Good day and welcome to the Onto Innovation Third Quarter Earnings Release Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mike Sheaffer, Investor Relations. Please go ahead.

Thank you, Rachel, and good afternoon, everyone. Onto Innovation issued its 2023 third quarter financial results this afternoon shortly after the market closed. If you did not receive a copy of the release, please refer to the company's website where a copy of the release is posted. Joining us on the call today are Michael Plisinski, Chief Executive Officer; and Mark Slicer, Chief Financial Officer. I would like to remind you that the statements made by the management on this call will contain forward-looking statements within the meaning of the federal securities laws. Such statements are subject to a range of changes, risks, and uncertainties that can cause actual results to vary materially. For more information regarding the risk factors that may impact Onto Innovation's results, I would encourage you to review our earnings release and our SEC filings. Onto Innovation does not undertake the obligation to update these forward-looking statements in light of new information or future events. Today's discussion of our financial results will be presented on a non-GAAP financial basis unless otherwise specified. As a reminder, a detailed reconciliation between GAAP and non-GAAP results can be found on today's earnings release. I will now go ahead and turn the call over to our CEO, Mike Plisinski. Mike?

Thank you, Mike. Good afternoon and thank you for joining the call today. We finished the third quarter just above the midpoint of guidance for operating income and earnings, despite top line revenue near the low end of guidance. This financial performance is just beginning to reflect the improvements from the initiatives we outlined in July. Shortly, Mark will outline how we expect to accelerate additional improvements through the next several quarters. Now, I'll share what we see as a new wave of opportunities for Onto Innovation following recent visits with several customers in Asia, including those leading the innovations in memory and packaging that are enabling this new era of artificial intelligence. Gartner estimates that today's semiconductors supporting artificial intelligence are estimated to represent less than 10% of the approximated $500 billion semiconductor market. By 2030, the overall market for semiconductors is expected to double, reaching $1 trillion in revenue. However, semiconductors supporting AI are expected to increase 6x to 8x, reaching $300 billion to $500 billion in sales as applications and hardware migrate from data centers to edge computing. Just as advanced packaging was critical to ushering in the mobility era, we believe it will be critical to this new era of artificial intelligence. By using the latest 3D and 2.5D packaging technologies, companies like Nvidia are able to deliver the performance required by end markets while delaying the higher costs of migrating to more advanced nodes. Controlling the formation of these 3D and 2.5D interconnects is critical to yields and creating a surge in demand for the dragonfly platform's comprehensive inspection and metrology capabilities. In the last 2.5 months, we added over $110 million in new orders in addition to the $120 million in orders from last August. These new orders include all three suppliers of high bandwidth memory, process control for 2.5D packaging, and emerging applications for our unique eco-acoustic metrology. We will now turn to another secular driver for Onto Innovation, the market demand for power semiconductors to support the electrification of everything from automobiles to gas-powered garden tools. Revenue from power customers remained near record levels in the third quarter and included inspection metrology and software products. In the quarter, we delivered our new LMNS systems to five silicon carbide customers to more effectively control the thickness of the epitaxial layer, which is critical for high voltage breakdown resistance of the device. Our software also gained a new customer in the compound semiconductor market with a significant order from a leader in wireless communications devices. By demonstrating the power of integrating our discover enterprise process analytics with our equipment control solutions, we're able to help the customer achieve better process targets where their previously installed systems have struggled. Based on the results, we expect this customer to place additional orders in the future and roll this out to factories across the globe. The advanced nodes customer spending reflects the broader weakness in demand for data center and mobile devices. As anticipated, we saw large drops in DRAM and logic revenue resulting in a 30% decline in the third quarter. However, we are making steady progress with our films metrology and delivered several systems to support gate-all-around pilot production in the quarter. The transition to gate-all-around transistors will be an important inflection point for innovation as we believe our positions in OCD integrated and films metrology will result in an estimated 30% increase in opportunity over our position and leading edge FinFET nodes. And now, I'll turn over the call to Mark to provide financial highlights.

