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Edited Transcript of RTEC earnings conference call or presentation 7-Nov-19 9:30pm GMT

Q3 2019 Rudolph Technologies Inc and Nanometrics Inc Earnings Call

Flanders Nov 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Rudolph Technologies Inc earnings conference call or presentation Thursday, November 7, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Sheaffer

Onto Innovation Inc. - Senior Director of IR, Corporate Communications & Marketing Research

* Michael P. Plisinski

Onto Innovation Inc. - CEO & Director

* Steven R. Roth

Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary

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Conference Call Participants

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* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* David Duley

Steelhead Securities LLC - Managing Principal

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* Quinn Bolton

Needham & Company, LLC, Research Division - Senior Analyst

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Onto Innovation third quarter earnings release. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Mr. Michael Sheaffer. Please go ahead, sir.

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Michael Sheaffer, Onto Innovation Inc. - Senior Director of IR, Corporate Communications & Marketing Research [2]

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Thank you, Aaron, and good afternoon, everyone. Onto Innovation issued its press release this afternoon shortly after the market closed. It included Nanometrics and Rudolph Technologies 2019 third quarter financial results and Onto Innovation's fourth quarter outlook. If you have not received a copy of the release, please refer to the company's website at ontoinnovation.com, where a copy of the release is posted.

Joining us on the call today is the Chief Executive Officer of Onto Innovation, Michael Plisinski; and the Chief Financial Officer of Onto Innovation, Steven Roth. As is always the case, I need to remind you of the safe harbor regulations, any matters today that are not historical facts, particularly comments regarding the company's future plans, objectives, forecasts and expected performance consist of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such estimates, whether expressed or implied, are being made based on currently available information and the company's best judgment at this time. Within these are a wide range of assumptions that the company believes to be reasonable. However, it must be recognized that the statements are subject to a range of uncertainties that can cause actual results to vary materially. Thus, the company cautions that these statements are no guarantees of future performance. Risk factors that may impact Rudolph's results are described in the company's latest Form 10-K as well as other periodic filings for the SEC. Rudolph Technologies and Nanometrics does not update forward-looking statements and expressly disclaims any obligation to do so. Today's discussion of our financial results will be presented on a non-GAAP financial basis unless otherwise specified. A detailed reconciliation between GAAP and the non-GAAP results can be found in today's earnings release.

And now I will turn the call over to Mike Plisinski. Mike, please go ahead.

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [3]

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Thank you, Mike, and good afternoon, everyone. It's our pleasure to introduce Onto Innovation to all of you today.

Before I begin, I want to congratulate the entire Onto Innovation team for the outstanding teamwork which ultimately resulted in a smooth and successful launch of this exciting new company. That teamwork is strengthening as we collectively identify opportunities to unlock operational efficiencies and explore the potential for additional value creation by leveraging our complementary technologies across broader served markets. This is an exciting time for the emergence of Onto Innovation with semiconductor content expanding into a wider array of consumer devices. These devices vary in complexity from the latest 5G-enabled smart products and IoT devices to advanced computing and storage to support growing applications and artificial intelligence and autonomous driving. These product innovations are made possible by advances in logic and memory architectures, and also in the complex integration of additional functionalities such as wireless communication, environmental sensing and vision. Onto Innovation process control solutions are positioned across this entire value chain from silicon wafer manufacturing through to packaged devices. We see Onto Innovation's greater scale and broader insight into the value chain as an advantage for customers seeking strong partners to help overcome the challenges of a more complex and distributed manufacturing process.

Now turning to our results and commentary. We will cover the third quarter from the Nanometrics and Rudolph perspectives separately in order to make it easier to bridge the progression from our individual second quarter earnings releases in July. As a reminder, at that time we were in a quiet period and neither company was able to conduct earnings calls to provide forward-looking guidance for the third quarter. Following the summarized financial results from each company, we will provide fourth quarter guidance for Onto Innovation, along with an explanation of how the closing in October impacts the financial statements for the fourth quarter.

