Onto Innovation Inc

NYSE:ONTO

Earnings Call Transcript 2018-Q4

[Operator]

Good day, and welcome to the Rudolph Technologies Fourth Quarter and Full Year Earnings Release Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mike Sheaffer, Senior Director, Investor Relations. Please go ahead, sir.

[Michael Sheaffer, executive]

Thank you, Lauren, and good afternoon, everyone. Rudolph issued its 2018 fourth quarter and year-end 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 at investors.rudolphtech.com, 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 is always the case, I need to remind you of the safe harbor regulations. Any matters today that are not historical facts, particularly comments regarding the company's future plans, objectives, forecast and expected performance, consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such estimates, whether expressed or implied, are being made based on currently available information and the company's best judgment at this time. Within these is 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 actual results to vary materially. Thus, the company cautions that these statements are no guarantees of future performance.

Risk factors that may impact Rudolph's results are described in the company's latest Form 10-K as well as other periodic filings with the SEC. Rudolph Technologies 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. A detailed reconciliation between GAAP and non-GAAP results can be found in today's earnings release.

Now I would like to turn the call over to Michael Plisinski. Mike, please go ahead.

[Michael Plisinski, executive]

Thank you, Mike. Good afternoon, everyone, and thank you for being on the call today. I'll start off today with an overview of the fourth quarter, then summarize highlights from the full year. After that, Steve will provide financial highlights for the fourth quarter and the full year. Finally, I will wrap up with our outlook for the first quarter of 2019, and at that point, we will open the lines for your questions.

So let's begin with the fourth quarter. As most of you have seen from our earnings release, we closed the quarter with revenue of $62.8 million, which was at the midpoint of our guidance. In spite of the industry headwinds, our fourth quarter revenue grew 4% over both the previous quarter and the fourth quarter of 2017. Earnings for the fourth quarter came in at $0.29 per share, near the high end of our guidance. It was clear from our guidance in November that the quarter was going to be constrained by the pause in capacity expansions from our customers in China and the lower CapEx numbers that were being forecast by our memory customers.

After our guidance, we experienced the softening of the smartphone market and increased macroeconomic concerns. But despite those market declines, our inspection revenue increased 20% over the third quarter, making up for a decline in our metrology business.

Most of the inspection gain came from our largest market, advanced packaging, where we enjoyed multiple wins with our existing NSX and new Dragonfly G2 product lines. These orders came from a variety of customers and applications, including copper pillar wafer-level packaging, RF communications and automotive. For example, a top 3 OSAT selected Rudolph's Dragonfly G2 system over the incumbent technology from multiple existing and new applications, including 3D metrology of the copper pillar interconnects. In this application, the quality of the measurements is a more critical deciding factor than the price of the tool as the 3D metrology data generated will directly impact package yields, which can include many dye, not just the one being measured.

These interconnects have been moving from 50-micron bumps to 20-micron copper pillars, and now we are seeing customers with 5-micron micro bumps. Measurement repeatability of plus or minus 2 microns might be okay for a 20-micron pillar, but will be totally unacceptable for a 5-micron micro bump. Rudolph's 3D metrology provides new levels of measurement capability, and we further augment this with our Discover software, which can quickly analyze up to 50 million interconnects per wafer and return judgment on dye coplanarity as well as potential process problems upstream.

In fact, our software solution saw multiple wins in the quarter from a wide range of customers that include memory fabs, 3 RF fabs and an automotive customer expanding across multiple locations globally. Using the power of big data architectures and our advanced analytics, we are helping our customers to achieve their vision to drive defect levels down to the part per billion level. As a result of these orders, our software was 12% of revenue for the quarter.

Another highlight for Rudolph was the announced win from a top 3 memory manufacturer aggressively transitioning high-end DRAM from wire bonded to copper pillar connections. The order included both legacy and new inspection systems, totaling $15 million. The shift from wire bonding is required to achieve higher data speeds and superior power distribution on thermal properties by using smaller and denser interconnects such as the copper pillars micro bumps and through-silicon vias for stack dye. We believe many advanced DRAM products will make this transition over the next 3 to 4 years.

Also in the fourth quarter, our recently announced NovusEdge product brings our macro inspection expertise from -- to the wafer manufacturing market, which Rudolph had not previously served. This system inspects the thin edge of the wafer to detect micro-cracks that can propagate into the interior of the wafer during fab processing, resulting in failed dye. The NovusEdge system also inspects the backside of the wafer for sub-micron particles that create yield issues for EUV lithography and potential downtime while the tool is being decontaminated.

We are quite pleased that the initial orders for $3 million from 2 customers were quickly followed by an additional $12 million of orders in the fourth quarter from 2 additional customers and repeat sales. We expect to ship all these tools in 2019, and we'll continue to work with these customers to expand the application of this technology into other parts of the process.

Summarizing 2018. The first half of the year, Rudolph was up 18% year-over-year and accelerating with the second quarter, representing a new record revenue of $77.5 million. The second half quickly declined with the slowing memory market, followed by slower-than-expected refresh in the smartphone markets, which created excess capacity in the fourth quarter. However, despite this rapid change in our markets, Rudolph completed our fourth consecutive record year, coming in at $274 million.

