Nova Measuring Instruments Ltd. (NASDAQ:NVMI) Q3 2017 Earnings Conference Call November 1, 2017 9:00 AM ET
Eitan Oppenhaim - President & CEO
Dror David - CFO
Miri Segal - IR
Edwin Mok - Needham & Company
Patrick Ho - Stifel Nicolaus
Mark Miller - The Benchmark Company
David Wu - Indaba Global Research
Good day and welcome to the Nova Measuring Instruments Ltd. Third Quarter 2017 Results Conference Call. Today's conference is being recorded.
At this time, I would now like to turn the conference over to Miri Segal, Investor Relations. Please go ahead.
Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova's third quarter 2017 financial results conference call. With us on the line today are Mr. Eitan Oppenhaim, President and CEO and Mr. Dror David, CFO.
Before we begin, may I remind our listeners, that certain information provided on this call may contain forward-looking statements, and the Safe Harbor statements outlined in today's earnings release also pertains to this call. If you have not received a copy of the release, please view it in the Investor Relations of the Company's Web site.
Eitan will begin the call with a business update, followed by Dror, with an overview of the financials. We will then open the call for the question-and-answer session.
I'll now hand over the call to Mr. Eitan Oppenhaim, Nova's President and CEO. Eitan, please go ahead.
Thank you, Miri. Let me add my welcome to everyone and thank you all for joining our 2017 third quarter financial results conference call. I will start the call today by speaking briefly to our third quarter results and performance highlights. I will then provide guidance for the fourth quarter of 2017. Following my commentary, Dror will review the quarterly financial results in detail.
Nova delivered another solid quarter, with revenue above the midpoint of the guidance range and profitability and EPS above the high end of our quarterly guidance. During the quarter, we continued to effectively execute against our strategic targets, to diversify our markets, customers and products, with notable success in all the key performance metrics.
Strength in both our Dimensional and Materials Metrology product lines supports our expectation for a fifth sequential record year exceeding our initial expectations. Our revenue guidance for the fourth quarter suggests annual growth rate of at least 32%, well above the consensus expectation for the industry growth. This significant milestone is supported by growth in all product lines, platforms and technologies.
With another record year clearly in our sights, we are progressing steadily towards our long term targets, to reach $300 million in annual revenue, while enhancing our product offering and expanding our market presence. This aggressive plan can be achieved through continuous growth of our organic product lines, as well as inorganic future M&A additions, which are well supported by growing investments in developing new disruptive solution, and growing cash reserves to fund our activities.
Our initiative to expand our presence in the Memory segment, continued to bear fruit this quarter as well, as we continue to benefit from growing contribution from leading Memory customers. As a result, the Memory segment accounted for 45% of the overall product revenue. In fact, our largest customer this quarter was a leading Memory manufacturer, that accounted for 30% of the product revenue.
This achievement is evidence of the attractiveness our portfolio is gaining with this growing segment paving the way for further growth in 2018, as the demand for Memory continued to surge on the waves of data growth. The increasing quantities for data, creates healthy demand for Memory bit growth, for the cloud based data center, as well as for mobile and sensor devices. We support the development of advanced technologies like deep learning and artificial intelligence. This new breakthrough technologies will fuel the need for better CPU and GPU performance, which along with advanced Memory devices, will further support demand for advanced semiconductors.
On the foundry side, although we see some digestion at our leading customer, while it continues building a 7 nanometer node in Taiwan and its new 60 nanometer in China, we continued to deliver solutions to support various other foundry customers as well. Our attractive offering to this segment, supported our delivery to multiple technology nodes, ranging from 40 nanometer and 28 nanometer, mainly in China, all the way to 7 nanometer, which has reached a commercial and technical tipping point for other logic customers to invest.
An ultimate achievement this quarter is our latest announcement about our most advanced XPS platform, the VeraFlex III that was selected by the leading foundry in the world for in line applications to be deployed in 7 nanometer and below technology nodes. This reflects the progress we make in transforming X-ray metrology from a lab tool to a fab tool and finally to in line production tool, which increased attach rates and extend our future business opportunities.