So let's begin with Nanometrics and the results for the third quarter. As outlined in our earnings release, revenue increased 8% over the prior quarter to $73 million. Spending from logic and foundry customers grew in the third quarter, and as a result, our product revenues from foundry, logic and other devices were up 47% from the second quarter. This growth was primarily driven by repeat orders of our Atlas optical metrology platform by customers adding capacity for their advanced nodes at 10-nanometer and below. NAND product revenues grew as well, with customers adding Atlas systems to provide more precise control of critical dimensions such as high aspect ratio channel holes. Overall, memory was flat quarter-over-quarter, with strength in NAND offsetting the weaker DRAM environment. Also in the third quarter, our integrated metrology tool IMPULSE EV was selected by a leading memory customer for 3D NAND CMP applications. This buyer was after an extensive evaluation of systems to support their demanding requirements for across the wafer and wafer-to-wafer process control. We expect production orders to begin later in 2020.

Overall, for the first 9 months of 2019 foundry, logic and other device revenues have increased 139% year-over-year, outperforming the overall industry, while our memory revenue has declined 46%, which is consistent with the overall industry decline in memory WFE.

I'll now ask Steve Roth, Onto Innovation's CFO, to cover the financial highlights.

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [4]

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Thanks, Mike. Before I begin my prepared remarks, I want to remind everyone that as usual, the financial results discussed here will be provided on a non-GAAP basis and will be presented as each company has historically accounted for non-GAAP items. Later in my remarks, I'll let you know how the new merged company will present our financial information going forward. So let's begin.

As Mike mentioned, Nanometrics third quarter revenues were $73.1 million, an 8% increase from the second quarter and 5% lower than the third quarter of 2018. Product revenues were $60.1 million, an increase of 14% from the prior quarter. And service revenues, which comprised 18% of revenues, was $13 million, a decrease of 14% from the prior quarter. By end market, product sales to the NAND segment were 41% and DRAM sales were 19%, resulting in the memory business being essentially flat with the second quarter. In addition, total foundry, logic and other devices increased quarter-over-quarter to contribute 40% of revenue compared to 31% in the second quarter. Nanometrics had 5 customers in the third quarter, representing 10% or greater sales. They were Samsung, Intel, SK Hynix, Toshiba and TSMC. Third quarter gross margin was 53.5% and was flat with the previous quarter. Product gross margins increased 143 basis points from the second quarter to 55.5%. However that increase was offset by lower service margins, mainly due to lower service margin -- service contracts in the quarter. Operating expenses were $29.9 million, flat with the prior quarter, with slight decreases in R&D, offset by similar increases in sales and marketing. Net income for the third quarter was $7.4 million or $0.30 per share compared to $5.3 million or $0.21 per share in the 2019 second quarter.

Now turning to the balance sheet. Cash and investments decreased to $144.1 million. The decrease was primarily driven by cash used to pay for merger-related expenses. Year-to-date, capital expenditures were $9.9 million. Those expenditures completed most of the previously announced upgrades to the manufacturing and information technology infrastructure and global office space.

Now I'd like to turn the call back over to Mike. Mike?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [5]

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Thank you, Steve. Now turning to our historical Rudolph business, revenue came in at $62.9 million, representing a 2.4% increase over the second quarter. Our macro inspection business grew 20% over the second quarter partially driven by strong sales of NovusEdge systems. As a reminder, NovusEdge systems are being adopted by leading silicon wafer manufacturers to meet the evolving process control requirements for wafers targeted for EUV applications. In addition, Dragonfly G2 continues to gain traction in a number of segments, including an additional top 5 memory manufacturer that will use 3D stacked packaging for their advanced memory product. This type of package uses through-silicon vias or TSVs to gain speed and reduce power losses between the stacked DRAM chips. In addition to 2D inspection, the demand for high fidelity 3D measurements has been growing with the adoption of copper pillar and micro bumps in advanced logic and memory devices. As a result, over the last 3 years, the adoption of our 3D metrology sensors increased with a CAGR of over 20%, including our current forecast through 2019.

We have taken orders to support both 3D and 2D applications from this memory customer and expect additional orders in 2020. Our metrology business in the third quarter was down approximately 40% from the second quarter, again, primarily due to declining CapEx spending from memory customers. Despite the decrease in volume, we qualified MetaPULSE at 2 additional NAND manufacturers for improved etch control of the hardmask layer. We added our sixth panel customer for our JetStep lithography tool in the third quarter. This tool will be used for process development of next-generation packaging technology of a novel 2.5D or multi-die application. As we've stated previously, the growing demand for heterogeneous packages is well served by the larger panel format. Though production ramp has been slower than expected, we continued to see investments in R&D and pilot lines from a growing number of customers. This positive development was offset by a number of lithography opportunities impacted by the prolonged trade dispute between China and the United States.

