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Rudolph Technologies, Inc. (NYSE:RTEC)

Q2 2014 Earnings Conference Call

August 4, 2014 16:30 ET

Executives

Bob Cook - Vice President and General Counsel

Paul McLaughlin - Chairman and Chief Executive Officer

Steven Roth - Chief Financial Officer

Analysts

Tom Diffely - D.A. Davidson

Dick Ryan - Dougherty

Farhan Rizvi - Credit Suisse

Ted Moreau - Barrington Research

Jairam Nathan - Sidoti

Operator

Good afternoon. My name is Nan and I will be your conference operator today. At this time, I would like to welcome everyone to the Rudolph Technologies Second Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the call over to Mr. Bob Cook, Vice President and General Counsel. Please go ahead sir.

Bob Cook

Thank you, Nan and good afternoon everyone. Rudolph issued its 2014 second quarter financial results release this afternoon shortly after the close. If you have not received a copy of the release, please refer to the company’s website at www.rudolphtech.com, where a copy of the release is posted.

Joining us on the call today are Paul McLaughlin, Chairman and Chief Executive Officer and Steven Roth, Chief Financial Officer. As is always the case, I need to remind you of the Safe Harbor regulations. Any matters today that are not historical facts, particularly comments regarding the company’s future plans, objectives, forecasts, and expected performance consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Such estimates, whether expressed or implied are being made based on currently available information and the company’s best judgment at this time. Within these is a wide range of assumptions that the company believes to be reasonable. However, it must be recognized that the statements are subject to a range of uncertainties that can cause the actual results to vary materially. Thus, the company cautions that these statements are no guarantees of future performance. Risk factors that may impact Rudolph’s results are described in the company’s latest Form 10-K, as well as other periodic filings with the SEC. Rudolph Technologies does not update forward-looking statements and expressly disclaims any obligation to do so.

I will now turn the call over to Paul McLaughlin. Paul, please go ahead.

Paul McLaughlin

Thank you, Bob. Good afternoon everyone and thank you for joining Rudolph Technologies’ 2014 second quarter financial results conference call. My prepared remarks this afternoon will address Q2 results, some selected highlights, guidance for Q3, and our revenue expectations for the full year 2014. After my remarks, Steve will review our Q2 financials in detail and then we will open phone lines for questions.

Let me begin with some highlights. Our results for the second quarter reflected the strength of our unique business model, which as many of you know targets selected front-end and back-end higher growth markets. This provides us a broad and expanding customer base with a more balanced product portfolio across all industry cycles. As consolidation continues among our customers, we believe it is increasingly important to have a broad portfolio of solutions as CapEx purchase timing usually varies within each customer and varies within each product area, thereby making quarterly numbers for companies our size very lumpy.

Now, that dynamic played out in the second quarter is highlighted by our software business. Our Data Analysis and Review Business Unit, DARBU posted record revenue and record operating profits. DARBU software solutions are often leading indicator, as customers look for ways to improve yields during periods of preparation for expanding production, such as we are in at the moment. During the quarter, our software business unit announced record sales of our Advanced Process Control Software following a record number of Yield Management Software installations in the prior six months. As most of you know, our number one market share ranking in process control software for 2013 as per Gartner Dataquest has come from our front-end customers and that was the story here in Q2.

Wins in Q2 included manufacturers in the U.S., Japan and Europe reflecting customers in the silicon mobile communications supply chain, hard disk drive business and the burgeoning power device market. Expanding on the nearly 800 tools connected in 2013, recent wins are adding another 1,000 tool connections in 2014. Obviously, the majority of these tools, connections are to non-Rudolph tools, although our software capability is often introduced by showing the data collection review and analysis benefits by connecting Rudolph tools first. So, that is a good sign.

Further to the strengthening of our DARBU business was the July 7 announcement of a partnership that allows users of Veeco’s industry-leading equipment access to Rudolph’s fault detection and predictive maintenance software to increase system productivity and improve manufacturing efficiency. Partnering with capital equipment leader like Veeco demonstrates the importance of DARBU’s yield analysis and data-mining software in maximizing production outcomes, not just for device fabs, but also for top OEMs in our industry.

Shifting gears let me divert a moment and describe a dynamic accelerating industry that affects both our front-end and back-end customers. And that is the battleground of middle-end-of-line better known as MEOL. We are in some of our front-end integrated device manufacturers, the IDMs, are looking to apply their expertise into the fast-growing MEOL advanced packaging market. Most notably is the recent announcement by TSMC regarding their new INFO solution, INFO stands for integrated fan-out packaging solution. The topic deserves more details and I will be happy to explain the specifics as I understand them of TSMC’s INFO offline as I just returned Saturday from a visit with a customer attending our yield forum in Singapore who has been evaluating TSM’s INFO for specific device packages. So, we will take that offline if anybody wants any further detail.

