Nova Ltd.

Good day and welcome to NOVA's first quarter 2021 results. Today's conference is being recorded. At this time, I would like to turn the conference over to Mary Segal of MSIOR. Please go ahead.

Thank you, Operator, and good day to everybody. I would like to welcome all of you to NOVA's first quarter 2021 financial results conference call. With us on the line today are Mr. Eitan Oppenheim, President and CEO, and Mr. Dror David, CFO. Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements, and the safe harbor statement outlined in today's earnings release also pertains to this call. If you have not received a copy of the release, please view it in the investor relations section of the company's website. Eitan will begin the call with a business update, followed by a drawer with an overview of the financials. We will then open the call for the question and answer session. I'll now hand over the call to Mr. Eitan Oppenheim, NOVA's president and CEO. Eitan, please go ahead.

Thank you, Miri, and thank you all for joining our first quarter financial results conference call. I will start the call today by speaking about our first quarter results and performance highlights. Following my commentary, Dror will review the quarter's financial results in detail and will conclude with the guidance for the second quarter of 2021. NOVA continues to perform well in the first quarter of the year, delivering outstanding results and exceeding both our revenue and profitability guidance. The growth in our business momentum, as reflected in our financial results, is driven by our entire product portfolio across markets, customers, and technology nodes. Our revenue grew 38% year-over-year to a record high, while our non-GAAP net profit grew at 52% year-over-year to a record level as well. During this remarkable quarter, we also achieved record bookings and operating cash flow. The solid growth momentum this quarter and the outstanding performance we demonstrated along the last year could be accomplished only by consistently executing our strategic roadmap while creating greater agility in our operational models. The flexibility we have built into our operating model combined with the investment we have made to secure our supply chain during COVID-19 enabled us to ramp up our production capacity by more than 30% to meet on-time delivery in this surging market. Our differentiated portfolio, honed by our commitment to innovation, continues to amplify our position with leading customers, as we address their challenging technical transitions to new generations of semiconductors, which combine innovative complex architectures with new novel materials. Our achievements this quarter mark another successful milestone in our healthy growth trajectory for this year, as we expand our market presence and deploy our new leading-edge technologies. NOVA's diverse revenue across multiple device segments is a result of the growing demand at the end markets for the electronics, which continues shaping the growing demand at the semiconductor fabrication supply chain. The main catalysts are driven by the growing digitization of multiple industries and include improvements in data management, network infrastructure, and broader usage of AI in different markets. In addition to pure demand for silicon, and in order to support these dynamic changes, the complexity embedded in building next-generation technology nodes requires a breed of innovative products, specifically in process control, to support the development and fabrication of new advanced memory and logic devices. Furthermore, in addition to these current demand factors, customers are more focused on growing their investment by optimizing productivity and diversifying their investment across multiple regions. When combined, these elements of accelerated technology transition, increasing complexity in new advanced nodes, and new investment in geographical distribution drive strong healthy WFC standing in 2021 and beyond. In this favorable environment, Nova is well positioned to capture more opportunities with its dimensional and materials unique process control solutions. Zooming into our quarterly achievements, I would like to highlight several business and technology milestones, which will also impact the rest of the year. This quarter's revenue was driven by record contribution from both our products and service sales, which included a mix of technology, functionality, and productivity enhancements to the install base. The growth in our traditional OCD and XPS business, along with several new technology and business wins, and the increasing volume in our service business reflects our progress and the momentum to meet our long-term organic targets. The broad diversity in our revenue stream across segments, territories, and customers was maintained in this first quarter, reflecting ongoing robust demands for both trailing edge and advanced 5, 3, and 2 nanometer logic devices across customers and territories. memory grew significantly compared to the previous quarter as we leveraged our strategic exposure and new technology wins in both DRAM and Vinant. The wide exposure we have built to both logic and memory is reflected also in our customer mix with four major customers that contributed more than 10% each to our revenue mix. This includes two of the world's leading memory customers, the world's largest foundry, and a leading Chinese customer. This mix of different customers in different geographies is reflective of our wins in different markets and will accompany the company throughout the year. During the current investment cycle, the leading customers are going through fundamental technology changes in the way they process new devices. In the 3d non roadmap, we have started to see involvement to multi stack scaling to contain more memory layers. The new design creates new challenges in both high aspect ratio applications, tilting and ultra thin layers with new materials. The prism with its unique channels and advanced data interpretation was created in order to provide the right sensitivity to these dimensional challenges. Following the introduction of the platform, we are expanding our penetration to more memory customers globally, which benefits from faster time to solution and advanced process control that can't be achieved with any of the traditional optic methods. In the first quarter, we continued our penetration efforts and established multiple new evaluations with leading memory customers that will decide on their capacity expansion later this year. On the material side, these new devices require a better approach to the way composition and ultra-thinsence are controlled. And following our introduction of the VeriFlex 4 XPS platform, we see more traction with memory customers as demand for high throughput and high precision inline methodology grows. I would like to mention again and refer to some competitive comments that this is non-destructive inline high productivity tool which measures tens of wafers every hour. As a result of this growing demand, XPSL's contribution maintain its record sales level in this quarter as well. In the logic foundry, new device architectures are introduced as well to meet the required performance of the high end market. Beyond continuous scaling to three and two nanometer, the leading manufacturers are adopting 3D structures like gate all around and nano sheets. The combination of scaling and new dimensional structures creates new process challenges which drive higher metrology intensity and new measurement schemes around in-die, in-line capabilities. The surge in demand for logic chips along with the technology transition to enhanced architecture drove high demand for all our platforms with integrated metrology reaching another sharp increase to a record high. In this manner, we are very encouraged with the market adoption of our newly introduced i570 integrated methodology platform that was designed to measure complex 3D structures, improving precision, productivity, and sensitivity. Multiple tools have already been installed in the field and are forecast to grow during the year. Another highlight I would like to mention in the progress we are making in introducing new products, which is the software solutions. Handling high-end applications in advanced nodes calls for more innovative solutions as tighter process specifications require more complicated methodology measurements while maintaining fast times of solution. Our product strategy is built on combining advanced hardware platforms and state-of-the-art machine learning, and AI software engines. Our software strategy brings a holistic approach that is built on four elements. Physical modeling, enhanced with mathematical modeling for accurate and fast measurements, and fleet management with automatic preventive maintenance, which focuses on tool performance control and enhancements. By adopting more software elements, we opened the metrology ecosystem to other references of other process control technologies, and by that, improves Nova's capabilities to provide better results to its customers. Our long-term software revenue goal, beyond the system traditional sequencing software, remains intact with the efforts to reach at least 10% of our product's revenues. Finally, all these successful businesses and technology milestones are reflected in our growing bookings which reached new quarterly records and drove a strong book-to-bill ratio. The fundamentals in the current market along with our achievements in the first quarter support our ambition to outperform this year as well. Before I hand over the call to draw to explain our financial highlights in more detail, I would like to recap our position post Q1 results. We are in an environment where industry fundamentals are strong, demand is healthy, and complex technical transitions are taking place. Moreover, semiconductor manufacturers are standing in large breeds of technology nodes, geographical presence, and new process methods, combining new materials with dimensional scaling. Based on our newly introduced products and technologies, NOVA is well positioned at the forefront of technology innovations to meet customer requirements and roadmap. Based on our diversified portfolio and exposure, solid operational leverage that has proven itself during COVID-19 pandemic, and our strong local teams, we expect to continue our organic growth in the current cycle to meet our long-term strategic goals. Alongside with the guidance we provided for the second quarter of 2021, we expect roughly 40% growth in revenue in the first half of 2021 versus the first half of 2020. Now, let me hand over the call to Dror to review our financial results in detail. Dror?

