Onto Innovation Inc

NYSE:ONTO

Earnings Call Transcript 2021-Q2

[Operator]

Good day, everyone, and welcome to the Onto Innovation Second Quarter Earnings Release Conference. Today's call is being recorded. At this time, I'd like to turn the call over to Michael Sheaffer. Please go ahead.

[Michael Sheaffer, executive]

Thank you, April, and good afternoon, everyone. Onto Innovation issued its 2021 second quarter financial results this afternoon shortly after the market closed. If you have not received a copy of the release, please refer to the company's website, where a copy of the release is posted.

Joining us on the call today are Michael Plisinski, Chief Executive Officer; and Steven Roth, Chief Financial Officer. As always, I need to remind you of the safe harbor regulations. Any matters today that are not historical facts, especially comments regarding the company's future plans, products, objectives, forecasts and expected performance, consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These estimates, whether expressed or implied, are based on currently available information and the company's best judgment at this time.

Within this as a wide range of assumptions that the company believes to be reasonable. However, it must be recognized that these statements are subject to a range of uncertainties that can cause the actual results to vary materially. Thus, the company cautions that these statements are no guarantees of future performance. Risk factors that may impact Onto Innovation's results are currently described in Onto Innovation's Form 10-K report for the year ended December 2020 as well as any other quarterly filings with the SEC.

Onto Innovation does not update forward-looking statements and expressly disclaims any obligation to do so. Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. As a reminder, a detailed reconciliation between GAAP and non-GAAP results can be found in today's earnings release.

I will now go ahead and turn the call over to Mike Plisinski. Mike?

[Michael Plisinski, executive]

Thank you, Mike. Good afternoon, and welcome to Onto Innovation's Second Quarter Conference Call. Across the semiconductor value chain, from silicon wafers to wafer fabrication and advanced packaging, Onto Innovation's products are contributing to the faster ramps and higher yields necessary to support the unprecedented global demand for semiconductors. Onto Innovation is broadly participating in this growth from logic at 7-nanometer down to the 3-nanometer design nodes to the latest DRAM and 5G communication devices and out to the rapidly evolving advanced packaging markets where accelerating design shrinks are creating strong demand for more sophisticated and versatile inspection solutions.

As a result, in the second quarter, we reported record revenue of $193 million, well exceeding the high end of our guidance, and we continue to see a stronger second half of the year. So let's begin by looking at the highlights from the second quarter, starting with our largest segment, specialty devices and advanced packaging.

End market demand for devices to support growing work-from-home and high-performance computer applications propelled revenue in this segment to increase by 45% over the first quarter and more than double the second quarter of 2020. Leading this growth was demand for inspection technology, which increased 24% over the first quarter and 65% year-over-year.

Our recently released Dragonfly G3 systems improved sensitivity, speed and integrated Clearfind technology is expanding our position in the most demanding and sophisticated packaging markets, while also opening new markets such as high-definition image sensors, where our growth continues ahead of expectations. For example, in the second quarter, we received orders from a fourth new image sensor customer, while a top 3 image sensor customer doubled their existing installed base to support the ramp of their latest sensor technology.

Another segment we see expanding our served markets is panel-level packaging. We believe this market represents an important inflection point for the industry, particularly for high-performance compute engines and large heterogeneous packages. Our newest lithography tools deliver high-resolution imaging across a very wide field of view, which is proving to be a key enabler for next-generation packaging technology for larger advanced packages.

We have started shipping our backlog and have received an additional 4 orders for shipment in first half of 2022. Our total lithography backlog is now over $30 million, and we expect to close 2021 with several more tool shipments and a fully booked production schedule for 2022. We're working closely with our customers and suppliers to determine additional capacity needs for 2023.

Revenue to support both power and 5G applications increased to over $24 million in the second quarter. This included demand for our inspection systems, new overlay metrology from our acquisition of Inspectrology and strong demand for metal film metrology. This also included the addition of 4 new RF and power customers, which we expect will contribute to our projected stronger half of the year.

Turning to the advanced nodes. In the second quarter, we set a quarterly revenue record for our flagship Atlas OCD metrology platform. This record demand was primarily in support of expansions for leading-edge DRAM and logic devices where our greater sensitivity provides a central metrology for a growing number of critical dimensions at speeds required for volume manufacturing.

