Nova Ltd (NVMI) 2013 Q2 法說會逐字稿

I would like to welcome all of you to Nova Measuring Instrument's 2013 second quarter results conference call and presentation, and thank management for hosting this call.

With us on the line today are Mr. Gabi Seligsohn, President and Chief Executive Officer; Mr. Eitan Oppenhaim, President and Chief Executive Officer Elect; Mr. Dror David, Chief Financial Officer.

I'd like to draw your attention to the presentation that accompanies today's call.

The presentation can be accessed and downloaded from a link on Nova's website at www.novameasuring.com.

Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements.

And the Safe Harbor Statement outlined in today's earnings release also pertains to this call.

If you have not received a copy of the release, please view it in Investor Relations or News section of the Company's website at www.novameasuring.com.

I will now hand over the call to Mr. Gabi Seligsohn, Nova's President and CEO.

Gabi, go ahead, please.

Thank you, operator.

Hello, everyone, and welcome to our second quarter of 2013 earnings conference call.

I will start today's call with some personal remarks and then describe the second quarter's business results.

I will turn it over to Dror for a closer look at the numbers, and finally Eitan will review the current situation in the industry and provide an outlook for the third quarter.

Today will mark my final conference call as President and CEO of Nova.

It is an exciting moment for me to sit here today and sign off after 15 years at a great Company.

I take enormous pride in our many achievements over the last seven years while I was privileged to lead this Company.

During these years, we went from being a single product, non-profitable Company to becoming a multiproduct, leading edge, and highly profitable solution provider.

We went from having very limited exposure to one area of the fab to wide scale adoption of our products across multiple steps of semiconductor manufacturing.

Today most of the industry leaders are our customers and rely on us to support their current and long term technology needs.

We have become a global Company with close to 400 employees spanning 10 offices around the world offering leading edge technology.

We defined an ambitious vision, and together we have been executing to that vision day by day.

It is my belief that I am handing over the leadership of the Company at an excellent inflection point.

The foundry sector is going through a broad based ramp up, which I believe will span through 2014.

Having become process tool of record at all leading foundries, I believe Nova now has the opportunity to expand and serve the addressable market with these customers.

I believe we have the products, the infrastructure, the aggressive roadmap, and the customer relationships needed in order to continue to outgrow the industry and become an even larger player in the process control market.

Eitan is inheriting a great management team and a great global team, and I wish the whole team great success in the future.

I would like to take this opportunity and thank our customers for their trust in Nova as their technology partner.

We are privileged to have them as our partners, and I am sure that under Eitan's leadership we will further deepen that partnership.

Let me also add my personal appreciation for the support and the vote of confidence that you, our shareholders, have given us.

It is a vote which we do not take lightly, and we feel privileged to be burdened by it.

Finally, I would like to add that I am confident that Nova's greatest days are still ahead of it.

Now let me provide some more details on our achievements during the second quarter.

The second quarter's business activities were a combination of existing installed base upgrades and qualifications of our latest models for 20 nanometer pilot lines as well as shipments for 16 and 14 nanometer development.

On the upgrade front, we received a significant order of software to support the transition of an existing fleet of tools to optical CD measurements.

We believe this transition will continue in cases where our customers would like to extend the use of production tools to technology nodes of below 20 nanometers whereby measurement complexity increases, requiring more advanced measurement schemes.

As mentioned in today's press release, several of our customers are busy preparing production lines for 20 nanometers and developing 16 and 14 nanometer processes.

Accordingly, many of our activities during the second quarter included installation of our flagship standalone and integrated metrology tools, the Nova T600 and the Nova i500.

Both have been selected as process tools of record at multiple customer sites for multiple process steps.

On the service front, we continued to see an increased level of revenues, which in Q2 reached a record high of $5.7 million.

Service gross margin was also relatively high, as the proportion of software upgrade revenues was higher than normal.

On the product front, we recently announced the introduction of the NovaMARS version 6.0, which represents a breakthrough in time to solution and ease of use.

Initial feedback from our customers to this new version is excellent, and we fully expect to have a strong contribution to our competitive position.

Finally, during the second quarter we secured acceptance of another V2600 for 3D interconnect.

