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Nanometrics (NASDAQ:NANO)
Q1 2019 Earnings Call
April 30, 2019 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Nanometrics first-quarter financial results conference call. [Operator instructions] Please note that this conference call is being recorded today, April 30, 2019. At this time, I would like to turn the call over to your host, Claire McAdams. Ma'am, please go ahead.

Claire McAdams -- Investor Relations

Thanks, Justin. Good afternoon, everyone. Welcome to the Nanometrics first-quarter 2019 financial results conference call. Speaking on today's call are Dr.

Pierre-Yves Lesaicherre, president and chief executive officer; and Greg Swyt, VP of finance and our principal financial officer. Shortly, Pierre-Yves will provide a recap of the quarter and our perspective looking forward, then Greg will discuss our financial results in more detail, after which we will open up the call for Q&A. The press release detailing our financial results was distributed over the wire services shortly after 1 p.m. Pacific, this afternoon.

The press release and supplemental financial information are also available on our website at www.nanometrics.com. Today's conference call contains certain forward-looking statements, including, but not limited to, financial performance and results, including revenue, margins, operating expenses, profitability, earnings per share and expected market demand. Such statements may be identified by the use of words like believe, expect and similar expressions that look toward future events or performance. Although Nanometrics believes that the expectations reflected in the forward-looking statements are reasonable, actual results could differ materially from the expectations due to a variety of factors, including general economic conditions, changes in timing and levels of industry spending, the adoption and competitiveness of our products, industry adoption of new technology and manufacturing processes, customer demand, shifts in timing of orders or product shipments, changes in product mix, our ability to successfully realize operating efficiencies and the additional risk factors and cautionary statements set forth in the company's Form 10-K on file for fiscal year 2018.

Nanometrics disclaims any obligation to update information contained in any forward-looking statement. During today's call, we will also refer to financial measures not calculated according to generally accepted accounting principles. Please refer to today's press release for an explanation of our reasons for using such non-GAAP measures, as well as tables reconciling these measures to our GAAP result. I will now turn over the call over to Pierre-Yves.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Thank you, Claire, and good afternoon, everyone. Thanks for calling in on this very busy earnings day. Nanometrics continues to operate with strengths and profitability in the current downturn in industry spending. Our first-quarter results reflected a somewhat different revenue mix compared to our forecast, resulting in revenues of $67.1 million at the higher end of our forecast.

Our gross margin of 52.5% was at the lower end of our forecast. The shift in product and customer mix took place very late in the quarter. And as the higher margin business will instead materialize in the current quarter, we expect to snap back in gross margin in Q2. During the first quarter, our outlook strengthened in the second half, which we expect will be up 25% to 30% from the first half.

As such, we made the decision to continue our level of R&D expenditure in Q1 in support of our longer-term strategic objectives. In combination, in spite of the higher revenue level versus forecast, earnings came in at the lower end of our forecast at $0.19 per share. It is important to note that the decision to maintain our level of R&D investments in Q1 reflects the stronger outlook for the year compared to our last earnings call. Our increased confidence that our revenue from the memory market have stabilized and will begin to recover from their Q1 low point, and a very strong second half forecast for the foundry, IDM and other device markets.

The highlight of our first quarter was a successful introduction of the Atlas III+, which is the latest version of our flagship automated Optical Critical Dimension or OCD system. The Atlas III Plus has rapidly gained traction with the world's leading semiconductor manufacturers with first-quarter revenues recognized from multiple customers across both memory and logic applications and in both development and high-volume production environments. With significant enhancement to the company's proprietary ellipsometry and reflectometry technologies, the Atlas III+ provides industry-leading metrology performance with increased productivity, sensitivity and accuracy. Another highlight was the award received at Photonics West in February by 4D technology, which we acquired in November of last year.

The 4D InSpec XL defect inspection gauge received the SPIE 2019 Prism Award in the test and measurement category. The Prism Awards for Photonics innovation event is a leading international competition that honors the best new photonic products in the market. The 4D InSpec XL won the award for its utility and importance in making instant qualifying 3D measurements of surface features for manufactured parts. Also, in the first quarter, we announced a new stock repurchase program.