We expect demand for our Atlas OCD to continue to strengthen in the second half of the year, both to support additional investments in advanced logic and DRAM and an increase in the number of applications on our tools in support of higher yields. Even as demand for our core products hit record levels to support overall market growth, we're enabling future growth by expanding our position in new markets such as planar films and high aspect ratio metrology for 3D NAND.

We're also seeing revenue synergies in specialty markets as we introduce our metrology suite to these customers. For example, in the second quarter, we received orders for our latest film system from 6 new customers in the specialty device markets. These orders will ship in the second half of 2021. And including projected repeat orders from our first customer, we expect second half growth of our planar films to be over 50% from the first half, providing nice momentum into 2022.

And finally, I wanted to also highlight our ongoing commitment to raising our corporate and social responsibilities by becoming an affiliate member of the Responsible Business Alliance. We are already actively committed to responsible environmental and social policies, but our membership in the Responsible Business Alliance is another important step forward.

By joining our fellow members of the RBA, we will serve an as example to our suppliers of how the RBA code of conduct can create a more successful industry climate and a better world. I will now turn the call over to Steve Roth, who will cover the second quarter financial highlights, before I provide some color on our third quarter. Steve?

[Steven Roth, executive]

Thanks, Mike, and good afternoon, everyone. In my remarks this afternoon, I'll provide some details on our Q2 results, then follow that with what we're seeing for guidance for the third quarter. As Mike mentioned, our second quarter revenue was $193.4 million, up 43% over the same period last year and up 14% over last quarter.

During the quarter, we received approval from the U.S. government to ship certain systems that we had in backlog since the end of 2020 to a customer in China. Those shipments totaled $13.1 million in the quarter. Due to a delay in getting this approval, our customers' ramp plans and their customers' orders shifted downward, and we agreed to cancel a portion of the original order totaling about approximately $8 million and redeploy those systems to other customers.

We still have other systems awaiting government approval, which at the end of the second quarter totaled approximately $7.3 million. Breaking down the revenue by market, 48% of the sales were from our specialty device and advanced packaging market, with strengths coming from RF and power markets, which combined were up 200% over the first quarter. The advanced node market represented 33% of sales in the quarter, down from Q1. While we did see growth in memory, both DRAM and NAND, those increases were offset by a temporary pause from logic customers.

Finally, software and services increased slightly in the quarter and represented 19% of revenue. Our gross margin continued its strong quarter-over-quarter performance, increasing to 55% compared to 54% in the first quarter. Higher revenues covering our fixed manufacturing costs and product mix helped offset supply chain cost increases in the quarter and drive the gross margin improvement.

Second quarter operating expenses were $55.8 million, an increase from $49.2 million in the first quarter of 2021. This unusual increase in operating expenses was mainly due to our variable compensation plans now forecasted to far exceed targets as well as -- and as such, we had to true-up our accruals, including a catch-up of the Q1 shortfall.

In addition, stock-based compensation expense was higher in the quarter due to annual employee grants and headcount increase to support growth we are seeing now and in the future. Even with the increase in operating expenses, our strong financial model resulted in an increase in operating margin to 26%, up from 25% in the first quarter. In fact, our operating margin has improved every full quarter since we completed the merger of Rudolph and Nanometrics, and we feel confident in achieving our long-term operating model, which at a revenue level of $800 million, calls for gross margins of 55% to 56% and operating margins of 29% to 30%.

Net income increased in the second quarter and was $45.9 million or $0.92 per share and above the high end of our guidance. In the 2021 first quarter, we reported net income of $36.3 million or $0.73 per share. Moving to the balance sheet. We ended the quarter with a cash position of $411 million, up $18 million from Q1. Accounts receivable increased to $175 million in the quarter due to an increase in revenues and the linearity of our shipments, which were heavily weighted to the back half of the quarter. Our inventory turns improved in the quarter. However, overall inventory increased slightly and ended at $207 million.

