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Nanometrics, Inc (NASDAQ:NANO)

Q4 2008 Earnings Call

February 19, 2009 5:00 pm ET

Executives

Tim Stultz - President and CEO

Bruce Crawford - COO and Former Interim CFO

Jim Moniz - CFO

Analysts

Gary Hsueh - Oppenheimer & Company

Weston Twigg - Pacific Crest

Edwin Mok - Needham & Company

Kelly Anderson - Sidoti & Company

Good afternoon and welcome to the Nanometrics fourth quarter and fiscal year 2008 financial results conference call. Before we get started, I would like to call your attention to the following Safe Harbor statement. This conference call contains 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 condition and the additional factors and cautionary statement set forth in the company’s Form 10-Q for the quarter ending December 27, 2008 and in other reports, which the company filed with the Securities and Exchange Commission and incorporate herein by reference.

Leading the call today will be Tim Stultz, President and CEO of Nanometrics. 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.

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

Tim Stultz

Thank you and good afternoon everyone. And thank you for joining us for the Nanometrics fourth quarter 2008 conference call. With me today are Bruce Crawford, our Chief Operating Officer and Former Interim CFO, and Jim Moniz, who joined us this week as CFO.

First a few words about Jim. After an exhaustive five months search, we found a Financial Executive with the right blend of professional, industry, business experience and drive to make immediate and long-term contributions to Nanometrics. That person is Jim Moniz.

Prior to joining NANO, Jim served as CFO of Photon Dynamics until its recent sales to Orbotech and with CFO of Nextest until its acquisition by Teradyne. Jim has more than two decades of senior financial leadership including serving as a CFO of two publicly-traded companies within our sector. We are truly very excited about having Jim joined our management team.

Now, turning to our quarterly report. Since Bruce Crawford was responsible in leading the finance team during the fourth quarter, I would ask him to present the details on our financial performance following my prepared remarks. I will also ask Jim to feel free to contribute during the Q&A session, where he feels comfortable.

Pervasive uncertainties in the global economies and financial markets put extreme pressure on long range planning and investment. Capital spending specifically within the semiconductor market has undergone a significant decline over the last year, dropping nearly 30% since 2007 and is expected to decline further in 2009.

Consolidation and company failures within our served customer base have also negatively impacted total capital spending and opportunities within our sector. Without a doubt however, the biggest challenge to effective management of companies during this time is not so much about the drop in business, which has certainly been severe, but rather the lack of visibility and uncertainty of the business in the future, how deep is the downturn, how long will it continue.

During these highly uncertain times, we believe it is imperative to strictly focus on those elements that are within our control. And in particular, to those which ensure are staying power and our longer term competitiveness. Where else at Nanometrics, this boils down to balance sheet and cash management, false control and reductions of costs and expenses, and new product introduction, which extend our served markets and provide a competitive advantage for future technologies and capacity spending.

Now I would like to take a few moments to address, each of these important areas. First, with regard to our balance sheet and cash position. During the quarter, we increased our cash through tight expense controls and reduction of inventory and accounts receivable.

At the same time, we could care of our vendors, with whom we share a co-dependence and reduce our accounts payable and days accounts payable as well. The net result was that we closed the quarter with nearly $24 million in cash, a 10% increase over the previous quarter.

On the operations side, through a combination of restructuring, workforce reduction and expense management, we brought our total operating expenses down 15% from the third quarter, net of restructuring and impairment charges. This brought our cash based revenue break even to less than $23 million.

Turning to our R&D investments and new product introductions. In 2008, we introduced new products into each of our major served markets, thin film, overlay and optical CD metrology. These products were specifically designed to address future technology notes on our customer’s product road map.

We have used the downturn to run evaluations and qualifications at customer sites. And our secured initial orders, which we believe positions us well to benefit from new technology purchases and expansion spending when they occur.

In addition, we introduced the Lynx metrology platform, an architecturally differentiated, a new concept for clustering or combining metrology tools, which offers the lowest cost of ownership and greatest flexibility of any product in its class. This product has been very well received and in spite of the downturn, we have received multiple orders and completed installations and acceptance for this product.

Turning briefly to revenues. We have stated repeatedly that we serve an inelastic market with little influence on the timing of magnitude of our customers’ capital spending budgets. That being said, we are fortunate to have a diversified product portfolio, serving multiple markets beyond the fabrication of traditional silicon ICs, including high-brightness LEDs, solar photovoltaics, disk drives and both silicon and compound semiconductor substrates.

