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Executives

Claire McAdams - IR, Headgate Partners LLC

Timothy Stultz - President and CEO

Ronald Kisling - Chief Financial Officer

Analysts

Weston Twigg - Pacific Crest

Patrick Ho - Stifel Nicolaus

Mahesh Sanganeria - RBC Capital Markets

Thom Diffely - D.A. Davidson

Josh Baribeau – Canaccord

Nanometrics Incorporated (NANO) 2Q 2013 Results - Earnings Call Transcript July 30, 2013 4:30 PM ET

Operator

Good afternoon and welcome to the Nanometrics’ Second Quarter 2013 Financial Results Conference Call. A Q&A session will be held at the end of the call. Until that time all participants will be in a listen-only mode. Please note that this conference call is being recorded today, July 30, 2013. At this time I would like to turn the call over to you host, Claire McAdams. Please go ahead.

Claire McAdams

Thank you and good afternoon, everyone. Welcome to the Nanometrics second quarter 2013 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 second quarter and our perspective looking forward. Then Ron will discuss our financial results in more detail 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 P.M. Pacific this afternoon. The press release and supplemental financial information are also available on our website at www.nanometrics.com.

Today's conference call contains certain forward-looking statements including but not limited to financial performance and results including revenue, operating expenses, margins, profitability and earnings per share, customer and end use concentration and mix, tax rates, technology and product development and adoption and market share. 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 general economic conditions, changes in levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demands, shifts and timing of orders or product shipments, changes in product mix, our ability to successfully identify complete and integrate acquisitions to realize operating efficiencies and to achieve reduced tax rates and the additional risk factors and cautionary statements set forth in the Company’s Form 10-K on file for fiscal year 2012 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 the call over to Tim Stultz. Tim?

Timothy Stultz

Thank you, Claire and good afternoon everyone. We appreciate you taking the time to join our call today. Today, my prepared remarks will address highlights of our second quarter performance, progress against key long-term initiatives and guidance for the September quarter. Following my commentary, Ron will provide a detailed revenue of our second quarter financial results.

An increased spending by our largest customers resulted in a 41% increase in revenues over the previous quarter, with product revenues more than doubling quarter-over-quarter. Whereas we experienced increased business across all our semiconductor end markets rebound was primarily driven by increased spending in memory, both in NAND and DRAM, which combined are accounted for 45% of our total revenues.

Our non-GAAP gross margin of 43.8% was above the midpoint of our guidance supported by 500 basis point improvement in our product gross margin. Our total operating expenses were a little over than we guided to however our commitment to forward looking R&D investments remains intact, as we focus on next generation products targeted at expanding our business and gaining market share in key growth areas.

And finally with higher than expected revenues and lower than forecast expenses, our loss for the quarter came in a little better than in mid-point of our guidance range.

Turning now to our key business initiatives, we have some encouraging progress that I will now briefly highlight. First, in our drive to increase market share within the foundry sector, we received an order from a leading pure-play foundry customer in Asia, for Atlas II OCD system and NanoDiffract software. This platform will be used for 20 nanometer pilot production while also setting the stage for further onsite evaluation for next generation 16 nanometer devices.

We also received multiple follow-on orders for our IMPULSE integrated metrology tools from that same customer. As it begins the high volume manufacturing [fan out] of this product for 20 nanometer critical layer etch applications. And our UniFire gained additional traction in the pure-play foundry sector as well. With multiple tool qualifications in different global regions for both advanced packaging and front-end-of-line topography control on 20 nanometer devices. These wins helped raise foundry contributions to 26% of our total revenues while also growing our advanced packaging business another key business objective.

Now turning for the industry and business outlook, we continue to see a strong a second half 2013 over first half revenues. With customer forecast and build (Inaudible), we also see sequential quarterly revenue growth through at least the next several quarters with 2014 shaping to be a solid year of growth. This growth has been driven by investments across all semiconductor device types.