Through 2018, the company has completed $18 million in stock repurchases. And in March 2019, we announced a new $80 million plan. Following the company generated over $100 million in cash flow from operating activities last year, the management team and Board of Directors expressed confidence in the company's future growth prospects in announcing this new program. The new buyback plan was announced at the onset of our blackout period in March.

And as such, we have not yet purchased shares against the new plan but expect to make opportunistic share repurchases in support of our continued commitment to returning capital to our stockholders. Now with some more detail regarding our first-quarter results. Our first-quarter revenue reflected a balanced contribution from the memory and non-memory markets. After more than 50% quarter-on-quarter growth in the prior quarter, first-quarter revenues from the foundry, IDM and other device markets grew nearly 40% sequentially and contributed 50% to product revenues in Q1.

Now while we saw a significant sequential decline in memory sales, which represented the other 50% of product revenues in Q1, our current forecast indicates that the March quarter is expected to be the low point for our memory business in 2019. We are not forecasting a significant rebound to occur from our memory business this year. However, with a modest recovery expected above Q1 levels in the current quarter and planned spending on the next technology nodes, as well as domestic China project spending, we believe that our memory business has stabilized and will improve in the second half of the year. For Q1, driving the 50% contribution of memory to our product sale were NAND contributing 30%, and DRAM the remaining 20%.

We should note here that the -- that we report all emerging memory technologies within the NAND segment. Our expectations for year-on-year decline in both DRAM and NAND are consistent with industry consensus. In contrast, our expectation for year-on-year revenue growth is very significant for the foundry, IDM and other device markets. While we expect a sequential decline in these segments during Q2, we expect strong growth to resume in the second half of the year.

For Q2, specifically, we expect gross margin to snap back to levels above our target model range for the expected revenue level. With revenue growth in the second half of 2019 expected to be up significantly from the first half, we expect to deliver a gross margin performance at or above our target for the remainder of the year. To summarize our drivers for second half growth, which, with our current visibility, we expect will be 25% to 30% stronger than the first half. First, as mentioned earlier, we believe the first quarter represents a low point in our memory revenues this year.

The stabilization in our forecast and modest recovery expected from Q1 level reflects continued technology investments in conversions and pilot lines, as well as project spending in domestic China. Second, our outlook for second half strengthened the foundry, IDM and other device markets has improved since our last call. Third, we expect increasing contribution from our other end markets in the second half such as those addressed by 4D technology and our materials characterization business, as well as from service. In total, our expectation is for a modest year-over-year decline in total sales, consistent with our stated objective to outperform overall WFE.

We also expect to grow profit faster than revenues in the second half of the year consistent with our objective to deliver significant operating leverage as revenues rebound. For the remainder of 2019, we expect we will deliver a gross margin performance at or above our financial model targets, and we are continuing our R&D investments in support of future growth. We have a robust pipeline of new products under development. During the last two years, we've been developing new platforms and technologies to address new applications for the next generation of devices.

More recently, our customers have been eager to see more performance and productivity enhancements from our flagship product. And therefore, for 2019, our product introductions have been prioritized toward these new launches, which demonstrate increased capabilities in our core products. The early success of the Atlas III+ launch with rapid adoption by multiple customers is clearly a testament to our innovative and industry-leading solutions. We expect to build upon today's announcement of the Atlas III+ with additional future revenue growth drivers.

Our strategy is to complement industry-leading revenue growth with strong operational execution, margins, cash flows and balance sheet efficiency. And we are firmly committed to creating shareholder value as we drive toward our revenue growth and profitability targets in 2020 and beyond. Turning to our guidance for the second quarter, which is for revenues of $61 million to $69 million, which, at the midpoint, represents a 3% decline from Q1. Gross margin of approximately 55%, plus or minus 1%.

Operating expenses of $29 million to $30 million and earnings per share of $0.13 to $0.28. I'll now turn the call over to Greg to discuss our financial results and guidance in more detail. Greg?

