Earnings Call Transcript - ONTO Q3 2025

Operator, Operator

Good day, and welcome to the Onto Innovation Third Quarter Earnings Release Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Sidney Ho. Please go ahead. Thank you, Rachel, and good afternoon, everyone. Onto Innovation issued its 2025 third quarter financial results this afternoon shortly after the market close. 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 Brian Roberts, Chief Financial Officer. I'd like to remind you that the statements made by management on this call will contain forward-looking statements within the meaning of the federal securities laws. Those 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 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 in today's earnings release. Let me now turn the call over to our CEO, Michael Plisinski. Mike?

Michael Plisinski, CEO

Thank you, Sidney. Good afternoon, everyone, and thank you for joining us on our call today. Underpinning our financial results, which came in ahead of the midpoint of our guidance ranges, the Onto Innovation team made excellent progress with our strategic initiatives, including new product adoption, advancing our offshoring activities and preparing for the close and successful integration of the Semilab transaction. We expect each of these efforts will enhance our leadership position in the exciting advanced packaging and advanced nodes markets and strengthen our outlook for growth in 2026. Market growth in 2026 is likely to include increased investments in advanced packaging to support the strong demand for AI compute. So we are very pleased to announce that our 3Di technology has successfully completed the full qualification process at not 1 but 2 high-bandwidth memory customers in the quarter. Our 3Di technology demonstrated superior performance on smaller denser 3D interconnects, critical for next-generation devices. Following these successful qualifications, we started discussions for volume orders with integrated 3Di and subsurface defect inspection to support next-generation HBM devices. Another win for the 3Di in the quarter was an order from a leading OSAT to support 2.5D applications for AI packaging. To support advanced 2D inspection applications, the launch of our next-generation Dragonfly system is progressing well with the first shipment expected in a few weeks, followed by additional systems in December. After last quarter's optical performance validation by a key customer, we have since completed successful in-house wafer studies for high-bandwidth memory and hybrid bonding applications, leading to several more evaluation shipments to customers in the first quarter. In fact, the success of these demos has several customers adding the new Dragonfly to preliminary discussions on volume needs for 2026. Turning to advanced nodes. We remain on track to deliver a record year in advanced node revenue outside of China. Contributing to this performance is the growing adoption of our Iris films and integrated metrology platforms, both on track to set records for the year. Looking at the markets broadly, recent headlines continue to reflect strong and sustained demand for AI and high-performance compute. NVIDIA projects that global AI infrastructure investments could reach $3 trillion to $4 trillion by the end of the decade, potentially reshaping the semiconductor supply chain. At the core of this evolution, our new memory and logic transistors and packaging architecture supporting chiplets for logic, 3D stacking for memory and nascent co-packaged optics, all designed to increase device performance while lowering power consumption. Onto Innovation continues to play a pivotal role by working closely with our customers across this broad value chain to develop and deliver the process control solutions required to support this AI era. In the immediate term, we expect revenue growth of approximately 18% at the midpoint of our Q4 guidance range. The greatest contributor to this growth is from 2.5D packaging customers, where we expect revenue to nearly double from the third quarter, driven by strong Dragonfly system demand. We expect advanced nodes revenue will also improve with increases in DRAM and logic spending. While discussions for capacity needs in 2026 are in early stages, our packaging customers are indicating the potential need for as much as 20% more tools to support expansions and new applications for our 2D subsurface and 3Di inspection technologies. While quarterly performance may show variation, we expect sequential growth in the first half of next year with more meaningful growth expected in the second half of 2026, driven by increased contributions from new products and potential capacity expansions. Supporting this growth is our aggressive ramp of our extended factories in Asia, and I am pleased to report in the third quarter, we successfully shipped over 30% of third quarter tools from these factories. Thanks to the incredible efforts of our operations team and supply chain partners, we are now on pace to be capable of shipping over 60% of our production demand from our international locations by the end of the first quarter of 2026. These efforts will enhance our competitive position, mitigate tariff impacts, provide greater manufacturing flexibility and allow us to expand gross margins in 2026. Finally, a brief update on our pending acquisition of 3 complementary product lines from Semilab. In October, in response to a second request letter from the Department of Justice, we amended the transaction to exclude a relatively small product line. We currently expect that the transaction will close in the coming weeks and be accretive to both revenue and earnings in 2026. And with that, let me turn the call to Brian to review our financial highlights and provide fourth quarter guidance. Brian?

