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

Ladies and gentlemen, good day and welcome to the Onto Innovation Third Quarter Earnings Release Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Sidney Ho. Please go ahead, sir.

Thank you, Lisa and good afternoon, everyone. Onto Innovation issued its 2024 third quarter financial results this afternoon shortly after the market closed. If you did not receive 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 Plisinski, Chief Executive Officer; and Mark Slicer, Chief Financial Officer. I'd like to remind you that the statements made by management on this call will contain forward-looking statements within the meaning of the federal securities 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 Onto Innovation's results, I would encourage you to review our earnings release and our SEC filings. Onto 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, a detailed reconciliation between GAAP and non-GAAP results can be found in today's earnings release. Let me now turn the call over to our CEO, Mike Plisinski. Mike?

Thank you, Sidney. Good afternoon, everyone and thank you for joining us today. Overall, we executed well in the third quarter with revenue coming in at $252 million and setting a new quarterly record for inspection. In fact, we're on pace to nearly double our inspection revenue this calendar year. We also improved our gross margin to 54.5% and operating margin to 28%. This resulted in record cash generation from operations of $67 million. Mark will soon discuss these highlights and our outlook for Q4, which was negatively impacted by over $10 million in JetStep lithography pushouts due to customers' capacity needs. But first, we'll review the third quarter highlights, starting with our specialty device and advanced packaging markets, where AI packaging revenue led the inspection business with growth in high-bandwidth memory offsetting a little less than projected decline in 2.5D logic packaging. Looking ahead, we expect to see increases in volume for logic packaging as well as an increase in capital intensity for process control to address the growing complexity and need for higher process yields. This includes new demand for our front-end metrology systems, particularly for films and acoustic metrology. In fact, advanced packaging was one of the largest markets for our metrology business this quarter. Revenue from power devices was the second largest market and also set a quarterly record. Growth came from both metrology and inspection process control systems. Our power semiconductor customers continue to focus on driving yield improvements, especially with challenges associated with transitioning to larger wafer sizes, even as end demand remains temporarily muted. We expect this focus on yield to continue into next year and at least sustain this record level of revenue. Inspection has clearly been a strong driver for us and we're expanding our core inspection technology with the tuck-in of Lumina Instruments announced earlier today. Lumina is a small company with a very rich background in laser-based inspection technologies used in unpatterned wafer and emerging panel applications. Their patented technology will allow us to simultaneously scan top, bottom and subsurfaces with sensitivities below 100 nanometers for silicon carbide and gallium nitride applications. We believe this technology will also be important for inspection of glass substrates and carriers used in 2.5D and 3D advanced packages where detecting surface defects, buried inclusion defects and residues on the silicon or glass core are important to yield. This new capability is complementary to our pattern inspection technologies with no overlapping capability. And as a result, we expect the new applications will expand our SAM by $250 million annually in the next 3 years. In addition to Lumina Instruments, we announced the acquisition of the lithography business from Kulicke & Soffa. With this tuck-in, we had an incredibly talented team with over 200 man years of lithography experience, 24 issued patents and 8 more pending. Based in Eindhoven, we believe this team and technology will contribute to the acceleration of our JetStep lithography road maps and extend our competitive differentiation. We expect the combination of these 2 small tuck-ins to be accretive to earnings within 12 months and generate up to $100 million in annual revenue in the next 3 years. For reference, revenue today is negligible. While we strengthen our opportunities in the specialty and advanced packaging markets, we also see a recovery from the advanced nodes. As expected, we saw growth in logic, DRAM and NAND in the quarter. In addition to our strong position in OCD metrology for these markets, we're seeing solid traction with our film metrology. This year, we're on pace to grow films metrology by over 50% versus 2023. Now I'll turn the call over to Mark to review our financial highlights and provide fourth quarter guidance.

