Veeco Instruments Inc.
Q3 2018 Earnings Call Transcript

Published: 1 Nov 2018

[Operator:]

Good day, and welcome to the Veeco Instruments Third Quarter 2018 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Anthony Bencivenga, Investor Relations. Please go ahead, sir.

[Anthony Bencivenga:]

Thank you, and good morning, everyone. Joining me on the call today are Bill Miller, Veeco's Chief Executive Officer; and Sam Maheshwari, our Chief Operating Officer and Chief Financial Officer. Today's earnings release is available on the Veeco website. Please note that we have prepared a slide presentation to accompany today's webcast. We encourage you to follow along with the slides on veeco.com. This call is being recorded by Veeco Instruments and is copyrighted material. It cannot be recorded or rebroadcast without Veeco's expressed permission. Your participation implies consent to our recording. To the extent that this call discusses expectations about market conditions, market acceptance, and future sales of the company's products, future disclosures, future earnings expectations, or otherwise makes statements about the future, such statements are forward-looking and are subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These factors are discussed in the Business Description and Management's Discussion and Analysis sections of the company's report on Form 10-K and annual report to shareholders and in our subsequent quarterly reports on Form 10-Q, current reports on Form 8-K, and press releases. Veeco does not undertake any obligation to update any forward-looking statements, including those made on this call to reflect future events or circumstances after the date of such statements. During this call, management may address non-GAAP financial measures. Information regarding such non-GAAP financial measures, including reconciliation to GAAP measures of performance is available on our website. With that, I will turn the call over to Bill for his opening remarks.

[William J. Miller:]

Thank you, Anthony. Good morning, everyone, and thank you for joining the call. Before we get into Q3 results, I'd like to share a few observations after my first 30 days in my new role. For starters, I'm thankful and delighted for the opportunity to lead Veeco into our next exciting chapter. And I say this for a few reasons

[Shubham Maheshwari:]

Thanks, Bill, and good morning, everyone. Today, I will be discussing our non-GAAP financial performance. You can find the detailed reconciliation between GAAP and non-GAAP results in the press release and on our website. First, I would like to address the expense reduction efforts Bill was referring to. And then, I'll provide some color on bookings followed by details on revenue. You may recall, we announced $15 million in annualized OpEx synergies when we acquired Ultratech. A few actions are still outstanding and we expect to complete them by early Q1 of 2019. We recently initiated additional expense reduction efforts to align our cost structure to the current business conditions. These new actions are projected to save an additional $20 million annually to bring our quarterly non-GAAP operating expenses to $40 million by Q2 of 2019. These expense reductions are being implemented primarily in SG&A with a minimal impact to our R&D and new product development efforts. Now turning to bookings details. In Front-End Semi, we experienced a sharp increase in orders driven by two EUV mask blanks deposition tools in Japan and an LSA tool which is being incorporated into a leading edge semiconductor node. In Industrial and Scientific markets, orders remained strong in data storage as well as our optical coatings business. In Advanced Packaging, MEMS & RF Filter markets, we booked multiple lithography tools with a large Taiwanese OSAT who is adding capacity to provide wafer level advanced packaging applications for their logic customers. In the LED Lighting, Display & Compound Semi markets, bookings continued to be weak as expected. Orders from China were weak across all of our product lines with no bookings for Blue LED MOCVD tools. As such, China made up only 5% of our total bookings. Scientific & Industrial orders were 39% of Q3 booking; Front-End Semi was 37%; LED Lighting, Display & Compound Semi were 13%; and Advanced Packaging, MEMS & RF Filters was 11%. Now turning to revenue detail. LED Lighting Display & Compound Semi was the largest portion of our revenue at $59 million or 46%. The majority of this markets' revenue was in Compound Semi area including MOCVD systems sold for specialty LEDs, Automotive, Photonics and Power Electronics Applications and PSP systems sold for RF device manufacturing. Blue LED MOCVD system sales in China were 21% of total Veeco revenue and, as I highlighted before, we expect this percentage to decline significantly going forward. Advanced Packaging, MEMS and RF Filter to revenue was $25 million or 19% of total revenue and included lithography and (09

[William J. Miller:]

