ACM Research, Inc. Q3 FY2020 Earnings Call

Good day, ladies and gentlemen. Thank you for standing by and welcome to the ACM Research Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, we are recording today's call. If you have any objections, you may disconnect at this time. Now, I will turn the call over to Mr. Gary Dvorchak, Managing Director of The Blueshirt Group.

Thank you, Andrea. Good day everyone. Thank you for joining us on today's call to discuss third quarter 2020 results. We released results after the U.S. market closed yesterday. The release is available on our website as well as from Newswire services. There's also a supplemental slide deck posted to the investor portion of our website that we will reference during our prepared remarks. On the call with me today are our CEO, Dr. David Wang; our CFO, Mark McKechnie; and Lisa Feng, the CFO of our operating subsidiary, ACM Shanghai. Before we continue, please turn to Slide 2. Let me remind you that remarks made during this call may include predictions, estimates and other information that might be considered forward-looking. These forward-looking statements represent ACM's current judgment for the future. However, they are subject to risks and uncertainties that could cause actual results to differ materially. Those risks are described under Risk Factors and elsewhere in ACM's filings with the Securities and Exchange Commission. Please do not place undue reliance on these forward-looking statements, which reflect ACM's opinions only as of the date of this call. ACM is not obliged to update you on any revisions to these forward-looking statements. Certain of the financial results that we provide on this call will be on a non-GAAP basis, which excludes stock-based compensation, a loss relating to a change in the fair value of a financial liability and an unrealized gain trading securities. For our GAAP results and reconciliations between GAAP and non-GAAP amounts, you should refer to our earnings release, which is posted on the IR section of our website. With that, let me now turn the call over to David Wang, who will begin with Slide 3.

