Good day, everyone, and welcome to the Veeco Instruments Inc. corporate hosted Q2 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Anthony Bencivenga, Investor Relations. Please go ahead, sir..

Thank you and good afternoon, 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. And with that, I will turn the call over to Bill for his opening remarks..

Thank you, Anthony. Good afternoon, everyone, and thank you for joining the call. Veeco executed well in the second quarter. Our revenue was near the midpoint of guidance at $97.8 million and non-GAAP gross margin improved 2 percentage points to 37.8%.

Our non-GAAP bottom line results were also within guidance with an operating loss of $1.6 million and an EPS loss of $0.06 per share. We continue to see strength in our technology-driven purchases but capacity-related orders were soft, resulting in bookings for the quarter of $78.2 million. This was expected given the soft macroenvironment.

But we remained optimistic about our long-term growth prospects. We are still working toward our goal of returning to profitability, and we'll be reducing infrastructure in the coming quarters to further improve the cost structure of the company.

I will provide an update on our markets and growth opportunities, and then Sam will provide more details on the financials. The semiconductor capital equipment industry is experiencing headwinds from multiple end markets.

Automotive sales growth has slowed, the memory market is in a cyclical downturn with high inventory levels and the smartphones supply chain is in a state of overcapacity as smartphone unit volume growth has slowed.

As a result of these headwinds, wafer fab equipment spending is expected to be down in 2019 and estimates vary regarding the timing of recovery. Veeco is impacted by the industry slowdown. But we benefit from technology inflection spending.

Veeco is proud to leverage a long history of enabling our customers' technology and facilitating their high-volume production and while we see softness in the short term, long-term-trends driving this semi industry are intact. We are making progress with exciting new products and remained focused on winning our customers business.

I will now give you an update on our growth initiatives supporting EUV adoption, front-end semi with laser annealing, MOCVD for the photonics market and advanced packaging. Looking at our EUV mask blank opportunities, our customers use our tool to deposit many essential layers of their mask blank.

All masks in the lithography process begin with a mask blank and it is critically important that they are defect-free. This is why customers choose Veeco's low-defect density Ion Beam Deposition technology. Customer demand for Ion Beam Deposition system is very strong and aligned with EUV adoption. There are several proof points supporting this.

In addition to TSMC and Samsung announcing their EUV readiness months ago, Intel more recently announced that they are also ready for EUV introduction and according to a Barenberg report, Samsung and SK Hynix are committed to using EUV for their 16-nanometer and 12-nanometer DRAM manufacturing processes.

This is consistent with ASML indicating they are seeing interest from DRAM customers for EUV in addition to the logic customers. Underpinning all these proof points on their most recent earnings call, ASML indicated they are on track to ship 30 EUV systems in 2019 and more than 30 systems in 2020.

There are many variables, which will drive the demand for our EUV mask blank tool, such as the number of layers produced with EUV, the number of exposures before mask must be replaced, scanner throughput, mask blank yield, colorful adoption and a number of take ups.

Regardless of how these variables evolve, we are well positioned to play a critical role in the adoption of EUV lithography with our Ion Beam Deposition system. Moving to our laser spike anneal product, we are excited by both the existing customer traction and the opportunity in front of us.

As previously announced, we have achieved production tool of records status for one annealing application and a major customer's advanced node. We are working on additional applications with this customer for their next node, and we are also excited to be working with another leading customer on multiple applications in their next node as well.

In addition to this leading-edge activity, we are also seeing order activity from customers in China for our LSA products. As you know, we have been enhancing our TurboDisc MOCVD platform for the photonics market. This market includes vertical cavity surface-emitting lasers, or VCSELs, edge-emitting lasers and red, orange, yellow specialty LEDs.

Initial feedback suggests our new product has advantages over our competition in key customer requirements, such as particle defectivity, growth rates, uniformity and run-to-run consistency. We are pleased to announce that we have now shipped the first of these beta MOCVD systems to our customer and we are receiving excellent feedback.

We look forward to continued success with them, and we continue to work with other customers to place additional systems. Future growth drivers for this market will be machine vision and industrial applications, world-facing sensors and automotive LIDAR. And we are working with customers to help them build capacity when the market returns.

Another source of growth for Veeco is advanced packaging, which is an exciting segment of the semiconductor industry. We are confident, manufacturers will continue to adapt advanced packaging techniques to improve performance of electronic devices. One of the big drivers of advanced packaging is artificial intelligence.