However, for today’s call, the data point, I wish to leave with you is that we believe TSMC has chosen fan-out advanced packaging, because that technology is expected to be the fastest growing top advanced packaging market according to MEOL and confirmed independently by us. Fan-out packaging is an area we are focusing on here at Rudolph as fan-out packaging in its multiple forms is likely we believe to be the package of choice for consumer mobility products, because of the increased functionality in an ultra-thin package that operates using less power therefore providing longer battery life.

You have heard us mentioned in past calls that our JetStep Lithography product are designed to “skate where the pick will be, not where it is now” according to that great philosopher, Wayne Gretzky. This is an example of what we have been talking about here, this fan-out. However, it is not just lithography tools, but that dynamic we expect will apply to our total solution offerings, which include inspection, metrology and software components as this fan-out advanced packaging market unfolds, it is just in its early days.

Another recent positive is our announcement of availability of new patented SONUS Technology. SONUS is a non-contact, non-destructive acoustic metrology and defect detection technique that is designed to be of higher resolution, faster, and less costly than other techniques. SONUS measures thick films and film stacks used in copper pillar bumps and for detecting defects, such as voids, in through silicon vias. Concurrently, we announced the collaboration with TEL, Tokyo Electron and NEXX, the subsidiary NEXX in using SONUS Technology to develop pillar bump and TSV plating process control for both development and high volume manufacturing applications.

Now, let me discuss we didn’t go to forecast in Q2. While our total bookings and our overall bookings including service were both above 1.0, we did not book any new JetStep tools. We have added new customers to the JetStep sales funnels and active discussion with customers continued at an ever increasing pace. Nonetheless, we are confident enough to be forecasting to ship two JetSteps here in Q3. I caution and only one maybe recognizes revenue in Q3 depending upon which customer places their order first. This patent probably would play out again in Q4 as we gain acceptance from other new customers. You may recall that JetStep WNS Series tool represent our JetStep tools designed specifically for high-resolution lithography, read that as for lithography at 2 micron lines and 2 micron spaces, on round wafers and on square panels. These square panels are likely to range up to a size of what’s known as Generation 3.5. Our JetStep G Series tools for the flat panel industry are often bigger in Generation 3.5. So, we could easily scale future S Series tools to something larger. However, we think that it mean is a couple of years away.

Another dynamic that has pushed sales to the right in the back-end is the price of various front-end type tools necessary to measure and inspect MEOL, middle-end-of-line packages. We see that in the increased request for demos coupled with increased multiple quotes. That being said, our customers are telling us they see the increased economic value with higher yields. On the brighter side, four of the top five OSAT have at least once increased their CapEx budget as they realized that they need to carve out a piece of this middle-end-of-line market, our risk being marginalized. In fact, in calendar year 2014, we are looking at the first $1 billion OSAT CapEx budget being forecast by ASA.

Let me spend a couple of minutes on our front-end business. The dynamics of front-end drivers of Moore’s Law scaling, 3D NAND and FinFET have been well-documented. There is speculation now that Intel may begin to fill fab 42 Chandler, Arizona with front-end tools later this year or early next year. The same speculation stood for Samsung for both DRAM and NAND CapEx spend later this year, but even there well-balanced portfolio of products is not immune to cyclical and sector disruption as recent results suggest. So, caution is warranted. The foundry world could be the bright spot in Q4 as both TSM and GlobalFoundries has apparently guided some sizable orders for leading-edge 20-nanometer and 14-nanometer chips.

Now, before I give you our Q3 forecast, I think it is constructive to spend a minute on earnings power of Rudolph long-term model. Using a normalized model of 50% for inspection, 20% for lithography and 20% for metrology and 10% for software our long-term model calls for gross margins of between 55% and 56% and operating margin in the mid to upper 20% range. You can see from our gross margin results that our diverse product portfolio makes hitting our target gross margins very achievable. However, to achieve our operating targets, we need revenue from both front-end and back-end markets to be peaking at the same time or close to the same time. It is not unrealistic to think that we could see this scenario play out in 2015 or 2016 as forecast by many in the industry.

With those front-end and back-end dynamics affecting Rudolph in mind, including revenue recognition issues for our litho business, we are guiding Q3 to be flat to up 5%. Non-GAAP earnings are forecast to range from $0.04 to $0.05. For the calendar year, we had previously guided $200 million plus or minus 5% or $190 million at the low end of guidance, which at that level mainly forecast of up 7.8% for the year. On new forecast, with all those considerations in mind, including that revenue recognition issues, is flat to up 5% from last year’s $176 million.

