Onto Innovation Inc (ONTO) 2012 Q1 法說會逐字稿

Good afternoon and welcome to the Nanometrics first quarter 2012 financial results conference call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded today, April 26, 2012. At this time, I would like to turn the call over to Claire McAdams, Investor Relations Counsel for Nanometrics. Please go ahead.

Thank you and good afternoon, everyone. Welcome to the Nanometrics first quarter 2012 financial results conference call. On today's call are Dr. Timothy Stultz, President and Chief Executive Officer; and Ronald Kisling, Chief Financial Officer.

Shortly Tim will provide a recap of the first quarter and our perspective looking forward. Then, Ron will discuss our financial results for the first quarter and second quarter outlook, after which we will open up the call for Q&A. The press release detailing our financial results was distributed over the wire services shortly after 1.00 PM Pacific this afternoon and is also available on our website at nanometrics.com.

Today's conference call contains certain forward-looking statements, including, but not limited to, financial performance and results, including revenue, margins, and earnings per share, customer concentration, tax rates and product adoption. Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of factors, including changes in levels of industry spending, the adoption and competitiveness of our products, our ability to successfully integrate acquisitions, to realize operating efficiencies and to achieve reduced tax rates, including the receipt and timing of pending approvals from tax authorities, changes in product mix, and the additional risk factors and cautionary statements set forth in the Company's Form 10-K on file for fiscal year 2011, as well as other periodic reports filed with the SEC from time to time. Nanometrics disclaims any obligation to update information contained in any forward-looking statement. I will now turn over the call to Tim Stultz. Tim?

Thank you, Claire and good afternoon, everyone. Q1 was a good start to 2012. Total revenues increased 23% over Q4, while product revenues increased 30%, bolstered by record revenues in our flagship product line, Optical Critical Dimension or OCD, more than offsetting sequential declines in some of our other business areas.

We also benefited from strong strategic positions with the industry's technology leaders and the two top industry spenders. And we saw continued strength in demand for and rapid adoption of our newest OCD platform, the Atlas II. Launched just last quarter, the Atlas II represented nearly a third of our revenues in Q1, easily surpassing the initial revenue contribution and growth rate of any new product we have ever brought to market and is on track to being the most successful new product ever developed by Nanometrics.

Now, turning from the top line, I will take a few moments to discuss our performance in other areas starting with gross margin. Last quarter, we discussed the negative impact on our near-term gross margins, driven by sales of our Atlas II. We also made it clear that the initial low margin of this product was the result of its cost structure and not the result of pricing pressures or concessions.

Over the last quarter or so, our manufacturing, engineering and procurement teams have been hard at work negotiating long-term volume purchase agreements and driving improved manufacturing efficiencies in order to increase margins on this product as we ramp it up. I'm pleased to say that those efforts are starting to produce results, as evidenced by the quarter-on-quarter improvement in our product gross margins and specifically for the Atlas II. We are confident that we are on track to raise the margin of this key product and bring it up to our more traditional levels of 55% or better within the next 12 months.

That being said, in Q1, we fell short on the improvements we expected to deliver for total gross margins for the quarter. Much of this is attributed to the timing and magnitude of improvements in margin on the Atlas II which were not quite what we forecasted the first quarter. The balance was associated with a decline in service margins, driven by lower core service revenues, lower upgrade sales, and increased cost associated with advanced hiring for planned fab [pan outs].

Importantly, however, we believe based on the product mix we currently see, the timing of additional cost improvements to the Atlas II and our overall business volume, Q2 should be the gross margin bottom for us, as further cost improvements take effect and lead to improved margin performance in the third quarter.

Now, I would like to turn to spending and investments. Over the last couple of years, Nanometrics has been successful in establishing itself as a key supplier and partner with the leading customers in the industry. This has resulted in market share gains, increased fab footprint and revenue growth above the industry average. These strengthened customer engagements have also led to invitations to participate in additional areas of the fab, as well as to partner on the development of new products and technologies that address future technology needs and product road maps.