Sales to those end markets represent at a quarter of our product revenues for both the fourth quarter and full year of 2008. Our recent acquisition of Tevet is also been a success and is an extend in our served markets both in the integrated metrology as well as solar photovoltaic providing incremental revenues at an accretive gross margin.

Combined with our service and upgrade business more than half of our total revenues in the fourth quarter, and 45% of our total revenues for the year came from sources other than capacity expansion within the silicon semiconductor IC markets.

Finally, I would like to say a few words about our gross margin performance. Over the last six quarters, we have made steady and significant improvement in our core service growth margins, largely due to our focus on product quality, training, and efficient deployment of service resources.

We have also benefited from the sale of upgrades to our large installed base, which was particularly strong in the fourth quarter. Over the same period, our product gross margins have held up fairly well.

In the fourth quarter, we saw our first significant drop in product gross margin over the last two years, as a result of the 21% sequential decrease in product sales and under absorption of manufacturing overhead.

I am pleased to report however, that our total gross margin has remained above 40% for seven quarters running, in spite of a 29% decrease in quarterly product revenues over that same timeframe.

In summary, in a difficult market and with the backdrop of 12% drop in quarterly revenues, in the fourth quarter we increased our cash by 10% and ended the quarter with $24 million. We reduced our quarterly operating expenses by 15%. We maintained total gross margins above 40%. More than half of our revenues came from sources outside of traditional integrated circuit capital spending and we continue to gain acceptance and traction with new products introduced within the last few quarters.

Although we are very cautious about the business outlook and for further declines in industry capital spending, we believe the steps we have taken to improve our financial performance, strengthen our balance sheet and bolster our product portfolio will enable us to weather the storm and put us in a strong position with operational and earnings leverage once spending resumes.

Finally, I want to emphasize that our entire management team is decided to further improving our near-term performance and long-term prospects in order to strengthen our business, its future and be worthy of your investment dollars.

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

Bruce Crawford

Thank you, Tim. Earlier today we released our fourth quarter and full year 2008 financial results, which you may find on our website at Nanometrics.com. Also on our website, a reconciliations to non-GAAP figures referred in our prepared remarks, such as cash operating expenses and cash-based revenue breakeven.

Fourth quarter revenues of $20.5 million decreased 12% from third quarter and 38% from the year ago period, relative to many of our periods the sequential decline was modest. Similar to the third quarter, we saw substantial change in product mix.

Our product sales decreased by 21%, while service revenue is increased 12% due primarily to strong sales of product upgrades during the quarter. We saw decline in our integrated meteorology revenues, which is partially offset by increased sales of our standalone automated meteorology and material characterization products.

In the fourth quarter, we have recognized sales of several standalone systems they have been pushed up from the third quarter. The breadth of our product portfolio and diversity of end markets continue to provide Nanometrics with relatively stable revenue base in fourth quarter.

That being said, we expect upgrade sales to decline going into this year and several of our major customers have announced further reductions in capital expending in 2009. We have and will continue to proactively streamline our cost structure and expenses in anticipation of continued weakening of semiconductor capital spending.

Our gross margin for the fourth quarter was 42%, compared to 44% in the third quarter and in the year ago period. Compared to the third quarter, product gross margin decreased from 50% to 40%. Due to lower volume of system sales, our service gross margins increased from 30% to 46%, benefiting from strong upgrade sales in the quarter.

As a testament to our continued efforts to reduce vertical integration through outsourcing, consolidation and manufacturing facilities, we have sustained gross margins above 42% for seven quarters in a row. Our operating expenses in the fourth quarter were $12.1 million, down 15% from the third quarter and down 24% from the year ago period.

Our cash operating expenses for the quarter were $10.1 million. Our operating loss was $3.5 million, while our EBITDA loss was $2 million. As [leaders] management exclude these items from our results in order to assess our operating efficiency on an ongoing basis.

A reconciliation of EBITDA to GAAP operating income maybe found on our fourth quarter results press release. Our net loss for the quarter was $2.6 million or $0.14 per share and includes the stock-based compensation expense of $700,000.

A few comments on the balance sheet. Receivables declined by over $4 million with DSOs decreasing to 75 days compared to 83 days last quarter. Inventory levels declined by $2.4 million. Inventory turn remain flat at 1.5 due to the sequential decline in sales volume. We added over $2.2 million to our cash balance, as we generated cash from our operations in the fourth quarter.

