Earnings Call Transcript - NVMI Q1 2021

Operator, Operator

Good day and welcome to Nova’s First Quarter 2021 Results. Today’s conference is being recorded. At this time, I would like to turn the conference over to Miri Segal of MS-IR. Please go ahead.

Miri Segal, IR Representative

Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova’s first quarter 2021 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 statement 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 section of the company’s website. 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.

Eitan Oppenhaim, President and CEO

Thank you, Miri, and thank you all for joining our first quarter financial results conference call. I will start the call today by speaking about our first quarter results and performance highlights. Following my commentary, Dror will review the quarter’s financial results in detail and we will conclude with the guidance for the second quarter of 2021. Nova continued to perform well in the first quarter of the year, delivering outstanding results and exceeding both our revenue and profitability guidance. The growth in our business momentum, as reflected in our financial results, is driven by our entire product portfolio across markets, customers, and technology nodes. Our revenue grew by 38% year-over-year to a record high, while our non-GAAP net profit grew by 52% year-over-year to a record level as well. During this remarkable quarter, we also achieved record bookings and operating cash flow. The solid growth momentum this quarter and the outstanding performance we demonstrated over the last year could only be accomplished by consistently executing our strategic roadmap while creating greater agility in our operational model. The flexibility we have built into our operating model, combined with the investment we have made to secure our supply chain during COVID-19, enabled us to ramp up our production capacity by more than 30% to meet on-time delivery in these surging markets. Our differentiated portfolio, honed by our commitment to innovation, continues to amplify our position with leading customers as we address their challenging technical transition to new generations of semiconductors, which combine innovative complex architectures with new novel materials. Our achievement this quarter marked another successful milestone in our healthy growth trajectory for this year as we expand our market presence and deploy our new leading-edge technologies. Nova’s diverse revenue across multiple device segments is a result of the growing demand in the end markets for electronics, which continues to shape the growing demand in the semiconductor fabrication supply chain. The main catalysts are driven by the growing digitization of multiple industries and include improvements in data management, network infrastructure, and broader usage of AI in different markets. In addition to pure demand for silicon and to support these dynamic changes, the complexity embedded in building next-generation technology nodes requires a breed of innovative products, specifically in process control, to support the development and fabrication of new advanced memory and logic devices.

Dror David, CFO

Thanks, Eitan. Good day, everyone, and thank you for joining our first quarter 2021 conference call. Total revenues in the first quarter of this year exceeded our guidance and reached an all-time record of $84 million, representing a 38% growth compared to the first quarter of 2020. Looking at product revenue distribution, approximately 65% was attributed to logic and foundry, and approximately 35% to memory. Geographically, Taiwan and Korea each contributed more than 25% to our product revenues, while China was slightly under 20%. On a per customer basis, four major customers accounted for over 10% of our product revenues, including two foundry customers and two memory customers. Blended gross margin in the first quarter increased to 57%. Product gross margin came in at 62%, while service gross margin increased to a normalized level of 39%. Operating expenses for the quarter increased to $28.2 million on a GAAP basis and $25.8 million on a non-GAAP basis. Sales and marketing expenses increased in the quarter mainly due to higher SIMS commission expenses and other costs of sales personnel. On a non-GAAP basis, we expect sales and marketing expenses to normalize between $8 million and $8.5 million in the upcoming quarters. The effective tax rate in the first quarter of 2021 was approximately 13%, slightly lower than our effective tax rate model of 15%. Earnings per share on a GAAP basis were $0.60 per diluted share and earnings per share on a non-GAAP basis were $0.70 per diluted share, both exceeding the company guidance for the quarter and representing a new record for quarterly earnings per share.

