Nova Ltd

NASDAQ:NVMI

Earnings Call Transcript 2019-Q1

[Operator]

Good day and welcome to the Nova Measuring Instruments' First Quarter 2019 Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Miri Segal of MS-IR. Please go ahead.

[Miri Segal, Founder & Chief Executive Officer, MS-IR LLC]

Thank you, operator and good day to everybody. I would like to welcome all of you to Nova's first quarter 2019 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 statement. And the Safe Harbor statement 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 section 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.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thank you, Miri and thank you all for joining our first quarter financial results conference call. I will start the call today by speaking about our first quarter results and performance highlights. I will then provide the guidance for the second quarter of 2019. Following my commentary, Dror will review the quarter's financial results in detail.

Nova delivered solid results in the first quarter demonstrating the efficient business model we have built which is based on growing diversification in our revenues, customers, and technology.

Through the quarter, we continue to execute our plan firmly in spite of the challenging near-term industry environment. All key financial metrics for the quarter came in above the midpoint of our guidance with both non-GAAP and GAAP EPS exceeding the high end of the guidance range.

This strong outcome in the fundamentally volatile markets is a result of the steady progress we are making in strengthening our operating model, differentiating our portfolio, and increasing our value in a larger addressable markets.

Our performance continued to be supported by a balanced customer mix which included five large customers. This group of leading customers included three Memory and two Foundry customers which reflects the improved position and the progress we have made with each one of them. As a result, Memory and Foundry contributed evenly to our overall product revenue in the quarter.

Based on this balanced mix, we believe that once the market stabilize, our stronger position will provide us with an advantage in several segments and support our long-term growth plans.

From a business perspective, we continue to enhance our penetration efforts and gain even stronger position with key accounts. One of the successful highlights from the first quarter is the selection of our VeraFlex X-ray in-line materials metrology solution by a global leading Memory customer.

This win already generated revenue in the first quarter and is expected to ease more as the customer continues to expand capacity and applications globally. This selection is further evidence of our successful progress in expanding our reach into the growing materials engineering space which undergoes massive changes and with that also many process challenges.

We anticipate that in order to improve device performance today beyond the traditional geometry, scaling, and verticality, IC manufacturers needs to embed more exotic materials in the process and engineering to be stable in high volume manufacturing. The main outcome from this major shift is that process control for materials is becoming an enabler for in-line production beyond qualification and R&D use cases.

Materials parameters will become increasingly important while new generation devices are developed. According to our expectations, in the Memory segment alone, we expect materials metrology intensity to grow significantly from phase-to-phase. This materials inflection point is already reflected in our results in the last few quarters where we successfully penetrated to all major Memory customers. We expect revenue to grow with these customers as they expand capacity.

As leader in this field, we enjoy this growth with multiple wins. We expect our unique offering to be a major differentiator in a strong growth engine going forward. Based on our analysis, by providing unique materials solution, which are based on multiple technologies, we can expand the available market by at least $200 million in the coming years.

An additional business highlights is the selection of our dimensional OCD metrology by a Memory manufacturer for developing its non-volatile advanced Memory device. The selection included our newest i550, the latest addition to our integrated metrology portfolio. This solution emphasize Nova's unique offering that interlaces hardware with advanced machine learning and deep training software engine to solve challenging applications that can't be solved by hardware alone in a wafer-to-wafer variations scheme.

The success we have had with this latest integrated metrology platform is also reflected in the number of manufactured tools so far which exceeded 100 units as of today roughly a year from the product launch.

In addition and as reflected by the customer revenue mix, we continue to extensively deliver our solution to the world's leading foundry for its 5-nanometer production line and 3-nanometer development line. As a result of the customer extensive evaluation Nova's application portfolio was expanded to include both frontend and backend solution in multiple steps in order to solve the most complex logic challenges in high-volume production.

Despite the current uncertainty in the market, mainly induced by memory we still believe that in the long term demand fundamentals will continue fueling the markets beyond the interim conditions. Therefore we continue investing in our strategic plan to develop and expand our organic growth engine.

