Nova Ltd

NASDAQ:NVMI

Earnings Call Transcript 2018-Q3

[Operator]

Good day, and welcome to the Nova Measuring Instruments Ltd. Third Quarter 2018 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, MS-IR LLC]

Thank you, operator, and good day everybody. I would like to welcome all of you to Nova's third 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 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 and Chief Executive Officer]

Thank you, Miri, and thank you all for joining our third quarter 2018 financial results conference call. I'll start the call today by speaking about our third quarter results and performance highlights. I will conclude by providing guidance for the fourth quarter of 2018. Following my commentary, Dror will review the quarter's financial results in detail.

Nova continued to perform well, setting quarterly record revenue at the high-end of the guidance and exceeding the profitability guidance for the quarter. These achievements are further evidence of our steady progress, demonstrating consistent execution of our long-term plans to diversify our product offering, differentiate our solutions and expand our available markets.

We are very encouraged by this progress, if the company continues to achieve solid results despite being three market volatility. Following our quarterly earnings and the guided revenue for December quarter, we expect 2018 to be our sixth consecutive growth year with revenues at record high. With this milestone clearly in our reach, we are progressing steadily for the long-term target of $300 million in revenue annually.

We plan to achieve this aggressive plan to continuous growth of our organic product line, which are well supported by significant investment in developing with new disruptive solution. In fact, the expected revenue mix this year reflect the growing portion of new differentiated application, which can be sold today exclusively by Nova. As a result, we are generating opportunities to setup the cost from the traditional competition and diversify our growth.

Our solid results are highlighted by growing revenue from the Memory segment, which reached a quarterly record with substantial contributions from all leading customers. In addition, following our press release this quarter, we initiated delivery of our Dimensional, OCD and Materials solutions to the most advanced 5-nanometer technology node.

Our strong performance is also reflected in our diversified customer mix, which yielded five large customers this quarter, three of which are leading Memory provider. As a result, Memory contributed approximately 65% to our overall product revenue setting new Memory record. The significant progress we've made been growing our markets in Memory, which resulted in increased annual revenues, [deserve emphasis] [ph] considering the recent softening in Foundry, which was the main revenue driver, a few years back with approximately 85% of our product revenue mix.

Our expected yearly contribution from Memory customers in 2018 is driven by more than 60% growth year-over-year, well above the expected market performance. This could be achieved continuously following the significant inroads we have made to strengthen our competitive position with all memory providers.

As for the territory mix, we continue to see strong demand for a broad range of products from our Chinese customers, both in Memory and Foundry. As a result, China accounted for roughly 30% of the overall product revenue this quarter. In our view, although, we may see a transition period, while local establishment move from R&D stages to high volume production, we still envision China as a significant sustained driver for our long-term growth.

As we continue to diversify our product offering to meet new process control challenges, we are encouraged by the strong traction, our new generation products are creating in the market. As part of our strategy, we anticipate that in order to improve device performance materials complexity will evolve to be one of the toughest challenges to overcome. To continue improving semiconductors, scaling and architectural changes are not sufficient enough and introduction of new materials are required.

Currently in order to scale the logic device, while increase the vertical memory cell are transit to 1Z [ph] DRAM structure, new materials are introduced to improve performance and reduce leakage. The number of periodic element that are used today [indiscernible] over the last few years, and so forth all the latest technical transition. This shift requires more control and more materials measurement in the production environment.

Composition, strength and others evolves to be major parameters to measure and are required in all device types, because of this trend we believe that materials metrology overall available market will grow significantly in the coming year.

Analyzing our performance in this area reveals continuous growth in materials metrology revenue, which come both from the OCD and X-ray solution. This part is one of our major differentiator going forward and will account for substantial future growth in order to support this direction and another unique growth engine, and it's previously discussed in both our first quarter and second quarter earnings call, we intend to maintain high level of R&D spending in 2018. Our previous investment years, we delivered such R&D spending support our long-term vision to expand our core differentiators; we setup the part from the conventional competition.

Our product rollout is on track and expected to be delivered to the market in the first half of 2019. Following this strong quarter in which we continue to leverage our efficient operational model and grow our cash reserve. We have decided to launch a share repurchase program to reflect our confidence in the company's long-term growth. Nova will continue to leverage strong cash flow and solid balance sheet to invest in disruptive new technology, pursue the merger and acquisition activity than enhance shareholders' value.

