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Veeco Instruments (VECO) Q3 2018 Results - Earnings Call Transcript
Nov. 1, 2018 2:17 PM•VECO
Veeco Instruments, Inc. (NASDAQ:VECO)
Q3 2018 Earnings Call
November 01, 2018 8:30 am ET
Executives
Anthony Bencivenga - Veeco Instruments, Inc.
William J. Miller - Veeco Instruments, Inc.
Shubham Maheshwari - Veeco Instruments, Inc.
Analysts
Brian Lee - Goldman Sachs & Co. LLC
Patrick J. Ho - Stifel, Nicolaus & Co., Inc.
David Duley - Steelhead Securities LLC
Auguste Richard - Northland Capital Markets
Presentation
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 - Veeco Instruments, Inc.
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.
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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 - Veeco Instruments, Inc.
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: First and this comes as no surprise to me, we have a great team here at Veeco. They are dedicated and capable of overcoming any challenge.
Second, when you examine our broad product portfolio, you'll see it is built upon exceptional core technologies. We have best-in-class deposition, etch and laser-based products solving tough customer challenges in many markets. For example, our leading Ion Beam technology was originally used for etching and depositing magnetic materials in the production of thin film heads in the data storage market. This technology is now being applied in the front semi-market to produce mask blanks for EUV lithography and to etch magnetic materials for magnetic RAM, an emerging embedded memory solution.
And third, the markets in which we operate are positively impacted by fundamental megatrends such as the explosion of data, artificial intelligence and next generation wireless communication. I am excited to work with Veeco's highly motivated team as we help our customers' progress along their technology roadmaps.
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Having said that, it has become clear some of our prior plans have been impacted for various reasons. The first was our forecast to grow full year 2018 revenue over 2017. Given our current visibility, full year 2018 revenue will be lower than pro forma 2017 revenue of combined Veeco and Ultratech. The revenue shortfall was driven by us U.S. foundry's decision to put its 7 nanometer FinFET program on hold. We are also seeing broader China softness across all of our businesses.
The second was our plan to exit 2018 with 40% gross margin. Our cost reduction efforts and improved product mix have helped gross margin. However, lower Q4 revenue and the resulting under absorption has more than offset the benefits. And third was our plan to release a tool for the VCSEL market in the second half of this year.
We are engaged with customers under a new VCSEL platform and have demonstrated many key requirements for VCSEL manufacturing, but commercial availability will be delayed at least three months as we optimize our technology. We will keep you posted on our progress.
I will now turn to Q3 results and then Sam will take you through the details. After that I will talk about specific initiatives to drive growth.
Third quarter results were mixed, with revenue coming in below our guided range at $127 million. However, our non-GAAP operating income and EPS were both above the mid-point of our guided range, coming in at $8 million and $0.11 per share, respectively. This profitability came from better than guided operating expenses and gross margin.
We generated cash in the quarter, while repurchasing 1.8% of our outstanding shares and our ending cash balance increased to $266 million. Bookings for the quarter were $100 million, reflecting softness in China across all of our business. Nevertheless, we are encouraged by strong bookings growth in our Front-End Semiconductor market.
We are working on many promising initiatives in Front-End Semiconductor and Compound Semi which offset the declining commodity LED business, but this transition will take time. Therefore, we have begun to take proactive measures to reduce expenses in such a way that we preserve our innovation capability and position Veeco for growth when our markets regain traction. Sam, will explain these actions in more detail.
Shubham Maheshwari - Veeco Instruments, Inc.
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.
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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 (09:48) systems sold to IDMs and OSATs for Advanced Packaging in automotive, memory and other areas.
Front-End Semi revenue was $13 million or 11% percent and included sales of STT-MRAM and 3D inspection systems. Scientific & Industrial revenue was $30 million or 24% and included shipments to various data storage and optical coding customers.
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Geographically, China was 31% of total revenue, EMEA was 24%, U.S. 23%, and rest of the world was 22%. Going forward, we expect the proportion of revenue from China to decline significantly.
Q3 ending backlog was $276 million. Typically, more than two-thirds of our backlog turns into revenue in the subsequent two quarters. However, less than half of Q3 ending backlog is expected to turn into revenue in Q4 or Q1 of 2019, primarily due to EUV systems which typically ship with the lead time of 10 months to 12 months. We expect these EUV tools to begin shipping after Q1 of 2019.
Now turning to P&L highlights for Q3. Revenue of $126.8 million was below our guidance range, due to broader China softness and the U.S. foundry discontinuing its 7 nanometer program. Non-GAAP gross margin was 38.2% higher than guidance due to favorable product mix and lower spending. Non-GAAP OpEx sequentially improved and was better than guidance at $40.4 million.
Please note Q3 benefited by a one-time credit of reversing previously accrued incentive compensation of $2.2 million. Non GAAP taxes was $0.8 million. And finally, non-GAAP EPS with $0.11 on the diluted share count of 47 million shares.
Now moving to the balance sheet. Cash flow from operations was $18 million and we ended the quarter with $266 million in cash and short-term investments. Cash increased from Q2 driven primarily by the reduction in accounts receivable, improving our DSO to 64 days. Inventory remained elevated as we continue to ramp EUV systems related manufacturing and also invest in new products for MOCVD. Consequently days of inventory increase to 173 days.
During this quarter we purchased $10 million of our common stock or approximately 1.8% of our outstanding shares at an average price of $11.58 per share. Long-term debt on the balance sheet was recorded at $284 million representing the carrying value of $345 million in convertible notes.
Now turning to Q4 guidance. Q4 revenue is expected between $85 million and $105 million. Q4 now contains negligible revenue from Blue LED MOCVD system sales in China as compared to 21% in Q3, thereby contributing to a sequential revenue decline. As compared to the previous outlook, Q4 became weaker due to push outs of non-MOCVD products from China based customers, as well as an unexpected discontinuation of 7 nanometer program by U.S. foundry.
Non GAAP gross margin is expected between 36% and 38%. Our product mix is shifting away from low margin Blue LED MOCVD systems from China, helping improve our overall gross margin. However, the overall decline in business volume is offsetting the mix driven improvement, preventing us from achieving our previously stated goal of 40% gross margin by Q4. We continue to target 40% gross margin or higher as volume picks up.
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Non-GAAP operating expenses expected between $41 million and $43 million. A midpoint of which is a sequential improvement from Q3 when adjusted for a onetime credit of $2.2 million in Q3. Non-GAAP operating loss is expected between $10 million and $3 million.
GAAP EPS loss is expected between $.56 and $0.40 per diluted share. Non-GAAP EPS loss is expected between $0.25 and $0.09 per diluted share. Please note we currently carry approximately $300 million of goodwill on our balance sheet. The carrying value of goodwill may potentially be impacted based on our market capitalization. Given the recent market price of our shares, it is possible that our stocks trading pattern could result in a non-cash goodwill impairment charge. The GAAP guidance I just provided you does not take into account any such impairment charges.
And now for some additional color beyond Q4. At this time, based on our backlog and current visibility, we see Q1 sales tracking slightly above Q4. We expect OpEx to continue declining towards the $40 million target by Q2 of 2019.
And with that I'll turn the call back to Bill for a business update.
William J. Miller - Veeco Instruments, Inc.
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.
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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.
Question-and-Answer Session
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 - Goldman Sachs & Co. LLC
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 - Veeco Instruments, Inc.
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 - Goldman Sachs & Co. LLC
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 - Veeco Instruments, Inc.
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.
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