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Nova Measuring Instruments Ltd (NVMI) Q3 2019 Earnings Call Transcript

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Nova Measuring Instruments Ltd (NASDAQ: NVMI)
Q3 2019 Earnings Call
Nov 7, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Nova's Third Quarter 2019 Results Conference Call. [Operator Instructions]

At this time, I would like to turn the conference over to Miri Segal of MS-IR. Please go ahead.

Miri Segal -- Founder and Chief Executive Officer

Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova's third quarter 2019 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 the business update, followed by Dror with an overview of the financials. We will then open the call for the question-and-answer session.

I will now hand over the call to Mr. Eitan Oppenhaim, Nova's President and CEO. Eitan, please go ahead.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, Miri, and thank you, all for joining our third quarter financial results conference call. I will start the call today by speaking about our quarterly results and performance highlights. Following my commentary, Dror will review the quarter's financial results in detail, including the guidance for the fourth quarter of fiscal year 2019.

In the third quarter, Nova delivered solid financial performance with revenue reaching the high-end of the guidance and profitability outperforming the EPS guidance range. Our results for the third quarter along with the guidance for the fourth quarter demonstrate our strong execution capabilities and the continued progress we are making on our strategic priority.

Although we are still facing some industry headwinds in few segments during 2019, we continued strengthening our position in our served markets as well as expanding our reach to new emerging markets. We are pleased with these results, which reflect the efforts we are making to leverage our operational model to persistently continue funding new technology innovations during different industry investment cycle.

We remain committed to the development of our growth engine, which will position us to outperform the market and will enable our long-term growth. Our continuous efforts to balance our customers' exposure, which now includes leading customers from different segments have strengthened the Company's position and its resiliency to various market scenarios. Our position today enables us to better compete and will allow us to capitalize on more opportunities when the market is fully recovered.

From a business perspective, our performance this quarter drove to a balanced revenue mix, which reflects our evolving position in memory and our strong position in foundry. Our business results highlight several notable achievements. First, following the growing demand for logic devices mainly for emerging solutions like 5G and AI, we saw growing demand for complete dimensional and materials metrology portfolio.

Revenues from the world's leading foundry for its 7-nanometer and 5-nanometer expedited ramp-up increased this quarter with further growth expected in the fourth quarter. Nova's application footprint has expanded in this node to include both front-end and back-end applications in multiple steps. This includes both the integrated and stand-alone platform, as well as our state-of-the-art algorithmic solutions and machine learning capabilities.

Furthermore, Nova's solution were selected for the development of the next-generation node beyond 5-nanometer. The growing demand for our tools in this advanced logic node is the result of the close collaboration with this leading customer over many years in many technology transition. All three nodes will continue generating revenues for us in 2020 as well.

Second Nova's growing position with key memory customers has positioned us to benefit from their advanced technology developments and will enable us to accelerate our growth once the sector fully recovered. One example is the major inroads, we are making into a large global memory customer across multiple sites and multiple technologies, which have yielded higher revenues in 2019 with expectation for continued growth in 2020 as well.

Third is our steady progress in China. We achieved multiple wins in both domestic and global customers for both memory and logic nodes during the quarter. With this significant share gain, we now serve these customers with both our materials and dimensional portfolio. We expect China to continue to be a solid revenue generator in 2020 while domestic memory and foundry manufacturers continue to expand their capacity in both middle and high-end devices.

Turning now to our product development progress and the challenges ahead of us. We are currently focused on addressing three major technology inflections, including 3D scaling, new device architecture and novel materials introduction to support architectural limitation. In order to improve customers' yield and assist them with shortening time to market, we are concentrating in bringing near and in-line solution that will be close as possible to the fabrication process.

Our unique approach to the growing challenges including interlacing hardware and software, dimensions and materials, and our growing investment in emerging technologies has proven itself to be very attractive to our customers. This differentiated approach allowed us even in a volatile year like 2019 to penetrate accounts that were crowded with our competition. Following the successful launch of several new models of dimensionals and materials, and metrology solutions this year, we also recently announced the launch of the PRIZM.

