Nova Ltd. (NVMI) Q3 2011 Earnings Report, Transcript and Summary

Good day and welcome to the Nova Measuring Instruments Third Quarter 2011 Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Kenny Green of CCG Investor Relations. Please go ahead. Kenny Green – CCG Investor Relations: Thank you, operator and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments third quarter 2011 results conference call and presentation, and I’d like to thank management for hosting this call. With us on the line today are Mr. Gabi Seligsohn, President and Chief Executive Officer; and Mr. Dror David, Chief Financial Officer. I’d like to draw your attention to the presentation that accompanies today’s call. The presentation can be accessed and downloaded from a link on Nova’s website at www.nova.co.il. Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements and the Safe Harbor statement outlined in today’s earnings release also pertains to this call. If you have not received a copy of the release, please view it in the investor relation section or news section of the company’s website at www.nova.co.il. Gabi will begin the call with a business update followed by Dror with an overview of the financials. We will then follow with a question- and-answer session. I’ll now hand the call over to Mr. Gabi Seligsohn, Nova’s President and CEO. Gabi, go ahead please. Gabi Seligsohn – President and Chief Executive Officer: Thank you, Kenny, and hello, everyone and welcome to our third quarter of 2011 earnings conference call. During the third quarter, we continued to demonstrate solid financial performance with significant net income and gross margins, both within our long-term financial model. We also continued to accumulate positive cash flow of close to $6 million, bringing our overall cash position to $84 million at the end of the quarter. Our penetration efforts continued to bear fruit during the quarter, as we announced having won yet another tool selection for the 2X nanometer technology node in a leading foundry. Since the beginning of the year, we’ve seen a significant shift by our leading edge customers in the direction of the 2X nanometer technology node. Three of our foundry customers and two memory customers have taken both stand-alone and integrated metrology equipment from us to support their transition to the 2X node. Looking at the first three quarters of the year, more than 50% of our revenues have come from this technology node and we expect that number to continue and climb as we move into 2012, given capacity insufficiencies at the highest levels, both in foundry and memory segments. During the quarter, we continued to ship more of our latest stand-alone metrology product, the Nova T600 and it is now installed at four different customer sites, solving the industry’s most complex applications. As planned, we were excited to meet our target and ship our first stand-alone metrology tool for the 3-D interconnect process to one of our leading foundry customers and are preparing to ship to a second customer in the near future. We are convinced that this new tool and technology that we have developed internally provides us with a competitive advantage and lays foundation for significant growth in the future, as more players in the industry become active in implementing and preparing for the move to 3-D packaging. Our service group continued to deliver robust performance during the quarter with gross margins of 37% despite a decline in revenues of a few percentage points. System upgrades continued to gain traction as many of our customers are looking for means to extend the lifetime of their fleet of tools, while they invest in new tools where they must. Now let me turn to overall market trends as we see them. As mentioned in today’s press release, macroeconomic concerns are weighing on our customer spending patterns. As a result and like many in our industry, we continue to evidence a reduction in bookings during the third quarter. Capacity utilization in foundries has fallen to around 70% and inventories have remained higher than previously anticipated. DRAM continues to suffer from margin degradation and overall DRAM demand is low due to slower growth in PC sales this year. NAND Flash demand remains healthy, but at the same time, several fab expansion projects have been delayed. The transition to the below 3x nanometer technology node offers our customers an opportunity to increase average selling prices and improve on their cost structure as well as improve their technology position with their end customers. This is especially the case in the foundry segment where the pressure is mounting to extract market share away from the market leader. At the same time, it is very difficult for many of the players to meet the yield requirements, given the relatively short development cycles they have gone through. In this state of affairs, the relative spend on process control equipment as a function of overall wafer fab equipment spending must go up. The move to such design rules implies significant changes to process methodologies and materials being used in the process and stabilizing the process with such significant changes in a short amount of time becomes very challenging. It is therefore not surprising that we expect over 70% of our revenues this year to come from that 3x nanometer technology node and below and that much of that spend is directed to the edging and CMP stuffs where many of the process challenges have come from. Looking into 2012, the expectation is that IC demand will grow modestly by about 5%. That growth will predominantly come from smartphones, which are expected to account for more than 50% of the growth as well as from tablets and SSDs, solid-state drives, that is, which will account for 20% and 10% respectively of that expected growth. The performance specifications of these devices demand a shift to the next technology node. We are very pleased to see that ultra-thin notebooks require a move to solid-state drives for weight and power consumption reasons. The move to volume consumption of solid-state drives has been long awaited by our flash memory customers, who will fuel their growth from both competing trends of tablets and ultra-slim (books) in the future. The implication for us is that our focus will remain as it always has on the highest end of technology. During my 