Now, before turning the call over to Steve, let me mention one other item. As we have publicly stated in the past, our vision has been to deploy capital in the best long-term interest of our shareholders through strong M&A execution, which we believe has been a forte for Rudolph. We also believe it is important to return capital to our shareholders. And as such, in June, we started implementing a stock repurchase plan based on previously approved guidelines from our Board of Directors. Under the plan, we purchased approximately 1 million of stock in June and anticipate that we will be making subsequent purchases in the quarters ahead as we deem appropriate.

Now, let me turn the call over to Steve to review our Q2 financials in more detail. Steve?

Steven Roth

Thanks, Paul and good afternoon, everyone. In my remarks this afternoon, I will provide some detail behind our Q2 results and also provide some guidance on gross margin and operating expenses for Q3. Quarterly revenues for Q2 were $43 million, up from $41.6 million in the first quarter of 2014. As we discussed on our last conference call, we were anticipating our back-end business would continue to strengthen and it did as we were – as we are seeing quarter-over-quarter increases in our back-end revenues since Q4 2013. On a percentage basis, back-end sales represented 49% of sales in the quarter. Of those back-end sales, approximately 70% went to advanced packaging applications. Inversely, the widely discussed slowdown in our front-end and the front-end semis also impacted us, as front-end revenues decreased to 51% revenue in the second quarter. That decline was mainly with memory customers. This resulted in a final market split of our front-end business being 22% for each of both foundry and logic customers and memory was the remaining 7%.

Our inspection products, which are leveraged to both the front-end and back-end markets were the major contributors to our sales for the quarter, representing 61% of the revenues. While overall inspection revenue was up quarter-over-quarter, gains in our back-end business were offset by weakening in our front-end inspection products. Our software business which had a strong quarter in Q1 had a record quarter in Q2 as Paul mentioned and accounted for 16% of revenues in the quarter and was a significant contributor to our strong gross margin then I will talk – discuss in a minute. Metrology products which are highly leveraged to the front-end market ended the quarter at 22% of revenue and as we discussed on our last conference call, we did not ship any lithography systems in Q2.

Switching to a geographical breakdown of sales in the quarter, Asia was the strongest region representing 61% of overall revenue, U.S. is 23% and Europe jumped to 16% in the quarter from 8% in Q1. From a customer concentration perspective, we had only one customer a major OSAT, which represented over 10% of sales in the quarter. As I just noted, we experienced strong gross margin performance for the quarter. Our previous guidance called for gross margin to be in the 50% to 51% range. However, due to the strong performance of our software group and our ability to control above line costs, our second quarter gross margins came in at 54%. This makes the 18th consecutive quarter that we have had plus 50% margins driven by diverse product mix. Looking at the 2014 third quarter, we are forecasting that our gross margins will be in the range of 53% to 54%.

Turning to operating expenses, second quarter total operating expenses were $32.8 million compared to $21.5 million in the 2014 first quarter. R&D for Q2 was $10.8 million, an increase from $10 million in the first quarter. The increase in R&D was primarily related to an increase in headcount in our lithography operations and an increase in project cost. SG&A expenses increased to $21.3 million and included costs associated with the unfavorable ITC judgment and severance cost related to some operational restructuring both totaling $10 million in the quarter. Excluding those items, SG&A expense increased $500,000 compared to $10.8 million in the first quarter, with the increase mainly due to compensation related costs. For the third quarter, we anticipate our operating expenses will be in the range of $22 million to $23 million, which reflects our continued cost containment initiatives offset by investments in our lithography operations.

Our effective tax rate for the quarter was 60% and was impacted by the ITC judgment, which significantly reduced our pretax earnings estimates for the year and our ability to utilize our tax credits including the R&D tax credit which was not being reinstated by Congress this year. For the full year assuming no reinstatement of the R&D credit, we anticipate our effective tax rate to be around 35%.

GAAP net loss for the quarter – for the second quarter was $4.4 million or $0.13 per share, in the first quarter of GAAP net loss was $724,000 and $0.02 per share. From a non-GAAP perspective, our GAAP results were negatively impacted by litigation, share-based compensation costs, restructuring charges and amortization expenses related to M&A activities. Excluding these items for our second quarter results, our non-GAAP net income was $1.4 million or $0.04 per share and at the high end of our previous guidance. This compares to a non-GAAP net income of $1 million or $0.03 per share in the first quarter.

Now, turning to the balance sheet, we ended the second quarter with cash and marketable securities of $177.3 million and net cash per share of $3.78. Our accounts receivable increased in the quarter to $50.8 million principally due to timing of shipments in the quarter, which were back-end loaded. Inventory increased to $65.6 million from $62.3 million in 2014 first quarter and that increase is primarily due to inventory purchases from our JetStep S systems.

Finally to wrap up, capital expenditures for the second quarter were approximately $600,000 and we ended the quarter with a total headcount of 608 employees. This concludes our prepared remarks. And now, I will open the floor for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tom Diffely with D.A. Davidson.

