Nova Measuring Instruments' CEO Discusses Q2 2012 Results - Earnings Call Transcript

Jul.31.12 | About: Nova Measuring (NVMI)

Nova Measuring Instruments Ltd. (NASDAQ:NVMI)

Q2 2012 Earnings Call

July 31, 2012 9:00 am ET


Kenny Green - CCG Investor Relations

Gabi Seligsohn - President & CEO

Dror David - Chief Financial Officer


Edwin Mok - Needham & Company

Patrick Ho - Stifel Nicolaus

Keith Maher - Singular Research

Greg Weaver - Invicta Capital


Good day and welcome to the Nova Measuring Instruments' Second Quarter 2012 Results Conference Call. For your information this conference is being recorded. At this time, I will turn the call over to your host today, Mr. Kenny Green, CCG Investors Relations. Please go ahead, sir.

Kenny Green

Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments' second 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

Before we begin, I'd like to remind all 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. If you have not received a copy of the release, please view it in the Investor Relations section or News section of the company’s website at

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 will now hand the call over to Mr. Gabi Seligsohn, Nova’s President and CEO. Gabi, please go ahead.

Gabi Seligsohn

Thank you, Kenny, and hello everyone and welcome to our second quarter of 2012 earnings conference call. The second quarter of 2012 marked the continuation of the positive trend that started December of last year. Strong bookings and aggressive delivery schedules led us to surpassing the top end of our guidance. Continued favorable product mix also led to EPS that modestly exceed our expectation while we continue to ratchet up our operating expenses to prepare for future opportunities.

The strong position we have built at foundries over the last several years makes our equipment an integral part of the current ramp of 28 nanometers at three of our leading customers. Having started only late last year our customers are still not able to meet the strong demand from their customers.

Most notably our largest customer, TSMC recently reaffirmed commitment to more than double their current 28 nanometer capacity by the middle of next year and communicated their plan to spend most of their CapEx next year on the 20 nanometer technology node, as in the case of 28 nanometer technology node. As in the case of 28 nanometers for which we started preparing three years ago with our customers we are continuing to supply initial units for 20 nanometers and 14 nanometer process development which in turn will allow us to play an integral role in those ramp ups when the time comes.

During the quarter, we reported additional technology wins on the memory front which position us well for the below 10 nanometer technology node. We were also very excited to announce the selection of our flagship T600 standalone metrology tool by a leading flash manufacturer for the development of future generation. The early stage at which our tool is being introduced positions us well to provide optical CD solution for multiple steps in their process standing lithography, Etch, CVD and CMP, all of which rely heavily on the unique ability to measure a three-dimensional gate structures.

At SEMICON in middle of July we announced our groundbreaking V2600 standalone metrology tool which is uniquely positioned as the only tool able to provide full profile information of a single via for leading edge three-dimensional packaging. It was exceptionally gratifying to present the capabilities of this product in a co-authored presentation with IBM which focused on the criticality of these measurements for transitioning to high volume manufacturing of three-dimensional interconnects.

As stated on many occasions, and as reflected by our results, I believe we have done a great job over the last two years in building our position in foundry segment. Looking at our future challenges and opportunities, it is clear to us that we must continue to invest in high growth potential areas for short, mid and long term growth. We will do so by widening our product offering and expanding our served addressable markets.

From the product standpoint, we will continue to rollout new products that have a high software content. Short term aspects tend to be more related to ensuring that we have sufficient field present to support our customer needs on the ground as their deployment of our equipment expands to more areas of the fab. This includes both service as well as application people, the latter of which have become key to the development of metrology solutions for high end applications such as three-dimensional gate structures and other complex patterning schemes.

For the mid-term, we see both the increased need for on tool process control solutions in Etch as well as the move to three-dimensional interconnect to start generating initial revenues during the second half of this year and the early part of next year. In the area of on-tool process control solutions for Etch, we will be deepening the work we are doing with our 2H OEMs Lam Research and Applied Materials in order to further mature existing integration schemes and add more features and functionality. This will entail shipping of our evaluation units to customers interested in accessing the usefulness of these solutions. We believe both foundries and memory customers will meet such capabilities for the more challenging processing sets at advanced technology nodes.