In addition, the company set another record for net earnings at $1.57 per share, which was 30% above the previous record of $1.21 per share set in 2017. Gross margin improved to 54%, and our cash remains strong at $175 million after a $21 million stock repurchase in the fourth quarter. We achieved this while continuing to increase R&D spending for market share expansion and TAM expansion, such as our lithography program for high-resolution mobile displays.

China continues to be an important region for Rudolph with 76% growth in 2018 and a 54% CAGR since 2015 from both domestic and multinational companies expanding in the region. The orders we experienced in 2018 matched our global markets and came from memory, RF, MEM sensors and AP customers for wafer applications.

In addition to the market diversity, we expanded our product diversity in China with initial sales of fabwide software and a lithography tool for advanced packaging. Our fabwide software was selected by multiple domestic factories to accelerate yield and improve ramp times. Our JetStep System was delivered to a domestic Chinese OSAT for fan-out of mobile phone processors serving the domestic mobile phone manufacturers.

Our focus on increasing the pace of innovation continues to gain traction. We are exiting 2018 with new macro inspection products for 2D and 3D, advanced packaging applications and a new macro inspection product for wafer manufacturing. We are delivering the industry's fastest 3D metrology capability, and more importantly, the accuracy and repeatability performance has also increased. Though lithography was flat year-over-year from a revenue perspective, we did see record numbers of customers visiting our lithography facilities to run both panel and wafer applications on our JetStep Lithography System.

Based on the level of activity we see in advanced packaging lithography, we believe 2019 will be a stronger year for our lithography business, despite general market headwinds that we see -- and we see growth continuing into 2020.

With that, I will now turn the call over to Steve, who will cover the fourth quarter and full year financials in more detail. Steve?

[Steven Roth, executive]

Thanks, Mike, and good afternoon, everyone. In my remarks this afternoon, I'll provide some details behind our Q4 and full year financial results and also provide some guidance on operating expenses for the first quarter of 2019.

Let's get into some details. Fourth quarter revenue was $62.8 million, up 4% from $60.4 million in the 2018 third quarter and up from $60.1 million in the prior year quarter. For the year, 2018 revenues was $273.8 million, up 7% from $255.1 million in 2017.

During the quarter, we saw strength in our memory and new bare wafer markets that were offset by a decline from our foundry customers. Our process control sales, which include memory and inspection solutions for front-end and back-end applications, increased quarter-over-quarter and accounted for 86% of revenue in the quarter. The increase is mainly driven by our recently announced new Dragonfly G2 and NovusEdge products.

As Mike mentioned, our software group had strong sales in the quarter, representing 12% of revenue for the quarter. It was a great recovery year for our software group with that business growing 14% year-over-year.

Finally, we did not ship the lithography tool in the quarter, as the potential shipment was pushed out to the first quarter of 2019. From a market mix perspective, our business was split 55% back-end and 45% front-end.

Moving to gross margin, our gross margin remained flat with the prior quarter at 52%. We have been able to maintain our margins even at these lower revenue levels due to the strong performance of our software products, offsetting lower product sales with other aspects of the -- in other aspects of the business. For the year, our gross margin was 54%, up from 53% in 2017 and was driven by higher software and metrology sales as well as the display systems sold earlier in the year.

Looking at the details of our operating expenses, fourth quarter total operating expenses was $21.8 million, down from $22.2 million in the third quarter and below our previous guidance. R&D for Q4 was $11.9 million, down from $12 million in the 2018 third quarter.

SG&A for Q4 was $9.9 million, down from $10.1 million in the previous quarter. The decrease in SG&A was primarily due to lower reserves for uncollectible accounts, mainly from China customers.

Looking ahead to the first quarter of 2019, we typically see an increase in operating expenses, as incentive compensation plans as well as payroll taxes reset. In addition, we continue to expand on our investments in our display program. As such, we currently anticipate first quarter operating expenses to be in the range of $22.2 million to $23.2 million. Net income for the fourth quarter was $9.2 million or $0.29 per share and at the higher end of our previous guidance. That compares to $8.5 million or $0.26 per share in the 2018 third quarter.

In the full year, net income was $50.6 million or $1.57 per share compared to $38.9 million or $1.21 per share for 2017. The year-over-year increase was primarily due to higher revenues and a lower effective tax rate.

Now turning to the balance sheet. We ended the quarter with cash and marketable securities totaling $175.1 million. On our third quarter conference call, we noted that in the beginning of the fourth quarter, we completed the purchase of shares under our previously board authorized stock repurchase program. In addition, we noted that our board had authorized a new $40 million plan. During the quarter, we repurchased $21 million of our stock under both these plans. Those purchases were the main contributor to the decrease of cash for the quarter.

For the year, we generated approximately $28 million in free cash flow, while still investing heavily in our display initiative. Accounts receivable decreased in the quarter to $64.2 million from $68.5 million in the third quarter, as several older receivables were collected. Inventory increased to $96.8 million from $91.4 million in the third quarter, primarily due to increases in our lithography inventory.

And finally to wrap up, capital expenditures were $3.4 million for the quarter and $7.5 million for the full year. Depreciation expense for Q4 was approximately $1.2 million.