For our Logic business, we expect that revenues will benefit as the multi fab ramp in next generation technology takes place. We believe further growth in our memory business will be driven both by investments in next generation devices as well as capacity expansions to meet growing mobile device demand.

And we expect further growth in our foundry business as we make new inroads into several areas of pure play foundry applications and benefit from the fan out of our integrated metrology business. Although upticks in our business will continue to play out over the next few quarters, we expect much of our revenue growth in this cycle to take place in 2014 and beyond, due to the timing of customer investments, installations and revenue recognition.

The timing of this revenue growth also means that our return to profitability will likely be in Q1. In the meantime however our business is expected to be cash flow positive before investments and working capital in the fourth quarter.

In summary, we are very pleased with our progress against our key initiatives to grow our business and shareholder value. Our OCD leadership position in advanced logic and memory markets remains intact. Our focused efforts to penetrate the foundry market are bearing fruit and our position in the emerging market of advanced packaging is gaining further traction.

We are also very optimistic about our long term business outlook and ability to outperform the industry during the next investment cycle. As our customers increase their spending on process control technologies to help solve the most demanding leading edge challenges for the next-generation devices.

As new technology inflection points create demand for higher performance process controlled tools and new applications. As our served emerging markets continue to expand and grow and as our efforts to gain market share at strategic accounts are successful.

With that, our outlook for the third quarter is revenues ranging between $36 million and $40 million up 4% to 16% over last quarter. Non-GAAP gross margin are 43% to 47%, operating expenses to be up $0.2 million to $0.9 million from Q2 and non-GAAP loss per share of between $0.03 and $0.14 Ron?

Ronald Kisling

Thank you, Tim, and good afternoon. Before I begin my comments I'd like to remind you that a schedule which summarizes GAAP and non-GAAP financial results discussed on this conference call as well as supplemental revenue segment information is available in the investor section of our website.

Second quarter revenues were $34.6 million, up 41% from Q1. Product revenues increased to 103% to $26.5 million compared to $13.1 million in the prior quarter driven by growth in sales for automated tools which comprised 68% of total revenues. Materials Characterization revenue was down 75% from the prior quarter to comprise 4% of revenues after an unusually strong first quarter driven by a small number of relatively high ASP tools to silicon wafer manufacturer in Asia.

Integrated Tool revenue was down 18% from the prior quarter and comprised 5% of total revenue. By end market, the largest increase occurred in memory which increased fivefold to comprise 45% of total tool revenues with increases in both DRAM and NAND. Sales into the logic end market increased 93% to comprise 22% of tool revenues on increased purchases by one of our largest customers. And sales into the foundry segment 198% to comprise 26% of tool revenues.

Revenues into the LED silicon wafer and discrete end market were down 75% and comprised 5% of total tools revenues. Total service revenues declined from relatively high levels in the first quarter due to the decline in upgrade revenue. By customer, revenues to Intel comprised 25%, SK Hynix 23% and Samsung 15% of total revenues.

Turning to other P&L metrics, my prepared remarks regarding income statement will refer to non-GAAP measures unless identify the measure as GAAP base. These measures exclude the impact of amortization of acquired intangible assets. Our Q2 gross margin came in just above the midpoint of our guidance range at 43.8%. This was an expected decrease from 45.4% in Q1, primarily due to lower upgrade revenue. Product gross margin improved to 44.1% from 39.1% due to the benefit of higher revenue levels against fixed manufacturing costs and service gross margin declined to 42.7% from 52.5% due to lower upgrade revenues compared to the prior quarter.

Operating expenses increased $0.6 million in Q1 to $20.4 million, approximately $600,000 under the low end of our guidance due to the timing of certain consulting expenses and accrual reductions in G&A. All of the increase over Q1 was in R&D spending with small declines in SG&A.

Our GAAP tax benefit for the first quarter was $2.4 million, representing an effective tax rate of 34.6% and our net loss for the quarter was $4 million or $0.17 per share compared to a loss of $5 million or $0.22 per share in the prior quarter.

