Nova Ltd (NVMI) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Nova Measuring Instruments Second Quarter 2006 Results Conference Call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. As a reminder this conference is being recorded, August 3, 2006. With us in line today are Dr. Giora Dishon, President and CEO of Nova; and Mr. Dror David, CFO.

I would like to remind everyone that the Safe Harbor language contained in today's press release also pertains to all content of this conference call. If you have not received a copy of today's release and would like to do so, please call Gelbart Kahana, Investor Relations, at 1-866-704-6710 or 972-3607-4717.

Dr. Dishon, would you like to begin?

Thank you, and good morning or good afternoon everyone. Welcome to our [quarterly conference call]. I would like to begin by presenting Dror David and the financial results. Dror.

Hi everybody. As reported in the press release, we are very much pleased that we have continued our revenue growth in the quarter and total revenues in the quarter were $11.4 million or 11% increase relative to the previous quarter. The breakdown of the sales by territories in Q2 were US 16%, Europe were 9%, Asia-Pacific was a major increase to 58%, and Japan 16%. As you can see the total Asia-Pacific and Japan regions were approximately 75% of all the revenues. We expect that to decline a bit in next quarter as deliveries to the US will increase.

90% of the system sales were integrated metrology in the quarter and 10% were stand-alones for Optical CD, and we do expect that the Optical CD stand-alone sales will account 10-20% of the system sales in the second half of 2006. 300mm sales accounted for approximately 70% of system sales in the quarter and the rest were 200mm sales. Sales from the NovaScan 3090 product series, stand-alone and integrated, accounted for approximately 40% of our system revenues and increased relative -- a major increase relative to the previous quarter, and we expect it to increase in the second half of 2006 as well due to continued demand of the advanced systems as the industry moves towards the technology nodes of 60 nanometers and below. Service revenues accounted for 20% of total revenues and decreased sequentially by approximately 8%, mainly due to some decrease in sales of spare parts in the quarter.

As you can see the net loss in the quarter was approximately $0.4 million relative to breakeven results in the previous quarter with lower sales volume. The main reasons for that are the following -- as we anticipated and as explained in our previous conference call, the mixture of products in the first quarter of 2006 included specific sales of products with relatively high gross margins. This resulted with gross margin of 46% in the first quarter. During Q2 the product mix was closer to the regular mix of sale, with -- resulting with 42% to 43% overall gross margin. This process is typical when new systems are introduced into high volume manufacturing and we are planning to reach better gross margin with this or higher revenues as the systems mature.

Operating costs have increased sequentially by -- the second reason is that operating costs have increased sequentially by $0.4 million or 8%. This increase is related to one-time increase in IP litigation costs and the enhancement of our AP, Asia-Pacific, and Japan sales and service infrastructure. The reports also include approximately $100,000 in the quarter of stock-based compensation expenses relating to the allocation of options which was done in the quarter. As we mentioned before, we do not include stock-based compensation expenses relating to prior allocations in prior years since these allocations were fully vested as of the end of 2005.

On the balance sheet, the company's cash has decreased by approximately $3 million in the quarter. This was used for working capital purposes to support revenue growth, mainly in accounts receivable. The cash position remains strong with approximately $18 million cash reserves at the end of the quarter. Another thing to note is that the increase of approximately $1 million in other assets in the balance sheet is related mainly to cost of the acquisition of HyperNex, which we announced some months ago and we expect it to close very soon.

The operational cost of the acquisition will be partially included in the result of the third quarter of 2006 from the date of closing. But due to purchase accounting -- purchase price accounting principles, these results will not include the deferred revenues of HyperNex as of the date of closing.

In general and overall we are very pleased with the financial and business performance of the company and with the increase in revenues and also significant and sequential increase in our bookings.

With that, I'll transfer the conversation to Giora.

Thank you. I would like to go a little bit over the business aspects of the quarter and the way we see the market and looking forward. Before that, maybe a summary or the highlights of the financials as we see them, the most important aspects of that. As Dror mentioned before, and definitely we are pleased with the results but we are not pleased enough and we think there is a lot that can be done and will be done.

We have seen 11% increase in the revenues to a total of 11.4 system and service, 3% decrease in the gross margin that we need to fix, about 8% increase in the operating expenses, and Dror gave you the details on why this increase. Net loss was only $400,000 compared to the breakeven of the previous quarter with some one-time type of expenses that contributed to that. Cash reserve is still strong, although we have seen 3 million decline mainly into accounts receivables. And then also in the accounting of the company we have adopted a new and more strict revenue recognition policy, updated that and also a significant challenge in handling the forthcoming acquisition.

