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Mattson Technology (NASDAQ:MTSN)

Q3 2012 Earnings Call

October 24, 2012 5:00 pm ET

Executives

David L. Dutton - Chief Executive Officer, President and Director

J. Michael Dodson - Chief Operating Officer, Chief Financial Officer, Executive Vice President of Finance and Secretary

Analysts

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Larry Chlebina

Benedict Pang - Caris & Company, Inc., Research Division

Operator

Good day, ladies and gentlemen, and thank you for your patience. You've joined the Mattson Technology Inc. Third Quarter Financial Results Call. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the call over to your host, the President and CEO of Mattson Technology Inc., David Dutton. Sir, you may begin.

David L. Dutton

Good afternoon, everyone. Thank you for joining us today to discuss Mattson Technology's financial results for the 2012 third quarter, which ended September 30, 2012. I will give you an overview of the business, then Mike will provide the financial results and progress on our cost reduction program, and last, I will close with our business outlook and guidance for the fourth quarter of 2012.

Before going into the specifics of the call, I'd like to remind everyone that information provided in today's conference call contains forward-looking statements regarding the company's future prospects including, but not limited to, anticipated market position, revenue, margins, operating expenses, earnings per share, tax rate, fully diluted shares outstanding for future periods, the company's ability to secure additional sources of liquidity to address working capital needs.

Forward-looking statements address matters that are subject to a number of risks and uncertainties that can cause actual results to differ materially. Such risks and uncertainties include, but are not limited to, those described in today's news release and in the company's Forms 10-K, 10-Q and other filings with the SEC. The company assumes no obligation to update the information provided in the conference call.

And now let me turn to the business of our third quarter. In the third quarter of 2012, we saw the continuing effects of a slowing global economy as our customer spending became more cautious. The European debt crisis continued to affect and slow economies of emerging countries and the sluggish U.S. economy kept downward pressure on semiconductor demand. In this environment, we are expecting existing fab capacity for DRAM and NAND to remain underutilized through the -- through at least the next quarter.

In the foundry area, we are seeing limited amounts of capacity being added for 20-nanometer to establish pilot line capacity for early yield burning. There are some spot 28-nanometer capacity being added as our customers ship products from 1 foundry to another. We are expecting foundry spending to remain lumpy due to equipment reuse and specific customer requirements depending on device yield and product demand. Currently, we do not forecast the change in these market conditions through the end of 2012.

In our last quarterly earnings conference call, we outlined our Phase 3 restructuring plans. Through the quarter, we have been executing that plan and are achieving the results necessary to navigate the company through this slow economic period and establish a streamlined operating infrastructure that will leverage improved profitability and cash flow during the next business growth cycle.

As part of our restructuring, we announced that besides his CFO duties, Mike Dodson has been appointed to the role of Chief Operating Officer, where he will have oversight of manufacturing operations, supply chain and administration. Mike has been a significant partner in implementing our cost reduction programs. With Mike focused on our tactical execution and further streamlining of the organization, I will be able to spend more time on our strategic directions, strengthening our products, customer relationships and culture for Mattson Technology to deliver the future.

We are in the final stages of lowering our headcount by greater than 25% versus the second quarter of 2012. We have now reduced our cash flow breakeven point from over $50 million to mid-$30 million quarterly sales run rate, primarily through restructuring activities and related spending reductions across the company. By the end of 2012, we expect that our cash flow breakeven will be approaching the low-$30 million quarterly sales run rate.

Our in-sourcing strategy included aggressive cost improvements in our supply chain. These cost-reduction efforts and our investments in new products positions, which increased customer value, are resulting in an improved gross margin base, further strengthening our breakeven level.

In regards to liquidity, we are pursuing other sources of funding, which include considering solutions that are not dilutive to current shareholders to strengthen our ability to meet the working capital needs within the industry rebound.

Mike will give more detail on our customer -- on our cost improvements and plans moving forward in a moment. But first, I will provide a product update.

In Etch, our paradigmE is extending further into the Etch applications stage [ph] as we have capabilities that improve on-wafer performance while keeping costs low. In the third quarter, our paradigmE moved into production at one of our foundry customers. We also announced that we shipped our paradigmE to a new customer where it is undergoing qualification for leading-edge dual-pattern Etch applications.

