Onto Innovation Inc (ONTO) 2015 Q2 法說會逐字稿

Good afternoon and welcome to the Nanometrics second-quarter 2015 financial results conference call. (Operator Instructions). Please note that this conference call is being recorded today July 23, 2015. At this time, I would like to turn the call over to your host, Claire McAdams. Please go ahead.

Thank you and good afternoon everyone. Welcome to the Nanometrics second-quarter 2015 financial results conference call. On today's call are Dr. Timothy Stultz, President and Chief Executive Officer, and Jeffrey Andreson, Chief Financial Officer. Shortly, Tim will provide a recap of the second quarter and our perspective looking forward. Then Jeff will discuss our financial results in more detail, after which we will open up the call for Q&A.

The press release detailing our financial results was distributed over the wire services shortly after 1 PM Pacific this afternoon. The press release and supplemental financial information are also available on our website at www.Nanometrics.com.

Today's conference call contains certain forward-looking statements, including but not limited to financial performance and results, including revenue, margins, operating expenses, profitability, and earnings per share. Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of factors outside of Nanometrics' control, including levels of industry spending, demand for our products, shifts in the timing of customer orders and product shipments, technology adoption rates, changes in customer and product mix, changes in market share, changes in operating expenses, general economic conditions, and the additional risk factors and cautionary statements set forth in the Company's Form 10-K on file for fiscal year 2014 as well as other periodic reports filed with the SEC from time to time. Nanometrics disclaims any obligation to update information contained in any forward-looking statement.

I will now turn over the call to Tim Stultz. Tim?

Thank you Claire. Good afternoon, everyone, and thank you for taking the time to join us on our call today. Today, I will speak to the highlights of the June quarter, comment on our progress and competitive positioning, discuss the drivers behind our revenue outlook and finish with our guidance for the September quarter. Following my prepared remarks, Jeff will provide additional details on our Q2 results.

In the June quarter, we delivered results that demonstrate the progress we have made in market share gains, the growing contribution from our newest key accounts, and the financial leverage of our business model. Our financial performance came in largely as expected, at the high end of our guidance range for both revenue and profitability. Even with a slight decrease in sales volume quarter-on-quarter due to lower upgraded installations, we improved both our gross margin and our operating margin as benefits from improved factory utilization, operational efficiencies and other cost reduction efforts began to bear fruit.

Q2 witnessed a substantial shift in memory spending over the prior two quarters with DRAM moderating and 3D-NAND sales achieving new record high levels. Importantly, our record 3D-NAND performance came as a direct result of the market share wins and new account penetrations we have been reporting on over the last several quarters. By the end of last year, we had won tool-of-record positions at every one of the four flash memory manufacturers producing 3D-NAND devices. And these slot wins are materializing into meaningful revenue contributions in 2015.

Our 3D-NAND market success and competitive wins are a direct result of NANO delivering innovative OCD solutions on both automated and integrated platforms that help our customers accelerate their yield ramps, maintain control over complex processes, and realize the performance and economic benefits of 3D-NAND versus planar architectures.

In addition to the growth in our 3D-NAND business, we also saw continued strong sales into the pure play foundry market, another area where our market-leading OCD solutions have led to new account penetration and competitive tool-of-record wins. Our growing strength in 3D and foundry are further evidenced by the fact that Micron and TSMC, relatively new key customers for NANO, each contributed more than 10% to our revenues in the quarter. Notably, these new account penetrations and the resulting broader customer base allowed us to deliver similar year-over-year revenues in the first half of 2015 in spite of lower process control metrology spending by our historically two largest customers.

And as a testimonial to our improving business model, in the first half of 2015, we delivered a 38% improvement in our non-GAAP operating profit versus similar revenues in the first half of 2014. This area of performance improvement continues to be a key focus area for all of us at Nanometrics.

A major part of our OCD market share success that played out in the first half of the year and will continue to do so going forward is our emerging strength in the integrated metrology market. IM sales grew more than 30% quarter-over-quarter, principally due to increased strength in 3D-NAND resulting from head-to-head competitive wins.

