Veeco Instruments Inc. (VECO) Earnings Call Transcript & Summary

Good morning. Welcome to the Barclays Global Virtual TMT Conference. I'm Tom O'Malley, mid-cap and semi-cap analyst here at Barclays. Very happy to have Veeco with us, Bill Miller, CEO; and John Kiernan, CFO. We're very excited to have you here. How are you guys doing today, first off?

Tom, great to be here. Really excited to spend some time with you.

Awesome. So I guess I'll just start in from just a very high level here. You guys are making really solid progress on Phase 2 of the company's transformation, which was driving growth. You've seen some solid traction on your near term business. And then you've kind of talked about some larger long-term opportunities. Could you just give us a brief update on, one, your performance over the past year? And any particular trends that you're seeing that are really strong as you exit the year?

Yes. Thanks, Tom, for the question. The first phase of our transformation is really behind us, and that was really all about pairing the company's footprint as we exited the commoditized China blue LED. We exited factories in Singapore, and we really restructured the company from 6 business units to each with a general manager, Head of Marketing, Technology and Engineering to a completely functional structure with one Head of Marketing, Technology and Engineering reporting to me. And that allowed us to really take out a lot of senior executives in the company without damaging the broader workforce. That really is what enabled us to take out a lot of cost, but it also had the other advantage that have allowed us to prioritize programs at the Veeco level instead of within each business unit. And so that really allowed us to focus our R&D spending and investments on the top priorities that are going to drive the company's growth, aligned with our strategy to grow in semiconductor and compound semi. And so you kind of mentioned -- I wanted to understand our near and long-term growth opportunities. The second half of this year will be up about 8% over last year. And that's really driven by good, great visibility in data storage, really driven by the cloud. Our laser spike anneal product in advanced logic as well as wet processing for 5G RF filters. So given our visibility and all of this activity, we are seeing growth of 10% next year over this year. So 2021, growing 10% over 2020. Also, as I mentioned, long term, now that we're prioritizing our R&D investments at the company level, for 2022 and beyond, we're making those R&D investments now and over the previous year in service applications. And our plan is to place many evaluation systems in semiconductor and compound semiconductor.

Great. Why don't we hop into the kind of the segments here. And I wanted to start in a place where we're seeing a lot of news from you guys recently in the MOCVD business. So I think in the past, it must be 3 months, I've seen an announcement in A-Pro, an announcement on Aledia and then an announcement on Transphorm about different machines and systems that you're shipping to those companies. Can you talk about, one, why are you having so much success here? Clearly, these customers are ordering these products; and two, can you comment on the end markets? Obviously, there's the VCSELs end market, but then there's also the power end market. Can you just walk through those opportunities and which one you see as kind of the driver of growth here?

Yes. Great, great question, Tom. Our MOCVD business is really at historical low levels. We exited the commoditized China blue LED business where we put a lot of focus and really drove a lot of our growth. As I mentioned, this whole transformation started as we lost about $150 million in the commoditized blue LED space. We had to pivot our investments and our focus to higher-value applications. So we're coming to market with 2 products today. The first is our Propel 200- and 300-millimeter gallium nitride single-wafer reactor; you mentioned A-Pro, Transphorm and Aledia. The recent press release is there. And really, the -- our GaN applications really are in power electronics, and that's fast charging for handsets, EV as well as disruptive microLED applications, and we can get into a little more detail on that later as well as GaN RF for 5G power amplifiers. The second product that we go-to-market with is our newly released Lumina arsenide phosphide tool. That product is used for Edge-Emitting Laser for data column applications as well as VCSELs for facial recognition as well as kind of the traditional red microLED. So we're competing with AIXTRON who has the large market share there. And we're really just clawing back a little bit at a time from pretty low levels. So I'm pretty happy with the progress we're making, but it's -- it's a long-term share gain play for us.