Tom Diffely - D.A. Davidson

Yes, good afternoon. First a question, you mentioned some restructuring in the quarter, it looks like the expenses are going up a bit, I am just wondering what the impact of the restructuring is on the model?

Steven Roth

It was just a limited amount of – Tom this is Steve, we did a limited amount of trimming of some headcount in some areas, where obviously sales were down in operations. And so – and yes, so the manufacturing in areas obviously we have been running at these – kind of these lower levels for a while. Overall, it wasn’t a big – there is some severance in there in the numbers, but it was not a big charge. So, it’s couple of $100,000 I think in the quarter.

Tom Diffely - D.A. Davidson

Okay. What about the impact going forward from that?

Steven Roth

It will be savings again couple of $100,000, $200,000, but as I said in my remarks, we are offsetting that with headcount. If you look at the headcount number I just gave out, it’s only a one head different from last quarter. So, we were offsetting with headcount in other places in the lithography group.

Paul McLaughlin

Tom, those actual headcount reductions in the last quarter, we would represent $1 million worth of savings in those units where the reductions were.

Tom Diffely - D.A. Davidson

Okay. And then maybe just quickly, you (indiscernible) up today as there is any other outstanding litigation that may or may not be active in the next couple of quarters?

Paul McLaughlin

Yes, we have our counts in the headcount. Steve, can you probably…

Steven Roth

Well, not from the negative standpoint, we did have an accrual leftover from the ITC litigation for potential exposure on attorney fees, but outside of that, the ITC is closed out. And as you know, we still have the ongoing Camtek litigation, but we are on the plaintiff side and we awarded judgments in our favor on that. So, we are working through that litigation.

Tom Diffely - D.A. Davidson

Okay. It’s always tough to tell timing on stuff like that?

Steven Roth

Always hard to tell.

Tom Diffely - D.A. Davidson

Yes, okay. And then Paul, when you look at the change in the guidance for the full year, it sounds like most of it’s coming from the front-end business, but I am curious on the back-end side, there was a large I guess flat panel TV type JetStep going out. Is that still on track for this year?

Paul McLaughlin

Yes, it is. Yes, it is.

Tom Diffely - D.A. Davidson

Okay. And then on the front-end side, it’s…

Paul McLaughlin

The litho business, Tom, this is the bright spot. I think we are seeing some very strong customer response to our lithography often, particularly Steve mentioned the buildup in inventory of our S tools, that’s the pit square panel tools, wanted the impression that I would not be surprised to see activity in that level over the next coming period.

Tom Diffely - D.A. Davidson

Okay. And is it safe to assume that the book of business looks about the same, but it’s just more of a timing issue on when it actually occurs that’s the issue?

Paul McLaughlin

Yes, that’s exactly it. I think the book of the business maybe a little bit bigger right now, because we have had I think I mentioned in the prior call that we were outfitting the facility in Massachusetts, our litho facility with a full panel systems in operation and that has already taken place and we are running morning more than night, we are running panels for customers. So, it is more customers that come out of the woodwork as soon as we went into the panel.

Tom Diffely - D.A. Davidson

Great. Okay, thank you.

Operator

Your next question comes from the line of Dick Ryan with Dougherty.

Dick Ryan - Dougherty

Thank you. Say Paul, given your guidance for the second half, what do you think litho represents for this year, I think you are thinking maybe 20% earlier?

Paul McLaughlin

Yes. The revenue recognition revenue issues have been more in the 15% to 20% range depending upon which tools come in and it will depend on how fast we can get customer acceptance on some of these new tools in new customers. So, all the tools as we have now a broad product line would really believe we have been shipping all three varieties of our JetStep G, our JetStep W, and our JetStep S. So, we will have some issues getting customer acceptance. And to that, we will put it probably 15 to 20 states in that range.

Dick Ryan - Dougherty

So, if you look at the – I think you said shipping 1 to 2 in Q3, was that right?

Paul McLaughlin

Two, yes.

Dick Ryan - Dougherty

Okay, two. Are any of those in S or would they both be the wafer?

Paul McLaughlin

It depends on who comes in first and so – and that’s what we are waiting to see. I have been moving through Asia recently and I am convinced that we will be getting orders from both of those kinds of tools in the near future.

Dick Ryan - Dougherty

Okay, okay. Would these be new – would either of these be new customers?

Paul McLaughlin

We do have revenue recognition problems in the banking, yes, we do.

Dick Ryan - Dougherty

Okay.

Paul McLaughlin

It depends on which customer comes in first. I want to avoid your question, because I don’t know who is going to be. It will depend on who shows up first.

Dick Ryan - Dougherty

Sure. And then the buyback program, you said $1 million worth in Q2, what’s the program size that’s been authorized?

