Onto Innovation Inc. (ONTO) Earnings Call Transcript & Summary

I think inspection is going to be the largest opportunity. By nature, it's almost always going to be the largest opportunity. But we are seeing metrology penetration. We are selling metrology tools. We also think there's going to be opportunities for some of our other tools in the space. So yes -- so when we come up with that SAM inspection will be, for sure, the highest opportunity. And that's reflected in the backlog we have now. The bulk is inspection, but also multiple customers adopting a couple of different metrology tools.

Got it. And there is a wide range of expectations on silicon photonics or CPO. Just curious to your $500 million number, what drives the upside or downside to that number?

I think the -- it's how quickly the technologies adopted at the server and then at the rack level between those 2. We're playing in both. So it's really -- I don't even think it's a question about if it happens. From what I've heard and what I've listened to in other executive forums from the NVIDIA's Broadcoms, AMDs, et cetera, they're committed to driving this forward. I think the hyperscalers are committed to it from a data center perspective. So it's just a matter of how quickly it gets adopted and ramped, the economics and the performance benefits are seeing everyone is convinced on that. So that would be the upside, downside or timing.

Understood. And if we stay in the specialty devices, I think silicon photonics is in part of that. But outside that, it has improved throughout the year. You are talking about photonics and also like power and silicon carbide demand beginning to show some signs of recovery. So how big is -- how big is data center power for Onto right now relatively to the -- traditionally, I was assuming it's more about auto and industrial power.

Yes. I think data center power is relatively small. But from the customers -- remember, we had a good run with the power semi. And then EV -- and even as EVs were slowing down, we were still growing quite nicely. And that was tied to driving yield improvements for those customers. We -- and then the expansions kind of slowed and their investment in the yield improvement. But now we're hearing from them that things are picking up and we need to prepare for this because of the data center power. So we're not seeing the actual orders. I don't have a good clarity on timing. But if they're already talking to us, I would say, 2027 into 2028, would be what they are thinking about.

So it could be kind of another leg of growth driver going into the next couple of years?

Yes. I don't know how big the magnitude of it yet, but it should definitely be -- and it would be captured under our specialty devices. But it will be -- we'll see. I mean, silicon power was pretty -- was on a tear for a while there. If the data centers and how big these data centers are that are being announced, could take quite a -- quite a bit of chips.

Yes. Understood. And on the panel-level packaging, we're getting here. So it it does receive a lot of industry attention, but adoption still appears to be relatively early. Where do you think the industry is right now for panel-level packaging?

I think it's an interesting market. So for enterprise servers, the adoption for advanced IC substrates was already very clear and the 2 big guys, Intel and AMD during the COVID explosions, they talked about being constrained by advanced IC substrates. And that's an area that the JetStep X500 and our Firefly play in. But then there was overcapacity, everything fell out, the whole story there. That has slowly come back and worked itself through. But now we're seeing the constraints in AI packaging or heterogeneous packaging, drive customers to look at panel packaging as an alternative. We also see as the adoption of heterogeneous packaging is kind of clear now. That's happening. Die are going to get bigger. I mean packages are going to get bigger. The economies of scale at the wafer level, just aren't going to work at the 310 by 310, they get better, but compared to 600 by 600 or 510 by 515, still much smaller. So these customers are looking at, all right, where can we drive some of this capacity to these other companies that have a mature process or, let's say, a proven process and can ramp right now. And that's what we're seeing in our business when we talked about it doubling and then growing again into 2027, that's now the accelerant we see. So it's -- and that part of the adoption you're right, is early, and I think that's going to continue over the next several years.

Understood. And you talked about you are addressing this panel level packaging market in 3 ways, like or 3 lines of products. So it could be a little bit early, but how should we think about the size of the opportunity in the next few years?

I forget what we've said publicly. I think we said it can be around $1 billion SAM, and our competitors have said even more. For us, that's going to include process -- basically inspection as well as the lithography. We're not going to get 100% of that SAM, they're our competitors. So could it be $200 million, $300 million? That would be a reasonable expectation over the next few years.

Understood. I'm going to take a pause here to see if any questions in the audience.

Do you see any headwinds at all to process control intensity going forward? Or is it pretty much up into the right in here?

Up into the right forever. In the near future, I don't see any headwinds. Demands are high. The industry is just driven by innovation, which drives complexity, which needs more process control. So I don't see any headwind other than when do things slow down. That's just a general industry comment. But as far as specific to process control, generally, it increases with the increase in complexity, and I don't think anyone believes that the semiconductor industry is going to get simpler in the future, it just always gets more complex. So process control intensity should always continue to increase. Yes. Actually, you're running the show, sorry.

Go ahead.

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Sorry, there was [indiscernible] there. I'm sorry.

Sorry. If you could just elaborate a little bit. You drew some parallels between the data center cycle that we're running right now and the [indiscernible] cycle as it relates to your business [indiscernible] but just can you elaborate on that a little bit and kind of where we are in those separate cycles and how they're so different [indiscernible] would be helpful.

So over the last several years, we saw really significant growth in the adoption of our process control, primarily inspection but also metrology for supporting our semiconductors and that wasn't driven because the market was going down. Capacity overall was coming down. So it wasn't driven by expansions from those customers. It was driven by the need to improved yield. Yields were in the 60, 70 range, not in the 90s like you typically expect. So they really used our tools to drive that yield improvement with the expectation they can drive higher output, right? So with higher -- but -- that recovery for the EVs hasn't really happened yet. But what customers are telling us now, those same customers is they're seeing demand from the data centers that's going to drive adoption of these power semiconductors. And so hopefully, that means another growth driver for them. And as they expand, they've already inserted our process control in the process, so we should benefit from that.