Given the repeated push out of extreme UV lithography, customers are required to add several very complex Etch steps to the process where onboard optical CD solutions offer an excellent means to monitor and control Etch-ray and multi-chamber matching.

On the three dimensional interconnect side, we were encouraged to see leading established companies such as Nvidia, Qualcomm, Broadcom, and others, and their representatives attending professional symposiums about Through Silicon Vias at SEMICON, which will focus on process control solutions needed for moving to high volume manufacturing.

Having a solution that is able to perform full via profile characterization, as well as more capabilities that are planned to be announced later this year and next, puts us in an excellent position to provide the needed process control solution for the partnering product side, for the partnering device manufacturers of the established companies namely the leading foundries that we serve.

Here we will continue to work collaboratively with our strategic customers to zero in on their inline process control needs and develop more measurement capabilities. We expect to ship several three dimensional interconnect evaluation units, and place the full headcount on the ground in order to expand our penetration efforts.

For our long-term efforts, we've been discussing the advent of 450-millimeter wafer sizes and the process control challenges associated with that transition. Here, yet again, we see our excellent relationships with our key OEMs Applied Materials, Lam Research, and Ebara, as well as leading endusers as a real advantage. Articulating there expectations from 450 millimeter processing, our customers are asking us and our OEMs, who are even better within wafer uniformity, higher productivity, and better reliability. The level of sophistication that will be required to meet these needs is a step function higher that what is offered today in 300 millimeters.

It is our belief that at 450 millimeters the need for onboard process control solutions will increase and will allow our customers to add our integrated metrology solutions to more steps in the manufacturing process. At the same time, standalone metrology tools will have to be even more productive than today as the customers will be looking to reduce the number of wafer stops in the manufacturing process as much as possible. To support this need, we intend to continue and develop products, which will offer the best productivity as we always have.

The recent announcement of Intel and ASML has provided a very clear indication that the industry is accelerating its preparation for this major transition. Since 450 millimeter high volume manufacturing is still several years out, our investments will expand multiple years through evaluation before revenues begin to ramp. Since the current state has five device manufactures driving this program, you can expect that efforts in this area will be covered by collaboration agreements that carry mutual obligations and engineering efforts being committed. We have become active in consortiums that are being developed by the customers and research institutes to secure our position at an early stage.

With all this in mind, we have taken a decision to continue and invest in these growth engines at a more aggressive rate. As a management team, we have shown time and again our ability to invest and grow while demonstrating excellent profitability. In doing so, we rely on an excellent business model, advantageous product offering, and well managed supply chain.

Today's reported earnings are good testament that our R&D investments, combined with excellent acquisition capabilities lead to continuous profitable growth. Having brought this company to its current size over the last three years and with a view to taking it to even higher level, we are certain that these investments will prove beneficial for our customers and shareholders.

Throughout this journey, we remained committed to achieving our long-term profitability model of 20% to 25% operating margins. As we increase our operating expenses, we lay the foundation for supporting a higher revenue base over time as we execute our plans for continued secular growth. Dror will provide more color on operating expenses in his prepared remarks.

Now, let me turn to our outlook. As stated, 28 nanometer capacity increases are expected to continue. Though in the short-term we are seeing some deceleration in order volumes, looking at current capacity levels, and comparing those to market demand, as well as through talking with our key customers, we believe that spending will have to continue well into next year. Those customers that are at advanced stages of solving related yield issue are continuing to increase capacity, while others who are still working through their issues may take some more time to add capacity.

Statements by TSMC in recent days about their planned investments next year in 20 nanometers are yet another indication as to just how competitive the foundry segment has become. Such announcements are sure to influence decision-making processes at other foundries. We, on our side, will remain closely engaged and ready to supply these needs through our close customer collaborations.

We expect memory spending to remain weak in the near term, and increase by the first quarter of 2013, at which point we believe technology shrink can no longer be further delayed. Our recent technology win wills secure our position once spending in that area revealed.

In today's press release, we stated our guidance for the third quarter of 2012. For the third quarter, management expects revenues of $23 million to $25.5 million with diluted earnings per share of $0.04 to $0.12 on a non-GAAP basis.

