Onto Innovation Inc (ONTO) 2017 Q3 法說會逐字稿

Good afternoon, and welcome to the Nanometrics Third Quarter Financial Results Conference Call. (Operator Instructions) Please note that this conference call is being recorded today, November 2, 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 Third 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 distribution over the wire just shortly after 1:00 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 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, shift 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 statements. 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 those 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 third 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 calls up for Q&A. Our third quarter results were consistent with our pre-release earlier this month with revenues of $56.7 million and earnings of $0.22 per share. A short fall in revenue compared to our initial guidance in August, was a result of a delay in revenue recognition of a few Atlas tools into Japan. These tools were follow on installations of our older Atlas platform into an existing that new area of a fab, which resulted in some unexpected delays in installation and acceptance. We fully expect to complete customer acceptance and recognize revenues for those systems in our fourth quarter results. Business wise, our focus continues to be on above average growth and improved profitability through customer footprint expansion, further share gains, new product driven SAM expansion and margin expansion through execution and business model leverage. Since our last earnings call, we have made progress on a number of these fronts. As we've mentioned before, the strong market response and rapid adoption of the Atlas III significantly exceeded our initial expectations. Notably, for the second quarter in a row, Atlas III comprised more than 50% of our automated tools sales. Significant performance improvement in sensitivity, precision and productivity have led the majority of our key customers to aggressively adopt this platform for their most demanding process control applications across all device types. This is by far the most successful new product launch in company history, both in adoption rate and revenue ramp contributions and continues to be a key factor in our progress on winning the additional key account tool-of-record positions. In July, we launched 2 new software tools for process control data analytics, and are making steady progress deploying them into multiple sites and applications. First, was NanoDiffract 4, the latest generation of our industry-leading OCD modeling software, delivering significant improvements in productivity, time to data and modeling capabilities. Retrofittable to our Atlas fleet, Diffract 4 has already been deployed at multiple sites. The second software tool was the newest member of our data analytics family, SpectraProbe. SpectraProbe is a proprietary OCD analytics tool, which provides rapid identification of process excursions and device feature shifts. Developing close cooperation with several key customers, SpectraProbe has been validated and deployed for multiple applications and contributed to our revenues for the first time in Q3. As a leading supplier of data rich process control hardware solutions, Nanometrics is in a unique position to contribute to the increasing demand for data analytics needed to ramp and drive fabs to profitability. In response to this opportunity, we have a pipeline of new software tools and development and expect data and analytics to be an important and growing part of our business in the future. On the hardware side, we have been investing in new process control technologies and platforms beyond OCD and films metrology. These new platforms are targeting the applications where current technologies and tools are hitting technical walls. Our first new platform is scheduled for introduction next year, following an initial delivery to a leading edge launch partner, that has been closely collaborating with us during the development phase. Successful development and introduction of new products and technologies are the lifeblood of companies in our industry. In addition to remaining competitive and relevant, new product solutions become additive to revenue profiles and ability to benefit for industry inflection points. We believe our long-term focused investments into new hardware and software solutions addressing these inflection points will expand our served markets and be instrumental in helping us to achieve revenue growth above the pace of industry investments.

Turning to our business outlook by end markets, globally investments in 3D NAND continue to be robust and growing. We expect our revenues from 3D NAND, while we have particularly strong market share to increase double digits from the 2016 record levels after doubling last year, and to once again be the largest contributor to our 2017 sales. We have already established high-volume manufacturing tool-of-record positions with the top 5 producers of 3D NAND devices and announced last quarter that we've recognized first revenues from a domestic Chinese 3D NAND customer. Overall, our confidence in the long-term outlook and spending by domestic Chinese fabs. In particular, our memory devices has increased this year from our earlier expectations and these customers are expected to become an important part of our growth story starting next year. While 3D NAND is clearly a major driver of our expected second-half and year-over-year revenue growth, we also expect every other business segment outside of DRAM to grow double-digits this year.

Turning to our outlook for next year. Current business trends combined with additive contributions from our R&D pipeline, and the prospect of further growth in spending our wafer fab equipment gives us confidence for growth and new revenue records in 2018, supported by 6 key drivers. First, increased 3D NAND and DRAM memory investments where we have established strong market share positions. Second, the emergence of significant spending from domestic Chinese fab projects. Third, secular growth in OCD for advanced 3 dimensional device structures. Four, share gains in thin film integrated metrology and DRAM. Fifth, initial revenues from our new product platform. And sixth, increasing contribution from our software and analytics products.

