Nova Ltd.

Good day, and welcome to NOVA's fourth quarter 2022 results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Miri Segal of MSIR. Please go ahead.

Thank you, Operator, and good day, everyone. I would like to welcome all of you to our 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 Dror with an overview of the financials. We will then open the call for the question and answer session. I'll now turn the call over to Mr. Eitan Oppenheim, NOVA's president and CEO. Eitan, please go ahead.

Thank you, Miri, and thank you all for joining our call today. I will start the call by summarizing our fourth quarter and full year performance highlights. Following my commentary, DRAW will review the quarterly and annual financial results in details. Nova's strong performance in the fourth quarter concludes another record year, highlighted by a notable increase in revenue and profitability. Despite market volatility and dynamic industry behavior, Nova was able to perform well during the fourth quarter and the full year, demonstrating the strength of our diversified and agile business model across customers, markets, and technologies. While we remain focused on addressing the interim challenges, we continue to implement our long-term strategic plans to solidify our position and seize various opportunities, particularly in these periods. We believe that in the current environment, our unique position in process control can help us strengthen the company's fundamentals through proliferation of our newest product portfolio, additional market share gains, and new penetration. As for the financial highlights, the fourth quarter revenue came in at the high end of our quarterly guidance, setting new quarterly and yearly records. While quarterly revenues grew 24% year-over-year, annual revenue grew 37%, outperforming the industry indexes for the year. Profitability for the year remains strong with new record high results, allowing the company to exceed EPS of $5 per share on an annual basis for the first time. Along with our record annual product sales across all divisions, dimensional, chemical, and materials, our services business also grew significantly in 2022 gaining 35% year-over-year and surpassing $100 million in revenue. This milestone demonstrates the attractiveness of our customized packages to extend the lifetime of the tool, increase productivity, and improve methodology results in our previous product generation. Following three years of significant industry growth, we expect 2023 to be more volatile, as customers adjust their capacity to meet a softer demand in some segments like PC, mobile, and possibly others. Amid these uncertainties, Nova ended the fourth quarter with record backlog, which we anticipate will enable us to relatively outperform in 2023. During this period, as the market undergoes capacity adjustment, we believe that our well-established fundamentals will help us navigate the risks and enable us to increase exposure to additional opportunities, either in adjacent markets, new customers, trailing edge nodes, or additional unexploited applications. To meet these short-term potential opportunities, as well as the continued industry growth in the future, our strategic priorities remain intact with continuous investment in our long-term R&D roadmap and building a tighter partnership program across all main territories. The growing diversification in our activities and its contribution to our agility and future growth were demonstrated once again in 2022 with the following notable highlights. First, I would like to highlight our revenue mix across various chip generations. Our revenue is well diversified across different technology nodes where approximately 50% of our revenue generated from advanced nodes while the remaining came from a variety of trailing edge nodes in different technologies and territories. While in the past, these nodes required basic process control, we saw during the year a significant growth in demand for cutting-edge metrology solutions in similar accuracy and applicability as requested in the front end. This is a result of continuous investment to improve performance, utilization, and yield in these legacy technology nodes. Additionally, since the past two days, to improve chip performance involves technology enhancement, also in the advanced packaging and pure backend, we were encouraged to see growing demand for advanced metrology solutions by customers that used to have very basic process control in the past. We believe that this trend will expand in the next few years where the need for accurate fast metrology will grow across other nodes beyond front-end. Second, I would like to highlight the progress we made in increasing the contribution of our materials metrology portfolio. Our goal, as outlined during the recent Investor Day, is to expand our leadership in this area and reach 30% to 40% of our revenue mix as part of NOVA 1 billion plan. In 2022, we succeeded in adding more customers and more applications in both the backend and the frontend segments, resulting in record revenue for both the chemical metrology, previously ANCOSYS, and the materials metrology division. The range of materials applications we serve today has greatly expanded from simple thickness measurements to include composition, stress, purity, complex floor filing, and more. We anticipate that advancements in materials engineering will continue and expand the application mix as customers aim to improve performance through inline materials modifications. The third highlight is our growth through technology diversification. In addition to introducing new solutions in our main product line, we continue to expand the adoption of our Prism technology among high-volume manufacturing customers, resulting in record sales of standalone OCD solutions with a significant increase in Prism sales. Furthermore, we are encouraged by the business performance of our latest addition, the Ellipson and Matrion, which were adopted by numerous logic and memory customers during the year. Both solutions are currently undergoing further evaluation by additional customers with decision expected to be made in 2023. We are confident that the metrology offering we have demonstrated in advanced NAND and logic, including nanowires, will broaden our market opportunities across different segments. Another growth engine that was amplified this year was the software portion of our portfolio. Our strategic plan aims to generate at least 10% of our product revenue from fleet management and machine learning for adaptive modeling-based software. By the end of 2022, we reached a new record high in this segment, putting us within the target model for the second year in a row. Finally, considering the current geopolitical environment, the geographical distribution of our revenues in 2022 should be highlighted as well. While Taiwan and China were the largest contributors, the U.S. and Europe leaped forward, approximately doubling the revenue contribution year over year. Diversity in our revenue across different territories has helped us counteract the impact of weak memory demand in some regions and will continue to support us in managing potential risks in the future. To summarize my part, I would like to refer to 2023 and its impact on our planning. We know by now that this year