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

Good morning, everyone, and welcome back to the Barclays Global TMT Conference. I'm Tom O'Malley, mid-cap semiconductor analyst at Barclays. I'm pleased to have Veeco here. We have Bill Miller, CEO; and John Kiernan, CFO. I think that we'll start with Bill sharing some slides for the group here, and then we'll jump into some Q&A. So without further ado, Bill, why don't you kick us off.

Thanks, Tom. Really excited to be here with everyone today. Let me just spend a couple of minutes talking about the company. No presentation is not without a safe harbor statement, please review this and reading in detail on veeco.com. Veeco is a global semiconductor capital equipment company. We have great technology that we have developed and acquired over 500 patents, over 1,000 employees. At the midpoint of our guidance, we're expected to have revenue of $580 million this year. We believe we have a differentiated product portfolio of high-value technologies, and we really have significant financial strength and agility. Just spending a minute talking about the history of the company and the 9 Vs Veeco is known as a data storage company with our Ion Beam Technology in the 2009 to '12 time frame, we saw significant growth in our MOCVD business, based on the adoption of LED TV backlighting followed by general lighting. In 2017, with a lot of the cash that we generated during that period, we acquired Ultratech, really because we really are excited about their opportunities in the semiconductor space, specifically laser annealing and their advanced packaging lithography. When I became CEO in about 3 years ago, in late '18, it was very clear that the company needed to exit the commoditized LED business. And with that, we lost about $150 million of revenue. And given that event that really forced us into a transformation where we significantly restructured the company. And let me share with you a couple of accomplishments we made over the last few years. We went from a collection of 6 business units, each with a General Manager and VP of Marketing, Technology and Engineering, the one functional structure where today, I have one head of marketing, engineering and technology reporting to me across the company. That allows us to take a lot of cost out of the company and improve our financial performance, without significantly impacting our ability to develop products and execute. We've improved our balance sheet. We've done a lot of work with the Board structure. We did publish recently our second sustainability report. We have a very good multiyear growth strategy that we started working on in 2019, and we see growth in 2022 and beyond. We've invested in up to 10 evaluation systems this year from historically 1 to 2 systems and made a lot of progress there. In September, we had an Investor Day where we came out with a 3- to 5-year model of $800 million revenue, 5% gross margin and 20% operating income. I believe we have a good path to achieve those numbers, and excited to share that with you today. We go to market in 4 primary market segments. The first is semiconductor, really driven by high-performance computing, AI. We have 3 product lines: Laser Annealing, Ion Beam deposition for EUV Mask Blanks and Advanced Packaging Lithography. In the compound semi space, we're exposed to 5G power electronics as well as micro LED with our wet processing equipment in MOCVD. And in data storage, we've seen this business over the previous decade in secular decline. We're seeing really resurgence in this business with the explosion of data stored in the cloud, and we have a lot of exposure there with our Ion Beam product lines. And finally, our scientific business, we sell a variety of products to universities and government research labs. And with that, let me just turn it over to John for a broad recap of our recent financial trends.

Thank you, Bill. And just as Bill highlighted the progress that we're making on our transformation Phase 1 to return to profitability, Phase 2 to grow, we're really starting to see this print out in the financial results of the company. So revenue increasing this year to about $580 million, which is a 27% increase over 2020. You see that we made a significant step up in the gross margin profile of the company from 2019 at less than 40% to the 42%, 43% range. And really, on the OpEx side, driving a lot of leverage now as the company is growing. We went from 37% OpEx in 2019, and we're forecasting about 28% this year. So what that all means is a significant improvement in the EPS of the company and driving from a slight loss in 2019 to about $1.36 in 2021.

That kind of covers the high level overview, Tom.

Perfect. Yes, thank you for being here, and thank you for sharing the slides. It's great to have you here again. I guess, kind of, as you described in the slides, you've really completed this Phase 1 of your transformation, where you've gotten back to profitability. I think you're squarely in Phase 2, which is this growth, with revenue growing close to 30% this year. So when you look at sustaining that growth into future years, could you talk about any particular demand trends that you're seeing as you exit this year that will help drive that top line growth?

