Good day, everyone. And welcome to the Nova Measuring Instruments Second Quarter 2017 Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Miri Segal. Please go ahead..

Thank you, Operator and good day to everybody. I would like to welcome all of you to Nova Measuring Instruments’ second 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 statements outlined in today's earnings release also pertains to this call. If you have not received a copy of the press release, please view it in the Investor Relations of the Company's Web site.

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 all for joining our 2017 second quarter financial results conference call. I’ll start the call today by speaking briefly to our June quarter results and performance highlight. I will then provide guidance for the third quarter of 2017.

Following my commentary, Dror will review the financial results in detail. Our 2017 second quarter business and financial results set sequential new quarterly record, reflecting robust growth in revenue and profitability that exceeded our quarterly guidance.

During the first half of 2017, we continued to exceed our targets and solidified Nova’s competitive position in the market by offering an innovative and unique portfolio of metrology solution to a growing addressable market.

Our ability to differentiate our offering and attract customers in the most advance technology node, increased our relevant market and creates an environment recent opportunities that will keep supporting our accelerated growth.

The outstanding results we announced today project that we are well on pace for another record year, reflecting growth potential of at least 25% in revenue, well above the forecasted industry growth rate and more than double in 2016 year-over-year growth rates.

Our 2017 achievements create for us the visible path to meet our goal of $300 million in revenues as part of our long-term strategic plan. This aggressive trend is driven by both organic growth in the dimensional and material product line as well as inorganic M&A activities, which are well supported by our growing cash reserves.

In the second quarter, we kept expanding our outperformance by delivering record high revenue of $56.1 million and record high GAAP and non-GAAP net income.

The strong quarterly profits demonstrates, once again, the value of our offering and operational efficiency we embedded into our financial model, which allows us to continue investing in our next generation disruptive solution and for long-term target.

Comparing our achievements in the first half of 2017 with the same period in 2016, we recorded revenue growth of approximately 60%. The growth was achieved across all product platforms and technology.

While the fastest growing segment in this period was Optical CD with approximately 80% growth compared to the same period in 2016, our XPS sales grew also significantly towards the new record high in 2017, reflecting the progress we made to transform the XPS VeraFlex platform from infra solution with couple of tools preferred to in line tool in production with growing attach rate in both memory and logic.

These solid results also validated significant progress we have made in diversifying our customer base across the industry. This quarter, five customers contributed more than 10% of our revenue, two of which are VNAND customers.

Our progress to expand our position within the memory space is well noted this quarter with several major achievements, including record revenue contribution from integrated metrology sales to 3D NAND customers.

Our progress is also supported by the quarterly customer mix that yielded a leading memory customer as the largest contributor with 24% of our revenue. Overall, memory contribution to our revenue this quarter grew sequentially to 30% and was driven by a mix of DRAM and 3D NAND spending.

This memory trend will continue for the rest of the year, as well, while the leading edge customers continue to invest with objective of reaching 96 vertical NAND memory curve and above in reasonable price structure to continue replacing the position of liner devices. In DRAM, we see continued growth as well in the next couple of quarters.

Trending in this segment is driven by favorable market supply demand sensitivity and technical efforts to keep shrinking DRAM devices to sub 20-nanometer. In the logic foundry part, we continue to deliver solution to support multiple customers, which are building their 10-nanometer and 7-nanometer nodes.

Our attractive offering in leading position in the segment supported our wide delivery to multiple technology nodes ranging from 28-nanometer all the way down to 3-nanometer.

As meaningful process control partner in this sector, we are taking an active part in the development programs today with all major customers and research centers to commercialize the next 3-nanometer logic device, replacing FinFET with a vertical or horizontal nanowire.

The continued growth in the last several quarters is a result of intensive efforts to transform node value to an innovative and leading process control supplier to deliver a differentiated metrology portfolio, a feeling to customers across the entire industry.