Thanks, Mike and good afternoon, everyone. We closed the third quarter with revenue of $207 million, down 19% over the same period last year, and up 10% versus the second quarter. Despite revenue below the midpoint of guidance, we did exceed the midpoint of our EPS guidance range, achieving $0.96 for the third quarter. The revenue decline from the same period last year is primarily due to the decline in our advanced nodes business, which had revenue of $26 million and represents 13% of revenue. Specialty device and advanced packaging with record revenue of $135 million increased 20% over Q2 and represents 65% of revenue. For software and services, we achieved revenue of $46 million, increasing 13% over Q2 and representing 22% of revenue. We achieved a 52% gross margin for the third quarter, exceeding our guidance range of 50% to 51% driven by favorable mix and our cost optimization efforts. Third quarter operating expenses were $57 million at the low end of our guidance range of $57 million to $59 million. We are realizing the benefits of our cost reduction initiatives put in place earlier in the year, driving our OpEx run rate well below our 2022 levels, while still maintaining investments in technologies to help enable advances in manufacturing of AI and powered devices. Our operating income of $50 million was 24% of revenue for the third quarter, compared to 21% for the second quarter. Our net income in the third quarter was $48 million, 23% of revenue versus 20% for the second quarter. Both our operating income and net income performance versus the second quarter highlight our improving operating leverage. Now moving to the balance sheet; we ended the third quarter with cash and short-term investments of $630 million, an increase of $82 million from the beginning of the year, with operating cash flow of $29 million within the quarter, representing 14% of revenue for Q3. Inventory ended the quarter at $346 million, a decrease of $6 million from Q2 as we actively managed down our inventory levels across the network. We are projecting further reduction in Q4; however, we are now targeting to be between $300 million and $320 million by the end of the year. This is a shift in our previous projection and is primarily due to the ramp in our dragonfly G3 orders which is requiring us to procure long lead time components. We are pleased that our focus is now paying off with a quarter-over-quarter reduction but we are certainly not satisfied with the current inventory levels, and this will remain a critical working capital focus area until we can get back to consistent cash flow performance levels of over 20%. Accounts receivable increased $22 million to $210 million in the quarter, and our day sales outstanding increased 2 days to 92 days. During the quarter, we did not execute any share repurchases, and we have $32 million remaining under our existing $100 million authorization. Now, turning to our outlook for Q4. We currently expect revenue for the third quarter to be between $200 million and $216 million. We expect gross margins will be between 51% to 53%. We are expanding our gross margin range partially reflecting the work on supply chain and operational efficiencies we have previously outlined as part of our 2023 cost reduction programs. We expect to see continued improvement in each of the next two quarters. For operating expenses, we expect to be between $56 million to $58 million. For the full year 2023, we expect our effective tax rate to be between 13% to 14%. We expect our diluted share count for Q4 to be approximately 49.5 million shares. Based upon these assumptions, we anticipate our non-GAAP earnings to be between $0.90 per share and $1.10 per share. As outlined during our June 1 Analyst Day, the programs we have in place are on track to deliver approximately $25 million of gross margin cost reductions over the next two years starting in 2024 and into 2025. We have already negotiated greater than 50% of the $25 million in savings and will start to see a portion of the savings realized in our gross margins starting in Q1 as we target 54% as a baseline goal. And with that, I will turn it back to Mike for additional insights into Q4.

