Veeco Instruments Inc (VECO) 2014 Q4 法說會逐字稿

Good day and welcome to the Veeco Instruments Q4 year-end 2014 earnings call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Debra Wasser.

Please go ahead, ma'am.

Thank you, operator.

And thank you all for joining today's call.

With me are Veeco's CEO John Peeler and CFO Sam Maheshwari.

Today's earnings release is available on the Veeco website.

Please note that we have prepared a slide presentation to accompany today's webcast.

We encourage you to follow along with the slides on Veeco.com.

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

It cannot be recorded or rebroadcast without Veeco's express permission.

Your participation implies consent to our taping.

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

These factors are discussed in the business description and management's discussion and analysis sections of the Company's report on Form 10-K, and annual report to shareholders, and in our subsequent quarterly reports on Form 10-Q, current reports on Form 8-K, and press releases.

Veeco does not undertake any obligation to update any forward-looking statements, including those made on this call, to reflect future events or circumstances after the date of such statements.

During this call, management may address non-GAAP financial measures.

Information regarding such non-GAAP financial measures, including reconciliation to GAAP measures and performance, is available on Veeco's website.

I'd now like to turn the call over to John for opening remarks.

Thanks, Deb.

One year ago, we said we'd transition Veeco back to growth and profitability.

We've accomplished just that.

We grew revenue and bookings, increased gross margins, realigned our cost structure, returned the Company to EBITDA profitability, and generated substantial cash.

We also told you that the path to improved financial performance involved delivering game-changing new products, and we've done that as well.

The EPIK700 and Propel MOCVD systems were successfully launched and will contribute meaningfully to our market leadership and future growth.

We gained market share in MBE with GENxplor.

Data Storage orders picked up nicely in the fourth quarter, a result of having great products aligned with our customers' road maps.

And lastly, we completed the purchase of SSEC, now called Veeco Precision Surface Processing, adding a new trajectory for revenue and profit growth in 2015 and beyond.

One major disappointment for 2014 has been our atomic layer deposition business.

We successfully demonstrated our FAST-ALD technology for flexible OLED encapsulation at a key customer.

However, the incumbent deposition technology has progressed to be good enough for the current market requirements, and we've not received any sizable orders for OLED encapsulation tools.

While this opportunity may not be permanently off the table, diminished near-term revenue potential required an impairment charge, and we will reduce our ALD spending.

Going forward, we will continue to assess our flexible OLED market opportunity and focus our ALD R&D efforts on semiconductor and other applications.

Turning to the fourth-quarter performance, I'm excited to report that we booked $196 million, our best quarter since 2011.

Orders improved 80% from the third quarter, and as a result, we start 2015 with over $280 million in backlog, setting the stage for another year of growth.

Revenue was $114 million, up 22% from the last quarter, and we reported positive EBITDA.

We generated approximately $50 million in cash from operations during the quarter, so even after the PSP acquisition, our cash balance remains quite strong at nearly $400 million.

I'm pleased that we continue to execute effectively and deliver better results.

I will turn the call over to Sam for the details of our performance.

Thanks, John.

And thanks to everyone for joining us.

I am pleased to report that Veeco delivered within our guidance range for both the top line and the bottom line on a non-GAAP basis.

Revenue for Q4 was $114 million.

On a GAAP basis, we completed the acquisition of SSEC, now Veeco PSP, and also took a charge for impairment of assets related to ALD products.

Due to these reasons, our GAAP diluted loss per share of $1.44 was significantly below the guided range.

On a non-GAAP basis, diluted EPS was $0.13.

Adjusted EBITDA of $8.3 million was significantly better than the prior quarter, and also ahead of the top end of the guidance range of $6.7 million.

Due to PSP acquisition, going forward we will be providing P&L guidance on both a GAAP and non-GAAP basis.

We use these non-GAAP financial measures to assess our performance and facilitate meaningful comparison to our historical operating results.

On slide 9, we have reconciled our non-GAAP measures to their most comparable GAAP equivalent.

Consistent with industry peers, our non-GAAP measures exclude share-based compensation and acquisition related items including intangible amortization, transaction costs, write-up of inventory and backlog.

I want to highlight some of the unusual one-time adjustments that we have removed from our Q4 non-GAAP results.