Thanks, Seitan. Good day, everyone, and thank you for joining our first quarter 2021 conference call. Total revenues in the first quarter of this year exceeded our guidance and reached an all-time record of $84 million, representing a 38% growth compared to the first quarter of 2020. Looking at product revenue distribution, approximately 65% was attributed to Logic and Foundry, and approximately 35% to memory. Geographically, Taiwan and Korea each contributed more than 25% to our product revenues, while China was slightly under 20%. On a per customer basis, four major customers accounted each for over 10% to our product revenues, including two foundry customers and two memory customers. Blended gross margin in the first quarter increased to 57%. Product gross margin came in at 62%, while service gross margin increased to a normalized level of 39%. Operating expenses for the quarter increased to $28.2 million on a GAAP basis and $25.8 million on a non-GAAP basis. Sales and marketing expenses increased in the quarter, mainly due to higher sales commission expenses and other costs of sales personnel. On a non-GAAP basis, we expect sales and marketing expenses to normalize between 8 million and 8.5 million in the upcoming quarters. Effective tax rate in the first quarter of 2021 was approximately 13%, slightly lower than our effective tax rate model 15%. Earnings per share on a gap basis was $0.60 per diluted share and earnings per share on a non-gap basis was $0.70 per diluted share, both exceeding the company guidance for the quarter and representing a new record for quarterly earnings per share. Moving on to cash flow, the company generated $33 million in free cash flow, an all-time record for the company. This significant increase in free cash flow was also driven by efficient management of working capital, keeping sales outstanding at 66 days and inventory turnover ratio at 2.3 times a year. Finally, I'd like to share our guidance. We expect the following for the second quarter of 2021. Revenues to be between 84 million and 92 million. Gap earnings per diluted share to range from 51 cents to 64 cents. Non-gap earnings per diluted share to range from 64 cents to 77 cents. At the midpoint of our second quarter estimates, we expect gross margins to remain at similar levels as the first quarter of this year. operating expenses to reach approximately $29 million on a get basis and approximately $26 million on a non-get basis, and effective tax rate of approximately 15%. With that, I will turn the call back to Eitan.