Referring to the market conditions and our operations, if we look back in the last 6 quarters, we have seen a sequential increase. We would like to forget the first quarter of 2005, so starting from the second quarter of 2005, we have almost doubled our revenues through this quarter sequentially. And the same being even more growth to our booking levels, that's more than doubled in the last five quarters and we hope of course to maintain this trend as much as we can.

It's very important to know that by geography, more than 70% of our revenues came from Asia-Pacific and Japan. We continue to strengthen that area and our subsidiaries there, and we hope to continue to see that trend continues. Although we expect in the coming quarters some significant growth in the US with some strategic customers there that have strong investments, such as TI, Micron, [Ion Switch] and so on.

And overall in the global thin film market in which we all see growing very nicely, and if we talk about thin film market, we talk about all the segments, we talk about the integrated where we continue to have the largest market share in the thin film -- non-metal thin film integrated, beginning to see entrance into the stand-alone and primarily into the Optical CD stand-alone. And for all practical purposes for us as for anyone else in this market, Optical CD uses the same system that are used for non-metal thin films with added capabilities, things that I will talk a little bit and we are planning to enter into the metal or so called metal thin films through the acquisition of HyperNex and this is also expected to be a fast growing segment.

As I said we have seen growth in both booking and revenues primarily in the new system, the NovaScan 3090 and we've seen significant growth from quarter-to-quarter. As Dror mentioned before, it -- on the penetration stage it impacts the gross margins as a new system entering into high volume manufacturing, but we expect to improve that as well. And we've seen to the extent that this is significant for us because we are so-called as Dror described before primarily OEM supplier. We've seen the booking versus deliveries over 1 for the last four or five quarters.

And so the major trends that we can see today is NovaScan 3090 orders up significantly from quarter-to-quarter. We see 200mm systems still accounting for about 25% of revenues and being the sole suppliers in the integrated [inaudible] millimeter, we expect that to continue to contribute to our revenues. We've seen the delivery of system for copper applications and for CD applications and we have a backlog of standalone systems as well, and as I mentioned before we did have some wins in the last quarter from strategic customers and we are working to continue to improve that.

So if I'll try to summarize the business review, the market is trending up and it's moderately but its there and we are definitely up with this trend and sometimes more. And we see growth in all parameters, booking and deliveries as well. And we've started the quarter, the third quarter with backlog that's bigger than any backlog we have seen in the last 1 or 2 years.

We started to see proliferation as a standalone in primarily the CD area, and for that purpose we and not only for that we introduced last Semicon West, a new system the 3090Next as a standalone system. The system was introduced at Semicon and did get wide acceptance with improvements in the accuracy, the application range, the throughput and the tool-to-tool.

We also introduced a new product and a totally new product at last Semicon, the NovaMARS, which is basically a friendly software product for modeling of advanced and complex CD applications for 3D structures and in-die measurement, and as we say for this CD measurement -- scatterometry-based CD measurement, if you can't model it you can't measure it, and that's why we developed a very user-friendly modeling capabilities for our customers.

As we said also in the press release, we expect to close the Hypernex acquisition very soon, and we expect very fast assimilation into the company. Of course, it will have some impact on the finance in order to take this acquisition forward. This is a very unique application or unique system of wide-angle XRD system primarily for 45 nanometers with very wide acceptance and beginning of sales process with multiple companies and multiple customers.

Cash level has gone down by $3 million, down to 18 which keeps us still in a very strong cash position, especially since the cash balance -- the reduction in the cash level was for working capital and to some extent for legal and acquisition expenses.

So looking forward, let me say a few words about the situation here in Israel first.

As you all know we are facing a political -- difficult political situation in the area. And of course we as anyone else hope to resolve that situation very soon, but I would like to note that this has not and will not interrupt in our operations whatsoever, neither in the supply chain management in building the systems, delivery and supporting the systems. So we know this is some area of concern and it always should be a concern, but it has no impact whatsoever on our activities. So looking forward we expect to continue to see growth and more -- and penetration into new strategic customers and more advanced applications, improve the financial performance with the acquisition investments having in mind and its impact on the financial of course and the acquisition primarily and also the standalone system, all with a much higher average selling price should help our business model looking forward.

With that I will -- we will be glad to entertain any questions, thank you.

