Nanometrics Incorporated Q1 2009 Earnings Call Transcript

Nanometrics Incorporated (NASDAQ:NANO)

Q1 2009 Earnings Call

April 30, 2009 4:45 pm ET

Executives

Tim Stultz - President and CEO

Jim Moniz - CFO

Analysts

Wen Jiang - Oppenheimer

Weston Twigg - Pacific Crest

Bill Sarix - Reveno Wood Capital

Operator

Welcome to the Nanometrics First Quarter 2009 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 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 they are not limited to, changes in demand for the Company's products, changes in the Company's ability to ship its products in the timely manner, changes in business or economic conditions and the additional risk factors and cautionary statements set forth in the Company's Form 10-Q for the quarter ending March 28, 2009 and in the other reports, which the Company files with the Securities and Exchange Commission and incorporates 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 would now like to turn the call over to Dr. Tim Stultz. Please proceed, sir.

Tim Stultz

Thank you for joining us for Nanometrics first quarter 2009 conference call. With me today is Jim Moniz, our Chief Financial Officer, who joined us in February of this year. Jim will be reviewing our financial performance in more detail following my prepared remarks.

Over the last several months, spend in our semiconductor capital equipment dropped severely, and along with the rest of our sector, we experienced a sharp decline in revenues.

During this period, our customers have had to adjust to the lack of visibility, market uncertainty, and reduced consumer spending, while at the same time accessing the effects, changes in the global economic environment were having on their respective businesses. These customers in turn took a prudent wait and see approach, holding back on spending to expand capacity or capability, effectively paralyzing normal industry capital procurement processes.

While we did anticipate declines in spending, this trough revenue quarter is unprecedented in its severity, with significant order push outs and cancellations. Throughout this difficult period, we continued to focus on our core business elements, while executing well on our cost reduction initiatives and efforts to align operations with the current economic and business climate.

At the same time, we remained steadfast in our commitment to invest in new products and applications, which will be the fuel for growth when steady resumes. For the fifth straight quarter, we reduced our ongoing operating expenses, and drove down our cash breakeven level. This was achieved through a combination of restructuring and consolidation of operations, head count reductions, plant shut downs, renegotiation of contracts for Company's services, and conservative management of operating expenses.

Assuming a normalized cash based gross margin, we have meaningfully exceeded our original goal of driving cash breakeven revenues to below $25 million. With Q1 breakeven at just over $20 million and an ongoing cash based operating expense declining to $9.1 million, a 28% decrease over the last three quarters.

Going forward, we expect continued reduction in these expenses, as we realized some of the benefits from steps taken in the first quarter, as well as additional reduction of ongoing operating expenses in the current and following quarters.

Analyzing our first quarter revenue, 75% of our total sales came from services, upgrades, and product sales unrelated to capacity spending by our memory and logic chip application customers. These results highlight the benefit of having a large installed base and a broad product line, in particular, when traditional semiconductor IC capital spending is down.

Specifically, our materials characterization business saw a slight uptick in the product revenues in the first quarter, but continued strong sales into high-brightness LED and solar photovoltaics markets. Additionally, our focus program to generate revenues by minding our installed base through customized upgrade offerings continues to be successful, both from the financial as well as customer satisfaction perspective.

In the quarter, we continued to make meaningful progress with our customers to qualify and gain acceptance of our new product offerings and for next generation applications. We are pleased with the reception to the architectural differentiation and performance of these products, and expect a benefit from expanded applications and growth in market share when our customers resume investments in capital equipment.

Though we are cautious about industry capital spending in the near future, we are seeing signs that the spending paralysis is ending as customers' need increased visibility and their business fundamentals improved, which in turn should lead to the return of more typical procurement processes. As an example, we are starting to see a meaningful increase in demonstration, quotation, and order activity. As so far this month, we have already received new orders, and shipped the products that have been canceled just last February.

In addition, customer fab utilization rates were on the rise and memory chip pricing is improving, encouraging signs to be sure. Our customers, however, has shuttered internal capacity that they'll first need to bring back on line before adding to it. We are also in the planning and development phases for production of next generation devices.