At June 29, our cash and investments declined to $86.3 million or $3.72 per share. After the end of the quarter, we paid off our mortgage of $4.8 million and as a result, you will notice that the entire balance is reflected as a current liability in the June 29 balance sheet. Our DSO increased to 84 days, up from 72 days in the prior quarter due primarily to an increase in deferred revenue on shipments that were not recognizable at the end of the quarter.

Inventories declined $3.4 million to $41.7 million at the end of the second quarter and our tangible book value was $184 million or $7.93 per share. We ended the quarter with headcount of 533 employees, a net increase of nine employees from the prior quarter.

Commenting on our guidance for Q3, our gross margin guidance range of 43% to 47% reflects our expected increase in product revenues and relatively flat service revenues. As Tim mentioned, operating expenses are expected to be up $200,000 to $900,000 and we expect our operating expenses to remain relatively flat at these resulting levels for the remainder of 2013. And for 2013, as a whole, we expect our effective tax rate to be in the 36% to 38% range.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Weston Twigg from Pacific Crest. Please go ahead.

Weston Twigg - Pacific Crest

First one I had was just wondering given Samsung’s aggressive CapEx commentary for the second half, I am wondering why you weren’t able to guide a little bit higher for Q3. I assume part of it might be revenue recognition timing, but I am wondering if you see reasonable path for upside to your guidance if Samsung comes in as aggressive as they implied last week.

Timothy Stultz

It’s Tim. I think the issue is more about the timing of the spending for a Samsung and compounded by some revenue recognition. If we send to some new regions, we obviously will have a delay between shipment and revenue recognition, but also I think if there is still some uncertainty as to when Samsung will spend the balance of its money whether it’s Q3 or more heavily weighted in Q4.

Weston Twigg - Pacific Crest

Okay. And is that also give you some conviction to the returning profitability by Q1 2014, is that may be some of the spend could happen in early next year or at least the revenue recognition piece of it?

Timothy Stultz

Yeah, that’s primary the way it is. If we look at the -- we feel really good about where the business is. We feel really good about the order flow, and I know visibility, but as you know Samsung is building some new factory in China which is a new location for us, so any tools going into that facility will have a slightly longer revenue recognition profile than our typical products going into Korea.

Weston Twigg - Pacific Crest

Okay. And then sound like in the quarter Hynix was the strong customer 23% of revenue and do you see, I guess income on Hynix specifically, do you see the memory spend actually holding up fairly well in September and December, maybe increasing in each of those quarters?

Timothy Stultz

I mean certainly memory is getting strong for us again, it is coming back both in DRAM and NAND. There is some fabs, that are being converted from NAND to DRAM. We are seeing investments in capacity in DRAM and we are seeing some investments going into the new technology on flash. So if you kind of look at the balance between the spending in the first half and the second half of all our key customers are primary customers. You are seeing that our revenue opportunities first half to second half kind of track the spending patterns.

Operator

Our next question comes from Patrick Ho from Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

Tim maybe just a follow-up on the last question about memory CapEx spending. As we go through the second half for the year, maybe just first a little bit of granularity of 3Q and maybe just the outlook for 4Q, do you see a bias towards DRAM or NAND booking a term and into 4Q or is that mix is going to be pretty steady on both fronts through the rest of the year?

Timothy Stultz

I don’t know if I use the word steady which has actually been a shift, I mean DRAM is coming off of a some pretty very low numbers and even with the boost in the DRAM business for us which has been quite substantial relatively like the quarter-on-quarter, it is still below the historical levels. If you look at go back a couple of years, half of our business was not only memory and half of that was split between DRAM and NAND. We still see NAND being more of a driver in the total memory side.

Patrick Ho - Stifel Nicolaus

Maybe just on the foundry side, so you talked about some of the new wins you had and some of the qualifications that you are going through. Are they revenue recognition timing issue related to that as well given that these are I guess some new breakthroughs and this going to take longer and that's why you are talking about, maybe I guess some of the revenues more into the early part of ‘14 versus the second half of this year?