Thank you, Gary, and welcome everyone to today's call. Our third quarter results represent another productive quarter with strong financial results, a new product launch, and greater progress on our strategic initiatives. Revenue grew to $47.7 million, up 43%; shipments were $59 million, up 37%. Both revenue and shipments were at a record level. We delivered a good balance of growth and profitability, with a 43% gross margin and a 22% operating margin. We are committed to delivering profitable growth as we continue to invest in R&D for new products and global sales and marketing. We ended the quarter with $92 million of cash. We also had $24 million of trading securities on our balance sheet from our investment in SMIC STAR Market IPO. I will now discuss recent operational highlights; please turn to Slide 3. Our momentum continued in the third quarter. We've had a strong shipment of new products to both our existing customers and our newer customers. We delivered another Tahoe tool revenue to our lead foundry customers, marking our third Tahoe in a production environment. We continue to see strong interest from current and prospective new customers. Tahoe delivers unique combinations of strong committed performance while using 80% less sulfuric acid. We delivered two ECP ap tools for repeat order shipments to our leading packaging customers. Our Ultra ECP ap is a backend tool that provides better 3D performance by putting a more uniform metal layer at a notch area. We also delivered the first tool of the new member of the ECP 3D to a leading foundry customer in China. The Ultra ECP 3D is a front-end tool that offers enhanced gap filling for high aspect ratio TSV applications, which is critical technology for high-density stacking of 3D chips, as our customers are moving to more advanced production nodes. In September, we delivered the second-generation TEBO tool to our existing lead customer. We had significant technology upgrades, including a process that delivered a higher particle removal efficiency, PRE, with a wider process window. We expect this will help accelerate the adoption of TEBO. This is the first tool and we expect revenue recognition upon qualification and acceptance. Also, last week, we announced an important milestone for TEBO, where the United States Patent and Trademark Office approved our fundamental TEBO patent. This strengthens our leadership position in advanced damage-free megasonic cleaning technology for sophisticated 3D semiconductor device structures with patent protection for nearly two decades. Our third quarter shipments included multiple semi-critical first tools to our newest customer, a China-based analog and power IC manufacturer. Their first tool includes a scrubber, a sprayed wafer backside cleaning tool, auto wet bench, and also a SAPS-II cleaning tool. We expect acceptance and revenue to be likely 2021 events. Looking at this graph achievement, I'm proud of our engineering team. Over the past several years, the team has added many new and innovative platforms to expand our product offerings beyond our flagship cleaning tools to include ECP training tools, SFP polish tools, and vertical furnaces. Now turning to Slide 4, for those of you who are new to ACM, I will reveal our product portfolio and the market opportunity. We estimate our current product portfolio addresses $5 billion of the total market opportunity. This spans DRAM, 3D NAND, foundry, power, and analog application devices. Our core market is for cleaning tools starting with our flagship single-wafer cleaning product, SAPS, TEBO, and Tahoe, and our fluid semi-critical cleaning product. We estimate this tool addresses about 80% of the $3 billion wafer cleaning market, for a $2.4 billion market served by ACM cleaning products. Our newer products add a $2.6 billion opportunity, including $1.6 billion from the vertical furnace and $5 million each from ECP and stress-free polishing products. We are focused on gaining market share by expanding our product line and winning new customers. Turning to Slide 5 for discussion of our customer base. We have five major front-end customers across DRAM, foundry, and 3D NAND. We have several back-end wafer packaging and assembly customers. Our newest customer manufactures power and analog devices. We believe these customers alone represent a significant opportunity for ACM. Many of them are still in the early and middle stages of a multi-year capacity expansion and are only buying a fraction of our full product portfolio. Naturally, we expect to continue to add new customers as we believe every major semiconductor manufacturer can benefit from our technology. As we discussed on the previous call, we are actively engaged with several potential first-year new customers in North America and Taiwan. Please turn to Slide 6. We are actively adding production capacity and development capacity to support our near-term and long-term growth trends. Our regional facility in Shanghai remains the headquarters of ACM Shanghai, which includes our R&D, SG&A, prototyping, and production of newer products. We began production at our second factory in September of 2018 and opened the second floor for production in the third quarter of this year. This increased capacity at our second factory from $250 million to more than $350 million. Our long-term solution is the Lingang facility, which will become our R&D center, providing employee housing, and will have the floor space to increase our production capacity five-fold. We broke ground on the Lingang facility in July of this year and plan to begin production by mid-2022. Before discussing our 2020 outlook, I would like to discuss a few important items. First, I want to address the short-seller report that was published in early October. We were surprised by the comments made in our October 8 responsible press release and we fully refuted the allegations made in the report. Over the past few weeks, ACM Shanghai's China IPO team, which includes our audit team, investment banker, CFO, and CWN, has performed a detailed review of all the allegations. Most of the items were easy to refute as a 43-page report from the short-seller included mainly statements of facts, contradictory opinions, and general misrepresentation of the state of our industry. For other items, the team performed complementary legwork, including interviews with customers, suppliers, and management, and a documentary review. The team has delivered a comprehensive report of their findings for the Shanghai Stock Exchange Commission. This report fully refutes all of the allegations on a point-by-point basis. At this moment, we have decided that we will not release the report. We are happy to take any questions after the call. Secondly, an update on ACM Shanghai's Stock Market listing in late May 2020, we submitted an IPO application through the Shanghai Stock Exchange Commission. After too long our question-and-answer session in late September, the STAR Market listing committee approved our application. At this point, the listing is subject to submission of a formal registration, review, and approval by the China Securities Regulatory Commission. With the timely registration, we expect to launch the process later this month and price the IPO by year-end. Before I turn the call over to Mark, I would like to discuss our 2020 outlook. Please now turn to Slide 7. Looking forward, we're excited about our business opportunities, and we remain optimistic about the remainder of 2020 and our growth prospects for 2021 and beyond. Accordingly, we have updated our full-year 2020 outlook as follows. We have reached the low end of our range. We now expect revenue to be between $145 million and $155 million, compared to the prior range of $140 million to $155 million. That revised revenue range represents 39.5% revenue growth at the middle point. The implied revenue at the middle point for the fourth quarter represents 58% year-on-year growth. Our outlook for the remainder of 2020 is based on several key assumptions. First, the COVID-19 situation remains stable in China and does not worsen on a global basis in the coming months. Second, Chinese semiconductor industry fab investment continues. Third, the revenue range assumes good growth from NAND and foundry customers and muted DRAM recovery. Our outlook also assumes limited contributions in Q4 from SMIC. Our results and outlook for our balance sheet reflect the successful execution of our strategy. Our strong growth is providing the capacity to our factory. Our R&D spending on new products ensures profitability that our investors expect. We’re building global sales and marketing resources to engage new customers in new regions, and we are scaling production capacity to support our long-term growth plan as we continue our mission to become a major equipment supplier for the global semiconductor industry. To conclude, I would like to thank our employees for their hard work and dedication. I also want to thank our customers, partners, and shareholders for their continued support and confidence in ACM Research. I will now hand the call over to Mark to discuss our financial results in more detail.

