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Executives

Kenny Green – IR

Gabi Seligsohn – President and CEO

Dror David – CFO

Analysts

Edwin Mok – Needham & Company

Leeran Roshman [ph] – Oscar Group [ph]

Marshall Herbes [ph] – Herbes Capital Management [ph]

Greg Weaver – Invicta Capital

Dave Diana [ph]

Ken Mass [ph] – Musco [ph]

George Borayma [ph]

Nova Measuring Instruments Ltd. (NVMI) Q4 2010 Earnings Conference Call February 15, 2011 9:30 AM ET

Operator

Good day, and welcome to the Nova Measuring Instruments Fourth Quarter Results Conference Call. Today’s call is being recorded. At this time I would like to turn the call over to your host today, Mr. Kenny Green, Investor Relations. Please go ahead, Sir.

Kenny Green

Thank you, operator and good day to everybody. I’d like to welcome all of you to Nova Measuring Instruments fourth quarter and full year 2010 results conference call and presentation, and I would like to thank management for hosting this call. With us on the line today are Mr. Gabi Seligsohn, President and Chief Executive Officer; and Mr. Dror David, Chief Financial Officer. I'd like to draw your attention to the presentation that accompanies today's call. The presentation can be accessed and downloaded from the link on Nova's website at www.nova.co.il.

Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements and the Safe Harbor statement outlined in today's earnings release also pertains to this call.

During this call, certain non-GAAP financial measures will also be discussed. These are used by management to make strategic decisions, forecast future results and evaluate the company's current performance. Management believes that the presentation of non-GAAP financial measures is useful to investors' understanding and assessment of the company's ongoing core operations and prospects for the future. Full reconciliation of non-GAAP to GAAP financial measures is included in today’s earnings release. If you have not received a copy of the release, please view it in the investor relations and news section of the company’s website at www.nova.co.il.

Gabi will begin the call with a business update followed by Dror with an overview of the financials. We will then follow the question-and-answer session. I will now hand over the call to Mr. Gabi Seligsohn, Nova’s President and CEO. Gabi, go ahead please.

Gabi Seligsohn

Thank you, Kenny. Hello everyone, and welcome to our fourth quarter of 2010 and full year earnings conference call. The fourth quarter continued to show strong business momentum, and marked the eight consecutive quarter of continued growth in revenues.

Most bookings during the quarter came from the foundry segment, an area in which we are particularly strong. Our foundry customers in Taiwan, China, Singapore, Europe and the US are all ramping up very aggressively to deal with the strong demand created by tablets, smart phones, mobile infrastructure, cloud computing and other applications.

Revenues during the quarter came in higher than the top end of our guidance, exceeding our expectations as a result of early sign off on a couple of tool evaluations, as well as higher-than-expected service revenues. Still, as previously communicated, much of the revenue is coming from our successful standalone metrology penetration made during 2010, have rolled into the first half of 2011.

At our third quarter conference call, we indicated that we plan to increase our operating expenses during the fourth quarter in order to accelerate our R&D efforts. Given the importance of these plans for our near and long-term roadmap, I’m pleased that we were able to execute faster than planned, resulting in overall spending of around $8 million in the quarter.

Dror will provide further insight into this area and to what you can expect operating expenses to look like going forward. I will state clearly that the needed increases are well managed such that we will remain with our long-term target financial model during 2011.

And now let me turn to the year as a whole. 2010 was the year in which Nova broke every possible record, clearly and as many others in our industry, we rode the positive way which came after the severe downturn of 2009. To me what is important though is the way by which we rode this wave and the foundations we have laid for continuing to ride this wave into 2011.

During 2010, we implemented adjustments to our best model in integrated metrology, we continued our penetration of the standalone metrology markets, and doubled our customer base, we improved the performance of our services business, and finally, we identified attractive new areas for growth in new process technologies.

Coming out of 2010, our financial and business fundamentals are at an entirely different place than where they were a couple of years ago. 2010 was the second consecutive year in which our product revenues significantly exceeded the growth rate of our industry. As you will see, when I will discuss our plans for 2011, we expect to continue this trend for the third consecutive year. We have always known that serving a global and advanced market such as the semiconductor manufacturing market requires heavy investment in technology and infrastructure, and that accordingly scale matters.

2010 marks a turning point for Nova in that respect. As I have said on many occasions the role we are now playing in the industry has significantly expanded, and therefore our business has scaled. Our technology has become an enabling element in high-end memory and foundry manufacturing processes. The challenges posed by the transition to the 3x technology node in foundry, the 4x node in DRAM, and 2x in NAND Flash has meant that the amount of measurement being performed has had to grow significantly.