Another growth engine we continue to materialize during 2017 with strong results in our third quarter revenue mix, is the rapid growth in our China business with our entire portfolio, including XPS, as well as also the [ph] integrated and standalone.
The investment in China, both by domestic and international players is driving significant growth in semiconductor topics, and Nova is well positioned to enjoy this growth in the next coming year. Business in this region is expected to contribute significantly to our 2017 second half revenue and bookings, and we expect to see continued growth in 2018 as well.
The solid performance of our product sales is also complemented by ongoing strengths in our service business, with new record high of approximately $30 million. Our continuous investments in enhancing our install base is bearing fruit, with various solutions that enable enhanced productivity, better utilization and improved metrology capabilities in previous models. This growing business is on track to deliver another record year in 2017.
As it relates to our financial results and statistically, our profitability, the strong quarterly profit demonstrates once again, the value our offering brings to our customers, the synergies we build in our portfolio, and operational efficiency we embedded in our financial model, as we grow.
We believe that our efficient model will allow us to continue investing in our next generation disruptive solution and for few long term targets. This strategy is already embedded in our product roll-out, where we have expedited the development cycle, and we intend to bring new disruptive solutions to the market faster, in order to match our customer's aggressive development cycle.
2017 expected growth is driven mainly by our intensive efforts to evolve as the leading product control partner, that delivers a differentiated and innovative metrology portfolio and appealing to a growing number of customers across the entire industry.
Following the final integration milestone of ReVera is our Materials Metrology division, Nova today can offer a wider range of solutions, targeting both the dimensional and Materials Metrology challenges.
The ability to create synergies between the technologies and offer unique solutions is expected to yield another record year in 2017, for both the X-ray and optical product lines. Following the expectations for continued growth and demand for semiconductors in 2018, we expect to continue our growth in both technologies next year as well.
As it relates specifically to our X-ray solutions, our efforts to increase our footprint in the most advanced sites are yielding good results, as major customers move our XPS tool into their most advanced in-line process tool. The implemented solution enable our customers to measure in-die thickness and composition parameter more accurate. Measuring this property in-line and in-die, is a key use case that enables more sensitivity to process variation. This is a unique capability that opens up more opportunities in both the logic and Memory space.
While our customer's progress to advanced technology nodes, the metrology market is going through a rapid change to increase accuracy, precision and reduce time to solution. In order to meet these challenges, Nova keeps releasing innovative solutions to the market. Solutions that are no longer based only on traditional hardware offering. Our ability to couple growing hardware sensitivity with unique software algorithms in one bundled solution, stretches the overall metrology envelope to meet growing challenges and solve wider range of applications.
Part of our success with recent share gains in the third quarter in multiple customers, is our advanced capability to integrate sophisticated deep and machine learning engine, to support the next generation of smart, hybrid metrology, which can create predictive mode to improve customer's yields. The unique ability to hybridize physical models with mathematical empirical model is the key to better solve the challenges arising from building vertical and 3D devices, which creates barriers to the traditional metrology method. This direction is supported by our elevated R&D investments to create disruptive techniques through the development of complementary software algorithm that exists in other data loaded industries.
By taking this innovative direction, we have significantly expanded our addressable market, secured new customers and increased our presence with key players in all segments. As a result, we enhanced our system sales, but also grew our standalone software sales, where we anticipate 2017 to be a record year for our software sales as well.
In summary, and based on our current estimation for the overall demand, we expect that the strong industry momentum will continue, while the market benefits from solid catalyst, mainly the data management world, that is key for continuous innovation in disruptive markets. This trend are related to the way we use data in mobile devices, sensor and cloud based data centers. In order to meet growing challenges, the semiconductor industry should continue with its efforts to constantly improve performance and costs. In this environment, where our customers are going through continuous inflection points, Nova is well positioned to benefit from the need to fabricate better devices in a shorter time-to-market.
