Onto Innovation - Q2 2024

Executive Summary

• Q2 revenue and EPS exceeded the high end of guidance on stronger AI packaging and gate‑all‑around (GAA) demand; revenue was $242.3M, GAAP EPS $1.07, and non‑GAAP EPS $1.32, with 53% GAAP and non‑GAAP gross margin.
• Specialty/advanced packaging set another record ($164M; 68% mix), while advanced nodes accelerated sequentially (up 21% q/q to $32M), and software/services rose to $46M (19% mix).
• Q3 guidance calls for revenue of $245–$255M, gross margin 53–55%, OpEx $64–$66M, GAAP EPS $0.98–$1.08 and non‑GAAP EPS $1.25–$1.35; management also disclosed >$300M in volume purchase agreements (VPAs) for AI packaging and GAA through 2025, bolstering 2025 visibility.
• Stock reaction catalysts: continued sequential growth guide with margin expansion, record cash from operations ($65M, 27% of revenue), VPAs signaling multi‑quarter demand support, and advancing glass‑substrate panel lithography capabilities (JetStep X500).

What Went Well and What Went Wrong

What Went Well

• AI packaging momentum: “fourth consecutive quarterly revenue record” in specialty/advanced packaging; Dragonfly platform achieved another record and inspection business projected to grow >70% in 2024.
• Strategic wins and visibility: closed >$300M VPAs across two customers for AI advanced packaging and GAA through 2025, providing multi‑quarter demand clarity.
• Financial execution: gross margin improved to 53% and record operating cash flow of $65M (27% of revenue); inventory reduced by $10M q/q with further reduction targeted.

What Went Wrong

• AI packaging “pause” intra‑2H: management acknowledged an aggregate ~10% pause in AI packaging spending across four key customers due to supply constraints and timing of expansions, though overall advanced packaging remains strong.
• China remains constrained: China revenue in 1H rose from Q1 to Q2 but stays mid‑teens of total, with local competitors gaining at the lower end and export restrictions limiting upside.
• Margin still below long‑term model: while improving, gross margin has not yet reached the prior 56–58% model range at a ~$1B run‑rate; management is working supply‑chain and mix levers and expects sequential improvement, aided by higher‑margin advanced nodes.

Transcript

Operator (participant)

Good day, and welcome to the Onto Innovation second 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.

Sidney Ho (VP of Investor Relations)

Thank you, Justin, and good afternoon, everyone. Onto Innovation issued its 2024 second 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 discussions 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. Now, let me turn the call over to our CEO, Michael Plisinski. Mike?

Michael Plisinski (CEO)

Thank you, Sidney. Good afternoon, everyone, and thank you for joining our earnings call this afternoon. Our second quarter revenue exceeded the high end of our guidance range, driven by better-than-expected demand of Dragonfly systems, supporting Advanced Packaging for AI devices, and Atlas and Iris systems for gate-all-around investments in the Advanced Nodes. Financially, we're pleased to see progress from our inventory management efforts, resulting in a quarterly record, generating $65 million in cash from operations. Margins also improved from the first quarter, and we expect it to improve again in the third quarter, which Mark will address shortly. We will now review the second quarter highlights, starting with our Specialty Devices and Advanced Packaging markets, where we achieved a fourth consecutive quarterly revenue record, driven by AI packaging, which accounted for over half of the revenue in these markets.

Advanced packaging has proven to be a key enabler for this new era of AI, and NVIDIA recently commented that it expects AI demand to outstrip supply well into next year, and we see the market attracting additional suppliers, each bringing unique requirements for wafer substrates, as well as interconnect sizes and densities. By broadly addressing these needs, the highly versatile Dragonfly platform achieved another revenue record in the second quarter. In fact, based on our current visibility, we project our inspection business will grow by over 70% this year, and we continue to expand our capabilities. Last quarter, we released a new sensor to detect yield-critical subsurface defects in ultrathin wafers, and based on market response, we already expect over 80 systems to be delivered with this capability through the end of next year.

