Onto Innovation Inc.
Q4 2007 Earnings Call Transcript

Published: 21 Feb 2008

[Operator:]

Welcome to the Nanometrics Incorporated Fourth Quarter and Fiscal Year 2007 Financial Results Conference Call. The speakers today include Tim Stultz, President and CEO and Gray Schaefer, Chief Financial Officer of Nanometrics. (Operator Instructions) 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 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 filed with the Securities and Exchange Commission and incorporates by reference. I will now turn over the call to Dr. Tim Stultz, please proceed sir.

[Tim Stultz:]

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 am very pleased to be announcing our 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 push outs of planned shipments which resulted in a sequential decline in our quarterly revenues in the fourth quarter. We fully expect to recognize these revenues in the first half of 2008. In spite of these decline in revenues however, we approved our product gross margin that generate $2 million in cash in its 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 lend in the data storage sector with head to head competition with our competitor. On a year-to-year basis, revenues increased 52% to $146 million. Those margins improved by five percentage points from 37% to 42%. Operating expenses decreased from 55% of revenue to 41%, and our cash grew by 87% from $8 million to $14.9 million. But we still see plenty of room for improvement where clearly a stronger and healthier company compared to our year ago. And importantly, we are on the right trajectory. Now, I would 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 the market where the demand is inelastic and our transfers’ capital expenditure timing cannot be precisely forecasted. We feel confident however about the increasing demand for our process controlled 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 geometers. We also feel confident in our market position. We have over 6000 systems in place in 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 the drive the timing of orders and 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 who undergoes repair. We will do this by working closely with our customers on applications development, offering competitive products with performance that is properly aligned to their own product through technology road maps and by working to strengthen our relationships through quality and responsiveness in all aspects of our products and services. To this end, we have stepped up our strategic account management activities and we organize around standalone, integrated metrology and materials characterization business units. These allow us to work more closely with our customers with product road map matching, applications development and other collaborative efforts. These efforts have already resulted in improved clarity through our own product roadmaps and better alignment with regard to our customer’s performance and timing requirements. As a result, our product development pipeline is more robust than ever with seven new products adjusting in each of our core markets scheduled to be released within the next two quarters. Just last month, we announced the major addition to our product lines, the NanoCD Suite. The CD Suite is principally a software solution set which works with our standalone Atlas and integrated OCD product offerings to enhance performance, increase productivity and provide seamless interconnectivity between multiple platforms. In addition to new OCD product sales, the NanoCD 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 its income, OCD and all the like 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 solar photovoltaic industry. These customers are not directly affected 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 many device makers. Finally, we are continuing to improve quality and customer satisfaction through tracking, training and discipline follow-through. We are already seeing benefits from these activities as measured by installing acceptance time and classic 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 and plating facility. I am pleased to report that the entire operation has been taken over by a third party business group to whom we outsource the fab assemblies previously manufactured by us in that same facility. The transfer responsibilities we have seen in inventory, we have in the supply of our products or any decreasing 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 near to a $1 million benefit to our gross margin in 2008 as a result of this transfer. In January announced a 7% reduction in our worldwide workforce. This combined with other expense control measures will bring us to our model target of $25 million cash for break even. Restructuring charges will be taken in Q1 and Q2 will reflect the benefits of our reduced cost structure. Last week, we announced that our Japanese partner Toho Technology Corporation had assumed the distribution rights for our material characterization products in Japan. This will improve our channel efficiency by expanding our sales footprint in that region for those products while supporting an increase focus in direct key account management and systems sales of our flagship products by our direct Japanese sales team. 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 with the first quarter of 2007, we have accomplished the reduction of about $3 million in the recurring quarterly asset we have spent, a 62% increase in our cash balance and a 7 percentage point improvement in gross margin. At the same time, we monetized a number of non-strategic assets, reduced our manufacturing incentives from 5 to 2 and significantly increased our outsourcing products at the system level. And finally to conclude my comments, I would like to say the following. We are focused on continuing to improve our business performance through gains and predictability, profitability and cash flow. We are making important strides to improving product and service quality, customer satisfaction and competitiveness. Demand for our core products remains strong with increasing interest in our materials characterization product offering. 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 lead in our current organization with a clear vision of our goals and a solid commitment to achieving them. Before turning over the call 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.

