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Newport (NASDAQ:NEWP)

Q4 2010 Earnings Call

February 2, 2011 5:00 p.m. ET

Executives

Robert Phillippy – President and CEO

Charles Cargile – CFO, SVP and Treasurer

Analysts

Jim Ricchiuti – Needham & Company

Derek Jose - Longbow Research

Mark Miller – Noble Capital Markets

Ajit Pai – Stifel Nicolaus

Jiwon Lee – Sidoti & Company

Dave Kang – B. Riley

Operator

Good day everyone and welcome to the Newport Corporation fourth quarter and full year 2010 financial results conference. Today’s call is being recorded. Now at this time I’d like to turn the conference over to the chief executive officer, Mr. Robert Phillippy. Please go ahead.

Robert Phillippy

Good afternoon and welcome to Newport’s fourth quarter 2010 conference call. With me is our chief financial officer, Chuck Cargile. Before we get started, I’d like to remind you that during the course of this conference call, we will be making a number of forward-looking statements that are based on our current expectations and involve various risks and uncertainties that are discussed in our periodic SEC filings. Although we believe that the assumptions underlying these statements are reasonable, any of them could prove inaccurate and there can be no assurance that the results will be realized.

The Newport team delivered a record financial performance in the fourth quarter and full year of 2010. I'd like to mention a few of the many highlights. First, our sales for the fourth quarter and full year 2010 were both all-time records for the company. Our 2010 sales of $479.8 million represented an increase of 31% over 2009. Our fourth quarter and full year orders were also all-time records, with 2010 orders of $510.1 million representing an increase of 41% versus 2009.

Our operating income for the fourth quarter was $18.3 million, or 13.7% of sales. Net income for the fourth quarter was $0.40 per diluted share, resulting in full year net income of $1.09 per diluted share, the first time we have exceeded $1 per share in a decade.

These strong earnings drove excellent cash generation. In the fourth quarter we increased our cash balance by $35.1 million and finished 2010 with $200.2 million in cash. We're very pleased with this performance, which resulted from a combination of favorable market conditions and solid execution by the Newport team.

Perhaps the most notable highlight for this call is that we believe we are very well-positioned to continue revenue and profit growth in 2011. I'll comment further on our outlook a bit later, but first I would like to provide an overview of our orders and sales in our target markets and characterize the market conditions and trends in that context.

Fourth quarter orders from research and aerospace and defense market customers were $43.4 million, an all-time record for Newport, increasing 12.5% sequentially and 3.7% over the fourth quarter of 2009. Our performance in this market was strong in all regions of the world, led by stellar results in both Europe and Japan. Fourth quarter sales to this market of $42.4 million were also excellent and represented growth of 10.9% sequentially and 6.8% versus the fourth quarter of 2009.

We continue to enjoy a very strong position in this market, and have just announced several innovative new products and tools that will expand our presence even further. I will comment on these a bit later in this call.

In the microelectronics market, fourth quarter orders were $41.2 million, up 52.6% over the fourth quarter of 2009, and fourth quarter sales were $42.6 million, up 72.9% versus the fourth quarter of 2009. Our semiconductor equipment OEM customers continue to be the key drivers of our orders and sales in this market, and our business levels with them remain strong.

In addition, recent forecasts for the semiconductor equipment industry have become increasingly optimistic as several of our Tier 1 semiconductor equipment customers have provided more favorable outlooks and have raised their expectation for sales levels in 2011. While we did have a slight sequential drop in orders from this market in the fourth quarter, they remain near historically high levels, exceeding $40 million for the fourth consecutive quarter.

We received $25.5 million in orders from life and health sciences customers in the fourth quarter. This represents an increase of 10.7% versus the fourth quarter of 2009, but a slight 7.3% decrease sequentially. Sales to life and health sciences customers were up 28.6% versus the fourth quarter of 2009, and 17.1% sequentially.

Recent forecasts for the global, analytical, and bioinstrumentation market range from 6-8% growth in 2011. With our increasing presence with Tier 1 OEMs, we expect our sales to this market to grow at a faster rate than the industry. We also continue to enjoy record orders and sales levels for our full suite of products for multiphoton imaging applications including our Mai Tai lasers, vibration control workstations, and wavelength extension modules.

Orders from, and sales to, industrial and other market customers showed continued strength in the fourth quarter. Orders of $20.3 million rose $23.6% versus the fourth quarter of 2009 and 3.1% sequentially, while sales of $19.6 million represented a 28.2% increase versus Q4 of 2009 and 5.4% sequentially. This performance is testimony to our increasing participation in applications such as high-precision materials processing, sensing, and fiber optic device manufacturing.

From a geographic perspective, we continue to benefit from our growing presence in Asia, and specifically China, where we have more than doubled our business in the last two years. In 2010, our orders and sales in Asia, including Japan, represented approximately 26% of our total sales and orders, for the first time exceeding the levels we achieved in Europe.