We used about $105,000 in the quarter for stock repurchases and we currently have $1.3 million remaining in our stock repurchase plan. Our tangible book value now stands at $4.66 per share based on 18.4 million shares outstanding at quarter-end.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Gary Hsueh with Oppenheimer & Company. Pleases proceed.

Gary Hsueh - Oppenheimer & Company

Yes, hi. I missed most of the prepared comments. But if I look at your business and the fantastic financial performance that you turned in the quarter, it seems to be driven by South Korea and standalone metrology in addition to some service contractor, software business that really kind of boosted the margins there. Is that in accurate characterization and if it is, and if it is South Korea, how sustainable do you think that is kind of going forward over the next one to two quarters?

Tim Stultz

Hi, Gary. Thanks for the question. We certainly have posted a quite bit revenue and sales in South Korea, but I'll point back to the comments, I made earlier is that over a half of our business came from non-semiconductor expansion spending that being our service, our upgrades on our materials characterization.

So, those have been pretty steady for us over the last, certainly last several quarters, the last year or so, and any reductions in Korea, we have exposure to certainly in the standalone area and we're going to be face with that effect continues, but we kept the benefit of the support from the other revenue generators.

Gary Hsueh - Oppenheimer & Company

Okay. Just to be clear, that the service business is more driven from non-semi business for software and upgrades or software and upgrades for semis.

Tim Stultz

It's relatively semis.

Gary Hsueh - Oppenheimer & Company

Okay. And that upgrade business, I think you have been enjoying margin expansion on that upgrade business at least for two quarters now. I mean, how much more can we expect you're going forward?

Tim Stultz

That's a good question. I'd like to just go back to a little bit, and originally you can see that the upgrade focus in strategy. The 2007 and when we're looking at 2008 its being the potential area, where a year, where we would see some revenue decline, its struck is that with an installed base of 6,000 systems. We have the opportunity to mind that installed base by providing productivity and performance enhancement to our customers.

And we originally vision that as a kind of a temporal short-term opportunity and that would have legs maybe the last a few quarters to a year. What we have learned from it since that time is this will become, I think it will be a steady contributor to our revenue stream maybe it had ups and downs to different periods.

But we see there is as part of our standard product lifecycle planning process and I expect to see contributions are going forward. Every product we now design and develop and bring to market. I have a plan to upgrade strategy associated with it.

Gary Hsueh - Oppenheimer & Company

Okay and just final question. Congratulations to Jim, joining the firm. Just looking at the inventory number, it kind of stands out is being something that could definitely work down and generate some cash from. What’s the plan here on inventory levels and is there a potential risk of impairment after that relatively high inventory number?

Jim Moniz

Gary, very nice to talk to you again, hopefully we will be doing business long-term. We are very happy with the fact that inventory decreased by $2.4 million last quarter, however we are not satisfied and certainly Tim and Bruce and I are not satisfied, but that's enough. My focus and Tim is made my focus is it would be anyway is to get this inventory number down with the emphasis being and turn that inventory into cash as quickly as we can.

We do have a very regimented excess and also the process that we followed, that we continue to follow in December just reviewing by our auditors. And there were no impairments in December and obviously business conditions will dry, what we do going forward. But our focus is on cash in 2009 and my focus is on making sure, turn that inventory into cash.

Gary Hsueh - Oppenheimer & Company

All right, welcome aboard. Thank you.

Jim Moniz

Thank you.

Operator

Your next question comes from the line of Weston Twigg with Pacific Crest Please proceed.

Weston Twigg - Pacific Crest

Hi, I had just a couple of questions. One, on the material characterization side, it looks like actually revenue was down quite a bit, may be in minuses before revenue drop. But there is one business that generally lumpy -- but is there something you think might grow in Q1?

Tim Stultz

The only has been lumpy with materials characterizations, in fact that we also include a product that is used for silicon substrate detect analysis and we saw a bit of drop-off in that last quarter and we see little bit of a sensitivity to that in the traditional capital semiconductor spending.

The other elements of the materials characterization have been and product sales have been very solid. And yes, I do believe that we're going to see, have a potential, seeing some improvement in the particular part of the substrates going forward.

Weston Twigg - Pacific Crest

Okay good. And I guess a couple there, short questions and then one little bit tricky. Just wondering if you could tell me how many Lynx units you sold so far and how many on your backlog?