Thank you, Mark. As Mark mentioned, we expect fourth quarter revenue to be essentially flat with the third quarter, but with improvement in both gross and operating margins despite the unfavorable product mix of lower advanced node metrology systems. In the fourth quarter, we see additional push outs in the advanced node market reflecting recent public announcements from leading memory manufacturers, indicating a decrease in their production utilization for the second half of 2023. In addition, the timelines for the new U.S. fabs are pushed out as a result of construction delays. This weakness is being offset by the surge in demand we see for the dragonfly G3, which we expect to grow another 50% in the fourth quarter, almost exclusively in support of customers ramping high bandwidth memory in 2.5D packaging. Based on current visibility and customer engagements, we expect the demand to continue to build into next year, resulting in overall growth for Onto Innovation in the first half of 2024. As the era of artificial intelligence progresses, we believe the market will increasingly turn to panel level packaging, where we expect our jet step lithography tool will play an important role in enabling the next generation of chiplet architectures. We recently received an order from a new jet step lithography customer to support their development of advanced packaging on a glass substrate. The glass substrate inherently offers better stability than existing substrates and as a result can take full advantage of our leading resolution and overlay capabilities. The advantage will be the ability to print smaller and denser interconnects to support the needs of next generation chiplet architectures. This new tool will ship in the middle of 2024. If the customer is successful, we expect many additional orders for glass substrates in 2025. Given the current slowdown in high-performance server markets and our lithography production not yet achieving full capacity, we've worked with customers to realign tool shipments. This means for the year, roughly $30 million of planned lithography shipments in 2023 will move into 2024, so the impacts to 2023 revenue are disappointing. This allows our team to further optimize the manufacturing process and be prepared for the next market ramp that we expect in 2025. In conclusion, we believe the AI era that is just beginning will drive many new opportunities for all of our lines of business including inspection, metrology, lithography, and software. Of course, everyone knows the impact that NVIDIA had on the market over the last few months in terms of unit volumes and revenue. Already, we see new products being announced by AMD and Intel to respond to this growing demand. Just this week, Samsung introduced their new generative AI model that is designed for AI applications on their devices for edge computing. We believe this expansion of offerings and new applications is an early indication of the broader growth of the industry. Given our established positions with the market leaders, we see this as a long-term driver for Onto Innovation as well. As I mentioned, AI device volumes are expected to drive our revenue growth in the first half of 2024 over the second half of 2023 independent of recovering advanced nodes. If the advanced node spending resumes in the second half of 2024, then that will only further increase the revenue opportunities we see in the coming year. And with that, I will turn the call over to Rachel for questions from our covering analysts.

Our first question comes from Craig Ellis with B. Riley Securities. Please go ahead.

Yes, thanks for taking the question and nice to see all the dragonfly momentum in the business. Mike, I wanted to start just by clarifying a comment that you made about expectations for panel litho shipments this year. You said that $30 million of expected revenue would shift from what you previously guided. So does that mean that in addition to the $10 million that we saw in Q3, there is $20 million that shifts into next year or am I misinterpreting what you're saying?

From the total year, I think we had some slips also prior earlier. So it's just we haven't been able to drive enough increased production capacity to cover the currently booked quarter and make up for the slips from prior quarters. So as a result, we're skipping steps and we need to stop that. So, in total $30 million is moving from 2023 to 2024, and that's in the numbers that we've been guiding to.

Got it. And then, really like to hear about the 54% gross margin in the first quarter. And I know you don't give a full income statement guide two quarters out, but can you just provide some color on some of the things you're seeing that support that 54%? For example, is advanced nodes now at a trough and just bouncing along the bottom? And I expect there is incremental momentum out of specialty but I would appreciate any color.

Yes, hi Craig, it's Mark. So I think certainly for advanced nodes, that will not be the ramp in Q1 driving that margin improvement. Certainly with the dragonfly and our inspection business, we're implementing second shifts, third shifts; we're driving supply chain efficiencies through that process. So we certainly will continue to see gross margin improvement in our inspection business with those tools in that ramp up. But we've also been able to take costs out, as I've alluded to, throughout 2023, which are fixed and that will continue to drive the benefit. Our goal is certainly 54% as our baseline goal, driving towards that goal of exiting at 55% plus, getting us back on model.