With that, I'll turn the call back over to Mike for comments on the next quarter. Mike?

[Michael Plisinski, executive]

Thank you, Steve. Looking ahead, we see megatrends such as autonomous driving, artificial intelligence, IoT and 5G communications continuing to drive demand for increased chip contents across a wide range of products and data centers. We see AI applications and the optimized hardware to run them, increasing as market strive to monetize the vast amounts of data being collected by the increasing number of mobile devices, which is now estimated by GSMA Intelligence to be over 5 billion devices worldwide.

These billions of devices increased in value with the data they provide and the speed at which it can be provided. The promise of 5G wireless to deliver up to 10x faster download speeds is encouraging wireless carriers to begin the careful rollout of these base stations in select cities in the U.S. and we see more aggressive rollouts from China.

As the proliferation of the base stations widens over the next several years, the automotive market will potentially see another wave of applications, as driver-assisted functions move to more autonomous driving by adding additional communication. For example, 5G could reduce emergency braking latency from 9 milliseconds to less than 1 millisecond.

Rudolph continues to strengthen our position in these markets by providing integrated process control equipment and software to help manufacturers attain new standards of quality. Quality of measurements and the speed at which decisions can be made often define success or failure of the products. In the case of the automotive within the healthcare industry, it can be -- it can have even more serious consequences. The Rudolph team is proud to be engaged with our customers to deliver solutions that limit critical failure and enable these future capabilities. For example, today Vision Zero describes one of the largest objectives in the automotive industry by making vehicles safe so that no serious or fatal accidents occur as a result of human error. Active systems such as pedestrian detection, adaptive cruise control, automatic braking, blind spot detection are no longer reserved for luxury vehicles and are becoming commonplace on midrange cars. This requires multiple known good devices to be worked in extreme conditions for years without failure. We see similar pressures on mobile consumer device manufacturers, which are driving quality standards from 1 part per million defect rates to now 1 part per billion defect rates.

Advanced packaging plays an important role in enabling future products with increased capability and smaller form factors with higher performance and higher reliability. Not only are we seeing more advanced packaging for mobile devices but also for high-performance computing and data centers, where performance gains are possible through 2.5D or full 3D packaging. We've discussed the growing move towards panel-level packaging and we see that technology playing a more critical role in leading-edge devices.

In the first quarter, we'll ship a JetStep 3500 to what will be our fifth-panel customer. This customer will be focused on a variety of end-use markets, using the panel technology for high-volume production of system and packaged devices. With Moore’s Law slowing as predicted, more applications are turning to advanced packaging to enable 2.5D system and package devices.

With a strong base of over 80% of the installed panel lines selecting Rudolph's JetStep, we feel good about continuing to grow as this market matures. However, we certainly see headwinds in the near term. We see the negative market dynamics coming from deteriorating macroeconomic conditions in China, where potential orders are being delayed by customers due to their uncertainty about the near-term demand. Smartphone and memory inventories are also contributing to an overall slowdown. For example, SK Hynix reported this week that their inventory levels had grown from 1 week in early 2018 to 3 weeks by the end of the year. As a result of macroeconomic concerns, they also pointed to lower server memory demand, as Internet data centers are now trying to optimize their existing infrastructure leading to a more conservative investment in memory.

Considering the first quarter is generally a soft quarter and these short-term headwinds, we expect Q1 to be in the range of $56 million to $63 million or down 5% at the midpoint. In this range, we expect earnings to be $0.19 to $0.25 per share.

Before opening the call to your questions, I'd like to provide a brief update on our Gen 6 display program. Our Gen 6 program continues to progress very well with the technical teams beginning to assemble a Gen 4.5 dual system, which will have the same optical bridge and control systems as the Gen 6. We expect to have G4.5, Gen 4.5 dual capability in demonstration in the summer, which represents another significant milestone in the program.

Commercially, we continue to engage with customers in China and recently, in Korea. After learning one of our Korean customers is using our previous-generation lithography tool for printing the critical layers on the iWatch forward display backplane, we've begun the process of sharing our roadmaps and capabilities with this Korean display manufacturer. However, our focus remains on the very dynamic market in China, as we continue to believe that to be the fastest path to a commercial partnership.

That completes our summary for the fourth quarter and the full year highlights and outlook into 2019. At this time, we'll open the line for your questions from our covering analysts. Lauren?

[Operator]

[Operator Instructions] Our first question come from Craig Ellis with B. Riley FBR.

[Craig Ellis, analyst]

Just wanted to start off with some clarification as it relates to the first quarter's guidance, and I'll start in the middle of the income statement. Steve, I think you mentioned that there were 2 drivers to a sequential increase in OpEx which looks like it's almost $1 million little bit short of that. Sounds like it's the typical FICA but also growth investments. Can you identify what the impact is from each of those, their relative contribution? And to what extent should we expect a further increase in growth investments to be part of the OpEx outlook for 2019?