Eitan Oppenhaim, President and CEO

Thank you, Dror. Before we take your questions, I would like to use this opportunity to thank once again Nova’s employees for their dedication and outstanding efforts, leading to these record results during these dynamic and uncertain periods. The past year has been a true test of the grit and resilience of the company and our local team across the globe. They didn’t miss a beat along the year. Our local offices were strengthened tremendously to maintain top quality service for our global customers and to capitalize on various emerging opportunities. Our production teams never stopped working, sometimes around the clock, to ensure we deliver on our promises and meet market demand. Every single one of Nova’s employees stepped up to the challenge and did their part. As we gradually and cautiously resume our familiar working routines, starting from Israel, where 97% of the employees are vaccinated, I would like to thank each and every one of them for their contribution to our performance and ongoing success. With that final note, we will be pleased to take your questions. Operator?

Operator, Operator

Thank you. We will now take our first question from Quinn Bolton from Needham. Please go ahead.

Quinn Bolton, Analyst

Hey, Eitan and Dror. Good afternoon and congratulations on the great results. I wanted to just start first with maybe a clarification, Dror. It looks like deferred revenue on the balance sheet jumped up pretty meaningfully and maybe to a record level. I was wondering if you could discuss what led to that increase? Is it reflecting greater software sales that are recognized over time? Is there a service component to that or could it be associated with some of the new tools that you are putting into the field? Thank you.

Dror David, CFO

Yes. So, the deferred revenues did increase significantly in the first quarter and most of the increase is related to the new products that we are introducing into the market. We have a few of these in several product lines. In some cases, we installed the tool; the customer is already paying and the acceptance is actually being delayed to a later period. So, most of this increase is related to these new product introductions.

Quinn Bolton, Analyst

Great. Thank you. The second question I have is many of your peers are citing growing capacity constraints that may be starting to limit upside in the second quarter or perhaps even in the second half. Wondering if you’re having or seeing any supply chain constraints that might be limiting your near-term outlook, either again in the second quarter or the second half, whether it be semiconductors, passive devices, or anything else that goes into your systems?

Eitan Oppenhaim, President and CEO

So, the answer is no. We took a lot of actions during 2020 in order to expand both our production capacity as well as securing the supply chain, understanding that once everybody goes back after the pandemic, we will have an over-demand issue with the supply chain. We secured both our inventory as well as the production capabilities, both in Israel and the U.S. and in Taiwan. Currently looking in 2021, we don’t see any issues coming from either productivity perspective or supply chain. Everything is based on the current situation. If something changes economically or from the COVID perspective, then we need to reevaluate. But as it looks right now, we don’t have constraints to increase capacity.

Quinn Bolton, Analyst

Okay, great. And then, Eitan, for you, my last question is it sounds like you’ve got an increasing number of PRIZM and listed some tools out in the evaluation stage. I was just wondering if you could give us any sense on other new technologies you’re developing, whether those technologies would be more in the dimensional space or the material space?

Eitan Oppenhaim, President and CEO

So obviously, once we release those technologies to the market, we will announce it. I think that on the current growth path that we have and the surge in demand for the current products that we have, it will take a few quarters more in order to introduce more new technologies. But definitely, the two areas that we are focusing on right now or the three areas are as follows: One is finding a new channel of information for the dimensional part, one of them being the PRIZM. The second pillar will be more products on the material side because it’s becoming a real issue to measure the profile composition and stress of those materials. You saw the ELIPSON coming in. The third element is more and more software, incorporating machine learning elements as they are compensating for parts of the hardware which are very difficult to reach given the tight specifications that the customers are asking. So most of the development and investment right now are going into these three directions.

Quinn Bolton, Analyst

Thank you, Eitan. Thank you, Dror. I will get back in the queue.

Eitan Oppenhaim, President and CEO

Thank you. Thank you very much.

Operator, Operator

We will now take our next question from Jamie Zakalik from Bank of America. Please go ahead.

Jamie Zakalik, Analyst

Hi, guys. Thanks for taking my question and congrats on the great results. I had a question on China. So how are you guys seeing demand from the domestic China region? I think some of your peers have mentioned they expect domestic China WFE this year to be around $10 billion, maybe slightly higher. So what’s been your visibility into demand and has the incremental upside you have seen been concentrated in any specific region?