Now let me turn it over to Dror for a closer look at the numbers.

Dror?

Thanks, Gabi.

Good afternoon to everyone and welcome to Nova's quarterly conference call.

Total revenues in the quarter were $28.1 million, at the upper end of the second quarter guidance, representing 3% increase quarter-over-quarter.

Product revenues were stable quarter-over-quarter, while service revenues increased to a record level of $5.7 million and included sales of software licenses for the existing installed base.

Product bookings distribution in the quarter was approximately 85% from the foundry segment and approximately 15% from the memory segment.

On a regional basis, 55% of the bookings in the second quarter came from Asia-Pacific, 36% from Europe, and 9% from the US.

The product mix in the second quarter was different than the previous quarter, resulting in product gross margin of 58%, 1% lower than the previous quarter, on the same product revenue base.

On the other hand, service revenues increased to record levels and included software licenses sales resulting in high services gross margins of 40%.

All these elements together accounted for a 1% improvement in blended gross margins, which came in at the very healthy level of 55% in the second quarter of 2013.

It is important to note that quarterly blended gross margin tends to fluctuate based on a few factors.

These factors include and are related to the overall revenue levels, the percentage of service revenues, and the proportion of software sales and new products.

As you know, new products are shipping at relatively low volumes, which initially do not enable us to take full advantage of cost reduction measures.

Thus, a larger proportion of new products in the mix mean a lower blended gross margin, and this can vary from quarter-to-quarter.

These fluctuations are an indication that our new products are being accepted by the customers, which in turn leads to improvement in our market position.

In addition, software sales tend to be lumpy as they depend on the way customers are using our systems and the pace at which they upgrade existing installed base to include high-end software capabilities.

Looking forward into the rest of 2013, we expect to continue to see fluctuations in gross margins based on the parameters I mentioned.

Our model for the third quarter assumes blended gross margin of around 51% due to our expectations of a less favorable product mix in that quarter.

Our reported operating expenses increased to $12 million in the second quarter, but included the impact of one-time items related to insurance proceeds on equipment damage and to employee retirement costs.

Ongoing operating expenses in the quarter were $12.2 million, an increase of $0.5 million relative to the previous quarter.

And all of this increase was in R&D expenses.

As previous communicated, this high level of R&D expenses is aimed to ensure that we deliver on our roadmap according to the pace by which our customers are implementing advanced technology nodes.

We believe the timing of these investments is important to maintaining our role as a key technology partner to our customers.

In 2013, our R&D plans include intake of prototypes related to the development of several new products, yet the exact delivery timing of these prototypes can vary based on the project timeline and milestones.

As a result, we are seeing fluctuations in R&D expenditures from quarter-to-quarter.

Specifically, in the third quarter of 2013 we expect R&D expenses to be lower than the second quarter, and we expect total ongoing operating expenses to be between $11 million and $11.5 million.

Tax expenses in the second quarter of 2013 were $0.8 million, and included mainly conversion of deferred tax assets created in 2012.

GAAP net income in the quarter was $2.8 million, or $0.10 per diluted share, based on a share count of 27.4 million shares.

Non-GAAP net income in the quarter was $3.8 million, or $0.14 per diluted share.

These results were $0.03 better than the high end of our guidance, mainly due to favorable revenue mix which positively impacted gross profit and net income.

Operating cash flow in the quarter was $3.5 million.

Moving into balance sheet key metrics, accounts receivables increased slightly to $19.7 million with DSOs at around 60 days.

During the third quarter of the year, we are starting a penetration phase into next technology nodes at several existing customers.

These customers are experiencing relatively high capital intensity.

And as a result, we were requested by these customers to extend their regular payment terms.

Obviously, our strong cash position enabled us to support that.

Hence, we agreed to do so in parallel to being selected as tool of record for the relevant technology nodes.

As a result, we expect DSOs to increase in the third quarter of the year to a level of approximately 70 days.

Inventories decreased by $0.6 million during the quarter, with inventory turns increasing to 3.1 times a year.

Gross capital investments were $1.2 million in the quarter, and depreciation came in at $0.9 million.