And then lastly, if I could, Mike. Historically, I always thought that specialty had a decent gang component, but it sounds like you're really getting good traction with silicon carbide. Any more color on what's going on with your customers?

You're correct. So historically, we've had a much stronger position in the gang. But recently, we've seen a lot of increased order uptake from silicon carbide customers, and I think that just reflects a lot of what the market is focused on right now. This includes several different types of metrology systems, as well as inspection, driving into those silicon carbide customers. It's also geographically dispersed; we're seeing Europe, the U.S., Japan, Korea, and China all as big systems.

Got it. Thanks, guys.

Our next question comes from the line of Brian Chin with Stifel. Please go ahead.

Hi, there. I appreciate it. Next, I just want to ask a few questions. Mike, maybe just clarification on remarks you made, and then maybe sort of the follow-up question on that. I think previously, you'd referenced a couple of months ago, $100 million plus in dragonfly orders into sort of mid-next year. Sounds like you made a reference to maybe an additional follow-on similar size, maybe a little bit larger slug of orders. Is that right? And can you talk more about that and sort of what timeframe against those orders in terms of deliveries are into next year?

Yes, we did not add more, but we got another $110 million in orders; actually, we got more than $110 million, but the bulk of it, let's say $110 million or so will be delivered through the first half of next year; so Q2 of 2024. There are some additional orders that extend beyond that, but the vast majority is all for Q4, Q1, Q2.

Understood. It's important to ensure that our revenue outlook for the first half of next year exceeds that of the second half of this year. Also, regarding your expectations, do you foresee order rates stabilizing in the second half for packaging, and could advanced nodes begin to accelerate next year?

I think advanced nodes will pick up the pace at some point. That's what we're hoping for. The leveling off is unclear. I'm surprised by how rapidly we are seeing the expansions and how broad they are. Originally, we were seeing a lot of demand for the dragonfly for inspection and some of the metrology capabilities in dragonfly, but as customers are ramping so aggressively, we're finding new challenges that some of our other metrology systems are solving, and we're seeing orders for them. I mentioned the Echo during the call; there are some others as well. So I think as the ramp happens and customers start driving yields and productivity up, there are more opportunities for process control, perhaps even through the second half that keeps that pace of revenue for us up.

Okay. Maybe one last quick one. I think you've shipped some Atlas, OCD tools for deal around applications in recent quarters, but what's your latest thinking in terms of the timeframe? When you'll start to receive volume-based orders and then start to ship against that backlog?

Yes, that's the million-dollar question. I think our customers are getting pretty ready, and it's really about the visibility they have into their customers adopting those lines. We have some construction delays here in the United States, but there are other pilot lines and low volume production lines around the globe that are ready for volume as soon as customers decide to take that plunge. In terms of timing, we hear that by the end of 2024, we should see orders preparing for a more aggressive ramp in 2025.

We will take our next question from the line of Charles Shi with Needham. Please go ahead.

Hey, good afternoon. Hey Mike, Mark. I want to follow up on the question related to high bandwidth memory plus 2.5D. If what I hear correctly, looks like you've got enough orders as much as $210 million+ to deliver between the second half of 2023 and the first half of 2024; is that correct? Because you mentioned about $100 million plus, that's your prior announcement, but you’ve got another $110 million. And all of that is going to deliver through the first half of 2024. I want to make sure I heard that correct.

Yes, that's correct.

Thanks. So looks like there's a good amount of growth for the second half of '23 into the first half of '24, because I think that what you've guided for, I mean, this quarter is quarter-on-quarter growth of that product; AI packaging related revenue. And the next quarter’s growth kind of suggests something about $70 million to $80 million, but that means next year is going to get to something like a first half next year, $130 million to $140 million. So that looks like a very good incremental revenue out there, but I just kind of curious, what about other parts of your business? Advanced nodes? It doesn't sound like you're expecting a recovery, but the third piece, I think you don't really break it down. But specialty devices have been strong in the second half, but what about the first half next year? Is it flat or up or down from the second half 2023 levels? Thanks.