Our strong year-to-date results, coupled with our outlook for the fourth quarter, indicates we are well placed for another record year in 2017. We are achieving this consistent results, due to a well executed business plan, with clear strategic initiatives, which are based upon innovative offerings, tight partnership with our customers, and an efficient operation model that support our healthy growth.
Based on our 2017 accomplishments and growth trajectory, we expect another growth year in 2018, and we see a clear path to meet our long term model.
As for the fourth quarter guidance, we expect revenues in the range of $53 million to $57 million. Diluted EPS on a GAAP basis, in the range of $0.29 to $0.37 per share, and non-GAAP basis diluted EPS in the range of $0.34 to $0.42 per share.
Now let me hand over the call to Dror, to review our financial results in details. Dror?
Thanks Eitan. Good day everyone. In my following prepared remarks, I will refer to both GAAP and non-GAAP results. You can find a detailed reconciliation between GAAP and non-GAAP results per item at the end of the earnings press release.
Total revenues in the third quarter of 2017 were $54.1 million, up 23% year-over-year. Product revenues in the quarter were $41.1 million, of which 55% came from the foundry segment and 45% from the Memory segment. The Memory portion in the quarter, has increased by 50% relative to the previous quarter, reflecting the significant inroads the company has made into the growing Memory segment. We expect Memory portion to remain high in the fourth quarter of the year, as the company continues to deploy its products and solutions into existing new Memory customers.
During the quarter, the company had four customers, which exceeded 10% of product revenues. Samsung accounted for 30% of product revenues; ESMC accounted for 16% of product revenues; and Global Foundries and Huali each accounted for 10% of product revenues.
Service revenues in the quarter increased by 16% to approximately $13 million, an all time record level for the company. This increase was also driven by service fees related to tool relocations as part of a major tool relocation process between different territories, executed by the company's largest customer.
Blended gross margin in the quarter was exceptionally high and came in at 61% on a GAAP basis. This outcome is better than expected and was attributed to high margin revenue mix during the quarter. This revenue mix included incremental softer revenues of approximately $2 million, which were pulled in by a major customer into the third quarter of the year, and included the earlier and higher than expected service fees, which I just mentioned.
Overall, during the first three quarters of 2017, we experienced exceptionally high softer revenue stream, which positively impacted gross margins across this period. Actually, softer revenues in these three quarters more than doubled relative to the whole year of 2016, due to extensive adoption of the different software platforms by several customers, including across existing installed base. On an annual basis in 2017, we expect the company to be close to its target model of softer revenues, accounting for 10% of product revenues.
In terms of the global infrastructure related to manufacturing and services, the company is in the midst of expanding its manufacturing capacity for Optical CD in Israel. The investment amount in this expansion is expected to be approximately $3 million, and to be mainly in incurred during the fourth quarter of 2017.
Combined with the existing manufacturing facilities in the U.S. and Israel, this expansion should enable to support more than $250 million in annual revenues for the whole company.
Operating expenses came in at approximately $18.3 million on a GAAP basis and $17.1 million on a non-GAAP basis. The effective tax rate in the third quarter was 24% on a GAAP basis and 21% on a non-GAAP basis. As previously discussed, starting 2018, we expect the effective tax rate on both GAAP and non-GAAP basis to be approximately 20%.
GAAP net income in the quarter was $11.5 million or $0.40 per diluted share. Non-GAAP net income in the quarter was $13.1 million or $0.46 per diluted share. During the third quarter of the year, the company generated positive cash flow of $9.4 million from operating activities.
In parallel, accounts receivables decreased by approximately $3 million, reflecting DSO of approximately 58 days lower than the company target of 70 days. Inventories have increased by approximately $5 million, reflecting inventory turns of 2.3 times a year, close to the company target of 2.5 inventory turns per year. The increase in inventories during the quarter, was attributed to the alignment of inventory levels to the current business volumes, as well as to the rollout of new products, which are currently going through first article batches and customer evaluation process.
