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Electro Scientific Industries, Inc. (NASDAQ:ESIO)

F1Q11 (Qtr End 07/03/2010) Earnings Conference Call

July 28, 2010 5:00 PM ET

Executives

Brian Smith – Director, IR

Nicholas Konidaris – President and CEO

Paul Oldham – CFO

Analysts

Jim Ricchiuiti – Needham & Company

Tom Diffely – D.A. Davidson & Co

Mark Miller – Noble Financial

Kelly Anderson – Sidoti & Company

Shawn Boyd – Westcliff Capital Management

Operator

Good day ladies and gentlemen and welcome to the ESI fiscal 2011 first quarter earnings conference call. My name is Christine and I would be your operator for today. At this time all participants are on a listen only mode. Later, we will conduct a question and answer session. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I will now like to turn the call over to your host for today Brian Smith, Director of Investor Relations. Please proceed.

Brian Smith

Thank you Christine and good afternoon everyone. My name is Brian Smith, Direct of Investor Relations for ESI. With me today are Nick Konidaris our CEO and Paul Oldham, our Chief Financial Officer. This conference call will cover our fiscal 2011 first quarter results. Before we go into the details of the call I would like to remind you that some of what we say on this call will include forward-looking statements concerning customer orders, shipments, revenue, gross margins, expenses and earnings.

These statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include a number of risks and uncertainties that are discussed in more detail in today’s press release and our filings with the SEC. Actual results may differ materially from those forward-looking statements. This call also contains time sensitive information that we believe to be accurate as of today, July 28, 2010 and which could change in the future. This call is the property of ESI.

Now, I will turn the call over to our CEO, Nick Konidaris.

Nicholas Konidaris

Thank you Brian. Good afternoon and welcome to our first quarter conference call. This was a very good quarter for ESI. We saw a strong demand across all our product categories. Revenue more than doubled from last year and we generated excellent operating cash flow. In addition, we began to see activity in our memory repair business. Our products continued to gain our share in key accounts and we recently launched the first of several new products this year, the 9900 ultra-thin wafer dicing.

However, gross margins and offer (ph) stability were impacted by unfavorable mix towards older products and sales of existing finished goods of inventory particularly memory repair. Revenues for the quarter were $58.5 million, down slightly from last quarter. Non-GAAP earnings per share were $0.03. Paul will go into more detail around the financials in a moment.

We generated $64 million of orders, compared to $54 million last quarter. The increase was driven by demand for memory repair systems as we saw orders from multiple customers. We’re pleased that after the long drought we are beginning to see the memory market investing again in repair. We also saw strong results in flex interconnect, passive component test and LED wafer scribing. And we received several follow-on orders for our advanced micromachining products.

Revenues in our semiconductor business were $90 million, up dramatically from last quarter and last year. The key driver of cost was a return of our memory repair business which accounted for over $10 million in revenue. In addition, in our LED business we saw strong revenues as we have acceptance of several AccuScribe Systems and one large comparative order in China.

Looking forward in our semi business. We expect to see a continuing improvement in the memory repair market driven by strong growth in PCs, servers and smartphones. In addition, all of our customers have recently announced increases in capital spending related to memory. Although all the quarter levels maybe choppy over the next few quarters as customers begin to up capacity and implement new technology. We are confident this will once again be a healthy long-term business for us.

Separately, we expect the LED scribing and LCD repair businesses to remain solid. We are also excited to enter the silicon wafer dicing market with introduction of our new model 9900 ultra-thin wafer dicing system which we announced two weeks ago. This system solves a fundamental problem plaguing the industry as it moves to our three dimensional packaging and stacked dice.

On still to-date that has been no effective solution to dice wafers that are thinner than 50 microns. Our model 9900 is specifically targeted for this application and it moves the aside into attractive adjacent market. Customers are currently evaluating the 9900 for new 3D applications and we expect to see meaningful progress later this fiscal year.

Our interconnect and micromachining group had another strong revenue quarter at $21 million after record setting revenues last quarter. With NIMG (ph), revenues in our flex interconnect business were particularly strong driven by continuous robust seasonal demand. In addition we saw customer acceptance of our new 5330xi which provides faster throughput and higher accuracy for SAB (ph) 70 nanometer VS. Looking forward we expect this business to continue to perform well driven by strong growth in consumer electronics.

We also had another good quarter in our advanced micromachining business. We received follow-on orders for the 5900 in multiple applications and received many additional opportunities for this platform in the future. We’re excited about our long-term growth potential as we expand our capabilities in glass, new generation PCBs and 3D devices.