With the readily evident increase in concentration of spending and technology dominance by a few customers, we view these invitations not only as an opportunity to further grow our business, but also as a necessity to stay relevant and sustain our position as a key supplier to leading customers through subsequent technology conversions.

In response to these challenges and opportunities which clearly go hand-in-hand, we've been investing in people, inventory, customer support and engineering. We've materially added to our global applications team, our service organization and our engineering department to help our customers meet the challenges of technology conversions, fab pan outs, production ramps and new product development.

Now, while we understand these investments dampened near-term financial metrics, we firmly believe long term, these commitments are not only necessary, but key requirements for taking the Company to the next level of growth and performance. New applications, new products and an expanded position with key customers is how we will further grow our market share, expand our margins, grow our revenues and increase the value of our business.

Speaking of expanding our served markets, I would like to say a few words about our newest product lines, the UniFire and SPARK which serves the advanced packaging and defect inspection sectors respectively.

Although it is still too early to break out or report on their specific contributions to our overall business, I'm pleased to report that we're seeing an increase in use and traction of the UniFire across a broad spectrum of packaging and topography applications in multiple industries. Likewise, we are already experiencing very encouraging interest in the SPARK, not only as a standard-alone product but also in combination with our other metrology products on an integrated Lynx platform.

The SPARK serves multiple market segments, including advanced packaging and lithography process control applications where key product placements have already been made. I'm very confident that our investments in these new products in the markets we serve will lead to material contributions to our overall business in the not-too-distant future, nicely complementing our strong and growing positions in OCD.

In summary, we are very bullish about the trends and opportunities resulting from our strategic initiatives which are laying the groundwork for significant growth in our business and business opportunities. And while we are acutely sensitive to the decline in our recent financial performance, we are addressing those issues aggressively, [we're the most] transitory and fixable, and are committed to getting back on to our business model of above-average performance as quickly as possible.

Finally, I would like to make some general industry observations as it relates to our business going forward. The consensus view on total spending has definitely improved since last quarter. For Nanometrics specifically, we see 2012 spending weighted more towards technology conversions and development versus incremental capacity.

We do not currently see a decline in the second half as suggested by some. And then, in fact, are beginning to see some visibility into spending -- into the spending environment in 2013. And we see reduction in customer concentration and a shift in revenue contribution for the remainder of 2012 as some of our other key customers begin to increase their spending on investments versus the last couple of quarters.

With regard to our business in served markets, we continue to view our major long-term growth opportunities to be centered around technology nodes at 2x and below; three dimensional devices such as FinFETs and 3D memory cells and 3D packaging, each of which we are deeply involved with at multiple customer sites with multiple products and multiple applications.

In addition, near term, we are benefiting from continued delays in EUV which have necessitated the development of alternate lithography strategies that require additional process steps and thus additional process control needs. And finally, there is the transition to 450 millimeter which will drive the lead for entirely new tool sets. Process control tools such as our OCD are needed at the forefront of wafer-size conversions, both the healthcare (inaudible) tools that will also support the development of new processes.

As we had previously announced, we will be shipping our first 450-millimeter tools during mid-2012 to multiple locations. So in spite of the near-term challenges of growth and expansion and the usual mix of uncertainties, both global and industry wise, we are optimistic about the long-term prospects for our business.

With that, our guidance for Q2 is as follows. Revenues of $51 million to $54 million; non-GAAP gross margin of 45% to 46%; operating expenses, flat to up $300,000 from Q4; and non-GAAP EPS of $0.05 to $0.09.

With that, I will turn the call over to Ron to discuss our results and guidance in more detail.

