Rudolph Technologies' (RTEC) CEO Michael Plisinski on Q4 2016 Results - Earnings Call Transcript

| About: Rudolph Technologies, (RTEC)
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Rudolph Technologies, Inc. (NASDAQ:RTEC) Q4 2016 Earnings Conference Call February 2, 2017 4:30 PM ET

Executives

Bob Koch - VP & General Counsel

Michael Plisinski - CEO

Steven Roth - CFO

Analysts

Craig Ellis - B. Riley & Co.

Patrick Ho - Stifel

Tom Diffely - D. A. Davidson

Operator

Good day and welcome to the Rudolph Technologies' Fourth Quarter Earnings Release Conference Call. Today's call is being recorded. At this time I'd like to turn the conference over to Mr. Bob Koch, Vice President and General Counsel. Please go ahead, sir.

Bob Koch

Thank you, Shannon, and good afternoon, everyone. Rudolph issued its 2016 fourth quarter and year-end financial results release this afternoon shortly after the close. If you have not received a copy of the release, please refer to the company's website at www.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, forecasts 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 the 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 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.

I will now turn the call over to Mike Plisinski. Mike, please go ahead.

Michael Plisinski

Thank you, Bob. Good afternoon, everyone and thank you for joining us this afternoon. We will start the call with business highlights from the quarter and year, followed by Steve's review of the financial highlights, after which I'll provide our guidance for the 2017 first quarter before opening the lines for your questions. So, let's begin.

I'm proud to announce our focus on supply comprehensive solutions to high value problems resulted in another record year for Rudolph with 2016's revenue of $233 million, increasing 5% over 2015's record year. This second consecutive record year marks a first for Rudolph and implies our strategy is resonating with our customers. The largest contributor to our growth was our lithography business which grew 32% year-over-year and has achieved a compounded annual growth rate of over 25% since 2013.

In addition to the JetStep W System shipped in Q4, Rudolph shipped its second panel stepper to a Top five semiconductor manufacturer, also in the fourth quarter. Recall for the last several quarters we've highlighted the growing interest from Top Tier semiconductor manufacturers and panel processing. To date, we've supported that interest by processing samples in our Wilmington facility and then shipping panels back to customers for analysis. Based on the encouraging results, this particular customer requested to accelerate their process development by placing our tool in their factory. The second JetStep S System is installed and currently being qualified by the customer. If the customer is successful with their process development, we expect to convert this tool to revenue in this fiscal year with additional tools in 2018. We continue to run samples in our Wilmington facility for a growing number of other customers exploring process development for panel level packaging.

Recall in the second quarter, we sold the JetStep G System to the largest Chinese display manufacturer to support R&D of next-generation OLED displays. Since then interest in our technology has been increasing from other Chinese display manufacturers focused on manufacturing high resolution OLED displays to serve mobile markets. To better respond to this interest, we are engaging with Simax, a company specializing in lithography process solutions for the Chinese market and led by a recipient of China's prestigious National Distinguished Experts Award for the accomplishments in lithography spanning the last 25 years. The initial focus of our partnership will be to proactively pursue the R&D and pilot OLED opportunities in the region and establish a demonstration facility in China to accelerate the education of the local market about our unique capabilities.

In parallel, we'll complete a Gen 6 display demonstration tool by the end of the third quarter. The tool be used to run smaller displays to further quantify our advantages for high volume manufacturing. Rudolph estimates the overall display market for lithography systems is over $1 billion annually with slightly over half those systems go into mobile displays today. Industry estimates call for mobile display volumes to triple over the next four to five years making this a very attractive market. The steps we are taking now will bring us closer to the potential customers and allow us to better assess their requirements and the size of the opportunity for Rudolph before committing to a large scale investment which would not be required until 2018.

