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Nova Measuring Instruments Ltd. (NASDAQ:NVMI)

Q4 2008 Earnings Call Transcript

February 18, 2009 at 9:00 am ET

Executives

Gabi Seligsohn - President, Chief Executive Officer

Dror David - Chief Financial Officer

Analysts

Neal Goldman - Goldman Capital Management

Robert Katz - Senvest Capital Inc.

Operator

Welcome to the Nova Measuring Instruments fourth quarter 2008 results conference call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question and answer session. (Operator's instruction) As a reminder, this conference is being recorded February 18, 2009.

I would like to remind everyone that forward-looking statement for the respected Company's business, financial conditions and results from these operations are subject to risks and uncertainties that could cause actual result to differ materially from those contemplated. Such forward-looking statements include but are not limited to product demand, pricing, market acceptance, changes in economic conditions, risks in products and technologies development and the effect of the Company's accounting policy as well as certain other risk factors which are detailed from time to time in the Company's filings with the various securities authorities. If you have not received the copy of today's release and would like to do so, pleas call GK Investor Relations at 1-866-704-6710.

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

Gabi Seligsohn

Yes, operator. Thank you and thank you all for joining today's call. We are today announcing our fourth quarter and overall year 2008 earnings. The 2008 was undoubtedly a very challenging year for our industry and for the economy as a whole. Unlike other industries which started to experience a slowdown around the third and fourth quarters, semiconductor equipments started to feel the influence as early as the first quarter. Clearly, the beginning of this cycle was the result of an oversupply and price erosion of memory chips while during the latter part of the year, demand subsided as well.

To further amplify the influence of these business trends, the devaluation of the US dollar which is the main currency of our income added yet another challenge costing us around $3 million for the year. As we mentioned on the last call towards the end of the third quarter and in preparation for a very weak holiday season, we started seeing significant declines in fab utilizations at most of our customer sites. This includes even major foundries which historically held up quite well.

This situation has led to a very strong pullback in orders for the entire equipment sector as indicated in earnings posted by several leading OEMs in the last few weeks, a phenomenon to which we are obviously not immune. During 2008, revenues declined by 33% going from about $58 million in 2007 to $39 million in 2008. Obviously at such revenue levels, growth margins took a significant hit and went from 43% in 2007 to 33% in 2008 though we were able to maintain product gross margins at similar levels to those of 2007.

Excluding inventory write off and inventory purchase commitment losses of $1.4 million in 2008 as it relates to anticipated lower demand for older generation products; growth margin was 37% for the year 2008. Faced with these challenges, our management team reacted swiftly to immediately reduce the running cost of our operation, conserve cash and minimize our losses. These measures included a reduction in force, salary reduction throughout the Company, a reduction of ongoing expenses and very effective in collaborative measures involving our supply chain.

As previously stated, the measures taken were selective and despite the challenging environment, we maintained the phase of our product development program and we are able to continue penetration into the standalone optical CD market. Several important accomplishments made during the year are worth mentioning.

First, our penetration effort continued to bear fruit and we doubled our customer presence in the standalone area. These customers include both major foundries and major memory manufacturers. We believe that these penetrations laid the foundation for future growth of our business. Second and equally important is the proliferation of our technology into more area than the fab. Our tools are now being used in the lithography, etch, CVD and CMP areas. Collaborative work with some of our leading customers and key OEM partners has led to the introduction of novel process control schemes to support their move to double patterning lithography and advance etching methods.

During the year, we also saw continuation of the trend to move away from traditional copper measurements to optical CD-based measurements or copper CMP process control and we believe that with the continued technology strength, this trend will increase. Third and worth mentioning is that during the year, we announced and shift a record-breaking tool, Nova T500, which offers our customers several benefits, the most important of which is industry leading true put and cost of ownership. Judging by performance of the tool so far, I am happy to report it is meeting our stated goals.

Service gross margins sought significant improvement and revenues increased by 14% during the year. Given the state of the industry, we expect service revenues will reduce somewhat in the near term but our hard work will eventually payoff when market conditions improve.

During the year, we also defended our market leadership in the area of integrated metrology despite new product introductions by our competitors. As stated by several of our customers, our integrated metrology platform scalability and reliability continue to impress them and provide them an easy and cost-effective upgrade path from 65 nanometers to 45 nanometers technology.

