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

Awesome. Well, welcome back to the Global TMT Conference here. I am Tom O'Mal, U.S. semiconductors and semiconductor capital equipment analyst. I'm pleased to have Bill Miller, CEO; and John Kiernan, CFO. Veeco, thanks for being here, guys.

Yes. Excited to be here.

So why don't we start off from a very high level, 30,000-foot view. We're obviously entering a weaker WFE environment. I think there's a lot of debate. Memory is obviously weaker already, but there's a bunch of beta on foundry logic where you guys have most of your exposure. Can you just start by just kicking off and saying, what's the market looking like today? You obviously reported a month and change ago, but how has that changed since then? And then what's your outlook into '23?

Yes. Thanks, Tom, for having us. Really appreciate being here with everybody. I would say we're looking at the same forecast you are, 28%, 30% down in WFE and much more down in memory. And I guess I'll just say that we have very little exposure today to memory. So I would think, in aggregate, we're going to be down flat to down less than WFE. I were to take a look at our view for 2023 qualitatively, I'd say when you look at our semiconductor business, our laser annealing, we still have great business activity going on at the leading edge in laser annealing in logic as well as the trailing nodes. Our second business in semi is EUV mask blanks. They were tied to ASML scanner shipments. I think that business is going to be steady next year, 3 to 5 systems. So we're feeling pretty good about that. And I'd say the one segment that's going to be a little bit off, I would guess, is advanced packaging lithography tied to consumer electronics like handsets and PCs. So I'd say in aggregate there, that's our qualitative view. It compounds semi. We are seeing softness in our wet processing equipment for 5G RF filters and power amplifiers attached to the mobile market. And in our MOCVD business in compound semi, we're coming off a very low revenue level here, and we are making investments in 2 areas. One is again on silicon power electronics and the other one where we have an evaluation system, the other one is in micro LED, where we just recently signed off an evaluation for red micro LED for the luxury TV market. And I would expect that to be just 1 or 2 number of tools for us in '23. And then data storage, surprisingly, when I look at '23, we are going to be growing over 2022. And really, '19 through '21, we saw 40% compound annual growth. This year, as expected, we've seen about a 40%, 45% down this year. And given our order activity, we see strength in the second half of the year. So I would say that's our qualitative view of '23.

It's a good overview. So why don't we hop kind of into each of these businesses as we go along. But I just wanted to start with the front-end semi business. So obviously, you've had a really strong franchise in LSA. Can you talk about what you're seeing there? You've had a bunch of evaluation tools in the market. I think at one point, it was 10. A couple of those have turned into actual agreements in revenue. How are those trending? And then the second part of the question is just recently on the earnings call, you talked about a little bit of a different mix shift in terms of geography in that front-end semi business. Can you just address that mix shift? And how you see that mix shifting in the coming quarters here?

Yes. We have been successful over the previous years, gaining share at the leading edge, and that continues with evaluation systems. We're signing off evaluation systems at, say, 7, 5 and now working on 3 and then 2-nanometer even placing tools there. So that's an ongoing activity with a number of customers to gain more application steps at each upcoming node. I would say on the third quarter call, Tom, we did say we had an increase in trailing node LSA business. So I would say that was fairly unique for the quarter. It drove a lot of cash deposits for us. But I would say it hasn't really impacted our long-term view of pattern change or anything like that. I would say we're kind of looking into where we're standing, I would say that was probably more of an anomaly from where we sit right now. So I say the business activity is back to a more normalized front-end, back-end mix at this moment.

Got it. Helpful. And then on the LSA side as well, you guys have talked about opportunities expanding into memory customers. You've obviously had traction at one. Can you just remind us how that's going there? And then I think historically, you've sized the opportunity as similar to your opportunity on the node logic side. Just talk about what strides you're making there with that existing customer? And do you still think that, that market could be of similar size to that node logic side.

We have shipped 2 evaluation systems to one customer, as you said, a while back, and both of those systems have been signed off. We've been notified that we're a development tool of record for N+2 at this DRAM customer. If that were to happen, that would mean orders probably in the late '23 timeframe for revenue in 2024. But the performance the customer is seeing is pretty significant, and they're looking to qualify us for N+1. Maybe they have their N+1 performance, but they may have a higher bandwidth, higher performance memory. And so we're looking to qualify for the higher performance piece of N+1. So if that were to happen, it would be a smaller piece of N+1, but it would mean orders earlier in '23 for revenue probably in the second half of 2023.

Okay. And then just one more on the memory side. When you show that you're a tool of record at a single customer, what does that do in terms of leveraging your ability to get into other memory providers. Is there an advantage there when a customer looks over and says, Hey, my competitor is using these guys. Can you talk about conversations you've had, I'm sure you're out prospecting trying to give in those businesses.