Advanced packaging scheme shortened the distant between logic and memory, resulting in higher performance, lower latency and reduced power consumption, which are characteristics AI devices require.

We are investing in a new lithography product for the advanced packaging market that delivers improved resolution, overlay, depth of focus and field size to meet next-generation requirements. We successfully completed several demos in our facility and expect to ship our first beta in the coming quarters.

I would like to spend a minute on how the data storage market is providing foundational support to the company. Builds of our Ion Beam systems to hard disk drive manufacturers have been strong for several quarters and we expect this to continue due to the growth in cloud computing.

As cloud computing becomes pervasive and continued growth in software as a service and as real-time data access continues to grow an importance, the amount of storage required is forecasted to grow exponentially. This is still a significant cost advantage favoring hard disk drives over solid state memory.

The solid state memory cost declined, our disk drive manufacturers must reduce their cost as well. Veeco has a long history of enabling this trend by helping our customers to improve their aerial density, driving down the cost per gigabyte.

Moreover, if the mix of hard disk drives is shifting from personal computer devices to high-capacity drives that enable the cloud, the total number of heads shift is forecasted to increase. This is another tailwind for Veeco. Now that we are halfway through 2019, let's look at our progress to date. We are making good progress with new products.

At this time, we have completed most of the development activity on our MOCVD system designed for photonics applications, our next-generation advanced packaging lithography system and our laser annealing system for the sub-7 nanometer market. And as we previously mentioned, we shipped our first production system for EUV mask blank manufacturing.

And lastly, we remain focused on profitability. Our gross margins are improving and as we further optimize our cost structure, we expect to see improved performance. With that, I'll turn it over to Sam for further details on the financials..

Thanks, Bill, and good afternoon, everyone. 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. Q2 bookings were $78 million and ending backlog was $274 million.

As a reminder, beginning in 2020, we will discontinue providing bookings and backlog results. Revenue for the quarter was $98 million. This was slightly below the midpoint of our guidance due to the recent trading restrictions with Huawei, which impacted revenue by approximately $2 million for us.

Scientific and industrial market made up 48% of total revenue, driven by Ion Beam system shipments to our data storage and optical customers. Front-end semi market was 25% of revenue, and was driven by shipments of our first EUV mask blank system as well as sales of multiple laser annealing systems.

Advanced packaging, MEMS & RF Filter market made up 17% of overall revenue, driven by multiple AP lithography systems sold for high-bandwidth memory and GPU application.

LED, lighting, display and compound semi was 10% of overall revenue, reflecting softness in the worldwide LED market and we are in the early stages of penetrating the photonics market. By region, the U.S. was 40% of overall revenue, driven by the data storage market.

Rest of the world, which includes Japan, Taiwan and Korea, was 27%, driven by our EUV mask blank systems sales. And China was 20% of our overall revenue, driven by services revenue and LSA product shipment. Lastly, EMEA was 13% of overall revenue. Now turning to the non-GAAP operating results.

Gross margin of 37.8% was a 2 percentage point sequential improvement from Q1 due to the improved product mix as well as cost-reduction efforts. OpEx for the quarter was $38.5 million on reduced R&D spending. We expect OpEx to remain at these levels for the remainder of this year and expect to reduce it in 2020.

Tax expense for the quarter was $0.3 million. Net income was a loss of $3 million and EPS was a loss of $0.06 on a diluted share count of 47 million shares. Now moving to the balance sheet and cash flow highlights. We ended the quarter with cash and short-term investments of $247 million, which was a sequential increase of $10 million.

Out of the $247 million in cash, $43 million were held offshore. Cash flow from operations was $14 million, driven by a decrease in accounts receivable and inventory as well as an increase in customer deposit, offset by reduction in accounts payable.

We made good progress reducing inventory by converting evaluation tools in this quarter, however, inventory is still high because we are experiencing slow-moving inventory in the LED business due to the ongoing softness there.

Long-term debt on the balance sheet was recorded at $294 million, representing the carrying value of $345 million in convertible notes. And lastly, our CapEx during the quarter was $4.3 million. Now turning to Q3 guidance, which is non-GAAP, unless GAAP is specifically mentioned.

