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spk03: Good day, and welcome to the Onto Innovation Third Quarter Earnings Release Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Michael Schaefer, Investor Relations. Please go ahead, sir.
spk07: Thank you, David, and good afternoon, everyone. Onto Innovation issued its 2021 Third Quarter Financial Results this afternoon, shortly after the market closed. If you have not received a copy of the release, please refer to the company's website where a copy of the release is posted. Joining us on the call today are Michael Plosinski, Chief Executive Officer, and Stephen Roth, Chief Financial Officer. As always, I need to remind you of the Safe Harbor regulations. Any matters today that are not historical facts, especially comments regarding the company's future plans, products, objectives, forecasts, and expected performance consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These estimates, whether expressed or implied, are based on currently available information and the company's best judgment at this time. Within these is a wide range of assumptions that the company believes to be reasonable. However, it must be recognized that these statements are subject to a range of uncertainties that can cause the actual results to vary materially. Thus, the company cautions that these statements are no guarantees of future performance. Risk factors that may impact Onto Innovation's results are currently described in Onto Innovation's Form 10-K report for the year ended December 2020, as well as other quarterly filings within the FCC. ON2 Innovation does not update forward-looking statements and expressly disclaims any obligations to do so. Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. And as a reminder, a detailed reconciliation between GAAP and non-GAAP results can be found in today's earnings release. I will now go ahead and turn the call over to Mike Blazinski.
spk01: Mike? Thank you, Mike. Good afternoon, everyone, and thank you for joining On2Innovation's third quarter earnings call. The On2Innovation team delivered a strong quarter, exceeding the high end of our revenue guidance and improving both growth and operating margins. While supply chains continue to be challenging, we expect demand to increase in the fourth quarter, with revenue growing 5% to 10% over the third quarter. Let's begin with highlights from the third quarter, starting with the advanced nodes market, which grew by 10%, driven by a surge in logic spending in the quarter. Smaller geometries and new 3D transistor structures are creating an increase in capital intensity for high-sensitivity, high-speed optical metrology systems. As an example, metrology applications to support the next-generation FinFET structures could increase as much as 50% over prior structures. Customers indicate that our combination of greater sensitivity and AI-enhanced modeling software is proving to be a powerful differentiator in these applications. In the third quarter, more than half our revenue at Advanced Logic came in support of investments for pilot lines for transistor structures below 5 nanometer. Our strategy to grow, share, and integrate in metrology is also progressing well with another leading DRAM manufacturer, selecting onto integrated metrology to support their production ramp of next generation high bandwidth memory starting the first half of 2022. This year, we've already added six new customers for integrated metrology, and each are expected to move to volume production next year. In addition to being positioned for those future expansions, we've seen a strong increase in demand this year from existing customers. In the first nine months of the year, Integrated revenue increased 50% over the same period in 2020. The Impulse 5 technology further improves our value proposition as we believe it is the only system capable of speeds matching the latest CMP tools while maintaining required sensitivity below 30 angstroms. This capability allows customers to increase line productivity by reducing rework due to over polishing in CMP. Now, turning to our largest market, revenue from our specialty and advanced packaging customers was comparable to the second quarter and 43% greater than last year's third quarter. Within these markets, demand for our inspection technology continued to accelerate, and for the second straight quarter, our inspection revenue increased by over 20%. The strongest demand is coming from the top IDMs to support investments in new heterogeneous packaging micro-bump, and 3D TSV technologies. We uniquely meet these challenges by augmenting our inspection platforms with advanced analytics leveraging artificial intelligence to provide actionable information to our customers. For example, DRAM memory customers have been challenged by micro-cracks induced by stress in the sawing process. These cracks can become costly reliability issues especially when several dye are stacked into single HBM or high-bandwidth packages. Increasing sensitivity would find the cracks, but also thousands of nuisance defects resulting in overkill of good dye or shipping dye with potential reliability issues. By leveraging our proven machine learning algorithms, we're able to detect the critical defects of interest while eliminating the noise, which resulted