Nova Ltd (NVMI) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Nova Measuring Instruments Ltd.

Second Quarter 2018 Results Conference Call.

Today's conference is being recorded.

At this time, I'd like to turn the conference over to Miri Segal of MS-IR.

Thank you, operator, and good day to everybody.

I would like to welcome all of you to Nova Measuring Instruments Second Quarter 2018 Financial Results Conference Call.

With us on the line today are Mr. Eitan Oppenhaim, President and CEO; and Mr. Dror David, CFO.

Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements.

And the safe harbor statement outlined in today's earnings release also pertains to this call.

If you have not received a copy of the release, please view it in the Investor Relations section of the company's website.

Eitan will begin the call with a business update, followed by Dror with an overview of the financials.

We will then open the call for the question-and-answer session.

I'll now hand over the call to Mr. Eitan Oppenhaim, Nova's President and CEO.

Eitan, please go ahead.

Thank you, Miri.

I'd like to thank you all for joining our Second Quarter 2018 Financial Results Conference Call.

I will start the call today by speaking briefly about our second quarter results and performance highlights.

I will then conclude by providing guidance for the third quarter of 2018.

Following my commentary, Dror will review the quarter's financial results in detail.

We are very pleased with the second quarter results, which reinforce our continuous efforts to execute on our strategic growth plan to diversify our customer base and technology offerings.

Revenues for the quarter were at the higher end of our guidance, with GAAP and non-GAAP profits exceeding our guidance.

This result highlights the progress we are making with our dimensional and materials metrology solutions across the different semiconductor fabrication segments with notable strengths in memory.

Our growing value creation, specifically in light of the current business environment, is emphasized by our increasing position in the front-end semiconductor supply chain.

Our effort to expose the company to the main, robust industry growth engine are well reflected in our quarterly results with solid achievements in memory, China, advanced 5 and 7 nanometer logic and new emerging process control applications.

As a result of our performance in the second quarter, our revenues for the first half of 2018 represent approximately 13% growth year-over-year and align with our target to continue our annual growth trajectory in 2018 as well.

As we detailed in length during our Investor Day last month, we continue to effectively materialize our strategic vision to expand our markets, customers and technologies.

This is reflected in our balanced revenue mix, which was driven by significant inroads we are making in the memory space.

Memory customers contributed approximately 50% to our overall product revenue.

Our relentless efforts to enhance our partnership with leading customers yielded 5 large customers this quarter, 3 of which are leading memory providers in Korea and China.

This unique mix expand our opportunity base for 2019, when both sectors should return to expected spending levels.

We are very encouraged by this progress as the company continues to achieve solid results despite the current business environment.

Notably, in 2014, the company's revenue from foundry customers accounted for more than 80% versus 65% in 2017 and forecasted of 55% this year.

Besides our growing penetration through all 6 memory customers, our biggest achievement is the ability to take share in the most complicated applications that currently can't be solved just with additional OCD, which was the common solution.

We could do that only by introducing unique coupled hardware and software solutions as well as combination of X-ray and optical technologies.

Our benefit here is that while metrology intensity and memory is increased, it's not necessarily implied for increased available market for the traditional methods, and in that environment, we prevail.

Additionally, our expectations for increased foundry spending in the next 6 months to the most advanced logic node below 7 nanometer are starting to come through with initial orders that are an outcome of a selection process that took place recently for all our materials and dimensional newly introduced models.

We expect we could start generating growing revenues in Q4 and onward.

Our strategic plan to diversify our source of revenue beyond device type is also evident by the continued changes in the geographical revenue mix.

China continued to contribute around 40% of overall product revenue this quarter with significant wins in 2 domestic leading foundry and 3D NAND customers.

In our view, although we may see a transition period while local greenfield establishment move from R&D stage to high-volume production, we still envision China as a significant, sustained driver for our long-term growth.

In addition to our efforts to widen our customer base, we are encouraged by the market reception of our new technological innovations.

We see growing adoption of our newly launched metrology solutions, where all of our recently launched products, the i550 integrated metrology, T600 MMSR standalone, VeraFlex III+ XPS and the Nova Fleet software engines, are all generating revenues and creating value in a growing number of applications.

In that respect and in light of our elevated R&D spending, we are also satisfied by the growing anticipation and the initial reactions to our next-generation products.

