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Operator
Welcome to the Nova Measuring Instruments Second Quarter 2008 Results Conference Call. All participants are at present in a listen-only mode. Following the management's formal presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS)
As a reminder, this conference is being recorded August 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 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 GK Investor Relations at 1-866-704-6710.
With us online today are Mr. Gabi Seligsohn, President & 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 please go ahead?
Gabi Seligsohn - President & CEO
Yes, Operator, thank you; and thank you, everyone for joining today's call. As you know, we are in the midst of a downturn in our entire industry and while we are certainly not immune to it, we are pleased that our performance is relatively better than of others.
Our belief and strategy is that we can capitalize on this low business period by further developing our products and driving growth of our market share through continued penetrations into more customers which we believe will turn into repeat orders when industry conditions improve. In today's call, we will share with you elements of our plan to position ourselves during this period.
Now, turning to the quarter; looking at Q2 of 2008, it was clearly another tough quarter for our industry and for our Company. With more than half of the year gone by, it is clear that the semiconductor capital equipment sector is strongly affected by the global economic conditions. Needless to say, this is amplified by the significant reliance on CapEx by memory manufacturers who last year represented close to 60% of overall capital expenditure, and this year are expected to show an aggregate decline of over 30%.
With most of our sales coming from the capacity-driven integrated metrology sector, our revenues have declined further to a level of $11.1 million. Having said that, we are pleased to maintain gross margins at levels that are close to 40%; as well as show a very minimal loss from operations of $0.5 million on a non-GAAP basis.
On top of that, we ended the quarter with a strong cash position of $21.5 million, having added $1.6 million in the quarter. Several factors contributed to this relatively good performance; an improvement in product gross margins, an improvement in service gross margins, and cost control measures taken over the last several quarters.
On a GAAP basis, net loss amounted to $1.3 million. As mentioned in last quarter's conference call, we took the last and final impairment charge of $0.6 million related to the HyperNex acquisition. Also during the second quarter, we received final acceptance of stand-alone optical CD systems from two different fabs in the Asia Pacific region. On top of that, we placed two additional stand-alone optical CD evaluation systems in Asia Pacific and Japan regions.
On the Product side, we have also seen significant progress. During SEMICON West last month, we announced a new stand-alone product called the Nova T500. I am pleased to report that the announcement generated several positive responses from our customers, as well as the professional press. It seems that our focus on providing a leading-edge stand-alone metrology tool with breakthrough throughput and productivity, as well as exceptional tool-matching capabilities, supports the strategy of our customers going forward.
It is no secret that productivity is key to our customers. And with the advent of mega-fabs running well over 200,000 wafers per month, the ability to have a very reliable and extremely fast measurement tool which allows high sampling rates needed for tighter process control provides our customers the capabilities they need. Having met several of our customers' executives at SEMICON, I was encouraged by their enthusiasm with our approach.
As I have previously noted on several occasions, we believe OCD technology is one of the most promising techniques currently being proliferated into the process control segment of semiconductor manufacturing. Through our activities with several market-leading customers, we continuously find more useful applications and uses for this technology.
The expectation that optical CD technology will provide a useful alternative to CD-SEM and traditional thin film measurement is now becoming a reality. Having performed this strategic process in the last few months in which our management team carefully analyzed our product portfolio and trajectories for the future, and having collected inputs from several customers as to their expectations for our future and that of our technology, we have come to several key conclusions.
I'd like to take this opportunity and update you on several of our findings. One, customers would like to extend the use of optical CD technology into more areas in the fab. Two, our customers would like to develop more advanced process control schemes based on optical CD. Three, customers believe optical CD technology offers better cost of ownership, precision and accuracy than CD-SEM in many applications. They would all like to alter the ratio of CD-SEM versus optical CD in favor of optical CD.
But very importantly, to do so, our customers need the technology offered by us and our competitors to further mature. The most fundamental improvement needed to allow this to happen, is in the area of ease of use and cycle time to solution. It is our belief that we have the technology needed to solve this issue.
Given our success so far in penetrating the stand-alone optical CD market and the interest our current and new products have generated, we would like to further invest and improve our offering in key areas. To do so, we plan on extending our product development and penetration efforts. We believe that by relying on our strong balance sheet and good market position, we are able to increase our efforts and investments in R&D with a view to coming out of this downturn with the most technologically-advanced product offering and better positioned to gain market share.
