Nova Ltd. (NVMI) Earnings Call Transcript & Summary

Good afternoon. Welcome to day 2 of Citi Global TMT Conference. My name is Atif Malik. I cover U.S. semiconductors, semiconductor equipment and networking equipment stocks here at Citi. It's my pleasure to welcome Gaby Waisman, CEO; and Guy Kizner, CFO from Nova. The format of our discussion is fireside chat. I'll go with my questions first, then open it up to the audience questions. If you have a question, please raise your hand and the mic will come to you. Welcome, guys.

Thank you so much for having us.

Gaby, before I start diving into the nitty-gritties of WFE and your products and HBM and whatnot, I want to give you an opportunity to maybe educate some of the audience here and the people at webcast. The reason we like your stock is because you are like the Swiss Army knife of all the secular trends happening in the sector. You have a lot of similar appeal as the large-cap equipment makers, very diversified. But I'd like to ask you to maybe just spend a few minutes kind of explaining what Nova does, your end markets and your customer exposure and all that.

Sure. So Nova has three divisions. Within those divisions, we're doing both dimensional metrology, material metrology and chemical metrology. Within the dimensional metrology, we have 2 key product lines. It's the integrated metrology that Nova pioneered the work way back and is mounted on top of the process tool, providing key advantages because of the fact that it's basically no queue time and you can do before or after process control. We have standalone OCD, which is mostly used in the etch critical dimension measurements. We have a unique portfolio of material metrology solutions, both on the material composition as well as depth profiling and stress, strain and crystallinity. And we have chemical metrology solutions for both packaging as well as front-end or copper dual damascene. So that's covering a broad range of measuring and providing analytics of the electroplating path.

Great. And then just on kind of the competitive landscape, KLA is kind of the big PDC equipment maker. Can you help us understand the markets you compete? Who are your competitors and your market position in those markets?

So I'll start with the fact that over the last year, we've moved to the second place in optical metrology market share overall after KT. But in terms of our competition landscape, it varies between dimensional, material and chemical. On the dimensional side on the integrated metrology, we are competing against Onto Innovation. And overall, we have about 70% market share. On the standalone OCD, we're competing with both KT and Onto. We are the smallest player, but the fastest growing. And on the material metrology, we have a sole-source position with a very unique portfolio. On the chemical metrology side, we are competing with KT.

Great. And just in terms of the end markets exposure, you're mostly exposed on the leading-edge product cycles. Can you kind of help us understand what percentage of sales are on the leading edge versus trailing edge? And how much memory, how much logic?

So in terms of the last year, we have a balance between trailing-edge nodes and leading-edge nodes. In terms of our exposure to logic versus memory, in the first quarter of this year, we had about 25% to memory. It went a bit down in the second quarter. But overall, I expect about 25% memory to 75% logic, whereas our long-term model calls for about 60-40, logic versus memory, simply because of the higher metrology intensity in logic. We've also ventured into the back end into advanced packaging or packaging as a whole. And right now, we are growing, I would say, our exposure to that market from about 10% to 15%.

Great. And Gaby, can you talk about your outlook for this year? You saw some strength from gate-all-around in your second quarter results, and you talked about acceleration moving forward. Just give us an overview on how you see the second half shaping. And also, if you can touch on Intel CapEx implications, investors have been asking about it. Have you seen any impact? Or this is mostly a zero-sum game for equipment makers, where the spending will eventually get shifted to a different foundry?

Gate-all-around is a major inflection point in the industry. Every 2 years, you have a new type of technology, in this case, we have gate-all-around, which requires additional process steps, introduces new material complexity and calls for technology -- specific technology in order to address the metrology challenges that it introduces. And that's the case with gate-all-around. We are well exposed to all 4 gate-all-around players. We see an increment of about 30% in the process steps required for metrology in gate-all-around. And we've mentioned the fact that we see an accumulated revenue of about $500 million by the end of '26 born over from gate-all-around. In terms of the business, we already see some initial business coming from gate-all-around. But obviously, this is very preliminary. We believe that that's going to be more material as we move towards 2025 and onwards. And in terms of your question with regards to Intel, our position with Intel is essentially on the leading edge front. Intel is very much focused on their 5-node 4-year plan, and we are working very closely with them in that respect. So we believe that the impact on their strategy moving forward, specifically for leading-edge nodes, would be very marginal.