in a more robust solution and improved yields. In addition to our tool-centric solutions, we see stronger demand for our enterprise software, particularly from the specialty device markets, including power and RF customers, which represented 50% of our enterprise sales in the quarter. The combination of enterprise-wide revenue and expanding tool-centric applications help set a new record for the business in the third quarter. We also see a new point of leverage for the software to enable enhanced productivity services to our fleet of installed equipment. Since the merger, we've been steadily transitioning our services business from a traditional break-fix model to a more customer-focused recurring revenue model with an emphasis on contracted services aligned with customer performance metrics. As a result of these efforts, contract revenue has increased each of the last eight quarters. Over the last several years, our software and services business has grown by about 30% and is roughly 20% of our revenue today. And we believe leveraging our software will provide additional future growth opportunities for this business. So it was certainly an exciting quarter across several areas of our portfolio. But perhaps most exciting is the progress being made on our latest JetStep lithography platform for advanced packaging. The first tool has been installed in the starting process qualification for panel-sized heterogeneous package technology. We shipped our second tool in the third quarter, and we received commitments for six additional manufacturing slots for delivery mostly in 2023. In order to support the commitments for 2023, we're expanding the manufacturing capacity at our Wilmington facility and with our key suppliers. Now, I'll turn over the call to Steve to discuss the financial highlights.
spk06: Thanks, Mike, and good afternoon, everyone. In my remarks this afternoon, I'll provide some details on our Q3 results and then follow with our guidance for the fourth quarter. Let's get started. Our third quarter revenue was $200.6 million, up 59% over the same period last year and up 4% over the last quarter. The sequential quarter-over-quarter increase was mainly driven by inspection sales and our software group, which Mike mentioned, had a record quarter. Breaking down the revenue by market, 45% of our sales were from our specialty device and advanced packaging markets, which continued to strength from the previous quarter. The advanced node market represented 35% of sales in the quarter and increased 10% over the prior quarter. That increase was driven by logic sales, which grew 80% quarter over quarter, offset by weakening in memory. Finally, software and services increased slightly in the quarter and represented 20% of revenue. Our gross margin continued its strong quarter-over-quarter performance, increasing to 55.1% compared to 54.5% in the second quarter. Higher revenues, including stronger software sales, offset supply chain and logistic cost increases in the quarter and drove the gross margin improvement. Third quarter operating expenses were $51.6 million, a decrease of $4.2 million from $55.8 million in the second quarter and lower than our guidance. The decrease is primarily due to variable compensation plan adjustments, which were recorded in the second quarter, which increased operating expenses in that quarter. In addition, there was lower stock-based compensation expense in the third quarter. Those decreases were partially offset by an increase in headcount in the quarter to support our revenue growth. We continued our quarterly operating margin improvements each quarter since the merger, with third quarter operating margins 29%, achieving our published $800 million long-term operating model on a quarterly run rate basis. We also remain confident in our $1 billion operating model, which calls for gross margins between 56% and 57%, and operating margins between 31% and 32%. Net income increased in the third quarter and was $48.7 million, or $0.98 per share, and at the high end of our guidance. In the second quarter, we reported net income of $45.9 million, or $0.92 per share. Moving to the balance sheet, we ended the quarter with a cash position of $461 million, up $51 million from Q2. Our free cash flow for Q3 was $48 million, or 24% of revenue, and year-to-date, we have generated over $115 million of free cash flow. Scouts receivable increased to $180 million in the quarter, primarily due to increasing revenue, but our day sales outstanding remained at 82 days. Our inventory increased to $222 million in the quarter, on higher plan revenues for Q4 and acceleration of inventory deliveries as a hedge against supply chain disruptions. After the end of the fourth quarter guidance, we expect revenue to be in the range of 210 to 220 million. Earnings per share in this range will be anticipated to be between $1.02 and $1.16 per share. We also expect that our gross margins will be between 55 and 56%. For operating expenses, we're aggressively recruiting and expect additional headcount on board by the end of the quarter. Therefore, we're currently anticipating that our operating expenses will increase in the fourth quarter and be in the range of 53 to 55 million. And with that, I'd like to turn the call back to Mike for additional insight into Q4 and into 2022. Mike?