Steven Roth

The Board previously approved 3 million.

Paul McLaughlin

3 million.

Steven Roth

3 million shares.

Paul McLaughlin

3 million shares, well, we started it in after the June 1. It was not a full quarterly program, but obviously those things vary by the price etcetera.

Dick Ryan - Dougherty

Okay. So, it was $1 million worth in Q2?

Paul McLaughlin

That is correct.

Steven Roth

Given that is with the Board approved as a plan, but that was back in 2008, so that’s been planned around for a while.

Dick Ryan - Dougherty

Yes. Okay, thank you.

Paul McLaughlin

Thanks, Dick.

Operator

Your next question comes from the line of John Pitzer with Credit Suisse.

Farhan Rizvi - Credit Suisse

Hi, thanks for taking my question. This is Farhan asking a question on behalf of John. My first question is on the back-end revenues. If I compare it to last year, I don’t see the kind of growth that I would have expected if I look at the strong CapEx guidance from ASE spill. And I just wanted to understand like what’s different between the CapEx that ASE spill (indiscernible) and why you are not seeing like year-on-year strong growth this year?

Paul McLaughlin

Well, I think we are and I think some of the – the ones that you mentioned, ASE situation it was specific and we have talked about what happened in Gao Chong and I can assuire you that, that is over now – over in July and volume purchase agreement with them has kicked in. So, that will get going in that particular taste.

Steven Roth

I mean, either the business did trial down through 2013, Farhan, so that was – and I said in my remarks, so it’s the third quarter up, so it is going back, but we have had and obviously ASE being the biggest customer in the back-end that did impact us earlier this year, sure as we talked about it.

Farhan Rizvi - Credit Suisse

Got it. Got it. And then but you still have like if you are spending like $1 billion, so does that mean the second half of this year should look a lot better than your normal seasonality, like normally like if I look at the back-end revenues over the last three to four years across the industry. In general, the third quarter is kind of flattish to second quarter maybe sometimes down and then you see somewhat of a significant decline in the fourth quarter. Is that how I should think about the business this year or just because the ASE is much more stronger this year and not spending a lot in the first half. The second half of this year should be lot better than what we would expect from normal seasonality.

Paul McLaughlin

That’s a good point, Farhan. I think ASE had a rearrangement of customers a little bit when they lost the – when they had their environmental issue, lot of that business has migrated to other places, we are fast trying to come back with that. And we expect they will have a very strong second half. And for us that will be part of what we talked about a volume purchase agreement with them.

Farhan Rizvi - Credit Suisse

Got it. So, I mean like….

Paul McLaughlin

Yes, the other guidance, 1 out of 5 have been given increased CapEx. And we think that gets into the inspection metrology very soon.

Steven Roth

What’s going on when you look at the guidance we gave out, flat to up 5% overall, I would tell you that as we are forecasting now and obviously it’s still early in the quarter, but I would say that we would probably continue that trend in Q3 that our back-end business will be stronger than it was in Q2.

Paul McLaughlin

Our problem at the moment is we have very little visibility in the front-end. Obviously, for various regions we have heard and we talked a little bit about in the prepared remarks with the Intel’s and Samsung’s and there are some very encouraging signs particularly with the foundry world. One here in the United States, that’s a very positive step in a right direction. And when will the Samsung kick in, it got multiple programs, multiple areas to do, I am cautiously optimistic that some of that could happen this year and that would – that is factoring to a better percentage of front-end business, which is always good for us.

Farhan Rizvi - Credit Suisse

Got it. And the reduction of your guidance it seems primarily from your lithography is that right to say or…?

Paul McLaughlin

Some of it’s – you are right, it pushed out to the point where we are going to have some challenges getting customer acceptance, you ship the tool in the third quarter, okay.

Farhan Rizvi - Credit Suisse

Yes.

Paul McLaughlin

These tools don’t drive up the door, put it in and plug it in, they have a start and they take six to eight weeks to install.

Farhan Rizvi - Credit Suisse

Got it.

Paul McLaughlin

And so you go through it, then go through a very rigorous acceptance test, if they have already gone through it at our facility. And that takes a period of time. Obviously, we are getting better at installing, particularly the W series. And that we think we can do very quickly in comparison when we first started a year ago. We have only owned the Azores resource since December of 2012, so we are about 18, 19 months in. And I would say that’s been a very big bright spot, the ability of our team to put together an installation program that is significant better than half amount of time cut to install the tools. And we have got to count on some of that work, because – but we are trying to be cautious to get it and we will have deferred revenue in the year end. We are not going to read them all right there. So, that’s going to be a dynamic that we are trying to reflect. And that by having things pushed to the right, so a myriad of reasons.