Our diversified portfolio which is based on a unique and differentiated product strategy for both dimensional and materials process control demonstrates clearly our competitive edge in a wider measurement capability where a growing portion of our product revenue generate today, is based on solutions that only Nova can provide.

Following the three new generation of dimensionals and materials metrology hardware models that we launched in 2018 we intend to focus on two additional growth engines in 2019. The first is to continue developing our machine learning software suite which significantly enhances our metrology capabilities and provides adaptive solutions.

These solutions are gaining more interactions with all of our customers and are recognized by the industry as a breakthrough technology for improving yields and time-to-solution.

During the quarter Nova and GLOBALFOUNDRIES were jointly awarded the Best Metrology Paper at Advanced Lithography Conference for demonstrating adaptive metrology capabilities using machine learning engines and predictive metrology in high-volume production.

Our uniqueness in predicting CD and electrical values from an inline measurement using machine learning engine has been implemented and are supporting our share gains with multiple customers.

The second is to continue aggressively prototyping our two main new technologies that we were talking about also in previous calls. These technologies are already been extensively evaluated by our main customers with multiple tools already installed at customer sites. Both technologies reveal unmet solution for both dimensional and materials metrology and we expect initial revenues from this new technologies in the second half of 2019.

To conclude my prepared remarks, I would like to briefly highlight the market conditions as we see them currently. In our view, the spending environment is largely influenced by a decline in memory spending in both DRAM and VNAND.

We believe that although we should expect the year of slower spending, the longer term growth opportunity for the industry remain solids fueled by more high-end applications that require better computation power and memory capabilities.

In our view the second half performance still depends largely on three catalysts; inventory correction and capacity expansion in memory foundry and logic yield improvement that will trigger further expansions and the adoption pace of our new technologies.

Though visibility today to the end of 2019 is challenging, our current view is that while an uptick in memory may occur in the second half of 2019, we believe that the large expansions will materialize mostly in 2020 which is starting to be developed into a fairly growth year.

As for Nova although we are not immune to the market volatility and current low visibility, we expect that given our widened exposure to multiple segments customers and geographies combined with the traction our differentiated portfolio is gaining in the market, we are well positioned to benefit from the long-term growth potential in multiple differentiated applications.

We envision 2019 as a transition year for Nova which we believe will lead to a stronger year in 2020, where the main elements to support our growth are the wider available market as a result of materials exposure and new portfolio rollouts which will increase our value offering and finally our balanced exposure to all industry segments.

Before I provide the guidance for the second quarter, I would like to emphasize that although the market as whole is experiencing a soft period, our operational model and the value we bring to the customers continue to support healthy profitability and gross margin as demonstrated in the first quarter. These fundamentals will continue supporting our investment in developing and rolling out new technologies.

As for the second quarter of 2019 guidance, we expect revenues in the range of $45 million to $53 million, diluted EPS on a GAAP basis on the range of $0.09 to $0.26 per share and non GAAP basis diluted EPS in the range of $0.17 to $0.35 per share.

Now, let me hand over the call to Dror to review our – results in detail. Dror?

[Dror David, Chief Financial Officer]

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 per item at the end of the earnings press release.

Total revenues in the first quarter of 2019 were $56.7 million at the high end of the company quarterly guidance. Of the company product revenues approximately 50% came from the foundry and approximately 50% came from the memory. On the customer distribution front TSMC, SMIC, Samsung, Hynix and Micron were the large contributors to the company product revenues in the first quarter. Blended gross margin in the first quarter was approximately 56% on a GAAP basis and 57% on a non-GAAP basis within the company target model of 56% to 59%.

Operating expenses in the quarter totaled approximately $22.9 million on a GAAP basis and $20.9 million on a non-GAAP basis higher than the previous quarters. The increasing operating expenses in the first quarter resulted mainly from lower R&D income in the quarter. Operating margin in the quarter was 15% on a GAAP basis and 20% on a non-GAAP basis. The effective tax rate of the company in the quarter was approximately 16%.

Earnings per share in the quarter were $0.27 per diluted share on a GAAP basis and $0.37 per diluted share on a non-GAAP basis higher than the company guidance for the first quarter.