will be a year of capacity adjustment as customers struggle with slower demand and high inventories in various segments. Although we strongly believe in the long-term industry growth pace driven by multiple engines and technologies, we are focused on navigating the risk in the current environment. Our focus is on balancing spending while maintaining R&D investments to drive competitive edge and meet customers' requirements. As in recent years, we expect to relatively outperform in 2023 as well by increasing market share, winning new applications, adding new names, and expanding our opportunity mix across industry segments. In conclusion, while 2023 is projected to be a softer year, following three years of robust growth, we remain confident in our $1 billion strategic plans outlined in our investor deck. Our solid operational structure, strong cash position, and competitive portfolio set us up to deliver outperformance and outgrowth over the next few years. Now, let me hand over the call to draw to review our financial results in detail. Thanks, Eitan. Good day, everyone. and thank you for joining our 2022 full-year and fourth-quarter conference calls. Total revenues in the fourth quarter of 2022 reached a record level of $151 million, up 24% year-over-year. Product revenue distribution was approximately 85% from logic and foundry and approximately 15% from memory. Product revenues included three customers in four territories contributing more than 10% each to the total, with the contribution of the U.S. territory growing to slightly above 15%. Gross margin in the fourth quarter was 55% on a gap basis and 56% on a non-gap basis, lower than the company target model, mainly due to specific unfavorable product mix in the quarter. we expect gross margins to return to normalized levels already in the current first quarter of 2023. Operating expenses increased in the quarter and came in at $47 million on a get basis and $43 million on a non-get basis. The increase was mainly attributed to higher research and development expenses. We expect operating expenses to decrease already in the first quarter of 2023 to the $40 million level as a result of cost-restraining measures implemented by the company management. Operating margins in the fourth quarter were 24% on a get basis and 28% on a non-get basis within the company's target financial model. The effective tax rate in the fourth quarter was lower than 10%, mainly as a result of higher than expected tax credit values in the U.S. Earnings per diluted share in the fourth quarter increased to $1.14 on a debt basis and $1.28 on a non-debt basis. Moving on to the annual results for calendar year 2022, revenues grew 37% to a record level of $571 million. This growth is substantially higher than wafer sub equipment in 2022 and was fueled by three main factors. The revenue contribution from the acquisition of ANCOSYS, a higher revenue growth rate than the industry average for each of our dimensional and materials metrology product lines, and a strong growth rate of the service business utilizing Nova's active install base of approximately 4,800 systems installed across the industry. Annual product revenue distribution in 2022 was approximately 70% from Logic and Foundry and approximately 30% from Memory, and the company had two customers in four territories, each accounting for more than 10% of product revenues. It is important to note that in the past two years, the company doubled its number of active customers through expansion into new front-end customers in China and through expansion into new back-end customers as a result of the acquisition of Ancusis. Gross margins for the year came in at 56% on a GAAP basis and 58% on a non-GAAP basis, within the company target model of 57% to 59%. Year over year, the company was able to present stable gross margins in a challenging environment of significant inflation and rising supply chain costs. This was achieved by increased operational efficiency through growth and by the continued proliferation of new capabilities and features that provide higher value to customers on the same product platforms. Operating expenses in 2022 increased significantly and came in at $173 million on a gap basis and $151 million on a non-gap basis. This reflects a 32% increase year-over-year on a non-gap basis as the company made strides in aligning its infrastructure, development projects, and sales teams to meet the current and expected business levels and opportunities. Operating margins for the year came in at 26% on a gap basis and at a record level of 31% on a non-gap basis at the high end of the company's non-gap target financial model of 27% to 31%. Earnings per diluted share on an annual basis grew significantly and came in at a record level of $4.40 on a get basis and $5.07 on a non-get basis. During 2022, the company generated $98 million in free cash flow and presented healthy parameters related to working capital management with day sales outstanding of approximately 60 days, and inventory turnovers of approximately 2.5 times a year. In addition, during 2022, the company deployed approximately $185 million in cash as follows. Approximately $90 million for the acquisition of Ancosys. Approximately $55 million for working capital during growth, mainly for inventories and accounts receivables. approximately $20 million in capital investments and facility expansions in all main sites, and approximately $20 million for share repurchases. Moving on to our guidance for the first quarter of 2023, we expect the following. Revenues between $125 million and $135 million, reflecting the adjustments in customer spending levels, Gap earnings per diluted share between $0.77 to $0.98. Non-gap earnings per diluted share between $0.93 and $1.14. At the midpoint of our first quarter 2023 estimates, we anticipate the following. Gross margins to improve relative to the previous quarter and come in at approximately 57%. Operating expenses on a gap basis to decrease relative to the previous quarter and come in at approximately $45 million. Operating expenses on a non-gap basis to decrease relative to the previous quarter and come in at approximately $40 million. Financial income to increase to approximately $4 million due to higher yields on cash reserves. and effective tax rate to return to a normalized level of approximately 14%. In conclusion to my prepared remarks, I would like to note that the company management continues to closely monitor the different scenarios of market demand and customer investment plans for 2023. To mitigate different scenarios, the company has already activated several mechanisms to restrain expense levels. These measures are expected to yield fruit and reduce operating expenses already in the first quarter of 2023. In addition, the company's cash reserves grew to over $500 million at the end of 2022 and are expected to further grow in 2023. This healthy cash level allows us to continue and execute aggressive growth strategies and infrastructure investments as part of the NOVA $1 billion strategic plan, as well as to continue and execute the $100 million share repurchase program, which was announced and initiated in 2022. With that, we will be pleased to take your questions. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Vivek Rhea from Bank of America. Please go ahead.