We recorded a non-cash impairment charge of $55 million, primarily due to changes in near term financial expectations for the ALD business.

We excluded a $3 million currency gain associated with the liquidation of our subsidiary in Japan.

And in taxes, we excluded a $5 million tax benefit associated with the resolution of an incentive tax rate in Asia.

Now moving to P&L highlights.

Our recent acquisition of PSP is already yielding positive top line and bottom line growth.

We completed the acquisition in early December 2014, and Q4 results include three weeks of PSP contribution.

We recognized revenue from two EPIK700 systems which received beta signoff during the fourth quarter.

While revenue for production EPIK systems will remain deferred until we receive final acceptances, the accounting treatment for beta 2s allowed us to recognize revenue in Q4.

Gross margin on a non-GAAP basis was 38.5%, a significant 3 percentage point increase over Q3, and higher than the guidance range.

Gross margin improved due to an increase in volume in MOCVD and Data Storage products, as well as the addition of PSP to our portfolio.

And while we are very pleased with our gross margin performance, we remain focused on driving down our manufacturing costs through Supply Chain Management and other initiatives.

We expect to continue to see some volatility in gross margin as we manage competitive pricing pressure which remains a factor for our gross margin.

Our non-GAAP operating expenses remain the same as Q3, even though we added additional expenses associated with PSP.

I am pleased to report that, excluding PSP, we met our expense reduction goals as stated in prior calls.

Adjusted EBITDA was $8 million, a good result, and achieved in part from the addition of PSP to our portfolio.

The strong performance in Q4 makes our adjusted EBITDA positive for the full fiscal year 2014.

In the tax area, we have structured our acquisition of PSP to preserve certain tax benefits, estimated to be worth up to $25 million over the next 15 years, as we can deduct a portion of the intangible asset amortization for tax purposes.

Moving to the details of bookings for the fourth quarter.

New orders were $196 million.

These were significantly up from $107 million in Q3.

MOCVD orders increased 75 percentage to $142 million, due mostly to the significant order received from [Sonan] to purchase 25 two-reactor EPIK systems.

MOCVD continues to strengthen, and like Q3, there were no order cancellations in the quarter.

On balance, we have more customers expressing accelerated delivery dates rather than postponement.

Data Storage bookings almost tripled from Q3 to $45 million in Q4.

In the hard disc drive market, we see signs of improved condition as cloud related expansion continues to demand higher capacity drives.

While these signs in fourth-quarter orders were encouraging, order pattern may remain uncertain in this business.

Orders from PSP were $3 million for the December quarter.

Now turning to revenue.

In Q4 we recognized $114 million in revenue, our first quarter above $100 million in two years.

PSP added $8 million of revenue in Q4.

Total Company book-to-bill for Q4 was 1.7, driven primarily by the large order from Sonan.

The total backlog at quarter end was $287 million.

PSP added $28 million of backlog to the Company as of the acquisition date.

Now turning to the balance sheet.

Q4 cash flow from operations was $49 million, and the quarter ended with $392 million in cash.

Overall, cash balance declined sequentially from Q3 due to purchase of SSEC for $145 million on a net basis after adjustment.

Cash balance was helped by the receipt of customer deposits, as well as collection of an income tax refund from the IRS for approximately $21 million.

Quarter over quarter, our AR balance has been stable, and the increase in inventory is related to getting ready for the production ramp.

Now turning to guidance for Q1.

In terms of our outlook for orders in the first quarter, given the fact that Q4 was nearly double the run rate that we were booking previously, and that the order pattern is lumpy, we expect Q1 orders to be $100 million or better.

Q1 revenue is expected to be in the range of $92 million to $100 million.

More than $25 million of EPIK tools will be shipped, built and invoiced in Q1, but we would wait to recognize revenue until such time as they are installed and final accepted by the customers.

Due to this revenue deferral, we have a dip in Q1 revenue and expect a corresponding increase in Q2 and Q3 revenues.

Although we are not guiding for Q2 or Q3 quarters at this time, they are expected to be much higher than Q1 in revenue.

Non-GAAP gross margin is expected in the range of 36% to 38%.

Non-GAAP operating expenses are expected in the range of $37 million to $39 million.

