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Nova Measuring Instruments Ltd. (NASDAQ:NVMI)

Q1 2012 Earnings Call

May 2, 2012 09:00 am ET

Executives

Kenny Green - CCG IR

Gabi Seligsohn - President & CEO

Dror David - Chief Financial Officer

Analysts

Edwin Mok - Needham

Patrick Ho - Stifel Nicolaus

Krishna Shankar - ROTH Capital

Amit Dayal - Rodman & Renshaw

[Abrupt Start]

Kenny Green

Thank you, operator and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments first quarter 2012 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 CEO; and Mr. Dror David, CFO.

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, I'd like to remind our listeners that certain information provided on this call may contain forward-looking statements, and the Safe Harbor statement included in today’s earnings release also pertains to this call. If you have not received a copy of the release, please view it in the investor relation or 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 with the question-and-answer session. I’d like to now hand the call over to Mr. Gabi Seligsohn, Nova’s President and CEO. Gabi, go ahead please.

Gabi Seligsohn

Thank you, Kenny. Hello, everyone and welcome to our first quarter of 2012 conference call. The first quarter of 2012 marked a very good start for the year. Our revenues during the first quarter were up by 18% versus the fourth quarter of 2011. Our revenues came in at the upper hand of our guidance and operating margins exceeded our expectations as a result of favorable product mix.

During the quarter, we executed per our communicated plans which included a carefully managed increase in our operating expenses. These development efforts are critical to allow us to continue and improve our market position. While the fourth quarter of last year marked the initial phase of the 28 nanometer ramp up in foundries, we are now clearly in full swing.

Moreover as recently reported by some of our leading customers there seems to be a severe shortage of capacity limiting short-term growth potential of some leading device manufacturers who feed the tablet and smartphone markets. This situation has led some of our key customers to announce an increase in their prime CapEx for this year and add capacity faster than they previously planned.

Since all leading foundries are our customers and all want to play a significant role in this current ramp up, all are either qualified or in the qualification for the relevant technology node which puts us in a favorable position since we have been designed in with all of them for quite some time.

On the memory side of our business, CapEx has so far been limited as a result of low average selling prices on the device level as well as short-term capacity efficiency. We expect CapEx in memory, both in DRAM and NAND not to significantly improve before the end of the year or even the beginning of next year.

We recently posted several important announcements, signifying both an increase in business volumes as well as technological wins for our product. The first was for winning a tool selection for development of 11 and 40 nanometer technology nodes at a leading edge logic manufacturer. This win was of strategic importance to us as it covers the most critical manufacturing steps of lithography, Etch and CMP both in the frontend and backend of the file.

We also announced the addition of another foundry customer for our integrated metrology platform and commented that we expect this particular win to generate significant business for us in the future. Now to give you some additional insight, let me review what happened during the first quarter.

Our focus on the foundry segment and the strong position we have achieved there over the past two years are clearly paying off. As stated the ramp up in foundries at 28 nanometers is very significant. Both our main product lines, integrated metrology and standalone are benefiting. Given the strengthening competition amongst foundries, customer focus also include investments in the next two technology node both 20 nanometers and 40 nanometers.

As stated in our last call, we expect to continue to receive orders for these two technology nodes in coming quarters and indeed got some orders during the first quarter as well. In light of supply shortages and the implications on device manufacturer's ability to support their customers' events, we expect device manufacturers who place orders with foundries to continue to get closer to the fabs as time passes.

We have recently received more indications that optical CD measurements play a significant role in data sharing between the fabs and their customers providing further evidence of the strategic role our technology plays in next-generation device manufacturing. This is most pronounced in the more critical steps of gate fabrications where on the one hand, process complexity is highest and on the other hand yield requirements and process tolerances are [tidiest].

From a wider market perspective and as mentioned memory spending continues to be low. Though we are seeing some capacity increases in NAND flash and DRAM, we expect customers to only change gears toward the end of 2012 or the beginning of 2013. With the technology transition for 30 nanometers and DRAM already in place at most customers, we expect that most if not all of the next ramp will be focused on below 30 nanometers.

On the NAND flash side, going below 20 nanometers will require significant design changes especially in Etch and litho creating a need for more optical CD based process monitoring and control.

As previously mentioned, the number of Etching and lithography steps is significantly growing as customers continue to circumvent the transition to Extreme UV Lithography for as long as they can for cost and complexity reasons. We expect to benefit from these trends when spending comes back in this sector where we are strongly positioned as well.

