Welcome to the Nova Measuring Instruments Ltd. First Quarter 2017 Results Conference. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Miri Segal. Please go ahead, ma'am..

Thank you, operator and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments' first quarter 2017 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 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. Let me add my welcome to everyone and thank you for joining our 2017 first quarter financial results conference call. We're excited today to share with you our 2017 first quarter results that set new quarterly business and financial records for Nova.

Our outstanding performance, as reflected by this quarter's results and next quarter's guidance, [indiscernible] our outlook for another growth year in 2017 as we continue to effectively execute our strategic plans and strengthen our competitive position across the industry.

I will start the call today by speaking briefly to our March quarter results and performance highlights. I will then provide the guidance for the second quarter of 2017. Following my commentary, Dror will review the quarterly financial results in details.

The growth momentum we built during the second half of 2016 continued consistently into 2017, resulting in another strong quarter for Nova. The company's outstanding efforts to meet its strategic growth plans are bearing fruit with quarterly revenues that exceeded our guidance.

In addition to the sequential growth in revenue to record high of $54.4 million, we also demonstrated once again the operational leverage we have built into our model. With substantial growth in our profitability, we had quarterly record high of $14.1 million in non-GAAP net income or $0.50 per diluted share.

The profitability outperformance that we continue to demonstrate is driven by an efficient and well-maintained operational model that is integrated with our value proposition with successfully coupled hardware and software solutions.

The strong financial metrics we announced today in both revenue, gross margin and profitability validate once again the value our holistic x-ray and optical portfolio brings to our customers across all semiconductor segments, where our differentiated technology today enables the most complex transitions in Logic, foundry and volatile and non-volatile memory.

Our growing competitive strength across the various market segments is evident this quarter with major competitive selections and new position within various front-end customers. Our progress to expand our position within the memory space is well noticed this quarter with several major achievements.

Following our press release from December 2016 announcing multiple orders from 3D NAND customers, we continued to proliferate our success during the first quarter of 2017 as well, resulting in record high bookings from 3D NAND customers.

Our progress is also supported by the quarterly customer mix that yield a leading memory customer as the second largest contributor with 27% of our revenues. Since we announce only 10% customers and since we had 2 strong contributors this quarter, we didn't share the rest of the mix that included other memory customers that grew as well.

In addition and as was announced in January press release, our compelling value is gaining more traction across multiple foundry customers with both the XPS and OCD solutions.

While our major foundry deliveries during the quarter supported a 10-nanometer impact by our leading customer, we also started to book systems for other customers that joined the 10- and 7-nanometer race.

The combination of market dynamics in the Logic space and our attractive offering, supported our growth in multiple technology nodes ranging from 28-nanometer all the way down to 3-nanometer and early starts of nano wired developments. This progress across multiple players resulted in record quarterly revenue from the foundry's base.

In regard to the geographical distribution of our business, we continue to see traction in the Chinese markets. We believe the share gains we had during 2016 will continue to materialize into significant revenue streams in 2017 as well.

As for our product portfolio, we believe our unique offering which combines a growing portion of software modeling solutions to enhance hardware performance, along with our synergistic portfolio of optical and x-ray technologies, set us apart from the competition and increase our available market and potential market share gains.

Our growth is fueled by successful execution of a differentiated and innovative product strategy that, in our opinion, is becoming more attractive that challengers are growing in the most complex next-generation nodes.

Our elevated investment in technology innovation is bearing fruit with holistic approach which intersects with customer needs both in the dimensional as well as in the materials metrology. In this space, I would specifically like to mention a few of our achievements this quarter.

The growing challenges in building 3D devices, including advanced chipsets, 3D NAND and advanced DRAM, created a strong demand for wafer-to-wafer control during the fabrication process. Customers are now requiring full dimensional measurements closer to the process in a very demanding production environment.

In order to meet this particular demand, Nova's integrated metrology solution was uniquely enhanced to support advanced CD measurements in the most difficult application space. In some cases, these challenges cannot be solved by other metrology or process control tools.

This can be achieved by introducing the best-of-breed hardware-sensitive tool integrated with advanced software algorithm models. This solution is resonating with customer with integrated metrology revenue growth to record quarterly high, including market share gain in the most advanced memory fabrication sites.

