Nova Ltd (NVMI) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Nova Measuring Instruments third quarter 2007 results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded November 6, 2007.

I would like to remind everyone that forward-looking statements for the respective Company's business, financial condition and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development, and the effect of the Company's accounting policies, as well as certain other risk factors which are detailed from time to time in the Company's filings with the various securities authorities.

If you have not received a copy of today's press release and would like to do so, please call [Gilbert Ghanna], Investor Relations, at 1-866-704-6710 or [972-360-74717].

With us on the line today are Mr. Gabi Seligsohn, President and CEO of Nova, and Mr. Dror David, CFO. I would now like to hand over the call to Mr. Seligsohn of GK Investor Relations (sic -- see press release). Mr. Seligsohn, would you like to begin?

Hello everyone and welcome to our third quarter 2007 earnings conference call. Let me begin by giving an overview of the third quarter. Business conditions in Q3 were in line with our expectation, and our team did an outstanding job of executing our plan, achieving a high double-digit sequential increase in bookings and a very strong backlog after week bookings in Q2. This gives us a positive view for the balance of the year and into 2008.

Two of our three main areas of focus are going extremely well. We are continuing to gain market share in integrated metrology. After good revenues from stand-alone in the first half of the year, we didn't have stand-alone revenues in Q3. I'm happy to report though that we did receive several new orders and requests for evaluation, indicating that our penetration of this market is very much on track.

We are struggling on the revenue side in x-ray, as prospective business that was identified at the time of the HyperNex acquisition last year failed to materialize. As a result of the longer than anticipated sales cycle, we were required to adjust the value of related assets on our balance sheet. None of these were cash charges. And it is important to note that we're actually cash flow positive in Q3. Adjusting for the non-cash items, we met our objective of continued profitability, and expect this to continue going forward.

Third quarter revenues are a good reflection of an overall industry trend of moving development and manufacturing to Asia-Pacific with about three-quarters of our revenues coming from that region.

Now I would like to move to some more details. Revenues for the third quarter were up year-over-year, mainly due to the widespread adoption of our NovaScan 3090 integrated metrology platform and its excellent integration with our key OEM partners, Applied Materials and Ebara Corporation.

Q3 gross margins obviously require some explanation. Product gross margin decreased from above 50% in the first half of 2007 to 46% in the third quarter. Overall gross margin, excluding the non-cash charge, decreased from 45% in the first half of 2007 to around 41% in the third quarter, and actually to 38% when eliminating our exceptional IP licensing revenues.

Several factors contributed to this phenomenon, and we believe all are temporary. A less favorable product mix, cost increase related to our [federal] penetrations, which is typical in such periods, and a reduction in overall revenues. We are certain that we will see an improvement in product gross margin and overall gross margin already in the coming quarter. And we believe it will continue to gradually improve over the next several quarters.

This will be achieved by an expected increase in revenues evidenced by the increase in bookings, including for our stand-alone product, as well as the success of our state-of-the-art modeling software, the NovaMARS. The team's focus remains on the continuation of successful penetration into this segment, and we can look forward to the positive impact on financial results in the near future.

There are no stand-alone revenues -- are reported for third quarter, we are very pleased to have received several new production orders and evaluation orders from existing and new customers for our NovaScan 3090 stand-alone productline. By doing so we continue to execute on our plan of penetrating several accounts in 2007, with a clear intention of building our market share and presence in this key area of stand-alone metrology.

Important to note is the fact that the tools being ordered are for use in both the patterning area, the [Resno] and Etch, as well as the [systone] area, thus broadening our addressable market into more areas in the fab.

Now I would like to explain the business issues that resulted in the non-cash charges related to HyperNex, the company which we acquired in August of 2006. At the completion of the acquisition we had clear expectations assuming a couple of orders from key accounts who are actively engaged in either evaluating the product for their needs or adding more units to ones already acquired prior to the acquisition. As a matter of fact, one of these customers has continued to perform [paid way] for testing for several months at our demonstration facility in order to support their process development needs.

Significant changes in both these customers' business plans brought their capital equipment purchase to an absolute halt. It had nothing to do with the performance of the product. While our prospects for more sales are actively evaluated, the sales cycle is quite long. And since we currently have no basis for predicting success and its timeframe, the prudent thing to do is to reflect the lower asset value on our books.

Meanwhile we are moving aggressively to contain costs in this business. Having completed the integration of HyperNex we were able to move product development to our headquarters in Israel and close the State College facility, allowing us to reduce our costs by about $1.1 million in 2008.

Development activities will now focus on further improving and extending the product capabilities and its ease-of-use. We have also installed a unit in our new demonstration and application development facility in Taiwan, which will be inaugurated next week, and are actively engaged with key customers in that region in demonstrating measurement capabilities on their wafers.