In summary, our lithography business continues to gain traction in advanced packaging where we now have five customers and 12 JetSteps running fan out production including the panel level packaging evaluation tools shipped last quarter. We continue to add new customers in applications against very entrenched [ph] competition with the markets transition to smaller interconnects and fan out in either wafer panel form, our JetStep systems value becomes more compelling. In addition, these transitions create more opportunities for our advanced process control technologies which as expected, advanced packaging was a strong driver for our process control group where revenue from outsourced suppliers grew approximately 20% over 2015.

Leading the growth, revenue from Rudolph's new 3D option for our NSX platform more than doubled in the fourth quarter. We expect the demand for our combination of 2D, 3D inspection solutions to continue as copper pillar and micro-bumps gain traction and require more sophisticated improve in process control technologies. Rudolph's advantage is in the quality of our measurements and in the use of our software to turn those measurements into actions that directly improve the process. This value is also helping Rudolph expand our customer base in the RF filter and MEMS market.

Starting with RF, in the fourth quarter we added another top five RF filter manufacturer based in Asia. This particular customers expanding their filter products which requires a more complicated process, and as a result selected Rudolph based on the value of our unique and proven RF solution which combines inspection metrology and software to provide more comprehensive process control. The customer will start with inspection, then add in components of our complete solution over the next several years. This same expansion strategy was employed by five other RF customers in 2016 as they optimized their previous capital investments in transitions from six to eight inch wafer sizes and reconciled factories from industry consolidation.

Qualcomm's announcement to form a JV with Top five RF manufacturer TDK/Epcos underscores the ongoing importance of this market. The JV intends to enable delivery of RF front-end modules to create fully integrated systems that will enhance current mobile devices and address fast growing segments such as IoT and automotive. We believe the increased complexity of packages such as these will be a strong driver for us software and process control solutions. Likewise, we expanded our customer base in the MEMS market where five MEMS manufacturers including two the Top five choose our NXS inspection and discover analysis system to enable the zero defect manufacturing required by the automotive and mobility markets. This powerful value proposition resulted in 40% of our MEMS business in 2016 being from accounts previously served by competitors.

Our software business which is a critical differentiator for Rudolph continues to grow well maintaining an 11% CAGR over the last five years. Leading the software growth in 2016, our tool-centric revenue grew by 32% over 2015 driven by increase in adoption rates and revenue from additional modules. Our fab-wide software is expanding in our core markets with one RF customer adopting complete factory control and expanding their use not only across tools in the fab but also across multiple front-end and back-end factories, giving this manufacture process optimization capabilities not available previously.

In summary, 2016 was another year of solid growth for Rudolph in which we continued to build a stronger future through new product releases, expanding customer bases in RF and MEMS market and continuing to expand our lithography business into new customers and applications.

Now let me turn the call over to Steve who will review our financials. Steve?

Steven Roth

Thanks, Mike, and good afternoon, everyone. In my remarks this afternoon, I will provide some detail behind our Q4 financials results, and also provide some guidance on gross margin and operating expenses for the first quarter of 2017. As Mike has already highlighted, we completed another record year for the company and we executed well in a typically slower fourth quarter.

On a year-over-year basis, Q4 revenues grew 6%. For the year all of our business groups experienced year-over-year growth with our software group like the total company also experienced a second consecutive record year of sales. Fourth quarter revenue was $54.1 million, up from $51.1 million in the 2015 fourth quarter and down from $61.6 million in the 2016 third quarter. These results highlight the seasonal trends that we have witnessed over the years where we see a slowdown in our mobility driven business, primarily with our OSAT customers in the fourth quarter. Then a re-acceleration in sales in the subsequent first quarter as budgets get reset following Chinese New Year.

While this quarterly dynamic is not new to us, what is important is our ability to grow our sales on a year-over-year quarterly basis. We have been able to do that over the last ten quarters and as you will see from the guidance that Mike will provide in a couple of minutes, we expect that trend to continue.