Customers are looking for measurement technology able to detect the most subtle changes in the process. They are looking to be able to visualize the process in a much more detailed way than ever before, and needless to say, they want to be able to measure at a speed which exceeds that of the process itself, and that is exactly where we come in.

Now let me turn to the overall market trends as we see them. On many occasions in the last several quarters I have referred to the role smart phones and tablet computers play in the lives of our customers. It seems that these two segments continue to break every possible record. Recently released data shows that for the first time ever smart phone shipments exceeded those of PCs such that in the fourth quarter of 2010 101 million units were shipped versus 92 million PC units.

A September 2010 report on tablets predicted about 40 million units for 2011. A report issued last month following CES, and as a result of a survey with the supply chain of the tablet market speaks of 80 million to 90 million units in 2011. In response to these numbers and strong demand, our foundry and memory customers are increasing the rate by which they ramp high-end capacity.

Based on their behavior, there clearly continues to be supply insufficiency, an important and positive indicator for our market. Most of the memory being consumed for tablets has been flash based for performance and energy consumption reasons. A recent report with (inaudible) expectation 5x year-over-year bit growth in flash memory consumption for tablet.

We have recently also learnt from one of our key memory customers that specialized DRAM content in tablets is on the rise, and should go from current levels of half a gig per tablet to ultimately 8 gigs. This DRAM is a high-end chip with very good margins, and will require more aggressive shrink and design rules bringing on the 3x technology nodes into high-volume earlier than expected.

Again, this is good news as the requirement for more process control should come as a direct result. Another market segment for which demand is on the rise is the solid state drive market. The key inhibitor to this market taking off has been price so far. But judging by how our key customers are lining up to use larger volumes, we expect unit shipments will increase and prices will decline.

Our exposure to this positive trend is very clear. Our three largest memory accounts all manufacture both DRAM and flash memory. All leading-edge foundry capacity utilizes our tools for many steps in the manufacturing process as well.

Now let me turn to our outlook. Before referring to the guidance we provided in today’s press release, I wanted to discuss the steps we are taking to increase our growth potential for the long term. At our first analyst event in New York last month, we presented details on our long-term growth strategy, which we believe will lead us to reach the $40 million quarterly revenue level during 2013.

Our strategic focus so far has been on execution and expense control, while maintaining adequate R&D to penetrate the standalone metrology market. Our main strategic goals for the next 12 to 18 months requires shifting gears and include four elements. First, expanding our share of addressable markets in existing segments, relying on the large number of customers we have penetrated by adding more measurable parameters in the four areas of manufacturing we are involved in.

To do this, we will release new hardware and software capabilities with significant competitive value during 2011. Secondly, expanding our total addressable market from about $700 million to about $1 million in the next couple of years by addressing emerging process technologies, going after three-dimensional interconnect markets, shipping several evaluation tools of the new product later this year leading to revenues starting in the first half of 2012.

Thirdly, continuing to focus on high-value, high margin products. And fourthly, and finally generating substantial free cash flow while also investing to support the next phase of growth.

We’re off to a very good start for the year given a very strong opening backlog and continued strong bookings from all our key customers. This momentum increases our confidence that we will outgrow the industry for the third consecutive year. It is important, however, to bear in mind that we don’t have specific visibility, which extends all the way through the year, so it would be unwise to expect this to exceed our own quarterly expectations quarter after quarter.

In today’s press release, we stated our guidance for the first quarter of 2011. We expect revenues of $27.5 million to $29.5 million with net profitability of 25% to 28%. This guidance represents a further improvement over Q4, which in itself exceeded our own expectation.

And with that, let me turn it now to Dror for a closer view on the fourth-quarter numbers. Dror.

Dror David

Thanks Gabi, and welcome everybody to our quarterly conference call. I will start with an overview of 2010 fourth quarter results, and will then move to 2010 annual results.

The numbers presented in the press release and in all the following discussions represents GAAP based results. The fourth quarter of 2010 was another great quarter for the company. Total revenues in the quarter were $27 million, up 11% quarter-over-quarter and up 77% over the comparable quarter of last year.

Product revenues in the quarter increased by 11% driven by higher standalone optical CD revenue. Service revenues increased by 12% driven by higher time and material activities and upgrades. Product booking distribution has changed during the quarter with approximately 75% of the bookings coming from the foundry segment, and approximately 25% coming from the memory segment.

In the fourth quarter of 2010, North America product bookings accounted for 28% of total bookings, a larger portion relative to the first three quarters of the year as memory and foundry manufacturers extend their investments in that region, and the rest of the bookings came from Asia Pacific.

