Veeco Instruments Inc (VECO) 2015 Q2 法說會逐字稿

Good day and welcome to the Veeco Instruments Second Quarter 2015 earnings call.

Today's conference is being recorded.

At this time I would like to turn the conference over to Shanye Hudson, Vice President of Investor Relations.

Please go ahead.

Thank you, Operator, and good afternoon, everyone.

Joining me on the call today are John Peeler, Veeco's Chairman and CEO, and Sam Maheshwari, our CFO.

Today's Earnings Release is available on the Veeco website.

Please note that we've 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 copyright material.

It cannot be recorded or rebroadcast without Veeco's express 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 products, future disclosures, future earnings 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 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 of performance is available on our web site.

With that, I'll turn the call over to John for opening remarks.

Thanks, Shanye.

Veeco delivered solid revenue growth and improved profitability in the second quarter.

Bookings were $124 million up 20% quarter-over-quarter and year-over-year, although a bit lower than expected.

Revenue was $131 million, the highest since 2012.

Adjusted EBITDA was nearly 10% of revenue, and EPS of $0.20 per share was above the mid point of our guided range.

We also achieved a couple of key MOCVD product release milestones in Q2.

We transitioned EPIK to a bifurcated revenue model, and we recognized revenue on our first Propel GAN power electronics tool only six months after its release.

Overall I'm pleased with our Q2 performance, and I'll turn the call over to Sam to provide further details.

Thanks, John, and good afternoon, everyone.

Today, I will be discussing our non-GAAP financial performance.

You can find a detailed reconciliation between GAAP and non-GAAP results in the Press Release and also on our website.

Veeco is continuing to perform well against our financial targets delivering results above the mid point of our guidance range across all P&L metrics for the Second Quarter of 2015.

Revenue was $131 million up from $98 million in Q1.

As a reminder, Q2 revenue levels were highly dependent on the timing of the transition of EPIK product to our standard revenue upon shipment model.

We achieved this significant milestone in late May which was in line with our expectation.

As a result EPIK tools which shipped after the transition date were included in Q2 revenue.

EPIK tools that shipped prior to this transition date will remain in deferred revenue until we receive final customer acceptance.

Q2 gross margin was nearly 38% up approximately 20 basis points from the first quarter and above the mid point of our guided range.

Higher business volume combined with a favorable product mix more than offset the impact of initial EPIK revenue starting to hit the P&L.

Importantly, the margin on EPIK tools we are currently booking is higher than tools we shipped in the first half of this year.

We have made excellent progress on our product cost reduction plans which we are implementing through the end of this year.

Operating expenses were $40 million compared to [$37] million in the first quarter attributed to higher business volume combined with our annual merit increases.

We continue to prudently manage costs while allocating R&D investments towards growth opportunities that offer the highest return.

We increased non-GAAP earnings per share to $0.20 based on diluted share count of approximately 41 million shares.

Adjusted EBITDA was $12.8 million and represented approximately 30% EBITDA margin on incremental revenue, Q2 over Q1.

These results illustrate the operational leverage in our model, and we will continue to focus on driving sustainable profitability.

Now turning to market data.

You may recall we changed our reporting method last quarter and now provide revenue and booking data by the end Markets we serve.

We believe this change more accurately reflects our business given that we sell multiple products into each of these end Markets.

Starting with bookings, we recorded $124 million in Q2 an increase of about $22 million over Q1 bookings.

Orders improved both sequentially and year-over-year, but as John noted earlier, they were still below our expectations driven largely by macro conditions.

In the lighting, display and power electronics business our orders were partially impacted by the volatility in the China market.

Certain LED manufactures experienced challenges in accessing capital through the credit Markets.

As a reminder Veeco requires a meaningful cash deposit at the time of booking which helps to lower our financial risk.

Based on our discussions with these customers, additional MOCVD capacity are still required, and we expect these delayed investments to occur over the next six to nine months.

Overall, lighting, display and power electronics increased to approximately 70% of Q2 bookings as compared to 59% in Q1.

Bookings for advanced packaging, and RF remain healthy at 14% of total orders.