Greg Swyt -- Vice President of Finance and Principal Financial Officer

Thank you, Pierre-Yves. Before I begin my prepared remarks, I'd like to remind you that a schedule that summarizes GAAP and non-GAAP financial results discussed on this conference call, as well as supplemental revenue segment information by end market and geographic region is available in the Investor Section of our website. The P&L metrics discussed are non-GAAP measures unless I identify the measure as GAAP-based. These measures exclude the impact of amortization of acquired intangible assets, cost related to acquisitions, severance and executive search and transition, as well as search and discrete tax and other items.

As Pierre-Yves mentioned earlier, our first-quarter revenues were $67.1 million, a decrease of 13% from the prior quarter and 18% from Q1 of 2018. Product revenues were $53.9 million, a decrease of 16% from the prior quarter and 24% year over year. Service revenues of $13.2 million were flat to the prior quarter and were up 17% year over year, contributing 20% to total sales for the quarter. By end market, product sales to the NAND segment were 30% of total product sales.

DRAM sales were 20% and all foundry, IDM and other device sales contributed the remaining 50% of product sales. Our 10% customers in the first quarter are SK Hynix, TSMC and Intel. Our Q1 gross margin of 52.5% decreased 320 basis points from the prior quarter and was at the low end of our gross margin range due to late quarter shifts in product and customer mix and the timing of higher margin products that will revenue in Q2. These factors affected product gross margin, which was 53.7% below our target range while service margins improved to 47.5%, an increase of 320 basis points from the prior quarter.

For the second quarter of 2019, we are guiding gross margin to 55%, plus or minus 1 percentage point. Operating expenses of $29.6 million were down 1% from the prior quarter but came in higher than our guidance range. Given that the outlook for the year strengthened during Q1, we elected to continue spending at our planned engineering levels rather than take actions to defer or curtail any development programs. We expect our overall operating expenses to average $29.5 million per quarter for the remainder of 2019.

Our non-GAAP tax expense for the first quarter was $1.1 million or 19.6% of pre-tax income, in line with expectations, and we continue to forecast our non-GAAP tax rate to be in the 19% to 20% range for the remainder of 2019. Net income for the first quarter was $4.7 million or $0.19 per share based on $24.8 million weighted average diluted shares. Turning to the balance sheet. Cash and investments decreased $3.7 million to $148.1 million or $6.03 per share based on 24,500 basic shares outstanding at quarter end.

Days sales outstanding were 61 days, up slightly from 59 days in the prior quarter. Inventory increased $1.7 million to $63.8 million at the end of the first quarter. In Q1, we adopted the new accounting standard ASC 842 lease accounting. The new standard requires public companies in 2019 to recognize both operating and capital leases on their balance sheet and to distinguish between right of use assets and lease liabilities.

Upon adoption, we elected to use all available practical experience and recognized right-of-use assets and lease liabilities prospectively for all leases that were in effect as of the first day of our fiscal year 2019. Right-of-use assets have been categorized into the following pools: facilities, logistic warehouse contracts and IT infrastructure leases. As a result of this implementation, we recorded $11.6 million for right-of-use assets and the associated lease liabilities. There was no adjustment to opening retained earnings related to the adoption of ASC 842.

This concludes our prepared remarks. Operator, we will now be happy to take any questions. 

Questions and Answers:

Operator

[Operator instructions] Our first question comes from Quinn Bolton from Needham & Company.

Quinn Bolton -- Needham and Company -- Analyst

Hi, Pierre-Yves.  Hi, Greg. Congratulations on the better outlook. Wondering if you could start just with the stabilization and memory and give us a little bit more detail. Was that sort of across the board? Was it driven by either DRAM or NAND? And any comments you can make about geography would be helpful?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

So it is across both NAND and DRAM. So we're seeing a -- and then from a -- I -- there is not really geography dependence at this point in time. So it's across the board, across the customer base in NAND and DRAM. Maybe a little bit larger in NAND.

And then DRAM being maybe a little bit later. But these would be the qualifiers.