[Gary Schaefer:]

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 at of $96 million achieved in 2006. For the fourth quarter, total revenues of $33.2 million represented a 14% decrease from our record prior 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 Solaris acquisitions. Revenues for the quarter declined sequentially primarily as a result of our customers cautious outlook on the macro economic climate as we witnessed our customers actually under spending their 2007 budgets deferring some Q4 shipments in 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 facilities as well as our shift to a less vertical manufacturing model which further reduced our fixed cost. Our service gross profit declined by $100,000.00 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 negative 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 installs base. The blended gross margin for the fourth quarter decreased slightly versus Q3 from 44.2% to 44.1% which is the result of the higher product gross margins being offset by the greater proportion of service as a percentage of overall revenues. 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 $400,000.00 towards the estimated pension obligation of the company sales office in Taiwan. The company had been contributing at the minimum required rate historically. To a lesser degree, other factors contributing to the increase were slightly higher legal and audit fees, an increase in the 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 of 2007 and an operating loss of $12 million to mid 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 channel as follows

[Operator:]

(Operator Instructions) Your first question comes from the Mr. Gary Hsueh of Oppenheimer, please proceed sir.

[Gary Hsueh:]

A quick question here, exactly how much push out from the December quarter in terms shipments into the second of 2008, are we talking something like $10 million, can you try and help give us a sense of the magnitude of these push outs?

[Gary Schaefer:]

The push outs will go into Q1 and Q2, Gary and I really cannot comment exactly as to the amount at this point in time, but these push outs are going into Q1 and Q2.

[Gary Hsueh:]

Okay, I just noted that the North America book to bill data suggests that bookings are actually up sequentially in the December quarter versus the September quarter by the tune of 5% to 10%, let us call it 7%. You know, if that were to apply to you guys, I think the shipments that you would recognize would be somewhere in the single digit range, I mean, I am just wondering if that is the kind of a right ballpark or December is a lot bigger than I am thinking.

[Tim Stultz:]

That is not a bad assumption. I think if you look, we had our business in North America regions, quarterly were normally flat and you will 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.

[Gary Hsueh:]

And just, kind of a bigger picture, the stock is already kind of traded down to $5.00 range. Clearly we are already discounting at a significant kind of capex correction year in 2008, so I think we have got that part figured out. What I am trying to understand here is just your material characterization business for the full year in 2007 and how you think the different buckets within your material characterization business could grow in 2008, booking the trend in semis. I just want to start off if we can kind of get material characterization is broken out by solar, high-brightness LED and maybe flatters in 2007 and how that might trend in 2008?

[Tim Stultz:]

We do not provide that much granularity on the material of characterization. We have experienced a nice increase in the number of inquiries and in the actual sum of the sales are particularly with solar photovoltaic. The materials characterization represents somewhere between 20% or 25% of our business and continues to be somewhat insulated as I said against the pricing swings that the chip industry have seen particularly in the memory market.

[Gary Hsueh:]

Okay, and one last question, I might just re-queue, in terms of your movement to a distributor in Japan, how would that impact margins in your materials characterization business in 2008 compared to 2007?

[Tim Stultz:]

Actually, we were thinking of considering the selling costs, our margins will hold well, in particular, our net margins that distributors also have been our outsource manufacturer and then so the relationship with them is actually along in the status quo that we have.

[Operator:]

Your next question comes from the line of Mr. Weston Twigg of Pacific Quest.

[Weston Twigg:]

I just wanted to follow up real quickly on the materials characterization piece, unless I missed it, kind of like there was only around $4.8 million this quarter or 14% of revenues that would actually be down from last quarter, but you are talking about it sort of being less cyclical in the semis in an area of strength for the company.

[Tim Stultz:]

Could you just speak up a little bit, you are barely coming through.

[Weston Twigg:]

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

[Gary Schaefer:]

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

[Weston Twigg:]

About 20%, maybe I misheard.

[Tim Stultz:]

Against total product revenues as opposed to total revenues.

[Weston Twigg:]

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

[Tim Stultz:]

I think the point there is, there are two things that occurred, one is that, it is still a relatively small number, so one system, one to two systems of our iron systems can cause a pretty significant swing in that number because of the granularity and we actually do have one supply issue because to shift one of the two from Q4 into Q1 that was more of our ability to deliver than it was for the customer to get the receipt of it.

[Weston Twigg:]

Okay, looking ahead into Q2, do you expect the materials characterization business to be at the same level as Q4 or come back to maybe in more of the Q3 level?

[Tim Stultz:]

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

[Weston Twigg:]

Also, I was just looking at the other income and I think maybe this time there is a little bit, but it was down pretty substantially from the last quarter and I am just wondering why that was and maybe how we should look at other income moving forward?

[Gary Schaefer:]

I have got other income that ended up at $38,000.00 in Q3. We had other incomes at $395,000.00 and that was down and that was primarily down because of the foreign exchange loss that we saw and foreign exchange gain that was there and that has now been reduced in Q4.

[Weston Twigg:]

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

[Tim Stultz:]

It is more of the story of what happened in Q3 and in Q3 we have an upgrades 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 did have quite the same level of upgrades in Q4 and so the margins are more reflective of straight service than the post upgrade supported service.

