Onto Innovation Inc (ONTO) 2016 Q1 法說會逐字稿

Good afternoon and welcome to the Nanometrics First Quarter Financial Results Conference Call. At this time all participants are in a listen-only mode. (Operator Instructions) 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 First Quarter 2016 Financial Results Conference Call. On today's call are Dr. Tim Stultz, President and Chief Executive Officer, and Jeffrey Andreson, Chief Financial Officer. Shortly, Tim will provide a recap of the quarter and our perspective looking forward. Then Jeff will discuss our financial results in more detail, after which 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. Such statements may be identified by the use of words like believe, expect, and similar expressions that look towards future events or performance.

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 product, 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 2015. Nanometrics disclaims any obligation to update information contained in any forward-looking statement.

During today's call we will also refer to financial measures not calculated according to Generally Accepted Accounting Principles. Please refer to today's press release for an explanation of our reasons for using such non-GAAP measures as well as tables reconciling these measures to our GAAP results.

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 recent highlights of our business and financial performance which sets the stage for continued revenue growth and operating leverage in the forthcoming year. I will conclude with our specific guidance for the June quarter. Following my prepared remarks, Jeff will provide additional details on our financial results after which we will open the lines for Q&A.

The first quarter of 2016 marks an inflection point in our financial performance. The solid revenue growth over Q4, a significant increase in profitability, and incremental margins well in excess of our target model. It was also the quarter during which we launched the newest addition to our flagship Atlas product family, the Atlas III. The customer response to this new product launch has exceeded our expectations. Multiple systems have already been shipped to our launch partner in the memory market with whom we work closely on performance specifications and the feature set.

Additional tools will be shipped in the second quarter to several other key customers, addressing every device type at the most advanced technology nodes, including 1X DRAM, third generation 3D NAND, and 7 nanometer and 5 nanometer foundry devices. Following shipments in addition to those already mentioned are scheduled for later in the year.

Our flagship Atlas platform combined with our Diffract modeling and analytical software has been the lynchpin of our success in winning share and maintaining market leadership in the Optical Critical Dimension or OCD market. We are off to a strong start with this latest introduction which offers significant performance improvements needed by our customers for the most demanding applications on their leading edge devices.

With the performance improvements in the Atlas III, we also have the opportunity to expand our position and increase our share of the thin films market which in aggregate is even larger than the OCD market. The first quarter was actually a record high for our thin film sales. We see growth in this segment as a significant opportunity for incremental revenues in the near future and will aggressively pursue it with the Atlas III.

3D NAND was a big part of our story in 2015 and clearly continues to be so in 2016. We started the year with a record quarter for both 3D NAND orders and revenue, both of which exceeded our previous quarter records by more than 70%. While we don't typically announce bookings, this past quarter's 3D NAND bookings of over $38 million was a standout, both in the magnitude of orders received with Q1 orders nearly as high as 3D NAND revenues for all of 2015 as well as being a record 3D NAND bookings quarter with each of three individual customers. Our participation in this growth market, fueled by strong investments by five major customers includes our flagship Atlas platform and a significant deployment of our integrated systems. These tools are being used for both OCD as well as films applications.

Turning to our other key end markets, we expect foundry spending to continue to be a strong contributor to our 2016 revenues, driven by capacity investments at the 10 nanometer node and development spending on 7 nanometer and 5 nanometer devices. Due to the timing of customer investments, we expect this business will be weighted to the second half of the year. DRAM also continues to be a strong market for us. Sales were up significantly in Q1 versus Q4. We expect spending in this market to strengthen in the latter part of the year as the balance between demand and capacity improves and next generation devices are brought to market. Finally, we do not see a significant resumption of IDM advanced logic spending until the end of 2016 or early 2017.

Looking at our big key business drivers, demand for OCD metrology solutions is continuing to increase at each technology node across all device types with investments occurring at a growth rate greater than most other areas of WFE. In addition, advanced process control strategies, use of metrology and data analytics are playing an ever-expanding role in accelerating the fab ramps and yield improvements. These industry trends are in turn increasing demand for both our automated and integrated solutions and our unique ability to offer both platforms from a systems solution perspective.