I'll now turn it back to Steve Roth to briefly cover the financial highlights.

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [6]

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Thanks, Mike. Here are the details behind the third quarter results for Rudolph Technologies. As Mike mentioned, third quarter revenue was $62.9 million, up slightly from $61.5 million in the 2019 second quarter. Increases in our inspection and lithography businesses were partially offset by lower metrology and software.

Gross -- moving to gross margin. Our gross margin decreased to 50% in the quarter from 52% in the second quarter. Software represented 8% of total sales compared to 12% in the previous quarter. And that coupled with the lower metrology sales and a JetStep lithography system combined to pressure the margins in the quarter.

Looking at the details of Rudolph's operating expenses, which are on a non-GAAP basis exclude the merger-related expenses, we continue to maintain tight control over our spending. Third quarter operating expenses were $21.9 million, down slightly from $22 million in the second quarter. Slight decreases in R&D project costs were offset by minor increases in SG&A. Net income for the third quarter was $9.8 million or $0.31 per share compared to $9 million or $0.29 per share in the second quarter. The increase in net income was primarily driven by higher foreign exchange gains, slightly lower revised tax rate for the year.

Now turning to the balance sheet. Cash and marketable securities increased $13.3 million to $193 million in the quarter, and our free cash flow for the quarter was $13.6 million. While we expect the new company to be a significant free cash flow generator, fourth quarter cash flow will be negative due to the payment of a majority of the merger expenses in the quarter. Accounts receivable increased slightly to $63.3 million and our inventory declined to $104 million.

That wraps up my comments on Rudolph for the third quarter. So now before I turn the call back over to Mike, I would like to take a couple of minutes to discuss some important financial changes that we will be making as we move forward as Onto Innovation. As we have discussed, the combination of Rudolph and Nanometrics is a merger of equals, and per the merger agreement, Nanometrics is the legal acquirer in the transaction. However, from a financial accounting perspective, Rudolph is the accounting acquirer, and that means Rudolph's financial results will be the surviving entity to be used from a historical comparative basis. We also need to conform our financial presentation basis of the 2 -- as the 2 companies differed in certain areas. As such, here are a couple of changes we will be implementing.

We have aligned our reporting formats as it relates to what's included in cost of goods sold. Certain costs Rudolph previously recorded in operating expenses will be moved above the gross margin line. And some of the Nanometrics costs that were in the gross margin line will be moved to operating expenses. The net result of these changes will decrease the overall gross margin by approximately 1% on a combined basis, compared to what you might expect if you just added the 2 historical results of the companies together. In addition, we will no longer adjust our non-GAAP results to remove Rudolph's stock compensation expense to be consistent with the Nanometrics' presentation format. The impact will result in a decrease in non-GAAP operating income of approximately $6 million to $7 million annually in the new company compared to historical results. GAAP operating income, of course, will remain unchanged. These changes will affect, obviously, all quarters moving forward.

Another important fact relates to the timing of the close of the merger and the effect on Q4 guidance. Since the merger closed during the quarter, on October 25, our fourth quarter financial results will be comprised of a full quarter of Rudolph operations, but only the activity of Nanometrics from the closing date through the end of the year. This results in approximately $14 million in revenue and $10 million of operating expenses not included in the Q4 guidance that Mike will provide in a couple of minutes. In addition, while the total shares outstanding post-merger will be approximately 50 million shares, the weighted average shares used in the calculation of the fourth quarter earnings per share will be approximately 43.5 million shares due to the exclusion of the fourth quarter Nanometrics shares prior to the closing.

And with that, I'll turn the call back over to Mike for comments on the next quarter. Mike?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [7]

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Thank you, again, Steve. As you may have already seen from our earnings release, we expect fourth quarter revenue for Onto Innovation in the range of $117 million, plus or minus 5%. This excludes the $14 million in October revenue from Nanometrics, which Steve discussed a moment ago. At the midpoint, the pro forma combined revenue decline year-over-year for Onto Innovation in 2019 is approximately 12%, showing solid performance relative to forecasted WFE. When we last provided forward-looking outlook on our respective first quarter earnings calls, our expectations were higher. But since then, the memory spending environment further worsened rather than improving as expected. And as previously mentioned, lithography opportunities were negatively impacted by the prolonged trade dispute with China. In this revenue range, we expect gross margin to fall between 51% and 53%, impacted by the 1% change Steve discussed in product mix. Operating expenses are projected in the range of $42 million to $43 million, which excludes approximately $10 million in premerger fourth quarter expenses. Those expected revenues and expenses would then produce non-GAAP net income per diluted share to be in the range of $0.32 to $0.42. We are confident in our ability to move the gross and operating margins into our model as we have focused on unlocking the synergies this combination provides.