Summing up, our 2018 outlook, we believe we are positioned for a fifth-year of double-digit revenue growth and another record revenue year. This combined with a leverage of our business model will lead to another year of expansion of both our gross and operating margins.

Turning to our forward-looking guidance. Q4 is expected to be an exceptionally strong quarter. Meaningfully exceeding our previous quarterly revenue records, even before adding the contribution of revenues delay from the third quarter. Our guidance for the fourth quarter is revenues of $72 million to $80 million. Gross margin of 53.5% to 54.5%. Operating expenses of $23.5 million to $24.3 million, and earnings per share of $0.40 to $0.50. 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 investor section of our website. The P&L metrics discussed are non-GAAP measures unless I identify the measure as GAAP base. These measures exclude the impact of amortization of acquired intangible assets, restructuring charges, executive search costs and discrete tax items. Third quarter revenues were $56.7 million, down 3.5% from the third quarter of 2016 and 12% from the prior quarter. Product revenues of $45.6 million, a decrease of 15% from the second quarter and 8% year-over-year. Service revenues of $11.1 million were up 2% from the second quarter and up 22% from the year ago period. By end market, product sales to the NAND segment continued to be the largest contributor at 36% of product revenues. Foundry sales comprised 20% of product revenues, DRAM sales were 14% and IDM logic sales increased to 13% of product sales. All other devices and substrates grew significantly to comprise 16% of product revenues. By product type, total third quarter revenues were comprised of 55% automated systems, 14% integrated metrology systems, 12% materials characterization systems and service of 20%. Our 10% customers in the third quarter included Samsung at 32%, Micron at 19% and Intel at 14% of total revenues for the quarter. Our Q3 gross margin of 54.4% increased 200 basis points from the second quarter and exceeded the high end of our gross margin range due to better-than-expected service margins of the 59%, well above our target model for the service business. Largely attributed to a higher level of utilization of our field service engineers to support the higher level of installations. Product gross margin increased 60 basis points from the second quarter to 53.3%. Our fourth quarter gross margin guidance, of 53.5% to 54.5%, results in our gross margin of the second half being in line with our financial models at the second half revenue level. Also in Q4, we expect to see our service margin normalized and product margins improving on the increased sales volume. Operating expenses of $23 million were up 2% from the second quarter and came in at the low end of our initial guidance range, primarily due to the timing of certain R&D programming expenditures. Below the operating line, other income was $36,000, consisting primarily of investment and interest income, largely offset by unfavorable foreign exchange losses. Our tax expense for the quarter was $2.2 million, or 28% of pretaxed income. Our tax expense on a GAAP basis, which includes the benefits associated with the difference between the actual settlement of employee equity earnings versus the initial grant value. On an ongoing basis, in 2017, we expect our non-GAAP tax rate to remain at approximately 30% and our cash, cash tax rate to be about 19% due to our ability to utilize our deferred tax assets during the year. Net income for the third quarter was $5.7 million or $0.22 per share.

Turning to the balance sheet. Cash and investments grew to $140.4 million or $5.49 per share. Day sales outstanding remain flat to the second quarter at 66 days. Inventory increased $7.8 million to $58.3 million at the end of the third quarter to support the record level of shipments in the fourth quarter, as well as reflecting several systems already shipped and awaiting customer acceptance. Cash flow from operations was $5.1 million and free cash flow for the quarter was $4.3 million. And with that, I'll turn the call over to questions. Operator?

(Operator Instructions) Our first question or comment comes from the line of Patrick Ho from Stiefel Nicolaus.

Maybe as a big picture question in terms of gross margin, Tim, you talked about some of the new products and some of the ones you did talk about generally have higher margins like software and some of the data analytics. But as you introduce new products, what is the potential impact of say new tool introductions or new features or things of that nature that potentially could impact margins for a quarter or so as they begin to ramp up?

Thanks for calling in, Patrick. It's a good question. There is always a kind of pressure on new tools when you bring them in because of the installation and the learning process. But if I look at the new tools where we're working on, they are very strong -- they will be strongly priced on our value basis. And I think they are going to be accretive to our gross margins, pretty close to coming right out of the shoot.

The follow-up question I have is, the mix of your customers has been pretty steady where you again mentioned that 3D NAND is going to be your largest contributor in 2017 to revenues. I know it's hard to look out forward into 2018. Do you believe that continues into 2018 as well where 3D NAND is the largest contributor? Or are there other segments that you think can either increase or become a bigger contributor for 2018 as a whole?

Yes. Right now, we think 3D NAND is going to be the strong player, again, for us next year. Both would be for the domestic as well as the Chinese National fabs, there are some very large investments that we are participating in. So I fully expect that that's going to be the largest contributor to our revenues looking forward.