Now, I will turn to an outlook of the industry and the steps we are taking to deal with it. Talking to our customers and reviewing industry trends, it is clear that our industry will continue to decline in 2009. As stated, fab utilization rates are low and spending in many cases is below maintenance levels. We expect lower services revenues near term because with low-chip demand, customers are cutting their fab running expenses and servicing their tools less than before.

Despite the downturn, we still have important opportunities. Our customers' roadmaps have not slowed down; on the contrary, their dependence on delivery of advances is actually growing. Printing more dies per wafer will continue to critically important into the future and the drivers are primarily economic. With that being the case, we will continue and focus on improving our offering and solidifying the vote of confidence we have already received.

Because we have been proactive in adopting our operations to industry conditions, we will be able to continue and position the Company to benefit once demand improves. A strong balance sheet and well-managed business operation allow us to take a sensible action and selectively increase our investments in product development and penetration efforts to insure that we continue to grow our share in the growing segment of standalone optical CD. We believe we have laid the foundation to enjoy growth once fundamentals improve.

Successful customer interactions have allowed us to define critical areas of differentiation for our products and we look forward to introducing new products and features during the year of 2009. While our near-term visibility remains low, our position within the industry has improved and we will continue to take necessary steps to ensure we have adequate financial flexibility to support our operations and development efforts.

With that, I would like to turn it to Dror for a closer look at the numbers. Dror?

Dror David

Thanks Gabi and hi everybody and welcome to our quarterly conference call. As Gabi mentioned, we continue to experience a slowing industry environment in the fourth quarter of 2008. This environment resulted in a 30% reduction in revenues relative to the previous quarter to $6.2 million in quarterly revenues. On the yearly basis, we witnessed a reduction of 33% in revenues from $58 million in 2007 to $39 million in 2008. The reduction in revenue in the fourth quarter and throughout 2008 was a result of lower demand for our integrated metrology products which are capacity driven. Looking at sales by territories, products revenues in the quarter had significantly shifted from US and Europe towards the east with Asia Pacific accounting for 78% of revenues in the quarter and the rest of the revenues coming from Japan.

On a yearly basis, we also witness a shift from the western regions toward the eastern ones as follow; Asia Pacific accounted for 68% of revenues in 2008 relative to 63% in 2007. US accounted for 18% in 2008 relative to 23% in 2007. Japan accounted for 11% in 2008 relative to 4% in 2007 and Europe accounted for 2% in 2008 relative to 9% in 2007.

Service revenues were similar to the previous quarter at the $3.2 million level. On a yearly basis, despite the tough market conditions, we were able to increase our yearly service revenues by 14% from $11.7 million in 2007 to $13.3 million in 2008. Looking into our gross margin performance excluding inventory write offs in all periods, blended gross margins declined from 34% in Q3 to 30% in Q4. Per segment, product gross margins have slightly decreased from 48% in Q3 to 46% in Q4%. While in the service gross margin, we saw an additional consecutive quarterly improvement from 11% in Q3 to 16% in the current quarter. On a yearly basis, our ongoing cost control initiative aimed to mitigate the turbulent shifts in revenues and the negative currency trends has enabled us to maintain the gross margins for each segment separately at the same level, 49% for products and 9% for services.

During the fourth quarter, we reduced operating expenses to $4.4 million, an additional 8% decline relative to the previous quarter and a 30% decline relative to the fourth quarter of 2007. On a yearly basis excluding one time charges, we were able to reduce operating expenses by approximately 20%. This figure understates our cost control accomplishments because of the unfavorable effect of currency fluctuations during the year. On a constant currency basis, we reduced operating expenses in 2008 by approximately 30% compared to 2007.

During the fourth quarter following the full recovery and the sale of our auction rate security investments, we reported a gain of $1.4 million. In terms of the bottom line, the Company reported a GAAP net loss of $1.6 million in the fourth quarter. Excluding non-GAAP items as detailed in the end of the quarterly press release, we reported a $2.3 million non-GAAP net loss in the quarter.

Cash flow wise, we reported a small negative cash flow of $0.7 million in the quarter as we focus on aggressive working capital management. Overall cash reserves at the end of the fourth quarter of 2008 were at the $20 million level and looking forward, we will remain focused on limiting the impact of the industry turbulence on our cash position. However, as Gabi mentioned, we also expect lower service revenues, supply chain adjustments and payments coming due.