On an absolute basis, Q2 represented the fifth consecutive quarter of growth for this market segment enhanced by the addition of our PSP business.

The scientific and industrial Markets made up approximately 10% of total orders down from 15% in Q1.

Data storage made up the balance of Q2 bookings at 6% down from 13% in Q1.

Slowing PC demand and a weak enterprise market caused hard disk drive manufacturers to reconsider their investment and as a result, a couple of orders we had forecast to close in the second quarter have been placed on hold for the time being.

Overall we expect LED lighting to drive orders in the near term, and we have indications for additional investments through early 2016.

Depending upon timing of these investments, we would expect second half bookings to be flat to up as compared to the first half of this year.

Now turning to revenue highlights.

Sales to the lighting, display and power electronics market made up a majority of Q2 revenue at approximately 62%.

Advanced packaging, MEMs and RF comprised 11% of total Q2 revenue and were relatively flat quarter-over-quarter on an absolute dollar basis.

PSP business makes up the underlying majority of this market segment; however, it's important to point out that we are cross-selling into our other market segments, and overall PSP sales were up nearly 28% in Q2.

Scientific and industrial sales were approximately 14% of total revenue, flat on a percentage basis with Q1.

This business tends to be lumpy with a broad range of customers spanning from universities for research purposes to our recently announced ion beam deposition sale to Germany based S1 Optics.

Data storage sales more than doubled on a sequential basis and comprised about 13% of Second Quarter revenue.

However, as noted earlier, weak market conditions are negatively impacting the hard disk drive market.

While capital budgets are not completely frozen, hard disk drive manufactures are scrutinizing every investment.

As a result, we expect our data storage business to continue to face a challenging environment with sales fluctuating from quarter-to-quarter.

On a geographic basis China made up about 50% of total revenue in Q2 driven primarily by demand from leading LED manufacturers.

The remaining 50% of revenue was spread fairly evenly across each of the other three geographic regions, the US, EMEA and the rest of the world.

We ended the quarter with a healthy backlog of $279 million, and lastly, our book to revenue ratio was just under one.

Now moving to the balance sheet.

Cash balance increased slightly to $396 million at the end of the quarter.

We continued to effectively manage working capital and generated approximately $8 million in cash from operations.

Now turning to guidance for the third quarter.

We expect Q3 revenue to be in a range of $135 million to $160 million driven largely by strong demand for EPIK product.

Non-GAAP gross margin is expected to be in the range of 37.5% to 39.5%.

We are driving gross margin improvements and targets achieving 40% or higher towards the end of this year.

We are guiding non-GAAP operating expenses to be between $40 million and $42 million consistent with our prior expectation for OpEx to be in the low $40 million range.

GAAP EPS is expected to range from a loss of $0.05 to a profit of $0.19 per diluted share.

On a non-GAAP basis, we expect EPS to be in the range of $0.22 to $0.40 per diluted share assuming an effective tax rate of approximately 20%.

Adjusted EBITDA guidance is between $14 million and $24 million.

Finally, we reiterate our view for 2015 revenue growth to be greater than 35% with second half revenues higher than the first half.

And with that, I'll turn the call back to John for our business update.

Thanks, Sam.

I'd like to start off by sharing our perspectives on the LED market.

For some time now, we've been talking about LED lighting adoption as the next industry growth driver, a third wave of demand which follows LED back lighting for Mobile Devices and TVs.

2015 is expected to be a crossover year marking the first time that LED unit shipments into the lighting space will surpass those shipped for back lighting applications.

Even so, we're still in the early innings of LED lighting adoption with penetration well below 10% on a unit basis.

LED lighting adoption for industrial and commercial purposes has progressed well.

Energy conservation and cost savings initiatives have spurred numerous cities around the world to adopt LED's for street lighting and other commercial uses, including New York, London, Shanghai, and Tokyo; however, cost remains a key barrier for broader LED lighting adoption and this is especially true of the consumer space which represents a large percentage of the $40 billion sockets worldwide.

