Anthony Bencivenga - Veeco Instruments, Inc. John R. Peeler - Veeco Instruments, Inc. Shubham Maheshwari - Veeco Instruments, Inc..

Brian Lee - Goldman Sachs & Co. LLC Y. Edwin Mok - Needham & Co. LLC Mark Miller - The Benchmark Co. LLC.

Good day, and welcome to the Veeco Instruments Second 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, Head of Investor Relations. Please go ahead, sir..

Thank you and good morning everyone. Joining me on the call today are John Peeler, Veeco's Chairman and CEO; and Sam Maheshwari, our CFO. 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. And with that, I will turn the call over to John Peeler for his opening remarks..

Thank you, Anthony. We had good operational performance in Q2. Our revenue came in at a $158 million. Non-GAAP operating income of $11 million and EPS of $0.15 were towards the high end of our guidance.

We also exceeded gross margin guidance in the quarter and closed out the first half at 36%, which was above our previously communicated first half expectations. Our book-to-bill ratio was 0.8 with bookings coming in at a $132 million.

Order softness was caused by the LED market, where we're beginning to see LED manufacturers delay orders as they absorb recently added capacity. Between 2017 and the first half of 2018, several hundred MOCVD reactors for Blue LEDs were shipped into the market and we expect an absorption period.

Also, due to a revision in projections for our Ultratech business, we were required to record a non-cash intangible asset impairment charge of $252 million, which Sam will explain in more detail.

Even so, let me reiterate that we remain confident in the strategic fit between Veeco and Ultratech and the long-term growth prospects of the combined company. Additionally, we continue to make progress towards generating synergies as we integrate Ultratech.

We recently initiated steps to rationalize our manufacturing capacity and closed Singapore-based manufacturing activities for Ultratech products. We expect to complete this initiative by the end of Q1 2019 and anticipate $2 million in annual savings.

We had several announcements throughout the quarter that highlighted the traction we are receiving as a result of our innovation. They highlighted customer wins in our exciting growth markets of Photonics, Display, Advanced Packaging for Memory and Power Electronics.

I'll get into some of these growth opportunities in a few minutes, but for now let me turn the call over to Sam for a financial update..

Thanks, John, and good morning everyone. Today, I will be discussing our non-GAAP financial performance. You can find a detailed reconciliation between GAAP and non-GAAP results in the press release and on our website.

First, I would like to address the asset impairment charge and then I'll provide some color on bookings followed by the revenue details. During Q2, our revised projections from Ultratech products were lower than those made at the time of the acquisition.

The reduced projections were caused by lower than expected unit volume of certain vendors' smartphones which incorporate Fan-out Wafer Level Packaging as well as a delay in the adoption of Fan-out Wafer Level Packaging by other electronics manufacturers.

In addition, there has been a delay in the build-out of 28 nanometer fabs in China who were expected to buy our LSA systems. Taken together, these projections required the company to assess the carrying value of intangible assets on the books. As a result of this analysis, we recorded a charge of $252 million for the GAAP financial.

Since this charge is non-cash in nature and does not impact the day-to-day operations or liquidity of the company, it is excluded from the non-GAAP financial. Again, this is an outcome of comparing current projection to the projections made at the time of the acquisition.

Relative to the current run rates, we are confident about the growth of this business in future in both the Front-End Semi as well as Advanced Packaging markets. Now turning to booking. Bookings for the second quarter were $132 million.

In Advanced Packaging, MEMS & RF Filter markets we booked multiple, we booked multiple lithography tools for a DRAM copper pillar application and multiple wafer (00:06:01) systems supporting Advanced Packaging application. In Front-End Semi, we received orders relating to STT-MRAM and EUV Mask Blank Deposition application.

We are optimistic about both of these markets as growth drivers for Veeco. In scientific and industrial markets, we experienced a sharp increase in orders from our data storage customers, particularly for Ion Beam Deposition tools. In LED Lighting, Display & Compound Semi market, bookings were soft.

Blue LED MOCVD orders from China for general lighting and backlighting purposes declined quarter-over-quarter. In summary, the overall distribution of bookings across our markets was more balanced, notwithstanding the very strong bookings for Scientific & Industrial.

Advanced Packaging, MEMS & RF Filters was 19%; Lighting, Display & Compound Semi was 14%; Front-End Semi was 21%; and Scientific & Industrial orders were 46% of total Q2 bookings.

Now moving to revenue, Q2 revenue was roughly flat to Q1 at $158 million; our first half 2018 grew 18% sequentially over second half 2017 and an impressive 53% over first half of 2017. Lighting, Display & Compound Semi revenue was relatively unchanged at $88 million dollars.