Thank you, Tim. Good afternoon. Before I begin my comments, I'd like to draw your attention to a new schedule of supplemental information we have made available in the Investors section of our website at nanometrics.com. This schedule summarizes GAAP and non-GAAP financial results, as well as revenue segment information regularly provided on our conference calls. We believe this will allow us to focus on the key drivers in our discussion, while making this information readily available and accessible to our investors. As always, a reconciliation of GAAP to non-GAAP results is also available on our website.

In the first quarter, revenues of $55.5 million, up 22.6% over the prior quarter. Total product revenues of $47.9 million increased 30% over the fourth quarter of 2011, reflecting increased spending by our largest semiconductor customers and strength in our OCD business. Service and upgrade revenues of $7.6 million were down 11% from the prior quarter, due to lower revenues in both core services and upgrades which tend to fluctuate quarter-to-quarter.

As a reminder, the revenue segmentation data I'm about to provide is also available on our website. First, by product area. Sales of our automated metrology systems were our largest revenue growth driver in Q1 and were up 49% in Q4 to reach a record $41 million in the quarter comprising 74% of total revenues. Our flagship OCD Atlas tools led this growth and over 40% of Atlas shipments came from our newly launched Atlas II. This strong growth more than offset sequential declines in our integrated metrology and materials characterization products.

Sales of our integrated metrology products were $4.3 million, down 14% in Q4 and comprising 8% of total revenues, reflecting a reduction in capacity investments by our primary integrated metrology customers. And sales of our materials characterization products were $2.6 million, down 39% from Q4 and comprising just 5% of total revenues, due to the decrease in capacity spending and the LED and bare wafer silicon sectors.

Turning to total revenues by geographic regions, we report revenues based on the ship to or first end-use destination. In the first quarter, revenues from South Korea were 50%, North America 21%, EMEA 13%, with the remainder comprising 17%. Our largest customers, Samsung and Intel, comprised 41% and 30% of our total sales, respectively.

In revenue by end markets, which reflects product revenues only, the most significant increase was in the Logic IDM segment which comprised 38% of product revenues in the fourth quarter. Product sales to the memory segment increased 30% over Q4, with a significant shift in spending toward NAND flash which comprised 36% of product revenues compared to only 3% attributed to DRAM spending.

Product revenues in the foundry segment were down slightly from Q4, to comprise 18% of total product sales. Our LED, solar and silicon substrate sales were down 45% from Q4 to 5% of product sales, due to lack of capacity expansion in these market segments.

Before I turn to gross margin, I would like to draw your attention to a GAAP reporting change in our treatment of amortization of acquired intangibles. Since the acquisition of Nanda, the portion of our amortization of acquired intangibles that relates to technology is now significant enough that we have split our total amortization expense into two line items. The portion that relates to technologies will now be reported in cost of product revenues, while the remainder will continue to be reported in operating expenses. To ensure comparability, we have applied the split retroactively. To aiding reconciling historical periods for comparison purposes, this presentation is provided on the supplemental information provided on our website.

Consistent with our treatment of intangible amortization as a non-GAAP adjustment, we are also reporting our gross margin on a similar non-GAAP basis, excluding the impact of amortization of acquired intangible. As non-GAAP gross margin is a metric directly comparable to our historical reporting, our references to gross margin in this call are on a non-GAAP basis unless otherwise specified.

Gross margin for Q1 was 46.3% compared to 46.6% in the prior quarter. The sequential decline was primarily due to lower service gross margins as product gross margin actually increased, from 46.3% in Q4 to 48.1% in Q1. However, our total gross margin came in lower than guidance, primarily because the expected improvements to Atlas II margins were less than we had projected for the quarter and while product gross margins improved on higher sales volume and from cost reductions in our Atlas II, the significantly increased mix of Atlas II systems in the first quarter largely offset the positive impact of higher revenues.

We expect to continue to see improvements in our Atlas II margin throughout the remainder of the year. Product mix will however impact our overall achieved gross margins from quarter-to-quarter. Specifically, in regard to our guidance for Q2, while we expect Atlas II margins to improve over Q1, this tool will comprise an even higher mix of revenues in Q2.