In the period of 2014 to 2016, we spent over $150 million in disruptive expansion and today, we are broadly bearing fruit with significant growth and market share gains.

Our offering evolves from a few Optical CD portfolio to a leading edge holistic metrology portfolio that offer significant process insight to our customer as the progress to the most advanced technology node.

The metrology market is going through rapid change to increase accuracy and reduce time to solution, and we are taking the leading position in that by offering the following unique benefits. First, Nova today is the only metrology company that can provide both dimensional and material measurement for a complete structure analysis.

On top of that, our ability to couple hardware sensitivity with software capability in one bundle technical solution stretches the overall metrology envelope to meet the growing challenges and fold more applications.

Additionally, all of Nova’s tools today are connected as one fleet in a client server environment, providing a state of the art infrastructure to handle big data of metrology information from several course steps to create a better controlling scheme.

Finally, and as part of our recent share gain, our solutions today utilize the most sophisticated machine learning engine and the collective data to support the next generation of virtual and smart hybrid metrology, which can create predictive mode to mange efficiency customer's yield.

This direction is supported by our elevated investment to create disruptive techniques through complementary algorithm software development that exist in other data loaded industries.

By taking this innovative direction, we have significantly expanded our addressable market, secured new customers and increased our presence with key players in each segment of the industry and in all key geographies.

The customer response to our disruptive element is encouraging and exceeded our previous expectation with growing demand for all of our dimensional and material products.

As a result from this solid voice of confidence, Nova plans to continue its elevated investment to aggressively launch multiple new disruptive products in the next six to 12 month, which will take each and every product line, including our software offering, to the next level.

Looking ahead and towards 2018, our main drivers for the quarters to come include the continued investment in DRAM growth continued building of 10 and 7-nanometer lines by multiple customers, and China contribution. In all of this, we plan to increase our market share and create new application which will expand our growth.

In summary, we are very encouraged with the strong first half of 2017 results and are increasingly confident that we will deliver another record year with at least 25% growth in sales, which outperforms the expected overall market growth.

We are achieving this consistent result due to a well executed business plan with clear strategic initiative, which are based upon innovative offering, direct partnership with our customer and efficient operational model to support our healthy growth. With that, I would like to share with you our guidance for the third quarter 2017.

We expect revenues in the range of $51 million to $56 million, diluted EPS, on a GAAP basis, in the range of $0.27 to $0.37 per share and on a non-GAAP basis, diluted EPS in the range of $0.33 to $0.43 per share. Now, let me hand over the call to Dror to review our financial results in detail.

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 second quarter of 2017 were $56.1 million, up 3% sequentially and up 68% year-over-year.

Product revenue distribution in the quarter was approximately 70% from the foundry segment and approximately 30% from the memory segment. During the quarter, the Company has five 10% customers.

Samsung accounted for 24% of product revenue, TSMC accounted for 23% of product revenues, SMIC accounted for 12% of the product revenues, and the Global Foundries and Hynix, each accounted for 10% of product revenues. Blended gross margin in the quarter was 59% on a GAAP basis and 60% on a non-GAAP basis.

The high blended gross margin in the last two quarters is attributed to several elements, including operational efficiencies related to high volume manufacturing and improved product mix, including elevated software revenue.

In terms of the global infrastructure related to manufacturing and services, the Company is in the midst of expanding its manufacturing capacity for Optical CD in Israel. The investment amount in this expansion is expected to be approximately $4 million, and to conclude by the end of 2017.

This investment should provide the Company with more than 20% additional manufacturing capacity in Israel, and combined with the existing manufacturing facility in the U.S., which should enable to support more than $250 million in annual revenues.

Given the depreciation and ongoing cost to operate expanded facility in future years, combined with a competitive market environment, we are currently maintaining our blended gross margin target of 56%. Operating expenses came in at approximately $18 million on a GAAP basis and $17 million on a non-GAAP basis.