Yes. We're seeing a lot of demand in terms of orders in the semiconductor space. We're seeing growth next year in all 3 aspects of our semi space. The first one being laser annealing. I mentioned we have 10 evaluation systems in the field, 5 of those are in laser annealing. We are placing tools that are 2 existing customers for their next nodes at the most leading-edge logic customers. We have an evaluation system at the third logic manufacturer -- leading-edge logic manufacturing. We have 2 systems at a DRAM manufacturer. And so we see this as a good long-term growth opportunity for the company. Also, we're seeing opportunities in advanced packaging lithography where with the adoption of heterogeneous integration, we're seeing the applications broaden, and we recently announced that we've received multiple system orders from multiple customers, and so we're really excited about that. And then the other piece of semi that we're seeing growth is in EUV mask blanks where one of our ion beam deposition systems is required for every 10 to 15 ASML scanners. And so we've taken up our outlook from 2 to 4 systems per year to 3 to 5 systems per year. And we see that's very exciting for us because it's over a $10 million ASP tool. So it's a good business.

Yes. That's great. I think that I almost asked this on every earnings call is just a rundown of the eval tools. I think you did a good job of explaining from a high level there. But could you talk about when you start to look at next year and looking at evaluation tools? Are you going to see that number continue to grow higher? I understand that there's a particular amount of investment that's required to keep supporting those tools. But one, I guess, is when you have an eval tool in the market, what's that time horizon look like for that to actually reach revenue? And two is, when you look out into next year, do you see that number remaining steady? Or do you think you'll continue to put more evaluation tools into the market?

That's a thoughtful question, Tom. And originally, when we put this together, it was very important for us to explain to our investors that we're putting 10 evaluation systems in the field as opposed to typically 1 or 2. And so that was a real C state change that we made. I would say we're expecting these tools to start to be signed off. And we're expecting to ship more evaluation systems to probably keep that number nominally in that $10 million, kind of, [ $12 ] million range going forward. And it's meaningful because we're making a lot of -- it's very expensive to put an evaluation system besides just the inventory and the investment of that. It's the support of -- 24/7 support that these mainstream semiconductor companies. And so we're spending well ahead of revenue, and at this time, and we're continuing to invest in service and applications people. And I would expect that investment to continue into the future. But as tools are signed off, I would expect in the natural course, given our R&D pipeline to continue to replenish those at this kind of similar level.

Okay. So part of the difficulty, obviously, with this rapid expansion that you're seeing is capacity limitations. And you've heard about that all over the market. But particularly with you guys, I think, you had an announcement several weeks ago about the first shipment from the San Jose facility. So congrats first, but could you talk about why that capacity expansion is so important for the company? And can you just remind us of the size of the investment and why you felt like you needed to do that at this time?

Yes. I'll start, and John can add some more color. Our Ultratech facility that we acquired, the lease was ending in early 2023. We made the decision to move to another facility about a model where we are outfitting a similar square footage about 100,000 square foot building, but we're actually doubling the manufacturing footprint, from, say, 30,000 or 35,000 to 70,000 square feet of manufacturing. And so that allows us to probably more than double the output from the facility. It's really purpose-built so that we have universal bays that we can manufacture laser annealing or lithography products in a given bay, which gives us a lot more flexibility than we have today. And frankly, we need that capacity because we are expecting significant growth in the future here from those product lines. John, I don't know if you want to add anything else?

Sure. And just to address, Tom, your question on the investment, it's about a $50 million investment for us over 2021 and into 2022. And as you just mentioned, we are bringing up the facility in phases, and we've just recently shipped the first system out of the facility, which was a big milestone. So our expectation is to transition fully out of the existing facility and into the new facility by Q3 of 2022.

Helpful. And then I guess the other side of the equation is the supply side. And I think you guys have fared pretty well here. Could you talk about what you're seeing on your -- in terms of your supply chain? How are you mitigating the issues? And if you're seeing issues pop up, is it improving? Is it worsening? Just the high-level view of the supply side, given its focus in the market right now?

Sure. I'll cover that, Tom. So the -- we're not immune to all the things that you just mentioned about constraints and challenges in the supply chain. And I think driven by longer lead times in certain part shortages. For us, Q3 was more challenging than Q2 from a perspective of just more escalations and parts being resourced from one supplier to the other. But I have to say our supply chain team has been doing a phenomenal job in mitigating any challenges and really meeting our customers' important requirements. So to date, the supply chain constraints have had a minimal impact on our revenue and Q3 revenue. And -- but I would say that we had some margin impact about 1% gross margin impact from higher logistics and material costs, and I think more weighted on the logistics costs there. So the actions that our supply chain team have taken -- we work very closely with suppliers to monitor upstream risk. We've been making selective buys ahead of demand. You can see this to some extent in our increased inventory. We've moved quickly, as I indicated, to alternative supply when issues have arose. And really, one of the things that we did pre some of this supply chain constraints is that we were moving part of our supply base to outside of semiconductor into the aerospace and defense supply chain given some of the capabilities and precision machining in that area. We have our leader, comes from that industry -- and that was actually a very fortunate move for us as well.