In our Etch customer base, our paradigmE has engaged in new applications, including advanced dual-pattern etching with major foundry customers and 3-dimensional NAND Etch. Our Etch systems are installed at 5 customers and we are engaged with multiple new customers. We have over 50 Etch systems in production and this number continues to grow. The emergence of dual-patterning and 3-dimensional structures is increasing the number of Etch steps in this $4 billion Etch market.

Our paradigmE's advanced Etch capabilities is resulting in its growing customer acceptance in these key Etch applications, and we expect that our Etch business will be a significant growth driver for Mattson Technology's future.

In RTP, we are seeing further adoption of our Helios XP in the foundry area. In the third quarter, our Helios XP rapid thermal annealing system moved into production at a second customer's fab, and we announced our first follow-on Helios XP shipment to a leading foundry customer. The Helios XP is now in production at logic/foundry, NAND and DRAM customers.

Our other leading RTP system, the Millios millisecond annealing system enables our foundry/logic customers manufacturing at the 20-nanometer regime to set low leakage transistor parameters in a single chamber at high-volume production speeds. The Millios now has 2 customers with multiple systems and the very unique MSA is moving into production phase at 20-nanometer and beyond.

As previously mentioned, we have achieved a dramatically lower breakeven level in order to strengthen our ability to manage through the cycles of this business, as well as leverage stronger profitability and increased cash generation during the up cycles. At the same time, we continue to advance our new product positions in Etch and foundry RTP. Our unique paradigmE etcher has shipped to a new customer, and we are looking -- and we are working with multiple new customers on demonstrating the system's ability to deliver cost-effective results for dual pattern etching.

Our Helios XP and Millios RTP systems together are established at 4 major foundry customers, enabling them to achieve at 20-nanometer node and beyond the low-power transistors required for the mobile era. The industry is at a critical inflection point as it utilizes etching to extend 193-nanometer immersion lithography beyond 20-nanometer and moves toward 3-dimensional transistor formation. Mattson Technology is well-positioned in dual-pattern etching and 3-dimensional transistors. And we are extending our applications portfolio for even more future growth potential.

Our new RTP technology and the Millios and recently-introduced Helios XL products are enabling our customers to achieve robust transistor formation at the very leading edge of Moore's Law.

Mike will outline our financial performance in the third quarter of 2012 and discuss further cost reduction actions that we are taking to reduce our breakeven level further. Mike?

J. Michael Dodson

Thank you, Dave. Before I discuss the details of the financial results for the third quarter, I would like to summarize the financial highlights for the third quarter and year-to-date periods. Putting the current industry downturn aside, we are beginning to see real traction coming out of our cost-reduction efforts that we have discussed in great detail on the last 3 analyst calls.

Our year-to-date gross margin is 36%, well ahead of our targeted improvement of 4 to 5 percentage points for 2012 over the gross margin in 2011 of 30%. In addition, the reduction in our operating expense is ahead of schedule, coming in at $13.4 million in the third quarter of 2012, representing a 25% decrease from the same period of the prior year and an annualized savings of $18 million.

To date, our efforts to improve gross margins and reduce operating expenses have lowered the cash flow breakeven point from over $50 million to the mid-$30 million quarterly sales run rate. Looking forward, we expect operating expenses to continue to decline to $13 million in the fourth quarter and leave the year at an approximate $12 million quarterly run rate. This would represent a 33% decrease from the third quarter of 2011 or an annualized cost savings of $24 million.

We believe this run rate of operating expenses, when combined with our gross margin improvements, will lower the cash flow breakeven point to the low-$30 million quarterly sales run rate as we leave the fourth quarter.

I would now like to discuss the detailed financial results for the third quarter and year-to-date periods for 2012. Net sales in the third quarter were $20.4 million, representing a decrease of $14.5 million, or 42%, compared to $34.9 million in the prior quarter. This decrease in sales was primarily driven by lower shipments of all products into memory applications.

Year-to-date net sales were $105.8 million, representing a decrease of $37.5 million, or 26%, compared to $143.3 million in the same period of last year. This decrease is primarily due to lower sales of Etch systems into memory applications.

For the first 9 months of 2012, just over 1/4 of the system sales were Etch, as compared to just over 1/3 of the system sales in the same period of the prior year. The gross margin in the third quarter was 38%, which is flat compared to the prior quarter. Despite lower sales levels, the gross margin percentage stayed flat with the prior quarter, primarily driven by a more favorable mix of higher-margin spare parts sales and the sale of an evaluation system for which the cost had been previously fully amortized.

