Veeco Instruments Inc (VECO) 2002 Q3 法說會逐字稿

Good day and welcome to the Veeco third quarter 2002 earnings conference call.

Today's conference is being recorded.

For opening remarks and introductions, I'd like to turn the conference over to Mr. Deborah Wasser (ph).

Please go ahead.

Thank you.

Good morning, everyone.

Welcome to our third quarter conference call.

I'm Deborah Wasser, Vice President of Investor Relations.

Also on today's call are Ed Braun, our Chairman, CEO, and President, and Jack Rein, our CFO.

Veeco announced our third quarter 2002 results at 7:00 a.m.

EST this morning.

If you haven't seen the press release, please visit our Web site or call 516-677-0200 extension 1403 to get a copy.

This is call is being recorded by Veeco Instruments and is copyrighted material.

It cannot be recorded or rebroadcast without our permission.

Your participation implies consent to our taping.

To the extent this call discusses expectations about market conditions, market acceptance, and future sales of the company's product, future expectations, or otherwise make statements about the future, such statements are forward-looking and are subject to a number of risks and uncertainties that could cause the actual results to differ materially from the statements made.

These factors are discussed in the business description and management's discussion and analysis section of the company's report on Form 10-K, an annual report to shareholders.

In addition, we refer you to today's press release to read specific information concerning filings for our proposed merger with FEI.

This is being Webcast live at the veeco.com Web site and will be available for replay and archive for future reference.

We do not plan to update the information on this Webcast one it's archived.

Veeco management will be participating in several investment conferences in the coming weeks.

Please visit our Web site for information about these conferences and simultaneous Webcasts.

I'd now like to turn the call over to Ed.

Thank you, Deb (ph).

Good morning.

This morning we reported our third quarter results, clearly reflecting industry-wide declines and uncertainty in semiconductor data storage and telecom wireless capital spending.

Only our scientific research bookings remain stable during the third quarter and are now running about 45 percent of total orders.

Our technology and product positions remain strong and are aligned with future growth opportunities, and our market diversification and strength in metrology (ph) helps to dampen the severity of current market conditions.

Unfortunately, we do not see a near-term improvement to our customer's capital spending constraints, so we will manage those resources that we can best control today, our spending and our head count, while continuing to invest in our core technologies and worldwide customer support.

But we will describe significant levels of cost reduction to be taken in this quarter.

First, let me comment on Q3 results.

Q3 bookings were 69.4 million below our guidance, which was to exceed 75 million.

Our book-to-bill was . 95 to 1.

Although our bookings were up 13 percent from prior year, we were down 11 percent sequentially from Q2, which is about half to a third the decline that others have reported for this sector; however, not much comfort to us.

Sequentially, our metrology (ph) orders declined five percent.

Our equipment orders declined 19 percent.

So metrology (ph) outperformed equipment for this quarter and for the nine months.

Our sales were 72.8 million, below our $75 million to $80 million guidance, and down 36 percent from prior year, down six percent sequentially; however, metrology (ph) had increased revenue of five percent, while equipment declined 17 percent.

Our GAAP EPS was the loss of seven cents, and our pro forma EPS was break even versus our positive two cent to four cent projection that was presented as guidance for Q3.

The decline in EPS was in line with our missed revenue.

I would say that, despite our lower (ph) sales, our gross margin increased from 45.5 percent to 47.2 percent for the quarter, reflecting earlier cost reductions and increased sales in higher margin metrology (ph) products in this quarter.

Our metrology (ph) group continued to benefit from customer acceptance of our new atomic force mycroscopy (ph) technology products, contributing to third quarter metrology (ph) sales of 43.2 million, a five percent sequential increase from the second quarter, with quite significant profitability.

Our process equipment group gad sales of 30.5 million in the third quarter, a decline of 17 percent sequentially from the second quarter.

Process equipment remained unprofitable, reflecting continued weakness in the data storage and telecommunication markets.

We are currently planning to launch significant new Veeco Etch (ph) and Deposition (ph) products in the Q4-Q1 time frame.

