Onto Innovation Inc (ONTO) 2018 Q2 法說會逐字稿

Good afternoon, and welcome to the Nanometrics second quarter financial results conference call. (Operator Instructions) Please note that this conference call is being recorded today, July 31, 2018.

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 2018 Financial Results Conference Call. Speaking on today's call are Dr. Pierre-Yves Lesaicherre, President and Chief Executive Officer; and Greg Swyt, VP of Finance and our Principal Financial Officer. Shortly, Pierre-Yves will provide a recap of the quarter and our perspective looking forward. Then Greg will discuss our financial results in more detail, after which we will open the call for Q&A. The press release detailing our financial results was distributed over the wire services 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 toward 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 products, industry adoption of new technology and manufacturing processes, customer demand, shift in timing of orders of 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 2017. 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 Pierre-Yves.

Thank you, Claire, and 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. Greg will then review the financial details of our recent results before opening up the call for Q&A.

Our second quarter results set new records for both revenue and earnings. Revenues of $88.6 million were at the upper end of our guidance range and increased 8% from our record first quarter and 38% from the same period last year. Our strong results were, again, driven by the robust spending environment for memory devices in the first half and our leading market share in those segments.

For the first half of 2018 in total, $171 million in revenue is an increase of 38% over the first half of last year and 27% higher than the second half of last year. Clearly, we have scaled to an unprecedented revenue level for Nanometrics and have been making increased investments in R&D and our global sales organization to support this increased level of business.

Gross margin performance, again, came in favorable to our long-term targets at 57.5% for the second quarter. The continued strong gross margin performance for the last few quarters is evidenced by our improved operations and certainly some favorable product mix as we scale to these revenue volumes. The strong gross margin in the second quarter drove our record earnings per share, which also benefited from a lower tax rate as Greg will detail shortly.

We continue to deliver strong free cash flow generation in the quarter adding $25 million in cash to the balance sheet to a record $149 million at quarter end.

Year-to-date, we have generated over $57 million in free cash flow equal to 33% of first half revenues. In total, the first half set new records in both product and service revenues as well as gross margins, earnings per share and cash flows. While our first half results demonstrate that the ramp in investment in both NAND and DRAM technology and capacity has grown to historic levels, our relative outperformance in terms of revenue growth this year is also indicative of our market share gains in both NAND and DRAM. While most industry expectations are for a flat-to-down spending year for NAND, our continued share gains and market leadership position are driving another strong year of growth in our revenues from the NAND segment in 2018.

During the second quarter, we won qualification of a fifth major 3D NAND manufacturer for our Atlas III flagship system and began shipping tools. We also reported a [near] 10% customer for Nanometrics with the largest domestic China 3D NAND manufacturer installing our full suite of process control metrology solution into their new fab. This 6th major 3D NAND manufacturer help drive significant quarter-over-quarter growth in our NAND revenues, which also benefited from some acceleration of 3D NAND project-spending by multiple key customers. This acceleration of multiple 3D NAND project in the second quarter was partially offset by a modest decline in our DRAM revenues off a record first quarter. The good news is, the deferral of then some DRAM project spending into the second half have resulted in DRAM revenues this year being more balanced than we previously forecasted.

So while there have certainly been shifts in spending between NAND and DRAM and among our largest customers, our forecast for revenues from the memory segment this year are consistent with our last earnings call. The fact that our memory forecast is consistent with our last call, in spite of reported push-off in spending, warrants some further discussion.

First of all, we've been consistent in our expectation that revenues from the total memory segment will be front-half weighted for this year. This has not changed. The change is that NAND became front-half weighted and DRAM is more balanced than we previously forecast.

Secondly, we reported 2 major market share wins earlier this year, 1 with a major DRAM manufacturer and 1 with a sixth major 3D NAND manufacturer. While we believe our 2018 memory revenues will increase year-over-year, even without these 2 wins, these market share gains are certainly helping drive our significant year-on-year revenue growth in both memory segment.

And lastly, it's important to remember that we have strong positions with all 6 of the largest 3D NAND manufacturers and if one of the largest customer decides to defer some wafer capacity additions into next year, we still have 5 other customers, who drive their own plans.

So even with the recent shift, pushes and pulls in customer spending plans for NAND and DRAM, we continue to forecast total memory revenues for Nanometrics will be up significantly this year.

We also continue to expect our foundry and IDM revenues to be second-half weighted off of the small base of revenues in the first half. This will result in an overall decline in foundry and IDM revenues compared to 2017 levels, given the major shift in Korea-based foundry spending towards memory this year and that the timing of our foundry and IDM investments in process control continues to push into 2019.

Our revenue outlook for the year continues to be balanced in the low-50s in the first half and high-40s in the second half. With our current visibility, we continue to forecast 2018 revenue growth of at least 20% year-over-year. This would clearly result in revenue growth outperformance versus the overall industry.