Thank you, David, and good day, everyone. We had strong financial results in the third quarter. Unless I note otherwise, I'll refer to non-GAAP financial measures, which exclude stock-based compensation, changes in the fair value of financial liabilities, and unrealized gains in trading securities. A reconciliation of these non-GAAP measures to comparable GAAP measures is included in our earnings release. Turning to Slide 8. For the third quarter, revenue was $47.7 million, up 42.6%. Growth was driven by solid demand for our front-end equipment and back-end tools. We had a strong contribution of revenue from three of our major front-end customers and also one of our back-end customers. Total shipments were $59 million versus $43 million in the year-ago quarter and $45 million in last quarter. As David noted, this marked another record level of quarterly shipments and an important demonstration of scale to the industry. Total shipments include deliveries for which revenue is recognized in the quarter, as well as deliveries of systems awaiting customer acceptance for potential revenue in future quarters. Gross margin was 42.8% versus 49.1%. Gross margin was within our long-term target of 40% to 45%. Gross margin varies on a quarterly basis due to a variety of factors, such as sales volume and product mix. Operating expenses were $10.1 million, up 29%. The year-on-year increase was driven by higher R&D on new products and higher G&A expenses related to the STAR Market IPO. Operating income was $10.3 million, up 19.8%. Operating margin was 21.6% versus 25.7%. Now some details below the operating line. Non-GAAP results exclude stock-based compensation and two additional items. The first, change in fair value of financial liability, is a non-operating non-cash book loss of $6.5 million. As described in last quarter's call and in our 10-Q filings, the liability was related to private equity investments in ACM prior to the 2017 IPO. The PE investment was restructured through a number of agreements to comply with the STAR Market IPO. The liability was terminated on July 28 with the issuance of an equity warrant, after which it became a balance sheet item and will no longer impact our income statement in Q4 and beyond. The second is the unrealized gain on trading securities of $9 million from our SMIC investment. The investment was marked to market at quarter-end, and the gain reflects the increase in value from the original IPO price. We will exclude this item from the non-GAAP results until the gain is realized when or if we sell the shares. Net interest expense was approximately $0.1 million, unchanged from last year. Other expense was $1.8 million versus other income of $1.8 million. This is a significant year-on-year swing of $3.6 million that impacted our bottom line. Other expenses were primarily due to realized gains and losses caused by currency fluctuations on our working capital during a given quarter. Tax benefit was $1.7 million versus $0.3 million. The large benefit in Q3 of 2020 was partly due to option exercises, which had a favorable impact on our global tax rate. The 2019 results also included a benefit that resulted from the release of valuation allowance. Our tax rate can have big fluctuations on a quarterly basis for a number of factors. We suggest you model a 12% to 14% non-GAAP effective tax rate for future periods. Non-controlling interest was $1.4 million versus $0.3 million. This line can vary as well. We encourage analysts to model about 8.3% of net income for this line item as a proxy for the minority interest in ACM Shanghai held by private equity investors. Net income attributable to ACM Research was $9 million versus $10.3 million. The currency and tax items contributed a net benefit of $0.3 million in the third quarter of 2020 versus a net benefit of $3.4 million in 2019. Net income per diluted share was $0.42 versus $0.53. If we exclude the currency items as discussed above and normalize tax at 12%, the apples-to-apples comparison is $0.40 versus $0.36. Now we reviewed the balance sheet items at the end of Q3. Cash and equivalents were $92.2 million, up from $86.4 million at the end of Q2. The quarter-on-quarter increase was due primarily to net cash provided by operating activities and our higher draw on our line of credit. In addition to the cash balance, we also had trading securities of $24 million on our balance sheet related to our SMIC investment. This is treated as a current asset as we were locked up for a year from the initial share purchase date. Short-term borrowings were $28.3 million, up from $25.8 million at the end of Q2. Total inventory was $64.2 million, up from $49.7 million at the end of last quarter. The total finished goods inventory increased to $23 million from $0.17 million at the end of last quarter. The $6 billion quarter-on-quarter change represents a net increase of first tools that have been shipped to customers for valuation. Note that finished goods inventory is carried on ACM’s balance sheet at cost pending customer acceptance and future revenue recognition. Year-to-date, we’ve spent a total of $16 million on Lingang-related investments. This includes $9.3 million for the land rights and $7 million in deposits for employee housing. In addition, we’ve spent $3.7 million in capital expenditures. We anticipate another $9 million to $10 million of Lingang facility CapEx and employee housing in the fourth quarter for a total of $29 million to $30 million of total CapEx in Lingang-related spending for the full year. To conclude, we are participating in the growth of major new IC fabs. We are ramping production and continue to develop and deliver innovative products. We are optimistic about our opportunities in China and expansion outside of China, and we remain committed to achieving our mission to become a major player in the semiconductor equipment market. Let’s open the call now for any questions that you may have. Operator, please go ahead.