Now turning to third quarter guidance. We expect revenue to be in the range of $190 million to $200 million. Earnings per share in this revenue range is anticipated to be between $0.85 and $0.99 per diluted share. We also expect our gross margins to be between 54% and 56%. For operating expenses, the compensation plan true-up I just discussed should have minimal impact on our quarterly operating expenses going forward, but we will continue to have active recruiting plans in place for the strong growth we are seeing. Therefore, we anticipate operating expenses to decline in the third quarter and be in the range of $52 million to $54 million.

And with that, I'll turn the call back to Mike for additional insight into Q3 and the remainder of 2021. Mike?

[Michael Plisinski, executive]

Thank you, Steve. We entered the third quarter with strong momentum across all of our markets and strategic initiatives, which include continuing to increase operational efficiencies to further strengthen our foundation for sustainable growth. We have a record backlog and visibility out to early 2022. So even with our strong results for the second quarter, we remain confident in the expectations set last quarter for continued growth in the second half, with the fourth quarter stronger than the third.

Specifically, for the third quarter, we expect spending on logic to increase significantly in support of additional expansions by several logic suppliers in the second half of the year. We see continued strong demand from packaging and RF customers in the third quarter and expect a sharper increase in the fourth quarter as our expanding number of customers increased their investments in 5G to support new applications and infrastructure and transportation in addition to the current growth in mobile applications.

We expect memory overall to decline in the third quarter with DRAM spending to pick up significantly in the fourth quarter to support investments from leading suppliers. With the continued growth we see for the second half of the year, our supply chain team is increasing their focus on deliveries and supplier backlog from each of our supplier partners to minimize impact to our customers.

As I mentioned earlier, our growth is not only driven by the surging demand for our products in existing markets, but also the progress we are making expanding into new markets, such as the image sensors, plainer films, panel packaging and high aspect ratio metrology. In total, these initiatives expand our served markets by over $350 million, creating additional revenue opportunities for 2022 and beyond.

And with that, we'll open the line for questions from our covering analysts. April, please go ahead.

[Operator]

[Operator Instructions] And we'll hear from Patrick Ho of Stifel.

[Patrick Ho, analyst]

Congratulations on a really nice quarter and outlook. Mike, maybe first in terms of the advanced packaging market, there's clearly a lot of growth opportunities, particularly at the most leading edge. You're seeing some of the top chip makers talk about their opportunities in advanced packaging. Can you give a little bit of a highlight of one of those opportunities on a big picture basis? And two, how they, I guess, come together in some of your volume purchase agreements that you've talked about it in the past, are you getting more of those because you're able to leverage kind of a one stock [indiscernible] some of the AP processes are becoming?

[Michael Plisinski, executive]

So Patrick, you broke up a little bit, but I think I understand the gist of your question. So from an AP -- from a packaging perspective, the demands are increasing across a variety of different applications. And the leading manufacturers, the leading IDMs are certainly investing significantly more R&D dollars and capital dollars towards expanding advanced packaging technology and capacity.

From a volume purchase agreement, you're right. These top IDMs, where we're also gaining traction with our metrology platforms on the front end, they're also seeing the opportunities on the back end, and we're able to leverage the increased volume, the similar service organizations. During COVID, we cross-trained a lot of our service and support organization. So we now have significantly better coverage with a lot of overlap and capability, so they can see benefit and service and uptime and the capabilities of buying from Onto as a supplier. And that gives us some benefit to offer customers as we look and negotiate volume purchase agreements going into 2022.

[Steven Roth, executive]

For sure, that's the case.

[Patrick Ho, analyst]

Great. That's helpful. And maybe as my follow-up question for Steve. First off, Steve, given your recent announcement, I want to, again, wish you the best of luck. It's been a pleasure all these years working with you. And I think going forward, I'll be 1 less person to harass you. So thank you again.

[Steven Roth, executive]

Thanks, Patrick. Thanks for the words.

[Patrick Ho, analyst]

Going to the near-term environment, given your results and outlook, you obviously managed the supply chain very well. The entire industry is going through constraints right now to varying degrees. Given your results and outlook, what have you been able to do differently from other equipment companies, with the full understanding that each equipment company is very different. Their supply chains are different and the types of components there are in short supply are also different. So if you could just give a little bit of color on what efforts you've done to mitigate the situation?