We expect these factors to initially lead to increases in technology spending or advanced lithography metrology as well as wind down of few capacity purchases and associated services. In light of the above, we believe Q1 represents a trough in capital spending. That is not to say that the industry is heading toward a rapid inflow recovery.

We, along with the rest of our peers, have to plan for several more tough quarters. Quarters that should be significantly better than the one we just closed are tough nonetheless. As such, we will continue to run the business conservatively, and take additional steps to reduce expenses and provide liquidity from our balance sheet.

Our focus going forward will be on strengthening the relationships and new product positioning with our customers at the leading edge in order to benefit from technology investments and subsequent capacity spending, driving down ongoing operational expenses, and effective management of our balance sheet, cash and cash equivalents.

We are confident that the steps we've taken over the last seven quarters to improve our business structure and financial performance, strengthen our balance sheet and access to working capital and bolster our product portfolio, will enable us to continue to weather the storm and put us in a strong position on operational and earnings leverage as the industry recovers and spending resumes.

In closing, I believe the best way to characterize our business outlook at this time is confident with cautious optimism.

I will now turn the call over to Jim Moniz.

Jim Moniz

Nanometrics' press release containing first quarter fiscal 2009 results was sent out by Business Wire today April 30 around 1 P.M. Pacific Time. The press release may also be found on our website at nanometrics.com.

Also on our website, a reconciliations to non-GAAP figures referred to in our prepared remarks, such as ongoing cash-based operating expenses and cash-based revenue breakeven. As Tim mentioned in his remarks, while we did anticipate declines in spending, this trough revenue quarter is unprecedented in its severity with significant order push outs and cancellations.

First quarter revenues at $10.1 million were down 51% from the previous quarter and were down 71% from the first quarter of fiscal year 2008. Revenue by geographic region is based upon the shift to or first-in-use destination. During the quarter, the break down was Japan at 47%, U.S. at 23%, Europe at 17% and rest of world at 13%.

Revenue by product type was materials characterization at 32%, standalone and integrated metrology at 17% and service at 51%. Gross margin in the first quarter was 28.3% compared to 42.1% in the previous quarter and 45.6% in the first quarter of fiscal year 2008. The lower level of gross margin was primarily the result of factory under absorption due to the short decrease in sales volume.

Service gross margins, however, remained above 30% for the third straight quarter. Our operating expenses in the first quarter were $11.9 million compared with $12.1 million in the previous quarter and $16.8 million in the first quarter of 2008. There was $0.7 million of restructuring cost in the first quarter, as well as $0.4 million for amortization of intangible assets. There was also a charge of $0.4 million in the first quarter for additional reserves for bad debt expense driven by a customer whose collections are now in doubt.

Ongoing cash-based operating expenses were $9.1 million in the first quarter compared with $10.1 million in the previous quarter. With the further reductions that were made in operating expenses in the first quarter of 2009, we have now reduced our cash-based revenue breakeven to just over $20 million a quarter, assuming a normalized cash-based gross margin.

Other expense in the first quarter was $1.6 million, and included $1.3 million associated with a loss on foreign currency. At the end of fiscal year 2008, we reclassified loans we had on the books with our Japanese subsidiary from permanent to non-permanent so we can have the subsidiary pay back some of those loans to bring the cash back to the United States' corporate headquarters to fund working capital worldwide.

Accounting rules require that when inter-company loans are no longer considered permanent, any changes in foreign currency rates for such loans are to be recorded as a period charge on the income statement rather than a component in equity. As a result of the loan reclassification and substantial weakening of the yen versus the dollar during the quarter, there was $1.3 million of expense on the income statement. The majority of which was non-cash expense.

The net loss for the quarter came in at $10.6 million or $0.58 per share. This compares to a loss of $2.6 million or $0.14 per share in the previous quarter and a loss of $0.7 million or $0.04 per share in the first quarter of 2008.

Turning to the balance sheet. Cash came in at $16.9 million, which was $7.1 million below the previous quarter. Substantially, all of the decrease was caused by cash used from operating activities which used cash of $7.3 million. Accounts receivables came in at $10.3 which was lower than the previous quarter by $6.7 million, driven by lower revenues.

