Onto Innovation Inc.

Good day and welcome to the Onto Innovation fourth quarter earnings release conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Michael Schaefer, Investor Relations. Please go ahead, sir.

Thank you, Jenny, and good afternoon, everyone. Onto Innovation issued its 2022 fourth quarter and full year 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 Mark Slicer, Chief Financial Officer. I would like to remind you that the statements made by management on this call will contain forward-looking statements within the meaning of federal security laws. Those statements are subject to a range of changes, risks, and uncertainties that can cause actual results to vary materially. For more information regarding the risk factors that may impact ON2 Innovation's results, I would encourage you to review our earnings release and our SEC filings. once innovation does not undertake the obligation to update these forward-looking statements in light of new information or future events. Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. As a reminder, the 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 our CEO, Mike Blazinski. Mike?

Thank you, Mike. Good afternoon, everyone, and thank you for joining our call today. With our strong finish in the fourth quarter, Onto Innovation has achieved an exciting milestone, crossing $1 billion in revenue this year. Throughout the year, we saw consistently strong demand for our systems, with revenue growing 32%, well exceeding market estimates of 9% growth for wafer fab equipment in 2022. Even more exciting, earnings for the year grew 43%, while we increased investments in R&D, manufacturing capacity, and established new training centers closer to our customers in Asia. Beyond the strong financial performance, we expanded our position in several areas of future growth. Starting with advanced nodes, Atlas Optical Metrology has been qualified by all three of the market leaders developing gate-all-around transistors. This increases our logic opportunity by over 20% versus prior nodes. In NAND, we extended our already strong position with Atlas OCD by qualifying our aspect diametrology at four of the top three top 3D NAND producers for measuring critical parameters of NAND with over 230 layers. Moving across the value chain to specialty devices and advanced packaging, our latest inspection products have proven themselves capable in sub-micron applications in both front-end and advanced packaging. This year, we had over 15 customers replace the incumbent competitor's tools with the Dragonfly G3 for sub-micron inspection. We estimate this to be one of the fastest growing segments in our macro inspection market. Finally, in panel packaging, We finished the year with roughly $40 million in revenue and expect to double that in 2023. We estimate this market to be roughly $280 million, with YOL projecting a CAGR of 12% through 2026. This high level of performance across the value chain would not have been possible without the passion and talent of our entire global team and their unrelenting commitment to our customers' success. Based on these results, we see even greater years ahead for our Onto Innovations team as these technologies migrate into production. Now, turning to our fourth quarter, we capped off this record year with revenue of $253 million above our midpoint of guidance. However, earnings of $1.57 per share was well above the high end of guidance aided by favorable tax and investment income, which Mark will speak to shortly. In the fourth quarter, revenue from our specialty and advanced packaging customers grew 22% sequentially, setting a new revenue record. As expected, leading that growth was our power and compound semi-markets, which grew 54% over the third quarter. Several of these customers selected onto innovation specifically for our connected solutions, integrating software and systems to improve yields. For example, aligning patterns layer to layer is particularly challenging in compound semiconductor applications due to the use of thick, transparent materials. By employing Discover Run-to-Run software to analyze our overlay data and other process data, we're able to automatically provide more precise corrections to the lithography systems. This improves layer-to-layer accuracy by over 50%, translating to several million dollars in additional yield per year. In the quarter, our inspection sensitivity and compelling cost of ownership resulted in several notable wins in hybrid bonding for future 3D chip stacking applications. In addition, Dragonfly G3 inspection was selected to provide process control to a supplier of mini LEDs for next generation displays of a leading smartphone manufacturer. The mini LED market is still small, but we expect additional orders in 2023 from this customer as well as others ramping to support growth estimates of 22% annually through 2028. Turning to the advanced nodes, after a record third quarter, revenue declined 23% impacted by both the U.S. restrictions announced last October and market declines in memory, especially NAND. However, looking deeper, we see nearly half of our advanced nodes revenue in the quarter was in support of R&D and pilot line production of next-generation nodes. As mentioned earlier, this included the sign-off and repeat order for Atlas Metrology at our third customer investing in gate all-around technology. We also successfully completed an Aspect Metrology evaluation at our fourth leading NAND manufacturer. The Aspect IR Metrology is the only in-line solution for characterizing lateral recesses, which are critical to maintaining the correct electrical parameters for NAND. Prior to Aspect Metrology, Customers would resort to far slower sampling measurements using offline x-ray systems. Finally, in the fourth quarter, we won tool-to-record position for Iris Films at another top five semiconductor manufacturer. Since its market release two years ago, Iris Metrology has now been qualified at three of the top five semiconductor manufacturers, as well as several new power device customers. So even while factory expansion is slow, our customers are fully engaged with us to develop and deliver the solutions they require to successfully migrate their new technologies into full production. Before I go into our outlook for the first quarter and give some color on the year, I'll turn the call over to Mark for the financial highlights. Mark?