We intend to accomplish this by hiring experts in the relevant areas and by introducing more evaluation units into the field in the very near future. The overall cost of this program is estimated at up to about $1 million per quarter for the next four to six quarters.
Our many years of experience in the semiconductor industry clearly demonstrate that the best time for introduction and testing of new technology is during the periodical downturns.
In our last quarterly conference call, we updated on the implementation of a flexible service business model which would better cater to our different customer needs and allow us to improve on our service business results. I am glad to report that we are already seeing a positive response from our customers as evidenced by an increase of close to 15% in service revenues in Q2 versus Q1 of 2008, and a significant improvement of service gross margin during the same period, on which Dror will further elaborate.
Now, I will turn to an outlook of the industry. Reviewing our industry fundamentals and looking at the results of our peers as well as those of our competitors, it is clear that the semi-cap space is taking a hard blow this year. Previous expectations that the second half of 2008 will be stronger than the first half now seem less likely than before, given the recent announcements by major players in the memory market, showing both losses as well as high level of inventories; putting them in an unfavorable position to increase spending.
However, living in a cyclical industry, we have been through this many times before and the bottom of this particular cycle does not look that much different from any other. Having said that, this time we have a strong cash position, we are hovering around the breakeven point, and we have the R&D organization to really take advantage of improving our product portfolio in time for the next upturn.
Finally, as has happened in all previous cyclical downturns, the recovery will come. As always, our industry is driven by killer applications coming and going. Our expectation is that the next one in the memory space is slated to be the move to solid-state drives which will replace less efficient magnetic-head hard drives in laptop computers.
For now, the price of SSDs is still prohibitive. It adds about $1,000 to the cost of a laptop. It is no secret that major flash manufacturers have programs in this area and it is expected that by year-end of 2009, their falling price will make them available on a large scale. With that in mind, we believe that an increase in equipment orders should take place at the end of this year or the beginning of the next.
In the foundries and independent device manufacturers, we still see high levels of utilization at the high end. Though manufacturers are dragging their feet on further capital investment, we believe they will have to return to investment sometime in the next couple of quarters.
So in summary, reviewing our customer list, it is clear that we are very well-positioned to capture business when things improve. Through this downturn, we have maintained our market position in integrated metrology and are continuously strengthening our position in the stand-alone area. Our strong balance sheet and well-managed business operation allow us to take a sensible action and selectively increase our investments in product development and penetration efforts to ensure that we continue to grow our share in the growing segment of stand-alone optical CD.
With that, I would like to turn it over to Dror to provide more insight into the numbers. Dror?
Dror David - CFO
Thanks, Gabi; and hi, everybody and welcome to our quarterly conference call. As Gabi mentioned, we have continued to experience a slowing industry environment in the second quarter of '08. This environment resulted in 13% reduction in revenues relative to the previous quarter, to approximately $11 million, with most of the reduction resulting from lower demand for our integrated metrology products.
In the previous con calls, we reported that we have moved into '08 with a relatively high backlog in evaluation orders in the stand-alone segment. We also reported that the 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.
During the last quarter, we received two more customer acceptances for tools from this backlog and we expect to receive an additional acceptance in the coming months. Because of the spread of revenue recognition from these tools, these acceptances were not evident in Q2 revenues, but will support our reported revenues from stand-alone product in the coming quarters.
In the integrated metrology segment, we have witnessed a 5% improvement in average selling prices related to new capabilities introduction and direct sales of integrated metrology. This improvement also helped to support our gross margins and net results in the quarter.
Sales by territories in the quarter are slightly shifted from Europe towards Asia Pacific as follows; US accounted for 21%, Europe 1%, Asia Pacific 67% and Japan 11%.
Service revenues were at $3.6 million in the second quarter of '08, higher than the previous quarter where we reported revenues of $3.2 million.
Looking into our gross margin performance, blended gross margins in the quarter slightly declined to 39%, mainly due to the decrease in product revenues. Product gross margin remained stable at 53%, despite the quarterly reduction in product revenues and were supported by our ongoing cost control measures as well as the increased average selling prices of our products. In the services gross margin, we saw an improvement from 1% to 10%, mainly due to the increase in service revenues.