Tim Stultz

No, we don’t disclose it to that level. It’s a good question but I can tell you its multiples and we follow on orders and revenue is generated and acceptance completed.

Weston Twigg - Pacific Crest

Okay. And then any 10% customers last quarter?

Tim Stultz

Yes. Samsung and Hynix.

Weston Twigg - Pacific Crest

Okay. And then, one thing I'd like to explore is the idea that Nanometrics is too important to fail. So, for one reason, you provided integrated metrology and TMP systems sold by pride to large vendors like Intel and Samsung. And for another reason your viable competitor KLA and Samsung, Overlay and OCD.

As I am just wondering, in the midst of what, AMAT CEO, Mike Splinter, yesterday called the worst downturn in the history of the semiconductor industry. Are any of your customers looking at contingency plans for Nano, such as encouraging like merger with larger companies?

Tim Stultz

Weston, I'm not sure, towards characterize everything that should say, contingency planning. I wouldn’t want to infer that there is any kind of a financial, an investment plan or strategy that’s been discussed. But I will tell you, that our customers do care about our survival; that we do play a key role and we've been very close to some of the key corporate purchasing groups, talking about matching product roadmaps and making sure that we're going to be in a position to support them as, when they start these, resuming their purchasing.

Weston Twigg - Pacific Crest

Okay. I guess another way to if you look at it, I mean I think Nanometrics is very well positioned to better increase the market share 210 nanometer especially with your OCD product against KLA. But I just wonder whether customers are concerned about actually awarding the business, Nano is such a small company I guess in the middle of the severe downturn. And are you hearing those types of concerns from your customers and what exactly you are doing about it?

Tim Stultz

I guess the simple answer to that is, no. We have great relationships, we match our product roadmaps. We believe that we are going to be gaining market share in our targeted sectors. And we believe that we are aligned to be a key supplier to the major customers out there. We feel very confident about that.

Weston Twigg - Pacific Crest

Okay, so you are not hearing clumps from customers about, will Nanometrics be healthy enough to support us over the long run?

Tim Stultz

No, I haven’t heard those clumps. And I do know that they listen to our calls and we had our conversations. But like some of our investors, they are pleased with our performance.

Weston Twigg - Pacific Crest

Okay. Thank you.

Operator

Your next question comes from the line of Edwin Mok with Needham & Company. Please proceed.

Edwin Mok - Needham & Company

Thanks for taking my question. A question regarding the emerging growth area, that you said growth account for 25% Europe. I’m just curious how do you view that market in light of the current environment, do you think that you can still drive more growth in that area. And if so what are the driver, which affect market, is it LED, is it solar that you think will drive growth in the coming year?

Tim Stultz

Hi, I did hear from you. The primary areas that, in our materials characterization we see some growth outside of the traditional semiconductor side, both in the high-brightness LED and the solar photo-voltaics. We are also doing some areas in compound semiconductors as well.

Solar photo-voltaics with the way the economic here is some of that spending slowdown, but we believe it's just a matter of time and we've got some good position with some of our products as we adopt them and their configuration and their applications for inline process control monitoring with a price point and performance factor that at last those applications specifically I suppose is a simple modification of a semiconductor tool.

So, we see that is a great area for us and I think that as those industries track up, we will track nicely with them.

Edwin Mok - Needham & Company

That can play a good market, right are you afraid on order how can you try to get into that business, are you a little more competitive in that area?

Tim Stultz

I'm sorry you have got a little bit gabble, could you repeat the question, please?

Edwin Mok - Needham & Company

Sorry about that. Performance not holding, but I'm just curious in terms of competition in that area, especially in photo-voltaics, if in case a good area and that will part of the increase, and do you say drop metrology in that area? Are you seeing more competition and how do you look at that in terms of competition?

Tim Stultz

Okay. So, I understand the question is, am I seeing a lot of competitions in that space and how we view it. In the solar photovoltaic and high-brightness, one thing is within the high-brightness LEDs, we always have a strong position. We have for several years some of our core products.

And when I look at the opportunities in the solar photovoltaic it reminds you a little bit of the semiconductor industry back in the 70s and 80s, where a lot of the manufacturer, who are actually designing building their own products, their own tools, metrology tools before the capital equipment industry has to brought commercial products to the market.

So, what we are seeing here is that, there are a lot of home grown solutions we would bring in a better class of ownership, better support and better performance and we are also leveraging the fact that we’ve been in this business for over 30 years for some of these core technologies and our core capabilities in the areas our photoluminescence and FTIR as well as in our reflectometry and scatterometry play well into those markets. So, we feel very good about them.