The favorable mix of higher-margin sales during the third quarter were partially offset by lower absorption of labor and fixed overhead costs due to lower production levels during the third quarter [ph]. As Dave will discuss later in the call, we expect our gross margins to be lower in the fourth quarter primarily due to less favorable mix of sales.

As we discussed on the last 3 quarterly calls, the company remains focused on driving improved gross margins. A combination of our efforts was targeted to improve our 2012 gross margin by 4 to 5 percentage points compared to the prior year's gross margin of 30%. With the year-to-date sales down 26% compared to the same period of the prior year, this gross margin improvement target has proven to be even more challenging.

In spite of lower production levels, year-to-date gross margin is 36% in 2012 versus 30% for the same period in 2011. And even with an expected production level in the fourth quarter that is flat with the third quarter, we are well-positioned to successfully meet our gross margin improvement targets for 2012.

Operating expenses, excluding restructuring charges, were $13.4 million in the third quarter, which represented a decrease of $2.1 million from $15.5 million incurred in the prior quarter and a second consecutive quarter of reducing operating expenses by at least $2 million.

Again, this quarter, we are 1 quarter ahead of our cost reduction targets. As we outlined in great detail in the prior 3 quarterly calls, there are 3 phases of cost-reduction programs that were initiated: Phase 1 in the fourth quarter of 2011, Phase 2 in the first quarter of 2012 and Phase 3 in the second quarter of 2012.

The key components of the first 3 phases of the cost reduction program included: Renegotiating our lease for a facility in Exton, Pennsylvania; consolidating our Millios product research development and prototype production from Vancouver, Canada, to our facility in Dornstadt, Germany; consolidating global manufacturing in Fremont, California, by discontinuing manufacturing operations in Germany; moving certain outsourced spare parts logistics in-house; reductions in force; salary reduction through furlough programs; elimination of certain contractors; lower level of investments in customer evaluation systems; renegotiating key contracts with outside service providers; production material cost savings; and reduced spending in discretionary areas.

The estimated onetime restructuring costs resulting from these 3 phases of cost reduction program is a range of $6 million to $7 million, of which approximately $4 million was incurred through the third quarter. That leaves an estimated remaining range of restructuring charges of $2 million to $3 million, of which the majority is expected to be incurred in the fourth quarter of 2012. This estimate may vary as certain plans are finalized and updated cost information becomes available.

In addition, we expect to incur approximately $1 million in capital expenditures in the fourth quarter to support the Millios consolidation into the Dornstadt facility and consolidation of global manufacturing into the Fremont facility.

Looking forward, excluding restructuring charges, we expect the operating expenses in the fourth quarter to be approximately $500,000 lower than the third quarter, coming in at $13 million. With the successful completion of Phase 3, we expect to leave the year with an operating expense run rate of approximately $12 million in the fourth quarter. This run rate represents a 33% decrease in an annualized -- and an annualized savings of $24 million in operating expenses from the operating expense run rate in the third quarter of 2011.

In addition, at the operating expense run rate of $12 million, when combined with our improved gross margins, the cash flow breakeven would be reduced to a low-$30 million quarterly sales run rate.

Interest and other income and expense netted to an expense of $9,000 and primarily represented a net foreign exchange loss related to our foreign-denominated balances at our U.S. operations. This amount in the prior quarter netted to expenses just over $200,000 and primarily represented similar foreign exchange losses.

Related to income taxes, we recognize a net tax benefit of $116,000 in the third quarter, as expected. The favorable tax provision during the quarter is primarily due to expected discrete releases of tax reserves in the back half of the year. We expect the quarterly tax provision to be approximately a $100,000 tax benefit in the fourth quarter.

The net loss in the third quarter was $6 million or a net loss per share of $0.10. Excluding the restructuring charges of $500,000, the third quarter net loss would have been $5.5 million or the same net loss per share of $0.10. The net loss in the second quarter was $3.3 million or a net loss per share of $0.06. Excluding the restructuring charges of $800,000, the second quarterly net loss would've been $2.5 million or a net loss per share of $0.04. Our weighted average share count for the quarter was 58.6 million shares.