Thank you sir. Ladies and gentlemen at this time, we'll begin the question-and-answer session. [OPERATOR INSTRUCTIONS]. The first question is from [David Fitzgerald], please go ahead sir.

Hello can you hear me?

Yes.

Yes.

Great results. I am really excited. It sounds like things are going on very well.

Thank you.

My first question is about the breakout of the product sales. You said 10% for standalone systems in the second quarter?

Yes.

Yes.

Well that seems like a pretty significant jump from the first quarter. I don't remember you breaking that number out in the first quarter. Is that right?

Right, in the first quarter it was approximately 7% -- 6% to 7%.

All right. Great. Couple of other housekeeping questions. What time within the next 12 months do you need to be compliant with the new Sarbanes-Oxley regulations?

Well, according to the current situation we would need to be compliant in the end of 2007.

Okay. Do you feel like you are pretty much ready for that anyhow or will there be more costs associated with beefing up the accounting even more?

Well I would say that we are 50% along the way, and we do expect some expenses to be incurred during 2007 but these will not be the increment.

Okay. Great. I think the last quarter or maybe it was the call before that you said that the patent litigation was costing you about 300,000 a quarter?

Right.

Is that expected to go up now that the more important events are going to occur at the end of this year, beginning of next year?

Well it's not more, it's more now than later. In the last quarter or maybe 4 months we have seen some increase that these were more active months as we are approaching the Markman hearing. So this definitely added cost and also the counter complaints of Nanometrics which as we said in the press release we think is very insignificant but still it carries costs with it, so in the last 3 or 4 months we have seen some increase, not insignificant increase, the -- currently the next stage of the complaint is scheduled for the month of October, so we expect that to go down to the level we've discussed before probably this quarter or next quarter.

Okay. Has there been any -- I don't know exactly how to ask -- its going along as you predicted, do you have anything to say about potentially future patent issues, has this in anyway disappointed you, are you happy with it so far how it is going along?

Well, I think that you can never be happy with litigations. That's something you don't necessarily like to do, that is something you have to do when you want to protect your intellectual property. So, I can't say we are happy but we definitely see that going forward [films] as we predicted is being longer than we expected especially because of the US system that you keep getting some postponement because the court is busy with other cases and we do see postponement here and there. So I would say probably it's now 3, 4 months -- if we look at where we are today, 3, 4 months longer than we anticipated. For example we thought we will have just probably around June, July, the Markman hearing and it's now scheduled for October. So anything longer could cost more money, but we still feel very strong about the case and everything we have done so far did not change our position that this is strong and this is the right thing to do.

Good. I guess that's what I wanted to hear as sometimes they kind of drag on and on and I wondered if that was in some way disappointing to you, but I am glad that you are continuing to stay the course. With regard to the HyperNex acquisition, is this -- are you mainly going after them for their technology or their patents or this -- is your focus going to be basically on giving their production tool out there to the customers or is that why you are buying them?

I'd probably tell you the last thing you mentioned is more accurate but not accurate enough. HyperNex developed a unique system, a wide angle X-Ray Diffraction system, which is capable to do work for high volume manufacturing, and this is the only system of that kind in the market, and therefore it presents a very unique opportunity to provide more capability solutions to our customers. It is something that nobody else is providing today. But it is something that was not needed in the 90-nanometers technologies or below that, so it's a new need, it's a new system, it's a new market; for that matter it is a new segment, application segments to develop. They developed a system and mature those systems [source toggle systems].

So, yes, it is to proliferate that to the whole world in that context to our whole world with the very -- looking forward – not the next two months but looking forward further and like I said, 45 nanometers high volume manufacturing. Today there is only one company I think that does preliminary work on high-volume manufacturing. So, looking forward beyond that, we think this is going to be a major capability, a major system we can provide, and this is a standalone high-priced system that will balance also our business model looking forward, [to] nice gross margins and will help us strengthen the company.

Alright, that's it. I guess that is what I figured. Are they currently selling any of these production tools, have they sold any?

Yes, they sold couple of systems.

Okay.

And --

Are they still -- they still have the funding to continue to try to sell those, they are -- you have given them some bridge funding, right?

Well, it is both, it's funding is one thing, the main thing is marketing channels, because we are positioned very well globally with almost all of the top 20 semiconductor manufacturers as our customers. We have a large install base, not in a sense of number of systems, but number of customers, selling channels, support channels, and this is critical when you want to penetrate with a new system. And that kind of sales channels and support channels that we provide, this will both help them, which is, soon enough will be help us proliferate, proliferate fast and across the board.