Q3 revenue is expected between $95 million and $115 million with gross margin between 37% and 39%. We expect OpEx to be around $39 million. GAAP EPS loss is expected between $0.40 and $0.20 per diluted share. Non-GAAP EPS is expected between a loss of $0.10 and an income of $0.10 per diluted share. And now for some additional color beyond Q3.

At this time, based on our current visibility, we are reiterating second half top line growth of roughly 10% over the first half. We continue to target gross margin of 40% by the end of this year due to the favorable product mix and cost reductions. And we expect positive EPS in Q4. And with that, Bill and I will be happy to take your questions.

Operator, please open the lines..

[Operator Instructions] We'll go first today to Patrick Ho with Stifel. And Patrick, you may have us muted but your line is open..

Sorry about that.

Is it better?.

Yes..

Yes. We can hear you..

Sorry about that. Maybe first focusing on the advanced packaging market. Traditionally, a lot of your past advanced packaging buys on the lipo side have been driven by the smartphone market. You mentioned you saw some memory buys.

Do you expect those trends to continue? Or are you seeing any indication that the smartphone market may turn soon and that'll drive some of your new buys over the next few quarters?.

Sure, Patrick. So since the Ultratech acquisition, we have seen some headwinds in the smartphone supply chain and that is a big push into the advanced packaging market. But we are seeing the breadth of applications starting to increase.

And so we are seeing some DRAM applications for copper pillars in high-bandwidth memory applications and we're also seeing some OSATs buying for GPU applications in advanced packaging. So we are seeing the number of applications broaden and that's certainly a very much of a positive thing.

But obviously, the smartphone market today is a big driver of the advanced packaging market. And certainly, AI is driving a lot of that as well. So it will be interesting to see how fast the advanced packaging applications for AI takeoff here..

Great.

And maybe, Sam, as a follow-up, you are on target to get your 40% gross margins by the December quarter, can you tell us what the biggest, I guess, variables or influence for gross margins are? Is this simply going to be product mix? Or do you get some of the cost-savings initiatives that you're putting into place, they start getting recognized on the gross margin line? What's the biggest influence that we should look at for the December quarter as well as going into 2020?.

Thanks, Patrick. That's a good question. So for the 2019 Q4 quarter, certainly product mix is definitely the strongest contributor to improvement in gross margin. The cost reduction is definitely helping us already in Q3 and Q4 but it is a small contributor.

Now as we go into 2020 with our guide of second half revenue growth and as we carry that growth into 2020, the volume should also begin to play its part in the overall gross margin expansion.

So I would summarize and say that product mix is the largest contributor and for the longer term, volume would be second, and then cost reduction is playing out as the third positive driver for the overall gross margin..

We'll hear next from Brian Lee with Goldman Sachs..

I had a couple here. Maybe just -- I know moving into 2020, bookings are no longer going to be reported and you're trying not to focus us on that metric anymore.

But they seemed relatively soft this quarter versus the revenue guide for 3Q? It sounds like you have good visibility into 3Q and 4Q though reiterating the 10% up view second half versus first half. So just wondering, is there something unique about the mix near term.

Just more turns business or maybe you could give us some more color there in terms of the bookings relative to the revenue guide sort of GAAP there?.

Sure. So definitely, we do agree bookings were soft in Q2. But actually, we've seen good bookings in July already. So some of the business that we were planning to close in June, it just got pushed over to the first 2 weeks in July. So overall, we are looking at improving our bookings in Q3 over Q2, so that's certainly encouraging for us.

And then in terms of the overall guide for the second half being 10% over the first half, a lot of confidence there is coming from the strong backlog that we are carrying. So at this time, we have about $275 million in backlog. So that enables us to ship in second half and gives us the confidence to enable the revenue growth.

And then your other question or other part of your question in terms of the mix. So right now, we are shipping quite heavy into the data storage industry. We have a very strong market share position there, and we are blessed with very long lead time there, so that's certainly helpful.

The other place where we are we are seeing some good activity, as Bill has talked about many times, is in the EUV business.

A piece of our business, particularly in the advanced packaging markets, generally has low visibility for us in the sense the lead time there generally can be from 3 to 4 months or 3 to 5 months, say, but that business has been running soft in the last couple of quarters and it is continuing to be soft.

So right now, our backlog gives us plenty of visibility to give us the confidence for the revenue growth. And hopefully, we are also looking for overall bookings growth in Q3..