[Operator:]

(Operator Instructions) Your next question comes from the line of Michael Amari of M. Amari Co. Incorporated.

[Michael Amari:]

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

[Tim Stultz:]

We are authorized to continue buying back stocks of up to $4 million during open trading windows. We have bought back about $750,000.00 worth of stocks so far and we have not been buying back in Q1 to date because it is in our black out period.

[Michael Amari:]

Yes, but basically, you think the price of the stock is quite low or quite adequate to stock buying around $5.50. I have another comment, on January 10 you came out with that announcement to cut 7% of the jobs. You left the announcement so vague that because we did not have any guidance for the fourth quarter, the stock market thought that you are just going to derail bad because of the change and the softness that you refer to. It feels to me, it seems like, if you were to give a guidance, it would be lot better than leave the market uncertain in such a way with stock market to cut the stock price in half, because of that four-line statement saying, ‘it is prudent to cut 7% because of the softness.’ It left us in such a way where we did not know how bad the situation is, so it seems like if you would spend a little bit more time in giving guidance or giving announcement that is clear that you would not have such a debacle for people that own the stock. That is very hurtful. We are not talking here about analysts, we are talking about investors that is either started from $9.00 to $5.00 in a day that because of a very vague announcement. I feel that area should be addressed.

[Tim Stultz:]

I understand your 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 are correct and because we do not give guidance, we could not make that change in that press release, in a 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.

[Michael Amari:]

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

[Tim Stultz:]

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

[Michael Amari:]

Well actually, the fourth quarter was not bad at all, I mean, when you wrote that announcement that you were experiencing softness et cetera, one would have thought that you were going to be having a terrible 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 do not see why this announcement has killed the stock internally. I do not know if the impact of that announcement was really very negative, maybe the market, but I am not sure. I would appreciate if you can put more thought before you put announcements like that in the future.

[Tim Stultz:]

I will take your comment seriously. Thank you.

[Operator:]

Your next question comes from the line of Mr. Westin Twigg with a re-prompt from Pacific Crest, please proceed sir.

[Weston Twigg:]

Hey guys, I did not mean to jump in front of anybody in the queue hopefully, but I did have a few more questions. Just wondering if you could break down for me your end-market in terms of DRAM, Nano, Logic and foundry customers last quarter?

[Gary Schaefer:]

Yes, our memory business represents about 55% of our total revenues with somewhere 55% to 60% of that being in the Nano section, foundry and logic represented about 25% and the balance was in the materials characterizations.

[Weston Twigg:]

And just kind of wondering also if I look at your earnings this quarter, strip out the amortization of intangibles which treats the same for TenCORE, it looks like you broke even this quarter at around $0.00 EPS, just wondering, once you complete your workforce reduction and restructuring, where would you expect that new break even point to be? I know you said $25 million, but would you expect a drop right down to $25 million or would it be somewhere between looking ahead maybe the next quarter?

[Tim Stultz:]

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

[Weston Twigg:]

You talked about previously, at one point, talking about getting to below 50% gross margin or 53% gross margin and getting to that this year, what type of revenue level do you think you need to achieve that gross margin of 53%?

[Tim Stultz:]

Unless there are some 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 margins, so we are pretty confident we can achieve the goal. Our quarterly gross margin did increase like 2% in the quarter and we did generate the profits from our service business where there are still upside and opportunities to improve those gross margins specifically, so I think that it is going to take a lot of work. It is not going to be an easy task, 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 build.

[Weston Twigg:]

Actually, I just had a couple more quick questions, your top customers; three greater than 10% customers, do you expect those to remain the same this quarter?

[Tim Stultz:]

Obviously, we do not speak specifically of any customers. We feel pretty comfortable with the ones that have been consistently above 10%. With the newest ones in the WD that is a pretty new win and a new embrace of this technology, so we would have to see whether or not there is a long-term trend on that one.

[Weston Twigg:]

I was 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?

[Tim Stultz:]

You want my flavor compared to everyone else’s list?

[Weston Twigg:]

Yes.

[Tim Stultz:]

Clearly, when we meet with our customers as you do when you do your own channel check, there is continuing demand for more chips. When we meet with fab managers, they are chopping it to bit to expand production. When we meet with the process developers, we push them really hard to get them to 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 my feeling is that when there is a little more comfort in the kind of a global kind economic environment and a little stabilization on the memory pricing, I think that some of those budgets that were not spent in 2007 are being held up in 2008 will start to be released.

[Operator:]

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

[Tim Stultz:]

Okay, well thank you for joining us today. We look forward to updating you on our Q1 results at our next conference call in Dubai.

[Operator:]

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