In addition to the progress we had with our OCD integrated tools, I would like to mention also the progress of our software portfolio that's contributing a growing share of revenue even this quarter. As part of this evolution, software revenues reached record levels, exceeding 10% of our revenues.

The software revenue mix included fleet management and unique software modeling engine that support our holistic infrastructure of multiple tools and technologies across several process steps and environments. Finally, I will mention briefly the progress we made with our XPS tools.

Our penetration efforts in the last few quarters are bearing fruit as well with more XPS tools moving to production in the most advanced applications in both 3D NAND and FinFET gate formation. The combination of XPS with XRF enable us today to measure materials composition and thickness very accurately.

And with the OCD contribution, it can be even enhanced further. This progress is evident with growing backlog for the XPS that will be materialized to revenue along the rest of the year. In total, we're very encouraged with the strong start for 2017.

We were able to achieve these consistent results due to well-executed business plans and clear strategic initiatives which are based upon innovative and differentiated offerings, tight partnership with our customers and an efficient operational model that support our healthy growth.

All in all, our progress in the last few quarters significantly improve our position in the market and emphasize the growing importance of Nova in the industry supply chain. With that, I would like to share with you our guidance for the second quarter of 2017.

We expect revenues in the range of $52 million to $56 million, diluted EPS on a GAAP basis in the range of $0.32 to $0.39 per share and a non-GAAP basis diluted EPS in the range of $0.38 to $0.46 per share. Now let me hand over the call to Dror to review our financial results in details.

Dror?.

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

Total revenues in the first quarter of 2017 were $54.4 million, up 8% quarter-over quarter and up 60% year-over-year. Products revenue distribution in the quarter was approximately 70% from the foundry segment and approximately 30% from the memory segment. During the quarter, TSMC accounted for 43% of the product revenues.

In parallel, revenues from Samsung accounted for 27% of the product revenues, a record level for the company, both percentage and dollar wise. Blended gross margin in the quarter was 60% on a GAAP basis and 61% on a non-GAAP basis.

These high, blended gross margins are attributed mainly to an exceptionally high level of software revenues during the quarter.

Operating expenses in the quarter increased by 2% quarter-over quarter on both GAAP and non-GAAP basis mainly as a result of 5% increase in sales and marketing expenses, while R&D and G&A expenses remained stable quarter-over quarter. Operating margins in the quarter were 28% on a GAAP basis and 30% on a non-GAAP basis.

The effective tax rate in the first quarter was 14% on a GAAP basis and 17% on a non-GAAP basis. These tax rates are different than our annual forecast for 2017 due to a different distribution of profits between the different territories and countries during the quarter.

GAAP-based net income in the quarter was $13.4 million or $0.48 per diluted share. Non-GAAP net income in the quarter was $14.1 million or $0.50 per diluted share, up 24% quarter-over quarter and up 242% year-over-year on a per-share basis.

During the first quarter of the year, the company generated positive cash flow of approximately $23 million from operating activities. Before concluding my prepared remarks, I would like to give some more details regarding the company guidance for the second quarter of 2017.

As Eitan mentioned, revenues in the second quarter are expected to be between $52 million and $56 million. Executing this revenue plan will reflect a revenue run rate of $200 million on a 12-month trailing basis. Blended gross margin in the second quarter of the year is expected to be approximately 57% on both GAAP and non-GAAP basis.

This expected blended gross margin is still positively impacted by continued software revenues in the second quarter of the year. We do expect software revenues to moderate at the second half of 2017 to normalized levels and gross margins in the second half of 2017 to be within the company target model of 54% to 56%.

Operating expenses in the second quarter of 2017 are expected to increase and come in between $18 million and $18.5 million on a GAAP basis and between $16.8 million and $17.3 million on a non-GAAP basis. We expect operating expenses to remain stable at this level in the second half of 2017.

At the midpoint of the revenue guidance for the second quarter, we expect operating margins to be approximately 23% on a GAAP basis and approximately 26% on a non-GAAP basis.

On the tax front, we expect the effective tax rate of the company in the second quarter of 2017 to be approximately 20% on a GAAP basis and approximately 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 take your questions..

[Operator Instructions]. And we will take our first question from Edwin Mok..

So my first question on your outlook. Just if I will compare to your competitor, I think both of your kind of your small and as well your large competitor, guide was sequentially up in the second quarter.