Thanks, Sam. We have several market opportunities in front of us and I will focus on a few of them today. The first opportunity I will focus on is our EUV mask blank deposition systems. In the Front-End Semi market, IDMs and foundries have been continually investing in next generation technologies to advance Moore's Law. The next investment inflection in this evolution is EUV lithography. We have been working on EUV mask blank deposition systems for the Front-End Semi market for many years and are excited to finally see this technology become adopted. Every EUV lithography step requires a photo mask and every photo mask starts as a mask blank. Our Ion Beam deposition systems are proven to produce EUV mask blanks with the lowest level of defects. We have three of these systems in backlog and expect to book another one in the fourth quarter. On a go forward basis as EUV lithography adoption continues, we believe we will have a sustainable business in EUV mask blank systems. These are complex systems with nearly 12-month lead times, and we are focusing on delivering to our customers as we grow this business over the coming year. The next opportunity I am focusing on is our Laser Spike Annealing or LSA system which is at the cutting edge of Front-End Semiconductors. Our LSA system serves a critical function in Front-End Semi manufacturing and has been a process tool of record for manufacturing advanced logic devices from 40 nanometers down to 14 nanometers. We have been working with leading foundries and IDMs for insertion in their leading edge nodes. During this quarter, after an evaluation period, we received an order for an LSA system from a market leader for their upcoming node. We believe this order may lead to multiple follow on orders from this customer and other foundries and IDMs for their leading edge applications. The last opportunity I will touch on today is our Advanced Packaging Lithography system used for DRAM packaging. Advanced packaging of semiconductors such as Fan-Out Wafer Level Packaging, through-silicon via, or copper pillars are methods for designers to enhance performance in applications such as Big Data Analytics and Artificial Intelligence. According to TechSearch International and IC insights, the number of wafers processed with advanced packaging techniques is expected to grow at an 11% compound annual growth rate through 2021. Our Advanced Packaging Lithography systems are performance optimized for these applications and afford our customers a superior cost of ownership. Primarily Advanced Packaging has been utilized in logic applications for application processors and GP use. However, more recently, DRAM manufacturers have adopted this technique as well. You'll recall last quarter we announced that major DRAM producer purchased two of our AP Lithography systems. Memory performance is a limiting factor as artificial intelligence proliferates into both commercial and consumer devices. To enhance performance, COG DRAM suppliers are transitioning from traditional wired bond to flip chip utilizing copper pillars. This enables finer pitch devices with better electrical and thermal performance. We are seeing increased interest in this application from our customers, and have recently placed systems into high volume manufacturing to support this expansion. In closing, the slowdown in our markets we spoke about is keeping us from growing year-on-year. In the interim, we are proactively taking actions to align our cost structure to the current revenue run rates. We are doing this in such a way as to preserve the customer evaluations and product development programs that are currently underway. I would like to reiterate that while we are in a soft revenue environment, we expect conditions to improve and we will return to growth. As I said, when we started the call, we have an exceptional team with extraordinary technology and are position to serve customers in exciting markets with many years of growth ahead. And lastly, before we take your questions, note that Veeco filed an 8-K this morning, reporting that we've recently discovered an attack on our computer systems by what appears to be a highly sophisticated actor. We have notified law enforcement of the attack and have retained forensic experts to assist with the investigation. I refer you to the 8-K for more information. As the investigation is ongoing, we will not be able to answer any questions at this time. With that, Sam and I will be happy to take your questions. Operator, please open the line.

[Operator:]

Thank you, sir. We'll now take our first question from Mr. Brian Lee from Goldman Sachs. Please go ahead, sir. Your line is open.

[Brian Lee:]

Hey, guys. Thanks for taking the questions. I had several here, so maybe if we could just start big picture. Bill, you sound like, you're setting the expectation that we're going to be in the soft revenue environment for you for a bit of time, and you do have pretty tough comps into the first half of 2019 given how strong revenue trends were for you in the first half of 2018. So just when I put all this together, you're annualizing the $400 million top line heading into 2019. What sort of the end markets that are going to put you back onto a trajectory for year-over-year growth? And is that something that you could see materializing by Q3 of next year? Or is this really going to be all the way into the end of the year where you obviously would have the easiest comp looking at Q4 guidance right now?

