Onto Innovation Q1 2023 Earnings Call Transcript

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May 4, 2023

There are 7 speakers on the call.

Operator

Good day, and welcome to the ONTU Innovation First Quarter Earnings Release Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mike Schaeffer, Investor Relations. Please go ahead, sir.

Speaker 1

Thank you, Danielle, and good afternoon, everyone. Onto Innovation issued its 2023 Q1 financial results this afternoon shortly after the market closed. If you did not receive a copy of the release, Please refer to the company's website where a copy of the release is posted. Joining us on the call today are Michael Plisinski, Chief Executive Officer and Mark Slessor, Chief Financial Officer. I would like to remind you that the statements made by management on this call will contain forward looking statements within the meaning of the federal securities laws.

Speaker 1

Those statements are subject to a range of changes, risks and uncertainties that can cause actual results to vary materially. For more information regarding the risks That may affect ON2 Innovations results, I would encourage you to review our earnings release and our SEC filings. ON2 Innovations does not undertake obligation to update those forward looking statements in light of new information or future events. As a reminder, today's discussion of our Financial results will be presented on a non GAAP financial basis unless otherwise specified. A detailed reconciliation between GAAP and non GAAP results Can be found in today's earnings release.

Speaker 1

I'll now go ahead and turn the call over to our CEO, Mike Plisinski. Mike?

Speaker 2

Thank you, Mike. Good afternoon, everyone, and thank you for joining our call today. ON2 Innovation closed the Q1 with revenue of 199,000,000 near the midpoint of guidance, while earnings came in near the high end of guidance aided by gross margin favorably impacted by product mix. The primary shift in mix was an increase in revenue from higher margin Iris film systems and 2 lithography tools sliding into the 2nd quarter due to delays Following the growth of the last few years, we're increasing our focus on strategic supply chain initiatives and expanding our development engagements. We expect our investment in the supply chain to yield over $10,000,000 in cost synergies in 2024 with additional savings to follow.

Speaker 2

Expansion of our development engagements allows us to participate earlier in our customers' process development. This provides us more time and insight to deliver the comprehensive solutions required for R and D and ultimately migrated into volume production. In the quarter, we were honored to have been awarded by world leader TSMC with the Novel Technology Collaboration Award for our contributions last year to advance both front and back end process control. With over 60% of our 1st quarter revenue tied to new R and D or pilot line investments, we believe we're setting a strong foundation for future growth across several exciting markets. So let's start with the highlights from our Advanced Nodes customers.

Speaker 2

Advanced Logic revenue was essentially flat from the 4th quarter and represented 53 Percent of our advanced nodes revenue. Over 85% of our advanced logic system revenue was for applications below 5 nanometer. Our latest AI to frac software incorporates an exclusive modeling technique to enable earlier adoption of OCD and R and D lines. We now accurately compensate for the broader process shifts associated with R and D without frequent and time consuming model retraining. This allows our customers to leverage the speed of Atlas 3 d metrology earlier in process development, including sub-two nanometer structures years ahead of volume production.

Speaker 2

Not surprisingly, revenue from memory customers declined roughly 50% from the 4th quarter, in line with several publicly announced capacity reductions and expansion delays. In the quarter, our Iris Films metrology was successfully qualified by a second top 3 semiconductor manufacturer. These systems are now part of a volume purchase Agreement that we believe implies a jump from 0 to over 25% share of films metrology at this customer. The agreement also implies integrated metrology share of over 70% and of course includes our Chip Atlas OCD platform and our echo and element metrology systems for opaque films and materials applications. The VPA covers shipments in 2023 and is valued at over $90,000,000 adding some confidence to our current estimates for the year.