The net of what we are saying is are indeed off to a good start for the year and have indications that spending will continue into the second half of the year. So in order for the industry and for Nova to grow year-over-year there would need to be a significant step function in spending in the second half. The positive developments I have been describing are good signs for the near term, but it's too soon to extrapolate this into a trend that goes beyond our visibility.

From a competitive standpoint, we were pleased to announce winning yet another foundry customer for our integrated metrology platform following a head-to-head evaluation. We proved yet again that our technology combines very high reliability, excellent productivity and cost of ownership as well as advanced and mature automation developed for foundries over the last several years.

Our latest model the i500 is continuing to gain traction at the below 20 nanometers, though some of our customers are opting to extend the reach our previous generation the NovaScan 3090Next.

On the standalone front, order intake combines our latest model, the Nova T600, the Nova T500 as well as the earlier 3090Next standalone. As indicated in today’s press release, operating expenses increased to about $9.3 million during the quarter. As previously communicated, we plan to continue and gradually increase operating expenses throughout the year in order to support our short and long-term development activities as well as take measures to support the continued increase in our standalone metrology shipment from a facility and product engineering standpoint.

Having an increased variety of [processors] in the field as well as new customer fabs to support has required that we increase headcount in our application and field service organizations. We have also put in place several engineering programs that are focus on continuous improvement of reliability, manufacturer ability and factory productivity, all of which are included in the said increase in operating expenses and capital investments. Discussions with our key OEMs as well as key customers and potential customers over the last several weeks show that the transition to 450mm programs will be happening more rapidly than previously anticipated.

Accordingly our plans include speeding up efforts in that area to secure our position for when revenue start ticking in expected towards the end of 2013 or the beginning of 2014 and onwards.

Today’s reported earnings are good testaments that our delivered roadmap which has included the addition of many features and functionalities to our products was the right way to go and has allowed us to increase our average selling prices and partially mitigate the short-term impact of increased R&D spending as we work to create more growth opportunities for the future.

Now let me turn to the outlook. Recent announcements by our leading foundry customers call for a continuation of spending at least for the next couple of quarters. Given the severe shortage in 28 nanometer capacity, we expect customers to continue and pull in deliveries wherever possible. Our mature supply chain and efficient manufacturing capabilities will allow us to support this need.

After some recent weakness we expect NAND and DRAM to come back towards the end of the year or beginning of 2013, fueled by signs of insufficient capacity at the high-end driven by demands for tablets, smartphones and ultra books as well as the launch of Windows 8. This improvement on the memory side should contribute to maintaining strong revenues into next year.

In today's press release, we stated our guidance for the second quarter of 2012. For the second quarter of 2012, the management expects revenues of $24.5 million to $26.5 million with diluted earnings per share of $0.14 to $0.19 on a non-GAAP basis.

Finally, we are pleased that we have continuously outperformed the industry as a result of a well executed strategy. We are determined to continue on this path by aligning our product strategy with our customer needs and allocating necessary development resources.

And with that operator, let me now turn it over to Dror for a closer look at the numbers. Dror?

Dror David

Thanks Gabi, and welcome everybody to Nova’s quarterly conference call. Before I start with an overview of 2012 first quarter results, I would like to note that the numbers presented in the press release and in my following comments represent GAAP-based results unless specified as non-GAAP.

Total revenues in the quarter were $22.6 million at the high-end of our guidance and up 18% quarter-over-quarter. Products revenues increased by 23% quarter-over-quarter, reflecting the improved business environment. Service revenues slightly decreased as a result of lower time and materials activity during the quarter. Product booking distribution in the quarter was approximately 70% from the foundry segment and approximately 30% from the memory segment.

On an annual basis, approximately 87% of the booking in the quarter came from Asia Pacific and the rest from US and Europe. Blended margins in the quarter increased to 56%, slightly above our target model. Products gross margin came in at a record level of 62% mainly due to favorable product mix plus higher than average software revenues.

Services gross margin decreased from 31% in the fourth quarter of 2011 to 26% in the first quarter of 2012 due to a reduction in time and materials revenues in parlance to higher costs related to new customer sites.

For the second quarter of 2012, based on the forecasted product mix for the second quarter we expect product gross margins to slightly reduce relative to the first quarter of the year. As expected operating expenses increased in the quarter and came in at $9.3 million. Research and development expenses increased in the quarter by $1 million or 22% to $5.6 million while SG&A remained stable at 3.7 million per quarter.