DSO increased to 92 days. Inventory came in at $32.6 million, which was an increase of $1 million from the previous quarter. We are disappointed in this increase, which is primarily driven by our providing more tools to customers for evaluations, some of which we had expected to contribute to revenue in the first quarter. This inventory will be a source of cash plus in the next few quarters as we record revenue for these tools and slowdown the inflow of new inventory purchases.

Our tangible book value was $4.10 per share at the end of the quarter. We ended the March quarter with head count of 414 people compared to 465 people at December year end. Although we believe business conditions are beginning to modestly improve, we will continue to proactively streamline our cost structure and expenses in anticipation of continued weakness of semiconductor capital spending.

As an example, we are currently in the process of further consolidating our manufacturing operations from two facilities to just one on Milpitas headquarters. This will help us improve the efficiency of our manufacturing operations and reduce fixed costs, while at the same time further increasing our ability to leverage outsource manufacturing.

As part of this consolidation, we will have restructuring and impairment charges in the second quarter associated with the closedown of our Korean manufacturing facility. We will continue to have direct sales and service in Korea to support our customers in that region. We expect to generate cash from the sale of this building. We will also put renewed focus on managing our balance sheet using our inventory to generate cash.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Wen Jiang with Oppenheimer. Please proceed.

Wen Jiang - Oppenheimer

First question is regarding the next two quarters, you're mentioning about the possibility of new shipments on orders canceled and new orders. Could you elaborate on those orders those in which categories and to which type of customers?

Tim Stultz

So the new orders, the ones that were canceled and the ones that were pushed out and the ones that are now reemerging in this quarter are all in the areas of front-end primarily in the technology purchasing areas and our standalone tools.

Wen Jiang - Oppenheimer

Okay, mostly in the standalone tools. Okay. In which area, memories regions and areas?

Tim Stultz

So we are getting increased business activity both in logic and memory areas.

Wen Jiang - Oppenheimer

The next question is regarding inventory reductions. Obviously, the inventory has been continually pretty high in the last several quarters, and it can be a major resource for working capital management. So you mentioned about shipping some of the systems that's currently in the inventory. What do you think realistically can we reduce the inventory in the next couple of quarters?

Tim Stultz

Actually there are important thing that we also look at, but I can't give you guidance and I am not going to give you a number, other than to say, the investments we made in the product demo tools and the last minute customer push outs were the main contributions to the net increase in inventory. We do expect that that inventory will turn in the second quarter and that inventory will be a source of cash for us in the upcoming next few quarters.

Wen Jiang - Oppenheimer

Last question is regarding some of the products fronts. Could you give us some updates on your overlay product evaluations and also the OCD product evaluations at customer sites?

Tim Stultz

We are actually seeing some very nice reception to all of our product areas. The two areas that I would point to that probably are amongst the most exciting then I think will drive most of our growth in the OCD area. Then with our Lynx platform as a metrology tool with a unique architecture that gives the lowest cost of ownership and the highest productivity.

We have head to head evaluations underway and also some of that are being concluded in overlay, thin film, OCD and integrated metrology. We are feeling very good about the position we are in with each of those key customers.

Operator

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

Weston Twigg - Pacific Crest

Just a couple of questions here. One, on the cash side, if I heard correctly, cash used for operating activities was $7.3 million and I am wondering if you had the same type of revenue level next quarter with some of the ongoing cost reductions, what would the cash level be next quarter.

Jim Moniz

Again, Weston, I would say that even at the same level of revenue next quarter or this quarter, as you say, Q2 versus Q1, I would not expect to see the same amount of cash decrease as we saw in the first quarter. The inventory that we have, we did expect to convert to revenue and to drive down into increased cash a little bit in the first quarter and we will see that in second quarter.

Weston Twigg - Pacific Crest

I guess in terms of the operating activities, the cash used for that, I assume that would be lower next quarter with some of the ongoing efforts. So at the same revenue level that would be less than $7.3 million next quarter?

Jim Moniz

I would say, yes, that will be less.

Weston Twigg - Pacific Crest

Okay. Then along the same vein, new breakeven level, I know you said that was around, let's say, over 20 million in this quarter, is there a chance that you can get breakeven below $20 million?

