Onto Innovation Inc (ONTO) 2015 Q3 法說會逐字稿

Good afternoon and welcome to the Nanometrics third-quarter 2015 financial results conference call. A Q&A session will be held at the end of the call. Until that time, all participants will be in a listen-only mode. Please note that this conference call is being recorded today October 29, 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 third-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 third 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 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, including general economic conditions, changes in timing and levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demand, shifts in timing of orders or product shipments, changes in product mix, our ability to successfully realize operating efficiencies, 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 I will speak to the highlights of the September quarter, discuss the drivers behind our business results and revenue outlook, and finish with our guidance for the December quarter. Following my prepared remarks, Jeff will provide additional details on our quarterly financial results, after which we will open the lines for Q&A.

Our third quarter came in largely as expected; however, with a revenue mix that differed somewhat from our initial expectations. We saw a higher mix of high-margin upgrades, which helped drive gross margin above the high end of our guidance range. Notably, this was our fourth straight quarter of gross margin improvement and the second quarter, wherein the gross margin improvement was achieved on lower sales volume quarter on quarter.

Margin improvement has been an important area of focus for us and we are pleased to see our efforts in driving operational improvements and maintaining tight cost controls bearing fruit. We are working hard to improve our overall financial performance by driving further operational efficiencies and improvements in our cost structure.

Turning to our business drivers, we saw continued strength in 3D NAND and foundry spending, as those two sectors represented greater than 50% of our product sales for the third quarter in a row. We expect this revenue trend to continue into the fourth quarter as well.

Our DRAM business continued to be solid in the third quarter; however, we do see a significant softening in DRAM spending in Q4 as investments in that market are shifting into early 2016. I would characterize reduced DRAM spending as being the chief change to our near-term outlook, while low spending on advanced logic continues to be a drag on our overall revenue story.

On the product side, our integrated metrology business has been firing on all cylinders, with 80% quarter-on-quarter revenue growth following 30% growth the previous quarter. Our first-half 2015 revenues from this product group doubled over the second half of 2014. And we expect a similar magnitude increase in the second half of this calendar year. As a result, we are on track to achieve record levels revenues in integrated metrology for the full year 2015, which clearly indicate our share gains in this segment.

Now I'd like to make a few comments about our overall business outlook and in particular, our performance relative to industry spending for the year. Our fourth-quarter guidance indicates a quarter-on-quarter revenue decline of between 6% and 15%, primarily resulting from the softening in near-term DRAM spending. Generally speaking, this quarter-on-quarter decline is less pronounced than the outlooks already given by many of our peers with a similar exposure to the memory market.

Further, given the expansion of our customer base, share gains, and success in 3D NAND and foundry businesses, we are actually looking forward to another solid year of growth for 2015. Our revenues are up 14% year on year for the first 3 quarters and we're still on track to achieve double-digit revenue growth for the full year 2015 for the second year in a row and to outperform WFE spending by at least 10 percentage points.

Also worth noting are the year-to-date margin improvement and P&L flowthrough associated with our revenue growth. Since the fourth quarter of 2014, we have increased our gross margin by more than 400 basis points. And at the midpoint of our Q4 guidance, our full-year gross margin flowthrough of about 60% and our operating margin flowthrough of about 70% both exceed our operating leverage objectives.

As we have mentioned before, the growth in our business is the result of market share gains as well as the increase in use of our flagship OCD technology for advanced technology and leading-edge node applications. Notably in 2015, we are expecting record sales for the foundry segment in addition to high levels of business from investments in ramps in 3D NAND devices.

We also expect to achieve record sales to TSMC, Micron, and Toshiba, further demonstrating the success we have had in expanding our customer base. And as I mentioned earlier, our integrated metrology business is tracking to record levels as well.

