Onto Innovation Inc (ONTO) 2016 Q2 法說會逐字稿

Good afternoon, and welcome to the Nanometrics second quarter financial results conference call. At this time, all participants are in a listen-only mode. (Operator Instructions). A Q&A session will be held at the end of the call. Until that time, all participants will be in listen-only mode. Please note that this conference call is being recorded today, July 26, 2016. At this time, I would like to turn the call over to your host, Claire McAdams. Please go ahead.

Thank you. Good afternoon everyone. Welcome to the Nanometrics second quarter 2016 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 quarter and our perspective looking forward. Then Jeff will discuss our financial results in more detail, after which we'll open up the call for Q&A. The press release detailing our financial results was distributed over the wire services shortly after 1.00 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 toward future events or performance. Although Nanometrics, inc. 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 any 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. Thank you for taking the time to join us on our call. Today I will speak to recent highlight of our business and financial performance, as well as industry trends and our business drivers. I will conclude with our guidance for the September quarter. Following my prepared remarks, Jeff will provide additional details on our financial results. After which, we'll open the lines for Q&A. Our June quarter results reflect continued revenue growth and increased operating profit. While at the same time our long-term business outlook continues to strengthen. The successful execution of our strategy to target key technology inflection points with industry-leading process control metrology solutions, has resulted in two record positions with every leading semiconductor manufacturer for every leading edge device. The share gains we achieved over the last two years, combined with planned investments on next generation technologies and incremental capacity, particularly for 3D NAND, where we have a commanding market share lead, that gives us growing confidence that our revenue growth will not only up on the industry in 2016, but also that 2017 will shape up to be another sequential year of growth and performance.

In the June quarter, we achieved multi-year highs in profitability metrics including product gross margin, operating margin, and earnings per share, with top-line driven by all-time records in NAND, integrated metrology and thin-film metrology. We also turned the corner in free cash flow generation which was 19% of Q2 sales, and added nearly $13 million in cash to our balance sheet. During the quarter, we launched the newest addition to our integrated metrology family, the Impulse Plus. We're pleased with strong customer response to this new product which contributed to our record thin-film metrology and integrated sales in the quarter. The introduction of the Impulse Plus follows on the heels of a successful Atlas III launch in the previous quarter, which continues to gain commercial momentum with multiple customers. The Atlas III has already shipped in volume, and is being used or evaluated for the most advanced technology nodes including, 1x DRAM, third generation 3D-NAND, and 7-nanometer and 5-nanometer foundry devices. Our strategy of offering complimentary metrology platforms, both automated and integrated, link together and enabled by our industry-leading diffract modeling and analytical software, has been the linchpin of our success in winning share, and maintaining market leadership in the Optical Critical Dimension or OCD market. In addition to OCD, we see significant incremental revenue opportunities within the thin-film market using our existing optical technologies and metrology platforms. With the performance improvements in both the Impulse Plus and the Atlas III, combined with new applications and development, we expect to gain share and expand our position in that market. Turning to our end markets, 3D-NAND has been a major part of our growth story for a number of quarters, and the second quarter was no exception. We started the year with a record quarter for both 3D-NAND orders and revenue,both of which exceeded our previous quarterly records by more than 70%. Following that strong Q1, second quarter 3D-NAND were up by more than 60% quarter-on-quarter. This led to records not only for total NAND revenues, but also record revenues from the overall memory market. The current spending environment in 3D-NAND is certainly benefiting the industry at-large, particularly for those companies leveraged to etch and deposition processes. The sheer size and intrinsic price elasticity of this market driven by a near insatiable need for all types of devices and platforms, is fueling aggressive investments in subsequent generations, and added capacity of 3D-NAND by nearly every one of our largest customers. Generational technology node investments not only mean new fabs, new build-outs, and more CapEx, but increasing intensity for OCD and films process control solutions, when we have established significant market leadership. With the architectural and process challenges at a company high aspect ratio 3-D devices, the role of in-line process control becomes increasingly important as our customers work to extract incremental performance and fab-like consistently across multiple process tools and process steps.