These numbers include full absorption of PSP into the Company.

Due to revenue being low in Q1, OpEx is somewhat low as well.

We plan to reduce spending run rate in ALD by $4 million on an annual basis, and expect to incur a restructuring charge of approximately $1 million.

Despite completing ALD expense reduction, OpEx is expected to increase after Q1 due to revenue growth and in the range of $40 million to $42 million.

I want to remind everybody that these are non-GAAP operating expenses and exclude equity compensation and intangible amortization.

GAAP EPS is expected to be a loss in the range of $0.59 to $0.53 per share.

Non-GAAP EPS is expected to be a loss in the range of $0.13 to $0.07 per share.

Adjusted EBITDA is expected to be in the range of breakeven to $2 million.

In closing, it is important to note that if we are able to take revenue on EPIK700s upon shipment, Veeco's Q1 revenue guidance would have been in the range of $120 million to $130 million, and the Company would be solidly profitable on an adjusted EBITDA basis.

With that, I will turn the call back to John for a business update.

Thanks, Sam.

Usage of LEDs in displays, signs and automobiles is growing due to lower power consumption and higher performance, while economics and energy efficiency continue to drive LED lighting adoption.

IHS recently predicted that LEDs, which were about 5% of the lighting market on a unit basis last year, will represent over 25% or $10 billion of the lighting market by 2020.

Interestingly, we expect 2015 to be the crossover year when shipments of LED for lighting surpass shipments of LEDs for backlighting.

While there was some seasonal pullback in utilization rates in 2014, strong end market demand has quickly pushed utilization rates back to high levels.

With nearly $200 million of MOCVD backlog starting the year, and some great new products that I will tell you more about, the business is set up for another year of growth in 2015.

LED manufacturing is an extremely competitive industry, and our customers' ultimate success requires that they increase their output while simultaneously lowering their costs.

The EPIK700 is a highly competitive product that improves productivity and yield and reduces customers' manufacturing cost.

An EPIK cluster with two reactors has roughly the same output as a MaxBright with four reactors and provides significantly better yield and uniformity.

From a cost of ownership and performance basis, EPIK is a real winner, and it's helping us to widen the technology gap versus the competition.

This added performance is not just good for our customers; it will enable us to achieve higher selling prices and better margins.

With orders from strategic customers in four regions, and solid quoting activity, highly confident that EPIK will drive both top and bottom line improvement in 2015.

We all know that electric vehicles have limited driving ranges, server farms run too hot and are very expensive to cool, and we prefer not to carry around large laptop chargers.

As power is switched and converted in modern electrical systems and devices, countless terawatt hours are wasted as heat.

Inefficient power conversion wastes tens of billions of dollars every year.

Many leading companies are working to solve this problem with gallium nitride based technology.

The goal is to make 400- to 900-volt devices with higher switching speeds, smaller footprints and better efficiency.

We've been shipping MOCVD reactors to power electronics customers for more than five years, and our customers have repeatedly told us that no one's MOCVD system was optimized for their application.

They told us they needed something different, and that's why we introduced Propel.

The Propel MOCVD system we launched in November is the industry's first system designed specifically to enable low-cost, high-yield, GaN power devices.

The first Propel is shipped.

We're quoting multiple customers, and we expect this system to be an important part of our future growth.

We developed the Propel 200-millimeter single wafer system with outstanding film uniformity, yield and device performance, with long campaign runs and for the lowest cost of ownership.

We believe that Propel can get novel GaN power devices out of the lab and into mass production a lot faster than otherwise would have occurred.

I'm excited to tell you more about our new business, Veeco Precision Surface Processing.

First, PSP extends our product footprint in exciting markets, into advanced packaging, a market that we believe has enormous potential.

And compound semi, where we already serve LED, power electronics and wireless customers with our MOCVD and MBD technologies.

And in MIMS, where we sell our Ion beam etch systems.

Second, PSP's core competency of single wafer wet processing is highly complementary to our current process equipment technologies and allows us to sell equipment for multiple process depths to the same customers.

And third, we expect PSP to add about $65 million of highly profitable business to Veeco this year.

While we've only owned PSP for a couple of months, it is exceeding our expectations.

There's a lot of customer overlap, and our sales team is already helping to expand their global reach.