Brian Roberts, CFO

Thanks, Mike. Good afternoon, everyone. Third quarter performance met or exceeded expectations across key financial metrics as we work to improve our forecasting processes and implement more disciplined spending controls. Revenue for the quarter was slightly ahead of the midpoint of our previous guidance range at $218.2 million. Gross margin for Q3 2025 was 54% and includes approximately a 1 percentage point impact related to tariffs. Operating margins of 21.1% exceeded the top end of our guidance range as we maintained our focus on variable cost control in the quarter. Finally, adjusted earnings per share for the quarter were towards the high end of our guidance range at $0.92. At a market level for the third quarter of 2025, advanced nodes generated revenue of $54 million or 25% of revenue as DRAM and NAND revenue decreased as expected sequentially from the second quarter. For the full year 2025, advanced nodes revenue is expected to double to approximately $300 million as compared to $148.5 million in full year 2024. Specialty devices and advanced packaging revenue was $113 million or approximately 52% of revenue. A strong rebound to approximately $150 million in specialty device and advanced packaging is expected in Q4, revenue for this market should finish slightly higher than $500 million for the full year. Software and services revenue of $51 million comprises the remaining 23% of Q3's results. The team did an outstanding job generating cash in the third quarter as cash from operations increased sequentially to $83 million from $58 million in Q2. This represents cash conversion of approximately 185% of our non-GAAP net income in the quarter. Given the pending acquisition of Semilab, we did not repurchase shares in the third quarter. Once the acquisition closes, which is expected in the coming weeks, we will pay Semilab $432.3 million in cash and issue 641,771 shares of our common stock. The value of the total transaction based upon Onto's closing price as of June 27, 2025, is approximately $495 million, a decrease of about $50 million from the original terms of the deal. Now turning to our outlook for the fourth quarter. Revenue is expected in the range of $250 million to $265 million, representing 15% to 21% sequential growth. As Mike noted, the majority of the Q4 increase is expected to be driven by strength in advanced packaging with more modest improvement in advanced nodes, specifically around DRAM and logic. At the midpoint of the revenue guidance range, we would expect to achieve approximately 50 basis points of sequential gross margin improvement in Q4. Our Q4 gross margin expectation also includes an anticipated percentage point impact of tariffs or approximately $2.5 million of cost, primarily due to inbound tariffs on raw material imports. Operating margins for the fourth quarter are expected to rebound to a range of 24% to 26%, on operating expenses of approximately $77 million. The fourth quarter, which will officially end on January 3, 2026, includes an additional 14th week, given the company's historical fiscal closing structure. The impact of this extra week is approximately $3 million in incremental operating expenses in the fourth quarter, representing approximately 120 basis points of operating margin. Starting with the first quarter of 2026, Onto Innovation will switch to a quarterly calendar schedule of March 31, June 30, September 30 and December 31. Earnings per share for the fourth quarter is expected in the range of $1.18 to $1.33 per share, assuming an estimated tax rate of approximately 13% to 15% and about 49.4 million shares outstanding. As a reminder, we are not including the pending Semilab transaction in our current Q4 guidance. And with that, let me turn it back to Mike for some closing thoughts before we take your questions. Mike?

Michael Plisinski, CEO

Thank you, Brian. In summary, we've made great progress on key initiatives that will position us for growth in the coming year. On the product front, we plan to ship our next-generation Dragonfly system in the coming weeks to a leading AI packaging customer with several additional systems slated for memory customers in December. Our 3Di technology has now been validated by 2 leading suppliers of high-bandwidth memory and adoption is expanding across a broader customer base. From a broader market perspective, the long-term outlook for AI and advanced node investments continues to build, driven by aggressive infrastructure expansion plans globally over the next several years. With our differentiated product portfolio and technology leadership in advanced nodes, advanced packaging, and specialty devices, Onto Innovation continues to be well positioned to serve our customers and capitalize on these secular trends. We expect to see organic growth in 2026 with momentum building toward the second half of next year. And now, Rachel, let's open the call for questions from our covering analysts.

Operator, Operator

And we will take our first question from Craig Ellis with B. Riley Securities.

Craig Ellis, Analyst

Congratulations on the good execution guys. I wanted to start, Mike, just by following up on your most recent comments regarding organic growth through the year. Can you comment on what you'd expect for your 2 big segments, advanced packaging and advanced nodes? And any color on the linearity with those businesses?