spk01: Thank you, Steve. I'll start with commentary on the supply chain challenges impacting many companies, including OntoInnovation. We see risks in the supply chain likely to continue through the first half of next year. We believe our U.S.-based manufacturing operations and predominantly domestic suppliers are proving to be an advantage by enabling closer cooperation and some reduction in logistics risk. However, supply chains are multi-tiered and complex, and overall we expect challenges will continue. Therefore, we're increasing our cooperation and proactive oversight with our vendors. We're taking an inventory as soon as it's available, and we're sharing our extended visibility with suppliers so they're better prepared to support the growing demand we see for our solutions. So assuming no dramatic surprises from the supply chain, demand in the fourth quarter will result in our fifth consecutive quarter of growth, up 7.5% at the midpoint of our guidance range. We see the strongest demand coming from our specialty device and packaging customers, with revenue growing over 15% from the third quarter. In particular, we see increasing demand We see spending increasing for compound semiconductor materials such as silicon carbide and gallium nitride, the so-called third-generation semiconductors for electric vehicles, solar energy inverters, charging stations, and power storage applications. In the last year, we've added significantly to our solution suite serving these markets. We now offer overlay metrology, inspection, planar films, and integrated metrology, all connected through our enterprise software to reduce customer ramp times and improve yields. In fact, we expect revenue growth from RF power and image sensor customers to more than double in the fourth quarter, representing roughly 20% of overall system revenue projected in the quarter. Within the advanced node segment, we see a surge in DRAM, offsetting pauses in both logic and NAND, essentially matching the record-setting third quarter. We expect 2022 to be another growth year for the industry, supported by many customers announcing capacity increases across our core markets and advanced nodes and specialty devices. With record backlog over twice the size of this time last year and success expanding our served markets, including traction and panel lithography, We're optimistic we will exceed the current wafer fab equipment projections of 10% for 2022. Finally, on this second anniversary for On2Innovation, I'd like to close by acknowledging and thanking the entire On2Innovation team for their dedication to our customers' success and their innovative spirit, demonstrated not only in the products we produce, but also how we approach and, more importantly, overcome exciting new challenges. It's truly an inspiring team to be a part of. And with that, I'll turn the call back and open the line up for your questions.
spk03: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions.
spk04: We'll take our first question from Craig Ellis with B Reilly Securities.
spk08: Yes, thanks for taking the question and congratulations on the strong results and guidance. Mike, I wanted to start by following up on some of the software comments that you made. It seems like there's some real strength in the business, and it sounds like it's multi-pronged. So can you just talk a little bit more about what you're seeing with respect to customer engagement in software? Because certainly the 28% quarter-on-quarter gain is eye-catching, and the interest is whether that was something that's really more episodic in the back half, or if you see that following through as you go into 2022.
spk01: No, Craig, we've seen steady gains in the software business over the last several quarters, and we didn't mention it because we wanted to make sure this is a trajectory that we're going to maintain and not just a talking point for a quarter or two. And we do believe it's a long-term trajectory. What we're seeing is demand, especially this rapid demand or growth for software Smaller companies, the OSATs, the specialty device makers, they're experiencing such demand. They need systems and software that can be more turnkey and allow for rapid deployment and rapid yield. So rapid deployment of the equipment and then the resulting analytics to drive yield. So we're seeing this playing out both at our equipment level, that's what we call the tool-centric, and we gave an example of that. There are several others leveraging other technologies we have, and also at the factory-wide level. And that includes not just FAB-wide analytics, but also control software for automatic process control or equipment fault monitoring and things like this. And then the third piece we talked about was leveraging the tool-centric capability and those equipment control capabilities I just spoke about to augment the services we're offering in our services business, our customer success group, by providing predictive analytics and predictive capabilities that increase the value of our equipment and of our install base.