Similar to what has been reported by our peers and customers, we see the fourth quarter driven by increasing spending from foundry and logic investments, particularly at the advanced nodes. We're benefiting from this in 2 ways. The first is from the growing adoption of our Atlas III+ metrology tool used for advanced optical critical dimension measurements. The second way we are benefiting is supplying process control solutions upstream to the leading suppliers of this advanced silicon. In fact, Onto Innovation has 2 product lines qualified by multiple top wafer manufacturers: the NovusEdge inspection system, and the QS series FTIR metrology system for composition monitoring of substrate and epi processes. This combination provides a more comprehensive process control suite for the most advanced silicon wafers targeting EUV process nodes. The recent announcement from ASML, highlighting strong growth in EUV stepper backlog underscores the optimism we have for demand of our solutions, not only in the fourth quarter, but also as we look ahead to 2020. It's interesting to note the growing adoption of 5G technology in handhelds is contributing to the increasing demand for sub 10-nanometer process technology. This is underscored by the recent statements from TSMC, "Since the middle of this year, we have been seeing an acceleration in the worldwide 5G development. This will speed up the introduction and deployment of 5G network for smartphones in several major markets around the world, which leads to the increase of our CapEx for this year.

Meanwhile, we expect the silicon content of 5G smartphones will be substantially higher than that of 4G smartphones. Power efficiency, speed and ability to incorporate additional functionality are critically important to 5G smartphones, which require TSMC's leading-edge N10 and N5 technology." The full transformation to 5G will take a number of years. But in addition to increasing demand for advanced logic, it is also driving new packaging requirements in the form of heterogeneous 2.5D packages, novel antenna and package designs and advanced silicon carbide-based power devices. Likewise, we see packaging activities by Tier 1 IDM and foundry customers continuing to accelerate as they seek to add competitive differentiation through new packaging technologies. Illustrating this is TSMC's CoWoS and info development with a projected $3 billion in revenue for 2019 and Intel's continued development of EMIB and Foveros packaging technologies into 2020.

In support of these investments, we expect another double-digit increase in inspection revenue for the fourth quarter, which would represent a 50% increase compared to the fourth quarter of 2018. We believe this increase reflects the growing optimism for 5G-enabled devices and the growing demand for more precise process-control solutions. We see a continued decline in spending on DRAM memory in the fourth quarter, offsetting the growth in foundry logic and advanced packaging and resulting in low single-digit decline at the midpoint of our guidance on a pro forma basis. While the exacerbated weakness in DRAM this year has impacted our expected growth in the second half of 2019, a potential rebound in DRAM in 2020 would also contribute to our optimism as we look ahead to next year.

In summary, Onto Innovation has opportunities across the semiconductor value chain, spanning wafer manufacturing, leading-edge memory, logic and specialty devices as well as advanced packaging, which enables all of this technology to come together in smaller high-performance form factors. We take pride in recognizing our innovations across this value chain are helping our customers to release new and innovative products that are changing the world.

I want to conclude by conveying how excited I am to be a part of the Onto Innovation team. This team is made up of an amazing collection of passionate and talented individuals that are eager to solve new challenges and maximize the opportunities ahead of us to the benefit of our customers, our shareholders and ultimately, our Onto Innovation team.

And with that, we will open the line for your questions. Aaron?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll go first to Quinn Bolton with Needham.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Congratulations on the combination. And nice job on the results so far. I wanted to start with some of the accounting treatments. I guess if I look at the revenue on a stand-alone basis for Nanometrics and Rudolph in the third quarter, you would have combined about $136 million. Your guidance for the fourth quarter inclusive of your $117 million midpoint plus the $14 million from Nano gets you to $131 million. So on a sort of pro forma full-quarter-to-full-quarter comparison, revenues are down. Is that all sort of driven by the decline in DRAM? Or are there some revenues that will not be able to be recognized as a result of the purchase accounting treatment of the transaction?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [3]