I was just curious, how do you kind of contrast that to your guidance? And then, I think generally, the commentary for the second half was really strong. Maybe you have - any comment beyond this quarter would be helpful..

So Edwin, thanks for the question. I think that I will take the opportunity and throw the question. Also, I will try to broaden a bit about our estimation for the second half following your question and the impact on Nova on the rest of the year. I'll refer to that with both the mix of memory customers as well as the foundry customers.

Although we don't guide beyond the next quarter, we were very clear in defining 2017 as another strong record year with growth momentum in all main segments. Following the first quarter results and the second quarter guidance, we already see very strong demand across all of our products which drove major increase in revenue in the first half.

I had also mentioned in my prepared remarks we believe that the new positions we took and the competitive selections we won in the last few months will be proliferated in high uptakes during the next quarter in both the memory, logic and foundry as well as the - as well as in the OCD and the x-ray.

And definitely in the last few weeks, we also started to see more clearly in the second half with stronger drivers an upside that - than we have thought about previously. And I can mention a few of them. The first one is, of course - the first driver is continuous spending by the leading memory provider in all segments, of DRAM, VNAND and Logic.

We have significantly increased our penetration into this customer, as evidenced by this quarter results and we expect it will continue in the next few quarters as well as this customer is continuously investing heavily in - at least in the Logic and some of the DRAM.

Besides the large investments by this customer, we believe that the rate of competitive achievement that we have will also impact the other memory customers, especially in 3D NAND. So we expect to see some revenue coming from that area as well.

Another factor is the resumption of spending by other foundry customers that started to invest in 10 and 7-nanometer. We definitely see in the next quarter or the next month some spending from other customers than TSMC in the 10 and 7 and is fueling our revenue in the next few months. The next driver is DRAM.

We see some DRAM modest recovery and definitely more spending in the second half. It started this quarter and the next quarter probably will be as well in the same level of existing new lines conversions. And it probably will include some multiple expansion later on.

I think that additionally to that, on a geographical basis, we also believe that China will continue its investments in both new fab establishments as well as the existing one, including, by the way, in new fab by TSMC in China which will be a significant event this year.

We believe that this investment in China will continue also in 2018, but it will have some revenue performance this year as well, by the way, both in memory and foundry. Now in regard to the TSMC and completing the picture with TSMC as well, we need to mention a few things about TSMC's spending pattern in specifically the fourth quarter of the year.

Following a strong half ramping 10-nanometer, we believe that the next ramp in spending will start again during the fourth quarter, with some 7 and 5-nanometer initial capacity. We think also that there would be some investment in some other nodes as well.

And as we see, the 10-nanometer is much more stronger node and the conversion will be much stronger from 10 to 7 than from 20 to 16. We expect some ramp over there. And definitely, we believe it will happen this year. Nevertheless, we remain cautious with that due to timing issues and we need to wait a bit until it clears up.

But we definitely think that spending will happen. As to our customer mix, we believe that the rest of the factors are really strong. And if they are materialized, it can mitigate some extreme reduction in TSMC spending.

So If I sum it up, all in all, we look at Nova's latest 4 trailing quarters, including Q2 guidance, we're definitely meeting our $200 million target in revenues which we believe we can exceed in 2017 if all drivers are materialized.

Moreover, we believe that if we will materialize those upsides, our financial model can be improved even further to exceed the 20% operating margin that we talked - to talk before. And of course, it will lead to an elevated EPS.

Well, I took these few minutes to just explain our situation in the second half and I hope these answer your questions, Edwin..

It's actually very, very helpful color. Just talk for a minute about the foundry-memory mix. Obviously in 1Q, you have 1 big foundry customer, TSMC. It was a very big driver for that [indiscernible]. And I think last year, you were roughly about 2/3 foundry, 1/3 memory.

Do you expect this year - as you go through it, do you expect to have a similar count 2/3 foundry, 1/3 memory? Or was the - when - so you've mention the memory.

Do you expect that memory share to - will actually be even bigger for this year?.

Well, obviously, the tendency is - from the point that we're in right now is towards memory and this is also evident in our booking in the first quarter which was practically more than 40% from the memory segment in the first quarter. So this would impact the ratio in the rest of the year..