PRIZM is the first of its kind metrology platform that combines traditional optical spectroscopy technology with interferometry and optical technology that is currently widely used for imaging and topography measurement. Following the shipment of several tools and the progress with this unique platform in the last quarter, this new platform was also selected by a leading foundry for its most advanced technology node.

Based on our strategic approach to take part in future IC development, we continue to proactively invest in partnership programs with multiple parties across the semiconductor industry. As part of our commitment to innovation leadership in emerging applications, IBM Research selected Nova's products to support next-generation chip development across logic, memory, heterogeneous integration and AI hardware.

The collaboration will rely -- sorry, relay on the use of Nova's most advanced product portfolio for both materials and dimensional metrology, combined with Nova's advanced machine learning solution. We are proud to be a partner of IBM Research, advancing our product portfolio to meet the demand of an ambitious roadmap for AI computation from the data center to the edge.

In addition, as discussed previously, we continue to execute our plan to productize new technologies that are differentiated from the competition. By following multiple engagements with leading customers, we are encouraged by the traction this platform to generates and the value it brings to our customers. We expect these positive results to be translated into revenues already in 2020.

Before I conclude my remarks, I would like to refer to the market environment as it relates to Nova's performance. From an overall demand perspective, our long-term territories remains intact regarding the growth of semiconductor fundamental drivers. The combination of demand for powerful computing and advanced memory will create more opportunities for process control as metrology intensity grows while customers improve device performance and time to market.

With regard to memory, as discussed previously, we expect that the market's soft demand will be better optimized through the next few months. The bit supply growth for NAND is starting to stabilize according to our current indication, and as a result, we expect prices and inventory levels to improve. While it's difficult to predict the exact timing of equipment spending, we believe that the environment is improving as we approach 2020.

Since DRAM inventories currently remain elevated, we believe that NAND will recover ahead of DRAM. In foundry and logic, demand has strengthened throughout the year with customers accelerating their investment in advanced nodes. Demands for diverse applications including 5G, AI and advanced CPUs fuel the expansion of 7-nanometer and 5-nanometer nodes and beyond with several customers.

Based on our quarterly healthy results and the guidance for the fourth quarter, we believe that 2019 is shaping up to be a significant year for Nova in multiple aspects. Our widened exposure to multiple segments, customers and geographies combined with the investment we are making in a new innovative portfolio has positioned us well to benefit from the long-term potential growth as the market turns favorable.

Now, let me hand over the call to Dror to review our financial results in detail. Dror?

Dror David -- Chief Financial Officer

Thanks, Eitan. Good day, everyone and thank you for joining our call. In my following prepared remarks, I will refer to both GAAP and non-GAAP results. You can find a detailed reconciliation per item at the end of the earnings press release.

Total revenue in the third quarter of 2019 was $52.5 million. On the product revenues' front, the distribution was approximately 60% from memory and approximately 40% from foundry. The increase in the foundry portion of product revenue was driven by increased deliveries into the most advanced foundry technology node.

Service revenues remained stable quarter-over-quarter. Blended gross margin in the third quarter was 52% on a GAAP basis and 53% on a non-GAAP basis. Operating expenses in the quarter totaled $21 million on a GAAP basis and $18.6 million on a non-GAAP basis, 3% lower than the previous quarter, reflecting reduction in net R&D expenses, which was partially offset by an increase in SG&A costs.

Operating margin in the quarter was 12% on a GAAP basis and 18% on a non-GAAP basis similar to the previous quarter.

During the quarter, the Company finalized several tax reporting and planning processes. As a result, the Company recorded a significant tax benefit and presented net income taxes of $1.2 million in the third quarter of 2019. Earnings per share in the quarter were $0.30 per diluted share on a GAAP basis and $0.40 per diluted share on a non-GAAP, basis both exceeding the upper end of the Company guidance.