[Steven Roth, executive]

So -- yes. So I gave a range on the OpEx of $22.2 million, which off of a $21.8 million a quarter would only be up $400,000, so that's the low end of the range. And then -- yes, and you're right, up to $23 million. So obviously, typically, you're right, FICA resets and those things. So from a salary perspective, our payroll taxes jump up. And also typically, we're redoing our incentive compensation plans and resetting them, obviously, they're set with financial goals and obviously going to the first quarter, we believe we're going to hit our financial goals. So we're accruing those at 100% and then, as the year goes by, we adjust. So that's why typically, you see a relatively larger jump up in the OpEx in Q1 because of those dynamics. And they hold a little bit through Q2 for sure, then the FICA starts to drop off. But I don't have the split -- maybe half of each, depending on where you pick the range on the OpEx uptick.

[Craig Ellis, analyst]

Yes, that's helpful. That's what I was looking for. And then the follow-up is with -- is related to the sales line. So as we look at the first quarter guidance, should we expect that, that -- that the litho tool that I think you expected might rev rec in 4Q as rev rec-ing in 1Q? And if you could give us some color on the positives and negatives in the first quarter versus what you saw in the fourth quarter for software metrology, et cetera, that would be quite helpful.

[Steven Roth, executive]

So I'll talk to the litho tool. Yes, the tool that we thought was possible for Q4 I mentioned pushed into Q1. We expect that to rev rec in the quarter for sure. So that -- you -- from my perspective, I would say that we're going to have at least 1 litho tool in the quarter.

[Michael Plisinski, executive]

So you wanted to understand -- sorry, Craig, I was trying to understand...

[Craig Ellis, analyst]

Yes, so the rest of the question...

[Michael Plisinski, executive]

What was going with the software?

[Craig Ellis, analyst]

Well, I was trying to understand what some of the gives and takes were. Clearly, you've got a positive variance sequentially in the litho business, but what are the -- what's happening elsewhere?

[Michael Plisinski, executive]

Yes. So the inspection business looks like it'll stay strong. We mentioned that in the fourth quarter, we went up 20% over the third quarter. We expect to continue at that level. Metrology is coming down somewhat. I think that's not unexpected. And then the other -- and again, we have added the lithography, but the other, let's say, change from the fourth quarter is NovusEdge. We had NovusEdge in -- a number of the AWX and NovusEdge products ship in the fourth quarter, and we expect fewer of those in the first quarter. So that basically is the shift. And from a software perspective, we think that will be relatively the same, maybe a little lower, but more or less flat quarter-to-quarter.

[Craig Ellis, analyst]

Following up on that last cormorant, Mike. I know that you made some organizational changes there some time ago, the business grew 14% last year. Are you pleased with the internal operations of that business and where it is with its customer engagements in its funnel or is there still more work to do?

[Michael Plisinski, executive]

No, I'm pleased with -- there's always more work to do, so don't get me wrong there. But I'm pleased with the progress that's being made. We're certainly avoiding surprises, so that's always a positive. We have a decent pipeline that's continuing to grow and now it's about driving -- continuing to drive the execution. But I think what the team was able to accomplish in 2018 is going to carry forward into 2019, and we'll see continuous improvement in '19.

[Operator]

We'll take our next question from Patrick Ho with Stifel.

[Patrick Ho, analyst]

Mike, maybe first off on your comments in the prepared remarks regarding the litho AP JetStep outlook, where you believe it will be stronger in 2018. I guess, two parts. One, what do you believe will be the application drivers? And secondly, do you believe it'll be driven more by panel than wafer or do you see it being, kind of, equally distributed between the two formats?

[Michael Plisinski, executive]

For us, we see definitely more panel business driving our lithography opportunities. I think that's where we're positioned the strongest and we're seeing a lot of investments increasing in that area. I think 2019, we'll see a steady flow and then, we'll see some level of ramping, and I'd say, borderline aggressive ramping in 2020. From the applications' perspective, I mentioned panel, and it's mostly 2.5D system and package type applications, more on the advanced side of the house. Logic and memory or multiple processors being -- creating for instance, RF modules, things like this, automotive modules.

[Patrick Ho, analyst]

Great. As my follow-up, in terms of the specialty devices market, you gave a little bit of color during the call regarding some of these MEM sensors and RF applications that you saw. Did you see the pickup that you expected in the second half of '18? And I guess, how do you look at 2019 as a whole for that group of products?

[Michael Plisinski, executive]

We expect -- we saw some pickup. It wasn't as big as we'd expected, that's for sure. They -- from -- in 2019, I think the jury is still out, we definitely see continued advancement on the, for instance, on the 5G side. We see continued advancement, continued investment, but not the big ramp that we were expecting. When the iPhone kind of struggled, we expected maybe some manufacturers would pull in some of their plans on 5G to try and drive 5G into the mobile markets more aggressively. But so far, we're not hearing anything like that. I think there's still a lot of work going on to prove-out the technology and to get that -- the base stations rolled out and the infrastructure rolled out. On the automotive side, I would say we're seeing some level of -- at least from the high end, from planning perspective, more aggressive planning but bad timing. So a lot of new fabs being discussed but fab timing is sort of second half '19 or fourth quarter '19 into 2020, where that falls out, it's not clear. What's driving it is, interestingly enough, a lot of emphasis on EV, on electrical vehicles. So we've always talked about infotainment and autonomous driving but we're seeing a lot more emphasis on electric vehicles, primarily because -- well, one of the reasons is because of the diesel situation, diesel crisis, diesel testing crisis from Europe. And a lot of the European cities are actually putting in some stricter regulations and to compensate for those stricter regulations, European car manufacturers are aggressively ramping up their EV vehicle programs. What that means for us...

