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Good day and welcome to the Nova Measuring Instruments Ltd. First Quarter 2018 Results Conference Call. Today's conference is being recorded.
At this time, I would now like to turn the conference over to Miri Segal of MS-IR. Please go ahead.
Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments' first quarter 2018 financial results conference call. With us on the line today are Mr. Eitan Oppenhaim, President and CEO and Mr. Dror David, CFO.
Before we begin, may I remind our listeners, that certain information provided on this call may contain forward-looking statements, and the Safe Harbor statements outlined in today's earnings release also pertains to this call. If you have not received a copy of the release, please view it in the Investor Relations of the Company's website.
Eitan will begin the call with a business update, followed by Dror, with an overview of the financials. We will then open the call for the question-and-answer session.
I'll now hand over the call to Mr. Eitan Oppenhaim, Nova's President and CEO. Eitan, please go ahead.
Thank you, Miri. I'd like to welcome everyone and thank you all for joining our financial results conference call for the first quarter of 2018. I'll start the call today by speaking briefly about our first quarter results and performance highlights. I'll then share our view on the current market environment and conclude by providing guidance for the second quarter of 2018. Following my commentary, Dror will review the quarter's financial results in detail.
Early quarter Nova delivered strong financial results for first quarter of 2018 with record revenue and profit, significantly exceeding our guidance. This strong support our outlook for another growth year in which we continue enhance our value proposition to our customers who benefit from the market's growing demand for variety of semiconductors. In this environment, where better performance and scaling are required, advanced process control is becoming a key enabler and drive growth and the quality intensity across all segments.
During the quarter, we continue to effectively execute against our strategic target to diversify our markets, customers and product with notable success in all key performance metrics. The strong momentum we are experiencing is reflected in our diverse sources of revenue, which were driven by the geographic shift towards China and the balance segment mix with growth in memory. These contributions were the main drivers for the significant surge in revenue this quarter. The continued effort to grow our position in memory are proving effective this quarter, as approximately 50% of our product revenue was generated by customers in this space.
This is a result of increased traction of both our dimensional and material solution. Our continued success in memory is also evident by the customer mix this quarter, which included two leading memory manufacturer who contributed approximately 20% each to the overall product revenues. This part of our growth we are entering 2018 with a significant shift in Nova's geographical revenue mix. While Korea continues its momentum in light of solid investment DRAM and FLASH, we are also experiencing persistent growth in China which accounted for approximately 40% of overall product revenue in the first quarter.
To demonstrate the growing momentum we see in China, we announced this quarter that a leading domestic customer chose our dimensional and materials metrology solutions for the next phase of expansion, which we expect to yield $20 million in revenue over the next 12 months. Investments in China which is being fueled by combination of domestic and global customers, including 10 new Greenfield facilities that were open recently is driving growth in semiconductor CapEx. We strongly believe that Nova is well positioned to benefit from this growth in the remainder of 2018, as we have significant position with these customers.
Although some of these customers are still in early stages of development and capacity ramp up, we believe the China is presenting us with a significant multiyear opportunity to expand. Chinese domestic manufacturer will continue their investment with the central and local government support to reach a competitive technological threshold and process and product control will be a key area of spending to achieve this goal in 2018.
In the foundry logic space, while several customers are trying to ramp up their 10 and 7 nanometer slowly as their main objective this year, we also seen incremental growth in contribution to mature trading node above 60 nanometer. This contribution accounts for approximately 50% of our foundry product revenue and we expect them to continue being stable throughout the year. Encouraged by the outstanding year we had in 2017, we continue steadily towards our long-term target to grow organically and reach $300 million in annual revenue. A key component of our evolution into a bigger company is our ability to deliver enhanced value to our customers while developing a cutting edge metrology portfolio of multi technology, coupled with advanced software for more accurate control and faster time to solution.
This strategy is already embedded in our product roll out for 2018 and 2019 when we plan to expedite our development cycle and launch multiple new solutions. Our expected elevated R&D spending in 2018 supports our long-term growth vision in multiple ways. First by funding investment in sustaining innovation in our traditional portfolio. Second by financing disruptive innovation to develop new differentiated product for emerging process control challenges. And third by expanding our third market which we expect to happen as a result.