PSP uses soak-and-spray processes to get wafers ready for thin film production with lower cost, higher throughput and greater stability than the other alternatives.

Competition between mobile device manufacturers, as well as the Internet of Things, is driving the need for higher device functionality in smaller spaces, which requires 2.5 and 3D advanced packaging.

The challenge here is to interconnect multiple devices in a single package at a commercially viable cost.

PSP is helping to make advanced packaging and TSVs less expensive.

So, for example, our TSV Revealer replaces up to four tools versus what is required for the dry etch approach, which would require a CMP plasma etch, silicon thickness measurement and wafer cleaning tools, whereas our PSP approach would require just a single tool.

This lower cost of ownership approach represents a more economically feasible solution for the industry.

We're excited about our entry into advanced packaging, a market forecasted to have better than an 18% CAGR and which represents a large expansion of our served available market.

At the start of this call, I told you that 2014 was a better year than 2013.

I'm confident that 2015 will be a much better year than 2014, and in fact, we're targeting over 30% growth.

We've got great new products to drive our growth in LED lighting, power electronics and mobile devices, areas like MIMS, wireless and advanced packaging.

We have a strong team, focused on continuing to lower our manufacturing costs, keeping our organization streamlined and improving our bottom line performance.

And we expect to be EBITDA profitable every quarter in 2015, with our profitability increasing as we proceed through the year.

With that, operator, we will start the Q&A session.

Thank you.

(Operator Instructions)

And we will now take our first question from Mehdi Hosseini from SIG.

Yes, thanks for taking my question.

Just as a follow-up to the EPIK700 and the revenue recognition, given how the backlog has turned out more than $280 million exiting 2014 and there is also revenue recognition, how should we think about the shipment and revenue beyond Q2?

And I'm not asking for a specific guide looking forward beyond Q1, but just for purpose of modeling and how the units are going to come out of backlog and shipping and revenue are going to be followed.

Any quantitative comment would be really helpful and I have a follow-up.

Thanks.

This is Sam.

The way we are looking at our business right now is that revenues over the quarter should be sustainably up beyond Q1.

Obviously, Q1 is down as I said in my prepared remarks because of deferred revenue.

But as this revenue gets recognized in Q2, Q3 time frame, they should be up.

And with almost about $300 million of backlog, that you just said, that we are starting the year with, it gives us great confidence that we would have a very good 2015.

And since we are beginning 2015 with a low Q1, so to say, on the revenue line, Q2, Q3, Q4 should be expected to be pretty strong.

Great.

And then one follow-up, I think John was talking about PSP revenue contribution as much as $65 million.

Would this be accretive on the operating margin, the PSP revenue contribution?

Yes, it should be.

We are looking at PSP.

It would be accretive on the gross margin and the operating margin, both of them.

Thank you.

We will now take our next question from Krish Sankar from Bank of America.

I had two questions.

First one, a housekeeping one for Sam.

What is the tax rate you're assuming for the March quarter?

And you also said if you had baked in the EPIK revenues, it would have been about $120 million to $130 million in Q1.

What would the gross margin have been at that run rate level?

I will answer the first question on the tax rate.

The tax rate is expected around 20% to 25%.

We have previously guided you in the low 20%s.

However, the way we are looking at taxes for the full year, the taxes would probably not change with the addition of revenue for Q1.

And then in terms of gross margins, I would say that it would be roughly still in the same range, even if we had added those revenues in Q1.

Got it.

Okay, that's very helpful.

And then as a follow-up, I wanted to find out when you look at the auto guidance given that it's coming back after a one-time uptick from Sanan, if you look at the landscape of your customers, it seems like Sanan and EPISTAR are probably the two big customers out there.

The rest of them are probably not going to be adding like 50 to 100 tools, probably more like 10 to 30 tools.

A, is that a right characterization?

And B, if that is the case, how does the landscape for MOCVD look like over the next few years if the customer size has really become smaller except for two of them?

Thank you.

Well, I think -- it's John here.

First of all, there are more customers.

There are more important customers than just Sanan and EPISTAR.

In fact, we've seen positive reception and actually orders from four regions for the EPIK700.

So, we think there is substantial purchases in other regions, other than China and Taiwan, and that's going to add on to the two large customers you mentioned.

