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Zygo Corp. (NASDAQ:ZIGO)

Q2 2008 Earnings Call

January 31, 2008 06:00 pm

Executives

Walter Shephard – Chief Financial Officer

Bruce Robinson – Chairman and Chief Exec. Officer

Jim Northup - President

John Stack – President, Optics

Analysts

Darice Liu – Maxim Group

Andrew Abrams– Avian Securities

Jon Gruber - Gruber & McBaine Capital Management

Jill Mastoloni - Catapult Partners

Operator

Welcome to the ZYGO Second Quarter Conference Call.

(Operator Instructions)

I would now like to turn the conference over to Walter Shephard, Chief Financial Officer. Please go ahead, sir.

Walter Shephard

I want to thank you for joining us tonight for our second quarter conference call. Before I turn over the conference call over to Bruce Robinson, ZYGO’s Chairman and CEO, I would like to read the following forward-looking statement.

All statements other than the statements of historical facts that are made during this call regarding our financial position, business strategy, plan, anticipated growth rate, and objectives of management for future operations are forward-looking statements. Forward-looking statements are intended to provide management’s current expectations or plans for the future operating and financial performance based upon information currently available and assumptions currently believed to be valid. Forward-looking statements can be identified by the use of words such as, “anticipate”, “believe”, “estimate”, “expect”, “intend”, “plan”, “strategy”, “project”, and other words of similar meaning in connection with the discussion of future operating of financial performance.

Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors. Among the important factors that could cause actual events to differ materially from those on the forward-looking statements are fluctuation in capital spending of our customers, fluctuations to net sales to our major customer, manufacturing and supply risks, dependence on timing and market acceptance of new product development, rapid technological and market change, risks in international operations, dependence on proprietary technology and key personnel, length of the sales cycle, environmental regulations, investment portfolio returns, and fluctuations in our stock price.

Further information on potential factors that could affect ZYGO Corporations business is described in our reports and filings with the Securities and Exchange Commission including our form 10K for the fiscal year ended June 30, 2007. Now I would like to turn the call over to Bruce.

Bruce Robinson

Ladies and gentlemen welcome to ZYGO’s Second Quarter Financial Results Conference. I am pleased with the progress we made in our second quarter this fiscal year. We have previously stated that our recovery would begin in the second quarter and continue to the last half of our fiscal year. In quarter two, this was demonstrated across orders, sales, margins, and EBIT. In our metrology division, our state’s metrology orders increased by 78% in quarter two over quarter one, as our customers used up their excess inventory and a major customer introduced the new 193 tool to the market.

Having worked their way through the last few quarters of declining orders in sales, we anticipate this OEM product will contribute increased earnings in the last half of this fiscal year. Having down-sided this group in our first quarter, we are now better aligned with forward-looking revenue. During the period, the display business sold orders of $7.5 million indicating that the long awaited release of CAPEX in this market has finally arrived. This quarter saw and had a new customer in China, for our color filter photo space metrology system; a second system in Japan to support the inkjet printer development programs and Tens Systems in Taiwan. The win in Taiwan was made up of four photo space and metrology systems and six particle review stations. This in-lined defect classification tool exhibits our ability to characterize defects in 3D. We are readying the launch of our new TFT tool and anticipate orders over the next two quarters.

Regarding our semi conductor initiative, we have installed two unifier systems and are continuing to expand the number of applications within these tools. One tool measures critical dimension, layer-to-layer registration, and film thickness. The other tool is measuring film thickness on a pattern structure and step bytes. Indications are that the acceptances will be received at both tools in the near future. Our design and engineering groups have completed several milestones in new product developments of customer applications in cytology and lithography optics. Qualifications on a high precision depends on aerospace window program was successfully completed in quarter two, thus paving the way for long term OEM growth in this sector.

Early in the second quarter, we extended a $1.5 million note to a non-related company to acquire certain assets and technology. In our do-diligence process, we confirmed our interest in the technology and felt that outstanding liabilities were beyond our willingness to proceed. Since our withdrawal, the company has gone in to receivership; we have taken a one time pretax charge against this note. We are now reviewing the value of the technology and assets without the liabilities under receivership. If we do acquire any assets or technology then a portion or all of the pretax charge maybe reversed.

In summary, quarter two is a nice step towards increasing profitability and we see no obstacles at this time in executing our strategic plans across the company. Progress continues in both the metrology and optics divisions. I will now turn it back to Walter.

Walter Shephard

REOs for the quarter of $43 million, this is the first time in four quarters that we have been over $40 million. The orders received 80% from our metrology division and the balances for our optical division. Within the metrology division, the instrument business unit followed the good first quarter of almost $15 million of orders with an even stronger Q2 of over $16 million. Additional reviews for this division is that both, the display solutions and PPS rebounded from a slow Q1 to show solid Q2 bookings. As mentioned in our press release, display solutions recorded orders of $7.5 million, PPS had orders of almost $11 million, although this is down from Q2 of last year by a couple of million dollars with a significant improvement over Q1 orders of $6 million.