We believe that the combination of a broader customer base along with a differentiated technology will present a larger market for us to pursue as early as 2019.

One of the major goals of our $300 million strategic plan is to continue maintaining our efficient and controlled financial model, which can accommodate elevated investment in R&D and still support our long-term profitability targets.

As previously discussed in both our Q1 earnings call and the Investor Day, we intend to increase our R&D spending this year to accelerate our innovations and introduce new breakthrough technologies in 2019.

Our expected R&D spending supports our long-term growth vision by investing in our core differentiators, which allow us to bring unique and competitive solutions to the markets.

Our product rollout is on track and expected to expand our available market in approximately USD 150 million to USD 200 million starting from 2019.

Since the acquisition of ReVera in 2015, the company changed its value proposition to deliver a holistic solution to its customers, combining both materials and dimensional metrology solution.

We believe then that in order to improve device performance, materials engineering will become one of the toughest challenges in the most advanced nodes.

To continue improving semiconductors, scaling and architectural changes would not be sufficient, and introduction of new materials would be unavoidable.

This shift would require more control than move new metrology method from the lab into the production environment.

Analyzing our performance in this area, reveals continuous growth in our materials metrology revenue year-over-year.

As a result of this inflection point, semiconductor manufacturers introduce new materials and new combinations of Nova materials, which are essential to improve performance in high-end logic and memory devices.

This growing trend along with continuous growth in revenue contributions from our materials portfolio reaffirm our vision that advanced metrology used to control material performance will continue to be a significant growth engine in the coming years.

To support this anticipated growth, our materials metrology solution has been installed in all major memory and logic customers.

This advanced solutions control material variations along with fabrication process, measuring in line and in dye structures through the production steps.

As a result of this trend, we believe that the materials metrology overall available market will double itself in the next 3 to 5 years.

In this growing market, we are adding applications on a daily basis where some of them can be solved only by our XPS solution, which is the most advanced productive X-ray solution in the production line today.

An additional notable achievement this quarter is the growth in our service revenue, which reached a record high and contributed 26% to overall revenue.

Our continuous investment in enhancing our installed base is bearing fruit with various solutions that enable better productivity, higher utilization and improved metrology capabilities in previous models.

Our continuous growth is mainly fueled by increased revenue from proactive software and hardware packages we develop to improve our installed base.

Our goal is that at least 30% of the revenues generated in the service segment will come from new products on top of the regular services to our customers.

In summary and in spite of the extreme investment challenges, we expect the long-term industry momentum to continue, while the market benefits from multiple solid catalysts.

This trend fuels the demand for silicon and require continuous technical improvement across all devices.

Our widest exposure to multiple customers and the traction that our differentiated portfolio is creating in the market position us to benefit from this long-term growth potential.

Despite the backdrop of the industry and the peer group earnings, I would like to share with you our third quarter guidance range, which reflects a higher potential versus the second quarter guidance: revenue, in the range of $58 million to $64 million; diluted EPS on a GAAP basis, in the range of $0.32 to $0.44 per share; and non-GAAP basis diluted EPS, in the range of $0.37 to $0.49 per share.

Now let me hand the call over to Dror to review our financial results in detail.

Dror?

Thanks, Eitan, and good day, everyone.

In my following prepared remarks, I will refer to both GAAP and non-GAAP results.

You can find a better reconciliation between GAAP and non-GAAP results per item at the end of the earnings press release.

Total revenues in the second quarter of 2018 were $61.9 million, reflecting a 10% increase year-over-year.

Product revenues for the quarter were $45.8 million, approximately 50% from the foundry sector and 50% from the memory sector.

During the quarter, Huali, YMTC, Hynix, Samsung and TSMC, each exceeded 10% of product revenues.

On a regional basis, this list includes 2 Chinese customers, 2 Korean customers and one Taiwanese customer.

Broken down by segment, it includes 3 memory customers, 2 of which are the leading memory manufacturers; and 2 foundry customers, one of which is the leading foundry manufacturer.

We believe this list and its spread reflect the diversification of the company revenue sources across regions, segments and technology nodes.

Service revenues grew 30% quarter-over-quarter as a result of several installed base upgrade projects.

Blended gross margin in the second quarter came in at 58% and included the impact of the opening of the new clean room facility in Israel.

Product gross margins came in at 61%, lower than the previous quarter due to a product mix, which included less software revenues and the new clean room facility impact.

