Nova Ltd

NASDAQ:NVMI

Earnings Call Transcript 2019-Q4

[Operator]

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

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

[Miri Segal, MS IR LLC]

Thank you, Operator, and good day to everybody. I would like to welcome all of you to Nova's fourth quarter and full year 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 statements 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 the business update, followed by Dror with an overview of the financials. We will then open the call for the question-and-answer session.

I will 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 us. I'll start the call today by speaking briefly to our December quarter results. I'll then spend time summarizing 2019 performance highlights. Following my commentary, Dror will review the financial results in detail including the guidance for the first quarter of 2020.

Nova reported strong results for the quarter demonstrating the meaningful value our differentiated portfolio brings to our customers. Our strong performance drove revenue and profitability to exceed the company's guidance and propelled our quarterly revenue to a new record high. This was an outstanding conclusion to a volatile year during which we continue to strengthen our market position and expand our unique portfolio in order to support our long-term goal.

Our results in the current market environment are further evidence of our steady progress to widen the company's exposure to whole semiconductor customers in all territories. As we enter a new calendar year, we are excited by multiple growth opportunities associated with the market reaction to our newly introduced products which were invented to meet the new challenges our customers going through, while they improve their device performance and time to market. The new technical transition to multi stack VNAND, DRAM scaling to sub 20 nanometer, a new dimensional structures in five nanometer logic and below expand Nova's opportunity reach for both the materials and dimensional metrology portfolios. Following our major investment in new products and technologies, we believe that Nova is well-positioned to strengthen its position furthermore in 2020.

The company performance in the December quarter was primary driven by our solid position across various segments and specifically in the logic foundry. We saw a growing demand for our solutions during the quarter as our logic customers go through extensive technology development and capacity ramped up in the most advanced technology nodes. Our strong position with the industry-leading foundry drove our product portfolio to reach record quarterly revenue reflecting the tight partnership we have with this customer across various technology nodes over several years. Our continuous partnership starts in the early development stage of each node, continues to a pilot and mini line and concludes in high volume manufacturing.

At any given moment, we are proactively investing in at least three concurrent cycles like that every year in the same customer. As we see it currently, the demand for logic devices will continue in 2020 while the overall market demand for AI and 5G enabled infrastructure continues to grow, while the main achievement this quarter was the elevated shipment made -placed to this customer for its five nanometer expansion, we started also to work with other leading logic customers to support their technical transition to five nanometer, three nanometer and below which incorporate new architecture beyond FinFET and traditional material stocks.

Our application footprint in this advanced node has expanded to include both front end and back end solutions in multiple steps utilizing all our newest portfolio solutions. The ongoing progress with leading logic and foundry customers solidifies our position in the segment and is reflected also by a multi-million dollar order received from another logic provider to develop its next-generation chips. The order includes several new generation standalone platform combined with our newest Nova fit machine learning capabilities who effectively reduced time to solution and increase accuracy and accountability.

The growth in logic was further enhanced by our quarterly customer mix which also included two leading memory customers that kept growing Nova's position along the year. Our increasing position in memory will enable us to accelerate our growth once the segment itself resumes high level of equipment spending. The progress we made throughout 2019 to expand our position is also reflected this quarter with our steadily growing hold in China. Our performance in the territory is highlighted by a couple of wins with leading logic customers, as well as continues inroads with established memory providers. Although, we are not immune to the current developing situation in China in Asia, we believe that the Chinese market will continue to be a major growth driver for us in the long term.

In this respect, I would like to address the Coronavirus situation and its implications on Nova. As the virus continues to spread, our primary concern is with the health risks and well-being of all people affected by the situation locally and globally in all our sites. We are taking several measures and needed precautions in all our sites. Additionally, we are also taking active actions to secure our supply chain and future deliveries that may be affected if the situation deteriorates. Although, we don't see currently major implications on the business forecast in the first half, we made some conservative assumptions and widened the first quarter guidance which will allow us to digest any future uncertainties related to our Chinese customers.

Finally, our service revenue also which record quarterly high with a growing contribution from proactive services and upgrades. Our continuous investment in enhancing our installed based is bearing fruit with various solutions that enhance productivity and improve metrology performance. Nova's solid results for the December quarter signify a positive end note to a challenging year for the industry. The more balanced and wider exposure we built over the past several years allowed us to execute well in 2019 despite softness in memory and the market headwinds. Following the challenging first half of 2019, we started in the second half to see encouraging signs of growing momentum towards the end of the year with expedited five nanometer logic ramped up and a slight improvement in the overall business environment.