When I walk the aisles of Home Depot, I can pick up a 60 Watt bulb for less than $10 and according to LED Inside, the global average selling price of the 60 Watt LED bulb is around $16 today.

Prices have declined by more than 60% since 2012, and LED penetration into lighting has more than doubled over the past two years which is encouraging and indicates penetration is accelerating as unit pricing declines.

For Veeco, this trend supports the need for additional MOCVD capacity over the next several years.

Looking beyond the general lighting space, an increasing number of LED applications are emerging.

For example, last quarter, we highlighted LED technology for indoor agriculture which is enabling year around food production using a fraction of the water and land required by traditional farming methods.

Just last month, construction began in New Jersey on what will become the largest indoor vertical farm in the world, and when complete, this facility will offer a highly efficient and sustainable food supply that's close to consumers.

LEDs are also playing an important role in the so-called internet-of-things.

Smart lighting combines LEDs with built in sensors and added intelligence.

For example, these connected devices can detect when a room is occupied in order to optimize energy consumption or even function as a security device.

One of the more interesting IOT applications is in the area of wireless communications.

LEDs offer the capacity for using visible light for mobile connectivity.

With mobile data traffic projected to increase by a factor of ten over the next five years the introduction of Li-Fi or LED based mobile networks could prove lucrative in extending mobile bandwidth.

These are just a few of the emerging applications that make up what we're describing as the fourth wave of LED demand.

These emerging applications drive additional MOCVD demand in the future, and accordingly, we project MOCVD dollar TAM to reach nearly a $1 billion by 2019.

Veeco's rapid pace of innovation and strengthening position in the MOCVD market positions us well to capitalize on these growth opportunities.

As recent industry reports point out, LED manufactures are facing acute challenges to remain relevant players in the space.

Declining LED bulb prices and steep competitive pressures have impacted profitability levels.

These challenges are very pronounced in Taiwan, one of the first regions to ramp LED capacity and now one of the first confronting an aging MOCVD install base.

By our estimates about one-quarter of their installed capacity is made up of older generation MOCVD systems which we believe are no longer cost effective to operate.

To address these challenges, LED manufactures are focused on lowering their overall production cost, and EPIK is the key enabler.

The cost to produce an LED on EPIK is significantly lower than prior tool generations.

EPIK's innovative design serves to maximize tool availability and improve production yield.

EPIK provides a 20% cost of ownership advantage compared with our prior generation Max bright tool, a 40% cost of ownership advantage compared to our K465i and an even bigger advantage compared to older tools from the competition, a compelling value proposition for our customers and a competitive advantage for Veeco.

We recently shipped our 50th EPIK MOCVD reactor which is equivalent to 100 K465i reactors.

That's an impressive figure considering that we just released the product late last year and importantly, this milestone illustrates the rapid pace of customer adoption and ongoing pull for EPIK.

Turning together our precision surface processing or PSP business, we're delivering solid performance in the core MEMs and RF Markets.

Our wafer storm product is the established leader for metal lift off applications, a key step in manufacturing MEMs and RF devises.

Our differentiated process technology enables complete film removal in a single tool which shortens the cycle time and maximizes yield.

We continue to strengthen our position, and in Q2, we won business with a leading European electronic components manufacturer resulting in the largest single customer sale in PSP's history.

Our award winning wafer etch product is gaining market attention for through silicon via reveal applications, an important step in advanced packaging applications.

Veeco solution offers cost and process advantages over alternative technologies, and we're seeing the benefits of leveraging Veeco's operational infrastructure and sales organization to identify and better serve these opportunities.

We're currently engaged with multiple leading device manufacturers across the US and Asia, and while it's early, we're very pleased with our results so far.

Overall PSP is executing very well against our expectations and is contributing to Veeco's overall top and bottom line growth.

We had established a target to grow the business by 10% on an annual basis.

We're ahead of that pace in 2015 with revenue expected to top our $65 million target.

Looking ahead, we have the opportunity to accelerate growth depending on our success in advanced packaging.

2015 is shaping up to be a good year for Veeco.

We're executing well against our strategic objective to drive profitable growth.

