Nova Ltd (NVMI) 2008 Q1 法說會逐字稿

Welcome to the Nova Measuring Instruments first-quarter 2008 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. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded May 5, 2008.

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 risk and uncertainty 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 GK Investor Relations at 1-866-704-6710.

With us online today are Mr. Gabi Seligsohn, CEO of Nova and Mr. Dror David, CFO. I would now like to hand over the call to Mr. Gabi Seligsohn. Mr. Seligsohn, would you like to begin please?

Yes, thank you, operator and thank you, everyone for joining today's call. I would like to start by an overview of the quarter. Q1 of 2008 was a challenging quarter for the Company. While it has become clear that our industry is experiencing a steeper decline in 2008 than had been originally expected, we are pleased that our Q1 revenues were down only 4% from the first quarter a year ago. Our strong execution last year, the broadened product portfolio and excellent product performance all allow us to defend our position in the market while we go through this challenging period.

Keeping a strong connection with our customers, we were able to read the change in our market while our cost control programs and flexible budget management methods allowed us to achieve a positive net income after reducing our expenses in the quarter by approximately 15%. In the latter part of the quarter, we also started seeing an improvement in profitability of our latest product as a result of additional capabilities, which we now offer to our customers.

This quarter, we also announced a follow-on NovaScan standalone order from the largest foundry in China as part of a multimillion dollar deal to supply its standalone metrology, integrated metrology and application development needs. According to the customer, the NovaScan standalone tool coupled with the NovaMARS modeling package demonstrated better performance than competitors, including higher throughput and advanced modeling capabilities. The customer also noted Nova's excellent support as a key decision-making factor.

Both of the customers' fabs will use a combination of our standalone and integrated metrology solution. This type of satisfied customer is the foundation for our future success, regardless of industry cycles and is clear evidence of our ability to provide solutions based on more than one product.

Our successful penetration of the Korean market continues to represent a major element of our business and we were proud to announce the installation of our 100th tool in that territory. Success in Korea is also translating into business in those customers' offshore facilities in China and in the U.S.

We were very pleased with the results of a recently published report by SEMATECH's ISMI group for its member companies, which include some of the largest IC manufacturers in the world. In that report, ISMI compared the key vendors of optical CD technology on quality of their metrology, the modeling software, which supports it, the ease of use and the speed of measurement. The report showed that we have clear advantages on all these fronts. As a result of the report, we have seen increased interest in the product and we are now engaged in several important system evaluations, which are progressing quite nicely.

Given our significant install base of over 1600 tools and our mature and professional service organization, it is our belief that we can generate improved profitability on service as well. Our operations team has put in place a plan to accommodate a flexible service business model to cater for various customer needs. We see this as an important measure since some regions have moved into an aftermarket situation requiring system upgrades and limited service contracts while others are still growing and installing latest generation tools. We hope to share positive results of these efforts over the coming few quarters.

At the beginning of April, we received results of a lengthy evaluation of our X-ray technology, which was performed with a leading customer. Though the results showed promising measurement capabilities, we were unable to demonstrate a significant enough value to the process. As a result and given the lack of progress with this product as a whole since its acquisition in August 2006, we decided to finally close the X-ray activity and liquidate the assets and IP related to that platform in the coming months.

We also took some cost reduction steps at the beginning of the second quarter in order to mitigate the impact of the currency exchange rates of which we are exposed as an international company selling in dollars and spending in stronger currencies. These measures do not interfere with our operational plans and we are continuing to execute on our aggressive roadmap objectives. You should not think of these as cutbacks, but as part of our continuous efforts to operate more effectively.

Now I would like to turn to an outlook of what is going on in the industry. In the past few months, we have seen several announcements of joint ventures being formed by several of our customers with each pledging significant amounts to be spent as part of their joint efforts. These joint ventures are primarily in the area of memory manufacturing where development costs continue to rise rapidly while product gross margins keep deteriorating. In this environment of continuing consolidation, it is clearly important that we are well-positioned with each of these customers and this will play a key role in our ability to continue to grow in the future.