This is an area of particular strength for Nano. Our process control solutions both automated and integrated, have been deployed fab wide, with the ability to share and exchange data, in both feet forward and feet backward protocols. Currently we see 3D-NAND spending continue to be strong into the second half of the year, although somewhat less than the spending we saw in the first half. Importantly, following conversations with our customers about their product road maps and investment plans, and supported by industry device demand forecasts, we expect 2017 to be another year of growth for 3D-NAND spending. Other areas of market are quite important to Nano. While many if not most companies see DRAM spending being down year-on-year in 2016, DRAM has continued to be a relatively strong market for Nano, and we expect 2016 DRAM revenues to be similar to 2015 levels. In contrast to NAND, we see DRAM sales be somewhat weighted to the second half of the year. Also in memory, we have key engagements in the development and production of new and novel memory devices, and we see the opportunity for incremental contribution to our overall memory business as these devices move into high volume manufacturing.

Turning to the foundry market, spending was relatively slow in the first half but it is clearly strengthening at this time. We currently expect foundry sales to be significantly weighted to the second half, driven by capacity investments at 10-nanometer node, and development spending on 7-nanometer and 5-nanometer devices. And lastly, while advanced logic investments are forecast to be minimal this year, we expect this market to be an additional driver for year-on-year growth in 2017. Summing it up, demand for our OCD metrology solutions has continued to increase at each technology node across all device types with investments accruing at a growth rate greater than most other areas of wafer fab equipment for BFE. In addition, advanced process control strategies use the metrology and data analytics as playing an ever-expanding role in driving fab ramps and driving the other improvements. These industry trends are in turn increasing demand for both our automated and integrated solutions, along with our diffract based modeling software, and data analytics products, and our unique ability to offer these platforms from a systems solution perspective. We continue to expect a stronger second half of 2016 compared to the first half, fueled by increased contributions from foundry and DRAM, and continued 3D-NAND spending, and we remain positive about the outlook for additional growth in 2017. Beyond targeting secular growth markets, competing for share gains, and delivering revenue growth, our operational focus on improving our profitability and increasing cash flow is also beginning to deliver results in a meaningful way. Relative to our published business model, in Q1 we reported gross margins and flow through above the target model. While our Q2 results and Q3 guidance are in line with the model, we do intend to continue to drive operational improvements throughout our business, to further improve operating margins in conjunction with incremental revenue growth. In closing, while share gains in operational execution is of key importance for the near term, our long-term strategy for growth, continued our performance and increased shareholder value is focused and execution on further expanding our fab footprint on key accounts, expanding our served markets with the development of new end used applications, and the development of new and disrupted technologies and platforms.

With that, our guidance for the September quarter is as follows. Revenues of between $55 million and $59 million and on a non-GAAP basis, gross margin of 51% to 52.5%, operating expenses of $20.6 million to $21.2 million, and earnings of $0.23 to $0.30 per share. I will now turn the call over to Jeff for a detailed review of our financial perform appears 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 and market and geographic region is available in the investor section of our website.

Second quarter revenues were $55.8 million, an increase of 17% from Q1, and 15% from Q2 of 2015. Product revenues were $47.5 million, an increase of 21% from Q1, and 15% from Q2 of 2015. Service revenues of $8.3 million were slightly up from Q1, and increased 11% from the second quarter of 2015. By end market, the NAND segment predominantly 3D-NAND, represented 67% of product sales, and increased 55% over Q1. DRAM and foundry saw small declines to comprise 12% and 10% of product sales respectively. Logic increased to 8% of product sales, and all other devices and substrates comprised the remaining 3% of product sales. By product type, total second quarter revenues were comprised of 48% automated systems, 33% integrated metrology systems, 4% materials characterization systems, and the remaining 15% was service. Our 10% customers in the second quarter included Micron at 36%, and Intel at 24% 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 51.8%. 70 basis points lower than Q1 reflecting a decrease in service gross margin, which was 37.9% compared to 45.8% in the first quarter. While product gross margin increased 30 basis points to 54.2%. Service margins were negatively impacted by a lower level of field service utilization, resulting in part from our improvements in installation cycle time, as well as higher than expected material costs in our contract service business.

As Tim mentioned, our gross margin in the first quarter was above our target model at those revenue volumes. Q2 is aligned with our model and our Q3 gross margin guidance is also aligned with the Company's target model inclusive of the impact of the first few Atlas III systems expected to revenue in the third quarter. Operating expenses of $21.1 million were within our guidance range of $20.6 to $21.2 million. For Q3, we are guiding to the same range for operating expenses which is marginally higher than our prior expectation to be in the $20 million to $20.5 million range in the back half of the year.