Edwin Mok - Needham & Company

Great, thank you. Sorry about my fault.

Tim Stultz

That's okay.

Operator

(Operator’s Instructions) Your next question comes from the line of Kelly Anderson with Sidoti & Company. Please proceed.

Kelly Anderson - Sidoti & Company

Hi, thanks for taking my questions and I just wanted to echo Gary's congratulations to Jim. It's an absolute pleasure to be working with you again. I’m just wanted to talk a little bit about the services revenue. A lot of companies out there, reporting drops in their services income right now on account to the fact that there is so many shutdowns going on. Is there anyway you can give us a little bit more color on how much of that is related to upgrades and how much of that is a just standard services business that could potentially be at risk?

Jim Moniz

Yes, we don't break that in a part Kelly and our standard core service business has been pretty steady. It’s certainly receiving the fresh air what others are experiencing as, our suppliers look at the capital budget. But we have done a pretty good job of getting the contracts renewed and really working hard on billable services.

So, I would say that we are under pressure not unlike the other folks out there. But it hasn't been as extreme as the CapEx and say, standalone capital spending for frontend meteorology.

Kelly Anderson - Sidoti & Company

Okay. And just a follow-on to that, is there significant margin difference between the standard services business and the upgrades?

Jim Moniz

Yes, there is. The standard service business, which I think we called out at different times, which about year and half is about minus 27%. It had been brought up to over 13% and the difference is made by margins in the upgrades.

Kelly Anderson - Sidoti & Company

Okay. And then just, we've been hearing a lot of press recently about the potential consolidation in the memory market and the bankruptcies that are going on there. Obviously, you are in a good spot, because you are lying with sort of the top guns in that space. But I was just, maybe wondering if you could speak to how comfortable you are with your current customers and how, any consolidation there might affect Nanometrics?

Tim Stultz

Clearly all of us are face to the fact that when we wake up in 2010, almost a certain probability is that, that we're going to have less customers out there. And so for us, the key issue is to make sure that we are strategically and commercially behind with those people that are going to survive.

And we've done a pretty good job. We put a lot of energy into those larger companies, in particularly ones that dominate their sectors in logic and memory, in foundry, and making sure that we are dialed into the 22 nanometer activities, but we are supporting them on the 32 and that we would benefit, a piece of consolidation, we hope that they consolidate, because that's where we will gain some additional leverage.

In a number of cases that we are watching, I think can actually work to our damage, because a couple of the consolidators are very strong customers of ours.

Kelly Anderson - Sidoti & Company

Okay great. And Bruce, maybe could you just tell us what the cash flow from operations was for the quarter?

Bruce Crawford

About $2 million.

Kelly Anderson - Sidoti & Company

Okay. Thank you.

Bruce Crawford

Yes.

Operator

Your next question comes from the line of (inaudible). Please proceed.

Unidentified Analyst

Several housekeeping questions. One is, do you give out a book-to-bill figure?

Tim Stultz

No. Obviously, we don't give that and so we don't give any reports on bookings.

Unidentified Analyst

Okay. Secondly what were the share count have been, had you been profitable?

Bruce Crawford

About another $300,000.

Unidentified Analyst

Okay. And the headcount now versus Q3 in the prior year end?

Tim Stultz

So, the headcount now is 467, Q3 was 487 and we started the year, at the end of 2007 it was 523.

Unidentified Analyst

Okay, very good. And could you please breakdown the inventories between or amongst raw materials holdings and finished goods?

Tim Stultz

Bill, I would not have to pass on that one right now.

Unidentified Analyst

Okay maybe a follow-up on that?

Tim Stultz

Sure.

Unidentified Analyst

Okay. Good quarter. Thanks very much.

Tim Stultz

Thanks, Bill.

Operator

At this time, I'd like to turn the call back over to Dr. Tim Stultz for closing remarks.

Tim Stultz

Thank you. Importantly, I'd like to express my gratitude to Bruce Crawford, who has worked tirelessly over the last five months. He's taken on the responsibility of CFO in addition to his role as COO. I also want to thank and give recognition to the extraordinary efforts and contributions of our employees for their continued support of our investor, in addition of the continued support of our investors and express my appreciation to the Board and our management team for their helping guidance during such challenging times.

Thank you all for calling in and we look forward to updating you on our first quarter results conference call.

Operator

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.

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