In the previous conference call, we announced the cost reduction plan of $5 million on a yearly basis. The full impact of this cost reduction measure will occur in the first quarter of 2008 further lowering our cash breakeven point. As mentioned in the press release, we are continuing our fiscal discipline and we will take additional steps if necessary to ensure we are keeping proper financial flexibility to support our operation. Gabi?

Gabi Seligsohn

Thank you and with that operator, we would be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Neal Goldman - Goldman Capital Management.

Neal Goldman - Goldman Capital Management

At the current level with reduced service revenues, what do you believe your current burn rate is on cash? Obviously there was some receivable reduction last quarter and inventory reduction. So I am just trying to get a hand on the current burn rate.

Dror David

What I can say is that our cash breakeven point in terms of revenue is being reduced to around $8 million in the quarter.

Neal Goldman - Goldman Capital Management

Okay and on the insole, if you did $5 million on the quarter, you are burning $3 million essentially?

Dror David

Yes.

Neal Goldman - Goldman Capital Management

Okay, alright. Is there any, I mean, when you talk to the foundries or other sub-customers obviously in the near term there is no visibility. Historically when do these guys think that you should start seeing a pick up just because they are burning through who are not doing even replacement products?

Gabi Seligsohn

I think, reference to history these days with the new world that we are dealing with that is kind of difficult, I would say normal downturns; they have a much clearer answer. What I can say is as I mentioned that utilization rates have dropped quite significantly. We are talking levels of probably 40% to 60% utilization and fab; it usually runs at 95% to 100%.

So I think it is going to take a while until they bring up the utilization rates. What we do see though is that some of them are migrating to higher level technology nodes because of the economics of it and in some cases there are more orders coming for that type of technology. So I think it is probably going to take a while until the capacity increases come back. I cannot, obviously these days, give any sort of a forecast as to what I believe that is but with those levels of utilizations staying low, it is going to take a while. Another phenomenon that is taking place obviously is consolidations between foundries, maybe but more on the memory side to be sure, and over there, the capacity is quite significant.

So I think for the most part business in the next several quarter is probably going to be focused primarily around the development area, incremental buys will be primarily focused on allowing transition to higher technology. I think the Intel announcement of spending of several billions of dollars which is focused on dealing with existing fab and up scaling them is probably going to be the way people are going to try to approach the situation when they need to migrate to the next technology node and I think upgrade capabilities and scalability will be beneficial to those vendors including ourselves that are able to offer those.

So, I think it is going to be primarily focused on technology for a while and capacity related buys will probably take quite a while.

Neal Goldman - Goldman Capital Management

Okay. This is the last question, in terms of the introductions of competitive products; do you still feel you have a significant advantage with your current products?

Gabi Seligsohn

Yes, we do. I think and I am glad you bring that up. I think one of the nice things that happened over the last two years and especially in this past year, we mentioned in the press release that we have doubled the customer presence in the area of standalone and so far in all these activities, we have demonstrated real advantages with our tools and so it seems like we are able to maintain it. If you remember in the past, I did mention that we have chosen than a single area of differentiation because we believe that it is critical to have a few and there are four key areas that we continue to focus on and the product releases that we are planning for 2009 will involve improvements in those areas so that we could further position ourselves. So I am happy to take the answer from a technology standpoint. It seems to be quite good.

Operator

Your next question comes from the line of Robert Katz - Senvest Capital Inc.

Robert Katz - Senvest Capital Inc.

I have a few questions. What do you think your expected burn rate on cash will be for 2009 and how do you keep your balance sheet cash rich, if I can say that?

Dror David

First of all, our cash is king. You are absolutely right. We are not going to give guidance on expectation for the end of the year but suffice it to say, in general, that all the plans that we have, operational plans that we have for the year take into consideration possibility of industry conditions remaining very, very low and still maintaining a good level of cash so we can continue to be strong on two counts.

One is still invest in technology and two, demonstrate to our customers that we have a financial strength and viability to stick around. So the plan is such… it is obvious that there will be some cash earning. I will not say no but we are trying to control that to level that is not going to put us in any sort of the dangerous predicament.

Robert Katz - Senvest Capital Inc.