Hi, this is Duxen Zhang speaking on behalf of Vivek. Thank you for taking my question. I know you are outperforming the broader industry but some of your peers are mentioning cancellations and order push-outs. Is that something you're seeing as well? And how do you view the near-term demand just broadly overall? Thank you.

Thanks for the question. So it's Eitan here.

So first of all, we are not giving guidance beyond the current quarter that we gave. And in this particular dynamic environment, it will not be responsible to to talk about the rest of the year. We do see a dynamic behavior of our customers. We do see push-outs cooling, and we do see that things are changing on a daily basis. Fortunately enough, we didn't see major cancellations. And currently, when we're looking on the rest of the quarter, as I said before, our target is to outperform the markets. even in the current situation. And as I said in my third remark, Nova knows in very difficult situations to identify opportunities for growth, either market share, geographical development, new products, new technology, and I believe that in 2023 it will be the same.

Understood. And then how much is services... contributing to that outperformance? I know you guys don't guide, but services has generally been more resilient over the last downturn. Should we assume similar dynamics this time around?

So obviously in the current situation, we also see some impact on the service business as well, maybe in specific areas which are a little bit less strong right now. But generally, we do expect service revenues to grow in 2023, obviously at a lower pace than it was in 2022.

Got it.

Thank you so much.

Our next question comes from Quinn Bolton from Niedermann Company. Please go ahead.

Hi, Aidan and Trevor. Congratulations on the nice results and the strong relative outlook. I guess I wanted to start with that relative outperformance that you expect in 2022. three, some peers will sort of say they expect to outgrow WFE. Other of your process control peers will sort of say they're going to grow faster than non-Litho WFE. And so when you're talking about outperformance, can you just sort of give us what's the base you expect to outperform? Is it just overall WFE, which I think people think are down 20-ish percent this year, or is it the non-Litho portion, which might be more down 25 to 30 percent this year?

So, yeah, thanks, Quinn. So, of course, looking right now on the little provider results, all of us need to deduct some of the little equipment and look on the rest of the industry. But when I'm looking right now on outperforming, I'm looking on two measures. One is the WFC that the consensus right now is it will be around, as you said, 20%. And second, outperforming my peers that reported. So both of them reported 20%. I think one of them reported even 23%. And we want to be better than that.

Understood. And I know you don't really want to guide beyond the current quarter, but just wondering, as you sit today, Do you have any sense where you think revenues might trough? Is that a first half of 2023 event? Do you think that revenue could be weakened to the second half? Just trying to think through relative weightings of what you're seeing from customers, kind of first half versus second half of 2023.