During previous discussions on the target P&L model, we mentioned that we are targeting blended gross margin higher than 55% based on product gross margin of 60%, and services gross margin higher than 30%. We are pleased to report that we have exceeded these targets in the current quarter.

Blended [ph] gross margin increased by 129 basis points quarter-over-quarter reaching record level of 57%. Product gross margin increased by 117 basis points to 61% mainly as a result of higher product revenues relying on existing infrastructure. Service gross margin increased to 36%, mainly as a result of the increase in time and materials and (inaudible) revenues.

In recent discussions and Analyst Day, we communicated our plans to introduce new products and develop new solutions for new segments, which require expansion of R&D investments. Following a fast start up of this plan, operating expenses increased by 25% quarter-over-quarter to 8 million with most of the increase coming from R&D. This increase was comprised of higher expenditures for prototypes, higher usage of subcontractors for hardware design and software development, and in parallel lower income from the Israeli Chief Scientist in the current quarter.

Looking forward, we would like to note the following; our plan is to continue to increase R&D investments during the first half of 2011, yet at a much slower pace than in the fourth quarter of 2010. Some portions of this increased investment is a non-fixed cost related to materials and sub contracting, which we will reduce once the development projects will materialize. And our guidance for net profitability in the first quarter of 2011, which is higher than 25%, includes the planned increase in expenses.

During the quarter, we reported net income of 7.5 million with operating margins of 25% and net margins of 26%. Diluted EPS in the quarter was $0.28, up $0.01 over the previous quarter on a diluted share count of 26.8 million shares. The fully diluted share count of the company is currently 27.8 million, including warrants, options and restricted share units. We expect 2011 first quarter share count for diluted EPS to be slightly above 27 million. Operating cash flow came in at 6.7 million in the fourth quarter.

Moving into balance sheet key metrics, accounts receivables were 13 million, similar to the previous quarter, and DSOs remained stable at the level of 45 days. Inventories increased from 10 million to 11 million in the current quarter, reflecting increase in manufacturing for our inventories to accommodate the increased market demand.

Deferred revenues decreased to 3.5 million by the end of the quarter due to recognition of revenues from previous quarter shipments. It is important to note that the deferred revenues in the balance sheet reflect unrecognized revenues, which were already collected in cash. The other portion which was not yet collected but was shipped to customers is presented only as inventory. Capital expenditures and depreciation in the fourth quarter of 2010 came in at 1 million and 0.3 million respectively.

I will now move to discuss 2010 annual results. 2010 was an exciting year for us shifting gears in each important element of the business, and leading the company to present record performance in all key financial metrics. Total revenues for the year were 87 million, 120% higher than ’09. Product revenues were 72 million, 142% higher than ’09. During the year, we have seen fluctuations in the quarterly distribution of bookings from the foundry and memory segment. Yet, on an annual basis the distribution was 54% memory and 46% foundry, reflecting the company’s strong and balanced position at both segments.

Blended gross margin in 2010 was 55%, with product gross margin at 59%, and service gross margin at 32%, all situated well within the target model. Annual operating expenses came in at the lower end of our target model mainly due to slower pace of scaling R&D investments in parallel to the significant revenue increase, and R&D as a percent of revenues came in at 15% relative to our target model of 16% to 19%.

Operating margin for the year was 25% at the higher end of our target model. Net profit for the year was 22 million, or $0.86 per diluted share. In parallel, following the steep ramp up in operations the number of employees increased by more than 30% from the beginning of 2010 until today, and we currently employ approximately 300 employees worldwide.

Our ability to scale the operation in parallel to maintaining DSOs at approximately 50 days, supplier days at approximately 70 days, and inventory turns at approximately 5 times a year is a strong indication of the leverage, which was built into the operations during recent years.

These elements played a critical role in our ability to generate record positive cash flow of 26 million from operating activities for the year. As previously communicated, we expect capital expenditures to be at the high level during the first half of 2011. As we expand our manufacturing space and build application and demo tools to support new products roll out.

On an annual basis, capital expenditures were approximately 2 million in 2010, and we plan to double this capital investment amount to the 4 million level in 2011. I will conclude with cash reserves, which increased to 62 million at the end of the fourth quarter, and provide us with the needed financial flexibility to execute on our business plan for the coming year.

Gabi.

Gabi Seligsohn

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

Question-and-Answer Session

Operator

(Operator instructions) And our first question today comes from Edwin Mok from Needham & Company. Please go ahead.