Thanks, Mike, and good afternoon, everyone. As Mike highlighted, we had another strong quarter with fourth quarter revenues of $253 million up 12% over the same period last year, and $3 million above the midpoint of our fourth quarter guidance range. This strong fourth quarter finish helped us achieve the significant milestone of surpassing $1 billion in revenue in 2022. This is an incredible achievement for a team that just came together three years ago and started at a base of just under $600 million in annual combined revenue. We also achieved several other financial records, setting company highs in full-year operating income of $302 million and net income of $275 million, contributing to our strong financial performance for the year. Now I'll move on to quarterly revenue by market. Advanced nodes revenue of $85.3 million grew 16% year-over-year and represents 34% of revenue. Specialty device and advanced packaging We achieved $125.4 million in revenue, grew 15% year-over-year, and represents 49% of revenue. Software and services revenue of $42.6 million was slightly down 1% year-over-year and represents 17% of revenue. We achieved 54% gross margin for the fourth quarter in line with our previous guidance range. We continue to experience inflationary pressures on raw materials and labor. Fourth quarter operating expenses were $61 million at the midpoint of our previous guidance and flat to the previous quarter. Our operating expenses slightly declined as a percent of revenue year over year and flat to the prior quarter. Our mix within operating expenses shifted with more investment into R&D during 2022 to support the strategic programs Mike highlighted earlier in his opening comments, which will help propel our growth during the next phase of expansion. Our operating income of $76 million which increased 10% year-over-year, was 30% of revenue for the fourth quarter. Our record-level net income in the fourth quarter was $78 million, or $1.57 per share, up 28% over the same period last year and 17 cents above the high end of our previous guidance range of $1.25 per share to $1.40 per share. During the quarter, we had several one-time discrete tax items that positively impacted our full-year effective tax rate, bringing it down to 10.4% as compared to our previous guidance range of 12% to 13%. Excluding the impact of these one-time tax benefits, we would still have exceeded the high end of our guidance range by approximately one penny. Now moving to the balance sheet, our cash and short-term investments were $548 million with operating cash flow of $137 million for the year, down from 2021 levels driven primarily by the increase in inventory within the year as we managed through supply chain issues, increased safety stock levels, and ordered long lead time items. Inventory ended the year at $324 million as we continued to receive in key components within the quarter to support the growth in our lithography business and to service our expanded install base. One of our top priorities for 2023 is to optimize our levels of inventory and return to the mid $200 million range in 2023. As a result, we expect inventories to start declining in the first half of 2023 and throughout the year. This will contribute to our free cash flow returning to historic performance levels of over 20%. Accounts receivable increased to $241 million in the quarter, and our day sales outstanding increased three days to 87 days, primarily due to the timing of revenue and receipts within the quarter. As commented on during previous quarters, we continually assess our capital allocation strategy, which includes the balance between internal investments, M&A, and share repurchases. During the quarter, we repurchased an additional 846,000 shares of common stock, bringing our year-to-date total share repurchases to just over 1 million shares, resulting in a return of capital to shareholders of $65.2 million. The share repurchases were executed under existing $100 million authorization. Now turning to our outlook for T1. We currently expect revenue for the first quarter to be $200 million plus or minus three percentage points. We expect gross margins will be between 51% to 53% as we pivot from and manage through our manufacturing cost profile in place, supporting our record year. For operating expenses, we expect to be between $53 million to $55 million. For the full year 23, we expect our effective tax rate to be between 14% to 16%. We expect our diluted share count for Q1 to be approximately 49.2 million shares. Based upon these assumptions, we anticipate our non-GAAP earnings to be between 80 cents per share to 95 cents per share. As we enter 2023, we have already started to execute plans to reduce annual spending in the range of $25 to $30 million, which includes driving further operational efficiencies at our manufacturing sites, staff reductions, reduced discretionary spending such as travel and outside services, while offsetting our annual employee compensation increases. With these efforts, we expect to move back into our long-term operating model when industry growth returns. And with that, I will turn it back to Mike for additional insights into 2023. Mike?