I will conclude with cash reserves, which increased to approximately $98 million at the end of the second quarter and provide the Company with the required flexibility to support the industry roadmap, the customers' ramp up needs, as well as to exploit business development opportunities.

Eitan?

Thank you, Dror.

Let me add my welcome to everyone on the call.

My part will include some market overview related to Nova's positions, our Q3 business objectives, and finally Q3 guidance.

I'll start with the markets.

The 28 nanometer ramp up in foundries, which we have been discussing in the last few quarters, is currently taking place across a broad base of foundry customers.

The struggle between different foundries to supply the 28 nanometer market demand has accelerated the technical maturity of these customers in providing 28 nanometer wafer, and has also triggered a faster transition to advanced technology nodes below 28 nanometer.

We expect to see additional orders for this ramp up in the second half of 2013.

While ramping up the 28 nanometer line, our largest customer also completed a total qualification process for its 20 nanometer technology nodes.

Systems were shipped for a pilot line that was established to accommodate the strong expected ramp up.

We expect additional shipment of our standard or nonintegrated system for this pilot line in the next few months before the production ramp, which is currently planned to begin at the end of the year or possibly Q1 2014.

At the same time, our main foundry customers are deeply engaged in the development phase of their FinFET gates for 16 and 14 nanometer.

Their expectation for ramp in 2015, along with some customers' demand, accelerated the development phase whereby we have started to see some initial tool shipments for R&D lines in those technology nodes.

Nova is well positioned with these customers with both its standalone and integrated metrology tools for multiple critical process steps for the advanced 3D gate structures.

The combination of advanced 3D structures along with advanced patterning solution, as well as actual shrinkage and unique material usage, require additional process steps that represent an increasing opportunity of around 15% to 20% growth in metrology demand when moving between tech nodes below 28 nanometers.

These numbers represent for us a potential total available market growth in foundries when advancing between technology nodes below 28 nanometer.

The foundries' aggressive roadmap demands another development cycle -- sorry, a shorter development cycle from R&D to production for any advanced node from three years to almost two years.

Additionally, during a period of 12 months, the leading foundries are expected to ramp two major nodes while developing a third one.

This aggressive roadmap also impacts on our plans where we have accelerated our development and lead time as well in order to accommodate both the production and R&D lines.

As a result of accelerating our plans, we are able to supply systems to a number of advanced nodes at the same time.

The acceleration of the roadmap plans as well as the transition to 3D FinFET structures requires extensive effort from our side as well to deliver an advanced modeling software.

We will also enhance development of our hybrid metrology solutions to accommodate the increasing number of measured parameters in a number of process steps, both in customers' R&D and production environments.

Additionally, ramp ups of such magnitude require better control over the metrology fleet, and we are starting to see demand for our fleet management software for improved tool matching and recipe managements.

Overall, the foundry sectors continue to be positive in the long run with relatively high capital intensity.

According to the latest development information, most notably from TSMC, we may see some order softness in the next few months until the start of the next ramp up cycle of 20 nanometer.

But, overall the trend we see is positive and strong going forward.

Nova is well positioned in this segment.

And along with the industry projected growth in 2014, we expect continuous demand for our tool in the next quarter to come.

We are well prepared with our product portfolio and design win for the expected 20 nanometer and 1X ramp up once it happens.

On the memory front, we have started to see some positive indications both in the DRAM and Flash segments.

While it's not yet translated to a sustainable investment cycle, we do see some incremental Flash memory expansion and transitions by the major players.

All of us are aware of the Samsung Xian fab as well as Toshiba Yokkaichi expansion, but we see some indications also from the others.

These customers are still trying to accelerate their VNAND development, and we may see some progress with that in the next month, though we believe it will be initial stages only where the full production is still two years ahead.

With these expansions ahead, and in order to accelerate the VNAND development, we do see major investments in the next several quarters in etch tools and CVD tools to accommodate the unique development requirement for this technology.

On the DRAM front, we believe that the current mobile DRAM and the DDR price scheme, as well as some signs of supply insufficiency, will trigger some capacity investment, which will probably take place mainly in 2014.