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

Dror David

Thanks Gabi, and welcome everybody to Nova’s quarterly conference call. Before I start with an overview of second 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 $27.1 million higher than the second quarter guidance and up 20% over the first quarter. Products revenues increased by 18% quarter-over-quarter, reflecting the improved business environment; and service revenues increased at a higher rate mainly as a result of higher time and materials activity during the quarter. Product booking distribution in the quarter was approximately 75% from the Foundry segment and approximately 25% from the Memory segment.

On a regional basis, approximately 83% of the bookings in the quarter came from Asia-Pacific and the rest from US and Europe. Blended margins in the quarter were 54%. Products gross margin came in at a healthy level of 59%, yet lower than the previous quarter due to the fact that software revenues in the first quarter were above normal level.

Services gross margin significantly increased from 26% in the first quarter to 33% in the second quarter due to higher portion of time and materials revenues.

As expected, operating expenses increased in the quarter and came in at $9.9 million. The majority of the increase was in research and development expenses which increased in the quarter to $5.9 million.

Operating margins came in at 17% at the highest end of the guidance for the second quarter.

GAAP net income in the quarter was $3.7 million or $0.14 per diluted share based on a share count of 27.3 million shares. Non-GAAP net income in the quarter was $5.4 million or $0.20 per diluted share. Cash flow from operating activities was $4.5 million in the quarter with cash reserves increasing to approximately $91 million.

Moving into balance sheet key metrics, account receivables reduced by $1 million despite the 20% increase in quarterly revenues and DSOs remained healthy and came in at 60 days slightly lower than the previous quarter.

Inventory significantly increased from $13 million to $16 million during the quarter. This increase is related mainly to the newly introduced standalone product platform of T600 and V2600 while portions of this new product inventory are already installed at customer sites for joint development programs and product evaluation.

Capital investments came in at $1.2 million in the quarter and depreciation came in at $0.6 million similar to the previous quarter.

Before I conclude, I would like to provide some color on our forward-looking financial and guidance for the first quarter. On the revenues front, in the second half of the year, we expect to start recognizing revenues from new products, the T600, which is the latest optical CD standalone product and a V2600 the 3D interconnect product.

The timing of recognition of this first in fab systems depends on customer formal acceptance until we reach a point of certainty which allows the recognition upon shipment. And evidently, in such cases the visibility of exact revenue timing is lower.

As a result, our guidance of $23 million to $25.5 million revenues for the third quarter includes a slightly extended revenue spread relative to the previous quarter.

On the operating expenses front, as Gabi explained, looking into the second half of the year, the company will need to further increase its research and development investment in order to properly address the coming industry transitions and opportunities.

As a result, total operating expenses are expected to increase by 10% in the third quarter. It is important to note that the timing of these increases is strongly dependent on the progress of headcount recruitment on the exact timing of design processes and most importantly on the exact timing of supply of the [stroke] prototypes related to the new product.

On the tax front, because of our improved profitability we expect to fully utilize the deferred tax assets created in 2011 within the current third quarter. Hence, our maximum tax expenses in the first quarter of 2012 will be approximately $0.4 million.

The changes in deferred assets are considered as a non-GAAP adjustment and, therefore, do not impact the company's non-GAAP earnings per share.

With regard to the company's overall tax position and plan, it is worth noting again that the company still has unutilized net operating losses for tax purposes in Israel and in addition the company is part of an Israeli government's incentive program which provides zero tax payment in the first two years after fully utilizing this NOL.

We expect to be still around to be relevant to most of the taxable income in the relevant years and hence, we do not expect the company to pay meaningful cash income taxes in Israel in the next couple of years. For the long-term, the tax rate for industrial companies in Israel is expected to be 12%. So, our business model assumes an effective tax rate of approximately 15% for the consolidated company in the long-term.

And so, taking into account all these elements, our guidance for non-GAAP earnings per share in the third quarter of 2012 is $0.04 to $0.12. Gabi?

Gabi Seligsohn

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

Question-and-Answer Session


Thanks so much, sir. (Operator Instructions) Today's first question is coming from Mr. Edwin Mok of Needham & Company. Please go ahead.

Edwin Mok - Needham & Company

So, actually, Dror, I've a few questions for you first. Relate to your, actually just related to your upcoming related tax, so did I get it correct that your deferred tax assets or your non-GAAP tax, if you will, probably for the group will be around $0.4 million and then for the rest of the year you would expect minimal non-GAAP taxes, how we think about the model?