As previously communicated, the Company has transitions to new offices in Israel and in the U.S. This transition was concluded in September 2019. During the office transition period, the Company is bearing duplicate office lease costs, and in the third quarter of 2019, these costs amounted to $888,000. These costs were adjusted for non-GAAP representation purposes under the item facilities transition costs.

The distribution of these costs across the Company expense items in the profit and loss statement is detailed at the end of the Company's quarterly press release. We do not expect such costs in future quarters. On the cash flow front, the Company generated $9.2 million in cash from operating activities in the third quarter and invested $7.9 million in property and equipment mainly in the new facilities.

Regarding the Company outlook for the fourth quarter of 2019, we expect the following, revenues between $56 million to $62 million, GAAP earnings per share between $0.32 and $0.42, and non-GAAP earnings per share between $0.40 and $0.50. At the midpoint of this fourth quarter guidance, we expect the following. Product revenues are expected to shift to foundry, as the company continues to deliver tools to leading-edge 5-nanometer and 7-nanometer foundry, as well as trailing edge foundries in China.

Service revenues are expected to pick up to the $15 million and above level as a result of an expected uptick in time and materials activities toward the end of the year. Blended gross margin is expected to increase to approximately 55%, operating expenses are expected to be approximately $20 million on a GAAP basis and approximately $18.5 million on a non-GAAP basis. This level of operating expenses includes the full impact of the fluent costs related to the new facilities. In addition, this result is after and offsetting of an expected income from the Israel Innovation Authority in the amount of approximately $3.5 million in the fourth quarter of 2019. This $3.5 million of R&D funding in Q4 is relative to a normalized income level of approximately $1 million a quarter.

On the tax front, we expect the effective tax rate in the fourth quarter to return to a normalized level with GAAP effective tax rate of approximately 20% and non-GAAP effective tax rate of approximately 16%.

Eitan?

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, Dror. With that, we will be pleased to take your questions. Operator?

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] The first question comes from the line of Quinn Bolton of Needham. Please go ahead. Your line is open.

Quinn Bolton -- Needham and Company -- Analyst

Hi, Eitan, and Dror, congratulations on the strong third quarter results. Eitan, in your comments about the new technologies, you mentioned revenue expected now in 2020. I just wanted to confirm that the guidance that you're providing for the fourth quarter does not include any rev rec from either of the two new technologies you're developing. Is that correct?

Eitan Oppenhaim -- President and Chief Executive Officer

Yes, that's correct.

Quinn Bolton -- Needham and Company -- Analyst

Okay. And I guess given the delay from kind of late '19 into 2020, can you -- is this just sort of longer qualification cycles? Is there anything about that delay that we should be nervous about? Or do you think it's just sort of -- the calls are just taking a little bit longer than previously expected?

Eitan Oppenhaim -- President and Chief Executive Officer

So Quinn, thank you very much for the question. So the plan is going according to what we plan in productizing them. And we knew upfront that it's coming on the wire for the last minutes on the quarter, OK. So obviously, to be conservative, we didn't take those numbers in the revenue, therefore, if something happens, it can be an upside. But in order to be conservative, in order to see what happens by the end of the year on the borders between Q4 and Q1, we didn't want to commit for the fourth quarter. But according to the -- according to our plan, everything has to happen on this period of a couple of months from now toward to Q1.

Quinn Bolton -- Needham and Company -- Analyst

Okay, understood. Thank you for that. And then you made some encouraging comments about receptivity to the new PRIZM tool with multiple customers, I think you said shipments. Is PRIZM already starting to generate revenue for you? Are you -- or should I say, are you recognizing that revenue on PRIZM, or are you just shipping those tools into eval and rev rec is more of a 2020 event for PRIZM?

Eitan Oppenhaim -- President and Chief Executive Officer

So the PRIZM is already installed in several customers, but in terms of revenue recognition, we have not yet recognized revenues from this product, and it is not yet embedded into the Q4 guidance as well.