Jim Moniz

I believe so, yes. We've already taken some steps in Q1 and we've got some additional activities in Q2 reducing some of our fixed costs and fully expect the breakeven numbers to come even lower.

Weston Twigg - Pacific Crest

Okay. Then back to that Lynx platform, just as a follow up, I am wondering how many Lynx tools are now placed in the field. How many customers do you have or I guess how many of those Lynx platforms have been revenued?

Jim Moniz

I won't give you a specific cal, but we have multiple tools that are more than one customer site there has been follow-on orders and they have been revenued.

Weston Twigg - Pacific Crest

Okay. To the other thing, so product revenue sounds like with orders coming in, we could expect that to a bit a higher without giving guidance for next quarter. On the service side, there was a bit of a drop. Maybe you can't afford, but why was the drop relatively down from 7.6 million in December down to 5.1? And should we expect that to be down in Q2?

Tim Stultz

So that there are two components of that. As you know, when we report service, that includes both upgrades and our core service. Although we saw continued strength in the upgrade business. We actually had a very high quarter in upgrades in Q4 and that represents one of the primary adjustments. Our core service is being pushed a little bit, but it's actually going up pretty well in this environment.

Weston Twigg - Pacific Crest

Okay. Is there an upgrade cycle that you would expect to maybe help over the next couple of quarters?

Tim Stultz

Yes. I think I am pleasantly surprised and very happy with our upgrade business. It may be a little bit lumpy based on different customer levels of granularity. I think that's as an area that has likes and will continue to contribute not only to our revenues, but nicely to our gross margins.

Operator

Your next question comes from the line of Bill Sarix with Reveno Wood Capital. Please proceed.

Bill Sarix - Reveno Wood Capital

Jim, you mentioned a charge in the quarter related to the Korean facility. How big do you think that will be?

Jim Moniz

We are determining that now. I don't have the number actually at this time Bill.

Bill Sarix - Reveno Wood Capital

And the building, have you sold the building or is it up for sale?

Jim Moniz

We actually just took the action in the last few weeks, so we were now going out to see what the building would be appraised for. So I don't have a concrete number for what that would be. We do believe that there will be a source of cash. Although I don't think we should count on that for the second quarter.

Bill Sarix - Reveno Wood Capital

Is it worth more than the charge?

Jim Moniz

As the building, if I knew the appraisal I could answer that question, but since I don't I can't.

Bill Sarix - Reveno Wood Capital

What do you think?

Jim Moniz

What do I think?

Bill Sarix - Reveno Wood Capital

Yes.

Jim Moniz

I think I would be very smart not to answer that question because I don't know, honestly.

Bill Sarix - Reveno Wood Capital

Okay. Then finally, a change in treatment in currency due to the change in the categorization of the loans, that 1.3 million hit that you have to take is not in your EBITDA analysis I take it?

Jim Moniz

No. It's not.

Bill Sarix - Reveno Wood Capital

Okay. So that's an additional 1.3 million non-cash item that existed in this quarter, correct?

Jim Moniz

If I breakout the 1.3 million, because we actually did transfer some cash back from Japan to the U.S., not all of the inter-company loans have been settled, and not all will be settled this year. Majority of that 1.3 million was a recognized translation loss, but not a cash loss.

Bill Sarix - Reveno Wood Capital

Right. Okay. So actually the EPS, the cash EPS is a little bit better than what you are showing?

Jim Moniz

Yes.

Operator

(Operator Instructions). At this time, we have no further questions. I would like to turn the call back over to Mr. Tim Stultz for any closing remarks. Sir?

Tim Stultz

Thank you. I want to once again give special recognition and thanks to the extraordinary efforts and contributions of our employees. It's been a difficult time and they are doing a terrific job, for the continued support of our investors, and express my appreciation to the Board and our management team for their help and guidance during these highly challenging times.

I want to thank you once again for calling in. We look forward to updating you on our second quarter results at the next conference call.

Operator: Thank you for your participation in today's conference. This concludes the presentation. You many now disconnect. Have a great day.

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