Nova Ltd. (NVMI) Earnings Call Transcript & Summary

Good morning, good afternoon, everyone. Welcome to Day 2 of Citi 2021 Virtual Global Technology Conference. It's my pleasure to welcome Nova, formerly known as Nova Measuring Instruments to our conference this year. We have Dror David, CFO of Nova. Welcome, Dror.

Hi, Atif. Thanks for hosting.

The format of our discussion today is fireside chat. I will kick it off with my questions. And then audience, if you have any questions for Nova, click in the window on your screen and type in your question, and we'll ask those questions towards the end of the session.

Dror, I'm going to start a question on your full year outlook. You're expecting $390 million sales for the year with an upside scenario to $400 million or 50% year-over-year growth, outperforming the broader process diagnostics control and wafer fab equipment market again this year. What's driving the above-average strength in your Dimensional Metrology products this year? And can it outgrow WFE again next year?

So when we look at the core markets of Nova, for optical CD and XPS, I think that, first of all, as we previously said, we are working in a niche, which is outgrowing wafer fab equipment as a whole. So the demand for metrology products of the store that we are supplying is growing more than the industry, given the move to new technology nodes and the number of measurement steps that need to be done when you move forward with the technology node. That's one thing. And within these core markets and niche, there are 2 distinct, I think, vectors, which are positively impacting our ability to even accelerate further our business performance in these core markets. The first one is the introduction of new products such as the Nova PRISM, which allow us within the optical CD market, where there is obviously competitive environment to increase our market share, and penetrate new customers with this new and unique product of the Nova PRISM. This has been going in the last 2 years. We just announced another penetration like that only yesterday. So that's on the optical CD market. On the X-ray XPS market, what is actually happening is that we are crossing some kind of a threshold below 7-nanometer, where the adoption of this technology is becoming more extensive in the large customers, and we see more and more applications moving into inline production monitoring. And this means that the usage of the XPS technology, which is unique for Nova, is significantly increasing as a result of the move to the new technology nodes. So both these elements together, the market share gains in the core optical CD market and the accelerated adoption of the XPS is creating a situation where we can outgrow, I think, both wafer fab equipment and also our specific competition within these core markets.

Great. Just on that topic on the design win with PRISM. I was getting quite a few inquiries yesterday. Can you give us a little bit more background? I think when most investors think of Nova to think of a much stronger logic/foundry position for your products, given your exposure to Taiwan Foundry and -- but on the memory side, what's driving the adoption of Nova for 3D devices, which have been around for quite a few years now. So what's changing on the kind of the layer architecture on 3D NAND, which is driving design wins?

Yes. So first of all, this is -- this announcement is the third customer penetration announcement that we did for optical CD stand-alone in the last probably 18 months or so. So this is the third one. So evidently, the Nova PRISM product, which is a new technology, it does create a momentum and new capabilities for the company to solve applications, which are unique in the market. It is true that one of the main targets or usages for these technologies within the VNAND market as you know, the VNAND applications or structure is very, very deep with high aspect ratio. And this new channel of information that we have with the PRISM product enables to make measurements in this specific high aspect ratio structures, which is not, I would say, visible or capable with traditional optical CD metrology tools. So this is why you see some of the announcements are being around specific VNAND applications.

Okay. Dror, you hosted an Investor Day in mid-July and talked about differentiated and broad X-ray and optical technologies for materials. I get asked frequently, what is the unique -- what is unique about your products and your technology versus some of your larger competitors?

So I think that, first of all, Nova started to measure materials already in 2015 with the acquisition of ReVera and with the product of XPS and there is a situation in -- I think in Nova today, where we have unique expertise, both in optical CD, including all the elements of software-related to it, the modeling and so forth. And very high end unique x-ray capabilities for materials measurements, which were bought and integrated with the acquisition of ReVera. What the company is doing today is combining all these elements together in order to create a new, I would say, step function and new technologies and introduce them into the market, which combine both optical and software capabilities with x-ray and materials measurement expertise. That practically, this combination is unique to Nova with the combination of both of these companies between 2015 and 2018. The results of this combination and know-how is few new products or technologies, which we are introducing into the market as we speak. One of them is the Nova ELIPSON, which was introduced to the market and the investor community at the end of last year. The second is a new technology, which we hope to announce by the end of this year, also resulting from a combination of know-how between dimensional measurements and materials measurements. And I think that, hopefully, by the end of this year, Nova would have 3 distinct technologies which are aimed for materials measurements. One is the XPS, the second is the ELIPSON, and hopefully, a new one, which we will announce by the end of this year. And this creates, based on our understanding and leadership, position in the materials measurement market, which is significantly growing as a result of the complexity of usage of materials in the new applications like gate-all-around, nanosheets and other applications. And I would say that in all these specific technologies, the XPS, the ELIPSON, which is using Raman technology and hopefully, the new technology that we will announce, Nova is actually the only company offering these technologies for in-line semiconductor metrology. So this position is, first of all, very strong. Second of all, very promising in terms of increasing and expanding the addressable market and growing the revenues from these products in the coming years.

