Welcome to the Nova Ltd. First Quarter 2023 Results Conference Call and Webcast. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Miri Segal, CEO of MS-IR. Please go ahead.
Thank you, operator, and good day to everybody. I would like to welcome all of you to Nova's first quarter 2023 financial results conference call. With us on the line today are Mr. Gaby Waisman, President and CEO, and Mr. Dror David, CFO. Before we begin, I would like to 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. Gaby 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'll now turn the call over to Mr. Gaby Waisman, Nova's President and CEO. Gaby, please go ahead.
Thank you, Miri, and thank you all for joining our call today. I'm excited to hold this call with you for the first time in my new role as Nova's CEO, and I want to thank you all for your continued trust in Nova and its leadership team. Let me begin the call by speaking briefly about our first quarter performance highlights. Following my commentary, Dror will review the quarter's financial results in detail. Nova's performance in the first quarter demonstrates the growing resilience of our business model amidst a volatile and dynamic industry environment. Our revenues surpassed the midpoint of the guidance, reflecting our focus on continued execution against our long-term strategic goals. At the same time, our solid profitability outcome, driven by software revenues and a favorable product mix, attests to the exceptional value of our portfolio and the agility of our operational model.
As our industry charts a path forward, framed by global industry and geopolitical challenges, we remain focused on our strategic plans to enable long-term growth while diligently working to increase our operational efficiency. We are operating in a complicated environment with lower visibility, which increases the business complexity for many semiconductor industry players. The slowdown in the traditional industry drivers, with PC and mobile slowing the most, is only partially counteracted by the increasing importance of automotive, AI, and industrial applications. Memory customers are taking significant measures towards lowering CapEx and inventory levels, while foundry and logic customers are more moderate on both accounts. Mature mode markets continue to fuel demand and balance some relative interim softness in advanced nodes. Irrefutably, the importance of semiconductors has reached an unprecedented height as they form the foundation of the digital economy.
Governments encourage, incentivize, and pressure our industry to build local and sometimes regional technological and manufacturing leadership. Simultaneously, multiple variants challenge manufacturers to successfully navigate design inflection points, including increasing die sizes, vertical complex structures, diverse designs such as chiplets and advanced packaging, new materials, and materials engineering. The consequence of these growing complexities of IC manufacturing is the rising importance of process control, and particularly metrology, to successful and effective manufacturing processes. This is why recent market reports indicate that the process control segments are among the fastest-growing WFE segments. This quarter, our foundry and logic customers dominated the business with more than 80% of our sales. Overall advanced node sales, including memory, were roughly half of our product revenue, led by orders from Taiwan and Korea. Of logic advanced nodes, 85% were derived from fab 5 nanometers and below.
This is a clear indication that while our customers may contemplate short-term capacity adjustments to meet softer demands, they are committed to investing in next-generation technologies. The other half stemmed from more mature process nodes, with 28 nanometers taking the lion's share, primarily led by Chinese domestic customers and followed by Taiwan. Our performance in China was especially strong, driven by the demand for a comprehensive portfolio from Nova, which has a diverse production base. To meet the different metrology demand scenarios, Nova continues expanding its three metrology domains, investing in our innovative and highly differentiated portfolio, which is a wide and healthy foundation for future growth. Our forward progress is further exemplified by the scientific collaboration with our customers, evidenced by papers presented at the recent SPIE conference.
One such example is a paper published with Intel. Following several years of close collaboration and research into cutting-edge optical critical dimension metrology for advanced logic nodes, utilizing combinations of physical modeling and machine learning. Another shining example is the award for collaboration in metrology granted for a 2022 joint paper with imec and a consortium of process vendors addressing a technology critical for enabling geometrical scaling in future nodes. The long-term fundamental growth drivers of our industry and of process control encourage us to stay on course with our investment plans in both infrastructure and R&D. We focus on maintaining our differentiated offering and innovative approach, readying our capacity to respond to future demand sprees, and addressing customers' varied technology roadmaps and production investment plans.