[William J. Miller:]

Yeah. Great, great question, Brian. I think we could take this from a couple of different directions. If I look at, say, Q2 bookings, I'd say $130 million and Q3 bookings at $100 million, those numbers have very, very little China business in them or Blue LED and that's an average of $115 million. So I think kind of where we are, that would be a place for us to target looking at our bookings. But to answer your growth question, I think we will see growth in EUV with our mask blank business. As we said in our prepared remarks this is a long-lead item looking at nearly 12 months, and so we won't see any of that revenue until Q2 of 2019 and continuing throughout the rest of 2019. So I think that would certainly be something that would be a growth driver. The second area that I think is a bit of a growth driver for us as we mentioned is the win we had in LSA in cutting-edge node. We haven't been in that space since 28 nanometer. So this is, I think, a big win for us and will give us an opportunity to win other applications with this customer as well as provide us an opportunity with other customers to gain share. And so this, as you know, will take some time to be adopted and won't be a quick panacea but certainly further growth there will drive our business longer-term. The other area of growth for us is in VCSEL. As I said, that business has been pushed out and will be not impacting us in the short term positively, so I would see that more later in 2019.

[Brian Lee:]

Okay, great. Now – that's helpful. Maybe on that last point, second question was going to be around VCSEL. Can you maybe elaborate a bit more on what's driving the delays there. Is this just technical qualifications, is it a slowdown in the overall end market where maybe your offering is coming in a bit of a wrong period in time in terms of the adoption curve, or is there some competitive dynamics playing out there? And then related to that, what sort of the -even if it's rough ballpark figures, what your revenue opportunity for that category as you think about it holistically?

[William J. Miller:]

Sure Brian. I would say I have to place the blame squarely on us here. The market is robust. We do have a tool running in our lab in Somerset New Jersey. We are making VCSEL today. We are closely engaging with customers. Many of our customers, all of the main players really are trying to pull us into this market space. They really, really want us to be there because of our production performance in high volume. At this time, we're meeting most of the specifications. But unfortunately, we do need more time to iterate the process to achieve all the requirements. I would say this market is $150-million market where we have very little share today. And so I think once we have our product out on the market, I would think we do have an opportunity to gain share in a rational manner. The market is pretty significant. I do believe we are in very early innings here. And I think we're seeing adoptions in facial recognition but there are opportunities for world facing VCSELs which require higher power and different wavelengths opportunities in automotive. And so I think although we've got to have a short term bump here, the opportunity is pretty significant over a number of years, so we'd certainly remain bullish on this market over the long term.

[Brian Lee:]

Okay, great. Appreciate that. Last one from me, on the gross margins, maybe for Sam. I appreciate the updates around OpEx and the quantification around how that's going to flow through over the next several quarters in terms of your savings initiatives. But if you guys do see this revenue run rate linger in the $400-plus-million range through a decent part of 2019, is there any actions being contemplated or underway for the manufacturing cost side of things where you can get to the 40% levels or above even without a meaningful expansion in the topline or is that not part of the game plan at the moment? Thank you, guys.

[Shubham Maheshwari:]

Yeah. Thanks, Brian. Great question again. So look, we have been reducing costs on the OpEx side quite a bit. As we look at the last few quarters' strength and as I guide towards the next two quarter, it's continuously coming down. So I think what we are trying to do here is to reduce costs in a measured manner and in a way that we can consistently keep on executing towards it. So overall right now, we are guiding you midpoint of 95 million and midpoint of 37% gross margin. But we started the initiative of reducing manufacturing costs in Singapore. It is more than halfway done, but the savings are not yet coming in through into the P&L. And towards the midpoint of Q1 2019, that would be completed. So gross margin side, cost reduction initiatives are yet to play out fully. We remain squarely focused on 40% or higher in terms of our gross margin. I do believe the $95 million run rate on revenue is causing headwinds for gross margin from a volume perspective, so I would say with $100 million or more, say $105 million, $110 million, we should be in the 40% range in terms of gross margin in one to two quarters because our cost reduction initiatives would be completed. So I get a little bit of benefit from volume, $95 million is somewhat low, and then we also get a chance to complete our cost reductions. So again overall, we continue to target 40% gross margin or higher at the levels you talked about.

[Brian Lee:]

Okay. Thank you, guys.

[Shubham Maheshwari:]

Thank you, Brian.