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Quinn, this is Steve Roth. So yes, factored into the lost revenue number of $14 million is some revenue, deferred revenue that is lost in purchase accounting. So that is factored into the numbers. So your comparison of $136 million pro forma to $131 million is the accurate math.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Okay, okay, understood. And then just looking into the Nanometrics non-GAAP results, they were running about $30 million in the September quarter. That includes some level of stock-based compensation, since the company will not be backing out stock-based comp going forward. Has there been any change as a result of the combination to the historical stock-based compensation of about $3 million that Nanometrics had included in their OpEx?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [5]

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No. I mean, the number -- there's no change because of the merger in the expense hit that would normally hit on a quarterly basis on the Nanometrics side. Obviously, as we work through integrations, there'll be some synergies and things that might impact stock-based compensation, as you can imagine, especially on the kind of the higher level, corporate overhead level. So yes, so those numbers will change, and we'll be giving more guidance as those start to materialize going forward. But basically -- the basis on which they've been -- Nanometrics will do their stock-based compensations remains unchanged.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Okay. Any chance you can give us sort of a stock-based comp number for the fourth quarter for the combined...

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [7]

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So for our side it is that the annual base is between 6 and 7 that would -- comp would be at. And then -- for us. For the Rudolph side, it's about $1.3 million that was in our historical results. And what was the...?

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Michael Sheaffer, Onto Innovation Inc. - Senior Director of IR, Corporate Communications & Marketing Research [8]

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We don't -- we haven't recorded it separately.

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [9]

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Okay. We'll have to get you that number, Quinn, because I don't have it right in front of me. We don't break it out, it's just in the numbers. It was already out of the...

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Operator [10]

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(Operator Instructions) We'll go next to Tom Diffely with D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [11]

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Another question along the lines of the Nanometrics business level. So before you went quiet a couple of quarters ago, the thought was that, that business would grow 25%, 30%, half over half. And obviously, it's at a level right now that's a fair amount below that. So I just wanted to clarify, is the difference between what we heard back then and today truly just the DRAM side? Or has the logic foundry portion, which was supposed to be the big part of the ramp come down a bit as well?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [12]

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No. It's truly the DRAM side has come down quite significantly from where the expectations were when those guidance numbers were provided. On the logic foundry and other side there -- when we look at the trailing 9 months, it's up 100-and-something percent, 130-something percent. And we expect it to be up again in Q4, but not enough to offset the continuing decline in the DRAM.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [13]

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Okay. And those, the 10- and 7-nanometer and 5-nanometer lines, those are multi-quarter build-outs?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [14]

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Yes. Yes. We saw some ramping in Q3, we see continued ramping in Q4, and we don't have firm numbers for Q1, but a lot of these are continuing into 2020.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [15]

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Okay. And then, Steve, on the fourth quarter model, are the expenses from the Nano portion and the first pre-close, are those also excluded from the numbers?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [16]

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Yes. So that was $10 million that we talked about in the prepared remarks. So in the guidance that Mike gave on the OP expenses, there's $10 million of, call it, October op expenses not in that number.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [17]

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Okay. And then it sounds like the services business on the Nano side was down a bit. Is it just because of what's going on with the acquisition? Or was there more to it than that?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [18]

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I think it was primarily related to fewer upgrades. They had a big surge in upgrades in the third quarter, mix of software and hardware upgrades, and that came down a little bit in this quarter -- in the third quarter, sorry.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [19]

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Okay. And then, Mike, in your comments, you talked about complementary product lines between the 2 companies. Maybe just a little more color on that. Are these products that from complementary point of view, at some point work together? Or are these just complementary in the fact that they don't overlap?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [20]

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We're exploring that. So they're certainly in the same parts of the line. So we're looking at our MetaPULSE technology and some of the Atlas products are in the same parts of the lines, and there could be opportunities to provide additional data streams to provide more insight for customers on critical challenges. And then the wafer manufacturers, those technologies, it's the same. They're in the same parts of the line. And we're just now starting to open up discussions about what does this mean? Can we wrap software around these 2 data streams and provide additional insight and potential equipment control solutions to further improve yields and time to ramp for these customers.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [21]

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Okay. Good. And then finally, when you look at the nice exposure that Nano has, especially on the memory side or I should say, the NAND side, are you starting to see some early signs of potential recovery like we heard from Lam and a few others? A little bit of hope on the NAND side, even though the DRAM side of the market is still pretty weak?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [22]

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So we saw -- I think it's a matter of timing. We did see a pretty strong growth in NAND in the third quarter. And that was largely to support installations of a number of process equipment. So obviously, you need the metrology systems in place first to qualify and ramp up the process equipment. So we saw some of that. From talking to the team, we do see continued investment in NAND growing into the 2020. But for this quarter, where we have more insight, NAND is down and DRAM is also down.