Sure. Do you have a feel for, it sounds like you are getting some good design wins with some new customers, what is their threshold for your balance sheet metrics are like do they care if you have $10 million or $20 million in net cash? Have you seen like that in the past issue? Is that no longer an issue because you have demonstrated that you have viable technologies?

Gabi Seligsohn

Well I think in this day and age, it is clear that people are more sensitive to different companies' balance sheets. I will be lying if I would say no. People are more sensitive to that and they look at it more but I can tell you that, first of all, we work closely with the customers. I spend most of my time in the field with fab management and supply chain management and the situation in that respect I think is quite good. They believe in the way the Company is being managed. They feel comfortable with our financial position and as much as we can share, we always do. We believe in that type of relation with them so I do not see that as a problem.

Robert Katz - Senvest Capital Inc.

How many employees do you have now?

Gabi Seligsohn

Two hundred and twenty right now.

Robert Katz - Senvest Capital Inc.

How does that compare to last quarter and last year at this time?

Gabi Seligsohn

Beginning of the year I think, beginning of 2008 I think we had 285 or 290 employees beginning of 2008.

Robert Katz - Senvest Capital Inc.

And last quarter?

Dror David

Two hundred and sixty five.

Robert Katz - Senvest Capital Inc.

And in Q1, it sounds like you are taking further cost measure?

Gabi Seligsohn

Well there is nothing that we are planning and it is obvious we do not share these kinds of plans anyway but there is nothing that is currently planned. What we are focusing on is operational cost, continue to manage operational cost and then as you saw in a very, very significant cut down in 2008.

Robert Katz - Senvest Capital Inc.

Sure and the shekel recently has gone back above $4 and almost $4.15 now. What impact does that have on US dollar reporting about that?

Dror David

Well evidently this has a positive impact on our expenses and most of our incomes are in US dollar then a significant portion is based around the shekel. So definitely we will benefit from that if it stays at this level.

Robert Katz - Senvest Capital Inc.

Do you hedge it or is that, you just have not disclosed?

Dror David

Well we were hedged at about 50% to 75% of the expenses on the first and the second quarter. The exchange rate for Q4 average was around $3.6 million to $3.7 million and the current exchange rate is 10% more so we should benefit in Q1.

Robert Katz - Senvest Capital Inc.

Okay and you decide to roll that forward. So that should start gradually going up forward the next few quarters.

Dror David

Yes.

Robert Katz - Senvest Capital Inc.

And just a broader question, it seems like in the near term industry as you said is not focused on capacity expansion but rather on technology advancement. Looking at your current business plan, what does that mean for you? Is that just less integrated stuff or more standalone? Is standalone basically technology play or integrated or is there also upgrades in integrated side? Can you elaborate on that?

Gabi Seligsohn

Yes, I think that is a very good question. We will try to give as much of a flavor as I can. Definitely the standalone type of business, one of the reasons we got in there in the first place is because of the fact that it does tend to be not just capacity related. Well a lot of it is technology related and so I do believe that the technology driving the industry will lean more towards buying a few standalone tools rather than a lot of integrated metrology tools.

Having said that, we do see some upgrade business both in 300 millimeter and in 200 millimeter within a greater metrology. I would say in the case of 300 millimeter since we have done I think quite a good job of putting a lot of tools out there already, well there are upgrades that are more related to technology advancement, for instance, such as the move to double patterning and the need to do more advanced etching processes. So we some interest in the area of integrated metrology for etch.

We also see it in high volume manufacturing in copper CMP and so there are some retrofits going on there. The other thing is in the 200 millimeter market, you can definitely usually ignore the 200 millimeter memory manufacturers for the purpose of ongoing business because those fabs, a lot of them are being decommissioned but there are fabs of discrete devices and logic as well as in the hard disk industry which we have been serving for many, many years that are taking incremental through orders for 200 millimeter and we are going back to what we saw very well several years ago which is process control for 200 millimeter.

We are doing it in some cases directly with the customers, some cases with our OEM partners and so there are opportunities over there. They are sporadic in nature. They can roll in that and they are very fab specific but a lot of work has been done in the last several months to qualify those opportunities and since it is a captive market for us, the 200 millimeter market, I believe there are chances and opportunities over there.

Robert Katz - Senvest Capital Inc.

And how many standalone systems did you sell in the most recent quarter?