As for the Company's balance sheet, I would like to further note that we continue to have a strong balance sheet, and we're cash flow positive, bringing our cash position at the end of the third quarter to $20.5 million.

Now I would like to give a brief industry outlook and our perception of what is going on in the industry. Having completed our 2008 business sighting session last week with the sales force visiting headquarters, and following several meetings with customers in the past few weeks, our understanding about next year is that capital expenditure will be 10 to 15% down year-over-year, very much due to sharp price declines and overcapacity in DRAM. More specifically and by segment, it is our expectation that Flash memory will be up, DRAM will be down, logic will be flat, and [salvy] will be flat to slightly up.

Despite this environment, we expect 2008 to be another year of growth for our Company. Growth will come from further increasing our market share at integrated metrology, as well as enjoying the fact that we are the tool of record at most fabs planning significant expansions next year, now that 21 of the largest 25 are our customers. Growth is also expected to stem from meeting our objectives in software and in stand-alone sales and further going our share in that key area. Our plan is to penetrate five more stand-alone customers and to continue to receive repeat business from existing ones next year.

In summary, now that three-quarters of the year are already behind us, we already know that 2007 will be an all-time record year for Nova, with 12 months trailing revenues already at $56 million. We are well-positioned for further growth in the future, as our revenues comprised mostly of NAND Flash and DRAM investments, which are still continuing in many of our customer sites, while we are awaiting eagerly to see foundry expenditure to come back again.

With the continued successful penetration of our market-leading integrated metrology platform, as well as the wins of several new stand-alone opportunities, we believe we have set the stage for another year of growth and profitability in 2008.

With that, I would like to now turn it over to Dror to provide more insight into the numbers.

Welcome everyone to our call. As Gabi mentioned, we have very well executed our financial plans for the quarter, with revenue growth representing an 11% increase in Q3 '07 over Q3 '06. The revenue increase in the quarter over last year's comparable quarter continues the consecutive increase in our last 12 months trailing revenues that started in Q1 '06, reaching $56 million in this quarter. Sequentially as expected, we have seen a modest 7% decrease in revenues relative to Q2 '07.

During the quarter we did not recognize revenues from stand-alone systems, however, during the last few months we continue to receive both production and evaluation orders. The backlog and deferred revenues for the stand-alone product are growing and currently represents more than the total revenues from this product in the first half of the year.

This is a clear indication that we will see increase in revenues from this product in the coming few quarters. We will start recognizing revenues from this backlog in the next three months and upon customer acceptance, which might vary, and it also depends on customers' internal processes.

During the quarter we have seen a major shift in product mix towards our newest NovaScan 3090 product platform. As Gabi mentioned, this new platform has driven our recent market share gains and penetration.

Sales by territories changed significantly relative to previous quarter, with Asia-Pacific accounting for approximately 70% of product revenue. As Gabi mentioned, this increase is related to recent penetrations into new customers in this region, as well as continued purchases of existing customers. In the quarter the U.S. accounted for 16% of revenues, Europe 9%, Asia-Pacific 73%, and Japan 2%.

Service revenues were $2.9 million in the third quarter of '07, and increased relative to the previous quarter related to sale of time and materials. As previously announced during the quarter, we have signed an agreement and received payments for patent licensing. The $0.8 million IP licensing revenues presented in the Statements of Operations are after deduction of legal fees and expenses.

Excluding the onetime inventory charge related to the HyperNex acquisition, blended gross margins in the quarter were 41%, similar to the 41% gross margin reported in the third quarter of '06. The sequential decrease in gross margins is related to the impact of the shift in product mix and to costs related to our new penetrations and market share gains in the Asia-Pacific region. As Gabi explained, we have a clear plan for improvement in that area.

Operating expenses, excluding the onetime non-cash impairment charge, has decreased by $0.5 million due to reduction in G&A expenses resulting from zero costs related to IP litigation, which was concluded in Q2, and from achieving the final balance of our cost savings from headcount reduction.

As mentioned in the press release, during the quarter we have reevaluated the activities of our Microstructure division after one year from the acquisition. In light of the sales cycle and our outlook for revenues we have either taken an impairment charge or written off most of the acquisition-related assets, including intangible assets and equipment, totaling $4.1 million.

In addition, we consolidated the State College R&D facility into Israel's headquarters, including headcount reductions of 10 employees. We expect these changes to result in cost savings of approximately $1.5 million in '08.

