Onto Innovation Inc (ONTO) 2010 Q4 法說會逐字稿

Good afternoon and welcome to Nanometrics' fourth quarter and full year 2010 financial results conference call. A Q&A session will be held at the end of the call. Until that time, all participants will be in a listen-only mode. Please note that this conference call is being recorded today, February 10, 2011.

At this time, I would now like to turn the call over to Claire McAdams, Investor Relations Counsel for Nanometrics. Ma'am, you may begin.

Thank you and good afternoon, everyone. Welcome to the Nanometrics fourth quarter and full year 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 financial results for the Company's most recently completed fiscal quarter and full year, which remain subject to adjustment in connection with the preparation of our financial statements and periodic report on Form 10-K for fiscal year 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 factors, including a contraction in current levels of industry spending, shifts in the timing of customer orders and product shipments, slower-than-anticipated market adoption, changes in product mix, increased operating expenses, 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, and good afternoon, everyone, and thank you for joining us today. In my remarks this afternoon, I will discuss the business and financial highlights for the fourth quarter and fiscal year 2010 and our view of the current and near-term industry environment. Following that, Jim Moniz, our Chief Financial Officer, will provide a closer review of our financial performance, after which I will return to provide you with guidance for the forthcoming quarter.

It is with no small measure of pride that I am able to announce that Nanometrics just completed the best year in its 35-year history. Our record revenues of $188 million were up 145% versus 2009 and 29% higher than 2007, which was our previous record year and the last peak year in industry spending.

Of particular note, our year-on-year revenue growth significantly exceeded industry growth of approximately 100%, highlighting the progress we have made in strengthening our position with key customers, extending our served markets, and gaining market share.

We also have emerged as the market leader in optical critical dimension, or OCD, metrology, which we believe is the highest growth segment of inline process control metrology, as it systematically supplants the role of CD-SEM technology for the most advanced process nodes.

Our operating profitability of 22% was also a Company record. And likewise, net income and earnings per share for the year, even when we exclude the $18.2 million benefit recorded for the release of our tax asset valuation allowances, were also Company records.

While we did experience some shifts in the timing of orders and shipments in the fourth quarter, leading to a decline in revenues compared to our record $54 million third quarter, Q4 was still the third-best quarter in our history, with revenues up 75% year over year and 19% higher than the peak quarter of 2007.

Notably, the fourth quarter marked our sixth straight quarter of profitable operations, our sixth straight quarter of gross margins exceeding 50%, and our sixth straight quarter of positive cash flow, demonstrating continued strength in our business model and overall execution.

Taking a closer look at our fourth quarter business results, we experienced increased contributions and growth from our wafer scale packaging business unit, which serves a market that is experiencing high growth and increasing focus by nearly every major chip manufacturer; our materials characterization business unit, which includes high-brightness LED, solar photovoltaics, and bare silicon wafer metrology; and our integrated metrology business unit, which is largely driven by capacity spending and where we are gaining market share.

We also saw a shift in memory spending from DRAM to NAND as end market demand for Flash continues to grow. These are all favorable trends we expect to continue in the near future.

Turning to the demand side and industry trends going forward, it is pretty evident to industry observers that fundamental demand for digital content and solid state components is continuing to rise, driven by smart phones, tablets, IT spending, cloud computing, and network storage. In order to benefit from these trends and these highly competitive market price and performance requirements, our customers are focused on continuing to push technology through shrinks, increasing their yields, and developing new device architectures such as stacked 3D packaging.

Over the last couple of years, we have aligned our product development roadmaps with these customers and have strategically focused on the areas of process control that are increasingly crucial for the 3X, 2X, and 1X nodes. As evidenced by our series of competitive wins, such as our recently announced tool of record selection by a major Japanese semiconductor company for our suite of OCD products, we have emerged as a critical and leading supplier to the majority of the world's leading device manufacturers.

From a more macro view, I'd like to help put the phenomenal industry growth in 2010 into perspective. Even though industry investment in capital equipment roughly doubled over 2009 levels, we still have not returned to the levels of spending and capital intensity seen in 2006 and 2007. The vast majority of industry analysts predict 2011 will be another growth year for semiconductor capital spending, in the range of 10% to 15%. This view is supported by recent CapEx forecasts provided by a number of the world's leading chip companies.