In summary, Nanometrics has executed well against our strategic initiatives: targeting key technology and flexion points with leading-edge solutions, growing our foundry business to record levels, and winning Tool of Record positions at multiple new accounts. All this while also improving our gross margin, demonstrating strong P&L flowthrough, and improving our bottom-line performance. Our work on improving our performance is far from over. However, we believe our focus and trajectory are clearly moving in the right direction as we look beyond Q4.

With that, our guidance for the December quarter is as follows: revenues of $39 million to $43 million, and on a non-GAAP basis, gross margin of 47% to 49.5%; operating expenses of $20 million to $20.6 million; and earnings of breakeven to a loss of $0.10 per share.

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

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

Third-quarter revenues were $45.7 million, down 6% from Q2, above the midpoint of our guidance of $43 million to $47 million, and up 68% from Q3 of 2014. Product revenues declined 6% to $36.4 million compared to $38.9 million in the prior quarter. And service revenues of $9.3 million decreased 4% from the prior quarter due to a lower level of upgrades.

By end market, over 80% of our product revenues in Q3 were in the memory and foundry segments, a similar profile to the second quarter. In particular, NAND sales represented 33% of product revenue and consisted primarily of 3D NAND shipments. DRAM sales comprised 22% of product revenue.

Foundry sales remained strong and were similar to Q2 levels, comprising 27% of product revenues. Logic sales increased slightly to comprise 7% of product revenues, and all other devices and substrates comprised 12% of product revenues.

By product, total third-quarter revenues were comprised of 46% automated systems, 24% integrated metrology systems, 10% materials characterization systems, and 20% service and upgrades. Our 10% customers in the third quarter included TSMC at 17%, SK hynix at 15%, Micron at 14%, and Toshiba at 13% of total revenue for the quarter.

I'll 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 Q3 gross margin was 49.7%, up 90 basis points from the second quarter and represents our fourth sequential quarter of gross margin improvement. Gross margin exceeded the upper end of our guidance, primarily due to some upside in high-margin software upgrades delivered in the quarter.

Product gross margin decreased to 47.2% from 49% in the second quarter, largely due to product and customer mix, while service gross margin improved significantly to 59.5% from 48% in Q2 due primarily to the incremental software upgrades shipped during the quarter and to a lesser extent better service personnel utilization. Operating expenses of $20.9 million were near the high end of our guidance due to the timing of R&D materials expenditures.

Our expectation going into this year was to maintain our quarterly operating expenses in the range of $20 million to $21.5 million per quarter, with the back half of the year being in the lower end of this range, as reflected in our Q4 guidance.

We are making progress on our operating model by continuing to drive additional operational efficiencies across the Company. Our GAAP operating expenses for the fourth quarter will include approximately $1.3 million of costs associated with the restructuring the Company executed in October. The goal of the restructuring was to better align our cross-functional organizations and business units as part of our effort to improve our operational efficiency.

Other incumbent expense included a favorable foreign exchange translation adjustment of approximately $300,000, equivalent to $0.01 per share, as compared to a $350,000 unfavorable adjustment equivalent to $0.01 per share in the previous quarter. Our tax expense for the quarter was also higher than our guidance due to the higher level of service profitability in our non-US regions. Our quarterly tax expense for the fourth quarter is expected to be approximately $700,000. Net income for the third quarter was $1.3 million, or $0.05 per share.

Turning briefly to the balance sheet, our cash and investments at quarter end were $84.6 million or about $3.50 per share. Days sales outstanding decreased to 74 days. Inventory increased $6.8 million to $49.9 million at the end of the third quarter due to the timing of systems which require acceptance for revenue recognition and the timing of our Q4 shipments, which required incremental inventory to support our customers' delivery needs.

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

(Operator Instructions)

Patrick Ho, Stifel Nicolaus.

Thank you very much. Tim, first a big picture question in terms of your integrative versus your stand-alone business. You noted the improvements on the integrated side. Do you believe you are seeing any secular trends towards these integrated systems or do you think this is more of a customer- or product-specific trend?