Before concluding my prepared remarks, I would like to give more details regarding the company's outlook for the fourth quarter of 2017. As Eitan mentioned, revenues in the fourth quarter of 2017 are expected to be between $53 million and $57 million. At the midpoint of this revenue range, we expect the following; blended gross margin is expected to be approximately 57%; operating expenses on a GAAP basis are expected to be approximately $18.5 million. Operating expenses on a non-GAAP basis are expected to be approximately $17.2 million. Effective tax rate is expected to be approximately 28% on a GAAP basis and approximately 24% on a non-GAAP basis.
With that, I will move the call back to Eitan.
Thank you, Dror. With that, we will be pleased to take your questions. Operator?
[Operator Instructions]. And we will first go to Edwin Mok, Needham and Company.
Hey, congrats guys. Great quarter. So first question I have is, Eitan, in your commentary about [indiscernible], I think you mentioned like two-three times on the call that, you are pretty upbeat on 2018. Can you help us dissect that? Is that more to do of your product momentum? It sounds like you have the momentum on both XPS and OCD? Or is it more just an upbeat market trend and what you hear from customers, in terms of the spending trend?
So I think that if we look on 2018 market catalysts, the list of the current technology developments in some of the industries, will keep wishing [indiscernible] to create better semiconductor devices in lower costs. All of us hear about the technologies like machine learning, deep learning, artificial intelligence, definitely keep using those technologies will require better processing power and definitely, more Memory. Either on the mobile devices, sensor or data management or data centers, and I think it keeps on reflecting on our market, and this is why we see that the semiconductor will keep on being strong -- or the demand for semiconductor will keep on being strong in the next year.
And so from the market perspective, with regard to that, we are -- really believe that it will be another growth year. Specifically in the markets and the segment, we believe that Memory will continue being strong next year, both DRAM and NAND, each one of them for its own reason with old players and we already know that, actually all of them announced that next year, our CapEx will be almost on the same levels as this year.
Additionally, if we put Memory aside, we see that China will continue its investment. We predict that for us, China will keep on growing next year. There are a couple of foundry customers that they keep on spending, and we started to see some Memory investments as well.
Regarding the logic and the foundry, and according the current capability [ph], 2018 is supposed to be another year of growth. I think that there are three elements in the foundry. The first on is the continued investment in 28 and 40 nanometer, specifically or specially in China. Second one, is the investment in 7 nanometer. I think that other leading customers are looking on the tipping point and understand that this is going to be a very strong node. So we started to see other customers investing besides TSMC.
And finally, with regards to TSMC, although we see some softness in the second half of 2017, I think that is just a digestion period for the next couple of months, while the -- completing the investment on the first phases of the 7 nanometer and 60 nanometer. And I believe that according to their topics announcement, they will spend in 2018 the same amount as this year, but we are definitely accustomed by now, that it might be on a different weight from the first half to the second half.
So looking right now on the markets, I think it is going to be -- from our side, the strong catalyst. Second regarding the successes that we had during 2017, we feel that penetration or the inroads into Memory will continue to materialize the next year, and the last one is the products mix. I think that Nova can say proudly today, that our product is totally differentiated from the competition. So we can compete on the same competitive landscape, but we also generate new applications in new markets, where we can expand the market, and when all of this are coming together -- the products offering, together with the market, and the success both of the optical and the XPS, we feel it’s a solid market next year.
Okay, great. That's good color. Specific on the software, I think Dror, you mentioned that it was a $2 million increase in revenue this quarter, of some [indiscernible] and I think your comment implied maybe down a little bit on the fourth quarter. Can you help us understand, maybe how you think about your software mix beyond this year? Seems like you are tracking ahead of that 10% target, do you expect that to continue to be the highest proportion of the total sales?
Yeah. So obviously, as I mentioned during the prepared remarks, the increasing software revenues this quarter was -- this year was very significant. It's more than doubled than last year. Our goal is 10% of revenue, and we are going to pursue that looking forward, and we currently expect that this -- in terms of 2018, we can't be -- again, close to this target of 10% of product revenues for software also in 2018.