Speaker 2

This account demonstrates the importance of our strategy to our customers. By working together earlier in their development, we're able To provide a portfolio of technologies that deliver better dimensional and material metrology at speeds required by high volume production. Similar to our Advanced Nodes customers, we see an increase in R and D engagements for inspection of new chiplet packaging designs. These designs require inspection resolution at submicron levels in systems that must also provide a wide range of metrology for denser 3 d interconnects and through silicon vias needed for chip stacking. In the quarter, Dragonfly inspection was selected by a top 5 semiconductor manufacturer implementing new 2.5D packaging technology.

Speaker 2

A second top 5 manufacturers selected Dragonfly Inspection and EB-forty for system on integrated chips or SOIC for 3 d chip stacking applications. Revenue from power devices in the Q1 was up 20% over the prior year, And our portfolio of inspection technology and dimensional and films metrology convinced 18 customers in the quarter to purchase a new Onto Innovation Products for their process and several added combinations of 3 or more products. Several of these systems went to support the high growth gallium nitride and silicon carbide segments of the power market. In closing, we're happy to announce our 2nd demo center opened in January in Taiwan to facilitate customers' Access to our most advanced equipment. Over 10 packaging and specialty customers have already hand carried their next generation wafers to our facility to work with our experts and latest technology.

Speaker 2

With our new training systems in place, our training capacity has more than doubled And the course offerings have expanded significantly. This will allow us to cross train over 60% of our field service engineers On our most advanced equipment paving the way to more efficiently serve future growth. Our improved support infrastructure and productivity is leading to a Pickup in annual and multiyear service contracts. In the Q1, we had 5 new customers moving to recurring Support contracts. Renewal rates for existing recurring contracts exceeds 95%.

Speaker 2

In the future, we see the opportunity to increase the value of these support offerings by integrating smarter software solutions. And with that, I'll turn the call over to Mark to review our financial highlights.

Speaker 3

Thanks, Mike, and good afternoon, everyone. As Mike highlighted, we closed the Q1 with revenue of $199,000,000 down 17% over the same period last And just below the midpoint of our Q1 guidance range, while achieving an EPS of $0.92 which is $0.04 above the midpoint of our EPS guidance range of $0.80 to $0.95 The impact of the memory market being the biggest driver of this revenue decline after coming off our record setting 4th quarter year. Now moving on to the quarterly revenue by market. Advanced nodes revenue Of $66,000,000 declined 35% year over year and represents 33% of revenue. Specialty Device and Advanced Packaging Achieved $93,000,000 in revenue, declined 6% year over year and represents 47% of revenue.

Speaker 3

Software and services revenue of $40,200,000 was down 4% year over year and represents 20% of revenue. As Mike stated, we achieved 54% gross margin for the Q1, exceeding our guidance range of 51% to 53%, primarily from the shift of the 2 JetStep systems into the 2nd quarter due to delays from our supply chain. 1st quarter operating expenses were $58,000,000 down $3,000,000 quarter over quarter $3,000,000 above the high end of our guidance range. We exceeded the guidance range as we maintained a higher level investment in R and D to drive our strategic growth priorities as well as several cost reduction initiatives Didn't see the immediate drop through expected in Q1. However, we are still committed to delivering $25,000,000 to 30,000,000 Of cost reductions for the year.

Speaker 3

Our operating income of $49,000,000 was 25% of revenue for the Q1 compared to 31% from the prior year. Our net income for the Q1 was $45,000,000 or $0.92 per share, Down 30% over the same period last year and as previously mentioned, dollars 0.04 above the midpoint of our guidance range. Now moving on to the balance sheet. We ended the Q1 with cash and short term investments of $584,000,000 Up $36,000,000 from the start of the year with operating cash flow of $50,000,000 representing 25 percent of revenue. Inventory ended the quarter at $338,000,000 an increase of $14,000,000 since year end, primarily driven by the delay in the shipments to JetStep Systems as well as the continued receipt of parts to service our expanded installed base.

Speaker 3

As stated during our prior earnings call, A top priority for 2023 is to optimize our levels of inventory to return to mid-two hundred million dollars range by the end of 2023. Inflows of raw materials are declining as we have worked with suppliers to continue to burn off our existing inventory. This will continue to be recorded. This will contribute to our free cash flow returning to historical and consistent performance levels of over 20%. Accounts receivable decreased $32,000,000 to $210,000,000 in the quarter, and our days sales outstanding increased 9 days to 96 days.