Our EPIK MOCVD tool is addressing our customers in media challenges, and in turn, they recognize the value we're delivering.

The PSP business is performing ahead of our expectations, capturing opportunities in core Markets, and gaining momentum in the new growth areas like advanced packaging.

We're targeting to deliver top line growth of greater than 35% this year, and we expect EBITDA to grow faster than revenue.

With that we'll start the Q&A session.

(Operator Instructions)

We'll take our first question with Paul Coster with JPMorgan.

Thanks for taking my questions.

Perhaps looking beyond the horizon just a little bit can you give us your latest thoughts on the use of [DALDS] technology and for that matter also the use of IBB and extreme ultraviolet lithography?

Are there -- is there any signs of progress in either of these areas?

Should we expect revenues at some point the next couple of years?

Sure.

Well, let me start off with the ALD.

We've been working to develop the ALD technology for some new applications for some time now.

We're not prepared to say a lot about that, but we are addressing some semiconductor applications which we think have large potential, and I think there is still an opportunity in the OLED encapsulation area, so that's the first thing.

Secondly on the EUV, that market does seem to be waking up a little bit, and we do expect or at least hope to get some additional EUV orders for mass blank deposition devices within I don't know six months to -- six months or more.

And on ion beam technology we're developing the technology for some important new applications there also well beyond the data storage market, so a lot happening in the new technology area.

We'll have more to tell you later this Fall on that.

Okay and then a quick follow-up.

You talked to the $1 billion MOCVD addressable market.

Is this third party research, or have you done some work internally that gives you comfort that that kind of level is attainable now as we move forward?

Hi, Paul, this is Sam.

This is our old modeling.

Of course we is have obtained inputs from other third party estimates, and then we have looked at the market.

The primary driver for this is the end option for general lighting along with a replacement cycle.

And overall on the secular modeling perspective it comes out at about 15% growth rate year-on-year and reaching $1 billion in TAM.

Of course a few things can accelerate that.

If the replacement cycle happens sooner it could accelerate these numbers even more, and then the more important thing is that we talked about fourth wave and if some applications get adopted faster, it could accelerate these numbers even more.

Okay, thank you very much.

We'll take our next question from Edwin Mok with Needham & Company.

First, actually just a basic housekeeping question for you Sam.

How much of your shipment that was done in the second quarter that was [pasdedut] deferred EPIKs [semi] revenue that you talked about?

Sure.

So as I said, we obtained our bifurcation model stated in late May, so all the product that shipped before May, Edwin, that got deferred, and that we would be able to revenue as we get final product acceptance.

We had started to provide ending deferred revenue for EPIK in the last quarter, because it was difficult to understand the shipment level that the Company was going through.

I would probably provide this one last time at the end of this quarter and expect you to not get this number from us in the future, but at the end of Q2, we have about $55 million of deferred revenue still on the books.

And as time goes by here we would be looking forward to getting acceptances from the customers and slowly working it down.

Now keep in mind the product that shipped after May it is already in our revenue numbers for Q2, and we are providing reiteration of prior guidance of full year 35% growth, so all those numbers are baked in the full year guidance that we are providing.

Great that's very helpful, and I think you made a comment about bookings being maybe a little stronger in the back half of this year versus first half.

Is that predicated of some of the Chinese customers able to get credit to execute expansion plan, or what other driver could let's say accelerate or increase that?

Yes, good question, Edwin.

We are guiding bookings to be up in second half over first half.

The macro conditions are definitely in play here.

As you know, more than half of our business is in China at the Company level, and some of these macro conditions are still playing out.

So there could be some volatility in the order pattern here, and overall the LED unit demand remains strong.

There have been these recent price reduction in [vols] which will further increase the unit demand, and our business is really driven by the unit demand of LEDs.

At the same time, we are hearing about lower utilization from some LED customers, and that has to do with as John talked about productive and unproductive LED capacity.

But for us as of now there is a lot of customer interest.