Timothy Stultz

Yeah, that also plays into, that's a good point, Patrick. It plays into because if you elected the two key areas I mean clearly with our established business with our key accounts that have been our 10% customers going into similar factories, similar applications, we have a straightforward revenue recognition pace and rhythm. If you look at shipping products into a new country like China or if you’re looking into a new customer where you need to establish a pattern of tool acceptance then that pushes (inaudible) a little farther from the actual tool shipments.

Patrick Ho - Stifel Nicolaus

And maybe again, maybe not specific on the customer, but how long does it usually take from when again, I guess you are announcing some of this today, how long does it take for the revenue recognition in terms of timing versus when you get in so when you can actually recognize it?

Timothy Stultz

That’s kind of a two-pronged answer to that question. So the first one, if these are tools if we take like Samsung in China and we're shipping to a new factory with an established customer and a similar application, then the typical revenue recognition really is tie to giving the tool itself, running the process and giving sign up on that application. And it's repeating the pattern, we've been through before. So, that's either one to two month period.

If you take a brand new customer, we're making new in-roads into the new customer, new location and new application then that whole process to get through full sign-off could be anywhere from three to six months depending on whether it’s a product evaluation, it's gone from technology development to $6 to high volume manufacturing or whatever the stage in process is.

Patrick Ho - Stifel Nicolaus

Final question for me, in terms of some of these new foundry breakthroughs, that's an area where one of your logic competitors has a pretty strong foothold in, have you seen any competitive responses which has impacted potentially pricing or other variables on your front?

Timothy Stultz

So you're absolutely right, it's been a tough battlefield as you know and we've been fighting tooth and nail for the last several years if not three to four years but most of the battle is on performance. We don't spend a lot of time, fortunately talking about price, in fact price is not, this market is not elastic. And so customers are not making huge decision based on 10% or 20% price swings, what they do care about are 10% to 20% or better performance as well as your ability to support and your experience in a particular area in one of the things that is important and plays well for us is we have a ton of experience in the thin fab technology we having OCD product into high volume manufacturing and as other customers begin to adopt that technology I think we have a compelling argument that says our experience plus our tool can reduce the risk for our customers and get them to higher yields and enter production faster.

Operator

And our next question comes from Mahesh Sanganeria from RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you. Tim can you talk a little bit about the material characterization transaction with business that's falling 75%, so and also it would be, the it was down quite a bit for 2012. Do we see another down year here for the overall and how we should we think about, where should that be at new reality level should be?

Timothy Stultz

That’s a great question, Mahesh. What's the new reality? Let me just put a little color on what our Materials Characterization group and the best way to understand is to look at what market it serves. So if we look at the business product lines, one of the biggest drivers, historically back in 2011, was there is silicon way for defect inspection. When they were adding capacity to make (inaudible) and blank wafers and that’s a big driver because it's built on a high ASP product as well as a good customer side where we got very strong market position.

Second market that has helped us through business was the LED and we have a LED product going out when there was a ramp in capacity and volume in that space and the third primary market that’s being served is the solar business, and so if we kind of look at those in reverse order, not a lot of capacity has been put in to, new capacity has been put in to bare silicon wafer, but we got a nice boost last quarter when we got some one quarter a bump in the defect inspection for bare silicon wafers.

LED market has been in the tank. Solar market has been worse than in the tank and so I think that there is some benefits that are going to come out of some improvements in the LED market. I don't know what the timing will be on bare silicon and we are doing some other things with our products to address some of these scientific instruments business to try to restore and bring up the MC business.