We continue to expand our production in Wuxi China and our sales and distribution channels, primarily in China, Singapore, Japan, and Korea. In the first half of 2011, we plan to open a sales and service office in Singapore to support our growing base of customers in that country. Global expansion is one of our strategic growth initiatives, and we continue to execute on our plan to increase our presence in Asia.

With these favorable market conditions and geographic expansion as a backdrop, we performed well in all of our financial metrics. I will now turn the call over to Chuck to provide more detail on these results. Chuck?

Charles Cargile

Thank you Bob. First let me address a few housekeeping items. The information we're discussing today is included in the press release and Form 8-K we issued earlier today. I also encourage you to visit our website at Newport.com and specifically the investor information section where we've posted supplemental financial information which includes historical financial statements, schedules that detail historical trends for sales and orders by market, and the performance of our two reporting segments. In addition, we've posted on our website our most recent investor relations PowerPoint presentation.

Lastly, I'd like to point out that we will be attending two investor conferences in February where we'll provide an updated presentation and host one-on-one meetings with interested investors. On February 10 and 11, Bob will participate in the Stifel conference in San Francisco, and on February 17 I will participate in the Deutsche Bank conference in Naples, Florida.

Bob's already provided an overview of our sales and orders and market dynamics, so I'll comment on our cash position and other aspects of our financial performance. In the fourth quarter of 2010, we increased our cash, cash equivalents, and marketable securities balance by $35.1 million. Since the beginning of 2010 we've increased our cash balance by $58.3 million.

This level exceeded our expectations and is reflective of the strong financial model we have in Newport. The increase was driven by a combination of solid earnings performance, augmented by our consistent focus on balance sheet management, even as we've ramped production to meet growing customer demands.

Our days sales outstanding was slightly below 55 days in the fourth quarter of 2010 and stayed below 57 days in each quarter of 2010. In addition, our current inventory balance of $84.5 million at the end of fiscal 2010 is $5.4 million lower than the level we had as we entered last year. Yet our backlog scheduled to ship in the next 12 months of $129.6 million is $27.5 million higher than one year ago.

And lastly, we spent only $8.9 million on capital expenditures in all of 2010.

As Bob noted, our total cash balance at the end of fiscal 2010 was $200.2 million. As a reminder, we have subordinated notes with a principal amount of $126.8 million due in February of 2012, one year from now. Even when considering this future demand on our cash, we have a net positive cash position of $73.4 million and we expect to continue strong cash generation in 2011.

We're always looking for ways to deploy our cash to enhance our strategic objectives. We recognize that the greater our cash balance, the greater our flexibility, and the wherewithal to pursue opportunities to enhance our company.

Our fourth quarter gross margin of 44.3% was 400 basis points higher than the comparable quarter of 2009. The increase, compared with the prior year quarter, was due primarily to improved leverage of manufacturing costs resulting from the higher sales level and to our overall streamlined operations. We indicated last quarter that we expect our gross margin to remain in the range of 43% to 45%, depending primarily on the mix of sales, product pricing variations, and manufacturing absorption levels.

Selling, general, and administrative expenses in the fourth quarter were $30 million, or 22.6% of sales. For the full year 2010, while we increased our revenue by approximately 31% over the same period in 2009, our SG&A expenses of $112.8 million were basically flat, with the total level recorded in 2009.

In 2009 we had a large amount of SG&A expenses related to our integration of New Focus and our cost reduction initiatives. Fortunately, these expenses did not recur in 2010 and we were able to invest more in new selling and marketing initiatives to further support our revenue growth.

We intend to continue to leverage our operating expenses while investing in appropriate growth initiatives. Our operating income in the fourth quarter of 2010 was $18.3 million, or 13.7% of sales. On a sequential basis, our operating income increased by approximately 15% over the third quarter level on only a 6% increase in sales.

Both of our operating divisions performed well, increasing their segment income sequentially, both in total dollars and as a percentage of sales. Our photonics and precision technologies division recorded segment income of $20.5 million, or 24% of sales. And I'm very pleased to report that our spectra physics laser division continues to post increasing levels of profitability. In the fourth quarter of this year, spectra physics recorded segment income of $4.8 million or 10.1% of sales. Companywide, our full year operating income was $52.7 million, or 11% of revenue. This percentage is the highest level Newport has recorded in a decade.

Our tax rate was 8.5% for the fourth quarter and 7.1% for the year. We continue to benefit from the tax shield we have for federal income tax purposes resulting from our valuation allowance. Our only taxes resulted from taxes on foreign earnings, state minimum taxes, and the U.S. Alternative Minimum Tax.

Our diluted shares outstanding for the fourth quarter and full year were 38.3 million and 37.7 million respectively. As a result of these factors, our earnings per diluted share were $0.40 for the quarter and $1.09 for full year 2010.

In summary, we're pleased with our financial position and how it was reflected in our results for 2010. We're very excited about our prospects for continued strong financial performance in 2011 and beyond.

Now Bob will make a few more comments before we address your questions.

Robert Phillippy

Thanks Chuck. I would now like to provide an update on some other important developments at Newport and then comment on our outlook for the coming quarters.

