高塔半導體 (TSEM) 2010 Q2 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by.

  • Welcome to the Tower Semiconductor second-quarter 2010 results conference call.

  • (Operator Instructions).

  • As a reminder, this conference is being recorded August 10, 2010.

  • Joining us today are Mr.

  • Russell Ellwanger, TowerJazz' CEO; Mr.

  • Oren Shirazi, CFO' and Ms.

  • Nati Somekh, Chief Legal Officer and Corporate Secretary.

  • I would now like to turn the conference over to Ms.

  • Noit Levi, Director Investor Relations and Public Communications.

  • Noit Levi - Director IR and Public Communications

  • Thank you, and welcome to TowerJazz's financial results conference call for the second quarter 2010.

  • Joining us today are Mr.

  • Russell Ellwanger, TowerJazz CEO, and Mr.

  • Oren Shirazi, CFO.

  • Russell will open the call, followed by Oren, with a discussion of our results in the second quarter 2010.

  • After management's prepared remarks we will open up the call for the question-and-answer session.

  • Before we begin, I would like to remind you that some statements made during this call may be forward-looking and are subject to uncertainties and risks factors that could cause actual results to be different from those currently expected.

  • These uncertainties and risks factors are fully disclosed in our Form 20F, F4, F3 and 6-K filed with the Securities and Exchange Commission, as well as filing with the Israel security authority.

  • They are also available on our website.

  • TowerJazz assumes no obligation to update any such forward-looking statements.

  • Now I would like to turn the call to our CEO, Russell Ellwanger.

  • Russell Ellwanger - CEO

  • Welcome to our second-quarter 2010 results conference call.

  • The second quarter contained multiple financial milestone achievements.

  • It was not just a record revenue quarter, and at that with record EBITDA, but for the first time we broke a quarterly run rate surpassing $500 million annual revenue.

  • More significant than this one-time achievement is that we see continued growth in Q3 and to our best visibility in Q4 and into 2011 as well.

  • Not only was this quarter the highest revenue in our history, but we surpassed the highest combined pro forma revenue quarters separately recorded by Tower or Jazz.

  • More significant, the Q2 EBITDA of approximately $42 million is about 2X higher than the combined EBITDA for the previously referred to best pro forma quarters.

  • This can only happen by bringing to market value add products and services produced with an efficient operation.

  • Q2 2005 was my first quarter at Tower.

  • I wish to thank our dedicated employees worldwide, and our customers who partner with us towards the creation of value, for bringing us from a 2005 Q2 revenue of $19 million at negative $11 million EBITDA to $126 million revenue at positive $42 million EBITDA.

  • Thank you.

  • We see no letup in our momentum and, as mentioned, expect to continue our record-breaking streak into the next quarter and nicely beyond.

  • Underlying our confidence is our continued design win momentum, which were obtained within a large group of diversified and global customers, many of which are marketshare and technology platform leaders in their respective markets.

  • During Q2 we had a record number of design wins of 123, beating the previous quarter record of 111, which in turn was on top of the 2009 annual design win record of 308.

  • Design wins typically take between 18 to 24 months to start production, with a ramp during the second and third year after the design win.

  • Hence our long-term optimism as a function of the apparent marketshare gains that these wins promise.

  • Our forecast going into 2011 is very strong.

  • We see significant new business opportunities.

  • We are currently operating at our Newport Beach fab and Migdal Haemek six-inch fab at full utilization, with the Migdal Haemek eight-inch facility to reach full utilization and starts in Q3; hence the need to increase capacity.

  • At the beginning of 2009 the Migdal Haemek six-inch, eight-inch and the Newport beach fabs were at capacities of 16,000 wafers per month, 27,000 and 15,000, respectively, for a total of about 700,000 wafers per year.

  • We have invested in capacity through both efficiency projects and capital expenditures that will increase our internal capacity to about 900,000 wafers per year.

  • Much of this increase will be installed and qualified by the end of 2010, with all being in place within Q1 2011.

  • When we fully build out our internal capacity our level can reach about 1.3 million wafers starts per year.

  • There are many attractive tool purchase deals available at present which would allow incremental capacity at a total installed cost of about $5 million per 1,000 wafer monthly starts.

  • Such investments would deliver return in a period of 6 to 9 months from two installations, and hence we are evaluating several such scenarios.

  • On top of our internal capacity builds we have a manufacturing agreement with HHNEC in Shanghai, which we have an equity stake, and are manufacturing several thousand wafers per month in that facility.

  • As previously mentioned, we continue our activities to look at external capacity through either acquisition, merger or joint venture, which capacity we believe will be needed in 2012 and beyond.

  • Other important strategic steps we are taking is to improve our balance sheet, lower our short-term debt levels, and shore up our credit line.

  • We are restructuring our debt in order to reduce the risk and leverage in Tower.

  • And in the second quarter we took three significant steps, which substantially improved our cash level, extends our credit line, and rescheduled short-term debt to the long term.

  • These agreements with our bondholders and lending banks demonstrate the confidence of the financial community in our Company and in its long-term strategy.

  • Oren will get into the details of these agreement in a few moments.

  • We continue to cement our leadership in specialty technology.