In the first quarter, we announced the opening of our new highly advanced cleanroom facility in Israel that will provide the required manufacturing environment to produce our most advanced platforms. The new facility will expand Nova's production capacity and complements the existing facilities, allowing us to improve procedures, shorten cycle times, and increase yields. We will also soon open an innovation and manufacturing center in California to expand our materials industry reach. We are building our new offices and production facility in Germany. These infrastructure investments are backed by our healthy cash reserves and serve our strategy to execute on our Nova's $1 billion plan. As reflected by our results this quarter, mainly the profitability outcome, Nova's embedded efficient operational model is built to deal with cyclicality and demand changes in the industry.
While we are attentive to market changes, we continue to believe in our long-term growth and outperformance. Let me shed some light on the significant product achievements of the quarter. First, we are encouraged by the record bookings for our materials metrology platforms, VeraFlex, Elipson, and Metrion, and believe our positioning in this domain is a business engine that is pivotal to our strategic growth. Our VeraFlex platform gained access to multiple new accounts this quarter, cementing that it has become a crucial solution on the production floor of every fab. Additional orders for our Metrion and Elipson solutions signal increasing interest in these unique breakthrough platforms and their potential. Second, the demand for our next-generation platforms is also reflected in our optical CD business.
We recently delivered several Nova Prism 2 platforms to a global leading memory customer who is utilizing the solution in the development of its most advanced memory nodes in multiple regions. This quarter also highlights our continuous success with advanced software sales, reaching a new quarterly record. Our software business is thriving because customers are constantly seeking to obtain an additional edge to productivity and yield. Demand for our smart lead management, top-notch generative AI, and machine learning capabilities was fueled by new fabs gearing up for high volume manufacturing in China, and by leading manufacturers in Taiwan and Korea, boosting capabilities for advanced logic and memory devices. Third, our chemical metrology division, formed through the acquisition of ancosys last year, continues to make strategic strides in expanding its presence in both front-end and back-end sectors.
We recently entered the qualified vendor list of a major OEM, setting the stage for new opportunities in the front end. We also secured an extended order from a leading IDM customer for its advanced packaging fabrication, expanding our market share in the logic sector. Finally, our healthy service revenues grew year-over-year, indicating the importance of our install base, which we expect to reach 5,000 active tools by the end of this year. We continue standing by our customers through thick and thin, clearly evident through the multiple service awards we received in the past months, especially as they adopt conservative production utilization measures with cautious operating-related expenditures. I would like to touch on our progress on environmental, social, and governance fronts.
In March, we published our first ESG insight review, reflecting the outcome of a strategic process that identified the significant ESG values and directions for Nova and set clear goals and milestones for the next few years. Our vision is to become a more active influencer in creating sustainable and equitable future. For our ESG strategy, we devised four pillars. First is governance, where we strive to elevate ethical and corporate governance methods. The second pillar is people and social impact, in which we focus on both individual and the surrounding communities. Third is our innovative approach, connecting our technical roadmap to our unique culture for long-term external impact. Our final pillar is environment and supply chains, where we target efficient management of our footprint, energy, and sustainable supply chain.
Nova's sustainable growth over the years has been based on our ability to combine a unique people-centric culture with distinctive innovative technology and advanced social engagement programs. For the benefit of societies around us. We are working towards embedding ESG principles into our operating model, business management, and decision-making processes. Let me turn briefly to our outlook on the industry and its relevance to Nova's performance. It's already become broadly acknowledged that in 2023, we will see capacity adjustments as customers align their investment plans with decreased demand in some segments. Specifically, this is more prominent in memory for both DRAM and NAND, while foundry and logic are also moderately impacted.
Looking at the bigger picture, we anticipate the demand drivers such as HPC, AI, industry, and automotive will continue to call for data-intensive workloads and a need for intelligent edge applications and are expected to drive our industry forward in the long term. We believe that Nova is well-prepared to take the right actions and invest in right areas during this year, including some market share initiatives to prepare the company to grow and outperform once the industry is fully recovered. To conclude my prepared remarks, markets and macroeconomic dynamics are creating short-term uncertainties, impacting consumer demand and customer decisions. Although the coming months will be more volatile and cyclic, we believe that the fundamental drivers of our industry will propel growth in the longer term. Our customers know this well, and they continue to push the envelope toward the next technology generation.