More recently, we announced a new 3D bump metrology sensor to address the need for bump height measurements of denser and smaller interconnects used in future high-bandwidth memory and hybrid bonding applications, where bump heights and pitch will be less than half the size they are today. Our new sensor uses proprietary technology, which we believe allows us to meet these new challenges at higher throughputs than alternatives. Though still preliminary, initial customer feedback has been positive, and we expect to ship several systems for production evaluations over the next 3 months. In addition to new wafer-level packaging technologies, we see growing interest in panel packaging technologies to support chiplet architectures and larger package sizes. We engaged early with leaders in this market, and to date, we've shipped over 30 panel lithography systems to customers around the globe.

In the quarter, we added a new customer to this list when we shipped our first fully automated JetStep X500 to support glass and substrate applications on a single tool. We believe the stability of glass will allow for smaller interconnects across larger package sizes, which is critical to many of our customers' packaging roadmaps. Finally, revenue from power customers grew significantly, nearly achieving a record, a quarterly record set last year. We continue to expect demand for process control to remain strong throughout the rest of this year for the power semiconductor market. Now, turning to Advanced Nodes, spending is picking up, and we are seeing growth continuing through the second half of 2024 and into the next year. In the quarter, orders from logic customers represented nearly half of the revenue from advanced node customers.

For gate-all-around applications, we are seeing an increase in adoption of our Iris films metrology in addition to our leading Atlas OCD metrology. Rounding out our optical metrology suite of Atlas, Iris, and Aspect is our integrated platform, Impulse. In the second quarter, we closed volume agreements from two of the top four manufacturers, which we believe will represent greater than 60% combined share at these accounts. We've also successfully qualified multiple systems and logic for gate-all-around applications below 2 nm, where requirements for speed and stability are increasing. Now I'll turn the call over to Mark to review our financial highlights and provide third quarter guidance.

Mark Slicer (CFO)

Thanks, Mike, and good afternoon, everyone. As Mike highlighted, we exceeded second quarter revenue and EPS guidance ranges while generating record operating cash flow of $65 million.

Operating cash flow yield increased 2 percentage points to 27% of revenues, representing a doubling of operating cash during the same period last year. Second quarter revenue of $242 million was up 6% versus the first quarter, and up 27% versus the prior year. Second quarter EPS increased 12% sequentially to $1.32, and up 67% versus the prior year. Both revenue and EPS exceeded our guidance ranges due to the 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. Looking at the quarterly revenue by markets, our biggest market remains Specialty Devices and Advanced Packaging, which grew 3% sequentially to a record quarterly revenue of $164 million, and represents 68% of our revenue.

Our biggest sequential increase was Advanced Nodes, which had revenue of $32 million, increased 21% over Q1, and represents 13% of revenue. Software and services, with revenue of $46 million, increased 6% over Q1, representing 19% of revenue. We achieved 53% gross margin for the second quarter, in line with the midpoint of our guidance range of 52%-54%, driving more than a hundred basis point improvement over the first quarter. Second quarter operating expenses were $64 million, just at the high end of our guidance range. We continued to make additional investments in R&D within the quarter, extending our product capabilities and technology differentiation to expand our served markets for 3D metrology, as well as future hybrid bonding metrology and inspection.

Our operating income of $65 million was 27% of revenue for the second quarter, compared to 25% for the first quarter, validating our ability to execute a leveraged operating model. Our net income performance, also 27% of revenue, was supported from favorable investment income resulting from our increased cash balance. Now moving to the balance sheet. We ended the second quarter with cash and short-term investments of $786 million, achieving operating cash flow of $65 million and converting 100% of our operating income into cash. Inventory ended the quarter at $320 million, down $10 million versus Q1. The team made great progress optimizing our inventory levels, even with the Dragonfly revenue growth and the expected increase in our Advanced Nodes business in the second half. We expect further inventory reduction of $10 million-$15 million for the third quarter.