[Steven Roth, executive]

Yes. It's a good question. I mean, I think a lot of congratulations goes to our supply chain team. They've been doing a great job of just keeping a finger on the pulse of where we are seeing some of the component and assembly delays, but we've been able to manage through them for the most part. I think we're obviously seeing stuff on the logistics side and just getting material to us. So in some cases, I mentioned a little bit of offsetting pressure on our gross margin, but that was really to cover expedited charges and things that we've been paying a little just to reduce transit time and make sure we get our stuff in on time.

So doing that as well as obviously looking out a little further and making sure that we're -- making sure we have adequate stuff on the books for the growth that we're seeing. So I think we've been doing a fairly good job of managing it, not that we're not experiencing it, but I think we've been doing a good job of managing it overall.

[Operator]

Quinn Bolton of Needham & Company.

[Quinn Bolton, analyst]

Congratulations on the nice results. And Steve, I'll say the same, congrats and best wishes to you. I wanted to start with just sort of the visibility that you have into the second half, sounds like Q3 up over Q2, Q4 up again. As you look at WFE, I think many analysts predict WFE up 30-plus percent, maybe even into the mid-30s. And based on your visibility right now, wondering if you think overall product revenue at Onto will sort of keep pace or perhaps even outperform that WFE level in 2021?

[Michael Plisinski, executive]

Yes. So Quinn, we believe that we'll be outpacing the WFE. If you look at the expanding capital intensity for our Atlas metrology platforms and the advanced nodes and we look at the different applications we see happening on the advanced packaging front, and then combine that with the new market expansions that we're only in the early stages of gaining traction. We look at all that combination and some of the guidance we've given would indicate that we're fairly confident in outperforming a 30% kind of WFE number.

[Quinn Bolton, analyst]

Great. And second question, as you're going through the comments looking into Q3, Q4, it sounds like you saw memory picking up in the fourth quarter. It sounds like that's driven more by DRAM, but wondering if you had any thoughts on the NAND outlook, Q3, Q4?

[Michael Plisinski, executive]

For us, we see the NAND softening in the second half. So despite all the strength, that is probably the one market that we've seen -- that we see softening a bit going into the second half, and it's roughly equal from what we can tell. Comes down and then stays at that reduced level quarter-over-quarter...

[Quinn Bolton, analyst]

Got it. Sorry, for Steve, on the litho. The litho backlog up nicely again this quarter. As you start to ship those systems, I know that carries -- those systems carry lower gross margins. Any concerns that, that could pull you below the 55% to 56% level that it looks like you're going to be getting pretty close to on a quarterly basis to that $200 million quarterly run rate, probably either at the high end of guidance for Q3, but if not, then definitely Q4.

[Steven Roth, executive]

Yes. So that's a good question. For Q3, I'm not concerned. We just started shipping systems. They're new systems. So we're going to have some rev rec things that are going to delay probably. When those tools get recognized, I don't anticipate the tools being recognized in Q3. Q4, we got to see how the mix shapes up, but we could actually have a slot of tools if they actually all were to get recognized in Q4, could have some pressure on the margin. The overall model anticipates litho with the lower margins built into it. So it just be -- might be a question if they back up onto 1 quarter, that might have the 1 quarter impact. But overall, the model does include litho with those lower than normal margins.

[Operator]

And next, we'll hear from Craig Ellis of B. Riley Securities.

[Craig Ellis, analyst]

Congratulations on the strong performance. Mike, I wanted to start off with you and go back to a point in the press release and from your script. I think the SAM expansion opportunity that you scoped was scoped at $350 million. But in my notes, I have that at $260 million. So maybe my historic notes were incorrect. But I think what's happening is that SAM expansion opportunity is growing, and that's really what the question centers on. As you are moving through calendar '21 and approaching calendar '22, do you actually see a larger SAM expansion opportunity in front of you than what you were seeing 6 to 9 months ago?

[Michael Plisinski, executive]

We do. We do in panel-level packaging, which is one of the areas. We see a little bit more in the CMOS image sensor, but the biggest probably shift is also on the planar films. So that's another area where we're starting to see a little more demand, not just in the traditional markets, but also in the specialty device markets. We didn't appreciate just how much opportunity there was there. And as we started to leverage our broader channels, our broader sales channels, the opportunities have been very positive. The customers have been very receptive to the new products.