Thanks, Mike and good afternoon, everyone. As Mike highlighted, we exceeded the midpoint of our revenue and EPS guidance, executing towards the high end of these ranges due to better-than-expected demand for advanced packaging for AI devices, gate-all-around investments in advanced nodes and stronger software and services within the quarter. We achieved another record operating cash flow of $67 million for the second straight quarter. Operating cash flow yield of 27% represents more than doubling of operating cash during the same period last year. Third quarter revenue of $252 million was up 4% versus the second quarter and up 22% versus the prior year. The third quarter EPS increased 2% sequentially to $1.34 and up 40% versus the prior year. Looking at the quarterly revenue by markets. Our biggest market remains specialty devices and advanced packaging, which was down slightly from Q2 with quarterly revenue of $161 million and represents 64% of revenue. Our biggest sequential increase was advanced nodes, which had revenue of $42 million, increased 32% over Q2 and represents 17% of revenue. Software and services with revenue of $49 million increased 5% over Q2, representing 19% of revenue. We achieved 55% gross margin for the third quarter at the high end of our guidance range of 53% to 55%, driving more than 100 basis point improvement over the second quarter and over 300 basis point improvement since the beginning of the year. Third quarter operating expenses were $67 million, exceeding the high end of our guidance range as we accelerated our ramp in R&D investments within the quarter, extending our product capabilities in integrated metrology and technology differentiation to expand our 3D metrology for advanced packaging applications. For operating income of $70 million was 28% of revenue for the third quarter compared to 27% from the second quarter. We achieved quarter-over-quarter operating margin improvement with 3 consecutive quarters totaling approximately a 300 basis point improvement since the start of the year. Our net income performance, also 26% of revenue, was supported from favorable investment income resulting from our increased cash balance. Now turning to the balance sheet. We ended the second quarter -- sorry, we ended the third quarter with cash and short-term investments of $855 million, achieving operating cash flow of $67 million and converting 100% of our operating income into cash. Inventory ended the quarter at $308 million, down $12 million versus Q2 and achieving 5 quarters of sequential decline. We expect further inventory reduction of another $8 million to $10 million for the fourth quarter as we [Audio Gap]

This is the operator. Please stand by. We are experiencing technical difficulties. Please stand by. I will place you back on a music hold while we reestablish the feed line. You may continue the conference, sir.

Okay. Well, thank you very much. Hopefully, everybody is still on the line and I will finish my prepared remarks and we'll go to questions. So in summary, we're aligned to several diverse end market drivers and we're well positioned to leverage our portfolio of inspection metrology and software to solve manufacturing customers' high-value problems. Through close customer collaborations, we have many exciting new product launches such as 3D bump metrology, which we recently delivered to a leading memory manufacturer and void inspection for wafer bonding applications that we expect to ship this year. In addition to the organically developed technology, our recent tuck-ins further enhance our -- bolster our portfolio of synergistic technologies and the markets that we can pursue. Combining the outlook for the end markets we're serving, with our new product opportunities, we expect another solid year of growth in 2025. And that concludes our prepared remarks. Lisa, please open the call for questions from our covering analysts.

[Operator Instructions]. And our first question comes from Brian Chin with Stifel.

[indiscernible] A few questions. And also just FYI, Mike, I think where you picked up versus where Mark may have left off, I think there might have been a break there in terms of some of that content but just FYI. Anyways, back on script here. The -- so TSMC effectively ran out of space to expand its CoWoS footprint this year but the demand is very high. And so I was kind of curious, what do you currently see as timing for when that activity could pick up again? And when you combine that with the visibility you have on gate-all-around expansion, how confident are you that Onto revenue will show further improvement from existing levels moving into first quarter or first half of next year?

Good question. We're, I'd say, highly confident. We're confident in revenues growing from here as we move into the first half of next year. And it's driven by not just gate-all-around but we also mentioned DRAM capacity expansions that we're seeing to support both the enterprise server starting to pick up a little bit but also the lack of capacity due to supporting all of the HBM growth. So we see both. And as far as the TSMC -- or sorry, the -- yes, what you mentioned, TSMC, the CoWoS expansion. They have been very aggressive at adding the capacity. We did mention on the prepared remarks that may or may not have made it out there that we expect the fourth quarter to see a fairly significant increase, while the -- yes, while the HBM maybe is a little more muted in the fourth quarter from an AI packaging perspective. So they're already starting to find space to add capacity and we expect that to be -- remain fairly strong in the first half.

Okay. Got it. And that's helpful. And so maybe a little bit earlier customer readiness from that standpoint to take equipment, it sounds like. And then in terms of that $10 million lithography delay, was that customer-driven? Any other sort of color behind that? And when has that been rescheduled to?

We're not clear on the reschedule. So that's still being discussed. But yes, it was customer-driven based on their needs. The tools are ready to go.

Okay. Got it. And maybe just kind of one more question in broader strokes. KLA last night on its earnings call, in addition to sort of being pretty upbeat on process control intensity, they're seeing at TSMC as that customer shifts from pilot to high-volume production. They also expressed a lot of confidence based on the high process control intensity that they would outgrow WFE in 2025. And so when you look at that, again, that high process control intensity, both for gate-all-around expansions as well as CoWoS, advanced packaging, maybe HBM, I guess how much confidence do you have in n Onto's ability to outgrow WFE again in 2025 like you did in 2024?