Last week we participated in Photonics West, our first major tradeshow of the year. We presented 30 new products at the show, which will help to accelerate our organic growth in a meaningful way. I'd like to highlight a few of these.

The first is NSTRUCT, an entirely new software platform for the laboratory environment that introduces an innovative new way to speed the implementation and improve the monitoring and control of scientific experiments. NSTRUCT provides an intuitive graphical user interface that enables users to easily start up and run multiple instrument and motion products in parallel and enables communication and data exchange between electronic hardware that would otherwise operate completely independently. In other words, NSTRUCT helps different pieces of laboratory equipment talk to each other.

We've also introduced a number of apps for our popular bench top instruments, motion controllers, and spectrographs for use with the NSTRUCT software. NSTRUCT's open architecture also supports standard programming languages for users to create their own applications and provides for the import of programs from other popular laboratory software. The platform software and its related apps are available for free download from Newport.com.

We've often said that one of Newport's key differentiators in the scientific market is the fact that we have the broadest technology and product portfolio in the industry. NSTRUCT leverages this product breadth by tying our products together with a common software link. This enables researchers in chemistry, physics, and biology labs around the world to use Newport equipment to monitor and control their experiments and to collect and analyze their results more efficiently than ever before.

Another important tool that will enable researchers to extend the frontiers of science is our flagship Spitfire Ace ultrafast amplifier. Using our proprietary XPert technology, Spitfire Ace sets new standards for long-term performance, low noise, and day-to-day reproducibility for the most demanding scientific applications. With industry-leading average power of more than 5 watts, along with excellent beam quality and flexible operating parameters, this new product will enhance the Spitfire's position as the tool of choice for laboratory applications requiring ultrafast laser pulses.

Another set of standout new products are our new Explorer XP and Mosaic all-in-one Q-switched green lasers. These products are built on an innovative new platform that combines the power supply control system and laser head into a single unit that has improved performance and is dramatically smaller and much more robust than other Q-switched products available today.

For example, the Explorer XP packs 5 watts of green power into a single box that can be held in one hand. This is less than one-seventh the size of the smallest competitive laser. The Explorer XP can produce constant average power over frequencies ranging from 60-300 kilohertz, enabling users to significantly increase throughput without compromising laser processing performance.

In addition, the Explorer XP's design and proprietary automated manufacturing process enables us to offer this product at the lowest cost per watt in the industry. The Mosaic has similar performance, size, and cost per watt advantages, and provides 11 watts of power. The Explorer XP and Mosaic are perfect tools for a broad array of applications, including LED chip marking, solar cell scribing and edge isolation, micromachining, and printed circuit board manufacturing.

We also introduced a number of new products during the fourth quarter in our precision positioning, vibration control, instrumentation, and optics product lines.

In summary, Newport's new product pipeline is quite robust, and we have implemented a number of processes and tools to enhance the efficiency of our R&D teams. These new products are excellent examples of these efforts, and we have many more product introductions planned for 2011. We have invested significantly to develop the broadest and deepest portfolio of photonics products and technologies in our industry, and we are resolved to maintain and build on this differentiated position.

I would now like to discuss our outlook for the first quarter and full year of 2011. As I mentioned earlier in the call, we continue to experience favorable conditions in all of our end markets. This, combined with the optimism in our customers' near term forecasts, in particular for the semiconductor equipment market, gives us a bullish outlook for the year.

For the first quarter of 2011, we expect sales growth of approximately 15% over the $10.7.2 million we recorded in the first quarter of 2010. And we expect our earnings per share to almost double the $0.14 per diluted share we achieved in the first quarter of last year. Further, we expect continued revenue growth throughout 2011, and expect our net income to grow at approximately twice the rate of sales growth.

The combination of favorable business conditions, our increasing market presence, and our significant profit leverage enabled us to achieve excellent financial results in the fourth quarter and full year of 2010, and bodes well for continuing strong performance in 2011.

That concludes our prepared remarks. We'd now like to address your questions.

Question-and-Answer Session

Operator

[Operator Instructions.] We'll take our first question from Jim Ricchiuti with Needham & Company.

Jim Ricchiuti – Needham & Company

What I was a little surprised by, in terms of the orders, were the bookings you registered in the scientific and research market. It sounded at least as we've gone through the year that you thought maybe the stimulus funding was starting to wind down, yet you had what looks like the strongest - really strong quarter for bookings in that area. What do you see going forward in that particular landmark?

Robert Phillippy

So our position in the market as exemplified by the Q4 results remains pretty strong, and if you look at it year-over-year, sales were up 11.7% and orders up 8.1%. And these rates are higher than historical averages and they do include the benefit from some stimulus funding. However, that stimulus funding appears to be winding down at this point. And looking forward to 2011, the global R&D market picture continues to be mixed. There are certainly growth opportunities that are meaningful in some countries. I mentioned the growth in Asia, and we would expect that to continue to be robust. But that will be at least in part offset by sluggish funding in environments just related to macroeconomic factors. So I guess the overall thing is it's not going to be a huge double-digit thing, but we would certainly expect to maintain our strong position. And remember that the market continues to provide a source of stable, profitable business for us and gives us a good platform to identify and capitalize on emerging applications for photonics technology.