Revenues in our passive components group were $19 million, the highest quarterly revenue in over two years as we shipped and gained acceptance for our newest high (inaudible). Orders were lower than the last two very strong quarters but still reflects healthy markets and good customer demand. Looking forward, we believe that the end markets driving passive component demand are healthy namely smartphones, PCs and high definition TVs. As such, demands will remain solid but would be down in the short-term as capacities absorb into the market.

Before turning to the outlook for ESI, let me just comment about gross margins. While we are not happy with gross margins this quarter, we believe that the factors overall lower margins are transitional images (ph). In addition, we were able to monetize adjusting inventory to mid customer demand. Looking forward, we’re confident that trends in our topline, and mixed our newer products and efficiency gains from globalization will enable margins to rebound next quarter.

Turning now to the outlook for ESI. After many quarters in the desert we are pleased that rain has began to fall again in the memory repair market. We mentioned before that this business is one of the key drivers to our growth in fiscal 2011, along with continued economic recovery and market expansion through new products such as the model 9900.

These drivers will take effect over the next several quarters. In the short term we expect revenues around the current level as we continue to see some choppiness in our markets. For the second quarter we expect revenues to be between $55 million and $60 million and non-GAAP earnings per share of $0.05 to $0.10.

Now I will turn the call over to Paul for detailed discussion of our results for the first quarter.

Paul Oldham

Thank you Nick and good afternoon. The following information includes results from our first quarter of fiscal 2011 which ended July 3rd. To improve comparability we are also providing earnings per share and related income statement results on a non-GAAP basis excluding the impact of purchase accounting, equity compensation, restructuring expenses and non-recurring items. Orders for the first quarter were $64.1 million up 18% from the prior quarter and more than double from last year.

As Nick mentioned, the sequential growth was driven mainly by the resumption of demand in the memory repair business and reflects our highest order levels since Q3 of 2008. In addition we had record LED scribe orders driven by a large competitive win for AccuScribe System in China. These increases were partially offset by the timing of service contracts and lower passive component orders as the customers installed and absorb new capacity.

Shipments in Q1 were $56 million compared to $66 million from the previous quarter which included the shipment of the large micromachining order received in Q3. Excluding the shipment of the large order last quarter shipments increased over 30%. With strong growth in passive components and memory repair. In addition, in both of these businesses, we were able to ship a significant amount of existing finished goods inventory. Ending backlog increased by $8 million to $49 million due to the strong bookings in the quarter.

Deferred revenue decreased by $2.6 million and is consistent with historical level. Revenue for the first quarter was $58.5 million, compared to $59.6 million in the prior quarter. Our book-to-bill ratio was 1.15 to 1. Gross margin for the first quarter was 37% including $570,000 in cost of goods sold for purchase accounting and equity compensation. On a non-GAAP basis gross margins were 38%, down from 44% last quarter. The decline in gross margin was driven primarily by a shift in mix towards our traditional flex drilling systems, component test and inspection tools and lower margin older memory repair systems.

In addition, we had increased sales from existing finished goods inventory particularly in our memory repair business. This allowed us to utilize existing inventory but at a cost. Not only do these products not absorb new manufacturing expenses but they also required effort to reconfigure and update. While we believe this was the right trade-off that contributed to strong cash flow, it negatively impacted margins in the short-term.

Looking forward we expect gross margins will largely recovered next quarter as the mix shifts back towards newer products and we ship more from current production. Over the longer term we are committed to achieving our gross margin objectives as we introduce new products and execute our ongoing actions to lower costs through globalization.

GAAP operating expenses were $23.1 million, down slightly from the previous quarter. Included in the first quarter’s operating expenses were purchase accounting and amortization of approximately $225,000 and stock compensation of $2.6 million. Increased stock compensation this quarter was due primarily to accelerated vesting of our annual board grants as we had got it previously.

Also included in operating expenses was a onetime credit of $900,000 related to the closing of the final escrow for our New Wave Research acquisition. Excluding the impact of these items, non-GAAP operating expenses were $21.1 million, down $0.5 million from the prior quarter. Increased R&D spending to drive new products was more than offset by reductions in other operating expenses. Looking forward we expect non-GAAP operating expenses to be between $22 million and $23 million due primarily to the impact of annual merit increases and increased project expenses related to new products.