The optical division bookings totaled $9 million; though the order did not match Q1 in numbers, this group is basically on its order plan for the first six months of the year. Overall orders from semiconductor related customers were 46% of the orders, which reflects the increase from display in PPS business units. ZYGO had another quarter over the positive book to bill and at the end of the quarter, our backlogs to it was just under $80 million. This also represents our highest backlog since Q3 of last year. Those are the quarter with just over $40 million, the sales to Canon; our largest customer was 17% in Q2 and for the first six months of the year.

Let us break it down between Canon consumer sales of 11% of Q2’s revenues, and sales for distribution which accounted for the remaining 6%.

Metrology Division accounted for 72% of the revenue with the optical division accounting for the remainder of the sales.

We are pleased with the gross profit in the quarter exceeding at 40% threshold coming in at slightly over 41%. The growth margin improved from Q1 as a result of two things; one a better product mix from our instrument group, and second, resizing of our PPS business with better aligned cost with expected revenue levels.

Operating expenses excluding the charge for the note receivables came in at $13 million as we continue to keep a keen focused on spending in this area. We continue to spend on RD&E. There is $5.5 million spent in Q2 pursuant to the Q1 spending amount. We consider the spending critical to our future growth especially if it pertains to the semiconductors solutions business unit. Finally, we return to profitability in Q2 and are profitable for the year.

Cash, cash equivalents and marketable securities was $59.5 million at the end of the quarter. There is a decrease of almost $11 million since the start of the fiscal year, but the main reason for the decrease being the stock buy-back program; in which we have buy-backed over $60 million worth of stocks through the end of the second quarter. This equates to approximately 7% of our shares. Our receivables remain in a very condition, our DSO’s at the end of quarter stood at 51 days, which is a significant improvement from the 73 days we had at the end of Q1 and down from 55 days at yearend.

Now the area we are pleased with is a drop in inventory of about $3 million since the end of the first quarter. As we have mentioned before, we are making a concerted effort to manage our inventory levels to match our revenue expectation, and this is the result of those efforts.

We now open the call to questions.

Question and Answer Session

Operator

(Operator Instructions)

Our first question comes from the line of Darice Liu with Maxim Group, please proceed with your question.

Darice Liu – Maxim Group

In terms of the industry right now, something that continuous to be negative and slowly offset by the great increasing CAPEX for FPD, reconciling that with your business, last quarter you have said fiscal year ‘08 revenue would be approximately down 5% to 10% from fiscal ‘07, what are your current expectations for the fiscal year?

Walter Shephard

We still anticipate and we made that announcement last quarter and we have not changed it at all.

Darice Liu – Maxim Group

Okay, are you seeing any deterioration within your semi-cap business?

Walter Shephard

No, not at the moment. We have not seen anything . Forty-six percent of our orders were in the semi-cap area last quarter, and in fact we were down the semi-cap area due to our OEM business on the Litho tools and that is rebounded considerably in this last quarter and we anticipate seeing continued strength in that area, so from the semi-structured tools stand point, the in-line tools of course, we are basically going through development programs with the customers, but we think that there will be spending not so much in the memory area certainly with the IDM’s.

Darice Liu – Maxim Group

And just a follow up regarding the inline tools, the status is still development, you have shipped two tools recently, are there any other status changes in terms of customer interest, more beta side, things of that sort?

Walter Shephard

Jim Northup is with us today along with John Stack. They are the two presidents of our two divisions. I will let Jim answer that question.

Jim Northup

Yes, we see some good forward progress. The two tools we have installed, we have an increasing level of application interest by those customer. We are engaged with a couple of more customers and we are not at a point of predicting specific bookings in a couple of quarters, but we definitely see some activity brewing. I think relative to your question of general CAPEX spending, obviously our share in the market is extremely low right now, so we are not really involved in the big buy decisions. We are being looked at as a next generation option in pretty much all of our discussions.

Darice Liu – Maxim Group

And then I guess, in terms of the focus of these tools seems to be 45-nm and we have heard from the leading players out there including TSMC this morning but they actually do not expect any type of 45-nm contribution until 2009. Is that also your timeline in terms of when you think these tools will really come into the market?

Jim Northup

Well I think that there are two parts to that question; the first one is that as advanced as TSMC is the IDM’s are usually spending money first at the technology node. As it turns out we are having more progress in our engagements with the IDM’s right now, ultimately the foundries are probably going to spend more money because that is where the growth is, so I think, timing wise, we see it happening at the IDM basis first.