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Operator [23]

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We'll go next to Patrick Ho with Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [24]

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Congratulations, Mike, to you and your team to getting this deal closed and going forward. And Steve, thank you for a lot of these clarifications, and I'm sure you've aged a few years with all the number crunching you've had to do over the past several weeks. Mike, this question may be a little bit unfair, given that it's still early in the combination of the 2 companies. But given a lot of the complementary solutions that both Nanometrics and Rudolph offers to, say, memory customers and particularly for some of the larger memory suppliers, where you're seeing both next-generation front-end changes in the manufacturing as well as advanced packaging, have any of your customers already come to you and asked you about, hey, can you help us in some of these now that you're one company? And how do you address some of those potential projects on a going-forward basis?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [25]

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That's a great question, Patrick. So the short answer is no. We haven't had that insight or direct questions from customers, but it's only been less than 2 weeks since we were even allowed to start sharing technology and product road maps and that kind of thing. So I think it's premature for -- to expect customers to be thinking along those lines. That said, in the initial discussions we've had, I think we've been pleasantly surprised to find out capabilities of systems that we didn't understand and various problems each team was solving with customers that our combination may help accelerate the solution. So we're still early in that exploratory phase, but we're encouraged by what we're seeing already, and including the impact software can have on tying these data streams together from the different metrology systems. We're going on a pretty extensive roadshow next month, where we'll be meeting with the leading customers -- executives from all of our customers, top customers. And that's where I expect we'll have some more detailed discussions around exactly that.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [26]

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Great. That's really helpful. And maybe as my follow-up question in terms of how we should look at OpEx and particularly R&D on a going-forward basis. Again, it's early in the consolidation of the 2 companies, given that a lot of projects are probably being evaluated as we speak. Maybe, Steve, how do we look at R&D, maybe on a kind of qualitative or a big-picture basis as we go into 2020?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [27]

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So obviously, you're right. We just started that process from an integration perspective. I mean our R&D -- we each had pretty robust R&D programs and the OpEx. So -- I mean, we've identified a number of synergies as part of our integration planning. I think you would start with the base numbers you have probably for both companies. I don't see any -- any big change right off the bat from there, but then we'll work in synergies. Clearly, as Mike said, looking at products and platforms and things that are overlapped or going to come out, we'll probably give you more guidance going forward as we lay out that synergy plan. But I wouldn't expect any significant change in the overall -- like if you see the guidance that Mike gave for Q4, that's somewhat the run rate of the 2 companies and we'll be taking, obviously, synergies off of that number. But there's clearly synergies in that area.

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [28]

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Yes. I would expect, Patrick, that we'll be able to provide more clarity to that in the January and April calls.

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Operator [29]

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(Operator Instructions) We'll take our next question from Craig Ellis with B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [30]

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I'll just ask a follow-up to Patrick's question to make sure I'm looking at things correctly, in terms of the information you can provide. I think the cost synergies target previously was $20 million. Guys, can you provide any color on how much of that is pure OpEx versus anything that you would get in COGS and just rough timing in terms of where and when that can be realized?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [31]

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Yes, Craig, I would say that of the $20 million, it was probably something like 25% in the COGS line and 75% in OpEx. I mean on a rough basis. So that's kind of how you could expect to start seeing it come out of the OpEx line of the $20 million.

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [32]

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On the timing, I would say, that's something we're just now starting to dig into and put together plans on what exactly we're going to do to achieve the synergy targets and look at the timing for those plans. And that's what I was referring to Patrick about. In the January and May -- April or May earnings calls, we'll be able to provide more guidance to that. I will say there is a priority to adjust and bring in some of those synergies a little sooner rather than later.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [33]

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Okay, that's helpful. And then, Mike, just a clarification on some of your fourth quarter commentary. And helpful to get the insights on inspection and advanced packaging and DRAM. I don't think I caught anything on NAND, is the expectation that given the strong third quarter, that's down sequentially? Or how do you expect the NAND business to play out in 4Q?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [34]

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NAND in the fourth quarter is also down. And so DRAM and NAND are both down. Again, we had a pretty strong third quarter set of orders for NAND, and we don't expect that to continue. So that's down in the fourth quarter. But offsetting that is very strong orders from logic foundry, up almost 50% between the 2.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [35]

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And from what your teams are seeing out in the field, what's your sense for how long this foundry logic strength can last? Do you have visibility into the first quarter of next year, would it extend beyond that? Just any further color on the momentum in that part of the business would be helpful.