Summing it all up, 3D NAND ramps and investments are clearly driving the strength in our near-term outlook. We continue to expect a stronger second half of 2016 compared to the first half, fueled by increased contributions from foundry and DRAM and possible upside in advanced logic. With the market dynamics, investment plans of our key customers, and our leadership position into record selections across all device types, our confidence in revenue growth and outperformance versus overall wafer fab equipment spending has strengthened since this time last quarter.

And finally, while operational execution in the near-term is of key importance as we respond to the growth in our business, our longer-term strategic focus continues to be on further expanding our fab footprint at key accounts, expanding our served markets through the development of new end use applications, and the development of disruptive technologies and platforms, each of which helps set the stage for continued growth and outperformance into 2017 and beyond.

Now, turning to our financial performance, our first quarter results clearly demonstrate that our business is at a major performance inflection. With revenues up 11%, our incremental gross margin was 76% and incremental operating margin was 71%. Total gross margin improved by 265 basis points and operating margin by 700 basis points. This performance is once again above our model targets as we continue to make progress on improving operational efficiencies and we benefited from strong upgrade sales in the quarter. The key takeaway here is that we're delivering significant operating leverage on incremental revenues while our revenue growth is outpacing the industry.

With sequential revenue growth expected for the second quarter, as well as for the second half, in combination with the ongoing improvements we are making to our business operations, we are well on track to delivering significant earnings growth and solid bottom line performance for 2016. With that, our guidance for the June quarter is as follows, revenues up 9% to 20% to between $52 million and $57 million. And on a non-GAAP basis, gross margin of 51.5% to 53%, operating expenses of $20.6 million to $21.2 million, and earnings of $0.21 to $0.30 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'd 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 and market and geographic region is available in the investor section of our website. Additionally, we have made a change to how the company is reporting upgrade sales and cost of sales. Upgrade sales were previously reported as a component of our service revenue and will now be reported as product revenue which more closely reflects the nature of upgrades being performed. While comparable prior period amounts discussed on this call and in the supplemental financial information file on our website have been recast to reflect this change, please refer to the supplements for all historical comparisons made on the call today.

Fourth quarter revenues were $47.5 million, up 11% from Q4, at the high end of our guidance range and down 6% from Q1 of 2015. Product revenues were $39.2 million, up 17% from Q4 and 9% lower than the first quarter of 2015. Service revenues of $8.3 million were down 9% from Q4 and up 11% from the first quarter of 2015. By end market, 52% of product revenues were in the NAND segment which grew 43% over Q4 and at this point is predominantly comprised of 3D NAND. DRAM increased to 20% of product sales while foundry declined to 19%.

Logic was 4% of sales all other devices and substrates comprised 6% of product sales, similar to last quarter. By product type, total first quarter revenues were comprised of 60% automated systems, 18% integrated metrology systems, 5% materials characterization systems, and the remaining 17% was service. Our 10% customers in the first quarter included Micron at 26%, SK hynix at 17%, Intel at 16%, Toshiba at 12%, and TSMC at 10% of total revenues 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 the acquired tangible assets and restructuring charges. As a reminder, all references made to revenue and gross margin on this call reflect the reclassification of our upgrades to products and can be found in the supplemental financial information file on the website.

Our Q1 gross margin was 52.5%, up 2.7 percentage points from the fourth quarter and represents our sixth sequential quarter gross margin improvement. Gross margin exceeded the upper end of our guidance by 2 percentage points and our target model at these sales volumes, due to operational improvements and a higher mix of upgrades in the quarter. These factors primarily benefited our product gross margin which at 53.9% increased 5.3 percentage points from the fourth quarter.