It's also worthwhile to note that as we look towards 2019, the pushup in some of this year's project spending across DRAM, NAND, foundry and Logic are all expected to resume in 2019, giving us increasing confident that the industry could see a sixth year of CapEx growth next year.

Along with expectations for positive year-over-year revenue growth, our gross margin profile is strengthening, which has enabled us to step up our investments in R&D and our global sales organization to support higher levels of business. This means that along with revenue outperformance, we are expending gross margin and expanding operating margin this year, along with significant free cash flow generation. I'll make a few more points before turning the call over to Greg.

One is to highlight the expanding adoption of our Atlas III system. I mentioned earlier that our newest flagship system was qualified by a 5th major 3D NAND manufacturer during the quarter, and we began shipping tools. This means that our Atlas III has now been adopted by each of the 5 3D NAND manufacturers and both of the 2 largest DRAM manufacturers.

As testament to the rapid and successful introduction of the Atlas III, we shipped our 100th system earlier this month. I also wanted to reiterate the multiple revenue drivers for our growth this year, which is expected to be a record year for both our automated and integrated metrology platforms, a year of increased contribution from software and analytics, a growth year for our optical critical dimension solutions, as well as a growth year for our sensor and material characterization product and a year with new records set for our service business.

Finally, I will summarize the call with some of the early indications of drivers for continued growth in 2019.

First, the pushouts referenced earlier are expected to become 2019 revenue events. Second, we expect a continued robust spending environment for memory, both in 3D NAND as well as DRAM. Third, we expect our foundry and IDM revenues will grow year-over-year in 2019 due to the timing of project spend on 10-nanometer and below devices. Fourth, we have a growing pipeline of new products and new customers that are incremental to our current level of business. And finally, we see openness for additional market share gains and further growth in our software and services businesses.

Each of these aspects of revenue growth we expect to complement with continued strong operational execution with expanding margin and strong cash flows, and we are firmly committed to creating shareholder value as we drive towards our revenue growth and profitability targets.

Turning to our guidance for the third quarter. We continue to expect the second half will moderate from the first half record rate. Our Q3 guidance is for revenues of $70 million to $78 million; gross margin of approximately 57%, plus or minus 1%; operating expenses of approximately $29 million plus or minus $0.5 million; and earnings per share of $0.36 to $0.52.

I'll now turn the call over to Greg to discuss our financial results and guidance in more detail. Greg?

Thank you, Pierre-Yves. Before I begin my prepared remarks, 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 end-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-based. These measures exclude the impact of amortization of acquired intangible assets, severance costs, cost related to executive transition and search costs as well as discrete tax items.

As Pierre-Yves mentioned earlier, our second quarter revenues were $88.6 million, an increase of 8% from the prior quarter and 38% from Q2 of 2017. Product revenues were $76.7 million, an increase of 8% from the prior quarter and 43% year-over-year. Service revenues of $11.9 million increased 5% from the prior quarter and were up 10% year-over-year and comprised 13% of total sales for the quarter.

By end-market, product sales to the NAND segment contributed 57% of product revenues. DRAM was 33% of product revenues and all foundry, IDM and other device sales comprised the remaining 10% of product revenues.

Our 10% customers in the second quarter were Samsung, YMTC, Intel and Toshiba. Our Q2 gross margin of 57.5% exceeded our forecast, primarily due to favorable product mix, including an increased contribution of high-margin upgrades. Gross margin was 30 basis points lower than Q1's record, which had benefited from onetime factors unique to the first quarter.

For the third quarter of 2018, we are guiding gross margin to 57%, plus or minus 1 percentage point. For the full year 2018 as we previously stated, we are seeing the benefits attributed from our 2017 cost-improvement initiatives in our product costs, as well as a higher mix of our flagship OCD systems and an increased acceptance of our software and analytics-based solutions. Given these items and the overall revenue growth projections, we expect to deliver gross margins near the high end of our financial model targets for the year.

Operating expenses of $29.5 million were up 11% from the prior quarter and exceeded our forecast, primarily due to accelerated timing of R&D project spending, increased investments in the global sales organization and increased accruals for variable compensation due to increased profitability. We expect our overall operating expenses to average $29 million per quarter in the second half of 2018.

Our non-GAAP tax expenses for the second quarter was $3.8 million or 18% of pretax income. Our tax expense on a GAAP basis includes the benefit associated with the non-GAAP expenses previously mentioned as well as the benefit associated with the difference between the actual settlement of employee equity earnings versus the initial grant value. On an ongoing basis in 2018, we are now forecasting our non-GAAP tax rate to be 19% to 20% as compared to the 22% to 23% range previously guided.

We continue to account for the changes from the 2017 Tax Cuts and Jobs Act based on our interpretation of the most current guidance available. Our effective tax rate for 2018 continues to be subject to revisions and changes as we complete our analysis of the Act.