Great. Dror, supply constraints is a hot topic in semiconductor supply chain these days. And are you supply-constrained currently, what are the equipment lead times for you? And you've announced a new clean room building coming online in mid next year. What kind of revenue capacity will you be capable of exiting next year?

So first of all, the supply constraints, in general, have started more or less 1 year ago when the COVID-19 was already half a year or 1 year into the process. We, as a company, have taken all measures actually already at the beginning of last year to ensure our supply chain. You can see this -- the implications of these decisions and actions in our inventories. We have significantly expanded our lead times with -- in buying patterns, I would say, with our suppliers in order to secure the supply of our products. I believe that we have already secured our supply chain through the end of 2021, at least and also into the first quarter of 2022. We also supported some of our suppliers in this process. We are in constant connection also with the second layer of our supply chain in order to ensure that everything is intact and can be delivered on time. We never had in the last 2 years, any, I would say, significant disruption to the supply chain where we needed to stop the manufacturing or something like that, the same as you hear from the automotive companies or something like that. We continue to do so and we are working and manufacturing, not necessarily only to orders in order to make sure that we have the sufficient backup for any increase in demand. In terms of the manufacturing clean room, the current capacity that we are working at is around 80% for our full capacity. So we are able to increase revenues also at the current state before we have the new clean room by approximately 20%, 25% when needed. The new clean room is an investment of approximately $10 million to $15 million investment throughout 2022. It will be available for manufacturing at the second half of 2022, and it will increase our capacity by approximately 30%, 40%. This is obviously an investment for the next 7, 10 years. It needs to embed not only the capabilities of increasing the capacity for the existing products, but the facility needs to accommodate also our capability to manufacture the new technologies, which, in some cases, require specific adaptation of new capabilities in manufacturing. So we expect these capabilities and the new clean room to be operational in the second half of 2022.

Great. Dror, equipment makers like Nova are clear beneficiaries of U.S. CHIPS Act and government-sponsored foundry spending, given 2/3 of your sales are exposed towards foundry logic. Currently, some investors fear that the equipment makers have benefited from a consolidation in semiconductors, leading to lower volatility in spending over the last few years and the emergence of new foundries and IDM 2.4 models could reverse all that. How do foundries sustain suspending and don't cause an oversupply down the road?

I think first of all, the -- we need to differentiate between trailing edge and leading edge. In the leading edge, given the investment required to facilitate 7-nanometer or 5-nanometer or 3-nanometer and even below technology node manufacturing site. These things are being decided and executed in a very thoughtful manner, where given the large investment, it's -- and the difficulty to create a manufacturing process for this technology node, it's unlikely that we would have overcapacity in these areas. Obviously, the only companies which are capable of doing these investments are TSMC, Samsung, and Intel. All 3 of them are planning to make such investments in the coming years in the U.S., as you mentioned. I would say that these are more financial decisions of the companies were to execute these fabs. It's related to government incentives and so forth. These are not related to the question of let's open a fab because we have the cash. So I think that in terms of the high-end technology nodes, there is less likelihood for overcapacity. We are actually very excited by these plans for new fabs by these 3 players in the U.S. in the coming years. Again, because we have a strong position in foundry and also because I would say that Nova significantly improved its position and product portfolio towards the investments in these high-end technology nodes with the new technologies and the Nova PRISM, actually, one of these customers, which is planning, this investment in the U.S. was not a customer of Nova 3 years ago, and this will be its first major expansion, which we hope to enjoy now that we penetrated this customer in the recent couple of years. In terms of the level of investment, as you know, in foundry, in general, as you know, TSMC has announced a $100 million investment plan over 2021 to 2023. They are going to invest approximately $30 billion in 2021. The investment -- they invested $15 billion, which is half of that in the first half of 2021. TSMC normally executes their plan and this means that actually in 2022 and 2023, we should see a $70 billion investment by TSMC in these 2 years, which is more than 2021. As you know, TSMC is our largest customer. So generally, I would say our expectation is that foundry investments will continue to grow definitely in the high end in the coming years. In terms of trailing edge, obviously, we have China, where most of the investment is going to. China did grow in the first half of 2021, especially for Nova, it was 30% of our revenues in the second quarter. We expect that on an annual basis, China with its trailing edge investments will be approximately 25%, 20% to 25% of our revenues, which is a reasonable level relative to the overall wafer fab equipment and China investments.