[Patrick Ho, analyst]

Great and final question...

[Michael Plisinski, executive]

Sorry.

[Patrick Ho, analyst]

No, go ahead.

[Michael Plisinski, executive]

So what that means for us is we are surprised with how much silicon content goes into the control of the powertrains for these electric vehicles. So our power devices and then also the processors around battery regeneration, battery charging and things like this, there's quite a bit of silicon content that goes with it. And obviously, we have a good position in that market from a inspection and metrology and software point of view.

[Patrick Ho, analyst]

Great. Final question for me. With the strong traction you've gotten for NovusEdge to date, how fast do you expect the backlog that you've built to be turned around? Is it 3 to 6 months? And when you mentioned new applications that you're going to be introducing for NovusEdge, is this one where you're targeting existing customers and giving them more application and maybe giving them some add-on features? Or are you also trying to target new customers with some of the applications you discussed?

[Michael Plisinski, executive]

So the backlog is for the full year. We have some suppliers or long lead time parts that are driving that backlog so -- or driving that refresh. I think we can continue to build on the backlog, but right now, our focus is trying to drive down the lead time so that we can get more out throughout this year. But right now, that's -- those are discussions we're having. As far as the new applications, the primary focus right now is within the existing customers that we've penetrated. They're actually driving the application of our tool and capability into new process areas. So we are helping them with that, there's some level of customization, mostly on a software and analytics side, but also some hardware. And that's opening up a number of new opportunities for us. The -- once we get that kind of settled and the lead times settled, then there -- we do think there's opportunities to take this into some other IDM, some of the wafer -- device manufacturers, chip manufacturers. But that's more of a 2020 focus, I would say.

[Operator]

We'll take our next question from Tom Diffely with D.A. Davidson.

[Franco Granda Penaherrera, analyst]

This is Franco in for Tom. I guess I just first want to talk about China. What were the contributions as a percentage of revenue this quarter and what do they do on a sequential basis?

[Steven Roth, executive]

So China for the quarter was about 17% of revenue.

[Franco Granda Penaherrera, analyst]

And then I guess, when you look at the softness in the region right now, what are you seeing in terms of spending of these customers in the current quarter? And then do you have any other visibility a couple of quarters out?

[Michael Plisinski, executive]

Well, we expect China to be relatively flat. I'd have to go look at what it is for this next quarter in particular. But over the year, we expect it to be relatively flat from the high that we've had in 2018. And again, it comes -- we sold into a broad range of customers. Some of those customers are expanding, others are trying to ramp their yields and still others are looking for customers. So this sort of runs the gamut. But the customers that are expanding are still continuing to move forward with their plans, and we are expecting repeat business from those customers to the extent that we should see roughly equivalent levels as we have this year, in 2018.

[Franco Granda Penaherrera, analyst]

Okay. And then I guess, moving over to the software side. You've had a particular strength in the software business, going up to 12%. What do you think the current dynamics are there and then -- till the rest of the year? And where do you expect that segment to go as a percentage of revenues to over time?

[Michael Plisinski, executive]

Well, let's talk about the dynamics first. So what we're seeing is an increased emphasis from customers to monetize their data and they're collecting a large amount of data within factories. And then with the consolidation in the industry, the interaction between those factories is a big gap, a dark space, so no one's connecting that data. We've announced products to connect that data going back 3, 4 years ago, maybe even longer. And so we had early adopters 2011, '12, and now we're seeing far more, basically customer pull for that capability. So deep analytics within the factory but then also across the supply chain. We see that creating an increased number of opportunities for the software team over the next several years.

[Franco Granda Penaherrera, analyst]

Okay. And then lastly from us, you talked about the timing on your Gen 4.5 is slated to be displayed this summer. When do you expect orders to start trickling in? And then moreover, what are the time lines for the Gen 6 tool is for you guys?

[Michael Plisinski, executive]

So the Gen 6 time line is still end of this year, maybe Q1 of 2020. So the Gen 6 time line is still relatively on track. The Gen 4.5 dual will prove-out a lot of the Gen 6 technology and concepts. So it'll be a relatively -- I'll say this and the engineers will get angry later, but a relatively smooth transition from the Gen 4.5 to the Gen 6. From an order perspective, revenue, we don't expect until 2020, so I'll be clear on that. We would expect to see at least an initial conditional purchase order this year in hopefully the first half of this year.

[Operator]

Our next question comes from Ed Roesch with Sidoti & Company.

[Edgar Roesch, analyst]

I had one follow-up on the China question earlier. The last quarter, you experienced mostly order push-outs, and I think only lost one to an outright cancellation. So just based on your comments that you should be flat this year with a pretty strong 2018, is it fair to say that that's still the case today?

[Steven Roth, executive]

For China specifically, you're saying, for the year?