The effective tax rate in the second quarter was 19% on a GAAP basis and 13% on a non-GAAP basis. GAAP net income in the quarter was $13.3 million or $0.47 per diluted share. Non-GAAP net income in the quarter was $15.2 million or $0.53 per diluted share, up 6% quarter-over-quarter and up 212% year-over-year on a per share basis.

During the second quarter of the year, the Company generated positive cash flow of approximately $20 million from operating activities. Before concluding my prepared remarks, I would like to give more details regarding the Company’s outlook for the third quarter of 2017.

As Eitan mentioned, revenues in the first quarter of 2017 are expected to be between $51 million and $56 million.

At the midpoint of this revenue range, we expect to follow; blended gross margin is expected to be approximately 58%; operating expenses on a GAAP basis are expected to be approximately $19 million; operating expenses on a non-GAAP basis are expected to be approximately $17.7 million.

These expected amounts reflect approximately $1 million increase in operating expenses relative to the second quarter. Most of this expected increase will be in R&D expenses as the Company accelerates development programs toward introduction of new products.

Effective tax rate is expected to be approximately 25% on a non-GAAP basis and approximately 20% 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?.

Thank you [Operator Instructions]. And your first question will come from Patrick Ho with Stifel..

This is actually Brian Chin on for Patrick. Thanks for letting me ask a few questions. First question, I think you referenced strong quarter, congratulations. I think you referenced that in 2017, you might have at least 25% growth. And so looks like there is an upward bias to that.

But I think it still suggest you could see little bit of a sequential decline in Q4.

Can you may be outline some of the puts and takes you’re seeing in Q3 and Q4 in terms of market environment?.

Looking on the divers for the third quarter and the fourth quarter are growth. I think that if you're looking right now on Nova’s drivers in this couple of quarter, the first thing that we're talking about of course is the continuous spending by the leading memory providers.

I think that if you looking right now on the leading provider, it will keep will spending both in logic but what is in DRAM and the vertical NAND. And I think that the other memory customer will continue trending in vertical NAND in the next couple of quarter as well.

The second one is DRAM, when we look on the market, we see that the favorable sensibility right now for price on demand and supply perspective is such that we start to see an over demand. And definitely we start to see investment in the DRAM customers in extending the DRAM capacity. We started with conversion and now it's moved into capacity.

The third element is the logic provider. So while we definitely will see some pause in different systems being in the next couple of months, we’ll definitely see the other logic providers starting to invest heavily in pilot lines and production lines in 10 and 7-nnaomter.

We’re also starting to see that customers that didn’t spend in this area for year or more started to invest more, because definitely a growth area for us. And the fourth element is China.

China is becoming a big story for Nova in the last couple of years, and we think it will continue in the next two quarters as well as the lift in the same level in 2018. So this is why we think that overall looking on those four elements, we will continue having good and solid results in next two quarters.

And we don’t guide beyond the third quarter but definitely, if you're looking on the yearly growth rate, significant growth relative to 2016..

And not to get too specific, but it's totally clearly. But looking ahead to 2018, I think you said China could be constant spending relative to what you’re seeing in 2017.

But in terms of your specific business, what are the one to two areas may be you can point us towards where you may be have the highest confidence of driving continued momentum in growth in 2018?.

So when I talked in my prepared remarks, I talked about several elements. First, I think that the inroads that we made into the memory segment with definitely the progress that we had with Samsung and the other memory customers that brought us to diversification of 30%. And I hope it will materialize and grow.

So this is definitely one of the drivers in the growth engine. Secondly, I think that today more than ever, the integrated metrology starting to become a tool of record in some of the customer that we didn’t have market share, and is definitely evident by the record that we see in the integrated parts.

Addition into that, we start to see that the XPS, as I said, moved from infra measurement tool that you have couple of them in the firm to actually an in line attach rate, the tool will significantly increase the revenue. I think that the standalone itself, which we’re looking right now, is the late comer.

We’ll achieve a growth in the next couple of quarters, as well.