Dror David

Well, actually the tax expenses, which you currently see in our P&L is mostly the adjustments for deferred tax assets. And as of the end of June, we almost utilized in full this deferred tax assets, which were created in the end of 2011. So practically, in the third quarter, we've only around $0.4 million to be in the P&L for the third quarter. And as a result, our maximum tax expenses in the third quarter would be $0.4 million.

Edwin Mok - Needham & Company

And then on the revenue recognition part on the incentive a little more, right. So basically you also talked about some new products and, therefore, typically it has a little more expanded revenue recognition time horizon. Is it fair to say then that you expect your shipment in the coming quarter to be above your guidance range that you've provided because of this extended revenue recognition? And which products are you seeing that? Is it just the new product that you guys have recently announced or is it T600, can you help us with that?

Dror David

Yes, currently only the new products have their revenue recognition which extends routine customers' acceptance. All the other products mostly recognized shipments and these product -- these new products are the T600 and the 2600 for the 3D interconnector. Definitely these revenue recognition aspects relates only the new products.

And with regard to the shipments, it mostly depends on the level of the bookings which also impacts the book to bill, but definitely given the fact that some of these products are already installed and working at customer sites waiting for acceptance, in the last quarter we did three shipments which are relatively high.

Edwin Mok - Needham & Company

Just to clarify, sorry, I jumped on late for the call and you have mentioned big gain, but what's your booking about the revenue on the June quarter now which your book to bill about one in the June quarter and how this booking trend (inaudible) in the September quarter?

Dror David

As you know, we don’t provide book to bill information when specifically, right. So, I'll say that it's hovering around the one, but we're not going to be able to give specific numbers book to bill in the quarter.

Edwin Mok - Needham & Company

Okay, that’s fair. Then Gabi, maybe if you can help us a little bit about your new product that you recently announced right on the 3 I/C how was your reception from customer and of the -- you unwrapped some for more detail recently, right? What is the customer feedback have you gotten from the customers on the product? If you can help us just to understand where you're at in terms of progress on number of customers that you have -- has either received the tool or how in discussion, that will be helpful?

Gabi Seligsohn

Sure. As I mentioned, this is really an exciting new product announcement for us and also the fact that it was presented in a co-authored paper with IBM was very significant for us because it was a very production focused type presentation by IBM specifying why this kind of capability which does full profile of a single via is so critical for high volume manufacturing. And so that in itself I think provided a lot of support.

What was also interesting is that we've been working with three customers already one of which obviously has been IBM. And one of those three customers feel so strongly about the capability that he has asked OEMs that are competing for their via technology to use us as the reference tool in order to evaluate and qualify the quality of the etching process that they're doing. I think that's a great indication as to how the customers are looking at this as a cheap process indicator.

The work that we've done, and it's been a very quick project. It took us two years to get to this stage, which is very quick for brand new hardware. Also, included significant innovation. This is a patent pending capability we're expecting the pat to be granted any day now on this new method that we've invented to perform measurements of a single structure non-periodic structure using optical CD like technology.

And so, this has been really something very significant. And what's also interesting is, as a result of this announcement and the support from that key customer, we had several customers approaching us for wafer demos more than the ones that we were able to address previously. So, I feel very good about this product.

Our goal as we stated previously, saw just reiterated as to how actually present at four customers by the end of this year. We mentioned in our initial press release that we're in the process of receiving initial orders for these tools, some of which will be actual revenue orders, but the timing of those, as Dror said, are not absolutely clear at this point, as far as recognition some are evaluation units.

And as I mentioned, in my prepared comments, part of the investment that we're making right now and you can see that in the growth in inventory is to ship more evaluation units given the fact that there is such significant interest.

Overall, we expect the TSV market to offer us an opportunity for a metrology and inspection market of about $80 million to $100 million over the course of the next several years, which for us is a meaningful served addressable market.

Edwin Mok - Needham & Company

And something back to kind of expecting optical metrology business, right, I think we too understand that foundries do remain relatively strong but it has been softening right. So, I understand there is a very somewhat limited but any kind of views about how that will trend as we go into the fourth quarter and may be little beyond that? And then, any thoughts about how the memory customers looking at optical metrology to speak -- I think we've seen how the foundry guys going back and look into existing line and add new metrology or even inspection steps to improve the yield rate. Have you seen similar issue with the metrology side as well, I'm sorry in the memory side as well? I guess a two-part question here.