We expect, in this current quarter, on reduced sales level of about 10 percent, metrology (ph) will remain quite profitable and processed equipment unprofitable, and that total Veeco will be unprofitable, losing about 10 cents to 15 cents on a pro forma basis for this quarter.

But we will take significant steps to reduce Veeco's spending going forward and bring our equipment group to profitability in Q1 of '03.

We are lowering a head count by approximately 20 percent, with a reduction of about 265 people.

Between Q3 and Q4 we took out about 60 people in Q3.

The remainder will come out of Q4.

And we will reduce or eliminate five operational sites out of our 11 total Veeco sites, with site consolidations to be completed over the next few quarters.

We will reduce our overall spending with the goal of achieving annualized savings of approximately $24 million for 2003.

We expect these cost reduction actions will restore profitability in the first quarter of 2003, even assuming a lower revenue level.

But we will provide a more detailed Q1 forecast at the completion of Q4.

Our strong balance sheet, with over $200 million of cash, our leadership position in our technology products, and our very broad enabling technology bases will allow us to continue to be supportive and strategically aligned to our worldwide customers.

To comment on orders by market for Q3, research was some 45 percent of the total.

The combination of semiconductor and telecom were 26 percent, about even with each other, and data storage about 29 percent.

On a geographic basis, international sales have increased significantly relative to domestic sales, and today about 45 percent of our sales are in North America and 55 percent internationally.

That's a flip from the position about a year ago.

If we look at revenue in the quarter, again, research was responsible for 47 percent of our market revenue, the combination of semiconductor and telecom about 31 percent, and 22 percent data storage.

When compared to the second quarter, revenue increased in research and semiconductor and declined in data storage and telecom.

Of our top 12 customers we continue to reflect a diverse market breadth.

Of our top 12 customers, five were data storage, five were a combination of semiconductor and telecom, and two were scientific research.

To comment on the status of the Veeco-FEI merger, both (inaudible) and I feel that the current conditions just serve to further highlight the value of critical mass in our sector and the strategic benefit of our combined companies.

Both companies have completed SEC responses and are working to expedite our Department of Justice responses to be submitted by the end of this month.

Integration teams have continued to meet to outline the merger process, and both companies are working towards a planned December close.

At this point I would like Jack to review the financials, and I'll return to make comments on individual markets and to answer your questions -- Jack.

For the three months ended September 30th, 2002, sales were 72.8 million, representing a 36 percent decrease in the prior year.

The decrease is attributable to process equipment products, which experienced a 54 percent decline compared to the prior year third quarter, as well as decline on metrology (ph) sales of 12 percent in the prior year quarter.

The decrease in process equipment sales resulted from a decline in sales to data storage as well as a decrease in sales of optical filter, deposition equipment to telecom.

The decrease in metrology (ph) sales is attributable to decline in automated system sales as well as parts and service.

Despite the lower metrology (ph) sales level, metrology (ph) had higher operating profit in the third quarter '02 versus the year ago quarter, with an operating margin of approximately 24 percent.

Gross profit was 34.3 million for the quarter, or 42.7 percent of sales compared to 50.4 million or 44.1 percent of sales for the 2001 third quarter.

Strong gross margin is attributable to a favorable mix in metrology (ph) products which yielded a 58.6 percent gross margin offset in part by a decline in sales volume for the process equipment products, which resulted in a 31.1 percent gross margin in process equipment.

Sequentially, gross margin improved 1.7 percent from 45.5 percent in the second quarter of 2002.

Sequential gross margin improvement resulted from the greater proportion of metrology (ph) sales that have higher gross margins.

Operating expenses came in at 33.1 million, or 45.5 percent of sales, down 3.4 million from the third quarter of 2001.

This reflects $6 million of spending cuts offset in part by the impact of applied EPI (ph), which included only two weeks of expenses in the third quarter of 2001.

R&D expense totaled 13.9 million, representing a decline of 900,000 from the 2001 quarter and was relatively flat sequentially from the 2002 third quarter.

Second quarter - sorry.