Net income for the second quarter was a record $17.4 million and $0.71 per share. Weighted average diluted shares outstanding declined to 24.4 million in Q2, reflecting the nearly 2 million shares purchased during the fourth quarter of 2017 and first quarter of 2018. Going forward, we expect the weighted average diluted share count to increase by approximately 150,000 to 200,000 shares per quarter.

Now turning to the balance sheet. Cash and investments increased to $148.7 million or $6.18 per share based on 24.1 million basic shares outstanding at quarter end. Day sales outstanding decreased to 55 days from 65 days in the prior quarter, due to the timing of our shipments and collections within the quarter. Inventory increased $1.5 million to $56.1 million at the end of the second quarter. Cash flow from operations was $26.3 million and free cash flow for the quarter was $25.8 million and 29% of revenue.

As included in our earnings release, first half capital expenditures were $1.8 million. We expect CapEx to increase in the second half to support the increased scale of our operations and growth in our strategic R&D programs. This concludes our prepared remarks.

Operator, we will now be happy to take any questions.

(Operator Instructions) And our first question comes from Tom Diffely from D.A. Davidson.

Yes. A quick question on just the ebbs and flows of some of these projects being pushed further. So obviously you had a nice win at the [Nanda] sense and some of the core business was done. I'm curious if you're seeing the same trends as have occurred the last week or 2 and truly just have a customer overlap that bases on the revenue numbers or perhaps with your products that we're seeing slightly different trends.

So we indeed have a few wins this year that make us a bit different from the other players in the industry. But the 2 that we reported, 1 were the Chinese 3D NAND customer and the other one were the DRAM customer, large DRAM customer. And that sets us a little bit apart. We do see some similar trends to what is being reported in the industry as far as NAND is concerned. So we see some pushouts in NAND from the second half into 2019 and this is why now we see the NAND being more front-half weighted than we expected. But we also, at the same time, see some other customers strengthening in DRAM for example, in the second half. And I don't know how much this has been reported and -- but that's also important to us.

Okay. And just to take that one step further. I mean, do you also see a little bit of delay in some of the logic and foundry ramps?

So yes, what we reported is we see the push out of that, some of that logic and foundry revenue into 2019. Still, second half will be stronger than the first half, but we're operating from a small base, and really some of these push outs into 2019 are actually strengthening 2019.

Okay, great. And when you look at your long-term model, what do you think the projected mix on a go-forward basis is going to be between memory and foundry logic for you? Is memory now going to be the dominant piece going forward?

Well, we have a very strong position in NAND. So we reported that we are a supplier to the 5 largest and now sixth one if I include the Chinese customer. So -- and that position is believed to be very stable based on the direction that these customers are taking. With 3D NAND structures becoming more and more vertical, we believe the need for OCD will continue increasing. So I don't see that declining. We have a very high attach rate in DRAM. We are participating with 2 of the largest customers. We're working very hard on the third one and if we're successful to penetrate the third one, DRAM will also be very important to us. So I expect memory to continue to be a strong segment for us. We are also working very closely on the logic and foundry business, sub-10-nanometer that the business is expected to ramp up next year. So I would expect next year to be a little bit more balanced than it is this year in terms of memory versus logic and foundry.

Okay. And then just finally, when you look at the -- kind of the pushouts and in some cases pull-in on the business right now, does any of that impact the launch of the release date of your new tool?

No, it's not related. So it has no impact.

And the next question comes from the line of Patrick Ho from Stifel.

This is Brian on for Patrick. I just want to, I guess, ask a few questions. First -- I guess first question, just to -- sorry, to double back for a second on some of the mechanics of the broader market. But Pierre-Yves, based on the update you provided is it right to infer the year revenues to up at least 20% for the year and you provide the Q3 guide. So can we infer that Q4 is sort of flat to down? Is that the right way to think about Q4?

So we did confirm that we expect to be up by more than 20% this year compared to 2017. And the way we see it today is Q4 will be at least as strong as Q3.

Okay. Got it.

So equal or above.

Equal or above. And just staying with this kind of rhythm, other equipment companies have talked about first half of next year being above second half of this year. And with you, based on your commentary about foundry and logic, some of that second half business perhaps pushing into next year, also some NAND activity pushing into next year, is it -- are you also in the mindset of first half '19 being above second half '18 as well as maybe even first half of '18?

Yes, we expect the second half -- the first half of '19 to be above the second half of '18.

Okay. Great.

So I confirm. No, no, I confirm that.

Okay. There's also first -- you're giving up all those project activity pushing in, in perhaps early part of next year, first half '19 above first half '18 as well?

That is difficult to tell. I -- we haven't -- it's more than 9 months out, so difficult to tell.