15 years in the industry, I have seen technology transitions taking place both during an up-cycle as well as during slower periods. In all cases, the baseline for the process depends heavily on the availability of measurement equipment able to cope with the many variables the process suffers from at its initial stages. Small amounts of equipments utilized in a technology transition taking place in a slow period turns into volume orders when the tight surge in demand increases. The dependence on optical CD to perform these prosperous changes continues to increase so much so that our recent checks show that the served addressable market per fab has more than doubled itself going from 65 nanometers to below 30 nanometers. Through continued close collaboration with our customers and to be ready with the introduction of new products and capabilities as the need first arise, we secure our inability to participate in the next generation ramp up when the general economic status improves. We plan to continue to innovate these close collaborations as they are the key to securing our long-term growth plans. Because we have been successfully pursuing this strategy for some time, it is our belief that we are well positioned to extract growth out of these opportunities as a combination of highly competitive products with widespread presence at leading memory and foundry customers mean that when spending growth (indiscernible) we will be there to take advantage of it. Now let me turn to our outlook. In today’s press release we stated our guidance for the fourth quarter of 2011. We expect revenues of $16 million to $19 million with net profitability of 1% to 8%. Clearly this is a sharp sequential decline and a clear reflection of recent trends and where the industry stands. It is our belief that this softness will not continue for a lengthy amount of time. Recent visits with our leading customers have revealed clear plan for expansions at the leading edge and in some cases we have already started receiving orders for delivery during the first half of next year. In terms of the company’s 2011 annual results, today’s guidance implies record annual revenues of $100 to $103 million and record annual net income of $23 million to $25 million. Achieving these numbers in 2011 puts us in an excellent shape to continue and outgrow the industry for the third consecutive year. With an expanded product offering, a strong position with the industry’s leaders and aggressive roadmap of new products and capabilities, we are clearly very well positioned to continue and grow when the overall mood improves. And with that operator let me turn it over to Dror for a close review on the numbers. Dror? Dror David – Chief Financial Officer: Thanks, Gabi and welcome everybody to Nova’s quarterly conference call. Before I start with an overview of 2011 third-quarter results, I would like to note that the numbers presented in the press release and in all the following discussions represents GAAP-based results. Total revenues in the quarter were $25.8 million around the midpoint of our guidance, down 13% quarter-over-quarter and up 7% over the comparable quarter of last year. Product revenues decreased by 14% quarter-over-quarter, reflecting the slowing business environment and service revenues modestly decreased by 5%. Product bookings distribution in the quarter was 48% from the foundry segment and 52% from the memory segment, similar to the previous quarter. On a regional basis, most of the bookings in the quarter came from Asia-Pacific. Blended margins in the quarter decreased to 55% within our long-term model. Products gross margin came in at 58% lower than the previous quarter as a result of different product mix and reduction in revenues and service gross margin came in at 37%. Net R&D expenses increased by 2% due to a decrease in the income from the Israeli office of the Chief Scientist, while gross R&D investments actually decreased by 2%. Sales and marketing expenditures increased in the quarter, as we continue to proliferate our new products into existing and new customers, which require extensive field related costs. The increase in R&D and sales and marketing was somewhat offset by a decline in G&A expenses and total operating expenses slightly increased relative to the previous quarter. Given the business environment, we are taking measures to reduce expenses relative to our original plans and we expect operating expenses to reduce in the fourth quarter of 2011. The extent of the reduction can be down to a level of $8 million in the fourth quarter of 2011. During the quarter, we reported record net income of $5.9 million with operating margins of 22% within our target model and net margins of 23%. Diluted EPS in the quarter was $0.22 based on a diluted share count of 27.1 million shares. Cash flow from operating activities came in at $5.9 million in the third quarter of 2011. Moving into balance sheet key metrics, accounts receivables significantly decreased by $7.5 million in the quarter to a level of $12 million as a result of effective collection activities and the reduction in revenues. DSOs remained healthy and came in at 55 days. Inventories decreased from $14 million to $11 million in the current quarter, mainly as a result of decrease in finished goods, including final acceptance in sale of inventory related to deferred revenues. Looking forward, we plan to continue with our aggressive plans to place new products at customer sights for evaluation and testing, yet on the other hand, we are taking measures to further align our supply chain to the current business level. Deferred revenues significantly decreased from $9 million to $3 million during the quarter, as we concluded our penetration in to several strategic accounts and received final acceptances from these customers. Capital investments increased in the quarter as a result of transfer of demo and application tools from inventory to fixed assets and depreciation came in at similar levels relative to the previous quarter. I will conclude with cash reserves, which increased to approximately $84 million by the end of the third quarter of 2011 and provide us with plenty of flexibility to execute on our business plans. Gabi? Gabi Seligsohn – President and Chief Executive Officer: Thank you, Dror. And with that operator, we’d be happy to take any questions.