Alright. Okay, great. I will step out, if anyone else has any questions. Thanks.

Thank you.

Thank you. The next question comes from [Moshe Levy] a Private Investor. Please go ahead sir.

Hello Giora can you hear me?

But, I didn't hear the lady so, who is that?

The name is [Moshe Levy], I am a private investor.

Okay.

Okay, hello nice that you hear me. Okay, my first question is, integrated is 90% of revenues, how do you see that ratio going forward? Are you moving more aggressively towards standalone as mentioned several times in the past or have you decided to leave it to the bigger players? Being integrated so long has negative impact on your gross margin.

Okay, thank you. Good questions. Integrated still is accounting for 90% as Dror said before. Looking forward we expect the standalone to account for maybe 20%. So, yes we are growing into stand-alone, but we are not growing as fast as we want it to, but we are growing into stand-alone, and we would like looking forward beyond the next quarter, growth beyond that. We think we have the capabilities such as by the introduction of the 30-90 mix stand-alone and the NovaMARS which is critical for providing full metrology solutions based on the stand-alone system, and as I mentioned before the introduction of HyperNex as a stand-alone high priced, high selling price, stand-alone system. So, looking forward, yes, we are going to improve that.

Okay. My next question also is regard to HyperNex, now that you mentioned it, how do you plan to integrate HyperNex in the company? You are working on this for several months, so I believe you have plans in hand or will be an R&D center with Nova or will it be business profit center?

Interesting question. I think, I will say a few words, but we cannot say too much before we close. So, legally it's not part of Nova and not much we can say. Nevertheless, you are right, we have been working from signing the definitive agreement til today on the process of integration and we also hired integration experts to help us integrate as [quick as] possible because as you know integration of companies is always a very big challenge and not always that successful. So we invested a lot in planning that process and we intend to keep the technologies division of HyperNex within the US and assimilate all the other activities -- sales, service, engineering, manufacturing within Nova.

Okay. So, how will the management [change] be divided to HyperNex then, as a business center or R&D center? I didn't get you quite right?

I think the better description for that -- it's not in R&D, the better description, it will be a product division of Nova that contains development and engineering and all the rest is within the matrix of the company's operations, as I said sales, service, manufacturing.

Okay. Now, thank you. I am following Nova for a few quarters and cannot see a clear direction of where the company is heading. What is its strategy? We were happy to see the previous quarter as almost break-even and now we're losing again and cash positive is moving down each quarter. My question is, how will you be able to stay as a viable player with [inaudible], and with so many challenges in 65 and 45 yet to come, which will consume more cash?

Well, I would say the following. The ability for us as a global company to be break-even and better is function of two things, one is of course the efficiency of the organization, the other one is the size. So, when you grow you expect to improve the financial parameters. You would say that this quarter we have seen revenue increase and yet we lost some money, and Dror gave explanation for that. We had some one time or singular events that we had -- we made some investments, some of them related to the litigation case, the jump in the expenses for the litigation. The other one is in the strengthening our presence in Asia-Pacific and Japan.

So, we made some investment in those areas. And that's why we are not breakeven, although we are not that far from breaking even. So, looking forward, with the revenue growth, we expect to improve our financial parameters. Nevertheless you've to remember that this quarter was -- some part of this quarter we already have expenses related to the acquisition and when you make acquisition you invest. So, we would see some investments but not always in the P&L areas defined as investment. But from -- the operation aspect of the company, you'll see some investments. We could see some investments in taking the company in and proliferating its products in the market.

Okay, we expect also for it to grow. But how can you grow if the cash is growing low. You cannot always find bargains like HyperNex for such a low cost and other acquisitions will probably be much more expensive?

Well, I didn't say that we are planning in the very near future acquisition. We'll have acquisition as we move forward depending on the type of acquisition you make of course that depends how it impacts your financials, and we are not planning to make an acquisition of cash draining operations. There are acquisitions hopefully with improving our share price we will be able to do more than we have done so far and leverage that to help the company grow.

Okay, that's safe. Thank you. Now my last question, hold on, is -- I am visiting the [inaudible] frequently I am at [inaudible Institute] for the past time and I've heard some of the company employees that they expect significant changes in the company management, especially following the nomination of a new Chairman not long ago, could you elaborate on this, is there any information or are there decision to take place on that that Nova investors should be aware of while consider investing in Nova or selling out positions?