On a GAAP basis, operating loss was $1.6 million or 3% of sales compared to net income of $2.4 million last quarter. Non-GAAP operating profit was $925,000 compared to $4.6 million in the prior quarter. The lower operating income is primarily the result of the lower gross margins I discussed earlier. Non-operating income declined from last quarter due to lower interest income, after onetime benefit last quarter did not repeat and the mark-to-market adjustment of our employee non-qualified deferred compensation plan.

Income taxes for the quarter reflected a benefit of $1.7 million offsetting the loss before taxes. The benefit was driven by the mix of US and foreign earnings and as a result of our tax strategy. Our non-GAAP tax rate was approximately 22%. Looking forward the GAAP tax rate will continue to roughly mere income or losses around the breakeven levels.

In the long-term we expect our GAAP and non-GAAP tax rates to be in the low 30s as operating income increases. On a GAAP basis, first quarter net income was $200,000 or $0.01 per diluted share. Non-GAAP net income was $800,000 or $0.03 per diluted share compared to net income of $4.4 million or $0.16 per diluted share in the prior quarter.

Turning now to our balance sheet. Cash and investments including restricted cash were a $180 million, up nearly $14 million from the prior quarter. Cash flow from operations was $14.8 million for the first quarter, the result of excellent execution in all areas of working capital. Inventories decreased by $2.2 million, however finished goods and available for sale assets were down over $5 million resulting from our sale of older equipment. This marks our lowest level of inventory since early 2006 and a reduction of over 30% from its peak in 2008.

Inventory turns as a result rose to 2.1 times. Accounts receivable decreased to $33.5 million on lower shipments reflecting excellent DSO performance of 52 days. Capital expenditures were approximately $1.3 million and depreciation and amortization excluding purchase accounting was $2.6 million. Looking forward, we expect our markets to continue to be choppy in the short term, with revenues around the current level. As a result, in the second quarter we expect revenues to be between $55 million and $60 million. We expect non-GAAP earnings excluding stock compensation, purchase accounting and other non-recurring items to be between $0.05 and $0.10 per share driven primarily by improved gross margins.

Now I will turn the call back over to Nick for a brief summary.

Nicholas Konidaris

To summarize, we completed a successful quarter. We’re pleased about several things. Our healthy recovering markets, our strong competitive position within those markets and our exciting new product pipeline. Although we are not happy with overall gross margin, we’re able to monetize all the inventory and take advantage of market opportunities.

Looking forward, we expect gross margins will largely recover next quarter as the mix shifts back towards new products. Over the longer term, our globalization efforts to lower our cost and our growth strategy would allow us to realize full value for our products and achieve our target margins. This concludes our prepared remarks. We’re ready for your questions. Christine?

Question-and-Answer Session

Operator

Ladies and gentlemen (Operator Instructions) Your first question comes from the line of Jim Ricchiuiti representing Needham & Company. Please proceed.

Jim Ricchiuiti – Needham & Company

Thank you. Good afternoon.

Nicholas Konidaris

Good afternoon.

Jim Ricchiuiti – Needham & Company

The question I had relates to gross margins and Paul, I just want to make sure I heard this right, there was a $5 million reduction in finished goods inventory and that – was that mostly related to memory repair tools?

Paul Oldham

Yes, it was mostly related to memory repair tools but we also were able to move some older component test and inspection tools and a couple of other areas where we’re able to see some reductions. But it was primarily memory repair tools.

Jim Ricchiuiti – Needham & Company

Okay, so the margins were down mostly in the semiconductor systems portion of the business and that’s due primarily to memory repair but also down as well and I’m talking about sequentially and passive components.

Paul Oldham

Yes, passive components were actually about flat or maybe even up a little bit as some of our newer products carry better gross margins. However the mix of passive components was much higher this quarter as a proportion of the total than they were last quarter.

Jim Ricchiuiti – Needham & Company

Okay, how about the interconnect portion and micromachining, how were the margins in that area?

Paul Oldham

As we mentioned we saw a heavy mix towards our traditional flex interconnect, the drilling machines and those are more commodity type products and carry lower margins associated with them.

Jim Ricchiuiti – Needham & Company

Got it. And then when you say you see margins recovering in the current quarter recovering, do you assume – should we assume they get close to the Q4 level?

Paul Oldham

Yes, we would certainly see them kind of recover back to what we’ve seen around these revenue levels. There is always going to be a little bit of variation related to mix but the mix this quarter was quite unusual, if you look at each of the individual areas. Also the inventory reduction that we saw this quarter has largely been completed, I think there could be a little more that could go, flow through there but that’s largely completed and so we don’t expect to see margin levels at this level going forward.