Yes. And it's interesting on the VCSEL side. I think when we first started talking, you had always mentioned, "Look, the industry capacity right now in Edge-Emitting Lasers is pretty full, and there's not too much room for growth there. Month after month, I've kind of heard more companies talking about VCSELs being used potentially in LIDAR applications, in autonomous vehicles and just the end-use applications for that technology growing. If that pie continues to grow, is there a chance where, maybe, it's a slow share gain story. But if the pie gets bigger, do you guys see your slice maybe get bigger as well? And can that be a bigger growth driver in this coming year than you originally expected?

It could be. AIXTRON is really entrenched there. And there has been overcapacity. Even AIXTRON is really not having a lot of business in this space. But certainly, you're right. I mean, as VCSELs become more ubiquitous, obviously. And as the volumes increase significantly, that does play to the strength of our TurboDisc technology in terms of high uniformity, but high productivity and uptime and consistent run-to-run capability and high-volume applications that we do compete well on those type of opportunities. So as that moves forward, I do think that's a longer-term growth opportunity for the company.

Okay. And then on the Propel side, GaN, obviously, another huge opportunity, more applications in the market there. Would it be fair to say that you think that there's more of a growth opportunity there because you don't have -- AIXTRON maybe isn't as entrenched there? And then can you talk about where you see that growth over the next couple of years? Have you -- I guess a better way to put it is, if you had to kind of rank your opportunity between those 2 machines, obviously, the Lumina is a new machine, but the Propel system seems to be gaining a lot of traction with existing customers. How can you kind of weigh those 2 with each other?

Yes, you're right, Tom. We are seeing more traction with our Propel GaN product. And we are winning at a number of customers. We're also seeing some very significant foundry opportunities with GaN Power, which kind of bodes, I believe, well, that GaN will grow in the future. But I would say, if I were to look at longer-term opportunities, I think microLED is a pretty good opportunity in the kind of the 2- to 3-year time frame. And this is an opportunity where microLED may displace either OLED or typical LCD displays with actual individual red green blue pixels. And so there's 2 ways to make microLEDs. The traditional way is to make blue and green LEDs on -- micro LEDs on sapphire and red on arsenide phosphide wafers. And that's -- a lot of investment is being placed there. And we're working with people there. There's also disruptive ways of making microLEDs. That's making all 3 pixels, the blue, the green and the red on silicon wafers, GaN on sil using GaN epi. And that's a disruptive approach that a company like Aledia is working on for those advanced microLED displays, where we have a very strong relationship with them. So I would say, in the short to midterm, we see opportunities in GaN power and RF we see opportunities, as you said, the pie growing in VCSEL and advanced photonics, kind of midterm. And then longer term, we see opportunities in micro LED with both disruptive technologies with gallium nitride on silicon as well as the traditional microLED opportunities.

Perfect. That's really helpful. All right. Let's switch gears over to the front end semi side, and let's start with EUV. Clearly been a very strong market. You guys have not only taken a pretty good share position there, but you've also kind of maintained that over the past year. Can you tell, one, when you look at guys like ASML, I think some of their forecasts for the coming year have kind of been revised down slightly. And I know that, that's likely a function of capacity, not really of the total TAM. But can you guys continue to grow that business even if maybe some expectations for growth come down a little bit next year? And can you just remind us of what you see in terms of the total TAM of that business and what you could grow into over the next couple of years?

Yes. The opportunity for us, just a little bit of brief history. We've been in this space for 20-plus years, actually. We did the original work with Lawrence Livermore National Labs on deciding is ion beam deposition or physical vapor deposition, PVD, the best solution to provide a low -- very low defect or 0 defect mask blank. And clearly, IBD is the preferred method. We work with 2 Japanese mask blank providers. They buy our equipment and use it to make the multilevel mask blank, which they then sell to companies like Samsung, TSMC, Intel's mask shop, the final masks. I would say -- and I'm using this as a broad rule of thumb because there's a lot of variables involved. I would say our business probably scales one of our tools for every 10 to 15 ASML scanners shipped. So I believe in kind of the near term, we're probably range bound at 2 to 4 systems per year longer term, if EUV is adopted much more broadly, that would obviously bode very well for us. But in -- kind of in the next 1- to 2-year period, we're forecasting about 2 to 4 systems per year. And the ASPs of these tools are pretty generous around $10 million or so a piece.