We plan to be below $300 million as we exit 2024, which will be a $50 million reduction from our 2023 inventory levels. Now turning to our outlook for the third quarter. We currently expect revenue for the third quarter to be between $245 million and $255 million, as HBM chip leaders continue to invest in Advanced Packaging capacity and new capabilities, as Mike discussed. We expect gross margins will be 53%-55%, reflecting the improvements in manufacturing and supply chain initiatives discussed in prior quarters. For operating expenses, we expect to be between $64 million and $66 million as we make additional investments in our R&D programs tied to customer roadmaps. For the third quarter, we expect our effective tax rate to be between 15%-16%, and 13%-14% for the full year.

We expect our diluted share count for the third quarter to be approximately 49.7 million shares. Based upon these assumptions, we anticipate our non-GAAP earnings for the second quarter to be between $1.25-$1.35 per share. Our focus for the second half of 2024 remains on executing on our targeted programs for further quarter-over-quarter gross margin and operating margin improvements, and continuing the progress made in the first half of the year. In addition, further growth of the Advanced Nodes business, driven by increasing orders for memory and gate-all-around logic, should improve our margin profiles as we exit 2024. And with that, I will turn it back to Mike for additional insights into Q3 and the remainder of 2024. Mike?

Michael Plisinski (CEO)

Thank you, Mark. For the third quarter, we see revenue from our Advanced Nodes customers increasing over 25%, with growth coming from both Memory and Logic customers. About half of our Logic revenue will support films and OCD applications for the gate-all-around node. Looking ahead, we expect to see Logic revenue grow further in the fourth quarter, with over 70% of Logic revenue in support of gate-all-around applications. We expect our Specialty Devices and Advanced Packaging customers to remain at these record levels in the third quarter and growing in the fourth quarter, potentially leading to a new quarterly record for the company. Leading this growth is, of course, the demand for Dragonfly systems, but we also see growing demand for our films and acoustic metrology systems and packaging for both logic and HBM applications.

We are still in the early stages of adoption for these systems, but expect to deliver over $50 million in package metrology system revenue by year-end. In aggregate, our view has improved for the second half of the year, and we now expect second half revenue to be 5%-10% stronger than the first half of 2024. Though still early, we're encouraged by the setup leading into 2025. We expect to benefit from continued investments in gate-all-around capacity and the announced capacity expansions from several high-bandwidth memory and logic packaging manufacturers. Specifically for HBM, or high-bandwidth memory, we expect new capacity coming online in the first half of the year to support the increase of HBM content for NVIDIA's AI processors from 80 GB to 192 GB, and for AMD, AMD's AI processors from 192 GB to 288 GB.

Adding to our optimism, we closed volume purchasing agreements with two customers with a combined value of over $300 million in the quarter. These agreements covered both AI packaging applications and gate-all-around investments through roughly 2025. A positive sign, not just for a strong finish for this year, but a stronger 2025 as well. That concludes our prepared remarks. Justin, please open the call for questions from our covering analysts.

Operator (participant)

Thank you. If you would like to signal with questions, please press star one on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you would like to signal, star one for questions. The first question will come from Brian Chin with Stifel.

Brian Chin (Director)

Hi there. Good afternoon. Nice results and outlook, and thanks for letting us ask a few questions. Mike, previously, you thought that Advanced Packaging revenue could pause or dip in 3Q, but your outlook today is more positive. What improved, and is it more on the foundry or HBM memory side?

Michael Plisinski (CEO)

Thanks, Brian. I think there was some confusion. What I said would pause would be specific to AI packaging, which is a specific set of really four customers, you know, one in Logic and three in Memory. I did say that overall, we expected growth to continue sequentially through the next couple quarters. Though we are seeing more revenue from those customers, there are still supply constraints that are limiting their ability to expand and to reach the levels of revenue that they were delivering, you know, or that we've been delivering to them in the first half. So we do still see a pause. I think it's definitely more constructive. Some of their announced expansions have been delayed.

We've seen some customers actually get creative and push on some of their subcons to open up capacity and make room for, you know, a faster ramp where their greenfields are taking a little bit longer. That said, we are more bullish, but I think there was a lot of confusion around my definition of strictly AI packaging and just a handful of customers versus, you know, overall Advanced Packaging and our overall business for the Specialty Devices and Advanced Packaging markets.

Brian Chin (Director)

Yeah. Yeah, thanks for clarifying that. And then looking at the $300 million in VPAs that you're announcing, it's sort of a multipart, but can you give us a, a rough idea of, of one, how that $300 million maybe splits amongst those two customers? Is it kind of like evenly weighted or maybe biased to one or the other? And then second, within that, maybe how that roughly splits amongst gate-all-around and Advanced Packaging. And then if you, if you still with me, lastly, kind of is that revenue recognition expected to be linear or kind of maybe more weighted to the last three quarters as opposed to the next three?

Michael Plisinski (CEO)

Yeah, I don't have the breakdown in front of me, but by memory, I would say that the Advanced Packaging piece was the larger chunk of that $300 million. The breakdown, of course, is gonna depend on when the expansions come out, but most of it was tied to 2025, you know, for, yeah, for next year.

Brian Chin (Director)

Thanks. And maybe just last quick one-

Michael Plisinski (CEO)

Yeah, it's mostly, it's mostly Advanced Packaging, so it's about... I just looked. I don't have the breakdown quarter to quarter, but, it's roughly 60% for Packaging, 40% or so for the, for the gate-all-around.

Brian Chin (Director)

Got it. Okay. That's really helpful. Just one last quick thing. What impact, if any, are you seeing this year in light of the reduced capacity expansion plans from Advanced Logic that was communicated last week? And how does this affect your thinking for gate-all-around revenue potential in 2025?

Michael Plisinski (CEO)

Well, we're more constructive. We're definitely seeing good adoption of our products in the gate-all-around logic. We're seeing customers continuing to take more product, and as we mentioned, we see the fourth quarter growing from the third, so you know, that's a positive sign. And you can tell from what I just mentioned on the volume purchase agreements, that customers are working with us to make sure we can continue a ramp of supply for them next year. So, and that's all still before they hit their volume production targets in largely in 2026. So we expect that to continue to improve. What's probably nice or a nice surprise is the increased adoption of the Iris planar films in this mix.

So in addition to the strong position we've had with OCD, we've been adding our market share for our planar films tool, the Iris system.

Brian Chin (Director)

Yeah, great. Thanks for the update.

Operator (participant)

The next question will come from Vedvati Shrotre with Evercore.

Vedvati Shrotre (Equity Research Analyst)

Thanks for taking my question. I guess the first one I had was, you know, we had an IDM customer of yours kind of cut down CapEx spending for 2025. Can you just help us think through how the conversations have changed for you, or if, you know, like, your expectations going forward from that particular customer?

Michael Plisinski (CEO)

Well, that remains to be seen. So they're certainly announcing CapEx cuts in general, but they're also reaffirming their desire to hit their next generation nodes and to ramp their latest generation processing nodes by 2026, I believe it was. So it depends on where they reallocate the rest of their capital. It's still a pretty big number. And, you know, to us, you know, we are on the leading edge, so my expectations are their spend will be more towards that leading edge, and we may not see any negative impact, maybe even a positive impact as an acceleration.

Vedvati Shrotre (Equity Research Analyst)

Got it. Understood. Then on the next question I had is, I think you mentioned second half that you see the pause in AI packaging spend and the total Advanced Packaging spend actually continues to grow. Could you maybe help us understand the puts and takes into what's driving that delta between the two? Like, are the OSAT starting to spend again? Is that what's really going on?

Michael Plisinski (CEO)

We definitely see OSAT starting to spend more, but if we take a look at our Advanced Packaging spend, that includes all of high-performance compute. It would include the lithography, et cetera, et cetera. So it would be a significantly bigger number. To try and help people understand specific Advanced Packaging or the AI packaging spend, we limited it to just the four customers that are playing and spending in that space. And I think they've been pretty clear where their capacity growth is going and what constraints they've had and what spending has been like for them. So I don't think there's anything new that we're highlighting.

Vedvati Shrotre (Equity Research Analyst)

Right. So could you remind me again what kind of decline you're—or kind of a pause you're seeing? Is it like 10%-15% decline in your AI packaging revenues, first half versus second half, or how, how would you characterize that?

Michael Plisinski (CEO)

Overall, in aggregate, maybe, yeah, or maybe around 10%, staying steady. But between different customers, some are growing significantly, some are doubling, some are cutting back, and it just really depends on the, you know, the ebb and flow of each individual of those four customers. But in aggregate, it's around the 10% that I just mentioned.

Mark Slicer (CFO)

Right.

Michael Plisinski (CEO)

10% to 15%.

Vedvati Shrotre (Equity Research Analyst)

Then one last one, if I may. On your gross margins, is the kind of 100 basis points increase quarter-over-quarter primarily driven by your product mix changing with more Advanced Nodes coming back?

Michael Plisinski (CEO)

Not all of it. I mean, certainly this, the improvements we've been talking about are certainly paying dividends within our manufacturing and supply chain. So, I think as we get into the second half of the year and you see Advanced Nodes certainly improving, yes, that will help accelerate that gross margin improvement.

Vedvati Shrotre (Equity Research Analyst)

All right, thank you.

Michael Plisinski (CEO)

I think it's also important, you know, there's a... Yeah, let me just finish one thing, please, Justin. There's a discussion around the AI packaging, and I think it's important to note just how big that's been for us. We gave some guidance. It's over 50% of our Advanced Packaging specialty market. That's around $88 million-$90 million. That's a lot of capacity that customers have been taking on. And as Dave mentioned, and we've reported today, there are capacity constraints, and the customers are announcing new factories for both HBM and Logic CoWoS. So I think that's needs to be put in context as well, just how much of that we've been already achieving.

Vedvati Shrotre (Equity Research Analyst)

Right. Thank you.

Operator (participant)

The next question will come from David Duley with Steelhead Securities.

David Duley (Managing Principal)

Thanks for taking my question. I have a kind of a two-part, technical question. If the CPU and GPU companies adopt rectangular glass substrates as, you know, a lot of technical papers are suggesting, how in total will that impact Onto? And then specifically drill down in, what exactly would your lithography tool do on these substrates? Would you be putting down the RDL layers, or what are the steps that you would address if that were to take place?

Michael Plisinski (CEO)

Yep. So to address your first question, what it would mean for us is we would get opportunities. All the different process control technologies we're applying from the Dragonfly in the packaging areas now would likely translate into the panel side through the Firefly, which is a panel version of the Dragonfly tool. So we would expect all of the inspection, ClearFind opportunities. We already see various metrology opportunities as well to drive a Firefly business. In addition, there's software opportunities, of course. Those customers aren't—let's say they're coming from a different point in the supply chain. They have opportunities to advance their process control capabilities through some of our fab-wide software. In addition, of course, the biggest thing is the lithography piece, and there we would be printing the RDL lines.

Primarily the, all the RDL lines, which would be, you know, right now in advanced IC substrates, we're doing up to, you know, 10 layers per side. For glass, we expect it to be less because we can go to finer resolution. And we expect it'll be all on one side, but, you know, we are seeing customers talk about both, both sides.

David Duley (Managing Principal)

Okay, and then as a follow-on to that is, you know, when you look at TSMC's roadmap, these substrates, whatever they're made of, are gonna get much, much larger. And, I was wondering how that might impact, if we did move to, you know, larger substrates, how that might impact the lithography business. And then finally, if you do move to glass panel substrates or some sort of more of a panel lithography solutions, would that help the CoWoS bottleneck?

Michael Plisinski (CEO)

I believe so. I mean, that would be a significant improvement in economies of scale. It might help some of the challenges that are being seen with the different substrates and thermal issues between the substrates, you know, heating at different rates, heating and expanding at different rates. So I think there'd be a technical advantage to going, in addition to an economies of scale advantage to moving to panel. And for the steppers, of course, it's iterative, so you're gonna have steppers to support this, or the volume of steppers would be required to support the volume of chips, but also the number of layers, so it's an iterative process.

So, it would be, you know, if they're gonna do eight layers, that's, you know, that all adds to the utilization of our tools and drives up the opportunity for us.

David Duley (Managing Principal)

And then the size of the-

Michael Plisinski (CEO)

So we think the size of the substrate, I think that's, you know, obviously good for us because we tend to have a because we came from the flat panel display world, we have the ability to handle significantly larger sizes of panels than anyone's even talking about now. So 650 by 650 is like a display 10, 20 years ago. So from that standpoint, there's no problem. But the real benefit that we offer is the high-resolution, wide-field optics. And if customers wanna print large package sizes without stitching and highly repeatable, they can pretty much only go to our tool right now for that capability, which, you know, will be demonstrated downstairs in our Advanced Packaging lab. And we're already scheduling demos for that system. Today, I think we have over seven or eight demos already planned.

David Duley (Managing Principal)

So I guess, just interpreting what you said is, you have some tools that are highly aligned to TSMC's size of their interposers or substrates going forward.

Michael Plisinski (CEO)

I definitely didn't say that, but we're aligned to the market needs. Let's put it that way.

David Duley (Managing Principal)

All right, thank you. I'll get back in the queue.

Operator (participant)

And the next question will come from Mayur Popuri with B. Riley Securities.

Mayur Popuri (Senior Research Associate)

Hi, yeah, I'm actually on for Craig Ellis. But, you know, you've obviously had some really great quarters in Advanced Packaging. I think, you know, three really, really incredible quarters. And then this one was just great, too. Kind of how do you see that ramp going? I know you said that, you know, next quarter is supposed to be even, and then you go back up again, but you all said this is just the beginning. So is this kind of a sustainable ramp? And, you know, how long do we kind of see this coming forward, and how sustainable is it?

Michael Plisinski (CEO)

Well, like I mentioned, we see the capacities for each—let's say, if you take an AI compute engine, we see the amount of HBM doubling on those, essentially doubling on those. So even if AI just stayed flat, which nobody's projecting, AI is supposed to go up, the HBM side is already doubling. In addition, of course, we do see AI demand continuing through next year. And we see that both from the end customers driving the—or talking about their demand side, and our own customers talking about supply constraints, and that they're, you know, looking at expanding factories into next year, early half of next year, in order to alleviate these supply constraints. So, you know, so that makes us pretty bullish about growth through 2025.

Mayur Popuri (Senior Research Associate)

Okay. Yeah, that's great. Thank you. I got another one that's kind of hopping off of that. So in the last week or so, we've seen kind of some meaningful signs of growing diversification, which I think is probably, you know, a bullish signal for your business. Have you guys seen any, or how do you expect at least kind of better pricing power or your ability to kind of penetrate these different suppliers in HBM?

Michael Plisinski (CEO)

Well, we're already in all suppliers for HBM, so it's a matter of maintaining our position and providing, you know, value propositions that matter. And then, generally, we negotiate, you know, our fair share of that value. I don't see that's changing in any way. I think if anything, it's getting better as we continue to add new technologies and accelerate our pace of innovation and release new capabilities that they need, that's only helping them to ramp faster, helping them to provide higher yields and become more profitable or gain more share from their customers. So I think, you know, from that standpoint, it gives us a win-win scenario with our customers.

Mayur Popuri (Senior Research Associate)

Okay. That's great as well. And just one last thing. I'm kind of bouncing off of David's question. So, you know, obviously, we've seen a lot of different challenges with CoWoS, especially CoWoS-L, and, you know, kind of the thermal design challenges and what have you. Do you expect that, you know, as this becomes more difficult than maybe what some people expected, that your products can deliver more value towards meeting CoWoS demand?

Michael Plisinski (CEO)

I think our products help to drive yields for and identify root cause for some of these challenges and issues. But some of these are physics, and of course, our products are not gonna change the physics. The customers need to use our tools to measure, identify, and determine how to adjust the process and adjust the physics in order to drive the yields up. So we're critical. That's why we're seeing demands for new types of sensors, new capabilities, and we react very quickly working with our customers. I think the one change to that is with the lithography, where there, we are helping to define a process. Our PACE lab downstairs is focused with our partners, several very talented partners and collaborators, are focused on solving challenges associated with the adoption of glass.

As we do that, we hope that that will be adopted by our customers and help propel the chiplet and Advanced Packaging roadmaps to the next level.

Mayur Popuri (Senior Research Associate)

Yeah. Thank you so much. That's a great answer.

Operator (participant)

The next question will come from Charles Shi with Needham.

Charles Shi (Senior Analyst)

Hey, good evening, Mike, Mark. The question I want to ask is about China. I know you tend to do a little bit more business with the leading customers, and the China exposure you had last year was kind of in the mid-teens, and the first quarter was actually fell to, like, single-digit percent of your total revenue. I haven't seen your Q2 numbers, but I just wanna get a sense from you, 'cause this year's WFE upside, a lot of that actually is coming from China, based on the commentary from your large cap peers. And are you capturing some of that upside? What's your expectation for China revenue contribution for the full year, and any trend from first half to second half?

Michael Plisinski (CEO)

Yeah. I think, you know, if I, if I look at our numbers, we think second half China revenue will be up over the first half. But it's not massive. It's still in the teens level. So we're seeing growth. We saw growth from Q1 over into Q2 from China. That was a fairly significant growth, which you'll see. But in general, I would say China, for us, is really about a lot of the specialty. We've talked a lot about power semiconductor markets. We are making progress in some of the mature logic areas, within China as well, but that's a little bit slower. And yeah, I mean, you know the challenges we have, selling into China, so I don't think that's a surprise.

I think it's good that we're able to achieve the growth rates we're projecting, even without the tailwinds of China that some of our peers are enjoying.

Charles Shi (Senior Analyst)

Thanks, Mike. So the other question-

Michael Plisinski (CEO)

You know, eventually it's going to, but-

Charles Shi (Senior Analyst)

Go ahead, finish your thought, please, Mike.

Michael Plisinski (CEO)

I was gonna say, which, you know, there's local competition in China, and they're getting stronger, and we see that at the lower end starting to take share. So, you know, I think for us, our strategy is to focus on the higher end applications, the most challenging applications, and where those applications are that we add the most value.

Charles Shi (Senior Analyst)

Got it. The other question is about that $300 million VPA through 2025. When do you expect to ship that $300 million VPA? When does that start? When does the shipment start, and when do you think we'll get to that peak shipment? If you can provide some color about that, would be great.

Michael Plisinski (CEO)

There'll be some initial shipments at the beginning, you know, in the second half. But most of the bulk of it is going through 2025.

Charles Shi (Senior Analyst)

Thank you.

Operator (participant)

The next question will come from Mark Miller with The Benchmark Company.

Mark Miller (Equity Research Analyst)

Congratulations on another good quarter. Just wondering, it appears that you're doing very well. Can you give us some insights where you think you've gained the most share, in what areas?

Michael Plisinski (CEO)

I think we've maintained a very high share in AI packaging, so in the HBM and the 2.5D logic, the CoWoS packaging. We've done well there. And then I think the gate-all-around, we've certainly had some nice increases in adoption of our Iris planar films that I hope will translate into, you know, further growth into 2025 and 2026, as the gate-all-around node goes into full production, and we see the full benefits of the slots that we're winning. I think those are the two biggest areas. Of course, the panel packaging is a strong position for us as well. Still small, you know, and not a lot of, let's say, growth right now.

There's a lot of overcapacity from a couple years ago, but our position continues to strengthen. We continue to add new customers, and I believe this move to the glass and our wide field optics with high resolution is setting us apart from our competition and creating opportunities for meaningful share gains there as well.

Mark Miller (Equity Research Analyst)

You just briefly mentioned Atlas, and just wondering what's going on with Atlas and OCD.

Michael Plisinski (CEO)

Oh, now, that's going very well. The OCD, the Atlas OCD tool is qualified in all of the gate-all-around applications, or at least the three major players. We've continued to—you know, we've talked about the increased capital intensity of OCD and gate-all-around, and that's continuing. And our opportunities for share gains there, that's continuing to prove out. So, that's for sure, you know, a tailwind for us and a strong one. That's an older story, so I didn't mention it earlier, but thanks for reminding me to bring that up.

Mark Miller (Equity Research Analyst)

Let me just squeeze one in more. People are talking about Michael Dell in particular about AI chips going into PCs. Do you see that as an opportunity? And if so, when do you think that starts to become an opportunity?

Michael Plisinski (CEO)

Well, yep, we've seen that. That's why I mentioned several new players are trying to enter into this space. I think it really depends on what is it-- what does the company mean by AI chips? So if it's just a repackaging or some software wrapped around their current architectures, probably won't change too much unless it drives up adoption. If it's more around packaging and bringing memory and logic closer together, hence what NVIDIA has been doing and some others, then I think it can mean a lot to us 'cause it drives up that specialty, more Advanced Packaging that we're so good at right now and creates more opportunities for our Dragonfly tools and sales. I think another big opportunity is where we hear customers from smartphone manufacturers talking about integrating more AI capability in their phones.

That could drive a refresh of phones, which, of course, drives a tremendous amount of Advanced Packaging content, and would, you know, nicely recover NAND memory, as well as the Advanced Packaging OSAT business.

Mark Miller (Equity Research Analyst)

Thank you.

Operator (participant)

The next question will come from Blaine Curtis with Jefferies.

Blayne Curtis (Managing Director)

Hey, thanks for taking my question, and great results. I just kind of curious, more color on the growth you've seen in Advanced Packaging or Advanced Nodes. I think it was, like, 50/50 Logic to Memory. Can you just, you know, kind of talk about where you've seen the strength in markets? And it's also, you know, the question had been the pace of recovery there, but you also have new products with, like, planar. So just kind of curious how much of it is recovery versus new products as well.

Michael Plisinski (CEO)

I wouldn't say a lot of it's recovery. For gate-all-around, of course, you there's that's more investment in the future and you know, a new node, a new inflection or transition. Most of the others are the same. So the NAND expansions that we've seen have been driven by the both new products, so like the Aspect for high-stack 3D NAND, and then some of additional of our more traditional products, again, to support high-stack 3D NAND. So these are mostly technical transitions or technical buys versus, let's say, a indications of a recovery in the market. I'd say the positive sign or the positive takeaway is these customers are seeing utilizations coming up. They are seeing

inventory is coming down, and so they're preparing and investing in these inflections for the next wave of orders and product launches.

Blayne Curtis (Managing Director)

Thanks. And then I just wanted to ask on gross margin. I think your, your model, long-term model is a little dated, but, you know, at a $1 billion run rate, which I guess you're at, where you're guiding, it was 56%-57%. I'm assuming the mix is different, but can you maybe just kind of talk through the ability to get gross margins back into that range of, you know, 56%-58%, and, you know, if, if some of the mix that you laid out back then is different now, and if that's still the right range?

Michael Plisinski (CEO)

Yeah, no, thanks for the question. We, you know, obviously, when it comes to the long-term model, you know, we're not in the- we're not ready to update that yet. Obviously, our commentary is when we're gonna get back into the model, and once we do that, we'll look at updating it further. But when we look at the gross margin, I mean, our goal this year is just to see quarter-over-quarter gross margin improvement, you know, with the objective to get back into that model gross margin, you know, at that $250-$260 million quarter run rate, and then, you know, look beyond that.

But I think the things that we've done from our manufacturing capabilities, driving continued leverage, and, you know, obviously, the mix will help as we drive more back into Advanced Nodes, which is our higher margin product.

Blayne Curtis (Managing Director)

Thanks a lot.

Operator (participant)

That does conclude the question-and-answer session. I'll now turn the conference back over to Sidney Ho for any additional or closing remarks.

Sidney Ho (VP of Investor Relations)

Thanks, Justin. We will be participating in a number of investor conferences throughout the quarter. We look forward to seeing many of you at these conferences. A replay of the call today will be available on our website at approximately 7:30 P.M. Eastern Time this evening. We'd like to thank you for your continued interest in Onto Innovation. Justin, please conclude the call.

Operator (participant)

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.