Jim Ricchiuiti – Needham & Company

Okay and lastly for me, any 10% customers?

Paul Oldham

We did have one 10% customer this quarter.

Jim Ricchiuiti – Needham & Company

Can you say what product segment that was in?

Nicholas Konidaris

It was in the passive components.

Jim Ricchiuiti – Needham & Company

Okay, thanks very much.

Operator

Your next question comes from the line of Tom Diffely representing D.A. Davidson. Please proceed.

Tom Diffely – D.A. Davidson & Co

Yes, good afternoon.

Paul Oldham

Hi Tom.

Tom Diffely – D.A. Davidson & Co

Just one more question on the memory repair systems, the older, the margin stuff. Was the margin lower because of a reduced ASP or was it simply just reconfigured in the cost associated with that?

Paul Oldham

Yes, it was really three things Tom, the biggest one is that we’re able to utilize existing finished goods inventory, that was great, but we did have to take things with basically built, tear them apart, make sure they were updated, ready to go and then ship those. Also the mix, because we saw acceleration of demand in the current quarter, the mix tended to be towards some of the older types units and therefore those tended to go out at lower prices.

And the third thing is we did want to have some hooks into our newer technology and so we committed to some upgrades in the quarter and that compressed margin because of deferred revenues and cost associated with that. So it’s really a combination of things with the biggest one being the fact that we were able to utilize a lot of the existing inventory.

Tom Diffely – D.A. Davidson & Co

Okay.

Nicholas Konidaris

Also by the way, a fact that came from finished goods do not allow for absorption.

Paul Oldham

That’s right.

Tom Diffely – D.A. Davidson & Co

Okay.

Paul Oldham

So we did a lot of work on them but no value was added to either inventory or cost.

Tom Diffely – D.A. Davidson & Co

All right. Okay, good. And have you seen any difference or any change in the competitive environment with the financial troubles of your biggest competitor?

Nicholas Konidaris

What we have seen, well first of all I am not commenting about our competition but competitor is going to compete and we take every competition seriously. What I can comment is that we see that our market share is increasing.

Tom Diffely – D.A. Davidson & Co

Okay. All right, and then just quickly on the new product, the 9900. Where do that fit in from a kind of a margin structure to your different categories?

Nicholas Konidaris

This is going to be in the semiconductor division and would be consistent with products in from a margin point of view, that of semiconductor cost basis (ph) equipment and the experience that we have to this products in the last several years.

Tom Diffely – D.A. Davidson & Co

Okay. And can you give us any idea what you expect kind of a growth profile to be over the next year?

Nicholas Konidaris

Yes, the – we think that the markets for dicing thin wafers is – next year is in the neighborhood of about $80 million to $90 million. But that is not focusing on the entire market, this is focusing on the ultra-thin which is 50 micron and below.

Tom Diffely – D.A. Davidson & Co

Right.

Nicholas Konidaris

And we believe that this ultra-thin market is really do not take-off and needs to take-off because of 3D packaging but do not take-off because there is no any effective solution in the market today. And we are the ones that we believe would provide that. As we provide that, we expect to see orders towards the end of the year, we are in evaluations right now and gradually as the market transitions into ultra-thin, we’re going to see a gradual growth of that market faster than the overall growth of dicing of thin wafers. Why, because more people are going to be transitioning to the ultra-thin.

Tom Diffely – D.A. Davidson & Co

Okay. And initially is it really the stack to NAND that is a big driver?

Nicholas Konidaris

That’s one of the very big drivers. And the other thing is, yes I mean its – this is the main point and the overall umbrella is that the 3D packaging.

Tom Diffely – D.A. Davidson & Co

Yes, Okay. All right, and can you give us a quick update on the factory in Singapore?

Nicholas Konidaris

Yes, the factory was – we opened a factory in March. It is producing right now products from two of our divisions. And as we have mentioned, we expect that in about two years time, would be producing products from all the divisions but right now it’s about one-third of our production is out of the Singapore factory. We have hired people, we’ll continue hiring people there. We’re very pleased with the results and this would be the factory, the main factory as we will follow-on (ph).

Tom Diffely – D.A. Davidson & Co

Okay and then Paul, could you just remind me what the restricted cash is for?