Eitan Oppenhaim, President and CEO

So thanks for the questions. Let’s start from the geographical distribution of the revenue. In the first quarter, we definitely saw more demand coming from Korea. Actually, it was a record revenue for us coming from Korea this quarter. We see growth both in DRAM, logic, and VNAND coming from Korea during the first quarter. Taiwan is already elevated with a larger foundry there that is spending on both 5-nanometer and 3-nanometer. Regarding China, we do see an increase in investment within the local domestic market. The fact that we can shift part of our product from Israel allows us to gain market share as well as to get into those investment schemes much easier than some of our peers, and we are benefiting from that. Looking ahead at the distribution over the year, China is very stable for us across the four quarters with some options for upside from domestic memory and domestic foundry in China.

Jamie Zakalik, Analyst

Got it. That’s very helpful. And then you guys talked about a number of impressive product offerings. I kind of wanted to ask a little bit more about the new ELIPSON tool. Can you discuss what’s driving the need for this specific tool, how it’s really different from what else is in the industry? And any color on customer momentum so far?

Eitan Oppenhaim, President and CEO

If I look at our total portfolio for material measurement right now, it’s very unique and one of a kind in the market. Both for the XPS and the ELIPSON, those are products that were used to measure material characterization in laboratories. We took them into production, and we took them to applications that are in-line, in-die. Besides Nova, I don't believe there are any other competitors in the market that are able to do either composition or stress measurement with any other technology. So, for that uniqueness, we are transitioning technologies from being slow laboratory tools to high-volume productivity solutions in the fab itself, which is creating a lot of demand. Now, regarding the application itself, we need to understand that today’s chip performance improvement isn’t just about scaling; it’s a combination of scaling and significant investment in materials. Therefore, we are seeing a lot of demand for materials measurement related to composition, stress, strength, crystallinity of silicon, and many other materials that need to be measured in process control, where we have a unique standing.

Jamie Zakalik, Analyst

Got it. And if I could squeeze one more in, some of your peers have mentioned that they now expect WFE to be back half loaded this year. Are you seeing the same? And what does that mean for your revenue profile throughout the year?

Eitan Oppenhaim, President and CEO

So usually, we don’t give guidance beyond the quarter, and I mention this every first quarter. It would be naive to look at the fourth quarter and assume that we know exactly what the visibility is. We do see upside in the second half, but I think that the second half will be better than the first half, although we don’t expect a major increase. Everything is based on the assumption that we don’t yet have full visibility on the fourth quarter.

Jamie Zakalik, Analyst

Got it. Thank you, guys.

Eitan Oppenhaim, President and CEO

Thank you.

Operator, Operator

Our next question comes from Patrick Ho from Stifel, please go ahead.

Patrick Ho, Analyst

Thank you very much and congrats on a nice quarter and outlook. Eitan, maybe first off, you’ve talked about a lot of your development work that’s now coming to fruition with new products as well as new node transitions as you look forward into the foundry logic. You mentioned in your prepared remarks, comments about the all-around nanowires and the future transition structure on the foundry logic side of things. How much capital intensity do you think it increases for both your dimensional and materials tools as the industry makes that migration?

Eitan Oppenhaim, President and CEO

If we’re looking right now, not only at logic but also at memory, there are two inflection points that require a lot of investment in creating a better profile of the chip. In the memory segment, this significantly increases the number of layers, which prevents you from executing one short edge or deposition. Therefore, you need to have a multi-stack structure, and this can only be controlled with more intensity on the metrology side, mainly focusing on dimensional aspects. For logic, the gate-all-around or nanowire structure necessitates a completely new approach. Transistors are no longer traditional; they are becoming horizontal, and in order to construct an accurate and precise structure, you need to add more materials, which is a complex structure to control. Consequently, with each challenge, there is a need for enhanced metrology and more intensity on those process control tools. Specifically, we are observing an increase in tens of percentages of intensity required for these advanced nodes, both in the VNAND layering and the nanowire structure for logic.