Jim Ricchiuti – Needham & Company

Bob, you gave us a sense of how we should think about the full year. You do anticipate growth year-over-year. Do you expect growth in each of your major end markets including microelectronics?

Robert Phillippy

I'll talk about it on, I guess, a macro sense first, then we can talk about any of those specific markets. I'm sure we will during the course of the Q&A. Overall, as I mentioned during the prepared remarks, we're pretty bullish, and we're bullish for two reasons.

First of all, we're coming off of a record year. We've got all-time record orders in 2010, and our backlog scheduled to ship is just shy of $130 million, which is $27.5 million higher than when we entered 2010. The second reason is that conditions in all of our markets remain pretty healthy. We continue to see pretty healthy activity levels everywhere, including the historically cyclical semiconductor equipment market.

So I guess as I look at 2011 in a macro sense, I say that because we're coming off a record year in 2010 we wouldn't expect to achieve the same growth rate on a percentage basis but we certainly would expect to continue to grow.

And then the other thing I mentioned is that we would expect from a financial model perspective that if we grow revenues we'll grow profit at about 2x the revenue growth rate. So for example, if revenues grow 10%, we expect 20% net income growth.

Operator

And we'll move on to Derek Jose with Longbow Research.

Derek Jose - Longbow Research

I was wondering if you could kind of give us a little more color on some of the puts and takes into next quarter, and not only the year in terms of tax rate, how much you guys may be seeing the advantage of that from the R&D tax credit. And then just general cap ex expectations.

Charles Cargile

So for 2010, as we mentioned, we still have a very low tax rate because of the valuation reserve that we have. That valuation reserve will stay in place for at least the first half of 2011, so our tax rate at the end of the year was 7%, it was 8% in the quarter. We think it's going to be about that same range in the first part of the year, so certainly for Q1. So that 8-10% range for tax rate is what you should be modeling right now.

And then as far as cap ex, we mentioned that we did about $9 million of cap ex for full year 2010, a little more than $2 million I think for the quarter. Q4 it was $2.4 million. It will be a little bit less than that for Q1, and then the full year level of cap ex will probably be a little bit higher but not a lot higher. So maybe in the $10-12 million range for the full year and probably a little less than $2 million or around $2 million for Q1.

Derek Jose - Longbow Research

Kind of looking forward, you guys are very bullish and I'm noticing from your cap ex levels it doesn't seem like that's where the cash is going. Excluding obviously paying off the debt next February, where do you see reinvesting this cash? Where are your focuses right now?

Charles Cargile

We are feeling really good about the cash generation. Q4 was extremely strong. As I mentioned we added almost $60 million of cash in the year. We don't have, as I just mentioned, going from $8 million or $9 million of capital to $10 million or $12 million, certainly isn't much of a use of cash. So I think we'll have a very strong year in 2011 as well.

The first thing that we'll keep an eye on is the subordinated notes that are due in a year. That's $127 million that we'll have to address. But we've also made no secret of our interest in doing acquisitions. So I would expect, although you can never really identify when exactly an acquisition is going to occur, I think as we look out in the near- to mid-term there will be some acquisitions that we could use the cash for.

Derek Jose - Longbow Research

And can you just clarify something about that? Are you looking in terms of bolt-ons or are you looking on terms of, say, [inaudible] expansions of perhaps different areas?

Charles Cargile

The strategy that we've articulated most consistently contemplates bolt-ons more, similar to the one like we did with New Focus last year. We think those are really good options and there's a lot of good alternatives for us to accelerate our growth. I think our model, our business model, is structured to accommodate acquisitions and we have a pretty good track record of late with the integration. So I think we'll always be careful to make sure that we have the appropriate strategic fit and we'll be careful with valuations, but beyond that we probably shouldn't comment on any of the specifics.

Operator

And we'll move on to Mark Miller from Noble Capital Markets.

Mark Miller – Noble Capital Markets

Just like to question about the backlog in terms of is it the same rough mix, or are we mixing up, or is that staying pretty much the same? It sounds like it's staying the same with your margin guidance.

Charles Cargile

There's not been a meaningful change in the mix of the backlog. It is at very high levels, which we appreciate, which is what gives us some confidence for the first half of the year, and the other positive for us is when we consider the guidance or the forecast that we have for our revenue in Q1, the percentage of that that's already in backlog is a little bit higher than what we've had over the last several quarters. So we have a good piece of it in backlog, which gives us more comfort in the forecast for sales.

Mark Miller – Noble Capital Markets

And the percentage of the business you're seeing from microelectronics, capacity versus technology type buys?

Charles Cargile

It's hard to put an exact percentage on that because, remember as an OEM supplier to the Tier 1 semiconductor equipment companies, we are in both current and future generation tools. We've been successful in gaining our - improving our share position over the course of the last industry cycle and a lot of that is for tools that are just coming into new product introduction at this point. But in terms of the application at the end customer's place, whether it's new technology or capacity, for us it's whether it's a new program or an existing program.