Patrick, thanks for calling in. With regard to whether we've seen adoption in a secular pattern, most of the success we are seeing in the increased demand is coming out of 3D NAND. So we are seeing a broad adoption across all the customers in that particular sector.

Great. Maybe in terms of the current business environment, you noted that you are seeing similar trends going into the fourth quarter. What are the specific foundry investments that you are seeing for the December quarter? Is it still for the leading edge or are you kidding any getting any potential, I guess, more mature to the technology node investments?

That's a good point, because if you look at our revenues and our revenue trends against some of the other folks in the industry, we don't participate in the -- we haven't participated in the older technology nodes, like 28 nanometer. All of our wins, our share gains, and our tools are going into the advanced nodes of 16 nanometer and some 10 nanometer and a little bit of the R&D beyond that. So all of our business in the foundry is the front end of the technology curve.

Great. Thank you very much.

Tom Diffely, D.A. Davidson.

Good afternoon. First, Tim, on the higher percentage of the high-margin upgrades, you said you are little surprised. I'm wondering what happened there. Are these upgrades in lieu of new systems?

So good questions, Tom. No, those were not in lieu of new systems. It wasn't a cannibalization of the business. But these do come in large groups, as I mentioned, at different times. And so when we get an upgrade request, it will be for multiple tools. The magnitude of that request was higher than we had originally forecast and so it complemented our margin and our revenue contributions nicely.

Tom, the other thing is they were software upgrades, so they carry a pretty high margin.

Okay. How much lead time do you typically have for something like this? Or I guess if it's software, you may not have much lead time at all?

Yes, there's really not much. There may be a little lead time if there's hardware tied to it. This was almost pure software, so it's a pretty quick ask and quick response.

Okay. And then obviously some very nice margin progression over the year. At this point, do you think your operations are in pretty good shape and to the model, so you just need to get the top-line growth to finish it out? Or is there more to do on the margin-specific items?

I'll speak a little bit to what I think we can do and I'll let Jeff add any other color. So we are far from done. I think we're very close to the kinds of numbers we've been talking to in terms of the [50-on-50] model that we've spoken to, that if we were at those revenue levels, I think you would be seeing those margins.

But there's still things we're doing. We are putting a lot more emphasis on our supply chain management. We are trying to get -- reducing our COGS through our partnerships. We are looking at factory efficiencies on the floor to reduce our cycle times.

We are looking at better management of our inventory. We are looking at our installation and warranty activities and seeing what we can do to reduce those cycle times. And all of those will contribute to margin improvements -- maybe not as in big of steps as we've been taking, but they are all incremental to what we are doing.

Okay.

The only thing I would add, Tom, is I think you are right: the factory is running at a relatively high level and that we are not going to get a bunch of leverage out of just the overhead. Most of what we're working on now are incremental improvements that Tim described.

Okay. Great. And then guess on that same line, is there a meaningful difference in product margins when you go between NAND and DRAM and foundry and logic?

Not enough to talk to. Most of our products -- there was a time when there was a fair amount of disparity in the product margins, but we've done a pretty good job of bringing them all up, getting them closer to our model.

So our Atlas platform, our IMPULSE platforms -- they are doing well. Obviously, the software makes a move on it. But we are getting close to where we could have been and where we'd like to be, but then we've got more that we can get out of the system in the way we go about building these products.

Okay. So will volume discounts be the largest factor going forward?

No, I don't think so. You are talking about volume discounts against our supply chain?

No; volume discounts of your customers as far as your margins go on tools?

We do a pretty good job of resisting that. We've got -- we're fortunate that our primary competitor also does a good job of resisting that. So we operate under a good umbrella there. And I haven't seen -- the conversations can be difficult, but there aren't a lot of alternatives. And when you are a Tool of Record, we really don't have to fold up the tent on those conversations. So I think we're doing pretty good.

Okay. Great. Thanks for your time.

