Good day, and welcome to the Nova's Second Quarter 2020 Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Miri Segal of MS-IR. Please go ahead..

Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova's second quarter 2020 financial results conference call. With us on the line today are Mr. Eitan Oppenhaim, President and CEO; and Mr. Dror David, CFO.

Before I begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements and the safe harbor statement outlined in today's earnings release also pertains to this call. If you have not received a copy of the release, please view it in the Investor Relations section of the company's website.

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

Thank you, Miri, and welcome everyone to our second quarter financial results conference call. On behalf of all of us in Nova, we hope both you and your families are safe and healthy at this volatile period. I extend these wishes also to our employees, partners, suppliers, and customers.

I will start the call today by speaking about our second quarter results, including the latest updates about our continuous efforts to meet the company's targets amid the various global uncertainties. Following my commentary, Dror will review the financial results in details. And we'll conclude with the guidance for the third quarter.

Despite several challenges, including the spread of COVID-19 and other geopolitical and macroeconomic disruptions, Nova delivered strong financial results in the second quarter of 2020 with both revenue and profitability, meeting our mid-guidance and significantly outperforming the same period last year.

Although, the environment is still fluid, we currently expect that the strong demand for our products combined with several meaningful share wins we had during the first half of the year was positioned 2020 as a growth year for Nova with solid momentum expected to continue also into 2021.

This is a clear demonstration of our execution capabilities and agility to adapt quickly to fast-changing markets.

Our decisive actions during the last few years to diversify our products, customers and geographies continue to support our growing resiliency during this period and propel our plans to emerge as a stronger partner once the environment is stabilized.

We are very proud of our ability to capitalize on several strategic opportunities, especially through this period when our teams are aggressively investing in gaining market share and securing further growth.

In spite of the continuous struggle, with the spread of COVID-19 and as a result of our employee's dedication and outstanding efforts, we managed to quickly ramp up our production lines and development capabilities to respond to demand volatility and fast changes in the semiconductor market.

Since we expect that the virus is here to stay for a longer period than we've seen previously, we have changed our working procedure to ensure employee safety at all times, high production capacity, supply chain resiliency, and customer support continuously.

We have adopted protocols to continue the work from home hybrid method for as long as needed, without disruptive – sorry, without disrupting any of our business or whatnot development targets. Our aim as demonstrated in the last two quarters is to continue executing our strategic goals despite the rapid changes.

Beyond the common measures we have taken to fundamentally change our working methods, we are also focusing on strengthening our local entities in order to continue servicing our global customers and capitalize on various emerging opportunities.

Our plan to increase production capacity specifically in this period is started to accommodate the supply chain disruptions as well as customers demand for shorter lead times. As a result, we may experience some inventory volatility during the next few months yet without changing our long-term operational model.

Our confidence in our new product portfolio and our ability to transform short-term pipelines into long-term growth engine dictate our operational goals currently independent of the current interim disruptions. Turning now to our business highlights in the second quarter of 2020.

Our performance continued to rely on breadth and depth of our customer mix, which was driven by five major customers, including three Foundry/Logic customers and two large Memory providers. As reflected in our customer mix, we are very proud to achieve two new share wins with both our stand-alone and integrated tools in China.

This mix of customers highlights the growing demand for our solution in both Memory and Logic, which is affected by growing demand for NAND devices, as well as for wide range of Logic devices, starting from 40-nanometer all the way down to 3-nanometer.

This outcome represent the overall positive momentum in the semiconductor industry that is dictated by the COVID-19 implication on the way we work, communicate, interact, stream data and rely on remote applications.

In our service business, we are expecting meaningful growth this year, as we continue to offer proactive service packages to our customers to improve their install base productivity and metrology capabilities as well.

Beyond revenue contribution from service contracts and time and materials services, our goal is to significantly increase the overall contribution from value-added services that are developed specifically for our customers, enabling them to better utilize the aging install base and to extend their life cycle.

Finally, for this part, I would like to mention again, our strong operational model, which is the basis for our continuous growth and ability to invest in our development roadmap, even when facing uncertainties.

The value of our products, along with Nova’s unique offering and efficient manufacturing capabilities, support our profitability model and are reflected in our strong cash flow generation during the first six months of 2020, which was much higher compared with the same period last year.

Embedded in our strategy, this cash position should accelerate our organic and non-organic plans specifically in this period. Let me now provide some highlights as for our product portfolio and roadmap development progress. The first highlight to mention is our announcement from July 27, about new additions to our optical CD integrated solutions.