Mahesh Sanganeria - RBC Capital Markets

Okay. I get the picture and then on the upgrades, I mean your services revenue went from 11.5 to 8 and I mean excluding the upgrades services business I would assume should be pretty steady, and should be getting by the considering the utilization improving, what would be the linearity on that upgrade business, how should that be, I was thinking may be something couple of $1 million to $2 million per quarter but looks like you didn’t have much in the June quarter and so how is that going forward?

Ronald Kisling

Mahesh, this is Ron. So the upgrade business that we said before it tend to be pretty tends to fluctuate quite a bit from quarter-to-quarter and it typically ranges, low end just under $1 million between $0.5 million in a million of the low end, we got a couple of really strong quarters at about $4 million. So it does fluctuate quite a bit. And so it's hard to predict when those come in and typically what happens is your customer will be fleet upgrade which is why a it tends to come in big chunks, in terms of sort of the core service revenue, I think your point is most of the change quarter-over-quarter was solely upgrades and the core service business is relatively flat over the Q1 to Q2 period.

Mahesh Sanganeria - RBC Capital Markets

Okay. And then on systems business you had pretty strong logic quarter, is that near term peak or does it grow from here, how is the linearity on the logic business?

Timothy Stultz

I think one way to look at it, the Logic business the (Inaudible) business is driven by one large customer and that large customer has multiple fab fan outs which are sequential and so it’s not a smooth and up until to the right quarter. So as you see them populate new fabs and they will get increase and as they shift over to the next fabs sometimes they're so small dip and then you'll see another increase as and they go to the next fab and there's multiple fabs, so it won't be a smooth quarter on quarter increase but will - we do expect to see some strength in that part of our business and some strong quarter is going out on the outside.

Mahesh Sanganeria - RBC Capital Markets

Okay, that is very helpful, thank you, Tim.

Timothy Stultz

Okay, Mahesh.

Operator

Thank you. And our next question comes from Thom Diffely from D.A. Davidson. Please go ahead.

Thom Diffely - D.A. Davidson

Yeah, good afternoon. And first maybe a clarification on your good and nice foundry order, is this the first time you I guess sold or standalone OCD tool to the LED foundries?

Timothy Stultz

So this particular foundry, it’s the first time we've sold standalone automated (Inaudible) OCE tool to this particular customer.

Thom Diffely - D.A. Davidson

Okay, and then what is the timing and how long is this product lines supposed to last, and when does it go to full manufacturing at that point what is the revenue opportunity?

Timothy Stultz

Well, I can't size the absolute revenue opportunity at that customer but there are couple of things going in parallel with a possible split between one is there is private line evaluation of tools and the beginning of transfer to a manufacturing for the 20 nanometer, there's also going to be a decision point when they look at what tools they'll carry forward from the 20 nanometer into the 16 nanometer and whether or not any change is going to be made. Those two decisions should both be made within the fourth quarter. The pilot line going to high volume manufacturing for 20 and then technology development going into pilot line for 16. We would like them to be as soon as possible, but we're actively supporting and we think we have a short at the business.

Thom Diffely - D.A. Davidson

Okay. So was this an unexpected order in a sense that, it seem like the bigger opportunities have always been when we move to finFET and so 20 nanometer seemed like it there was a bit more of long shot in this 16 nanometer node?

Timothy Stultz

Yeah. I would say it's not, it wasn't totally unexpected. But I didn't my under/over on it wasn't the as high as it is on the 16 nanometer. So we didn't spend a lot of time talking to it, to me that's all upside against our primary focus which was to get into the 16 nanometer finFET business.

Thom Diffely - D.A. Davidson

Right. Okay, thanks. And then Ron when you look at the model, what is your current estimate for a breakeven?

Ronald Kisling

Joe on a P&L basis, our breakeven is mid 40s and on our cash flow breakeven before investments in working capital is a high 30?

Thom Diffely - D.A. Davidson

Okay. So, I mean, it sounds like with the ramp (Inaudible) from the two of your three biggest customers that there should be sequential revenue growth again in the fourth quarter. And so it seems to me that there's pretty good chance of getting back to breakeven in the fourth quarter. So I'm just curious if you're seeing some seasonality in other parts of your business that might offset then?