[Craig Ellis, analyst]

Got it. Got it. And then, Steve, I'll do a follow-up with you. So if I were to annualize the current quarter's revenue guidance, I get something that is close to $800 million, not quite there, but close. And the gross margin is very close to the target, but it looks like operating margin has a bigger gap to target. So I'm just wondering if you can walk through some of the things that will be needed to close the operating margin gap from where we are now to target levels at 29.5%.

[Steven Roth, executive]

Yes. So the only -- the thing that's throwing you off a little, Craig, is that the -- as I mentioned in my prepared remarks, the comp plans, the variable comp plans are running well above 100%. And the model assumes they're at 100%. So there's a lot of catch-up entry going on in the quarter. That's throwing that off a little bit. But -- so that's why I say I'm confident if you were to back out that run rate. As a run rate, you'd actually be very close to the long-term model.

[Craig Ellis, analyst]

Great. And then lastly -- and I'll keep it there. And before I ask the last question of you, Steve, I just want to join the group in echoing the thanks for all the help over the years. You've been tremendously valuable, not just with Onto, but with the broader industry. And I greatly appreciate that and wish you well.

But as we look at the next milestone now that we're really at the midpoint gross margin target looking up to the next level, which is 56.5%. Is it about an equal contribution between mix and volume that get us there? Or what are the ingredients that take us to your 56.5% target from today's levels?

[Steven Roth, executive]

Yes. It's just keeping the standard mix of metrology inspection. Obviously, litho is built into that, too. So it's really just to keeping a somewhat growth across all the segments, given that Mike talked about where you see a lot of the growth. You keep that proportionally up, you start leveraging up into those numbers that you see in the next level of our long-term operating model.

[Operator]

Next, we'll hear from Tom Diffely of D.A. Davidson.

[Thomas Diffely, analyst]

First, Steve, I'm very sorry to see you go. You've been the one constant in the 20 years I've been in this business, and I'll miss our chats. So maybe starting with you. When you look at the supply challenges you've seen over the last few quarters, how would you characterize the transition of the model, the move of them? Are they getting better? Are things getting resolved? Is it getting worse? How do you view the supply chain issues?

[Steven Roth, executive]

Yes. I'd say right now, we're kind of -- I don't see them getting worse right now. I think they've been on kind of a level. I think initially, it was you saw it in the extended kind of logistics side of the shop first, where you saw freight taking longer to get stuff here, especially, we bring a lot of stuff in over through container ships. And so I think we initially saw that. I think it evolved a little bit. Obviously, you hear it among other people to a lot more on the one component side, maybe assemblies. And even our suppliers' suppliers is where we're really seeing -- we're constantly with our suppliers trying to make sure they're testing where they're getting their stuff from because we're seeing a couple, like, I'll call it, Tier 2 issues that are causing our vendors to deliver to us on time.

So I think that is probably what it's evolved to. But I would say it's kind of in -- at least over the last month or 2, it's kind of leveled out. I haven't seen it getting dramatically any -- dramatically worse.

[Thomas Diffely, analyst]

Okay. That's quite helpful. And then, Mike, when you look at the long-term drivers in your market and your products serving those markets, what do you think the natural split between specialty and advanced nodes is for you?

[Michael Plisinski, executive]

Over time, I think we're going to continue to be right around that 50-50 mark. Right now, we're 60-40, where specialty and AP is a bit stronger. But as the expansion of our new metrology suite continues, I'd expect that to balance out. So we'll alternate quarter-to-quarter, but I would say that when we look out 4, 5 years and full adoption of these new products and additional new products, new markets and expansions, I'd guess that we're going to maintain this 50-50 kind of split, maybe slightly tied to the advanced packaging specialty just because we have more products that play into that in a bigger way, and that's growing fairly aggressively right around that level.

[Thomas Diffely, analyst]

Okay. That's helpful. So would you say over the next year that perhaps the biggest drivers is just all the products you have that serve this emerging foundry war that's going with the leading edge?

[Michael Plisinski, executive]

Not just that, but also the planar films and some of the new market opportunities we're seeing for the aspect or the IRCD metrology for 3D NAND, high aspect ratio metrology. I think we're opening up the doors to some markets we didn't participate in, in advanced nodes in the past. So I think that's going to drive some outsized growth for us in advanced nodes, while at the same time, we have the growth on the advanced packaging and specialty.