On the net result, I'm happy to announce that, excluding the onetime non-cash charge, the Company has presented a second consecutive profitable quarter with approximately $0.5 million net income relative to $1.1 million net income in the second quarter of '07. In addition to the onetime non-cash charge, net results for the quarter included $0.7 million of non-cash regular expenses, comprised of $0.3 million of stock-based compensation and $0.4 million of depreciation and amortization.

Moving into the balance sheet, I will briefly move through the main changes. Cash reserves in the quarter modestly increased by $0.1 million. We expect this trend to continue as we presented healthy EBITDA in the last two quarters. Accounts Receivable have increased by $1.5 million in the quarter, relative to the end of Q2. And this increase is related to the timing of shipments and within quarter collections. Inventories had decreased by $2.3 million, while the majority of the decrease is related to HyperNex assets revaluation, and the rest is related to improvement in operational efficiencies. And finally, intangible assets were fully written off this quarter.

Overall the Company reported in this quarter a healthy $1 million or 7% EBITDA, and our balance sheet and cash position continues to be strong with over $20 million cash reserves and approximately $22 million of working capital.

Combined with bookings that have shown strength in the quarter, and increasing overall end quarter backlog, this will enable us to successfully finish year '07 and to continue the execution of our business and financial plans for the coming quarters.

And with that, operator, we would be happy to take some questions.

(OPERATOR INSTRUCTIONS). Yaniv Rahimi, Ramco Investment [House].

My question is with respect to the IP license payment in this quarter. Is it an onetime agreement or should we expect such agreements in the future or in the near future for Nova?

The revenue which has been recognized for the specific license that has been signed is fully accounted for. We are in any several other discussions, but are not at liberty to discuss the outcome of them right now.

[Clearya Gore, IN Asset Management].

Maybe you can tell us what your expectation regarding the gross margins going forward?

As I explained in my notes, generally we expect the gross margin to go up. Actually specifically in Q4 we already expect a significant increase in gross margins more close to what we are used to, and definitely above the 40% level. Long-term the plan that we have, and that is for the next several quarters, is comprised of a more beneficial product mix, which will provide for the improved gross margin, as well as an increase in overall sales.

Our expectation is that this quarter is a unique quarter. This is a unique drop in gross margin that we don't expect to see repeating. And it is a result, as we said specifically, of the combination of three things. One is the less advantageous product mix. It is the penetrations which have been successful, but the costs associated with them. Those are the key things that it is coming from.

What about the book to bill figure, can you tell us what it is?

It is significantly above 1. It has gone up double-digit, and it is significantly above 1. And we're actually feeling very good about that at a time where the overall industry right now is at about 0.8 book to bill. And we believe that that increase is related very much to successful penetrations, and the demand for the product has really increased a lot in the quarter. Coming into this quarter, as we spoke about last quarter, just like the rest of the industry we had seen bookings drop, and we're very happy to see this very significant increase, which bodes for a very good roll into Q4 and then into next year as well.

And last one. About the G&A, do you expect it to stay at those levels?

I think we should expect modest decrease in the next quarter, but this is -- these are the levels of $0.7 million, $0.6 million.

[Sy Gerson] (inaudible).

The close of the facility in Pennsylvania, was there any onetime charges that you took in Q3, or are you taking any charges for that in Q4?

Can you repeat the question? Sorry, I didn't hear you so well. (multiple speakers).

The closure of the facility in Pennsylvania, did you take any charges for that in Q3 or will you take any charges for that in Q4?

Actually we don't expect to take any additional charges relating to this activity, and the savings that we will see we expect this impact to start in Q1 in '08.

There will be no saving in the next quarter (inaudible) '08?

The savings will start in '08. We don't expect a restructuring charge or something like that (multiple speakers).

What was the charge for depreciation and amortization in the quarter?

$0.4 million.

And stock-based compensation?

$0.3 million.

Robert Katz, Investec.

Gabi, can you talk about how many stand-alone shipments you made so far in 2007? And looking forward to 2006 with the existing customers, what type of volumes are you anticipating? What is the potential for '08 with the existing customers? And where does that (inaudible) from new customers?

For obvious reasons, we wouldn't like to share the exact number of tools since this is very competitive information. What I will say is that we started the year with a single, very large customer that had well over a dozen of our tools, and now have a few others that we have already penetrated. Some of them are actual rolling into production, some of them are evaluation tools.

Our plan for 2007, as remember, was to penetrate a few accounts, and that is going quite well. We are seeing several accounts taking on tools. The reason is the tool offers several advantages over competitive products, and so that is turning into a very successful operation.

As far as what we expect for next year, we expect to see an increase both in revenues and in bookings from that platform. Part of it will be what is rolling of course from this year into next, meaning related to revenue recognition. Part of it will come from new POs that will come through. Our clear expectation is also that the evaluation tools should turn into actual revenue tools, and then hopefully turn into repeat orders as well.