Both in foundry and memory, the transition to 3D and FinFET structure in advanced tech nodes in 2X and below, as well as the shrinkage in DRAM below 3X, increase the process control and optical metrology intensity.

Nova is well positioned to enjoy this transition and expansion.

With this positive market atmosphere, let me now provide some outlook about our major planned activity in the second half.

Although we expect orders from the industry leading foundry to continue to be soft in the coming quarter, we already experienced some order pickup from the other foundries for the 28 nanometers ramp.

These customers are under pressure to increase their 28 nanometer capacity and become a real alternative supplier for this technology node.

And by that, we continue seeing standalone and integrated metrology tools orders for these customers in the second half of the year.

In addition to the 28 nanometer continued ramp up in Q3, we will continue to deliver tools to the 20 nanometer pilot lines in order to be prepared for the extensive ramp up later this year or at the beginning of next year.

During the qualification progress that took place in the last few months, both our standalone and integrated metrology tool were certified for multiple process steps in the 20 nanometer tech nodes, and we are well prepared to ship significant amounts of tools once the ramp will start.

Additionally, we will start shipping our IM tools for 16 and 14 nanometer R&D lines for the FinFET development with the major foundry customers.

These tools will be shipped with our latest modeling software tool to allow extensive 3D development in R&D environments.

As mentioned before, on the memory front we are seeing signs of possible pick up in the demand.

We expect some orders later this year from a fab build out by one of our major memory customers.

We also expect some orders from capacity addition with a few other customers.

Although these projects are not large in size, we see these developments as positive, which can help to weight some foundry softness if it will occur later this year.

During Q3, we will continue our efforts to keep penetrating the growing 3D interconnect market where we are working on gaining acceptance for our fourth tool.

On our development front, we will continue our product portfolio diversification efforts with continued penetration of our software solutions.

Both our hybrid metrology solution as well as our integrated process control solutions are in advanced evaluation stages with major customers.

And we expect to finalize these evaluations by the end of the year.

We also expect to continue and see some additional upgrades and software retrofit opportunities as we saw in Q2 for our existing installed base.

Finally, reflecting on our H1 revenues and the strong financial performance we have demonstrated for the last six months, we are showing a 10% year-over-year increase in our revenues in comparison with H1 2012.

With that in mind, we believe we are well on our way to exceeding industry performance for a fifth consecutive year.

With that, I will move to the guidance.

Now let me turn to our guidance.

For the third quarter of 2013, we expect revenues of $24 million to $27 million with GAAP diluted earnings per share of $0.03 to $0.08.

On a non-GAAP basis, which excludes adjustment of deferred income tax, assets, and stock-based compensation expenses, we expect diluted earnings per share of $0.06 to $0.12 for the third quarter of 2013.

And with that we will be pleased to take your questions.

Thank you, sir.

(Operator instructions.) Edwin Mok from Needham & Company.

Hi.

Thanks for taking my question.

And Gabi, good luck with your next endeavor and thank you for your support all these years.

Thank you very much, Edwin.

And that you for your support of the story over the years as well.

Appreciate it.

Thanks.

So, Eitan, I guess my first question is on the guidance, right?

I'm trying to understand, if I listened to you correctly, it sounds like there's a few projects, one from your largest foundry customer, as well as maybe a memory project that you believe you guys have some position in.

And therefore, beyond the third quarter, business should remain pretty robust in the fourth quarter.

Am I reading that correctly?

I think that -- I don't think that we give any guidance beyond this quarter.

And we're guiding right now Q3 only.

So, the result that we have right now and we guided is for Q3.

We don't have right now good visibility on the timing of the 20 nanometer ramp in foundry, which may happen in Q4 or beginning of 2014.

And also, we don't have good visibility on the memory expansion level that will happen in Q4.

So, right now the guidance that we are giving is for Q3 only for the $24 million to $27 million.

I see.

So, it's fair to say that those projects, it's not 100% set in stone they will start in the fourth quarter.

But, if they do, then obviously 4Q will be a good quarter.

I think maybe that's --.

If we're looking at the environment going through 2014, we look -- we see a very strong market both in the foundry and a very good pick up in the memory.

So, overall, going into 2014, it's a very good environment.

