Good day, everyone, and welcome to the Nova Measuring Instruments Ltd Third Quarter 2016 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Miri Segal, Investor Relations. Please go ahead..

Thank you, operator and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments Third Quarter 2016 Financial Results Conference Call and Presentation. With us on the line today are Mr. Eitan Oppenhaim, President and CEO; and Mr. Dror David, CFO.

I'd like to draw your attention to the presentation that accompany today's call. The presentation can be accessed and downloaded from the link on Nova's website at www.novameasuring.com in the Investor Relations section.

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

Thank you, Miri, and thank you, all, for joining us today for our quarterly earning conference call. I will start the call today with the highlights of our third quarter business results. Following that, I will provide some perspective as for the industry trend and the market drivers and they relate to opportunities in the market.

Prior to turning the call to Dror, I will conclude my prepared remarks with the guidance for the fourth quarter.

We continue to demonstrate consistent growth during the year as a result of focused efforts to partner with our customers to deliver the most innovative process control solutions that enable better device performance and shorter time to markets in the most advanced technology nodes.

But the results, Nova delivered another strong quarter of sequential growth, announcing the record revenues and significant growth in non-GAAP profitability, both exceeding our quarterly guidance. Our exceptional execution, in-depth quarterly revenues of $44.1 million and sequential growth of our non-GAAP profitability to $9.54 million or $0.34.

With this strong results, we're affirming our previous forecast for stronger second half and based on our announced guidance for the fourth quarter, we are gearing up for another growth year, demonstrating four consecutive years of growth and record revenues.

The strong financial metrics we announced today validates the value of our holistic X-ray and optical portfolio brings to the customers across all semiconductor segments where our differentiated technology today enables the most complex transitions in logic, DRAM and flash.

The acceleration in our market position is evident by a fourth straight year of revenue growth, continues our momentum toward achieving aggressively our business plan as communicated following ReVera acquisition which included $200 million in revenues and non-GAAP EPS of $1 per share in this revenue scenario.

The expected annual results coupled with healthy industry growth and growing visibility increase our confidence and present a clear path for us to reach our planned revenue targets as part of our multi-year business plan. On the profitability side, we are heading towards a significant growth this year.

According to our fourth quarter guidance, we should meet our target of non-GAAP EPS of $1 already on the current 2016 projected revenues well ahead of our plan. This demonstrates the consistent efficiency we have been into our business model.

This is an outcome of well-executed business plan with clear strategic initiatives which are based upon innovative and differentiated offering, tight partnership with our customers and an efficient operation model that support our healthy growth.

All in all, our progress in the last few quarters significantly improve our position in the market and emphasized the growing importance of Nova in the industry supply chain. Another milestone we announced this quarter is ongoing strength of our service and option sales with a new record high of $11.1 million.

Our continuous investment in enhancing our install base is bearing fruit with various solutions which enable enhanced productivity, better utilization and improvement metrology capabilities in previous models.

The pace of the last nine months including our forecast for the fourth quarter suggest that we are closer to our long-term business model with more than $40 million in annual revenues coming from services. Let me now expand my remarks in regard to our customer mix during the third quarter and the changes we experienced during this period.

While our segment exposure in the third quarter continues to be elevated towards boundary, in light of the 10 and 7 nanometer ramp up in our expanded market share in this segment, our in-housing [ph] memory is also evident with growing exposure to two leading memory customers, Micron and Samsung to both DRAM and V-NAND applications.

Last year's efforts to diversify our revenues by increasing our exposure to memory customers has been successful as we had approximately 30% revenue contribution for memory in 2015 compared to only 15% in 2014.

Encouraged by this growing trend, we continued our investment during 2016 as well with several key evaluations across multiple customers for the most advanced memory growth steps. Should these effort conclude successfully, they will start generating revenues at the beginning of 2017 and will extend our market share through the year.

Despite the progress in leading edge nodes, we also continued to extend our footprint and win businesses in China with SMIC becoming our second largest customer in the quarter.