spk08: Got it. Got it. And it seems that that strength is something that's giving gross margins strength in the fourth quarter. I wanted to follow up on the panelists' comments because that has been something that you've talked about recently as getting to that on-ramp that we've been looking for, and it seems like that's here. The question is, as we look ahead to calendar 22, From the three shipments that I think you mentioned you had in the quarter, what's possible from a shipment standpoint? And Steve, on your end, how should we be thinking about REBREC with panel with them?
spk01: So what's possible from a shipment standpoint, we're basically booked out for capacity. So I won't give exactly what that number is, but it's It would be record year for sure. So if you go back, I think prior record year might be eight systems, six to eight systems shipped. So it would be more than that. And then I'll let Steve talk about RevRec.
spk06: Yeah, from a RevRec standpoint, as Mike said in his prepare remarks, we've shipped our second tool. But, you know, this is the first of this model. So we're going through the process quals now. But I would not expect that. because it's a process tool to be done by the end of the fourth quarter. So we're looking probably in Q1 where the tools that we ship this year will be recognized in Q1.
spk01: Got it. Craig, just to add on to that in case it wasn't clear, the demand we're seeing all the way through 2022 and into actually through 2023 is driving us to increase the capacity to fill that demand. So we're actually increasing capacity, which will come online in 2023, to fulfill the increased demand we see and booked, or at least have commitments for in 2023.
spk08: On that point, Mike, and I know the portfolio is diverse across advanced packaging and advanced nodes. Can you just comment on the level of visibility that you have across the business right now? Certainly in Panalitho, it extends way out. But what about in other parts of the business?
spk01: We certainly have more visibility. As we've become a much larger, more important supplier to our customers, we're getting access and having discussions earlier on about expansions going out into the following year. So visibility is definitely stronger just from that. Then you increase or you add on top of that the concerns with supply chain and being able to secure slots and some of our equipment's in fairly high demand. So we're getting an added level of discussion as customers want to ensure that they have access to our equipment. Got it.
spk08: That's real helpful. Guys, good luck and thanks for the help.
spk03: Thank you, Craig. Our next question comes from Patrick Ho with Stifle.
spk00: Thank you very much, and congrats on the nice quarter and outlook. Mike, maybe first off, in terms of the advanced packaging business, you mentioned Jet being driven by heterogeneous integration. From your overall advanced packaging portfolio, is that the big driver, or are you seeing broad-based type of adoption of your different product portfolio across FanOut, Bump, Can you just give a little color in terms of the application and what's driving your overall advanced packaging business?
spk01: Overall, I would say it's more what we mentioned. It's a lot driven by wafer-level type packaging, whether it's 3D TSV structures or micro-bump and fan-out packaging. We've seen some you know, resurgence and fan out as well. So I'd say, you know, the more traditional wafer level packaging is certainly driving, especially as we've seen, you know, large foundries investments in packaging and driving down design notes or RDL, you know, the interconnect sizes continue to shrink. And that drives the demand for much higher resolution and much more precise systems. which we're seeing playing out across the IDMs and the OSATs trying to support that business as well.
spk00: Great. That's helpful. And maybe as my follow-up question, Steve, really strong gross margins in a challenging supply chain environment. You did highlight some of the variables and things you've done over the past few quarters to mitigate it. But with those strong gross margins, how are you able to manage costs overall, given that probably – are not going down. How are you keeping gross margins in that mid-50% range in the near term while these issues persist?