  • In the past few conference call as we spent some time describing how in the analog space, as compared to digital, one can keep older technologies alive and vital through content enhancement, rather than through aerial shrinkage.

  • We continue to drive innovation by engineering solutions to solve the problems of interfacing digital systems to the real world through a vast array of specialty semiconductors, such as wireless RF, analog, high-voltage analog, imaging and other sensors and communication chips.

  • As the leader in specialty foundry, our capability has grown beyond simply that of producing high-quality wafers on complex analog technology, but increasingly we are helping customers bring new products to market through our product enablement capabilities.

  • I would like to take a little time to familiarize you with our activities in this area.

  • Product enablement results in a faster time to market and more highly differentiated products for our customers.

  • It encompasses a set of capabilities that starts with a deep understanding of our customers' markets and ends with services and tools, such as advanced model, custom design tool, IP blocks, process technology customization and design services, which are targeted at their specific markets.

  • We have invested in product enablement in specialty markets, such as the aforementioned RF, analog power and CMOS image sensor, and we are the only pure play foundry that has a fully capable design center focusing on accelerating time-to-market.

  • Our staff in the TowerJazz Design Center includes analog experts, specializing in our technology.

  • We use this unique dimension in design enablement in order to provide solutions to our customers, as only can be done by designers who are not only experts in design, but as well, on our technology platforms.

  • As an example, in the RF market we have built models that predict second-order effects, such as noise, linearity, high-frequency losses, more accurately than typical industry models and result in a higher first pass success rate than usual.

  • We then build custom designed tools that use these models to speed and optimize our customers' design.

  • For example, our inductor toolbox optimizes inductor design based on customer specifications.

  • And given that the inductors often consume the most area, and are the performance constraint in many RF circuits, our customers have the unique ability to reduce their die size, and hence their cost per die, and improve performance, gaining both performance and cost differentiation relative to their competitors which are using other foundries.

  • In the area of the power amplifier and antenna switch we have gone beyond design tools and characterize the IP that can be used as a starting point for a customer design, including an extensive library of power cells and switches.

  • For customers that need additional help, we provide design services to augment their own resources either through our internal TowerJazz resource or through a network of design houses familiar with our technology.

  • For example, enabling the use of our 200 gigahertz silicon germanium process for high-frequency design and automotive radar, optical networking and 60 gigahertz Wi-Fi, we have partnered with design houses to create IP and expertise that our customers can leverage.

  • In fact, our partnership with Toppan in Japan is a recent example of this activity.

  • RF designs are all about the accuracy of the model, however, pure accurate modeling is not enough.

  • We built proprietary tools around the model to give our customers the ultimate design experience.

  • Our powerful and efficient tools enable unprecedented accuracy in device models, and our unparalleled customer support at every stage of the design flow ensures confidence and design at near zero risk.

  • Our CMOS image sensor offering include pixel ICs where our R&D team customizes the pixel that best fit the customer's application.

  • We believe that by providing not just a single device, but rather an optimized pixel that includes layout and sensing circuits, we give our customers a significant advantage.

  • We have developed a test vehicle complete with an evaluation board to give our customers another advantage when developing image sensors at TowerJazz.

  • As we focus on high-end market and high-end market applications, it is obvious that the best pixel performance is a key for our customers to win their market.

  • We have invested many years in developing our pixel technology, and now are able to tailor our technology according to any customer needs using a vast knowledge of the technology and the application requirements and our own development platform.

  • This is a unique enabling solution, and we see more and more custom design houses that specialize in high-end markets turning to us to become their sole source foundry.

  • In Power Management the TowerJazz platform is the most cost effective and rich platform currently available in the market.

  • Our platform includes not only our scalable power devices that allow achieving best [guide] area, but also over 100 devices to enable best possible performance for our customers' IC products.

  • This great offering is possible as we have developed our power platform as a modular add-on to our rich CMOS analog platform.

  • We understand that power design requires manual tailoring design skills and intimate device knowledge.

  • This is why our design kits are built with the designers in mind, offering toolkits and design references to give the power designers instant intimacy with our process.

  • Our design center includes Israel's best analog and power designers.

  • This team, together with our device development team, are working closely together, as we know that only by seeing our offerings through the designer's eyes really have the best and most complete solutions.

  • Our design team is available to provide design services to customers accelerating even more time to revenue.

  • As TowerJazz is a pure play foundry, our design service strategy is solely aimed at enabling the customer, protecting its data, and never competing against it.

  • In terms of guidance, we expect the third quarter of 2010 revenue to jump up to between $132 million and $137 million, a midrange sequential growth of 7% quarter-over-quarter and about 70% year-over-year.

  • We believe we are well on the way to surpassing our full-year revenue goal of $500 million.

  • In summary, we have been the number one growth boundary over the past four years, and we see our first-half result in 2010 and second-half forecasts as a strong promise that we will extend this number one growth position to this as a fifth year.

  • Based on our current run rate, the growth rate this year should surpass the $500 million in 2010 compared with $300 million in 2009.

  • The current EBITDA run rate would indicate that all incremental growth will occur at at least a 60% EBITDA margin.