As a result, we are concluding the year better than previously anticipated. This demonstrates our long-term ability to execute well in a dynamic environment, as well as the strengths and resiliency of our operational model. Our well balanced mix of device segments, different technologies and various customers keep strengthening our long-term fundamentals and support our ability to succeed in different market conditions. The solid performance we demonstrated in memory despite the weakness of the memory customers this year indicate our continued progress in gaining shares. As a result, memory still represents approximately 50% of the company's annual revenue.

During 2019, we invested significantly in research and development to support the market rollout of new innovative and differentiated technologies. This investment is aimed at expanding our served markets but is also important for forming new metrology challenges, which arrived from the complexity of new generation semi devices. This accelerates rate of innovation in chip design evolves into a new array of needs in metrology. As part of Nova's strategic plan, we are extremely focused on executing our organic growth engine to enhance both the dimensional and materials metrology portfolio.

Our goal is to develop new metrology solutions that will set us apart from the competition and allow our customers to overcome new emerging challenges as they move to a new generation of semiconductors. Our technology roadmap has four directions all of which were brought to the market in 2019. First is our new optical CD dimensional portfolio. Following the launch of our Nova PRIZM platform this year, we see promising traction decked up with initial orders received in Q4, 2019. Nova PRIZM is a first of its kind metrology platform which combines traditional optical spectroscopy technologies with spectral interferometry technology.

The new method can extract unique physical information from the measured device that is inaccessible by traditional optical techniques. As the leader in integrated metrology would continue to deliver an array of solution to the market. From a simple thin film measurement done by one channel to complex all CD measurements done by multiple channels. Based on our strategy to solve complex high-end metrology needs, our newest i550 integrated platform reached annual record revenue with wide market adoption. The tool was designed as the unique hardware platform to enable broad usage of prediction and training software capabilities to accurate fast measurements.

Second is the growing materials metrology portfolio. As part of our strategic plan, we intend to focus more on the evolving materials engineering markets. This segment is experiencing fundamental changes that create many fabrication and metrology challenges. We strongly believe that materials control will become increasingly important as new generation devices are developed. The need for tighter materials control drives faster transition of laboratory process control technologies into inline production steps. Like we did with the XPS transition to a fully in line production tool we intend to bring other methods from the relaxed laboratory environment into the demanding production environment. Some of these solutions are already developed and are evaluated on sites. We are very encouraged by the traction the new platforms are generating in the market with the initial order already received in the fourth quarter of 2019.

Obviously, the need to precisely characterize and control material composition, thickness, stress and profiling are growing in advanced memory and logic node and require innovative solutions which are not yet introduced today in inline production. Furthermore, customers require multiple measurements per wafer enabling in-die monitoring within wafer uniformity. Our new platforms with our tested on sites aim to provide all of this. The last layer is our growing investment in software solution. We are seeing growing adoption for machine learning and modeling solution in high-volume manufacturing. Our holistic strategy brings together the traditional physical modeling together with the machine and deep learning software supported by a strong computational management layer.

It allows our customers to tighten the process control, improve yield faster and shorten the time to market. Finally, our elevated spending in new products is a mutual evolution of the tight cooperation we have with our customers across multiple initiatives. Before I conclude my prepared remarks, I would like to briefly highlight the market dynamics as we see them currently assuming no further material impacts by the Coronavirus. Additionally to the recent growing investment by the leading foundry for its five nanometer expansion, other logic customers also planned for capacity growth in multiple sites during 2020, combined with the forecast for improvement in memory prices, we anticipate that 2020 should be a growth year. We believe as do many other semiconductor companies that the long-term growth model for the industry stays intact and continue to be fueled by more applications that require better computation power and memory capabilities.

To wrap up as we enter a new calendar year, we are excited by multiple growth opportunities which are associated with the technology transition our customers are experiencing. Given our innovative position, new product rollout and our growing exposure to grow the range of opportunities, we believe that Nova is well positioned to capitalize on these opportunities in 2020. Our expectation based on the current market dynamics are that the combination of strength in logic demand from multiple customers, stronger momentum in memory and our new portfolio introduction will drive the better environment for us to grow in 2020.

Now let me hand over the call to Dror to review our financial results in details. 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 fourth quarter of 2019 were $64.6 million, an all-time record for Nova, up 23% quarter-over-quarter and exceeding the company guidance range for the quarter. On the product revenue front, we saw a significant shift towards foundry which came in at approximately 80% of total product revenues. The increase in foundry revenues was mainly driven by extensive deliveries into the most advanced foundry technology node including sampling from 2020 to 2019, as well as continued deliveries to the local leading Chinese foundries for training edge technology nodes.