Okay, all right. I guess, my last question is on the inorganic pipeline; I think you mentioned in your prepared remarks that you guys are pursuing that as well. Kind of any updates on that and any color in terms of which area are you targeting for that kind of growth?
So Edwin, it's Eitan here. I think that, when we are looking at the organic growth -- sorry, on inorganic growth, we are looking on two areas. One is, trying to enhance the technology with other product control technologies. We think that today, the product control has all -- we see a lot of challenges in measuring those smaller and smaller devices and complicated devices. So we are looking on some technologies that would complement our offering, and will be able to advertise together with other optical and X-ray technologies, this is one.
Second, we are looking on companies in process control, which can be in various phases of the semiconductor manufacturing. It can be from front end all the way down to back end and other places. I think that this is the area where Nova is specialized. I think that we can bring a lot of benefit to those companies with our advanced technologies in the front end. So that's mainly the two areas that we are looking at.
Okay, great. Any thoughts on the timeframe, rough time frame in terms of when you think it's possible to do an acquisition?
So we talked about it starting from January. You know that the market currently is in high valuations and it's going higher and higher. So I think that the environment is becoming tougher. Nevertheless, I think that we are looking in some areas that it's maybe a benefit to be in such valuation, and therefore, we will do it whenever we find the right targets. We are -- we have the right cash, we have the right balance sheet, and once we will find the target like that, we will do it when we can.
Okay, great. That's all I have. Thank you.
And we will next go to Patrick Ho with Stifel Nicolaus.
Thank you very much. Eitan, maybe as a follow-up to the increasing Memory exposure you guys are seeing, can you give a little bit of color of like the mix between DRAM and 3D NAND, and how you see that moving forward, as you look at 2018?
So we will look in a second on the numbers, and see if we have here, the allocation between them. I think that it softly [indiscernible] between them and when we are looking right now on the second half, it started with big growth in majorly vertical NAND or 3D NAND. And when you are looking right now, somewhere at the end of the third quarter and the fourth quarter, we started to see increasing on capacity on DRAM. So that's roughly the allocation. And when I am talking about DRAM, then I am talking about all the players that are producing both. So we see it both in Samsung, we see it in Hynix and also we see it in Micro.
Great. That's helpful. Maybe moving to the foundry side of things; there is obviously a lot of activity that's starting to emerge on the very leading edge of 7 nanometers. How do you look at -- from an industry perspective, do you see that being much more concentrated with one player in 2018, or do you believe that you will see kind of a broader mix of 7 nanometer investments from multiple players, in terms of 2018 as the year?
I think that from the way we look at that, all players are investing in 7 nanometer, each one of them is in a different phase. But no doubt, that if you are looking on 2018, there is one dominant player in 7 nanometer. Nevertheless, if you are looking towards the full year, there is investment going on both in the other foundry players. Everybody understands it's going to be a strong node. The expectation is that the foundation from 10 to 7 will be much more robust, and with more capacity than the foundation from 20 to 16. And therefore, if I am looking right on the real competition, I think it will happen somewhere by the end of 2018, beginning of 2019.
Great. Thank you very much.
[Operator Instructions]. And we will go to Mark Miller, The Benchmark Company.
For 2018 in terms of pure dollar amount, what product area you think will show the most growth, will it be X-ray?
So when we -- I think that we need to look on -- so we don't break down the growth of each one of the product line. But looking right now on the 30 plus percentage growth that we had in 2017, it's actually divided almost equally. So I think that in 2018, you will see the same thing.
Okay. Can you provide what China sales were last quarter? What percentage of sales?
So what I can say is that, in terms of booking in the third quarter, bookings were more than 30% from China.
Do you expect that to improve next year?
Well we do expect it to increase next year. Yes.
Okay. That does it for me. Thank you.
And we will go next to David Wu, Indaba Global Research.