Gabi Seligsohn

Yeah. Regarding the fourth quarter, as you know we provide guidance only for the third quarter. I will say that if we are able to achieve a flat second half versus the first half of the year, this will be a very good achievement for us, because it will mean that we're doing again better than the industry for a fourth consecutive year. So that's what I'd like to see us doing, it's not in our pocket but it is something that we're focused on making happen.

I think to your question as to how I see the industry playing out as we roll into 2013, I think it's always a case but in this conference call we already talked about next year. As I had mentioned, we are really seeing a huge gap of being able to support the demand at 28 nanometers right now. I mean if you go all the way down to the food chain and I know that you cover it, I mean, look at it, Edwin, very closely all the way from arm through Nvidia and Qualcomm and then the TSMC, UMC, Global Foundries and Samsung, you see the same story which is strong demand and capacity. I think words from Morris Chang last week were great indication, when he mentioned specifically that he is looking to double the 28-nanometer capacity.

And so I think that that right now from our vantage point 2013 should be a good year for foundry and when you hear the talks about 20 nanometer that we've been very active in that area. We've been supplying tools, as you know also for 14 nanometers, even for 11-nanometer development in some cases, we're prepared to tackle that. And so my feeling right now is that foundry continues to be a strong into next year.

On the memory side, to your question on optical CD utilization in memory, it's pretty extensive. Actually it's growing in its usage and I think on two fronts, one is the vertical gate structures that you're starting to see in DRAM and NAND flash, those absolutely require an optical CD measurement. There's simply no other way to measure it, and it's extremely complicated to process, these new processes. And these design win strengths in the case of DRAM to below 20 nanometers and flash too down to the 1X technology nodes they depend so highly on making that happen that I think optical CD utilization rates are going to grow on the memory side.

So if indeed we're correct in assuming the DRAM spending should be back in the first quarter, NAND I think is a little bit less easy to predict right now, what the timing of NAND coming back is going to be. But if indeed it is correct that DRAM comes back beginning of next year and foundry is as good as I believe it's going to be, it makes for a pretty good year in 2013, and I think optical CD continues to play a key role that allows it to do better than the industry. This is my vantage point at this point in time.

Edwin Mok - Needham & Company

My last question though, just curious in terms of accounting, basically the opportunity in OCD right, OCD related included into their metrology, right. Just curious from 28 and 20 nanometer how much incremental if you can put per se fairly some color around incremental increase that you have 28 to 20 nanometer?

Gabi Seligsohn

I think that the increase, if you look at it -- let's start with looking at it from a process standpoint and then try to deduce from that the metrology implications. One of the key areas that is enjoying that a growth of spending that the foundries have been talking about and you remember the numbers that we talked about, when they talk about spending more in the move from 28 to 20, one of the key areas is Etch and the addition of Etching steps in order to circumvent you know extremely deeper as long as they can the double patterning, the quadruple patterning and the solutions that Etch offers there in order to somehow mitigate the dependence on litho tools which are also more expensive, I think that's where the growth potential is. This is what I have spoken about in the last several quarters.

I think Etch is where optical CD is going to grow most significantly, both on standalone and on the integrated metrology front. And you heard me talking about on tool process control may be something that I have not spoken about before, I have always talked about integrated metrology. The reason I mentioned that is because you can expect that the type of solutions that we start offering are going to be more significant than just the tool itself.

There are things in the making that we'll be adding significant software elements to our offering that will allow process controls to have a set function going forward. So I am bullish about that opportunity.

Now to the question that interest you most which is quantifying that that's a little bit difficult for me. I can say that I see an addition of 50% more Etching steps from 28 to 20 nanometers. How much of those we're able to continue through both standalone and integrated meteorology wins depends on continuing to grow our market share. Etch is the place for us to grow, no question about it.


(Operator Instructions).

We will now go to Mr. Patrick Ho of Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

First just looking at your OpEx at least on a going forward basis you gave guidance for 3Q. On a going forward basis now in for 4Q, but beyond do you see it remaining at these type of elevated levels or the increases or decreases forthcoming as we go forward?