Service revenues significantly increased by 28% quarter-over-quarter to an all-time record level of $17.6 million in the fourth quarter. Blended gross margin increased in the fourth quarter to 54% on a GAAP and non-GAAP basis. Operating expenses in the quarter total $20.2 million on a GAAP basis and $18.3 million on a non-GAAP basis. This result is after offsetting R&D income in the amount of approximately $3.7 million.

Looking forward in 2020, we expect R&D income to be at a normalized level of between $1 million and $1.5 million per quarter. Operating margin in the quarter was 22% on a GAAP basis and 26% on a non-GAAP basis significantly higher than the previous quarter mainly due to the increase in business volumes. Effective tax rate in the quarter came in at approximately 19%. Earnings per share in the quarter were $0.43 per diluted share on a GAAP basis and $0.51 per diluted share on non-GAAP basis exceeding the high end of the company guidance.

On the cash flow front, the company generated $15.5 million in cash from operating activities and invested $5.7 million in property and equipment mainly in the company new headquarter facilities in Israel. On an annual basis, the company reported revenues of $225 million. Product revenue distribution was approximately 50% from foundry and approximately 50% for memory on an annual basis. Blended gross margin in 2019 was 54% on the GAAP basis and 55% on a non-GAAP basis.

Operating margins in 2019 were 16% on the GAAP basis and 21 on a non-GAAP basis and the effective tax rate in 2019 was 11%. Earnings per share in 2019 were $1.23 per diluted share on a GAAP basis and $1.59 per diluted share on a non-GAAP basis.

On the cash flow front, in 2019, the company generated $41 million in cash from operating activities and invested $21 million in property and equipment mainly in the company's new headquarter facilities in Israel and the US. During the year, the company also repurchases shares in the amount of $7 million. The company concluded 2019 with cash reserves of approximately $190 million. Regarding our expectations for 2020, we would like to note the following. 2020 revenue stream is expected to include revenues from new products. The company already received initial customer purchase orders for the new Nova PRIZM optical CD stand-alone product and in addition received a purchase order for one of its new technology products, which were not yet announced.

Some of these orders were received based on application demos and the revenue recognition from these orders is subject to final evaluation processes at the customer site and final acceptance by the customer. We currently expect to start recognizing revenues from these orders in the second quarter of 2020. As previously communicated, we expect the market adoption of these and other new products to be gradual and to continue to require long and extensive evaluation periods by the customers.

Service revenues are expected to increase in 2020 at a rate which is similar to the company installed based increase of approximately 5%. Gross margins are expected to improve relative to 2019 under the assumption of higher business volumes, utilizing the existing infrastructure and generation of revenues from new products with higher gross margins. Effective tax rate is expected to be approximately 20% on the GAAP basis and 15% on a non-GAAP basis. Capital expenditures are expected to be approximately $10 million in 2020.

Moving into the company outlook for the first quarter of 2020, we expect the following. Revenues between $50 million to $60 million. This wider than usual revenue range includes possible business implications of the Coronavirus situation. GAAP earnings per diluted share between $0.18 and $0.34. Non-GAAP earnings per diluted share between $0.26 and $0.42. At the midpoint of this first quarter guidance, we expect the following. Service revenues are expected to reduce to the $14 million level. Blended gross margins are expected to be approximately 54%. Operating expenses are expected to be approximately $21.5 million on a GAAP basis and approximately $19.5 million on a non-GAAP basis.

We expect to see a reduction in SG&A expenses while net R&D expenses are expected to increase mainly due to normalize R&D income. Overall, net R&D expenses are expected to be between $11.5 million to $12 million on a GAAP basis and $11 million to $11.5 million on non-GAAP basis.

With that I will turn the call back to Eitan.

[Eitan Oppenhaim, President and Chief Executive Officer]

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

[Operator]

[Operator Instructions]

We will take on first question from Quinn Bolton from Needham and Company. Please go ahead. Your line is now open.

[Quinn Bolton, Needham]

Hi, guys. Congratulations on the record results in the fourth quarter. I wanted to start with first the outlook for the foundry, advanced foundry business in 2020, it looks like it's probably taking a step down in the first quarter, but wondering could you give us your thoughts on how you see that advanced foundry business playing out in 2020. And then a second question, you referenced the new orders for the Nova PRIZM tool. I think you said that was coming from a logic customer, just wanted to clarify that. And if it is -- is that an existing logic customer at a new customer, if you could provide any more detail would be helpful. Thank you.