Overall I would say the expectation is that the accounts that we had chosen for penetration, our focus is to turn them into repeat order accounts, and that the penetrations that we continue to make are through accounts that are able to generate more than a single tool.

Are most of these accounts memory?

That come from a combination of DRAM, Flash and foundry. So quite good trends in all three areas.

And your (technical difficulty) your growth will come across all three areas next year, or do you think DRAM will be down through next year?

I think that Flash will be the largest. As I commented on the overall environment, I think our plan right now very much reflects that. In the area of Flash definitely we're going to see an increase there. And then DRAM, very much depending on specific customer plans that I think are yet to be defined,. In the case of foundry there are some orders as well. But I think to answer your question, Flash is going to be the largest.

In terms of geography, how do revenues break out this quarter in terms of Taiwan, Korea, Japan, the Americas.

We didn't give the breakdown within the Asia-Pacific region. We don't generally do that. Asia-Pacific accounted for 73%. And I have to admit that our strongest country has been Taiwan. South Korea is growing dramatically as well.

David Fitzgerald, private investor.

I wondered if you could give any update on one of your patents that is under re-examination at the Patent Office? Can you say anything about that? Has it comes to conclusion or is it still under progress?

Generally the overall patent situation is that we have ceased all legal interaction with Nanometrics. As far as our re-examination processes of different patents we don't generally discuss that. We feel our patent portfolio is quite strong and we continue to feel that way. The pursuit of more patents is a continuing process in the Company. We already have close to 70 patents in the Company, so we continue to grow that. And we don't see a significant concern, or any concern actually, relating to the re-examination of our patents.

On a different note, how many tools, or if you don't want a given number, can you say that you actually placed tools within the lithography area of the fab this year, or is that completely unpenetrated still?

No, we have placed tools in lithography.

Do you see an increase in that particular area of the fab going into 2008?

Are you talking about stand-alone or integrated or both?

I'm actually specifically thinking about integrated.

We have placed tools in integrated metrology. And whether that is going to increase a lot or not I think depends on the adoption rate of the technology. That is yet to be seen. We have decided to take a two pronged approach and go after that business both with integrated and with stand-alone. And the reason we have done that is because the adoption rate of integrated in litho, though it has -- really I have to admit it is still quite slow, but the dependency on optical CD technology in that area in the fab is quite significant, and it has become a fact of life that everyone is pursuing that.

The reason is that the cost of ownership associated with these tools, the nondestructive nature that they offer, and the complexity of structures that they can resolve are such that they can replace in many cases things such as CD (inaudible) and other destructive measures. So the stand-alone focus that we have used to be at and greater than the litho area throughput. Which is one thing that we have stated very clearly and have continuously delivered on is very, very high throughput, so that customers that choose to go with stand-alone, which is still the primary focus in the industry, have what they need in order to support the sampling schemes that they need for that area of the fab.

Integrated it still in business developmental phase. Even so we have seen some installations, both at a customer site and in our research and development facility, which is important for us for [APC] scheme development that that process control scheme developments.

Can you tell me a little bit about the software, the software that you have been selling? If I heard correctly you didn't book any revenues from the software in Q3, but can you tell me if it has gotten more competitive? Have there been more competitors trying to enter the software market, anything about that?

On software we look at several aspects. One is -- a key one is associated with the modeling necessary to perform the optical CD measurement. There is also lots of software associated with productivity, such as networking of our products, data transfer, and all sorts of automation related things.

The key component though is the modeling software. Revenues in that area are still lumpy. The reason is because we're focused on penetration, so there are quarters where we see an increase in revenues, and there are quarters where we don't see revenues. I expect that to improve rolling into next year because it looks like we have brought a product which is very competitive. The ease-of-use that it offers is exceptional and the ability to measure very, very high end applications is also there. The backlog actually did continue to build in the quarter, but the recognition, as you well know, is spread over a maintenance period.

The drop in deferred revenue this year, or going back maybe four or five quarters, is that just improving the efficiencies in your Company or you are getting acceptances quicker? Or should we expect to see that bounce back up going forward?

No, I think we improved in the process, and we should not see that significantly increase going forward.

Good job. Thanks very much.

(OPERATOR INSTRUCTIONS). There are no further questions at this time. Before I ask Mr. Seligsohn to go ahead with his closing statements, I would like to remind participants that a replay of this call will be available in three hours on NovaScan's site, www.nova.co.il.

Thank you, operator. And thank you all for attending this quarterly conference call. Goodbye.

Thank you. This concludes Nova's third quarter 2007 results conference call. Thank you for your participation. You may go ahead and disconnect.