And I think that the last one that is coupling everything together and combined it to one unit solution, I think that our ability right now to take engines from other industries for machine learning and Big Data and effectively, install it as part of the metrology to control better the process node.

is something that definitely increase the intention of our customers to increase Nova’s market share. So I think that, Brian overall, those are the triggers for 2018, we definitely look on 2018 as a growth year. So maybe customer mix will be different, but definitely it's a growth year..

Just one last one from me, just to quickly follow-up on the XPS dynamics.

Are you seeing the move to more inline attach rate happening both at foundry and memory, memory NAND, right now?.

Correct. You know that one of the core competencies of Nova is move tools from rate environment into a production environment. This is what we did with Optical CD being part of the element, and when we acquired ReVera we took it as in the first initial step when they moved from a lab tool into the fab.

And we took it in the last two years an extra mile and actually put it in production. So today, the XPS tool has been deployed in several applications actually on the same mechanism as the OCD. So it's nothing more one or two fabric actually part of the customers is spare capacity.

So definitely this is why I said in my prepared remarks that we are going to have the record revenue for next year to this year after the acquisition..

From Needham and Company, we’ll hear from Edwin Mok..

First, actually let me just give some question to Dror.

So Dror, what happened to your gross margin decline this quarter and can you tell us what’s the percentage of sales coming from software this quarter, and what do you expect in the second half of the year?.

So the decline in the current quarter in the blended gross margin was attributed mainly to services, because 1% decline because we increased actually the expenses and investments in the infrastructure of the service organization in the second quarter. We do expect that to improve in the second half. So that’s one thing.

In terms of the software element, as we discussed in the conference call in the first quarter, in the second quarter, we did see some reduction in software revenues. And we expect another slight reduction towards the second half of the year.

And this is part of the element that has an impact on our guidance, which is lower in terms of gross margins in the third quarter..

I mean, it's still healthy though even with lower software, you expect for 38%, right. And then my next question is actually on 3D NAND. Eitan you mentioned some other customers thought to looking to take a layer of 3D NAND. To the extent customer convert 3D NAND line from, I don’t know, let's say 64 to 96 layer.

How does that benefit your business? Or is there a way to think about that conversion versus redo installation? In terms of how much revenue you can generate from those 3D NAND customers?.

So I’ll refer to that in two levels, one level is integrated metrology. So you can see from the results, actually the integrated metrology is becoming a huge contributor in the 3D NAND space. And definitely, is coming from two areas; you have an increase in investment in CMP; and also increasing investment in edge.

And integrated, as part of integrated metrology on [indiscernible] is benefiting from that clearly, because specifically in vertical NAND when you add layers, you want to have more control in wafer-to-wafer than lot-to-lot that is done in standalone.

So we see both increase in the attach rate, both increase in the CMP process and edge process to refill, as well as move some applications on standalone to integrated, so they’re definitely a growing market.

Secondly, the whole environment, as I said, of trying to take Big Data of metrology measurement on a fleet of tools and try to predict and learn the pattern of the process in order to improve nodes on the process tool itself is something that we pioneered and the memory customers that has issues of controlling process along the time and join the benefit from that, that’s the second.

The third one is regard to standalone. So of course, there’s conversion from phase-to-phase definitely also there is attach rate in the latest phase, phase three and moving into 100 layers the attach rates will increase. We are the smallest player in the standalone and we're increasing our market share.

So it's difficult for me to say how the conversion is done on the install base. But entering into the standalone market in the VNAND, we definitely see that -- from phase-to-phase it’s around 20% growth in attach rate..

I guess, so going back to Brian's question around China, I think you expect -- you said that you expect to be robust into 2018.

How do you think about -- what are you seeing in terms of the customer, especially the local Chinese customer, or where they are in terms of the investment plan cycle? Well, first on some of the -- your peer competitors or peers that talk about they start to get orders from those in the just Chinese local chip makers.