Michael Plisinski, CEO

You mean for 2026?

Craig Ellis, Analyst

For 2026, yes.

Michael Plisinski, CEO

Yes. I believe it's a bit early to offer a detailed view of the quarter-to-quarter linearity. However, if we analyze the first half and second half, we anticipate that the first half will outperform the second half of 2025 sequentially. We expect growth in the first half, with even more significant growth in the second half, driven by various expansions our customers are discussing and the broader adoption of new products as they move into volume production. This includes the 3Di and the new Dragonfly system.

Craig Ellis, Analyst

Yes. Nice to see the new products. And then the second question is for Brian. Brian, as we look at gross margins next year, can you just help us with some of the gives and takes? Tariffs have been in gross margin, but when can that come out? And how should we look at some of the other gives and takes with that line item?

Brian Roberts, CFO

Sure. On the gross margin front, I mean, I think we'll start to see the tariff impact start to mitigate next quarter. Keep in mind, most of our tariffs are on inbound and so they sit in inventory for a quarter and then they start to come out. So as we continue to ramp up expansion of the offshore extended factories and more tools are going from there and supply chain is going right directly to those factories, we'll start to mitigate the tariff risk. I think as we go through the transition to extended factories, we'll see a little bit more meaningful gross margin expansion as we get towards mid and the latter part of 2026. But we're certainly poised to have a good solid year of gross margin expansion.

Craig Ellis, Analyst

Got it. And then lastly and somewhat clerically, once Semilab closes, do you plan to host another conference call? Or how will you update us once that's done?

Michael Plisinski, CEO

My expectation is we'll just update you as part of the next earnings call. I don't think we'll provide an update right after close. We're going to take a little bit of time meeting with the team, having some more detailed discussions and then provide a more informed view of the business probably in the next earnings call.

Operator, Operator

And we will take our next question from Ezra Weener with Jefferies.

Ezra Weener, Analyst

First one would be about your commentary on 2.5D packaging. You talked about sequential growth into March. I just want to make sure I heard that correctly and you weren't talking about the entire business. And then the other sequential question would be, when you talk about sequential growth in the first half, is that half over half or quarterly sequential growth?

Michael Plisinski, CEO

When I referred to sequential growth, I meant half over half. In the second half of '25, we expect the first half of '26 to be sequentially stronger than the second half of '25. And could you clarify your question regarding 2.5D?

Ezra Weener, Analyst

You had talked about sequential growth immediately after 2.5D packaging. I was wondering if that comment had to do specifically with 2.5D packaging.

Michael Plisinski, CEO

No, mainly AI packaging is driven by the growth from Q3 to Q4, and it is primarily due to the demand for Dragonfly systems.

Brian Roberts, CFO

But the sequential growth in the first half of '26, we were discussing the entire business, Ezra.

Ezra Weener, Analyst

Understood. And then the second question would be, with the understanding that you might not see revenue until the second half from the new Dragonfly. Can you talk about the ecosystem between now and then and the timing of when you would see revenue from that?

Michael Plisinski, CEO

I didn't say we wouldn't see any revenue. It's very possible we'll see revenue in the first half. It's just going to be small amounts until it starts shipping in larger volumes. The second half will be more significant. However, I would expect to convert some of these early shipments as soon as the first half.

Operator, Operator

And we will take our next question from David Duley with Steelhead Securities.

David Duley, Analyst

Regarding the qualification of the 3Di tool at 2 HBM customers for bump inspection, is that tied to the ramp of HBM4? And are you going to be the first source or the second source there?

Michael Plisinski, CEO

We are not aware of any other companies being qualified through our rigorous tests so far. Our preference is to be the first choice. This qualification is linked to HBM4. We have been collaborating with customers on different methods to improve existing processes for better yield impact. By integrating our 3Di technology into various process steps, we can enable some rework capabilities that assist customers in addressing any issues, ultimately leading to higher yields. This is a unique ability of our tools, though it is a very new feature. Customers are currently evaluating the potential impact on their processes and deciding whether to implement these changes now or in future projects.

David Duley, Analyst

My second question is more of a clarification. I wanted to make sure I understood everything you said. Regarding the Dragonfly, you're going to start shipping the new tool to your primary customer, with whom you've lost share, in the next couple of weeks. Could you please repeat everything you said about the Dragonfly so I get it right?