  • This is an excellent number that should only increase over the next quarter's forecasted revenue increase.

  • This growth has been accomplished by winning at the major Tier 1 companies, who are the undisputed leaders of their respective markets.

  • These are customers with whom, based upon our performance, we can grow marketshare and high-value products over many years to come.

  • These customers have substantial share to get.

  • For this reason we remain bullishly optimistic on our long-term future, both in revenue growth and in profitability.

  • I would like now to hand over the call to our Chief Legal Officer and Corporate Secretary, Ms.

  • Nati Somekh.

  • Nati Somekh - Chief Legal Officer and Corporate Secretary

  • Thank you, Russell.

  • Now I would like to add the general and legal statements to our results in regard to statements made and to be made during this call.

  • Please note that the second-quarter 2010 financial results have been prepared in accordance with US GAAP.

  • And the financial tables in today's earnings release include financial information that may be considered non-GAAP financial measures under Regulation G and related reporting requirements, as established by the Securities and Exchange Commission as they apply to our Company.

  • Namely, this release also presented financial data which is reconciled as indicated by the footnotes below the tables on a non-GAAP basis after deducting depreciation and amortization, compensation expenses in respect to option grants, and financing expenses net, other than interest paid, such that non-GAAP financial expenses net include only interest paid during the reported period.

  • Non-GAAP financial measures should be evaluated in conjunction with, and are not a substitute for, GAAP financial measures.

  • The tables was also contain the comparable GAAP financial measures to the non-GAAP financial measures, as well as the reconciliation between the non-GAAP financial measures and the most comparable GAAP financial measures.

  • EBITDA is presented as defined in our quarterly financial release.

  • EBITDA is not a required GAAP financial measure, and may not be comparable to a similarly titled measures employed by other companies.

  • EBITDA and the non-GAAP financial information presented herein should not be considered in isolation or as a substitute for operating income, net income or loss, cash flows provided by operating, investing and financing activities, per-share data or other income or cash flow statement data prepared in accordance with GAAP.

  • And is not necessarily consistent with the non-GAAP data presented in previous filings.

  • I would now like to turn the call over to Oren Shirazi, our CFO.

  • Oren Shirazi - CFO

  • Hello everyone.

  • Second quarter was an excellent quarter for us from a financial and business perspective.

  • We improved our balance sheet by reducing debt to next year by $120 million, reducing total long-term debt by $37 million, as compared to the start of the year, increasing cash balance to $85 million, and strengthening our shareholders equity to $69 million.

  • The $80 million exchange deal with Jazz major noteholders and the $45 million credit line from Wells Fargo, all due not before 2014 and 2015, proved the confidence of our lenders in our financial position and our business plan.

  • Further, we achieved record quarterly results with an all-time record EBITDA of $42 million, and all-time record revenue of $125.7 million in the quarter, growing 10% sequentially or 2.1X year-over-year.

  • We also saw another quarter of strong growth in operating profitability on both GAAP and non-GAAP basis, as well as very strong non-GAAP net profit of $36 million or $0.15 per share in the quarter.

  • Going into further debt and a review of the balance sheet item, we also see improvement in all [parameters thus far].

  • Cash balance at the end of the second quarter increased from $82 million in the end of December '09 to $83 million at the end of March and to $85 million at the end of the second quarter.

  • The cash balance is more than 2X the cash balance of $38 million we had as of June 30, 2009.

  • The improvement trend is presented also in our current assets, which increased from $167 million at the end of December '09 to $180 million at the end of the previous quarter, with further growth to $193 million for the current quarter.

  • Shareholders equity at the end of the second quarter increased to $69 million as compared to $65 million at the end of the previous quarter and $56 million in the end of December 2009.

  • We achieved this improvement in cash, current asset level and shareholders equity, whilst our long-term debt decreased from $429 million in December '09 to $405 million in the previous quarter with a further reduction to $392 million at the end of the current quarter.

  • We recorded an increase in current liabilities from $97 million in the end of the previous quarter to $121 million at the end of the second quarter.

  • However, the main reason for the increase is attributed to cash in received from customers, which will be recognized to revenue in the next quarter.

  • Our current ratio, which is total current assets divided by total current debt, increased from [1.468] as of the end of June 2009 to 1.60 as of June 2010.

  • On the debt front in the past three months we have restructured a substantial portion of our long-term debt.

  • On July 15 we closed the Jazz bond exchange deal, under which $80 million of Jazz convertible bonds originally due 2011 were exchanged for straight bonds due June 2015.

  • We also signed an agreement with Wells Fargo, Jazz' lender bank, to extend our credit line from 2011 to September 2014.

  • The interest on the broader amount is LIBOR plus 2.75%, and the credit line amount is up to $45 million, which as of June 2010, the outstanding borrowings were $22 million.

  • These agreements with our bondholders and the lending banks demonstrate the confidence of the financial community in our Company and its long-term strategy.

  • As previously announced, we are in discussions with our other lenders, targeting further improvements of our balance sheet in order to position us as an even stronger competitor in the industry.

  • We believe that these agreements are all very important in enabling us to execute on our continued long-term strategic growth plan, improving our balance sheet and financial condition.