Further compounding the mix change will be sequential declines expected for higher-margin products such as the Atlas XP and sequential increase is expected for lower-margin products such as the UniFire and certain materials characterization tools. As a result, our gross margins for Q2, as Tim mentioned, are expected to fall within a range of 45% to 46% which we believe will be the low point for our gross margins, as continued improvements in Atlas II margins take effect.

Service gross margin declined to 34.9% from 48.1% in Q4. The sequential decline is attributed to a combination of lower core service revenues, lower upgrade revenues and higher service costs, reflecting needed support for our customers in the coming quarters. We expect service gross margins to improve in the second quarter.

On a non-GAAP basis, operating expenses were $20.8 million, up $3.5 million compared to $17.3 million in the prior quarter. As we discussed in our last conference call, this increase was largely driven by inclusion of a full quarter of Nanda operations, typical payroll tax increases in Q1 versus Q4, and reduced number of holidays compared to Q4 which impacted all functional groups.

For the second quarter, our operating expense guidance of flat to up $300,000 anticipates a decline in G&A due to professional fees that were unique to the first quarter which will be offset by modest increases in R&D and applications development. Non-GAAP operating income for the first quarter was $4.9 million or 8.9% of revenue compared to $3.8 million or 8.4% of revenue in the prior quarter.

Turning to income taxes, we recently made changes to certain tax elections to improve our ability to benefit from expected losses generated by certain foreign subsidiaries which will result in an improvement to our 2012 structural tax rates from a previous estimate of approximately 40% to the mid-30s. The GAAP effective tax rate of 54% in Q1 includes approximately $655,000 in tax expense related to certain foreign losses that we cannot reflect in our tax provisions until these elections have been approved by the IRS which we expect to occur in the second quarter.

Upon approval, we expect to recognize these first-quarter losses as a tax benefit in the second quarter, resulting in a very low Q2 tax provisions. As a result, our overall first-half 2012 tax rate is expected to be in the mid-30s, in line with our expected 2012 structural tax rates. Therefore, in order to show comparable non-GAAP earnings, we have reflected the impact of this expected benefit in our non-GAAP earnings for Q1 and our guidance for Q2 subtracts the equivalent benefit that will be recorded in our Q2 GAAP results. On a non-GAAP basis, our net income was $2.9 million or $0.12 per diluted share compared to $2.3 million or $0.10 per share in Q4.

As Tim stated, our non-GAAP EPS guidance for Q2 is $0.05 to $0.09 per share and reflects the same effective tax rate as our non-GAAP earnings for Q1. The GAAP EPS guidance range also happens to be $0.05 to $0.09 per share. Our GAAP and non-GAAP EPS guidance happened to be the same for Q2 because the positive impact of the tax benefit from Q1 forward losses that we will record in our Q2 GAAP earnings is roughly equivalent to the negative impact of amortization of intangible assets.

Turning to the balance sheet, our cash declined $2.2 million due to lower beginning accounts receivable and payment of our legal settlement accrued in Q4 2011. We ended the period with $95.9 million -- $95.5 million or approximately $4.07 per share based on 23.4 million shares outstanding at March 31.

Our DSO was 63 days, well within our target range of 60 days to 70 days. Inventory decreased by $3 million, while our inventory turns increased from 1.8 times to 2.3 times in Q1. Our tangible book value increased to $189.7 million or $8.09 per share. We ended the quarter with headcount of 565 employees, a net increase of 13 from last quarter.

And with that, I'll turn the call over for questions. Operator?

Thank you. (Operator Instructions) Weston Twigg, Pacific Crest.

Hi, yes, thanks for taking my question. Just actually a couple of questions. I'm wondering on the gross margin profile through the year. So I know it's still taking a hit in Q2, but how can we view that improving in the September-December quarters? Maybe even an exit rate in December would be helpful?