Fair enough. A question about cash, your current group cash close to $60 million I think, free cash flow year-to-date. $150 million almost on the balance sheet. I noticed you didn't buy back any stock in the quarter, maybe you can kind of talk about sort of the minimum cash you want to hold on the balance sheet as well as sort of how we should think about the remainder on the buyback going forward.

So we completed the buyback at the end of -- or within Q1. You are right, we generated $57 million actually, in the first half and the current balance is $149 million at the end of the quarter. We -- at this point in time, we have not announced any decision on the further buyback. We're considering options. We are definitely investing in the business in R&D and then after that, as you know, the options are either returning cash to the shareholders or using it for M&A, and we're considering our options today.

Great. That's very helpful. And maybe one last question, to sneak it in. Just curious if you've seen a -- to completely switch gears here for a second here, but curious if you've seen any fall for UniFire, driven maybe by high-bandwidth memory [TXD] or perhaps other wafer-level packaging application. Also just how does UniFire, back in the [trials] at least, fit into Nanometrics longer-term strategy?

Well, UniFire is a tool that we developed more than 10 years ago. It's not a -- it's a very, very small portion of our sales today. We do not have a continuing product after that. So it's really not an important product in our strategy going forward.

And our next question comes from the line of Weston Twigg with KeyBanc Capital Markets.

First just wanted to clarify, it sounded like you said, you mentioned you saw some push-outs of NAND. Did you mean multiple customers, because most have been pointing to 1 major customer and so I'm just wondering if you've seen that spread and if you did, how recent those changes were.

No, it's mostly 1 customer.

Okay. That's helpful. And then the big Chinese customer that you mentioned, that you have some incremental NAND business with this year, do you think that flattens out or maybe drops off next year? Or do you see that spend continuing through 2019? I'm just wondering because I would expect them to focus on [Palleck] activity for a while. And I'm wondering if they've -- can spend what they need to spend for a while.

So the plan was for that customer to install the first 5K in capacity and then prove that they can get to yield by the end of the year and they're targeted to that. So we expect that there's going to be a ramp next year, a progressive ramp of additional capacity in that fab. Given the position I think we will benefit from that.

Okay. That's very helpful. And then just finally, if I could, at which 3 you mentioned some NAND and DRAM traction, you didn't mention logic and foundry. I can't recall if you've had some wins or how the sphere around those might occur next year. If you could help us understand that, that would be helpful.

We're in the process of getting wins in orders in both the largest logic and the largest foundry customer. So this is in process. We're very confident about that and it might happen either in Q4 or Q1 next year.

(Operator Instructions) And our next question comes from the line of Mark Miller from Benchmark Company.

You mentioned 1, a Chinese domestic manufacturer, expected to ramp significantly next year. Do you see any other opportunities among the Chinese domestic manufacturers for a ramp next year?

Yes, we're engaged with quite a few of the customers there. There are 2 DRAM companies in Metron and (inaudible). Fuji and (inaudible) and [IC] -- WHIC. So we're engaged with both the DRAM customer, with the NAND customer. We're engaged with Snake and others in foundry, and we're also engaged with sensor company HIDM. So we have a strong team in China. We're penetrating these customers. The business volume, where the Chinese domestic customers, is ramping up slowly I would say, except for the NAND customer this year. But we expect that this will improve in the coming years.

Can you give us any color or opportunities, whether it's upgrading in terms of software, your software opportunities, or do you see significant upgrades or new sales of software?

It is actually a new sale. It's a new software, it's the SpectraProbe, which is a data-analytics software based on machine learning. So it's a very advanced AI-type software that runs on our tool, additional to the tool software and allows to extract advanced information and has very specific use cases where we can predict the profile. For example, of a tranche, whether there's bold field shift twist. So that's the type of software we are selling today.

And would that be available to existing customers, prior customers?

Yes, it's available to existing customers. What we see is -- we work with a few of them to develop a use case, that specific yield issue that they have linked to overlay, to misalignment or to some shape changing in their structure. And once we develop that, typically, we will sell them the software after we can prove the use case. So this is what's happening. Every one of our customers today can buy that software and have that additional level of data analytics performed on the tools that they have.

Margins for the software I assume are at or above the average?

Yes, they're significantly above. You -- we're in line with what software typically sells in the industry. So it's significantly additive to our margin.

And I show no further questions at this time. I would like to turn the call back over to Dr. Lesaicherre for closing remarks.

First, thank you for joining our call today. Together with the leadership team and our employees, we remain focused on responding to the day-to-day challenges and opportunities in front of us, executing in a robust spending environment and profitably growing our business to create incremental stakeholder value. I look forward to updating you on our next earnings call in October. In the meantime, we have plans to attend the D.A. Davidson, KeyBanc and Jefferies conferences in August and look forward to seeing you at one of these events. And that concludes our call for today. So long.