Great. Let's stick with the foundry topic. Some of the foundries, like you mentioned, TSMC, they have talked about asking for pricing discounts from the equipment and material makers to lower CapEx burden and gross margin headwinds. I understand these customers are always asking for pricing discounts to their suppliers. Is there something unique going on in the supply chain? And is there risk to equipment gross margins from pricing discounts and the pressure from these customers? Or you can just -- in the past is to back to them or lower to your suppliers?

So obviously, this is a complex environment, especially where in the areas where there is a competitive environment, for example, in the optical CD. This is always the case where equipment where our large customers are pushing the suppliers for 2 things. One is competitive pricing and the second is performance. I think that this environment will continue. Obviously, it is always, I would say, accelerating in terms of the discussions with the customers. On the other hand, we need to understand that there are 2 counter factors to this environment. The first one is the fact that the volumes are significantly increasing, right? So there are efficiencies happening together with this increasing volumes and so this is one thing. And the second thing is that this push for performance from the customers, given the new applications, the new technology nodes, creates a situation where, especially at Nova, we bring into the market, additional product value almost every year to almost every core product platform that we set. And once you bring value, the discussion is obviously moving to a different area. I think that the current environment, where we have all these elements working together, we have the new portfolio, we have the new technologies. Volume is increasing. We are winning market share. And on the other hand, there is this constant push for cost effectiveness in terms of the customers. This environment is, I would say, reasonable. It enables, on one hand, to give discounts to the customers and being competitive given the volume is increasing. And on the other hand, enables the company to introduce new capabilities where the customers are willing to pay the extra premium in order to make sure they have the best technology that they need.

Great. And on the topic of lagging edge foundry investments, you're clearly better positioned than some of your U.S. peers with respect to China as you have manufacturing facilities out of Israel and U.S. So you can ship to China without restrictions. In terms of the profile of the Chinese foundry investments, what end markets are -- is the spending going into? If you can talk about how much is memory, how much is lagging edge? And is there a risk that the investments that are growing this year is likely due to few of U.S.-China trade tensions and some kind of oversupply being built in China.

So first of all, in recent years, most of the investments in China have went to foundry. The U.S.-China tension I think in general, at least right now, were focused on specific companies. There are only 2 manufacturers out of these 20 manufacturers in China, which was impacted by this tension, which is SMIC and JHICC, which is a very small customer. So it's not across the industry of China manufacturing. It's very specific. Obviously, we don't know how things will develop, but this is the situation right now. Where it meets Nova is the fact that I think, given this export ban on SMIC, which happened in the end of last year, all China manufacturers understand that they need to develop a second vendor or qualify additional vendor on top of what's available in the U.S., and they are doing that gradually, both in foundry and also in memory. This creates some opportunities for Nova, obviously, because the optical, at least the optical CD section of our business is being manufactured and the intellectual properties in Israel. So we can ship without -- these restrictions are not impacting our ability to ship these products to China. In terms of the Chinese investments, again, when I look at the level of Chinese investments over 2020 and 2021, it is, I would say, rather stable. It was around 20% of our revenues in the last 2 years, 2019 and 2020. It is expected to grow a little bit, probably 23%, 25%, we'll see by the end of this year in 2021. So we don't really see I would say, excessive investment in China, which deemed to be -- is overcapacity. Most of this investment, by the way, is mainly by the local Chinese players. It's less by the international players, which will hopefully happen only next year. So China is remaining, I think, stable over the years. And the reason that Nova has more, I think, exposure or success in China or increase this year is not -- is related to market share gains and what you discussed about the tensions between the U.S. and China.

Great. Dror, your stand-alone product sales were a record in the June quarter. What are the key drivers of your stand-alone product sales versus the in-line metrology products?

So in -- as you know, approximately 2.5 years ago, we announced the Nova PRISM, which has a new channel of information, which is unique to Nova. This channel of information enables the company to see and measure things which are not measurable by the traditional optical CD techniques, which we have, but -- and also the competition. I think that the main driver for the increase in optical CD stand-alone is this specific capability, which enables the company to penetrate new customers, as I mentioned, we already announced the third penetration as a result of this technology to a customer, which did not use Nova optical CD stand-alone before the announcement of Nova PRISM. So again, the main driver for this growth is these penetrations.

Great. And then the software sales were 10% of overall sales in the June quarter. Can you talk about the Nova fleet deep learning software suite and how it adds value to your customers? We hear from Applied Materials, KLA, ASML talk about machine learning in PDC area. Can you share your thoughts on how will the use of machine learning lead to improved device fields for the fab managers in the future.