Yes, hi, Wes. I don't have a number that I want to give you for the exit rate in the end of the quarter. I did say that we expect to get back to our traditional margins of 55% or better within the next 12 months. We're doing our best to bring that in as quickly as we can. There are some extended negotiations and then there is receipt of materials and then there is the normal flow-through through finances. It does impact the actual timing of the recognition, but we have a plan to get that tool up to where it needs to be. The team is doing a terrific job. We will get there and we will do our best to get there sooner than later.

And I know you tried to address this in the call, but I'm still having hard time understanding, why the big surprise in Q1 on gross margin? Why did this seem to take a longer than may you expected a quarter ago?

So the big hit on the margin actually turns out to be the service margin decline, which was based on revenues, upgrades and the lower upgrade sales and some additional investment. The other side of it was on the Atlas II and whereas we realized, a large part of what we've set out to pull in on our margin improvement, there are a couple of things that are slipping into the next quarter. So we missed it by a few weeks, so we missed it -- but we are not going to miss it in terms of the entire program.

Okay. And then, just finally, on the OCD ramp, so it sounds very strong, especially with the Atlas II. So can you help me understand why revenues got lower in Q2? What piece of the business is coming down?

Well, the -- we are kind of a little bit low or flat and the primary issues that we are seeing in some wind-down in some of the fab pan-out activities that consume a lot of tools and we're seeing a shift in the demand and purchasing towards the new technology nodes. This quarter, we actually had record stand-alone business, record OCD business which certainly offset some of the declines in some of our other business areas, but all of our new business that's coming in and where we are seeing the strength is down in the 1X nodes, both for logic and in the NAND, and then we're starting to see some improvements in the foundry contribution too. But we're seeing some of that more in the second half than in the next quarter.

Okay. Very helpful. Thank you.

Okay.

Thank you. Patrick Ho, Stifel Nicolaus.

Thank you very much. Tim, maybe can you give a little bit of color in terms of some of the variables on the improvements that you're making in both the manufacturing, the supply chain for the Atlas II? I understand that you are going to probably start seeing those improvements in the second half of the year and into 2013. But what are some of the specific actions taken that will lead to these tangible gain?

Sure, Patrick. What we really did is we -- when we launched the Atlas II, which went out a little faster than planned, most of that was based on our engineering buys and not benefiting from high-volume long-term purchase agreements. So we -- the team went out and looked at this tool from the AI runs down, looked at the big-ticket items such as the stage, the head assembly, the packaging, the automation -- factory automation and worked with our suppliers to both give them visibility in towards the ramp of the tool as well as to get the benefit of some improved cost models.

In addition, we're doing some -- or finally, with the transfer into manufacturing we are doing, we'll have the opportunity to train more of the folks inside to get better efficiencies and quicker turnaround which ultimately lowers the cost. But while leaving no stones unturned, we see -- we saw -- we've identified actually some very significant opportunities. I'm very confident that they're going to come into place because based on the conversations we're having with our supply chain, and this Atlas II is just going gangbusters and we are pretty excited about it actually.

Great. That's very helpful. Second question related maybe to Wes' question about the revenue outlook, I'll take a different approach to it. What is the customer concentration looking like for the second quarter because obviously, you were very heavily tilted towards two customers in Q1? What's the customer concentration like? Is one of them falling off or is it going to be the same mix but on a lower revenue basis?

That's a good question. I would like to kind of rephrase that question in two areas. One is that we do really well and we've got strong positions in logic and memory. And so, although our performance with the foundry business is growing, it's not as big a contributor and so the swings in foundry spending don't benefit us as much as they do some other folks. That being said, we're seeing a decrease in the concentration going into Q2, in particular the Q1. We had 71% of our business came out of two customers. We're seeing some slowdown of spending on one and we are actually seeing pickup in some of the other customers who haven't been represented as strongly in the last couple of quarters which we'll more than make up for that in general.