As discussed previously, we continue to experience a geographical shift in our business this year towards China with Nova's portfolio including XPS as well as OCD integrated and standalone toolset installed in every major memory and foundry foundations.

Summing up our market position, Nova continues to solidify its strong foundry position, not only in leading edge technology nodes that go through complex technical transitions in both 10, 7 and 5 nanometer, but also in the training matured nodes of 28 nanometer and above.

As a result, we expect that our solid position in this segment will yield record-high revenues in 2016. Our unique offering is also supporting the significant inroads we made into the memory space by enabling unique process control schemes that only our products can support.

Additional to the OCD progress, we are also encouraged by the XPS adoption in memory with major customers moving tools into production for the most advanced V-NAND steps.

As evident by the growing metrology intensity in the recent technology transitions, we are confident that demand for advanced metrology for both critical dimensions and materials is increasing to enable key technology infliction and faster time to market.

We believe that the demand to process control across all segments in both advanced and training nodes will continue throughout 2017 as well. This is translated into a large opportunity for Nova in 2017 as we gear up for another growth year, leveraging our growing position with existing and new customers.

In order to continue our profitable growth in the years to come, we leverage our financial strength and sign this quarter a royalty buyout agreement with the Office of the Chief Scientist in Israel. This non-recurring payment eliminated approximately $24 million long-term obligation.

The agreements, coupled with our efficient operational module should enhance our financial flexibility, allowing us to concentrate on long-term organic and inorganic growth.

In summary, we believe that our growing focus on executing our strategic plans combined with our operational efficiency and our differentiated offering present a multi-year opportunity to continue our growth in the years to come. Let me now turn for short updates on our products.

We believe that our unique portfolio, combining a growing contribution of software modeling solutions along with our synergistic portfolio of optical and X-ray technologies sets us apart from the competition and increases our available market and potential market share gains.

With several growth engines across the optical slips as well as the X-ray, we are positioned well to benefit from the increasing demand for process control scheme.

Our ability to present a unique hardware road map, coupled with advanced software modeling engine allow us to introduce a combined solution that extend the metrology and process control performance envelop and create a tangible competitive edge in both the traditional thickness and OCD markets, as well as in the materials metrology space.

I would like to specifically mention the growing demand this year for our OCD solution for various publication step, which will be reflected as annual record delivery for both the standalone and integrated metrology product lines.

Our ability to provide a holistic approach combining both integrated and standalone tools in one process control loop across several process steps in under one flip is becoming a great asset that supports our customer's agenda for title control towards the elevated complexity in multi-layers high optic ratio Vertical NAND, 1x DRAM and next five and three nanometer logic devices.

As it relates to our X-ray family of tools, our efforts to increase our footprint in the most advanced memory sites are bearing fruits as major memory customers move our XPS solution into their most advanced V-NAND steps.

The implemented solution enable our customers to measure in by thickness and composition parameters which provides the customers with the ability to accurately measure parameters not measurable with any other metrology tools.

Turning briefly to the market trend they relate to us, while V-NAND spending was the main catalyst this year, we experience the shift in the second half towards increasing fund respending, many waited towards 10 and 7 nanometer investment, as well as capacity additions to trailing nodes in China.

We believe the investment in 10 and 7 nanometer will continue next year, complemented by other players as well. In our view, non-spending will continue in 2017 as well with the leading edge customers trying to commercialize the next V-NAND device beyond 48 layers to high density storage.

Investment took place in the recent months and will continue moderately through the remainder of 2016 with continuous investments in 2017 as well. In DRAM, spending remain focused on 2x and 1x nanometer scaling.

In our view, DRAM manufacturing would recover moderately through the next few quarters, still with high sensitivity to supply and demand trend which creates some quarterly fluctuation. In summary, we believe that the market dynamics for the remainder of the year and through 2017 present a growing opportunity for Nova.