The need for better in-die and in-wafer metrology performance in the most advanced Logic and Memory nodes is converging with our legit leadership in the integrated metrology market and supporting our aggressive future roadmap.

Our tight partnership with customers and our leadership position were both reflected strongly in the second quarter with record high revenues for integrated metrology across all front-end segments.

The new announced platform, the i570 and ASTERA extends Nova’s leadership in integrated metrology process control and targets the development and manufacturing of next-generation IC architecture. The Nova ASTERA platform is the first of its kind in the industry, providing stand-alone level performance in a compact form factor of integrated metrology.

The new platform utilizes multi-channel measurement, providing the best solution in the market in term of accuracy, precision, tool-to-tool matching and extendibility.

This platform is targeted to support the development of next-generation device technologies beyond 3-nanometer Logic and 256 layers multi-deck 3D NAND nodes, and as such is expected to enter the market over the course of the coming years through R&D line first.

The second new solution is Nova i570 single channel SR platform, which is in the center of Nova’s mission, as the integrated metrology market leader to provide the most reliable and highest performance integrated metrology platform solution for high volume manufacturing fabs.

The new addition offers the highest throughput in the market supporting the new faster CMP polishers and new etchers allowing better within-wafer variation control by measuring more sites, as well as pre and post-wafer measurements.

By introducing these platforms, Nova expands its leadership position by offering a wide range of integrated solutions from single channel thin film fast solutions to multichannel OCD complex solution for CMP deposition and edge.

With this announcement for new integrated metrology platforms, along with the new PRISM standalone OCD market rollout and the new technologies that are evaluated currently in the field by multiple customers.

We are planning to enter 2021 with a completely differentiated and unique portfolio that will support the expenditure of our total served and available markets going forward. As part of our strategy and at the heart of the technology roadmap, we'll continue to invest in enabling software technologies that support innovative hardware developments.

Our main efforts in this part are to embed more deep step capabilities in our solution, including machine learning, AI, Big Data and adaptive training. All our latest product announcement includes an element of advanced software engines to enhance hardware capabilities and overall metrology performance.

As a result of these efforts, we received a significant order from a logic customer this quarter to enhance their entire new install base with the complete machine learning solution that allows them to tighten process control schemes, improve it faster and shorten time to market.

Before I conclude my prepared remarks, I would like to briefly highlight some market dynamics and their relevance to Nova performance.

Though we are very encouraged by the business space in the first half, and the improved momentum towards the second half of 2020, which is significantly higher compared to the same period last year, we remain watchful for possible changes in the market and their effects on Nova.

As for the current demand characteristics, we believe that the global pandemic and the changing in social behavior, it is dictating – it will accelerate key long-term technology inflections.

These changes are driving investments mostly in cloud-based services, advanced communication ecosystems to allow better streaming and video calls, growing needs for automation and AI, stronger compute power and memory capabilities in every device.

These Hi-tech application, right technologies, enhancement in both logic and memory and create a solid demand for more metrology control. Although COVID-19 will continue to present some challenges and fluctuations, we still believe that all these triggers create a compelling event for solid WFE spending in 2020 and 2021.

To conclude, we delivered strong results for the first half of 2020, and we are guiding the third quarter to continue performing at the same elevated levels. We are seeing positive momentum in our efforts to gain market share, expand our available markets and rollout new technologies.

This soundly demonstrate the contribution that our diversified product offering and store customer brace bring to the company resiliency, which in turn drives our ability to adopt quickly and perform well even in challenging periods.

Although, we've yet to know the full impact of COVID-19 on global economies, we still believe in the long-term semiconductor technology innovation and the significant opportunity present to Nova in the long run. Now let me hand over the call to Dror to review our financial results in details.

Dror?.

Thanks Eitan, good day, everyone. In the second quarter of 2020, the company continued to perform well. The financial results met expectations and company guidance, despite the turbulent global economy environment caused by the COVID-19 pandemic.

Total revenues in the second quarter of 2020 were $62.6 million, 3% higher than the previous quarter and 22% higher than the second quarter of 2019. Product revenue distribution was approximately 70% from logic and foundry and approximately 30% from memory. Service revenues grew sequentially and came in at $15.5 million.

Geographically, product revenues were well distributed between the major semiconductor manufacturing territories with approximately 30% of product revenues generated from each of Taiwan, Korea and China. On a per customer basis, five major customers contributed 10% or more to the company product revenues, including two local Chinese manufacturers.