Looking forward, we anticipate some quarterly fluctuations in 2023, followed by stabilization and growth in 2024. We maintain a clear focus on building for the future while tightly managing the present, standing shoulder to shoulder with our customers and partners and working towards mutual success. I'd like to take this opportunity and acknowledge the contribution and leadership of Mr. Eitan Oppenheim. I appreciate his mentorship and continued support as our chairman of the board. I am confident that together, we will ensure Nova's long-term success, and I'm committed to the execution of Nova's $1 billion strategic plan. Now let me hand over the call to Dror to review our financial results in detail. Dror?
Thanks, Gaby. Good day, everyone, thank you for joining our 2023 first quarter conference call. Total revenues in the first quarter of 2023 were $132 million, down 1% year-over-year. Product revenue distribution was approximately 80% from logic and foundry and approximately 20% from memory. Product revenues included three customers and three territories that contributed 10% or more each to the total. Blended gross margin in the first quarter was 58% on a GAAP basis and 60% on a non-GAAP basis, topping the company target model of 57%-59%. The high gross margin in the quarter was attributed to a favorable product mix, including record-level software revenues and the adoption of newer product configurations by several customers, demonstrating the high-value proposition of these products to our customer base.
We expect gross margins to gradually normalize into alignment with the company target model in the coming quarters. Operating expenses in the quarter were $42 million on a GAAP basis and $38 million on a non-GAAP basis, decreasing by approximately 10% quarter-over-quarter. This reduction is a direct result of the cost-restraining activities implemented by the management to adjust to the current business environment, as was communicated in our previous conference call. Operating margins in the first quarter were 27% on a GAAP basis and 31% on a non-GAAP basis at the high end of the company target model of 27%-31%. This excellent result was driven by the combination of healthy quarterly gross margins and the expense control initiatives. As expected, financial income for the quarter increased to approximately $5 million, driven by higher yields on cash reserves.
The effective tax rate in the first quarter was approximately 14%. Earnings per share in the first quarter on a GAAP basis were $1.09 per diluted share, earnings per share on a non-GAAP basis were $1.23 per diluted share, both exceeding the high end of our first quarter guidance. Finally, I would like to share the details of our guidance for the second quarter of 2023. Currently, we expect revenues for the quarter to be between $117 million and $125 million. GAAP earnings per diluted share to range from $0.75 to $0.89. Non-GAAP earnings per diluted share to range from $0.92 to $1.06.
At the midpoint of our second quarter 2023 estimates, we anticipate the following. Gross margins of approximately 57% on a GAAP basis and approximately 58% on a non-GAAP basis within the company target model. Operating expenses on a GAAP basis of approximately $42 million. Operating expenses on a non-GAAP basis of approximately $38 million, similar to the previous quarter, reflecting management's determination to restrain expenses despite a rising inflation environment. Financial income and the tax rate to remain similar to the first quarter. To conclude my remarks, I want to mention the company's cash reserves, which grew to approximately $550 million at the end of the first quarter. This healthy cash level allows us to continue and execute growth strategies and infrastructure investments, as well as to continue and execute the $100 million share repurchase program announced and initiated in 2022.
With that, we will be pleased to take your questions. Operator?
We will now begin the question-and-answer session. To ask a question, you may press Star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star then two. The first question comes from Vivek Arya of Bank of America. Please go ahead.
Hi, this is Dakshanjaya on behalf of Vivek, and thank you for taking my question. Just one on gross margins. You've guided to 58% in June, but that's obviously a step down from March quarter. What really drove the strength in March? I know you said mix and new product adoption, but still it was at a lower revenue run rate. Do you think that strength can continue into the second half and beyond? Thank you.
As I mentioned in my prepared remarks, the main drivers for the first quarter, high gross margins was significantly higher software revenues, which obviously embed the very high gross margins, north of 80%, and also some adoption of new products within the quarter, including newer platforms which embed the higher average selling prices and value to customers. Obviously with the new product, we will see fluctuations going forward, and also we expect software revenues to normalize in the coming quarters. On top of that, as Gabi mentioned, we are opening or have opened the new clean room in Israel in the end of the first quarter. All in all, we do expect gross margins to normalize across the coming quarters across 2023.