Mahesh Sanganeria, RBC Capital Markets.

Thank you very much. Sorry, I might have missed something. I was running between a couple of earnings. Tim, just on the overall, how do you see the next year shaping up? I know that the visibility is hard to get, but in terms of thinking broadly in the foundry and logic and NAND and DRAM, what are the puts and takes on various segment for next year?

Yes, that's a good one and we don't have a lot more visibility than you do. In fact, I think you do a better job at this than a lot of people.

But when I look out there, if you look at some of the commentary as well as the talks with our customers, we see some foundry opportunities that continue to go forward. There's some uncertainty about the timing of DRAM until that market improves. Some logic spending by one of our key customers is going to be tied much more to what happens with Apple products and who wins that business.

And then the advanced technology nodes in our advanced logic is kind of a latter year activity. The good news for us is we are a Tool of Record in position in all those areas. And we are tracking what their spending and there's a couple of other areas where we are trying to expand our footprint.

I think if I stand back right now, we see year on year we don't see huge changes in the WFE capital spend between 2015 and 2016. But it's pretty early for us to be saying -- giving that with any more color than you probably already have.

And so just along that line, I would think that it seems like that this year turned out pretty negative in terms of foundry and logic spending or IDM spending. So I think the bar is pretty low from foundry and logic spending. So that should -- even if the overall WFE is flat, that should grow and that should benefit you both two ways: one, the market share gain in foundry and your exposure to logic foundry. Is that a good way to look at it?

I think it's a reasonable way. I think the way I look at it is that there is certainly upside to where we've been and where we've been tracking on the advanced logic. That's been a real -- as I mentioned during my script, that's been a real drag on our revenue story. And we're -- as you said, it's a pretty low bar. So I think that it's reasonable to assume that should improve going into next year.

On the foundry, we are tracking with record foundry revenues, record customer -- TSMC has just been a terrific customer for us. So that talks to our footprint. And as they invest in the next nodes, we hope to carry that forward. So we think that that will track nicely.

3D NAND has been really great. We've got -- everybody that makes a 3D NAND has adapted our tools and Tool of Record. So that is the timing of the extension of their capacity and going into the next node of incremental layers. And I guess the one we are all looking at is whereas DRAM carried us nicely up to this point, it is whether or not you have a one- or a two-quarter softness in DRAM spending going forward.

Okay. That's very helpful. And one last question on the 3D NAND. We have several new fabs starting and maybe even new supplier online.

As just a very generic question: when you start a new fab or if you're somebody entering the market, typically I would think that they would start with a pilot kind of line and get the yield learning before they fan out mass production. Is that a reasonable way to think or you think that two or three new fabs coming, they are going to be aggressive at the get-going and you are going to see something big in the first half of next year?

That's kind of a customer-specific question, I think. It depends on where they are. A couple of the customers get their pilots going in the older fabs and they are working on it right now for next generation. So when they start tooling up the new fabs, they are really ready to launch it. And what you will see is incremental capacity added in steps -- whether they go 30K, and then another 30K, and then maybe a 40K or whatever it is depending on the size of the fab.

As you said, there's one new entry in there that's going to be having to learn a little bit more about how to make these devices and how to produce them. And I think that that one will probably be a slower start.

For us, one way to look at it that's important, Mahesh, is that generally they front-end load the procurement of the metrology tools and process control tools at the beginning of the fab to both qualify tools as well as to get the yield moving. And we usually benefit a little earlier in that whole sequence against other WFE expenditures on processing capacity.

Okay. That's very helpful. Thank you, Tim.

Weston Twigg, Pacific Crest Security.

Hi, thanks for taking my question. First, just wondering on the service revenue line, do you expect that to be down again in Q4? Or is the decline mostly product-driven?

Most of it is the upgrades. We are not planning any significant declines in the core side of the business.

Okay. So product revenue would be more flattish?

