Rudolph Technologies, Inc. (NASDAQ:RTEC) Q3 2018 Earnings Conference Call November 1, 2018 4:30 PM ET
Mike Sheaffer – Senior Director of Investor Relations
Michael Plisinski – Chief Executive Officer
Steven Roth – Chief Financial Officer
Patrick Ho – Stifel
Dick Ryan – Dougherty Brokers
Ada Menaker – Credit Suisse
Good day, everyone, and welcome to the Rudolph Technologies Third Quarter Earnings Release Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Mike Sheaffer, Senior Director of Investor Relations. Please go ahead, sir.
Thank you, Christy, and good afternoon, everyone. Rudolph issued its 2018 third quarter financial results this afternoon shortly after the market closed. If you have not received a copy of the release, please refer to the company’s website 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, 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 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 go ahead and turn the call over to Mike Plisinski. Mike?
Thank you, Mike. Good afternoon, everyone, and thank you for joining us on the call this afternoon. We’ll start the call today with a few business highlights from the third quarter, followed by our outlook for the fourth quarter. We’ll finish with Steve’s review of the financial highlights. And at that point, we’ll open the lines for your questions. So let’s begin.
The third quarter represented several mixed revenue trends for Rudolph. We saw strength from RF and automotive customers, but not enough to offset the decline from the larger memory and foundry customers. Orders from RF and automotive customers increased by 70% quarter-over-quarter and represented nearly 29% of our system revenue in the quarter. The largest revenue gains resulted from RF process control solutions, including software, metrology and inspection.
Over the years, we’ve steadily grown our position in the RF communications market expanding our customer base to include 4 of the top 5 RF filter manufacturers as well as multiple leading module manufacturers. In fact, this quarter, we sold systems for RF process control to 7 different customers. The majority of these systems were to support investments in the manufacturing of sub-6 gigahertz devices for the initial build-out of 5G infrastructure.
As we have highlighted in the past, these devices require extremely precise process control to meet performance requirements. Underscoring that, Broadcom’s CEO, Hock Tan, commented recently that, "Imminent 5G bands are 3 to 6 gigahertz for the next several years. And when you go to those frequencies, it’s extremely hard to make traditional filtering technologies work. You will need much more complex filtering technologies like FBAR, which require precise process control and the cadence continues for increasing complexity and technology required in our RF analog front end."
One of the exciting applications for 5G communication is autonomous driving. Not surprising then, our other growth segment within the specialty devices market came from automotive customers producing NAND and ADAS devices. As with the RF market, the automotive market is also increasing the demands on process control systems for the next generation of devices.
At our recent Yield Forum in Dresden, one of our automotive customers presented data suggesting that defects per billion is superseding the prior standard of 1 defect per million, explained that defects per million is no longer good enough with the volume of electronics being added to cars even a defect rate of 1 part per million per semiconductor unit will result in a passenger car fail rate of potentially 5 roadside engine stops per 1,000 cars in today’s premium class, which is obviously totally unacceptable.
Advanced packaging, which represented approximately 50% of system revenue for the quarter is gaining traction across a wider range of devices. As an example, this quarter we saw orders for advanced packaging technologies that included memory baseband and application processors, RF and IoT modules as well as automotive sensors. Depending on the device type, different advanced packaging technologies are required for customers who want tools that can be flexible enough to support these widening range of requirements.
To better serve this market, we recently announced the Dragonfly G2 system, which is based on the same platform as the first generation Dragonfly system, but will be up to 50% faster and will include an option for the powerful Clearfind technology, which was previously only available on the Firefly system. This Dragonfly tool will provide customers with the increased performance and measurement flexibility for 2D and 3D applications in the majority of advanced wafer-level packaging lines.
For example, during the third quarter, over 60% of the Dragonfly G1 tool shipments were sold with 3D metrology capabilities. Initial market reaction to the second-generation product have been very positive and we expect multiple shipments in the fourth quarter and further increases into 2019.