Quinn Bolton -- Needham and Company -- Analyst

OK. Great. And then second question just Lam, on their call last week, talked about a pretty good opportunity in their installed base business upgrade process chambers. Wondering if you have sort of similar upgrade capabilities to improve the productivity tools in the field? Or are you seeing stabilization in memory and node conversions to say 96-layer NAND or 1Y DRAM.

Is that just driving new tool demand for OCD given the increase and intensity of OCD at those higher nodes?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

So we are seeing growth in our service business year over year, and it was even quarter over quarter from Q4 to Q1. But what -- and one of the components of that is the upgrades business. Now we are different than -- from Lam in a sense that we don't have chambers that we replace. We tend to have a longer cycle in our upgrades in general because our tool doesn't degrade as a niching or deposition chamber.

So we are continuing to drive the upgrade strategy. And the growth in the installed base business, both the service and the upgrades, and we expect that to be a contributor of growth this year over last year.

Quinn Bolton -- Needham and Company -- Analyst

Great. And then just last question, you introduced the Atlas III+ with enhancements. Can you give us any more details on what kind of enhancements are these? Just better throughput or software improvements? Any other additional color would be great. Thank you.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Yeah. It's pretty comprehensive across the board. So it is, as I mentioned, improvements in the hardware, both the spectroscopic ellipsometer and the reflectometer, but it's also improvements in what we call choreography stage movements, which helps with the throughput, as well as some software improvement. So it is pretty much across-the-board improvement.

And it's really a significantly higher value tool for customers, which explains the high adoption rate that we're seeing right now.

Quinn Bolton -- Needham and Company -- Analyst

Great. Thank you.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Patrick Ho from Stifel. Your line is now open.

Brian Chin -- Stifel Financial Corp. -- Analyst

Good afternoon. This is Brian Chin on for Patrick. Maybe the first question, maybe digging into the outlook that you provided for second half. Obviously, very constructive.

I'm wondering -- clearly, I think there's a strong lean there toward the foundry and logic, additional strength. But Pierre-Yves, could you maybe attribute how much of that, say, $30 million, $40 million second half revenue increase might be attributable to memory? Give us kind of some sort of a sense of that.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

So for the -- for memory, we are saying that the memory will be second-half weighted. And right now what we're seeing, and of course this could change because there's still a lot of uncertainty with memory in the second half, especially, if you look at Q4. But what we're seeing today is maybe the wait for the years would be -- for memory specifically, will be the low 50s in the second half and high 40s in the first half.

Brian Chin -- Stifel Financial Corp. -- Analyst

OK. Also, just curious, in terms of that second half incremental pick up, is it sort of -- do you see sort of like a 3Q building, 4Q building off of that? Or do you see more like a higher slope kind of pick up or kind of bias one quarter or the other, 3Q versus 4Q?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

So with our current visibility, we expect Q4 to be the strongest revenue quarter of the year. Now this being said, in order to achieve the 25% to 30% growth in the second half, we obviously would need to see strong sequential growth starting in Q3.

Brian Chin -- Stifel Financial Corp. -- Analyst

Sure. Sure. One more question just about that and I have one more follow-up. In terms of foundry spending, logic spending, you obviously think Taiwan, you think U.S., in terms of the improving strength you're seeing in second half in visibility, is it a broader customer set, maybe inclusive of regions like Korea, China? Any color you could give would be great.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Yeah. Well, it's across the board. I mean it is definitely U.S. and Taiwan, but it's across the board because memory, as you know, is very distributed.

But if your question was specifically on logic, foundry and others, it is mainly driven by the U.S. and Taiwan.

Brian Chin -- Stifel Financial Corp. -- Analyst

OK. OK. Maybe just one last thing, just in terms of the gross margin permutations, Q1 versus Q2. How much of that would you attribute maybe just having a new product like the Atlas III+ and potentially having more immature margins, kind of the initial get go before you hit stride there.

Is that kind of a large attribution in terms of what's happened in Q1 versus Q2?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

No. No, that's not. What happened is, we had some upgrades that were planned at the end of Q1 that did not happen, that shifted into Q2. And the mix were really customer and products related.