Are you talking about the split between products and service?

Just wondering where most of the decline comes from in Q4?

Yes, it will come primarily from the products side. There will be some decline for the upgrades that we saw this quarter in service.

Okay. Also wondering maybe if you could talk about the impact of your relationship with Lam with respect to the KLAC merger. I know that you are doing some integrated metrology programs. KLAC doesn't necessarily have a directly competitive project, but I don't know if you can give us any context or color on that relationship. And if you've had any customer discussions regarding that merger?

So it's a good question, but actually, the answer is the relationship is with the end user. So when you look at our integrated metrology adoption Tool of Record positions, it's the customers that's made those determinations. And the primary engagement we have with the OEMs is making sure that our platform has been qualified on their tool and -- but we sell directly to the customer. We support directly with the customer. We work with them on process and process control with the customer.

Okay. So you don't expect any impact to your business. That makes sense. But maybe a bigger picture. Looking at just your growth, it hasn't accelerated as much as you've needed it to to be consistently profitable. Meanwhile, your big competitor is getting bigger as they merge with Lam.

So big picture: how do you manage that situation? Do you feel like you are undersized? And then is there a solution other than waiting for customers to spend more money?

Well, Wes, we are David and they are Goliath; there's no doubt about that. We try to be more nimble. We try to find those opportunities that are either underserved or an opportunity for us to bring some technology to the market. We've been pretty successful in taking market share in our served markets away from them.

With regard to what's going on right now, we are hopeful that they are going to be busy integrating and solving the acquisition issues while we are busy going after our customers and seeing what else we can do to gain some additional share.

Okay. That's fair. Do you feel compelled to more closely partner with Applied or Tokyo Electron as opposed to Lam, given the merger? Maybe try to come up with some holistic solutions that would reflect something similar what Lam and KLA talked about?

I don't have a good answer for you on that. Right now, we're pretty agnostic to who we work with because it is a customer-driven area. Clearly, if for some reason the Lam and KLA merger resulted in them trying to do some internal development, that would be competitive to what we're doing. As you know, KLA is not in integrated metrology nor is [it an issue] for process. But if that evolved in that direction, we certainly would have to look for alternative ways to participate in that market.

Okay. Very helpful. Thank you.

(Operator Instructions)

Mark Miller, Benchmark.

Good afternoon. I'm just wondering in terms of technology next year, especially with the XPoint chip starting to come to the market, any technology challenges or opportunities do you see, especially in regards to XPoint?

Yes. Actually, the XPoint -- or Crosspoint, depending on what you want to call it -- we see that as a pretty neat device that's got some interesting metrology requirements -- process controller requirements. And we're a Tool of Record with both Micron and Intel. So we are working in on that device. We are helping to solve some problems and we see a chance to expand our application space based on it.

We also see trends in logic devices as they go from FinFET to gate all around. And we see additional opportunities as they increase the number of pairs in the VNAND. So from our side, all the device structures and architectures going forward are creating incremental opportunities for us.

What about the transition to 10 nanometers? When do orders really start to ramp there?

Ramp is a good question -- orders are occurring. We are shipping tools; they are being used. I think that the timing is kind of -- it depends where you are looking and which one. But if you feel like it's the two leaders in there, it is kind of a midyear type of thing before you are going to see some significant high-volume manufacturing in that area.

And just a couple housekeeping. I missed the percentage of sales to Micron.

I think it was -- hold on one second. Micron was 14%.

Did you buy back any shares back this quarter?

We did not.

Thank you.

At this time, I am showing no further questions in the queue. I would like to turn the call over to Timothy Stultz for any closing remarks.

Well, thank you once again for participating in our call. A special thanks and continued appreciation to all our employees and business partners, whose passion and commitment to our mission and business objectives are helping to drive a better Nanometrics each and every day. With that, we conclude our conference call for today. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This concludes your program. You may now disconnect. Everyone, have a great day.