Nova Ltd. (NVMI) Earnings Call Transcript & Summary

Good morning, good afternoon and good evening. Thank you so much for joining us this morning. I'm Vivek Arya. I cover semiconductors and semi-cap equipment at BofA Securities Research here in New York. And I'm so delighted to have Mr. Dror David, the CFO of Nova Measurement (sic) [Nova Measuring Instruments], joined us this morning to share his insights about Nova, but also just the broader industry, where we are in the cycle. And then focus on the long-term secular trends that Nova is benefiting from. So really warm welcome to you, Dror. Really appreciate you taking the time to join us. And I think it will be very useful to perhaps give a quick overview of Nova for many investors who might not be as familiar with the history of Nova and your very specific differentiated position in the industry.

Yes. Hi, Vivek, and thanks for hosting us. Hi, everyone. My name is Dror David. I'm the CFO. I've been with the company for a long time. I've been the CFO in the last more or less 10 years. Nova is actually a company which operates in the process control segment. We are selling metrology to the semiconductor manufacturers. In the last few years, the company has made a significant trajectory in terms of its position in the market, the number of products, the diversity of customers, geographies and technologies. And we have been able to grow to around -- to more than $500 million actually in the Q2, for the first time. We announced the Nova 500 plan probably 3 years ago, and were able to execute it only recently. One of the caveats, which is important to note about Nova is the fact that we are operating in a segment which is outgrowing the industry. The reason -- in process control as a whole, the reason is that the complexity of the technology transitions, new materials, new dimensions, new transistors, new structures creates much more demand for our tools and more measurement steps in the industry. And the combination, I think, of being in the right segment, being able to win market share within the segment on innovation, bringing new growth engines to the story, including acquisitions of new technologies and companies enables the company to continuously outgrow the market in recent years.

Perfect. Thank you, Dror. So Dror, we will come to the long-term secular dynamics for Nova soon. I just wanted to quickly get your insights into some of the near term cyclical dynamics. We saw Micron warn for the second time this quarter, right? We had the warning from NVIDIA yesterday. So it's clear we are going through a cyclical correction in the industry. But at the same time, we also have the secular trend of rising complexity. We have perhaps greater spending stimulus because of the EU or the U.S. CHIPS Act, et cetera. What kind of demand signals are you seeing from your customers for the next 3 to 4 quarters? What is better or worse than what you thought the situation might be 6 or 9 months ago?

Yes. So first of all, I think the Micron announcement is very interesting, not because of the announcement itself and more by how you interpret it because the memory segment obviously goes through a correction every, more or less, 2 years. And the question is the situation right now with Micron and memory as a whole, because the rest will follow, is that something which is specific to the memory cyclicality or is related to something which is more fundamental in the demand or the macroeconomics and so forth. And at least based on the customer plans that we see from the big guys like TSMC and others, all the projects which are going on in China, the bookings levels that we have, the backlog levels that we are at right now, which extend well into '23. The analysis of the announcements by other significant wafer fab equipment players such as ASML which had, I think bookings in the last quarter were almost 50% to 80% higher than their quarterly revenue. So I think the -- this is very interesting times where it's -- on one hand, you see specific customer announcements like Micron and the memory -- specifically in the memory segment creating a different environment in terms of the expectation for growth and investment. But on the other hand, it's clear that all the capital equipment suppliers cannot actually meet the demand as it is right now and until the end of '22. And I think what this means is that if this correction in memory is specific to this segment and assuming the plans for 2022 are intact with some spill off to '23, we are still in a healthy environment where wafer fab equipment is growing in '22, and we'll continue to grow in '23. And obviously, the good companies which can outperform the market will continue to do well.

Got it. Absolutely. I think to that point, we saw TSMC, they lowered their CapEx this year from $44 billion to $40 billion, I think Intel reduced their net CapEx. We heard from GlobalFoundries earlier. But like you said, I think the biggest reason for that, especially on the foundry logic side has been the limited availability of tools. So maybe talk to us about what is restricting supply in terms of tools for the foundry logic customers? And when do you hope to catch up on the demand forecast that you have from these customers?