In conclusion, though the industry is currently experiencing some challenges, mainly in adjusting memory capital intensity and improving yields, we expect to continue executing successfully our long-term growth projections. We believe that the long-term industry momentum, we continue that the semiconductor market benefits from multiple solid catalysts, which are driven by the increasing demand for center [ph] powerful devices and dent [ph] memory cell.

Technical infliction such as scaling and materials engineering will continue in order to enable new device architecture in both Memory, Logic and Foundry. Our widened exposure, the multiple segment customers and geographies combined with the traction our differentiated portfolio is creating in the market position us to benefit from the long-term growth potential in multiple differentiators application.

As for the fourth quarter guidance, we expect revenue in the range of $56 million to $64 million, diluted EPS on a GAAP basis in the range of $0.28 to $0.40 per share and diluted EPS on a non-GAAP basis in the range of $0.35 to $0.46 per share.

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

[Dror David, Chief Financial Officer]

Thanks, Eitan, and 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 third quarter of 2018 were $63.6 million, a record quarterly level. Product revenues for the quarter were $49 million from - of approximately 65% from the Memory segment and 35% from Foundry. Hynix, Huali, TSMC, Micron and Samsung each accounted for 10% or more of product revenues.

Service revenue came in at normalized level of $14.6 million, a reduction relative to the previous quarter, which included major upgrade project to the existing install base. Blended gross margin in the third quarter increased to 59%. Product gross margin increased to 64% largely resulting from the favorable product revenue mix in the quarter.

Services gross margin decreased to a normalized level of approximately 42%, after reaching a record high of 49% in the previous quarter, which included higher revenues related to the install base upgrade.

Operating expenses for the quarter totaled $21.7 million on a GAAP basis, and $20.1 million on a non-GAAP basis, slightly lower than the previous quarter. The decrease in operating expenses resulted from a decline in sales and marketing expenses, while R&D and G&A expenses remain stable. As previously communicated, the company currently invest in several product development projects, which are expected to move into the product rollout phase during the first half of 2019.

Most of the R&D funding that the company currently received for this investment is generated by several European funding program. In parallel, the companies working to complete the transition of its local Israeli research funding from a royalty-bearing program, which was concluded under a royalty buyout agreement in 2016 to a non-royalty-bearing program, which is called generic R&D program.

Although, we do not have control on the timing of that transition and it's final approval by government authority, we hope this transition will conclude in the coming month, and we will generate additional funding opportunities for current and future R&D investment.

Operating margin in the quarter was 25% on a GAAP basis and 28% on a non-GAAP basis. The effective tax rate of the company was approximately 19%, slightly higher than the average in 2008 due to the mix of profit between the different tax jurisdiction. GAAP EPS in the quarter was $0.46 per diluted share and non-GAAP EPS was $0.52 per diluted share both higher than the company guidance for the third quarter.

The company cash reserves increased to approximately $172 million at the end of the third quarter of 2018. This cash level will enable the company to continue to pursue new business opportunities in parallel to executing the amount $25 million share repurchase plan.

Regarding the company guidance for the fourth quarter of 2018 at the midpoint of this guidance, we expect the following: blended gross margin is expected to be approximately 57%; operating expenses are expected to be approximately $22.5 million on a GAAP basis and approximately $20.5 million on a non-GAAP basis.

Effective tax rate is expected to be approximately 17% based on the midpoint of Q4 guidance annual gross margins for 2018 are expected to be approximately 58% and annual operating margins for 2018 are expected to be approximately 26% both within the targeted financial model of the company.

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

[Eitan Oppenhaim, President and Chief Executive Officer]

Thank you, Dror. With that, we are pleased to take your questions.

[Operator]

Thank you. [Operator Instructions] And we'll take our first question from Patrick Ho of Stifel. Please go ahead.

[Brian Chin, Stifel Financial Corp.]

Hi. This is Brian Chin on for Patrick. Thanks for letting us ask a few questions and congratulations on the solid results. First question for Eitan, in terms of the new product data shipments, it sounds like the shift - shifting on the schedule here in the second half. And you expect those revenue contributions timing wise for the first half of next year. It is fairly assume that these are more focused on the advanced Foundry, Logic applications rather than Memory?