[Edgar Roesch, analyst]

Yes. So is it mainly just push-outs, you haven't seen cancellation of orders pick up at all?

[Steven Roth, executive]

Yes. No, we have not seen cancellations, no, any further deterioration, I think to go back to Mike's comments, where we think by the time the year ends, we should be somewhere flat based on what we're seeing today.

[Edgar Roesch, analyst]

Got it, okay. And then a question on the G2 Dragonfly. I mean, orders for 12 machines seems pretty impressive, would you say that it outperformed your own expectations? And then if you could comment a little bit on the incrementality of that G2 versus what you had in the prior generation. If you have any color on that front, that would be great.

[Michael Plisinski, executive]

So I wouldn't say it's outperforming our expectations, I think it's somewhat meeting our expectations. Mike here says that's because my expectations are too high. But I would say, it's meeting our expectations. Put a lot of money in the R&D and we expect good returns from that. As far as what was changed, primarily it's in the optical and software subsystem. So we increased the capabilities within our optics and then to take advantage of those increased capabilities, we also added some new inspection algorithms and some enhancements to the processing power so that we could, well, basically drive much higher throughputs than the previous generation system.

[Edgar Roesch, analyst]

All right. Last one for me, on the unpatterned wafer market. I'm not sure, is it more driven by the wafer suppliers on the outgoing side? Or those receiving them or maybe both?

[Michael Plisinski, executive]

That's a great question. So it's -- our focus is mostly on the wafer suppliers, and what I mentioned to Patrick is -- and we're looking at new applications within those wafer suppliers. And then maybe in the 2020 time frame, we do see an opportunity to potentially bring this same technology to the receiving -- the incoming quality assurance for some of the wafer -- some of the device manufacturers or chip manufacturers, potentially, even on the monitoring side. So within -- so not just incoming QA, which I'm not sure how much of that market -- how big that market is but on the monitoring side, monitoring wafer side, there could be much higher potential.

[Operator]

We'll take the next question from David Duley with Steelhead.

[David Duley, analyst]

I had a couple. First, when you talk about the instinct going on in your inspection business, it's not exactly a strong period in the end-markets. And so I'm wondering, what sort of update cycle you're seeing here? And I think you mentioned the catalyst was that the bumps got smaller or closer together. Could you help me -- help us understand that at what geometries the current install base needs to upgrade their inspection tools?

[Michael Plisinski, executive]

Well, I wouldn't call it a refresh as much as expansions of new lines with new technology and new capabilities because we're not seeing some of the older systems or technologies being mothballed. So it's really, how many new packages are transitioning to, for instance, copper pillar processing, which we're seeing a number of over the last -- well, actually in 2018, we had a stepper or wafer-level packaging stepper, gets sold for copper pillar processing, now we had a couple of orders. We've talked about some pretty big transitions, including the memory guide. So those are all expanding capabilities, adding new capabilities, new lines. So as you continuously -- to see those kinds of transitions, you will see more adoption of our, in that case, 3D metrology as well as the 2D metrology for the finer pitch RDLs.

[David Duley, analyst]

Okay. And one of the big OSAT -- or the largest OSAT in Taiwan was talking on the conference call about over the next couple of years, we're actually seeing a fairly substantial increase in fan-out revenue and in more SiP revenue. I think they mentioned fan-out revenue's going to grow $50 million to $100 million a year, and SiP revenue would grow $100 million a year going forward. Now I'm just kind of curious, when you see that type of ramp going on with that large customer, what sort of opportunity is that for Rudolph?

[Michael Plisinski, executive]

Well, I won't categorize how many tools we'd get because that's highly dependent on the number of layers and the critical layers and things like this and what they can do within a liner. But our applications are in the lithography, also the inspection and the 3D metrology depending on if they're doing bumping or not, which almost all of them would be. So we'd have inspection, lithography and metrology as well as software opportunities in those factories. Just to give you an idea of process control of, let's say, normal-sized or fairly large OSAT, we might have 20 or 20 to 30 process control tools in place. And on the steppers, we could have 4 to 8, to give you a range.

[David Duley, analyst]

And are these the types of the applications, SiP and fan-out -- I know those are ones that typically are -- people talk about where we have a lithography adoption at panel level. But I'm kind of wondering, when you hear team Taiwan starting to gear up finally with the big revenue dollars in this area, is this -- have you penetrated that customer across the board with those applications? Or is just mainly on the inspection side that you should see the benefit here?

[Michael Plisinski, executive]

Yes, I don't know which customer you're talking about. But we've penetrated -- if there's a customer doing advanced packaging, we're in there with one product or another, almost any customer around the globe, anywhere. So whether we'd have the lithography, I think we've explained. We have 80% of the panel customers in lithography. So pretty much every panel line that's out there with the exception of maybe one as our JetStep. And then on the inspection side, I would say, we probably have tools in every manufacturer.

[David Duley, analyst]

Excellent. Final question from me is, even though it's -- the timing of 5G adoption is difficult, I understand that the complexity of the antennas and the RF front end is going to be such that there could be a whole lot more either fan-out or SiP-type package types. And I'm just curious, is that what you're hearing from your customers? And do you think that's going to be a major opportunity for adoption for you guys?