Well, it depends on what you're expecting WF to be. But if it's in this 5% to 10% range, which is where I think most of the consensus is landing, then we're highly confident in outperforming those numbers. For the same reasons and I did talk about increased process control intensity, especially in the area 2.5D logic or AI packaging, based on the complexity of the process as well as the needs for much better yields. I mean these are very expensive devices. And any yield issue across any of the products is going to drive a pretty expensive loss. So yes, there's a lot of process control intensity. And yes, we're seeing that as well. And they're still learning. So a lot of the capabilities of our Dragonfly with the many different sensors, we see the customers working with us to combine different sensors to find the solutions and metrologies that don't exist today in any other tool. So there's a lot of learning that's going on through our collaborations with the customers.

And our next question comes from Vedvati Shrotre.

So the first thing I wanted to ask about is, last quarter, you had talked about volume purchase agreements for gate-all-around nodes. I think they were roughly $120 million. Can you give us an idea or a sense of how that splits out between customers given that some of the leading-edge customers are now facing issues with their gate-all-around transition? So has your visibility on those VPAs changed? Is there any conversation changes where you may not get that whole $120 million?

Not any major degree, no. In fact, we continue to work off some of that VPA, there's still quite a bit left for 2025 and our backlog continues to strengthen and look relatively good across the board. So no, I would say that, yes, there's certainly some movement by some customers but our position remains strong and growing or strengthening, I should say.

Is it primarily because of the leading foundry customer being strong? Is that a way to think about it?

Yes, that's one but we did mention that the number we talked about were 2 customers and both look still strong.

Okay. Understood. So now maybe on -- changing tracks on the HBM kind of a ramp. What's the visibility you have on the HBM capacity additions? Like one of the things Teradyne pointed out on their call, they're seeing HBM capacity additions could be muted next year as in the growth for Teradyne's HBM revenues could be muted next year. What is your sense or visibility into how that HBM piece of the business goes into, or the trajectory of that business into 2025?

Well, I also mentioned that in my remarks around -- we're seeing a quite an increase or doubling in capacity from the 2.5D logic side. And last quarter, we talked about HBM increasing. So that alone would drive an increase -- an expected increase in HBM. And then, of course, you have an additional intensity, additional number of HBM around each GPU for the new, latest devices. That said, we also see, let's say, we're not seeing movement on HBM expansion yet. And so I echo that. And that's what I mentioned in the prepared remarks is that it's not clear yet but we would expect that some kind of expansion would have to follow to support all of that new 2.5D logic that's coming on board. My guess is there could be still some conservatism by the players and still trying to understand who's going to win, what share from, let's say, the major driver, the major end customer. And so they're careful with the capacity expansions. That's my guess but I don't know but we are seeing that muted behavior from HBM right now.

Got it. That's fair. And then the last one I had was on the power semiconductors, could you help us understand sort of the size of that revenue opportunity for you? And given that you're seeing a big downturn in the auto markets but your inspection revenues continue to be strong on the power side, it would be great if you could provide like what's the disparity there? What continues to drive your revenues versus we're seeing CapEx cuts across the board.

Yes. I mentioned it the last couple of quarters, it's all about driving yields and higher yields. And I mentioned there's some wafer transitions, whether it's silicon carbide going from 6- to 8-inch or GaN moving from 8 to 12 inch. That has an impact on yields and sort of creates a requirement for additional process control or better process control capabilities. So we're seeing some of that. And then I think it's pretty well publicized that the yields in general are not that high. So customers tend to want to -- if they want to increase output or prepare for increased output, they can focus on yield instead of adding just capacity and throwing away. So that makes them more profitable when they do actually ramp.

So how should we think about the opportunity for you as in kind of the size of the business? Or any color there would be helpful.

Well, you know we don't break it all down there but it's becoming one of our top markets behind AI packaging in the specialty and advanced packaging market. So I think it is #2 in that space.

And we'll move to our next question from Edward Yang with Oppenheimer.

Just wanted to drill down a little bit deeper into your outlook into 2025. You're expecting continued growth there and outpacing WFE. But obviously, this year, you're looking for revenue to grow about 20% and that's well a multiple of how much WFE grew this year. So thinking about all the different puts and takes, what are the things that give you confidence or less confidence? And will you -- can you size up again? Are there any reasons why growth should meaningfully accelerate or decelerate from your '24 run rate?

I would say, since I said we'd grow, there would be a meaningful acceleration. And that would be in advanced nodes for sure. That's been bouncing along the bottom and now we've talked about gate-all-around opportunity expansions but we now also are starting to see and gain more confidence in DRAM, additional DRAM capacity and growth there, driving our advanced nodes. So we see that staying -- growing quite nicely. The AI packaging, for sure, gate-all-around and the process control intensity and volume increases there is creating opportunities. We'll see what happens with the HBM. Does it stay muted or not? If not, I think there'll be some significant growth there. I don't see how it could stay as it is if the CoWoS essentially doubles. So we'll see but that's that. And then we talked about the power semi. And in there, I said we would at least sustain these record levels in the prepared remarks, which implies we would expect to exceed and set new record levels. So this would be a floor for us. And so that will be another growth driver for us as we look at 2025.