Service gross margin decreased to 45.8% from 54.4% in the fourth quarter due to lower spare sales and a lower level of utilization of our field service workforce. Operating expenses of $20.7 million were in line with our expectations for the quarter and to lower our full year operating expense again in 2016. For Q2 we are guiding a level that exceeds the $20 million to $20.5 million range we expect it to be within this quarter due to R&D activities related to our recently launched Atlas III platform.

As we look at the full year 2016 and depending on the levels of profitability and variable compensation, we expect quarterly operating expenses in the second half to normalize in the $20 million to $20.5 million range resulting in a year over year reduction.

To comment further on the operational efficiencies and margin improvements we are achieving at this performance inflection point, at the midpoint of our Q2 guidance, the first half of 2016 will be similar revenue-wise to the first half of 2015 but with over 4 percentage points of improvement to the gross margin and over 5 percentage points improvement to the operating margin, resulting in at the midpoint, a near doubling of operating profit on roughly the same revenue volumes. Below the operating line for the first quarter, other income was $117,000 as a result of foreign exchange gains.

Our tax expense for the quarter was approximately $380,000 and was lower than expected due to a favorable adjustment of approximately $500,000 or $0.02 per share. For several quarters I've provided a dollar-based ranges for our tax expense but given the improvement in our outlook we will be subject to a minimum level of US tax. Given this, our quarterly tax rate for the remainder of 2016 will be in the range of 17% to 20% per quarter, depending on the level of profitability with Q2 being at the lower end of the range. Add income for the first quarter was $3.9 million or $0.16 per share.

Turning briefly to the balance sheet, our cash and investments at quarter end were $83.3 million or about $3.42 per share. Days sales outstanding increased to 84 days from the prior quarter, principally due to the increase in deferred revenue billings that will be recognized as revenue in future quarters.

Inventory increased $3.4 million to $54 million at the end of the first quarter. The increase is driven by incremental inventory needed to support the higher level of revenue in Q2, the initial builds of our new Atlas III platform, as well as an increase in the number of first in fab systems requiring acceptance in order to recognize revenue for our policy. The increase in deferred revenue was also mainly attributable to the initial Atlas III shipments and first in fab systems requiring acceptance.

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

(Operator Instructions) Tom Diffely, DA Davidson.

Yes. Good afternoon. So, first on the really strong 3D NAND business, you talked about how some of these other drivers were going to continue or start up and drive growth in the second half of the year. What is your view for 3D NAND specifically in the second half of the year? Is this a slug that's going through that's going to be qualified and have to move on to the other stuff? Or is 3D NAND going to continue on?

Tom, yes, this is Tim. We see 3D NAND spending continuing. It won't be as strong as we're seeing in the front half but there's additional investments that are going to be made and we should participate in that. But we need a little support from the DRAM and the foundry to give us a stronger second half than the first half.

Okay. It looks like obviously record orders from three customers. Are you still engaged with the other two players in this space? And do you expect them to spend this year as well?

Yes. We have record positions with all five of the 3D NAND manufacturers and in fact we have a really good market position across there and we are participating in all the fab installs, ramps, and next generation development.

Okay. And the record bookings in the first quarter for 3D NAND, most of that revenue is going to be in the second quarter or does some of it pull into the third quarter as well?

It's across both those quarters.

All right. Moving to the product, the new Atlas III launch, what is I guess the key data point of the Atlas III going forward? Is it a cost of ownership improvement? Is it truly just a technology improvement of what you can see? Is it pricing? What is it that makes you most excited?

It generally has to be all of those things to bring out a successful product. The cost of ownership, there's always a lot of pressure on us to deal with cost of ownership but first and foremost it's the technology performance, it's the precision, signal to noise, resolution, repeatability, and ability to measure -- bring fidelity to the measurements of very small geometries. On top of that we clearly have to deal with the productivity and the cost of ownership.

I guess in cycles past you've had -- I don't want to say issues, but you've had some growing pains as you've ramped up a new tool. At this point is this one where you want it to be from a margin point of view?