Okay. Actually that's helpful information. And then maybe a quick question on the software. I guess [indiscernible] question. First is, just a housekeeping. Did you say it was 10% of total revenue or product revenue? Just to be really clear on software.

Because I think historically, you guys provided software as a percentage of product revenue, right? And then I have a quick follow-up on software..

Yes, it was more than 10% of the total revenues of the company in the first quarter..

Okay. Okay, great. That's helpful. And then in terms of, well, kind of what's driving the software, I know you guys historically have kind of the free management software which can become somewhat lumpy, right? If a customer is building capacity, they might buy a pretty sizable - I think you're going to get pretty sizeable revenue.

Was that a driver? Or was it more just these modeling software? Can you give some color around what's driving that?.

Well, I think - Edwin, it's Eitan. I think that it's - the way that we constructed the software business is it's - of course, if there are multiple expansion, it helps, but it also goes into the existing installed base.

And it's not a feature upgrade but a total solution from software perspective, that we're upgrading a fab that had - that have multiple fleets of Nova. As I said before, there are several solutions in that end. The first one starts with what we call fleet management.

That started at the beginning of more of recipe distribution and the fleet itself from management's perspective. As we have - in one customer, we can have hundreds of tools in different segments, in different process steps. Part of them are x-ray, part of them are optical.

So we had a way to implement a software environment that actually talk on the fleet, that can instruct - I can instruct the tool to do that and can extract information; at the end of the day can compare and look at the fleet as a - one big metrology of many tools. And by that, we can do many things on each one of the tools.

So this is one solution that keeps on expanding. The second one is what we kept on saying is the hybrid solution, the way to take information from either metrology or process control tools and improve either the x-ray or the OCD measurements. It can be both from our own XPS, in our own OCD, but it can be done also differently.

And the third one is, what we call the software modeling engine.

We see today that because we have multiple tools in multiple process steps, the fact that we can enhance the hardware measurement by some engines - by algorithm engines actually gives the customer the benefit that he can measure the application in a faster way, much more accurate, precise. And it shorten the time to solution.

So those are the 3 engines that keep on growing and kept on growing in the first quarter as well..

You saw growth across all 3 piece? Or one particular piece was a faster growing - growth driver for your software business in total?.

So we don't break it. We don't break it into pieces. But we definitely see that the software modeling engine is growing more than the rest..

[Operator Instructions]. And we'll move next to Mark Miller with Benchmark..

And let me add my congratulations on your record results. Some people - you've noted certainly memory and also DRAM picking up. I just wanted - some people are also talking about a rebound in the Logic market.

Could that be an upside opportunity for you in the second half?.

Well, thanks, Mark, for the question. Definitely. And one of the elements that I talked about on the upside, it has a Logic portion that can trigger some upside.

Definitely in one - in our biggest customer that we can have some upside and in the other foundry customers as well, in at least one major element which is the growth in spending by other customers in 10- and 7-nanometer which we definitely see an upside..

You mentioned a couple major customers.

How many customers in total did you have this quarter?.

Well, obviously, Mark, we sell across the industry. I mean, there is no one customer which is doing below 28-nanometer capacity buildup which we do not sell to and we have sold to all of them during the quarter..

I was wondering what your breakout was in sales, into older nodes versus the up-and-coming nodes?.

Yes, so what I can say is that - and Eitan mentioned them - mentioned that before, that our sales during the quarter were across from 40-nanometer and below. And I can say that approximately 30% from the foundry has come from 28-nanometer and above and the rest 20-nanometer and below..

Okay.

Final question, are you seeing any upgrade revenues?.

Meaning upgrade of existing installed base?.

Yes..

So we have two kinds of upgrades. One is, as Eitan mentioned, the software enhancements that we sell. So that's one thing. And we do see fluent upgrades of existing fab, but that's not a major portion of our revenues..

And our next question will come from Patrick Ho with Stifel..

Eitan, first, can you give me a little more color about the Chinese investments you're seeing today and whether you're seeing a mix of both memory and foundry? Or is it biased towards one or the other?.

And so thanks, Patrick. So when we're looking on China, we look obviously on 3 segments. One segment is the local establishment which are totally local Chinese ones. Second one is customers that are coming from abroad. And then there is the third one which is a mix.