Now taking a look at our balance sheet. We ended the third quarter with working capital of $49.6 million, which was down $5.6 million (sic) from $55.6 million (sic) at the end of the prior quarter. This decrease is primarily due to a decrease in our cash balances during the quarter. Cash balances at the end of the third quarter were $25 million and represented a decrease of $5.8 million over the prior quarter. The decrease in our cash balances was primarily driven by the $6 million loss that represented a net cash usage of approximately $5 million. Including advanced billings in the calculation, the DSO for the third quarter was 55 days compared to 54 days in the prior quarter.

In summary, from a financial performance perspective, the results for the third quarter were better than expected. Our revenues came in just above the top end of our range. Our gross margins were flat with the prior quarter but better than we expected, and we finished the quarter ahead of our plan for cost reductions. The net effect, excluding restructuring charges, was that our net loss per share of $0.10 was better than the range of guidance at the beginning of the quarter.

We also ended the quarter with $2 million more of cash in the top of our guidance range. Looking forward, given the near-term weakness of our sector, we will continue to execute Phase 3 of our cost-reduction efforts aggressively to reduce the cash flow breakeven point further.

We also are actively pursuing other sources of liquidity, which include considering solutions that are not dilutive to current shareholders, to help strengthen our balance sheet, to ensure our liquidity requirements are met, and we have enough flexibility to meet the working requirement needs as the industry rebounds.

Now I will turn the call over to Dave, who will provide fourth quarter guidance and elaborate further on our business results and prospects. Dave?

David L. Dutton

Thank you, Mike. Our outlook for the near-term global economic environment remains cautious. We are currently seeing that the slower macroeconomic conditions continue to keep semiconductor capital equipment spending low for the remainder of 2012. Visibility remains very low as we look to the first half of 2013 with customers maintaining very tight control over their capital expenditures. We believe that NAND spending will remain muted in early 2013. We expect that foundry spending will be lumpy for the next few quarters as customers spend on key technology upgrades to begin 20-nanometer pilot lines, so that they are ready to ramp when the economic conditions improve. As a result, we remain very cautious for the fourth quarter of 2012. Our guidance and outlook for the fourth quarter of 2012 is as follows:

We expect fourth quarter revenues to be in the range of $15 million to $20 million. We expect margins to be in the range of 24% to 28%. Earnings before restructuring charges will be in the range of a loss per share of $0.16 to a loss per share of $0.13. Cash will be $16 million, plus or minus $3 million.

We have aggressively reduced our cash flow breakeven to the mid-$30 million quarterly sales run rate and will be reducing it further as Mike explained. Our balance sheet has approximately $50 million in working capital or over $0.80 per share and a streamlined cost structure to allow us to maintain liquidity through this downcycle.

We are structuring the company to manage cost tightly through the steep cycles of this industry. And in effect, we are transitioning Mattson Technology from an Etch start-up company to a streamlined organization that will be able to manage through the cycles of this industry while meeting the future technology demands of Moore's Law. We believe that we have the appropriate resources to move successfully through this muted economy and keep Mattson Technology positioned at the leading edge of Etch, RTP and strip.

And with that, I'd like to thank you very much for listening to our business and financial updates. We are open to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Patrick Ho of Stifel, Nicolaus.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

A couple of questions. First, Dave, maybe in terms of the industry. Now obviously, the memory CapEx spending environment is soft right now. It's been soft, especially on the DRAM side, for some time. Just given that there's a higher level of reuse and upgrades and conversion on the memory side, do you believe whenever we get this catalyst or stimulus from both DRAM and NAND that there will be capacity buys? Or will this kind of conversion and reuse continue over the next few nodes?

David L. Dutton

Yes, Patrick, I think that's a good question. And it's -- I think it has a blend, but I do believe that we will see -- when demand picks up, I think we will see, still, some capacity being added. I believe, if you look out there are actually fabs being built that capacity will be added to. So I think our customers are showing they believe they'll need to add capacity -- it won't just be with the shrink. And I think also our customers are looking at moving from planer NAND to vertical NAND, which will require new capacity and new technology, and those are areas we're all working on. So I think the good news is we are seeing spot NAND prices moved up. I think it moved up about 40% over the last few months. And I think if we look forward, even though now we see there's enough capacity. What we're hearing from customers, especially if we see a little more aggressive SSD adoption, or we start to see a stronger tablet sell-through with the tablet wars maybe starting up, we could see that -- that, that could help accelerate or pull in some of the NAND projects. But right now, I think for the near term, we are expecting the current capacity to handle most of the NAND. But, I do believe we'll see more capacity adds before we go into just a pure technology growth mode.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Great. And I've got 2, just company-specific questions. First, it's encouraging to hear that you guys are expanding your Etch products into the foundry segment. As we look forward to the transition from 28 to 20-nanometers, for you, in terms of your Etch business, will the growth come from the simple TAM expansion, that a lot of your peers have talked about from going from 28 to 20, or are you going to be having additional applications that will give you additional growth as you move from 28 to 20-nanometer?