Yes, so I think two things. Going back to the HBM and the packaging, a couple of really significant events happened in the last few months that helped drive that business. One is, we had talked about having some evaluations that I would add the third HBM memory manufacturer; we had two, not the third. Very quickly the demo and evaluation tools demonstrated our value and we quickly saw some aggressive ramps. In addition, we saw new metrology opportunities; so that's contributing to the stronger growth we see in the first half of next year. Going back to power semi, which is one of the big areas of growth in the specialty area; we do see a bit of a slowdown in the first half, but not significantly. I'm guessing that that will start to pick up as the rest of this year progresses.

Thanks. Lastly, can you provide a breakdown of the incremental $100 million? How much of that is from HBM and how much is from other sources?

I knew you’d ask that. Right now it's more heavily towards HBM, but as I’m looking at the data, it's still pretty well balanced between the two groups.

Our next question comes from the line of Vedvati Shrotre with Jefferies. Please go ahead.

Hi, thanks for taking my question. So I wanted to double click on the litho panel opportunity. So, I know we started the year with about $80 million that you're expecting; and then in the second quarter there was some push out, so it came down to $60 million. And so now, could you give me a sense of how much litho turns out to be in 2023? And you said $30 million gets pushed out; so if you could help me understand what happens in the second half of 2023 or fourth quarter?

So you're right; we did have a plan and the expectation to be able to deliver $80 million this year in bookings. Because of the $30 million moving out, that means we'll deliver $50 million this year and not the full $80 million; those other tools are going to move into deliveries for next year.

That would affect your gross margins, right? Because those tools have lower gross margins. So the cost-saving initiatives would offset that; is that correct?

We're still shipping litho tools now. So built into the gross margin profiles where we're delivering now; for the last couple of quarters, we've been delivering two to four litho tools a quarter. And so that's going to continue, but at the same time we've talked a lot about how aggressively we're driving the litho margins north. I think each of the quarters next year, we're going to see improving gross margins from litho to the point where it's not going to be the big issue that it's been for sure all this year.

Yes, got it. And then the other question I wanted to ask you, a lot of your peers are benefiting from China being a stronger territory. Is that playing out for you in any sense? If you could elaborate on that.

China is definitely not as strong for us as it is for our peers. I've seen 40% and 50% of our peers' revenue is coming from China. For us, it's more like 15%.

In Q2 and Q3, we're about 15%. Year to date, we're at 18 to 19%.

So it's a lot of specialty devices, you know; a lot of new markets where we have some generally unique metrology that then brings in some of our other products. But that's definitely not the 50% we see from some of our others.

Thank you. And I have one more, but I’ll get back into the queue.

We'll take our next question from the line of David Duley with Steelhead. Please go ahead.

Thank you for allowing me to ask a question. I want to focus on the lithography issue. You've experienced delays in your systems for two consecutive quarters, if I remember correctly. Is this primarily related to your internal production problems, the performance of the tools, or is it that customers aren't ready for the product? Could you provide more detail on why we're seeing these delays?

Yes, that's a good question. It's been a mix of factors. In Q2, the challenges stemmed more from customer changes that required us to adapt, which prevented us from completing all the necessary work. As we transition these tools into the next quarter, we were unable to deliver everything we had promised for that quarter while also taking on some additional work. These tools are large and require significant space in the factory, and any delays have a substantial impact. Additionally, it's important to note that out of the 17,000 major parts needed to create a lithography tool, approximately 3,200 are custom-engineered by our team. For instance, in our most advanced metrology system, there are only about 100 custom-engineered parts. The complexity of the systems, the manufacturing workflows, and the calibration and integration times require more effort to enhance discipline and processes, making these systems more predictable despite that complexity. However, because we handle much of the custom engineering internally, we’ve been able to make significant improvements. For the first four systems we delivered, we've improved cycle times by 40%, doubled our overlay capability, and boosted throughput by approximately 30%. There is certainly a trade-off; while having a highly engineered system offers advantages, it also brings increased manufacturing complexity.