Great. That's very helpful. Thanks again, guys.

Okay.

Thank you. Mahesh Sanganeria, RBC Capital Markets.

Hey, thanks. This is Richard Grace there for Mahesh. Hey, Tim, you had mentioned that you're seeing benefit as -- due to the delays in EUV. Is this simply because there are more process steps being added in or is there more to it than that? And then, secondly, when do you see EUV ramping?

I'll give you an answer to the first question and I'll let somebody that is closer to the business on the second. So it is basically more steps. It's more mask levels. So when you're doing double patterning and quadruple patterning, that begets additional process steps and sequences and therefore you apply more metrology. It [doesn't] necessarily goes a one-to-one if not four-to-four, four [lethal] steps meaning four times as many process steps because some are done sequentially, but it is an incremental benefit to us on the process control and as far as when the EUVs [come to us], I think I'll let you talk to [Eric Morise] or someone else on that.

All right. Are you actually seeing customers [use] quadruple patterning right now?

Absolutely. Yes, we are.

(multiple speakers).

Now, we're engaged with the multiples, including quadruple with our tools.

Okay. Thank you, [Tim].

Thank you. Tom Diffely, D.A. Davidson & Co.

Yes, good afternoon. I guess, first, hoping for a little bit of an update on your view of the growth of OCD and your Company specifically versus the market. In the past, you said that you expected to outgrow the market by 10%, 20%. I wonder if that's still the case or if the customer concentration has changed that view?

Yes. Tom, I think what we have said before is that based on our calculations, the OCD market grew about 30% last year and our OCD business grew 40%. If you look at our stand-alone business and our -- and the traction of both the Atlas II and the Atlas XP, our two flagship products, we're achieving record revenues on that and we believe that that growth is still greater than the growth of the sector in itself. And I think it leads to us coming to a conclusion that we're continuing to gain some market share.

Okay. So if the markets were to be flat to down a little bit this year, you would expect to outperform that from both a share gain as well as just your OCD, your faster-growing segment. So wondering how would that balance then by some of the other markets, been a little weaker right now? Do you see a recovery in the adjacent markets as well then?

Yes. I don't know about that. When I look at the materials characterization, which is driven a lot by LED and solar, that's coming down quite a bit. It has come down quite a bit. The bare silicon wafer or substrate market, we have seen come down and so those areas, I don't see anything that's going to suggest they are going to have a significant turnaround. We hope to see some improvement, but there is nothing out there in the horizon that drives that.

What I'm really optimistic about and pleased by is that our core business, which is in process control metrology, primarily serving the semiconductor and data storage industries, is growing nicely and that's not just OCD, but as I mentioned during my script, or my prepared remarks, we're seeing some nice improvements in the contribution from the UniFire and some initial indications that we're going to see similarly nice contributions from the SPARK. And so, when I look at what's going to drive our business and what's going to really improve our outlook, it's really all about process control metrology and I have less dependence or less confidence in the areas of solar LED and bare silicon substrate.

Okay. And then, what about an update on the -- more of the advanced packaging or 3D packaging? In the past -- that seemed to be kind of a late 2012 time frame. Is that still in the cards, you think?

Yes. I think that's probably right. In terms of timing, this is one of the things when it finally takes off [or recognizes]. We've got tools deployed basically everywhere. We now have multiple tools deployed in most places, both looking at the through silicon vias as well as the microbumps. We've got applications not only for the UniFire, but potential applications for the SPARK as well. And so we're pretty excited about that. And I think when it's -- I think, if there is an inevitability to it and so, for me, it's being properly placed. So when it turns, we benefit and I think we are.

Okay. And then, finally, when you look at the OCD market stuff, what's the relative capital intensity of OCD tools when you compare the DRAM to the NAND to the foundry markets?