Turning to our lithography group. One of our OSAT panel customers purchased our JetStep wafer system for expansion of their wafer-level bumping line in the third quarter. The JetStep System will be used in the copper pillar bumping process to package automotive radar devices. Copper pillar bump size and shape is highly dependent on the imaging quality of the stepper and the JetStep tool selected by this OSAT based on our ability to meet these exacting requirements with a wider process window, which is important for high-volume manufacturing.
The JetStep System has established a strong brand for fan-out lithography applications, so many of our wafer fan-out customers have also been taking advantage of its imaging versatility to run wafer-level CSP packaging applications. We estimate about 50% of our current customers have leveraged the JetStep System to qualify both fan-out and wafer-level chip scale processes. To open up more of the larger wafer chip packaging market, we are driving improvements in the cost of ownership and expect to announce the availability of our new JetStep System in the first quarter.
Another new but important market for lithography is the panel level packaging market. After announcing the StepFAST solution at SEMICON West in July, we’re demonstrating to customers that we can help make the advanced panel market more economical by overcoming die shift challenges across the large panel area. As a reminder, the StepFAST solution is comprised of a JetStep tool, a Firefly system and Discover software working together to optimize the stepper throughput and increase yields.
In the third quarter, we had 7 current and potential panel customers working with our team in Wilmington to evaluate the advantages of our integrated StepFAST solution for their applications. Most customers who have seen the results recognized the value and ROI of the StepFAST solution, and we expect to add additional panel customers in 2019.
Also in the third quarter, our software business brought in some notable new accounts. After extensive quality and productivity assessments by a top 5 automotive device manufacturer, we received an order from multiple sites to adopt our enterprise-level Discover Yield Software suite. This customer is focused on driving IoT innovation in the secure connected vehicle. With its back-end assembly and test facilities in various parts of Asia, they are now able to get data from 4 different sites to implement process improvements and provide overall process knowledge to their manufacturing management team.
We also expanded our fab-wide solutions at a top 5 RF customer by delivering our Discover Run-to-Run Software in order to provide real-time control of the tools involved in producing RF modules, especially concentrating on metal film deposition and edge processes across the manufacturing lines within their fab.
Lastly, our software team installed our Discover Yield Software at a micro LED fab in China serving the high-definition display market. This new fab found that our software is a key factor to meet their challenging goals of producing micro LED displays for leading-edge mobile devices by allowing pixel-level traceability from wafer to the display reconstituted on the large panel. This capability is a strength of our Discover suite and is becoming increasingly important as system and package and multi-chip module become more prevalent.
Now as we look ahead to the fourth quarter, you may have seen our announcement this morning that we introduced a new product, which will incrementally expand our total available market to include a segment of the unpatterned inspection market. We will also deliver multiple NovusEdge systems for edge and backside inspection of unpatterned wafers totaling over $3 million in revenue in the fourth quarter.
This product is the result of a successful multi-year collaboration with bare wafer manufacturer in Japan. This customer and others we spoke to highlighted the need for stricter edge and backside control for wafers to be used at the 10-nanometer and below process node. The need was to increase the sensitivity and speed of defect inspection on the edge and backside of these wafers.
Typically, increased sensitivity means a decrease in throughput, but our engineering teams responded to the challenge and the NovusEdge system has delivered up to 50% higher throughput and edge sensitivity that is 2 orders of magnitude better than the incumbent technology. The orders announced this morning include a repeat order from our partner and an initial order from a new customer.
We estimate the TAM for edge and backside inspection in this market to be roughly 15% to 20% of the overall unpatterned inspection market, which Gartner estimated at over 400 million in 2017. We see this as a great leverage of our technology portfolio to solve high-value problems for customers and incrementally add to our growth.
In the fourth quarter, we also see continued incremental growth from our specialty devices market driven by both RF and automotive customers. We see memory picking up again, but less than the peaks from the first half of the year and offset by continued softness from our foundry customers. We see advanced packaging continuing to be a solid part of our business and more advanced DRAM transitioning from wire bonding processes. The transition to advanced packaging by a wide range of devices will continue to grow as we look ahead.