I can't say from the current position that how H2 will land, because everything depends on the memory and the pace of recovery, okay? So, again, it will not be responsible to try even predict what will happen in the fourth quarter. I think that if you look right now on at least on the quarter ahead of us, we would like to be approximately in the numbers we reported the guidance. Got it.

Okay. And then lastly, last quarter, I think you called out only a $10 million impact to the materials metrology from China export controls. Wondering, you know, as we've had another quarter of data, are you seeing any impact on the OCD business from some of those China restrictions?

So I'll divide this answer to two. So first of all, We are still remaining the same version, saying that the impact is minimal, and as you said, around 10 million on the material side that is coming from the U.S. The second level is that the question is the amount of pressure that is going on from Japan, Netherlands, U.S., on the Chinese semiconductor industry can lead to something else that can influence the overall industry. We don't see it right now, but we need to be aware of that. Our current planning is that China will stay stable in 2023.

Understood. Okay. Thank you very much.

The next question comes from Mark Miller from The Benchmark Company. Please go ahead.

You mentioned some evals going on, and I'm just wondering if you could provide some more color on the evals in terms of numbers and what areas these evals are going on.

Yeah. So we will not discuss about the numbers and the customer profile, but we can discuss the basis of what we did so far in 2022. And when we look right now on the results we had in 2022, we had we had the privilege, and it was good that we started with the evals of the Ericsson and the Metreon with the leading customers. So some of them already accepted the tool, and therefore the reference in the industry is much better should we start it with different customers. So we have an opening page, which is good now, going to the rest of the customers. Looking right now on both the Ericsson and the Metreon, as I said before, the solution is changing the whole metrology scheme. So therefore, every customer that you are coming, you need to go through the EVAL, changing of the metrology scheme in the SAD, and then going into high-volume manufacturing. So therefore, in 2023, we have a couple of them, and we think that by the end of those EVALs, we will be able to say that we covered, you know, the whole front-end segments.

Would you expect to gain new customers from these evals if they're successful?

Yes, we are. Thank you. Our next question comes from Atif Malik.

Please go ahead.

Hi, thank you for taking my questions and good job on the execution. And Eitan, can you talk about the areas of outperformance that you're expecting this year? On the logic side, is it coming from all-around applications? And on the memory side, where do you expect the outperformance of your products to come from?

Yeah. So I'll talk about the different growth engines as I look at them this year, which is disconnected from the capacity. So first of all is the new product, right? So we think that the pace of recognition this year of the new product that we introduced will be higher than last year. This is one. Second, when you're looking right now on the customers, and even if we're looking right now on the logic that we are very strong, there is a lot of place to grow in the logic with our Prism solution and the standalone as overall, okay? Because we have a lot to do over there, and there's a lot of available market for us to grow in the logic with those standalone tools. The third one, should be everything that is related to materials, okay? The combination of moving material metrology in line and the fact that customers are starting to change materials during the process, opening a lot of unexploited applications that before they measured in the laboratory and now they started to measure in line. So this is the third one. And the fourth one is everything that is related to chemical metrology, the anthocyanins, that we bought last year and already reached a record revenue, which in that part, when we bought Ancocis, we said that Ancocis was not so strong in the front end. They were very strong in the back end. And we do see now that with our efforts, the front end is becoming a strong part, and we expect to grow over there as well.

I think that's the core element.

Great. And one for Drawer. When I look at the commentary from your peers on the services for this year, they're still expecting services sales to grow. Some of them are saying it's flat. I don't want to put words in your mouth, but is there any reason to believe that your services business behaves differently from your peers?

No, I don't think so. I think we also expect services business to grow in 2023. Obviously, they grew significantly more than 30% in 2022 because of several reasons. So the growth in 2023 would be more – would be less than that, but we do expect the business of services to grow in parallel to our install-based growth, which practically in 2023 – is expected to cross 5,000 systems in all territories.

And the software component, does that behave similar to services, or is it more attached to your system sales?

It's more attached to system sales, and most of the software business is presented within product readiness. So I just want to add to that... I just want to add to that with Satan here that when we are talking about software sales, we are not talking about the part that is attached to the system. So we're not talking about version sales or software upgrades. We're just talking about the advanced software, which is around the machine learning stuff, the model-based algo, the things that are sold as a standalone solution to enhance the slits.

This is on top of the service. Got it. Thank you, guys.

This concludes our question and answer session. I would like to turn the conference back over to Eitan Oppenheim, President and CEO, for closing remarks.

Thank you all, and thank you, operator. See you in the next call. Thank you for joining the call today. Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.