Yes. That's also interesting from analyzing on the specific level rather than the overall level because at the end of the day, ASML with their lithography tools, they are marking and I would say generally dictating the pace in which fabs are built. And the fact that ASML announced that they had probably around 10% of their revenues spilling off to '23 would probably have this impact on TSMC. I think the good thing is that despite this environment, we at Nova continue to see good results also in Q3. We expect ASML, for example, is expecting growth of 10%. In 2022, we expect probably more than 30% is the current models if you analyze our expectation for Q3 and all other aspects. So generally, I would say that we do not see how the general demand for equipment is being answered in 2022. Definitely, customers want more in '22. But the industry just can't end supply. So this will move into '23 and create, I would say, a more healthier environment in terms of the balance between the 2 years. And one important note about Nova is the fact that actually the -- in some cases, the metrology equipment is being taken very early in the process, specifically for new fabs or new technologies where the yield is expected to be low and you need to do more measurements and the initiation of the fab. This is true for China. It's true for pilot lines of 3-nanometer next year of TSMC. So all these elements together would have an impact on next year. And I think that, again, the combination of level of backlogs that the industry and the wafer fab equipment players are having today, and the fact that at least 10% of ASML demand is moving to next year is creating a situation of, I would say, over demand steel and equipment at least in the next 2, 3 quarters.

Got it. So Dror, if I were to put you on the spot to try and make a call on next year's WFE. So like this year is shaking out probably somewhere in the low to mid 90s billion, that's the expectation that it's not the $100 billion that people were thinking of even though it seemed like unconstrained demand is probably in that range. So if this year is low to mid-90s just based on conceptual trends, I'm not asking you to make a call on Nova per se, what's your early sense on what we could see in '23 from a trend perspective?

So we currently expect growth under the assumption that memory will continue to invest lower, but will continue to invest and continued expansion of wafer fab equipment in the Foundry and Logic segments which we need to remember, we have all the initiations of the U.S. fabs by probably 3, 4 customers are going to be initiated and ignited next year mainly. And this bill of investment by TSMC will move to next year. So overall, we expect growth in wafer fab equipment next year. From this point in time, it's probably at the lower range of single-digit growth. So let's say, around 5%, we are not there yet to model more than that. But I think with all these things, the backlogs and the spill of ASML, 10% to next year, is a good indication that we could see growth also next year, which is actually averaging the expected growth for '22 over 2 years' period.

Got it. Now you mentioned that your growth is significantly higher than the 10% or so WFE growth, right? And I would even go as far as to say, that's not a 1-year phenomena, right? Nova has been consistently outgrowing the WFE market. Why is that? Is it because you think that you have been taking share? Or do you think it's because process control intensity, demand for metrology has been secularly growing faster than just broader WFE?

So I think this is a major I would say point regarding Nova, and we have been working in the last years very hard to really extend the diversification of the company across segments, customers, geographies, China, U.S. and also new growth engines. Now if we analyze the outperformance of Nova, it's related to a few, I would say, levers which are on top of each other and creating some kind of a ripple effect which creates the situation that we continue to significantly outgrow. And if I try to pinpoint the main caveats of that. So first of all, we are in the right segment, okay? The segment of metrology and the tools and technologies that we supply are in the -- are really helping the customers with their technology transitions to the new technologies and structures what our customers are doing, and this is clear in order to move to nanosheets or gate-all-around. The whole structure is being changed. The materials which are used are being changed, and the company is specializing and measuring these features. Therefore, the demand and the measurement steps in each technology evolution is growing, and we see more business as a segment. And this is true for us and everyone which is playing in the metrology segment, dimensions and materials metrology. And on the other hand, we have been able to develop in the last 3, 4 years, new products for the core markets that we serve, both optical and x-ray. And these products are able to win market share against the competition because we added specific features or capabilities which the competition does not have. And these capabilities are able to measure applications, which are new because of the technology transition, and we are able to gain market share based on that. On the other hand, we did invest a lot because of the margin profile of the company, which is high, we were able to invest a lot also in new technologies. So we have products like METRION and ELIPSON, which are really growth engines, we just started selling in the last 1.5 years. So the combination of all these elements together creates a situation where the company can significantly outperform. And also, obviously, we are acquisitive. We acquired a company in January of '22. It's already impacting revenues as we speak. And it's another addition of revenues to the company in our performance. In that aspect, we are also putting emphasis in buying companies where the combination with Nova creates synergy in terms of cross-selling and top line. Specifically for ancosys, it was more sales in the front end where they were not present with the sales force of Nova. So I think all of these elements together, growth, organic growth engines, with the new technologies, market share gains, the right segment, acquisition really creates a situation where the company outperform and outperform over time.