[Operator]

[Operator Instructions] Next, we'll hear from David Duley of Steelhead Securities.

[David Duley, analyst]

Congratulations on strong results. And Steve, congratulations on your retirement, and good luck to you on everything. I guess my first question involves, can you just help me with what the TAM of the planar films business is of this new $350 million that you're referring to?

[Michael Plisinski, executive]

So it's about $200 million of that. So it's about half of the overall planar films. Remember, we split it into the really critical films, some ultra-thin films and then some more standard planar films. And right now, our products are better suited for the common films. It is about half of the overall planar films market.

[David Duley, analyst]

Okay. And do you have a revenue target perhaps you could share with us for this product, either this year or next year? Or help us frame how big of an opportunity it is for you in the near term?

[Michael Plisinski, executive]

Steve, how would you frame that? So we've -- I mean, we gave you some level of hints on momentum. So we talked about it growing about 50% in the second half. We said an achievable goal would be $50 million by the end of, I believe we said 2022. So you can see that as kind of the momentum. If you're thinking about we start at 0 at the beginning of the year or maybe a couple of million in the first quarter, or end of the last year, then you can see that trajectory can probably come up with a model.

[David Duley, analyst]

So $50 million would be the total over 2 -- over 2022 and '21? Or that's what you might expect for 2022?

[Michael Plisinski, executive]

That would be -- that's what we said we would -- we could achieve when I was pressed a couple of quarters ago. That's what we could achieve as we look out 1 or 2 years. It was not cumulative as on an annual basis.

[David Duley, analyst]

Okay. Great. And then as far as the advanced packaging inspection business, could you -- you gave us some great statistics about how much it was going to be up in the back half of the year. How much do you think it will -- when you look at that prediction, what will be the growth rate for all of 2021 for that business?

[Michael Plisinski, executive]

We didn't break it out, but it would be -- we grew, I believe, over 20% last year, and we'd be growing similar levels this year.

[David Duley, analyst]

Okay. And then final question for me has to do with the advanced packaging lithography business. Congratulations on, I think you mentioned you got 4 additional orders. So the $30 million backlog is a great achievement. Can you -- you mentioned your slots are full through 2022. So if your slots are full, then you kind of know, if you execute, what your revenue will be. Maybe you could share, do you think you can ship all of this $30 million backlog? Or what are -- how should we think about the revenue potential of this business over this year and next year?

[Michael Plisinski, executive]

Yes. We'll provide that guidance as we get closer to it, but I never -- I didn't say -- just for a correction, I didn't say the slots were full. I said we expect to end the year with full slots for 2022. So we're continuing to build the backlog. Now that backlog includes shipments we plan for this year as well as shipments expected or slots available for next year. And we expect that with the engagements we have to close out the open slots for 2022, well ahead of the end of this year. So they're not closed yet.

[David Duley, analyst]

Okay. And then, I guess, theoretically, if you do close all your slots, how should we think about the revenue potential for the advanced -- for the lithography business, either this year or next year? Or however you can help us frame it at this point?

[Michael Plisinski, executive]

Really good. I'd say you can look at the $30 million and consider that a pretty decent bottom estimate, and then we should be above that if we do succeed in filling all of the -- all of those slots.

[David Duley, analyst]

And I guess the core reason that this business has all of a sudden taken off is you've got multiple customers that have moved into actual production with your tools?

[Michael Plisinski, executive]

Well, we just shipped the first one. We have multiple customers planning to move into production. Yes.

[David Duley, analyst]

And again, congratulations on nice results.

[Michael Plisinski, executive]

Thank you.

[Operator]

And there are no further questions at this time. I'll turn the call back over to Mike Sheaffer for any additional or closing comments.

[Michael Sheaffer, executive]

Thank you, April. As a reminder, we will be participating in the B. Riley Summer Summit on August 18 and Needham Semi Cap and EDA Conference on August 24. We'd like to thank everyone for participating in the call today and for your interest in Onto Innovation. That concludes our remarks for the call. April, please wrap up the call.

[Operator]

Again, that does conclude today's conference. Thank you all for your participation. You may now disconnect.