Gabi Seligsohn

Well, what we are seeing, Patrick, as I mentioned, is that we are seeing several growth opportunities going forward and to facilitate those we must put in place the infrastructure in order to support those opportunities both on the software development in algorithm development side as well as hardware development. Add to that the 450 millimeter program which we have already initialized as you know but the pace of execution there given the opportunity needs to continue and grow.

So, at this point in time, as Dror mentioned, the growth that we are planning right now is a 10% growth for operating expenses. I think our plan which is coming up soon for -- annual operation plan is coming up in the coming quarter right now being the third quarter and the planning we are going to do for next year at that point we will be able to share with investors in more detail what is that we plan on the OpEx side. But I do want to say again to all our investors, I think we have show as a management team that we know how to plan and manage our operating expenses in a reasonable enough way that combines the need to invest in the future while also remaining profitable in a healthy level.

So hope I'll be able to add some more color on this in the next few months once the full plan for next year materializes, I will be able to answer that. But again as mentioned, I think and as we have shown, we will manage between these two because of the need to invest and the need to remain profitable and successful in what we do.

Very important to say also this is in order to set the stage for higher revenue base. This is what all this is geared toward. So of course in looking at the future and I have spoken on several occasions about taking the company to the next level with the (inaudible) growth we've been showing so far and where we want to take it, we want to be able to put in place enough infrastructure and enough investment so that we can see the step functions continuing for a secular growth rate and, therefore, know if you look at a bigger revenue base I think this will also help have a more advantageous I would say operating expense model.

One more word about this, as I stated, we remain very committed to our long term profitability model. This model that we have stated on several occasions of 20% to 25% which we have already hit last year I will plan it to go back to that model, I am not forecasting for you at this point and time exactly when, but everything that we are doing and the decisions that we make look at that as part of a growth plan for the company and therefore everything that comes back from that bottom line to the top line we'll take a look at when we do our planning looking forward.

Patrick Ho - Stifel Nicolaus

Great. That's helpful. Gabi, just looking, I think in your prepared remark you talked about memory coming back in the first quarter of next year. Given all the moving parts in both I guess NAND and the weakness in DRAM, do you see one of those two segments has been I guess the first to pick up or is it kind of a mix of both?

Gabi Seligsohn

Well, if I look at our bookings in the second quarter, as Dror said I think it was 75% Foundry and 25% memory. So, we are having, we are seeing business to memory and that has been a continuous case obviously but as stated it has been quite weak. What we are starting to hear on the NAND flash side is that I think I it is going to take longer in order for a ramp up to take place. But we think that DRAM situation requires a shrink as soon as possible and our customers are looking to focus on the higher ASP part types. All of those require further investment in either in their existing fabs or also by adding further capacity. So, I believe DRAM will improve before NAND Flash improves at this point in time. And I have to admit that it has been an evolutionary picture that we've seen, maybe my vantage point was a little bit different a quarter ago, but as things unfold this is what I'm seeing currently.

Patrick Ho - Stifel Nicolaus

Great. And a final question on the long-term growth prospects for you guys, you've obviously now entered the TSV market and looking for growth opportunities there. With a lot of the investments that you're putting in right now, is it fair to assume that you're going to be full going into other markets as well and those are some of the stuff that we should be watching on a going forward basis?

Gabi Seligsohn

I think right now the addition of the 3D interconnect product has such capabilities that it could touch upon other sectors within the food chain. I think that it may create an interest beyond just the Through Silicon Via that is focused on right now. Other adds, so I cannot say anything specific right now, but I think that that technology and that capability opens the door for several things.

And also as I mentioned in my prepared commentary, we plan on adding more capability to the V2600 tool second half of this year and beginning of next year, and I think that could also expand this addressable market.

As far as the other sectors, I think that for us the best growth opportunity is to expand the reach with the optical CD platform further with the customers that we've penetrated and also the recent penetration on the NAND flash side that offers an interesting opportunity. So at this stage, this is the way I look at things.


Thanks, Mr. Ho. We'll now go to Mr. Keith Maher of Singular Research. Please go ahead, sir.

Keith Maher - Singular Research

I was hoping if you could talk a little bit more about what was going with product gross margin and I know it's a little weak? And if product mix between standalone and integrated have anything to do with that as well?