As previously communicated, during 2019 the company will conclude the transition of its main offices in Israel and the U.S. to new locations. As a result, during the office transition period, the company is bearing duplicate office lease costs. In the first quarter of 2019, these costs amounted to $614,000 and were adjusted for non-GAAP representation purposes under the item facilities transition costs.

As discussed in the company's previous conference call, starting January 1, 2019 the company was required to implement the new lease accounting rule known as ASC 842. This rule require the company to present operating leases, which extends for a period of more than one year as an asset and liability in its balance sheet.

As a result of this accounting rule implementation, the company balance sheet as of March 31, 2019 included an operating lease right-of-use assets in the amount of approximately $28 million, operating lease long-term liabilities in the amount of approximately $26 million and operating lease current liabilities in the amount of approximately $3 million. The majority of these lease liabilities are denominated in New Israeli Shekels and are linked to the consumer price index in Israel. Therefore, they are exposed to exchange rate fluctuations on the full amount of the liability on affluent basis.

During the first quarter of 2019, the exchange rate differences and linkage to the consumer price index of these liabilities amounted to US$484,000. These costs were adjusted for non-GAAP representation purposes under the item revaluation of long-term liabilities.

Regarding, the company outlook for the second quarter of 2019 at the midpoint of the company guidance, we expect the following. Blended gross margin is expected to be approximately 56%. Operating expenses are expected to reduce to approximately $22 million on a GAAP basis and approximately $19.7 million on a non-GAAP basis. Effective tax rate is expected to be approximately 15%.

I will conclude my prepared remarks with the cash reserves of the company, which increased to $193 million at the end of the first quarter and will enable the company to explore business development opportunities in parallel to the execution of the company's 25 million share repurchase program.

With that, I will turn the call back to Eitan.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thank you, Dror. With that, we will be pleased to take your questions. Operator?

[Operator]

Thank you. [Operator Instructions] We'll go first to Jaeson Schmidt at Lake Street.

[Jaeson Schmidt, Lake Street]

Hey, guys. Thanks for taking my questions. Wondering if you could first comment on the linearity of order patterns in Q1. I recognize Chinese New Year can throw things off, but just curious overall big picture how linearity was in the quarter?

[Eitan Oppenhaim, President & Chief Executive Officer]

So first of all the first quarter has just started. So we're just at the end of the first month of the quarter. But we do not see a major change in the order pattern between the flow in the last -- in the first quarter and the starting of the second quarter.

[Jaeson Schmidt, Lake Street]

Okay. That's helpful. And wondering, if you can provide any additional color surrounding the sequential decline in the service revenue line. And I guess you had previously talked about service revenue growing in that 10% range in 2019. Has there been any change to those thoughts?

[Eitan Oppenhaim, President & Chief Executive Officer]

No in general we are not changing our view on the service growth plans. The first quarter of the year is always a soft quarter for service revenues. And we do expect them to start growing starting the second quarter of 2019.

[Jaeson Schmidt, Lake Street]

Okay. And the last one for me and I'll jump back into queue, how should we think about CapEx for 2019?

[Eitan Oppenhaim, President & Chief Executive Officer]

As Dror mentioned before, we are in the midst of transitioning the offices both in the US and Israel, which requires more expensive I would say one-time investment in facilities. So in the first quarter the investment was around $2 million. You should expect an acceleration starting the second quarter and we should conclude these projects by the end of 2019. And overall investment for these facilities should be around $20 million for the year.

[Jaeson Schmidt, Lake Street]

All right. Thanks a lot guys.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thank you.

[Operator]

And we'll move next to Quinn Bolton at Needham & Company.

[Quinn Bolton, Needham & Company]

Hey, guys. Congratulations on the nice 1Q results. Obviously, we're going to soften a little bit sequentially in the second quarter, but wondering if you might be able to provide some thoughts on the second half. One of your competitors in the OCD space last night talked about seeing the second half of the year, up 25% to 30% half-over-half driven primarily by advanced logic and foundry. I think that's probably largely driven by TSMC's Phase 2 of their N5 build out, and I know you have exposure there. Do you expect to see a strengthening in the second half as Phase 2 is built out?