While our revenue outlook for the year remains generally unchanged since our last earnings call, our improved profitability is resulting in a higher level of variable compensation, which along with the higher stock price has also increased our stock compensation expenses. While the net change is modest, we now expect operating expenses for the full year to be similar to 2015's level. Below the operating line for the second quarter, other expenses were $449,000, equivalent to $0.02 per share, as a result of foreign exchange losses incurred during the quarter. Our tax expense for the quarter was $856,000, and was lower than expected due to the timing of a favorable adjustment of approximately $500,000, or $0.02 per share. Given the improvement in our profit outlook for the year, we'll be subject to a minimum level of US tax given us our quarterly tax rate for the remainder of 2016 will be in the range of 21% to 22% per quarter, depending on the level of profitability. Net income for the second quarter was $6.5 million, or $0.26 per share. Turning briefly to the balance sheet, our cash and investments increased $12.6 million from Q1, and ended quarter at $96 million, or about $3.89 per share. Days Sales Outstanding increased slightly to 87 days from 84 days in the prior quarter. Principally due to the increase in deferred revenue billings that will be recognized as revenue in future quarters. Our deferred revenue of $25.6 million is mainly attributed to the initial Atlas III shipments, and first and fab systems requiring customer acceptance for revenue recognition. Inventory decreased $3.3 million to $50.7 million at the end of the second quarter. We expect to see further decreases as we recognize revenue on the deferred Atlas III systems. Cash flow from operations increased to $12.7 million, reflecting the increase in profitability along with the reduction in working capital. As Tim mentioned, free cash flow grew to 19% of sales, and we expect free cash flow performance to be stronger in the second half compared than the first half. With that, I will turn the call over to questions. Operator.

Thank you. (Operator Instructions). Our first question is from Patrick Ho of Stifel Nicolaus. Your line is open, sir.

Thank you very much. Tim, first in terms of the industry, you've seen better than expected DRAM revenues than most of your peers. Do you believe that's due to increasing capital intensity transfer to OCD, metrology and DRAM, or do you believe share gains have contributed to your better than expected DRAM numbers?

Hi Patrick. Thanks for calling. I think the primary contributor is both the timing of investments for process control metrology on new fabs, fab ramps, as well as the increasing intensity of OCD to address the scaling and the process control challenges on the 1X type devices.

Great. That is helpful. Maybe a second follow-up question in terms of your business specifically. You have talked about some of the increasing opportunities in thin-film metrology. Can you detail some of the application drivers, and also your thoughts on share gain opportunities in that market segment?

Yes, so there are a number of areas, what is key for us on films, is the films market is one that we can address with our current core competencies, our optical systems, and software requires a little bit of applications development. There are a number of areas in the films deposition, film thickness that we're looking at, and that we've actually won some on. We believe that with a focus on these markets, we have a meaningful opportunity to expand our position in that market, which will be a relatively new contribution to our total revenues.

Great. Final question for me, maybe for Jeff in terms of the gross margins, two-part question. You talked about some of the pressures on the services gross margins in the June quarter. One, do they kind of continue into the September quarter in terms of their effects, and then secondly, how long do you believe this roll-out of the Atlas III will have a drag on gross margins?

So let me start with service. So service, I think there were some anomalies in service. We would expect them to recover a bit. Also on the Atlas III, we would expect probably through the end of the year, seeing some of the initial tools roll out between the next few quarters. I would like just maybe to point out one thing. Even though the margin was down quarter-over-quarter, we were essentially on our model for the quarter, and when you compare first half of 2015 to first half of 2016, you'll see on a 4% increase in revenue, we doubled our operating profits. So we are on the model. Q1 was a little bit better so it makes the quarter to quarter flow through look a little bit low. When you compare the quarter to quarter flow through for Q2 and Q3 versus the prior year or even Q4, you'll see we're at the model or above the model in each one of those periods.

So Patrick, I would also add that even though our total margins were down, you look at the product margins were up quarter-on-quarter. So even though there's always a new product launch drag, it's pretty minimal right now, and once we get through those first builds and first installations, we think that there's going to be nice contribution, accretive contribution to our gross margins with the Atlas III.

Great. Thank you very much.

Thank you. Our next question is from Tom Diffely of DA Davidson. Your line is open, sir.

Good afternoon. So I guess just to confirm so it sounds like the product margins might come down a little bit next quarter, too because of Atlas but the surface margins will come up. All in all, they were relatively flat overall?

Well, I mean we don't want to be too specific on guidance at the product level. But being back on it, our model incorporates some mix change and other stuff, but we're essentially on the model. But with the recovery of service, you could imply that the product margins might be down just a touch.

