Onto Innovation Inc (ONTO) 2017 Q2 法說會逐字稿

Good afternoon, and welcome to the Nanometrics Second Quarter Financial Results Conference Call. A Q&A session will be held at the end of the call. (Operator Instructions) Please note that this call is being recorded today, August 1, 2017.

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 2017 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 will open up the call for Q&A.

The press release detailing our financial results was distributed over the wire services shortly after 1 p.m. 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. 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 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 2016. 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. Today, in my prepared remarks, I will briefly review our second quarter results, share our views on the current business environment and give our perspective looking forward. Jeff will then review the financial details of our recent results before opening the call up for Q&A.

Our second quarter came in largely as expected with revenues achieving a new quarterly record, up 9% quarter-on-quarter and up 16% year-over-year. Sales were at the lower end of guidance, resulting from the timing of acceptance of an Atlas shipment. Gross margin improved as expected and increased over 400 basis points from Q1. Importantly, gross margins are trending up due to improved manufacturing efficiencies and supply chain improvements and are expected to be back in our model ranges in the second half of the year. We expect roughly another 100 basis point improvement in Q3.

Continued strength in the memory segment, combined with our strong market position in 3D NAND, led to record revenues for memory. With strength also coming from our Foundry business, we achieved a new quarterly record in total sales of our optical critical dimension, or OCD, metrology products. For the first half of 2017, revenues were up 20% from the first half of 2016. Our expectations for the full year remain unchanged from our outlook in May, with second half revenues expected to be up 10% over the first half and full year sales outperforming the industry and last year's strong growth as well.

Similar to what others are seeing in the industry spending patterns, we expect the December quarter will be the peak quarter of the year, exceeding our Q2 record revenues by 15% or more. Importantly, with stated investment plans of our key customers, in combination with new investments in the domestic China semiconductor industry, we expect that quarterly strength in our sales volume at the end of 2017 to carry into 2018.

Strategically, we are continuing to make progress on our objectives of growth and continued revenue outperformance through customer footprint expansion, share gains and foundry expansion. Since our last earnings call, we have announced several key competitive wins and new product releases. In the category of share gains and footprint expansion at existing customers, we won multiple new tool-of-record selections for thin film process control deposition steps in the memory market, adding to our growing films business. In China, we won business from a domestic fab, booking, shipping and recognizing revenue on multiple IMPULSE Integrated Metrology tools during the quarter. Our integrated products are being deployed on CMP tools in a pilot line for this emerging 3D NAND customer who has a multiyear investment plan to build out up to 300,000 wafer starts per month capacity, clearly a significant long-term opportunity for Nano.

On the software side. During the quarter, we introduced the SpectraProbe, a model-less OCD metrology software product. The SpectraProbe was developed and validated through close cooperation with multiple key customers and is currently in use for some very unique applications. It is the newest member of our software and data analytics product offering. We also released the latest version of our industry-leading NanoDiffract OCD modeling and analytics platform with upgrade potential across our full fleet of OCD tools. NanoDiffract brings to our customers an improved user interface, improved modeling capabilities and shorter time to data. Software and analytics is a growing part of our business with revenues expected to be up meaningfully in 2017 and becoming a significant contributor to our overall business story in years to come.

Turning to the Atlas III. The strong market response and rapid adoption of this new tool significantly exceeded our earlier expectations. As a result of the major performance improvements, including sensitivity, precision, productivity and applicability to some of the most demanding process control challenges, the majority of our key customers have opted to aggressively move applications for the most advanced devices onto our newest platform. Atlas III sales comprised over half of our second quarter automated tool sales, and we now expect it will contribute to more than half our full year of automated tool sales. This is even stronger than the 40% contribution we suggested at our last quarterly update.

In the second quarter, we shipped Atlas III to 4 of the 6 leading spenders for semiconductor fab equipment and recognized revenues from 3 of them. Importantly, sales and applications for this product span across all device types, 3D NAND, DRAM and logic devices. We can safely say this is the most successful new product launch in company history, both in adoption rate and revenue ramp contributions.