That's a great question. You've got a long memory. Actually as you know we did hiccough on one major product launch. We've got our -- I believe we've got our act together. We've got a more robust new product introduction business process. Our manufacturing, service, and commercial teams have been working closely together. There's always going to be a little bit of margin pressure in the very first tools going out just due to operational efficiencies and first builds. But this product is going to come out and hit the ground running and it will be a nice contributor to both revenues and gross profit.

Great. And then finally, when you look at the upgrades that really help from time to time with the high margin, what is your outlook for the next few quarters from an upgrade point of view? I know that can be quite lumpy.

It is lumpy. In the first quarter they were pretty strong. I think we see year over year, we see potential growth. But they are lumpy. I wouldn't want to give you too much specifics. But they won't be as big in Q2 as they were in Q1.

Okay. Great. And that's fully absorbed though in your guidance?

Yes.

Tom, one other thing I'd point out is that Jeff mentioned earlier on how we're accounting for upgrades and I think it also reflects what's going on in our commercial environment, that I would say historically upgrades have been more of an opportunistic sale. We'd look at the install base and look for opportunities to sell software or hardware to existing accounts. Right now the upgrade strategy is much more tied to the front end of the commercial operations. When we're selling products, we're also selling the roadmap.

And we have an upgrade strategy tied to it. And so it's much more of a product sales activity than it was a post-sale service activity. That both explains why we're changing the accounting but it also shows a strengthening of the relationship between what were telling the customers, what we're delivering, and when we'll deliver it. So, with all the pressure on tool reuse, it's very important to have a very good and strong upgrade strategy to carry those tools forward.

Can you upgrade an Atlas II to make it an Atlas III? Or is it a completely different hardware piece?

Yes. We can do it. We have upgrade strategies for some of our installed tools.

Thank you.

Patrick Ho, Stifel Nicolaus.

Thank you very much. Congrats on the nice quarter. Tim, you've talked about in the past market share gains across many different customer segments like foundry and NAND flash. Can you just give a little bit of color in terms of your products? What I mean by that is your automated systems and integrated. I'm assuming you've gained share in both of those areas. But can you give a little bit of color on, I guess, how you've gained in both of those product segments?

Sure, Patrick. I'll see if I can answer that. You're right. At the outset we've gained share on both the automated Atlas platforms as well as integrated. We've gained share across multiple product types, particularly in the foundry and the 3D NAND. 3D NAND has been very strong. I would say on a percentage basis, starting with a slightly lower number, the integrated metrology share gains have been large as an absolute percentage than the others, but the revenue contributions on the automated is much more substantial with almost three times the ASP on product on product.

Great. That's helpful. Maybe looking at both the margin improvements you've made to date and the ramp up of the Atlas III, maybe following from Tom's earlier question about -- I don't want to say the hiccoughs in the past, but what have you done this time around in terms of your manufacturing operations to prepare for this expected ramp over the next couple of quarters that you're projecting? How do we get confidence on the manufacturing side that you'll be ready to meet the increasing demand?

It's a good question. Once again, thank you for having a wonderful memory of bad times for us. But we really have changed the way we run our process. We've got much more robust business processes. The tools, we're into double digit building of the Atlas IIIs already and they're being built in the manufacturing environment. We did a really smooth handoff between the engineering and the manufacturing organization. We also engaged our service and applications groups in this handoff. We learned from our lessons in the past and I'm very confident that you're going to see a very smooth transition as we ramp this product.

Great. Thank you very much.

Weston Twigg, Pacific Crest Securities.

Hi. Thanks for taking my question. I just wanted to dig into the gross margin a little bit. On the last quarter I think you said we should be using the target model which it would be around 50% gross margin and $50 million in revenues. You're running well ahead of that. And just wondering if this is a number we can use moving forward, this higher level, or if you think there's a risk that maybe it comes back down towards the target model?