Got it. And you alluded to the next topic that I was going to turn to, which is of M&A. You mentioned you closed the acquisition of ancosys. So maybe give us a sense for what it adds to Nova, how complementary is it, how much is it expanding your addressable market? And Nova is generating very strong free cash flow. Do you see enough targets to help you kind of consistently keep active on the M&A side?

So regarding ancosys, ancosys is ending for Nova chemical metrology capability. So whereas Nova is measuring all the features on the wafer as it's been manufactured, actually, ancosys is doing a new thing, which is measuring the liquid as it flows into the process. Now in the new technology nodes, it's becoming very important, this metrology because any change in this liquid can create a significant loss of yield to the customers. And we have seen several events in recent years where customers had a major recall activities, customers like TSMC or Kioxia in Japan because of a problem in the liquids, which flew into the process. So we expect the usage of this metrology to grow in the coming years. And I think the beauty of Nova acquiring ancosys is with the fact that ancosys was mainly active in the back end. And Nova has a full approach to all the front-end customers. And ancosys has just started in the last 2 years selling to front-end customers. And the combination with Nova can really accelerate this process, and we hope to see benefit from this combination already in the second half of '22 and moving into '23. Obviously, the big customers, Intel, Samsung or even TSMC, have problems to engage with a very small company, working in Germany, which they need to depend on. And now the combination of Nova puts this concern aside, and we can really -- I think ancosys can really proliferate its technologies more widely across the industry. So that's regarding ancosys. In terms of cash flow, it is true, Nova -- we finished the Nova 500 plan with approximately $500 million in cash as of today. So it is true that we are aspiring to be -- to acquire more companies. Obviously, in the semiconductor business, there are not hundreds or tens of companies out there. But we are monitoring all companies which are selling equipment to the industry. And the reason we are not, I would say, serial buyers is less because there are no targets out there, which, again, it's not 50 companies. But because we really want to buy companies at the right time, and obviously at the right price at the time where we can add something to the equation in terms of using the sales force or the technology depth that Nova has. In the aspect of ancosys, it was their -- as an example, it was their proof that their technology is useful for the front-end market. So as this was done, I moved in and purchased the company. And we are tracking these companies all the time, and we do expect to continue to be acquisitive in the future.

Got it. I wanted next, Dror, to touch upon the topic of China. So first, from the perspective of China as a customer, both in terms of their domestic requirements and then also the multinationals operating in China, how do you see that demand? Do you think that demand tends to be more volatile because there is always the concern of restrictions? Or does Nova not get affected by any U.S. restrictions?

So I would say the following. First of all, in the last few years, China was obviously heavily investing in semiconductors, and it was growing to 20% to 25% of our annual revenues. So China is significant. It is stable. It is fluctuating over quarters, but on an annual basis it's at least 20% of our business. The company is positioned very well in China because of many reasons including this trade war with U.S. companies. I think that generally speaking, the restrictions by the U.S. on equipment suppliers to China did not really have a significant impact as of today. The reason is, first of all, Chinese are not going down more than 14 nanometer. They don't have the technology and the capabilities. So it's less impacted by this restriction. And the second, the number of companies which were actually restricted is very small. The only one which could -- which had an impact is SMIC. And also there -- as the company is not going below 14-nanometer, the government is also already issuing some licenses to sell from the U.S. We also have the U.S. activity, which is in the Silicon Valley. This is the x-ray division. So we also have a license to sell some of the equipment. So generally, I think this environment of the trade or did not have a significant effect on the investments in China and maybe even a little bit accelerated it, right, in order to do it as fast as possible.

Got it. Were you surprised, Dror, to hear about the media reports about SMIC somehow being able to fabricate a 7-nanometer chip? I don't know what the yields are or what the volumes, et cetera, are so time will tell. But was -- did that come as a surprise to the industry, do you think?