You can see this on the TechSearch International sharedowns, which showed 2 wafer-level package devices in your first iPhone, to 25 packages in the iPhone 6, to now 67 advanced packages in the iPhone X. As the processes mature for these packages and prices has come down, we see adoption expanding from high-end mobile devices to mid-level phones which, of course, drives more volume
We believe our new Dragonfly G2 system, JetStep System and Discover software will create additional opportunities for us to compete, not only at the high-end of the advanced packaging, but at the more cost-sensitive end as well. Given what we see across our major markets, we are guiding the fourth quarter to be flat to up 10% in the range of $60 million to $66 million. We expect non-GAAP earnings to be in the range of $0.24 to $0.31.
And with that, I will now turn the call over to Steve to discuss the financials. Steve?
Thanks, Mike, and good afternoon, everyone. In my remarks this afternoon, I will provide some details behind our Q3 results and also provide some insight into what we see for gross margin and operating expenses in the fourth quarter. Third quarter revenue was $60.4 million, which is down 10% on a year-over-year basis. Our revenue was impacted by the previously publicized slowdown in memory spending, coupled with over 50% quarter-over-quarter decline in spending coming out of China. This decline resulted in existing orders and forecasted Q2 shipments being pushed out into the fourth quarter, some into 2019 and in one case, cancellation of a customer order.
Our process control sales, which included metrology and inspection solutions for front-end and back-end applications, decreased 23% quarter-over-quarter and accounted for 83% of revenue in the quarter. The decrease was mainly driven by our metrology products, which are tied to memory and foundry customers.
Our software group sales declined in the quarter, but still remains strong and increased to 11% of sales in the quarter. And finally, as Mike mentioned, our lithography group shift the wafer system in the quarter, which drove that business to account for the remaining 6% of sales. From a market mix perspective, we were equally weighted in both front-end and back-end businesses.
Moving to gross margin, our gross margin for the quarter was 52%, which was still quite strong despite the revenue decline in the lower margin litho tool shipping in the quarter. We were able to maintain this margin level due to our continued strong performance from our software group as well as the cost and operational efficiencies we have implemented over the last several years. For the fourth quarter, we see increasing strength in our process control group, driven by new products and slightly lower software sales. Based on this forecast, we’re anticipating Q4 gross margin to be in the range of 52% to 53%.
Turning to operating expenses. Third quarter total operating expenses was $22.2 million, down from $22.7 million in the second quarter. R&D for Q3 was $12 million compared to $12.1 million in the second quarter. The slight decline was due to the completion of R&D programs in our process control group, being offset by increases in expenses related to our display initiative. SG&A for Q3 was $10.1 million, down from $10.6 million in the second quarter. The decrease in SG&A is mainly due to the lower accruals for incentive compensation plans to reflect the lower revenue expectation for the year.
Looking ahead to the fourth quarter, we anticipate maintaining tight control over our core operating expenses while increasing our spending on our display initiative. Therefore, we’re expect operating expenses to be in the range of $22.5 million to $23.2 million. Net income for the third quarter was $8.5 million or $0.26 per share and above the high-end of our revised guidance. That compares to net income of $16.6 million or $0.51 per share in the 2018 second quarter.
Now turning to the balance sheet. We continue to generate positive cash flow, with cash increasing $10.9 million and ending the quarter with cash and marketable securities at $194.3 million. Year-to-date, we have generated over $20 million of free cash flow, even while investing in our display lithography initiatives.
Accounts receivable decreased in the quarter to $68.5 million due to improved collections from China customers and lower sales volumes. Inventory increased to $91.4 million. That increase over the period this quarter was primarily due to completed systems, which remained in inventory at the end of the quarter due to push-outs, an increase in display inventory and an increase in customer service inventory for new products.
Finally, to wrap up my financial comments. Capital expenditures were $1.9 million for the quarter and depreciation expense for Q3 was approximately $1.2 million. For those who might have missed the press release we released this week, subsequent to the close of the quarter, we completed the purchase of shares under our previously authorized stock repurchase plan. A number of shares of purchased -- a small number of shares was purchased at the end of Q3, with the remaining purchase of shares being purchased after the quarter closed.