Our process control group accounted for 80% of the sales in the quarter. This compares to 81% in 2016 third quarter. During the quarter our lithography group shift a JetStep system resulting in lithography being 7% of revenue into the quarter. And finally, our software group had another strong performance coming slightly below last quarter but still representing 13% of revenue for the quarter. Breaking down our revenue by end markets on a percentage basis, dealt to back-end OSAT to counter for 32% of the system revenue, specialty devices was also 32% with half of that going to RF customers, memory was 13%, foundry 12%, logic was 4% and 7% was in the remaining other category.

Our gross margin for the quarter was 52% and was impacted by the sale of the used evaluation JetStep lithography tool which reduced our gross margin by 1%, and slightly lower software for the quarter. For the 2017 first quarter based on our projected product mix, we are forecasting gross margins to continue to be strong and in the range of 52% to 53%.

Looking at the details of our operating expense, fourth quarter total operating expenses was $18.9 million, lower than our previous guidance. This compares t0 $19.2 million in the third quarter. R&D for Q4 was $9.9 million, a slight decrease from the $10.2 million in the third quarter. The decrease in R&D was primarily due to lower compensation costs, due to a small restructuring in the beginning of the quarter and slightly lower project costs.

SG&A for Q4 was $9 million, the same as it was in the third quarter of 2016. We expect to continue to maintain tight control on our operating expenses. However typically, we see an increase in operating expenses in the beginning of the year as payroll taxes reset and new compensation plans are put in place. As such we anticipate our operating expenses to be in the range of $19.2 million to $19.8 million in the 2017 first quarter.

Our effective tax rate for the year was 28%, this rate was lower than our historical effective tax rate, primarily due to higher utilization of foreign tax credits after implementing changes to our international transfer pricing policies in 2016. For 2017 modeling purposes, we would expect our effective tax rate to be approximately 32%. Net income for the fourth quarter was $6.6 million or $0.21 per share and in line with our previous guidance of $0.18 to $0.22 per share. This compares to net income of $9.1 million or 29% -- $0.29 per share in the 2016 third quarter. For the full year 2016 net income was $31.4 million or $0.99 per share compared to $26.4 million or $0.82 per share for 2015.

Now turning to the balance sheet; we ended the fourth quarter with cash and marketable securities of $125.7 million. During the quarter we substantially completed the redemption of outstanding warrants that were issued in conjunction with our convertible debt issuance back in 2011. The cash outlay to retire the warrants was approximately $10 million, was higher than previously anticipated to the increase of our stock price over the last several months. Accounts receivable ended the quarter at $64.9 million, the decrease from the previous quarter was primarily due to the resolution of a delay in payments from one of our Asian OSAT due to the integration issues they were having with their new parent company and collection of several older outstanding balances. Inventory decreased to $65.5 million from $68.6 million in the third quarter as we continue to see benefits from our supply chain initiatives.

Finally, to wrap up -- capital expenditures for the quarter were $768,000 and depreciation expense in Q4 was approximately $900,000.

Now I'll turn the call back over to Mike. Mike?

Michael Plisinski

Thanks, Steve. Looking ahead to 2017, we see continued investment in fan out packaging, copper pillar and panel packaging lines from OSATs and new players such as TSMC where we expect another info ramp to occur in 2017. The ability for fan out technologies to lower packaging costs for large and small devices and facilitate multi-dye packages is attracting an increasingly diverse set of products and driving multiple expansions creating opportunities for all of Rudolph's product lines.

We also see growth returning to our RF and MEMS customers as utilizations continue to rise and demand for complex filter package packages necessitates sophisticated process control solutions. We expect expansion in 3D NAND to renew demand for our MetaPULSE and macro-inspection systems used in the front-end. Our MetaPULSE Technology is proving to be critical for hard masked applications in 3D NAND allowing customers to avoid the use of slower X-ray technologies. We are working with a number of customers on this application and expect incremental growth in the first half of 2017 as a result.