And I think you can see it now, people are trying to sort out where they are going in the middle end of the line. We have got a real good battle shaping up between the primarily the foundries on the IDM side, although internal expense on non-foundry operations playing as well and as does Micron as does others, GlobalFoundries will be in time a bigger back-end player than they have get out of the data on so far. Having said that, that’s a dynamic that has pushed things to the right pad and that is maybe it’s acceptance as of – in getting orders for the litho tools a much more difficult. Does it make sense?

Farhan Rizvi - Credit Suisse

No. Yes, it makes sense. I mean to be honest like I think like you guys are doing the phenomenal job just considering the size of the market and how fast you have been able to ramp up your revenues there, can you just briefly talk about what is the breadth of customer base that you expect in your lithography business by end of the year and how many customers have you shipped the tools so far and where do you expect by end of the year?

Paul McLaughlin

Okay. We talked about that a little bit. We have one major customer who is a leader in fan-out packaging. And we have come to find out that a lot of other people once we get into fan-out and got some things out there, that assumes to be hot area. Yole has estimated the growth rate in that part of the advanced packaging business to be north of 32% now, even if they are not right or two-thirds right, that’s a big growth area. And then dynamics of fan-out packaging are very aggressive, very good such that that you had people like TSM trying to play today. As I was trying to mention in my comments, they have come out with the INFO process, which is an integrated fan-out process little bit different than some of the other. I have seen three or four or five different times of fan-out packaging. It makes tremendous sense in fan-out packaging.

And just think far end of me, the things that I have seen we are traveling around is what a good example is the internet of things – in flexible internet of things. The flexible kinds of devices are going to be needed, so we are going to get that. You are going to probably do that in fan-out packaging and you could perhaps do it on glass, plastics on a row, on a row. So, it’s you roll it up and you roll it out and then they do the lithography on it, so that’s the only thing that I can see at the moment and that’s what I am hearing is where these very, very same devices are going to be able to be manufactured, particularly those with new body and all of those kinds of things people want in thin and make sure they thin. And I think that’s the dynamic at fan-out office. And it’s in the very early stages. It’s being driven by people like Qualcomm, Broadcom and obviously now TSMC is doing it. And there are others. And I won’t go into who they all are until they become public, but I can assure you fan-out packaging is a hot growth area as we speak.

Farhan Rizvi - Credit Suisse

Got it. So, but in your expectations for the year, do you need to have additional customers, do you think like even with one customer, you would be able to ship the four systems that you kind of talked about in your prepared remarks?

Paul McLaughlin

No, we will get some other customers.

Farhan Rizvi - Credit Suisse

Okay.

Paul McLaughlin

I am counting on other customers and you will hear about that.

Farhan Rizvi - Credit Suisse

Good. And before I go, just one quick question on software, obviously like that was a very strong quarter for software sales in June. How should we think about the software growth going forward? Is it something like on a year-on-year basis, what kind of growth are you expecting over next two, three years in that business? And secondly like what is kind of like the operating margin, if you were to look at that portion of the business?

Paul McLaughlin

Okay. When you look at the software business, it’s had a very, very strong first half. We’re expecting a very good second half and will be back to a – we expect to be at record year this year from all timing. And our record before is in the $23 million, $24 million range, so we believe we will be north of that. The operating margins are very strong at all well above 40% because we have a philosophy we try in the software development approach, we build it once and sell it many times. That’s where these relationships when we’re talking about the Veeco’s and other kinds of companies when you are hooking up more and more tools to our software.

That becomes a very good dynamic for Rudolph’s revenue going forward on a continuing basis. So, when upgrades come to the software, they automatically go to all of these customers around the world, and we’re trying hard to build that base. So, that you do the design and development of it and as you perhaps know that over the years, we have put in a lot of money and we bought a couple of companies that have done work from the government, so that we believe we have over $225 million worth of R&D money spent in this area. This is not easy stuff to do. And the things that are exciting to me is it absolutely reasonably with the customer of this past weekend, past Friday.

We’ve been talking about in Asia, talking about the data mining activities that could, that are possible here. They are primarily front-end customers, back-end, I hope you can convince more and more back-end people, but when you look at our software dynamic by hand 90% of the software right now goes into the front-end. So, we got a wide open world here for the software in the back-end. So, I think it will grow, but Steve mentioned that the model in what we think would go forward on it using a 10% number that’s realistic, but we expect it to be 10% of a lot bigger number from the rest of Rudolph. Right now it was 16% this quarter because we have not kicked in with some of the other friends that we’ve just talked about.

Farhan Rizvi - Credit Suisse

Got it. And just one final question in terms of your buyback, you obviously started at this quarter. I just wanted to ask you like how should we think about buybacks going forward? Do you want to be opportunistic in terms of buyback or do you think like you just want to..