Services gross margins came in at 49%, very high results as a result of the steep increase in revenues during the quarter.

Operating expenses for the quarter totaled $22.1 million on a GAAP basis and $20.6 million on a non-GAAP basis.

An increase of approximately $1.6 million over the previous quarter.

This increase reflected the company's continued efforts to execute its plans to introduce new technologies and products within the next 12 months and the regional distribution of the company revenues from China, which include higher sales channel costs.

Operating margin in the quarter was 22% on a GAAP basis and 25% on a non-GAAP basis, while the effective tax rate of the company was approximately 16%.

GAAP EPS in the quarter was $0.41 per diluted share and non-GAAP EPS was $0.46 per diluted share, slightly higher than the company guidance for the second quarter.

Regarding the company guidance for the third quarter, revenues are expected to be between $58 million and $64 million.

This revenue guidance, assume a return of service revenues to a normalized level of approximately $14.5 million a quarter.

At the midpoint of this revenue guidance, we expect the following.

Blended gross margin is expected to be approximately 57%.

Operating expenses are expected to be approximately $21.5 million on a GAAP basis and approximately $20 million on a non-GAAP basis.

This is slightly lower than the previous quarter and reflects an expected reduction in sales and marketing expenses, which will be partially offset by an expected increase in research and developing expenses.

Effective tax rate is expected to be between 17% and 18%.

Regarding the target long-term financial model of the company at a $300 million revenue level, we continue to target gross margins between 56% and 59%; operating expenses, which are approximately 30% of revenues; and operating margins between 26% and 29%.

With that, I will turn the call back to Eitan.

Thank you, Dror.

With that we are pleased to take your questions.

Operator?

(Operator Instructions) We will take a question from Edwin Mok with Needham & Company.

So my first question is on, I guess, second half outlook.

I think personally -- Eitan, you talked about second half roughly flattish to first half.

What kind of recent update in the market?

Do you have any update on that?

And that would -- if I assume flat to the first half at midpoint of the guidance that will imply fourth quarter will grow from the third quarter level?

Is that correct?

Or can you give some color on that?

So I think, Edwin, we stay with the same statement that we gave before.

Although we -- not yet seeing the full fourth quarter, the visibility right now to our largest foundry customer is clearer than a month ago.

So if I'm looking right now on the fourth quarter revenues, I'm more optimistic on that part, the big question is timing.

So we're not clear yet on the exact timing between the end of the fourth quarter and the first quarter in regard to capacity.

So therefore, we stay with the same statement as we said before.

Nevertheless, there are a few upsides that [cannot realize].

I see.

Okay, great.

And then I may -- obviously, I mean, you guys have talked about your new platform that you guys plan to launch.

Can you provide any update on that?

Where you stand on that?

Do you still expect to start shipping them, I think, previously you guys said start shipping late this year and potentially start seeing revenue in '19.

Can you give some color on that?

Yes, so the -- we talked about 2 new technologies.

I will not give the details about exactly where they go into fab and exactly which application they are going to solve.

It's different technology that we did before.

The 2 new systems are -- or the 2 new technologies are going to start (inaudible) somewhere in Q3, Q4.

And therefore, we -- very optimistic on getting the revenue on both of them in 2019.

I see.

So shipments are already planned -- shipments are already planned and you guys accepted that.

Okay, great.

Entering better agreement, and (inaudible) refined, and the customers are refined as well, so we know exactly where we ship them.

Okay, great, great.

Thanks for clarifying that.

And then, I guess, my last question is on this memory improvement mix.

So I think you guys (inaudible) 1/3-2/3 memory, and now it's 50% right?

How much of that is driven by (inaudible), the new software that is enabling customer to do a new type of metrology they haven't done before?

And there is that a way to kind of talk about how much is not tied to NAND versus DRAM?

And do you expect this 50% range to be sustainable?

Right.

If you look right now on the expected revenue for memory customers in 2018, we are going actually to double the amount from 2017.

So it's a tremendous amount of systems that we're shipping right now to memory and a significant growth, which -- actually outperforming the memory growth this year in the market.

So definitely, most of the (inaudible) that we had in a very dense, competitive environment is coming from our ability in some cases to come as a third vendor and to increase our market position and market share.

And we could succeed in doing it in coming and solving the most complex solution that could not be solved up to that moment.