Wes, it's Jeff. Some of the growth, obviously is mix related with the upgrades growing faster or larger in the quarter. But I think what we're seeing is some of the operational efficiencies that we've been driving now for a year and change really starting to bear some fruit. So, we do believe we can stay a little bit ahead of this at these revenue volumes. But just noting that product mix can swing you 50 basis points up or down within the systems sales.

Okay. That makes sense. And then maybe just moving forward since you've taken the upgrades out of the service line, should we use that 45% to 46% gross margin on the service line moving forward?

I think the more normal gross margin in service will probably be between 45% and low 50%. We've said before, so I think it can improve a little from here obviously. And some of this is in Q1 you just get a lot of holiday effect of utilization.

Okay. And just finally, you said you're working on further improving the financial model but you didn't update the target model. Can you give us an idea of when you might have an opportunity to update that model or when you have confidence in giving us maybe some improved forecast numbers?

I think what we meant to say is we're not ready to update the model but we're continuing to work on all the operational efficiencies, supply chain savings that we can do to continue to drive that operating model. And I think if we get confidence that we can stay above it, we'll recast it. But we're not planning to do that right now. But there is more efforts that we think we can bring to the table on the operational side.

Okay. Sounds good. Thank you.

Mark Miller, The Benchmark Company.

Congratulations on your quarter and your efforts to improve your margins. Just was wondering, you talked about share gain, I was just wondering the area of CD-SEM, that technology is reported to be running out of steam. What are you seeing there? Are you capturing more share from that other technology?

Yes, Mark. We do see that. There are technological limitations to the CD-SEM as we start to see shrinks and thinner films and also the performance and productivity requirements. So, I think that OCD will continue to take share in the CD market away from CD-SEM.

Do you feel that's accelerating now? Is it running at the rates you expected?

I don't know. I wouldn't say accelerating. I think it's been pretty steady. It may accelerate as we get down to some of the 7 nanometer, 5 nanometer, the gate-all-around. Right now it's been a pretty steady shift as more customers adopt OCD, become comfortable with the technology and the models, and then deploy it from one generation to the next.

I'm wondering what's giving you -- whether it's quoting activity or your expectations for improvement, most people have been pretty down about DRAM. But you're expecting that to come up and compensate for some of the slower growth in NAND in the second half. What's giving you optimism there? Are you seeing quoting? Or is it just the transition to the 1X and nanometer nodes? What's your feeling there that that could be some upside there?

It's primarily based on our direct conversation with our customers, the roadmaps and planning that they have, the fab investments they're making. It certainly turns into quotes and bookings and backlog that we track but I think people -- it depends on also where you are on that cycle, Mark.

With metrology, they use metrology to bring in a fab, the qualified tools to do the ramps, to tweak on yield and we get the benefit in a variety of those areas and we continue to see the -- we've had stronger DRAM than some of the other companies that reported in the last couple quarters and we think in the second half it's going to continue to help us.

You also mentioned potential upside in logic. Now, we've been hearing from another manufacturer, an equipment manufacturer that they are seeing more at the 10 nanometer node, more people expecting the expanding capacity of 28 nanometers and instead they're expecting the 7 nanometer to be the big ramp for 3D. I'm just wondering what's your viewpoint on that?

I probably should separate those two, Mark. When I talk about upside in logic, I'm talking about advanced logics. So, it's really talking to the SOC manufacturer, the IDM, which has been sliding out for us which we've got a very strong position but their development, going from 14 to 10 nanometer has been pushed out with a lot of tool reuse. We're hoping -- we'd like to see a little bit of recovery towards the end of the year but we don't know for sure.

Speaking more specifically to what you were referring to, the 10 nanometer, 7 nanometer, that's more, I believe, a foundry question. Our feeling is that 10 nanometer's going to be a good node. We're seeing most of our business and discussions run 10 nanometer. 7 and 5 are out there and we're working with them but I know at least one company's talked about leapfrogging 10 and jumping right into 7. We see 10 as a good, solid node and we think we're going to enjoy nice contributions to our revenues from 10 nanometer.

So, it's still too early to say whether 7 will be actually bigger than 10 for NAND?