Edwin Mok - Needham & Company

Hi, thanks for taking my question and congratulations on a great finish for the year and good guidance.

Gabi Seligsohn

Thank you Edwin.

Edwin Mok - Needham & Company

So, the first question is on – so, the question is on the margin side, so in the fourth quarter you guys did 61% product gross margin, and if I kind of look at your guidance, it seems to imply that you guys expect to stay within kind of around that level in the product gross margin, is that a fair way of thinking about that, and what is the driver for increased margin, and is that software and should we expect those drivers to remain throughout the year?

Gabi Seligsohn

Well, as Dror mentioned in his commentary, the increase in gross margin on the product side came from growth in the revenues, which leverage the same operational basis. So as far as our model is concerned, I think that the upper 50s level is where we should be, somewhere between 57% and 60% is where we should strive to be at, and that fits well within what we communicated as our long-term model. I think what is also helping the overall blended margin quite significantly is the service side of the business, which Dror mentioned, in the quarter went up to 36%, and there as we have mentioned in the past, lot of the revenue is coming from upgrades and also time and material based, rather than contract-based revenues.

As far as software components, indeed average selling prices have increased throughout the year quite nicely, which translates itself to these very good product margins, and as far as our roadmap is concerned that trend is going to continue. We will continue to invest in software capabilities. The customers are accepting them very, very well. They appreciate them and they understand that the value that they have, and that helps the overall offering improve in conjunction with the ASPs and the margins that come with it.

Edwin Mok - Needham & Company

Great. Those were helpful, and maybe talk a little bit about mix between standalone and integrated, I think in 2010, there was quite a sizeable increase in DRAM capacity, so I imagine integrated was a pretty meaningful amount. But you guys have won a number of new business, so anyway you can kind of quantify ballpark what is the split between the two piece of business in 2010, and how to kind of think about in ’11?

Dror David

I will try to answer it a little bit from a different direction. The integrated metrology revenues were very, very high that they actually exceeded our expectations. What we have found and have actually mentioned in the past is that these moves in foundry, DRAM, and flash have required a lot more integrated metrology than it used to be consumed. And I think the reason there is because of the fact that the ramps, technology migrations are much faster than they used to be.

The cycles are now down to 6 to 9 months, and customers see the investment in integrated metrology as something very, very useful in order to reach their yield targets at a very fast pace, sampling actually 100% of the wafers with a lot more measurement site [ph], and so there we have seen a significant increase in revenues. On the standalone front, I think the biggest thing has been the number of customers. As we mentioned, we have doubled the number of customers. I will say and it is difficult for us to break down the revenues at this point, but what I will say is that in the fourth quarter a lot of revenue growth that we saw in the fourth quarter came from the standalone side, and what is very encouraging is when we roll into 2011, we already see the repeat orders from the successful penetration that we have made.

So, I believe, from a mix standpoint integrated is still the larger portion for our business. In 2011, I think the standalone is going to come up significantly, and therefore will represent a different percentage point. As far as the actual numbers, we won’t discuss that today for competitive reasons, in order not to shed too much light on that, but I will say as I mentioned integrated revenues are very, very high exceeding our expectations, and then stand-alone penetration, which turned into a significant increase in revenues as of the fourth quarter, which is something that we see actually materializing going forward in 2011.

Edwin Mok - Needham & Company

Great. That was helpful and then, Gabi maybe you can talk a little bit about kind of wins that you had with foundries throughout 2010, I was wondering how should I think about maybe increasing penetration of these foundries, you know, I understand all the time these wins are driven by one application, but once you get it to a customer you might (inaudible). Should we expect that to potentially drive continued growth beyond just the share – all this last year you won a number of wins, and probably you are into the [ph] revenue right now, how do you now think about that longer term?

Gabi Seligsohn

Yes, I think your observation is correct, and indeed when you make a penetration, you penetrate with the standalone into specific areas of the fab, and the nice thing about standalone is that it is able to accept wafers from all parts of a fab, and as you build that relationship and trust, people bring more wafers to you. And therefore, we have seen a move, strong move actually coming into etch, and we see also signs of success in the litho area. As we communicated in our analyst event last month, we spoke about the fact that as we have carved deeper into the four areas that we cover, which is litho, etch, CVD, and CMP, we have revealed with the customers actually several applications that they would like to start making use of.

In order to be able to cater for those, we are going to be doing two things. One is they are actually starting to proliferate us into more areas with the existing tool set, but also our roadmap is very much geared in that direction and you can expect us to announce significant progress on the product side, both the platform itself and the software. To cater for the fact that the customers are going to be wanting to measure more applications that they have before.