Paul McLaughlin

It’s a mixed bag. It is exactly that. We are opportunistic and you will see that in varying degrees depending on where the stock price is.

Farhan Rizvi - Credit Suisse

Thanks, Paul. That’s all I have.

Paul McLaughlin

Okay. Thank you, Farhan.

Operator

Your next question comes from the line of Ted Moreau with Barrington Research.

Ted Moreau - Barrington Research

Great. Thank you for taking my questions here. Paul, you were talking about the middle end of line business and the better ground that’s going on there and a little bit about the – it’s pushing out quite a little bit because of pricing and what not. But can you talk about the competitive dynamics that you might be facing there as those guys battle that out, I mean does – with the guys like TSMC getting into that business, does it mean like some of your – some of the bigger, some of the equipment guys are going to be battling you for that business. Can you talk a little bit about that, about them and the competitive dynamics?

Paul McLaughlin

I think we have a good dynamic there as you perhaps recall when you call at Rudolph we’ve had TSM that’s one of our – at one time our number one customer in a given year. So, we are very close to them over there. So, I’m optimistic that if they go down in that path, we will be a player. Right now it is a very early stage, but they’ve said they’d like to get a billion dollars out in the next year.

That’s a lot and whether they can do that is really questionable, whether their cost structure will allow it to getting their margin accepting margins you know very well that the back-end is – their gross margins are less than half of the front-end guys. We are looking at TSM at $0.50 and $1 and you are looking at the big guys in the back-end the ASEs and Amcor is at $0.20 and $1. I am ball-parking boy but it’s like 40% of what the foundries are. So, can the foundries come up with the way they do in integrated fan-out package and can they sell a one-stop shop, I think there will be a market for it, just how big I am not sure, but from a Rudolph perspective we will play both places, we will play in both environments.

Ted Moreau - Barrington Research

Okay, great. And then..

Paul McLaughlin

I don’t have a whole lot of preference, but obviously we’re close to TSMC in particular because of our relationship over many, many years in all our products. So, that’s a good dynamic, but it will be competitive, there’s no question, that it will be a competitive world. But they are in that environment schedule, there will be the ability to bring software in some of our total solution really adds value to a combination of predictive maintenance in all sorts of different kinds of capabilities that we have in software. You know we have the broadest portfolio in the business and we think that will play more at a TSMC growing a fan-out package than it really anybody else’s. We talk to the other people and I’ll be very honest with you, the OSAT world is not a yield oriented world in anyway near like the front-end. Having said that the back-end people now realized to play successfully in middle end of the line, they’re going to need those kind of techniques, we got lots of excitement out there, but as I said it’s still only 10% of the software business.

We are working very hard to be the first guy to adapt those techniques in the back-end. And those software – we think is a nice glue that hold the thing together, but it’s not an easy sell because they are not used to that. If you traveled the floors of various OSATs and you will see all sorts of dye and chips on the floor, you will know that, that’s been a modus operandi for many, many years and takes a while to overcome that. I think they realize it, each one is now spending more money and Amcor just notes that another 100 million. Three years ago Amcor is spending $250 million, $275 million, they’re going to be $675 million this year this time. That’s nice. Amcor is our tough customers last quarter, wasn’t that, not that first quarter.

Steven Roth

Yes.

Paul McLaughlin

First quarter they were. So it’s – there’s opportunity there and so I’m cautiously optimistic that no matter who does it, Rudolph will have a solution that may help them.

Ted Moreau - Barrington Research

Okay, great. And then speaking about OSATs, one of the OSATs has been engaged in some ownership changes dialog there. So, just kind of wondering as you think about to grow and with your guidance for the second half of this year, is there any risk that, that continues to push out I mean how stable do you feel like the business already is at that customer?

Paul McLaughlin

Well I wish I could give you some inside information because I have been there recently, but I can’t, I know that’s a process going on. It is good and bad, and good if somebody with deeper pockets because there is this consolidation outside of the industry. Stats is always one of the best technical leaders, it really are – I have got some very, very fine technology, but they are also number four. And so if somebody had higher up in ASE or an Amcor spill the guys ahead of them, but one of those guys ends up being in the race and I have no idea of anyone actually in here, obviously in speculation, but – and I don’t know. But that would – there is two things that could happen, one they could shutdown that stuff and only go with one technology or they could jump on the technology that stats has. They would do wise to jump on the technology that stats has. To me, they are one of the finest technical houses in the business.

Ted Moreau - Barrington Research

Alright. Okay. And then…

Paul McLaughlin

Somebody else like a private equity or a Chinese company who wants to make a name in the business and they have – in the Chinese year a five-year plan said they wanted to have 20% of the OSAT business within the next couple of years, they are going to have to buy stuff that came to it, organically in China. So, I am hopeful that if somebody that will value the technology.