Michael Plisinski, CEO

I have the complete details on the Dragonfly. I mentioned that we will be shipping the Dragonfly to a 2.5D logic packaging customer in a few weeks. Additionally, I noted that more Dragonflies will be shipped in December, mainly to memory customers. Looking ahead to the first quarter, and following the successful demonstrations we've conducted in the third quarter, we are planning to ship several more Dragonflies. Our shipment expectations for Dragonflies have already increased.

David Duley, Analyst

Okay. And it's not just to one customer, it's to multiple customers?

Michael Plisinski, CEO

Correct. Yes. It's to multiple customers. Yes.

David Duley, Analyst

And then the final question for me is, as far as your core inspection business with HBM, do you think that's going to be a growth factor in 2026? Or has it started to turn on with the ramp of HBM4? Or how should we think about that?

Michael Plisinski, CEO

I think customers are still trying to figure that one out. From their perspective, there will definitely be some growth. However, the implications for process control are not entirely clear yet. Customers are reviewing their allocations, what they spent on process control last year, how much can be reused, and whether they need to adjust sampling plans, among other typical considerations. Those are the discussions we're currently having with customers. A strong takeaway is that our tools are demonstrating unique capabilities for next-generation devices. As customers begin to integrate those next-generation devices into higher volumes, especially in the second half of next year, we should see a significant positive impact from that.

Operator, Operator

We will take our next question from Matthew Prisco with Cantor.

Matthew Prisco, Analyst

So I guess, first, I'll stick on Dragonfly. It seems like making good progress in the quarter. So kind of after you shift these initial valuation tools, what milestone should we look to from here? And how should we think about the timing of customer adoption decisions both at TSM and all these ancillary opportunities? And then the transition from those adoption decisions to revenue, how quickly can those kind of start shipping for production?

Michael Plisinski, CEO

So I think it would be reasonable to assume second half. In fact, we said that in the second half, we would expect to see more meaningful revenue from the new products that we're shipping. So as we're qualifying, and that's the good news about shipping to a variety of customers, we're getting those qualifications started such that they're also intending to try and ramp into the second half to cut these technologies into the second half. So as long as we continue to execute, as long as the tools perform as well as they're demonstrating now, yes, I would expect, like I mentioned earlier, incremental revenue in the first half, that means closing out some of these initial tools with more meaningful revenue in the second half tied to the volume adoption that cut into production.

Matthew Prisco, Analyst

That's helpful. And then maybe going to that 3Di, those new qualifications. Can you kind of give some more color on what drove the wins there? How you're seeing your competitive positioning in that technology today? And then how do we think about the translation of those wins to the P&L and potential magnitude of impact there?

Michael Plisinski, CEO

I don't anticipate a significant leap for the 3Di in 2026. There will be gradual improvements, with a more substantial effect expected in 2027. By gradual, I mean that 3Di will generate tens of millions of dollars. So, why are we succeeding? What makes the 3Di so crucial? There are several factors. Firstly, as mentioned in the last call, the technology is unique due to its use of laser-based coherent light. This coherent light enables us to focus between dense, smaller bumps, achieving the high throughput and precision that our customers, who are transitioning from HBM3 to HBM4E and beyond, require. This is one reason we've been able to secure two qualifications through a rigorous evaluation process. Secondly, this capability is allowing us to explore several new applications. For instance, we can apply 3D bump metrology at a different stage in the process, enabling customers to perform rework and enhance yield. Additionally, there are two other applications where our technology's speed and precision can facilitate various types of metrology on surfaces, including die warpage metrology and specialized metrology for 2.5D packaging.

Operator, Operator

And we will take our next question from Brian Chin with Stifel.

Brian Chin, Analyst

To follow up on the 3D discussion, it sounds like this pertains to the pre-reflow bump metrology step, Mike. Is that correct? Is this an additional or new metrology step for many of these adopters?

Michael Plisinski, CEO

Correct. And it is a new metrology step because previous technologies couldn't reliably measure at that pre-reflow step. The light would scatter too much is what we're told.

Brian Chin, Analyst

Okay. And would you expect that the amount of time or the metrology time required after reflow could potentially decrease?

Michael Plisinski, CEO

I believe you would eliminate the need for post-reflow measurements. The focus is on the customers, their intentions, and our discussions regarding shifting the metrology to the pre-reflow phase. This approach negates the necessity for a post-reflow measurement, and there is a strong correlation between the two, although you still retain the capability to perform rework if needed.