In this conditions involving few catalysts and very demanding solutions, our offering is becoming even more attractive to enable the next challenging technology transitions.

Our growing focus on executing our strategic plans combined with several tangible opportunities to strengthen our position even further, we continue to believe in a multi-year opportunity and continuous growth. With that, I would like to share our guidance for the fourth quarter of 2016.

We expect revenues in the fourth quarter in the range of $42 million to $46 million. Diluted GAAP EPS is expected to be $0.23 to $0.29 and non-GAAP EPS is expected to be between $0.31 to $0.40. Now, let me turn the call over to Dror to review our financial results in detail.

Dror?.

first, Nova is relieved from any future royalty payments on the previous funds received from the OCS, enabling improved gross margins; second, the agreement enabled Nova to apply for R&D program funding without future royalty payments beginning in 2017, enabling greater flexibility for R&D investments in new markets and products.

And third, the payment is expected to be tax-deductible in Israel and to reduce the company's tax payment by approximately $2 million in 2016. Blended gross margin in the quarter was negative on a GAAP basis and included the non-recurring expense related to the royalty buyout agreement.

In addition, it included 1.9 million of inventory write off as a result of customers' recent decision to adopt the later-introduced advanced product of the company as they ran the technology nodes of 10 and 7 nanometer and start to develop the five nanometer technology node.

On a non-GAAP basis, blended gross margin came in at 56%, 3% higher than the previous quarter.

The increase in blended gross margin was achieved as a result of the significantly higher revenue level, utilizing the same existing infrastructure and as a result of the fact that following the royalty buyout agreement, non-GAAP gross margin did not include any royalty payments to the Office of the Chief Scientist.

Operating expenses increased by $1.3 million in the first quarter of the year and came in at $16.6 million on a GAAP basis and $15.5 million on a non-GAAP basis. Operating margins in the quarter were negative on a GAAP basis, mainly due to the non-recurring royalty payment and increased to 21% of revenues on a non-GAAP basis.

We have previously communicated that the company's target financial model is achievable at any of the revenues of approximately $175 million in revenues. This target model assumed gross margins of 53% to 55% and operating margins of 18% to 19%.

We are happy and proud to announce that during the third quarter of the year which reflected annual revenue run rate of approximately $176 million, the company was able to achieve and even supersede this target financial model.

Tax expenses in the third quarter were positively impacted by the $2 million tax benefits related to the royalty buyout payment and therefore came in at lower than expected levels.

On a GAAP basis, the company reported tax income of $1.9 million and on a non-GAAP basis which excludes adjustments of deferred tax assets, the company reported $0.1 million tax income. GAAP-based net loss in the quarter was $4.8 million or $0.18 per diluted share.

Non-GAAP net income in the quarter was $9.4 million or $0.34 per diluted share, significantly exceeding the high-end of the quarterly guidance and up 100% quarter-over-quarter.

Excluding the royalty buyout payment of $12.9 million, the company generated approximately $11 million of overrating cash flow in the quarter and concluded the quarter with $94 million in cash reserves. We expect to continue and generate positive cash flow in the fourth quarter of the year.

Now, let me give some additional insight regarding the company's guidance for the fourth quarter of 2016. As Eitan mentioned, we expect revenues in the fourth quarter to continue to be robust between $42 million and $46 million. Blended gross margin is expected to be approximately 56% in the fourth quarter of the year.

Operating expenses in the fourth quarter of the year are expected to be between $16 million and $16.5 million on a GAAP basis and between $15 million and $15.5 million on a non-GAAP basis.

At the midpoint of the revenue guidance for the third quarter, we expect operating margins to be approximately 19% on a GAAP basis and approximately 22% on a non-GAAP basis. On the tax fund, we expect third quarter tax rate to be between 15% and 20% on a GAAP basis and approximately 5% on a non-GAAP basis.

All these elements together lead to robust earnings per share in the fourth quarter of the year, which are expected to come in between $0.23 and $0.29 on a GAAP basis and $0.31 to $0.40 on a non-GAAP basis.