Great. And just on the gate all-around topic, at SEMICON West, you guys shared with us a number, 30% increase in intensity of metrology steps. And if you can just maybe kind of double-click on that intensity number? And point out what products are benefiting from the rising intensity around the transistor architecture?

So the additional complexity results from the transistor architecture, but it also boils down to additional steps required for the super power rail or for the backside power delivery. No matter how you call it, both the complexity of the gate itself with the nanosheet formation as well as those additional steps required for the super power rail are driving this metrology intensity. It's mostly focused around dimensional and material. There is some trickling down to the chemical because of the additional shrinkage or additional budget, let's say, reduction in metrology budget also for that. But mostly, what we see is the need for better performance and additional capabilities around dimensional and material metrology solutions.

Great. And I'm going to give this one to Guy and still around services. With increasing installed base and we see equipment makers' services sales continue to grow at anywhere from 10% to 15% growth rate across your peers, will your services revenue growth be similar to your peers? Or are there similarities or differences to their products? And if you can just talk about the impact of that to your gross margins or profitability?

So our gross -- our service business, we're looking on that, [ 5,900 ] tools that installed in the field and measuring wafers as we speak. This installed base creates revenue coming from the contract time and material and value-added services. So when we are looking on our long term, our growth for the service is 10% year-over-year.

And then you believe it's fairly sustainable as long as installed base keeps on growing?

Yes. Based on our strategic plan of reaching $1 billion, this is part of our strategic goal. In terms of contribution of margins, so the service gross margin is between -- around 45% for us. On EBITDA, it's more or less the same as product. The R&D investment is less intense there.

All right. And are there elements of like software upgrades, features like that, to the services business that makes it extra sticky for customers?

Sure. So when we're looking on the value-added services component is when we bring new capabilities to existing installed base, and this is what's driving the additional growth.

Gaby, let's talk about advanced packaging. It's -- the new phrase is the back end is the new front end, and everyone wants a piece of this back-end market and you yourself are staying in this market. Can you help us understand, on the AI packaging side, HBM, how are you participating in that market growth? And then what products are benefiting from that?

So we have a strong position in the advanced packaging through our chemical metrology division, and that's been growing phenomenally for us over the last year. But we've added another very important component to the mix, which is the dimensional metrology. Within the dimensional metrology, we have identified the need for integrated metrology early on, then we've customized this tool to address specific requirements of advanced packaging and essentially positioned our integrated metrology tools in that market. Now it's important to note that we're in the infant stages of adopting integrated metrology into advanced packaging. We are reaching an inflection point in that respect in which the performance requirements in polishing, additional requirements specific to high-bandwidth memory, and of course, hybrid bonding, et cetera, calls for the need to have an initial attach rate of integrated metrology tools on board polishers. And that's going to grow. So we already have that business. We believe it's going to grow twofold. One, because of the higher attach rate going forward, the evolution of high-bandwidth memory, 3, 3E, 4, et cetera. Similarly, on the logic advanced packaging architectures and the capacity, which is going to grow. So both axis of higher attach rate and the capacity are going to drive that business. In addition, we have developed a very unique capability, tapping on the spectral interferometry hardware that we have as part of the stand-alone OCD solution, coupled with the very strong software modeling and machine learning in order to address specific applications around through-silicon via and others, in which we have a better performance and an attractive cost of ownership to our customers. So we are displacing other technologies in order to introduce stand-alone OCD and increase our market share over there. It's a new market for us, which we're very pleased in having. So both dimensional and chemical are contributing to our advanced packaging and packaging position. My expectation is that we'll also see material metrology becoming relevant for advanced packaging in the coming few years. And that's going to add to the mix and cover our entire portfolio, let's say, most of our portfolio in going into the advanced packaging space.

Great. And Gaby, we had KLA here yesterday and Onto this morning. And KLA's case is that they have very high-end tools and back end. There's a need for those high-end tools. And Onto, on the opposite side, that is coming from an incumbency position, where they're saying, you do not need to spend large ASP numbers on these tools. These tools are overbuilt. But you need to focus more on the, I guess, the surface topology of the micro-bumps and all that. So I wanted to give you a chance in terms of explaining to us, is back end really very different kind of area than front end, requirements are very different? And will incumbency be an advantage in that market for newcomers like yourself or even KLA? What is different about back end that will kind of help the leaders on the front end succeed?