David L. Dutton

Patrick, actually a lot of what the company is focused on -- and in Etch first. In Etch we entered with a -- what we call the noncritical applications and it really moved into the critical space more around the dual pattern Etching area. And some of the trim Etches with the 3-dimensional structures. So those new areas are adding Etch growth, or Etch TAM growth, but on top of that, those are the areas we've targeted and where I think we'll really see our etcher excel and really start to see -- drive growth for the company. So it's both with the extending TAM, I think the key thing for us is coming from no Etch. That's really where our inflection point, our investment, has been and those investments are starting to bear fruit. And as they ramp, yes, we will see further expansion of our Etch business. And if I can just pile on to that question a bit, just because this -- our critical kind of investment strategy has been at this inflection point of moving towards 3-dimensional structures. Our Millios RTP also has been targeted and shows -- and delivers to the customers some real capabilities at the 3-dimensional node and going forward. And that's where, again, we're seeing the tool is actually working at customer sites, moving forward and we expect that to be an incremental growth driver as well as we transition to these nodes.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Great. And then final question, actually related to your Millios, the flash and yield product. It's obviously taken some time for the industry to gain traction, whether it's flash or whether it's laser spike anneal on that front. As you move to these smaller technology nodes, do you see whether it's either flash anneal or LSA, does that replace or potentially cannibalize existing RTP solutions, which obviously could hurt some of your existing business? Or is this something that's additive?

David L. Dutton

It's a -- it cannibalizes about 25% of the traditional RTP layers. So in that sense -- and that's around the ultra-shallow junction and some of the quick activations that are required. So it does cannibalize a piece of that, but at the same time, because of the higher cost of those tools, I think you'll see that overall it does also create an additive growth to the business.

Operator

Our next question comes from Edwin Mok of Needham & Company.

Edwin Mok - Needham & Company, LLC, Research Division

First question on -- I guess a follow-up to Patrick's question regarding your products. On Helios, you mentioned that your foundry customer right now looks like making progress there. I was wondering what node are those customer looking at that or using that Q4? And as you go from 28-nanometer to 20-nanometer, are those designs -- do you expect that to continue? Or will some of those being replaced by Millios like some of the things that you were just referring to?

David L. Dutton

Yes, I think -- so for our conditions, Edwin, on the Helios, most of our inflection point with our customers is 20-nanometer. So it will continue to grow. In fact, what we'll see as that 20-nanometer comes on, I think we'll see RTP grow over where it is today, because that's -- if you remember we just penetrated foundry recently with that. As far as where its focus is, is in some of the more traditional RTP steps. So the gains we're making with the Millios is augmenting, or complementing, the gains we're making with Helios. So I think we'll see growth in both areas and essentially the customers are seeing in Mattson Technology a -- really a full product portfolio able to deliver their thermal needs across the base and that's where we're really seeing traction and gaining progress as we move forward.

Edwin Mok - Needham & Company, LLC, Research Division

Moving on to Etch, you mentioned there is a new customer for the dual patent etching application. Can I ask you what type of customer is that? Is that a large customer, in terms of answering the question how far along is that customer? And when do we expect that to translate to actual revenue...

David L. Dutton

Yes. I think the first customer is actually a memory customer, is a new memory customer for Etch. We expect that if their current projects hold we'll see second half of next year the growth opportunities, where we move off of this first tool, which is actually pretty far along in running their material and through the yield analysis and stuff. And right behind it, we are working with -- I mentioned also a couple of new customers on double-patterning and some of those are foundry customers as well.

Edwin Mok - Needham & Company, LLC, Research Division

Great, very helpful. And then one follow-up question on Etch, right? One of your major customer, they, obviously, have memory as well as logic facilities, right? I was wondering, how much are you worried that, that customer -- let's start with this by saying, can that customer actually reuse Etch tool that was originally for memory in logic? And if so, are you worried that, that could be something that would offset your opportunity there?