Okay. Now that's helpful color. Appreciate that, Sam. And then on the VCSEL MOCV data tool, congrats there, I know you guys have been speaking about that for a couple of quarters running here, so good to see the progress.

But can you give us some more color on whether this customer is new to the VCSEL technology market? Or is this a customer just looking to do source off the current vendor that they use? And then is there sort of a time line you can provide us in terms of converting the beta? Are you including this as part of your second half revenue expectations?.

Sure, Brian. Yes, thanks for the shout out on getting the -- our arsenide phosphide tool out there. Yes, it's a long-standing customer of Veeco's and it's really for photonics applications, including VCSEL. So I would characterize them as not being in that space today, but their desire is to enter that.

So to answer the second half of your question, we're -- typically, a beta would go, say, 6 to 12 months. So we're thinking more like early 2020 and so the revenue from this tool is not in the second half guidance..

And from Northland, we'll hear from Gus Richard..

On the EUV side, you've got a mix of DRAM guys coming in.

Could you give us a little bit of help on how many Ion Beam Dep tools you need for stepper and does it matter if it's memory or logic?.

Sure. There is a lot of variables that go into that. Certainly, the number of steps that are going EUV matters pretty significantly. The yield of the EUV mask blanks, whether pellicles are introduced and just the absolute number -- the number of applications and products that are willing to go EUV make a big difference.

Another key item is obviously the yield of the mask blanks themselves are fairly low today and the wear off mechanisms of the masks is a variable as well. So there's a lot of variability and I'd like to give you a rule of thumb for that.

But given all those caveats I just told you, it's probably in the neighborhood of 1 EUV mask blank tool per 10 to 12, 15 ASML scanners, something like that..

Okay....

It's a pretty wide range -- I apologize, but we'd have to see kind of how this market shakes out..

Right. And we don't know how long the mask blanks will last in a machine. So okay, that's helpful. And then on the arsenide phos for MOCVD tool, is the initial customer using that for an edge-emitting laser, VCSELs or red, orange, yellow LEDs..

So I would say, they are a full-service photonics player in the world and they are probably -- they're planning to use it for all of the above applications..

Okay.

And then the timing on the -- do you expect to ship another beta before year-end? Or any color there?.

Yes. We're working very closely with a number of customers to ship another tool certainly -- that's certainly a strong goal of ours. And we're just working through the issues and certainly, we'd like to get 1 shipped certainly here in the -- another one in the second half of the year for sure. Still work in progress..

Okay. On the spike anneal, from my understanding, we should start to see risk reduction for 5 nanometer in the fourth quarter.

I would imagine the customers have, kind of, decided what they're going to be using? Have you gotten any color or indication on additional layers at 5 through the spike anneal?.

So we are clearly the tool of record at 5 for 1 particular application and we are working with them at their next node. Obviously, we are the incumbent on that particular application, but we are actually working with them to qualify 2 to 3 other applications at the next node.

So our exposure at 5, as far as I understand, was really only the 1 application..

You mean 7?.

Yes..

So you have 1 layer in 7 and you're working on 2, 3, more at 5 but no indication of additional layers at 5s?.

No, let me just be clear. The one -- the application, we've won it actually at 5 and now we're working with them on their next nodes for multiple steps -- multiple user steps..

Got it. Got it. Sorry, my misunderstanding. And then....

And just to fill in a little more color. Similarly, we're working with another customer and have qualified at a one-step -- 1 application, say, 7-nanometer or so. And we're working with them to qualify 2 to 3 additional applications at their next node. So 2 customers, 2 steps and then moving the next nodes to more steps..

Got it. And then last one for me.

You've noted that bookings pick up in July, can you give a little color on which end market or which end markets were picking up?.

I would say, I'll pass it to Sam for more color, but I would say, it was really just timing. I mean we were actually forecasting these orders in Q2 and some just slipped over. I think in particular, there was a laser anneal and maybe some wet, clean, etch tools order. I think those are the 2 that come to my mind..

Yes..

[Operator Instructions] We'll hear next from David Duley with Steelhead..

I was wondering with the mask blank tool, EUV mask blank tool, is that what's going to drive second half revenue up above first half? Or maybe the question is, what's going to drive the second half 10% growth over the first half?.

Sure, David. I'll try to answer your question. Yes, EUV mask blank tool definitely plays a part in it. The other part, which is stronger in the second half is related to our shipments to the data storage industry. And there is also a few other areas of improving business in the MOCVD side..