Our current perspective is consistent with those estimates, and thus our outlook for 2011 is quite optimistic. We have consistently emphasized our objective to outperform the overall industry. In 2010, we clearly achieved that goal. As we enter 2011, we believe we will be able to continue to outperform the industry, leveraging our improved competitive position to benefit from the increasing adoption of OCD for thin film and critical dimension applications, expanding implementation of wafer scale packaging and 3D device architectures, and growth in adjacent markets such as high-brightness LED, solar, and bare wafer metrology.

All taken, and barring a global economic dislocation, we expect these factors, combined with execution and operational excellence, will lead to another year of solid growth for Nanometrics in 2011.

I will now turn the conference over to Jim, who will provide you with details on our financial performance, following which I will return to give next quarter guidance. Jim?

Thank you, Tim, and good afternoon, everyone. Nanometrics' press release containing our fiscal fourth quarter and full year 2010 results was sent out by Business Wire today, February 10, around 1.30 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.

Starting off with a review of the full year, 2010 was the strongest year in the Company history. Record revenues of $188.1 million were up 145% compared to $76.7 million in fiscal 2009. Our gross margin increased from 47.1% to 54.4%, and notably, our product gross margin increased from 45.9% to 57% for the year.

In support of this strong growth, our operating expenses, net of impairment and restructuring charges, increased by just 30% year over year. The result was record operating profitability, with record income from operations of $41.3 million and record operating profit of 22%.

2010 was also a record earnings year. We recorded net income of $55.9 million, or $2.43 per share. This includes the release of a tax valuation allowance in the fourth quarter in the amount of $18.2 million, equivalent to $0.79 per share. On the balance sheet, we increased cash and investments by $22.9 million in 2010, ending the year with $66.5 million, or approximately $3.00 per share, up from $2.00 per share at the end of 2009. Our tangible book value per share increased to $7.38 per share, up from $4.64 per share last year.

Now I will provide more detail on our fourth quarter results. Fourth quarter revenues of $46.1 million were down 14% from the previous quarter and were up 75% from the fourth quarter of 2009. Product revenues, up $38.2 million, decreased 14% quarter on quarter but increased 91% year on year. The sequential decline in product revenues was primarily due to a reduced level of sales to our logic and data storage customers in the fourth quarter.

Service revenues of $7.9 million, down 17% from $9.5 million in the prior quarter and up 26% compared to the fourth quarter of 2009. Revenues for both upgrades and core service declined sequentially, largely driven by a lower level of upgrade revenue and lower revenue from parts replacement sales in the field.

Fourth quarter revenues broke out as follows. Revenue by geographic region is based upon the ship-to or first-in-use destination, and during the quarter the breakdown was South Korea at 29%, US at 17%, Japan at 14%, Singapore at 12%, Taiwan at 10%, and rest of world at 18%. Revenue by product type was automated metrology at 46%, materials characterization at 20%, integrated metrology at 17%, and service and upgrades at 17%.

Gross margin in the fourth quarter was 52.7%, declining from 54.5% in the third quarter as a result mainly of lower service margins. Product gross margins were 57% compared to 56.9% in the prior quarter and 53.3% in the fourth quarter of 2009. Service gross margins came in at 32.1% in Q4 compared to 43.6% in the prior quarter, reflecting lower revenues as well as continued investment in service personnel, gearing up for increased installation and support of systems in 2011.

Total operating expenses were $15.6 million, an increase of $100,000 over the prior quarter. We maintained tight control of expenses in response to the decrease in sales volume, yet still increased our investment in R&D by 6% over the third quarter.

Operating income was $8.7 million in Q4 compared with $13.8 million in the prior quarter and $0.7 million in the fourth quarter of 2009. Our operating margin was 18.8%.

Net interest and other expense in the fourth quarter was a net expense of $0.2 million, which compares to the prior quarter's net expense of $0.4 million and net expenses of $1.1 million in the year-ago period.

Before I get to net income, let me explain the release of our valuation allowance appearing as a favorable adjustment to our income tax expense. As a result of the amount of profit the Company achieved in 2010 and the expectations of continued profitability on an ongoing basis, management has concluded that it is more likely than not that we will realize the benefit of certain deferred tax assets. Therefore, we have recorded those deferred tax assets back onto our books by releasing the valuation allowance which we had been carrying against them.

The amount of this valuation allowance was $18.2 million, equivalent to an EPS benefit of $0.78 per share in the fourth quarter. Our GAAP EPS for the fourth quarter was $1.12 per share, including the benefit of releasing the valuation allowance that I just went over. This compares to net income of $0.53 per share in Q3 and a net loss of $0.02 per share in Q4 2009.

