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Zygo Corp. (NASDAQ:ZIGO)

F1Q08 (Qtr End 9/30/07) EarningsCall

October 25, 2007 6:00 pm ET

Executives

Walter Shephard - CFO

Bruce Robinson - Chairman and CEO

Analysts

Darice Liu - Maxim Group

Tom Clevens

Operator

Ladies and gentlemen, thank youfor standing by, and welcome to the Zygo Corporation First Quarter ResultsConference Call. During the presentation, all participants will be in alisten-only mode. Afterwards we will conduct a question-and-answer session.(Operator Instructions). And, as a reminder, this conference is being recordedThursday, October 25, 2007.

And it is now my pleasure to turnthe conference over to Mr. Walter Shephard, Chief Financial Officer. Please goahead, sir.

Walter Shephard

Thank you, Mark. Good evening,everyone. I want to thank you for joining us tonight for our first quarterconference call. Before I turn the conference call over to Bruce Robinson,Zygo's Chairman and CEO, I would like to read the following forward-lookingstatement.

All statements, other thanstatements of historical fact, that are made during this call regarding ourfinancial position, business strategy, plans, anticipated growth rates andobjectives of management for future operations are forward-looking statements.Forward-looking statements are intended to provide management's currentexpectations, or plans for the future operating and financial performance,based upon information currently available and assumptions currently believedto be valid.

Forward-looking statements can beidentified by the use of words such as "anticipate,""believe," "estimate," "expect,""intend," "plan," "strategy,""project," and other words of similar meaning in connection with thediscussion of future operating or financial performance. Actual results coulddiffer materially from those contemplated by the forward-looking statements asthe result of certain factors.

Among the important factors thatcould cause actual events to differ materially from those in theforward-looking statements are fluctuations in capital spending of ourcustomers, fluctuation in net sales to our major customers, manufacturing andsupplier risk, dependence on and timing of new product development, rapidtechnological and market change, risk in international operations, dependenceon proprietary technology and key personnel, length of the sales cycle,environmental regulations and fluctuation in our stock price.

Further information on potentialfactors that could affect Zygo Corporation's business is described in ourreports on file with the Securities and Exchange Commission, including our Form10-K for the fiscal year ended June 30, 2007.

Now, I would like to turn thecall over to Bruce.

Bruce Robinson

Ladies and gentlemen, welcome toour first quarter Fiscal 2008 earnings call. Management was extremelydisappointed with the first quarter results. We had indicated on our last callthat expected net income results would be at, or slightly above break even. Thesemi-cyclicality coupled with the continued delay by our major OEM customer andreleasing their new tool, has adversely affected both margins and shipments.

Action was taken to reduce 5% ofthe workforce, and we will continue to address expenses, as we work to recoverfrom a significant downturn in revenue and orders.

We anticipate fiscal 2008 salesand earnings will be skewed towards the second half of the year based on thestrengthening in business conditions.

We have been spending heavily onour semiconductor initiative, and ship their first multifunction back end ofthe line tool in the first quarter.

It is anticipated, they will beaccepted this quarter, since it is presently meeting all specifications asoutlined by the customer. We now have ceded tools in all areas of the fab, andhave been encouraged by the results. It will now be necessary to execute andexpand both the applications and the customer base. It is a slow progress,additionally hindered by the downturn in semi-CapEx spending.

We have identified with ourcustomers, areas of differentiation, and will continue strong fundingthroughout fiscal 2008.

Our core instrument metrologybusiness has shown strength in the first quarter, with orders up 13%, comparedto quarter one last year, and looks to continue contributing positivelythroughout this fiscal year.

Our Optics Division continues itsdouble-digit growth with orders in quarter one up 38% from the previous year.We've been very pleased with the success of our strategy, to add value to ourcomponents business through design and manufacturing of electro-optical assemblies.There are number of opportunities in this area that will continue to fuelgrowth.