Operating expenses in the second quarter, excluding a one-time non-cash impairment charge, decreased to $5 million, a 5% decline relative to the previous quarter and a 17% decline relative to the second quarter of '07. This decrease reflects our ongoing cost control initiative throughout '07 and in the first half of '08; as well as the effectiveness of our currency hedging activities.
In the previous conference call, we reported a headcount reduction and the closure of the X-ray activities which took place at the beginning of the second quarter. This move was aimed to improve the cost effectiveness of our existing operations. The current quarter includes costs related to this move and we expect the full effect of these reductions to be evidenced starting the third quarter of '08.
The enhanced program for investments in R&D and marketing, which was described by Gabi, was well synchronized with this cost effectiveness improvement and will start offsetting the cost reductions mainly in the fourth quarter of '08.
On the net result, the Company reported a $0.5 million non-GAAP loss, resulting from the slowdown in our industry and related reduction in product revenues.
Cash-flow-wise, the Company presented positive cash flow from operating activities of $1.6 million for the quarter. This positive cash flow resulted from our effective working capital management as evident in the reduction in the Company's accounts receivable levels.
In addition, this positive cash flow relates to the spread revenues of stand-alone sales where the cash flow from collection precedes the timing of recognition of revenues.
Before concluding, just a quick update on the Company's $1.7 million investment in auction rate securities; during the quarter, no adjustments were made to our ARS investments as the bids did not change quarter over quarter. These auction rate securities are rated A and above and pay competitive monthly interest rates. However, following the quarter end, the auction rates faced some deterioration in bid value related to the conditions in the financial markets. We continue to closely monitor the developments of these securities.
Overall, our strong balance sheet and cash position with over $21 million in cash reserves and over $23 million in working capital; together with our ongoing cost controls, will enable us to continue and accelerate the execution of our business and financial plan for the coming quarters. Gabi?
Gabi Seligsohn - President & CEO
Thank you, Dror. And with that, Operator, we'd be happy to take some questions.
Operator
Thank you. (OPERATOR INSTRUCTIONS)
The first question is from Neil Goldman of Goldman Capital Management. Please go ahead.
Neil Goldman - Analyst
Good afternoon guys, I guess; right?
Gabi Seligsohn - President & CEO
Hi Neil.
Neil Goldman - Analyst
You're sitting with cash per share of $1.11 based on the $21.5 and your shares outstanding, which puts a total enterprise value on the business of like $4 million, right? I guess what a year and a half ago you licensed some technology for like $20 million or $10 million. What was that?
Gabi Seligsohn - President & CEO
License technology for $10 million?
Dror David - CFO
No, it was approximately $1 million.
Neil Goldman - Analyst
Okay. Obviously there are some underlying patents that have a value far in excess of the enterprise value, separate from the core business. Are we close to any sort of licensing deals or --?
Gabi Seligsohn - President & CEO
As previously commented on, in this area Neil; there are active discussions. The nature of these discussions are that they take many, many months for people to assess; not just the validity of the IP, but also what position they want to take. So I can report that there are continuing to be a few active discussions, but I can't report any specific progress on that.
Neil Goldman - Analyst
Okay. Do we an ability to buy back stock at these values?
Gabi Seligsohn - President & CEO
Ability as in --?
Neil Goldman - Analyst
Given the tax laws in Israel, can we buy back stock in the open market and shrink the cap, given that we're paying nothing for the business at this point?
Dror David - CFO
Well in general, there is a legal possibility to do a buyback; however, it depends on some complicated process and is mainly for companies who have accumulated profits during the two years before the buyback. So generally we can, but it's a more complicated process for Israeli companies than in the US.
Neil Goldman - Analyst
Okay. I mean I was just -- I'm not saying -- obviously you have some R&D projects and the bulk of cash will be used for future growth; but I would urge at this point to do some sort of buyback for a couple of million dollars; because the valuation makes no economic sense at all. So, I'd urge you to consider it. Thank you.
Gabi Seligsohn - President & CEO
We understand. Thank you.
Operator
The next question is from Robert Katz of Senvest Capital. Please go ahead. Robert?
Robert Katz - Analayst
Hi Gabi and Dror.
Gabi Seligsohn - President & CEO
Hi Robert, how are you?