And just to clarify, when you say accelerate, I mean, do you mean accelerate off of a 20% revenue growth rate?

Yes. Good point. No, I'm not trying to imply we'd grow above 20%. No. So I should have used the word not accelerate.

And one of your larger foundry customers signed an advanced packaging deal with an OSAT in Arizona earlier this month. Does this have any relevance to your order book? And again, can you speak to the broader ability of your customers to place tools at this point? It seems like things are loosening up a little bit. Is space still at bottleneck?

Things are loosening up. So there's new capacity coming up. But even signing that deal, there's time lines to transfer and to qualify and to bring in tools, et cetera, which -- some of it's in process. So -- but there's not an immediate like launch, right? So yes, it's all part of the breaking of the current bottlenecks in the CoWoS capacity. There's also actions being taken by that large customer as well, internal. And there's been discussions about the Intelex purchase. And in my prepared remarks, I did mention Q4, we see a nice big uptick from the gate-all-around -- sorry, for the 2.5D logic packaging and we expect that to maintain pretty healthy in the first half.

And just a final question maybe for Mark. I saw the SG&A ticked up a little bit sequentially. And is that a good run rate going forward? Or was there any extra spending in there that impacted the quarter?

Yes. I mean I would think our goal is to hold total OpEx in line or better than Q3. So I'd use that run rate from Q3 into Q4, in my prepared remarks, which might have been abbreviated. Our goal is to drive offsets to the cost of the tuck-ins within Q4. So we can -- our goal is to stay at those levels for Q4, or better.

And we'll move to our next question from [indiscernible] from B. Riley Securities.

I'm actually on for Craig Ellis. But you mentioned packaging pickup in the fourth quarter. Is that kind of related to the increased complexity needs as we move into this RDL-based packaging, or is it more to do with just general volume increases? And if it's to do with this LDL -- RDL-based packaging increase, is that a trend that we can expect to continue as RDL picks up over the incumbent?

I think the complexity increases is from 2 things -- a couple of things. One is, yes, they're introducing some new processes that they've talked about. But 2 is, yields haven't been -- yields have room to improve. So they're also looking at areas that could be impacting yield and how can they measure, so you can't fix what you can't see. So how can we see -- help them see what is impacting yields so then they can make the adjustments and fix it. And that's -- that dynamic is also in play. And that's where I mentioned the incredible breadth of capability we have on the Dragonfly platform to bring to bear different types of sensors and metrologies and inspection in order to combine that data and see things that you wouldn't see on any single tool. So that provides new insights into the yield, opportunities to improve.

Okay. Yes, right. No, that's a great answer. So I have a question on the flies, the Dragonfly and Firefly. Obviously, they're really capable tools in 2D metrology. But you've also pointed out before how they're incredibly capable in the 3D inspection space. Do you see that kind of picking up share? I know you mentioned 1 memory customer who wanted it for these 3D inspection processes. Do you see that 3D inspection aspect to these tools picking up?

So there's localized 3D capability, which is very powerful and we use that for high aspect ratio, 3D, very high precision metrology. That is part of the 2D applications. What I was talking about was 3D bump metrology. And that's early -- that's still early stages. So it's too soon to predict how big or how much that could be. It depends on adoption rate and how well we do in production. The tool we shipped is an evaluation tool. So they'll now -- based on the data exchanges we've had and all the wafers we've run for them in our facility, they now want to take the tool on site, prove it in production and then hopefully, we start to see revenue. And that's probably 3 to 6 to 9 months on the outside type process.

All right. Got you. That's -- yes, I hope that goes well. And then about those volume purchases [indiscernible].

And we expect -- sorry, we do -- I was going to say we do expect to ship additional tools in the fourth quarter to additional customers for evaluation.

And that's evaluation on 3D?

Yes.

Okay. Great. And again, about those volume purchase agreements, so we were talking about last quarter, I forgot exactly who asked this question but there was some talk about how these might convert into kind of larger agreements in the future. Is there any progress there in terms of kind of converting these initial agreements into perhaps larger partnerships going forward?

I think what I might have said is that we would expect perhaps additional revenue through the year. And right now, they are still working on this. So I think it will -- they got to cut through this and then we'll see what happens in the second half of the year. But that's still my projection. I wouldn't -- if I was going to bias it, I'd bias it towards they're going to need some additional tools in the second half versus not.

And our next question comes from Charles Shi with Needham.