As we have discussed previously, in addition to our investments in our OCD, hardware and software solutions, we are investing in the development of an entirely new process control product, which is intended to significantly expand our served available market. Progress on this new system is going well, and we expect to meet our target of our first shipment to our launch partner by the end of the year. As part of this program, we made an initial investment into a certain third-party entity to acquire technologies which will complement and accelerate the time to market of this tool. We're very excited about in the potential of this new process control platform and expect it to be a key growth driver in 2018 and beyond.

Turning to our business outlook by end markets. Globally, investments in 3D NAND continued to be strong, and we now expect 3D NAND spending where we have a particularly strong market share to increase from the 2016 record levels and to once again be the largest contributor to our 2017 sales, while our long-term outlook on total spending by Chinese national fabs for 3D NAND devices has actually increased. With first revenues already recognized in Q2, we believe meaningful contributions and opportunities in this market will be a significant part of our 2018 growth story. DRAM is again quite strong for us this year and is expected to be relatively evenly weighted between the front and back half of the year.

Within the Foundry segment, we continue to expect significant year-on-year growth with Foundry becoming the second-largest contributor to our revenues behind 3D NAND in 2017. Total Foundry revenues are expected to be relatively evenly spread between the first half and the second half with Taiwan-based foundry revenues weighted to the first half and South Korea and China-based foundry revenues weighted toward the second half. We believe our experience and market position in OCD for FinFET device structures offers a competitive advantage with domestic Chinese foundry fabs developing this capability and that this opportunity will be a contributor to our 2018 growth story.

In the logic segment. We are encouraged by improvements in the spending outlook for the second half of the year and expect that we'll see meaningful growth in logic sales driven by our tool-of-record position, albeit off a small base in 2016 and first half of 2017. Finally, in the second half of 2017, we expect increasing contributions from our materials characterization business driven, in part, by growth in the CMOS sensor markets, along with continued strength and contribution from our service business. In summary and in light of the forecast for second half industry investments in markets where we have high participation, we continue to expect a 10% increase in 2017 second half revenues versus our first half business levels.

To sum up our thoughts on the year, whereas 3D NAND is clearly a major driver of our expected year-over-year revenue growth, continued strength and investment in Foundry and DRAM are helping to propel us to record revenue levels for the year 2017. In addition, investment in domestic Chinese 3D NAND fabs has begun. Our films business is increasing, and logic spending is beginning to improve. Simply put, every segment of our business is growing this year, between memory and logic, materials characterization and service and software and analytics.

For the full year 2017, we expect to deliver record revenues, our fourth sequential year of double-digit revenue growth, year-on-year growth above the growth rate of 2016 and our fourth sequential year of outperformance versus overall industry spending. Our 2017 business trends, combined with additive contributions from current and planned new product offerings and a prospect of growth and spending on wafer fab equipment in 2018 not only gives us confidence in closing out on a record year in 2017, but also for strength, further growth and new records in 2018 driven largely by the following 6 factors: first, continued strong spending trends for the 3D NAND, DRAM and Foundry; next, the emergence of significant spending from domestic, China fab projects; next, secular growth in OCD for advanced 3-dimensional device structures; fourth, share gains in thin film and integrated metrology; fifth, initial revenues from our new product platform; and lastly, increasing contribution from our software and analytics products.

Turning to our next quarter. Similar to the other leaders in the industry who are weighted toward memory, we expect third quarter shipments to moderate slightly, followed by significant growth in the fourth quarter, where we expect to achieve a new company revenue record. And with that, our Q3 guidance is as follows: revenues of $60 million to $64 million, gross margin of 53% to 54%, operating expenses of $23 million to $23.5 million and earnings per share of $0.22 to $0.31.

I'll now turn the call over to Jeff to discuss our financial results and guidance in more detail. 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 Investors section of our website. The P&L metrics discussed are non-GAAP measures unless I identify the measure as GAAP-based. These measures exclude the impact of amortization of acquired intangible assets, restructuring charges, executive search costs and discrete tax items.

Second quarter revenues were $64.4 million, up 9% from the first quarter and up 16% from Q2 of 2016. Product revenues were $53.6 million, an increase of 11% from the first quarter and up 13% year-over-year. Service revenues of $10.9 million were relatively flat to the prior quarter and up 30% from the year-ago period. By end market, product sales to the NAND segment continued to be the largest contributor at 52% for product revenues, increasing 45% from Q1. DRAM sales experienced the largest growth as compared to the first quarter, increasing 73% to comprise 21% of product revenues. Foundry sales remained strong and comprised 21% of product revenue. IDM logic sales were 1%, and all other devices and substrates comprised 5% of product revenues.