Okay. And on the LSA tool, you mentioned that you're -- you've qualified with a second customer.

Just curious, is there some technical needs at 5 or 7 nanometers, whatever these advanced nodes are, they might be switching from a different type of annealing technology or adopting those or what is driving this?.

Yes. We're clearly seeing a desire for our laser annealing technology. We're particularly strong, not only with the speed with which we can ramp, but also the very fine temperature control. And so with these finer nodes, controlling the peak temperature is really important.

And the more standard techniques aren't as effective at maintaining that temperature peak as well. So that does seem to be a positive tailwind for us..

We'll hear next from Mark Miller, The Benchmark Company..

Intevac, which supplies the deposition equipment for hard disk, indicated they were seeing increased utilization in their tools and I'm just wondering, are using similar things in terms of your head manufacturing systems..

Yes. I would say, we're seeing a variety of technology buyers for HAMR and MAMR as we've discussed previously, Mark. But certainly, overall demand certainly on the head side seems to be up. We're talking with one customer about potentially upgrading to a larger wafer size for added capacity.

So I think it's a pretty strong environment with a mix of technology and capacity buys right now..

You mentioned the Huawei picture for about $2 million in sales last quarter.

Has this been changed with the recent revision by the administration? Or are you still expecting some headwinds from the Huawei restrictions?.

Yes. We are taking all the steps that we need to take to ship product to Huawei. But so far, we have not been successful at it in terms of obtaining the licenses and what else is needed. I just want to remind Mark and -- Mark, you as well as everybody that our exposure to Huawei is quite minimal. Overall, it's $5 million or less for the entire year.

But we do have a very small amount of backlog that we are carrying. Now it's a little bit more complex than that because not every single entity of Huawei is restricted, there are some entities, it might be okay to ship, some entities, it might not be okay. So it becomes a lot more of a detailed question.

But we are trying to ship it, but so far we have not shipped..

Do you see any impact on the possibility of increased tariffs coming by the September? Will that have any additional impact on your business?.

So in terms of tariff, I would break it down in a couple of areas. The first one, which is a simpler one to answer is that any supply chain procurement from China for us, which might include tariff, that impact is going to be minimal so we can ignore that. Then the second piece is, our shipments into China.

Overall, we believe, on an annual basis, our revenue exposure to China in the new Veeco, sort of say, is around 10%.

So we do ship non-LED related product to China, and we are continuing to ship and so we have to see what happens with those products in terms of what are the actions that the Chinese government takes in terms of tariffs or whatever have you.

And the third impact, which is rather unknown to us, is the indirect impact of all of these trade tariffs and it slows down the macroeconomy or it slows down the revenue levels of our customers and how that may impact us is rather unknown to us. I must say that we are not immune or insulated from the macro softness.

But we really do not have a way to very accurately quantify that impact. So that's the way I think we are looking at this situation..

Any exchange risk in terms of challenges that devalue its currency, any exchange risk you see?.

So Mark, we -- most of our cash has already been brought onshore, so our cash balances in China are fairly small. And a lot of our sales in China are U.S.-dollar denominated. So as such, exchange rate does not have a direct impact on us. And the expense side can help us, but it is again very small impact to us.

So overall, the exchange rate impact on us, I would say, is minimal. The only one place where I may not have an answer for you is that since our sales are dollar-denominated and in yuan terms, it may become a little bit more expensive for our customers over there. How that shakes out, we don't know, it's just too soon on that front..

And at this time, I'd like to turn things back to Bill Miller for closing remarks..

Thank you. And thank you, everyone. I just want to close with the thought that we are in the midst of a transformation of Veeco. And we're really focusing on working on much more challenging and differentiate end-customer applications. We're starting to see some proof points there as we talked about in EUV and LSA at leading-edge nodes.

And we do at this point, now that we have some traction, think it's an appropriate time to start working down our cost structure in our legacy business -- businesses where industry challenges are really not as significant. So an example of that would be LED for general lighting.

So by doing this, this allows us to invest into solving tough materials challenges and improving our profitability as we continue to transform the company. So I look forward -- Sam and I look forward to talking with you next quarter to update our progress in -- towards meeting our longer-term goals. Thank you, again..

And that does conclude today's conference. Again, thank you all for joining us..