[Eitan Oppenhaim, President & Chief Executive Officer]

So thank you for the question. So basically in good years and even in software, we don't guide beyond the next quarter, specifically in this year in order to be conservative and cautious because of the unclear visibility for the end of the year, I would like to be even more cautious because we have a volatile market.

Regarding specifically to what we see in the second half and as I said in my prepared remarks, it depends on three catalysts that hopefully will happen. One is the recovery in memory, which we see some time for this recovery. It has to be recovered both in NAND and DRAM. And we believe that the price elasticity, as well as the demand will start increasing somewhere in the second half.

This is one second is the foundry and logic yield improvement that at the end will reflect on capacity expansion, which specifically in TSMC should be reflected in the second phase. But as we see that and according to their call as well never announced, okay. We believe that the yield of the 5-nanometer will continue to grow. Probably some of the capacity of the Phase 2 will happen in the fourth quarter. But we don't see it yet.

The third issue is the rollout and the pace of our new products. So as I said in my prepared remarks and as Dror said as well, we have multiple battles with our tools, which represent a large or very big ASP related to the product portfolio. And we expect initial revenues to come in the second half.

So if these three catalysts will happen, we definitely will see uptick in the second half. From the current position that I have and in order to be very responsible we take cautious approach and we don't guide beyond the quarter.

[Quinn Bolton, Needham & Company]

Understood. Understood. Thank you for that color. Wondering if you might just sort of give us your thoughts on the China foundry segment as you look through this year. Is this a year where you expect that business to be fairly soft? Or do you think you see or is there some activity in the local China foundry market that you're seeing?

[Eitan Oppenhaim, President & Chief Executive Officer]

So, on the contrary, when we look right now on the Chinese market, we look on – there will be two segments. We definitely see some soft spending from the – on the memory parts largely by the largest VNAND provider. And when we look on the foundry, we look at the two main foundries, the SMIC and Huali continue spending money. We see that in our revenue in the quarter and we probably will see it in the next quarter. It doesn't mean that the whole China markets will be greater than 2019. But definitely for this specific customer both for 28 and 14-nanometer in part of them, we do see continuous investment.

[Quinn Bolton, Needham & Company]

Thank you, Eitan. The last question just on the new – the tuning tools, I believe one was already sampling by the end of the first quarter with the second expected to go to eval by the end of the first half. Wondering has that second tool been shipped for evaluation or will that still happen this quarter?

[Eitan Oppenhaim, President & Chief Executive Officer]

So we actually expected that best of – betters in our customers. We have multiple tools now and not one. The two better that we're talking about them one technology is already rolled out to a better in two customers and one of them in one large global customer. And all of them going according to the plan and if everything is materialized we are supposed to see the initial revenues coming in the second half. So there's no change in the plan. On the contrary, we actually expedite that.

[Quinn Bolton, Needham & Company]

Great. Thank you very much.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] We'll go next to Patrick Ho at Stifel.

[Patrick Ho, Stifel]

Thank you very much. Eitan, it's well known now that memory spending is quite muted at this time. But as you look forward both into the second half and 2020 maybe on a qualitative basis, which segment do you see a potential recovery occurring first either a NAND or DRAM?

[Eitan Oppenhaim, President & Chief Executive Officer]

So first – so first one I'm looking on the memory customers and the ability to spend. I do see the two large memory customers spending in China, okay, the global one. And we are definitely starting to see orders coming from China for those two global memory customers. The question right now if it will be full capacity only part of what they announced. We will see in the next couple of weeks, but we started to get orders and I think that those two investments are on the way.

Second regarding the questions of DRAM and vertical NAND we start – when we are looking right now on those customers, we – for the first phase we see conversions and then we start to see new orders. So for the DRAM part, we started to see the conversion. So I assume that somewhere in Q2 or the beginning of the third quarter, we will start to see some orders for DRAM. So regarding to your questions, I think that DRAM come first.

