% and as Tim commented in his remarks, was right in line with our target business model that we have shared with you over the past six quarters. Our non-GAAP operating income, which excludes non-cash and non-recurring expenses, was $15.6 million compared to $8.7 million in the prior quarter and a non-GAAP operating loss of $2.3 million in the second quarter of 2009.

Net interest and other expense in the second quarter was a net expense of $0.1 million, which compares to the prior quarter's net benefit of $0.1 million. Net income for the second quarter was $11.6 million, or $0.51 per share on a weighted average share count of 22.8 million shares.

Turning to the balance sheet, cash came in at $54.9 million, an increase of $9.7 million above the previous quarter. This was another quarter of very strong performance and cash generation and reflects over $14 million in cash generated from the P&L, less investments in working capital and a $1.4 million payment made to Zygo.

Accounts receivable came in at $35 million, which was up $9 million from last quarter, driven by higher revenues. DSO is at 62 days, which is down slightly from last quarter's DSO of 63 days. Inventory came in at $34.8 million, which was down $0.9 million from the prior quarter. Inventory turns increased to 2.6 times from 1.9 times in the previous quarter.

I would like to make a comment on the mortgage financing we obtained on our Milpitas headquarters two years ago. We ended the June quarter with a balance due of $12.9 million. With our current stronger cash position and with our continued focus on increased cash generation from operations, we decided to make a partial pay-down of the mortgage right after the end of the second quarter. We paid down 20% of the outstanding amount, or $2.6 million, which is the maximum amount we could pay without penalties. This has the effect of reducing our annual interest payment by $200,000 per year.

Our tangible book value at the end of Q2 was $121 million or approximately $5.50 per share. Finally, we ended the June quarter with headcount of 424 employees, a net increase of 19 from last quarter end.

That concludes our prepared remarks and now I would like to open up the call for your questions.

(Operator instructions) Our first question is from Gary Hsueh with Oppenheimer.

Tim, if there's one thing that we've kind of seen through earnings season this quarter is that there's definitely an increased sort of focus on chip makers on metrology, as you said, to get them to the next technology node. We've seen pretty big order increases in metrology from KLA, Nova and Rudolph and everybody seems to be pointing at share gains in the thin film side. Can you walk us through what the competitive environment for thin film, particularly OCD is right now on a standalone basis and where NANO can continue to gain share and offset any kind of losses here and there in the second half and into 2011? And I've got a few more follow-ups.

Thanks for calling in. Let me see if I can try to respond; there were several elements to your question. I think the general nature of it is that with everybody claiming market share gains how does that add up. Our revenue numbers, our growth rates in particular in metrology as compared to any other metrology provider, is superior to their growth rates and I think that the map speaks to itself with regard to market share, market share opportunities. We're all benefiting from increased investment in process control. We individually are benefiting from an expanding number of applications for optical critical dimension which is now displacing CD SEMs and as well as other more traditional thin film metrology. And then we're getting some nice contribution from the capacity driven integrated metrology OCD applications as well as, as we mentioned, wafer scale packaging and high-brightness LED.

Great. One thing that we had heard based on some industry checks is that you guys had struggled a little bit maybe in the middle of the year with tool to tool matching; is that still the case and where are we in terms of reliability of your tools at customer sites?

I appreciate you bringing that up. I would like to make a couple of straightforward statements. The first thing is that we have not lost any business that we have won, nor our position with any key customer. I think that there is some inconsistency or inaccuracy in some of the models that might exist out there, but the most important thing is that any assertion that we have a performance issue that impacted either our near-term or long-term business opportunity with any account, in particular 22-nanometer position is categorically incorrect. Our outlook today is as good, in fact it's greater at all of our advanced node companies than it was a quarter ago.

Tim, you made a comment about integrated metrology, you guys haven't spoken about integrated metrology in a long time. What's happening there and specific to the model and the target model, any kind of negative impact to that? Is integrated metrology these days more of a direct business or is it still behind the veil of semi-cap equipment OEMs?

What's happening there, and specific to the model -- in the target model? Any kind of negative impact to that? Is this integrated metrology these days more of a direct business or is it still behind the veil of semi-cap equipment and OEMs?

That's a good question, Gary. We've been working pretty hard over the last couple of years to modify our model to do more of a direct sale, direct support for a number of reasons. One is, it shores up our margins because there's little less margin sharing. But most importantly, it brings us closer to the customer and allows us to hold ourselves personally accountable for customer satisfaction and performance of the tools.

So more of our revenue recognition for integrated metrology is actually a result of direct sales through. And that business is starting to pick up very nicely. It's actually very robust growth, primarily drive by capacity expansion at some of our accounts where we are the tool of record.

Last question from me for Jim. Jim, just a real small thing here. On the balance sheet, I noticed that the long-term deferred revenue account has gone up again in the June quarter. And it was up from the March quarter. Is that one tool? And specifically what application is that for? Is that for the fraction-based overlay? Any kind of light you could shed there would be helpful. That would be great. Thank you.