And this ticket to get into those sophisticated memory customers came from 2 main capabilities besides the measurement itself.

One is the combination of the hardware and software.

We are going a lot today into more mathematical, sophistical, virtual metrology stuff, which assists the hardware measurement, this is one.

And secondly the ability to combine the XPS or the X-ray measurements together with the optical measurement.

We see today there is a shift in cross application that today if you have the [reference] coming from one of the tools, the other technology can perform much better.

So if you look right now on a company that has only one of those technologies that they cannot actually solve the same application as we are because we have the pre and post measurement data, so we can tighten the measurement much better.

And it's allow us to get in and to bring something else to those customers and actually solve the applications that were not solved before.

Basically, some of those applications either went to TAM or went to other process control tools, which currently we can do on our portfolio.

This -- those were the key.

Edwin, if you want to translate all these successes into the numbers, so when we look at the first half of the year, 50% of the revenues of the company came from the memory segment.

And the guidance for the third quarter also assumes around 50% of the revenues coming from the memory segment.

And because we also believe the memory strength will continue into Q4 for us, looking year-over-year, we are lucky we had only 35% of our revenues coming from memory.

We should see this year an increase in memory revenues year-over-year of approximately 40% to 50%.

And we believe, this is actually double than the peer group or the growth in memory investments in the industry as a whole.

Our next question comes from Jaeson Schmidt with Lake Street Capital Markets.

Just the first one, wondering if you could comment on the order linearity you saw in the quarter.

So in general, we were not giving -- the company is not giving booking numbers or book-to-bill, but we can say that bookings in the second quarter were higher than the previous one.

Okay.

That's helpful.

And then, curious if you could comment on what percentage of the revenue came from trailing nodes in Q2?

So it's approximately 60% from trailing nodes and 40% from high-end nodes.

Okay, perfect.

And the last one from me, and I'll jump back into queue.

How should we think about the service business growing longer term?

Obviously, it's dependent on the growing installed base, but what, sort of, kind of long-term growth rate should we look for that business to generate?

So Jaeson, I'll answer this question from the segmentation in the service revenue, and then Dror can talk about the financials.

But I want to emphasize one thing about the service revenue.

So our long-term target is to be at around 25% of the overall revenue.

But one of the thing that I emphasized in my prepared remark is that we look on the installed base not only as an installed base to service and then get some money for contract and time and material.

Actually, 30% out of the service revenue coming from proactive packages that we develop, specifically to this installed base.

So we're looking on the installed base like another market for Nova to sell products to.

And it's accounted in the service, but that's where we try to increase this number beyond the growing installed base that we have every year.

So in terms of the numbers.

So our strategic plan assumes between 10% and 15% increase in service revenues every year, which relates to the increase in the installed base, and as Eitan mentioned, specifically for 2018, we might see a higher growth rate in 2018 because of these upgrade projects and specific plans.

Our next question will come from Patrick Ho with Stifel.

Eitan, maybe as a follow-up to some of the commentary you gave on the memory side of things.

3D NAND has obviously been a key driver for increasing OCD metrology use, and you have benefited from some of the share gains with your customers.

Can you talk a little bit about the opportunities in DRAM and where you see both OCD as well as X-ray metrology potential uses for DRAM relative to 3D NAND?

Sure, I think that if we're looking right now on DRAM, it's more similar to foundry than it's to the VNAND.

So therefore, we see actually 2 segments of measurement.

-- 2 segments of metrology.

One of them is the geometrical or the architectural change when the customer's going below 20 nanometer, the 1, Y, X, Z, where they start to vary the gates in the silicon, and therefore, the application or the complexity of measuring both materials and dimensional actually are increasing.

So if we're looking right now on the intensity in the last quarter in the DRAM spending actually is going higher than we experienced before.

We see both the X-ray and the OCD growing.

So the intensity grows, and I think that most of the growth coming from the changes in the technological and the architectural structure of the device.

Great, that's really helpful.

And maybe as a follow-up on the foundry side of things.

Obviously, you have a very strong position with the leading player in Taiwan.

And as they are moving to both 7 nanometers and beginning some of their 5 nanometer pilot lines.

Where do you see, I guess, greater activity right now?

Is it partly with the 7 nanometer capacity build?

Or are you seeing some of the 5 nanometer pilot line activity that your customer has talked about?