Yes. Obviously, it makes a difference. It makes more of a difference when you're actually process tool of record instead of development tool of record. That's obviously a bigger proof point and a bigger concern for the industry. But certainly, we're out there prospecting. We are working with the other memory leaders, not only with our current product, but next-generation product that may be suitable for their specific applications. So I would say the engagement is high with the other leaders in the industry. And I would say if you kind of fast forward, say, 5 years, I think memory does have an opportunity to be similar size, SAM, as the logic space. And that could be a $400 million opportunity, server market opportunity.

Great. Let's pivot over to the data storage side. So I think this has been the most debated end market for you guys for a couple of years now. Obviously, you saw a very large ramp in the data storage business. You saw the hard disk drive guys have a couple of very strong years. You've seen a turn in revenue from the hard disk drive companies, and you guys have called out a weaker year before it happens. So you're on top of that. You're talking about an inflection in '23 where you're actually seeing a recovery in that business. I guess what gives you the confidence that '23 is this up year even as you're seeing some of these end customers kind of turn over. And I know it's off a low base, but talk about what's driving that business and maybe the time line for when that starts to turn around.

This is a question where we've been asked 8 times today by every investor that went into our one-on-one room. So what we're seeing is our equipment is typically on average, a 12-month, even 13, 14-month lead time item. So if you think that it's over a year for us to ship a tool to them, then we have to install it for 3, 4 months, then our customer has to integrate that into a new line that could take 3 to 5 months. So when they're placing orders with us, it's for 18 to 24 months out future demand. And so I think the whole industry is seeing, obviously, an inventory correction happening now, clearly. But the 30% growth in data stored in the cloud is still driving a lots of head business for us and for our customers. And so we're in a unique situation that we provide the equipment to manufacture the heads to not only -- the vertically integrated hard drive manufacturers, but there's also a foundry. And so we sell to all of those. So it gives us a unique view of the whole industry.

Okay. So you would say that where you stand now, you guys were very early talking about a 2023 inflection. You're still confident in that ramp into next year, and you're seeing a lot of the same signs that you saw earlier in the year as well.

Right. We are getting orders with deposits for firm dates in the second half of '23. We actually took orders, and we took cash deposits for tools to be shipped in 2024 that we wouldn't put into our backlog because of a 12-month fence. So we're taking orders beyond our booking window even into '24, and we're holding their cash. So that's a statement.

Yes. All right. So other side of the coin, those are some of your longest lead time customers. Let's talk about some of the shortest lead time customers. So on the last earnings call, you talked about some of the AP and wet processing customers who tend to be on the shorter end the scale, cancel some orders or push out some orders. I think you said mostly pushing out orders. What are you seeing from those customers? What are those conversations like? I think it's very useful to kind of hear when a customer is actually pushing out an order now what that sounds like are they coming to you or do you need to go to them to kind of get that information. Give us the status quo of what you're seeing there? And then what kind of happened there in the quarter?

What we've seen, I would say, predominantly, and John, correct me if I goof this up. But we've seen a softness in orders, bookings for our advanced packaging lithography and 5G or filter wet processing equipment for the consumer market. And so we've seen a reduction in bookings and so we've seen a reduction in our visibility was kind of running at 3 quarters is now kind of 1.5 to 2 quarter visibility. And I think we have had a few customers come to us requesting rescheduling of a quarter, not even 2 maybe. So they're coming to us. They have come to us. It's not -- they're coming in bureaus. It's like we've had 1 or 2 reschedulings.

Okay. And I mean that obviously aligns with a weaker RF market that we've seen for quite some time. When you have a conversation with a customer who wants to reschedule, is there a view that, that demand profile is recovering potentially into next year or is that just they have enough capacity right now for what they need? Any insight into that kind of conversation with those customers is helpful.

Obviously, they have enough capacity for right now in this period. We haven't really had any discussions about, hey, we need to cancel this because it's never coming back. They've definitely given us hard rescheduled dates that we've negotiated. So I wouldn't say it's hitting the walls yet, but you'd have to have your head in the sand if you think there's nothing going on.

All right. Next business segment here. So compound semi, there's been -- you guys have had some success early here in this next generation of compound semi tools. I think that you guys have talked about GaN Power Systems. And then you've kind of moved on from the photonics. We can put that aside on the microLED side, right? So can you talk about share gains that you potentially beginning at AIXTRON and then what that business you think into next year? Are you seeing the same positive trends that you kind of laid out going into this year to kick things off?