If I try to quantify this, if you remember in the past I spoke about 65 nm fab foundry with 100,000 wafer starts per month, representing maybe a $30 million or $40 million opportunity, I think that at 28 nm and below that actually has an addressable market goes at least time and a half, it is not even two times, from that number. So I think if you look from a bottoms up analysis, the addressable market is definitely growing, and I believe it is very much roadmap related, meaning if we can continue to deliver the capabilities that we have, the customers are actually very, very happy to take in these tools, and migrate from existing measurement techniques such as CD-SEM in favor of optical CD, or from existing metal measurement techniques to optical CD as well. So that is kind of a summary of how we see things.

Edwin Mok - Needham & Company

Great. So, one thing I want to touch on that is in terms of expansion within an end market, or the TAM that you talked about on the number, does that include TSV as an option, I think just talk about that being an area to growth, or potential growth for your guys, and then in terms of (inaudible) you mentioned that revenues to be expected on these new products on the first half of 2012, does that relate to TSV?

Gabi Seligsohn

Yes, absolutely. Just to make sure that everyone got this clear, I spoke about two development efforts, one is an effort to actually increase our share of our existing addressable market, which are product roadmaps related to the area that we are already in, and then I spoke about what you just asked about, which is TSV, which is three-dimensional interconnect.

Indeed, we are going to be shipping first units the second half of 2011. From the early interaction with customers, they are very excited about the capabilities that we’re going to be coming out with, and as I mentioned indeed for that area for TSV, you can expect to start seeing revenues in 2012. As far as the addressable market is concerned, what I did mention was that if we believe that the addressable market that we address today, and let us say as of 2012 is about $700 million. I would add to that about $250 million once we start addressing the TSV opportunity, and actually once the industry starts ramping up, which right now is expected in 2013, is the year in which we believe high scale manufacturing using TSV technology will actually pick up.

Edwin Mok - Needham & Company

All right. Great, thanks. Very helpful, and one last question for Dror, I think on the analyst day, you guys you talked about operating expense may increase by $1 million to $1.5 million in 2011, obviously in the fourth quarter you have already increased quite a bit, actually 1.6 million already. How do you kind of think about that, is that – was that – a lot of that already came in the fourth quarter or should we attack on an $1 million to $1.5 million on top of that or…

Dror David

Well, in the fourth quarter approximately 0.5 million from this $1 million to $1.5 million plan increase already happened. So looking forward to the first quarter, it should be between 0.5 to 1 million.

Edwin Mok - Needham & Company

Great. That is all I have. Thank you.

Operator

Thank you. We now move to our next question, which now comes from Leeran Roshman [ph] from Oscar Group [ph]. Please go ahead.

Leeran Roshman - Oscar Group

Hi guys. Congratulations for the quarter.

Gabi Seligsohn

Thank you.

Leeran Roshman - Oscar Group

And my question is regarding the booking, Dror mentioned that 75% of the booking this quarter came from the foundries, this is something that – it is consistent with the industry or something in our business?

Gabi Seligsohn

Well, I will say that the way we look at our businesses, we are exposed to the DRAM and flash market on the memory side, and then the foundries. These are the segments that we are focused on. What has happened and that is kind of what Dror was trying to allude to is that I think for the entire year, I think revenues were about 50-50 between memory and foundry, and then what we see in the particular quarters, we see fluctuations in which it may go in any given direction, either in favor of memory or in favor of foundry.

As far as whether it coincides well with the industry, I would say the following is that all the sectors are ramping up quite significantly, meaning flash memory, which is expected to grow quite significantly and foundry are very much ramping up. And so I think the takeaway should be that we are very well exposed to where the growth is. In particular quarters, certain customers invest more than others, and you can expect that to change and vary throughout the year.

I will say the foundry segment is extremely competitive right now. Samsung and Globalfoundries are going aggressively after TSMC’s business. There was an announcement today, which was quite astonishing that Samsung and Apple have signed an $8 billion contract in which Samsung is going to be providing LCD screens, and then processors and memory, and then on the processor and memory side, Nova is very, very well exposed.

And so I think the entire food chain would consist both of processors, and memory is experiencing a continued growth situation, and there is a continuous increased capacity. You will see as you continue to follow our activities that there are fluctuations, and they very much relate to investment decisions, which are particular to a given customer, but I would look at the overall sector, and in general we see very nice growth.

Leeran Roshman - Oscar Group

Okay, it was very helpful. And another question regarding the competitors, who do you see the competitive landscape right now, are you expecting to keep growing in LCD or can you talk about this a little bit?