Increasing demand for our integrated products and solutions led to a doubling of our IM sales for the first half of 2015 compared to the previous six-month period, and we could see another similar step function improvement in integrated revenues in the second half of 2015. With this outlook, 2015 could be an all-time record year for integrated metrology sales with revenue growth outpacing performance by our competitors in this sector.

Turning to the full-year 2015, we see increasing demand for OCD metrology on 3D devices such as FinFET and 3D-NAND, the opportunity for continued market share gains in both automated and integrated markets and incremental contributions from small but growing markets such as advanced packaging, image sensors and other solid-state devices.

In 2014, we achieved 24% year-over-year growth in product sales, exceeding wafer fab equipment growth by at least 10 percentage points. And our metrology product sales exceeded our competitors' by an even wider margin.

With the trends, drivers, and opportunities discussed earlier, 2015 is setting up to be another year of outperformance. Specifically, we could again exceeded WFV growth by 10 percentage points or more in spite of dramatic cuts in spending by our leading logic customer and lower overall process control metrology spending by the leading chip manufacturer in Asia.

Summing it up, we remain optimistic about overall industry spending and our business outlook. We are confident in our ability to continue to innovate and bring new products and technologies to our customers that enable us to successfully compete for additional market share. And we are committed to improving our financial performance through a leveraged business model, improving operational efficiencies and focus on cost controls.

Looking to the third quarter, we expect product revenues to be relatively flat quarter-on-quarter with a decline in service revenue due to a drop in upgrade sales following completion of a couple of major projects last quarter. Similar to Q2, the end market mix of product sales in Q3 will continue to be driven by both 3D-NAND and foundry. With that, come our guidance for the September quarter is as follows: revenues of $43 million to $47 million; and on a non-GAAP basis, gross margin of 47.5% to 49%; operating expenses of $20.4 million to $21 million; and earnings of breakeven to $0.06 per share.

I will now turn the call over to Jeff for a detailed review of our financial performance and outlook.

Thanks Tim. Before I begin my comments, I'd like to remind you that a schedule that summarizes GAAP and non-GAAP financial results discussed on this conference call as well as supplemental revenue segment information by product and market and geographic region is available in the Investors section of our website.

Second-quarter revenues were $48.6 million, down 3% from Q1, above the midpoint of our guidance of $45 million to $50 million and up slightly from Q2 of 2014. Product revenues increased 2% to $38.9 million compared to $38.3 million in the prior quarter while service revenues of $9.7 million decreased 19% from the prior quarter on lower upgrades as compared to the near record level of upgrades in Q1.

By end market, two-thirds of product revenue in Q2 were in the NAND and foundry segments. In particular, 3D-NAND sales more than doubled over Q1 and planar NAND sales increased as well, more than offsetting the anticipated decline in the DRAM segment. NAND sales were 41% of product sales in the quarter while DRAM comprised 16%.

Foundry sales were down quarter-on-quarter but remain strong at 26% of product sales. Logic was fairly flat at 5% of product revenues and all other devices and substrates comprise 13% of product revenues, up from Q1, due to increased sales for wafer substrates and optoelectronic devices.

By product, total second-quarter revenues were comprised of 60% automated systems, 13% integrated metrology systems, 7% materials characterization systems, and 20% service and upgrades.

Our 10% customers in the second quarter included Micron at 32%, TSMC at 17%, and SK Hynix at 10% of total revenues for the quarter.

I will now discuss the remainder of the P&L, which are non-GAAP measures unless I identify the measure as GAAP based. These measures exclude the impact of amortization of acquired intangible assets.

Our Q2 gross margin was 48.8%, up 110 basis points from the first quarter and representing our third sequential quarter of gross margin improvement. Gross margin was at the upper end of our guidance and improved toward the target model, in line with our expectations. Product gross margin increased to 49% from 47.9% in the first quarter, largely due to improved factory utilization and other cost improvements, while service gross margin was 48%, up from 47.1% in Q1, primarily due to improved service personnel utilization and lower expenses.

Operating expenses of $20.7 million were near the low end of our guidance. We continue to make progress against our target financial model as we were able to maintain an operating profit of $3 million despite a 3% decrease in revenue.