Great. That's helpful. So I think we've really covered some of the high-level moving pieces. I just wanted to dive a little bit into each of the business lines here. So let's just start within semi, the LSA business line here. In terms of what you've seen over the past year, obviously, what are the biggest drivers of your success you're making headway at several customers and into a third now. And what you recently mentioned is just the opportunity in memory. And I think you talked about the TAM really doubling with the addition of memory. One, could you talk about the opportunity of memory as a whole? And then why is it going to be important for memory customers to have this technology going forward? And why do you win there?

We've been successful in logic because with our laser annealing technology, we can significantly reduce our customers' thermal budget. And so from flash technology or heating up the whole wafer, we just very locally heat up a section of the wafer, and we heat it up to over 1,000 degrees, but only for 200 microseconds. And that allows the dopants to be activated, but not diffusing. And as the lines and spaces and the size of the transistors become smaller, that's a real enabling advantage of our technology. What we're seeing, Tom, is that same problem starting to manifest itself in memory. That memory makers have the same problem. They're just lagging a bit. And one particular customer is very interested in adopting laser annealing for their next-generation node. And you're right, we see this market opportunity potentially doubling our served available market. That being said, today, we only have evaluation systems at one customer and that would -- to double, we'd have to have success at more than one customer, but it's certainly a very exciting opportunity for the company.

And I don't want to draw a straight line, but you've talked in the past about how success at one logic customer is indicative of potential further success across others. In the memory market, is there any barriers to entry at other customers? Or do you find that if you have success with this first customer, there's not any reason why you wouldn't expand your reach there?

That's a thoughtful question. I would say there are opportunities to expand our reach. Today, memory customers do their annealing a bit differently and that we are working with customers on a road map to -- in memory, to support their specific needs for memory beyond what Logic is doing. So I think the answer is yes, we do have opportunities. And I think the answer is also, we are developing products specific to memory applications as well.

Helpful. Forgive me, but I'm just going to jump to another growth driver here. But on MOCVD, you talked on the last earnings call about micro LED revenue early next year. This seems like it's a little bit of an acceleration from what you guys have talked about in the past. Can you talk about your competitive positioning in that market? Is it coming a little sooner than you thought? And in the end, what applications is that being useful from a technology perspective today? And where do you see it proliferating to over the long term?

In the micro LED space, we have exposure in 2 ways. The first is, we have evaluation system for red micro LEDs, the traditional approach. So making red, green and blue pixels on separate wafers and then doing a mass transfer movement of those. So we're exposed to that. Our evaluation system is running well, and we're hearing positive signs from that evaluation. The second area is, there's a disruptive approach using GaN on silicon to manufacture all 3 pixels on the same wafer, blue, the green and the red at the same time. And the advantage of this is, it has the potential to significantly simplify the mass transfer process. It's also today, they're being run on 200-millimeter wafers. [Audio Gap] A lot of the existing CMOS infrastructure for all the back-end processing, which people believe is a real cost advantage. We are working with a well-funded startup company, Aledia, in France, and they're making very good progress. So our exposure is really twofold, but the disruptive approach using GaN on silicon and a traditional approach for making micro LED.

Helpful. Moving on again. So the most common question I would say that I get from investors about you guys is the trajectory of the data center or the data storage business. I think you've done a good job of highlighting the strength that you've seen over the past year and then also the rationalization of that market. But could you give us an update on the visibility in that business? Obviously, when we last spoke at earnings, you indicated some slowdown, but is it falling off as quickly as you anticipated? And is there a scenario in which in the fall that you described? Any color there would be really helpful.