Our shipment volume of MOCVD tools to customers in China was healthy in Q2, which made up nearly 31% of total Veeco revenue. However, going forward, we expect this volume to decline due to the softness in China bookings I described earlier. We also shipped a number of tools for a variety of photonics and RF device applications in this market.

We expect photonics and RF devices to continue to provide growth potential for us. Advanced Packaging, MEMS & RF Filter revenue was $25 million and included lithography and PSP systems for Advanced Packaging and RF Filter applications.

Front-End Semi nearly doubled this quarter to $18 million, which included revenue from STT-MRAM and Laser Annealing System. Scientific & Industrial revenue at $27 million dollars was down quarter-over-quarter and included shipments for data storage as well as optical coding applications.

We expect to pick up momentum in this market, given the strength in Q2 booking levels. Geographically, China was 45%, U.S. 21%, rest of the world 18%, and EMEA was 16% of total Q2 revenue. Ending backlog was solid at $305 million, roughly two-thirds of which is scheduled to ship in 2018.

The other one-third includes longer lead time Ion Beam systems which are scheduled to ship in the first half of 2019. Now turning to P&L highlights for Q2. Non-GAAP gross margin was 35.8% higher than guidance due to better product mix as well as favorable cost structure in warranty and manufacturing areas.

Non-GAAP OpEx was sequentially lower and better than guidance at $45.7 million dollars. Non-GAAP taxes were $2.1 million dollars. And finally, non-GAAP EPS of $0.15 on a diluted share count of 47.4 million shares was better than guidance midpoint, primarily driven by gross margin upside and well-managed expenses. Now moving to the balance sheet.

We ended the quarter with $261 million in cash and short-term investments, a decrease from Q1 driven by working capital investments.

Accounts receivable rose due to backend loaded shipments in the quarter; inventory increased as we invest to get ready to launch new products; and lastly, customer deposits decreased due to reduction in orders from China-based MOCVD customers.

Long-term debt on the balance sheet was recorded at $281 million, representing the carrying value of the $345 million in convertible notes. Now, turning to Q3 guidance. Q3 revenue is expected between $130 million and $140 million.

Quarter-over-quarter decline in revenue comes from softness in China MOCVD shipments, partially offset by strength in the Ion Beam Systems. Non-GAAP gross margin is expected between 36% and 38%, in line with previously stated expectations of improving margins in the second half.

Non-GAAP operating expenses are expected between $43 million and $45 million. Non-GAAP operating income is expected between $4 million and $9 million. GAAP loss is expected between $0.25 per diluted share and $0.15 per diluted share and non-GAAP EPS is expected between $0.03 per diluted share and $0.13 per diluted share.

And now for some additional color beyond Q3. Overall, we continue to expect to grow in all four market segments in 2018. Low margin Blue LED MOCVD system sales in China are expected to decline. As sales from the rest of our businesses grow and increase as a proportion of our overall business, we expect gross margin for the company to pick up.

As of now we see Q4 revenue tracking flat to Q3, but with higher gross margin. We remain committed to a target of exiting the year at 40% gross margin. Beyond Q4, gross margin for calendar 2019 is expected to be higher than 40% as a result of sustainable better product mix and completion of cost reduction initiatives.

And with that, I'll turn the call back to John for a business update..

first; our disk drive manufacturers are continually looking to improve the areal density of their magnetic heads; second, the overall number of thin film magnetic heads is forecasted to increase. Both of these factors require additional process steps and drive additional business for Veeco.

In Q2, we also maintained our momentum for Ion Beam Sputtering by shipping systems for industrial laser and optical coating applications. The Scientific & Industrial market has consistently provided foundational support to our overall business.

These are just a few examples of where our best in class Ion Beam technology is enabling our customers' success. In closing, let's revisit our 2018 objectives. First, we continue to anticipate growth in all four markets this year.

Second, we're committed to innovation; our development efforts are in full force, and we will be announcing new products in the second half of the year. Third, we continue to stay on track with Ultratech integration. After unifying our ERP systems, we're now eliminating redundant manufacturing operations in Singapore.

And last, we continue to execute well. Based on our solid second quarter results, we have improved our operating margin in the first half of 2018 compared to the first half of 2017. And with that Sam and I will be happy to take your questions..

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

Hey guys. Thanks for taking the questions. I had several here.

I guess just first off, Sam, on the Ultratech write-down, can you give us a little bit more color on whether that's assessed quarterly or if that's an annual assessment? And then with respect to timing, it seems like the business had been tracking below expectations for a little bit of time here and post the deal.