spk06: Well, for the most part, like I've said on previous calls, really, I mean, there has been some impact, you know, from the supply chain. Obviously, the one that people talk about the most is the shipping costs, the freight costs going up. You know, obviously, you've Stuff that we bring over the water has been taking longer and longer lead time. So we've done some expediting to get around those longer lead times. So we had some increasing costs on the freight and logistics side that we've seen. I mentioned that was kind of a little bit of an offset, but not really enough to move the margins because obviously we have pretty strong product margins. As for the overall cost increases from the suppliers, you've got to realize that we order out well in advance. Obviously, we're out with purchase orders. So we haven't seen any material price increases hit the numbers yet. But I think that's a risk that's out there that we keep looking at. But I think overall, our product mix, we've got a very strong supply. product portfolio with nice, strong product margins. We've got the new products that are, you know, obviously adding more value and therefore come in with a higher margin. So as they continue to gain traction, I think they help, you know, help any of the negative wins that might be coming the other direction.
spk00: Great. Thank you again, and congrats again on the really nice work.
spk04: Thanks, Patrick.
spk03: We'll take our next question from Quinn Bolton with Needham & Company.
spk02: Hey guys, I'll offer my congratulations as well. I guess sort of big picture question, Mike and Steve, as you look into 2022, you talked about WFE growing 10% and your hopes or confidence that you'll be able to outgrow WFE next year. And I was just wondering, could you sort of rank order maybe the top two or three drivers that allow you to outperform WFE? You've talked about a lot of drivers on the call. You've talked about advanced packaging, heterogeneous integration. You've talked about JetStep. What are some of the biggest drivers you see going into next year?
spk01: Well, I think we see one of the biggest drivers is packaging in general. When I look at some of the numbers here, we see some significant drivers. Spending happening in in advanced packaging particular at the higher end, you know the more advanced Or smaller interconnects that that we just talked about so that's that's in both the driving both the inspection so it's both at the wafer level but also at the panel level as as you know that those Steppers are fairly expensive. So such a backlog is pretty pretty impactful to the business and And then beyond that, we still see a lot of strength in the advanced nodes. So the adoption of the Atlas for some of the more critical measurements, the rolling out of sub-5 nanometer across several different customers that we're expecting, that's also driving what we talked about was a higher capital intensity and something that we think we're pretty well positioned to benefit from. So we see some you know, nice growth there. And, you know, DRAM, you know, memory is also going to be much stronger next year, and we've always been well positioned for strength and memory. So that'll be part of that advanced nodes growth we just talked about. I think, yeah, and also the specialty devices. So if I go into three different buckets, the third would be the specialty devices, which we think is, you know, continue at some relatively high levels. So relatively meaning, you know, compared to several years back, prior peaks, specialty devices is growing, you know, pretty, pretty meaningfully.
spk02: Great. Thank you for that, Claire. And then just want to ask a sort of specific follow-up. Mike, you highlighted some wins with the new integrated metrology. I think you mentioned six new customers that start to ramp next year. How big of an opportunity is that in terms of share gains? Is it, you know, a few million dollars? Is it tens of millions of dollars across those six customers? I'm wondering if you might be able to size that for us a little bit.
spk01: I think it's in the orders of tens of millions. Maybe, you know, somewhere, you know, in that 10 to 20 range. It's hard to... It's hard to give you an exact figure, but it's definitely significant, or I wouldn't have mentioned it. We're definitely seeing very positive feedback on the capabilities of our tool, and obviously it's an important decision for customers because it's a relatively inexpensive tool compared to the cost of the CMP tool and the importance of the process step. But the data we're seeing, the traction we're gaining, I mentioned the the 50% growth in the first nine months of this year compared to the prior year, that's well ahead of WFE projections for the year. So, you know, we're definitely gaining traction, and customers are having a meaningful impact on the, you know, advanced nodes revenue stream because of the integrated.
spk04: Great. Thank you, Mike. Once again, if you would like to ask a question, please press star 1 now.
spk03: We'll take our next question from David Dudley, my apologies, with Steelhide Securities.
spk05: Thanks for taking my questions. Did you guys mention what the backlog was? I think you mentioned that you have a record backlog. Could you share what it is at this point?