By product type, total second quarter revenues were comprised of 60% automated systems, 16% integrated metrology systems, 7% materials characterization systems and service of 17%. Our 10% customers in the second quarter included Samsung at 30%, SK Hynix at 23% and Toshiba at 10% of total revenues for the quarter. Our Q2 gross margin of 52.4% improved over 400 basis points from Q1. Product gross margins were 52.7%, an improvement of 540 basis points from the first quarter. Service margin declined from the first quarter to 50.6%, principally due to lower spare parts sales. Our guidance for Q3 gross margin of 53% to 54% is in line with our financial model at this revenue range, and we expect gross margin to be up again sequentially in Q4.

Operating expenses of $22.6 million was below our guidance range, primarily due to the timing of certain R&D program expenditures. For the remainder of 2017, we expect to remain at a similar quarterly expense level as our Q3 guidance of $23 million to $23.5 million with the increase being primarily R&D spending. Below the operating line, other income was $258,000, consisting primarily of investment and interest income, offset partially by foreign exchange losses.

Our non-GAAP tax expense for the quarter was $3.6 million, a 31% of pretax income. Our tax expense on a GAAP basis also included a benefit associated with the adoption of a new tax accounting standard that now requires the differences associated with the settlement of employee equity earnings that differ from the grant value to go through the GAAP tax rate. On an ongoing basis, in 2017, we expect our non-GAAP tax rate to be approximately 30% and our cash tax rate to be about 18% due to our ability to utilize our deferred tax assets during the year. Net income for the second quarter was $7.8 million or $0.30 per share, slightly below the midpoint of our guidance range as a result of the revenue coming in at the low end of our guidance range.

Turning to the balance sheet. Cash and investments grew to $135.7 million or $5.33 per share. Days sales outstanding declined to 66 days from 73 days in the prior quarter. Inventory increased $5.7 million to $50.5 million at the end of the second quarter with the increase a result of the higher level of second half shipments. Cash flow from operations was $7.2 million, and free cash flow for the quarter was $5.7 million.

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

(Operator Instructions) Our first question comes from the line of Weston Twigg from KeyBanc Capital Markets.

Sure. Just first question, just wondering, you hit the lower end of the guidance in Q2, said you had an analyst tool that pushed out. I assume that would land in Q3. So I'm just wondering if you can give me a little more color on why you think Q3 revenues biased down from June. What are the moving parts?

Sure, Wes. This is Tim. Thanks for calling in. The shift is really just a timing of customer spend and where those markets are driving. And if you look at where we have the highest exposure, particularly the memory side, where the investments and tool deliveries were required is going to be more about weighted towards and biased into the Q4 time frame. It's really just timing issue and when they take the metrology tools.

Okay. And that probably helps with the next question. But how do you have conviction that December would be up so much because by my math you're looking at a very substantial uptick in the December quarter?

It's a combination of the tools that are being shipped that are subject to revenue recognition and acceptance, the investment plans of our customers, the orders and backlog. We have pretty good visibility, and we see the -- we have pretty high level of confidence in that Q4 number.

Our next question comes from the line of Tom Diffely from D.A. Davidson.

So I wanted to dig in a little bit to the new Chinese 3D NAND customer that you have. I think you mentioned along the way that this is potentially a 300,000 wafer start a month customer. And just curious, is this still the same buy rate that would be somewhere in the $5 million to $7 million per 10,000 wafer starts of your OCD tool?

It's in that area, in terms of opportunity. I wouldn't say it's by OCD tool, although we hope to get -- capture it all, but it's that same range, yes, it would be. They're looking at equivalent to second-gen 3D NAND devices. Those fabs will be built out sequentially. They've got -- they're expected to come in to 3 stages, 3 100K fabs each. And we feel pretty good about our competitive position and the product offerings and hope to capture a lot of that business.

Okay. So the OCD portion would be roughly $16 million per 100k fab then?

Yes, if you (inaudible).

Okay. And then I guess when you look at the 3D NAND business that you're seeing today, when you move from the first, second and third generation, are you seeing the addition of OCD orders? Or how does that play out as far as the transition goes with the impact on OCD?