So, wondering if anything had downticked even further here to drive the impairment decision at this point?.

So thanks, Brian.

So, at around the anniversary of the acquisition – we had done the acquisition if you would remember in – towards late May, early June of last year and as we assessed the business, particularly for accounting reasons, we – we have to look at the new projections and these projections are lower than what we made at the time of the acquisition.

And so, that is what triggered the impairment. However, I want to say that the current projections for out-quarters here is higher than the current run rates that we have experienced so far with Ultratech.

You know it is not new news; we have shared with you before that since the time of acquisition, Ultratech business has been soft because of various delays in either the smartphones or the adoption of Fan-Out Wafer Level Packaging.

And as we look at the last one year of experience, we are required to kind of take those results into consideration and develop projections based off of that experience. And so these projections are made on an annual basis, and that's what we've done.

But more importantly, I want to stress that we are very confident about the strategic fit of the business with Veeco. And also, we are confident about the growth of this business going forward compared to what we have experienced so far.

Maybe John, do you want to add something to Brian's question?.

Well, I'd just reiterate that we are – the business fits well with ours. We sell Ultratech products to Compound Semi customers. We are seeing a lot of sales synergy in the business, and we think over the long-term, it will be a good addition to Veeco. The impairment is really something that the accountants made us do..

Yeah. So, I mean the other thing I want to stress, Brian, is that this is completely a non-cash charge. It has no impact on the liquidity or operations of the company in any which way..

Okay. Now, that's helpful color. I appreciate the context. And your second question – or two questions related to sort of the state of the business and some of the strength you're seeing here. I guess first off, on the bookings. John, you mentioned the strength in Scientific & Industrial Ion Beam and Data Storage related.

It sounds like it's one of the bigger quarterly results I think we've seen for that segment in a little bit of time. So can you speak to how sustainable you think that momentum is, or if this is something we should expect to moderate here? I'm not sure where you think we are in terms of the CapEx cycle for some of the Data Storage players..

Well, there is – there's tremendous growth in the amount of information to be stored due to the cloud and various enterprise applications.

So, our customers in the Data Storage market are working to improve their areal density, they are changing their designs and they need more equipment to make more advanced heads and more advanced disk drives that store more and work better.

So, we do think this business will continue and it'll be a healthy business for us both in terms of products and services. It was particularly strong this quarter, but we see more ahead over the next year..

Brian, I'll also add that in this business, traditionally we've had a number of technologies residing inside this business. And the same type of Ion Beam technologies, we are finding a lot of solid and very good traction in the EUV market and certain other Optical Coatings market.

So this business is generating revenues for us, not just from Data Storage but also from other type of applications. And it's kind of beginning to pan out for us and we are seeing some good strength in these other areas also..

Okay, great. Maybe last one from me and I'll pass it on.

Just on the Blue LED side, can you update us on what you're seeing in terms of utilization trends across some of your customers and then you know specifically in China, how you are thinking about the supply/demand balance out there given your comments around capacity digestion, just maybe how – how much time you think that might require for us to see a pickup back in China.

Thanks..

Okay. Well, utilizations have come down slightly, not a lot. I think in the China Tier-1s they are still in the high 80s. Tier-2 has dropped. We've heard of some inventory buildup at certain Tier 1 players. And then outside of China, utilizations have dropped a little bit too.

And it's not surprising; in 2017, we believe there were over 400 reactors added to the market or K465i-equivalent reactors. And in 2018, it's going to grow substantially over that. So I think we've put a lot of product into the market. Lighting adoption continues at a very fast pace, but it's just going to take some time to absorb what's out there..

Just to clarify, John, on your comments; so, you estimate 400 K465i-equivalents were added in 2017 and that in 2018 more than 400 incremental units are going to be added?.

Yes, yes..

Okay. All right, thanks a lot guys..

Thanks, Brian..

Thank you. We can now take our next question from Edwin Mok from Needham. Please go ahead..

Hey guys. Thanks for taking my question. So first question, John, on some of those new applications that you talked about, so GaN and also Micro LED.

One, do you expect those to be growth driver in 2019 and specifically on Micro LED, do you think that the customer base need to buy new tools to replace the Micro LEDs, or can it use existing capacity?.

I think first of all on Photonics and GaN Power, GaN RF, we do think that 2019 will be a growth year for us. We've announced important deals in Photonics and GaN Power to Lumentum on Semi and Alidia (00:29:42) this quarter. So we are winning deals and we have new products on the way that I think will make us even stronger in certain applications.