Ladies and gentlemen, we’ll now begin the question-and-answer session. Our first question comes from the line of Patrick Ho from Stifel Nicolaus. Please go ahead.

Thank you very much, and congrats on a nice quarter and outlook. David, maybe first off in terms of the market environment, you’ve obviously posted very strong shipments and revenues in the September quarter. Can you discuss with your customer discussions whether you’re seeing an accelerated shift of localization efforts? And how that’s potentially helping you as you look at 2021 as a whole? Are you seeing more chip makers come to you as the geopolitical tensions rise and the effects of that for your business?

Okay. Hi, Patrick, thank you. We had a very strong quarter achievement this year in Q3, and we also see this trend continuing in Q4. Additionally, we have good indications for the first half of next year. However, as we normally provide projections for next year, we typically do this by early January. So probably, we’ll provide those next year guidance at that time. Again, this represents real opportunities here while fabs continue to expand. Our major customer community continues to grow their fabs, and we also see a recovery at some point next year. We’ve been adding new customers to our base, and we’re also seeing new products qualifying such as ECP and semi-critical cleaning tools, and Tahoe, including our recent vertical furnaces. As of Q3, we have about $40 million deferred revenue.

I think you covered it well, Patrick. Do you have another question?

Mark, my follow-up question is more for you. So you mentioned inventories went up primarily due to the inventory you were building for some of your evaluation units. Given that there's still a bit of disruption in the supply chain related to COVID, can you just give a little bit of color on whether you're building any inventory for your general core product lines, whether you need to do that as well? Or has the supply chain opened up enough where you feel comfortable in the procurement of key supplies and parts?