The caution that we are taking for Q4 is due to the reason that we don't know exactly the timing of the start of those two major projects, either in the end of Q4 or beginning of Q1 2014.

Can I ask you a kind of more material question?

Is it possible that a customer would start some -- to the installation of those projects, but because of where you guys are positioned in those customers relative to the installation, that your equipment might not -- you just -- the customer just doesn't need your equipment until maybe later part of that build up?

Is it possible that that kind of scenario could play out?

So, let me start maybe with -- let's talk about the 20 nanometer project, for example, in TSMC and then we'll talk a little bit about the 16 and the 14.

With TSMC doing a project like that for 20 nanometer, actually they started something like one year ago.

So, we started shipping systems for R&D lines one year ago.

And we keep shipping systems in Q1 and also Q2, an increasing number of systems where we -- in the beginning, we shipped for R&D lines.

Later on we shipped for a pilot line.

And currently what we see with this customer, which actually is increasing the ramp on the pilot line, in order to be ready for the -- to the massive ramp.

So, we are going to see more and more tools for 20 nanometers even for pilot lines in Q3.

I see.

Okay, actually that's extremely helpful.

And then, second question, I guess, and another question I have is one of your pretty large customers who has -- his work has a very low market share in the foundry area has kind of talked about that they won some positions in both standalone and integrated metrology.

Sounds like more than one foundry, right?

Are you seeing them making inroads into your foundry segment?

And do you see that as a competitive risk for you guys?

Let me share with you our position in Global Foundry.

Actually, we are BKM PTOR in Global Foundry for multi process steps including etch from the beginning of the ramp both in New York and in Dresden.

And we keep seeing orders coming in for 28 nanometers as well as 20 nanometers and 40 nanometers these days for those fabs in Dresden and New York.

The question was on Global Foundry, correct?

Yes.

Well, just in the foundry segment in general, right?

So, it sounds like they have made penetration beyond that one customer, right?

Also, your largest customers is also there.

So, we are looking right now, we are well positioned in TSMC and in Global Foundry and, by the way, in UMC and SMIC and the other foundries, in all the ramp of the 28 nanometers.

And we are actually positioned very well in Global Foundry and in TSMC, well in all those processes in the last one year.

So, I won't refer specifically to my competitors, but I can tell you that, in order to be ready for a ramp that is going to take in Q4, you probably had to ship systems a long time ago.

And we didn't see it.

I see.

Great.

That's helpful color there.

One question on the 3D interconnect product.

I think you mentioned that you guys are working towards the fourth acceptance.

So, I presume the first two got accepted and therefore you guys recognized revenue in the second quarter.

And in terms of beyond the fourth acceptance, how do you kind of think about kind of position or penetration of that too?

So, I'll answer regarding the acceptances of the existing orders.

So, we practically started recognition of revenues from this product line in Q4 2012.

And in each of the quarters, Q1 and Q2, we had one or two systems, probably one system in Q1 and one or two systems in Q2.

And we expect to recognize the fourth tool in the third quarter of 2013.

I see.

Okay.

Now, let me add on that one.

If you're looking on the future projection of those tools, we'll average a lot.

The fourth system has already been accepted.

And during the next two quarters, we have other customers that part of them will start demo and evaluation.

And I hope that we'll have much more news by the end of the year with a few customers more.

I see.

Great.

One question I have on -- kind of on revenue recognition, right?

So, I think we talked about some of these are new products and therefore you have some deferred revenue which results in kind of lower margin or expected lower product margin, especially in the coming quarter, right?

Is this a phenomenon that you guys expect to continue to go on for the next few quarters?

Because it seems like, beyond just your core [OCD] product, you also have some software products and some -- and this 3D interconnect may penetrate new customers.

So, are we looking at this kind of deferred revenue effect on gross margin drag out maybe for a few more quarters before we start to see the benefit of these new products coming -- supporting gross margin?

Yes, that's a good question.

I think it's very important to emphasize that the way to look at it is over a few quarters or a year.

And as you can see, the gross margin -- the blended gross margin in the first half of the year was quite robust.

It was 54%.

Definitely on a quarterly basis, we do see fluctuations in gross margin.