That's a good question and I'm not sure -- I don't have that in front of me, but I'd rather not guess. I'd rather get back to you on that and give you some of that. Clearly, the DRAM process is a very -- it's a much more complex process, but there is not a lot of spending going on there. So what I would like to do is let me get some accurate numbers and get back to you on that.

Okay. Thank you.

You bet.

Thank you. (Operator Instructions) Gus Richard, Piper Jaffray.

Yes. Thanks for taking my questions. Just real quick on 450, I'm sure you're starting to spend on that and I was wondering if you could give us some idea of what that investment profile looks like for you and when do you think you might start shipping 450 tools for a front-end fab, not wafer manufacturing?

Well, we are actually shipping -- the tools we'll be shipping are for a front-end fab, they're not for wafer manufacturing. The first tools will be going out. And we are actually starting the discussions about some additional tools going out to other locations. So we already have multiple tools going to multiple locations. It's not for the wafer, but it's actually for some front-end process development as well as tool characterization.

I think that we are going to see probably some front-end loading of those tools and tool demand, and there's probably going to be a little bit of digestion period sometime in the 2013 time frame in the middle of it. And then, before you start to see any meaningful ramp in that product line, but we're seeing pool across, so it's not just OCD but we're actually seeing pool of -- on the -- for the SPARK platform, the UniFire and the overlay tool.

Okay. And so, where are you in the development of 450 area? Is most of that spending in your R&D already or have you got more to go, kind of what does the spending profile look like?

So the spending profile is captured in our current engineering spend and we're, within a few -- couple of months, two to three months, shipping our first tools. And so the guidance we're giving our OpEx includes not only the kind of the product road map we're spending but it also captures the spending for the 450.

Okay. And then, to get to flat year-on-year, you're going to have, I would imagine, a pretty healthy step-up in the back half. Is that -- sort of if you're going to outperform the stock or flat to slightly down, is that kind of how you're thinking things are going to play out?

Yes. I think -- I mean, if the spending goes the way everybody says, or at least what consensus says, well, we see it being flat and if we're going to outperformance it. Where we see the contributions coming from, as I mentioned earlier, is almost this all 1X nodes for new technology development and conversion, both in logic and in the memory side, in particular the NAND. We don't have -- we're not seeing any significant step-ups in DRAM spending right now.

We're also seeing the -- some improving contributions from foundry. We've actually been -- had some nice new gains in footprint and penetration into foundry for across our product line, both in the UniFire, the OCD and integrated metrology and those should play out when we get down to the low 2 and the 1X nodes. And then, where I think you're going to start to get to the point where the UniFire and the SPARK give us some contributions as well.

Got it. And then, so this last one, I apologize in advance. I'm sorry, I didn't quite catch it, Ron. Could you go over the tax rate for the first and second quarter just one more time?

Yes. So the combined rate that we expect to see for the first half is going to be in the mid-30s. The rate for the -- in Q1, where we weren't able to benefit certain foreign losses came in at about 54%. Q2 on a GAAP basis is going to be at a rate that brings the first half to that 30.5%. Our non-GAAP numbers assume a rate in both Q1 and Q2 at the mid-30s.

Got it. Okay. Okay, got it. So both GAAP and non-GAAP are in the mid-30s and you just need to adjust to GAAP to compensate for the tax benefit you didn't capture in Q1?

It will be captured in Q2, correct.

Right. Got it. Thank you. Thank you so much for saying that out.

Thanks.

Thank you, sir. Graham Tanaka, Tanaka Capital.

Hi. Hi, guys. Thanks for the level of detail, there's a lot going on. The service margins, you're talking about the more positive swing in the second quarter. Can you sort of put bookings around that, kind of size it?

So we think that it's going to get -- it actually took this dip in Q1 and it was a combination of slightly lower revenues and lower upgrades, and we think that we're going to see improvements in both of those and that generally just goes straight to the margin, because it's almost -- it's revenues against almost a fixed cost on there. So I think you could look at our average margins across multiple quarters and start to think about those as being realistic in a way to look at it.