Operator

Our next question comes from Stifel Nicolaus and Ajit Pai.

Ajit Pai – Stifel Nicolaus

A few questions. I think the first is sort of the three new products that you said that you talked about at SEMICON West. Could you give us some idea as to what the market size of those three products could be? And also, three years out, what the potential revenue contribution, even a broad range would be fine. And then on the first product, it sounds very similar in some ways to LabVIEW, or at least some applications where LabVIEW is used. Is it a product that would compete with LabVIEW, sort of in the lab environment? Or is it completely different instruments controlled in a completely different way?

Robert Phillippy

Good questions actually, but tough ones, at least the first one in terms of the revenue and market potential for our products. And let me answer it in this way. It was three of 30. It was three new products that I chose to highlight because I wanted to make sure that products don't get lost in the mix. We're a technology company and technology companies are built around products and our product portfolio is a pretty important thing to us.

But we have so many products, 15,000 standard end items, that any particular one isn't going to have $50-100 million worth of growth potential. These are all products that we think will be multi-million dollar sellers, with the exception of course with NSTRUCT, because it's going to be a free download. But it's not something that's going to be $50 million or $100 million on a single product basis. What's really the differentiator for Newport is the combination of all of our products offering really broad-based solutions for people in each of the markets we serve. So that's the answer to the first question.

To answer the second question, NSTRUCT is fully compatible with, and intended to be, a complement to LabVIEW, not a competitive product to LabVIEW. What it does is it helps to make our instruments - bench top instrumentation, motion control products, as well as spectrographs and other things, work well and you can import LabVIEW software applets into it.

Ajit Pai – Stifel Nicolaus

Got it. And then the second question is, you talked about increasing your share and lots of new product introductions, a dozen product introductions at SEMICON West. But I just wanted to get a sense of when you look at the semiconductor capital equipment market and it has historically been a very cyclical market and you've gained share there. But do you think with the new product introductions that you have right now and also the higher share that you have, offsetting factors, that if the industry slows or declines in revenue by 10%, that you could still grow your revenue or keep it flat?

Robert Phillippy

I'll answer it in a generic way rather than responding directly to the 10% number. But we're proud of the fact that over the course of the last full semiconductor equipment cycle we have gained share in the markets that we participate in, or I should say in the semiconductor equipment industry. And I think our results show that. We would hope and expect to do that over the course of the next industry cycle as well. As it pertains specifically to new products, there's always a meaningful design cycle associated with getting a product implemented and into a production environment and so whether or not that happens to match the industry cycle is going to be hard to say.

Ajit Pai – Stifel Nicolaus

Right. And if you're looking at the health of end markets, all of that that you talked about, you know you still see pretty robust demand, do you expect the semiconductor capital equipment market to grow in 2011 year-over-year? Not your business, but the market itself? Or do you expect that in certain quarters the market itself might decline?

Robert Phillippy

As we look at the semiconductor equipment market, we look at the same, I guess, couple of pieces of data that most do, and that's the overall forecast that everybody reads in the public domain about industry conditions. And then we of course look very carefully at the earnings releases and outlook statements from our key OEM customers. And then we also have another piece of information which is I guess really where the rubber hits the road, which is their forecast internally to us, and their pull rate on our demand. So all that being said, it's unlikely that we're going to be any better than anybody else at picking the inflection point of an industry cycle. But as we sit here today, current data from all those sources is pretty optimistic. Some of the recent announcements in particular have been quite upbeat for growth in 2011. So I think it's very possible that the industry could have a growth year in 2011.

Ajit Pai – Stifel Nicolaus

So you think that your customers believe Intel and Samsung, when they talk about increasing their cap ex in 2011, that your customers are managing towards their public announcement of their customers?

Robert Phillippy

I don't want to necessarily second guess our customers, but what I'd say is that they come out with their own guidance and that's based on their processing the information that's been presented to them just like we're processing the information that's presented to us.

Ajit Pai – Stifel Nicolaus

Got it. And your view is more conservative than your customers' view and your customers are likely to also be more…okay. So the second question would just be looking at the sort of life sciences opportunity. And you talked about the analytical instrumentation market and the growth rates there. And you talked about your growth being faster than the market. But given your very low penetration in that market and significant investments over five years, why wouldn't you be growing materially faster, about 3-5 times the base of the market growth rather than just faster than the market growth?

Robert Phillippy

I appreciate the sentiment, and we'll certainly drive it as aggressively as we can, but for us it is more about programs and about the timing of new product introductions and we're pretty proud of the results that we've had on a year-over-year basis, but on a particular quarter-to-quarter basis it's hard to characterize an inherently lumpy orders pattern like all OEMs are going to have.

But we have a number of programs in gestation at this point, a number of new products, which will be perfectly applicable to the life and health sciences market, but it's all based on design cycle. We've been fortunate in 2010 to have a couple of significant programs come through that design cycle and now they're starting to show up in our revenue results, and that would continue in 2011. But the pace at which that growth accelerates is all based on when new OEM programs come online.