As far as TSMC spending matching up with ours or in general spending matching up with our, I think it is consistent because there are quite a few companies that have got their pilot lines going in, they are making their first wave decisions and we are positioning ourselves to try to get involved in some of those buy decisions for the big orders.

Darice Liu – Maxim Group

In terms of positioning yourself, this is my last question for the inline tool, you have positioned yourself recently mostly with the Logic players, are you positioning yourself with the non-players yet?

Jim Northup

Certainly we had early success with Logic, we are looking at Flash we have not really had any engagements in the DRM at this point.

Darice Liu – Maxim Group

I guess I care more about Flash and DRM at this moment. So actually, do you have a beta site with the Flash player?

Jim Northup

No we have activity.

Darice Liu – Maxim Group

Activity, and then moving on to display, CAPEX is coming in greater than expectations up maybe over 40% to 50% year-over-year, your market shares mostly center around Taiwan, how has your forecast changed considering the pulling in of 8.5G fab?

Walter Shephard

I think our forecast is based on that we are very strong in Taiwan, but we are also very strong in China and there is increase investment going into China; we also are very strong in Japan. One place where we have been relatively weak because of our lack of organization was in Korea. We are hoping through this CAPEX cycle to be able to break that down that barrier.

Darice Liu – Maxim Group

Are you making head spin in terms breaking that barrier?

Walter Shephard

I would say more than we ever have in the past.

Darice Liu – Maxim Group

Fair enough, and would it be mostly just with the color filter tools or with the TFT tools?

Walter Shephard

Probably with TFT.

Operator

(Operator Instructions)

Our next question comes from Andrew Abrams with Avian Securities. Please proceed with your question.

Andrew Abrams– Avian Securities

I was wondering, you said Litho was beginning to feel better maybe even actually getting better, can you be more specific. Is this Canon or is this something outside of Canon more on a general basis?

Walter Shephard

I think that the customers we had in anticipation of strong sales built up some inventory in Fiscal 2007, which may have been burning off in 2008, and that is basically all our customers in that segment. Certainly if you look at Fiscal 2007 First Quarter, we were somewhere in the area of $18 million worth of orders in that segment and then we were $6 million first quarter of this year; so the difference was considerable.

Most of that inventory has now been burned off and we saw on the second quarter an increase in orders and I believe we will continue at that level throughout the remainder of this particular calendar year.

Andrew Abrams– Avian Securities

And was Canon on that same situation?

Walter Shephard

Canon was a major part of that situation.

Andrew Abrams– Avian Securities

In terms of the LCD orders that you received in recent weeks, was that for a single customer or was that for more than one customer?

Walter Shephard

That was for more than one customer.

Operator

The next question comes from the line of Jon Gruber with Gruber & McBaine Capital Management. Please proceed with your question.

Jon Gruber - Gruber & McBaine Capital Management

My question is the same on those lines of the LCD orders and flat panel. I missed what you said in the presentation on the orders for what? Seven for the December quarter is that correct?

Walter Shephard

Seven and a half, yes.

Jon Gruber - Gruber & McBaine Capital Management

I did not hear the last caller’s question, you have a whole bunch of new ones in January is that correct?

Walter Shephard

No, what he was asking was in that particular quarter, I believe the question was in the second quarter of the 7.5 we got was that more than one customer.

Jon Gruber - Gruber & McBaine Capital Management

Okay, so okay my question then is do we expect higher LCD orders March and June than we just experienced?

Walter Shephard

In all the indications are that there will be a number of decisions made over the next two to three quarters and we anticipate to being a part of that.

Jon Gruber - Gruber & McBaine Capital Management

Was that a yes or no?

Walter Shephard

I think what we are saying is that we are active with all the customers that are building new fabs, the CAPEX spending is such that we expect orders this quarter, next quarter and the quarter after as much more significant than we saw in Fiscal 2007. The Q2 was not a one-off.

Operator

Our next question comes from the line of Darice Liu with Maxim Group. Please proceed with your question.

Darice Liu – Maxim Group

Just to follow up on the non-semi business, can you give us some color in terms of visibility for the industrial group concerning the macroeconomic environment?

Walter Shephard

Well on the metrology side we have seen fairly good strength in terms of the instrument business and so almost across all Americas we have been receiving a number of orders and certainly strong backlog in that area. From the optic side I have John here and he can talk about where he is in terms of the optics business.

John Stack

Overall, our medical effort and our defense effort have not seen any real change or indication of movement; and then in terms of some of our industrial, again we have not seen any major changes in that segment or either so at this point in time, there is no indication of any major movement.

Darice Liu – Maxim Group

You have been invested quite a bit within the medical and defense area, how is that materializing into order and revenue activity for calendar 2008?