Our product roll out is expected to contribute to our growth by gaining market share and adding approximately $160 million in served markets. These efforts should yield better customers in 2018 and revenue by 2019 for both our optical and x-ray technologies. This approach is already bearing fruit as evidenced by the latest Gartner publication for 2017 where Nova continues to gain market share in 2017 as well.
Despite investment challenges, we continue to maintain our efficient and controlled financial model, which can accommodate elevated investment in R&D, while still supporting our long-term targets. Based on this ambitious plan, we were excited this quarter to launch a differentiated software suite of engine to accompany our hardware fleet. Following the three newly launched metrology hardware system to enhance both dimensional and materials metrology performance, we announced this quarter the launched of NOVAFit which includes breakthrough machine learning software suites to complement the traditional physical modeling software that has been used in the industry for years. Together with our Big Data sleep management infrastructure, NOVAFit utilize fleet-wide information to provide adaptive metrology solution based on continuous training.
The platform is also open to numerous other technologies in various hybrid metrology information to improve training and validation. Our unique approach of combining physical software model with mathematical engine enables our customers to shorten production time of the most advanced 1x DRAM scaled logic in advanced stages of vertical NAND. In this context, I would like to emphasize that this software additions to our portfolio are way beyond the simple analytic tools, and deliver qualities that none of our competitors introduced. The product is already generating revenue and should support our software revenue growth in the coming years. While growing revenue organically, we are also looking at ways to maximize the company's current valuation and its cash position of approximately $160 million to keep pursuing various M&A direction.
Our goal is to complement our portfolio with other process control capabilities in the different semiconductors steps. In our view the successful acquisition and integration of ReVera proved the technological capabilities of the company to embed other technologies to offer a wider holistic approach to our customers.
Before concluding my part, I would like to share our thoughts regarding the macro-environment in the different semiconductor segments as we see them in 2018. We believe that the demand for semiconductors will remain healthy throughout of the year, driven by strong catalysts that are dominated by the growing need for mobile data and data management infrastructure. As a result, we see continuous demand for advanced FLASH and DRAM memory devices. While investment will stay steady throughout the year, we expect DRAM investment to grow faster than in 2017 among all of our customers.
In the foundry space, while we experience some softness at the beginning of the year in advanced node, we see incremental growth in the logic trailing node of 60 nanometer and above, which we expect to continue mainly in China in the following quarter as well. Regarding investment in advanced node, the majority of spending in 2018 will cover 10 and 7 nanometer with early investments in 5 nanometer in the second half of the year as planned. If we extend our outlook to include the overall logic environment, we think that the demand for more computing power, as well as demand for performance based sensor will continue steadily as more vertical applications are launched into the market.
Finally, as I mentioned earlier, we see the Chinese market continuous development going forward driven by investment of domestic and global manufacturers in variety of devices in both memory and logic. In summary and based on our current estimate for overall demand, we expect the long-term healthy industry momentum to continue, while the market benefits from solid catalysts which are fueled by continuous innovation in this active market. These trends are related to the way we use data in mobile devices, sensors and cloud-based data sensors.
In order to meet these growing challenges, the semiconductor industry should continue its efforts to constantly improve performance and costs. Our wider exposure to multiple customers in both the memory and foundries, the exposure to both trailing nodes, as well as advanced logic and memory nodes, and the traction that our differentiated portfolio is creating in the markets position us to benefit from this environment, and continue our growth as well.
For the second quarter guidance, we expect revenue in the range of $57 million to $63 million, diluted EPS on a GAAP basis in the range of $0.30 to $0.40 per share, and non-GAAP basis diluted EPS in the range of $0.35 to $0.45 per share. Based on this guidance, our revenue mid points for the second quarter of 2018 project a growth space of approximately 10% in the first half of 2018 compared to 2018, and in line with our expectation.
Now let me hand he call over to Dror to review our financial results in detail. Dror?
Thanks Eitan. Good day, everyone. In my following prepared remarks, I will refer to both GAAP and non-GAAP results. You can find a detailed reconciliation between GAAP and non-GAAP results per item at the end of the earnings press release. Total quarterly revenues in the first quarter of 2018 were $62.6 million, reflecting a 15% increase year-over-year. This result is higher than the top end of the company guidance for the first quarter, also as a result of a specific customer pooling of tools which were initially expected to shift during the second quarter of the year. Products revenues for the quarter were $50.2 million, approximately 50% of which came from the memory sector, and approximately 50% from the foundry sector.