So, if you look at our target model of between 52% and 55% for gross margins, we definitely aim to be within this range on an average basis.

In specific quarters where, in that specific quarter, we see higher portion of new products which at the penetration phase embeds maybe higher cost because you cannot utilize volumes for cost reductions -- and also there are several costs related to the penetration phase.

In these specific quarters, you would see a reduction in gross margins in that quarter.

And as I mentioned before, we do expect that to happen in the third quarter.

But, then again, gross margin would be around 51%, which is very close to our model.

And looking forward, we do expect, on an average basis, to be within the target model.

I see.

Okay, last question and then I'll go away.

On the software product, it seems like you guys have developed several products there.

I think in the prepared remarks you guys mentioned that some of them is already getting qualified, for example at your largest customer, right?

How do you kind of think about the actual revenue impact of those products?

Is it going to be -- are we going to -- should we expect to see some of those revenue benefits and probably margin benefits as well on those products starting to come in in even early 2014, or is it more longer term?

Can you give us some kind of timeframe or way of thinking about that?

So, looking right now at our product portfolio, and as we discussed in the last few months, we would like very much to diversify the portfolio to have more software products.

And when you're looking on the software products, actually it has a few directions.

One is the modeling software itself and the licenses that we can actually gain from retrofitting an installed base.

This is actually revenue we started to see in the last two quarters.

We had a press release about it, and we are starting to sell more and more licenses on the installed base.

So, this is one direction.

The second direction is what we call the fleet management, what I referred to in my notes regarding the large fleet.

So, if we will do the ramp of 20 nanometer, that will require tens of systems.

We developed a tool -- a software tool that can actually manage all the fleet in one place through a software.

And this one has been shipped already and it's been evaluated.

And we expect it to be accepted by the end of the year, so we might see revenue in Q4 or might see revenue by Q1.

It will be on the border between Q4 and Q1 2014.

The third direction is the standalone software product that we discussed along in the last few months.

One of them is the hybrid.

It already is installed and working in production in a very large customer.

And we finalized the acceptance, so probably we'll see revenue still this year.

And in this level also, we have what we call the integrated process control that we are right now doing evaluation with one of the OEMs in one of the biggest customers that we have.

This one might take longer, but definitely we are processing very well and will start to see some revenue at the beginning of next year.

Great.

That's helpful color.

Thank you.

Thanks, Edwin.

Patrick Ho of Stifel Nicolaus.

Thank you very much.

And I know it's been only a short period of time, but first off, Gabi, I want to personally congratulate you on the work you've done at Nova.

And I think the accomplishments and where the Company's at today is a reflection of the great job you've done.

So, congratulations again and best wishes on whatever your next endeavor will be.

Thanks a lot, Patrick.

I truly appreciate that.

Eitan, good luck to you as well going forward.

And this question is for you.

In terms of the business outlook, I think you gave a really good color in terms of how both the foundry and memory markets are shaping up for the second half of the year and into early 2014.

I guess without getting so granular, but can you give a little bit of color on how you think the mix between DRAM and NAND shapes up over the next couple of quarters?

Is there a bias towards one in terms of capacity buys where you're seeing that more in the DRAM side, or in terms of technology buys where you're seeing NAND moving to 3D structures?

What's the bias at this point?

Well, let me divide it into two.

I'll talk a little bit about the DRAM a bit.

If you're looking right now at the DRAM market, there are signs of recovery in the market that are coming from various elements.

First of all, as all of us see, the DDR3 and 4 prices and the mobile DRAM, the prices have held very nicely in the last few months, and actually with the very reasonable price of about $20 per chip, which got it back to a reasonable number to start thinking about expansion.

Beside that, as you know, the mobile DRAM and the servers are accounting right now for more than 50% to 60% of the overall DRAM capacity, which shows some transition to the mobile DRAM.

And also, we see some supply insufficiency that probably will create some kind of demand for expansion.

We have only three main players in this DRAM arena, and we know that one of them with Samsung has actually bought around 300 million chips from Hynix on existing capacity from Hynix, such a magnitude that accounts something like 15% of Hynix' capacity.