And you have a pretty in your estimation, a pretty significant moat there, where if you look at the market share, you guys are clearly a leader. You feel as though there's not really a competitor that can come in and kind of disrupt your share there either.

We believe so. Obviously, this is a pretty exciting opportunity, and there are competitors out there. But to date, we have been able to rely on our experience in this market to hold our position.

Great. Switching to the other side of front-end semi, I wanted to talk a little on LSA. One, for those who aren't as familiar, can you remind us where you are today with customers at certain steps? And then I can kind of dive into some questions on where you're headed in the future.

Yes. We acquired this technology in the Ultratech acquisition, and they had success at the 28-nanometer node and then lost their position. It became a real focus of our company to go in and win back those applications. And so over the past, I would say, 1.5 years, 2 years, we've been able to win back one application at 2 customers at their most advanced nodes, 7 nanometers and beyond. So we're highly engaged, and this is in logic, obviously, with those advanced logic customers. We are working to expand the applications to a second and possibly a third application step with those customers. And we're also starting to engaging and providing an eval to a third leading-edge logic customer. That's the current state of play, let's say.

And then you also, on the most recent call mentioned potential memory customer. Could you talk about why your machinery would work in that realm? And is that opportunity of similar size to some of the ones that you just described?

Yes, it's a very exciting opportunity for us. Memory, we never had our product in the memory space, it's been very much logic focused. What we're seeing in logic is as the nodes are shrinking the thermal budget is really decreasing. And we have a distinct advantage in terms of reducing our laser time from 250 milliseconds to 200 milliseconds to 150 milliseconds, as the nodes shrink. In the memory opportunity, it's -- they're actually solving -- they actually have this similar type problem, except they are a number of generations behind the leading edge logic. So it really is the same class of problem in terms of managing these thermal budgets that we are working on with the memory customers. So we've placed our first evaluation tool -- it's tools. It's a 1-year evaluation, and we're going to work very closely with them to qualify. If that were to happen, it would be, I would think, a pretty good growth opportunity for the company in 2022 and beyond.

Very interesting. And can you remind us again, you historically have kind of mapped out what it means from a revenue perspective to win a step at one of these companies. Obviously, it's not just one machine. This is a generation, and these guys are going to continue to use your tools over the lifespan of that step. What does a win at one of your existing customers for a new step or potentially a new customer get you in terms of revenue for the lifespan of that win?

I would -- Tom, I would characterize it as today, there are like 3 customers at advanced nodes. And depending on the customer, there are 5 to 6 annealing steps. Our product is probably best suited to 3 of those steps. So 3 customers, 3 applications are really applicable to us. And today, we have 2 of those. So obviously, there's some opportunity for us to expand there. And I would consider each application at these advanced nodes as they progress, about $20 million a year for a few years -- for 2 years or so as they ramp that application. That's how I would characterize it.

So very healthy. Okay. I want to switch again to the data storage side. I think I'm not sure it was surprising to you guys, but surprising to the market that you've really seen some strong HDDs increasing kind of the heads per drive, which in turn has kind of really helped your machinery sales as well. Can you talk about, one, your expectations going forward? I think you've mentioned historically some build-outs of brick-and-mortar applications in HDDs, which you really haven't seen before. And then two, you're obviously going to restructure the business to kind of highlight certain areas of growth. Was the growth in HDDs in the storage business, really the thought process behind breaking that out because you want to see growth there as well? Can you just walk us through one the storage business, why it's been so good and why it will be good and two, the new segments.