Looking forward with respect to operating expenses to further increase towards the 10 million level per a quarter as we continue to investment in the execution and the initiation of research and development programs related to next generation product in 450 millimeter tools set.

Operating margins came in at 14% higher than our guidance for the first quarter, driven mainly by the favorable product mix and improved gross margins. For the second quarter of 2012, we expect the combination of higher revenues on one hand and the higher research and development investments on the other hand to result in operating margins which are similar or higher than the first quarter of 2012.

GAAP net income in the quarter was 2.7 million or $0.10 per diluted share based on a share count of 27.2 million shares. Non-GAAP net income in the quarter was 4.9 million or $0.15 per diluted share. Cash flow from operating activities came in neutral in the quarter due to the increasing in working capital requirements related to the ramp up in business volumes and as reflected in the higher accounts receivables and inventory level at the end of the quarter.

Moving into balance sheet key metrics, DSOs remained healthy and came in at 63 days. Inventories significantly increased from 9.6 million to 13.3 million during the quarter. This increase is related mainly to higher production inventories aimed to support the increase in business volumes as well as to higher level of inventory related to new products which were already shifted and installed at customer site but were not yet not recognized in revenues.

Capital investments came in at 0.9 million in the quarters and enhance our manufacturing facilities towards development and manufacturing of next generation product in 450 millimeter tools. Depreciation came in at 0.6 million slightly higher than the previous quarter.

I would conclude with total cash reserves which remained at the 87 million levels during the quarter. Gabi?

Gabi Seligsohn

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from Edwin Mok of Needham. Please go ahead.

Edwin Mok - Needham

So first question I have is, it appears that your reported results has just got a booking trends as far to [decelerating] into the second quarter. Have you guys seen that for your business and if so, where is it, just our rating is not wide (inaudible) tune better it than it appears?

Gabi Seligsohn

Did you ask whether it is decelerating or accelerating, I couldn’t hear?

Edwin Mok - Needham & Company

[Decelerating] (Inaudible)

Gabi Seligsohn

[Decelerating]

Edwin Mok - Needham & Company

Just made booking at decelerating, yes?

Gabi Seligsohn

No, I think in general the trend is quite positive right now as indicated by our guidance, we see that business continues to be quite strong right now. So the years after good start, I might say also that you know we are seeing a good move into generally the second quarter that I think in general the trends continues to be quite positive and in general I’ll say book-to-bill is definitely above one. Actually, I think the things right now as we started the year and also moving into the second quarter, we make quite good.

Edwin Mok - Needham

And then compared to your commentary for the second half and for the full year; it sounds like second half you expect memory to be a little bit remains somewhat soft okay, and the foundries continue to grow. So with that in mind and for full year you might not be able to outgrow 2011, am I correct?

Gabi Seligsohn

Yeah, I think it’s a little bit too really still to say that we could grow better than the previous year. We need to remember where we started 2011 which was a very, very strong beginning for the whole industry; indeed in grants there was that strong very big softness in Q3 which led to lower revenues in Q4.

So my statement was that we are off to a good start to the year; you see what our guidance is for the second quarter and indeed as to extrapolate from that it requires things to go up step function; I think could, but I think it’s a little bit too early to say that and therefore we are taking a cautious approach as to the second half in saying that we think the overall year looks quite good, but it’s difficult for us to say that it’s going to be a growth year at this point. This is how you should interpret what I said.

Edwin Mok - Needham

And then now coming back to the foundry area, so you talked about the (inaudible) some orders right. Just wondering two questions related to that, one, how do you think of positioning those versus the 28 nanometer, do you see that you are stronger or there is some more work to be done there?

And then the second question is, do you expect investment in call the 20 nanometer and 14 nanometer nodes at your customer side or these forges are in the development work at this point in time?

Gabi Seligsohn

It’s a very good question. I mean I think that we have a very strong position at 20 and 14. If anything customers are looking to expand the application usage of our tools both integrated and standalone.

So I think what they are trying to do is to benefit from what they have already proven that we’re capable of doing and even expanding which goes part and parcel with what I have been saying all along about optical CD that is going into more Edge layers, that is going into lithography, that the gate structures require more and more measurements. You remember my comment also about the fabless companies and how much attention they are paying to these critical steps which are associated with these advanced gate structures.