[Michael Plisinski, executive]

We are hearing that. And yes, we do think that's an opportunity for us. It requires higher precision lithography, which is one of our capabilities. So from an SiP perspective, as they want to use these RDLs for various capabilities such as antenna. The printing of those very accurately and very finely is critical, so our systems are -- have a good demand there. Yes, and also on the process control is also critical. So you want to make sure that you have not only the metrology capabilities we've talked about with the MPG, with the MetaPULSE, but also on the inspection, the finer resolution of our Gen G2 Dragonfly is going to become more critical as well.

[David Duley, analyst]

Okay. I guess to summarize then, you kind of see Rudolph position that they have at least 3 or 4 product lines to address some of these new advanced packages that are coming out. So you have across the board, product breadth. And then would you agree that 2019 looks like, for the first time, that we've been talking about advanced packaging, actually see multiple customers move into production?

[Michael Plisinski, executive]

Yes, I see a lot more investment in advanced packaging. Moving forward, I think '18 saw a few customers, and I think '19 is going to continue to see more adoption of advanced packaging, absolutely. But I think the panel level package can be there too.

[Operator]

Our next question comes from John Pitzer with Crédit Suisse.

[John Pitzer, analyst]

Guys, realizing that the current environment is extremely uncertain, both bottoms up and tops down, I'm just kind of curious, as you look at this year unfold, is it your expectation that March will be the trough quarter in revenue? And if not, what other levers on the OpEx side do you have to maintain profitability? Or do you just feel like, with so much opportunity over a multiyear period, R&D is pretty sacred in this environment?

[Michael Plisinski, executive]

Well, last time I tried to call a trough, I got burned in Q3, so I won't call a trough. But I definitely see things starting to plateau. I mean, you can see the big declines we saw in Q3, Q4 and then it sort of stabled out into Q1, which is normally a soft quarter for us, a volume-driven business. Q4 and Q1 are usually weaker and then things really ramp up Q2, Q3. Based on -- well, let's put it this way. When people come back from the Chinese and lunar new year, we'll start engaging and getting a lot better understanding of where people, where our customers' expansion viewpoints are for Q2. Right now, I'd say they're going to be better than Q1, but to what level? We have to -- we're not going to call it yet. What was the second part of his question?

[Steven Roth, executive]

Maintaining OpEx within that, is R&D sacred?

[Michael Plisinski, executive]

Yes, we do have a lot of programs that -- we're -- we consider sacred, that we are going to continue to invest in the display lithography and some of our other programs as well. But we do also have some opportunities to move some programs around and share actually, R&D across business units and product line. So I would say, we have some flexibility in the OpEx line, but we're not so concerned that we have to make some dramatic shifts or cuts in order to maintain profitability. We have a great history of maintaining the profitability, and we believe we'll continue to do that while still investing in our future and the opportunities we see in the near -- within the 12-month horizon.

[John Pitzer, analyst]

That's helpful, Mike. You guys do a great job kind of helping us dissect the revenue breakdown by kind of product category, and you give us some qualitative around geography like China. I'm just kind of curious, as you think about some of the megatrends that are driving your business, is there any way to kind of break down the revenue by end market? How exposed are you to the handset market versus the auto market versus the industrial market? How should I think about that?

[Michael Plisinski, executive]

Well, it's a little bit difficult for us to say because for instance, advanced packaging is being leveraged across a number of these different markets so -- and we don't always know. So let's say, we go -- we win some business at an ASE or Amcor, another OSAT, we don't always know the products that those OSATs are processing. So are they MEMS? Are they automotive? Are they mobile? But in general, I would say, we're more strongly tied to mobile. We have a big -- obviously, because there's a lot of chips going into mobile, and we inspect -- we're part of a lot of that supply chain, value chain. So we have a sort of natural extra tie there. But we also very strong positions within the RF and automotive market, we're thinking some of our materials, we highlight 70% of the RF filter manufacturers have adopted over 2 to 3 programs, product lines from us, so whether it's software, metrology, inspection. So that gives us a very strong baseline as that market continues to grow. We'll see increased revenue there. But yes, it's hard for us to say on the end market side where we're most tied. But I would say, we're on the leading-edge devices. So not on the chip flip side of the market but more advanced processors, more advanced system and packages. So whether that's going into automotive applications or mobile applications, that's where you'd see Rudolph's tools being selected the most.

[John Pitzer, analyst]

And then my last question, if you can quickly just walk through and help me better understand, on the software and parts side of your business, that's held up much better. It's still kind of showing a growth pattern. Is that an area that you expect to continue to grow this year in calendar year '19? If so, can you give us a magnitude? And I guess, help me better understand the key driver of that growth.

[Michael Plisinski, executive]

We do expect it to grow. We'll wait and see on the magnitude piece but that -- the driver's primarily the increased pressure on a variety of customers. Mobile, automotive, nearly everybody on quality, on improving quality. Especially when there's more and more focus on system and packages or 2.5D applications, where you're bringing chips together from multiple wafers and into a single device. You need an increased level of traceability and analytics to understand if there is a failure, where that failure's coming from and to prevent the failures because not only are you going -- you have one dye that's bad, you end up scrapping this entire package, which might be made up of 5 or 6 other dye that were good. So there's a capability we've had in our software to -- called genealogy to be able to do that. We've applied it to automotive customers. Bosch we went public with the press release a number of years ago. Western Digital talked about it in our Analyst Day a number of years ago. So we've done this for a number of customers over the years, and we're seeing increased adoption and increased customer pull for the capability now. And so that's why we believe that we're well positioned to see this business continue to grow.