The decline in R&D is primarily related to approximately 2.1 million of spending cuts in all product areas, with the exception of Atomic Force mycroscopy (ph) products.

SG&A came in at 19 million compared to 20.9 million in the third quarter of 2001.

The decrease was due to the drop in selling and admission expense as a result of the decreased sales volume, as well as other spending reductions.

Restructuring costs of 83,000 during the third quarter of 2002 included approximately 900,000 of severance expenses related to the employment reductions in response to continuing poor industry conditions and the level of new orders.

The reduction in workforce took place principally in the process equipment operations.

The 900,000 of severance costs was offset by approximately 800,000 of equipment related to the settlement of a post-retirement benefit plan.

Amortization expense of 3.2 million in the third quarter of 2002 versus 1 million in the third quarter of 2001.

The increase was due primarily to the intangible assets acquired in connection with the acquisition of applied EPI (ph).

Interest expense net totaled 1.4 million as compared to net interest income of 300,000 in the year-ago quarter.

The increase in interest expense is a direct result of the issuance of our subordinated convertible notes in December 2001 and January 2002.

Earnings before interest, taxes, amortization and restructuring charges totaled 1.2 million compared with 13.9 million in 2001.

The third quarter 2002 net loss was 2.1 million, or 7 cents a share compared to net income of 1.8 million was (ph) seven cents of income per share in the third quarter of 2002.

Pro forma EPS for the quarter was at break even using a 35 percent tax rate, and excluded net restructuring charges and amortization expense.

This is compared to 36 cents of profit in the 2001 third quarter.

Backlog at September 30th was approximately $93 million dollars, net of approximately $9 million of order cancellations.

Cancellations were approximately one-half data storage and one-half telecom.

For the nine months, sales totaled 230.2 million or a 35 percent decrease compared to 2001, due principally to a decrease of 107 million in sales of process equipment products.

Gross margin for the nine months was 44.9 percent of sales compared to 46.1 percent in 2001.

The gross margin decline is related to volume decreases in process equipment sales, in particular sales of optical filter deposition products to the telecom industry.

R&D expense totaled 41.2 million, a decrease of 3.6 million from 2001 due to our cost reduction efforts.

SG&A was 57.4 million, down 5.3 million from 2001, resulting from decreased selling and commission expense in response to decreased sales volume, as well as other cost reduction actions.

Other income expense net improved to $100,000 of income compared to 2.5 million of expense, due to the reduction of foreign exchange currency losses experienced in the first quarter of 2001.

Restructuring costs of 2.8 million for the nine months were incurred and principally comprised of severance costs associated with reduction of approximately 14 percent of the workforce.

These costs were offset by 800,000 of income related to the settlement of post-retirement benefit plan I previously mentioned.

Amortization expense was 10.1 million in the first nine months of 2002 versus 3.4 million in 2001 comparable period.

The increase is due primarily to the intangible assets acquired in conjunction with the applied EPI (ph) and TM Microscopes (ph) acquisitions.

Interest expense net totaled 4.4 million as compared to net interest income of 1.4 million in the comparable 2001 period.

Increase in interest expense resulted from the subordinated notes.

Earnings before interest, taxes, amortization, and restructuring charges totaled 4.8 million compared with 52.3 million in 2001.

Eco's nine-month 2002 net loss was 17.2 million or 25 cents per share compared to income of 24.7 million, or 97 cents per diluted share in 2001 at nine months.

Pro in forma EPS for the nine months was a penny, using a 35 percent tax rate and excluding net restructuring charges, amortization and discontinued operations.

This is compared with $1.38 for 2001 nine months.

The 2001 pro forma EPS also excludes an $8.2 million charge for write off of purchase in process technology associated with the acquisitions.

We're currently forecasting fourth quarter '02 revenues in the range of 62 million to 66 million, with forecasted pro forma loss in the range of 10 cents to 15 a cents.

We have outlined the cost reductions currently underway and expect to be profitable on a pro forma basis in the first quarter of '03.

Cash equivalents totaled $207.6 million at September 30th.

We experienced negative cash flow of 13.6 million during the third quarter of 2002.