So if anything I expect that our addressable market for each of these fabs and how well we've done is that we've designed ourselves well into at least assess that we have been in and even in most cases actually more so than before.

As far as the ordering pattern, I think what is going on now and I can speak freely about this because there has been so many announcements by TSMC and by Qualcomm, etcetera; what's going on now with the rest of spending which is to try to catch up with the requirements and on the other hand the other foundries UMC, GLOBALFOUNDRIES and others positioning themselves in order to be qualified for 28 also implies that all these fabs need to show that they are ready for the next technology node after that.

Because I think what happens in these situations is that the customers want to feel confident and comfortable that the next phase generation and even the one after that are actually being developed.

And so I think what we may see happening as I said we have seen orders for 20 and 14 for several quarters already and its continued in the first quarter and will continue in the second; was there a ramp up rapidly? I think it will take some time; I think the indications that we have is that 28 nanometers is a significant technology node; I know that there were questions about whether it’s a significant node or it’s transitionary. I think right now, it seems like there are going to be significant build out of 28 nanometer capacity given what’s going on.

But at the same time, I think what these guys are going to be wanting to show is the availability even of limited capacity at 20 nanometers as the next step etcetera. So I think, gives me shift the timing of that is not clear. I do think that most money will continue to be spent right now on 28 and foundry.

Edwin Mok - Needham

I have one more question always, so on the gross margin line you improved quite a bit and very strong in the first quarter. How much you said was driven by new product that you guys are selling versus just software and why are you guys (inaudible) product gross margin come down in the second quarter?

Gabi Seligsohn

Well, first of all I’ll try to comment on the first quarter and I’ll let Dror comment on the second quarter. On the first quarter, our revenue combines now new products and older products as well.

As I mentioned in my prepared remarks, a lot of our revenue still comes from the older versions, but the nice thing that has happened is that they now include several features and functionality that did not exist maybe a year ago and therefore average selling prices have gone up on those products.

At the same time, the new products that are rolling out are rolling out at a favorable average selling prices as well. And so those things combined together are helping us; I think obviously, as I said this is not a coincidence where we have work really hard on is the value proposition in the last two years.

And as you know, we’ve always focused on productivity which is a critical virtue, but also we have learned that an ecosystem of capability surrounding the platform, it’s absolutely critical as well and I am glad to say that several sectors in foundry, foundry is definitely enjoying those capabilities and ordering the tools significantly with those capabilities. So that’s helping the product gross margin quite significantly.

I’ll let Dror comment about Q2 on product and also about services.

Dror David

Well, for the second quarter, the difference in gross margins is first of all as I mentioned in the first quarter of 2012 we are enjoying higher than average software revenues. These contributed around between 1% and 2% to the high gross margin in the first quarter and this will probably not repeat itself in the second quarter according to the forecast, so our gross margins will be a bit lower.

In addition to that as mentioned before the product mix has its impact and we see some shift in the second quarter to products which are not fully featured with all the software capabilities and this will have also some small impact on gross margins. So we expect it to be slightly below the 60% level.

On the services gross margin, we do expect to see increase in revenues in the next quarter and this should drive gross margins towards the 30% level for services.

Edwin Mok - Needham

Sorry, one last question, how should we think about the GAAP tax rate for the year or the coming quarter?

Dror David

25%.

Operator

We will now take a question from Patrick Ho of Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

Gabi, in terms of the last question, I think what you were talking about in terms of opportunity in the fab, as you go to 28 and eventually the 22 or 20 nanometers, what's the dollar content opportunity for fab at those nodes?

Gabi Seligsohn

You know for us what we have said on several occasions that we believe in the these fab situations on a per fab basis, let's say for a 100000 wafer stock per month foundry, we are as at, at around 65 nanometers, we modeled that at being something like $30 million to $40 million as rest of the market for us.

We now believe it's about $80 million to a $100 million at those technology nodes and actually we did a review of that just a few months ago, so this is pretty fresh data. So I think it's more than doubled itself actually over the last two years with the transition. I think this also bodes well with the comments heard from Morris Chang recently at TSMC, where he spoke about more than doubling his CapEx, the need from 65 to 28 and he also mentioned that it would even not go X2, but probably go at least you know 1X more in addition when moving to 22 and below, so I think OCD is also a reflection of that and with penetrating more layers in the production perhaps it's even a exceeding those rate sometimes.