It is important to note that the company could present these record revenue levels in parallel to a continuous decrease in high-end foundry investment of 10 nanometer and below technology nodes. Actually during the first quarter of 2018, foundry investments in 10 nanometer and below technology nodes were at their lowest quarterly level during the last two years. We believe this is a strong evidence of the continued diversification and balance of the company revenue sources. We also believe that the company will continue to enjoy this diversification in years to come, especially when leading-edge foundry investments will resume.
During the quarter, the company had four customers that exceeded 10% of product revenues. Samsung accounted for 22% of product revenues, Hynix and TSMC accounted each for 19% of product revenues, and FMIC accounted for 14% of product revenues. Blended gross margin increased in the first quarter compared to the previous quarter and came in at 58%. This increase was attributed to the higher revenues, better utilizing the existing infrastructure and two favorable product mix which also included slightly higher software revenues.
Services gross margin came in at 33% mainly as a result of higher expense levels in the quarter including material usage. We expect a similar service gross margin in the second quarter before trending up in conjunction with expected service revenue ramped up in the second half of the year. Operating expenses in the quarter total $20.3 million on a GAAP basis and $19 million on a non-GAAP basis. Most of the increased quarter-over-quarter was a result of higher R&D expenses. Effective tax rate in the first quarter was 14% on both GAAP and non-GAAP basis, and included the impact of the US tax reform.
The combination of higher revenues, improved gross margins and lower tax rate significantly increased the company's profitability in the first quarter of 20187. GAAP EPS in the quarter was $0.49 per diluted share and non-GAAP EPS was $0.54 per diluted share, significantly higher than the company guidance for the first quarter. During the first quarter of the year, the company generated positive cash flow of $12.2 million from operating activities. Regarding the company guidance for the coming quarter, revenues in the second quarter of 2018 are expected to be between $57 million and $63 million.
This revenue guidance includes the impact of customer pooling in the first quarter, which I previously mentioned. At this revenue level between $57 million and $63 million in the second quarter of the year, we expect the following. Blended gross margin is expected to be between 56% and 57% and includes the impact of the expanded manufacturing clean room space in Israel, which started operating at the beginning of the second quarter.
GAAP operating expenses are expected to be between $21.5 million and $22 million and non-GAAP operating expenses are expected to be between $20.2 million and $20.7 million. Most of the increase in operating expenses is expected to be in research and development. This increase reflects the company efforts to accelerate its development plans in order to organically meet its strategic target of $300 million in revenues. We expect these expense levels to remain stable during the second half of the year. Effective tax rate is expected to be between 17% and 18% and remain stable over the course of the year.
Regarding the targeted long-term financial model of the company at $300 million revenue level, we continue to target gross margins to be between 56% and 59%. Operating expenses to be approximately 30% of revenues and operating margins to be between 26% and 29%.
With that I will turn the call back to Eitan.
Thank you, Dror. Before opening the line for questions, I'd like to invite you all to join us for the Investor day that will take place on June 14 in New York. At the event you'll have the opportunity to meet Nova's management team, as we provide more color on our strategic business plan and future trajectory.
With that we are pleased to take your questions. Operator?
[Operator Instructions]
We'll go first to Edwin Mok at Needham & Company.
Good morning, guys. Thanks for taking my question, good quarter. First question I have it seems like on the OPEX side you guys have to increase the OPEX now right to drive this revenue growth long-term, right. Dror you mentioned it's kind of long-term target objects is going to be 30% right versus so a midpoint of guidance is more than 34% this quarter now, right. Is this high level of OPEX, should we expect this higher level of OPEX to stay for even if you start to see some growth and probably kind of normalize longer-term or is it just call the step up now and you're expected this at same old level over main quarters or how do you accounting for that.
I think that the right way to approach it is that we have a step function now and as I mentioned it will remain stable across the remainder of -- expected to remain stable across the remainder of the year. And you should expect the stability also going into 2019.
Edwin, its Eitan here. I would like also to add looking on the cycles of the company went through in the history you can see that the 2017 results actually a results of growing spending on the years before. So definitely we look on 2018 as investments year because we want to start seeing results in 2019.