To sum up, excellent growth inthe Optics Division, coupled with strong orders in metrology instruments.Weakness in semiconductor market across both OEM and standalone metrology,affected by the duality of semi-cyclicality and the customers new productintroduction issue.

Under certain conditions that maybe prudent to reduce R&D spending on our semi-initiatives to match therevenue downturn. This would be very short-term view. We are focused on ourlonger term outlook. And believe that semi-initiative will be successful atdriving growth and margins. And willultimately provide shareholder value beyond what we see today. For this reason,we will continue to invest in R&D and closely monitor every step throughoutfiscal 2008.

Thank you, I will now turn thecall back to Walter.

Walter Shephard

Thank you, Bruce. And I'll nowgive you a brief overview of the numbers. For the quarter, our orders were $37million, of the orders received, 60% was from our Metrology Division, and thebalance of 40% was from our Optics Division.

As Bruce mentioned, within theMetrology Division, the instrument business unit, have strong quarter with ourfourth $3 million in orders, which represents the 13% increase from Q1 of lastyear.

PPS had orders of $6 million oforders in Q1 down from $80 million in Q1 of last year, reflecting the downturnthat we have mentioned.

In the Optics Division, ouroptical assembly group on its significant order over $4 million to manufactureone range night vision surveillance camera as a group continues to expand into strategicmarkets that leverages it's optical assembly's capabilities.

Reflecting the comments that Brucemade earlier about the slowdown our semiconductor businesses, orders fromsemiconductor customer represented 40% of our Q1 orders versus the traditional60% or better compared to our industrial customer. With the positive book-to-billin the quarter, our backlog rose over $77 million.

Sales for the quarter was $32million. Our Metrology Division accounts for 63% of the revenues in the quarterwith the balance coming from our Optics Division. The Optics Division revenues asa percentage of sales grew significantly, from our historically model of averagingin the 25% to 30% range.

The majority of the Metrology'sDivision revenues came from the instrument group, where our PPS business unithad revenues of $6 million in the quarter, as declining orders for this unithave suffered over the past three quarters. Sales to Canon, our largestcustomer was 18% in Q1.

The gross profit in quarter of35% was one of our weaker results in quite a while, and well off our target ofover 40%. The weak performance can be attributed to a number of factors. AsI've just mentioned, our optics products were a greater part of our revenue mix,and they have been in the past. These optics products carry lower margins thanMetrology Division products.

The lower sales volume in thequarter coupled with delays in some of our factories, due to vendor issues,caused these factories to run less than optimal performances.

Operating expenses came in at $30million as prudent hiring and cautious spending help to bring our expenses downsignificantly this quarter. We spent $5.6 million in RD&E, which as apercentage of sales was to 18% of sales, due to lower sales volume in thequarter.

RD&E spending is up $200,000compared to Q4 of fiscal '07. We will continue to monitor our spending, and wedo expect these expenses to increase moderately during the coming quarters, asbusiness conditions dictate.

Cash, cash equivalents andmarketable securities was $62 million at the end of the quarter, a decrease of$8 million from the end of last year. Sales in the quarter from last year'sprofit sharing bonuses, as well as our stock buyback program was a primaryfactors. Regarding our stock buyback program, so far, we brought backapproximately 540,000 shares at a cost of roughly $7.5 million.

Our receivables remained in verygood shape, although, due to low Q1 sales, the calculation with DSO shows alarge increase to 73 days. We expect our DSO average to come down to normallevels in the coming quarters.

Our inventory levels increased by$0.5 million from the beginning of the fiscal year. As we mentioned in lastconference call we are adjusting our inventory purchases to meet our currentexpected future shipments, and programs have already been put in place to pushour inventory levels down in fiscal '08.

Before taking questions, I wantto summarize our current expectations for fiscal '08. It is mentioned in ourpress release, we are now expecting sales for the current fiscal year to be 5%to 10% below last year's sales level. The decline is due to lower lithographyand semiconductor revenues partially offset by growth in revenues from ourOptics Division or instrument business unit.

Our gross profit as a percent ofsales will recover in second half of the year, we expect for the full yeargross profit will average 40%.