Patrick Ho - Stifel Nicolaus

Looking at the memory side of things where you guys are trying to make inroads, as the industry shifts to vertical NAND, how do you see that impacting, one the OCD market and secondly for you specifically?

Gabi Seligsohn

Yeah well first of all it's important to state for everyone, I mean our position in memory is quite strong. Historically about 50% of our revenue comes from memory and what we are looking to do now obviously is to continue to strengthen our position where we have been extremely strong and memory has been with integrated metrology and at least in a group of customers also quite strong and standalone.

I think the growth opportunity for us in memory is primarily in the area of standalone metrology. I think that the move to virtual NAND is a huge opportunity. If you look at the virtual NAND design and this has been in several publications, so we can talk about it. This is extremely complex, things like what they call the staircase application. It turns out that the only way to measure those things is with optical CD. There's no other way.

So I think that in itself provides a huge opportunity for all of us that are competing on the optical CD market and a lot of our algorithm development focus these days is growing in that direction as well as activities that I won't be able to discuss too much, but I will say more deep activity these days with the Etch OEM, the equipment manufacturers since we believe the need for onboard metrology at below 20 nanometers for the virtual NAND is going to grow significantly as well.

But I think overall this is a good opportunity and as we go down the design rule, these opportunities continue to grow. So we are quite bullish on that opportunity to be honest, Patrick.

Patrick Ho - Stifel Nicolaus

And final question for me, in terms of the industry outlook for both EUV and the delays that are occurring there. From your perspective, especially on the OCD metrology front; one, what are you seeing in terms of the delays in EUV; and secondly how does the, I guess the current state of double and multiple patterning, how does that help you guys in the near term until EUV gets adopted on a production volume basis?

Gabi Seligsohn

Yeah, I think these situations are and I remember this was the case when ASML went after immersion lithography and extended the life of 193 nanometer lithography. This continuous extension of extreme EUV means that there are more litho steps. Actually there's a lot more etching steps. I have said before that we know there is to be 50% more etching steps as well to allow this extension of the lifetime of immersion lithography. It's all good news.

It means basically that people are depositing lines which are coming closer and closer to one another and that their tolerances for any mistake whatsoever are becoming smaller and smaller. What it's requiring us to do obviously is to continue to be aggressive on our roadmap, continuously increase our tool sensitivity to subtle changes in the process, continue to develop algorithms that are able to deal with the complex structures. So definitely there's a direct link between that trends and how we are managing our roadmap and what our customers expect us to deliver?

Operator

Our next question comes from Krishna Shankar of ROTH Capital. Please go ahead.

Krishna Shankar - ROTH Capital

What was your mix of standalone versus integrated tools for the quarter and how will that trend through the rest of the year?

Gabi Seligsohn

We don't provide that breakdown on a quarterly basis. I will say that generally, we are gradually climbing up to the level where on an annualized basis, things range somewhere between 40% and 50%. Our long-term model is to reach a level which is sustainably around the 50% between those two products, until obviously we introduce more products which we intend to do, so but we don't provide that on a quarterly basis, I apologize.

Krishna Shankar - ROTH Capital

And then do you see a broadening of foundry capacity additions in addition to TSMC, do you see people like UMC, GlobalFoundries and other expanding 28 nanometer and build capacity and given the expected pickup in memory spending at the end of this year, should all this result in sort of a smooth progression in our orders through the rest of this year?

Gabi Seligsohn

For you third question, absolutely the foundries are spending. As I mentioned in my prepared remarks these companies are either in qualification process or trying to get into a qualification process with these big players, you know the Qualcomms, the NVIDIAs, the Broadcoms of the world et cetera.

And so indeed we are seeing order traction from those two customers that you had mentioned and quite healthy. I think that that’s going to continue at least for the next couple of quarters, could continue even beyond that. As far as the memory as I mentioned we expect that to be more towards the end of the year. We have seen some memory traction. As Dror mentioned, 30% of our revenues were memory and in Q4 there were only 15%.

So there is traction still ongoing in memory, but we think that that is going to happen later perhaps that is even a good time. If it pours into the next year, it could help us all in the industry continue with the positive trends into 2013. I don’t think they’re going to be able hold off for much longer, much like what we said six months ago about 28 where we knew the transition would have to happen, but none of us, everyone included knew about the extent of it or to forecast it.