Ronald Kisling

Yeah. I think the seasonality that we see, I mean typically, we have seen Q4 being a little bit lower, but I think you've got the [overlying] demand which is driving increases in the second half that we expect to continue to through to Q4. And though we haven't given specific guidance on Q4, I think Tim's comment is that with the timing of revenue recognition on some of these tools is that profitability maybe after the first quarter.

Timothy Stultz

So Tom I want to be really clear that we do see sequential growth quarter-on-quarter going forward and the issue is the magnitude of the growth against the breakeven points. And if things got really robust and super strong in the fourth quarter, we will have to see where it takes us. We are very close to where that. We tend to have the cusp of all those transitions, small perturbations make big, have big impact on the bottom line as you get very close crossing the line from losing the money to making money, but I think what's important is the business has continued to improve. We are seeing increased spending across all of our sectors at little sequence and timing, a little bit of. We are seeing a little bit of strength in their terms strengthen in the logic as we go into Q3 and we see more strength in memory going into Q4 and we see combined strength going into Q1. So we just feel more confident talking about Q1 and we will do our best to pull it in as always possible based on our customer spending patterns.

Thom Diffely - D.A. Davidson

Okay. So when you look at the business over the next couple of quarters, in the current quarter you had 60% in your top three customers, do you expect most of the business is driven by growth in those top three customers or you see a little bit of broadening of the customer base as well?

Timothy Stultz

Most of it still be driven by those three customers but we like to see. When we look at our the pattern of our business against the customer spend, we are seeing a very close parallel between the ratio of what they spend first half and second half and our business from them second half and first half again second half with a notable exception of a pretty significant uptick in our foundry business based on some inroads we are making up here on pure play foundry. We are coming up a low number there, but that one will not track their spending patterns because that's all about market share gains for us.

Thom Diffely - D.A. Davidson

Okay. Final question. Are you still comfortable with your kind of low to mid 50% gross margin range on a longer term basis and do you think anything happens on an operating expense side to hurt operating margins going forward?

Timothy Stultz

So I absolutely do feel comfortable in that gross margin range. That’s where we need to be. We're absolutely driving our product. What we call our standard product margins will support that is really getting good factory absorption, making sure we don’t have any usual mix issues. Our total service margin, even though our upgrades drop down, we're still above 40% and that’s a pretty solid number of contribution from the service margin. Product margin is improving. We will get to where we need to be. We're absolutely committed to that. We are not having price initiatives. It's not about pricing. It's really about growth, volume and factory absorption.

In terms of our spending, right now our focus is on the account penetrations and gaining some traction and new account activities. There are some programs that maybe temporal in nature, but we won't roll those up until we've completed the development of the tools and technology, the applications and we've secured the positions in the market we're going after. If we do that and it turns in to more sustaining opportunities, then you will see that we have an opportunity to kind of grow this business without increase in any of the operating expenses and they may even come down somewhat.

Operator

Our next question comes from [Edward Mark] from Needham & Company. Please go ahead.

Unidentified Analyst

First question. Tim, I think on the press release and on the call you talked about some of the software products that are you selling in to (inaudible) product module maybe coming in 2014, would that help drive your gross margin or your product gross margin back to you normal range?

Timothy Stultz

The software side in our upgrade business always helps drive it, but the core factor for us is we look at a couple of things, when you had a low revenue base by year in product revenues against your service margins then small product base is an upgrade and service have a bigger impact on your total margins. As we grow the product revenues which will occur as our key customers continue to spend, we absorb the fact, we’ve then what really is the big stick moving the product margin or the total margins or the product margins. So they are nice adders on the software, they are great margins on the software, we get great margins on upgrades, but we need to the way we solve this problem is to increase our product revenues and improve those product margins grew factory absorption.