Thank you, Mark. As Mark just mentioned, we expect a slow start to 2023. For the first quarter, we see specialty and advanced packaging declining by mid to upper teens, impacted by both the broader market slowdowns and the effects of seasonality. We expect advanced nodes revenue to decline by an estimated 30%, primarily due to sharp reductions in memory spending and restrictions in China. Looking beyond the quarter, we see customers reducing wafer starts or delaying expansion plans in response to the current oversupply of chip inventories. Advanced logic investments continue, but higher volumes are not expected until 2024, with slowing smartphone sales driving down utilization of lines and advanced packaging. Overall, wafer fab equipment spending estimates are down 20% for 2023, However, analysts at Stiefel and Morgan Stanley are forecasting equipment spending to be down an estimated 30% after excluding front-end and lithography spending. Despite this weakening environment, we remain confident in our thesis for outperformance, which includes backlog to support our lithography business doubling in revenue this year, Novus Edge inspection increasing 50% to support EUV wafer manufacturing, And we expect revenue from our power and compound semiconductor customers to grow this year. In total, we see at least 70 million in incremental revenue from these markets, giving us a range of market outperformance that is down about 18 to 22% year over year. In response to the industry slowdown, we've taken steps this quarter to reduce our overall expenses by about 11%, which includes both operating and manufacturing expenses. The majority of these reductions were in variable costs with minimal impact to our full-time employees. These adjustments will allow us to maintain a healthy financial model while continuing to invest in the R&D programs critical to our customers. We will also take advantage of this time to focus on supply chain initiatives that will strengthen our margins and, again, move us closer to our long-term operating model when growth returns to our markets. So though timing for that return to growth is not clear, the longer-term estimates for chip growth has not diminished and is currently estimated to be $1 trillion by 2030, nearly double the current demand. In addition to strong unit growth, the complexity of the device is increasing and thus requiring additional process control innovations at a higher capital intensity to maintain viable yields. This is a great environment for OntoInnovation to continue to expand our customer partnerships across the semiconductor value chain and contribute to the introduction of the exciting new devices that will enable a smarter, greener, and more connected future. And with that, we'll open the call for your questions. Operator?

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. And if you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll pause just a moment to allow everyone an opportunity to signal for questions. And we will go to our first question from Brian Chin with Steeple.

Hi there. Good evening. Thanks for letting us ask a few questions. Mike, maybe just to clarify, I think, what I heard in the remarks, but the way you're kind of aligning the air at this point, you see revenues down, was it 18 to 22% year over year? And I guess that would, let me clarify that. And I guess, do you see maybe revenue tapering off a little bit further into 2Q and then maybe stabilizing there and kind of flattening out for the year? Is that sort of the contour that you're anticipating or is there sort of a different pattern?

We see a lot of movement right now.

That's what we believe. We think we're going to stabilize Q1, Q2, and start to see some improvements. But again, there's been a lot of movements, both in and out. We've seen movements into Q2. We've seen movements out. But right now, you know, we're expecting that to be flattish, maybe slightly up from Q1. Flattish and slightly up, okay.

How about, you know, gross margins relative to some of the cost reduction efforts that you talked about, I think the 25 to 30 for the year, are they focused sort of balanced between OPEX and above the line or how should we sort of maybe dial that into our models?

Yeah. Yeah. Brian's Mark. Yeah. No, I think, you know, I would say it's probably 60, 40. I mean, there's definitely more down in the OPEX because I think there's, You know, there's a little bit more discretionary in that level related to traveling and other third-party services and things like that. I mean, we are looking at all areas of gross margin as well, you know, driving efficiencies there. You know, we've had some benefit from freight reductions and things like that. So that will flow through margin.

Got it. That's helpful. And then I guess tied to the gross margin guide for Q1, Obviously, there's some volume impact there, but how much has NICs come into play there? It sounds like the panel lithography business should still be incrementally strong this year. So how much is maybe NICs related to in that gross margin guide?

Yeah, certainly there's some amount of NICs in there, but I think the bulk of it is being able to make the adjustments Relative to the change in volumes, the adjustments to manufacturing costs and capacity relative to the change in volumes. So that's the bulk of it. There is some impact of a relatively strong lithography quarter. So it's nearly 50% greater than the prior quarter. But we do expect margins to start to move back into our level even as early as QP and moving into the second half of the year as well. As a reminder, we did say we were going to have incremental improvements throughout the year on the lithography tool margins in the end 2023 with those margins at target.