So first of all, I'll say that the perspective of Onto, KT and us is probably different. And Onto's business, for example, is very focused on inspection, whereas we are coming from a...

Integrated.

CD metrology space. And KT is obviously covering a broad space of area over there. In our case, what really helps are 2 components. One is the close relationship with those customers. I mean, those customers, and that's what helps, I guess, the incumbents, are front-end customers. So when we're introducing those solutions to advanced packaging, they obviously have the reference and experience working with us on the front end, which works in our favor. In addition, once you introduce -- and that's true for both packaging and for front-end. Once you introduce an appealing technology that offers better time to solution, better performance and definitely a better cost of ownership, you have an opportunity. And we are tapping on that opportunity in order to position ourselves in a growing market in which we didn't have presence before.

Let's move on and talk about another hot topic to investors, hybrid bonding. And Citi wrote a [ TIC ] report on this, and we think this is as big of an inflection as EUV lithography was for the front end. Just curious on your thoughts about the timing of the adoption of hybrid bonding and what does your opportunity look like?

So the opportunity in hybrid bonding is significant in the sense that we are seeing our dimensional metrology portfolio well positioned for hybrid bonding as well as the chemical metrology one. But definitely, the dimensional metrology offers a great opportunity. Time line-wise, I mean, it depends on our customers, of course, in terms of the adoption rate. But we are seeing the good position that we have and being able to serve those customers as the primary objective and our first and foremost focus. So we are positioned well with the different players that are targeting hybrid bonding. We see the unique capabilities of our tools in order to address some of the challenges that hybrid bonding introduces. And luckily for us, there are some challenges that we can solve. And I think that one of the advantages that we have is developing the trust with those customers and being the go-to supplier, go-to partner in order to deeply understand what the challenges are and being flexible enough to be able to develop fast enough the solutions to address those challenges. And I believe that we've developed these intimate relationships in order to help us both drive that part of the business as well as look into the future challenges that hybrid bonding or additional challenges may bring in order to make sure that we have the right technological answer to address those challenges going forward.

And Gaby, on that point of partnerships and close collaboration with your customers, I believe one of the reasons you guys acquired ancosys in your chemical metrology was to leverage some of the synergies. Like have you guys seen that work? Like the revenue synergies from chemical metrology translating itself to other areas?

I will start by saying that we've more than doubled the revenue from chemical metrology since we acquired ancosys, and it's been a very successful acquisition for us. And when we decided on the acquisition, we definitely identified synergies in a few areas. One is, of course, tapping into packaging where we establish presence, relationships, acquaintance through the acquisition. But on the flip side, we were able to establish the go-to-market into the front end and position those chemical metrology tools in front end, whereby Nova's position was stronger. So we capitalize on both sides. So moving or being able to tap into packaging with our other divisions, while taking the chemical metrology and position it also in the front end in order to gain market share versus our competition, so that synergy works well. In addition, and this is important in synergy, we can port some of the other core competencies that we have, for example, in software into chemical -- into the chemical metrology world. Tapping into some of the core technologies in which we have deep domain expertise to understand how these could be relevant and how these could address some of the future chemical metrology challenges that we are seeing down the road. So all those synergies combined have resulted both in more than doubling the revenue as well as opening up additional opportunities for us going forward.

Great. And then Guy, staying on the M&A topic, you have more than $750 million cash on the balance sheet. And you've been talking about -- you've been doing, I would say, tuck-in M&A acquisitions for a few years. What are the areas that you think are still important to you, maybe on the back end where you can look into future M&A? And will M&A remain kind of a core approach to add inorganic growth?

Yes. So as part of the strategic goal that we introduced in 2022 of reaching $1 billion by 2027, about 15% to 20% coming -- should come from the inorganic growth. When we are looking on the inorganic strategy, we are -- we have very strict financial criteria what kind of inorganic companies we want to engage. So the first criteria is need to be accretive with deal up to 12 months after acquisition. It needs to be a fit to our financial target model. And it's -- we need to identify specific synergies in terms of the company. And only by then, we are engaging with the company. Given said that, it's practically saying that we need to target the process control in the semiconductor area, and this is our focus. We are not limiting ourselves in any space in that area, but this is our go-to for that.