So I think there's good potential for orders.

I think the trend will remain intact.

We've seen good growth over the last eight quarters, when you average it out for the ups and downs.

We expect good growth in the future, and we think 2015's going to grow and 2016 also.

So, I think there's a good market out there.

Okay, thanks, John.

We will now take our next question from Mike Ritzenthaler from Piper Jaffray.

Good afternoon.

In terms of utilization rates across the key geographies, are we seeing more tightness in MOCVD capacity, and how do you see that seasonally as we head into the March quarter?

Yes.

Well, we've seen -- we saw the rates take a dip in Q4, and we've seen them pick back up since then and getting back in the high 80%s or even to 90% in some regions.

I think utilization rates are tightening up and people will -- are getting near their capacity, which is why we expect orders to continue.

Sure.

Okay.

Thanks.

And then on the FAST-ALD strategy going forward, any renewed expectations on timing for revenues as you refocus that?

Are we looking two years out?

And then any go-forward expectations for the cost reductions that we can embed in our model from the OpEx line?

So on the first part of that, I think we're not going to see revenues of substance in 2015.

I think it's going to be 2016 and beyond, whatever we sell is going to be a new product and will have an extended revenue recognition cycle on the front end.

It is going to push out, and that's one of the things that drove us to take the impairment.

And I'll let Sam answer the cost reduction.

So Mike, Sam here.

Looking at possibilities of reducing expense run rates here, we think about $4 million or in that range on an annual basis that we would be able to reduce.

And that would be across people, tools, depreciation, et cetera, all those types of expense reductions.

And probably about $1 million or thereabout in terms of restructuring charge that we may take in Q1.

Okay.

Perfect.

Thanks, John.

Thanks, Sam.

Thank you.

We will now take our next question from Edwin Mok from Needham & Company.

Hi.

Thanks for taking my question.

So first question regarding the order trend beyond this large order that you got on EPIK.

How fast are customers converting to EPIK here?

Maybe a better way to ask this, what do you expect the order mix to be as you go into first -- let's say first half of this year, between EPIK and the older MaxBright or even K65I?

How do you think about that?

Well, first of all, we are still selling 465s, 465Is, more into niche applications.

We're also selling MaxBrights and expect to continue to sell those.

I think as we get into the second half of the year, we will be more than 50% EPIK products, and it could reach that in the first half too.

But it's going to be mixed.

But I think eventually as we get later in the year, we will certainly be more than 50% EPIKs.

We do expect the EPIK to help us improve our gross margin and get to the targets that we're looking for.

Okay.

That's helpful.

I want to squeeze two questions into one.

So question on Propel, is that a product that will allow you to address the silicon carbide market, or is it still only GaN based power device?

On PSP, I noticed that the revenue target of $65 million is flat to last year, but at the same time we see some growth in end markets.

Why the difference there?

On the Propel, we won't be addressing silicon carbide initially.

That's not where we focus.

That's not to say that it can't do that, but at least initially, we're really focused on GaN power electronics.

So we will stay with that for the beginning.

Sam, you want to take the other.

Edwin, on PSP, the business in 2015 is expected to grow.

If you remember, when we had done the PSP acquisition, we had highlighted growth rate of about low single digits for that business.

And this is in line with that.

So what John said, $65 million is essentially a growth over what they did in their business last year.

Of course, they were not with Veeco.

So those numbers are not provided.

Also, the revenue recognition for them was different when they were standalone company.

So revenue recognition changes here, and we are still looking at about the same number, $65 million or so for PSP in this calendar year.

Great.

Thanks very much.

Thanks, Edwin.

Thank you.

We will now take our next question from Paul Coster with JPMorgan.

Thanks.

Sam, can I just make sure I understand.

With respect to deferred revenue, we're going through a one time event here and the revenue recognition rules will normalize by the end of this year.

Is that a correct statement?

Hopefully much sooner than that, Paul.

In Q1, we are shipping $25 million or more of product, and we are spending money on manufacturing those tools and testing them and everything else that comes along with shipment.

But we really are not able to get benefit from that revenue in Q1.

But we expect that we would be able to meet the thresholds for revenue recognition on shipments sometime in Q2.