Paul Oldham

Yes Tom, the restricted cash is related to the IP suite that we’re prosecuting in Taiwan. We had originally had a cash deposit in Taiwan and we were able to extract that cash in lieu of a letter of credit and so we were able to get the cash back but because there is a letter of credit against that cash then we reported as restricted cash.

Tom Diffely – D.A. Davidson & Co

Okay. And then just to clarify on the bookings front, most of the bookings kind of the strongest bookings in I guess two or three quarters – two or three years was driven by the semi repair business?

Nicholas Konidaris

Well this is the strongest bookings since last calendar quarter of 2007.

Tom Diffely – D.A. Davidson & Co

Okay, yes.

Nicholas Konidaris

And so it’s really a good record. Paul is checking just.

Paul Oldham

Tom, if you look at the overall bookings, I would say it was, it was pretty balanced across our business. Certainly the sequential increase came from semi business. As I described in strong LED orders, we also had very good bookings in our interconnected micromachining business. The passives was down a little bit as we discussed as people absorbed capacity and also the timing of our service contracts which when we book as service contract we recognized one year of that orders was down because, just because we tend to get to get a lot of service contracts renew around year-end which was last quarter.

Tom Diffely – D.A. Davidson & Co

Okay, all right. Well, thank you very much.

Nicholas Konidaris

Thank you.

Operator

Your next question comes from the line of Mark Miller with Noble Financial. Please proceed.

Mark MillerNoble Financial

Nick or Paul, could you kind of just break out backlog a little bit more in terms of, I assume it’s more passive interconnect and are these newer systems, higher margin systems or what?

Nicholas Konidaris

Yes, Mark the backlog is in the neighborhood of about, half of it would be interconnect, 30% would be semiconductor and 20% would be passives.

Mark MillerNoble Financial

Okay, are these more higher margin tools or more legacy tools?

Paul Oldham

It’s kind of a mix if you look at the total backlog. I would say our backlog is more of a normalized mix versus what we saw this quarter.

Mark MillerNoble Financial

Okay. Just wondering if you could comment on the latest update which we’re seeing in each of your three areas for the factory utilizations, are the typical factory utilizations in memory, interconnect, and passive?

Nicholas Konidaris

Yes the – we do that update regularly every quarter and I remember in the recent past, we’re hearing numbers of 80% or below but in the last few quarters in almost all businesses that’s in the neighborhood of 90% and above. And one way of thinking about the tone of the business is that our markets have returned to health and this year, the driver, the main driver for growth this year is going to be memory repair as that comes back to traditional levels and then further out, this thing is going to be augmented by growth from the many new products and platforms that are targeted to go to Beta (ph) and some production orders later in the year.

And these new products would be the ultra-thin wafer scribing which we announced, the 9900, but later on we plan to introduce an LED Tester, this is totally new business for us. we’re working very hard on improving our presence with scribing LED in the high brightness segment which we think is going to be, is going to our growth in our LED presence and then lastly, it would be the laser direct ablation product for we have, in fact an order for that product that we’re shipping it later this calendar year.

We think that gradually it’s going to fall into the whole drive with 3D packaging and would be allowing high density interconnect and IC packages to become even denser and therefore smaller and therefore helping the ascend of 3D packages.

Mark MillerNoble Financial

Just wondering, we’ve heard recently from some people in the PC Chain under this derived companies, I think (inaudible) also said they were seeing signs of weakening of what was a strong result this quarter especially from consumers while business remains strong. I’m just wondering what’s your visibility is there?

Nicholas Konidaris

Yes, we – I would not say that we see signs of weakening, we see of course headwinds that are macro level but what I would say is and that is not signs of weakening is that business in our traditional segments is going to be choppy for the next few quarters. This is because fundamentally our business is lumpy.

Mark MillerNoble Financial

Thank you.

Nicholas Konidaris

Thank you.

Operator

Your next question comes from the line of Kelly Anderson representing Sidoti & Company. Please proceed.

Kelly Anderson – Sidoti & Company

Good afternoon guys, thanks for taking my questions. First up, just to be clear the utilization rates that you quote, were those specific to memory and if so, could you talk a little bit about utilization in the passive components market and given the rapid growth we’ve seen in passive components demand, if there is a kind of digestion period, how long do you think it will take for that problem to be solved?

Nicholas Konidaris

Yes, the utilization was not specific to memory, it was a joint statement across all of our lines. The utilization in passive components, we hear that’s in the 90% and the problem with the – it’s based on the customers that we’re hearing but there is other customers that may have lesser utilization because for instance traditionally they have been focusing on automotive applications.