So I didn't talk about 7 nanometer because it's ongoing expansion.

We have -- where we see capacity added on a smaller amount in the last 2 quarters.

What I referred specifically is the anticipated 5 nanometer that everybody waited for the orders to be released.

I think that when we're looking right now if it will happen at the end of the year, or it will happen at the beginning of next year, it's a timing issue, but we do see a clearer picture on that.

I think that delays or pushouts came in light of -- in my mind in light of the business environment, were extending because of the EUV was so high where the cost was an issue, how you start building this fab, but I think that most of it was cleared out, and I think that we will start to see more orders coming in the next couple of weeks to start shipment of tools in Q4.

This was the main remark that I gave.

It's important for us, because it's -- it might be an upside.

Right.

And maybe a final question from me, maybe for Dror, in terms of gross margin in services business.

Actually, your services gross margins were very strong, and I think you mentioned some of the drivers there.

As we look at services going forward, particularly with the growth rate you talked about, I guess, what are some of the levers on the services side where you can maintain the gross margins in that, I guess, 56% to 59% target model that you're looking for?

What are some of the levers on the services side to help, I guess, not dilute the gross margin levels?

So in our model for gross margins of 50 -- blended gross margins of 56% to 59%, assumes services gross margins of between 35% and 40% and product gross margins, which are north of 60%.

We do believe that given the increase in service revenues, which -- a significant portion of that is related to time and material, rather to contracts, which are heavy on headcount cost and fixed cost.

Therefore, there is some upside there for services gross margins to continue and be at the high end of this range of 35% to 40%, more on the 40% side and, as you mentioned, support the overall gross margin -- blended margins of the company.

We'll now hear from Mark Miller with The Benchmark Company.

You indicated memory is going to be strong in third quarter, and also in fourth quarter.

That's -- one of your competitors is talking about the impact of pushouts into 2019.

Is that just because you're serving different customers?

Why you have a different outlook for memory in the second half?

So I think, Mark, from what we see, the -- we're looking on the overall demand, and we're looking on the market share.

So you know that sometimes when the demand goes up, and you stay on the current levels, it means that you get more market share than you're getting into more penetrations into the memory.

This is what we see in the third quarter and also the fourth quarter.

We definitely see it as the majority of the penetration that we had was dematerializing in the third and the fourth quarter, therefore, we are -- we think that the ratio will stay roughly on the same levels.

And again, the implication of that is that year-over-year, we expect 40% to 50% increase in memory revenues for the company, which we believe is almost double than the average growth in memory investments between the 2 years.

And that's for 2017 to 2018?

Right.

What about logic?

Do you see logic -- I think you said logic was strengthening as we go out of 2018.

Do you think that continues to strengthen in 2019?

Well, we think that definitely at the beginning of 2019, we'll see the -- we'll see some 7 nanometer expansion as well as the start of the N5 extended pilot line.

So definitely, we expecting the first half '19 to be weighted towards foundry.

We'll go to David Wu with Indaba Global Research.

I want a clarification, if I might, on the memory side, and a question on the logic foundry side.

The memory side, your pattern is very different from both KLA and Nanometrics as well as the Lam Research that reported.

Is it the function of your different stage of penetration into the memory market or a different customer mix, which makes your pattern much more level in the second half than the -- many of those competitors that have a dip in Q3 and a rebound in Q4?

Well, these companies that you are referring to, obviously, have wide exposure to the memory market across all the customers, as we do.

However, the fact that the company is able to show stable revenues from the memory segment going into the second half despite the reduction that other providers see in the market mean that we are able to win market share as a result of the applications that Eitan mentioned before.

Okay.

Do you see a widening of 7 nanometer spending in foundries in the first half of calendar '19, besides TSMC?

So Mark (sic) [David], it's very difficult to say from now, we know that at least 2 other customers and TSMC are spending time and effort to qualify their 7 nanometer.

And it's hard for me to say right now, if it will expand more in the first half.

It definitely depends on the number of customers they will acquire.

Thank you.

With no additional questions I'll turn the floor back over to Mr. Oppenhaim, for any additional or closing remarks.

Thank you, operator, and thank you all for joining our call today.

With that, we conclude our Q2 2018 Earnings Conference Call.

Thank you.

Thank you.

Ladies and gentlemen, again, that does conclude today's conference.

Thank you all again for your participation.

You may now disconnect.