Yes. We've been the leading supplier of ion beam products, Ion Beam Deposition, Ion Beam Etch, diamond-like carbon coatings to the disk drive industry. We've been decades-long partners with Seagate, Western Digital, TDK Headway and really been working with them on their road maps. What we've seen is with the explosion of the cloud, the demand for HDDs has grown, not only growing tremendously, but really grown in these large-format drives, 20-terabyte plus drives. So that the amount of heads per drive is increasing. So the absolute value of the number of the heads, which is really the heart of the disk drive has been increasing even though the number of drive shipments has been decreasing. Also that's a tailwind for us. The other exciting area is that the industry is moving to energy-assisted magnetic recording. In one circumstance, one customer is using heat and another customers using microwave, but it's all towards the idea of driving the aerial density of the head. As they move to these more complex drives, the number of passes through our equipment increases significantly. The customers are, as I mentioned, making brick-and-mortar expansions -- and the almost 2 decades I've been in this business, that hasn't happened. So it's a pretty significant change. And to answer -- address the second half of your question, our data storage business sits -- is kind of buried within our scientific and industrial segment. And it's -- we think it's very important to give transparency to our investors to see that. So as part of the resegmentation, a big piece of that is to give investors visibility into the data storage business.

And is that resegmentation really just for the benefit of investors seeing growth? Or do you plan to reinforce that with any kind of operational internal strategy changes or employment changes where you would realign your product or portfolio? Or is that really just for the benefit of saying, "Hey, this is really important to us. This is a big growth driver. We kind of want to highlight this to you.

Tom, let me take that part of the question. So really, the purpose of the change in the reporting structure is to better align with our strategic focus and with the way we'll allocate resources and monitor business performance going forward. And breaking out the data storage is a piece of that, given the size and importance there. But also in the -- if I talk about the other markets as well, in the semiconductor market, this is an area of strategic focus for us. And now we'll include both the semi front end and the advanced packaging as well. And as we've mentioned, we're really excited about the opportunity both in the near-term and longer term in this market and particularly with our laser annealing solutions. And then really, the compound semi market, which we're also classified here is another area of strategic focus for us and we'll now include both the RF filters and devices in 1 market, and they were previously broken out in a separate category. So we're seeing strength in the wet, clean and etch business there, particularly for 5G RF filter applications. And as Bill mentioned earlier, we're starting to gain traction for our MOCVD products and compound semi applications as well.

Great. That's helpful. And John, I still have you here, there was recently a convert kind of swap. Can you talk about why you guys chose to do that? And then from a -- on an ongoing basis, from a debt perspective, what your plans are over the next year plus there?

Sure, Tom. So we entered the year with one tranche of debt due in 2023 with $345 million due. And it was our objective to refinance that debt during the year, principally to stagger out the maturities. So we were able to accomplish that in 2 transactions, a transaction earlier in the year, in May, where we issued $125 million of new notes due in 2027. We use a portion of those notes to purchased back 2023 notes. And then more recently, we entered into an exchange transaction with the current holder of the 2023 notes and exchanged those notes out for notes due in 2025. So essentially, what we have now is 3 tranches of debt, almost equal tranches due in 2023, 2025 and 2027. So at this point, we feel good about that structure, Tom.

Perfect. I think we have time for one more, and I just want to go back to Bill really quick. So you guys have outlined a 10% growth year for '21. Obviously, really good, looking at kind of where the company has come from and where you're headed now. If you guys were to exceed that 10% growth in kind of upside, where would you kind of see that grow from? So another way to phrase that is, what area do you think can surprise you to the upside in 2021 as you look out to the next year?

I would say, we're really in the 3 growth areas are really data storage, laser annealing and what processing. In data storage, in particular, were really pretty much booked out for the year, which gives us a lot of confidence in our growth. But given our lead times, I don't see that having too much upside to the plan. Where I would see the upside coming is really in laser annealing as well as the exciting growth we're seeing in 5G RF filters. The Apple iPhone 12, I think, has 60-plus filters, kind of, coming from the mid-40s. And as 5G develops, I wouldn't be surprised if that continues to increase. So I think that those are probably the 2 exciting upsides, I would say, for 2021.

Great. Thank you. And I think with that, we're out of time. Again, Bill and John, thank you very much for being here. We appreciate having you here, and good luck the rest of the year and into '21.

Tom, thanks for having us. It's really exciting.

All right. Thank you, Tom.

Have a good one, guys.

Yes.