As far as memory is concerned, there is customer that basically needed the product yesterday and there is other customers that still have excess product that from the previous up term and they’re trying to utilize that fully by keeping their designs to the extent possible to a level that can be processed to its previous generation products. But – so utilization is overall is healthy. There is pockets of under (ph) in every segment, there is pockets of almost 100% in almost every segment and in particular on in passive components you have another phenomenon other than utilization which is sometimes because the utilization approach 100% people order a lot of systems and then take some time to absorb that. So we have that problem of continually balancing in the short term demand and supply.

Kelly Anderson – Sidoti & Company

Okay, and then in terms of the 5900 tool, just a clarification, I think you said that you had some follow-on orders there, I assume that’s from the same customer and if so could you talk about whether if there are any additional customer engagements for that particular tool and also with the follow-on orders that hit during the quarter, would your order rates still have been up without the follow-on there?

Nicholas Konidaris

Yes, the – for the 5900 we have one customer right now, but we have several applications from with that customer and the number of applications is expanding. We do have however other customers in advanced micromachining that would be candidates for 5900 and they are candidates for other products that we’re having. So the – we have overall multiple customers in multiple applications in advanced micromachining. The follow-on orders were significant from an order point of view but really do not make any difference in shipments or revenues for Q1.

Kelly Anderson – Sidoti & Company

Okay.

Nicholas Konidaris

Those would be having in effect starting in Q2.

Kelly Anderson – Sidoti & Company

Okay and then if I could just quickly touch on the balance sheet, sorry to kind of belabor this issue but I think you had said that most of the inventory had sort of worked its way through, I guess I’m a little bit concerned because inventory turns versus lot of your peers in this space are still a little bit low. Do you have any further plans in place to get that, more on track with or more on par with the levels seen from some of the other equipment vendors?

Paul Oldham

Yes, Kelly that’s a good question. If you look at our inventory, one large component of course is our service inventory, that’s probably fully a third of our inventory maybe a little bit less and its – that’s going to roughly stay at that levels. As our business grows it doesn’t need to grow a lot but it’s not going to probably decline much. We do see opportunities to continue to reduce inventory, that’s less and less a function of moving older equipment. We have moved a lot of that, there is a little bit more as I said that we can and will come down. But it’ll be more a function of how do we manage our supply chain and how do we be more efficient in not having to add inventory as business grows.

So I think it can still come down some, but certainly as we see business grow, our goal is not have it increase.

Kelly Anderson – Sidoti & Company

That’s very helpful. Thanks guys.

Paul Oldham

Yes.

Operator

Your next question comes from the line of Shawn Boyd representing Westcliff Capital Management. Please proceed.

Shawn Boyd – Westcliff Capital Management

Hi, so the first question I was wondering in terms of the shipping out the order of systems this quarter and the impact on the gross margins. Were those in backlog going into the quarter and I’m just wondering if this is sort of pop-up business, why we didn’t have a little more visibility that this was coming out (ph).

Paul Oldham

Yes, it’s a good question. These were not in backlog at the beginning of the quarter and particularly on the memory repair side, we saw an acceleration of some customer activity in that business during this quarter. In fact Nick, kind of referred a little bit to that that there were some customers that popped up in all of a sudden needing stuff yesterday. So we were able to respond quickly, we were able to utilize some existing inventory, took some work to get that out the door but we are able to meet really pretty quick turnaround for, to meet short term ramp requirements in that market.

Shawn Boyd – Westcliff Capital Management

All right, okay. And in terms of the guidance that you’re giving now for the September quarter, it looks like we’re about two-third booked on that, how much of that needs to be turned?

Paul Oldham

Not much, if you look at things that come in the door, our service business and our, what we call our tooling business which would be belts in place for our passive components. Those tended to roll-on pretty well. So we are largely booked for the second quarter.

Shawn Boyd – Westcliff Capital Management

Okay and can you just speak with come out with few different questions but in terms of the revenue breakdown as we go into September, maybe you could just review directionally how you see each of these, it looks semi is probably up quarter-over-quarter maybe passive is down, but can we break that down a little bit better and just to quantifying the segments here?

Paul Oldham

I would say as a general matter, if we look at what’s in backlog and the timing of the customer demand, we would probably expect to see semi down a little bit. We had quite a lot of shipments as I said kind of come up at the end of the quarter, things pulled in. we still see some demand there but the timing of shipments were probably skewed a little more towards the third quarter. That business is probably the most choppy of them all right now. We would expect probably to see our interconnect and micromachining business to stay healthy and probably up a little bit and we still have backlog to deliver in our passive component business, so it’s probably flat to up some as well.