Underscoring this broad market optimization, we expect Q1 revenue to increase to a range of $57 million to $60 million and earnings to be between $0.22 and $0.25. This represents an increase in revenue of 11% on the high-end and an increase of 7.5% at the midpoint over our fourth quarter. This does not include a JetStep system in the first quarter. Reflecting our broad market optimism for 2017, we see a healthy balance of customers in the first quarter with memory, advanced packaging, RF filter and MEMS customers; all contributing to what could be a record start to the new year.

Thank you. And this concludes our prepared remarks. And now we will open the floor for your question.

Question-and-Answer Session

Operator

[Operator Instructions] We do go first to Craig Ellis with B. Riley.

Craig Ellis

Thanks for taking the question. And congratulations on a successful 2016 and consecutive growth. I wanted to start off just following up on some of the comments in your prepared remarks, Mike and some that were present in the press release with regard to the RF and MEMS business. Clearly, that's been an area -- that's been one of strength for the company in the past. I'm wondering if you can help us quantify how large that businesses is as a percent of sales in those business as I should say. And if you can give us some color on the linearity of the strength you would see [indiscernible] if it's more first half way to more consistent through the year?

Steven Roth

So Craig, this is Steve. I'll take one of the parts of that. So as a percentage of our business when you add up all the quarters, it's slightly below -- just below 10% of our business for the year. It's been -- you know, year-over-year actually some somewhat about flattish this year I think as Mike mentioned a little bit; we saw a lot of retooling and digestion from our first quarter big year in 2015 and the initial year. So it's got a good business for us but it's running around that 10% range.

Michael Plisinski

Craig, for 2017 we expect basically double-digit growth in both of those markets over the 2016 levels. And if I look at the customers in the forecast, I can't say that it's -- I would say it's more evenly distributed throughout the four quarters. I didn't notice any first half, second half kind of dynamic in play.

Craig Ellis

Okay. And then going back to the comments regarding the panel successes that you're seeing. You talked about potentially having some significant investments in 2018; can you go into more detail in terms of what would be entailed with that?

Michael Plisinski

Well, the big driver if they are successful making the process work at the price points they need to, to bring it to volume production. So -- so far they are investing quite heavily, they are optimistic about what they are seeing and we're engaged heavily in making sure they are successful. At the end of the day that's going to determine the ramp.

Craig Ellis

And then lastly, Steve, going back and looking at one of the guidance elements which was gross margin; that's real clear -- it looks like the business will be on a trajectory where it's growing year-on-year in the quarter and I would expect it would do so given some of the comments that were made just regarding the strength of the business. With regard to gross margin what should we expect for the contour of gross margin through the year this year, not asking for specific guidance but just some general color would be helpful.

Steven Roth

Yes, good question. Again the -- I think the dynamic that rose there [indiscernible] to give you know where we're going to be. As obviously revenue grows, we'll see some leverage in overall CCR margins rise but lumpiness comes in on the quarters in which we ship both tools. That throws the below corporate margins and where they are. I mean obviously you can see we did a 52% margin with the lithography tool this quarter, I'm guiding 52% to 53%, Mike mentioned without a lithography tool. So, you know, I think it will be in that range. As revenues rise, I think we'll be at the higher end of that range. But then again, it just depends on how lithography tools play out for the year. Go ahead, Mike.

Michael Plisinski

And also how quickly the software business grows.

Craig Ellis

Sure. Thanks guys.

Operator

I'll go ahead and move to Patrick Ho with Stifel.

Patrick Ho

Thank you very much. On the events packaging side, I think it's clear, right now we're seeing the continued traction on the fan out and the copper pillar ends. Mike maybe can you give a little bit of your thoughts on the opportunity for TSV, maybe just even a little bit of the timeframe of when you think that gets some greater mainstream adoption in the marketplace?