You mean for foundry logic?

I'm sorry. For foundry logic.

Yes, I think it's a little early on that. I think 10's got to play out. A lot of this is going to be driven by the fabless and what they need in their performance and how well they come off the yield curve. As you know there's been still a lot of investment in the 28. But I think 10 -- it really -- also it ties into the strategy of the EUV, what they're going to do on critical layers. But I wouldn't shortchange what the opportunities are in 10 nanometer. Right now it doesn't look like a stub period for us. We think it's a solid node.

Just, Tim, another though. What about EUV? That's been controversial so long, do you think that finally arrives at 7? Or beyond 7?

Well, there's at least one customer talking about one or two critical layers of EUV. We'll have to see how well that's deployed in the HBM. I think most of the EUV you're going to see is going to be played out more on the 5 nanometer and even in that case it's only going to be in a couple layers where they have either triple or quadruple patterning. I think immersion will still be used for the majority of the layers. So, I don't think there's a huge market shift in terms of the demand for products like ours in either case.

Thank you.

(Operator Instructions) Graham Tanaka, Tanaka Capital Management.

Congratulations, Tim and Jeff. Great quarter and outlook. It seems like a bit of a non sequitur almost between what you guys are looking at and seeing versus a lot of the other providers. I'm just wondering how much of this is the new product cycle and just hitting stride? Or is it mix? Or what else is it? Thanks.

Yeah. Graham, good to hear from you. I realize that there's a couple of points where we seem to be contrarians but we're kind of used to being in that place. We were contrarians when people were expecting a certain amount of spending in IDM advanced logic and we didn't think that was going to occur and it didn't. A lot of our performance is all about share gains and being with the leading edge areas.

For instance, a lot of competitors are still counting on revenues going into 28 nanometer in foundry. And as you know, we don't have a position in 28 nanometer. Everything we do is beyond there. It's 14 and 10 and 7. Everything that we do on the NAND part of the business is 3D NAND. So, we're doing the new fabs, the new ramps, we're tied in on the early stages, we're tied in on driving yield.

And over the last years we've worked very, very hard to make sure that we have a balanced revenue and customer mix that gave us much more balanced revenue. We're not overly weighted any longer in just memory or just DRAM or just advanced logic. So, we get multiple contributions which smoothes out our revenue outlook and gives us a lot more confidence in the second half.

The other thing is it's a bit of a surprise, the surprise is the margins. I guess I was trying to understand, the Atlas III higher margin -- if we didn't have Atlas III in the mix, are you still seeing higher margins?

The first thing is there's no Atlas III in the margin at all. We're shipping the Atlas IIIs, they're going in, we have not hit the point of revenue recognition in the Atlas IIIs. We ship multiple tools to one customer. We have other ones going out. But all that margin improvement is with our current product line and it's mostly driven by our operational efficiencies. We put a lot of energy into making sure we can reduce our installation and warranty expenses. We work on our supply chain, we work on our cycle time. That's just having our shirt sleeves rolled up and doing a better job inside the factory with the existing product line.

The Atlas III, congratulations again. It's really critical to get the key platform going in place solidly. How long is that product cycle versus prior cycles?

The cycle between Atlas III and the previous one?

The life cycle of the product.

The life cycle of these products is generally 1.5 years to 2 years in terms of by that time you've got to introduce the next generation. The product itself will be out there for 3 to 4 years. We actually had a little longer. If you look at the time since we introduced the Atlas II to the Atlas III, that was a little longer than our normal cycle. We put a lot more energy in the development, some of the technical challenges were steeper than they were in the past. But the rhythm you'd like to have is to have a new product cycle, at least a significant upgrade, at each technology node. The customers expect that from us.

Congratulations again. Thanks.

Thank you, Graham.

Thank you. I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Tim Stultz for any closing comments.

Thank you once again for participating in our call. And special thanks and continued appreciation to all of 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. And with that we conclude our conference call for today. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.