Speaker 3

During the quarter, we repurchased an additional 46,000 shares of common stock, bringing our cumulative share repurchase To just over 1,000,000 shares under the current program or $68,000,000 return of capital to shareholders. We have $32,000,000 remaining under our existing $100,000,000 authorization. Now turning to our outlook for Q2. We currently expect revenue for the first quarter For the Q2 to be $203,000,000 plus or minus 4 percentage points. We expect gross margins will be between 50% to 52%, down versus Q1 due to the forecasted mix in the Q2, including a projected record 6 JetStep systems.

Speaker 3

For operating expenses, we expect to be between $58,000,000 to $60,000,000 For the full year 'twenty three, we expect our effective tax rate to be between 14% to 16%. We expect our diluted share count for Q2 to be approximately 49,200,000 shares. Based on these assumptions, we anticipate our non GAAP earnings to be between $0.75 per share to $0.90 per share. Looking ahead to the Q3, we expect to be back to 54% gross margin levels due to the improving contribution from our JetStep systems. We expect OpEx to be in the range of $55,000,000 to $56,000,000 as we move past the annual one time compensation elements in Q2 And see the full benefit of our cost reduction activities.

Speaker 3

Together, this will result in exceeding 1st quarter earnings levels. As I referenced in my earlier comments and highlighted during our February earnings call, we are reducing costs in the range of $25,000,000 to $30,000,000 Which includes driving further operational and supply chain efficiencies at our manufacturing sites, staff reductions and reduced discretionary costs. With these cost reductions predominantly permanent in nature, we expect to move back into our gross margin and operating profit metrics of the long term operating model when industry growth returns. And with that, I will turn it back over to Mike for additional insights into Q2 and the remainder of 2023. Mike?

Speaker 3

Thank you, Mark.

Speaker 2

As Mark just mentioned, we expect only a slight uptick from the Q1, reflecting the continued weakness in memory And weaker advanced logic spending projected in the 2nd quarter. Offsetting that weakness is strong demand from specialty customers in power, packaging And EUV Wafer Manufacturing. Collectively, we believe our specialty and advanced packaging markets Reached the bottom in the Q1 with solid growth into the 2nd quarter and incrementally stronger second half. Although we believe advanced nodes will bottom in the 2nd quarter, the rate of recovery remains uncertain. So even while revenue projections reflect Broader market challenges, we're very pleased with the progress we're making expanding into new accounts in new markets.

Speaker 2

We continue to grow our position in the planar films market. We're growing our layer share for leading edge logic and each quarter we see new submicron applications moving to our Dragonfly G3 platform including

Speaker 1

power applications in

Speaker 2

GaN and silicon carbide. Including power applications in GaN and silicon carbide. We expect these wins to position us well for outsized revenue growth When markets recover and our customers once again focus on ramping production to meet the growing demand for complex semiconductors. With that demand, combined with the initiatives to strengthen our financial model, we expect to be more we expect to more efficiently serve this projected growth, which should be reflected in higher margins and greater shareholder returns. I'll now turn the call over to Danielle for your questions.

Operator

Thank We'll take our first question from the line of Quinn Bolton with Needham and Company. Please go ahead. Your line is now open.

Speaker 4

Hey guys, thanks for letting me ask a question. Mike, I guess kind of going through the puts and takes in the business, understand the weak memory environment and Some pressure on the Advanced Foundry Logic in the Q2 that you mentioned. But you talked about a $90,000,000 contract, Talked about strength in specialty. I think the China and mature nodes businesses seem to be second half weighted For the industry in whole. And I guess I'm wondering, do you guys see a stronger second half relative to the first half?

Speaker 2

Relative to the first half, yes, but I wouldn't say we're Expecting a massive snapback in the second half.