[Operator:]

We'll now take our next question from Patrick Ho from Stifel. Please go ahead, sir. Your line is open.

[Patrick J. Ho:]

Thank you very much. And thanks for taking the questions. Bill, maybe just first to start off, looking at the bigger picture of the red-yellow LDE market and the MOCVD opportunity there. You just mentioned about VCSEL being a 2019 story, but if you look at the big picture for that segment, do you see new customer gains as a driver in 2019 or are some of the customer wins that you generated in 2018 turning into volume, will that be the bigger driver?

[William J. Miller:]

Thanks. Thanks, Patrick. As I think about it, I think this would largely be, as it relates to VCSEL, new opportunities for us going forward. We do have little share in that space today and so this would be a lot of new customer opportunities for us. Although, some of them actually are also ongoing customers, but I would say, on an 80-20 I would say most of these would be new customer opportunities for us.

[Patrick J. Ho:]

Okay. Great. Moving on to the LSA segment. It's very encouraging to hear you get a leading edge win given how muted that business has been for some time now. I guess what's been the change because it has been several nodes where our customers have not employed LSA at a high volume basis. I guess, what's the change or what are some of the manufacturing challenges that help you to at least get this qualification win at this point?

[William J. Miller:]

Yeah. Thanks for the question. And you and I had a few conversations about this over time and we see this as a big win for us and what we needed to do is do a better job of basically listening to our customers, understanding their needs, supporting them and delivering the results. And there is nothing overly magical other than listening to our customers and doing things well for them to get this win. So we're quite proud of it and it has been a number of nodes since we've been near the leading edge. So we are excited. This is a first step for us. I think this is a milestone that we can certainly leverage with this customer as well as other customers as well. We also see opportunities with our Melt technology to make some inroads in terms of reducing contact resistance as well. So we're finally delivering on some of our commitments there right.

[Patrick J. Ho:]

Great. And final question maybe for Sam in terms of the OpEx cuts, they obviously make a lot of sense in the near term, but you've been in the industry especially on the semi cap side were things can turn very quickly. I guess given the cuts now, how flexible or how reactive can you be if business suddenly turns that have "enough" manufacturing capacity as well as people to meet a potential turn in demand?

[Shubham Maheshwari:]

Sure. Yes, Patrick. Thanks. So as I said, most of these cuts are coming through into the G&A area. And so it's mostly general and administrative functions. So we are trying to keep all of our manufacturing capacity other than places where we do know it is an excess, for example in Singapore. So we are keeping sufficient upside capability for the industry to turn up and then we should be able to meet it. We also have a number of relationships with the outside contract manufacturers and outside partners. We are preserving those as well and those are very valued partners. So I think we would have that capability. The one thing I'd like to add and make sure we all realize that the businesses that we are now getting particularly in terms of EUV, they come with a long lead time. So it gives us a lot more visibility. Then, also with Ion Beam technology we get lot longer lead times from our customers as opposed to quicker book and ship in the same quarter and these such things. So it gives them more visibility. The business is higher margin, the business is much more value add, and the quick turn less than six months or five months type of visibility that we use to get on the LED side, that business as the overall proportion of revenue is declining. So I continue to feel good about our ability to turn and be able to address should the demand pick up.

[Patrick J. Ho:]

Thank you very much.

[William J. Miller:]

Thanks, Patrick.

[Operator:]

We will now take our next question from David Duley from Steelhead Securities. Please go ahead, sir. Your line is open.

[David Duley:]

Thanks for taking my question. I wanted to ask a few questions on the Advanced Packaging market. There's been lots of OSATs and IDMs talking about ramping up, pan out in different volumes. And I was wondering what you were seeing there? Is that something that you're participating in? And also and that's more on the foundry logic side. You mentioned that the package being adopted more in memory, I think, for high bandwidth memory applications, if you could just elaborate a little bit more on what's going on in that segment of the market, I would much appreciate it.

[William J. Miller:]

Sure, David. No problem. We are seeing growth in Fan-out Wafer Level Packaging. We recently received some orders from a very large OSAT for this exact market. So we are still very much a major player in this. We still have a very strong market share and don't see that eroding. So we will be participants in that market. I think if you just – it's more of the Taiwan market Korea et cetera, but in China, we have seen some softness in the OSAT space. But that's a little bit more color I'd like to add there. As it relates to high bandwidth memory, what we are seeing is customers move towards advanced packaging techniques to eliminate wire bonding etcetera, and we have been successful in winning business there. So I think that will provide an additional market opportunity for us going forward.