Okay Gary. Thanks for the question. And actually, the deferred revenue, almost the total amount of the deferred revenue, and especially all of the deferred revenue that's in the long-term section of the balance sheet, is service-related revenue. There's no tools in that revenue at all. It's all long-term service contracts where customers who have purchased tools also have long-term service agreements with us.

Okay. Got it. Thank you so much.

Our next question is from Mahesh Sanganeria of RBC Capital Markets. Your line is open.

Congratulations on very, very good results, Tim. First question, was the revenue you reported, 25% above censuses, was that your expectation going into the quarter or there was surprise as you went along or whatever you can add? Maybe comment on what was the linearity of that upside if there was any.

Mahesh, thanks for calling in. Actually, it's kind of split. Our expectations going into the quarter were higher than the general consensus. But the net result was actually higher than we had originally expected going into the quarter. We're seeing a lot of aggressive advance investment in the equipment and our customers are asking for shorter lead times in order to meet their ramping and their technology-node investments. So, we just saw that there was a lot more demand to deliver tools with a shorter lead time and we've done our absolute best to meet the requirements for our customers so they can stay on track.

Okay. So the other question, one of your bigger customers seems like they have been investing very heavily on the DRAM side and then moving more towards the foundry side, the same customer moving more of their dollars to foundry side and the NAND side. As that mix changes, does your exposure to that top customer in NAND, DRAM and logic side, do you have a different exposure or you will see a change because of this change in the investment pattern?

I think you're probably referring to the investment pattern of Samsung. And our experience is that they've been very aggressive in their DRAM investment for several quarters. And there was initially a shift -- we saw a shift in their general investing patterns towards some of their foundry business, driven a little bit by the Apple chips, in fact. But more recently we're seeing a shift on that back into the memory side, at least discussions with that customer as well as our observations of the reports, that the pullback in memory spending that looked like it was being diverted to foundry, is actually being pushed back into some of the memory spending. And we expect to see some nice business out of them going forward.

Okay. So the other thing you talked about was that you see the second half higher than the first half. But is it still your expectation that business can continue to grow from here? Because second half higher than first half can mean multiple things. I just want to see if you can give us some help in modeling those quarters, coming off of such a strong quarter. I mean, it's hard to see that you can continue to grow for the next couple of quarters. If you can provide some help on that, that would be good.

Okay, well obviously I'm not going to let you corner me into giving you specific guidance on us, but I would like to try to answer that by talking about what we're seeing in the business environment.

What we're seeing in the business environment, capital spending backed up by the fact that there's still a number of companies that are just coming on line, such as Toshiba has yet to really make any serious large-scale investments. Some of the Micron activities are starting to pick up. Hynix has certainly started to participate. But you also have some additional tools spending coming out of Inotera, Nanya, [Smik] and so on.

I think that you're starting to see the other large companies as well as second-tier companies, picking up spending. Add that to the fact that there's somewhere between 12 and 15 fabs, certainly not all of them are greenfield, but 10 to 15 fabs that have been announced that need tooling. I feel pretty bullish on overall capital spending for those companies that are positioned with those products that enable. So think that that favors areas such as lithography. I think it favors areas such as CNP. I think it particularly favors areas such as process control, where you're trying to improve yields, get more working dye out the wafer. And I think companies that have a product of record position, and have that type of tool should be able to enjoy continued growth in the rest of the year.

Thank you, Tim. That's very helpful.

Thank you. Our next question is from Weston Twigg of Pacific Crest Securities. Your line is open.

I was just kind of wondering on the OCD side, if you could maybe explain in a little bit more detail about what some of the new applications and opportunities are and how much you think the TAM actually grows for OCD over the next couple of years?

Well, I think we've spoken to this on a number of occasions. So when we look at OCD, I think one of the unfortunate, almost misinformation is to call it optical critical dimension, because the application is much more broadly based and profound in terms of use in process control metrology. It clearly is displacing CD SEMs. And I think many people have spoken to that for technology limitation reasons with regard to the CD SEM.

But as we look at what an OCD platform can do by combining reflectometry and ellipsometry, scatterometry, you're able to collect three-dimensional information on multiple components or features within a single measurement in less than a second. So you're looking at films, you're looking at walls and slopes, you're looking at pitch, you're looking at wall angles. And all of those are falling under what we call optical critical dimension.

Optical critical dimension is also, in that core technology, is now starting to address the overlay market to compliment the imaged-based overlay which has been the more traditional tool. So our CD as a platform is really an optical metrology platform that is growing of its own accord, displacing some other technologies and also being used in some areas that hadn't been explored previously.

So that's great. I'm just wondering how much is the growth opportunity for OCD in terms of TAM expansion over the next two years?

Wes, I don't have that percentage growth right in front of me. It's an area that is clearly outgrowing all other areas, in our opinion, in process control.

One of the more difficult issues as we start to look at say the different analyst reports or industry reports, is what is captured under the OCD banner. We measure thin films and that's still with an OCD platform. We measure critical measures of OCD platform. And so it's really difficult for us to quantify in a defensible way what that is. But I think that when you start to consolidate all the opportunities and applications that OCD can address, you're probably looking at 40 to 50% growth in the TAM, for that technology.