So there are 2 -- the 2 main platforms that we are using software products is the Fleet Management, which is actually a tool which enables you to manage the whole fleet inside the fab of Nova products from a concentrated place. This is very important for foundries where you have many products flowing through the fab and you need to change recipes and change specs of the systems and the process again and again through the manufacturing process. So that's one product platform that we have. We also use it to monitor the health of the tools and the maintenance and so forth. This is really enabling the customer to improve its ability to control the fleet, the fleet to increase the availability of the tools and reduce maintenance and actually increase the yield of the fab through that. The second platform is the modeling platform, which you mentioned, these are very sophisticated algorithms, which are laying on machine learning capabilities and also artificial intelligence. This is correlated. This capability is correlated to what I discussed before regarding the, for example, the Nova PRISM because if you think about it, now that Nova added a new channel of information to an already extensive information that we get from the wafer once you do the measurement in the traditional optical CD for many angles of incident, there is exponential information coming from the wafer once you do the measurement. And the only way to do these measurements very effectively, very accurately, very fast, is to use these machine learning capabilities in order to choose the right channels to relate to and to differentiate between the most important information and less relevant in order to do the measurement, again, very accurately and very fast. We have already embedded these capabilities into the systems a few years ago. And the combination of the Nova PRISM with the traditional optical CD arena, again, creates a lot of information, which you need to digest and analyze very fast. And these tools, modeling tools enables us to do that through the measurement process with the Nova PRISM and obviously, other optical CD tools. The situation today is that these machine learning capabilities also enables to predict measurements, as Eitan mentioned on the call, and really changed the way that you relate to metrology throughout the fleet of Nova products. And as a result, we see higher adoption of these capabilities across the installed base and also across the new fleet, which is going to high-end technology nodes. The software sales today for Nova is probably approximately 7% to 8% of the annual revenues, at least historically. It was higher than that in the last quarter, and we hope to increase that to the 10% level from overall revenues.

Okay. Great. I'm going to take 2 questions from the audience, and then I'll come back to my questions. The first question is, does your Nova PRISM design win at the memory maker, help you get to the $400 million revenue number for the full year?

So I can't relate specifically to this success. What I can say is when we discussed the upside for the $390 million to go beyond $400 million, the main gap between these 2 numbers is evaluations, which are going on either with the Nova PRISM, its penetration to new customer or the new technologies, either mid buys or the new technology, which we did not announce, where the finalization of these processes is taking -- is, I would say, hard to predict. Will it happen within this year or the next year and any announcement and success in this aspect of concluding successful evaluation is promoting us to, I would say, accommodate and execute this upside.

Great. And the next one is, any changes in DRAM spending plan given elevated inventories and prices are peaking?

So we don't see a change or delay in DRAM investments recently, but it will obviously have an impact on the appetite of these players to significantly increase investments, which is long awaited, right? But we don't see, I would say, change of plans from these customers from where we were, let's say, 3 or 6-week or 6 months ago.

Okay. Dror, your Nova 500 model is targeting $500 million organic sales exiting 2024 and $1 EPS on a quarterly run rate. What are the key assumptions you're making for the overall equipment market and your market share and the margins to hit this target?

So obviously, Nova has a very clear financial model. This model is aimed to capture, I think, combination of elements in our, I would say, multiyear secular growth story. The first one is robust gross margins with the existence of new technologies at high end -- for high-end applications with high ASP and high gross margins. And the second one is high investment in R&D, which enable us to create the next cycle of growth and the new and invest in new products, which can create the new growth engines for the company. The combination of these elements is bringing us to robust gross operating margins of between 26% to 29%. As a model, obviously, in 2021, at least the first half, we were higher than that level, even around 30%. The reason is that the steep growth in revenues where which happened very fast. Our model is that we will be between these 26% to 29% in this $500 million model. It is worth noting that if for some reason, the market growth or the adoption of the new technologies or market share gains, which are happening faster than expected or stronger than expected, we would move to the level of higher revenues. Obviously, operating margins, the same as 2021 could be higher.

Great. And on the capital allocation plans, how should we think about M&A appetite in faster-growing areas like back end packaging and other areas. So just thoughts on your capital allocation plan.

So as you know, Nova has approximately $500 million in cash. Some of that is from convertible debt, which is due in 2025 of $200 million. Most of this cash is planned to be allocated for M&A. The areas of interest for Nova is obviously back end packaging, advanced packaging, chemical metrology and I would say, emerging memory metrology applications. We are working on that very diligently and trying to find the right candidates for acquisition. We want to buy businesses and not necessarily technology, which can contribute for -- to the revenues and the business from day 1. And we are looking for deals, which can be accretive within a short time after the acquisition.

Sounds good, Dror. We're almost out of time. I want to thank you for attending the Citi Conference.

Yes, thanks for hosting us, and thanks, everyone, for joining.