Because we have reversed the valuation allowance and we have also substantially used up in 2010 all of our NOLs, as we go into 2011, we are projecting a 35% tax rate, and we are currently evaluating restructuring changes that might enable us to reduce that rate in the future.

Now let me turn to the balance sheet. Cash came in at $66.5 million, an increase of $2.5 million above the previous quarter. This marked the sixth straight quarter of positive cash flow from operations. In November, we initiated a stock repurchase plan of $10 million, and in the fourth quarter, purchased and retired 65,000 shares, using about $0.8 million of that plan.

Accounts receivable of $44.5 million increased $2.8 million from last quarter, driven largely by our customers' end-of-year cash management practices. As a result, DSO is at 87 days, which is up from last quarter and above our target of 70 days. We expect this trend to reverse in the first quarter of 2011.

Inventory of $44.6 million was up $6.1 million from the prior quarter as we prepare for a strong ramp going into 2011. As a result, inventory turns of 2.0 were down from turns of 2.6 last quarter.

We ended the year with headcount of 456 employees, a net increase of 14 from last quarter end. Since year end 2009, headcount has increased by 57 employees, or by 14% for the year.

That concludes my prepared remarks, and now I would like to turn the call back to Tim.

Thank you, Jim. I'd like to make a couple of comments before giving you specific guidance on the quarter. In 2007, we made the decision to discontinue giving guidance based on a number of factors, not the least of which was our own uncertainty of our business outlook and our inconsistent business performance and execution. Underlying that decision was the strong belief that our focus needed to be on improving the fundamentals of our business with a long-term perspective for our stakeholders, and not to compromise those efforts for the sake of meeting short-term performance metrics. Our performance over the last two years has demonstrated this unwavering belief and focus.

Today we have a high degree of confidence in our ability to execute and a significantly improved position in relationship with the leading customers in our industry. Consequently, we have a much better visibility on our business outlook and feel comfortable sharing that with you.

But I must add an important caveat before going forward, and that is although we are initiating guidance, we will not alter the way we run the business. We will give you our best perspective of the near-term business outlook, and we will do our best to perform toward those levels, but we will not compromise our future growth or profitability simply to meet the guidance or consensus estimates.

There are occasions when, just as we saw at both year end of 2009 and 2010, our customers asked for commercial concessions in order to hasten tool delivery and revenue recognition within the quarter. We will continue to review these concessions in every case, irrespective of quarterly guidance. This is how we have run the business since 2007, and we firmly believe it is in the best interest of our shareholders to continue doing so going forward.

That being said, our outlook for Q1 is very strong. We see revenues growing more than 20% over Q4 levels, coming in between $56 million and $60 million, with gross margins of 54% to 55%. Operating expenses are expected to increase about $1.2 million in support of a higher sales volume and increased spending in R&D, as well as salary increases and beginning year payroll taxes.

With regard to Q1 earnings, we expect our operating income to be between 24% and 27%, and our earnings per share to be between $0.36 and $0.44 with a tax rate of 35%.

In conclusion, we are more confident and enthusiastic about our business and the business outlook for Nanometrics than ever before. With the improvements we have made to strengthen our product offerings, especially in OCD, advanced wafer scale packaging, and LEDs, our strong competitive position, our demonstrated ability to execute, and a positive outlook on industry fundamentals and spending, we are looking forward to setting new performance records in 2011.

With that, operator, we will now open up the line for questions.

Thank you. (Operator Instructions.) Weston Twigg, Pacific Crest.

I have a couple of questions here. One, I just wanted to get an idea on the 3D packaging opportunity in 2011 to 2012, wondering if you could maybe help size it in terms of revenue?

We're not ready to break that out yet in terms of sizes for you in absolute numbers. We've got some announced positions that I think you're aware of as tool of record with Intel, which actually was announced publicly by Zygo when it was first won. And we've got a number of new installations that we believe are going to lead to quite appreciable growth in that space.

When we start having consistent levels above the 10%, which is our nominal cutoff point, then we'll start breaking that out and sharing it with you in more detail.

Okay. On a related note, can you give us an update on how the UniFire business is ramping at the new foundry customer you announced in December?

I can just tell you that we've got tools in, signed off, applications being developed, and we expect follow-on orders accordingly.

Okay. Follow-on orders this year, probably?

Yes.

Okay. Also, earlier in the call, you said that you expected to outperform the industry this year. I know that historically your market share position in foundries has been a little bit light. Do you expect that share position to improve meaningfully this year to allow you to outperform the market?