I think the same is going to have to happen with memory. I don’t think that they’re going to be able to stay at the current design rule. ASPs have shrunk so much that from a gross margin standpoint, printing more chips for dyes it's going to be absolutely necessary. So my personal feeling and from speaking to our customers is that I think it's going to come back, it should come back quite strongly because of the need that's going to start driving it.

Operator

We will now take a question from Keith (inaudible) Singular Research.

Unidentified Analyst

I want to revisit the just the margins and the ASPs on the product side and I know you can’t, you are not going to give a breakdown between standalone and integrated, but how much is the higher growth in standalone driving the margins in the overall pricing. If you can just give us a little more color in that area?

Gabi Seligsohn

I can say that both products are with healthy gross margins round about the levels that we gave; that level of around 58% to 60% on a normalized basis.

As Dror had mentioned, we had significant software sales during the quarter. Software sales are either included in systems and they drive the specific system average selling price upwards or it is sold separately. The separate sales of software is still a lumpier business and therefore it’s difficult to build a trend around that.

So I would say that both contribute these days quite well to the margin picture. Both are positioned well because of the features and functionality as well as I mentioned the productivity that they offer. So I think both sides of the business are enjoying a healthy trend right now and contributing to the results.

Unidentified Analyst

And kind of a follow-up to that; is there at some point when standalone kind of stabilizes as you are saying kind half year product sales, is that – is margin growth at that point kind of going to be driven more by this functionality from things like software?

Gabi Seligsohn

One of the things that also matters of course is the introduction of new versions and new capabilities; though the product portfolio is not stagnant; it’s a moving target and changes overtime and what we have tried to do and I think we have done successfully to drive average selling prices and margins upward.

Again, for the benefit of the customers which is the most important thing is, that doesn’t just happen on its own, it happens as a result of these things. So as far as whether it’s going to stabilize; we are focused on growing the top-line, continuing the growth trend of the company as enjoyed in the last several years and you know what those 50% represents is a function of the size of revenues that we are driving, right.

So the company is still we think on a secular multiyear growth trajectory and overtime there could be some changes in the prior gross margins. What we have intimated in our long-term model for overall margin for the company is to stay overall at about 55% for the overall business, combining both services and products. And we think that that’s a good long term model for us. In the third quarter we exceed that just like in this particular quarter, third quarters were a little bit below that which happens as well. So this is a little bit about my perspective on margins. Hopefully that’s helpful.

Unidentified Analyst

I have another question; I guess this is more for Dror and having to do with the working capital. In terms of inventories, you mentioned some percentage of the shipments, were at customers that (inaudible) inventory, you couldn’t recognize the revenue. Could you talk about what impact that might have on if we look at DSOs picking out back or effect that had DSO?

Dror David

Well, in general this did not significantly impact DSO, because when the revenues are not recognized then the accounts receivable are also you know do not appear in the balance sheet. In general, I would say that regarding inventories, we do see also in the current quarter that inventories turns are around 3.5 a year which we believe is a robust level and hopefully our plan is to stay at that level looking forward.

Operator

We will now take a question from Amit Dayal of Rodman & Renshaw. Please go ahead.

Amit Dayal - Rodman & Renshaw

In terms of segments, you know in relation to your operating expenses going higher, where are we spending money to beef up resources?

Gabi Seligsohn

The spending increase as I had mentioned is mostly in the R&D area. The increase in expenses there is to drive new programs that we are working on. One of the things that I had mentioned in the call is the 450 millimeter program which for quite a while for the industry was really on hold.

What we have seen actually in recent weeks to be honest is speeding up of that. We have at least four or five interactions with customers and research institutes that are pushing very hard for much more aggressive deliveries than they had before. But that could change that we have seen and it’s going to require some shifting of gears.

But also from the plans, more plans activity standpoint there is a continuation of rolling out new versions of our products both software as well as hardware.

Also on the operations side internally, as I had mentioned, from facility standpoint, of what I had just mentioned right, now we are now a bigger company, the infrastructure did require digging us a notch further up on the engineering and manufacturing capacity side, so some spending is going in that direction from a capital standpoint.

And as I mentioned also, new fabs as well as penetrations that we made require some adjustments to the headcount upward of service and application people. So this is where things are being spent these days.

Amit Dayal - Rodman & Renshaw

So just from a longer term view on this with the expansion of the infrastructure, would OpEx remain at current levels going into the future or once this is taken care of should we expect it to come down a little bit?