David L. Dutton

Yes, I think -- well, they obviously, I think, can reuse some of the tools. Typically for -- I think some of the applications we're working on with them, they would have to either upgrade those tools, or move on to our more recent tools, which -- we're not standing still, so we're adding things to our etcher to improve the on-wafer performance, increase the capabilities and help us, like I said, extend into these more critical Etch areas. So I think it's, of course, new tools is always a preferred approach, but the upgrade capabilities that are starting to appear for the company as we move further along in Etch, I think, will be helpful and will start to show great promise too versus strippers and RTP tools typically extend further without as much upgrade potential.

Edwin Mok - Needham & Company, LLC, Research Division

Great, that was very helpful. So I can't not ask -- have to ask a question for Mike just to kind of keep him busy there. But a question on margins, you mentioned that favorable mix helped, you also mentioned that you just sold a previously amortized tool, right? Is there a way you can quantify that? How much does that benefit margin for the last quarter?

J. Michael Dodson

We don't give the magnitude of it. But we were really -- the bigger impact would have been the mix from the spares revenue. Just being a higher mix with the lower revenue base, and then the secondarily was the evaluation tool.

Edwin Mok - Needham & Company, LLC, Research Division

I see and the margin guidance for the coming quarter it's because you have a lower mix of spares?

J. Michael Dodson

Yes, first we don't expect to receive the benefit on the -- for the evaluation sale. And then we did have -- included in our spares and service this quarter, we had a number of big projects that are not going to repeat -- we don't expect to repeat.

Edwin Mok - Needham & Company, LLC, Research Division

Okay. That's helpful. And then you mentioned that exiting this year, your guys' OpEx is at a run rate of around $12 million, right? And that's with the completion of this Phase 3 of your cost reduction program. But based on your commentary, it sounds like you guys are looking for potential additional steps that you are taking? Is that fair? That's the first question. And the second question is, on this $30 million or low-$30 million of cash breakeven, what is your margin assumption in that model?

J. Michael Dodson

Yes, margin assumption there is the mid-30s, so we think we're being conservative from that standpoint. And the completion of Phase 3 and those activities will get us down to the $12 million level. So it's everything that we've already started, but we're just -- we're finalizing a number of those steps here in the fourth quarter.

Edwin Mok - Needham & Company, LLC, Research Division

And are you looking potentially to a Phase 4?

J. Michael Dodson

There will be -- I mean, never say never, but if we look at this downturn and this continues, we will look at continuing to reduce our expenses.

Operator

[Operator Instructions] Our next question comes from Larry Chlebina of Chlebina Capital.

Larry Chlebina

Dave, we track your stock price on the large flash trips, and many of them are at the prices they were at the beginning of the year or even higher. And when we look at the drivers, for instance Friday, all these Windows 8 thin PCs are going to be introduced, plus your neighbor over in Cupertino is expected to sell twice as many iPhones in the fourth quarter over the second quarter. And so I guess my question is, assuming the price is reflecting the supply and demand balance, how fast, assuming there's lithography capacity out there, how fast could somebody get equipment and turn more capacity on in flash?

David L. Dutton

Larry, thanks. Actually, I was just in Asia talking with our customers. It's very similar to your questions, I mean, they're talking about the other way. I think they're running their capacity very tight right now and you have a good sense of that. It shows up in the pricing, like you say, and I think there's a couple catalysts on the horizon. Definitely FSTs [ph] are one of the bigger drivers, which would really be with ultrabooks, plus kind of getting FST [ph] prices down a little bit. So the key point is, there is empty fab space out there. So in other words, there's building space that can receive these tools and I think our customers would be expecting that probably within about 3 to 4 months from when they say go, they can start to be moving tools into this empty space and ramping NAND if they need to. So I think even though we're being very cautious, that is a hidden potential in the industry. If we continue to see some of the economy strengthen and continue to see some further adoption of these new products, which will help boost NAND demand enough that we could see some extra kind of spurt capacity be put in. But I think the key point is, there is essentially waiting sockets there for equipment as soon as the demand is starting to tick up.

Larry Chlebina

So the billions of dollars being spent around EUV, it still looks like their goals by 2014 is still going to result in a lithography cost being upwards of 8x what the current immersion cost is. And I guess it cries out for a work around and I know you have -- that's your target in the double and quad pattern etching, but how far can that reach? Is that 2 nodes, 20 and 1x, or...