At the midpoint of this guidance for earnings per share, the company will generate over $1 of non-GAAP earnings per share in 2016, well ahead of our communicated plan and the time of closing ReVera acquisition.

Given the impact of the royalty buyout agreement and the fluent business changes in the company's mixture of product sales and service revenue levels, we are slightly updating the company's target model.

At this time, blended gross margin model is expected to be between 54% and 56% instead of 53% to 55% with product gross margin higher than 59% and services gross margin higher than 40%.

On the other hand, we are maintaining operating expenses model between 35% and 37% of total revenues and operating margins level between 18% and 20% of total revenues on a long-term basis.

We believe that this target model reflects the right combination between continued investments in aggressive R&D programs, which eventually fuel the company growth as well as continued expansion of the company global SG&A infrastructure and between generating fluent profitability which ultimately increased shareholder value over time.

On the tax front starting 2018, we expect normalized tax rate to be approximately 20% on both GAAP and non-GAAP basis. For 2017, which is expected to be the final position year towards a normalized fluent tax rate, we are currently modeling tax rate of 20% on a GAAP basis and 15% on a non-GAAP basis. With that, I will move the call back to Eitan..

Thank you, Dror. With that we will be pleased to open up the call for questions.

Operator?.

Thank you. [Operator Instructions] And our first question will come from Edwin Mok of Needham & Company..

Great. Thanks for taking my questions. Congrats for a great quarter. First question I have is I think I recall you talked about how you assess the memory customer.

Can you give us some color in terms of where the products are gaining traction, XPS you are gaining traction or increased penetration, or on OCD side? Also I think you touched on both V-NAND and DRAM. Just curious, I think we've seen some pickups in DRAM.

So I just want to understand what pipeline of winds secure for the DRAM side that is more forward-looking to you? Thank you..

Well, thank you very much, Edwin. I'll try to answer both from the market perspective, as well as for the opportunity for Nova.

And I'll start first on the market as we see that 2016 was a good year for Vertical NAND, for the flash where we sold multiple investments along the year and I think that those investments will continue moderately on the fourth quarter with some customers taking equipment for the new fabs [ph], and it will continue also through 2017 and we think that this two years, '16 and '17 are strong years for Vertical NAND.

As I said in my preferred remark, we are investing tremendous efforts in all those to diversify our portfolio and increase the exposure into memory. We had success in 2016 where we doubled actually the exposure to memory with the 30% exposure to memory.

And by this traction we continue to invest in this segment to the last few quarters and if we look now on the last three quarter and diversification of customers, you actually can feel over on a quarterly basis more memory customers including actually old, the four memory customers and this one is happening with all our portfolio.

It happens with OCD, but it has happened also with the ability to take the XPS tool and start penetrating more and more the high end V-NAND application which require more and more steps in that in order to measure both thickness as well as composition on a multi-layer structure. That is what we reported.

Additionally to that, we also said in the prepared remark and we hope that all of them will be materialized, but according to the evaluations and the inwards that we're going through - and we see some progress with that - hopefully everything will be materialized, we'll start to see more of it coming from a memory starting from the beginning of 2017.

We look on increasing actually the mixture, to see more diversification coming from memory in 2017. This is regarding V-NAND specifically. In regard to the DRAM, as you know, DRAM spending reduced a bit this year, but starting from the beginning of the third quarter, we started to see more and more add-ons to DRAM.

Not in the same pace as we saw years before, but certainly we see it coming from different angles. We see it coming from customers that we'd like to take a better position in the market and grow to some technical transition in moving to the most advanced DRAM structure. We see it from a technical transition moving from scaling on the DRAM.

And as obviously all was in the process control, metrology is the one of the tools that are -- been purchased early in the process so definitely we see it coming through the R&D and pilot lines before it goes into production.