Operating expenses were in theyear at approximately $55 million again based on business conditions. Andfinally, we expect our tax rate to remain in the range of 36% for the fullyear.

This concludes our remarks and wenow like to turn the call over to questions. Mark?

Question-and-Answer Session

Operator

Thank you. (OperatorInstructions). And our first question is from the line of Darice Liu from theMaxim Group. Please go ahead.

Darice Liu - Maxim Group

It's Darice.

Bruce Robinson

Hi Darice.

Darice Liu - MaximGroup

Hi. You'd mentioned that thisquarter was impacted by some of those acceptance and supplier delivery issues,and you mentioned no cancellations. So, when should we expect these revenues tomaterialize?

Bruce Robinson

Believe it or not, despite thelow sales that you see there, these affected areas of the factories that arefully loaded. And it will not be possible in the second quarter to recover thetotal amount of those shipments. And so, they will go over the next two to threequarters, Darice.

Darice Liu - Maxim Group

Including the acceptance issues,as you said this was about $4 million, correct?

Bruce Robinson

Yes. Darice.

Darice Liu - Maxim Group

So, those are for shipments,those are for tools or products that have already been shipped out. So, $1.5million, I guess I can see from two to three quarter like are being spread out.But what about the $4 million which is a part of the chunk?

Walter Shephard

Darice. Most of the acceptanceswill be in the second quarter, approximately one machine that will fit into thethird quarter, just because of products performing in the field.

Darice Liu - Maxim Group

And they are new products or Iguess I am trying to figure out what the issues were with the tool?

Walter Shephard

Well, as, you know, that some ofour inline tools, we wait till we get acceptance from the customer in thefield. Sometime some of them run well, sometimes there are issues not only justfor the machine but intentionally with the fab that is in and to make it workproperly. There is also one, what we call are special on the instrument group,that’s been out there and that will get accepted in the second quarter.

Bruce Robinson

It's in the flat-panel area,Darice.

Darice Liu - Maxim Group

Okay, fair enough. Speaking offlat-panel, I guess, when you take a step back the [semi-chip] industry werehearing a lots of news that CapEx will be down in 2008 by about 5% to 10%. Youalso have an FPD exposure which CapEx is expected to be up over 20% next year, Iguess, I am wondering (a) What your seeing, and (b) If those stats arerelatively correct what that’s means for your new product initiatives? You hadmentioned in your remarks (inaudible) you had some R&D effort but I amwondering, during the downturns actually a better time to show off your newproducts, since your customer has time to actually look at it and evaluate it?So, just want to get your thoughts on it.

Walter Shephard

Yeah. I think on the flat-panelarea, the spending as we see it is shifting, there will be some increase inspending in CapEx in calendar 2008 in Japan and Korea, and it looks like therewill be if not flat it may be reduced spending in Taiwan. And I think, as youknow, we are very, very strong in Taiwan,and not as strong in Korea.So, we have adjusted what we believe our sales will be going forward in thelatter half of our fiscal '08.

I think you are absolutely right,during these downturns, when customers have an opportunity to try your tools,and to determine whether they will use them when they increase their CapExspending, and I think the fact that we have been able to see their tools crossall areas in fab now. And continue to add applications to those tools byspending in R&D. I think we will have a better chance in seeking the rewardwhen the CapEx spending comes back.

Darice Liu - Maxim Group

I know its going to take a while andit does take a while for these new products to penetrate the market. Can youjust give us an update in terms of the interest level of potential customersand current customers?

Bruce Robinson

We are quiet pleased with theinterest level. The customers in actual fact are leading us to areas of theirfab, where they believe that our tool will be superior to other tools that theyare using there today, or where our tools will solve problems where they cannotmake measurements today.

We are working in at least twoareas in the front end of the line. We have this new tool out now in thebackend of the line and of course, we have the one there ready for customer andwe continue to add applications to these tools. So, I think that we have seenwhere we can differentiate ourselves. We are not developing a [me too] toolwhat other people have in the marketplace. We are not going up against peoplebased on price. We are trying to differentiate our technology and our tool fromwhat's out there today and I think customers appreciate that.