Okay great. And then just along the same lines, can you explain to us again maybe how your platform is a little bit differentiated from the competition?

Well, we have a number of ways. I mean, the first one is if you look at how you compete, you compete in a series of steps and the first one is always technical. But what you're finding in a competitive environment is that it's less dependent on the hardware and much more dependent on the intellectual property that is contained within the software that's used for analysis, modeling, yield management and yield control, and process control.

So, the key area of differentiation comes from the software, which is clearly proprietary to the company, which allows you to model complex devices with multiple free variables and do it rapidly, precisely and with repeatability. And that's usually the deciding point that comes into the OCD decision tree.

Okay. Just changing track a little bit here, I'm also wondering, it looks like foundries are spending a higher percentage of the capital equipment pie this year. And I'm wonder if that helps you in the same way it helps KLA Tencor, which has a higher percentage of sales to the foundries, and if there's maybe some opportunity to win some share in the foundry space?

So you've pushed your finger on our weak spot, right. So we've actually done quite well in the memory sector and the logic sector, but we have reported, you know, in previous calls, but one area that we do not have solid and robust representation is in our position within the foundry business, and obviously that's TSMC, GlobalFoundries, UMC. And those are all opportunities for us. You know, you have to turn something that's a negative into a positive. And for us, our absence of meaningful market shares are negative, but our strategic efforts to gain some market share is clearly an upside opportunity for us.

I guess they're saying they have opportunity there. Are you in active selections that could be finalized within the next 12 months for example?

We have a presence in any account, and basically all the accounts, with tools going through evaluation where the door is open to a competitive opportunity. Absolutely. And then we're using our strength in balance sheet and our resources, internal resources to try to gain market share in those areas.

Thank you very much.

Our next question is from Michael Amari of Amerco Incorporated. Your line is open.

Congratulations for a great quarter.

Thank you, Michael

I'm still kind of livid of what happened on July 16th when your stock was sent down to eight bucks. And you courageously came out with a statement saying that your business is good and everything is fine. I just want to make sure, I want to leave this to rest, that you have not lost any business to Intel, and you're not going to lose $0.40 in the coming year like some analysts, who are supposed to be a friend of the company, came out with an announcement that day. So I would like to know where you stand, and lay this to rest.

Okay Michael. I can't speak to any specific customer. And I tried to be clear at the beginning, we have not lost any business that we won. We have not had any performance issues that impacted in any way, negatively impacted in any way our near-term or long-term business. And our business with all of our customers, in particular with the advanced technology nodes, is stronger today than it was a quarter ago.

Well, let's put it another way. I know you mentioned that, but what kind of 10% customers do you have right now? What are your major customers right now, if you can speak to that?

Our three 10% customers this quarter were Samsung, Intel and Hynix.

Okay. Thank you. That should lay everything to rest. Thank you very much.

Our next question is from Paul Sweats of Capital Flows. Your line is open.

Congratulations on the quarter. Simple question. If the good results end up opening up a few more chits to add employees, what functional area would you focus on? Where do you need some shoring up?

That's a good question. Outside of kind of the obvious ones, which are to make sure that we have the manufacturing capacity to address the growth, I would like to take this moment to once again really commend my operations team. We grew from 37 million to 50 million and they met all the customer requirements and shipped without incident, which is just a terrific achievement on their behalf. They just did a great job.

But, as we look at our continued desire and direction of growth, you're going to see that we're going to want some technical support to add to our software area, our applications and modeling area, and some of our customer support areas, where we're putting more tools in because we have a growing installed base.

Thanks.

Our next question or comment is from Gus Richard of Piper Jaffray. Your line is open.

Hi everyone. It's actually Jen Baxter for Gus. Congratulations on the great quarter. I was actually wondering if you're seeing any supply constraints during the quarter?

No. Good question and that kind of goes back to what we mentioned earlier. We put a lot of energy over the last two years into having an outsourced model, developing our supply chain and also improving our capabilities and expertise in supply chain management, which we believe is a core competency that's necessary to address these ramps. Right now we feel very good. We stay very close to our suppliers and we haven't had anything that we couldn't respond to within the timeframe requested by our customers.

Great. Thanks a lot.

Thank you. And I'm showing no further questions or comments at this time. I would like to turn the conference over to Mr. Tim Stultz for any further remarks.

Thank you. In closing, we continue to be very confident and enthusiastic about the business and business opportunities for Nanometrics in the foreseeable future. We move forward with resolve to distinguish ourselves through management and execution and we are committed to delivering above-average performance and value to our shareholders.

Finally, I'm ever grateful to the terrific team of employees at Nanometrics, who continue to work tirelessly and with passion to grow a stronger and more competitive company and one that we are all very, very proud of. I want to thank all of your for joining our call and we look forward to updating you on our third quarter results in November.

Thank you. This concludes today's teleconference. You may now disconnect.