  • Based on our targeted 2010 revenues of $500 million and EBITDA of $160 million, we currently have a debt to EBITDA ratio as of June 2010 of 2.5X as compared with ratio of l above 4X in the past.

  • This completes my balance sheet analysis.

  • I will be happy to receive any follow-up questions in today's Q&A session.

  • We will now go to the P&L analysis.

  • After we reported in the previous quarter a turnaround to get operating profit, we achieved again this quarter with $4.3 million, and additionally achieved a positive GAAP gross profit for the third consecutive quarter.

  • This means that our operations generated enough revenue to cover all the OpEx of the Company, which are all the costs involving operating the facilities, including R&D, M&A, G&A and depreciation.

  • Revenue was an all-time record for the quarter, reaching $125.7 million, more than double the one year ago $60.6 million.

  • We achieved a $38 million higher EBITDA on the reported $65 million revenue increase, which represents 58% incremental EBITDA margin.

  • Also, comparing our $500 million revenue and $160 million EBITDA with 2009 results, we see $120 million higher EBITDA over $200 million higher revenues, which is once again 60% incremental EBITDA margin.

  • (inaudible) is that for the $65 million revenue increase we had a year-over-year $30 million non-GAAP net profit improvement, representing 46% incremental net profit margin.

  • On a GAAP basis we achieved gross profit for the third consecutive quarter, this time with $22 million, which is $33 million better than in the second quarter of '09, and $6 million better than in the previous quarter.

  • Gross profit on a non-GAAP basis was $57 million in the quarter, over 3 times as compared to the second quarter of '09 and 15% higher than previous quarter.

  • This represents a gross margin of 45% compared with gross margin of 26% in the second quarter last year and gross margin of 43% in the previous quarter.

  • We are very proud achieving 45% non-GAAP (inaudible).

  • Operating profit on a non-GAAP basis grew by 18% over the previous quarter to $42 million, and significantly improved when compared to $4 million reported in the second quarter of '09.

  • This represents an operating margin of 33% in the current quarter compared with 6% in the second quarter of '09 and 31% in the previous quarter.

  • Looking at our OpEx, the operating expenses as a percentage of revenue is another evidence of the continuous improvement in our margins.

  • Our R&D expenses in the second quarter of 2010 were 5% of revenue.

  • That is compared to 10% of revenue in the second quarter of '09.

  • Our M&A and G&A expenses dropped from 12% in Q2 of '09 to being 9% of revenues in Q2 2010.

  • The total OpEx reduced from 22% in the second quarter of '09 to 14% this quarter.

  • Our GAAP net loss for the quarter was $9 million, and it is important to note that this figure includes financing expenses of $10 million, meaning that excluding those financial expenses, we would have made a small profit on a net -- on a GAAP basis.

  • Net profit on a non-GAAP basis in the second quarter was $36 million, representing net margins of 28% or $0.15 per share.

  • EBITDA for the second quarter of 2010 was $42 million, an all-time record, and $38 million higher than the second quarter of 2009 with a $7 million growth versus the previous quarter.

  • Now we would like to open the call for questions.

  • Operator.

  • Operator

  • (Operator Instructions).

  • Vernon Essi, Needham & Company.

  • Vernon Essi - Analyst

  • Thank you and congratulations on the results.

  • And the nice -- the 60% incremental EBITDA is a nice ratio there.

  • I wanted to take that into the context of the GAAP numbers on the gross margin side, and just walk through some scenarios here.

  • You've got what looks to be an incremental gross margin of 45% on a GAAP basis.

  • If I recollect your depreciation schedule is going to be basically cut in half, if I recall, into next year.

  • I am wondering if there is anything else on a GAAP basis that would drive that down on the cost side, so you might have a better incremental gross margin in the next couple of quarters?

  • I am trying to understand the range around how that might look.

  • Oren Shirazi - CFO

  • Okay, so this is Oren.

  • Basically the gross margins of 45% is not exactly incremental.

  • This is really taking into account on the cost.

  • So generally in the foundry industry, and also in our case, the fixed cost is higher -- is very high compared to other industries, which means that when you have more revenues, you actually improve the margins.

  • That is what exactly we see in TowerJazz and also in the industry.

  • So when the (inaudible) goes up like we compare to 2009, additional $200 million revenue in 2010 versus '09 brings us $120 million additional EBITDA, which is 60% EBITDA margin.

  • So for sure the gross margins are even slightly better.

  • So what I want to say is that while the gross margins are 45%, if the revenues go up, the gross margins go up -- even the margin, because the variable cost is not that high of a portion from the total cost of the fab.

  • You are indeed correct about the depreciation, that from the next quarter Q3 2010 should slightly go down by, let's say, 20% from the current amount, and in the end of 2011 should have another step function going down to about 60% of the current amount.

  • Vernon Essi - Analyst

  • If I look at the way your OpEx has been trending very -- pretty much flattish to up a little bit, at the upper end of your revenue range you're going to be within a whisper of a GAAP operating profit.

  • Is that the right way to look at that?

  • Oren Shirazi - CFO

  • GAAP operating profit, we already have, right?

  • Vernon Essi - Analyst

  • I apologize.