Ajit Pai – Stifel Nicolaus

Got it. And are there any significant ones imminent?

Robert Phillippy

Not as imminent as the next quarter or two.

Operator

We'll hear next from Jiwon Lee with Sidoti & Company.

Jiwon Lee – Sidoti & Company

First of all, what was the sales from Wuxi in 2010 and how will that change this year?

Charles Cargile

We've said all year that the goal for Wuxi was to have $30 million of external revenue and we achieved that goal. And we expect to grow Wuxi even beyond that in 2011. The contribution from Wuxi has been very meaningful for us and very successful.

Jiwon Lee – Sidoti & Company

You gave us some sense for the top and bottom line growth this year, but is there some type of baseline you're comfortable talking about and so similarly how far into the future quarters do discussions typically take place with your large [inaudible] customers.

Charles Cargile

Well, all we've talked about like you mentioned was 2011, the guidance for 2011. And we have not been in the practice of attempting to forecast externally beyond one year. Internally, we have a rolling three-year look at our markets and our business for our strategic planning purposes, but it's exactly that. It's internal strategic planning, so we don't intend to be in the business of trying to give guidance for beyond one year.

And then in terms of what kind of discussions we have with our customers beyond one year, I'll let Bob address that one.

Robert Phillippy

We look at forecasts to the extent that customers will provide them to us and we certainly look for their - particularly on new product introductions - for their macro sense of what the ultimate revenue target is. But particularly in the semiconductor equipment market, which has some inherent cyclicality associated with it, the further out you look the less time predictable the outlook is. Not to say that they're not pretty good in terms of anticipating what the total revenue run rate will be for a particular product, but it's really hard to pick the time because you've got the industry cycle fluctuations in there.

So when it comes to actual sales releases, and I should say orders and production and shipments, our visibility is a quarter or two because that's the firm level of commitment that we have that we dial into our production process.

Jiwon Lee – Sidoti & Company

That's very helpful, but my question more related to whether or not you had some baseline expectations on the top line front for this year.

Charles Cargile

Sure. We have, as we mentioned in the prepared remarks, we have $130 million of backlog that's scheduled to ship this year, so we know the $130 million. And then based on discussions with our customers across all markets, not just semiconductor, we get a feel for what we think the orders that we'll take during the year - what the orders and ship will be. It's more precise for the first half of the year and it's more of our own experience and judgment for what we think it will be in the second half of the year.

Jiwon Lee – Sidoti & Company

Okay, and if I can jam in one more question, how many [inaudible] customers were there last year?

Charles Cargile

How many what for the year?

Jiwon Lee – Sidoti & Company

10%

Charles Cargile

Oh, for the year? There were no 10% customers. There were a handful that were in the 5-10% range but none that were over 10%.

Operator

And we'll hear next from Dave Kang and B. Riley.

Dave Kang – B. Riley

Can I get some numbers first? What were depreciation and amortization and did you give out stock compensation?

Charles Cargile

I didn't give it, but I will. For the year, depreciation and amortization was $22.7 million. For the year, cap ex was $8.9 million. For Q4, depreciation and amortization was $5.9 million and cap ex was $2.4 million. And for stock compensation, for the year it was $4.8 million and for the quarter it was $1.5 million.

Dave Kang – B. Riley

And then given gross margin target of 43-45%, what do you think your operating margin will be, or your model?

Charles Cargile

We're pretty close to it now. As we mentioned, there's a little bit of leverage we think we can get in the gross margin depending on the things that I mentioned, the product mix and pricing nuances that you might have in the quarter. But if we're balancing between 43% and 45%, and we have our SG&A now below 23%, we'd like to spend a little bit more in R&D. We've been running at about 8%. We intend to increase that a little bit. But we'd like to be in a position where we're around the 13-14% operating income. And then if you look at it over a longer period of time, the model that we'd like to have is that when we're in a down cycle, or when the market headwinds are against us, we never have an operating income that goes below 10%. And when the market winds at in our favor and product mix is good, and we're hitting on all cylinders, that we should be at 15%. And then in a moderate time period we'd be in the 12-13%. So kind of have that 500 basis point band where you can get as high as 15% but never fall below 10%.

Dave Kang – B. Riley

And then I think you gave out the tax rate for the first half, but what about second half and beyond? What kind of a tax rate should we be using?

Charles Cargile

I would suggest that you use the 8-10% for all of 2011. At some point in 2011 or early 2012, once we have an adequate amount of sustained profitability and a cumulative profit for a period of time, we'll be required to reverse that valuation reserve, and that will cause a very, very large noticeable tax credit to come through the tax line. And then after that, presumably in 2012, then we would go back to a normalized tax provision, probably in the 35-40% range. Now we'll have a provision in the P&L but we'll still have protection for cash taxes until we exhaust the NOLs that we have.

Dave Kang – B. Riley

And the last question is can you just talk about [inaudible] that your customers are sufficiently semiconductor customers?