Dror David

In the last quarter, we sold actually one system and recognized in fab in an Eastern foundry.

Robert Katz - Senvest Capital Inc.

Sold and recognized, and all of 2008?

Dror David

It should be five or six systems.

Robert Katz - Senvest Capital Inc.

And looking into 2009, do you expect that to grow or is that also at this time treading water?

Gabi Seligsohn

I think we have opportunities which are even more significant than that number. I think the biggest question is execution on the customer side, right? Meaning we have weighed the foundation for more through orders. Many of these tools were penetration as you can well imagine. Therefore most of these tools were penetrations and therefore the follow on business as what we are focused on primarily, they are more penetration targets obviously and I think it has a lot to do with suspending decisions that are made at the customer side.

If they will decide to spend, we have opportunities which are larger. I even say it is significantly larger than that number.

Robert Katz - Senvest Capital Inc.

Is there a risk section the industry is trying to do a capital freeze? Is that when the customers do come back to spend sort of a new game that is like kind of and they are putting all the equipment up for reevaluation or is that a risk?

Gabi Seligsohn

Reevaluation, well usually what happens with evaluation is that what you get tested on is the most advanced technology nodes that they are working on which are usually, in many cases, a distance from going to high volume manufacturing.

What we actually see is a combination of what they are planning on doing and what they are doing currently and in many cases, what happen is that we get backfilled into their manufacturing process and also demonstrate that we have capability for one or two technology nodes down the line. So, it is a possibility but I think it is a not a very highly probable possibility just because of the method by which customers conduct evaluations which are primarily forward looking because they are looking to possibly change vendors or go a different direction than they did previously and one of their condition usually is to have it looking significantly into the future so that they do not waste their time.

So I think that the risk there is small.

Robert Katz - Senvest Capital Inc.

You eventually doubled the number of penetration that would be for your customers. How many customers do you have now?

Gabi Seligsohn

We have 10 customers standalone.

Robert Katz - Senvest Capital Inc.

Ten customers for the standalone.

Gabi Seligsohn

Yes and then I include there the number of fabs is significantly higher because many of these are global. The customers are 10.

Robert Katz - Senvest Capital Inc.

[That is a significant change in your business in 2010, if one industry trends].

Gabi Seligsohn

We strongly believe so and that is why all the development efforts are continuing over there and I think Robert the key thing, and we have mentioned this in the past, is to bring the maturity of this technology called Optical CD to a level that it is easier to use and it moves more to mainstream and I think that is going to be the case. Our roadmap is going to be focused on that and if we can influence that, I think that the addressable market is growing because it is no longer a question that this is good technology, that it is necessary for high end manufacturing. Really what has been holding things today is the difficulty of using it, the time it takes, etc and we believe we have several advantages in that area and that is where we are going to focus things. So, I think that the foundations are all definitely there, the cash that we have, the presence that we have in most leading edge manufacturers. Really all of that is in place and as you probably know, with technology it takes time to even get to that position. Therefore we feel that there is a good trajectory opportunity here when things change direction.

Robert Katz - Senvest Capital Inc.

Well hold on to your cash as much as you can.

Gabi Seligsohn

We will. We will do. We have got it in peaches and hamburgers.

Operator

(Operator's instruction) You have a follow up question from the line of Neal Goldman - Goldman Capital Management.

Neal Goldman - Goldman Capital Management

In regards to the standalone, what is the average ASP versus the full metrology?

Dror David

It is ranging from 800 to 1 million.

Neal Goldman - Goldman Capital Management

Okay, so actually looking at opportunity, okay thank you. I appreciate it.

Operator

There are no further questions at this time. Before I ask Mr. Seligsohn to go with his closing statement, I would like to remind participants that the replay of this call would be available in three hours on the Company's website, www.nova.co.il. Mr. Seligsohn, would you like to make concluding statements?

Gabi Seligsohn

Yes, thank you operator. As stated, this is a difficult period. We expect the difficulties to continue for quite a while. As previously stated, the Company is in good position to capitalize on growth when it comes back. We thank you all for joining the call and hope to see you in the next quarter. Thank you very much.

Operator

Thank you. This concludes the Nova Measuring Instruments fourth quarter 2008 results conference call. Thank you in the participation. You may go ahead and disconnect.

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