This one, together with this insufficiency of supply, will create some kind of demand in DRAM.

And I'm sure that we'll see in 2014 expansions in DRAM fabs, some of them in China and probably in Taiwan, and of course in Japan.

So, this is as I see the DRAM, and I think that it has a flavor of expansion.

If I'm looking right now on the Flash, NAND and VNAND, I think that, if we'll start right now with the VNAND, I think that the memory customer actually has four types of VNAND.

Each one of them has its own complexity when going down for 1X, 1Y, 1Z.

Some of them are easier to do.

Some of them are more complicated to do, but we see some progress that actually move and cross the technical barriers, at least on 24 layers.

And therefore, I think that we will see in the beginning of 2014 some expansion in NAND that later on will be converted to a VNAND, at least on the basic level.

But, as I said in my comments, I think that it will be only on a very low level where the high volume manufacturing will not start before 2015.

Great.

No, that's really helpful.

Maybe a second related question to the 3D NAND side of things.

What do you see your total available market opportunity growing between planar and the shift to 3D NAND?

What's the -- I guess the growth opportunity there for you guys specifically?

So, moving right now for 3D structure, actually both the FinFET and the VNAND creating increasing -- and process steps in all the steps, by the way.

It's a little bit more intense in the foundry, but it's also intense in the memory.

As a result, I think that we do see some increase in demand for etch tools and CVD tools.

What it creates to Nova, once you increase the steps -- the process steps and you increase the process steps in region where we are very strong in our standalone, which is etch, both backend and frontend, this will represent a very large opportunity for us.

Now, I said in my commentary that the intensity, once you move from a tech node to a tech node below 28, represents something like 15% to 20% increase in total available market.

I can assume that this is the number in memory as well.

Right.

Thanks again, guys.

Thanks, Patrick.

(Operator instructions.) David Wu from Indaba Research.

Yes.

I have a question about is there a uncertainty about how much production would TSMC be ramping on a 20 nanometer planar versus the 20 nanometer FinFET?

And has that resulted in soft orders until they sort out how much they really want for each with those two nodes for the second half of this year?

All right.

So, let me see if I understand the question right.

As we see right now, the big foundry or the little foundry, what they are doing right now is completing the ramp in 28 nanometer, which -- this is the regular planar.

Moving to 20 nanometer, it probably will be a regular planar, the same as 28 but shrinking the device.

According to the capacity that they are going to ramp, you know by the announcement that they have, it's going to be a regular mega fab like the 28.

But, we need to remember that later on in 2015 we start to see the 60 nanometer or the 40 nanometer that will be partially a FinFET structure.

And the main question yet to be seen, if the 20 nanometers will ramp fully or it will be ramped only in 2014, and then they will move strictly to 14 and 16 and will ramp more aggressively in those tech nodes.

I hope it answered your question.

Yes.

For booking purposes, really it's -- it sounds like it should not affect your bookings really from them for calendar '14.

So, let's -- yes.

Let me answer that one.

Actually, it's on the contrary.

There are a few reasons.

First of all, only by reduction in size, moving from 28 to 20, 20 to 16 represents around 10% to 15% increasing in metrology intensity between the tech nodes.

So, moving from 28 to 20, they are more process steps which will increase the demand for optical metrology, and the total available market should increase only by the shrinkage by 10% to 15% available market.

Secondly, when those customers will start to do a FinFET structure, never mind if it's frontend, backend, a mix, or a full FinFET, there's going to be a demand for extra metrology, because in order to create those structures, you need more steps and you need more tools, basically standalone tools, between the process steps.

So, you have the 10% to 15% increase.

And on top of it, once they will move to FinFET, you may see more increase to the metrology intensity.

Okay.

So, it should help your orders.

Calendar '14 should be a very good year for those kind of business.

If the technology will go in this direction, and according to the expectation that next year semiconductor will increase between 10% to 20%, it's going to significantly improve our opportunities.

Yes.

Well, thank you very much.

Keith Maher from Singular Research.

All right.

Good evening, gentlemen.

I had a first question just trying to understand that the gross margin on the services line was helped by software sales.

And I just wanted to have you guys clarify what software sales would run through the product line and which would run through the services line.