And maybe a final question just for Jeff in terms of cash flow. Obviously, revenues were pushed out this quarter in terms of the timing. Did that also push out some of the cash flow and the cash delivery on some of those systems as well? And we could we expect an increase in the cash flow from operations in Q4? Or is that a Q1 story?

Hey, Patrick. So it pushed a little bit, but I wouldn't say it was a giant contributor. In Q4, I would say we're going through a pretty health ramp, so we're investing in working capital. And so I think you'll start to see this cash flow improve going into the first quarter.

Our next question and comment comes from the line of Tom Diffely from DA Davidson.

So I guess following up on the memory questions, you talked about that -- it's still going to be one of your drivers in the out year. Does that -- are you expecting both DRAM and NAND individually to be up year-over-year as a driver?

Yes. So we do think that NAND is going to be a big driver but we do see growth in the DRAM investment profile and we think it will be an increasing contributor next year.

Okay. And some are now starting to speculate that we're going to have some greenfield DRAM facilities opening up here pretty soon. Is that your view as well? And do you think DRAM becomes a pretty large percentage of the business over the next couple of years?

So there are some Greenfield DRAM facilities and there are some specifically some in China. There's -- we're also seeing some new developments in Korea that will be dedicated to DRAM that have recently been -- we've been made aware of. So yes, we see increased capacity and investments in DRAM. Most of it that we understand is less on total wafer starts as much -- it's really to offset the reduction in the number of die as they go into the next generation devices.

Okay. So the total industry wafer starts essentially staying the same, but maybe getting split out into some new facilities to cover the lower (inaudible) ?

Well, no. There will be some facilities. I'm sorry. I misspoke on the starts. But there'll be more capacity put in place but the total bits, if you look at what they're trying to drive and the number of die, they're trying to deal with the reduction in number of die on -- with a new scaling structures and to put the capacity to offset that as opposed to bit demand which will be in the low single digits.

Okay. As they moved down to the different 1Y nodes, do they get more capital intensive for OCD?

They do, yes. They definitely do, especially with some of the high aspect ratio components and the tighter process tolerances.

Okay. So even an existing fab upgraded their facility and didn't increase our wafer starts, you would still see some incremental business?

Yes. We absolutely do. We do see a growth in our business in DRAM and it's both driven by the technology nodes as well as the additional capacity and some of the new players coming on in China.

Okay. Also in reference to new product has been a driver next year so you expect revenues in the second half of next year even if it's released in kind of midyear?

Yes. We think we have a solid shot at that. I mean, the plan is that and we're looking at least getting a launch partner, transition from the mutual evaluation feedback and adoption. And we're looking at second half revenue contribution.

And then you'd a few times referenced double-digit growth. I just want to confirm that you referenced that for both '17 and '18?

Yes. Absolutely.

And then on the super side, margin -- service margin was pretty strong. What drove that?

Hey, Tom, it's Jeff. It was mainly just a high level of utilization as we go through these ramps, we have our field service engineers working on all these installations, and that basically is attributed to the product revenue. So the service utilization was up and it drove the majority of that upside. And now we're starting to hire some new people to support the higher levels of revenue and installations that we see going forward. So that will normalize down as we bring some more people on.

And then tax rate, you talked about 30% has been your current rate. When you look forward especially with the cash tax rate at 19%, how long can you sustain a cash tax rate at that level before you would expect it to go back up towards the normal rate?

Yes. I think as we look at the next year, I think it will be certainly in the first half of the year, we'll be able to continue to utilize it, but you get some limitations and so they vary by type of tax assets. So I still think it will be well below the 30% range and as we look to next year, we're probably seeing a moderate increase in the tax rates with the growth we see now because it's U.S.-based profits.

And, finally, the other part of your business seems to be percolating here. What is the driver behind that, the non-semi side?

So there are a couple of areas. The adoption of our tools in CMOS sensors and also bare silicon wafer applications for our infrared systems.

Our next question or comment comes from the line of Weston Twigg from KeyBanc.

I have a couple of them. I want to ask the growth question actually in a different way. Just -- can you outline which customer segments are there DRAM, NAND, Foundry logic will drive the most growth for Nanometrics in 2018, the most upside?

Yes. We are still seeing a lot of strength primarily coming out of NAND as being one of our biggest opportunities because of a lot of new capacity we've put in place. We think Foundry is going to be coming up for us in the second half. There is, again, China is going to help in some of those areas. DRAM investments in China are new opportunities with Greenfield fabs. I would say the one we are looking to but don't have as clear handle on would be the advanced logic. Right now, we see some improvements in it, but I don't know if it's a strong driver going into '18.