Speaker 4

Okay. But modest half over half growth Consistent with your expectations.

Speaker 2

Yes. And as I mentioned, the advanced logic, the advanced nodes continue to be the most, So let's say the where the recovery is the furthest out, but we do see our at least our specialty and advanced packaging markets Growing fairly nicely in the second quarter and maintaining that rate of growth or at least strong growth Right through the second half. So that's really going to carry the strength of the growth we see in the second half.

Speaker 4

Got it. Thank you for that. And then I guess a question, it looks like you guys continue to see strength or Share gains in the planar films segment with the Iris tool. I think last year you said you generated about $50,000,000 of revenue. As you looked at 2023, how do you see Iris and what's the outlook there?

Speaker 4

Do you think you can continue to make share gains In 2023 with that solution?

Speaker 2

Yes, we definitely do. I mean that was the exciting part of The highlight I made for the Q1, having Iris qualified by another top 3 semiconductor manufacturer. We had one before and we had several other smaller customers. Now we have another one. And we have, as we mentioned in the 4th quarter, Evaluations at nearly all of the top 5 semiconductor manufacturers now.

Speaker 2

So momentum is building, the value proposition is being proven, And I think that momentum will carry forward this year in revenue growth, certainly Double digits, fairly strong double digits. And then once the industry really recovers and we see Broad based expansions, those 2 of the record positions we win are going to have much longer or bigger tails, a broader Impact on our revenue.

Speaker 4

Got it. And then just a quick one for Mark. As you look to the Q3, you mentioned gross margin coming back to the range of roughly 54%. Should we assume that you're back to sort of a more normalized run rate of 4 litho JetStep X500 systems At in the Q3? Yes.

Speaker 3

Yes. Quinn, that's a good assumption. Yes. I would say that that's consistent with what we're seeing.

Speaker 2

And also just to add to that, we did say in the past that we were working through the Cost reduction of the margin improvements in litho throughout this year with the Q4 being sort of reaching our target model. And so we'll see the benefit of that as well as we move into the second half, not just a realized number, but also better margins on those tools.

Speaker 4

Excellent. Thank you.

Operator

We'll take our next question from the line of Craig Ellis with B. Riley Securities. Please go ahead. Your line is now open.

Speaker 5

Yes. Thanks for taking the questions. And I'll start with one for you, Mike, and just make it high level. So In the past, you've often characterized your expected performance versus industry as either in line or outgrowing and often outgrowing. But As you look at this year and acknowledging we've got some pretty significant crosscurrents, where do you think the business shakes out versus industry growth?

Speaker 2

Where does the industry growth end up? I've seen A lot of different numbers right now on where industry growth shakes out. I think we're comfortable with The guidance we've provided, we don't see any deterioration to that. We're working hard to actually drive some upside to that previous Guidance. So you see the emphasis we have on the power semiconductors, some of the 2.5 and 3 d Packaging Technologies, we're engaged in, which are coming online.

Speaker 2

The IC or the panel packaging Business with the litho and then bringing in process control or introducing process control into those markets as well. So where the spend is, we have more to offer those customers. And so from our perspective, Our thesis for why we were going to outperform remains the we've talked about the films also adding some upside growth. So if you look for us, wherever you look at the market, we've said down 20%, and We're expecting or at least we're fighting to be above that.

Speaker 5

Got it. That's real helpful. And then Mark, I wanted to Dig in deeper on where we stand with $25,000,000 to $30,000,000 in cost savings. How much of the $25,000,000 to $30,000,000 is comprehended in the color that you provided for operating expense to be back at $55,000,000 in the Q3 and what does that leave for the Q4? Because it doesn't seem like we really captured anything in the first So I want to understand how we're progressing and when we realize the full benefit of that.

Speaker 3

Yes. No, I mean, we did capture Sure, Sam. And when you look at our run rate coming off of Q4, we're in the low $60,000,000 $61 range of OpEx. So we did have some reductions, Certainly not where we want it to be for Q1. I think just coming off the strong year end and pivoting into the drop, I mean, we're certainly trying to capture that.