Have you started to see that and do you expect that to be become more meaningful as you go into 2018?.

So I’ll start by discarding our situation in China and our overall investment. I think that looking on my previous comments, referring only to [YMTC] is major contributor in China is definitely not the biggest thing happening in China.

So when I am looking right now on the growth of investment in China and we see it continue in 2017 and ‘18 as well, we need to talk about growth of spending. The first one is the Korean customers. So we see that both Samsung by their plan in [indiscernible] fab to increase it another 100k wafer start capacity, and also Hynix and [indiscernible].

We definitely see plans in that direction. Then we have the Taiwanese group. So we definitely saw in 2016, ‘17 investment by UMCI in [indiscernible] and definitely we’ll see the move of TSMC into Nanjing this year, which in my mind, will have some capacity improvement and some spending, and that’s beyond just conversion and transfers of line.

And then we have the [indiscernible] that are investing as well. We have Intel with the second shell been built in the second phase of memory capacity coming in volume. And the last one is the local investment.

So the local investment we have the high area where we have SMIC and Huali, which continue moderately spending and we see both of them spending also in the third quarter and the fourth quarter.

And the third one is what everybody is excited with is the two recent news, which one of them is [YMTC], which is a government owned fab or majority of the government, which they declare it for the next couple of years to build the mega fab of 300k capacity for memory, which is unique in China.

But I’m conscious about when this investment will take place, because it’s hard enough to expand the memory line. Now, we’re talking about doing everything from scratch and I think that they took several tools only for -- and also pilot line and development line.

And the last recent news that it was also announced that Global Foundries going to add another mega fab in China, which is a significant investment.

Now looking right now where Nova is positioned, we are China for couple of years with aggressive organization, and we are established there, I mean all of those establishments and expansion that I just briefed about..

Actually, last question I have on the foundry side. I think, very much you talked about you’re starting to work on 3-nanometer on nanowire. Maybe not to follow it under 3-nanometer, but at 5-nanometer, where are those foundry customer right now in terms of pipeline and development.

And how do you guys see [indiscernible] in 5 nanometer versus say 10 and 7 nanometer?.

So I think that looking on all those foundry logic players, all of them are contemplating in establishing a pilot line or develop line in 5-nanometer, and this is going to be shrinking the FinFET. So the big question in the 5-nanometer is how the overall fabrication scheme will look like because of the UV. But definitely this is achievable.

We measure today 5-nanometer on a FinFET structure, which has a lot of benefits. I think that the big move right now will happen on the 5 to 3 nanometer because from performance perspective, you need to change or modify the structure in order to increase performance.

And today, we are part of the development in several places but actually, have nanowires in place with new materials, because material is becoming non-controllable issue as well.

So we have invested in those programs to be part of those, either horizontal or vertical nanowire, which is a totally new structure and totally new materials for the next generation logic devices..

Next from The Benchmark Company, Mark Miller..

Just wondering the current plan at Samsung is just starting power production. And give us some feeling for the opportunities there in terms of how they rollout over the next year or so.

What percent of equipment have they bought that is going to go into the plan and what percent is coming, and what's the time frame?.

So when we’re talking about Samsung, we look right now on three investments. The condensed one that all of us saw right now in the results is the VNAND investment in the next phases of the 3D NAND devices. And there are two investments in place, one is in Pure Tech fab and the other one is in Xi'an in China, it was declared by Samsung.

And the majority of the delivery that we have into the memory in Samsung was to the Pure Tech fab in Korea, both as long as -- in addition to that, we had some capacity moving also to the existing lines that are developed to do the next phase of VNAND. So this is the majority of the investment process.

The second one is the logic, Samsung is investing both in 10 nanometers as well as in 7 nanometer, both in existing lines as well as new lines, Korea and the U.S. [indiscernible] and we are having equipment sold and delivered there as well.