  • I guess I wasn't -- I was thinking more of to cover your financing expense, the pretax profit.

  • I apologize.

  • Oren Shirazi - CFO

  • You mean net profit.

  • Yes (multiple speakers).

  • Vernon Essi - Analyst

  • I don't know about what your tax -- I have another question, but just on a pretax basis you t would be very close to profitable, correct?

  • Oren Shirazi - CFO

  • Correct.

  • Russell Ellwanger - CEO

  • Correct.

  • Vernon Essi - Analyst

  • My apologies there between pretax and operating profit.

  • Then just one other question, just on the end market side, obviously a lot of mixed data points out there off most of the second quarter's results out of your customers.

  • Is there any areas that you think particularly are pretty strong drivers going into the third quarter, and any of that look to be weaker than where you were before?

  • Russell Ellwanger - CEO

  • Any that are weaker -- there is always questions on an end market with cell phone and what is happening with cell phone.

  • That is -- if something is weaker, it doesn't necessarily look weaker at present, but there is always questions about the burn rate of inventory and how much inventory is being sort stored for cell phone.

  • Other than that, everything looks very, very strong.

  • The high-end optical transceivers, everything in that area is moving nicely.

  • I don't see any single segment that doesn't look strong.

  • And even within the cell phone presently forecast remain very strong.

  • Vernon Essi - Analyst

  • Okay, that's helpful.

  • Thank you very much.

  • Operator

  • Jay Srivatsa, Chardan Capital Markets.

  • Jay Srivatsa - Analyst

  • Going back to your comment on GAAP affability, I think in the past you talked about being able to achieve that in the second half.

  • Is that something that you're still looking for in terms of -- at a net income level?

  • Russell Ellwanger - CEO

  • Yes, it is.

  • We had that as a target for a number of years now.

  • It is still our target within the second half of the year to achieve GAAP net profit.

  • So it still sits there as our target.

  • Jay Srivatsa - Analyst

  • All right.

  • In terms of gross margins, it appears you're running a pretty close to full utilization.

  • Do you expect further opportunities to improve gross margin through capacity utilization or are you looking at it coming from other areas?

  • Russell Ellwanger - CEO

  • As I mentioned during the call, we are right now in two of our factories for the present capacity at full utilization.

  • And in the third we will be by start at full utilization by the end of this quarter.

  • But we are concurrently increasing capacity.

  • So the revenue level that we would have by maximum capacity in Q3 will be less than the maximum capacity revenue in Q4 in Q1 and Q2.

  • And Q2 of next year should be with the President's activities and CapEx that we have purchased, that is when the max shipments would occur from the capacity would be in Q2 of next year.

  • So obviously the margin will increase as all the fixed costs is predominantly absorbed.

  • So I would, as stated in the call, that the next quarters will see incremental EBITDA margins as we [haven't] seen to date.

  • Jay Srivatsa - Analyst

  • In terms of further increasing capacity, you have talked about how you're looking at improving internally, and also internally just being acquisitive and stuff.

  • Can you expand on what the timing is of you increasing capacity significantly to grow your business, or do you feel pretty comfortable where you are today to meet the demands of next year?

  • Russell Ellwanger - CEO

  • We can -- off of the organic capability or the -- by capability we would have at this point the capital to build ourselves out to the 1.3 million wafer starts.

  • So off of our capability to build out to 1.3 million wafer starts as compared to the 700,000 that we had at the beginning of this year -- the 900,000 that we will have at the end of first quarter of 2011, at the 1.3 million we would be able to fully meet the revenue forecast that we have internally for 2011, and by that, obviously, meeting the customer demand that we see growing.

  • In the 2012 timeframe and beyond, for that we would need additional capacity beyond what we can grow organically.

  • Jay Srivatsa - Analyst

  • In terms of your debt, it looks like you're taking pretty aggressive moves to lower your debt and restructure some of that.

  • Given all the restructuring you have done, you still have a portion that is still coming due next year.

  • How do you hope to address that?

  • Oren Shirazi - CFO

  • So like I mentioned in my part of the call, we are in discussions with other lenders, which is mainly the Israeli banks.

  • And we believe we will have very good news about it.

  • Jay Srivatsa - Analyst

  • Last question.

  • It looks like your business is tracking well.

  • You feel pretty comfortable with the end market demand.

  • What are you concerned about?

  • What can go wrong here in terms of your continued growth looking into next year and for the second half?

  • Russell Ellwanger - CEO

  • Candidly, any time that you're running a factory at full utilization even small fab excursions can hurt, because you cannot make up for the revenue loss.

  • You can't backfill wafers and expedite them through the line.

  • So the biggest concern is truly just operational execution.

  • Now you always want your factories to be running at full utilization, but when you are there there is no room for mistakes.

  • And by that I mean if you're running at 70% utilization, you can always run through an extra 500 wafers that something might be happened in the line [two].

  • But at this point you put out the guidance.

  • The guidance is running the factories full steam.

  • If there is a misstep operationally it is very hard to make up for this wafers.

  • So the first and the foremost would be just the concern of running at such high utilization, if there is a mishap in the fab, you have a difficult time making up for that revenue.