Operator, Operator

I will now take our next question from Edward Yang with Oppenheimer.

Edward Yang, Analyst

Just to clarify on a couple of numbers, the tens of millions of 3Di you're talking about, that's for 2026, correct? And I also heard you say something about shipping more tools. Was that related to AI packaging?

Michael Plisinski, CEO

Correct. Yes, it's based on initial discussions. We're getting early indications of a certain level of demand, but that can change. We are still in the early stages of discussion, so it's difficult for us to provide any real guidance on that. But yes, the 3Di was for 2026.

Edward Yang, Analyst

And the 20% more tools comment you had in the script?

Michael Plisinski, CEO

It's for primarily AI packaging. Correct.

Edward Yang, Analyst

Okay. And that would account for the fact that you wouldn't be shipping or recognizing much revenue from your new high-res Dragonfly G5 tool until the second half of 2026, right?

Michael Plisinski, CEO

Correct.

Edward Yang, Analyst

Okay. Wonderful. And could you just comment or provide your thoughts on the tightness and the strong pricing your customers are enjoying in memory markets and how that might pertain to 2026? You had a $69 million DRAM VPA starting this year. Does that cover this current market strength that you're seeing in those memory markets? Or do you expect more orders coming down the pipe?

Michael Plisinski, CEO

I believe the existing VPAs for this year have been addressed, and we've made good progress on those. We've had a solid year in advanced nodes, so most of that is already accounted for. The discussions we are having now are about new VPAs for next year and a bit further out.

Edward Yang, Analyst

And my follow-up would just be on Semilab again. On the amended terms, were you surprised that regulators had wanted some scrutiny around that? And could you just provide your updated confidence in approval with the changes that you made and the timing on that?

Michael Plisinski, CEO

Well, since it's not closed and not wanting to ruffle any feathers from potential regulators, I will say, yes, we were surprised, but we worked cooperatively with Semilab team, with everybody to find a very reasonable solution.

Operator, Operator

And we will take our next question from Vedvati Shrotre with Evercore ISI.

Vedvati Shrotre, Analyst

The first one I wanted to understand was the first half '26 sequential increase that you talked about, like where do you have the most confidence, advanced node versus packaging? Is one doing better than the other? If you could give any directional sense on that?

Michael Plisinski, CEO

I don't have the numbers in front of me, but I believe that advanced nodes in specialty devices are likely continuing to show strength. Advanced nodes are also performing adequately, but many of those factories are expected to have a stronger performance in the second half of the year.

Brian Roberts, CFO

Yes, I think the advanced packaging segment, along with specialty devices, is likely to emerge in the advanced nodes during the second half. However, as Mike noted, many of those discussions are still in the early stages as we determine the exact timing of spending with customers and related factors.

Vedvati Shrotre, Analyst

Understood. Okay. And then I think last quarter or the whole of this year, you sort of had that view that one of the HBM suppliers isn't qualified and that's kind of limiting the visibility you have on HPM progression. How has that conversation changed last quarter versus this quarter? Has the visibility gotten much better now that the demand dynamics have changed so significantly for the memory suppliers?

Michael Plisinski, CEO

Well, I won't say the visibility is improving regarding our discussions with the suppliers, but who's been qualified and what the allocations are, I'm not so sure that visibility has gotten much better.

Vedvati Shrotre, Analyst

Understood. Okay. And then the third thing I kind of wanted to understand was, if I sort of take the larger caps, like the Lam, not necessarily your competitors, but a lot of them are already seeing like strong quarter-on-quarter growth on HBM and DRAM like fourth quarter versus third quarter. Are you seeing any of that?

Michael Plisinski, CEO

In the fourth quarter, we mentioned that we are seeing strength in memory, particularly with DRAM and some logic. However, NAND remains quite weak.

Vedvati Shrotre, Analyst

And HBM is muted. Is that kind of fair?

Michael Plisinski, CEO

HBM is also seeing significant growth in packaging, particularly driven by AI, which we believe is nearing 50%.

Operator, Operator

And at this time, we have no further questions. I would now like to turn the call back. Thanks, Rachel. We will be participating in a number of investor conferences throughout the quarter. We look forward to seeing many of you there. A replay of the call today will be available on our website at approximately 7:30 Eastern Time this evening. We would like to thank you for your continued interest in Onto Innovation. Rachel, please conclude the call. This does conclude today's call. Thank you for your participation. You may now disconnect.