Michael Plisinski

That's a good question, Patrick. From the litho perspective, we're not engaged in any TSV activity but our nuclear clear-fine technology is being used in a number of memory manufacturers that are looking at TSV pilot production even now. So they are starting the pilot production and I don't know when they are planning ramps, second half of the year; sorry, second half of the year they may going into 2018 is what we are hearing. But they're -- like the panel markets they are also trying to optimize their process to get enough yield to make that cost effective, the price performance trade-off viable. I know at least two of the customers are testing some of the memories with their customers to see where that price performance trade-off is right now.

Patrick Ho

Great, that's helpful. And maybe going through the display side, on the display end for the lithography business, it's very encouraging to hear some of the potential opportunities emerging in China. Can you give a little commentary or color on the traditional LCD opportunity in China? And how that could also play into it because OLED could be a little bit ways away for the Chinese given that it's a very difficult technology. And truthfully, today we only have one major player out there. What's the LCD market potential given that that looks like where China is first going to build a lot of capacity.

Michael Plisinski

Yes, for us we're not focused on the LCD, I don't think for us to break in there with the price point and the performance of our stepper, it would make sense that those -- our steppers really gear towards the higher resolution, higher finer pitch OLED displays which will be used for -- like you mentioned, further out use for virtual reality, wearables, and next-generation mobile devices. So that's really the inflection we're going after with our stepper where we think we can -- at least what we know right now coming with a very compelling value proposition.

Patrick Ho

Great. And final question for me and maybe for Steve in terms of this display opportunity and the investments and the resources that may be needed over the next couple of years. How are you balancing that versus your current operating model which -- you guys have done a really good job on the OpEx side of things for the last several years; how do you gauge the investments that will be needed in the Chinese market forces maintaining your operating model?

Steven Roth

It's a good question Patrick, I mean I think that's what Mike was trying to touch on in his prepared remarks is we're approaching it very carefully. Obviously signing up with this partner where we can kind of test the waters and do things in kind of prototype stage before we jump in with two feet. We're working that within our existing structure, in our existing models, so there will be some increase in R&D expense this year but nothing dramatic -- you won't be able to pinpoint, they will look at this dramatic increases due to the OLED investment. We're working it into that we do not overly burden our models, we expect to be extremely profitable, operating margins as we continue through the year. The bigger question will be, as the results of all that and the impact maybe on 2018 and that's to be determined.

Patrick Ho

Great, thank you very much.

Operator

Next question comes from Tom Diffely with D.A. Davidson.

Tom Diffely

Good afternoon. So I guess on that same line; when you look at the model going to China through distributor versus with your own facilities, what is the ultimate margin difference between those two models?

Michael Plisinski

I am not sure we really fully flushed that out yet Tom, I mean we're in this initial stage, we're trying to figure out and map out how we're going to work through this. I mean, I think the displays margins will be better than the JetStep semi systems, lithography systems, obviously higher price points to play with. And so I would say the jury is still out but it would not be -- it's not an additional 40% margin business, it will be lot better than that.

Steven Roth

And to add to that Tom, when we looked at the different options for growing this business and exploring this opportunity, the investment necessary just to initiate relationships and to start to educate the market is fairly significant. And to take that without a clear path for when the revenue would come in, didn't make a lot of sense to us. So by partnering with this with Simax and it's a customer -- a partner we know well; [indiscernible], the company we acquired had a very close relationship with this company. That allows us to more aggressively go after the market without -- in a more cost effective way.

Tom Diffely

Okay.

Steven Roth

They have the relationships, they have the skills and the knowledge and they have the facilities in China already which we have to acquire and build out. So that -- yes, they'll make a little bit on each tool but it's more than compensated by what they are providing in the way of this partnership.

Tom Diffely

Okay, that makes sense. Alright, and then we look at the second round of info business that sit in the market. I know the first time around you -- I mean we're in a position to bid on the litho side of it, it's mainly just the inspection side. Curious if litho is a possibility for the second round or is still mainly an inspection play for you?

Michael Plisinski

It's certainly a possibility, we're in discussions with everyone. When they are going after their one micron RDL, that's where our next inflection will be, so we're certainly in discussions. This next ramp is more -- we're not in discussions for this next ramp for 2017, we're in discussions for future ramp.