Yes, that was really polite for you to say that our foundry position was light. It's actually been quite weak. But as I've announced over the last year or so, we've been using the strength of our balance sheet to put tools into the key accounts for evaluation in order to penetrate those markets. We've got some initial traction, and I believe that pretty soon we're going to be segmenting that and showing you the growth in a pretty appreciable way.

Okay. Would that be growth that would hit the top line in 2011, or would that be something a little bit further out, maybe 2012?

No, I think in 2011 it's going to be a nice contributor to our overall revenues and be above the 10% mark, which will allow us to share with you.

Okay, great. And then just one more question on upgrades. With the service line down $1.5 million this quarter, does that go back up in Q1? In other words, do you expect upgrades to pick back up in Q1?

Yes. As you know, for the last several years, our upgrades have been between $1.5 million and $2 million and up as high as $4 million and as low as $1 million and bouncing around about $1 million a pop. I think it will all average out. One time we shared that we thought that upgrades would be 7% or 8% of revenues. But the revenues have grown more than we had projected at that time, and I think that you're going to see upgrades leveling off right around 5% of the revenues going forward.

Okay, perfect. Thank you very much.

Gus Richard, Piper Jaffray.

Just following on to that question on service, what was upgrades in the fourth quarter?

We don't break that out, Gus. Thanks for calling, Gus. No, we don't break that out from the service.

Okay. And then the gross margins, clearly in the fourth quarter on the service side, came down. You indicated you hired a bunch of people, and the revenue there was a little bit lower. Should we expect service gross margins to stay in this low 30s, or will it creep back up into the 40s?

The decline in the margins really came from three areas. One is that we had lower upgrade revenues. We did front-end load some hiring to prepare for the ramp in 2011, because it takes anywhere from 3 to 6 months to properly train the folks that are going to be deployed on an international basis. And overall service revenues actually had declined, primarily on the parts side. I think that you'll see as the ramps go, then we'll do a better job of fully absorbing our service personnel, and we would expect some recovery in the overall service revenues on the parts side as well as on the upgrades.

Got it. And then just to be clear on the tax side, you basically had to take your reserve in the fourth quarter, giving you that pop in revenue. And then you've essentially taken off all your NOLs, and then going forward, we should assume a 35% tax rate. Is that correct?

Yes, Gus, that's correct. Just one clarification. When you said we took a pop in our revenues, we took a pop in the income because -- .

Income. Sorry, I misspoke.

No, no, I knew what you meant. So yes, that is correct, because we essentially now have determined that it's more likely than not that we'll continue the profitability. We had to reverse the valuation allowance and cume the benefit all at one time, which happened in Q4, and we're projecting right now 35% tax rate as we go into 2011.

Okay. And then just a couple product questions for me. Do you have a sense of what your market share is in CD-SEM and what the market size is in '10?

We have a sense, but I wouldn't tell you that we have that down to a science. It's a little hard, because the various analysts and reports don't really capture all the elements of OCD side by side in a self-consistent manner. We have shared some numbers on our IR presentation, showing there's been a change from the mid-teens of market share of OCD against CD-SEMs in the total CD market, growing up into like 30% to 35%. And we think that's going to continue to grow pretty substantially. We're seeing over 100% compound annual growth rate in the application space of OCD, which is coming largely at the expense of the CD-SEM market.

And then last one for me, just on the overlay market -- any update on how you're doing with your newer tools?

We've got some tools that we're taking in that we talked about, I think, last quarter. They're in place. They're tool of record. And we feel really good, but it's not as broad-based of a strength as we'd like to. There's some other accounts we're trying to get into with those. And we would like to get the tool of record position on the overlay in more locations. And that's another area of focus for us.

Okay, great. Thanks for taking my questions.

Patrick Ho, Stifel Nicolaus.

Thanks a lot and congratulations on a great quarter and a great year. Can you give a little bit of color on your progress with the foundry customer segment? And where I'm trying to get with that is you guys have made significant inroads in both logic as well as memory based on the node shrinks. Given some of the technology challenges that foundries have experienced, particularly over the last year to year and a half, how has that opened up some opportunities for you guys on a going-forward basis?

That's a good question, Patrick, and thanks for calling. As we've shared pretty consistently for the last several years, we've made good progress, as you point out, in logic and memory. But we really have not established a strong market-leading position in the foundry space, and it's a part that we've put a lot of energy into, in particular over the last year where we placed some tools, used our balance sheet, put some resources onsite to try to open those accounts.