Thank you, Dror. Before we take your questions, I would like to use this opportunity to thank once again NOVA's employees for their dedication and outstanding efforts leading to these record results during this dynamic and uncertain period. The past year has been a true test of grit and resilience of the company and our local team across the globe. They didn't miss a bit along the year. Our local offices were strengthened tremendously to maintain top quality service for our global customers and to capitalize on various emerging opportunities. Our production teams never stopped working, sometimes around the clock, to ensure we deliver on our promises and meet market demand. Every single one of NOVA's employees stepped up to the challenge and did their part. As we gradually and cautiously resume our familiar working routine, starting from Israel, where 97% of the employees are vaccinated, I would like to take to thank each and every one of them for their contribution to our performance and ongoing success. With that final note, we will be pleased to take your questions. Operator?

Thank you. If you wish to ask a question at this time, please press star 1 on your telephone keypad. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. Again, that's star one to ask a question. We will now take our first question from Quinn Bolton from Newtown. Please go ahead.

Hey, Ethan on the drawer. Good afternoon and congratulations on the great results. I wanted to start first with maybe a clarification drawer. It looks like deferred revenue on the balance sheet jumped up pretty meaningfully and maybe to a record level. Wondering if you could discuss what led to that increase. Is it reflecting, you know, greater software sales that are recognized over time? Is there a service component to that? Or could it be associated with some of the new tools that you're putting into the field? Thank you.

Yes, so the deferred revenues did increase significantly in the first quarter, and most of the increase is related to the new products that we are introducing into the market. We have a few of these in several product lines, and in some cases we install the tool, the customer is already paying, and the acceptance is actually being delayed to a later period. So most of this increase is related to these new product introductions.

Great. Thank you. The second question I have is many of your peers are citing, you know, sort of growing capacity constraints that may be starting to limit upside in the second quarter or perhaps even in the second half. Wondering if you're having or seeing any supply chain constraints that might be limiting your near-term outlook, either again in the second quarter or in the second half, whether it be semiconductors, whether it be passive devices, anything else that go into your systems?

So the answer is no. We took a lot of actions during 2020 in order to expand Both are production capacity as well as securing the supply chain from the understanding that once everybody will go out from the corona, we'll have here an over-demand issue with the supply chain. We secured both our inventory as well as the production capabilities, both in Israel and the U.S. and in Taiwan. And currently looking in 2021, we don't see any issue coming from either productivity perspective or supply chain. And everything is based on the current situation. If something will change economically or from the COVID perspective, then we need to evaluate again. But as it looks right now, we don't have constraint to increase capacity.

Great. And Eitan, for you, my last question is, it sounds like you've got an increasing number of PRISM and It looks on tools out in the eval, but just wondering if you could give us any sense on other new technologies you're developing, whether those technologies would be more in the dimensional space or the material space.

So, obviously, once we release those technologies to the market, we will announce it. I think that on the current growth path that we have, and the surge in demand for the current products that we have. It will take a few quarters more in order to introduce more new technologies, but definitely the two areas that we are focusing right now, or the three areas we are focusing right now, one is finding new channel of information for the dimensional part, and one of them you saw is the prism. The second pillar will be more products on the material side because it's becoming a real issue to measure the profile, composition, stress of those materials. And you saw the Ellipson coming in. And the third element is more and more software machine learning elements as they are compensating part of the hardware. that will be very tough to reach in this tight windows and tight specification that the customers are asking. So most of the development right now or most of the investment right now goes into these three directions.