So not specifically related to the shipments or adoption of the Atlas III+.

Brian Chin -- Stifel Financial Corp. -- Analyst

OK. That's very helpful. Thank you.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Thank you.

Operator

[Operator instructions] Our next question comes from Tom Diffley from D.A. Davidson. Your line is now open.

Tom Diffely -- D.A. Davidson and Company -- Analyst

Yeah. Good afternoon. So just following up on the last question. In cycles passed when a new product came out, a lot of times there was a bit of a margin hit, but it sounds like the Atlas III was already fully designed for manufacturability and all that.

So it -- the margins are in line with expectations and in line with the predecessor?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Yes. The -- you're talking about the Atlas III+, I believe.

Tom Diffely -- D.A. Davidson and Company -- Analyst

Correct. Yeah.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Yeah. So the Atlas III+, yes, the margins are in line with our expectations and our model. And this is why now with the adoption of the Atlas III+. This year, we expect to get back to the financial model in terms of gross margins.

Tom Diffely -- D.A. Davidson and Company -- Analyst

OK. Great. And then looking at the increase in demand that you've seen on the foundry and logic side, is it skewed more to foundry or logic?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Well, what I would like to say first is that it's our strength in foundry logic is, first -- most important and I think it's that the most advanced technology nodes for each customer. And we don't like to comment specifically about one customer or the other, and with very limited number of customers in logic and in foundry, we prefer not to distinguish that. But if we look at the Atlas III+, we mentioned the adoption in the foundry logic margin, which is an important part of this year's growth story.

Tom Diffely -- D.A. Davidson and Company -- Analyst

OK. I guess what I was getting at is, I guess I worry a little bit that both foundry and logic are very strong right now and will be for a few more quarters. But what gives you comfort that there won't be a pause in that strong spending before memory comes back in earnest some time in 2020?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

It's the visibility that we have already for Q3 and the relationship we've had with customers over the years that -- in particular, these customers, in foundry and logic, they tend to be very reliable with their forecast and their sales plan so -- or their plans to us, so our sales plan. So we're very confident that this is going to happen given the visibility that we have right now.

Tom Diffely -- D.A. Davidson and Company -- Analyst

OK. Great. And then given that the memory is a little soft right now, has that impacted at all your -- the timing of your new product that you're working on or either your R&D spending or delivery times?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

No. It hasn't. As I said, we have continued to invest in R&D for new products. We had put a little bit more interest just in the last few quarters on releasing the Atlas III+, enhancing the current line of products.

But that has -- the current spending in memory hasn't impacted our ability to conduct R&D and continue developing new technology.

Tom Diffely -- D.A. Davidson and Company -- Analyst

OK. And then just finally, when you look at some of the other markets, the material characterization, is that more for technology capabilities? Or is that capacity-driven demand?

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

It is more about technology actually. It's -- we have a few new products coming out there as well. And it's adoption for advanced technology, as well as the activity at 4D, the continued growth in 4D.

Tom Diffely -- D.A. Davidson and Company -- Analyst

Yeah. OK. Thank you for your time.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Thank you.

Operator

Thank you. [Operator instructions] I am showing no further questions. I'd now like to turn the call back to Dr. Lesaicherre for further remarks.

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Well, thank you for joining our call today. Together with the leadership team and all our employees, we remain steadfast in addressing the challenges and opportunities in front of us and profitably growing our business to create incremental shareholder value. I look forward to updating you on our next earnings call scheduled for late July. And this concludes our call for today.

So long.

Operator

[Operator signoff] 

Duration: 30 minutes

Call Participants:

Claire McAdams -- Investor Relations

Pierre-Yves Lesaicherre -- President and Chief Executive Officer

Greg Swyt -- Vice President of Finance and Principal Financial Officer

Quinn Bolton -- Needham and Company -- Analyst

Brian Chin -- Stifel Financial Corp. -- Analyst

Tom Diffely -- D.A. Davidson and Company -- Analyst

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