[Patrick Ho, Stifel]

Great. That's very helpful. Maybe as my second question in terms of some of the new products you've introduced it sounds like they add a lot of value and enhancements to productivity and yield enhancements that customers are looking for. But at the same time a lot of times new products tend to have lower gross margins initially. Can you comment in terms of as these new products roll out the impact to your margin profile as well as on your earnings leverage?

[Eitan Oppenhaim, President & Chief Executive Officer]

I want to start answering that – by that – by saying that Nova is not releasing news about productivity announcement. So you will not hear from us product x plus or product x productivity. The target in our product rollout is to bring new technology, which is actually more interesting to the market and differentiating the portfolio that we are providing to the market. The productivity part is part of our business. We always provided and each one of the customers is having a new publication site, always asked for better productivity and we have it on a yearly basis.

But this is not the major investment that we have. The new technologies that are coming to the market is a continuous approach that we have to our portfolio, which means we concentrate more in spending money for the materials market. And over there we are going to bring a unique solution. And when you are looking right now on the dimensional part, we always brought to the market the combination of hardware and software that gives very unique capabilities to measure application that cannot be measured today. Those all – those are the specific criteria for rolling new technologies. And it's the same with a new product that, we are bringing to the market right now.

[Patrick Ho, Stifel]

Great. Thank you very much.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thanks, Patrick.

[Operator]

We'll go next to Mark Miller at The Benchmark Company.

[Mark Miller, The Benchmark Company]

Congratulations on your report. Just wondering in terms of X-ray, do you expect X-ray revenues to grow in the second half?

[Eitan Oppenhaim, President & Chief Executive Officer]

So, again, Mark, we can't -- we can't and we don't guide beyond the next quarter. I do think that if you're looking on the next couple of quarters and if you look right now on the previous couple of quarters, definitely the materials part, as part of our overall revenue is growing. And I expect with what I said in my prepared remark that the market is growing in this part and materials engineering is becoming a unique issue. Even more important these days from the dimensional on OCD, definitely the X-ray or the materials capabilities will grow.

[Mark Miller, The Benchmark Company]

Do X-ray orders or sales represent 10% or more of your backlog or your recent sales?

[Eitan Oppenhaim, President & Chief Executive Officer]

Well, we don't disclose backlog information. But definitely X-ray revenues are much higher than 10% of the product revenue of the company.

[Mark Miller, The Benchmark Company]

There seems to be some difference from what you said today you expect foundry and logic to remain strong in second half. But some people feel that after this quarter foundry and logic kind of tails off. But you're saying basically you're expecting stronger foundry and logic to continue in the second half. Is that correct?

[Eitan Oppenhaim, President & Chief Executive Officer]

No. What I said is that all of us know that actually the ones that are spending money right now on the logic and the foundry is Intel and TSMC. In each one of them there's a different capacity expansion program that is taking place. One of them is the 10-nanometer and the expansion of the next-generation. And the other one is the rollout of 5-nanometer and the next-generation of 3-nanometer. So when we're looking right now on the second half, there is expectation that in both customers, the rollouts -- and again, according to the yields improvement, the rollout space will increase in the fourth quarter. If it's Intel in the proliferation and if it's TSMC for the phase two 5-nanometer, but again, I would like to say that was never announced. All right?

So this is the two -- this is the two major catalysts, Mark. So when everybody's talking about logic and foundry, they're talking about -- mainly about those two inflection point that may occur in the second half and will trigger a large capacity spending in logic.

[Mark Miller, The Benchmark Company]

Do you expect to see much from Micron or Samsung, because they've been reported at least in memory they just have very large inventories?

[Eitan Oppenhaim, President & Chief Executive Officer]

So, I don't want to refer specific to customers, but we do see some movement in inventory reduction and orders in the leading memory customers.

[Mark Miller, The Benchmark Company]

Thank you.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thanks.

[Operator]

And that does conclude the 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.

[Eitan Oppenhaim, President & Chief Executive Officer]

Thank you, operator and thank you all for joining our call today. By that, we conclude our Q1 2019 earning conference call. Thank you.

[Operator]

Thank you. And that does conclude today's conference. Thank you for your participation.