Shawn Boyd – Westcliff Capital Management

Okay, very helpful. Thank you. Another if I may, the 9900, the wafer dicing product we were talking about earlier, we’re trying to quantifying that, I heard a number of I believe it was the $70 million to $80 million, excuse me $80 million to $90 million per year kind of market, but then we have clarification that was really the ultra-thin so are we referencing a subset of that, I guess what I want to do is just quantify the size of that market versus the 5900 for the micromachining (ph)?

Nicholas Konidaris

Yes we’re referencing the $80 million to $90 million what we consider the wafer synchronization (ph), the ultra-thin is addressing subset of that which is going to be the fastest growing part of that market because that cannot grow because you don’t have the system like the 9900.

Shawn Boyd – Westcliff Capital Management

Got it. Okay and in terms of the 5900, how do you guys size up that market?

Nicholas Konidaris

This is a bit more difficult because this is higher earning (ph) applications that are totally new, it’s really advanced micromachining, but a good way of doing that is to take the business that we have had in the last six months from that market and somehow extrapolating growth of that is commensurate to consumer electronics, that would be one way of approximating it.

Shawn Boyd – Westcliff Capital Management

Okay, so Nick when you think of magnitude over say the next 12 months, do you think there is the potential for greater contribution then out of the 9900 in the launch of that product versus the 5900 or the?

Nicholas Konidaris

I would think that 5900 is going to enjoy higher margins than 9900. 5900 is designed in many applications and continues to get designed even in additional applications and 9900 requires to be designed in and these applications require to really take off the expense of other more traditional wafer businesses.

Shawn Boyd – Westcliff Capital Management

Got it. Okay and last question from me, going back to I think an answer you gave to Mark perhaps on the comment about orders being choppy. Would you say that this is just typical lumpiness that you normally see or have you seen things shift a little bit over the past quarter or so that looks a little bit more choppy at this point and also...

Nicholas Konidaris

Well it’s the choppy and lumpy I used that interchangeably and its typical lumpiness, I think I referred to, business is healthy, came back out of the base of 2008 and grows, and our forecast is that CapEx is going to be growing through 2012, but grows and but it’s not linear. It’s lumpy because of the nature of this CapEx business.

Shawn Boyd – Westcliff Capital Management

Got it, very good. Okay and you know what, I like one last one if I can, on the operating expenses. If I heard correctly regarding those up a little here $22 million to $23 million to the September quarter. What’s driving that increase again and what can we think about as kind of a steady state that we can run this company going forward?

Paul Oldham

Yes it’s primarily related to our annual merit increases which take effect basically going into this current quarters, a little bit last quarter but it primarily affects Q2. And those are for our intended purpose sort of permanent increases because they are – they are the merits that go across the company. Also we are seeing some increases related to project spending for our new products. this will be kind of a peak here this year because of the number of projects that we have were coming out this year, I think we’ll see that number bounce around a little bit quarter-to-quarter.

As we think about it, at least in the intermediate term I think this is sort of $22 million to $23 million is probably a reasonable way to think about it. With possibly some opportunities see that that’s comes down moderate down a little bit out two or three quarters once some of the new products are launched.

Shawn Boyd – Westcliff Capital Management

Moderate down on an absolute basis?

Paul Oldham

On an absolute basis. And certainly as we see revenue growth, we would look to leverage our operating expenses. And if you look at the spending it’s pretty clear, really the additional investment is going into R&D, if you looked over the last several quarters and that’s where we’ve made a big commitment, we think we have a lot of opportunities and irons in the fire there and want to see those through.

Shawn Boyd – Westcliff Capital Management

Very good, okay. And as I recall kind of longer term target model at a 50% growth margin we should be knocking out the 20% operating margin?

Paul Oldham

That’s right and we would see roughly 30% operating expenses at that level and of course that’s a function of volume, but absolutely that’s the target we’re seeing for.

Shawn Boyd – Westcliff Capital Management

Okay, very good. Well congrats on the acceleration on the topline.

Paul Oldham

Thank you.

Nicholas Konidaris

Thanks Shawn.

Operator

(Operator Instructions) And your next question comes from the line of Jim Ricchiuiti representing Needham & Company. Please proceed.