David L. Dutton

Well, I think a lot of people feel quad patterning can reach -- yes, down into -- down into the 1x -- not only 1x but the 10-nanometer area. So double and quad patterning will continue even after EUV is implemented fully in production. It won't be on every layer and the customers I think will still stretch 193-nanometer immersion litho in layers where it's more cost effective. So I think you can almost think of -- as you even look out into 20-nanometer -- or 10-nanometer and below, you'll see EUV on specific layers as long as it does make it over the development hurdle, it has still got work to do. And on top of that, I think we'll still see a lot of demand for the quad patterning and double patterning. And that really starts at the 20-nanometer node. I think that's what's exciting is what -- we're going to see a fundamental shift where, I call it Etch-assisted litho, really starts to become mainstream. And I think it's here for a long time.

Larry Chlebina

Okay. And then, yesterday there was news that 2 Korean memory manufacturers are going to start moving to 20-nanometer on VRAM from 30. Is that imminent? Or is that something that is going to take place over the next year? Do you have a sense of that?

David L. Dutton

Well, I think it's -- it'll take place over the next year. I think they're kind of -- they start in the top of the 20s and by the end of 2013, we expect them to be towards the low, the 22-nanometer node and that's, again, I think we'll see more use of quad patterning and some of those things as they get down into that.

Larry Chlebina

And one last question, Mike. Your reduced cost structure, that you’re going to have in place by the end of the year. How much of that is sustainable and for how long, as we get into the -- as we will ramp on the other side of this downturn?

J. Michael Dodson

Yes, I would say that the majority of it is sustainable. And what I mean by what's not sustainable, we have certain furloughs in place, salary reductions that, call them temporary, they are not baked-in forever. The majority is real cuts that are sustainable. But as we come out and we're growing, we would expect to add to our operating expenses, but not nearly at the rate of the growth. So we would benefit from a significant amount of leverage from the work we're doing today.

Operator

Our next question comes from Ben Pang of Caris & Company.

Benedict Pang - Caris & Company, Inc., Research Division

First, on restructuring, what was your headcount at the end of 2Q 2012 and what is it now?

David L. Dutton

Roughly, at the end of -- the second quarter, our headcount was right around 380 and it currently is about 340. And when we get done with this, we'll be sub 300.

Benedict Pang - Caris & Company, Inc., Research Division

And what are the functions that allow you to take it down? I mean, you were like 600 just a few years ago, right?

J. Michael Dodson

Yes.

Benedict Pang - Caris & Company, Inc., Research Division

So, I mean, are you sacrificing something? Or what allows you to cut it this much basically in 1 quarter? Is it manufacturing based or...

J. Michael Dodson

Well, a lot of it is -- I mean, part of it is that we've been working the last couple of quarters about consolidating the Millios development and such out of our site [ph] up in Canada, into Germany and that's really reducing it's -- it's not like we moved a lot of the headcount. We reduce it are more efficient over there so that we're able to do it. And then as we talked about moving manufacturing all under 1 consolidated area, that improves our operational efficiencies, reduces the administration overhead. So, yes, I mean I think we've been able to drive, pretty aggressively, headcount reductions, while not sacrificing at the moment our technology position. I think that's what's critical. So I think the proof is in exactly what I'm talking about. We're at 20-nanometer, we're actually right there at the leading edge with our big competitors and we're doing it on a much more streamlined organization. And I think that the key really is -- as Mike said, even as we grow, I think when you look at this industry, it's -- the amplitude of the cycles is getting quite large and very kind of steep drops. And so we've made the shift to where we will keep a lower breakeven, so that again, we can be able to manage through these as we move forward. And now that we've got Etch established and we've got Millios established, we're really driving now on a much more efficient operating model because now we can continue to build on those technologies. And it's not infusing new technology, but continuing to then develop those technologies moving forward from their base. And so we'll start to bring in our CFE model on this newer, more efficient structure as we grow. And I think that was very successful for us back in the middle of the last decade, the '05 to '07, and that's what you'll see us doing moving forward.

Benedict Pang - Caris & Company, Inc., Research Division

And in terms of the gross margin, what was the original guidance for the third quarter? And what -- did you incorporate the, I guess, the larger project on the spare parts?

J. Michael Dodson

Yes, the original guidance was 24% to 30%.

Benedict Pang - Caris & Company, Inc., Research Division

Yes, did that have the -- this one-time spare parts thing you're talking about?

J. Michael Dodson

During the quarter, we had a couple, call them blue bird upgrade opportunities, that helped us quite a bit.