Blended gross margins, significantly increased sequentially by more than 220 basis points on both GAAP and non-GAAP basis and came in at 58% on a GAAP basis and 59% on a non-GAAP basis.

The increasing blended gross margins was attributable to improved product mix in the quarter, which led product gross margins to increase to 64%, while services gross margins remained at the higher than usual level of 44%. Operating expenses in the second quarter of 2020, totaled $26.3 million on a GAAP basis and $21.5 million on a non-GAAP basis.

G&A expenses in the second quarter on a GAAP basis included a one-time expense related to an incident in which a financial institution used by the company for certain financial transactions wired-out company found without company authorization.

These wire transfers were executed based on instruction given by a fraudster directly to the financial institution. Based on U.S. GAAP accounting rules, the company was required to provide a one-time expense for the related amounts in the second quarter financial results.

The company is taking appropriate measures with the relevant parties to fully recover the fraudulently transferred amount. The related amounts were adjusted for the presentation of non-GAAP financial results in the second quarter of 2020.

Operating margins in the second quarter of 2020 came in at 19% on a GAAP basis and increased to 25% on a non-GAAP basis. Effective tax rate in the quarter came in at approximately 19% on a GAAP basis. Earnings per share in the quarter were $0.30 per diluted share on a GAAP basis and $0.48 per diluted share on a non-GAAP basis.

Moving to the main balance sheet items. Trade accounts receivables reduced by approximately $11 million as a result of effective collection during the second quarter, and days sales out came in at 72 days.

As expected, the company recognized higher than usual inventory levels due to business continuity measures taken as a result of the COVID-19 pandemic.

We expect to continue to gradually increase the company's supply chain commitments and relate inventories in order to secure the production and delivery of products and services, as much as possible across different locations and territories throughout the year.

Inventories at the end of the second quarter accumulated to $56.6 million with inventory turns of 2 times a year. During the second quarter, the company generated $19.1 million of operating cash flow accumulating to $32.5 million of positive operating cash flow in the first half of 2020.

Pre-cash flow in the same period, the first half of 2020 was approximately $30 million representing a healthy free cash flow generation of 24% of total revenues.

As a result, overall cash reserves at the end of the second quarter accumulated to $218 million, a level which will enable the company to explore different business opportunities during the COVID-19 global pandemic crisis. Regarding the company outlook for the third quarter of 2020, we expect the following.

Revenues between $58 million to $66 million, GAAP earnings per share between $0.25 and $0.39, non-GAAP earnings per diluted share between $0.34 and $0.47 cents.

At the midpoint of the third quarter guidance, we expect the following, blender gross margins are expected to be approximately 58%, given the COVID-19 situation, the company continues to build backup resources across its global workforce. In parallel, we continue to focus on introducing and proliferating new products globally.

In that respect operating expenses are expected to be approximately $25 million on a GAAP basis and to increase to approximately $23 million on a non-GAAP basis. Most of these expense increase is expected in R&D expenses. Effective tax rates are expected to be similar to the second quarter of 2020. With that, I will turn the call back to Eitan.

Eitan?.

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

Thank you. [Operator Instructions] We will now take our first question from Charles Shi from Needham. Please go ahead, your line is open..

Hey, Eitan, congratulations on the nice results and solid guidance. I have a few questions, first off looking at Intel recently announced seven nanometer push out.

What is your view, the impact on your business especially any impact on the revenue ramp of the present product run?.

Thanks for the question. So regarding the big logic customers that we announced, I think that in our business model, the revenue perforation coming from this account will start this year and will it grow gradually next year, and we took into account that the 7 nanometer will start the investment – the real investment actually will start next year.

So it's embedded in our plans where we thought, and we planned that we'll have few systems going in this year and then more system going in next year when they start ramping up the 7 nanometer.

Although, they are one of the customers for this technology, we have other customers that are using the PRISM, we always say that there are multiple installations with these tools for standalone in both memory and logic. Therefore, we still expect multimillion revenues from this tool this year..

Okay. Thank you very much.

Any impact, I mean, for the same logic customer to push out of the RAM and impact on the new technology quantification? I know you got the new technologies that are being evaluated by multiple customers, but that does – this one project customer impact – are you still expecting some revenue recognition in second half this year?.

So as we said last quarter and we continue talking about the new technologies, we said that there are three things, right. We said that there is PRISM, which we just talked about.