And just on that comment, some of your peers are -- they've done acquisitions outside process control into process equipment, whether they wanted it or not. But it came with it, whether it's KLA or even Onto, through lithography and laser. There's a mixed bag of things that they're doing. So I'm very curious to know like do you think there is an advantage of having some process know-how if you're kind of tapping integrated metrology on it or inspection on it? Like is it important for a PDC company to know what the process is? Or you think being neutral is the best approach?

I think that bringing real synergies, you need to know the market. And this is why we are targeting the semiconductor specific area. Obviously, we are not limiting ourselves if they have a strong presence in the semiconductors. But on top of it, other exposure to other sectors, we are not dismissing it. But it needs to have a strong semiconductor presence.

I would probably add to that, that having intimacy with future process challenges is essential. It's instrumental. You definitely need to develop a way to deeply understand the metrology constraints that are derived out of process-related challenges. The question you're asking is whether or not it makes sense to own a process company in order to improve your understanding. And I'm not 100% sure that, that's the case. Having that understanding is instrumental, it's imperative, but it's not necessarily that you need to own such a process company in order to develop that intimacy.

Very clear. All right. Let's talk about China. If you can kind of remind us what percentage of sales are exposed to China? And what kind of demand trends are you seeing in China?

So last year, we had about 36% of our business coming out of China. We have good visibility to the business in China this year, and we already have a backlog for next year. We have a relative strong position in China. And we believe that China is committed to continuing and developing its industry in order to address the strategic goal of having 70% of their domestic needs being addressed by local semi manufacturers. So we believe that the China business will continue going forward. Ratio-wise, the investment on leading-edge nodes, it's obviously going to reduce the portion of China out of the business. But nominally, I believe that it should stay where it is today.

Okay. Now we've been talk about the end market NAND, which has been fairly dormant for a few, I would say, couple of years now. Can you share with us what are your expectations in terms of a recovery for NAND spending?

So NAND is expected to resume WFE growth next year. The latest number I've been seeing is about 64% growth in WFE for NAND next year. Obviously, it's coming from a relatively low point. So it's a high growth but still coming out of a trough. So we do expect some NAND recovery next year, probably skewed toward the second half. We still see some growth in DRAM. But obviously, in a much slower pace than the NAND, but DRAM is already part -- a significant part of the business. So the growth should accelerate next year, probably starting the first half.

Look, the only piece you did not give is foundry logic. So if you can talk about the strength that you expect for next year for foundry logic?

So I would start by saying that overall WFE is expected to be between high single digit to low double digit as a whole. Logic foundry out of it is around, let's say, 10% growth next year, whereas most of the growth is going to come from leading-edge nodes, and we are going to see some decline on the trailing-edge nodes. And probably to complete the piece of the puzzle, advanced packaging is expected to grow packaging -- advanced packaging is expected to grow about 17%.

Very helpful. Let me pause here and see if there are any questions in the audience.

I want to ask about the materials metrology. You guys have a very, very strong position there. And I was just curious, how big is the market and like why you are so strong? Like is there any emerging competitors in that area?

So I'll start with talking about the TAM of, let's say, the new material solutions that we are developing as an indication of the importance of material metrology to Nova. So the new material metrology solution TAM, and I'm relating specifically to the in-line SIMS and the Raman-based tools, was about $200 million last year, and it's going to grow to about $300 million in 2027. It's an attractive market for us, not necessarily so for other players. And we've been investing over the last few years in order to have a unique technology offering, tapping on a lab-to-fab strategy, meaning we are taking lab technologies and bringing it into the fab. And this is similarly to what we've done with XPS over the last 15 years or so. What we are seeing is the advantage of taking those solutions in fab and improving on the efficacy of the fab, they are understanding of the process and definitely on -- eventually on the yield. And I'll give you a few examples of that. Take SIMS, for example. Today, that lab tool requires you to take a wafer out of production, break it into coupons, manually analyze it with a SIMS tool in the lab. It takes you few days or more to send the information back to the fab. And by that time, you downstream thousands of wafers and you don't have this information fast enough in order to deduct activities that need to be done during the production line. We're cutting that time to minutes and hours, doing it automatically, sending this analyzed information directly into the host and being able to downstream the wafer, all providing better returns and better ability of the fab to really understand the process when it happens, what needs to be fixed, and being able to look at different points of the wafer or different dies on the wafer, rather than just having a singular point. This is required, I would say, more when you're moving into advanced nodes. But we already have 4 customers using that tool and will relate, of course, to where we are, specifically with this tool later on. But what we are seeing is the appeal of that strategy of moving from lab to fab, and it's true for XPS, for Raman and for SIMS. We do believe that we have a unique technology and position by investing for such a long time in developing the solutions, and we definitely expect to continue and drive that business for us in years to come.