Okay, great. All right. Thanks. Appreciate that. And we will go next to Craig Ellis with B Reilly Securities.

Yeah, thanks for taking the question, and congratulations on all the financial records and calendar 22, guys. Nice to see. I wanted to start just by digging a little bit deeper into the cost savings. So, nice to see that you're protecting margins. The question is for the savings that look like about 16 million in OPEX and 11 million in COGS, how much of that is included in the guidance that you've given for the first quarter And then with some incremental benefit through the year, how should we think about the linearity of what's left beyond what you realize in one Q?

Yeah, Craig, it's Mark. Yeah, no, certainly a portion of that, those savings are in our guide for Q1. We've certainly tried to start executing even at the end of Q4 to have those reductions be impactful to our Q1 guide and our results. There's certainly a lot of work we still need to do and we plan to do. As we said to, as Mike just made note, that the improvement around margin, that'll occur in Q2 and beyond. We will see, obviously, historically, Q2 does pop up from an operating expense standpoint with the annualization of our merit and other stock-based comp items. Um, but again, we're, we're doing our best and we've got plans in place and we've done, uh, um, you know, we started to execute to offset those as much as we can. Um, so I think you'll see, you know, I would say it's probably proportional, uh, throughout the year. Um, and, uh, you know, we're going to continue to look for areas, uh, to drive the efficiencies up.

Okay. Proportional to the year, but with cogs really starting in two queue rather than one queue. Is that right?

Yeah, I would say there are some elements in Q1, but I think you'll see the majority of that probably in Q2 and beyond.

Okay, got it. Go ahead.

No, it's just the pivot from Q4 into Q1 and just looking through the overall absorption and volume issues.

Got it. And then, Mike, just very helpful to get your view on industry generally and and where the company will shake out. It looks like the excess growth to industry is pretty similar to what you saw three months ago. If we take litho out of WFP, we're at about minus 28, your midpoints minus 20. So that's about the 750 basis points you were looking for before. Is that the right read? And related to that, it looks like, at least versus my tracking, panel litho is up a little bit. versus what we were expecting before. I was looking for 60 this year. I think you talked about 80. So just help me frame the macro and then come back to the micropoint on Panalito.

So definitely since our last call in November, we've seen, let's say, more of a pullback, a more broad pullback from, as I mentioned in my prepared remarks, from the advanced nodes, even logic a little bit, but DRAM and memory, NAND and DRAM, very significant pullbacks. And then even in the packaging area. Yeah. So, and as far as the, you know, what we're seeing, so that, when we originally talked, we talked about a 20% down market. Now we're looking at maybe a 30% down X front-end litho. So that looks to be where the market's leveling out. And based on the several areas of booked out performance and litho being one of the areas, as you pointed out, then we've had those bookings of the full 80 million in place. And then the Novus Edge is also booked with that upside. And then we already have several orders for compound semiconductor manufacturers that bought complete suites of tools, which is quite exciting. The value proposition of our broad portfolio and the connected solutions we have with the software is really resonating in the compound semi-market. So we see bookings there going up primarily from power customers. And that's part of why we believe we're going to, you know, why we're confident in our thesis for outperformance in 2023.

Just on that last point, Mike, I think if I think back over the last 18 months, we first started seeing customers buying full suites of tools. And I think I remember seeing that in DRAM and NAND. And so now you're seeing it as well in compound semi. So it seems like the solutions that you're offering are really resonating. And, you know, any thoughts on what the demand profile looks like more intermediate term beyond just 2023? How do you look at the growth potential for compound semi on a multi-year basis?

Oh, we think on a multi-year basis, we think our position in compound semi is just in the early stages of building out. We've always had a very strong software focus there, and we have a good software position. But as far as the inspection and metrology, that hasn't been as big a focus as we looked at other areas. And now what we're finding out is there's a number of high-value problems that are For instance, our sub-micron resolution for the inspection, many of those 15 customers were tied to, several of those 15 customers were tied to power applications. And then the metrology, where it wasn't really promoted to those customers, we're finding some real opportunities. As far as the size, what you asked for, we haven't really looked at 2024. It obviously depends on On the continued growth there, the numbers we see is double-digit continued growth, annual growth rates, at least for the next few years. So with that, we expect to grow better than that, better than double-digit. Well, I mean, if it's 10%, maybe we're going to grow another 50% better to 15% or 20% based on the fact that we're introducing new products into a broader portfolio or suite. That seems to resonate with the customers.