  • Now it is not only the revenue that you have a hard time, basically you let down your customers, because they need the product now as well.

  • It is difficult to make up for it.

  • So that is the number one concern that we would have.

  • As far as what we see over the next quarters, what we see for the next year, candidly a person would be foolish to say that they have no concerns.

  • You know, the old expression that when the tide goes up, all ships go up; when the tide goes down, all ships go down is really true.

  • But you can modulate that to some degree by growing marketshare.

  • If you look at the pretty much monotonic increase that we have in design wins quarter-over-quarter for the past close to two years, it is evident that we are growing marketshare.

  • And the 2009 design wins are what will be fueling the 2011 -- especially the second half of 2011 growth -- it was a very high amount.

  • The design wins that we have now will be fueling the growth of the 2012, 2013.

  • So on a long-term perspective I do believe that we have gained substantial traction in marketshare.

  • And in growing marketshare you are not ever insular to the overall economy, but you do have some ability to dampen impacts from the economy, right?

  • Jay Srivatsa - Analyst

  • Okay, thank you very much.

  • Good quarter.

  • Operator

  • [George Berman], J.P.

  • Turner & Company.

  • George Berman - Analyst

  • Congratulations, another great quarter.

  • A quick question, it seems to me that your Company's stock market valuation is being held back by the long-term debt you have, a number of warrants and stocks that are being issued at or below market price.

  • There is always the overhang question on those Israeli capital notes, on the one hand, and a grant that I guess is overdue -- long overdue, on the other hand.

  • Can you clarify that situation a little bit more?

  • Oren Shirazi - CFO

  • Yes, so on the investment center grant, the Israeli, this is only an upside.

  • Today it is not in our balance sheet.

  • This is just an amount between $40 million to $80 million of cash for no dilution whatsoever, that the government owes to us, from our point of view.

  • The government -- the Israeli government is using some very strange excuses why not to transfer the funds to us.

  • Therefore, we filed a petition against them.

  • And we are trying to get it in any way that we can, because we really deserve this cash.

  • On regards to what you mentioned that we issued lately like a warrant or share below the market, I don't think it is accurate.

  • We issued lately somewhere and to the debt holders for the exchange of the notes from 2011 to 2015, but it was at $1.70 when the stock was at $1.35, so it was more than 20% premium to market.

  • And the stock that we -- the only fund-raising or the only equity raising that we did this year was to (inaudible) funds, which we grant them shares -- straightforward shares, ordinary shares at 3% discount to the market without any warrant coverage, any debt vehicle, anything whatsoever.

  • And, for example, the last grant was at $1.37 when the stock price was at $1.39, so it was even actually only 1.5% discount, which is very good terms for us.

  • So that is about it.

  • And about the debt, we moved $120 million from 2011 maturity.

  • We reduced the debt from $429 million to $392 million by a $37 million reduction in the debt this year.

  • And like I mentioned, we still have another way to go, in which case we are now discussing a very progressive discussions with (inaudible) banks.

  • George Berman - Analyst

  • That would be those capital notes, correct?

  • Oren Shirazi - CFO

  • No, no.

  • The capital notes have nothing to do with any debt.

  • We are talking with them on what the first investor asked, which -- not investor, analyst, Vernon, asked, which is regarding the loans.

  • We have loans owed to them of $190 million at LIBOR plus 2.5, which are maturing between the end of 2011 and 2013.

  • So about that we are negotiating with them.

  • George Berman - Analyst

  • If any or all of those grants from the Israeli government were to flow through that would be straight cash to you?

  • Oren Shirazi - CFO

  • Yes, yes.

  • George Berman - Analyst

  • Thank you very much.

  • And we will be looking forward for further progress in the coming quarters.

  • Operator

  • Eric Reubel, MTR Securities.

  • Eric Reubel - Analyst

  • Russell, on the CapEx that you mentioned getting wafer starts of 900,000 by the end of the year, could you -- you mentioned that you could be looking at something in the area of $5 million per 1,000 wafer starts.

  • Can you walk me through the CapEx guidance that you expect to spend in the back half of the year to get you to that $900 million -- 900,000 wafer starts?

  • Russell Ellwanger - CEO

  • Actually, most of that has already been spent, so it is not back half of the year that we are spending.

  • It is already announced CapEx, and it is efficiency project.

  • Eric Reubel - Analyst

  • So that -- and then the next wave of CapEx would get you to the 1.3 million that you need to sometime in 2011.

  • And if -- is it the same sort of math that applies the $5 million per 1,000 wafer starts?

  • Russell Ellwanger - CEO

  • I was actually talking about that for the $5 million -- that next expansion was the $5 million I am talking about.

  • From the 700,000 to the 900,000 was much less than $5 million, for the fact that was a substantial amount of efficiency projects that were involved in that.

  • Eric Reubel - Analyst

  • With the HHNEC capacity agreement, what is sort of the maximum amount of wafers that you could get from that, and where are you now?

  • Russell Ellwanger - CEO

  • There really is no defined maximum amount of wafers.

  • And the agreements that we have are a sub-supplier to us.

  • There are certain flows that they are qualified on.

  • The capacity isn't limited per se.