I am not aware of anyone selling positions. Yes, we have a new Chairman and we welcome the new Chairman and we think he is a long time in the industry and he can definitely help the company move forward, the strategic aspects of that, but the Company is moving forward and there is nothing significant that we can add to that.

So you said the rumors that I heard about the management changes are not true?

I am not discussing rumors.

Okay, hello.

Yes.

Thank you. [OPERATOR INSTRUCTIONS]. We have a follow-up question from David Fitzgerald, a private investor. Please go ahead.

Hi, a couple of more questions. More generally speaking, it's been about a year now or maybe a little less than a year since Tokyo Electron purchased Therma-Wave's integrated metrology unit, and if I recall correctly at that time there was some speculation that they might use that acquisition to make a move into the integrated market and since then I haven't heard anything from anyone, do you think that's dead in the water or is there any indication they might try to go forward into the integrated market?

Just to [inaudible] on it, I would say two things, one the acquisition of the integrated division of Therma-Wave by TEL, the previous [sensor system] at least by the declaration of TEL was in order to guarantee continued support of the products that Therma-Wave was building and supplying to TEL customers and at least the best indication that he had was that TEL was very much interested in making sure they continue to supply especially to existing systems.

So I would assume this is still going on. I have no knowledge, detailed knowledge of the number of systems but definitely it's not very widespread. Just to remind you that the Therma-Wave sensor system are very low performance type systems that weren't good at that time, for example [no BQE] or no polarization so this is not a big time entry into the integrated metrology especially for Optical CD for litho for anyone and we don't have any indication that TEL would like to make a very wide strength -- wide span proliferation of integrated metrology. At least from what we understand, TEL is not interested to be a very significant metrology player, but more interested in providing solutions to their customers. So I don't see that as a very strong competitive threat in that segment.

Okay. So I guess that never really came to fruition, I guess we could take them seriously that they really did just want to continue that product for their customers? But along those same lines, they have about 90% market share in track. And recently Applied Materials and Dainippon announced a partnership to create opportunities in track. Do you see that affecting at all potentially your strategy with regards to integrated metrology and lithography? Will that change anything, Applied Materials' joint venture?

Probably yes. I mean it's a very slow rate and yes because I am sure that a client of this Sokudo Company company, this joint venture will try to position itself in the integrated metrology for litho as well. Having in mind that they have 5% market share or something, we don't think this will change the playing field that significantly but we are following it very closely.

But in addition to that we -- our observations are that integrated metrology in general for lithography is not accelerating very fast. We see more getting into Etch [of course in] CMP and very slow into litho. And in addition to that in lithography you need to distinguish between [marker] inspection, overlay measurement and CD or Optical CD.

So as you look at the overall we don't see a significant proliferation as a major trend in the track, so it could be more -- we think more as positioning type of approach having the capabilities, looking down two, three, four years down the road. So we are following it very closely, but we are not anticipating that to be a major market segment very soon.

Okay that's helpful thanks for that information. One last question about your gross margins. Do you have any kind of target for your blended gross margin, you said they were a little bit lower this quarter, but the product gross margin though looked like it was only maybe some very slightly lower, is it going to stay around 43% or do you have a target for that that you can disclose?

Well our long-term model is 50% of gross margin. We expect the gross margin to improve through the second half of 2006 by few points.

Okay, so the --- about 50

Both the standalone system and the new product, the NovaMARS which is a software product are definitely two areas which will help us improving the gross margin and achieve this, as Dror described, the target of 50% and we think we can do it.

Yes. It looks to me that the stand-alone has some momentum now and going forward it’s now you said 10-20% of your product revenues in the second half of 2006. Are those the higher margin products, is that what you were seeing?

Yes.

And the HyperNex product will be right at the top of that higher margin. Is that correct?

Absolutely.

Okay. All right, thanks all for answering all those questions and I will see you next quarter.

You are welcome.

Okay.

There are no further questions at this time. Before I ask Dr. Dishon to go ahead with his closing statements, I would like to remind participants that the replay of this call will be available in 3 hours on Nova's website www.nova.co.il. Dr. Dishon.

Okay, well, thank you very much for attending our conference call -- our quarterly conference call. We had a good quarter and we are looking forward for much better quarters as we move forward. Thank you.

Thank you. This concludes Nova's Second Quarter 2006 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.