Under our previous plans, we have repurchased approximately 13% of our shares outstanding. In addition, we also announced our Board of Directors have authorized a new plan to repurchase an additional $40 million in Rudolph stock.
Thank you, and that concludes our prepared remarks. And with that, we will open the line for questions. Operator?
[Operator Instructions] It looks like first we have Patrick Ho from Stifel.
Thank you very much. Mike, maybe first off, in terms of the volatility that we’re seeing in China and some of the broader commentary about a slowdown within the country as well as the impact on tariffs. Given that it’s still going on and given that it created some of the tension in the third quarter, what’s your outlook right now at least for the December quarter and the early parts of 2019 as it relates to your Chinese customers?
For our – within the domestic Chinese, we still see, let’s say, a bit of a pause. We expect spending to be resuming in the first quarter, but I think what we’re seeing more of or let’s say, the other customers that are building out factories within China, particularly in memory areas, we see them adding expansion and still moving forward with their expansion plans within China. And that’s -- so normally, we haven’t been differentiating, but in this case, we need to differentiate. There’s clearly some different thinking from the Asian countries that have set up operations in China to the actual domestic Chinese operations.
Great. That’s helpful. And maybe as a follow-up question in terms of the advanced packaging. You talked about some of the new memory adoption of, I guess, advanced packaging techniques, stuff like flip chip and things of that nature. How fast do you see memory customers adopting it because that should, obviously, then have a very positive trickledown effect for you guys. Is this an adoption that you believe is a 2019 story? Or is this still a little bit weighed out in terms of the transition to some of these more advanced packaging techniques?
We’re seeing opportunities in 2019.
Great. Thank you.
[Operator Instructions] We have no further questions – I’m sorry, we do have a question. Dick Ryan from Dougherty Brokers.
Thank you. Say, Steve, what was the China contribution this year? And the litho side, I think, previously, you were looking for potentially multiple opportunities in Q4. What are you looking for now?
When you say, Dick, the China opportunity...
I mean what did it contribute? How much did it contribute to business in Q3?
Hold on a minute. Q3 was down -- yes, so it’s about 25 -- yes, so about -- I was just looking at the numbers for Q3, so it’s about 20 -- it’s 20% of the revenue for the quarter is coming from China. Is that, right? And then the other -- sorry, your second question, Dick, was about?
Your litho assumptions in Q4.
Right now, we don’t have any litho assumptions for Q4. There are opportunities, but with the timing we’re expecting more Q1.
[Operator Instructions] Next, we’ll take John Pitzer from Credit Suisse.
This is Ada Menaker calling in for John. How are you thinking about inventory going into the December quarter and then exiting the year?
It’s a good question. I would say our core inventories in our like our process control group, we see trailing down in the quarter, but that’s being offset by inventory investments that we’re making in the display initiative which, if you heard our commentary, that revenue is not probably generated until early 2020, so we’re building obviously a lot of inventory that will not move out for another year. So I’m expecting inventory to be somewhat close to the current levels, maybe slightly down.
Thank you. And then in terms of the news that came out today from -- in regards to an indictment for the Chinese memory makers. Do you have any input on that and how we should think about that?
There’s not a direct impact to us for that particular account. It’s relatively small account. But the -- but it’s certainly sending a signal of concern to, I think, some of the Chinese domestic customers going back to Patrick’s question. And that there’s a pause in deciding, okay, we’re going to invest all of our capital spend on an American company that may or may not be able to deliver and trying to understand what’s the framework for decision making coming out of Washington. So I think that’s -- that has some of our Chinese customers, domestic Chinese customers -- that’s on the top of their mind.
And we have no further questions at this time. I’d like to turn it back to Mike Sheaffer for closing remarks.
Thanks, Christy. We’d like to thank everyone for participating in the call today and for your continued interest in Rudolph Technologies. That concludes our remarks. And Christy, please wrap it up.
Thank you. That concludes our call for today. Thank you for your participation. You may now disconnect.