As mentioned, we now see a decline in the industry, which is more significant than previously expected. While only a few months ago, wafer fab equipment was expected to decline by 10% to 15%, we, as well as industry analysts, now believe the decline will be around 20% to 25%. While we are not entirely immune to these conditions, we believe that we are well-positioned to outperform the industry in 2008 based on a few considerations.

One, our continued penetration of the standalone metrology segment; the second one, our standalone backlog from last year, which was quite significant; the third, our ability to further grow our service business. The need to continue to shrink geometries means that our customers will be spending a lot of their time and money developing their next-generation technology nodes in coming months rather than increasing current capacity. The diversification of our revenues into the area of standalone will allow us to capture this business. Then when capacity increases return, our excellent position in the integrated metrology market will yield more growth opportunities.

So in summary, though we are facing a challenging year in our industry, our relative performance is quite strong. We are in the segments where the most spending is happening and we have market-leading products and we are continuing to improve our operational efficiencies.

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

Thanks, Gabi and hi, everybody. Welcome to our quarterly conference call. As Gabi mentioned, we have experienced a slowing industry environment in the quarter. Although industry conditions were weak, this softness has resulted in only a 4% reduction in revenues relative to the first quarter of last year.

In the previous quarter, we reported that we are moving into 2008 with a relatively high backlog in evaluation orders from the standalone segment. We also reported that a larger portion of this backlog is related to first in fab bundled hardware and software systems, of which revenue recognition is spread ratably over a 12-month maintenance period starting at customers' acceptance dates. We have already received the first customer acceptance and we expect to start receiving additional acceptances for this backlog in the coming months.

Sales by territories in the quarter have slightly shifted from U.S. and Asia-Pacific towards Europe and Japan as following. U.S. accounted for 20%, Europe 5%, Asia-Pacific 64% and Japan 11% of revenues.

Another important aspect related to our revenues is the fact that we have experienced improved average selling prices related to new capabilities introduction and direct sales of integrated metrology, which helps support our gross margins and net results in the quarter. Service revenues were $3.2 million in the first quarter of '08, similar to the previous quarter, fourth quarter of '07.

Looking into our gross margin performance, blended gross margins in the quarter slightly declined to 40% relative to the previous quarter. Per segment, we have seen a drop in services gross margins while service revenues remain flat. This drop is mainly related to a change in the overhead and warranty location between products and services, which we started to implement in the current quarter following a business and financial review of our service activity. Although this allocation change does not have any impact on our net results at the moment, we believe it better reflects our cost structure and through time, will drive better performance of our service business.

Operating expenses decreased to $5.3 million in the quarter, a 16% decline relative to the previous quarter and a 21% decline relative to the first quarter of '07. This decrease reflects our ongoing cost control initiatives throughout '07 and in the current quarter, as well as the effectiveness of our currency hedging activities.

Looking into the second quarter, the impact of the approximately 10% evaluation of the U.S. dollar against most currencies in '08 and to date will increase our reported operational expenses because we are less hedged in that quarter.

As Gabi mentioned, we took cost-cutting measures in the beginning of April. The full effect of these cost reduction measures will materialize in the third quarter of '08 and beyond. As part of this process, which included the closure of R&D projects related to the X-ray technology, we expect to take a non-cash charge of approximately $0.6 million in the second quarter of '08, reflecting a full depreciation of fixed assets used in this specific activity.

On the net results, the Company presented a fourth consecutive profitable quarter on a non-GAAP basis with $0.2 million net income in the first quarter of '08. Cash flow-wise, the Company presented negative cash flow from operating activities of $1.9 million in the quarter, mainly due to an increase in mainstream finished goods inventory due to delays in customers' orders.