Yes. Thanks for the question, Patrick. Yes, you did mention that a lot of the inventory uptick was from demo tools, so that was a big factor. We carry those costs, and those are really multiple tools that our customers are evaluating. Typically, for these demo tools, we’d expect to take revenue on them within two to four quarters. Regarding our overall supply chain, there’s always work to be done on that. We did see some lead times with certain items, but we're working really closely with our suppliers. We don't feel like we’re really building any additional inventory because of any potential tightness. The inventory we've built up was really just in front of a good ramp that we expect next quarter.

Great. Thank you.

Thanks, Patrick.

Thank you, Patrick.

Thank you. Our next question comes from the line of Charlie Chan from Morgan Stanley. Please go ahead.

Hi, good morning. Good afternoon. Again, congratulations on your great future. I would like to ask about the report you mentioned earlier, which I think was very helpful. As usual, I wanted to follow up on your progress with some top-line customers for TEBO, the leading logic foundry, and those U.S. memory accounts. Can you give us some updates here? Thank you.

Great. We’re still continuing to work with our leading customers in both Taiwan and North America. We have been making progress, especially with one of our leading customers who are very familiar with our tool. We’re talking about delivering the demo tool, and hopefully by the end of this year, we can receive that demo tool to deliver probably next year. There may be another six to ten months of qualification required. Meanwhile, we’ve been working with multiple other customers in North America and Taiwan. Next year will be another exciting year for us as we penetrate top-tier customers. I have confidence in our TEBO and Tahoe tools being premium tools for customers in Taiwan.

Okay, good. Given the recent M&A activity, do you think that is the kind of tailwind for you to expand your business in NAND flash after this merger?

Yes, definitely. I think that there’s potential here. The recent news about this M&A indicates that it may take some time to complete, likely a few years. However, there is a growing need from our customers, and also fabs relocating to China, so we see good positive impacts for us to enter this market in 3D NAND. Our processes are well established, and we're familiar with the 3D NAND process. Our fabs and our future strategy all contribute significantly to our ability to capitalize on these opportunities.

Thank you. Next, I would like to follow up on the China CapEx. I know you cannot provide guidance yet, but do you think the CapEx size will be larger this year considering there could be challenges, especially with SMIC's around $6 billion to $7 billion this year, dropping into tougher comparisons for next year?

So far, we see a good potential with our key customers driving demand next year. We have positive expectations based on their planned expenditures. We've seen similar plans from other major customers including ITC and Huahong, and we’re optimistic despite uncertainty in the global market.

Lastly, do you have any idea on the expanded market cap of your China subsidiary for the IPO?

That’s a good question, but we are currently in a sensitive period and cannot comment on that. However, comparing our market cap with other semiconductor equipment companies, our expectations for a successful IPO pricing is consistent with our belief that we have a strong outlook and the best interests of our stakeholders.

Thank you. Our next question comes from the line of Suji Desilva from ROTH Capital. Please ask your question.

Hi, David, hi Mark, congratulations on the progress here. So a couple of specific questions: on the Ultra C Tahoe product, you've had success in the foundry segment. Is the memory customer base looking at that aggressively, or will that take longer?

Our Tahoe product is performing well, and we have received additional orders from existing customers, which is a positive sign. We’re also engaged with multiple memory customers, so we expect this tool will generate revenue for us next year. The feedback has been very encouraging.

Could you update us on the China analog customer that you announced last quarter, and also about the U.S. OEM partnership, any updates there?

Yes, we have made progress with our new customers in analog and power devices. We’re delivering tools to one of those customers, while another customer is expected to receive their tool around Q1 next year. Regarding the U.S. OEM customer, we're already qualifying their process, and they’re satisfied with our cleaning capabilities.

Thanks, Suji.

Thank you. Our next question comes from the line of Donnie Teng from Nomura. Please go ahead.

Good evening. Good morning, David and Mark. Thank you for taking my question. My first question is regarding your 2020 guidance. You mentioned that your outlook assumes limited contribution in Q4 from SMIC. Can I have some more clarity on this assumption? I think not all the equipment suppliers received U.S. government’s notifications on shipping equipment to SMIC, so I’m curious if this assumption may be too conservative.