  • We are presently running, I think right now it is on the order of 3,5000 wafers per month, something on that order that is being run at HHNEC.

  • But that number goes goes up and down, depending on our need and also depending on their internal loading.

  • What would be the maximum amount?

  • They are (multiple speakers).

  • Eric Reubel - Analyst

  • Can you give a sense of the wafers that they are qualified for the programs that you are if you were to ship all of that capacity to HHNEC, how much could that be?

  • Russell Ellwanger - CEO

  • If we were to ship all of it, it would probably be on the order of 12,000 wafers, 13,000 wafers per month, something on that range.

  • Eric Reubel - Analyst

  • Right.

  • Russell, looking at some of the leadtimes from some of the semiconductor component suppliers that we have seen, we are seeing leadtimes stretch into 13 and 14 week range.

  • When we see leadtimes get this extended we sometimes think that we could be headed for an inventory correction, that there could be some double ordering.

  • Are you seeing any of that, or do you expect that we can get to a soft landing in 2011, where when you put in this new capacity you can get to a place where we could see some normalized growth in 2011, or are you concerned about double ordering?

  • Russell Ellwanger - CEO

  • I'm not overly concerned about double ordering for a variety of reasons.

  • But maybe one of the predominant ones is that a large portion of all of our business is full source.

  • So it is a very close relationship with the customer on both sides.

  • The forecasting process becomes more accurate.

  • The trust between the two becomes very accurate.

  • On the analog side the more specialized the platform the more difficult it is to run the product at multiple factories.

  • So by the very nature of our business model we drive to being a sole source through specialization.

  • So I think the forecasting we see is predominantly very accurate.

  • It is not that someone puts in more numbers than they would be it ever able to be able to meet.

  • They're not trying to secure capacity.

  • There is, I think, almost across the board a very, very strong trust level between us and our customers in both ways.

  • They depend on us to be able to ship wafers to them.

  • If one would ever be continually over forecasting and under-ordering, obviously, it wouldn't be to the customer's benefit long-term.

  • And if we don't deliver what they need products, it is not to the customer's benefit, so we would lose.

  • I think the relationship we have by being more specialized is different than maybe you would be familiar with with other digital factories, where a customer could order from one factory or another, and to try to secure additional capacity at one might double order at two.

  • Does that make sense of what I am saying?

  • Eric Reubel - Analyst

  • It does.

  • I guess the only caveat I would suggest is that since you are so fully booked and you mentioned that if there is a problem in the fab that there would be very -- it would be very difficult to make up those wafers.

  • I was just getting your sense of whether or not customer forecast to deliveries has remained steady and whether or not you thought that there might be some double ordering.

  • My sense is that we can be headed towards a soft landing in 2011, and I just wanted to get your thoughts.

  • Thanks a lot.

  • And a very good quarter, thanks.

  • Operator

  • Paul McWilliams, Next Inning Technology Research.

  • Paul McWilliams - Analyst

  • Congratulations on the continued progress.

  • You guys are just doing a great job.

  • A couple of questions here.

  • I really appreciate you addressing what you're doing to optimize [diary] and time-to-market for your customers.

  • I think that is a very good way to go.

  • Are you realizing yield improvements from those steps or other steps you might be taking?

  • Russell Ellwanger - CEO

  • It is a little bit hard to quantify it because the activity is with the design kit you don't have a comparative to.

  • You're putting out the design; you are measuring it.

  • The accuracy of the models should give a higher yield, because you are then addressing the circuitry to run optimally within the spice models that are accurate to begin with.

  • Right?

  • Paul McWilliams - Analyst

  • Yes.

  • Russell Ellwanger - CEO

  • So it is, on that side, it is hared to answer from the design service are we seeing yield improvement.

  • I think we optimize yield through the design services through very accurate models, but it is not -- it is not such as a kaizen program where you take out and you're not going to continually improve the design that you have done.

  • But the models definitely should -- the more accurate the model, the better the performance of the part, the less fall-off you have, because you're not running around corners.

  • Paul McWilliams - Analyst

  • That would make sense.

  • I was just wondering if you had contrasted it to designs down prior to the introduction of the tool?

  • Russell Ellwanger - CEO

  • I don't have a quantified answer for you.

  • I don't.

  • I would imagine (multiple speakers) that if we look back on it, we would say, yes, there is, but I don't have a black and white answer to give you.

  • Paul McWilliams - Analyst

  • Okay.

  • It is not always easy to measure, because comparing -- it is often an apples and oranges comparison, I understand.

  • Russell Ellwanger - CEO

  • Correct.

  • Paul McWilliams - Analyst

  • In regards to the pending grant that we all hope comes through from the Israeli government, will there be any royalty strings attached to that?

  • Any form whatsoever of payback or getting money back to the Israeli government?

  • Oren Shirazi - CFO

  • No, surely this is a participation of the Israeli government and the cost of us buying equipment, tools, manufacturing tools in the past.

  • So we invested already in the period of, say, the last three years, we invested in amount to more than $200 million in CapEx new tools.

  • And the Israeli government, of course, had a very big motivation that we will do that, because bringing additional manufacturing tools to the sites in Israel means very more employment and more tax payments to the government and all the good things that the state is enjoying.