Ted Moreau - Barrington Research

No doubt. Okay and then on the memory side in the quarter, it looks like it was you had a couple of nice quarters, Q4 last year, Q1 this year and now it’s kind of comeback to previous level, so just kind of wondering does that surprise you at all. And then also – and then what kind of direction do you think that that’s going because I was under the assumption that memory was a – will get better if spending environment in memory was a little better than the other areas?

Paul McLaughlin

No, the way we look at memory, it’s being very healthy for the industry to consolidate, but that has made customers push their CapEx out of CAD, which is really down to a few guys, right, you get the bit of playing here. And Samsung still leads the bucket. And when Samsung decides to move, the others will move or it will be closed. Hynix is playing strong, Micron very, very different company today than a year ago than a hybrid queue kind of thing. They have done a fantastic job, but they too are showing some discipline in spending money and that’s what consolidation has done. We have brought some discipline in enormous rates if you will. Will it happen? We thought it would be sooner than it is, but all pushed out a little bit. And Samsung being a leader in that area, they have pushed things out. And you asked me at the beginning of the year what would be happening in the third quarter? I have said we would be delivering more tools to Cheyenne to ramp up the next 30,000 to 40,000 wafer starts. That’s the next phase. But guess what, it’s not happening. There is not to rule out, I don’t know if it will kick in, sometimes this quarter, next quarter or whether it will push to 2015. There are yield issues. There are other issues. So and those are being widely discussed. So I am not going to spend a lot of time on it, but front-end has got its own set of dynamics and there is a pause in the industry, some call it a down turn, some call it a pause but that’s related pretty much to the front-end.

Ted Moreau - Barrington Research

Okay. Sorry, go ahead.

Paul McLaughlin

Does that help you?

Ted Moreau - Barrington Research

Yes. Well, thanks for taking my question guys. Good luck.

Paul McLaughlin

Okay.

Operator

(Operator Instructions) The next question comes from the line of Jairam Nathan with Sidoti.

Jairam Nathan - Sidoti

Hi, thanks for taking my question. Just probably mentioned in your prepared remarks about the operating margin of mid to high-20% target and how that would require both front-end and back-end doing well, now I just kind of – (worried as) to figure out like, when you look at your OpEx, how is that structured in the sense, do you have a different back-end team and the front-end team or how is – how should we kind of think about the operating expense structure?

Steven Roth

There is not – it’s we have the R&D teams are setup for working across diverse product lines, but doesn’t – it’s not between front-end and back-end. Our inspection products kind of go between front-end and back-end we have talked about that in the past are very similar. So you don’t see – you are not going to see R&D back-end ramping up just because R&D it – our R&D is for the entire company across the product lines. So it doesn’t leverage in based on what’s moving front-end or back-end.

Jairam Nathan - Sidoti

Okay. Thanks and my next question on the fan-out packages is – does the increasing penetration of that particular technology, is it imperative for the MTU’s Rudolph lithography tools or like I am just trying to see is there one to one relationship between I know higher penetration of fan-outs to better lithography sales?

Paul McLaughlin

It’s a good question. Right now, there are multiple ways to do fan-out. When you look at fan-out packaging that is actually shipping devices in volume we have the number one market share, but it’s a small business, when you ship the tools and then in that area from a lithography point of view and (indiscernible) shift to other kinds of inspection to rules in software into that segment. And we think we have the number one in the year, but it’s very small. That’s one of the reasons why that we all think it’s going to be the fastest growing section. It’s sort of validated by the PSMs jumping in there. And so they are going to have their own things and we hope to play there in some degree. And each house is going to do it a little bit differently. The market is kind the broad concept will be different and some guys will take off on one area, whether it’s a flexible device we can picture all, whether it’s flash device or whether it’s a laminate device or it’s some organic material device.

So everybody is going to have a little bit different. We are kind excited with the market is demanding higher and higher resolution, better and better and we think the market well today nobody is doing two micro lines in spaces. We expect they will be there. That’s where we believe fan-out packaging is building. And the people who drive that are the fabulous guys. And the most notable one of course is Qualcomm. So, I think that’s the dynamic that’s going to play out. There will be multiple ways to do it. You will not be the only one, sure, but we are surely at the front-end of this at the moment. I fully expect typically we have been noticing going to the technical conferences and hear about the advantages of fan-out packaging and say hey, we got to play. I can guarantee you fan-out packaging is being utilized in multiple locations.

Jairam Nathan - Sidoti

Okay. Thank you.

Operator

This concludes the Q&A portion of today’s call. I would now like to turn it back over to Mr. Paul McLaughlin for any remarks.

Paul McLaughlin

Nan, thank you. And thank you everyone for joining us today and for your continued interest and in support of Rudolph. We look forward to seeing you at upcoming investor conferences. Thank you and good evening.

Operator

Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.

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