Gabi Seligsohn

Well, we said that we expect this year to reach somewhere around the $10 million level on a quarterly basis. We may you know at first to be to continue on our remark on the previous call, the expectation was that it would take probably until the end of the year that we would reach close to $10 million level.

We’re going to do that a little bit earlier; now we think it’s a prudent and the right step and a right direction for us given all the opportunities that we seek. So we’re trying to normalize them at the $10 million level.

As far as being long-term sustainability of that, Dror you may want to make a comment about that?

Dror David

First of all our long-term model is for R&D to be between 16% and 19% and for operating expenses to be between 30% and 35% of revenues. So in general, looking forward, we do not expect operating expenses to go down in the near future, so that’s in general.

Amit Dayal - Rodman & Renshaw

And just one housekeeping question, in terms of tax expectations for the rest of the year, what should we be looking to target that around?

Dror David

First of all, it’s a good opportunity to mention again that the tax expenses that are seeing now GAAP results, only most of them if not all, reflect adjustments to protect their assets.

So these are not actual cash payments of taxes within 2012 and because the company has NOLs of approximately 425 million at the beginning of 2012, plus tax intensive program from the government which applies for zero tax rates from the first year which we have taxable income.

This means that probably our focus is that during the next three years, we are not expected to pay any significant cash tax expenses from the headquarters in Israel.

So however because of the accounting needs and rules, we did need to create the tax assets in the end of 2011 and what you see right now is adjustment to this tax asset in the P&L. The effective tax rate for 2012 and for the second quarter as I mentioned, is expected to be 25%.

Operator

(Operator Instructions) We will now take a question from Jay Dela of (Inaudible). Please go ahead. Your line is now open.

Unidentified Analyst

Gabi, just to be clear on the OpEx commentary, I think in response to the last question, you said that the goal was to kind of trend up towards $10 million per quarter by the fourth quarter of this year for OpEx, but because of 450 accelerating and what not, that may happen sooner which I presume means 2Q or 3Q. Is that what you are saying?

Gabi Seligsohn

Yeah, yeah. That’s what I am saying that we are going to get to that level earlier than we had previously communicated and the reason is that we see more opportunities in front of us that we would like to react to those and believe that that bodes well or for the long-term opportunity for the company. So that is indeed the case.

Unidentified Analyst

And based on what you know right now, are you contemplating flattening it out to $10 million when you get there and then just starting to leverage some revenue growth from that point forward?

Gabi Seligsohn

Yeah Jay I mean right now from our vantage point, my answer to you Jay is correct yes. I mean that's kind of the level, it could mitigate downwards a little bit or at that upwards but right now that is the level. Obviously you know our objective is to continue, at the same time as to grow the top line and OpEx as a function of revenue to come closer to our long-term model. That's the objective right.

As Dror mentioned that's 30% to 35% OpEx we are obviously not there right now and we are exceeding that in this particular time, but we think this is a necessary step to continue and demonstrate growth and I think you know as we have shown in the last two and half years, as we have gradually ratcheted it up, expenses, we've also grown significantly as a company.

I think this is the right direction for us right now, but yes I think for now I am sharing with you to the best of my knowledge and my thinking of this, we'd like to try to flatten out at that level. Perhaps if we could bring it down a little bit, we will but I think let's give it a couple of quarters and see where we stand.

Unidentified Analyst

And then, so if you look at the pickup in OpEx and particular in R&D and what not, that you have executed over in the last several quarters and including the first quarter and what you are looking for in the second quarter, do you believe that some of that will manifest in new product revenues in the third or fourth quarter of this year?

Gabi Seligsohn

Yes you will find it in I think larger portions of new product revenues of already announced product, obviously as you know the cycle of seeing revenues from the announcement take some time and so what you will probably see is a bigger portion, you know, revenues going in the direction of the new products as we add feature and functionality. The other thing is as we have said, we believe that the 3D interconnect product that we have will start generating some initial small revenues in the second half and more so in 2013.

But these things do take some time, you know, from a recognition standpoint. There's always the evaluation. Dror just discussed the implications on inventories. So these things are all tied in together but I think generally the answer is yes. You are going to start seeing some revenues coming from new products in the second half.

Unidentified Analyst

Okay, because the reason why I asked that is because you are expressing some level of optimism that there's a chance that your revenues continue to grow sequentially in the second half on some level. Obviously, that depends on the magnitude of this foundry momentum continuing and whether or not memory comes back.