[Operator]

We'll take our next question from Dick Ryan with Dougherty.

[Richard Ryan, analyst]

So Steve, with the litho tool delivering in Q1, what is the gross margin expectation?

[Steven Roth, executive]

It's a good question. I would say, the range on the gross margin's going to be -- with the guidance range that Mike gave on revenue, anywhere from 51% to 53% gross margin.

[Richard Ryan, analyst]

Okay, okay. How should we view taxes?

[Steven Roth, executive]

I think they're going to stay down at like 17% range, 16%, 17% effective rate.

[Richard Ryan, analyst]

And I think you said the inventory build was largely due to litho. Is the suggestion there that we could add additional deliveries in Q2 with that build?

[Steven Roth, executive]

No, I wouldn't read into that. I mean, it's a combination of both AP and well as display inventory. So when I say litho, I'm meaning both buckets of inventory builds.

[Michael Plisinski, executive]

Remember on the display side, those lenses are extremely expensive, and we need 2 lenses per tool. And we have multiple lab tools being built up so the inventory levels are being impacted by that.

[Operator]

[Operator Instructions] We'll take our next question from Craig Ellis with B. Riley FBR.

[Craig Ellis, analyst]

I wanted to go back to a longer-term topic, and it's a bit a follow-up to John's question. Understanding that the visibility is quite low, especially here in the middle of lunar new year, Mike, the question is, as we look at the full year 2019, do you see the potential for the business to grow year-on-year? And if so, beyond software, which you commented on earlier, what would be the drivers to that growth? And if we weren't to see growth this year, what do you think would be the impediments to year-on-year growth for Rudolph?

[Michael Plisinski, executive]

So I think the impediments would be just general slowdown in the market. So general macroeconomic conditions impacting people's adoption of new devices, cars aren't getting bought, something like this. So I'd say that would be an impediment. The potential for growth I think is there, for sure. And I would say, one of the bigger drivers of that would be the lithography business. I've mentioned a few times, we're seeing a lot of activity on the panel side. We're shipping yet another panel system in the first quarter to a new panel customer. And eventually, the panel customers that we've already sold to are going to continue to ramp and then need new tools. And at the same time, we've got a growing pipeline of customers planning investments in panel. So that would be -- if all that starts hitting at the same time, that's a pretty significant amount of growth. And that's not just lithography, those customers also require process control. So they require inspection systems, they require software and yield analysis. So -- or yield analysis, so our software capabilities, which have been optimized for the panel market. Obviously, you have squares substrates, you have the complete process is going on. You want to be able to trace back to the wafers where that came from, all that capability's important, and it's being built into our systems. So I think if there's going to be the upside, it's going to be -- that's going to be one of the big drivers. From a market perspective, I would say -- from an end market perspective, I would say growth in advanced packaging would be another driver for Rudolph if we're going to help this one.

[Craig Ellis, analyst]

Just a follow-up on the panel comments. It sounds like that could be a very material opportunity for Rudolph. Obviously, it's something that's got momentum now, and I'm not sure how much business can fall into this year versus potentially being a multiyear opportunity. But as you look at where that business can go, can you give us some sense of how that opportunity stacks up against another initiative that we've been following closely, which is OLED? Does it have the potential to match the size of OLED? Could it be bigger? Or would you expect that revenues there would, for whatever reason, remain smaller than what you expect to capture with your OLED initiative?

[Michael Plisinski, executive]

I think that the OLED initiative or the Gen 6 display because it's -- we can also handle micro dots and the quantum dots in the micro LEDs. I would say that, that opportunity is still much larger. The price of the tool, by its nature, is almost equivalent to 7 or 5 panel steppers, the advanced packaging panel steppers. So that's a significant difference. And then the number of fabs and what you see from transition, I'd still think the Gen 6 display program has the higher potential. The panel side, I think it can be significant, the question is timing and the timing of the ramp. We've talked a lot about it, and we've had some relatively flat years, where we were expecting -- even 2018, we've sort of guided that we thought the second half of the year could see a lot of panel -- well, a lot of steppers being sold, and we ended up with less than we expected. So I'll be a little cautious about that. Just telling you that we're seeing -- when you ask about what the upside could be, that would be where we see some upside. And the level of activity engagement we have is very encouraging. And I could mention, we're just shipping another tool in this quarter. So the ball keeps rolling for that one.

[Operator]

And there are no further questions at this time. I'd like to turn the conference back to Mike Sheaffer for any additional or closing remarks.

[Michael Sheaffer, executive]

Thank you. We'd like to thank everyone for participating in the call today and for your continued interest in Rudolph Technologies. That concludes our remarks. Lauren, please wrap up the call.

[Operator]

Thank you. And that does conclude today's conference. We thank you for your participation. You may now disconnect.