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [36]

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Yes, it's probably a little early to say, but from what we are -- what we see, most of these expansions will probably continue into the first quarter. The question is, will DRAM -- will some of the memory business recover as well. And that's what we'd be looking for to really start to see some significant growth in the numbers.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [37]

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Okay. And then my last question is going to be a higher-level question for you, Mike. So obviously, this call has a lot to do with the specifics of bringing the companies together, and congratulations on getting that job done and getting us started. The question really is about calendar '20 and I'm wondering if you can just reflect a little bit on the things that you're excited about as you look at the combined portfolios? The opportunities that you see that exist for the company -- the new company next year? What are some of the things that investors should look for as milestones as Onto unleashes innovation and tries to realize significant growth in the market?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [38]

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Sure. Thanks, Craig. Well, I think we're most excited about the inflection that 5G is bringing. So as 5G starts to drive both the advanced logic and the -- in support of the growing smartphones, growing number of smartphones, that will also pull in and create some potential drive in growth for the NANDs and all the specialty devices that we've been working on penetrating over several years now. So we're pretty excited about that inflection and what it means for a number of areas where Onto Innovation plays. So obviously, milestone wise, you'd look for continued growth in those areas. We're also excited about the wafer manufacturing, the position that we have now as Onto Innovation with multiple products, supporting these advanced wafer process control for wafers for EUV. That's been a significant growth driver, and it looks like a significant growth driver moving forward. And then I think from a sort of financial perspective, big milestone is to see -- and we haven't laid this out for you yet, but we will, is to see us start to hit and deliver on the synergies that we forecasted. And again, we want to do that sooner rather than later.

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Operator [39]

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We'll go next to David Duley with Steelhead Securities.

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David Duley, Steelhead Securities LLC - Managing Principal [40]

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Just a couple of clarifications. I think as people have fleshed out, your guidance is down sequentially on a combined basis. Could you just talk about -- you mentioned memory, DRAM, I guess, but there was also something about advanced packaging. Could you just elaborate exactly why revenue was down sequentially?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [41]

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Okay. So it's primarily memory, so it's primarily DRAM. That's been -- drove down some Atlas potential, which was offset by the meaningful growth on the logic foundry side. And then on the MetaPULSE, which is also pretty heavily tied to memory, obviously that's down, I think I said 40-something percent in the prepared remarks. And that's really the $3 million, $4 million that we're talking about being down quarter-over-quarter.

As far as advanced packaging, actually, I believe we were implying that's going to grow. We expect after a 20% or so growth in the third quarter from Q2 to Q3, we expect still a double-digit growth in our inspection business moving into the fourth quarter.

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David Duley, Steelhead Securities LLC - Managing Principal [42]

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And could you elaborate a little bit more about the lithography business? I guess you referenced a couple of shipments that aren't going to happen or just elaborate on what that -- what was going on there?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [43]

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Yes. So we had a number of accounts that we were expecting to close at least -- several, 2, 3, in China, which did not happen for a variety of reasons related to the trade dispute. So that was one negative side. The other is we shipped the panel tool in the third quarter, so that was a positive. We expected another customer, similar, to take a panel tool, and that also did not happen that looks like a push out into 2020. So most of it is push-outs or delays related to the China situation. But overall, the advanced packaging research and the lithography's position in that research for the next-generation of packages remains pretty strong, and we remain encouraged by our position there.

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David Duley, Steelhead Securities LLC - Managing Principal [44]

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Okay. A clarification question, you gave gross margin guidance for Q4 for the combined company, and I just missed that. Could you repeat what the Q4 gross margin is?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [45]

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Sure. It was 51% to 53%, right?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [46]

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53%. Right. And that got impacted by the change that we're conforming the presentations by about 1% based when -- versus, well, if you had added the 2 companies together, what you might think it would be.