Okay. So when you say NAND offers the most -- or -- what did you say before, the strongest segment. You also expect the most growth to come from NAND?

Out of 3D NAND, yes.

3D NAND, okay. The other question I had is this year just looking at the numbers. I have semi-CapEx now up over 30% and part of that is from the Samsung guidance. But it looks like Nano growth should be a little over 16% this year. So it seems like there is a little bit of disconnect between the CapEx level in the industry and where Nano is growing. I just wonder if you could help us understand that it is not on its revenue recognition or something else?

Yes, that's a good observation. We, over less the 3 or 4 years have clearly grown at a pace quicker than the investment profile. And this year we're actually behind the investment profile of the industry for the first time, like I said, in almost 4 years. There are a couple things to look at. One is what was our growth rates over the 2 or 3 years before this year. Because it was materially above and it was the process control investment, so the timing of these customers, and where our customers are putting the tool. So there are some timing issues. When you look at our growth over multiple years, you will find out we're still outpacing the industry. We've also, if you look at one of the biggest contributors for us, has been -- and for many of the folks in the industry has been Samsung and we've seen -- we've got some -- we've seen growth at Toshiba. We've seen growth at Samsung. But some of the other elements haven't been as strong for us and it's really a timing of those investments. So one of the things that I'd like to point out is that over the last 4 years, our NAND market share has grown 80% and -- with the advent of 3D NAND. So last year, we had -- we doubled in it. This year we've got double-digit growth on top of that. And at some point when you're tracking so far ahead of the industry, you rollover a little bit. We're seeing the resurgence of that and we fully expect to outpace investments in WFE next year. As a lot of these new sites come on board. The growth in the 3D NAND where we have strong market position, the opportunities in Foundry, I think all of those are going to contribute.

If I get sneak in one more, this one should be pretty easy, I think. OpEx, looks like it is running a little higher than you thought it would be a quarter ago, just a touch in Q4. Just wondering if you get help us understand the difference in any of the trends on OpEx heading into 2018.

West, it's Jeff. Yes it's a little higher in Q4 than we -- maybe we thought a quarter ago and some of that is just related to the timing of spend in engineering on a program. It can just shift a week or 2 and it shifts quarters. And I think our view of the second half is about the same. I think as we exit the fourth quarter and look into the next that's probably our run rate and we'll probably need a little incremental investment to support some of the platform roadmap that Tim talked about and then a little bit infrastructure to support China it is how we are looking at it right now.

Our next question or comment comes from the line of Mark Miller from The Benchmark company.

You mentioned you saw strong growth in Toshiba and Samsung. Did you lose share in any of their customers?

In total, no. There's always some shift of share in any market and it was a move around. But if you look at our revenue growth. I mean, take Samsung for instance, which is the big spender. In the first 9 months, year-over-year, our revenues were up over 5x, versus last year's first 9 months. And we've got a very strong members coming out of that; great growth in Toshiba, great growth in Samsung and so on. So there are always puts and takes, but we still believe we have over 70% of the 3D NAND market. We've got the strong position in all of the major customers, where there is a couple of other times where we are holding on our own on a couple of different strategies, so I'm trying to get into more of the foundry business where we've been successful in getting critical layers. And we're trying to get additional layers. But I think when you roll it over and you look at our revenue growth and you look at where it comes from, we've done a really good job not only of defending our markets, but actually taken some shares in a couple of key areas.

For your platforms plan for next year, what are the incremental improvements?

It's not an incremental improvement. It's a brand-new platform. It's a brand-new tool. So it's not an extension of the OCD or films markets. It's a product that we've, as we mentioned, we've developed in collaboration with 1 key customer, actually multiple customers have been involved in helping direct this. And its target at an application that is not served at this time but has become a critical process control parameter for our customers.

I am showing no additional questions in the queue at this time. I would like to turn the conference back over to Dr. Stultz for any closing remarks.

Thank you. Before ending this call, I want to offer a brief update on our CEO succession plan and progress. Our board is well along in the search process for our next CEO. We consider this process and decision be the most important one a Board of Directors makes. And to that extent, the Board is working hard to ensure that the next CEO will be exceptionally well qualified to lead Nano through next phase of growth and expansion. Meanwhile, with the support of my leadership team and our employees, who I thank for their hard work and dedication, we remain focused on responding to the day-to-day challenges and opportunities in front of us, executing in a very robust spending environment, and profitably growing our business to create incremental stakeholder value. And with that, I want to thank you all for joining our call and we'll end the call at this time.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.