And we said there are two more technologies that are being evaluated with leading customers, and they are evaluated in customers, which is different than this specific logic customer. So we don't see any disruptions into the acceptance process because of these delays.

Actually, if the fact will be proven true that the capacity of this logic customer going to another leading foundry, then we'll enjoy from that even more with the new technology next year..

Great. And then one last question from me.

Definitely, we saw that the foundry logic revenues, as the percentage is coming up, going into third quarter, do you – what is the general trend line here? Do you continue to see foundry and logic remain at a high level, like 70% plus-minus? Just the reason why I asked this is KLA yesterday apparently guided foundry logic systems revenue as a percentage will go up sequentially.

I wonder whether you guys seeing similar trends here? Thank you..

So, as we talked many time about the diversified portfolio we have, and the customer mix, which is balanced between memory and logic foundry, I think that what we saw in the last two quarter was starting with an even portfolio then because of the leading foundry that went into 7 nanometer, we started to see growing revenue from foundry.

And in the third quarter, we expect to see that we will have some foundry growth mainly from China, which will move the portfolio to be much more or more weighted into the foundry.

Nevertheless, when we’re looking on the fourth quarter, we’re starting to see that the mix is starting to be evenly distributed because of NAND recovery in the market and more orders coming from memory customers in Asia.

So we see that as – if you look at the end of the year, probably you will say that it will probably be at 160% foundry, 40% memory in 2020..

Thank you very much..

Thanks..

We will now take our next question from Jaeson Schmidt from Lake Street. Please go ahead, your line is open..

Hey guys. Thanks for taking my questions. Just want to make sure I heard correctly. I mean, you guys are still anticipating some supply chain disruptions in Q3.

And if that's the case, just curious if you could sort of ballpark or quantify what sort of headwinds do you think that is impacting this quarter?.

So I want to clarify Jaeson that we said that on the second quarter, where we had to secure our supply chain disruption, and therefore, we continue to ramp up our production lines, but we don't see any disruption beyond what we already saw in the last few months in the coming quarter. So we don't see it as an issue..

Okay. That's helpful. And then just to follow-up on service gross margin.

It remains very elevated here, is this sort of the level we should be thinking about going forward?.

So as you know, our model for service gross margins is 40% and above. I do believe that in the third quarter – gross margins for services trending a little bit down to the 40% level.

And, again, in order to balance between the need to have a very good service level to our customers in terms of availability of resources and headcount at customer sites and profitability, our model remains 40% and this is what you should expect looking forward..

Okay. Thanks a lot, guys..

Thank you..

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

Thank you very much and congrats on a nice quarter. Maybe following up on the services question, you guys posted some strong results in that business, given the COVID-19 environment.

What changes, how are you adjusting? Are you doing more remote type of “services” to help your customers out, given some of the restrictions that are still out there, given the strong revenues and the margin profile? What efforts have you taken there to continue the growth in that business segment?.

Patrick, thank you for the question and I think that there are two levels to this answer. The first level is that Nova during the last few years strengthened a lot to the independency of the local entities. So, we are very much independent on their capabilities to sell, service, market our equipment.

So in the regular mainstream products, we don't see an issue with this COVID-19, as we don't need to fly any way people to support these products. And the main centers in Korea, Taiwan, China, Japan are very strong entities.

On top of that, when we started the COVID, we strengthened even more the technical capabilities of this group with extra spare parts, extra people and things like that because we understood, it will take time until we'll come back to the regular flight mode.

So in that respect, we didn't – we are not worried and it's going according to our strategic plans and everything is okay.

We did see at the beginning – this is the second level, we did see at the beginning some disruptions to the new products and the new technology that we are providing to our customers because we have multiple evaluations with the new technologies and multiple evaluations with the PRISM and the new integrated, which required some support from the headquarters, either U.S.

or Israel. In that matter, we adopted everything that is needed in order to do remote. So even the customers are open up a bit more the IP restrictions in order to have remote access so everything that can be done remotely is been done remotely. Additionally to that, we adopted some standard of augmented reality capabilities.

So we have people in the headquarter sitting and have all these augmented reality to activate the system from remote. And it's been proven as a good interface with those systems. So we are going to adopt it in the future as well.

So beside the fact that we had to ramp up a bit different approach to the remote access we see right now that in the – going into the third quarter, we don't see almost any disruptions because of service capabilities, not to the existing install base and the existing tools installations, as well as the new technology evaluation..