Before concluding, just a quick update on the Company's investment in auction rate securities. During the quarter, we adjusted by $0.3 million, the value of the auction rate securities, to their indicative bid values as of March 31, '08. This adjustment was classified as temporary impairment, which is presented in shareholders' equity and not in the P&L report due to the fact that these auction rates are AAA rated, pay competitive monthly interest rates and have witnessed continued improvement in bids since the month of March and to date.

Overall, our strong balance sheet and cash position with above $20 million in cash reserve and approximately $23 million of working capital together with our ongoing cost controls will enable us to continue the execution of our business and financial plans for the coming quarters. Gabi?

Thank you, Dror. Operator, we would be happy to take questions at this point.

(OPERATOR INSTRUCTIONS). Excuse the interruption. We are now going over to the question-and-answer session. (OPERATOR INSTRUCTIONS). Robert Katz, Senvest.

Hi, Gabi and Dror. I have a question about a few things. How many standalone systems did you sell in the quarter? And you made a comment about, on the integrated side, about selling direct integrated. Can you elaborate on that and what impact that will have on your business? Can you comment also about what you are doing to improve gross margins on the services? As well, can you review what your guidance is for the upcoming quarter and year? Thank you.

So your questions again just to make sure I got them was regarding standalone, service margins, integrated metrology business and outlook for the coming quarter?

Yes.

First, thanks for hanging in there despite that technical difficulty.

I wasn't sure what I was supposed to do.

Us neither. We will try to check that and we apologize to everyone for the hold. Regarding the standalone, what we saw in the quarter were a couple of new orders, one from an existing customer and one from a new customer. So we were quite pleased with the increased interest in the product both from the existing customers and the new customer.

On the service side, I mentioned operations putting together a program for service. As mentioned in my comments, when you look at the market and what is going on in semiconductors right now, obviously there are regions such as the U.S. where you see a significant amount of output of manufacturing coming from fabs, many of them already fully depreciated, where we have hundreds of tools. You also see that quite a bit in Asia-Pacific and in Europe.

Those fabs, their needs and their cost considerations are very different from leading-edge customers that are still installing the latest and greatest most up-to-date technology and in this plan that we have put together, we would like to address those customers differently in order to offer them something that fits their specific needs better.

There is also a significant opportunity for system upgrades that exist when you have such a significant install based of 1600 tools. So actually our hope is to improve on service gross margin as a result of that process. What we would like to do is to demonstrate the results of that process over time and then share a little bit more detail on the factors associated with the gross margin increase there, but it is mostly associated with fine-tuning the solutions that we have. We have a very strong service organization, a lot of people dealing with services provision with quite strong capabilities and we think we can gain more capability out of that group of people.

As far as your question regarding the integrated metrology business, as you well know, integrated metrology business is very much a capacity-related buy. Integrated metrology is known to improve cost-effective manufacturing and productivity and reduce cycle time. While we still enjoy quite a bit of revenue coming from integrated metrology and there are indeed several fabs that are still increasing capacity and there are also many that are doing retrofits, you can imagine that in the state of decline in the industry, you're going to see less capacity bias and more technological bias and that is really relating to the comment that I had made about integrated metrology.

As far as outlook for the current quarter, as general practice, we don't talk about the current quarter performance, but we did mention activities that we already did at the outset of the quarter associated with our continued cost controlling measures, etc.

For the year as a whole, I mentioned outperforming the entire industry and the reference point, of course, is the fact that the industry is supposed to decline to the extent that I mentioned of 20% to 25%. So hopefully that answers the questions, Robert.

Okay, thank you.

Gary Simon, UVE Partners.

Hi, Gabi, good morning or good afternoon I guess. Two questions, one specific to the industry itself. Understanding that the market or the industry is declining, the CapEx is declining, how does the rate of decline that occurred in both the first quarter year-over-year and sequentially, how does that relate to the industry's decline?

Well, the industry -- you get a mixed bag of different companies reporting different results, right? We have seen some companies reporting flat to a little bit up in Q1. We have seen a few that reported significantly lower revenues in bookings. So it is a mixed bag. I think my observation generally for the industry is for the entire year of 2008 and the comment about our slight decline was, of course, specifically about Q1 versus the previous year's first quarter. Versus Q4, indeed, we did see a decline of 20%. Some of it I will say is seasonal. We have always seen a slower Q1 than a Q4 and of course, some of it is related to the overall environment.

But it appears that you feel that your rate of decline, whether it be sequential or year-over-year, is somewhat less than the industry's decline.

That is correct.

Okay. So you anticipate that continuing throughout 2008 and hopefully you will grow faster than the market when it starts turning? Having said all that, it appears to me that the valuation of the stock bears no relationship to the value of the Company itself. With a dollar, around a dollar, maybe a little bit more depending on if you keep the reserve that you have for severance in your cash balance or not, most of your value is in your cash and it appears that your operations -- you have cut the breakeven and although revenue is not growing, it is at a rate that you should continue to be profitable throughout. EBITDA margins are still pretty decent.

Right. Regarding Company valuation, obviously, as CEO, I strongly believe in the Company's capabilities and in the Company itself. Obviously, I am not allowed to comment about the pricing of the stock and where it stands. What I can talk about is the measures that we are taking in order to induce the business of the Company itself and in the hope that obviously ultimately reflects itself in the stock valuation as well.

I think the comments that you made generally about the operation and where we stand are pretty correct. We really think that we have taken the right measures to manage a very cost-effective company. We still maintain a very significant amount of money for development because that is a critical element of being a technology player in a big and very aggressive and competitive market such as the semiconductor market. So we believe we have found a good way to balance all those things together now about a year and a half into the change of the management of the Company and we see that as a streamlined process, which is continuous.

I think what we are trying to do and we have done quite effectively and I think the numbers of 2007 spoke for themselves and with a better industry I think would have been reflected even stronger in our numbers is that we have laid the foundation for further growth into the future. The Company does have very competitive products. That evaluation that I had mentioned by SEMATECH is a huge achievement and it is not something which is temporary. We saw similar results in 2005 from that very same body. The work that we are doing really is to create an adoption cycle, which is more aggressive of our standalone product while we continue to defend our marketshare and integrate it where we already have the leadership.

So as a whole, I think the Company does have very nice trajectories going forward. The foundation is in place, the customer trust is in place and growing continuously as they see execution and all I can say is I hope it would reflect itself in share valuation.

Well, I guess there are two issues, both having to do with your size. One is from an operational point of view. Do you feel negatively impacted because of your size that your distribution is not as strong as it can be? I guess said differently, if you were a division of a much larger company, would you be able to grow your division much faster?

That is a good question. I think big companies have larger spending capabilities obviously. I think the way that we have chosen to do this process of penetration into the market is going after select customers that have the ability, one, to yield repeated orders when they get convinced that the technology is good and two, have pretty leading positions in their specific segments.

I think the key thing now that since the semiconductor industry, as I mentioned in my comments, is consolidating and you are seeing people grouping together. Ultimately at the end of this process, you might see seven to ten groups that exist, maybe three in each of the memory segments -- DRAM and NAND flash, foundry and then logic -- and so I think that what we are doing right now we are addressing as many of those as we can. Could we spend more money and do it faster? Possibly, but I think really the rate of adoption is very much associated with going selectively after each customer, demonstrating capability and leveraging that for growth.

All right. Well, good luck and hopefully we can get some liquidity in the stock because that is probably what is really impacting it.

Thank you very much, Gary, for the questions and the comments.

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

Yes, operator. I just wanted to finish up by thanking everyone for attending this quarter's call. We thank you for the continued interest in the Company and we look forward to meeting you and seeing you on the next conference call. Thank you and have a great day.

Thank you. This concludes the Nova Measuring Instruments first-quarter 2008 results conference call. Thank you for your participation. You may go ahead and disconnect.