Thank you. (Operator Instructions) We will take our first question from Edwin Mok from Needham & Company. Edwin Mok – Needham & Company: Hi, Dror. Hi, Gabi. Thanks for taking my question. So, my first question actually was on the financial model. Just curious if I look at the model and I think Dror you mentioned that you expect somewhere around $8 million on operating expense in the coming quarter. Two-part question. First is, though imply, gross margin a little bit below 50%, is that mostly coming from just lower volume or do we expect some reduction in gross margin on the service gross margin line as well?

Yes. First of all, you’re correct. The model for the fourth quarter should be gross margin – blended gross margin of around 50%, 50, and the reduction is mainly because of the reduction in revenues. Edwin Mok – Needham & Company: I see. So the service margins will remain at this 30 something percent range?

Yes. Edwin Mok – Needham & Company: Okay, great. Very helpful. And then – and just kind of following on operating expense, you mentioned that there are some work that you guys are doing to reduce your operating expense, I was curious are those one-time expenses that you guys are putting in or are you guys actively lowering operating expenses? Sometimes, when I see company lowering the operating expense throughout the quarter, the next quarter actually you could potentially even a bit lower level OpEx just because it takes time to put those programs to work through, so is that how we think about OpEx or how do we think about that?

Yes, definitely in the short-term we’re doing things which are more of one-time event and as you know we’re currently making our plans for 2012. So we need to see how this will come in, in the following quarters, but definitely for the short-term for the fourth quarter we -- a portion of this reduction is a one-time event.

I think so, Glenn if I may add just to follow-on on that. As you know the issue of maintaining profitability is very, very critical for us. As a management team we continue to see that as a critical focus while at the same time we continue to invest significantly into R&D. You can expect that direction to continue as we move into 2012 even before referring to market condition and therefore as we do our planning for next year we will take into consideration those two aspects and try to build a model that actually allows us to do the two things, continue to develop aggressively and at the same time maintain profitability. Edwin Mok – Needham & Company: I see this. Great. And then Gabi in your prepared remarks you talked about booking continued to trend lower during the first quarter right. I was wondering how did that trend in the month of October and have you at least see it stabilizing now or have you seen it improving?

Actually I’ll try to give a general reference because it’s already within the fourth quarter, but I can’t say that yes there is an uptick in orders during October, which we’re seeing. So there is some improvement coming during the month of October and when I look what kind of orders those are, those are very much focused as I had mentioned in my prepared remarks on the highest end of technology meaning things that are in the 20 nanometer section, our customers are investing in that area as I mentioned still investing cautiously, not in very, very significant amount, but yes orders have improved. If I look at the specific month of October we do see some improvement there. Edwin Mok – Needham & Company: I see. And you mentioned in your prepared remarks that you start to see some orders for beginning of next year. I thought typically OCD over the lead time tend to a bit shorter than that. Is it just customer indicating that they will start to need those equipments or is that more for longer term type like you said for (indiscernible)?