Other income and expense included an unfavorable foreign exchange translation adjustment of approximately $350,000, equivalent to $0.01 per share, as compared to a $700,000 favorable adjustment equivalent to $0.03 per share in the previous quarter.

Our tax expense for the quarter was also higher than our guidance due to a year-to-date adjustment driven by a change in the expected geographic mix of profits for the year. Our quarterly tax expense for the remainder of the year is expected to be in the range of $400,000 to $550,000 a quarter.

Net income for the second quarter was $1.8 million, or $0.08 per share.

Turning briefly to the balance sheet, our cash and investments at quarter end were $74.8 million, or about $3.11 per share. DSOs increased to 82 days due mainly to the timing of shipments late in the second quarter. Inventory in the second quarter increased to $43.1 million to support our customer delivery requirements and an increase in finished goods pending customer acceptance.

And with that, I'll turn the call over to questions. Operator?

(Operator Instructions). Patrick Ho, Stifel Nicolaus.

Thank you very much. Tim, maybe in terms of the September outlook in terms of the market mix, you mentioned that 3D-NAND and foundry will continue to be healthy in the September quarter. Do you see a broadening of customers in both of those segments, or are they going to still be concentrated in your largest customers from the June quarter?

Patrick, thanks for calling in and good question. So, there are actually four customers out there that are pushing on the 3D-NAND area. We've obviously identified some of the new ones coming up front on this quarter. We are seeing deployment in some of the other areas and I would expect to see an expanded mix of customers going forward on the 3D-NAND.

And also on the foundry side, would you see a broadening of that or is it still going to be concentrated primarily in Taiwan?

Yes, the foundry will stay put. The mix in customers will stay pretty much the same as it's been on the foundry side.

Great, that's helpful. Maybe bigger picture also for you, we've seen a lot of headline news recently regarding 10 nanometers and the issues that your largest logic customers had in pushing that process out actually over a year. How are you seeing I guess your development work with the customers, both with them as well as others in terms of the polls and pushes? Some may be accelerating. Obviously one is pushing out. What's the type of effort that you are seeing on the 10 nanometer front?

That's a good question. We are deeply engaged in all the 10 nanometer development activities, both with our applications team and scientists as well as with our tools. I think it's been pretty well documented, the push outs on our largest customer. We see continued commitment on the other side but I haven't seen anything that I would characterize as a pull-in. I think most of it's been playing out the way we saw with a little bit of a surprise on the very back end of the year by our largest logic customer with further push-outs.

Great. And final question from me, on the advanced packaging market, we are starting to see a little more activity in terms of some of the applications related to either copper pillar bump, fanout. What are you seeing on that front and how do you see that marketplace progressing as we head into 2016?

I think 2016 has the potential to be a good year for our UniFire platform, which is primarily serving the advanced packaging market. As you know, we have tools in almost every major account with tool-of-record positions. We've been working on both TSV, micro bumps and micro pillars. And it's still a low-volume activity, but I think it's a serious commitment to the development of that area and we are seeing it both in kind of the hybrid modules as well as the interposer structures. And we are hoping that 2016 starts to see maybe a -- begin to see an inflection in the spending at its space. That's yet to be seen.

Great. Thank you very much.

Mahesh Sanganeria, RBC Capital Markets.

Yes, thank you very much. Tim, the question on 3D-NAND, you are reporting 32% revenues from Micron. That suggests that you are winning some pretty good business over there. But Samsung is also ramping pretty rapidly in the Xeon fab. I'm surprised I don't see you there. Is that more weighted towards Q3?

Well, yes. First of all, welcome Mahesh, good to hear from you. So for us, as we look at it, as you know, the timing of the metrology investments in that area and the fact that we did win the Phase I activity, we expect to be tool-of-record and continue to push forward on the Phase II. But it's more of a timing issue than it is, so we've seen Micron's spending is ahead of what we've seen on the Samsung side. But we expect that to start to play out for us.

And the second related question, I think Micron's process on 3D-NAND is a little different in terms of like Samsung being charge strapped and micron Intel -- they are doing floating gate. Does that change the content of OCD between the customers or are they similar?