Charles Cargile

The inventory levels of our customers?

Dave Kang – B. Riley

Yeah. Like you sell subsystems and modules, right?

Charles Cargile

For us, Dave, we have that on a micro level more so than we have it on a macro level. The macro level is whatever they publish in their results. What we look at is what they have in terms of our products. Because what we're most interested in is ensuring that we have continuous supply available to them in a ramp condition. And many of our OEM customers are on Kanban-type pull programs where they want to make sure they keep a continuous source of supply and we have the appropriate degree of buffer stock in the channel to ensure that happens. So as it relates to a micro view, we are not plugging the channel with inventory if that's kind of the implication of the question at all. Their demand levels remain high and we are pulling, and in some cases pushing, hard to make certain that we can achieve their requirements.

Dave Kang – B. Riley

And what is your expectation out of Chinese customers for this year and how do you think that will change if and when the Chinese government tightens their policy?

Charles Cargile

When the Chinese government tightens what policies?

Dave Kang – B. Riley

Fiscal policy. They raise interest rates.

Robert Phillippy

We still have so much runway to grow in China. It's been certainly the fastest growing revenue spot for us around the world, but there's still a tremendous opportunity for us as we've mentioned before. Today the $30 million of product that we ship from Wuxi is all export. We do ship more than $20 million into China today, but that's not manufactured in Wuxi. We think that now if we can use Wuxi as the catalyst to drive greater product sales in China there's a tremendous opportunity for us that won't be largely impacted or hampered by government policy. So we are in a very good position and very optimistic about what we'll do in the near and mid-term.

Operator

And we'll hear a followup from Jim Ricchiuti from Needham & Company.

Jim Ricchiuti – Needham & Company

I was wondering if you can provide some color on the solar portion of the business from an orders standpoint for Q4 and maybe for the year. And I'm trying to get a sense as to how you're viewing that portion of the business in 2011.

Robert Phillippy

Solar, in some respects, is a bit of a wildcard within the microelectronics segment that we have. Long-term industry forecasts continue to be quite bullish, and we're pretty bullish on our growth prospects in the market. But as you know, we participate in several technology areas: lasers, solar simulators for test applications, motion control, and even a certified test and calibration lab. All of those go through an OEM or integrator model in terms of the overall supply chain into solar fabs. We also for a single discrete application - thin film solar panel scribing - we build a complete system. And that final category for our business it's a very targeted set of customers and the business is somewhat digital. It's subject to, I'll call it choppiness. And because we are working with a discrete set of customers, it's going to take some time to develop. So I guess the way I'd characterize it is it's single-digit, low single-digit millions at this point, subject to grow but in sort of a choppy and uneven fashion.

Jim Ricchiuti – Needham & Company

And Chuck, just turning to the operating income of PPT and the laser business. It looked like you were pushing at the outer boundary of operating margins last quarter in the PPT area and you came in and you did 24% operating margins. Is that sustainable? Or was it just an unusually profitable mix? And what's your sense on the laser side where you continue to show some nice improvement?

Charles Cargile

The PPT operating income was truly, truly impressive, and it's at a historical level and we continue to get great benefit from the interaction in Wuxi. The New Focus acquisition has been a real homerun as we fit it in with PPT and the fact that the markets are all going so strongly for us, all those factors have just played right into getting PPT true world-class performance. I wouldn't expect them or hold them accountable for 24% operating income every quarter, but I think it's very indicative of the leverage that they have when all things are going well. So we've been happy with PPT any time when they're above 21-24%. So we think that that part is certainly sustainable, and those business units have done a terrific job.

The laser side, I think there's still a little bit of room for improvement. We are over 10%, which was a goal that we articulated early in the year to say that we would exit this year at 10%, but the interesting thing for me for lasers is when I talk about having opportunity for improvement, recall that we started the year well below 10%. So our full year lasers operating income is only 7.8%. So if we just stay above 10% in lasers for the full year, that's another over 200-basis point improvement that we would be able to capture for the full year. So there's still room for improvement there on a full year basis and we'll just keep up the world-class performance in PPT.

Operator

And we'll take our next question from Mark Miller with Noble Capital Markets.

Mark Miller – Noble Capital Markets

I just wondered about 2012. Did you say we should model up to a 35% tax rate for the entire year?

Charles Cargile

Well, that's a little difficult now because what will actually happen is there could very well be a very, very large credit, a one-time discrete event. It could be as early as Q4. It could be first half of 2012. We won't know until we're farther into the year. And the fact that it's in any event a non-cash event, I'm not exactly sure how you want to work your model. If you want to have 2012 be comparable to the most recent period, I would just keep it at 10%. If you want to highlight that in fact there will come a time in 2012 where we go back to being a full federal taxpayer, you can factor that in. But it won't be until 2013 or '14 that we become a cash taxpayer would be my guess.