Gabi Seligsohn

Sure. I think first of all the competitive landscape is very, very aggressive. On the LCD front, in optical CD we have two key competitors, which are Nanometrics, and KLA-Tencor. I will say openly that every deal requires significant competition. I think that the customers are definitely leaning in the direction of allowing themselves to get the best technology, as well as the best deal they possibly can at any given moment.

So I will say that from a direct competitor standpoint, it is highly competitive and for that exact reason, we are upping the investment in R&D because we need to deliver more and more capability as we go. The nice thing about optical CD is that the market is just actually asking continuously for more and more improvement, because they want to deploy it more extensively.

I believe this will continue to lead to market share gains as we go, and also back to the question that was asked previously, I think that what it is also going to lead to is the fact that we expand our footprint in any given fab by adding more and more applications. So, on a direct competitor basis, there is a lot of competition. On the indirect competition level, which are the other markets such as CD-SEM, and then such as the metal market as well, is very competitive also, and I think there what we are focused on is offering higher productivity than those two other techniques, as well as better precision in measurement stability. These are the key drivers that drive customers to want to change from an existing technique which is not optical CD in the direction of optical CD.

So I think, overall our expectation is to continue to grow our share of the market, but we also understand that there is no free lunches here, and that we need to invest very heavily to keep ourselves at the top of the technology curve, and be one step ahead of technology at any given moment.

Leeran Roshman - Oscar Group

Okay. Thank you very much and good luck.

Gabi Seligsohn

Thank you Leeran.

Operator

Thank you. We now move to our next question now from Marshall Herbes [ph] from Herbes Capital Management [ph]. Please go ahead.

Marshall Herbes - Herbes Capital Management

Good afternoon, and congratulations to a successful quarter and year. Just a follow up to the previous question, from a competitive momentum point of view, are there any market segments where you are currently gaining or losing market share?

Gabi Seligsohn

You know, I think for the most part our feeling is that that we have gained market position. I would say as far as market share concerns, on the integrated metrology front we have more than held our market share, and even increased it a little bit. On the standalone metrology front, I think that we have increased our number of customers, and held on from a revenue standpoint kind of held on to our market share standpoints where we were.

In 2011, I think that we have an opportunity to further increase our standalone market share by taking the duplicate or repeat orders from the penetrations that we have made. So, from a customer base foundation standpoint, we have laid good foundation for more market share gains in 2011 on the standalone front.

Marshall Herbes - Herbes Capital Management

Okay. And are you competitors doing anything irrational as it relates to production or pricing, and secondarily are there any pressures regarding material costs and lead times?

Gabi Seligsohn

I don’t know what irrational means. We all manage our companies to the best of our ability, so you might need to be more specific if you want to understand that a little bit more. I’m not sure what that question alludes to. As far as lead times are concerned, our industry is very much driven by short lead times. You know, one of the things we have done very successfully over the last couple of years is improve the operations.

Dror gave a few numbers there that you may have listen to, inventory cycles of 5 times per year et cetera. So, I would say that we are always looking to reduce our lead times in order to satisfy the customer demand, and we have worked the supply chain in a way that allows us to have the flexibility that we need on the one hand, and on the other hand manage our inventory and finished goods inventory I think in quite a healthy way.

You may want to try to specify more specifically what you are asking for regarding the competitors.

Marshall Herbes - Herbes Capital Management

Yes, are there any competitors doing any strong discounts or reduction in pricing, anything in that regard?

Gabi Seligsohn

You know, you have those situations occasionally, and where we try to position ourselves is rather than go in that direction, basically add feature and functionality and capability. I think the best indication is that in general average selling prices have improved for us in 2010 because that we have added more functionality and capability. There are situations in which customers are very much cost conscious, but I will say that for the most part in the equipment sector, especially in metrology that needs to be so advanced these days, customers also understand that there is only a certain extent that prices can be driven downwards, and they really need capability more than anything. So while each negotiation is a process, I don’t think that we are in a situation where we see price erosion as a result of competition.

Marshall Herbes - Herbes Capital Management

Okay, and one last question, was there anything in the quarter of generally non-recurring nature, any expense that would ordinarily be there or credits?

Gabi Seligsohn

No, nothing specific.

Marshall Herbes - Herbes Capital Management

Excellent. Thank you.

Gabi Seligsohn

Thank you.

Operator

Thank you. We now move to our next question now from Greg Weaver from Invicta. Please go ahead.

Greg Weaver - Invicta Capital

Hi, nice quarter.

Gabi Seligsohn

Thank you.