Great. That's really helpful. Maybe as my follow-up question, your business in China also continues to increase and diversify and expand. You have both Memory and Foundry/Logic customers.

Maybe in the Foundry/Logic end, there's a higher mix in China right now, trailing-edge type of capabilities versus the leading-edge where you've made a lot of gains in other regions.

Can you maybe give a little bit of qualitative color in terms of the opportunities on the trailing-edge side, given that in China itself, the advanced technologies are somewhat limited to one player today?.

No, we didn't break down the Foundry/Logic segments into a trailing-edge and advanced node but I talked about it in my prepared remarks, where it can be understood that there is a major portion of the Foundry capacity and the contribution of revenue it is coming from trailing node.

And by the way, it's China with two to three major customers over there, that got boosted because of the trade war with the U.S. and it's coming also from the leading Foundry that invested also in this trailing nodes, mainly in 28.

So overall, when we look right now in the capacity of Foundry in the second quarter and it will go through the third quarter as well. We see a wide range of extensions coming from 28-nanometer all the way to 16, 14, and even seven and five. So it's a mixed range of capacity coming from Foundry.

Of course that the major capacity is led by Taiwan with the advanced nodes, but in the rest of the region, we see a mixed nodes coming from the trailing node. I can say that in the last few months, because of the political situation in the U.S.

coming into November, and also the trade war between the nation, we starting to see more investment in the Chinese local or domestic Foundry customers to start ramping even advanced nodes like 10 and 7-nanometers. So this is overall the mix of Foundry..

Great. That's very helpful. Thank you very much..

Thank you, Patrick..

[Operator Instructions] We will now take our next question from Mark Miller from The Benchmark Company. Please go ahead. Your line is open..

Taiwan Semiconductor announced that they were increasing their capital – CapEx budget by about $1 billion. They're also planning a new fab in Arizona. Are you starting to see increased traction there? I know that's always been a major customer.

Are some of these plans starting to show up in your orders?.

Yes. So we do see if we try to anticipate the end of the year of 2020, we do see a stronger year in this customer from what we previously expected. It's composed from investment in the trailing nodes, as I said, like 28 and 16 but also from elevated spending in the 7 and 5-nanometer. So we definitely see a stronger CapEx investment by this customer.

It's too early to look and understand what will happen in both the Arizona case, as well as the Intel comment about capacity. But yet, if we're looking on 2020 and 2021, we expect elevated use from these customers..

Great. Thank you. A lot of firms are starting to see some attraction from the ramp of 5G.

Do you see any evidence that 5G starting to impact your business in terms of opportunities?.

We definitely see that. Okay. So we see – we saw some hiccups in the first half when investment in the handsets that are driven for 5G as well as the ecosystems are delayed a bit.

But when we're looking right now on the mix of the results that we have for the second quarter as well as the prediction for the forecast for the third quarter or the second half, we do see more spending in the 5G both the ecosystem as well as the handset-driven 5G..

Thank you..

We will now move to our next question from Quinn Bolton from Needham & Co. Please go ahead. Your line is open..

Hi, guys. I apologize because I missed some of your prepared comments. But just wanted to ask on the competitive front, Onto Innovation announced new family, both stand-alone and integrated OCD system.

Just wondering competitively how do you see the Atlas V standing up to the PRISM tool? And then any comments on the competitive dynamics on the integrated metrology side would be great. Thank you..

Thank you, Quinn. So I'll try to – want to talk about it without getting into the complicated competition struggle.

But as I said, in my remarks, and I keep on saying it in every summary that I have, that we step aside from this rush competition on every nanometer of measurement and came with a full portfolio, which is innovative and differentiated from our competition. Actually, it's different from both competitors.

But if we're looking right now on our portfolio, the PRISM is totally different from their line of products is bringing SR plus interfor method into the game, which they don't have. In the integrated, we are bringing a multi-channel, which they have only single channel.

And if we're looking right now on the material world, we are looking on material metrology coming out from x-ray, which I think only us and KLA have for the metrology. So I think that looking specifically on this tool announcement, I don't see it competing with us at all..

Thank you, Eitan..

This concludes today's question-and-answer session. I would now like to hand the call back to Eitan Oppenhaim for any additional or closing remarks..

Thank you very much, operator and thank you all for joining our call today. We wish you all good health and please be safe. By that, we conclude our earnings conference call for the second quarter. Thank you..

Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect..