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Nova Measuring Instruments Ltd (NASDAQ:NVMI)
Q1 2020 Earnings Call
May 14, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Nova Measuring Instruments First Quarter 2020 Results Conference Call. For your information, today's conference is being recorded. I would now like to turn the conference over to your host, Miri Segal of MS-IR. Please go ahead.

Miri Segal -- Founder and Chief Executive Officer, MS-IR LLC

Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova's first quarter 2020 financial results conference call. With us on the line today are Mr. Eitan Oppenhaim, President and CEO; and Mr. Dror David, CFO.

Before we begin, may I remind our listeners that certain information provided on this call may contain forward-looking statements, and the Safe Harbor statement outlined in today's earnings release also pertains to this call. If you have not received a copy of the release, please view it in the Investor Relations section of the Company's website.

Eitan will begin the call with a business update, followed by Dror with an overview of the financials. We will then open the call for the question-and-answer session.

I will now hand over the call to Mr. Eitan Oppenhaim, Nova's President and CEO. Eitan, please go ahead.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, Miri, and thank you all for joining our first quarter financial results conference call. I sincerely hope that you and your families are safe and healthy in this extraordinary time. I would like also to extend my wishes to our partners, suppliers and customers.

I will start the call today by speaking about our first quarter results and performance highlights, including our extensive plans to meet the Company's strategic targets amid the global spread of COVID-19. Following my commentary, Dror will review the quarter's financial results in detail and will conclude the guide -- will conclude, sorry, with the guidance for the second quarter of 2020.

Nova delivered strong results for the first quarter of 2020 with both revenue and profitability exceeding the high end of the previously announced guidance. These results demonstrate our solid execution capabilities, as well as our agile operating model, which allow us to adapt quickly to volatile market conditions. Our sound achievements in diversifying our customers and products in recent quarters allow us to successfully mitigate cycles in the different market segments. Our sustainable operating model and long-term strategic objectives will continue to provide us with a solid framework to meet our customers' demand even in these unprecedented times.

Before I discuss our performance highlights for the quarter, I would like to share with you our main actions and priorities in addressing the challenges caused by the spread of COVID-19. Our well-organized comprehensive plan is aimed at confidently navigating the Company through market uncertainties and constant changes. Our collective experience in managing frequent delivery challenges in Israel due to other reasons allowed us this time to respond effectively to the evolving situation by adopting our well-practiced disaster recovery plan.

Our plan is focused on four elements that have been implemented since the beginning of March. First and foremost, our top priority remains the health, safety and financial well-being of our employees, partners and their families. We are complying with all local and global directives in order to prevent infection and spread of the disease. As part of our fast response, we offered employees remote working arrangements, we restricted work-related travel and limited customer interactions. Beside the health measures we implemented, we are also proactively offering financial support to our employees and partners that may be affected from the pandemic's economical aftermath.

Second, we took proactive measures to secure our supply chain and business continuity in order to meet customers' varied demands. Although the pandemic has a global impact, we have worked extensively to strengthen our supply chain, including qualifying new suppliers as part of the mitigation plan for unpredicted risks. As part of this plan, we are also securing inventories and spare parts throughout the year and aiming to maintain full production capacity to mitigate volatility and shortage once the situation recovers. This may be reflected in the Company inventory levels in the coming quarters. Additionally, we have moved all our production team to work in shifts and split turns, isolated from the rest of the Company with a clear mindset to meet any customer needs within a reasonable lead time.

Third, we are focused on strengthening the capabilities and expertise of our regional teams and offices to meet our customers' local requirements. Although we anticipate cross-region travels to resume gradually only in the third quarter, we are working closely with our customers to minimize delays in installing new products.

Finally, as Nova plays a major part in the local communities around the globe, we are proud to have multiple volunteering initiatives in various places, including medical equipment and fund contribution. This is part of our corporate social responsibility policy, and I am proud of all the projects we led in the last three months to support the fight against the corona spread.

Turning now to our performance highlights, during the first quarter of 2020, our performance continued to be supported by a diversified customer portfolio, which drove a balanced revenue mix between Memory and Foundry/Logic. Our customer mix for this quarter comprises of three major customers, including the largest foundry in the world and two leading memory customers.

During the quarter, we achieved a major milestone in our continued effort to strengthen our position with the top-tier customers. Following our press release from May 5, we are proud to have selected by the world's leading logic manufacturer for its global manufacturing sites. The customer selected Nova's optical CD solution due to its unique combination of advanced hardware and software, including advanced deep tech algorithm. We have already received multiple orders and recognized initial revenues this quarter.

Following the strong customer traction we had during the first quarter, we entered the second quarter with significantly improved book-to-bill pace, driven by record quarterly bookings. This achievement exemplifies the important role Nova plays in our customers' R&D phase in the most leading edge nodes. As a result, a decent portion of our revenue came from customer investments in strategic developments, which are more resilient to the current market volatility.

These encouraging milestones demonstrate soundly the contribution that our diversified product offering and balanced customer mix bring to the Company resiliency. Moreover, we believe that once markets fully recover from the pandemic implications, our growing position will support our profitable growth plans in the future.

Let me now turn to our product portfolio and development highlights. As we discussed in the last several earnings calls, we are in the process of introducing new dimensional and material solutions for the advanced front-end semiconductors. The first harbinger was the PRISM optical platform that was introduced in the third quarter of 2019. Since then, we have conducted several evaluations simultaneously with leading customers, and we are pleased to inform today that initial revenues were recognized already in the first quarter.

In addition to the PRISM, we are extremely focused on introducing two new platforms that are aimed at converting laboratory techniques into semiconductor high-volume production tools. By nature, these are very long evaluations as they change the way the customers are working and qualifying their devices. Although we see good progress with several field evaluations, we are experiencing some schedule deviation due to the COVID-19 restrictions, including customer site isolations and travel limitations.

Another meaningful effort to mention in regard to our product road map is our software and advanced algorithm development. As part of our strategic approach to enter more into the deep tech capabilities, we are seeing increased adoption of our machine learning and modeling solutions in high volume manufacturing. Currently, our main investment is to bring together combined hardware and deep tech solutions like machine learning, big data in adaptive training into the heart of semiconductor manufacturing. In all of our last wins, we proved that this combination allows our customers to tighten their process control, improve yield faster and shorten time to market.

Before I conclude my prepared remarks, I would like to briefly highlight some market dynamics and their relevance to Nova's performance. Though we are very encouraged by the business pace in the first half of 2020, which is higher compared to the same period last year, the visibility for the second half is still low. Despite several announcements of COVID-19 exit plans in Asia and Europe, the recovery pace and demand behavior are still hard to predict. Nevertheless, we still believe that in the long term, demand fundamentals remain solid and will continue fueling the market beyond the interim conditions. Amplified by the current environment, we believe that demand for enterprise and cloud applications will grow along with demand for advanced data infrastructure and 5G ecosystem.

To summarize, we are dealing with a challenging period, facing global uncertainties and frequent dynamic changes. But against the evolving backdrop of the pandemic, Nova has proven its ability to adapt quickly without compromising either the safety of our people or the aggressive execution plans to meet our strategic goals. While we should keep being prudent in our approach to the current dynamic environment, we strongly believe in the Company's long-term prospects.

I would like to conclude my remarks with stating again our main focus today, which is to secure the safety and health of our employees and their families, while ensuring the business continuity of the Company.

Now, let me hand over the call to Dror to review our financial results in detail. Dror?

Dror David -- Chief Financial Officer

Thanks Eitan. Good day, everyone. Total revenues in the first quarter of 2020 were $61 million, exceeding the Company guidance range for the quarter. Product revenues included revenue recognition of the first tools sold to a new logic customer in connection with the selection win we announced several weeks ago. Product revenue distribution was approximately 55% from Logic and Foundry and approximately 45% from Memory. Following an uptick in service revenues in the previous quarter, service revenues in the first quarter came in at the normalized level of $15.3 million.

Blended gross margin increased in the first quarter of 2020 to 56% on a GAAP basis and 57% on a non-GAAP basis. The increase in blended gross margins was attributed to improved product mix in the quarter and to higher service gross margins, which came in at 44%.

Operating expenses in the first quarter of 2020 totaled $21.5 million on a GAAP basis and $19.8 million on a non-GAAP basis. Gross R&D expenses were stable during the quarter, while R&D income came in at a normalized level of $1.5 million relative to $3.7 million in the previous quarter. Sales and marketing expenses reduced significantly, mainly due to a different regional sales distribution and related lower sales commissions.

Operating margin in the first quarter of 2020 was 21% on a GAAP basis and 24% on a non-GAAP basis. Effective tax rate in the quarter came in at approximately 16%. Company profitability in the first quarter of 2020 was better than expected despite the COVID-19 impact. This result was driven by strong demand for the Company products, leading to outperformance in revenues, improved product mix and related gross margins for products and services, and lower international travel expenses, which more than mitigated increased costs related to COVID-19.

As a result, earnings per share in the quarter were $0.41 per diluted share on a GAAP basis and $0.47 per diluted share on a non-GAAP basis, exceeding the high end of the company guidance.

Moving to the Company outlook for the second quarter of 2020, we expect the following: revenues between $58 million to $66 million, GAAP earnings per diluted share between $0.29 and $0.43, non-GAAP earnings per diluted share between $0.37 and $0.51.

At the midpoint of the second quarter guidance, we expect the following. Blended gross margins are expected to be approximately 56%. Given the COVID-19 pandemic, the Company is working diligently to create backup resources across its global workforce. In addition, the Company is gradually increasing its supply chain commitments and related inventory in order to secure the ability to manufacture and deliver products and services as much as possible across different locations and territories and throughout the year. In that respect, operating expenses are expected to increase in the second quarter to approximately $23 million on a GAAP basis and approximately $21.5 million on a non-GAAP basis. The majority of the expense increases are expected in R&D and sales and marketing, while G&A expenses are expected to reduce.

With that, I will turn the call back to Eitan. Eitan?

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, Dror. With that, we will be pleased to take your questions. Operator?

Questions and Answers:

Operator

[Operator Instructions] Our first question comes today from Patrick Ho of Stifel. Please go ahead.

Patrick J. Ho -- Stifel -- Analyst

Thank you very much and congrats on the nice quarter and outlook, and glad to hear everyone is well. Maybe for both of you, Eitan and Dror. As it relates to COVID-19, can you give a little more color of some of the, I guess, supply chain, manufacturing and parts procurement challenges you faced? And you did mention in the prepared remarks some of the issues you're trying to do to mitigate it on a going forward basis. What are some of the restrictions that are still potentially hindering you as you go into the June quarter?

Eitan Oppenhaim -- President and Chief Executive Officer

Thanks Patrick for the question. So, there are a few levels of -- in the questions, and I'll answer each one of them. So first of all, regarding the production facilities, in all the production facilities, we are-we move to work in shifts and split turns around the clock. So, we don't see any damage to any supply chain capabilities as a result from the production capabilities on our clean rooms and production facilities. For that, we are doing the upmost in order to isolate those places, so nobody can enter and make a damage or distribute something that we don't want. This is on the first level.

Second level is the supply chain. So, every place that we thought that we have a risk, we qualified already a second vendor, which is very challenging in this pandemic because the pandemic is attacking globally. So at the beginning, we'd like to find some sources to the Chinese supply chain. And after that, we came back to China. But nevertheless, we currently have secured the dual vendors to the whole critical parts. And therefore, we are pretty safe on that. We're of course having a risk management plan where we're placing those suppliers then even offer them some financially help in order for them to supply the whole capacity. So this is the second one.

The third one, as I said in my prepared remark and Dror mentioned it as well, you probably see some dynamic changes in our inventory going forward because our belief is that, the target right now is to produce as many systems as we can in our production line. In order for us to be prepared to the day when everything will be finished, so everybody will go to the same suppliers. So we are trying right now to secure as much inventory as we can until the end of the year. So we will not be dependent on any economy or any hit that will happen during this period.

So I think that those three levels should secure the deliverables that we have for -- until the end of the year. Talking about that, we need to take it with a very prudent approach that the pandemic hits everybody everywhere. So at the end, there might be some suppliers that will have some hit and maybe will delay some of their parts. But currently, when we're looking at least for the next quarter, we don't see such a problem.

Patrick J. Ho -- Stifel -- Analyst

Great. That's really helpful. And maybe as my follow-up question, it was great to see the recent announcement of the win by the Logic customer. Obviously, that's a great penetration on your end. Have you looked at additional application opportunities? Given their strategy of using basically a copy exactly anywhere across the globe, what's your efforts now to get additional applications with this customer?

Eitan Oppenhaim -- President and Chief Executive Officer

So I want to-Patrick, I want to be very careful with my answer because we are -- we don't want to reveal anything competitive-wise with this specific customer. But I think that it's a great achievement for Nova entering into this customer. It was a real battle for the last couple of years. And the jewel in the crown was always getting into the logic part because we are partners of this customer in the memory side. So when we went in, in the Logic side, of course we went in, in a very challenging application and we are now, and we will be in the next couple of quarters, working with this customer evaluating other applications as well. When, I'm saying other application, it's not only optical. So this customer is very advanced in materials metrology as well. And there is a match between the demand of this customer and the requirement to our portfolio. So, I'm pretty sure that we will see more application coming in on the OCD platform. And if I can look right now on the strategic partners with this customer, there is a lot of potential on the materials as well.

Patrick J. Ho -- Stifel -- Analyst

Great. Thank you very much.

Operator

Thank you. We take our next question from Quinn Bolton of Needham. Please go ahead.

N. Quinn Bolton -- Needham & Company, LLC -- Analyst

Hey, guys. Congratulations on the nice results and outlook in a challenging environment. Wanted to follow-up on Patrick's question about the new customer, so a couple of questions there. It sounds like the wins, the applications were critical applications. But just wanted to confirm, these were sort of critical applications at this customer rather than say semi-critical. And then, a follow-on, you mentioned that you already have multiple repeat orders from this customer. Just wondering, are those orders scheduled for delivery later this year? Or are those potentially further out into calendar '21?

Eitan Oppenhaim -- President and Chief Executive Officer

So, Quinn, I will answer the first one and Dror will take the second one. So, I can tell you very shortly that this win is on the most advanced production application for this customer in the logic advanced nodes, OK? So it's not any R&D or a small win. It's a win in the center of the activity in this customer's production. Now, Dror will answer you regarding the orders.

Dror David -- Chief Financial Officer

Yes. We definitely -- hi Quinn, we definitely expect additional revenues throughout the year -- additional deliveries and revenues from this customer.

N. Quinn Bolton -- Needham & Company, LLC -- Analyst

Great. And then, just my follow-up, Eitan, you had mentioned the new materials and dimensional technologies were facing some perhaps qualification or eval [Phonetic] delays as a result of COVID. Wondering if you might be able to update us on any expectations when you think those new technologies might be able to rev rec. Is that something now that might push into the second half of the year where its visibility is just too low to trying to time when those tools and new applications may rev rec?

Eitan Oppenhaim -- President and Chief Executive Officer

So, we are not talking here on major delays. So, I think that we can expect them to be recognized in the second half.

N. Quinn Bolton -- Needham & Company, LLC -- Analyst

Great. Thank you.

Eitan Oppenhaim -- President and Chief Executive Officer

Thanks.

Operator

Thank you. We'll take our next question from Mark Miller of Benchmark Company. Please go ahead.

Mark Miller -- Benchmark -- Analyst

Thank you for the question, and congrats on another good quarter and outlook. And I'm glad everyone has been safe at Nova. Just trying to get a little more color on revenues, in particular, in terms of software related and X-ray characterization related revenues. Can you give us a little more color on those revenues? How they have been trending and what you expect?

Dror David -- Chief Financial Officer

So, obviously, we don't -- we do not break down the revenues per product line. In general, the revenues in the first quarter were a little bit more lenient to the -- with [Phonetic] more software revenues and with the products which include a little bit more products on the high end with higher gross margins. We should remind that we have a target model for software revenues to become up to 10% of our product revenues. We hope that this year, we will be able to see some growth in software revenues and it's already started in the first quarter.

Mark Miller -- Benchmark -- Analyst

Thank you. There's been some talk -- more US restrictions, especially in shipping into China. Do you see that is having any impact on your sales?

Eitan Oppenhaim -- President and Chief Executive Officer

So, there are two things on that. So first of all is the old restrictions or the previous situation with the trade war between the US and China. As you know, we have facility both in the US and in Israel. And we're mostly restricted in the US and we follow that. At that time, there was only one customer, JHICC, that wasn't a big issue from the US administration to ship tools, and we were banned from doing anything, according to the federal rules, with this customer as well. Nevertheless, there are less restrictions on the Israeli entity. And therefore, we don't expect any kind of effect on the Israeli side shipping equipment to China. We're definitely looking and learning and analyzing all the time, the new rules coming from the US.

I just want to say that, it might be an opportunity for us to enjoy from [Indecipherable] because we have less restriction in Israel and therefore we can compete more. And as a result of this, those restrictions, we might see more semiconductor fab in the US, and then we enjoy again. So I think that this is not a healthy situation, but I don't see an impact on our strategic plans following those kind of restrictions, unless it will go into some kind of economical -- global economical crisis that will affect the whole semiconductor.

Mark Miller -- Benchmark -- Analyst

Thank you.

Operator

Thank you. We'll move now to Krish Sankar of Cowen and Company. Please go ahead.

Krish Sankar -- Cowen and Company -- Analyst

Yeah, hi, thanks for taking my question. I had two of them. Firstly, just to follow up on your earlier comments, is it fair to assume, if things do get worse with the US-China relations, it's only your XPS product line, which is being made in the US, would be impacted, not the optical CD line? And then I had a follow-up.

Eitan Oppenhaim -- President and Chief Executive Officer

So, first of all, yes. So, most of our X-ray tools are going out from the US and they will have those restrictions. We need to learn them carefully and they will have a restriction like other US-based company. Regarding the Israel facility, so -- the Israel facility is not producing only optical CD, it's producing optical tools. Some of them are doing materials. Some of them are doing CDs. But Israel -- as I said before, the Israeli facility is not fully obliged to this -- to those rules coming from the trade war.

Krish Sankar -- Cowen and Company -- Analyst

Got it. That's very helpful. And then, as a follow-up, is there a way to parse out, your Q1 numbers, growth year-over-year, how much of that was underlying industry growth? How much of it was share gains?

Eitan Oppenhaim -- President and Chief Executive Officer

Can you repeat the question?

Krish Sankar -- Cowen and Company -- Analyst

The March quarter revenue strength you saw on a year-over-year basis, it was up 8% year-over-year, how much of that was the industry growing and how much of it was from your share gains?

Dror David -- Chief Financial Officer

I think, I would assume that most of it is related to either new products or penetration into new customers, rather than the industry growth.

Eitan Oppenhaim -- President and Chief Executive Officer

Krish, it's Eitan. So, it's a stronger quarter in a very cyclical environment. So, you can imagine that both the market share and the position was strengthening a lot during this quarter. So, you see right now the rest of our results, and I assume that decent portion of the revenue came either for -- from selection to strategic investment by our customers that are less influenced by the COVID, as well as a great portion coming for market share.

Krish Sankar -- Cowen and Company -- Analyst

Got it. Thanks Eitan and Dror, and congrats on the interesting results.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you very much.

Operator

[Operator Instructions] We'll now take a question from Jaeson Schmidt of Lake Street. Please go ahead.

Jaeson Schmidt -- Lake Street Capital Markets, LLC -- Analyst

Hey, guys, thanks for taking my questions. Just curious if you could quantify the amount of revenue that was impacted in Q1 due to supply constraints?

Eitan Oppenhaim -- President and Chief Executive Officer

So, Jaeson, we -- the impact that we see on the supply chains are -- the most of it, it's maybe delays from one quarter to another. So we don't see any capability that was damaged so far by the supply chain. I think that starting from the crisis in China somewhere in January, beginning of February, we started immediately to elevate our inventory and chasing after our suppliers. So, there are suppliers that we -- by Nova kept alive and open during the crisis in order to supply our production capabilities and supply chain parts. Of course, there are some challenges in the way. But if I'm looking right now on the damages or some challenges that we had in the first quarter, it's just delays that moved to the second quarter. We don't see any cancellation. We don't see any major delays right now from the customer demands that we have.

Jaeson Schmidt -- Lake Street Capital Markets, LLC -- Analyst

Okay. That's helpful. And looking at the opex line, understanding sort of the moving parts in Q2, should we expect this sort of elevated level to be consistent throughout the remainder of the year? Or is this sort of a near-term bump and then going back to more normalized levels?

Dror David -- Chief Financial Officer

No. So, as I mentioned, we are increasing our, I would say, redundancies across the world to ensure delivery and customer presence. So, I would say this is a new level, and you should see across the second half maybe low-single digit growth every quarter starting Q3 until the end of the year.

Jaeson Schmidt -- Lake Street Capital Markets, LLC -- Analyst

Okay. Thanks a lot, guys.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Now I'd like to turn the call back over to Mr. Eitan Oppenhaim, President and CEO, for his closing remarks.

Eitan Oppenhaim -- President and Chief Executive Officer

Thank you, operator, and thank you all for joining the call today. I really hope that you and your families remain safe and stay healthy in the next period. By that, we conclude our first quarter earnings call. Thank you very much.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Miri Segal -- Founder and Chief Executive Officer, MS-IR LLC

Eitan Oppenhaim -- President and Chief Executive Officer

Dror David -- Chief Financial Officer

Patrick J. Ho -- Stifel -- Analyst

N. Quinn Bolton -- Needham & Company, LLC -- Analyst

Mark Miller -- Benchmark -- Analyst

Krish Sankar -- Cowen and Company -- Analyst

Jaeson Schmidt -- Lake Street Capital Markets, LLC -- Analyst

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