I won't to speak directly to what technologies our customers use. We obviously are tightly bound with NDAs. But when I look at the applications of OCD on both looking at layers and looking at the underlying active circuits, we see pretty much the same opportunity for the tools regardless of the particular strategy or structural architecture they are pursuing.

And where do you see the capacity plan from other two customers? It looks like Samsung and Micron are pretty active. Do you think that Hynix and Toshiba, they are more for next year -- they will be ramping 3D-NAND or do you have any visibility into something that --?

Well, we certainly have some visibility into it as they share their plans with us. If I referred to the publicly announced statements, I think that Toshiba has talked about some fab expansion and development in Yokkaichi and us enjoying tool-of-record position there would benefit with that as they populate those. I don't think it's as far out as you might be suspecting now.

Okay, that's very helpful. Thank you.

Tom Diffely, D.A. Davidson.

So Tim, is this the first time in a decade or so that Samsung and Intel have not been one of your top three customers?

I don't know if it's the first time in a decade, but I think it was like Q3 of last year was the first time -- was one of the first times where it was very notable. There were drops in spending. I think combined they dropped like 80%.

So, yes, we are blessed to have been successful in our account broadening strategy to get into foundries, to get into the 3D-NAND and grow our integrated metrology business, which is where the spending is occurring. And I think that's consistent with what you are seeing in other companies too. If you look at their revenue mixes coming out where they are seeing the business, DRAM has clearly softened up. The logic spending in some of the foundries has been soft and the real push has been in 3D-NAND and foundry. And we see that going on for at least another quarter.

Well, that's good news that you can have such a strong quarter without the two big guys. Like you mentioned a year ago when that happened, it was a bit of a disastrous quarter, so things have changed quite a bit over the last year.

Yes. We've worked very, very hard on this, as you know, because we were pretty exposed when we were a three-account company. And having meaningful positions with the other big spenders and being able to deal with the different cycles in their spending patterns has really helped us produce more consistent revenues and performance.

Okay. So when I look at the 3D-NAND spending, a year ago in the March quarter, you had a nice slug of business and then again today for this quarter. Is it driven by the fact that these are new facilities or is it just when they move to 3D-NAND there is no reuse going on with the older inspection tools?

That's a kind of a two-part question. It's a good question. So the first one is, a year ago, most of our business came from one major customer who was making a significant thrust in building a new fab and capacity and we put a lot of tools into that space. What we're seeing now are the other 3D-NAND manufacturers finding and getting their -- what I'd call their Phase II. Even though they may be doing Phase II technology nodes, it's a Phase I investment effort. And we don't see a lot of reuse I think particularly in the integrated metrology space where these are being deployed on other platforms. And so it would require a broad-based reuse of all the other platforms as well, and we haven't seen that on the 3D-NAND side.

Okay. And then you've made some nice penetrations into a couple of 3D-NAND players. Is there a chance to maybe backfill or get into their DRAM business as well at some point with kind of this foot in the door?

You are reading my strategy crib notes. Yes. Exactly.

One of the things we've spoken about quite frequently about our share gains in the new positions. But we have so much green space, greenfield space, that we can still go after. Winning 3D-NAND hopefully means that we demonstrate our capability to be a good supplier with good products and have a meaningful conversation to gain incremental footprint in some of these other fabs such as areas where we have the NAND business and we don't have a DRAM business. And we're working very hard on that.

Okay. And then Tim, in your prepared remarks, you talked about a lower level of process control spending by one of your large Asian customers. I wonder if there's more to that than just this was kind of an off quarter. Is there a longer-term plan to cut the intensity of those tools?

I think all of them are -- all of the customers are looking at tool reuse but the intent of the comment was more about the timing of their spend patterns and the timing of their investment schedule.

Okay. And the last question here. You had a nice little uptick in the other business, discretes, LED. Is that sustainable at all or are these kind of one-off toolsets?

Well, it's something between one-off and sustainable. I think that we are opportunistic in some of those areas. We have some good spots. If we look at the image sensor market, it's been some nice business for us, the optoelectronics, and I think that -- and even some of the alternative substrates. It's hard to tell at this point, at this early stage, whether or not that's going to have multi-year traction. But right now, it's improving and it's nice to get some incremental contribution from our materials characterization group as well.

Great. Thank you.