Gabi Seligsohn

And hopefully heard well enough the question. You said something about product gross margin and also wanting to understand the breakdown we can integrate it standalone, correct?

Keith Maher - Singular Research

Yeah, that would be helpful.

Gabi Seligsohn

Yeah. Generally, as we've indicated before our product gross margin tends to range between 58% and 62%. And as you saw in the first quarter, it was 61% this quarter it was 59%. And the way you should look at that is that in particular quarters in which the extent of software revenue is more significant, it goes to the higher end, and in those quarters that it's on a more normal basis than it goes to the lower end but within that range, which we feel very comfortable with. That kind of product gross margin range is a good product gross margin position to be and it's something that we look at kind of on a continuous basis. So that's on the product gross margin. Again it's a product mix associated thing indeed as you had mentioned.

Regarding the breakdown between standalone and integrated metrology, we don't provide that on a quarterly basis. As I've mentioned in the past, our long-term goal with the current product set and again that's an expanding product set, but were we to stay with the current product set is to get to a level of 50-50 on the product revenues. There have been quarters where it's been at that level.

So standalone side of the business does continue to grow on, I would say, on a normalized basis is getting to very significant level, but specifically I'm not able for competitive reasons to provide that breakdown.

Keith Maher - Singular Research

Okay, sure. And just one question on the tax rate. Once you use up -- it looks like you'll use them for the deferred tax asset next quarter and then I think in the past you talked about and you mentioned today that 15% tax rate but that you wouldn't really be getting that for what, several years down the road?

Dror David

Yes, actually the timing in which we will start seeing actual cash income taxes for the consolidated company will be only after a couple of years from now. So everything that you'll see in our income taxes in the next couple of years will probably be more of deferred asset adjustments and so forth.


Thanks, Mr. Maher. We'll now go to Mr. Greg Weaver of Invicta Capital. Please go ahead.

Greg Weaver - Invicta Capital

Just a follow-up on the gross margin question here. Dror, I'm coming out with about 52% margin if I backed into it relative I think the midpoint of your revenue guidance as well as your operating margins. I guess, can you speak to that in terms of why we might see that go down again for Q3?

Gabi Seligsohn

So, Greg is asking you said 52% is the midpoint of our guidance, he want us to understand why we're seeing that decline?

Dror David

Yeah, I'd say that in general product margins are expected to good in the third quarter and also services, gross margins are going to be in the ranges of the second quarter around 30%. So, however, overall because we have some revenue decline, the blended gross margins would decrease in one or two percentage. So you're correct, the midpoint is around 52%.

Greg Weaver - Invicta Capital

Okay. And the inventories being up, now is that I think you might have addressed as well, that due to the new tools that are being shipped is that expected?

Dror David

Well, most of the increase of inventory in the quarter as I mentioned in the prepared remarks is related practically to the two new products which we announced and are proliferating lately which is the T600 for standalone optical CD and the V2600 for the 3D interconnect. So some of that is within the manufacturing cycle right now and some of that is already installed in customer sites waiting for acceptances.

Greg Weaver - Invicta Capital

Okay. All right, and nice generation again. Any sense what you are going to do with that plus the warning that you raised before in terms of acquisitions, anything going on there?

Dror David

Yeah, as I mentioned Greg in previous discussions in the quarterly conference calls we are actually looking at a few opportunities. There are some interesting opportunities for us which we think can be significant for us as a company. I mean, this expanding cash base is very helpful because it allows us to focus on deals which would be both be cash based, if not all cash based. At the same time, whatever transaction we do we would be leaving a significant amount on our balance sheet, because we believe that in this industry it is important to have a strong balance sheet. So if that continues to be the case.

These discussions are ongoing as you can imagine and the timing of these things obviously are not things that we can completely control. Obviously we have some influence, but only to a certain extent, and so our hope is to try to execute something in the not too distant future, but nothing specific to report at this time.


(Operator Instructions). As we have no further questions at this time, I will turn the call back over to the host for any additional or closing remarks. Thank you.

Gabi Seligsohn

Thank you, operator. I want to thank everyone for joining today's call. As stated, our focus continues to be on continued growth up for the long term and we look forward to getting the opportunity to update you on progress in the next conference call. Thank you.


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

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