Quinn Bolton -- Needham and Company -- Analyst

Great. Okay. And then last one for you, Dror. If I did the math right, you talked about the $3.5 million credit, I think in December R&D offset, so opex down about $18.5 million. If I do the math, it sounds like you typically get more like $1 million a quarter. So should we'll be thinking about opex kind of a natural run rate probably back in the $20.5 million to $21 million level for the March quarter?

Dror David -- Chief Financial Officer

Yes.

Quinn Bolton -- Needham and Company -- Analyst

Perfect. Okay, guys. Thank you very much.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, Quinn.

Operator

Thank you. We will now take our next question from Patrick Ho of Stifel. Please go ahead.

Patrick Ho -- Stifel -- Analyst

Thank you very much. And congrats on a very nice quarter and outlook. Eitan, and maybe first off, you gave some really encouraging commentary regarding China and some of the emerging opportunities there. Given that's a growing region, but on the foundry side of things, they're like the trailing edge, and memory, they still lag the leading edge guide. What type of products are you selling them and how can you expand to I guess both your newest products as well as some of the integrated OCD and X-ray products that you're selling to a lot of the more advanced chipmakers today?

Eitan Oppenhaim -- President and Chief Executive Officer

So I think when we're looking on our portfolio, we are trying to have a common as possible on the two types. So if you're looking right now on China and the share wins that we talked about is around middle to high-end technology. So if you're looking right now on some of the logic or foundry domestic China, we're talking about the customers that are investing in 28 and below, which for us, it's the same tools as we ship for 14 or 10 and even 7.

So when I'm looking right now on China, it's a growth potential exactly as the rest of the world in the matter of tools. Obviously, when we're talking about the new technology and mainly on the high-end dimensionals and materials metrology capabilities, it's probably will not be installed first in China.

Patrick Ho -- Stifel -- Analyst

Great, that's helpful. And maybe, I have a follow-up question. Yes?

Eitan Oppenhaim -- President and Chief Executive Officer

Go ahead, Patrick.

Patrick Ho -- Stifel -- Analyst

Okay. Thank you. As my follow-up question, in terms of some of the emerging opportunities in 3D NAND, particularly as we go to over 128 layers, obviously the more layers, the more metrology intensity, and obviously some of your other product intensity increases as well. How do you see the industry migrating again to 128 and above layers, and some of the opportunities ahead for both your existing product portfolio, as well as some of the new ones, both dimensional and material side that you've talked about?

Eitan Oppenhaim -- President and Chief Executive Officer

So when we're looking right now on memory, there are separate challenges on the dimensional sides and separate challenges on the materials side. Nevertheless, when you're looking right now on increasing the number of memory sales, both sides are benefiting from the challenges. Mainly when we're looking right now on the CD side -- on the optical side is once the high aspect ratio is growing. And once you have more layers, you have challenges around the bottom CD or the profile of the device, as well as the new challenges that are coming from the fact that almost all customers are doing it in multi-stack capabilities and then you start to have tilting issues and all kind of other challenges that increasing actually the intensity.

If previously you had only one hole to measure, now just imagine that you have a couple of stocks that starting to be not be aligned to each other and you have more challenges to measure. So definitely when we're looking on the optical side, and this is why we came with the PRIZM is that you need to start evolving the OCD part to start measuring challenges that are really growing in multiple layers. And this is why we brought the PRIZM to the market. This is one.

Second, on the material side, it's a whole encouraging story. There are new materials coming in. The thickness of the layer is becoming much thinner, and you have multiple cells to measure the materials in. And a couple of the last shipments that we had on the XPS side is coming on the fact that the intensity for materials in memory, especially in Finland is increasing tremendously. And we are encouraged from the fact that looking right now on composition on those layers, the only solution that is right now provided for inline or in production capabilities is the XPS capabilty. So measuring today composition can be done mostly by XPS. And as you have more layers and you have more evolving VNAND memory's capabilities or production, you need more and more XPS capability.

So everything that I said right now is supported by the results, which you see right now that even in a weak memory year where foundry actually is not fully offsetting the memory, Nova still have 50% of the revenue coming from -- at least 50% coming from memory.