Patrick Ho, Analyst

Great. That’s helpful. As my follow-up question regarding the services business, you mentioned you had a record quarter this year. Over the last couple of years, you’ve increased your capacity, particularly in Israel, which has obviously helped with the manufacturing side and getting tools up. Can you discuss your services infrastructure and whether you need to invest more to keep pace with the growing business and the number of tools that are starting to hit the field?

Eitan Oppenhaim, President and CEO

As we increase the installed base, we indeed require more services and need more resources to support it. However, looking at the larger picture, the service revenues are distributed across three elements. One is the contract or service-based licenses for these tools in the trailing edge. The target, of course, is to maximize the number of tools in those service contracts or license-based contracts. The second part consists of time and materials, meaning those customers that prefer not to engage in a contract, we must support through calls, which is part of our service revenue. Lastly, there are the value-added services, which are the growing component. Therefore, we invest in a specific service roadmap that means productivity upgrades, hardware and software for trailing tools and installed bases. Additionally, we have unique software elements to control tools in large volumes specifically for the service part. Much of our R&D is directed towards developing these value-added services. I’m not just referring to release upgrades or throughput upgrades; I’m referring to substantial functionality changes that can generate revenue from the existing installed base. So yes, there is investment in that, and we are seeing growth in investments in services.

Patrick Ho, Analyst

Great. Thank you very much.

Eitan Oppenhaim, President and CEO

Thank you, Patrick.

Operator, Operator

We will now take our next question from Atif Malik from Citi. Please go ahead.

Atif Malik, Analyst

Eitan, you talked about the 10% goal for software to be a percentage of the products. Can you help us understand where you guys are right now in terms of software as a percentage of your sales?

Dror David, CFO

Yes. So, in the first quarter of 2021, we were at approximately 7% to 8% of product revenues.

Atif Malik, Analyst

Okay. And then as my follow-up, I just want to understand what percentage of your product portfolio is integrated metrology and how much of that is exposed to kind of the decision-making at the OEMs, the processing tool companies in the U.S., and how much of it is influenced by your direct customers? The reason I ask this is that some of these OEMs are included in discussing a holistic integration of metrology, and they talk about in-house capability concerning putting metrology capabilities on the processing tool. So, I want to understand how much of your card is exposed to integrated metrology and if there should be any concern regarding in-sourcing risk at these OEMs? Thank you.

Eitan Oppenhaim, President and CEO

Atif, thank you for the question. Regarding the first part, we don’t break down the revenues coming from integrated and standalone product lines, as doing so would provide competitive insights once we start breaking it down following market demand. As for the second question, I would like to shed some light on metrology and the decision-making process. Although integrated metrology connects to an OEM tool, it operates in a completely different market determined by the customers. The OEMs don't have a say in this matter. In terms of metrology, we can break it down into three categories. The first is standalone tools, which function independently and give control over the wafers. The second category encompasses integrated metrology, which connects to the OEM and provides wafer-to-wafer control. Lastly, we have the institute category mainly used for polishing or etching processes. Nova does not compete with the institute, nor do they compete with integrated solutions. Therefore, OEM discussions concerning internal metrology through these institutes or advanced sensors do not cannibalize any of our markets.

Atif Malik, Analyst

Thank you, Eitan. Very clear.

Eitan Oppenhaim, President and CEO

Thank you.

Operator, Operator

As there are no further questions at this time, I would like to turn the conference back to Eitan Oppenhaim, President and CEO, for any additional or closing remarks.

Eitan Oppenhaim, President and CEO

Thank you, operator, and thank you all for joining our call today. Please stay safe and healthy. Bye.

Operator, Operator

Thank you. That will conclude today’s conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.