We do expect gross margins to be within the target model for the year and also, as I mentioned, in the second quarter.
Understood. As a follow-up, I believe you said that services will grow this year. Do you still abide by that? Just in the overall demand for the business, how are you seeing the demand levels trend over the second half? As in what kind of visibility do you have, especially given memory investments are at a low point currently? Thank you.
I'll take the service revenue expectation, and Gaby will allude to the business. In terms of the service, we do expect services to grow in 2023. Obviously, as Gaby mentioned, customers are becoming more aware to controlling their operating expenses recently. We at that point in time, we expect maybe that service revenues will grow less than expected in 2023. Overall for the year, we do expect them to continue and grow.
To add to Dror comments and to address your question, we obviously only provide guidance for the next quarter, which is the second quarter of 2023. Yet in the current challenging environment, we strive to maintain business stability for the remainder of the year.
Understood. Thank you so much.
The next question comes from Parvati Shrote from Jefferies. Please go ahead.
Hi. Thanks for taking my question. I wanted to sort of get your puts and takes into, you know, I know, I understand you're not guiding for the second half, but just trying to understand the areas, the pockets where you're seeing strength, the pockets where, you know, you expect the weakness to sort of continue. Going off of that, you know, you talked about your bookings for materials metrology being high. Does that sort of continue into second half? Even on the trailing note, there's some strength there from Chinese domestic customers. Does that continue into the second half as well?
Again, as Gaby mentioned, there is a lot of volatility, I think in customer decisions and business in the current environment. We see projects and plans shifting between different quarters. Generally, we do believe that China will continue to be strong across the year, but obviously, memory is very, very dormant and also we see fluctuations in logic. Again, as Gaby mentioned, our goal right now is to strive for stability across the remainder of the year.
Got it. For my follow-up, you know, on the gross margin side, is one of the factors that, you know, you're seeing more material metrology solutions being adopted, is that sort of driving your margins higher in this quarter? Then, how do you feel, I mean, is that the part that drives strength in for the remainder of the year?
In terms of gross margins, the answer is definitely yes. When we mentioned the high-value products to customers, this includes obviously these material products. Because as you know, all the products offering that we offer into the materials market, the VeraFlex, the Metrion, the Elipson, are unique technologies for Nova and with a very high value to customers, so they definitely have positive impact on our gross margins.
Great. Thank you.
As a reminder, if you have a question, please press star one. The next question comes from Mark Miller of The Benchmark Company. Please go ahead.
Thank you for the questions. Can you give us a little color on what's happening in your X-ray business?
X-ray business is essentially two product lines that we offer, which are, as Dor said, unique to Nova and part of our material metrology offering. One is the XPS-based VeraFlex platform, and the other is the in-line SIMS, the Metrion. Both are seeing strong demand, which we are very encouraged of, and strong value offering, which I believe will continue. If we're looking at 2023, of course, we understand that there are some short-term challenges. Overall, we are very encouraged by the penetration to additional customers and the growth in the material metrology, and especially in those products, which is across our broad customer base and new customers that are joining.
We see the momentum picking up, and that will definitely support our business this year and growth next one.
Can you comment about your tax situation? Looks like the taxes are trending down. I'm just curious.
Generally, our effective tax rate model is around 14%-15%. This is our expectation on an annual basis. This is a combination of the main territories where we have, where we are generating IP and profits, which is Germany, Israel, and the U.S. Obviously, Germany is a little bit higher in terms of tax rates, but Israel and the U.S. are actually quite low. We do expect to be within our model also in 2023, meaning between 14% and 15% on an annual basis.
Thank you.
This concludes Nova's first quarter conference call, and I will turn the call over to Gaby Waisman, President and CEO, for closing remarks.
Thank you all for joining us. I'm planning to attend the coming investor conferences in June as well as the SEMICON West in July and invite you to contact our IR and set meetings. With that, we conclude the call for today. Goodbye.
The conference has concluded. Thank you for attending today's presentation. You may now disconnect.