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David Duley, Steelhead Securities LLC - Managing Principal [47]

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Okay. So that's just shifted the cost around between operating expenses and gross margins. But that doesn't -- there's no change in stock comp because you didn't have a lot of stock comp on the Rudolph side in the cost of goods sold number, just like $200,000 or $300,000, right?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [48]

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Yes, correct.

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David Duley, Steelhead Securities LLC - Managing Principal [49]

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Right. Okay. Thanks for that clarification. Now a couple of things. Going forward, will you be providing a revenue breakout on a quarterly basis amongst metrology, inspection, lithography and software? Or how would you be presenting the numbers to us as far as the breakouts of the revenue?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [50]

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We're having discussions on that now, and we'll have that laid out for you in the January call. January, February, whenever the next earnings call is.

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David Duley, Steelhead Securities LLC - Managing Principal [51]

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Okay. And then final question for me is you mentioned cash flow would be negative in the fourth quarter, driven by M&A expenses or merger expenses. Could you just articulate how much those are? And without those, what the cash flow -- do you have an estimate for what cash flow from operations might be?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [52]

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Yes. So if you -- so you're talking about 20 -- over $20 million. If you look at the guidance in the press release, you can see the impact on a per share perspective that we've put in there. But you're talking at around $20 million or so, $25 million to $28 million, I think, is the total, but it's not all cash in the quarter, so...

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Michael Sheaffer, Onto Innovation Inc. - Senior Director of IR, Corporate Communications & Marketing Research [53]

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$20 million.

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [54]

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Yes. So about $20 million in cash flow probably impact on the quarter in those numbers.

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David Duley, Steelhead Securities LLC - Managing Principal [55]

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Okay. And then you said cash flow would be negative. What -- could you give an exact number, so we can just basically back into what cash flow from operations might be without the onetime events?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [56]

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I think -- so on a combined basis. No, we have -- we would -- that, we would just be a couple million cash flow positive, I think, at the end of the quarter, without that in there. We're going from a combined -- hold on a second, 3...

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [57]

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Well, we were 13 and...

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [58]

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Yes, I'm just trying to find that. Dave...

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [59]

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We'll get you that number, David.

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [60]

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Dave, I'll get to the number. It's $20-something million, obviously, of cash out the door, and I got to see what the cash -- the pro forma would be on without that.

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David Duley, Steelhead Securities LLC - Managing Principal [61]

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And will you be providing pro forma numbers on a historical basis?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [62]

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That's a little more difficult. Obviously, with the -- because the purchase accounting is going to change the numbers going forward, but we'll be able to -- it'll be, yes, we won't be -- we can't put them in the documents per se, but you can add the 2 companies together. I mean, obviously, from a historical basis, but there'll be accounting differences that won't allow us to just sit there and do comparatives.

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Operator [63]

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We'll take a follow-up from Quinn Bolton with Needham.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [64]

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Steve, on the gross margin, I understand the reclassification hit you by about 100 basis points. As we look out to the long-term model that you gave with margins of 55 to 56. Was that 55 to 56 inclusive of those changes? Or do we need to think about that 55 to 56 coming down by 100 basis points due to the reclassifications?

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Steven R. Roth, Onto Innovation Inc. - Senior VP of Finance & Administration, CFO and Secretary [65]

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Yes, I would take the 100 basis points off that. So I think the top end is probably fine, but I would think it's probably 54 to 56, Quinn.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [66]

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Okay, great. And then just on the business side, I think you had mentioned a win on the integrated metrology side, and wasn't sure if you said that, that was part of the current strength you were seeing in the NAND business. Or whether that was business that you expected to ship either in Q4 or sometime into 2020?

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Michael P. Plisinski, Onto Innovation Inc. - CEO & Director [67]

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That was business that will be -- that has been pushed out to 2020.

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Operator [68]

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Ladies and gentlemen, that will conclude our Q&A session. I'd like to turn the call back to Michael Sheaffer for any additional or closing remarks.

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Michael Sheaffer, Onto Innovation Inc. - Senior Director of IR, Corporate Communications & Marketing Research [69]

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Thank you, Aaron. I would like to thank everyone for participating on the call today and for your interest in Onto Innovation. We are clearly excited about beginning this new era with the company and look forward to future calls. That concludes our remarks for the day. Please wrap it up, Aaron.

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Operator [70]

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Ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.