[Shubham Maheshwari:]

And David, I also like to add there that with the new iPhone, the size of the chip is higher (38

[David Duley:]

Okay, well that was one of the next questions I was going to ask. I'll go on to the -- other one is as far as the Advanced Packaging market when you look into 2018 for Veeco, do you think they'll see more growth from the memory side or from the fan-out foundry logic side?

[William J. Miller:]

I would say, David, the answer is both. We do see opportunities in memory for sure. I think that it's a significant opportunity for Veeco and we do see, as Sam just said, the utilizations picking up in the mainstream fan-out space, and we are seeing OSATs add capacity as well. So, I think it's an opportunity in both spaces looking out into 2019.

[Shubham Maheshwari:]

And I would add, David, to Bill's the answer there that in memory -- I think in logic its more driven by technology change as well as capacity, whereas our initial thinking in memory is that we have a tool that has a unique ability provides a really good cost of ownership advantage to our customers. So, at least our initial view is that our technology is coming in initial application and it's a big market. Typically, we've not sold AP tools and memory in the past. This is what changed in the last six months. So we remain hopeful and we hope we are able to crack into more applications in memory. But I would say it's mostly around technology and capacity on the foundry logic side and some work about much more unique to Veeco, unique to Veeco tools on the memory side

[David Duley:]

Okay. And final question from for me. Sam, I think you mentioned something about valuation triggering another impairment charge. If you could just elaborate a little bit more on that particular statement.

[Shubham Maheshwari:]

Sure. Absolutely. So, Veeco reports their numbers in one segment so to say (41

[David Duley:]

We appreciate that. Unlike the impairment charge you took, I think, last quarter, which was directly tied to Ultratech's business performance, this isn't necessarily tied to that; this is purely tied to the market cap of the combined entity.

[Shubham Maheshwari:]

Yes. Your understanding is completely correct. And that makes it in a way simpler than the Ultratech situation which was dependent upon performance and bookings and revenues et cetera.

[David Duley:]

Thank you.

[William J. Miller:]

Thanks, David.

[Operator:]

We now take our next question from Gus Richard from Northland. Please go ahead. Your line is open.

[Auguste Richard:]

Yeah, thanks for taking my questions. On the LSA tool order is what node is that?

[William J. Miller:]

You know, I'm really not at liberty to say. I would tell you with the next node. I'm sorry, Gus.

[Auguste Richard:]

All right. That's all right. I get it. And then you haven't mentioned your strain (44

[William J. Miller:]

We actually are in the midst during 2018 of addressing some product issues that we've had with our customers, and we are expecting to come out with a series of product improvements and upgrades to that. And we are certainly seeing very strong customer interest in that. I just don't want to get too far ahead of ourselves in that space but certainly the technology is – customers find it quite interesting. We just need to make sure that we can meet all of the requirements to meet their product roadmaps.

[Shubham Maheshwari:]

Gus, I would add, that product is generally focused around the memory side and the memory side has been running weak. There are certain product advances we need to make that Bill just mentioned, but at the same time, the overall memory market in these last six months have been soft as you very well know. And so that's what we are going through right now.

[Auguste Richard:]

Okay. It will be product enhancements move that beyond the memory market or is it still going to be primarily focused there?

[William J. Miller:]

It will stay probably in the memory market both NAND and potentially DRAM.

[Auguste Richard:]

Got it. And then on the EUV business, have the mask makers move beyond pellicle issues so that EUV can be used on other layers, other than via?

[William J. Miller:]

That's my understanding. Obviously resist in pellicle issues have been an issue but we are seeing customers starting to take out EUV. So, we are following that market very closely obviously.

[Auguste Richard:]

Got it. Okay. Thank you very much.

[William J. Miller:]

Thank you, Gus.

[Shubham Maheshwari:]

Thanks, Gus.

[Operator:]

There are no further questions over the telephone at this time. I'd like to turn the conference back to our host for any additional or closing remarks.

[William J. Miller:]

Thank you, operator, and thank you, everyone, for joining our call today. And I look forward to giving you an update next quarter. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.