Thank you, Ethan. Thank you, George. I'll get back in the queue.

Thank you. Thank you very much.

We will now take our next question from Jamie Zaslavik from Bank of America. Please go ahead.

Hi, guys, thanks for taking my question and congrats on the great results. I had a question on China. So how are you guys seeing demand from the domestic China region? I think some of your peers have mentioned they expect domestic China WFE this year to be around 10 billion, maybe slightly higher. So what's been your visibility into demand? Has the incremental upside you've seen been concentrated in any specific region?

So thanks for the questions. So let's start from the second question regarding the geographical distribution of the revenue. We definitely in the first quarter see more demands coming from Korea. Actually, it was a record revenue for us coming from Korea this quarter. So we see a growth both in DRAM logic and Vinant coming from Korea during the first quarter. Taiwan is already elevated with a larger foundry over there that is spending both on 5 nanometer and 3 nanometer. And regarding to China, we do see increasement of investment in the local domestic in China. The fact that we... when part of our products can ship from Israel, allow us to gain market share as well as to get into those investment schemes much easier than part of our peers, and we are enjoying from that. And if you are looking right now on the distribution over the year, China is very stable to us across the four quarters with some some option for for upside from domestic both domestic memory and domestic foundry in in China.

Got it. That's very helpful. And then you guys talked about a number of impressive product offerings. I kind of wanted to ask a little bit more about the new Ellipson tool. Can you discuss what's driving the need for this specific tool? How it's really different from what else is in the industry and any color on customer momentum so far?

If I'm looking right now on the total portfolio of SNOVA for material measurement, it's very unique and it's one of a kind in the market. Actually, both for the XPS and the Ellison, those are products that used to be measuring materials characterization in the laboratories. And what we did actually, we took them into the production and we took them to applications that are inline in dye. And beside the Nova, there isn't any other competitors in the market that is doing either composition or stress. with any other technology in the market. So for that uniqueness that you're taking some technology that will not exist today in the production and taking it from a very slow laboratory tool and bring it to high volume productivity in the fab itself, it's creating a lot of demand. Now regarding the application itself, we need to understand right now that In order to improve today's performance on a chip, if previously everybody talked about the Moore Law and scaling, today it's a combination of scaling, which is dimensions, and a lot of investment in materials. So we do see in the future, as we see in the last few quarters with our materials portfolio, a lot of demand for materials measurement. It's always running around composition, stress, strain, crystallinity of the silicon and many other materials measurement that are really needed today in process control and we are very unique in that.

Got it. And if I could squeeze one more in. Some of your peers have mentioned that they now expect WFE to be back half loaded this year. Are you seeing the same and what does that mean for your revenue profile throughout the year?

So usually we don't give guidance beyond the quarter, and I'm saying it always in the first quarter. It will be a bit naive to look on the fourth quarter and assume that we know exactly what is the visibility in the fourth quarter. And we see this upside in the second half, but I think that the second half will be better than the first half, but we don't see it as a major increase in the second half. Everything is under the assumption that we don't yet see the full visibility on the fourth quarter.

Got it. Thank you, guys.

Thank you.

Our next question from Patrick Ho from CFO. Please go ahead.

Thank you very much, Anne. Congrats on a nice quarter in Outlook. Atom, maybe first off, you've talked about a lot of your development work that's now coming to fruition with new products as well as new node transitions. As you look forward into the Foundry logic, you did bring up in your prepared remarks comments about gate all around, nanowires, and the future, you know, transistor structures on the Foundry logic side of things. How much capital intensity do you think it increases for both your dimensional and materials tools as the industry makes that migration.

So I think that if we're looking right now, by the way, not only on the logic, if we're looking also on the memory, there is two inflection points that that is requiring a lot of investment in creating a better profile of the chip. Okay. In the Vinand, it's majorly increasing the count layers of the memories, which don't allow you to do one-shot etch or one-shot deposition, and therefore you need to have a multi-stack structure. And this multi-stack structure in the Vinand creating a lot of difficulties that can be controlled only with more intensity on the on the metrology side, mainly dimensional part. And if you're looking right now on the logic, the gate all around, or the nano-sheet structure with three and maybe five sheets later on, create a whole new story, okay? So the transistors are not anymore, traditionally they are standing and currently they are becoming horizontal, And in order to make it as an accurate and precise structure, you need to add a lot of materials, and it's a very tough structure to control. And every time that something is tough to control, you need more metrology, and you need more intensity on those process control tools. So definitely when we are looking right now on the advanced nodes, both on the The north of the 170 layers in Vinand, as well as the nanosheets, two nanowires with three sheets in logic, we definitely see increments in tens of percentage of intensity in those technology nodes.