Weston Twigg, Pacific Crest.

Thanks for taking my question. First, just wondering, on the services side, it looks like it's actually trending down a lot from $12 million to $9.7 million and then maybe roughly $6 million based on guidance in Q3. So just wondering, beyond that, do you see that coming back up? And what is a pretty stable baseline we might think about for 2016?

Wes, it's Jeff. The reduction kind of quarter-over-quarter, as Tim said, was mainly related to some upgrade projects that finished up. The core service business is kind of growing from the low $7s million and we hope to grow that to the $7 million to $8 million a quarter range. So any fluctuation that you are seeing is really coming out of (technical difficulty) core services. It's kind of staying within that band. And there's a lot of emphasis on trying to get that to grow with the installed base increasing. So, a normalized run rate for upgrades is a hard thing to say because they do fluctuate up in time and as you can see, in the first two quarters, they were fairly significant because they are actually the biggest delta quarter-over-quarter.

And Wes, I would also just add to it you know that we had the offset in the total service revenues, which reflects the decrease in upgrade sales, but you saw the margin improvement, which means that, operationally, we are doing some pretty good things to be able to produce 40% plus margins on just core service activities.

Okay, yes, good. That's good to highlight. I'm wondering also on operating expenses. I don't think that you reiterated the plan to keep OpEx at $20 million to $21.5 million per quarter. Maybe you did but is that still the plan for this year?

Well, I think you've seen that -- what we said is entering the year, that was the range we wanted to operate in and that, at the end of the year towards the second half, we are trying to get down to the lower end of that. And we are right about in the middle for Quarter 3, so we are on track with what we want to do with OpEx.

Okay, good. Yes, that helps. And then, just finally, I know everybody's been asking about demand commentary, but any thoughts beyond next quarter how -- what mix might look like in terms of foundry, 3D-NAND, DRAM? Does DRAM start to come back, etc.? Any color on that visibility would be helpful.

Yes, well, my commentary will be somewhat wishful thinking, not enlightened thinking at times because we can't see that far out. But we see continued strength both in integrated and 3D-NAND at this time with some increasing revenues and pull-ins on our tools. But I think that when we start looking out Q4 and in Q1, Q2 of the following year, we would expect that, at some point, DRAM spending needs to start to recover as the demand capacity balance shifts from the way it is right now. And we certainly would hope that our advanced logic customers starts putting some tools in place for their 10 nanometer business, but we don't see that before 2016.

Very helpful. Thank you.

(Operator Instructions). Mark Miller, The Benchmark Company.

First of all, congratulations on your progress. I'd just like to follow up a couple of things. In terms of your upgrade revenues, are they at higher margins than your other service revenues?

Yes, they are above. Core service revenues fluctuate from high $30s million to kind of, as Tim said, low $40s million. And we are maybe a little bit better now with the utilization and upgrades are I would say hi $50s million, low $60s million generally, depending on the content of material.

Okay. As we go to the 10 nanometer node, a lot of people, especially on the logic side of chip manufacturing, are saying that that will be a significantly larger mode in terms of equipment in the 16, 14, which face challenges with slower ramping. Is that your take, that the 10 nanometer provides more opportunities than what we've seen in 16, 14 for 3D?

Yes, that falls back into that bucket of wishful thinking for us, which I think that there is some data that suggests that we've seen a -- with all the tool reuse from 22 to 14, and as they pursue the 10 and then on to 7, the technical challenges are more challenging, or they are more difficult. We think process control plays a key role in helping them ramp to yield. And so we've got our fingers crossed that that translates to increased investment in our products.

A competitor has recently -- well, actually, it was over a year ago -- has entered the stress measurement area, and it's a relative measurement tool. I'm just wondering the pros and cons of that tool. And they just reported this morning they were citing some further penetration. I'm just wondering what you're seeing there in terms of has the market changed at all?

Yes, it's a good question. You know, that's a relatively new product still in terms of from being on the commercial front. We don't really see it. We don't do toe-to-toes or head-to-heads with it. We have an absolute measurement and we pretty much are in a very solid position providing data. That really translates to quantify distress intelligence for the customers. And I think there is -- it's yet to be seen whether or not that relative measurement tool actually gains meaningful traction going forward. But I would just say that we are not -- it's not a market share issue for us because we actually don't find ourselves competing toe-to-toe with them.