The other part of that equation, besides trying to put our tools in, is to have a pull from the customer side. If they don't have a problem, they're willing to look at your tool, but they're not willing to buy a bunch of tools, and they're not willing to make a change. As the foundries are pushing down on the 2X nodes, they are running into some technology issues, as you point out. And it does open the door for us to demonstrate what we can do and how we compare vis a vis our competition. And so that's a crack we needed, and I think that that's going to play out nicely in 2011 and 2012.

Great. Thanks a lot, guys.

Graham Tanaka, Tanaka Capital Management.

Tim and Jim, congratulations. Just wondering how many evaluation tools you have out now, roughly, versus a year ago?

We don't count the total number of tools, but at last count, I think we had about $8 million in finished goods. The overwhelming majority of it was represented by tools that are installed in different locations.

And are they concentrated in any one particular type of IC manufacturing process or area?

They are all addressing -- well, I shouldn't say they all -- the overwhelming majority of them are addressing the 2X nodes, and the overwhelming majority of them are addressed at gate needs to the foundries, since we already have a pretty strong position in the memory and logic sites.

How about new product launches and revenue recognition? Is there anything in terms of lumpiness in revenue recognition versus shipments, either the recent quarter or a couple of quarters coming up?

No, that's a good question. Actually, I'll let Jim talk to you about rev rec and what we're doing there.

Okay, and then Tim could talk about product launches. But as you can imagine, rev rec is really, really important for an equipment manufacturer like us. And so we have not had any problems. We have not had any issues. Certainly, if you look at our deferred revenues in Q4, it went up a little bit from Q3 because we do have some equipment out there that we don't have an acceptance for at the end of Q4. But there's nothing abnormal. It's the normal course of business, and we have a very strict revenue recognition policy that we follow very carefully.

And launches coming up and whether there might be some more rev rec expansion in the first, second, third quarters?

So we certainly are going to be doing some combination of new products and product refreshes, which we will be announcing as the year goes on. But we generally, those go into locations that do not impact our outlook on our revenue and our revenue recognition, but more strategic placements to address more the 1X nodes impact.

And then just a rough breakdown on either fourth quarter or last year's shipments to logic versus foundry, and then types of memory, NAND or DRAM?

Yes, so memory actually was a growth sector for us. We saw a shift -- in the third quarter, our memory revenues, we ran in about 45%, and this quarter the total memory spend was about 56%. Within that, we saw a shift from the DRAM being the larger portion of that to Flash. And Flash will be about 31% versus the 26% of DRAM, and logic being the balance.

Logic the balance, great. Thank you very much. Good luck in the year.

Rick Solomon, Verition.

I take it from your comments that in general you expect your business to improve over the course of the year from the first quarter?

Yes, I think it's two things. We feel really strong. We have great visibility, I would say, and feel very good about the first two quarters. And there was some concern in general in the industry about our lack of visibility into the second half, and there was some speculation that the second half of the year might be down. But with the recent announcement by Global Foundries stepping up their spending and Intel stepping up their spending and Samsung holding their spending, I think we're starting to get some confidence that the second half could be as good or even possibly better than the first half.

But none of us have the level of granularity we need to yet, because we haven't got those forecasts and commits. And we're looking forward to getting those, and then we'll share them with you as we get them.

Great. And then on the tax rate, you say you're looking at ways to reduce that. Can we expect that possibly anything will be done within this year, or is that just somewhere down the road?

Yes, I think you're going to find that the tax planning will be something that the benefit -- you won't see a lot of the benefit in fiscal 2011, but it will be more down the road.

Okay, thanks.

(Operator Instructions.) I'm showing no questions at this time. I would now like to turn the call over to Dr. Stultz for concluding remarks.

Thank you, operator. As many of you probably know, this is Jim Moniz's last earnings call with Nanometrics. It has been a genuine pleasure working with Jim over the last couple of years, and I will tell you without reservation that he was a key factor in contributing to the turnaround of the Company and helping Nano achieve new levels of operational excellence. All of us here at Nano thank Jim for his contributions and wish him the very best with his planned retirement.

And last but not least, I once again gratefully acknowledge the outstanding performance and contributions of the global Nanometrics work force, who are directly responsible for all the goodness that I am privileged to report on.

Thank you once again for joining our call, and we look forward to reporting to you on our first quarter results in April.

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.