Great. That's helpful. And maybe as my follow-up question, in terms of the services business, you mentioned you had a record quarter this year. I know over the last couple of years you've increased your capacity, particularly in Israel, that's obviously helped with the manufacturing side of things and getting tools out. Can you discuss your services infrastructure and whether you need to invest more to keep pace with that growing business and the number of tools that are starting to hit the fields?

So obviously, once you increase the install base, you need more services and you need more resources to support this install base. But I think that if we're looking on the larger picture, the service revenues are distributed over three elements. One is the contract or the service-based licenses for services for those tools, the install base in the trailing edge. And the target, of course, is to have as many tools as you can in those service contracts or license-based contracts. This is one part. The second part, of course, is time and materials, which means those customers that don't like the contract part, you need to support them by call, which is a part of the service revenue. And the last one is everything that we call the value-added services. This is the growing part and this is where we invest both on roadmap. We have a specific service roadmap which means productivity upgrades, hardware and software of trailing tools and install base which are installed for a couple of years. We have in this part also unique software elements to control the tools in large volumes only for the service part. And, of course, many more. So part of the development that we have in the R&D is to develop those value-added services that actually you can earn money by add them to the current install base. And I'm not talking just about release upgrades or just throughput upgrades. I'm talking about real functionality changes that we can squeeze money and revenue from the install base in order to give more functionality and productivity to the customers. So definitely there is investment in that. And definitely we are growing in investment in services.

Great. Thank you very much.

Thank you, Patrick.

We will now take our next question from Atif Malik from Citi. Please go ahead.

Ethan, you talk about the 10% goal for the software to be as a percentage of the products. Can you help us understand where you guys are right now in terms of software as a percentage of your sales?

Yes. So in the first quarter of 21, we were at approximately 7% to 8% of product revenues.

Okay. And then as a follow-up, I just want to understand what percentage of your product portfolio are integrated metrology and how much of that is exposed to kind of the decision-making at the OEMs, the processing tool companies in the U.S., and how much of it is influenced by your direct customers? And the reason I ask that question is because some of these OEMs are increasingly talking about kind of a holistic kind of inspection and metrology, and they talk about some in-house capabilities in terms of putting metrology capabilities on the cross-instrument tool. So I just want to understand, you know, how much of your part are exposed to integrated metrology and if there should be any concern in terms of, you know, insourcing risk at these OEMs. Thank you.

So thank you for the questions. In regard to the first part, we don't break down the revenues coming from integrated and standalone. And we would like to stay in this policy because it has a lot of competitive information once we start breaking it down following the market demand. In regard to the second question, I would like to shine a bit light about the metrology and the way that it's been decided. So integrated metrology, although it's connected to an OEM tool, it's a totally different market decided by the customers and the OEM, besides the fact that they need to be ready to connect to the integrated, and of course that we have very good relationship with all of them, decisions are made by customers and the OEM Don't have a say in that, okay? Now, looking right now on the way that metrology has been divided, it has three parts. The first part is the standalone. It's tools that are standing as a standalone station, not related to the OEM, and the wafers are traveling to this standalone system. If you go one level down, it's the integrated metrology. which connected to the OEM and give metrology as wafer to wafer control, okay? So we know how to control the metrology between the wafers. And if you go, and this is where NOVA exists, and if you go one level down, you go to the institute. This is what the OEM are doing. An institute usually is for the polishing or the etching process itself. It can't even compete with the integrated. So it's three different markets that exist by itself, and NOVA is not competing with the institute, and the institute is not competing with the integrated. So therefore, the OEM discussion about having internal metrology through the institute or very smart sensors are not cannibalizing any of our markets.

Thank you, Etan. Very clear. Thanks.

As a reminder, to ask a question, please press star. As there are no further questions at this time, I would like to turn the conference back to Etan Oppenheim, President and CEO, for any additional or closing remarks.

Thank you, operator, and thank you all for joining our call today. Please stay safe and healthy. Bye.

Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.