[Eitan Oppenhaim, President and Chief Executive Officer]

Thanks Quinn for the questions. So, first of all, regarding the foundry market, so obviously as we see it with other providers as well the leading foundry for five nanometer probably will reduce a bit spending in the first half. But we're definitely looking on the sign in the market and anticipate that it will resume the third or the fourth phase somewhere in the third or the fourth quarter. That's regarding these customers. Beyond that as I said in my prepared remarks, there is at least two customers that are going to spend more money on the advanced nodes in 2020. And we expect them to generate revenue for Nova as well additional to the leading foundry.

Regarding the second question, yes, it's a foundry customer, but we can't reveal the name. So we don't --we can't say who it is, it's an existing customer.

[Quinn Bolton, Needham]

Great. And just for that -- with that outlook for sort of the leading foundry to be a little soft in the first half and then come back in Q3, Q4 plus the additional two customers you referenced. Do you think overall foundry logic businesses is up in 2020 or do you think the growth really comes from a recovery in the memory side of the business?

[Eitan Oppenhaim, President and Chief Executive Officer]

Well, I think that foundry will continue its growth in 2020. Again according to what we see now will continue its growth, modest growth actually in 2020 and as we see it, memory and firstly the non customers will start resuming capacity as well somewhere in the third quarter, actually in the second half.

[Quinn Bolton, Needham]

Great.

[Eitan Oppenhaim, President and Chief Executive Officer]

Actually it's a mix between --

[Operator]

Our second question from Krish Sankar of Cowen & Company.

[Krish Sankar, Cowen & Company]

Yes. Hi, thanks for taking my question and congratulate, Eitan and Dror on the good results. I had a couple of questions. Number one is over the last year or so can you-- look like you guys are gained from market share really all have some interesting new products coming out. How do you think about this when memory spending recovers, would it be share gain that helps drive outperformance or would it be the new products or is it a combination of both? And then I had a follow up.

[Eitan Oppenhaim, President and Chief Executive Officer]

So I think it's a combination. If you're looking right now on the diversification that we went through and the customer mix that we have and the allocation between the segments, if we could finish a year like that on a 50% basis for the memory and the foundry. I anticipate that when memory and foundry will both resume growth in high volume, we will probably outperform the market. Secondly, you are right regarding the new product. So if --when you're looking right now on the market and we look on the new products we assume that the new products will allow us to do better than the market. So we assume that introducing those new products would allow us to continue the growth in --to continue the long-term growth and resume again growth in 2020.

[Krish Sankar, Cowen & Company]

It's very helpful. And then just a question on, you kind of highlighted about how with the leading edge foundry going to five and they'll eventually three nanometer. There are all new challenges and I think Eitan has spoken about product being both on the material and dimensional metrology side. Would you say the challenges at 5 and 3 from a process control inspection side, is it more materials or do you think is it more dimensional or is it a combination? And then I had one last question.

[Eitan Oppenhaim, President and Chief Executive Officer]

So I think that when you're looking right now in regular scaling between 7 and 5 actually it's more dimensional increase in both intensity and the mid. If you're looking right now on going below five nanometer actually three and two, you need to add also a change in structure to probably FinFET -- or sorry, nanowire from a different sort and the materials are going through tremendous changes. So going to five it's more dimensional if you go below five you start to get actually significant changes in material. So we will see the demand for the materials metrology higher.

[Krish Sankar, Cowen & Company]

Got it. Then a final question for Dror. I think you mentioned services revenues could grow 5% this year if I am right. Kind of curious clearly your installed base have grown that should help some part of it, but as like the many customers start loading up your factories, shouldn't that drive incremental upside or is it all baked into the guidance?

[Dror David, Chief Financial Officer]

So I would say the following. Obviously, in recent years before 2019 we saw higher level of increase in service revenues which was more at I would say probably between 8% and 10% annually. So there is a possible upside to this 5% projected growth in 2020. Obviously, it depends on many factors including the one you alluded to. Our plan of record in general is that service revenues would grow eventually at a rate which is similar to the growth in the installed base and in 2020 it's around 5%.

[Operator]

Our next question comes from Mark Miller from Benchmark Company.

[Mark Miller, Benchmark Company]

Let me add my congratulations on the record results this quarter. You indicated that you expect memory to start accelerating in second half of the year. Do you see that trend? A lot of people are expecting memory because of the 5G really to be significantly stronger in 2020. I know that's sticking their neck out. But do you think that momentum will continue throughout the second half year into 2021?