All these mix we were being -- we were able to experiencing in the third quarter and we believe that it will be the same in the fourth with some strength in 2017. Now both the DRAM and NAND as I said before is a combination of XPS2 and OCD. This is somehow the overall picture in memory.

Okay, great that's helpful color. The second question I have is, can you price up us some update on kind of high maturity asset that you guys have put in -- I think you guys talked about previously, still developed metrology solution XPS plus -- but also components using data from other processed equipment to -- into your modelling system.

Where are you on that asset?.

Yes, so in regard to the hybrid solution, we mentioned last time that we start doing the same solution that we had with other metrology capabilities which are not optical. And X-ray, during the last quarter we started to add the XPS as well.

We keep making progress with several metrology companies which -- at least one of them is in production and the target is to combine several parameters for of course for a better process control which we I think the combination can give something that separate meteorology cannot give so the combination actually creating a better synergy.

That light that we shared last time and I can talk about it time as well.

It's actually when we -- when you can take thickness measurement in the thickness measurement including some material characterization that you can think from the XPS2 and combine it with the CD parameter or the dimensional parameters which are not so -- actual rate when measure materials, so when you combine both of them together actually you have a better solution because you have one-stop solution for the structure and you actually eliminate some parameters that you couldn't measure accurately before by only OCD.

The projects that we have are mainly in the most advanced note which means the nanometer and also the advanced memory on top of the 48 layers when you go for a very advanced Xenon layers. And this is again -- this is one-step of the hybrid which probably will materialize more in 2017 with more customers taking it.

But it's also with other methodology parameters that we take from either meteorology tools. One of the things that I can mention here is that we have these hybrid concepts not only with XPS or X-ray, we have it also with the CD.

So the combination of parameters both, OCD, XPS and CD can actually give the customer a complete picture that he doesn't have today. So this is roughly where we are with that..

Okay, great, that's helpful. Last question I have as usual, for your 4Q, guidance -- seems like your OpEx eligible guidance is guiding for below your target model for OpEx, maybe a little bit better than what you were targeting.

Is that just timing of spending on the fourth quarter specifically or can you help now in terms of how do we think about OpEx longer term beyond this quarter?.

Yes, I think in the fourth quarter there are some things related to timing of mainly R&D expenditures which are a bit lower in the fourth quarter relative to other quarters that we've seen this year and we'll probably see next year.

So next year we do expect operating expenses to pick up a bit relative to the fourth quarter and be closer to what I guided as the target model..

Okay, great. That's all I have, thank you..

And our next question will come from Patrick Ho of Stifle Nicolaus..

Thank you, and congratulations on a nice quarter. Eitan, first in terms of the market environment and you talked about SMIC and the China opportunity.

There is two part question; one, how big do you see the China opportunity for Nova particularly over the next few years? And secondly, given that they are still behind the leading-edge guys like TSM, how do you see the market opportunity for 28 nanometers and potential addition penetrations over the next few years?.

Thanks, Patrick, thanks for joining, it's a good question. As I said in my prepared remarks, we definitely see a geographical shift this year.

And if you're looking right now on the customers that we acquire during this last few quarters, we definitely are going to be at more than $25 million coming in revenue from China which is the great shift for us from the territory perspective.

Looking right now on the portfolio this is installed currently in China is going to installed in part of them in the next few months, it's a combination between local foundry initiatives like SMIC or some other customers in the foundry ground. It has also the movement of Taiwanese customers into China, of course including UMC and others.

And we definitely are installed with our equipment in the latest memory foundation that we can see in China.

If we are looking right now into overall opportunities for Nova, based on the fact that we win some business in China this year, and we have a footprint in all of those foundation; I think that if the investment will keep being sustainable in the next years to come, it's a great ground for Nova to continue its growth..

All right, that's really helpful. Dror, maybe just going to the supply chain side and just the working capital management; you talked about cash flow generation containing at least through the December quarter.