Yes.

So, normally what happens is that when we sell software on existing installed base, this one goes to the service revenues.

And this is the situation in the second quarter and probably in the third quarter as well.

And this relates also to the press release that Eitan mentioned before that we issued.

In cases where the customer is buying a new system which includes high end software capabilities, in such cases the software revenues are connected to the system and will appear in the product revenues.

Okay, got it.

Next, moving on to what you'd said earlier in the -- I guess this is what Dror was saying, about the potential increase in DSOs.

And I just wanted you to expand upon, is that -- you're offering better terms to your customers.

And what was the motivation for that?

Yes.

As I mentioned, what happened in the second half is that a few of our customers are moving into next technology nodes, either in 28 or 20 nanometer, or even 16 nanometer.

And as you know, the capital intensity in these technology nodes is significantly increasing, and at the first phase of the pilot lines, until the customers see the actual cash flow and revenues, they do have some cash flow requirements.

And they have approached us that, during this period, we will give them some extended payment terms.

And we have agreed to that.

Obviously, our cash position is strong, so we were able to accommodate for that.

So, we do expect that during the next six months, because these are the phases in which the customers are ramping these technology nodes, we will see increasing DSOs in that period.

And would that be -- so, after the next couple quarters, we'd probably see that go back down?

Yes.

Yes, we do expect that, going into 2014, the DSOs will go down -- back again.

Okay, thanks.

And I guess my final question, you've touched -- it's been touched upon a bit here on the call, just the overall total addressable market.

And in particular, I'm thinking now just on the foundry side.

And I was a little confused because a couple different numbers were thrown out.

But, how much -- I'd appreciate it if you could go through it again, just how much larger the opportunity is going to be in the foundry segment at 20 nanometers versus 28 nanometers.

So, we discussed it in the comments.

First of all, the number is around 10% to 15% more, okay, just by the shrinkage.

When we are looking right now in the foundry behavior, if we are looking right now in 28 nanometer, probably the total available market for us is around $80 million to $100 million.

Once you move into 20 nanometer technology nodes, it's immediately moving to around $180 million to $200 million total available market.

This is how basically we calculate the total available market in moving between technology nodes, specifically between 28 to 20.

Okay.

I was just a little confused because, I mean, in your slides you say -- well, I guess it's less than 28 nanometer.

You have it at $150 million to $200 million.

Okay.

All right.

Thanks.

A follow up question from Edwin Mok from Needham & Company.

Hi.

Just a quick follow up on the operating expense.

Dror, I think your guidance, you suggested that your OpEx will come down in the coming quarter.

Can you kind of remind us how we should think about OpEx, maybe not for this quarter, but over a longer period of time?

Yes.

So, at the beginning of the year, we did mention that we are seeing increasing operating expenses mainly in the R&D area year-over-year.

So, we did explain that we expect operating expenses in general to be at the $12 million level on a quarterly basis.

As I mentioned in my prepared remarks, we expect a reduction in Q3 because of some timing of prototypes received for the R&D project.

So, generally for operating expenses, you should expect a level of -- a normalized level of between $11.5 million and $12 million looking forward.

In the third quarter, it will be lower.

And it's very important to note also that these investments are for the short term, midterm, and long term projects that we have in R&D.

It's very important for us that, in parallel to these investments, we are able to maintain very good gross margins and also SG&A within our model in a way that, once revenues will pick up, we will see the benefit of that going into the bottom line.

Great.

Thanks for clarifying that.

Thank you.

Okay, guys, I just want to clarify the question that was asked before regarding the total available market in foundry, just wanted to make sure that it was cleared enough.

When we are talking about 28 nanometer foundry fab of around [100 and K] wafer starts, we're talking about the opportunity is around $150 million to $200 million in a 28 nanometer fab.

When moving to 20, it's actually jumping to $200 million to $250 million.

Thank you, sir.

(Operator instructions.) And it appears we don't have any further questions at this time.

So, thank you, operator.

I want to thank you all for joining the call today.

Thank you.

Thank you.

That will conclude today's conference call.

Thank you for your participation.

Ladies and gentlemen, you may now disconnect.