You can't simply take the systems that were delayed last quarter and expect to build them this quarter. Essentially, we need to produce twice as many. How do you address this issue? When will it be resolved? Clearly, additional internal capacity is required. Is that the reason it doesn't improve until around mid-April?

Yes, exactly. We need to finish some of these processes, we need to get our supply chains to be more responsive; we've had a lot of issues with incoming quality that require rework and take too much time and too much base space. So we can't move these systems. As we work through all this, and again, we're making steady progress; it's just not fast enough. It's no fun for me to keep guiding and then updating the guidance or missing the guidance. So we're resetting, giving the time team to get more predictable, and I expect, you know, in the middle of next year, so by the second quarter, we will be able to reach our full capacity, which is significantly more than $80 million.

And so let's just boil that down; so you're going to go from three tools a quarter to be able to produce six tools a quarter, because that seems like what your problem is now.

Yes, that's fair.

Okay. All right. One final one for me. Thank you very much for that clarification; that was appreciated. You mentioned the TAM for your films tool will grow by 30% as we move to gate-all-around, and I've seen backside powers in that calculation too. Could you just help us understand what the PAM is and also help us understand what you're kind of what that means for how much revenue that would be for Onto?

I don't have that well broken down. I’m trying to think what are publicly stated SAM is for the FinFETs at 10,000 wafer starts. It would be a 30% increase above that. The comment was really around our growing position within gate-all-around and how that will increase our opportunity given the same amount of wallet chips, given the same amount of expansion. So if they both expanded a FinFET node, a gate-all-around node expanded by 10,000 wafer starts, we'd see estimated 30% more revenue in that gate-all-around expansion than the positions we have in FinFET. This is driven by more layers going to us on the OCD, insertion opportunities in integrated and as well as the films layers that we've been able to start to win and qualify for to record positions. But I don't have the exact dollar number for you.

Okay, we'll get that base number another time. Thanks for answering the questions.

We'll take our next question from the line of Mark Miller with Benchmark. Please go ahead.

Thank you for the question. I just want to clarify something; the litho tools that were delayed last quarter were due to customer-specified revisions. But the reason these tools are further pushed out is component availability, fab availability, and just why the further push out most tools?

Yes, that's a good question. It has different tools. So those tools from Q2 were delivered and shipped shortly after the quarter or within the early part of this quarter. The additional slip-outs were sort of the knock-on effect. We had a little bit of delay in other ones; we couldn't start the additional tools, the tools that were already planned for Q3, and with some other production issues. So these were mostly internal issues. We ended up not delivering on time.

Thank you. I'm curious about what you are observing in China. Is the power segment experiencing a slowdown there or in another location?

I don't think so. I don't think we see a slowdown in China, per se. Overall, just not. I think we're doing a nice job of rebuilding and recovering from some of the customers, the good customers we had that were put on the Entity List. So I think that's a growing part of the business. More of that pause or delay or lower visibility right now is more in the established markets, so some of that is in Europe and U.S. markets.

And your geographic area in terms of geographic sales in the September quarter was in the September quarter?

Yes, 19%.

It appears there are no further questions at this time. Mr. Sheaffer, I would like to hand the conference back to you for any additional or closing remarks.

Thank you. Just a quick reminder for everybody about some upcoming events. First, Onto management will be participating in the Morgan Stanley TMT conference in Barcelona next week. We will be participating in the Wolf Research Small and Mid-Cap Conference in New York on December 6. Thanks again for joining us today. A replay of the call will be available on our website approximately 7:30 Eastern Time this evening. We'd like to thank you for your continued interest in Onto Innovation. Rachel, please conclude the call.

This concludes today's call. Thank you for your participation, and you may now disconnect.