Okay. And the Atlas III, does it have capabilities that the II didn't have to do the 1X DRAM, and the third generation 3-D, or is it an evolutionary change that makes it even more efficient for the customers?

It's boat of those, Tom. The product has had additional capabilities both in its precision, its resolution signal to noise. It also has productivity improvements. A lot of new components within the system to address both, some of the leading edge on DRAM, as well as the 3D-NAND with the optical source. So it's an evolutionary tool in that it's still fundamentally the Atlas platform. But the optical assembly and the capabilities of the tool are materially improved.

Okay. Now that you penetrated several new customers and you're going to show off your thin-film capabilities, what kind of timing do you think there is for just the roll out?Do you go into a trial for multiple quarters, and then this is a 2017 opportunity?How do you think it rolls out?

So that's a good question. I'll speak a little bit to our film strategy without going into a lot of detail for competitive reasons. The first and foremost is to understand that the film's market is closely adjacent to the OCD market. It is a little more fragmented, and it is addressed by a number of different types of technologies and tools, but within the area where you can use optical metrology, we have the core competency with the ellipsometry and scatterometry, and it is really about applications development, and just some of the performance specifics that are directed for films applications.

Our strategy in general is that now that we've penetrated all of the major accounts that do both OCD and films, and we've established ourselves with a highly differentiated OCD product, we have a very, the threshold and the barriers to entry are lower for us, to go after the thin films market with our core competencies and the platform strategy we have now. We expect this to be kind of a, what I call a land and expand strategy. We'll go after specific layers. We'll go after specific nodal areas, and we have the benefit of tools that are already on-site, so the evaluation and testing of our platform for those new applications is pretty straightforward. So we think this is going to be, it won't be a step function but I think it is going to see, continue a gradual increase in our share. And as we mentioned earlier, that we had record films revenues in this last quarter.

Yes, great. Last question, when you look at the 3D-NAND business in the second half, does that require a new round of spending, or is that just the timing of orders that were placed earlier in the year?

It is both. There is some incremental spending that's been forecast. We've got in the pipeline. There is also some delivery against forecast orders that have been given to us.

Great. Thanks for your time.

Thank you. Our next question is from Weston Twigg of Pacific Crest. Your line is open, sir.

Yes, hi. Thanks for taking my question. First, I just wanted to come back to the low service gross margin. So I think the two reasons I heard you say were the lower level of field service utilization and then higher than expected materials costs. But both of those sound like surprises to me. So I am wondering if you could be more specific about what you're doing to fix those, in terms of increasing your field service utilization, and how you can, get better visibility into your materials costs?

So I will take the material costs question first and when you have service contracts, it's like a warranty on your car. You're never quite sure when things break. The costs were a little bit higher. Sometimes they're a little bit better. They do have an unpredictable nature to them. So they'll come out, I hate to say it, but they'll average out over time. This quarter we had higher than expected.

On the service utilization as we continue to drive, improve cycle time particularly and product reliability, we'll reduce the need for as many hours to be applied to our installation and warranty, and then what we need to see is an offset in growth and service-related labor revenue where the guys will work it, otherwise we get these types of disconnects, which we can get in the short term. We also have pretty significant revenues the last three quarters, and a lot of installations going on.

Some of that is just timing as well. In the quarter from when we entered the quarter to when the tools actually started to install.

Wes, I would add to that, there is an element of this where we're a victim of our own success. We put a lot of energy into the installation and warranty efficiency and our cycle times, and the success of reduced cycle time means that we have service time that would normally be allocated to that, which is basically unallocated and gets moved, affects margin, but doesn't reflect the efficiency improvements. So as we redeploy those resources to address either growth and/or other areas of the business, then you'll see an improvement in the margins.

Okay. That makes sense. The other question I had was just, I was pretty surprised at how concentrated your customer base was last quarter. So I was just wondering if you can help us to understand if you expect that to broaden out through the balance of the year, and maybe you can give us an idea of the upside and downside risks, not by customer, but maybe by categories, like NAND, DRAM, foundry, in terms of being overly concentrated?

Right. So the concentration is a direct reflection of the strength of the 3D-NAND business. Our two largest customers, our greater than 10% customers, had to do with 3D-NAND. As you start to look forward in the fourth quarters, we expect 3D-NAND spending to continue, but we also expect DRAM spending to come back, and we also expect the improvement in foundry, which will give us a little broader customer contribution to our overall revenue matrix.