Speaker 3

We will see some of it in Q2, but again, we have the spike in the annual kind of compensation elements that Historically, we've always hit in Q2. And then we'll see I think we'll see the bigger benefit in Q3 and Q4. And that's why we're confident that we're back into that $55,000,000 range of operating expense, which It's certainly lower than as you'd expect to our 2022 run rates where we were topping out at we're at the 60% to 62% range.

Speaker 5

So are you saying that you think we've gotten perhaps a third of it now through the second quarter, but with some of The second quarter is really not visible because of the annual expense increases that you have. Yes. If you look at The remaining 2 thirds in 3 in 4Q?

Speaker 3

Correct. Yes. That would be

Speaker 2

And then you said

Speaker 5

some of it would be Some of it would be structural. So how much of the savings that we're seeing is structural and how much of it is just more temporal? Thanks, Mark.

Speaker 3

Yes. I mean, I'd say majority of it is permanent. I mean, that's what we're striving for, obviously, As we want to see when the growth comes back, so we want to be able to drive that leverage. I mean, there obviously is some variable spend as you'd expect Items like sales commissions and things like that to come down. But again, we're aiming to make those structural changes long term.

Speaker 3

And I wouldn't consider this cutting variable spend that's going to come back up the second we see that growth. It's going to We managed to the point where we're going to get back into the model of an expense profile that has that contribution, that drop Through that, we want to get as far as the model dictates. So, to answer your question, predominantly, as I said, Taking those out and then keeping those costs out and managing the other variable spend to the degree we can.

Speaker 5

Got it. Thanks, guys.

Speaker 3

Thanks, Craig.

Operator

We'll take our next question from the line of Advani Schroeder with Jefferies. Please go ahead. Your line is now open.

Speaker 6

Hi. Thanks for taking my question. So I think in the last quarter, you had quantified about $70,000,000 coming from 3 opportunities. The bigger piece of it was JetStep in 2023 and then the next two pieces were NovusEdge And the panel portion of it, has this $70,000,000 changed? Could you just give some puts and takes?

Speaker 6

Like do you expect To see more from JetStep or NovaEdge or the panel piece of it.

Speaker 2

I think power, not panel, JetStep is part of the panel piece. So that is pretty well Established, so we're

Speaker 6

I'm sorry, I meant the same piece of it then. Yes.

Speaker 2

The planar films. Yes. So planar films, we definitely, as we sort of alluded to, we see Some growth there, some upside there. We expect to exceed or meet or exceed our targets there. Power, we're definitely going to exceed our targets They are based on what we're seeing also from the adoption we talked about in the call on the Q1, 18 new customers Selecting one of our products in the portfolio and our intent and expectation is we can sell them additional products in the As they realize the benefits of a suite of products tied together by our Discover Enterprise software platform.

Speaker 2

So that momentum is, I think, building nicely. And then the other piece you mentioned was the NovusEdge. There, we're also Constrained by manufacturing, which we're trying to speed up or release that constraint, but the That is at least going to maintain the guidance I provided, I think roughly $70,000,000 $80,000,000 If not exceed, if we can release some more product, customers will take it.

Operator

There are no further questions at this time. Mr. Schafer, I'll turn the call back to you for any additional closing remarks.

Speaker 1

Thanks, Danielle. Just a quick reminder for everybody about 3 upcoming events. First, ONTU Management will be participating at the B. Riley Conference in LA on May 24. And second, we will be hosting our analyst event at the New York Stock Exchange on June 1.

Speaker 1

And third, we're participating at the Stifel Conference in Boston on June 6. Thanks again everybody for joining us Today, a replay of the call is going to be available on our website about 7:30 Eastern Time this evening. We'd like to thank you for your continued interest in ON2 Innovation. Danielle, please conclude the call.

Operator

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

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