This use of cash was attributable to several factors -- accounts receivables increased by $8.1 million, as days sales outstanding were 88 days, up 13 days.

This increase is due to a general slowdown in customers payment practices, as well as a significant shift in our Q2 revenues from the domestic to internationally.

Historically, our revenue profile has been 45 percent international.

In the second quarter of 2002 this shifted to approximately 65 percent international, where we averaged 104 days sales outstanding versus 59 days domestically.

We have reallocated our sales personnel to address this issue.

Inventories increased 2.5 million as several international shipments did not reach customers and were at Veeco subsidiaries at quarter end.

In addition, due to back-end loading of orders and shipments in the quarter, some inventory was partially built but not able to be shipped until Q4.

We are focused on improving both of these areas.

While Q4 will be cash negative due to the anticipated losses, we are targeting a recovery of positive free cash flow in the first quarter of '03, largely as a result of the cost reduction actions that we are undertaking.

Cap ex was 6.3 million for the nine months of 2002.

Depreciation expense totaled $11 million for the nine months.

Our balance sheet and cash position of over $200 million remains quite strong.

At this point we will return to Ed for additional comments and your questions.

Thank you, Jack.

I'd like to comment on individual core market activity.

In semiconductor we received orders for 12 automated Atomic Force (ph) microscopes for .3 micron feature size applications, including our first two orders for the new dimension X3D AFMs that we introduced at Semicon for lithography and mask applications, and we shipped our first Dimension X3D in the United States, now undergoing customer field acceptance, with revenue expected in Q4 or Q1.

Low yields continue to drive AFM technology metrology (ph) interest from early AFM adapters.

Our overall semiconductor technology opportunities are plentiful, but capital spending remains very difficult in semiconductor -- among semiconductor customers.

In wireless telecom we received orders in the quarter for five molecular beam Epi-Taxi (ph) compound semiconductor deposition systems and for two Spector (ph) optical deposition systems, almost all from university sites.

So we continue to see research in compound semiconductor, but not commercial activity presently.

We expect Q2 '03 growth in wireless network YFI (ph) applications based upon the expected transition to high frequency five and six gigahertz devices using semiconductor compound materials.

We expect later to have an increase in optical telecommunication based on white light (ph) and LED activity, expected in -- commercially in 2004, so in the interim, continued research and ion source business from both St. Paul and Fort Collins.

In data storage we received orders in the quarter for combinations of ion beam deposition, ion beam etch (ph), PVD, physical vapor deposition, and atomic layer deposition.

These were principally technology buys for advanced GMR and TMR heads, about $19 million in the quarter.

We are expecting introduction of our next-generation ion beam deposition and ion beam etch (ph) tools scheduled for Q4, principally for 80 to 120 gigabyte thin film head development followed by a next generation PVD Veeco tool to be introduced in Q1 of '03.

Capacity buys for the advanced heads are expected in mid-2003 associated with high aerial density drives for network storage, server, and new consumer applications, which is video games, digital video recorders, advanced TV set top boxes.

We're also expecting faster connections to the Internet to encourage customers to continue to download greater amounts of video, audio, and text in new entertainment and storage appliances.

IDC, an industry research firm, estimates that the total number of disk drives for consumer electronic applications will reach some seven million units a year by 2006.

And lastly, in scientific research, those orders now represent about 45 percent of our total, and are less volatile than the information age markets we serve.

Research orders included increases in nanotechnology and life sciences, some decreases in electronic material research, and we did, in Q3, see order growth in our newer products, the Veeco PICO Man (ph) and Nanoman (ph) Atomic Force (ph) microscope manipulator products and in our new research AFM (ph) products.

In addition, we are opening a new China nanotechnology center in November in Beijing in collaboration with the Chinese Institute of Science.

So, in all, the diversification of our core markets and our strength in metrology (ph) continued to dampen the severity of the current capital equipment trends.

Operator, we would be pleased to pause at this point and take questions

Thank you, Mr. Braun.

Our question and answer session is conducted electronically.