Okay, great, yes. I just want to clarify that. On your commentary about the end market demand right. I think you mentioned that you expect NAND to remain relatively steady throughout the year with DRAM increasing right. We heard from a large equipment manufacturer right, [Indiscernible] said that they expect caused their shipment to be lower in second quarter and probably mostly down in the second half and understanding is a lot of data to NAND. Can you kind of help us reconcile why they're so different user.
So I can elaborate from what we see currently, so when we look currently on the fixed memory provided, part of them are providing the NAND only and part of them are doing FLASH and DRAM. When those that are doing FLASH and DRAM, we see that the DRAM spending is increasing. So actually when we look right now on the first half, there are multiple expansions that we see. I'm not too sure that the differences between our views are not shipment or lead time because the process control actually shifts before the project process tool, when you go into a new fab. So I think it's only a timing issue but definitely when we look on the spending mainly by Samsung, Hynix and Micron, we see that the facility that are producing DRAM are increasing capacity in Japan and Korea, and it will continue in the second quarter as well. And we'll see some strength in the third quarter as well.
Great, that's helpful. On the kind of new product offering, I saw some new software. Just curious where those products right now? Are we starting to ship those? I think you mentioned there are a few new hardware products that you guys announced and also a new software suite right. Just curious where we on that kind of new program cycle. Do you expect that to be a growth driver as you go into second half?
Yes. So that when we launched our products, our policies to be conservative and make sure that we are getting revenues before we launch the product publicly. So once we launched it in a press release, so once we launched the product it's something that already went through better at least in one customer, and its generating revenue. If I'm looking on the track records of launches when we launched three new hardware products in the third and fourth quarter of 2017, they are after data and generating revenue. In regard to the NOVAFit, the new software engines, so most of the market share that we gain in memory came from the combination of the software and hardware that we could actually bring a must in -- better accuracy and a better time to solution in those memory customers. So we could get in as part of the market share. So definitely the NOVAFit is generating revenue and when we're talking about the fleet management and the big data, actually 90% of our customers are using that already. So the combination of changes in infrastructure, where we combine new hardware, new machine learning mathematical engine and the fleet management which is actually a big data in the customer fab or connected together right now in all the leading customers. So definitely the software revenue growth or a combination of all that. So definitely it's running revenues already. It's part of our development of the software revenue. And it will be part of our growth engine going forward.
Okay, great. One last question I have already -- just you mentioned that some win from second quarter to first quarter, anyway can you quantify how much that was and what kind of customer that broke that point, what type of customer?
So obviously we can't detail the specific customer, but I think most if not all the performance in revenues over the high end of the guidance that we gave for the first quarter is related to these early shipments.
And we'll move next to Jaeson Schmidt at Lake Street Capital Markets.
Hey, guys. Thanks for taking my questions. Wondering if you could just talk about if your overall visibility for the second half of this year has changed significantly over the past three months?
Well I would like to tackle these questions by zooming out a bit, and talking about the basis of Nova currently and the resilience of the exposure that we have to multiple customers, multiple products in multiple segments. It's important because when we're looking right now on the first half revenues, actually as Dror mentioned although our biggest customer that we had in 2016 still don't spend a lot of money and moving to the 5 nanometer if the company could reach record levels. So if we were looking right now on the second half, I think that the revenue mix will be a combination of DRAM spending, steady VNAND spending and there are some upside it probably can happen from the fact that there's a big customer is going to spend some CapEx on the five nanometer rollout. We don't see yet the fourth quarter but most of the revenue probably will come from the same sources as the first half with upside that can come from this leading foundry customer. So currently what we see a flat second half with an upside to be a bigger one.
Okay, that's helpful. And then just looking at gross margin kind of 56.5% at the midpoint for Q2. How should we think about any potential snapback in gross margin in the second half of this year?
So I think that first of all our model is 56% to 69% on an annual basis for the gross margin. First quarter was 58% which is at the high end of this range. And in general I think that in a year of revenue growth we should expect to be around the middle of this range or higher.
Okay and then the last one for me and I'll pass the baton. I know with the additional clean room space in the first half this year CapEx is probably running a little heavy. How should we think about CapEx throughout the remainder of this year?