We had good delivery within Q2 and Q3 for SMIC, and we estimate the contribution standpoint for SMIC next year may be 10% to 20%. However, we aren’t sure of the total projection for the following year, so we are being cautious.

Okay, so basically, we gained meaningful shares at SMIC in Q2 and Q3, but in Q4, momentum is temporarily slowing down due to customer's sales recognition schedule. I'd like to clarify if ACMR has received any notification from the U.S. government. If we haven’t, does that mean we can continue to ship into SMIC as long as they are still investing in capacity extension?

Clean technologies have been developed in Shanghai since about 2006-2007. While I can’t comment on future notifications, deliveries to SMIC depend on export control laws in the U.S. and our consultations with export control lawyers.

Thank you for that. My second question is regarding your gross margin. I know Mark mentioned your long-term target is around a 40% to 45% range. But could you elaborate on the gross margin level across different types of equipment, given the diverse product pipeline?

Sure. At a high level, our single-wafer cleaning tools generally have higher margins, while semi-critical cleaning tools tend to have lower margins due to their more mature technology. Each tool carries a different margin based on customer needs and the competition within the marketplace. As we balance our strategy over time with various products, we maintain our projection of a long-term gross margin between 40% to 45%.

Great. Thank you, David and Mark.

Thank you.

Thank you. Next question comes from Charlie Chan from Needham and Company. Please ask your question.

Hi, David and Mark, good evening, good morning depending on where you are. My first question perhaps a follow-up to Donnie’s question on SMIC. Can you provide a quantitative sense of revenue exposure to SMIC this year?

Over the last two years, our revenue from SMIC was around less than 10%. This year, we saw that increase to potentially 14% or 15% of our revenue from SMIC depending on the fourth quarter’s results.

Thanks. That’s really helpful. Now, regarding the market demand outlook, looking at your revised 2020 outlook with slight growth rate, what are your expectations for WFE growth from domestic Chinese customers? Do you see additional share opportunities among these customers?

We expect to see continued demand from major customers in DRAM and NAND, driving growth. Our aim is to expand both domestically and globally, seeing great potential going forward based on current pipeline and activities.

Just to build off that, we’re planning for growth next year, especially given the early stage capacity expansions of some of our key customers. We're optimistic about gaining share with new products and the current customer deliveries will help our revenue pipeline.

Thank you for the clarity and for my questions.

Thank you. Our next question comes from Krish Sankar from Cowen and Company. Please ask your question.

Yes. Hi, thanks for taking my question; David and Mark. David, you spoke about gaining traction with a large U.S. logic customer. Has manufacturing delays affected your timeline and could this be seen as an opportunity cost?

Mark, do you want to address that?

So Krish, while we would have loved to have had the demo tool installed last year, we are not seeing the overall opportunity diminish significantly due to timelines.

Got it. That's very helpful. As a follow-up, could you just discuss where we are with furnace product adoption and customer interest?

Yes, we've received positive feedback regarding our vertical furnace products. We delivered the first tool in Q1 and are in the process of qualification, potentially by the end of this year or early next year. We've seen additional interest in the product from both existing and new customers.

Thanks, David, and Mark.

As there are no more further questions in the queue, I'll now turn the call back to Mr. David Wang for closing remarks.

Thank you, operator and thank you all for participating in today's call and for your support. Before we close, Gary is going to mention some upcoming events.

On November 11, we'll attend the ROTH’s virtual technology conference. On November 12, we'll be at the Benchmark Technology virtual one-on-one conference. And on November 17, we'll participate in the Craig-Hallum Alpha-Select virtual conference. Attendance at all of these conferences is by invitation only, so please contact your respective sales representatives if you want to schedule any one-on-one meetings with us. This concludes the call, so you may all disconnect. Thank you.