Robert Katz - Analayst
Good. I guess you're navigating the downturn pretty well. When do you think we will see more uptake in the stand-alone and more predictability in that part of the business?
Gabi Seligsohn - President & CEO
I think that's a good question. What I've been focusing everyone's attention on has been penetration, as you know. And I think right now what we feel is that the -- first of all, in all cases where we've penetrated apart from the ones that are very new from the last quarter obviously, we've not only seen orders but also repeat orders. What we're looking for obviously, as are you, is something much more significant as far as the number of tools that a successful penetration yields.
I believe that we should be able to see things like that starting to materialize hopefully in the near future. It obviously depends on the investment cycle and I think the key focus right now is to make sure that we're the process tool of record in each of those fabs that we work in, such that when capital is released, it's released in our favor and not in favor of our competitors.
So to make it predictable, I think what would really help obviously is the change, the needle changing in the right direction as far as the industry. And hopefully that will start pretty soon, if things turn around. But I think for the most part, the key thing is to be selected and as a result of it, to see the repeat orders coming from it.
We plan to close 2008 with presence in no less than 10 customers, which I think is a huge step ahead for us actually, as far as achieving market presence.
Robert Katz - Analayst
That's for the stand-alone -- for the stand-alone, 10 customers?
Gabi Seligsohn - President & CEO
Correct. And if you remember, we finished last year with a lot less than that, so I think for you and for the rest of the investors; I think one of the most important things is to track progress from the direction of successful penetration. And I have to say, and I'm proud to say that our success rate so far in each evaluation has been 100%, which I'm very proud of and it of course requires a lot of very hard work of the entire team.
But I think an indication of where the Company is headed should be probably derived from how successful the penetrations are.
Robert Katz - Analayst
Okay. The integrated part of the business is tied more towards capacity expansion and through your OEM partners. Is there an argument that the stand-alone might be driven more just by a technology buy, not necessarily always a capacity buy?
Gabi Seligsohn - President & CEO
I'd say that to explain -- first of all, I generally agree that that is the case. I think the way I would put it though is that when a technology buy takes place; meaning a fab is testing out 45-nanometer or 32-nanometer technology, what they will do at the early phase is buy one or two stand-alone tools. What you want to do at that phase is get designed into the process and then see the follow-on orders.
So you could say, and I think it is the case that you can continue to see some stand-alone orders during a downturn; but you won't see very large-scale ones because the capacity-driven ones obviously don't exist at that period of time. But the technology-based ones do and that's why I mentioned in my summary of the quarter how important it is to utilize the downturn to make these penetrations right now; because customers now do two things.
One is; they're busy pushing for the next technology node for the same reason that every technology company does that; basically get ready for the next wave. And number two; they're spending very, very carefully in order to facilitate the process of inducing new technology coming into the fab.
So for us, obviously, it's a great opportunity. They're open-eared, they're open-minded at that point in time and they are stressed financially like everyone else; but they're more open to trying out things and that's what you want to do during these periods.
Robert Katz - Analayst
Who are you taking market share from? Who do you compete against for these new stand-alone opportunities?
Gabi Seligsohn - President & CEO
We compete against KLA Tencor and Nanometrics and to some extent also with Rudolph. And I think for the most part we run into KLA Tencor.
Robert Katz - Analayst
Okay. And that's long been their story is that even in a downturn, companies invest in technology node migration and there's demand throughout the cycle.
Gabi Seligsohn - President & CEO
Yes, I think that's correct. I think they obviously enjoy a lot more scale and diversity of product than we do. But that is the reality and I'm humble enough to say that.
Robert Katz - Analayst
Okay. Well, good luck with the stand-alone and hopefully the downturn doesn't last too long.
Gabi Seligsohn - President & CEO
Thank you Robert.
Robert Katz - Analayst
Thanks.
Operator
(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 on Nova's website www.nova.co.il. Mr. Seligsohn, would you like to make your concluding statement?
Gabi Seligsohn - President & CEO
Yes I would, Operator. Again, just to reiterate, I think as everyone, we are going through a difficult period right now. But I'm very happy to see how the operation is running during this period and the technology seems to be very, very capable and promising and I think we have a lot of it to leverage going into the future.
I thank you all for attending the call today and hope to see you in the next call. Thank you.
Operator
Thank you. This concludes the Nova Measuring Instruments Second Quarter 2008 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.