John Stack

On the medical front, we continue to have the very strong players in there; one being a strong sustaining customer and then another one is ramping up, so along those fronts, we continue to see good opportunity and we continue to strengthen our portfolio customers there. On the defense side, that too was seen actually with increased activity and we see no downturn and more opportunity.

Darice Liu – Maxim Group

Maybe I will ask my question a little bit more bluntly; concerning the amount of investment that has been put in and the progress that you have talked about in the past couple of quarters, should we expect revenues for two segments, medical and defense to sequentially increase as these projects take off which has been talked about for the past four quarters actually.

Walter Shephard

We anticipate that we have seen double digit growth in those particular areas and we anticipate we will continue to see double digit growth in those areas.

Darice Liu – Maxim Group

And there was some over hang in terms with the margin profile for some of these projects just because of the start up then, you know getting in and doing beta rounds with them, should we expect the margin profile for this segment also to improve?

Walter Shephard

I think in Fiscal ’09, we should start to see improvement in that area, in margin improvement, yes. We have been, and this year we have been seeding a lot of new projects and as such those projects, to get them started into production you see fairly low margins to start out, but as we go throughout the year, we should see a strengthening in those margins.

Darice Liu – Maxim Group

And in terms of Litho, it seems like your top customers finally released their 193 tool; in terms of your visibility, it seems like you are rather optimistic for Litho growth to continue throughout the year, is that based more on them penetrating the market or just the whole market in general?

Walter Shephard

I think the whole market in general in terms of Litho is not going to be as strong in calendar 2008 as it was in calendar 2007. I think what we are seeing is they are going to make sales although the whole market may be down; our ability to get more orders is going to go up because they have burned off this inventory so, we are looking at mostly reduced CAPEX in this area from all three Litho players I believe reduced sales, but from our stand point, increased sales and orders as our customers correct some of these issues.

Darice Liu – Maxim Group

Okay and last question; LCD, lots of activity going on which I think everyone is talking about, you talked about market share gains possibly in Korea materializing this year, any other customers that you see potential market share increases?

Walter Shephard

I do not know what customers per se, but in the areas, we have been very successful in China and we do see China’s future growth. In this area, we have had a very good reputation there, we serve the customers well and I am very positive about ongoing opportunities in that area. I think Taiwan, we have major market share now and we continue to serve our customers. We plan to hang on to that market share. Japan has been very good to us and so there is one country left.

Darice Liu – Maxim Group

Japan you just penetrated in calendar year ’07 for the ink-jet printing product, do you start also to penetrate them from the TFT side?

Walter Shephard

It was not just the inkjet, we did penetrate also from the color filter side. The issue now is the TFT side, we will have to wait and see.

Operator

(Operator Instructions)

Our next question comes from the line of Andrew Abrams with Avian Securities. Please proceed with your question.

Andrew Abrams – Avian Securities

Just one follow up on the LCD space, in terms of activity that you are seeing and you mentioned China, so I assume in China we are talking about Gen5 or less; is there activity from your perspective at levels above gen5 that you are seeing or are we talking about kind of retro fitting gen5 lines or gen4 lines?

Walter Shephard

You are talking, in China itself, there are certainly the older generation, but if you look at Korea or Japan or Taiwan, you are looking at G8’s and plus.

Andrew Abrams – Avian Securities

Fill me in if I am incorrect, are you guys able to sell a Gen7 or Gen8 line at this point?

Walter Shephard

We have supplied Gen7 and Gen8 lines.

Operator

Our next question comes from the line of Jill Mastoloni with Catapult Partners. Please proceed with your question.

Jill Mastoloni - Catapult Partners

Back on the gross margin question, looks like you guys had substantial improvement in your margins this quarter and as you see maybe the mix in flat panel towards the second half of the year, does that skew your margins up and could you quantify sort of where you think your gross margins could be as we exit the year?

Walter Shephard

Flat panel, although we have been getting large orders, also the acceptances will be in the next fiscal year, so we do not see a lot of shipments from flat panel in this particular year because of the cycle and you cannot declare a ship on a course until you get acceptance at the customer side.

From a margin standpoint, we do expect to see as we go forward margin improvement, I mean our goal is to be north of 45%; not in this particular fiscal year, but we had a bad first quarter and what we are looking forward to is steady increase in gross margin going forward.

Jill Mastoloni - Catapult Partners

Okay so maybe about 100 to 150-basis points sort of sequentially the next couple of quarters depending upon?

Walter Shephard

Depending on the product mix.

Operator

(Operator Instructions)

There are no further questions at this time. I will now turn the call back to you, please continue with your presentation or closing remarks.

Walter Shephard

I want to thank everybody for being on the conference call tonight and I look forward to the next one. I think we had a good quarter, I think you are seeing exactly what we said you would see and we anticipate going forward and you will continue to share with us this evening. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference call for today, we thank you for your presentation and we ask that you disconnect your lines.

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