  • So the government has a plan to encourage people to put manufacturing tools in areas like Migdal Haemek, where the Company is located, and giving 20% grants.

  • So basically we spend the money.

  • We spent -- invested more than $200 million in equipment tools, and the government participation should have been 20%, so $40 million.

  • And they didn't deliver those funds.

  • Paul McWilliams - Analyst

  • I see.

  • But there is no -- like with the Officer of the Chief Scientist there is a royalty stream that goes back on that.

  • There is no royalty stream that would go back on this?

  • Oren Shirazi - CFO

  • Right.

  • For the Investment Center Grant that we spoke about, the $40 million, there is no royalty stream going back.

  • You are correct, that regardless of this program there is other programs with another government agency called the Chief Scientist, for which we are getting an amount of about $2.5 million per year for the last many years.

  • And from money some, not a big portion, some of the portion is paying back for royalties, but this is really a very insignificant amount that we are paying back.

  • Paul McWilliams - Analyst

  • Now on the OCS is that removed from your GAAP presentation as well as your non-GAAP?

  • Oren Shirazi - CFO

  • What do you mean removed?

  • No, the OCS grant are actually participation in R&D expenses, so they are reducing the R&D expenses that you see.

  • So the R&D are reflected net of the government participation.

  • Both in the GAAP and in the non-GAAP there is no -- any exclusion of them.

  • Paul McWilliams - Analyst

  • Okay, that's what I meant.

  • My bad choice of words.

  • So then in the gross profit, where you are paying the royalty, which is very minor, that royalty is subtracted from -- or added to, I guess, your cost of goods sold in the GAAP and the non-GAAP?

  • Oren Shirazi - CFO

  • Actually, it is included in the R&D line.

  • Paul McWilliams - Analyst

  • Oh, the royalty goes back to the R&D line?

  • Oren Shirazi - CFO

  • Yes, because this is participation in the R&D expenses.

  • Paul McWilliams - Analyst

  • I see.

  • Now this might be a better one, this is a housekeeping question, but it might be better to go off-line with.

  • I would like to get the separation or the division between amortization and depreciation at COGS, R&D and SG&A.

  • Is that something we can follow up with better?

  • Oren Shirazi - CFO

  • Yes, sure, sure.

  • But basically I can tell you that it is a very immaterial amount of amortization, so the huge part is the depreciation instead.

  • Paul McWilliams - Analyst

  • Yes, I would guess so.

  • I just like to divide those out.

  • Then my last question has to do with the capital notes.

  • I know that a gentleman earlier brought that up.

  • And I'm wondering if you have had made any progress on coming up with a resolution for those capital notes?

  • Tell me what you can.

  • Russell Ellwanger - CEO

  • I think that the article that you wrote about them was very interesting.

  • I wouldn't want to make more comment than the article that you wrote.

  • Paul McWilliams - Analyst

  • Okay.

  • I understand.

  • And by the way, I did correct something in that article subsequent.

  • So I hope you saw the correction too.

  • I made an error in that.

  • Okay, I understand.

  • And can I assume it is still a goal to resolve those capital notes in some fashion?

  • Russell Ellwanger - CEO

  • Resolve them?

  • I think that the capital notes are for the most part already taken into the model of the Company, so I -- but at some point they will be exercised or not.

  • So, yes, I mean, we are in discussions about them.

  • Paul McWilliams - Analyst

  • Okay.

  • I just wanted to know that it is still moving forward or moving somewhere at least.

  • Thank you very much for your time.

  • And, again, congratulations on your great efforts.

  • Operator

  • There are no further questions at this time.

  • Mr.

  • Ellwanger, would you like to make your concluding statement please?

  • Russell Ellwanger - CEO

  • Certainly.

  • So again thank you all for your time, for your interest.

  • I am really thrilled to be the CEO of such a large group of talented and dedicated employees.

  • Now it is very interesting as I travel and visit customers and even potential customers throughout the world, it is the most rewarding thing to see confidence that they have, that they are, or that they will be placing in us by putting many of their most critical new projects in our hands.

  • That is really the case right now throughout the world, almost every region.

  • Many of the big customers, their most critical roadmap projects are coming to us.

  • We are a very different Company now than we were five years ago, three years ago, even a year ago.

  • And I trust we will be in a much different Company next year as we continue to strive to achieve our vision to be the world leader in specialty foundry solutions, as measured by our customers, investors and our employees.

  • As a very last note, we will be presenting in New York on September 13 at the Rodman & Renshaw conference.

  • I think the time of the presentation is 12.30 in the afternoon, so a very convenient time.

  • Whoever would be able to come there, I would love to meet with you.

  • There is always breakout sessions, one-on-ones, which I would be very happy to spend as much time as one would desire to explain our Company, our strategies, our successes and really our vision for the future.

  • So thank you very, very much again.

  • And I look forward to chat with the next quarter, and to continue to track with you the progress of the Company.

  • Operator

  • Thank you.

  • This concludes the Tower Semiconductor second-quarter 2010 results conference call.

  • Thank you for your participation.

  • You may go ahead and disconnect.