So any new capacity kind of tracks with the model we've shared with you and can be found on our IR presentation in terms of OCD opportunities per 10,000 wafer starts that captures both the automated and the integrated. There are some additional conversions going on, whether taken plain or into 3D NAND, and that will probably track more like 20% to 25% of that total opportunity described in the greenfield fab. But yes, it's -- I think we're finding that, that model and opportunity is tracking well. The kind of little variation occurs whether or not they're going to stack devices versus a continuous 96-pair example. There's a little difference in the OCD opportunity there.

Okay, great. And then when you look at the incremental costs for the new tool that you're developing, I guess it was a little unclear. You said that the -- obviously, the R&D level is going up over the next few quarters, or is at a higher rate now. You also mentioned there was a third-party investment. I didn't catch that portion of it.

Yes. So I'll let Jeff speak to where you'll spot it. But we did make an investment in some intellectual property and know-how in exchange for exclusivity that ties directly into this tool and the direction we're taking this tool and allows us to use some parallel development and accelerate the timing of the market of certain features of this tool which strengthens our conviction and belief on where this -- the market we'll be serving and our ability to generate revenues from it. And Jeff, you can tell him where you can spot that.

Yes. You'll see it on the cash flow. It'll be in the investment section where we have an investment and certain assets. When you look at the run rate year-over-year, Tom, as you model out R&D, you'll see that it's growing a bit year-over-year, and it's almost all related to the new products. So that's where we added our expenditures for the year.

Okay. Will there be a royalty payment for this technology as well as systems go out the door?

No.

No.

Our next question comes from the line of Patrick Ho from Stifel, Nicolaus.

Tim, maybe as a follow-up question regarding the Chinese entry or the penetration into the 3D NAND. How does that potentially impact your margin profile given that typically new tools or new entrants into new customers tend to have a little bit of a lower margin at the beginning? Your margins were very strong this quarter, and the outlook looks good. How do we account for those new penetration as we look forward?

It's a good question. I'm not going to give you all the details for competitive reasons, but I can tell you that we're not seeing any margin erosion. If nothing else, we're going to see improved margins in that environment because of the technology edge and what we're bringing to that market and the nature of the customers in that environment.

Okay, fair enough. Second question, in terms of the thin film applications you're talking about and the wins you've accumulated. Can you get a little more specific on what type of application wins you've achieved? And what are some of the ones that you're looking for, say, over the 6 to 9 -- over the next 6 to 9 months?

Most of it is an expansion of use in our Atlas platform for -- beyond the OCD applications to also play in the films market. The films -- it's a front-end area of the films. Film thickness is the primary area and very complementary to where we are on the etch side of the transistor formation.

Our next question comes from the line of David Duley from Steelhead.

Yes. I'm just curious. For Nanometrics, how much growth should you -- will you see in the DRAM market in '17 versus '16 based on your assumptions for the current calendar year?

So you're talking about the '17 versus '16 in terms of total DRAM? We see that kind of as a flat market for us right now based on the spending and where the investment patterns are with our key customers year-on-year.

So flat spend '17 versus '16 in the DRAM market?

Yes.

Would you expect that to be up in '18?

I don't know. I'd be honest with you. As you know, it's very much of a capacity demand balance and the spot pricing. We think that there are signs that DRAM spending could be up, because of some of the investment patterns. But right now, I don't have any more information on that.

Okay. And as far as the China investments go in memory, would you expect there to be another customer in 2018? Or could you take a guess at how many customers you'll think will be spending in the memory area in 2018 in China?

That's a good question. We're certainly aware of at least 3 investment plans. The large investment group, unit group in China has identified 3 different location sites and customers that they plan on bringing 3D NAND capabilities to. The timing of the other 2 beyond the ones that we're working with are a little uncertain, but there's some suggestions that by middle or the latter part of the year that they could start to receive some funding.

Okay. And final question for me. You talked about this new tool, and I know you haven't really given people the details on that, I guess. But could you talk about how big the market opportunity is for you? Or do you have revenue targets or goals for that tool in 2018?

I can give you kind of relatively size of the market. And of course, we have revenue goals and objectives, but we won't be speaking to those. We see that market comparable to the OCD market we currently serve. And so if you look at where our key products serve, which is OCD and films, which have a roughly similar market sizes, that this new tool will potentially expand our directly served market by about 50% or more.