Mark Miller – Noble Capital Markets

Okay, I'm just wondering, you've done a good job as you noted of constraining operational expenses, but I'm just wondering, you're going to be seasonally lower in sales. Are expenses going to track down next quarter in terms of percent of sales, or are they going to remain at levels similar to the December quarter for the op ex?

Charles Cargile

I think they'll be relatively similar. There's pluses and minuses. Generally, Q1 is a little bit higher in payroll-related expenses because there's so many of those that tap out at a certain level and so everyone's paying all the taxes in the first part of the year. But the flip side is because we did have such strong performance, many of our incentive plan accruals created higher expense in Q4. In other words, we had accrued at overachievement levels whereas in Q1 we'll be back to accruing at target levels. So I think all in, with the pluses and minuses, relatively flat SG&A would be the way to model it, even though the revenue will be down a little bit seasonally.

Operator

And we have time for one last question. That will come from Ajit Pai with Stifel Nicolaus.

Ajit Pai – Stifel Nicolaus

Just looking at your free cash flow for next year, for 2011, I think for 2010 you mentioned a target at the beginning of the year and that moved up during the course of the year. Now you have a definite deceleration in growth rates and your working capital, all of that, doesn't need to grow anymore if that's the case, both inventory as well as receivables. So could you give us some indication as to what kind of free cash flow generation we can expect for this year, broadly?

Charles Cargile

This year we, as I mentioned, we increased our cash balance about $60 million. If you want to speak very broadly, I would say something similar to that for 2011 would be reasonable.

Ajit Pai – Stifel Nicolaus

Why wouldn't it be higher if you have slowing growth on the top line and less need to grow your working capital?

Charles Cargile

Part of it is a Q1 dynamic. If you take a look at the balance sheet, you can see the amount of payroll accruals for incentive compensation, accounts payable, for the ramping production and backlog that we have. Both of those are significantly higher Q4 2010 than they were Q4 2009. So fortunately we blew the doors off cash flow for Q4 but there will be some downward pressure on cash in Q1 as those bills come in and have to be paid in the first quarter. And I mentioned that we'll probably spend a little bit more in cap ex. We have really restricted cap ex in the last three years. It's not going to be double, but as I mentioned we may go from $8-9 million to $10-12 million. So it will be a little bit higher there. So I'm very confident in the overall cash generation, but I think there might be some more demands on cash in 2011 than there was in 2010.

Ajit Pai – Stifel Nicolaus

And since you don't have your 10-K as yet, can you give some color as to what the total reserve against your deferred tax assets are? Like what is the total amount of assets you have, either NOLs or deferred tax assets?

Charles Cargile

As you allude, we're in the middle of finalizing our 10-K now, so the numbers I'll give you may change a little bit, but it will give you an order of magnitude. But we've got about $25 million of NOLs on the federal side, about a little over $30 million for state NOLs, and about $13 million or so for foreign NOLs.

Ajit Pai – Stifel Nicolaus

And these are NOLs, untaxed NOLs, or fully taxed? Are these deferred tax assets?

Charles Cargile

These are NOLs that we would be able to offset the cash taxes.

Ajit Pai – Stifel Nicolaus

Got it. And then the last question would be when you talk about, look at the sort of acquisition pipeline, there have been potential acquisitions in the pipeline for a long time. So looking today relative to last year, since nothing has closed in the past year, are you seeing the potential acquirees being more willing or less willing? Is the probability of something happening over the next six months - the way you feel about it - is it significantly higher now than it was at the end of last year when you're looking at speaking to folks, thinking that something could happen?

Charles Cargile

Yes, we believe there is greater opportunity, and I believe the greater opportunity goes both ways. It's twofold. Number one is we're a lot more confident in our financial position today than we were a year ago. And so it gives us more confidence as we look at doing acquisitions. We're more confident not only because of our financial position, but because of the success and the experience that we got out of the New Focus acquisition. And then on the side of the potential sellers, I think as market conditions have solidified, it makes valuations more rational. It makes people not as scared. They don't wonder is there another double dip coming, and there was a lot of uncertainty for sellers over the last couple years as well. So I think it works both ways, positively for us as we consider acquisitions.

Ajit Pai – Stifel Nicolaus

And the valuations for sellers must have gone higher now than it was about a year ago? Or is it roughly the same expectations?

Charles Cargile

I think valuations are higher. I think you see that. I'm not speaking specifically to the people that we talk to, but all you have to do is look at comparable transactions that are being done and you see that valuations are higher today than they have been.

Operator

And that does conclude our question and answer session. I'd like to turn the conference back over to today's speakers for any additional closing remarks.

Robert Phillippy

Thanks again for joining us today and for your continued interest in Newport Corporation. Keeping in mind that it takes strong teams to produce excellent outcomes, I also want to take this opportunity to thank the Newport team for their incredible efforts on behalf of our company. It is indeed a pleasure to be a spokesperson for our record financial performance, and I'm very mindful of the fact that it is the energy, resourcefulness, and commitment of our employees that makes these results happen. The Newport team is simply outstanding, and I truly appreciate the opportunity to be a part of it. With that, we look forward to next quarter's update. Goodbye.

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