So actually our investments, capital investments in the first quarter were low. I think it was even less than a $0.5 million. And we should expect CapEx in 2018 to be normalized around the $ 5 million level that we had in previous years for 2018.
And we'll move next to Patrick Ho at Stifel.
Dror may be just a little bit of color both in China that you saw in the quarter --
I think you are disconnected.
Hello.
Yes, Patrick, now it is better.
Okay. I apologize. May be can you give little bit colors between the mix versus the domestic and how you see that trending on a daily basis? Do you [Technical Difficulty] closure to those companies.
I think that I thought that I caught you or your question so appreciate if you go to a better reception area. But I'll try to answer regarding China in overall. So when we're looking right now on the Chinese investment or the customers in China, actually we are looking on between 20 to 25 sources of revenue coming in right. And as I said in my prepared remarks, around out of those 20 to 25, 10 are new Greenfield or just established from last year until Q1, 2018. And we still have some every investment they've even started like Global Foundries and some other customers probably will come. In regard to the domestic investments versus the global investment. I think that there are pretty healthy global investments mainly by Intel, TSMC, UNC and probably the two Chinese --sorry two Korean customers. The Shian by Korea --sorry by Samsung and Hutchie by Hynix. Beside that regarding the domestic spender, you need to divide these groups to two. You have the group of the main foundries like Huali and SMIC not in a new comer, but they are still spending capacity to meet the advance node. And also you have several Greenfield new customers that are coming both in memory, as well as in logic foundry. Of course, we have YMTC investment in memory. We have couple more one that's investing in DRAM and FLASH. And also there are small ones that are investing in foundry. If we look on the map and the location actually it's becoming very distributed in much location in China. So it's not anymore Shanghai and Beijing, it goes from Dalian in the north with Intel all the way down to JH ICC, and other small customers that we have in Shin-Chan in those provinces. Now when you're looking right now the spending, you see that each one of them getting support by the local government in each one of the provinces, as well as the central government support. So in 2018 you have a multiple investment by all those segments. We need to see in 2018 how those new Greenfield spending R&D money moving into production. And ramp up which is actually 2019 revenue or increasing revenues. So this is starting the picture in China.
Great, that's helpful. And maybe as a follow-up question for Dror in terms of the increase in R&D spending that you said in your prepared remarks. I know there are a lot of variables that go with R&D spending, new product development also supporting on the engineering side, your customers. Can give a little bit of color of the breakdown given how much your revenue have ramp in quarters? What's being targeted for next generation product development versus kind of the engineering support that you need to provide for your customers given the revenue where you see in the last few years?
So I think that you said correctly that it goes to many elements of the company product portfolio and roadmap, but in general I think we can say the two-thirds of the increase in R&D expenses, the expected increase in the remainder of 2018 is going to new product and new technology development. And one third is going to I would say the next generation of products and sustaining the existing platforms.
We'll go next to Mark Miller at Benchmark.
Congratulations on your record sales. In terms of common semiconductor was significantly in the quarter just reported. Are you still expecting more greater contributions in a second half a year from them?
You are talking about the overall semiconductor market?
The Taiwan semiconductor. It was -- you refer.
Yes. So if you're looking right now on the advanced nodes. I think that multiple customers are investing currently in trying to develop and ramp the 10 and 7 nanometer, it goes from Intel, Samsung and also SMC. Now there is spike that we expect will happen in the second half which is the pilot line of five nanometer of the SMC. According to their announcement and according to what we see, it's supposed to come in Q3 or Q4. The timing is not clear yet and also capacity is not clear yet. But definitely we see it happened and once it happen, of course, the SMC contribution in the revenue will go up.
Can you give us a little more color what's x-ray expectations? Were there orders and sales this last quarter and also what's going on with the x-ray business?
So obviously we don't break down revenues to technology. However, we can say that we see increase in both technology revenues in 2018 relative to 2017.
And that that does conclude today's question-and-answer session. At this time, I'd like to turn the conference back over to Eitan Oppenhaim, President and CEO for closing remarks.
Thank you, operator, and thank you all for joining our call today. We conclude our Q1. 2018 earning conference call. We hope to see you all soon in our Investor Day. It will take place on June 14th in New York. Thank you. And have a nice day.
And that does conclude today's conference. Again, thank you for your participation.