I was just kind of curious that if you are baking into that commentary some level of assumption that some of your new products from your pick up in R&D over the last three or four quarters plays into that so that Nova can actually a little bit better than the general wafer fab equipment trends not only because optical CDs is picking up share but because you start to see the benefits of some of your branded products picking up.

Gabi Seligsohn

I think that's a fair assumption, Jay. I think that's exactly how we look at it and I think if I would look on a multi-year basis, this is exactly how things have played themselves out. We continuously work with our customers two generations ahead. That's why I made the commentary on 20 and 14 nanometers. It’s proven to be the exact right direction, and in doing so, we also involve them in the planning process of the roadmap in getting their feedback on what we are developing.

That way we secure the fact and when we kick off a new product and roll it out in the field, we actually get the traction that we are looking for and so, yes, that is the case and I think if I would look historically just to put ourselves at ease, this is actually how it happens. So I think, yes, I think in the second half you will get to see more of a new product coming online.

You know, usually during the year, around the middle of the year we announce new things and so you can expect us to continue to be aggressive on that. The market is demanding that and we are there to pick up that demand. I mean that's so critical because as I said it’s just -- it’s a very interesting field to be engaged in because of the dependency level growing so much. So, you know, my answer to you is, yes, I think you understand correctly our strategy.

Unidentified Analyst

Okay. And Gabi, I am not sure if I remember this correctly or not but my recollection is that there maybe a large foundry out there that was traditionally not completely focused on foundry but is getting bigger in foundry that I don’t recall it’s a standalone tool customer too. And then of course you've got some big IDMs that haven’t exactly been your biggest customers. Are you seeing any traction with your standalone tools with any customers that traditionally have always brought integrated or nothing from you?

Gabi Seligsohn

Yes we are. Since you are hinting on customer names, I will avoid muttering myself up to the specific customers but yes we are growing and actually penetrating with standalone, more so with, actually at this point pretty much; almost all of them are customers, and standalone. All of them are customers and integrated.

As I had mentioned in our press release earlier was at the beginning of this quarter, I think, meaning the second quarter, the press release that we had on adding a new integrated metrology foundry customer, that was an interesting situation because that's the customer that started by being standalone metrology customer and now it’s taking big, big portion of integrated metrology as well.

So in most cases, we’ve grown some integrated standalone. There is already a situation of a major foundry that’s taken in the other direction.

Unidentified Analyst

I guess what I am for this really getting at is I think there are some pretty big spenders out there that are not necessarily standalone customers there yet. And I am just curious if there is any [emails] going on there or presenting chance to those big chunky spenders could stuck by standalone from you guys, just any visibility on that?

Gabi Seligsohn

I’ll just make a general comment, we’re gaining traction with standalone on both memory and foundry and also for competitive reasons I’ll keep it at that if that’s okay with you.

Unidentified Analyst

And then my last question Gabi is, you guys were sitting, I hate to beat the dead horse; I think I asked you this question in the other quarter, but you guys are sitting on a very impressive, very nice cash situation considering the size of your company.

And it doesn’t appear that buybacks of dividends are in the strategic plan. It seem like it’s more dived in for future growth in some shape or form. Just wondering if there is any creative use of cash that might be happening tactically this year?

Gabi Seligsohn

You know creativity, we want to apply to the use of cash and I have said this before on the conference call and elsewhere is that we are very actively looking for an acquisition. We believe it would be a better use of portion of our cash to induce more growth into the company.

And so that’s where we would focus a certain amount of that cash and other amount would obviously stay on the balance sheet to procure what we need to do from a growth standpoint. So that continues to be the case. We are very active in that area. Obviously there is nothing to announce right now and everyone would hear about it. But we are active there and we would like to continue with that direction.

Unidentified Analyst

Is it your goal to stay a process control company in that sort of scenario or they can imagine there is a kind of thing out there which you would be looking to broadening your product line into other areas?

Gabi Seligsohn

Nova is very good at process control. This is what we specialize in. This is the company with know-how, core competence, using all sorts of electro-optic signals and other types of signals is what we will do in the future. We think that’s our strength. We think that there are opportunities for us to grow within the semiconductor market in process control and that is our focus right now.

Operator

Gentlemen, we have no further questions at this point of time.

Gabi Seligsohn

Operator thank you and I would like to thank everyone for attending today’s call. Look forward to speaking to you next quarter. Thank you.

Operator

Ladies and gentlemen that will conclude today’s conference call. Thank you for your participation. You may now disconnect.

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