So, all the customers that wehave gone to in different parts of world have indicated that they see the value,that they are interested and we are receiving wafers. We are making testing andwe are making some good progress. But as you say, it takes some time.

Darice Liu - Maxim Group

Fair enough. Just a housekeepingfollow up from that. You mentioned two areas in front end line back in '09 andalso there is always a customer. Do you also still have you data storagecustomer?

Bruce Robinson

Yes, we do.

Darice Liu - Maxim Group

And Walter, a housekeepingquestion from the financial side. You mentioned booking is 40% withsemiconductor. Can you breakout what FPD was and then can you also breakout thebacklog between semi and industrial?

Walter Shephard

Hey, Darice, on the FPD side, wegot orders about $1 million in the quarter. On the backlog side, I don't havethe breakdown, Darice. I can get that information for you and let you know whatthe back is. But I don't have it within right now on the backlog between semi.I will tell you if I weighted heavier to the Optic side.

Darice Liu - Maxim Group

Okay.

Walter Shephard

But, I don't have the breakdown.

Darice Liu - Maxim Group

Okay. Thanks guys.

Walter Shephard

Okay

Operator

(Operator Instructions). Our nextquestion is from the line of [Tom Clevens]. Please go ahead

Tom Clevens

Hi guys. Just a quick question.The $4 million of acceptance revenue, will that decrease receivables orinventories?

Bruce Robinson

That will decrease inventory.

Tom Clevens

So, you do have that around theinventory.

Bruce Robinson

Yes, we do.

Tom Clevens

Okay. And I just wanted to beclear on the new tools because that’s obviously where there is a little bit ofstruggle, beside the PPS service. How many tools do you guys have in field thatyou have in the field and then how many of you have gotten expectance on this? Didn'tyou have five tools in the field and you have got expectance on one. Is thatfair or is that wrong?

Bruce Robinson

I think this number may be off bya two, because I don’t have that information, but it’s approximately of fivetools in field, the inline semi tools and we have four of those accepted.

Tom Clevens

Fours of them accepted.

Bruce Robinson

Yeah. Between last year and thatwas since we started the shipping in last year.

Tom Clevens

Okay. So, when we (inaudible) nonexpectance on is the UniFire, some of the backend of the line.

Bruce Robinson

That’s right.

Walter Shephard

That is correct.

Bruce Robinson

We anticipate it will be acceptedthis quarter.

Tom Clevens

Okay. And where are the highestchances of follow on from what you guys can see so far? Is there any visibilityon follow on depending by application?

Bruce Robinson

Yeah. I believe that all thoseareas were we now have tools have the opportunity for follow on orders and alsoorders with other customers. There was a great interest in Asiaon one of those tools to start out with the reducing in CapEx spending has beenpushed that off. We anticipate coming back on that in the next couple ofquarter. But both with the existing customers that we have and with othercustomers, I think there's opportunity for good follow on orders.

Tom Clevens

Because didn't you guys have theAP-600, I believe it was for backend of line before you -- ?

Bruce Robinson

Yeah. Those tools, we have inthat area between the CP-300 and CP-600, we have approximately 27 of those of. Thoseof all have been accepted.

Tom Clevens

No. I guess I was sort of hopingthat the Unifier you would have a higher probability of getting follow-on on Unifier.That's sort of where I was leading to by the way but I just trying to --

Bruce Robinson

I think, we do but we have justshifted our first tool. It’s a Beta and we expect acceptance this quarter andthen we'll build on that. So, as we introduced these tools, we want to makesure, that we meet customer expectations before we propagate them to othercustomers.

Tom Clevens

Okay. And then I've tried to getthis question answered before and you guys have tried to answer for me. What isyour base revenue from just street metrology, like the NewView 600 going intoindustrial or non-semi applications that’s kind of on going?