Tom Diffely

Okay, alright. And then moving over to the RF world, when you see the transition, the conversions from 6-inch to 8-inch, does that do anything to your tool set? Do you need to upgrade anything or add capacity or what are the changes?

Michael Plisinski

No, it doesn't. Our tool set support both 6 and 8-inch and the customer gains a tremendous amount of capability, 30% when they move from 6 to 8-inch wafer sizes. So what we saw was a lot of our orders this year in 2016 where we would have seen nothing, we saw orders because of the expansion of our Rudolph solution; basically customers wanting to optimize the yields more quickly during their transition from 6 to 8-inch, so they wanted to add more of our software capabilities or more of our metrology capabilities to help that ramp. So we saw more of the expansion from our solution, spreading that across the factory, the more -- to better optimize the factory versus just expansion because the customer was expanding. Now in 2017 we think that's going to shift a little and we think that with the utilizations going up, that will see revenue not only from expanding the use of our solution but also because the customers are planning some ramps.

Tom Diffely

Okay, all right. And then finally, from time to time you hear about the possibility of using the litho tools for the LED market; is that something that you looked into or are interested in?

Michael Plisinski

We haven't looked at that. No.

Tom Diffely

Okay, thank you.

Operator

[Operator Instructions] And we next move to Farhan [ph] with Credit Suisse.

Unidentified Analyst

Hi, thanks for taking the question. My first question is related to the OLED plans that you talked about today. Is there any sort of financial commitment from either Simax or you through this partnership to address the marketing channels? And also if you can talk about what level of PPI that you're looking at or the resolution -- just to give us an idea of what percentage of the market down that you're addressing that you would be targeting with the new -- with these tools that you're planning on OLED side?

Michael Plisinski

So there is a financial commitment on both sides from the relationship, the partnership; so that exists, there is skin in the game on both sides and that's built into our models as we've shared. As far as the PPI, I'm trying to remember correctly, there are about four inflection points going up to 800 PPI, each one drives increased value proposition for our technology. We believe we can -- I think the next one was a 400 PPI; we believe that we have value there but as the PPI continues to increase, the need for our high resolution becomes more compelling. And so that -- that we think as the market continues to transition, the demand for our systems is going to become higher and greater.

Unidentified Analyst

Got it. And then just as a follow-up on the China partnership; is there like a JV arrangement that you could consider just to basically reduce some of the financial obligation the next year or investments that you're thinking about for next year and the impact to the overall company?

Michael Plisinski

We've explored the options also, yes.

Unidentified Analyst

OK. And then another question I had was on the 3D NAND; you talked about the MetaPULSE opportunity for [indiscernible], I wanted to clarify if this is something that you have won recently or if this was already a market for you last year and it's just that their 3D NAND market is bigger this year then that's why you're seeing that growth. So basically, I want to understand if the magnitude of impact it can have for your business this year?

Michael Plisinski

We definitely sold a number of systems last year to at least one of the leading NAND manufacturers. So there was some amount of revenue but what I'm seeing from the forecast, we're seeing other customers adopt that that same process step and we're seeing the ramps, them buying more of the tools. So it's not -- it's not going to be $40 million but it's going to be as I mentioned in my prepared remarks, certainly some nice incremental revenue for the metrology business.

Unidentified Analyst

Got it. That's all I have. Thank you very much.

Operator

And ladies and gentlemen, with no further question in queue, I'd like to turn the conference back over to Mike Plisinski for closing remarks.

Michael Plisinski

Thank you, Shannon. I just like to close by thanking our employees for the passion and energy they reflected in 2016 which created value for our customers and made 2016 another record year. Thank you everyone and best wishes in the New Year which is already off to an exciting start.

Operator

And thank you ladies and gentlemen. That does conclude today's conference. We do thank you for your participation. You may now disconnect.

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