spk06: We don't normally give out the actual backlog number. I think Mike mentioned in his prepared remarks that, you know, that we've seen a double from where it was at this point last year, but we don't put up a specific number.
spk05: Steve, maybe just tell me what the backlog was the last time you published it. That's probably at year end.
spk06: Actually, we didn't publish it. It's not even a requirement anymore, Dave, so we don't – actually, we don't publish – we haven't published backlog in a long time.
spk05: Okie dokie. You mentioned that you got, I think, orders for six more JetSteps. Could you remind us, I think in the last few conference calls, you've mentioned how many jet steps are in the backlog to be shipped. Could you share that number with us now?
spk01: Last time we mentioned, we gave an indication it could be around 30 million. And this would be, you know, on top of that. But keep in mind, these were commitments. So some of them are, you know, dollars to reserve the slot, some purchase orders. So, you know,
spk04: Formal commitments. Okay.
spk05: And as far as the – are you seeing any activity from the arm hyperscaler type guys? Has that started to creep up into where those guys are starting to order tools or starting to move the needle on any sort of purchasing activity?
spk01: You're speaking specifically about Jetstep or generally?
spk04: Just generally.
spk05: If you want to answer it on Jetstep, that would be fine.
spk01: No, I think generally, you know, Apple has been, you know, I'm not sure exactly where you're going with this, but, you know, Apple has their latest processors going through kind of an arm... It's doing very well, and everyone's aware of who they're using to manufacture those. That's obviously a large customer for us. So, yeah, we've definitely seen activity in that regard.
spk05: One reason I ask is there are the AMDs of the world, and there's some, I think, new companies coming to market, and some of the traditional hyperscalers are developing their own chips. I've seen some of the chips, pictures of them. They're huge dye. So I was wondering if you're starting to see any activity in the lithography area from some of these ARM-based processors.
spk01: Yeah, from the packaging side, we understand our customers are supporting multiple logic design boundary customers. It's reasonable to assume we are seeing that if they're developing advanced microprocessors that we're seeing it.
spk05: Okay. And then I think you mentioned your inspection business was up 20% sequentially for the second quarter in a row. Now that you've given guidance for Q4, could you share with us what you think the size of your inspection business will be in 2021?
spk04: And do you expect inspection to grow in 2022?
spk01: We don't break out the inspection per se by size. We talk about advanced nodes, specialty, AP, et cetera. So we try and tie it to markets. But we do expect inspection to grow, you know, ahead of, you know, if the market's going to grow by 10% next year, you know, our expectations would be inspection grows more than that based on what we're seeing from, you know, Like I mentioned, the specialty device and AP customers growing fairly significantly.
spk05: So just to kind of recap, I guess you expect growth in your JetStep business. There's growth in the inspection business, which is kind of the old Rudolph business. And then there's growth in the advanced nodes, which is the combination of both the Rudolph and the nanometrics business. So all the buckets are growing in the upcoming year.
spk01: Yeah, that's, I guess, an impact when there's, you know, these chip shortages. There's a lot of customers trying to fill that demand, and we're seeing the demand right across the markets we serve, which are not just the leading edge, you know, Logic and DRAM and NAND, but also the RF and the power customers and Compound Semi and MEMS for automotive. Yeah, and with everybody... announcing expansions, we're seeing some pretty decent demand for our solutions.
spk05: Well, excellent. Congratulations on nice results, and it looks like the future is going to be quite bright as well.
spk04: We hope so. Me too. Thanks, Dave.
spk03: That concludes today's question and answer session. Michael Schaefer, at this time, I will turn the conference back to you for any additional or closing remarks.
spk07: That concludes our remarks for the call, David. We'd like to thank everyone for participating in the call today and for your continued interest in On2Innovation. Please go ahead and wrap up the call.
spk03: This concludes today's call. Thank you for your participation. You may now disconnect.
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