Yes, good afternoon. I was wondering, if I look at TSMC's historic profile, they tend to have very strong first and fourth quarters of the year, and calendar 2017 looks to be a different kind of yearly pattern. Do you expect TSMC to go back to historic patterns in terms of their capital spending first and fourth quarter loaded in calendar 2018?
So I think that we need to take 2017 as the base for the calculation of a price. And if you are looking right now in 2017, it was very loaded on the first half, when they took 10 and 7 nanometer capacity, and the second half is like a digestion and building the right to ramp and yield and converting them to 7. Another event that happened in 2017 on second half, was the moving one of the 16 lines to China. So it was more on the first half weight. But the total spending will be around $10 billion.
If we are looking on 2018, and it probably will be on the same amount, they declare it will be roughly the same amount of more than $10 billion. But our expectation from the visibility that we have right now, it will be more weighted into the second half. So TSMC has three events to invest next year. They need to invest in expanding the 7 nanometer, which will not happen before they finalize this stage. They need to invest in the expansion of 60 nanometer in Nanjing, which will not happen until we stabilize the fab in Nanjing, and the need to build a complete [indiscernible] for 5 nanometer.
The way that we look at that, is that -- the first couple of months of 2018 will be digestion and building the current capacity, and then slowly, they will pick up speed towards the second half.
Okay. The other question I have is on Samsung; their capital spending has been extremely strong and do you see a yearly pattern to them as well; because your business with Samsung really boomed in the second half of calendar 2017, and I was wondering, whether that the yearly pattern would also be the same in calendar 2018.
You know, looking right now on the results or the earning that they talked about and the prediction that they discussed about, talking about the $26 billion in spending, and I think that they said the same thing going to next year, where they need to keep on expanding the DRAM capacity in some of the existing lines, as well as extending the vertical NAND in the optic fab. So according to their estimation, it's going to be the same spending next year as well.
Regarding visibility, we see that the first couple of months of 2016 are strong. Beyond that, we just can't see currently.
The other foundries besides TSMC are supposed to be ramping to 7 nanometer in calendar 2018 second half, right?
There are -- each one of them is in a different cycle or stage. I think that, both the big foundries that are competing with TSMC will have a product to release by the end of 2018. I am not so sure it will be the second half of 2018 or it will be the end of 2018, but currently looking on the development cycle, it's towards the end of the year.
Well, I was wondering, if I look at your revenue run rate, you are at a $220 million annual run rate right now, and it sounded like the first half of calendar 2018 will probably be approximately at the same rate, as you have in the last couple of quarters, and then a growth phase in the second half? Am I getting it correctly that most of the growth in calendar 2018 on a year-to-year basis will be loaded in the second half?
Well David, we don't guide beyond the next quarter, and really the visibility will be there for the beginning of the year, just in a couple of months. So when we are looking right now on the guidance, we look right now on two things; one, the guidance for the fourth quarter and the second one is that overall, 2018 is going to be a growth year. I don't want to talk right now about how the quarters will be distributed. I really don't see it yet.
Okay. Thank you.
And we will go to a follow-up from Mark Miller, The Benchmark Company.
The share gains you reported this quarter, was that in Memory, I assume?
Okay. Thank you.
And Edwin Mok, Needham and Company.
Hi. Just a quick question on the capital allocation. I think previously, you guys had done some buyback. Any thoughts around that, as you said business is generating decent level of cash. Any thought around buyback or use of capital or are you going to see that up -- will [indiscernible] this year?
Yes definitely. We had a plan for buyback which we concluded, I think at the beginning of 2017, and we are considering the next step in terms of such plans, and we will update on that in the next conference call.
Great. That's all I have. Thank you.
And there appear to be no further questions at this time. I will now hand over to Eitan Oppenhaim for any additional or closing remarks.
Thank you, operator, and thank you all for joining our call today. By that, we conclude our third quarter 2017 earnings conference call. Thank you.
That does conclude today's conference call. We thank you all for joining us.