When I'm looking right now on segments of foundry and memory, when we're looking on the last 2 quarter, it's a combination. We have a memory that - an OC customers that spends in memory that we see actually expediting some of his spending. And of course, we're experiencing that one in our revenue.

But we also see some local Chinese foundries like SMIC, UMCI, Huali and others that spend as well. I think that in the - along 2017, I think that we will see continuous investment by this particular memory customer or Logic customer that spend in memory.

We will see in the third quarter the movement of TSMC into China which will involve some capacity as well. And we see some moderate spending by the other foundry as well, where most of the new memory customers in China, beside the one that I just spoke about, will happen in 2018..

So I just want to make clear that most of the spending you're seeing today or in 2017 are from what we would call the multinationals and you think that the indigenous Chinese spending or the local Chinese spending will pick up in 2018?.

So the range of customers that spend right now ranging from Intel to TSMC, UMCI and some other small Taiwanese ones, that we'll see in 2017. Regarding the Chinese, what we will see in 2017 is Huali and SMIC. And the rest of the local memory ones, we'll see them in 2018.

The significant amount, R&D, we already see, but the significant one will come in 2018..

That's helpful. Going to the XPS solution, you talked about applications like [indiscernible] that are driving the sales this past quarter.

Was it moving - were they integrated with OCD? Or were these that's kind of standalones that are now getting into the production lines?.

So as I said, there's two different questions that I'm talking about. So the first one is what we talked about, the increasing penetration into VNAND. It's by the stand-alone XPS, by itself. So in VNAND, we see more potential.

It's very critical to manage the thickness and the composition on structure in order for the device to meet the performance specs like, for example, endurance. And therefore, we see more adoption of XPS stand-alone tools in memory. We definitely see some evaluations to try to adopt also some hybrids in memory.

But definitely, when we're looking right now on the growth in the last few quarters, by the XPS by itself..

Our next question will come from David Wu with Indaba Global Research..

My question really relates to the numbers. If you look at your first half, essentially it's roughly $110 million in revenues.

And I was wondering, what would cause the second half revenue to be materially higher or lower than the first half? Is it the timing of the next phase of TSMC expansion in their 7- and 5-nanometer node? Or is there something else?.

So as Eitan mentioned in the previous answer, I think all the catalysts are showing good trajectory into the second half, including memory and other foundries joining the 10 and 7-nanometers. And yes, the spending by TSMC at the end of the year will be the one that will have impact as TSMC is our large customer.

We currently believe that it will start the spending in the fourth quarter, as it did in the last 2 years. And yes, it will depend on TSMC's spending..

Now, David, I just want to - in fact, I just want to mention one thing. When I talked about the environment in the second half, there are few upsides and catalysts that we believe that can cover our growth in H2, even mitigating the fact that maybe TSMC will have timing issue.

So this is why we saw strong delivery in growth and record year this year as well..

Basically, it's - it would take a major negative unforseen surprise for your revenue to be below $200 million this year anyway, right? I mean, that's the way things look at this point..

Well, obviously, we do not guide for the year. We only guide for the next quarter. But Eitan did discuss the catalysts for the second half..

[Operator Instructions]. And we will take our next question from Robert Sussman with Bentley Capital..

Could you explain the extraordinary level of software sales in the first quarter and why you're confident it's not sustainable for the rest of the year?.

So this actually relates to the business model of our software revenue. The business model of our software revenues is licensed based, meaning when a specific sub, for example, wants to upgrade the existing software platform that it has to a new one, it's being done on a wide sublicense basis and so forth.

Therefore, when these revenues are based on license, they're not necessarily recurring each quarter. We did see fluctuations in these revenues also in previous years. We do expect 2017 to be at a very high record level of software revenues.

And we do expect software revenues to continue to be high in the second quarter, but we do not expect this high level to continue throughout the year..

We have no further questions at this time. I'd like to turn the conference back over to Mr. Eitan Oppenhaim, President and CEO, for additional or closing remarks..

Thank you, operator and thank you all for joining our call today. I would like also to thank our committed employees that contributed to our success in this quarter as well, supporting our vision with passion and dedicated hard work. With that, we conclude our quarterly conference call. Thank you..

This concludes today's call. Thank you all for your participation. You may now disconnect..