Unidentified Analyst

And then on this IMPULSE one that you talk about on at a pure-play foundry, is that a new customer that you (inaudible) customer that guys are winning that you already have integrated in a product and you are winning additional products?

Timothy Stultz

That with a new position for us.

Unidentified Analyst

And then lastly I guess some of the customers talk about 3D NAND as a technology they are pursuing right, one of them obviously a very large customer of your right, I was wondering how do you guys think about your market opportunity as NAND producer goes from 2D to 3D and not specifically on OCD do you see that as upgrade driver for OCD’s come similar to what we talk about for thin film.

Timothy Stultz

Yeah. We right now it’s a little tough because nobody is really launching the full production and so it dust hasn’t settled on the utilization rate, but our first looks at this suggest that there will be incremental use of OCD going from per 10,000 acre size going from the planner devices into the vertical devices and we think that is going to improve the size of our submarket, but we really don’t know that until we start ramping manufacture and find out where the problems are and where they need to dial in more process control.

Unidentified Analyst

Actually that is very helpful, so it sounds like actually you stop ramping production there might be a incremental opportunity that gets added to this production or this new device, is that correct?

Timothy Stultz

Yeah, I think that right now when we look at the number of potential applications for OCD in the vertical devices we see a large number. When we look we’re using our tools they help in the technology development. We see a large number of applications, but in the end the customer will if they have a 150 to 200 steps whatever is, they will use process control to get the production going to get there to the yield and then what will happen is if there are particular steps that are well under control that they don’t have ability they may reduce the use on process control. So I would say it looks like it is going to be more in higher multiple, but kept that until they actually start doing some real part of production on it.

Operator

Our next question comes from Josh Baribeau from Canaccord. Please go ahead.

Josh Baribeau – Canaccord

You talk a lot about market shares use with your larger competitor or the company that happens to be larger. If I follow the revenue trend of the smaller competitor, it looks like historically been what’s called about half of what your sales had been and then recently it is looking like they are creeping up towards something like almost even to talk about some of things you are seeing there from a competitive standpoint and maybe the changes that are happening there?

Timothy Stultz

Yeah, I don't know that that I would agree that they are coming roughly even to our base, our revenue levels, I'm not sure how it occurs in that one out Josh. But in terms of the competitive environment, they've done as you know they have a very solid position in integrated metrology, which is a large part of their business, we are doing our best to gain some market share in that space. On the high end OCD automated tools, we can compete against the larger company and then there are some things in the middle. I think we are holding in our own in all of our major accounts. I feel very confident we haven't lost any market share in our established accounts and I think we are, we can point you that is we are gaining market share both in IM and in standalone.

Josh Baribeau – Canaccord

Okay. And more on the P&L side, should we think of the increase in R&D is something more, something longer term going forward as these tools require or become more complex as nodes and processes become more complex or is this really a push to gain market share at really one large customer that you are trying to win?

Timothy Stultz

The majority of the increase which represents about a 10% increase in the spend in R&D was really focused on develop some platforms that helps us penetrate from the accounts where we weren't as well as to address some technology inflection points. So I think as those have become success, well because they were required investments in our both the platform as well as the application support for their platform, is they have application development. I think that we get more into a technology evolution and sustaining mode and there may be some opportunities for that to come back a little bit next year.

Unidentified Analyst

Okay, now if I look at where a lot of the memory spends is happening at least so far this year it’s a lot of conversions and I think you alluded to that a little bit earlier. I would sort of have assumed that a lot of the conversions would be more of a service or software upgrade but seeing as how that business is falling is it more, is it proper to think that that's more new buys versus the upgrades for those DRAM conversions?

Timothy Stultz

Yeah, those are definitely some new buys and when we say conversion we are typically talking about fab conversions maybe NAND, fab going to DRAM. DRAM is more difficult process sequence requiring additional tools so when they convert from NAND to DRAM we will see incremental tool demand and the other is most of our upgrades go into the older fleets to give them sustained productivity and to give them sustained productivity in their older technology nodes.