[Eitan Oppenhaim, President and Chief Executive Officer]

So anyway we-- thanks Mark for the question. So when we're talking about memory we definitely look at two segments. One is the DRAM and the other one is the -- it's a vertical NAND. When we talk about resuming capacity and spending in the second half, we're talking about, firstly, the VNAND to resume growth and yes it will continue to 2021. DRAM is still a question for us. So we don't see yet when the demand will reach to a point when we'll start to see demand for metrology growing.

[Mark Miller, Benchmark Company]

Do you expect your material calculation -- characterization, your x-ray will grow this year?

[Dror David, Chief Financial Officer]

Yes. In general, I would say I think we can say that Eitan mentioned we are looking to grow in 2020 and this is based on increased demand on both elements of the business. Both dimensional and material.

[Mark Miller, Benchmark Company]

Well, you signaled to increase R&D early last year that came down in the fourth quarter. Do you expect higher R&D this year compared to 2019?

[Dror David, Chief Financial Officer]

Yes.

[Operator]

Our next question comes from Jason Smith from Lake Street.

[Unidentified Analyst]

Hi, guys. Thanks for taking my questions. I know in your comments you noted that some revenue from Q1 might have been pulled into Q4. Just curious if you could quantify how much you think was pulled in?

[Eitan Oppenhaim, President and Chief Executive Officer]

So, Jason, we can't say the numbers because we cannot reveal the information and also we don't know exactly the customer's plan and how he justifies the purchasing. But if you are looking right now on this specific customer, we need to look on the long cycle of spending. So it start in the beginning of the third quarter and probably will continue somewhere in Q1. And over these eight to nine months there is a timing issue. So some of the equipment has been ordered soon, some of them ordered later and this is why you see the variability of earnings between Q4 and Q1.

And by the way it's not new. The TSMC is always spending, at least in the last few years in the fourth quarter and therefore there is a timing issue always between December and January. And therefore we should look on the spending from this customer over a period. So if you are looking right now on Q4 and Q1 is probably this is the way to look at that. So we have massive orders came from this customer. Some of that will pulled into Q4; some of the stay in Q1 wherein the others will the opposite. But overall I can tell you that looking right now on the strength of the result that we have, the thing that we can assume that Nova actually strengthened the position over this customer specifically in this node.

[Unidentified Analyst]

Okay. That's helpful. And then, sorry if I missed it, but how many 10% customers that you have in Q4?

[Dror David, Chief Financial Officer]

So in Q4, we had -- the company had three 10% customers, sorry, in Q4 we had, yes, three 10%, it is important to note that as Eitan mentioned, that the company did improve its position in memory so overall for the annual results the company may had one new memory customer as a 10% customer in 2019 and hopefully when memory investment will resume we will be able to even more enjoy that.

[Operator]

We will now take a follow up question from Quinn Bolton from Needham.

[Quinn Bolton, Needham]

Hey, guys. Just wondering if you might be able to quantify any revenue impact from the Coronavirus that you think shifted from Q1 perhaps into Q2 or Q3. Is that something you can quantify or should we be thinking about the $55 million midpoint of guidance is kind of what you think that the natural demand would have been for the quarter? Thanks.

[Eitan Oppenhaim, President and Chief Executive Officer]

So, Quinn, before going into this specific question and answer specifically, wouldn't it --wouldn't we have this virus threat and spreading over the last few days probably we would have guided higher, okay. Nevertheless, we don't see any impact right now on deliveries or any kind of shifts between quarters due to the Coronavirus. But things are evolving fast and we wanted to be conservative in our approach to digest some uncertainty if it happens.

If I'm looking right now on the higher level, I think that beside the fact that we have customers in China which is one element; the impacts can go also to the supply chain and also for the people and restriction between the territories. So currently we can restrict movement of people and secure our supply chain. So we don't see any delivery problems and shift between Q1 to Q2. But nevertheless this virus is spreading fast without seeing the peak, so you want to be very cautious about our prediction and forecast.

End of Q&A

[Operator]

There appears to be no further questions at this time. So I'd like to hand the conference back to Eitan Oppenhaim for any closing remarks.

[Eitan Oppenhaim, President and Chief Executive Officer]

Thank you, operator. And thank you all for joining our call today. By that we conclude our fourth quarter and full year 2019 earning conference call. Thank you.

[Operator]

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