If you would like to ask a question, it's star one on your touch-tone telephone.

Again, that's star one.

If you're using a speakerphone, please make sure that your instrument is not muted, as that will block your signal.

Again, star 1.

We'll pause for a moment to give everyone a chance to signal.

Our first question comes from Brett Hodess.

He's at Merrill Lynch.

Good morning, Ed.

First, I was wondering, can you break out what AFM is as a percentage of the business at this point and what the trend specifically on AFM as a whole product family was sequentially, and what you think it might be in the next couple of quarters?

Let me take a look.

From a revenue -- in the 72.7 million revenue number for the third quarter, AFM is 32.8 million.

45 percent.

Do you think that business is going to, as a whole, that product line, hold steady here or is that declining some in the near term as well?

Well, it certainly increased in the first nine months.

If I read - the revenue for Q1 was about 28.7 (ph).

The revenue for Q2 was 28.7 (ph) again.

So it increased to 32.8 (ph).

So the revenues have been increasing.

Give me a moment and I'll look at the booking portion of that.

Hang on, Brett.

Sure.

Bookings -- in the 69.4 million of total bookings, metrology (ph) was 39.2, and within that, AFM in total was 31.4.

So it started the year about 20 million in bookings in Q1, it was 33 in the second quarter, and about 31.3 in the third quarter.

And we would probably project that it's about 30 million to 31 million in the fourth quarter.

So, holding its own quite nicely with some growth from earlier in the year in comparison to equipment.

And it sounds like the research portion on the metrology (ph) side is pretty high.

How does the research portion of AFM hold up with -- in margins relative to when you're selling automated ones to the semiconductor industry?

It's quite good.

If you take the whole metrology (ph) group as a whole, little AFMs, big AFMs, and optical all rolled up together, the margins are over 55 percent.

I think the gross margins on the research AFMs are probably closer to 60 percent.

And then my next question, when you go through all the cost cuts that you outlined today with the headcount reductions and whatnot, will you pick up the -- if revenues are flat in March, you say you'll be back to break even.

Will you pick that mostly up in gross margin and SG&A, and will R&D stay in the current ranges or will R&D come down also?

Ed Braun (?): R&D will come down modestly compared to the cuts in SG&A, and you're right -- gross margins, particularly with the higher metrology (ph) content, will remain stronger.

But there will be a lot of reduction in SG&A.

Great.

Thank you

We'll now go to Glen Yeung at Salomon Smith Barney.

Just to follow up on that one, or Jack, what do you expect gross margins to be at break even?

We'll probably be in the -- hang on one second, probably in the 45 percent range.

Gross margins in this quarter, which we weren't very excited about in terms of profitability, gross margins were 47 percent as a result of metrology being sort of 58 percent and process equipment 31 percent.

If you take a look -- just looking at your guidance, suggesting that you are profitable in Q1, is that to suggest that you believe your Q1 revenues will stay around where you expect them to be in Q4?

I expect that, but I would rather have you not accept this as an early Q1 guidance, but rather as a statement that our cost reductions are significant enough that, even at a reduced revenue level, a modestly reduced revenue level we will be profitable.

The uncertainty is so high I think I'd rather have you wait until the end of Q4 to have a detailed Q1 guidance.

Sure.

Makes sense.

If you look at your top 12 customer base, I note that only two of them are research-oriented, yet it's almost half of your business, suggesting it's a pretty broad customer base and your least concentrated one.

I wonder if you could talk about your sales trends there.

I'm not thinking just in terms of dollars, but in terms of process and how you're able to leverage that.

Are we in a position now where we're getting critical mass as a core division of Veeco, and is the sales process so significantly different that there's more SG&A and other costs associated with the business?

Well, as you were saying that I was scanning the list of our top 20 customers by bookings.

And you're right -- I mean, they're absent from the top five, although number five is a research customer.

But of the top 20, 10 are universities.

It's a broad-based business.

And we size the SG&A appropriately for that size business.

There are some opportunities to reduce costs there.

But we expect it to be very broad.

We expect it to continue to have a good gross margin.