And beyond that, Q3, Q4, it should normalize.

So Q1 and Q2, they are going to go a little bit through a dip and then come up.

But at the same time, and in the meantime, we are expecting we will also be shipping all the product that we've been booking so far.

Got it.

And then John, you talked, I think it was, 30% growth this year.

If I strip out the PSP business, then we're talking about somewhere in the region of 10% to 15% growth, which doesn't seem that much of a stretch, given your bookings recently.

Can you just comment on that, please?

Yes.

Well, first of all, we said more than 30%.

We are at least working to do quite a bit more than that.

But Sam, why don't you take the rest of this?

Even if you strip out PSP, the non-PSP business, even if we go with the lower bar that John put out, 30%, ex-PSP business is growing about 20%, plus.

So 20% plus growth on ex-PSP business.

Then we add PSP, and then all this is with the idea that we are seeing 30% or more.

Okay.

Thank you.

That's helpful.

We will now take our next question from Patrick Ho from Stifel Nicolaus.

Please go ahead.

Mr. Ho, your line is open.

Thank you very much.

John, given how well your gross margins have held over the past few quarters and in your outlook, are you seeing any pricing pressures on the new EPIK product?

Well, there's certainly pricing pressure, but I do think we will be improving our gross margins, so I think the environment's getting better.

The tool's an excellent tool.

It produces great results.

So that certainly helps a lot.

And our goal is to get our gross margins back above 40% by the end of this year.

So the new tool will help us do that.

Great.

And my follow-up in terms of some of the applications that you talk about for PSP, some of them obviously target on TSV type of applications or stuff that hasn't really gained mass adoption as of yet.

How do you look at the adoption for TSV as well as some of the more complex advanced packaging techniques, how that can impact or potentially provide some upside for your business this year?

I think with TSV, it's been a -- this has been a moving target for the last few years, and it's been shipping out.

So it's a little hard to predict when it is.

But -- and I think it does give us tremendous upside because there's not a lot of TSV baked into our base plan.

On the other hand, we are sampling wafers with multiple IDNs for TSV.

They told us the process works, and we think we have better economics on this process than the older approach of a dry etch.

So we think it really gives us some good upside, and we're able to address the other applications that we've been selling into.

So good feedback from customers, and I think when it takes off, there will be some really good business for us.

Great.

Thank you.

We will now take our next question from Brian Lee from Goldman Sachs.

Hey, guys.

Thanks for taking the questions.

Apologize if some of these have been asked already.

I had to jump on a little bit late.

First off, what percent of your MOCVD bookings this quarter were for the EPIK700?

And then separately, what percent of the orders in MOCVD this quarter were from China?

Brian, we do not disclose bookings by product type.

We just disclose bookings for MOCVD.

But I would say that a large percentage of bookings was for EPIK.

And then coming back to your second question, I think we do disclose overall companies booking by region, not particular product line or particular business and its bookings by the country.

I would say a large percentage of bookings in this quarter were from China.

Okay.

Fair enough.

And then as a follow-up, I guess just wanted to dig into what type of environment you're seeing amongst your US and EU customers on capacity expansion, particularly as it relates to the MOCVD business and whether or not that's more of an upgrade or new system activity that you're seeing in the region.

And then lastly, if there's any impact you guys are seeing from GaN on silicon transitions.

Thank you.

So first of all, by utilization rates have picked up from earlier, let's say earlier in the fourth quarter.

There was a depression there in the early fall.

They've picked back up.

They're in high 80%s.

Some are in the 90%s.

We've seen interest in and purchases in multiple regions of the world, so not just China but China, Korea, US, and Europe.

And so we do have new order activity in all regions.

And what was the third question?

Any impact from GaN on silicon transitions that you're seeing, whether in that region or more broadly?

We're selling products into GaN on silicon for LEDs and have done quite well.

Some of our customers have achieved excellent performance for GaN on silicon, and so our approach is we can sell you a product to do sapphire-based LEDs or GaN on silicon.

It doesn't really matter to us.

So we don't look at that transition in any negative way.

Okay.

Thanks, guys.

Thank you.

Thanks, Brian.

(Operator Instructions)

We will take our next question from Vishal Shah from Deutsche Bank.

Hi, thanks for taking my question.