So can you just say more about your partnership with Kaku, I know you guys initiated a 27% stake. I think transactions have closed second time this year. Maybe just talk about that partnership and also the appetite by the entire company and just...

So we won't -- first, it's closed. So that's done deal. But we won't talk about appetite for what the future steps could be. Obviously, our history is not to make partial investments in companies, but we're not going to talk about what the next steps would be. That said, the partnership was strategic in that for us looking forward, and actually, this is a misunderstanding. So some investors thought this was because we saw OCD eventually running out of steam and x-ray becoming, let's say, the next step or the next thing. That's not what we see. What we're seeing is OCD, at least for us, we can continue to push OCD and serve the market for the foreseeable future. But as the world goes to more 3D, 3D transistors or 3D stacking of die or wafers, there are elements of the process between these layers that customers are interested in that optical can't solve. So x-ray is a potential solution, a potential way to see through these layers and provide information to the customers. Also our acoustics, our acoustic metrology, sound wave metrology is a very unique capability for that in the metal space. But it has limitations. And so the partnership with [ Rigaku ] we've started with 2 different customers. We went up against the leading player in x-ray, and we beat them at both customers. So the combination of our AI defract, our strong modeling engine, which is used in optical also and the very strong sensor capability, our x-ray capability from Rigaku makes a real compelling value proposition. That's one. The next is kind of this idea of a hybrid metrology. So the idea that the speed of optical and the precision from x-ray, but it's much slower, can combine to provide a more compelling value proposition for our customers. And the combination is made much simpler because the AI defract our software is aggregating all these data streams we're already modeling. So now we can model the aggregate instead of just one or the other. We'll see what I'm saying. So we get more information in the models. So that's another advantage to this partnership.

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Co-exist, right? So -- so, so far, we can push optical metrology to the extent that the road maps are that we see with our customers. So we're working with them on nodes that you're not aware of. So we're pushing the technology. As long as optical can make the measurement, it's the fastest way and the cheapest way to make the measurement. Customers will always choose optical. So that's one. But the limitation of opticals, it can't see through thick layers of metal, materials, et cetera. So there's gaps as the world goes more 3D. Now when it was a planar world, didn't matter, things got smaller and thinner and optical could see through. As things get stacked and they get thicker, then we need a new technology. We have acoustic metrology for part, but it's not a full solution. The x-ray can be a complementary solution in a world of 3D.

We have a few minutes left. I do want to ask about gross margin. So Q2, I think you did 57%, you talk about incremental 50 bps in the next couple of quarters. I guess, going forward, how much further can gross margin go? And is pricing in -- is a consideration in that?

So '26 has really benefited from the move to the extended factories. So all of the margin really that we've driven to date as well as what we expect to drive here in the second half of '26 has driven early operational productivity and efficiency. And that is the move of manufacturing from the U.S. over to these international factories over the course of the year. And we talked earlier that. A year ago this time, we were shipping our first tools from our international factories. And in Q2, we shipped about 70% of our tools, just a [indiscernible] rise up the curve there. As we move into '27, certainly, the benefits of the Dragonfly G5, right, having that highly accretive margin profile, some of these other products, Mike mentioned, the Atlas G6 is another, will give us some ASP lift, which will help us to continue alongside productivity, drive towards a margin that starts with the 6. So that's certainly still what we believe is that we can have a margin -- a gross margin profile that will start with 6. That then is dropping through at a higher rate to our operating margin. To date, we've driven 250 bps of gross margin. We've doubled that at the operating margin line. And with the growth in the business, it's allowing us to continue to invest in R&D and become more operationally efficient, but also then continue to drive more to the bottom line. So hopefully, we'll continue to see that operating margin expand at a faster rate than what our gross margin has been driving towards.

Is there any possibilities to reprice some of the existing products except from the new products are getting higher pricing and I get that point, but like for existing product portfolios.

Yes, certainly, I mean, it's not lost on anybody that the 2 major headwinds in '26 have really been focused around memory costs and probably freight, fuel, right, fuel shortage. So we've tried to help offset some of the fuel shortage by again being in region. That's been a helper for us. But as we go into kind of the '27 pricing season, if you will, budgeting season, certainly, some of those conversations are ongoing with customers around the existing product portfolio, too.

Got it. And to that point, people ask -- in this market is good. People ask about capacities, both Onto's perspective and also the supply chain perspective. So are you -- first of all, are you supply constraint? And second, do you see any supply bottlenecks?

I'd say 2 parts. So one is, again, the move to extended factories is really fortuitous timing because it allowed us to be able to have partners that can expand alongside of us and give us excess capacity in these new clean rooms without us having actually put out a lot of CapEx dollars, right? So that's been a big benefit for us. On the supply chain side, like anybody that says it's perfect is kidding you. But the reality is our operations team has done a really good job of kind of diving our way through the supply chain, using the incremental visibility that we see from customers and being able to, I think, get ahead. of where we see potential bottlenecks. Certainly, we're using our balance sheet a little bit. Our inventory balance has grown, but I think we're doing a good job of mitigating that risk. Never perfect, but overall, we're not missing customer dates and our lead times have really not grown too much.

All right. That's good to know. And we are out of time right now. So thanks, Mike and Brian, for coming to our conference.

Thank you very much.

Thanks for having us.