We are pretty fortunate. We haven't really had a lot of exposure to tool reuse and so it’s really a population of new capacity, fab conversions and NAND technology development.

Unidentified Analyst

What about mDRAM from PC2 let's call it mobile DRAM, is there any need for any new buys there?

Timothy Stultz

Yeah, most of the business we are addressing is in terms of within the DRAM market is for the mobile DRAMs devices. We are seeing that, that's got a higher demand than the obviously weak PC market and the DRAM is associated with the PC world.

Unidentified Analyst

Okay and just finally for me I think you had mentioned that NAND and DRAM combined are I think 45% or 46% of the sales this quarter. Could you break that out between each, between NAND and DRAM?

Timothy Stultz

So between the NAND and DRAM, I am just looking up to make sure I say it right here. So in the second quarter, DRAM represented 16% of the revenues and NAND was 29%.

Operator

Thank you. (Operator Instructions) And our next question comes from Robert (inaudible) from Semiconductor Advisors. Please go ahead.

Unidentified Analyst

Hi, quick question. You indicated in your presentation and KLA did in theirs that process control increasing as a percentage of overall spend overtime. In the near-term, obviously the shift to 3D and thin fab should likely cause a near-term increase. Would you view that as a sort of two to three year bubble of increased spending to get over the hump of the change to 3D technology or will this be an ongoing higher growth rate of process diagnostics as a percent of overall wafer spend. That's first question.

Timothy Stultz

So I expect there are two elements to that, Bob. One is that process control, investment process control usually is higher during a new technology phase or a new node. So if you look at our spend pattern through the development, going into whether it's a 28 nanometer, 20 nanometer, you will see process control intensity higher at the front end and you see more process tools in the back end. So there is timing with any of these ramps but on top of that, I do believe process control as a total expenditure within a fab and a technology node is increasing as we try to squeeze, our customers try to squeeze more performance out of the giving tool sets, where a lot of innovation has in essence taken place.

Unidentified Analyst

Question is that the conversion to 3D increased at rate of change or do you think it’s just once we get over the hump of the change that it goes back to sort of normal increasing pattern?

Timothy Stultz

No, all I see which is -- I think there is a normal increase in pattern, there will certainly be some increase spend on process control as they try to figure out what to do to get deal. So we always see especially on the technology development side we see a large commitment to a new tool as a sort through a myriad of questions of where the yield issues are then and that maybe what you are talking about a bubble or maybe an overspending gains what they will be in a more sustaining mode. So I think against the backdrop of continuing increased intensity in process control, there will be when you have a large architectural change, you will see an incremental spend at a beginning stages just as we did in thin fab.

Unidentified Analyst

And second question, if I would categorize sales as share gains capacity buys or technology buys, of course your six different product lines, can you kind of, I know it’s hard to categorize it, obviously because it’s a mixture of all three to some extent. But could you give us some ideas as to what's driving your different sectors, where you think you have the best opportunity with share gains, where the best opportunities for capacity and where the best opportunities for technology wise in your product offerings?

Timothy Stultz

Yeah. I try to answer that in a kind of a straight forward way, our business in advanced logic and our business in the memory market we have a solid leadership in each of those and it’s really defending those market positions and supporting our customers as they go to the next generation devices and next technology nodes.

When I look at our foundry business, we have to look at the difference between captive and pure play. We actually have a strong position in the captive foundry market and captive logic in foundry but we are making inroads into the pure play foundry and in the pureplay foundry we believe that most of the growth and benefits to the company will come from market share gains.

Operator

Thank you. I am not showing any further questions at this time. I would now like to turn the call back to Timothy Stultz for any further remarks.

Timothy Stultz

Okay, thank you once again for participating in our call. I close by thanking the employees and business partners of Nano who are the real champions behind the scene and deserve all the credit for any success we enjoy. We look forward to reporting on our results of our operational and financial performance for the third quarter of 2013 this coming October.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.

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