So, this is where a lot of our future growth will come from. I think in Micro LED, it's a little early to say when that's going to take off. But we've clearly shipped tools into Micro LED, but we haven't seen product announcements that are really ready to ramp here yet (00:30:20). So it may take another year or two.

I think there are new tool requirements for this market. Some applications can be handled with existing tools, but there are new tool requirements for Micro LEDs to really work well. So I think that will be a growth opportunity..

Yeah, so John, maybe just a quick follow-up on that. I think you've talked it about before; you guys are developing a new tool for Photonics and then also GaN Power market.

Are you also working on new tool for Micro LED, or is it just a improvement of – in that platform on that?.

Yeah, we've been working with the key players in Micro LEDs around the world and there were quite a few of them and we have a product pipeline that will deliver what the market needs and we'll roll that out as – basically at the right time when Micro LEDs are really ready to go..

On the LDD Ion (00:31:25) can you clarify it? Is that a multi-tool orders and when do you expect the products to be shipped?.

Well, we booked one additional unit this quarter. We have a strong interest in more and we expect more bookings in the coming quarter. Those tools will ship in 2019. And so I think they'll give us a good source of growth there in 2019..

So, Edwin, these tools have pretty long lead times. These are very complex tools, as you can imagine and pretty much we are the only provider for that blank – mask blank deposition capability in the market. And so, we are quite excited about this. But these tools do have long lead times.

And there is, as John just said, pretty strong customer activity in that market for us..

That's very, very helpful. And then lastly, Sam, just for you. If I see, your guidance implied (00:32:29) should be down sequentially. Is there a way to think about long term OpEx run rate? Is this is the new run rate that we should think about OpEx or (00:32:38) revenue you can give some guidance on that..

Yeah, sure. Yes.

So you know what's been happening is if you look at the OpEx performance over the last [Technical Difficulty] (00:32:48) and into the guidance for this quarter, it's been steadily coming down and [Technical Difficulty] (00:32:54) of our continued efforts on working on the synergies with the [Technical Difficulty] (00:33:01) acquisition.

So as these initiatives gets completed, we are able to bring the cost structure down. And so it's been continuously coming down and I think it is going to be trended further lower.

I just don't have a magnitude to [Technical Difficulty] (00:33:18) at this time, but it's largely dependent upon [Technical Difficulty] (00:33:23) that are already underway, but them getting completed and so – so we'll guide you a little bit, but definitely expected to trend further lower here..

Okay. Great. That's a great trend. That's all I have. Thank you..

Thanks Edwin..

Thanks Edwin..

Thank you. We will now take our next question from Mark Miller from the Benchmark Company. Please go ahead..

(00:33:53) the semiconductor equipment suppliers are reporting some push-outs into 2019 on their equipment related to the smartphone and NAND.

Is that impacting your Ultratech or your other front-end businesses?.

We haven't seen that impact. So, you know our weakness was more in the Blue LED market. We've performed I think well in the front-end and other markets. Advanced Packaging is an overcapacity situation at a large [Technical Difficulty] (00:34:32). But we've received orders from OSATs and we've penetrated a new memory customer.

I would say we haven't seen that trend..

You reported sharp increase in business from Data Storage.

Is that for Ion Beam Deposition and Ion Beam Etch and its thin film head related I assume?.

Yes. Yes. We developed what we think is the best Ion Beam deposition [Technical Difficulty] (00:35:07) technology, period, for the Data Storage market, and those tools are used to make heads on hard disk drives. And as our customers work to get more to improve their areal density, they need to do more steps and they need more tools.

At the same time, [Technical Difficulty] (00:35:32) same technology and we've applied it to other applications. And you saw earlier in the [Technical Difficulty] (00:35:40) Ion Beam Etch for SST-MRAM use our Ion Beam Deposition for EUV mask blanks. Our Ion Beam Deposition for Optical Coatings is actually doing very well.

So I think a solid quarter for Data Storage and the [Technical Difficulty] (00:36:06) playing well in new applications, we expect more of those in future..

So these Ion Beam for thin film heads, it's more for new designs rather (00:36:15)?.

Yeah. They – it's new designs that basically enable better areal density and enable more capability. Lot of times the customers have to take more passes [Technical Difficulty] (00:36:36), so they'll need additional tools..

Thank you..

Yeah. Thanks, Mark..

There are no further questions on the phones at this time. So, I would like to hand back to our hosts for any additional or closing remarks..

Thank you for joining us today and we look forward to seeing you in the [Technical Difficulty] (00:37:01) months out on the road. Thanks..

Thank you..

This concludes our call today ladies and gentlemen. Thank you for your participation. You may now disconnect..