I would say this year has been very low market share compared to AIXTRON. And we have a couple of programs, as I mentioned, in GaN-on-silicon power electronics to support the 6-inch to 8-inch transition. We have sold a handful of 8-inch machines to a number of customers, just straight sales. So we are like we're kind of seeding the market and getting a bit of traction there, looking for some follow-on business. But I would say the evaluation we have at 8-inch with the foundry is certainly taking longer than we expected. We're working with the customer on technical challenges with the transition from 6-inch to 8-inch wafers. And I would expect that evaluation to continue into 2023.

And then you talked about a different approach to the MOCVD business and how your tool varies from your customers, and that's an area where you think you can gain share. Can you just explain to us again why you think your tool is advantageous to your competitors and does the market need to move in a certain direction for your tool to be the tool of record at some of these customers or do you think that regardless of where people go in terms of production, people will use your solution?

So in the GaN-on-silicon space, we go to market with a single wafer reactor. Our competitor has a batch system. So you can imagine we can make higher quality films, but they can make them a lot less capital-intensively than we can. And so clearly, 6 inches batch. And I would say, clearly, 12-inch is single wafer. And I would say 8-inch, it's a battleground, and we are working and we've gained a number of positions at 8-inch, but the way we will differentiate is on quality of the film and overall yield compared to a batch solution at 8-inch. That's kind of our value proposition at 8-inch.

So kind of just circling up on the group of businesses here, something from a production standpoint. Obviously, you guys have the San Jose facility. You guys have begun production there. Congratulations on getting that done this year. So can you talk about, one, what -- this may be more of a CFO question here. But one, what does that do from a gross margin perspective, bringing in a lot more production in-house? And then 2, you brought on all this capacity, is there going to be a challenge given the fact that you may be seeing a slowing market? Is utilization an issue? And can you just talk about what ideally you'd like to run that facility at.

Sure. Well, I'll take that, Tom, and thanks for hosting us here. The San Jose project, the expansion project and just an overview of the project. We moved into a new facility. We fully moved in, in the third quarter of this year into a similar-sized facility that we were operating in, but with the capability to double the output. We finished the building on time. We fully transitioned into the third quarter of this year and clearly needed the capacity to meet the customer requirements. So in this year of 2022, our semiconductor business hit records in Q1, Q2 and Q3 and that really was required this investment in San Jose. So that was good. The utilization rates currently there are at high utilization rates. And as Bill mentioned, with the activity that we currently see with the laser-annealing product line as we roll into '23, the utilization rates are similar. So I don't see an impact either positively or negatively in any material way there with impact on gross margin, but clearly a really successful project for the company.

Absolutely. And then on other gross margin levers, obviously, long term, having the expanded capacity footprint allows you guys to, one, grow your product profiles and then to control gross margins to some extent. But in terms of the near term, what other levers are you able to pull from a gross margin perspective? You obviously saw some fall in the quarter. Some of that is out of your control. But just in terms of what you can control and what you're looking to do into next year, can you just name some of the bigger levers that you can use?

Yes. I think you're right there, Tom, in terms of quarter-to-quarter variations in gross margin, and there's a number of factors that impact gross margin from quarter-to-quarter. But if we look at a little bit of a longer horizon, our expectation coming into this year is that we were going to see gross margin expansion. So we're coming in at the midpoint of our guide for Q4 around 41% gross margin this year. And we saw about a 200 basis points impact for, call it, the inflationary items in 2022, right off the bat, much higher freight and logistics costs, higher cost of materials and certainly wage and labor inflation there as well. So it's a focus for us. We've taken a number of steps to mitigate that as much as possible, but had more than a 200 basis point impact for us. As we roll into 2023 and as Bill indicated earlier, it's a little early for us to provide a very specific guidance here on 2023. But some of those factors are still in place. So I would say, as we start to roll into the beginning of 2023 here shortly, we would expect a similar margin profile than we're experiencing today. And then again, given you could see quarter-to-quarter variations there.

And then just on the expense control, you guys talked about initial expense controls already in the past call in terms of hiring. What levels are you comfortable with in terms of coming back? How much is discretionary or variable spend that you could take out? Just any kind of color on if you were to see a more negative scenario, how much action could you actually take on the expense line?

Yes. So you're right. We did indicate that in the third quarter, we actually underspent our initial forecast of spending, and we had been hiring to support the growth opportunities there. But as we've been increasing OpEx, it's been levered in a way that revenue had been increasing faster than OpEx. So in this macro environment and some of the uncertainties, we felt it was prudent to start to -- we didn't put a hiring freeze in. I wouldn't call it a hiring freeze-in but really substantially control new head count coming into the company. So in the one sense, we're really balancing -- we've got these growth opportunities in front of us that Bill just described and we want to fund these opportunities. And on the other side of it or the other hand is, there's an uncertain environment clearly in front of us here. So we do have levers in terms of our variable OpEx before we need to go into headcount reduction or something like that. So we really don't have that plan right now. But yes, we're really sort of working both ends here. We really want to fund the growth opportunities, but we want to be cautious at the same time. So we're really going to try to maintain OpEx spending within a percentage of revenue. And if we see the revenue not growing or coming down, we'll tighten it a little bit more.