For my last question, you talked about you didn't see any or much possibility of reuse for 3D-NAND. I'm just wondering in terms of logic, because the Company also reported that they were seeing some reuse on some of their 28 nanometer tools, different technology of course, but they were seeing some reuse sliding over in the 16, 14. Do you see much reuse in terms of the logic, in terms of your measurement tools?

Yes, I think that -- Mark, I think that the reuse pressure that we are seeing is more on the logic side than it's been on the memory side in terms of the companies trying to shift it. And in particular on the 28 dropping it down to 16, actually 28 and looking a little bit at 20 before going to 16. The intent at that time was to buy tools that would translate straight across those nodes, at least if we're talking about the same account. And so that doesn't surprise me.

As we start pushing to the next node of FinFET architecture, though, I think that there's a point where you have to adopt a leading-edge technology in process tools as well as metrology tools, and that should work in our favor.

And that goes through 10 and 7. Is that correct?

Yes. I think that tool reuse is a fact of life for all of us, but I think it depends on -- you have to look at how disruptive or what the discontinuities are in the process flow that affect it going from one node to the next. If it's a simple slide sideways, you are going to see more tool reuse. If they've made a significant change in either the device architecture or the materials they are using or any of the structures, then you see incremental opportunity for metrology and process control tools.

Well, I would assume, as the aspect ratio increases, that it gets harder and harder to make these measurements and that would require better lamps, better signal to noise. Does that push that button?

Yes, I think that that's ultimately what we need to do. What we have to do is to keep bringing forward new technologies that have compelling improvements and differentiation over what was out there before that then causes the customer to buy the new stuff. If we don't bring out -- if we don't continuously innovate and bring new technologies to the market, then they will find ways to reuse or they will be obliged to reuse the tools. So, part of it is on what are we doing to advance our capabilities in parallel while they are trying to advance their device challenges.

And excuse me for asking one more, but if you do integrate new detectors or new sources, how does that affect your bill of materials? Do you -- does that change your margin profile at all?

If we do it right, it improves our margin profile. We're working very hard. We've actually strengthened our -- it's a good question because we've strengthened our supply chain management skill set, working much more closely with our suppliers on the key components. And while we are driving improvements in the technology, there's a huge amount of pressure from our customers to give them better cost of ownership, and that translates in some cases to both higher productivity and lower cost of materials so we can offer them competitive pricing on that overall tool. And we engage much more closely than we did in previous years with our key suppliers to try to help them drive their roadmaps while containing their costs.

Thank you.

Jairam Nathan, Sidoti.

So, with respect to your comment on integrated, is 3D-NAND more integrated intensive? Is that the point or is it just that you're winning more share on distributed?

Well, the first -- the primary reason our business is growing is share gains. There's certainly -- we've seen some growth in the integrated metrology market. We see pretty high demand in the memory side of it, of the business, as compared to some of the, say, advanced logic, some of the other areas. But, first and foremost, it's been pretty substantial shifts in share, in market share, in our favor that's helped us grow the business.

Okay. And as far as the shift goes, does that impact margin especially on the operating side, or you don't see that?

Could you repeat the question? I missed that.

As the mix of integrated goes higher because of the lower ASP, does that impact your margins on the operating margin -- especially the operating margin side?

No. Actually, we have done a really good job of increasing the gross margin of the products and we are seeing a higher volume. If you look at the number of integrated tools on a given platform, there's multiples of them. So it's not a one-to-one. So if you have a particular -- if you pick a process tool that may have four chambers, there's four integrated metrology opportunities. So they have lower ASPs but they have a higher volume, and the gross margins tend to be on par with the other tools.

Okay, great. That's all I had. Thank you.

(Operator Instructions). And I see no further questions. I would like to turn the conference back over to Timothy Stultz for any closing comments.

Thank you and thank you once again for participating in our call. Thank you to all our employees and business partners whose passion and commitment to our mission and business objectives drive every aspect of any success we ultimately enjoy. With that, we conclude our conference call today. Good night.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.