I apologize if some of these have already been asked.

I jumped a little late on the call.

But maybe John, can you talk about the outlook for the OLED business?

I know you guys took some charges.

How do you see the evolution of that product at your customer this year?

When do you expect bookings, if at all, for this year?

Your bookings in the fourth quarter were very strong, but even despite the deferred revenue in Q1.

Q1 revenue outlook looks a little light.

So maybe talk about what's going on there?

Sure.

Well, first of all, on OLED, so with our large customer, we did demonstrate the ALD approach to OLED encapsulation.

We got good film quality.

It worked.

But that technology's bigger benefits come from very highly flexible displays and more foldable displays.

So for the current generation, what's happened is the incumbent competitive technology has progressed, and the customer made decisions that that was a better approach in the near term.

And that's what basically told us we weren't going to get any orders from that customer in the near future.

We're still talking to customers in multiple other regions, so it's not to say that the opportunity is dead, but there -- things are not as clear.

So we're back evaluating how we will do there.

Q4 bookings were great.

They were the best since 2011 when the market was doing spectacular.

And Q1's shipments are really strong.

I think that's the message.

And Sam can explain why there's not more revenue.

But Q1 shipments are excellent.

Q1 shipments as John just said are pretty strong, and we expect shipments to remain strong through the summer for sure that we can see.

We have certainly started this year with a very strong backlog of about $300 million.

And we will be working our way down on the backlog and at the same time expect to see some strong bookings also here during the spring and the summer time frame.

That's helpful.

Just one last question.

Can you maybe talk about what percentage of your Q4 bookings were service?

Typically, overall our service business runs about 30% of our revenue.

Okay.

Great.

Thank you.

Thanks.

(Operator Instructions)

We will take our next question from Mark Heller from CLSA.

Thanks for taking my question.

Again, also apologize if this has been asked.

I was bumped off the call.

The Sanan orders, are they all occurring in Q4 of 2014, or are there some orders that are also rolling into 2015 as well?

A large majority of that is in Q4, and then some of that is going to be in 2015, depending upon the service requirements.

Okay.

And can you also just talk about the general environment in China?

I guess there's been some talk about a reduction in subsidies over there.

Are you seeing that?

And what's the potential implications?

Thanks.

Well, I think there has been talk of reduction in subsidies.

What we've seen so far is that our customers, the large companies in China, are still getting subsidies and expect to get those in the near term.

I think there is some thinking that that may go away, but it's not really clear exactly what's going to happen.

At the same time, we see it for the longer term that when the subsidies go away, it will be better for the market.

That we will have a more level global playing field across the world and we will see less artificial influence in the market due to subsidies, because in the end what's going to drive LED tools or MOCVD tools to make LEDs is lighting.

We know that end market is growing.

It's got a better than 30% CAGR.

Capacity utilization rates are high.

So as subsidies change, there may be some short-term aberrations in bookings and things.

But we think overall it's going to settle out and will be healthy for the market, but not clear exactly how that's going to work yet.

Thank you.

We will now take our next question from Mehdi Hosseini from SIG.

Thanks for letting me ask a follow-up.

On the MOCVD pricing trend, there was a comment on the prepared remarks that your gross margin is somewhat dependent on ASP.

I'm just wondering if you could elaborate on the current ASP trend.

Should we assume a flattish environment, or is it pretty much a fluid dynamic?

When we develop a new tool and we launch a new tool, we build in new technologies, advanced technologies.

We improve performance, and as we sell that to our customers, they get a benefit.

So their newer tool gives them a better cost of ownership or a better yield or uniformity than their old tool.

But they have to pay some more for that too.

The net expectation, and it's really hard to talk about ASPs because reactor sizes have changed and many things have changed.

I think the net expectation is that we expect our gross margins to improve and that as we get later in the year and up the learning curve a little bit for this new product, as well as sell to more and more customers that we're going to get our gross margins back over 40%.

So I think the pricing environment from that perspective will improve -- is improving.

Got it.

Thank you.

And with no further questions, I will now turn the conference back over to John Peeler for any closing comments.

Thank you for joining us tonight, and we will look forward to seeing you again next quarter with some great results.

Thanks.

Thank you.

This does conclude today's conference.

Thank you for your participation.