I'm not sure, Glen -- repeat your question in terms of ...

I just wonder if it -- because it seems to be a relatively dispersed (ph) business if somehow there's a different business model in the research division that there is in the semis or other.

Ed Braun (?): It's less volatile.

It's individual transactions, often of a couple hundred thousand dollar level, rather than million dollar tools.

It's funded by a combination of federal government, state government, and some industry participation in nanotechnology.

So it is a different model.

And I think it's a quite profitable sector of our business right now.

Okay.

And then last question was on, if you look out at the telco business, suggesting that you only saw universities willing to participate in the reported quarter, when do you expect to see some commercial pickup in that?

And I'm looking more for any concrete indications from the customers as opposed to what you think the technology trends might be.

Ed Braun (?): I keep watching the -- we have a sales forecast technique that lets salesmen enter their forecast and suspects going out nine to 12 months.

So it's kind of interesting when you look at that prospect list that, certainly for Q4 and Q3, it's very heavily dominated by research organizations.

Q1 Q2 starts to include a lot of commercial names.

We do expect early in '03, even though there may not be a tremendous difference in the revenue level of the business, we expect to see a higher concentration of people like RF, Micro Devices, the more traditional commercial companies working on three-five semiconductor compounds coming back into purchasing.

Thanks

Next question comes from Mark Fitzgerald at Bank of America Securities.

Good morning.

The guidance for first quarter profitability, is it a GAAP or is that pro forma?

It's pro forma.

And I think we'll -- the hope would be that by second quarter or so we would be GAAP positive as well.

Some of the plant site consolidation moves, Mark, that we're taking will show up more slowly at the GAAP line, but we'll certainly be profitable at the pro forma line at Q1.

In giving this pro forma number -- this may be a question for Jack -- I'm wondering, why do you include the things you do in terms of what you include to come up with this thing, if you could go kind of through these line items and explain why that goes into or why that's excluded from the pro forma.

Mark, we have honestly looked at the way that the Street has asked us to report these things and looked at the way comparable companies have in order to give sort of guidance consistent with the industry.

We haven't any particular knowledge other than to say that restructuring and amortization are things that people have historically said should be looked at differently than sort of the continuing operations.

So that's the logic that we've used.

Have you seen the new study out of S&P, Standard & Poor's, about core earnings, because they've really come after and addressed this whole issue that's been abused on the Street in terms of pro forma, and they've gone and dialed in what they view as core earnings.

Is that something that you've looked at and could you use that in the future?

We certainly report our GAAP earnings as a primary -- before we talk about pro formas we always talk about GAAP.

We certainly are aware of the S&P study, and we're also aware of what the GAAP rules are.

We're just trying to give additional flavor.

People like yourself can pick and choose which version you want.

But it is important, Mark, and I think you'll see us and others sort of closing the gap, pardon the pun, to let people go easily from pro forma to GAAP and understand the pieces.

But have you done any work on this Standard & Poor's core earnings?

And do you feel that's more reflective of -- in terms of valuating (ph) the company?

I mean, what we're really trying to get at the Street, what's the best way to value the company?

And I'm not sure what the Street is voting (ph) is that this pro forma analysis isn't.

Although we might have done it historically, that's not the methodology going forward that people are going to focus on.

I think, as greater consensus around a standard for pro forma, we would be pleased to use it.

Okay.

Thank you

We'll now go to David Duley -- he's at Wells Fargo Securities.

Couple questions.

One housecleaning.

You mentioned what your gross margin was in your metrology (ph) business this quarter, and I didn't hear that.

Could you review that and give us what it might be, or your expectation for fourth quarter?

Also, could you break out exactly what your IC business was, orders and revenues?

And then the final question would be when you talked about your different businesses and which one was profitable and not profitable, you're focusing in on process equipment.

Could you give us kind of a three-step way in which you plan to improve the profitability of that particular business?

You're well rested, Dave.

Let me catch up with you.

To start, the gross margin that we gave was that metrology (ph) was about 58 percent, 59 percent gross margin Q3.

Process equipment was 31 percent gross margin.