Our next question comes from the line of David Wu from Indaba Global Research.

I have 2 things -- question. Number one is that the -- your logic customer that has been dormant for quite a few years, is the recent pickup in activity due to their upgrading to Atlas III? Or is it something else? And I have a follow-up.

Sure. David, I don't know if that customer would like to be called dormant. But certainly, the revenues with us have been down. It's not a conversion to that platform. The business we're seeing on the logic side is a continuation of adoption of the current platform that's tool-of-record. That customer also has investments in memory, and they are working with newer platforms in their memory area.

Oh, I see. That thing I have about -- you mentioned about the current customer you have and the Chinese domestic fab. That customer, I guess, has got a license from Spansion. I was wondering, can you give us a rough idea about these 3 different phases of expansion? You mentioned we're obviously starting on Phase 1, but usually there's a pause and then followed by Phase 2 and then a pause and then Phase 3. Can you give us a rough order of magnitude of when the different phases get in and out?

I'll give you a -- what I'll share with you is more about my experience than any stated plans that they've laid out in detail for us. But they're -- right now, they're looking at building 3 separate fabs of about 100,000 wafer starts per fab. And our experience has been on a 100,000 wafer start fab, there's usually 2 or 3 phases to populate that fab. So we would expect the initial investments to go into the first fab -- phase of the first fab, and then that usually goes from 6 to 9 months. And then they start to populate that fab before they go to the next fab and break ground on the next shell.

(Operator Instructions) Our next question comes from the line of Mark Miller from The Benchmark.

You just discussed the 3 investment opportunities in China, but the forecast are for significantly more fabs to come up in China next year. I'm just wondering are these fabs coming up later next year? Why are we only talking about 3 opportunities here in China next year?

So Mark, what I was speaking to specifically are the 3D NAND fabs that we've -- that we're aware of. There's additional logic fabs being planned and -- or foundry fabs, and then there's additional potential investment in DRAM. So there's certainly -- you're absolutely right. There are more fabs planned, but I think the question was specifically about 3 NAND.

And you feel you have opportunities in a number of these?

Yes. I mean, we think that we're very competitive with our market position and experience . I think we're very competitive in all those areas, and we're going to do our best to capture more than our fair share of that business.

What about the Samsung fabs and the Pyeongtaek facility that just started the production. It's supposed to ramp to some estimates, 1 million wafers, and I'm just wondering how big an opportunity. Will that be your biggest opportunity? And then the final question is what about TSMC? I mean, traditionally, they tend to buy not so much in the September quarter. Do you think sales come back stronger later this year, first quarter next year from TSMC?

Okay. Well, so on the Samsung, certainly the big story is spending of Samsung. Samsung is materially upped their stated and committed spending on wafer fab equipment. Pyeongtaek, being the largest project. And beyond Pyeongtaek right now is being -- is dedicated primarily to 3D NAND. But Samsung is also spending money on logic in their S III fab where Samsung is a good customer for us across all device types, 3D NAND, logic and DRAM, but we see the primary opportunity and upside for all our businesses in what's call P project, or Pyeongtaek project, for 3D NAND. On TSMC, our current visibility is that TSMC was first half of the year weighted in their spending. And we see -- as we've mentioned-during the call that we see foundry spending in the second half of this year being driven largely by Korean foundry and Chinese foundry. And we'd be looking for some resumption of spending from -- in the Taiwan area in the beginning of 2018 unless something changes.

And at this time, I'm not showing any further questions on the phone line and would like to turn the call back over to Timothy Stultz for any closing remarks.

Thank you. Before ending this earnings call, I want offer a brief update on our succession plan and progress. We are well along the search process for our next CEO and have identified several very strong candidates for the position. Our Search Committee with the help of the full board, is working closely with our executive recruiter to reduce the list to 2 finalists. I personally am pleased with the level of talent and consideration for the position, and I'm confident the next CEO will be exceptionally well qualified to lead Nano through its next phase of growth and expansion. Meanwhile I, along with the support of my leadership team and all our employees, remain focused on responding to the challenges and opportunities in front of us, executing in a robust spending environment and profitably growing our business to create incremental stakeholder value.

And with that, I'll thank you for joining our call and close it.

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