Patrick Ho -- Stifel -- Analyst

Great. That's really helpful. And maybe a final question for me for Dror. Gross margins have some variability depending on the quarter, product mix and things of that nature. As you look at 2020 and with the potential of a recovery in WFE and higher volumes. How do you offset I guess some of the new product introductions, some -- maybe the lower margin initial tools shipments that you're sending to customers versus some of the benefits of a higher revenue outlook for 2020?

Dror David -- Chief Financial Officer

Yes. So that's a good question. As you know, currently, we expect the markets to remain general volatile. And in addition, we are proliferating new technologies and project which margins can fluctuate based on the final standing price and initial cost structure. I think that on top of that, customer and product mix are constantly changing, also due to the investment pattern of large customers in specific quarters. Therefore, gross margins will continue to fluctuate as -- the same as we have seen in recent quarters.

And again we are keeping our targeted gross margin model of 56% to 50% on an annual basis. But again quarterly, gross margins will continue to fluctuate.

Operator

Thank you. [Operator Instructions] Our next question comes from David Wu of Indaba Global Research. Please go ahead.

David Wu -- Indaba Global Research -- Analyst

Good evening. Can you talk about any other than TSMC as a 10% customer in your third quarter? And I got a question on -- in memory, it sounded like Nova's exposure to NAND is a lot more than its exposure to DRAM. Can you sort of quantify roughly, the 2:1 ratio of NAND versus DRAM or even higher? Thank you.

Dror David -- Chief Financial Officer

Well, I would say the following. First of all, we do not disclose specific 10% customer names. But what I can say is that during Q3, we had 110% foundry customer, and 310% memory customers. On another note regarding NAND and DRAM, the portion is I would say in Q3, specifically, it was approximately 60% DRAM and 40% NAND.

David Wu -- Indaba Global Research -- Analyst

Okay. Thank you.

Operator

Thank you. We will now move to our next question from Mark Miller of Benchmark Company. Please go ahead.

Mark Miller -- Benchmark -- Analyst

You see foundry and logic both strengthening and you had very good sales considering the memory companies talking about cutting capex. I'm just wondering in terms of the margin profile foundry versus memory, do you ship a similar array of tools? There is no real difference. Or do you ship the higher-margin tools in either of those spaces?

Dror David -- Chief Financial Officer

Yes. So in general, we do not see a major difference between memory and foundry in terms of margin.

Mark Miller -- Benchmark -- Analyst

Okay. What about the X-ray? You didn't break out X-ray. How is the X-ray tools selling?

Dror David -- Chief Financial Officer

Yes. We do not break down the revenues between dimensional and materials, We discussed that before, average selling price is high. And this is for us competitive information, so we do not disclose this breakdown.

Mark Miller -- Benchmark -- Analyst

Thank you.

Eitan Oppenhaim -- President and Chief Executive Officer

Mark?

Dror David -- Chief Financial Officer

Yes.

Eitan Oppenhaim -- President and Chief Executive Officer

Mark, this is Eitan. Just to add on Dror comment, the reason that we are not breaking down the numbers between the X-ray and Optical, it's because of the reason that the synergy between the product allows us in some implication to measure with the X-ray some application that was measured traditionally by CD and vice versa. So it's complete competitive information that once we break it down with customers, competitively enough people will understand exactly what are the applications. So we are not breaking it down.

Mark Miller -- Benchmark -- Analyst

Thank you.

Operator

Thank you. As there are no further questions in the queue, I would like to turn the call back over to Eitan Oppenhaim for any additional or closing remarks.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, operator, and thank you, all for joining our call today. With that, we conclude our third quarter 2019 earnings call.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Miri Segal -- Founder and Chief Executive Officer

Eitan Oppenhaim -- President and Chief Executive Officer

Dror David -- Chief Financial Officer

Quinn Bolton -- Needham and Company -- Analyst

Patrick Ho -- Stifel -- Analyst

David Wu -- Indaba Global Research -- Analyst

Mark Miller -- Benchmark -- Analyst

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