Very helpful. Something I get asked about a lot, and I'm sure you guys got asked on today as well is just the China exposure and how that impacts your business. So clearly, there's a material impact for the larger semi cap equipment companies. You guys addressed this briefly on the call, but can you just remind us, one, what do you think your exposure looks like there; 2, have any of the bands or any of this impacted the way that you're shipping? And if there's any outcomes from those entity lists or new restrictions that either benefit or hurt you guys?

Yes. So we haven't really seen any change in the environment back at our earnings call and when the new regulations came out in October. So for some context, we have about 20% of our revenue coming from customers in China. And as we look into next year, again, there could be quarter-to-quarter variations, we see a similar pattern or expectation of revenue in China. The impacts to us, we believe that we would be able to ship and we'll ship the substantial majority of our backlog. And let me touch on the reasons why there. So if I look at the areas, first of all, not all of our business in China is in the semiconductor space, right? So we've got business outside of the semiconductor space that wasn't part of these new restrictions. So if we look at one of the area of the new restrictions that may have impacted others in the semi equipment more than us is that there's a new requirement in these regulations regarding licensing requirements with deposition equipment that meet certain criteria. We sell hardly any deposition equipment into China. So that really didn't have an impact on us. And then if you look at the restrictions regarding advanced manufacturing in China at the device level and you look at the restrictions for logic, NAND, DRAM, we have virtually very, very little exposure to NAND and DRAM. So that really didn't come into play for us. So when we look at the logic side and the requirements on having 16-nanometer or below or FinFET is really where the regulations were geared towards that had very little impact on our business in China as well. And then the third area was companies being added to the unidentified or unverified list there, and that didn't have a significant impact on us. So nothing has really changed there. And our view is that we should be able to shift the vast majority of our backlog from customers in China.

Helpful. Just want to focus back on just the main growth driver here and I want to follow up on the LSA business. So clearly, there is a need in the market for your solution. You've seen a lot of customers move -- nearly all leading-edge customers move to your solution. Can you talk about what your conversations with those leading customers, the larger guys are today? And are you sensing from them a desire to already pull back in terms of ordering or are they just kind of expressing caution and you're sensing that from them? Just any sort of conversations you're having with those larger customers just because you've seen such a strong growth profile, compare and contrast, I guess, the conversations you had 6 months ago with them and kind of their tone on this environment right now?

I would say surprising. We're seeing not a lot of change in tone. What we're talking about are, hey, at 5 nanometers, I need a thermal dwell of 200 microseconds, in 3 nanometers, I need to be under 100 microseconds, how are you guys going to do that? How are we going to evaluate that. And so the customers still seem very engaged on road map development with us. And so that remains very strong and very solid with the leading-edge guys, and that's where we're spending our money in our R&D dollars. We're not really spending much in the trailing node where someone places an order, we will fulfill it. But commercially, at the leading nodes, John, I don't think we've seen much change in profile there. Is it.

No. And I think just to add on to your statement there. We're in really nice discussions with customers about evals for advanced nodes, right? And I think that's the important thing here because that's going to drive the future business for us. So if we could always have evaluation program and tools at these most advanced nodes, I think that bodes well for the future. So that's where we're concentrating. That's where we're concentrating our R&D. That's where we're concentrating to meet these road map requirements. I think that's fully intact.

And then just to conclude here, I think that such a big part of the story to-date has been that front-end semi business, specifically the LSA side. Clearly, we're in an uncertain environment. But looking out into '23, if you were to point to one area that you think would be a catalyst that could go better for you guys outside of that business that you're excited about, which business is that? And just kind of describe what makes you excited about it today?

Clearly, we are excited about laser annealing. We've got a lot of shots on goal with customers and logic. I think if we were able to have some success in memory, that would probably be an incremental catalyst for us with that N+1 that we talked about for higher performance memory, that would clearly be a catalyst to the upside. I think we would be looking at how the data storage market unfolds. Is this a 1- or 2-quarter inventory correction? Is this a longer-term thing? I think that's something we're watching very, very carefully. I think some of the challenges that we have is the businesses that are doing really well from an order standpoint, as you said, are laser annealing data storage, which are long lead. Our ability to impact 2023 much beyond that are what happens with handsets advanced packaging, 5G filters. And are those going to snap back here quickly. We're not seeing it yet, but that would be something that would impact 2023 to the positive.

Awesome. Well, I appreciate that these are uncertain times and that these things are evolving day by day, but it's great to have you guys here, and thanks for joining us.

Thanks for hosting us.