And it's solving real problems for them.

Go ahead.

Sorry, I just mentioned it's also solving.

Yeah, I think we've been picking up data points that the yields are certainly tough in certain areas of compound semi, so your solutions would be quite appropriate. Lastly, I think you mentioned that there were three specific initiatives, Thin Films, Novus Edge, and panel that could add an incremental $70 million of revenue. Looks like panel would be about half of that. Did the other two shake out about 50% each, or how do we think about the relative contribution of the three?

So thin films is additional upside. That could be potential upside. So we mentioned a lot of that, but a lot of that is tied to some of the front end. So we didn't mention that. What we said was Novus Edge and then Compound Semi power devices, and that includes a suite of products. But it's the power market that we see driving fairly good growth. As far as the shakeout, I'd say it's 50-50 of the other 30 million, 50%, so 15 million each, roughly.

Got it. Thanks very much, guys. Good luck.

You're welcome. And we will go next to Quinn Bolted with Needham & Company.

Hey, guys. Just wanted to maybe follow up on the compound and power market. I think last quarter you said it was the second largest segment. I apologize if I missed what you said it was.

this this quarter but wondering if you could just sort of give us a slice how big is that business for you now on an annualized basis uh you know quinn we don't break it out but it's definitely becoming a more significant i'm looking now at where it's definitely becoming a more significant part of the business it remains One of the largest segments in the fourth quarter. It grew a lot, but we also had a lot of Foundry Logic spend, as we mentioned. DRAM tank, but Foundry Logic stayed okay, so it's still relatively second in the categories, which is a high. And like I mentioned, it grew 54% quarter to quarter. So does it continue that way? No, I don't think so. It's a lot of small numbers right now. But does it continue double digits? You know, I think that's reasonable.

Got it. Got it. And then just thinking about the year, you know, you got it to 200 million at the midpoint for the March quarter. You know, if I just look at you're down 20 percent, you know, outlook for 2023, you know, from the billion dollar base, you know, kind of feels like. you're going to run rate at about 200 million for each of the four quarters. And so I just wanted to make sure that I'm thinking about the linearity. It sounded like in response to an earlier question, Mike, you thought maybe there was a little bit of chance for growth in Q2. And, you know, I think previously you were looking for a slightly stronger second half. So just trying to get the shape of the year right in terms of your current expectations.

Yeah, Quinn, I think that's about right. Obviously, you know, things changed a lot from last November when we first guided, so we're just trying to reflect what we believe is a, you know, I guess a bottom-end scenario, and hopefully we can start, you know, as we start getting better visibility and seeing more of the other activity, packaging, for instance, we'll see what the smartphone technology refresh cycle looks like, et cetera, 5G transition, you know, when we move past this inflationary period and recessionary mindset, and we'll see what that does to, you know, to inventories and then further expansions. But right now that's, that would sort of be our, our bottom case.

Got it. Okay. And then I guess for more, you know, it sounds like with the cost reduction actions, you can get back towards a 54% gross margin in Q2, and if not Q2, certainly by second half of the year. But that's on kind of flattish revenue. As I look into 24, 25, to the extent revenue gets back to the 250 million or higher quarterly level, it feels like there'd be some pretty good absorption benefits to gross margin. So I guess I wanted to ask you, you know, getting to 55 or 56, you know, feels like you could get there pretty easily just on an absorption basis. And so I wonder, you know, are there some cost, you know, offsets that maybe come back as revenue starts to grow that would pressure margins? Or do you think that, you know, getting to 55, 56, maybe even higher as revenue recovers is now possible with some of these cost reduction actions you've taken?

Yeah, no, Queenie, you're absolutely right. I mean, our goal is obviously to go through and have these reductions be effective this year, help drive the profitability and stay in that range of that higher margin and maintain the OPEX. But certainly for 24 and beyond, I mean, our goal is to get quickly back on track to the long-term operating model and and reap the benefits of, I guess, the operational efficiencies that we're trying to drive in 23.