Given the increase in shipments and the revenue ramp that you're forecasting; where are some of the levers and the balances that you're doing on the supply chain as well as inventory to allow the strong cash flow generation to continue?.

So obviously, the high -- the main generator for the cash flow is the higher profitability of the company across 2016 and in terms of managing the working capital I believe in general the company is very efficient.

It can be seen from two aspects from example increasing the major increasing revenue in the second half of the year including separate the Q3 and Q4 we were able to keep the account receivable and inventory is almost at the same level.

I think overly - over you know in general the working capital requirement for the company in the next I could say two quarters are not that high therefore most of the profitability is going to flow to the cash flow and [indiscernible] expectations is that the company should be able to be very close or even higher to than $100 million in cash by the end of the year.

And obviously, next year we'll continue to generate cash, operating cash flow as part of the business of the company..

Great so maybe as a follow up so you don't have any major concerns of the need to build inventory ahead of a shipment and revenue ramp that you are forecasting over - at least over the December quarter and possibly in 2017..

Exactly these process was already done actually and is already embedded in general by actually the end of the second quarter results preparing for the Q3 rate. That's already inside..

All right, thank you again..

Thank you, Patrick..

[Operator Instruction] Our next question will come from David Wu of Indaba Global Research..

Good afternoon, I have two questions really first one relates to it looks like all street thickness of your and Marcus will be increasing calendar 17 I was wondering whether you can give us a flavor of maybe the contour of the year in terms of the first half versus the second half and the other question I have is coming off such a strong second half of this year.

Is there much growth from your leading edge foundry customer in calendar '17?.

David, I'll start first from your last part. Definitely, we see that process control is becoming very important and actually the intensity and the advanced node not only in foundry, but also in the most advanced V-NAND going up to 64 and even more - actually the number is in the intensity for metrology increasing.

We're not talking on a single-digit growth, we're talking about some of the steps, even 100% growth in metrology intensity. It has become clear that in order to enable those infliction, you need to rely more on process control and specifically on metrology.

Therefore you see it also on the numbers when the infliction point is becoming materialized, you see more and more revenue into the metrology and this is correct. For foundry it's correct, for logic, it's also correct for both Vertical NAND and the DRAM.

So definitely when we look right now in 2017, we assume that all the catalyst are coming into play in this year, but again, we need to look on how each one is contributing to the overall CapEx with the Fab equipment spending. We think that V-NAND or Vertical NAND and foundry will keep on being strong in 2017.

We think that DRAM will have moderate growth and not coming yet to the thickness that we had two years back. Nevertheless in the year like that, we expect to continue growth. I said in my remarks, 2017 looks for us as a growth year.

We also mentioned in the prepared remark that we announced our $200 million plan one year and-a-half back on the profitability. We already achieved the targets of the $1 EPS on a much lower revenue side and we definitely in a very aggressive way to meet the revenue targets as well.

One disclaimer that I can say, we don't guide the yearly numbers, so I will not talk about that, but as we look right now on the visibility in the market, it's supposed to be a growth year for Nova..

Okay. Can you give us at least a preliminary look at the contour of the business? This year was a very second half-loaded year.

Would next year be more even between the first and the second half?.

I want to be very conscious on trying to predict the weight between the quarters and the half during the year. I can tell you from our visibility right now, Q4 is evident by our guidance. It's going to be very strong and from what we see Q1 is supposed to continue to be strong.

Which by that, the cycle is a bit different from 2016 where first half was very weak. I don't see totally yet the second quarter or the third quarter, so therefore I was referring from trying to predict that..

Thank you..

[Operator Instructions] And it does appear we have no further questions at this time. Gentlemen, I'll turn the conference back over to you for any additional or closing comments..

Thank you, operator, and thank you, all, for joining the call today. I would like also to thank our committed employees that contributed to our success day-in day-out in supporting our vision with passion and dedicated hard work. With that, we conclude our quarterly conference call. Thank you, guys. Thanks..

And that does conclude today's teleconference. Thank you all for your participation..