So in other words, if gross margins improve as you expect [where are] they going to get, they are going to bottom the same quarter but [does] improve in the second half, what are we going to see and how much is service revenue margins going to be affecting the Q2 and the second-half gross margin? Are they nominal, or are they having a significance?

Yes, that's somewhere between nominal and significance again. I mean just because of the total revenues, service revenues are anywhere between $6 million and $8 million. The margins have been -- our core service margins have been kind of in the low 30% and our upgrade business tends to be at the higher margins and it really depends on the contribution upgrades to the total service.

Let's see now, the industry spend, you had talked about encouraging signs and I just was wondering if you could maybe give us some more granularity on that, what sectors and particularly with some -- I know it's difficult but some comment on 2013 if you can? Thanks.

Sure. Well, I think that most of us -- most everyone is seeing the announcements that the three big disk players, Intel, Samsung, and now -- and just yesterday, TSMC, all announced fairly large increases in capital spending because you've got to drill down a little bit deeper to understand what part of it that's WFE, but since they are the dominant spenders and players, that's important to us.

If you take that against the expected flat to down of some of the other industries, I think that most of the consensus is getting to kind of a flat CapEx spend. Some of that CapEx spend this year is going to go onto buildings and this leads into our discussion in 2013 where at least -- I've read at least one report that suggests that Intel, for instance, will have CapEx down in 2013, but wafer fab equipment will be up in 2013 and to that extent that we benefit from that.

We're also starting to see some of the other memory folks, who have been pretty silent over the last couple of quarters, starting to spend and they will start to help us reduce the concentration against a couple of customers, while some of the major ones slow down perhaps in the second quarter.

By the memory folks being silent, you're talking about memory in general or are you talking about NAND?

Pretty much NAND -- it's NAND because there is not a lot of spending in DRAM, but I mean if you look at capital spending across the board, or without talking about specifics are [because] just in general, Hynix has been notably low on their spending, Micron and its NAND (inaudible) but notably low and we are starting to see some improvement in outlook for some of those companies.

Okay. As you're going to be ramping UniFire and SPARK, what kind of gross margin experience are you -- are we going to be seeing there? Are we going to be seeing a little mini repeat or repeat of what's been going on with Atlas, or is that going to be a more -- a higher gross margin to begin with?

Well, that's a fair question. Well, the -- so the SPARK platform, because it's a fairly straightforward platform because we manufacture ourselves. In fact, the SPARK platform is being transferred to the Milpitas facility. I'm pretty confident that the SPARK is going to hit the ground running with good margins on the fill-up tool. The UniFires, we've spoken to several times before, does not enjoy quite a series of margin -- or is higher margin because of the margin sharing that goes with our relationship with Zygo.

And what we're doing to improve that is more about adding features that we can -- and benefits to the tool that have a value that we can charge for and that's a different approach, but that's pretty much our major weapon to improve that, the margins on that tool. You're also integrating that tool onto our Lynx. So we're putting the SPARK onto the Lynx, we're putting the UniFire onto the Lynx. We've got the overlay tool on the Lynx and we have the Atlas II on the Lynx. So we're going to get some additional benefits from having everything on a common platform.

Okay. Great. Thank you.

You bet.

Thank you. And I would now like to turn it back to Dr. Stultz for any closing remarks.

Well, thank you very much. And thank you again for participating in our call. I'd like to remind everyone that Nanometrics' performance is tied directly to the hard work and commitment to excellence of our global workforce whom I consider to be among the very best in the industry and with whom I'm truly excited to work with each and every day. I look forward to reporting on the results of our operation and financial performance for the second quarter of 2012 in July. With that, the call is ended.

Thank you. Ladies and gentlemen, this does conclude your call for today. You may now all disconnect. Thank you very much and have a wonderful day.