Yeah, Quinn, it's kind of funny to say, but never let a good downturn go to waste. And so what we mentioned is we're going to still invest in supply chain initiatives and some of the – remember the second-level synergies we talked about after the merger that we never got to because we were just so – growing so fast? Now we have a chance to get to those and we've got some pretty aggressive plans to try and complete some of them this year so they'll be impactful in 2024 so there's there's quite a bit of of strength that we hope to bring into our foundation for 2024.

Great my last question was just really just a clarification on the on the lithography margins. Mike, I think you said that you now expect to get to kind of target levels by the end of 2023. I thought previously you thought some of those margin improvements might not happen until 24 because of the time to increase manufacturing and, you know, just time to reduce component costs. And so I'm wondering, have you been able to pull in some of that margin benefit or perhaps improve pricing that's leading to better margins today? Or did I misinterpret your comments around lithography margins?

Yeah, I think it's a little bit of both. We've been very aggressively pursuing the margin situation, both from the cost side as well as a little bit on the pricing side. But we're also seeing some of our advances. So some of the new advanced technology we're beginning to release where we're seeing the ability to charge for for the value of that, where two years ago when we booked a lot of these orders, we were still selling PowerPoint presentations and demo lab equipment. So they didn't really get to see. Now we're proven, we're understood, the capability is clear, and we're able to charge more of the value for the new capabilities we're bringing in, whether it's overlay upgrades or illumination and throughput upgrades and things like this.

Got it. Okay. Thank you. And we'll go next to Hans Cheng with DA Davidson.

Hi. Good afternoon. Thank you for taking my question. So first I want to follow up on the industry commentary. I was wondering what's your thought on the memory downturn, like given your conversation with the customer, When do you think the memory spending could resume?

I would say at the earliest, it's the tail end of 2023 and possibly into 2024. The caveat to that is that would be production, but there could be some spending in in R&D. So more spending in some of the high-stack 3D NAND lines, which are still in the infancy. We could see that where the customers want to, when they go to market, be more aggressive with their newer products going to market and hopefully make up some of the ASP erosion. And a similar story in DRAM. So that'll be the inflection, or that'll be the decision points that our customers are thinking through. But right now, they're they're really focused on watching the inventory levels, watching ASPs, and working this through the supply chains.

Got it. Okay. And then, even in your prepared remarks, so the Atlas PHY that's being selected by O3, the manufacturer for the gate overrun transistor, so does that imply you have 100% market share. And just wondering, is there any competition on that?

There is competition. So we don't have 100% share.

So depending on which customer we talk about, our share position is different, each one. In general, we're fighting to achieve over 50% share, and we have that at the majority. And if I take the average, it would be well over 50% market share, if I take the average of all three of them. And again, these decisions aren't fully made, so we continue to fight and try and bring more layers onto our systems. We're also looking at You know, the gate all-around transistor is the hardest thing to measure, but we're also looking at moving outwards, outside of that, into the back-end aligned metallization layers that are further downstream. They're a little easier, but again, with our platform, the capability of our platform to be optimized for price performance, we're better suited for those applications as well.

I see. And is that share similar or higher compared to the previous notes?

It's definitely higher. In my remarks, I mentioned that, you know, based on this, we would expect at least a 20% improvement in revenue based on the dynamics of higher capital intensity and higher share versus prior notes. Yep.

Okay. And then also, I was wondering, you mentioned mini-LED. It's kind of smaller right now, but it seems like it could have some potential here. Just wondering how would you characterize the size of the opportunity from the mini-LED?

I chuckle because I've got several display customers, and they have different opinions on the mini LEDs, so I want to be a little bit careful. I think there's certain applications where the mini LEDs are being looked at, and certainly very aggressively by one of the large smartphone manufacturers. Whether or not that proliferates and becomes the... You know, the new display type, replacing AMOLED displays, I'm not sure yet. There's certainly different opinions from the experts in the display manufacturing.

Okay. Got it. And then lastly, just I wonder if you have any update on the capital allocation strategy, just especially in just given that you have very healthy balance sheets, and would you consider more share buybacks, or would you prioritize for the MMA and so on?

Yeah, definitely, as we look at the capital allocation, if the opportunity presents itself based on our set criteria for buybacks, we will execute that in the quarter. and continue to do that within the approved limits.

And we're also, of course, looking for M&A opportunities and being as aggressive as we can there. It's a great time right now, so we'll continue to search that as well.

Okay. Thank you. Thank you, Hans. And we'll go next to David Dooley with Steelhead Securities.