And the last spending that we started to see some feeds in the last couple of quarters and it's growing is the DRAM investment that started with conversation and will continue with some expansion. I hope, Mark, this is shining a bit light about the Samsung..

What about TSMC, I mean, traditionally they’ve had some seasonality in their ordering pattern, usually at the end of the year early in the first part of next year.

Do you think that continues?.

So looking at TSMC spending this year, we had different cycle from what we used to in the previous year. So 2017 was weighted more to H1 versus the second half.

The different between in TSMC and I think that something that they discussed by themselves, the 70% of their profit will invested in the first half and 30% will be invested in the second half with different capacity in the third quarter. But I think that TSMC spending in the second half will decline.

Looking on Q4 and next year, TSMC declared by themselves and we see the magnitude of spending and the magnitude of customers that are waiting to the seven nanometer I think that next year spending will be at least the same as this year.

The big question that we still have and from the visibility perspective is how 2018 will be balanced it will be balanced towards H1 or H2.

Looking right now on the challenges and the things happening in the 7-nanometer and the 10-nanometer, I think we’ll see another increase in the first quarter, which will continue to increase towards the end of the year in 2018..

You then speak to in prior calls, you talked about interest in acquisitions, anything new there in terms of your thinking?.

So when we look on the acquisition, we’re looking on two main areas that we would like to invest in. One is technology direction. I think that in process control today where it go with the investment in the software algorithms and some schemes. There are interesting technology investments that we can make.

And the second one is we looking on other companies that can leverage our position and technology, and expand our market in companies like ReVera size or even bigger. So we’re definitely heavily all are heavily invested in making it happen and part of our plan we declared publicly that we want to grow also by M&A.

So now that we know that the organic part is increasing well, we’re investing in doing the other part as well. Looking onto our results in 2017, we definitely have more resources to make it happen..

[Operator Instructions] Next we’ll go to David Wu with Indaba Global Research..

I’ve got -- since many questions been asked, I have one which is the -- if you look at the memory customers, they’ve been spending with everybody at a very rapid pace in the first half of this year.

Do you see that this pace of spending will continue into the second half or do you expect a drop off towards the end of the year?.

So the two major customers that we are exposed to are obviously Samsung and Hynix and these two customers are expected to continue invest in the second half of the year, at least to the same pace even higher.

And we did see that are penetration into Samsung was very strong in the first half of the year, so this should have positive impact on our results for the second half. Obviously, we are also exposed to Micron, Toshiba and Intel.

And in general, these customers, in terms of memory and accept into, which is also expected to increase investments in China, as I mentioned. The other two are expected to be at the same level..

Approximately what percent of revenue in Q2 came out of China, either multinational or local?.

I would assume it’s around 20%..

So about 20%. Last question I have is really, if you look at Global Foundries, they have been absent for a while. I guess into the ramp up of 7-nonmeter for calendar ‘18 volume production. And I was wondering besides them I see UMC stepping in, starting production on 14-nanometers.

Would those be incremental demand for you late this year into the first half of calendar '18?.

So maybe they take and there are few levels of spending in the foundry side in the advanced node. So you have UMC and SMIC that probably will go into the 16 and 14, which probably will happen in 2018 as well. And you have the second group, which is TSMC, Samsung and Global Foundries, and of course Intel that we will continue investing in 7 nanometer.

We believe that the move from 10 to 7 is actually bigger or more significant than the move from 20 to 16. So if you're looking right now on the 7 nanometer, all of our deliveries the huge investment customers are waiting. There are multiple customers that are waiting for this device.

It's supposed to be a long and a big device with a longer time in the market..

And then the bulk of that will happen in calendar '18?.

Correct..

[Operator Instructions] I'm seeing no other questions at this time. I would like to turn the conference back over to Eitan Oppenhaim, President and CEO..

Thank you, operator and thank you all for joining our call today. By that, we conclude our quarterly earnings conference call. Have a nice day..

Ladies and gentleman that does conclude today's presentation. We do thank everyone for your participation..