So I guess the question should be maybe more specific. Since you had such high business at Intel and Micron this quarter, presumably they took a lot of tools, they might do some digestion. Your revenue guidance is I understand that you expect some DRAM spending to come back in. Are there enough other customers in 3D-NAND to make up the difference?I know that you said that it might be down a little bit in the second half. I want to get a sense of your level of confidence in the DRAM and NAND mix, in the categories of the revenue through the second half?

Let me see if I can get closer to what you're trying to get to. We have five 3D-NAND customers. Two of them were very strong this last quarter. But we have three others that will be taking products. We expect some spending in the second half of the year in 3D-NAND. We have a couple of DRAM customers and we expect some spending in that area to strengthen which gives us, brings another customer to the matrix. We also have one major foundry customer as well as a couple of smaller ones, but we expect foundry to increase. We have confidence in foundry and DRAM, and we have decent visibility. We see additional contribution in 3D-NAND from some of the other ones that weren't as strong this last quarter.

That is very helpful. Thank you.

Thank you. Our next question is from David Wu of Indaba Global Research. Your line is open.

Good afternoon. Just wondered at this point do you have any visibility into Q4 to assure us that the uptraded revenue continues from the level of Q3, based on DRAM spending and possibly some catch-up in foundry, in 10-nanometers and 20-nanometer nodes?

David, that's a good question. We have some visibility into Q4, but our industry is one of those ones where the visibility isn't as crisp as you would like it to be. There is also the timing of some of the tools we're shipping out with the new products, the Atlas III that have to go through, we're sending those to multiple customers. There is a revenue recognition element with the new installations that get tied in. Some of it could be Q3, and some could it will be in Q4. We have a very high confidence that second half will be stronger than the first half. We obviously have confidence in our guidance on Q3. We also believe that our year-on-year performance is going to be at least cresting the double digit performance. We have a pretty good confidence in the overall business. A little bit of the timing uncertainty between Q3 and Q4, and Q4 is starting to come into more clarity, but there's still more to be accessed out.

If I were to look at your guidance in Q3 by location, Q4, the only reason why you're not showing double digit guidance for Q3 really is that the DRAMs and the foundries are ramping up, your 3D-NAND business has peaked in Q2. And shipments in the second half in both third quarter and fourth quarter can be below the level of the second quarter. Is that generally accurate?

No. I think there's a different mix. I think part of it is the timing of the investments and the new ramps. 3D-NAND again, I know I am repeating myself. 3D-NAND has been very robust for us going on three quarters now. I think that there is not a full appreciation of the fact that 3D-NAND should be fairly strong during the second half. There was some concern in the industry that 3D-NAND was going to roll off pretty far, drop down. We're looking at 3D-NAND being more like a 60/40 split. First half and second half. And if I look at kind of the DRAM, it is the other way around on the order of a 40/60 split. First half to second half. Foundry, we think could be as high as 30/70 first half to second half. We see strength in foundry. Improving DRAM and continued spending of 3D-NAND because there's so many big players in it.

Okay. Last question is the Intel 3D-NAND start-up, those orders have already shown up in your books, right?As opposed to still to come?

Yes although, I am assuming you mean revenues because we don't report on orders, David. Yes, we are shipping tools and selling tools and benefiting from the Dalian fab. We're look forward to that first phase to be closed out. And we're confident, hopeful that as that customer starts to see yield, their second phase which is planned, starts to benefit us in the not-too-distant future.

Thank you.

All right.

Thank you. (Operator Instructions). Our next question is from Mr. Mark Miller of The Benchmark Company. Your line is open.

I was wondering if you could break out the sales to TSMC and Hynix last quarter? What percent?

If they don't make 10%, we don't break them out, Mark.

Okay.

So the only we had were for Micron and Intel that crested 10%.

Deferred revenues doubled in the quarter from what they were when the 2015 ended. I assume that's the Atlas tools that need to be recognized, most of that increase?

Most of that increase are the Atlas III tools that are pending acceptance.

Okay. Then finally, because we jumped around so much last year, tax rate guidance. It was up last quarter. What do you expect for the second half of the year?

21% to 22%. And for the full year, based on the guidance I provided last time, it is about the exact same level. It is just a timing shift between the quarters.

Okay. Thank you.

Okay.

Thank you. At this time, I see no other questions in queue. I would like to turn the call over to Mr. Timothy Stultz for any closing remarks.

Thank you. Thank you once again for participating in our call. A special thanks and continued appreciation to all of our employees and our business partners, whose passion and commitment, hard work and support of our mission, and business objectives are helping to build 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 in today's conference. This concludes the program. You may all disconnect.