Yeah, thanks for taking my question. One of the things I think in your press release, you were talking about how your DragonFi system was qualified, I think, to do some hybrid bonding applications. Could you just talk a little bit about what's going on in that particular product line and area?

Yeah, so it turns out one of the critical issues with hybrid bonding is the surface roughness of these pads And when you're pushing them together, any kind of deformity, particle, or issue with the roughness, you have a bad adhesion. And, of course, it just takes one of the thousands or millions of interconnects per die, depending on what we're talking about here, to then now destroy two packages that you've just tried to connect. So the ability for the Dragonfly G3 to not only have the sensitivity... to detect the defects, but also leveraging the ADC to eliminate all the nuisance defects so the customers can really focus on the true yield-killing defect. That's a big advantage. In addition, you may recall the ClearFind has always been a source of a reliability, like improved reliability, where resist residue, which can't be seen through normal optical techniques, can also be on these pads, and you can have a good bond You can have an electrical test okay, but because of the resist residue, that bond through heating and cooling and from cars and taking your phone out, walking around in the weather, you have a break. It ends up being an electrical failure. So that is another big advantage for the Dragonfly G3.

Now, is this dye-to-dye attachment or dye-to-substrate when you talk to pads, so that's dye-to-substrate?

We're seeing applications for both. So we're involved in both dye-to-dye and dye-to-substrate. Okay.

And regarding your compound semiconductor business, is the recent – increase in growth rate. You talked about power. I was just wondering, is there a significant contribution from silicon carbide at this point, or is that a focus, or can you help us understand what your exposure is there?

Yeah, we definitely have seen more interest and growing interest from silicon carbide. It's still a small part of the overall power, but it's certainly a fast-growing area and an area that people are investing a lot in, and they have a lot of yield issues. So we're engaged there, but I'd say from the growth we saw in the last quarter, it was, I'd say, less than half, maybe a third of maybe a little less than a third silicon carbide and the rest again and some other compound semi-applications.

Okay, and then final question from me is, you talked about additional qualifications, I think, for the IRIS tool, but it wasn't on the list of products that are going to grow on a year-over-year basis. I'm imagining that's because of the memory sector, but maybe just give us a little bit more color. I think that product was, you know, a quarter ago was expected to grow year over year. And now you've excluded it on that list. And so is that the area where you're seeing the most reductions and, you know, to kind of adjust for your new guidance for next year?

Actually, the iris is going to grow, but not as significantly as some of the other products. So, and, you know, it's, relatively mild growth is in the face of several of those customers, you know, reducing expense fairly significantly. You mentioned the memory. Memory is expected to be down 50% for wafer capital equipment. Logic will also be down maybe in the 10 to 15% range. And yet our IRIS platform, based on the initial penetration and the new customers that continue to adopt it and including some power customers that are adopting it. The IRIS platform will grow, but it will be incremental. It won't be huge. The beautiful part is we're planting all these seeds across the major customers, so when expansions do occur next year, hopefully, maybe late this year, we should see fairly significant growth in IRIS.

Okay, great. Thank you. Yep.

And as a reminder, it is star one for questions if you have a question at this time. And we'll go next to Mark Miller with Benchmark.

Let me add my congratulations on a very good year in 2022. I was wondering if you could estimate in terms of the projected sales decline, what percent of that is coming from the related to the new U.S. restrictions?

Oh, it was about 8% to 10%.

8% to 10%, okay.

Yeah, and that was mostly booked, so that was a big hit.

There's been a lot of funding by the U.S., Europe, and Japan, as well as several new fabs have been announced and are currently coming up. But you're not optimistic. Are you optimistic when these opportunities will start to show up in orders for you? Will it be more 2024?

We're seeing orders now.

So, you know, from, although that's not chipsack money, but some of the, you know, like the TSMC FAB going into Arizona, we're seeing orders now. So those incremental orders are happening, but You know, the Samsung Taylor fab, the Ohio fab from Intel, et cetera. I don't think we see any real significant volume of orders until 2024. Thank you.

And at this time, I would like to turn the call back to Michael Schaefer for any additional or closing comments.

Thank you. We'd like to thank everybody for joining us today. Our replay of the call will be available on our website about 7.30 Eastern time this evening. We'd like to thank you for your continued interest in On2Innovation. Jenny, please conclude the call. Thank you.

And again, this concludes today's call. Thank you for your participation. You may now disconnect.