I would say we're really bullish about the long-term prospects of the data storage business. Data being stored is growing at 35% per year. Our equipment is used to manufacture the most sophisticated part of the hard drive, that had the read -- the ability to read the bits and write the bits. And what we're seeing is the amount of data stored and the size of the drive, the nearline drives growing from 16 to 20 terabytes. And therefore, we're seeing the number of heads shipped actually increasing in absolute value, 8% to 10% per year. Also, at the same time, the industry is looking at technology transitions to energy-assisted magnetic recording, which is forecasted that we're going to see an 8% to 10% increase in the complexity of those heads per year. That means more steps through Veeco equipment. So long term, we see very strong growth patterns. That being said, we've seen growth of 40% to 50% over the last 3 years in our shipments and revenue, and we operate typically with a 9-plus month backlog. And given the orders that we've seen this year, we are forecasting a slowdown next year, a digestion period, if you will. We're not expecting that to fall off a log, but we are expecting some downturn. That being said, we are talking to customers about their 2023 or late '22 expansion plans. And so at this point, yes, we can obviously still make equipment for the back end of '22, given our lead times. And it's really just a matter of timing of customer orders and their need date, whether it's later in '22 or early in '23. I think the bottom line is though, and I think it's really important for your investors to understand that even with the downturn in data storage, we are able to more than offset any reduction in data storage with growth largely in the semiconductor space. We spoke about with laser annealing, lithography and EUV and compound semi. So I think we're going to make a lot of progress towards our model, make some progress in '22 towards our model and even with a bit of a downturn in data storage.

Helpful. And then just one more on some of the businesses here. I think in your preamble about growth drivers, you mentioned advanced packaging and I think that when you've talked about that business in the past, it tends to have some of the shorter lead times of any of your businesses. So when you're looking at success there, a lot of these businesses you're booked out for a long period of time, but when you look at what could drive upside in the near term, just given the fact that those have some shorter lead times, when you get those orders there, are you able to fulfill those and then see upside in the model over the next couple of quarters? Or is that something where you still are a bit constrained there? I just want to understand that dynamic given the strength that you're kind of highlighting.

Yes. I'll try to answer that, Tom. John, do you want to add any more color, feel free to. I would say, historically, this business has run closer to a book and turn within a quarter kind of business. And what we're seeing is customers coming to us with longer-term business plans. And I would say, at this point, we are probably booked out through the first half of next year into the second half. So we're not fully booked for the year. But I would say we're in a very strong backlog position exiting this year.

Great. I think that covers it well, Bill. I think that we are -- we do have increased visibility, the discussions with customers are more forward-looking at this point, which gives us good confidence level that we're going to have growth in the advanced package and lithography business in '22 over 2021.

Helpful. So I think we're running out of time here. But John, I wanted to conclude with a question on the model. So on the margin profile, I understand there's a dynamic of product mix, but could you talk about the company's goals, you've obviously put out a long-term model at the Analyst Day. But what are the drivers that get you into that mid-40s gross margin profile longer term? Can you just walk us through the biggest moving pieces, just so that investors better understand kind of how you're getting to that model?

Sure, Tom. And we see a clear path towards 45% gross margin that's in our target model. Today, we're operating this year and around 42% gross margin. And it's worth highlighting the investments that we're making to support the growth and the future growth of the company that are included in gross margin. So we talked about this expanding evaluation support, Bill covered that. We're making significant investments in our service capabilities for our semiconductor companies. We are making the capacity expansion that we talked about earlier, so we have some duplicate costs in 2022 as well as in 2021. So I think what we'll see as the volume increases and some of these investments as a percentage of revenue or investing ahead of revenue mitigate a bit that we'll start to see the benefits of higher gross margins. And we do expect to make progress towards that in 2022, where we would expect gross margins to be higher than our current 42% that we're expecting for 2021.

Helpful. And then just a second part to that is, in terms of low-hanging fruit, clearly, there's difficulty with freight right now that we're hearing across the industry. There's other factors that have kind of been put into play here over the past year with the state of the world. Is -- would you say that most of that transition to the higher gross margins is a factor of that low-hanging fruit? Or are there more structural changes, just given the dynamic of production facilities, et cetera, that you kind of are doing internally. Just walking us through the differences there would be helpful as well.

Yes, sure. Well, outside of the benefits that we see in the longer-term model as the new capacity comes in place is that we've undertaken a number of initiatives in terms of gross margin improvement around adding value to customers and getting higher value from our products as well. So it's been a real focus of the company and to drive our gross margins and all of the products that we sell closer to or higher than the company current average. So there's a lot of effort going on there in addition to the items that I just previously mentioned.

Great. Well, I think that's about time here. I wanted to thank Bill and John again for joining us. Congrats on a great year and looking forward to more in the future. Thanks again, guys.

Thanks, Tom.

Well, thanks for hosting us.