Benedict Pang - Caris & Company, Inc., Research Division

Okay. And then kind of moving on to the products, at 20-nanometer for the top 10 capital spenders, how many decisions are still left for RTP?

David L. Dutton

Say that again, Ben, I apologize.

Benedict Pang - Caris & Company, Inc., Research Division

The 20-nanometer -- let's say the top 10 customers at 20-nanometer technology, how many equipment decisions are still left for RTP?

David L. Dutton

Oh, boy. Let me see off the top of my head. I'd say, at the 20-nanometer node for -- if you're looking at top 10, I would say on a top 10 there's probably at least about 60% have a decisions yet to make.

Benedict Pang - Caris & Company, Inc., Research Division

So, I mean, isn't that going to entail pretty high cost? I mean, is your demo activity or your activity to push those -- that market share being compromised by this cost reduction?

David L. Dutton

Well I -- we don't believe so. And I think the reason why -- so the initial push into those is always where your most cost is and you kind of get to that threshold where you have enough critical mass that it is a more sustainable penetration cost. But if you look at it, I mean -- so if you look at just on the 2x nanometer for foundry side, there really are 4 -- and you include the logic customer, 5 major customers, we are already past the majority of those. And so the next 4 or 5 would be a smaller set of customers that typically follow the decisions of one of the big ones. And I -- so I think again that's where the lower cost is.

Benedict Pang - Caris & Company, Inc., Research Division

Okay. And the final question for me, you talked about the shipment pattern through the first 3 quarters. What is the ship -- what's the shipment pattern for foundry applications, for your tools, on the first 3 quarters?

David L. Dutton

As far as technology node?

Benedict Pang - Caris & Company, Inc., Research Division

No, I mean I think you gave the update that 25% of your tool shipments are Etch, right?

David L. Dutton

Right, right.

Benedict Pang - Caris & Company, Inc., Research Division

I'm just wondering, like on an application basis for the end user, are you showing significant growth in foundry?

David L. Dutton

Yes, foundry is, right now -- our application base would be about 60% strip and about 40% RTP, and Etch is still a single-digit percentage on the foundry side.

Benedict Pang - Caris & Company, Inc., Research Division

So, could you repeat that, please, then? 60% on strip...

David L. Dutton

Right. If you are looking at foundries, majority is still strip. RTP is approaching the 30% to 40% range and then, again, Etch is a small amount of the foundry side.

Benedict Pang - Caris & Company, Inc., Research Division

Okay, but wasn't -- or is Etch still the fastest-growing shipment area for you through the first 3 quarters? Like if I compare the 3 quarters of this year versus the 3 quarters of last year, is Etch still the fastest-growing?

David L. Dutton

Well, I think -- well if you look at it this year, over the first couple of quarters I think Etch was the fastest growing, and the third quarter where we've seen NAND slowdown, which is where a lot of Etch's strength is in some of the silicon etching there. We've seen Etch slow in the third quarter. So I think for a balance -- well we've seen -- in the first half of the year, I'd say Etch was still our fastest grower. As we get into the second half, I think RTP is starting to show that strength, as 20-nanometer foundries start to be implemented.

Benedict Pang - Caris & Company, Inc., Research Division

So if foundry/logic is strong in the first half of 2013, is your shipment pattern going to lag? Because Etch is memory based?

David L. Dutton

Well, no, because I think RTP starts to pick up. And RTP is a very strong product for us with also very strong pricing. So I think our shipments -- we'll see a mix shift, but it'll be a positive mix shift for the company still.

Benedict Pang - Caris & Company, Inc., Research Division

So if foundry/logic is kind of flat on the first half of 2013 through the second half -- relative to the second half of 2012, you guys will be up on RTP? That's the way I would think about it.

David L. Dutton

Yes, that's the way to think about it.

J. Michael Dodson

That would be fair.

David L. Dutton

Will it fully replace the NAND volume? No. So that's -- don't overset the expectation. But, yes, we would expect the foundry RTP to be an incremental growth for us.

Operator

And as there appear to be no further questions in queue at this time, I'd like to turn the call back over to David Dutton for any closing remarks.

David L. Dutton

Thank you very much, Operator. I'd like to thank you all very much for listening to our business and financial updates for the third quarter of 2012. And we look forward to updating you again at the end of the fourth quarter and year end. Thank you.

Operator

Thank you, sir. And thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a great day.

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