Jim Ricchiuiti – Needham & Company

Nick, I wondered if you could talk a little bit about the 5900 and the demand you’re seeing for that, is it coming mostly from new applications or is coming from increased capacity, capacity wise.

Nicholas Konidaris

Yes this is a very flexible system, so the demand comes from both new applications and existing applications.

Jim Ricchiuiti – Needham & Company

One more than the other in terms of the activity you’re seeing?

Nicholas Konidaris

One more than the other but it’s not two, it’s multiple.

Jim Ricchiuiti – Needham & Company

And as you look at the – your outlook for orders in the next couple of quarters, do you think, it sounds like there is going to be period of digestion in the passive component area, will the orders view as you see it now, it would be driven primarily in semi or I mean perhaps you could just talk a little bit about the outlook for new order activity in interconnect?

Nicholas Konidaris

Yes, the – as I said the tone of the business is that in the short term we’re short term we’re going to see choppiness amongst our businesses, clearly the main driver is going to be the resurgence of memory repair, that was a dominant business for us for more than a year and a half and that is coming back alike, so that’s going to play a big role, play a big role in our growth for this year.

The passive components business is going to be from a point of MLCC is going to be choppy for the next few quarters, choppy from the point of view that next quarter people need to absorb what it bought earlier and then we may see another great quarter but it’s very difficult to forecast more than a quarter or two but the business is healthy. And there is an opportunity there as automotive comes back to life to see additional growth in the MLCC.

But in that segment we’re lumping the LED Tester and I think that is going to be an opportunity for growth, LED continues to be and is going to be a very strong business for whoever participates and we’re going to be introducing a Tester that we think is going to be a unique solution when it comes to high volume, very high beam testing of packaged LEDs. In the micromachining, I think we are going to continue seeing healthy much less choppy growth in the, but with some seasonality in the reaffirmation for flex. The reason for that is that flex really addresses many consumer products that all of them are very healthy right now.

As far as the advanced micromachining, we are working very hard and we’re very encouraged by the flexibility of the 5900, the flexibility of that 53 as it being reincarnated in with our universal architecture and becomes more modern system and we’re very encouraged by the richness of opportunities to do unique advanced micromachining applications with few customers right now but these are big substantial customers that can absorb fully our capability.

But in the interconnect – in the micromachining, we also like the opportunities that to see with what we call the laser direct ablation, that’s the ability to process in another way PCBs and make them denser, and also we are very excited with opportunities to process glass and these are going to be opportunities that are going to be coming later. But the overall idea is that existing markets would continue choppy for a while. We’re going to be adding to that the memory repair and later on the new applications.

Jim Ricchiuiti – Needham & Company

Would you remind us in the last cycle for memory repair, roughly how bigger business was that for you at the peak of the cycle?

Nicholas Konidaris

At the peak of the cycle assuming the peak of the cycle was, I mean it was for fiscal year ‘08 it was in the neighborhood of a $100 million plus.

Jim Ricchiuiti – Needham & Company

Okay and from where you see it now assuming we continue to – we see continued investments, is there any reason to think at the peak of the cycle that perhaps you would get close to that level again?

Nicholas Konidaris

My expectation is that we’re going to be getting close to that again, at the peak of the cycle.

Jim Ricchiuiti – Needham & Company

Okay and last question, did you say – I’m sorry.

Nicholas Konidaris

On an annual basis.

Jim Ricchiuiti – Needham & Company

On an annual basis.

Nicholas Konidaris

Yes.

Jim Ricchiuiti – Needham & Company

Thank you. And then just the last question from me Nick, I may have missed it, did you give any kind of a timeline as to where you are with the LED Tester in terms of when you might see Beta (ph)?

Nicholas Konidaris

Yes we see LED Tester, we’re working very hard with teaching customer and other customers and we expect to have a Beta (ph) out in last quarter or calendar quarter of this year.

Jim Ricchiuiti – Needham & Company

Okay, thank you.

Paul Oldham

Thank you.

Operator

At this time there are no additional questions, I will now turn the call back over to Mr. Nick Konidaris. Please proceed.

Nicholas Konidaris

To reiterate with memory repair beginning to recover, all of our markets are now active and healthy. We’re executing well in delivering innovative systems to our customers and in developing our next generation of products that will expand our addressable market and fuel profitable growth. Thank you very much for joining us. You are welcome to call Paul, Brian or me if you have further questions. This concludes our call. Thanks for your interest in ESI.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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