Walter Shephard

I think what you are referring tothis Tom is the Instrument Group.

Tom Clevens

Right.

Walter Shephard

And in fiscal '07, that group didapproximately about $53 billion in business, and we expect that's growing thisyear. So, let's say, between $55 million to $60 million run rate type ofbusiness for us.

Tom Clevens

Okay. And then the last thing isOptics. Are there any big programs out for bid now that are interesting andkind of what are your expectations for that business this year?

Bruce Robinson

We expect that business to benorth of $60 million this year with good solid growth, and there is number ofareas where we received an order in the first quarter for us, as Walter outlinedfor the night vision system. So, both in homeland security area, in the medicalarea and in the defense and aerospace, there are number of opportunities thatwe see going forward and the orders have been very strong.

Tom Clevens

Okay. I appreciate it.

Bruce Robinson

Thank you.

Walter Shephard

Thank you.

Operator

And we have a follow-up questionor comment from the line of Darice Liu.

Darice Liu - Maxim Group

Hi, guys.

Walter Shephard

Hi, Darice.

Darice Liu - Maxim Group

I didn't mean to skip over theindustrial group. So, we all have been focusing on the new initiatives onsemiconductor side. You have also announced some new initiatives on theindustrial side, most notably in medical as well as others. Can you talk aboutthe status of it? What you expect? When do you expect these initiatives to takeoff from a revenue standpoint?

Bruce Robinson

I think there will be, on themedical side, as you know, we qualified for FDA ISO, and we expect this quarterto get our qualification from FDA for the full qualification. We have beenworking with a number of major Tier 1 customers in the medical side to look attheir programs, and participate in the design of some of those products. We did$27 million in contracts last year in the medical and, we expect that toincrease this year.

So, we have been making a lot ofprogress as we have gained the reputation of being able to do very, very highprecision manufacturing. And I would like to say that I think the fact that wecan accomplish that, and searched by those customers is because we also supplymetrology, and we know how to use it internally for manufacturing and suchthat's been very important to us. So, medical is growing. We got our firsthomeland security project. We expect more orders in the next half for thoseparticular products and defense and aerospace continues strong.

Darice Liu - Maxim Group

Can you now tell in a little bitmore in detail in terms of the new initiative (inaudible) the applications asfar as you have got FDA ISO qualification? What does that mean in terms of whattypes of applications do you want to pursue?

Bruce Robinson

Well, in the areas of theeffecting the [eyes] and the products that we do there; as you know we don’t doall the products at the moment, because we weren’t FDA certified. We areattempting to convince the customer that now when we get FDA certified that hewould be in better hands if he gave us the whole tool. So, we will be able tomanufacture once we get our FDA certification, we will be able to manufacturecomplete tools not just part of the tool. Because the last half of the tool hadto be done by people who were FDA certified, which have to be the customer inthis case.

So, I think that will allow us toincrease our revenues for existing medical things that we are doing. On theother side, Daniel Metrology with our very large customer is ramping up. Weexpect orders this quarter and on going for significant amounts of those asthey are marketed worldwide. That marketing launch is about to be taken by thatcustomers. So, we expect good things there. And then we are working with thelarge medical customer on some new technology, which I can't talk about at themoment, but we anticipate that that will turn into orders sometime in the nextsix months.

Darice Liu - Maxim Group

Is there a lot of customers whodon’t know what you are talking about with cytology?

Bruce Robinson

Yes.

Darice Liu - Maxim Group

Okay. Thank you.

Bruce Robinson

Thank you, Darice.

Operator

And we have no further questions atthis time.

Bruce Robinson

Okay. Well, thank you very much,ladies and gentleman. I must reiterate that this quarter, we should see a morepositive result than last quarter. We are certainly anticipating that; working hardto do that, and we expect the second half of the year to be much stronger. So,we want to thank you for your participation and we look forward to talking toyou the next time. Thank you.

Operator

Ladies and gentlemen, that doesconclude our conference call for today. We thank you very much for yourparticipation and ask that you please disconnect your lines.

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