Well first of all as I mentioned we have actually received some orders for delivery during the first half of the year. So it’s not just indications, it is actually orders and the reason customers are doing that is in order to secure capacity. Still you need to remember when six to nine months ago where all of us I think in the equipment sector had visibility, which was much longer of about five, six months. In general in the industry visibility has reduced down to about three months I would say. And so I think what’s happening now, which is again it is somewhat encouraging I would say that we do see some orders coming in for the first half of the year and again these are for those specific projects that I had mentioned and I think that if I look at what we are starting to see, we are trying to right now actually making our plans for 2012 et cetera. What we are seeing is from our discussions with our customers is that those investments that they will make will all be focused on the highest end and that’s why we’re so focused on that right now. And so they have articulated what their plans are, where they are able to share them. Those plans in general remain pretty cautious as far as the extent of increasing capacity. But I think from my recent trip to both Taiwan and Singapore, I heard directly from the customers that foundry is operating at 60%, 70% utilization at 45 and 65, but it’s way above 90% when it comes to 28 nanometers, which means that these people need to go ahead and equip themselves. The same thing by the way applies to the DRAM sector and the NAND Flash sector. The move to this next generation technology node is an absolute necessity. There is vested interest of all types, their financial interest, when it comes to printing more diaper wafer. Their cost – obviously those are associated with cost. Its average selling prices, which are higher and I think most importantly and this is the thing we’ve been talking about repeatedly, this is more of attrition going on in foundry trying to attack the pole position of TSMC. TSMC realizes that and their competitors realize that. And so they’re working really hard to position themselves with their OEMs as having sufficient yields in order to take these orders for 28-nanometer and below and we already know that many of these new products rolling out next year already have that technology designed in. So I think that picture is a little bit clear right now. I think what does remain to a very high extent and uncertainty which is macroeconomically influencing decisions is the extent of needed capacity and I think that’s the guessing game that all our customers are playing right now and they themselves are very cautious in saying what they expect to see. Edwin Mok – Needham & Company: Great, very, very helpful. Just one clarification, the (indiscernible) you guys mentioned on the prepared remarks, are those all for these leading edge applications?

Yes. All of that is focused on leading edge. It touches upon the most critical applications such as things like 3-D gate structures, what are also called FinFETs. It touches on very, very high-end copper applications, it touches on very high-end etching applications in high-k metal gate structures. This is really geared and focused on all that and that’s why this is important for us. That’s why we’re investing very heavily in that area to make those evaluations successful and set the stage for repeat orders. Edwin Mok – Needham & Company: Great. And then on the three – the new 3-D and (indiscernible) the product that you’re also packaging the product that you actually mentioned on your prepared remarks, that is still a new product, so there is no revenue recognition this month, the fourth quarter or even early part of next year, am I correct on that? And you mentioned that you’re shipping at, you have shipped at to the first customer, how many other customers are you guys engaged with on discussion with this product?

Right now we’re actively engaged in with several customers. There’s already a second one that is in very, very advanced stages and it’s great news I mean there have been some products out there that have won some traction in the last year, year and a half and this product takes to a new level, several of the needed parameters and measurements we’re purposely being cautious on sharing what that is. We are building we believe a very competitive advantageous tool and our expectation is that in next year’s revenues, you’re right probably more in the second half of the year, you’re going to start seeing some more significant, actually some I believe some pretty significant revenues as this market starts becoming a real market and is gaining traction. We see more and more evidence that the 3-D packaging is becoming a reality. We believe that market in a few years from now will be well above $200 million opportunity, it’s still at its early stages and given the interactions we have with customers, they have a real interest in what it is that we’ve built for them. So I’m very excited about this product. Edwin Mok – Needham & Company: Great, very, very helpful there. One last question, I’ll go away. So Gabi, just curious what is your mix on foundry versus memory in the fourth quarter. My understanding is the foundries had really cut back pretty dramatically in the second half of this year in terms of capital spending. So I presume that your foundry mix is relatively low right now, am I correct on that?

Actually, it’s been about 50-50ish on average for the year. And this third quarter was no exception there. I actually see some more orders coming from foundry right now and I expect that we’re going to start seeing some orders for DRAM as well because that transition to 3x must happen. So right now at least what I am thinking and seeing right now is that foundry is going to be somewhat stronger actually than memory. Edwin Mok – Needham & Company: When you say that Gabi, just wanted to be clear, are you talking about bookings likely to be strong on foundry, but on a revenue basis, I presume that’s slower. Am I correct on that or just to clarify that?

Yes, yes, that’s correct. Edwin Mok – Needham & Company: Great. Very, very helpful. That’s all I have. Thanks.

Thank you.

(Operator Instructions) As there are no further questions in the queue, that would conclude today’s Q&A session. I would now like to turn the call back to the host. Gabi Seligsohn – President and Chief Executive Officer: Thank you, operator. To end the call, I would like to say that indeed we are facing a more difficult period in the short-term. I draw everyone’s attention that I’ve been working with us over the years. This company continues to grow significantly, having grown more than x2.5 from 2009 to 2011 and our work-in plans continue to be in place in order to build this company to be a much larger company over the next several years. That will continue to be our focus that will continue to be the driver in the direction that we take the company and we look forward to discussing it with everyone in the near future again. Thank you everyone for attending the call.

That will conclude today’s conference call. Ladies and gentlemen, thank you for your participation. You may now disconnect.