[Eitan Oppenhaim, President and Chief Executive Officer]

What - so thanks for the question. So - regarding the new product what we said at the initial delivery will take place in the first half, while we expect to see revenue in 2019. Regarding the application, the applications are not unique for Foundry or Memory, it's for both. Actually, we started - we're starting those products [ph] in the Memory side.

[Brian Chin, Stifel Financial Corp.]

Okay. Got it. And another question have around sort of the contributions that new products could make next year, and this is servicing a baseline in some - and the service revenue as well. Firstly, in the service - is there any reason in the same service when in grow another, say, 10% plus in 2019, it's been operating add above that in the past couple of years?

And then secondly, just in terms of understanding our materiality of the new product contributions, it's something in the level of 500 basis points of incremental growth in 2019. Is that sort of a reasonable expectation?

[Eitan Oppenhaim, President and Chief Executive Officer]

So in terms of the service revenues, obviously, this year we saw slightly higher growth relative to the average. Service revenues are driven mainly by the increase in the install base, and, yes, we do expect the install base to grow an average 10% a year, and service revenue grow should be parallel to that.

In terms of new products given the fact that we are in early phases of better interest and introduction into customers. I would say, it's early to say exactly how much contributions will be in 2019. However, we do expect initial revenues at the second half of 2019.

[Brian Chin, Stifel Financial Corp.]

Okay. Got it. And so just - consisting with that, should we expect OpEx to kind of run above the 30% sales long-term model maybe through the first half of the year and then somewhat into the second half, when you start to maybe deliver against those new products?

[Eitan Oppenhaim, President and Chief Executive Officer]

Right.

[Brian Chin, Stifel Financial Corp.]

Perfect. Maybe one last thing, real quick. I think, previously you talked about how the spending tends - in the industry could shift towards your Foundry, Logic in the first half of next year from the Memory strength this year. Just curious from a baseline perspective, other companies have started, but kind of flattish product shipment environment first half of next year versus second half of this year. Do you think that sort of the assumption, you're all playing against with it.

[Eitan Oppenhaim, President and Chief Executive Officer]

So I think, Brian, if it's - it's a more broad question, and I [indiscernible] talk about the market that we see that entering into 2019. So obviously, we don't guide beyond the coming quarter. And recent challenges in the volatile market reduced anyway the visibility. Therefore, it's hard to predict exactly the timing and capacity of each investment in 2019. Nevertheless, I can discuss the overall environment in investment pattern in the different segment.

So I think that in terms of Memory, we expect that balance investment mix where we still see continues investment in DRAM and moderated investment in NAND. We have to pay attention also that there are also some other elements influenced Memory beside the supply demand situation, which are the technical transition in both VNAND feature phases like 96-layers [ph] and more. And in DRAM, the scaling below 20-nanometer that required more investment besides the capacity.

Additionally, we expect in Memory, some investment of the global players in China, it's not only for one place, we're talking about both the Korean players as well as the U.S. players. In logic Foundry, we expect, if you said one major event revamping 5-nanometer. We do see it happens in the first quarter, we don't yet see the full visibility on the capacity and exact timing, but we see that happening. But we also see capacity add-ons in 10- and 7-nanometer by other customers as a result of global Foundry muting [ph] investment in this 7-nanometer node.

And we also see some investment in [indiscernible] Taiwan, Korea and China. Big difference in Taiwan, where we started to ship equipment and we should increase the revenue from this customer - from this customer leading foundry to be the highest - in the highest level for the last six quarters, so we definitely expect this event. Combining these elements together at this point in time, our best assumption would be stability in overall business level, at least when we enter 2019. In addition to that, on the rest of the year or what will be evolved the second half, you can't predict currently, and I think the damage [ph] we cannot predict.

[Brian Chin, Stifel Financial Corp.]

Okay. Very helpful color. Thank you so much.

[Operator]

[Operator Instructions] It appears we have no further question at this time. Mr. Oppenhaim, I'd like to turn the call back to you for any additional or closing remarks.

[Eitan Oppenhaim, President and Chief Executive Officer]

Thank you, operator, and thank you all for joining our call today. With that, we conclude our Q3 2018 earnings conference call. Thank you very much for joining.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.