Greg Weaver - Invicta Capital

A related question to the last one, so in terms of the services gross margin, is there anything unusual there, I mean do you have to hire more people, or is there additional leverage opportunities?

Gabi Seligsohn

I think that from a service standpoint you should expect our gross margins to range between 30% and 40%, probably at the higher end of that for the foreseeable future. And the reason there is again the revenue mix has changed. We have gone more in the direction of timing and material base, and selling more upgrades than we did before.

I mentioned that one of the reasons why we exceeded the top end of our guidance was the fact that we got more service revenues than expected, and also at higher margins, specifically the deals that were relevant there. So, as far as leverage is concerned, as Dror mentioned, in general we have increased headcount, we will increase headcount a little bit more, mostly actually in the development side. But I think the operation is definitely able to handle what we have planned for 2011.

Greg Weaver - Invicta Capital

Okay, great. And related to that I think Dror, you might have covered it, I’m sorry I missed it. But from an OpEx perspective, I believe you said at the analyst day, on a go forward basis, you thought you would be able to keep it within $8.5 million to $9 million a quarter range, are you sticking with that?

Gabi Seligsohn

Yes, definitely.

Greg Weaver - Invicta Capital

Okay. And back to the margins again, in terms of the standalone versus the integrated, is there any discernible gross margin differential in it.

Gabi Seligsohn

No, actually the gross margins are pretty comparable. Sometimes stand alone is a little bit higher, but they are pretty comparable.

Greg Weaver - Invicta Capital

Okay. And any view in terms of I guess, in the last month or two in terms of 2011 industry group for your addressable market?

Gabi Seligsohn

Yes, I think as I mentioned, I think that we should continue to outgrow the industry for the third consecutive year. I think things have changed quite a bit in the last month with the big announcement from Intel and from Globalfoundries, and TSMC and Samsung and so, I think people are now expecting a growth here.

You know, I’m hearing different numbers. I am sure that you are hearing the same thing about 10%, 15%, or 20% growth. We feel comfortable that we can grow more than the industry, and I think the reason for that is the things that we had mentioned, the adoption rate of optical CD, which is increasing continuously. The need to measure more, one of the things that we had mentioned in the analyst day was that our compound annual growth rate over the last five years has been about 26%, or as overall equipment has been about 2% to 3%.

So I think we are fortunate to be in this specific technology sector, it is a sector that is growing tremendously. And so I think I have a pretty positive view of the year, and even with the positive view of the year, I think that still wafer fab equipment will probably still not be at the levels of 2007, but it is going to start getting closer to that I think as the year progresses.

Greg Weaver - Invicta Capital

Great. Thank you very much.

Gabi Seligsohn

Thanks Greg.

Operator

Thank you. (Operator instructions) We will now move to our next question from Dave Diana [ph], Private Investor. Please go ahead.

Dave Diana

Thanks very much. Nice execution gentlemen.

Gabi Seligsohn

Thank you.

Dave Diana

Just one quick question, given your robust cash flow, just wondering if there is any plans for something shareholder friendly with that cash such as a buyback or a dividend?

Gabi Seligsohn

Well, we are considering possibilities there. You know, in any event consideration should take us some time. Our annual report, our 20 F should be submitted by the end of March, and if there is something announceable, it would probably be around that time. So, we’re looking at that. We are discussing it with the board of directors and looking at possibilities there.

Dave Diana

Okay, and then the second question I had is are there any plans for you to make any acquisitions, or conversely have you seen any indications that any larger companies might be interested in taking a look at Nova?

Gabi Seligsohn

I think that as far as our growth is concerned in an organic way, we are continuously evaluating and looking at things. I think the important thing for us as we look at opportunities, and there are a few opportunities out there, is to go for something that continues to support the P&L that we have built in the company. It is very, very important for us to show progress as we go, and that is something that is a key consideration when we look at things. I do believe that we have built enough brand equity in the company and customer intimacy that we could bring more technology to market, and that is the reason why we are looking at possibilities, as I have indicated on several occasions, Nova is a company which is poised to grow, and grow organically and inorganically, and therefore we are not in any discussions on selling the company.

Dave Diana

Great. Thank you.

Gabi Seligsohn

Thank you Dave.

Operator

Thank you. We now move to our next question which comes from Ken Mass [ph] from Musco [ph]. Please go ahead.

Ken Mass - Musco

Thanks for the wonderful quarter, and for let us say the long-term vision of what you folks are building. Really very impressive to see it is coming together like it is here. I’m sure it is very gratifying to you guys.

Gabi Seligsohn

Thank you.