Maybe one more on the packaging side. Are you seeing the panel-level packaging getting increasingly more adopted? And just your thoughts on the adoption of glass substrates and use of photonics in the future. Like are you working on products? Are you hearing from your customers? Is there pull for these sorts of things?

There is interest in the panel-level packaging. There is interest, of course, in going into glass substrates. And obviously, we're monitoring the requirement and the need. And should it be needed, we'll modify our tools in order to serve those markets as well.

Okay. And then Guy, on the gross margins, they were high in the first half of the year. And you're expecting it to normalize in the second half and reach the high end of the 57% to 59% range, according to the target model. How should we think about this target model in the long term? Can you go higher? What drives them higher? And is it just a function of mix? Or is there some element of cost and scaling involved?

So in the first half of the year, we had an elevated gross margin by having favorable product mix and manufacturing efficiency, and it's above the target model. We finished with 61% in the first half. In the second half of the year, we anticipate a normalization in the gross margin as the product mix shifts. And by the end of this year, we will finish at gross margin of 59%. This is the high end of our model. Looking at the long term, so we believe that 57% to 59% gross margin range is a solid one. It reflects the current business dynamics. Given said that, we do believe that there is an opportunity to push the gross margin beyond that. But it mainly depends on our ability to introduce new technologies and unique solutions, as we explained before. So this is the main drivers to accomplish there.

And then in the operating expenses, how do you think about that if you want to outperform WFE every year by at least [ 5 ] points or more? But how do you think about investing? And what -- and how do you kind of prioritize the areas?

So if you will look on our investment, we invest around 16% of our revenues in R&D. And this is very high percentage-wise, if you will look on the peers and the competition. And we believe this is what driving the ability of us to outperform the business, to double our revenue every 5 years, and actually to present the business plan that we are presenting. So we believe this is our ability to do that, and this is the main driver. And we will continue to doing that in order to tell the next story beyond the 2027 target plan that we have.

All right. And then the last question, we asked this to Onto and others as well, it was on consolidation. I mean, do you expect -- do you see a need for further consolidation, particularly in the process diagnostics control area, where we still have multiple equipment suppliers? Or you would think their differentiations are good enough for them to remain as separate entities and it will become more of an antitrust issue if those companies get together?

So we are definitely on the acquisition path. So we are looking at deploying most of the cash we have, more than $750 million, to acquire different companies. And we believe there is a -- there are companies out there that fit our model. So we are definitely looking at integrating one or more of those companies into our business. I'm not sure that on a macro level, there is a need to consolidate that market. But on our level, on the Nova side, on the Nova perspective, there's definitely a logic, sense in combining forces with other companies for a win-win solution.

And then one other one I forgot, a client was asking about this was -- as we look into the adoption of high NA in the future, generally, optical inspection companies, metrology companies, the benefit whenever there's a wavelength change in the market because of the dimensions. And so it should be a positive change for you, guys. But FinFET is a device type, which I presume, is maybe using less EUV, but you guys can benefit more on. So do you expect the PDC trends to kind of separate itself from the lithography trend for the next couple of years as gate-all-around ramps and then kind of sync in with the adoption of high NA as that comes along?

So it's difficult for me to relate to the litho side of the business. It's less of my expertise. What I can say is that the adoption of high NA is a result of the need to further shrink the size, follow the Moore's Law, and being able to address some of the challenges that the semi industry has and, of course, coping with their customer requirements for power, for performance, et cetera. Every such adoption, every metrology budget, which is reducing or shrinking, every material -- new material introduction that adds complexity to the process is driving our business. Such complexity is where we thrive. We are working very close with our customers in order to further understand their needs in that respect. And our challenge is obviously to have the right technology to answer those challenges when it comes. And high NA is definitely driving some of those complexities moving forward.

Great. We're almost out of time. Gaby and Guy, thank you for coming to the Citi Conference.

Thank you.

Thank you very much.