Ken Mass - Musco

In relationship to the inventories that you are showing, I gather that a significant portion of those are actually let us say, blended tools that are out there that are basically, let us say, based for the ultimate where the user can quantify the value of it, and then step forward. What kind of percentage of the $11 million worth of inventory is out there on that kind of a basis do you think?

Gabi Seligsohn

Well, I would say that because the implication of this amount is also forecast [ph] of revenues, we would not like to disclose this amount. What I can says is that during recent quarters, the level of inventories related to evaluation tools, or tools which were shipped to the customers and waiting acceptance was kept more or less at the same level.

We do expect some reduction in debt in the first and second quarter, as most of the systems finish evaluation and revenues are recognized.

Ken Mass - Musco

Thank you. And on the upgrades on your selling service, that I assume is “software” and what kind of a range of a sale is a thing like that for a unit that is out there. Are we dealing with 10,000 or 50,000, or 100,000.

Gabi Seligsohn

All those numbers are good numbers, actually because it really depends on the age of the system which is being upgraded. In some cases, it is a system that was purchased a couple of years ago, and so there would be you know, a smaller amount spent on it, but because we have been in the market for quite a while, and Nova has an active installed base of over 1000 systems, there are also deals that exceed the 100,000 number level as well.

So it really varies – it is very important for us to develop packages for upgrades that actually includes different price points in order to cater to specific customer requirements, and that is how we are building that business.

Ken Mass - Musco

Very interesting, and thank you folks for doing just a really spectacular job, and keep up the good work and good luck. Thank you.

Gabi Seligsohn

Thank you very much Ken.

Dror David

Thank you.

Operator

Thank you. We now move to our next question now from George Borayma [ph], Private Investor. Please go ahead.

George Borayma

Thank you for taking my call. Good quarter guys. My questions were related to the 3-D market opportunity, at this time do you guys have any evaluation installations, or you do a tool a record [ph] anywhere?

Gabi Seligsohn

So, as I mentioned, we have been in off-site back and forth with a few strategic accounts. We are building towards shipment of first units to customer sites, beginning of the second half of the year. But we do have the capability to evaluate our competencies already in-house, and that is what is creating a lot of interest and a lot of excitement on our side. It looks like we’re building something very useful, so there is nothing out there yet. As I mentioned at the second half of 2011 when you can expect that to start going out there.

And because of the fact that we expect that market to really start taking off in 2013, we believe the timing is very good. Then we want to be there with the customers as they mature the process. The reason it is going to take customers to mature [ph] that markets quite a while is several reasons. One is, the process itself that allows chips to be stacked one on top of the other. It is quite complex. There are several steps in the manufacturing process which will be added as a result of this. And because of it people are going to need to measure a lot more.

There are also industry standards that need to be created in order for instance, to allow a processor to be connected to a memory chip directly. And then thirdly, it is a cost consideration. The end markets, meaning the fables company such as Qualcomm, Broadcom, and others have said very clearly that they will not allow the wafer cost increase to exceed $100 per wafer as a result of this change.

And everyone is working very hard to bring the efficiency levels to those levels. So, I think the next 18 months or so is when all that gets worked through. Our industry has shown its ability to do that, and being there at a reasonably early stage allows us to take part in that and assess and evaluate, what will become what I call the in-line measurement requirements.

That is the area that we have always focused on because it is an area that requires several wafers to be measured, and as a result of it several systems per fab.

George Borayma

Okay, excellent. And on the market opportunity for that, obviously it is a large addressable market. In terms of slice of the pie and opportunity to Nova, how do you feel, I know it is kind of early innings, but how big do you think the realistic addressable market is for that?

Gabi Seligsohn

It is going to be difficult to say at this point in time. I will say that what still needs to be defined is what I just mentioned, which is what applications will become in line applications, and therefore consume a large portion of the quarter of a billion-dollar market that I mentioned. I will say that we are in this business in order to achieve number one or number two position. I think our market in general requires you to shoot for those levels. And we’re building a product strategy that should get as up to that level, otherwise it would not fit with the way we do business.

George Borayma

Excellent. Thank you Gabi.

Gabi Seligsohn

Thank you very much.

Operator

Thank you. As we have no further questions, I would now like to turn the call back over to gentlemen for any additional or closing remarks.

Gabi Seligsohn

Thank you operator. I want to thank everyone for driving today’s call. As mentioned, 2010 was a momentous year for the company. We are very excited about 2011, and we believe it is going to be another great year. We look forward to seeing you on the next conference call. Thank you very much.

Operator

Thank you. That will conclude today’s conference call. Thank you for participating ladies and gentlemen. You may now disconnect.

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