There's a lot of quoting activity going on, and, although the market may be somewhat soft, but it seems to us from our vantage point that there is some compensation going on for the products competitive differential performance, so we are seeing a lot of activity here in terms of specifically how it falls out and which quarter it is not entirely-- it cannot be predicted accurately at this time.

But overall, the demand remains very strong, and if the customers in China are not able to fulfill that demand, our expectation would be that some other customers in some other countries may pick up that supply and fulfill that demand.

Great, very helpful.

If I can squeeze one in on PSP, it looks like that business is going quite well.

Do you think that -- for the 10% growth you guys are targeting for this year and beyond, is that mostly, do you expect mostly of that to come from comp growth of advanced packaging or what other drivers of that business will drive upside or downside of that business?

Well, most of the existing business is not advanced packaging.

It's really products to support mobile applications, MEMs, RF filters, some power electronics, some LEDs, kind of a broad spectrum of compound semiconductor type processing.

That business has been growing well for us, and then on top of that, we've got the advanced packaging business which is getting larger.

And we're seeing a lot of pull from some key IDMs and really important customers in the market.

We can do the 10% we believe --

Thanks for clarifying that.

We can do the 10% without a lot of advanced packaging.

That's all I have, thank you.

We'll take our next question from Krish Sankar with Bank of America Merrill Lynch.

Hi thanks for taking my question.

I have two.

One is you spoke about the macro and financial impact on China customers.

I'm kind of curious, of your 50% sales in Q2 how many customers was it divvied it up by, and are most of these customers well capitalized companies, big ones with good connections, or are you seeing a huge spectrum of customers in China?

Krish, this is Sam.

Our business in China is largely driven by the LED segment.

These customers are well capitalized.

I do want to remind you though is that whenever we count any order as booking we require a meaningful deposit at the point of calling an order of booking, so it is important for some of our customers to access those lines of credit and be able to provide that advanced cash deposit for us to take the purchase orders.

Got it, okay all right and then the follow-up kind of curious if you look at how your competitors results for this didn't seem to shift any MOCVD tool in Q2.

From your vantage point what do you think your market share is today, or where will you exit 2015 in terms of MOCVD market share?

Krish, our product is doing very well.

It is getting very good reception.

There is a lot of quoting, and there's a lot of customer interest and we are continuously getting more requests than less in terms of accelerating the product shipments.

So we are really proud of our team and my colleagues here in the MOCVD business unit that have released this product, and we are extremely pleased with the performance of the product.

So just to add to that, we've seen a very rapid transition of many of our customers from the K465i and the Max Bright to the EPIK product probably faster than usually happens, and I think that's indicative of the strength of the product, how confident the customers are in using it and the ease of which they're moving their current past recipes from our other tools onto this new tool.

I would just add to that that I think we are moving in the true north direction here.

We just have to wait for the third parties to come out with their numbers in terms of the specific analytical question that you have, but we are definitely moving in the right direction from our vantage point.

Got it.

Thank you guys.

Thank you.

Thanks, Krish.

We'll take our next question from Vishal Shah with Deutsche Bank.

Hi this is Jeremiah Booream-Phelps for Vishal.

Thanks for taking our question.

I was just hoping you could expand a little bit on the orders for this quarter and you mentioned that a couple were pushed out.

Do you know if those are just pushed out, or if it could be permanent issues with the Chinese market?

In terms of the LED space, it's more of a push out in terms of customers' ability to access capital or access credit.

The plans to expand remains intact.

Our orders were also impacted by weak -- continued weak demand in PCs and enterprise servers in the data storage segment, and there it is not entirely clear whether those investment by our customers is permanently on hold or is just a push out.

It is not entirely clear to us on the data storage side.

Okay but so for the EPIK systems that you're looking to ship that's still looking all right?

Yes, that seems more like push out, yes.

Okay and then just generally speaking on utilization rates, I know you said you're seeing lower rates, is that more a function of the degrading tools or the industry, and what are the implications there for orders going forward?

So when we look at the utilization rates of the -- what we would call the productive tools, the tools that can cost effectively make an LED today, it's still quite high.

It's about the same in China for Tier 1, 90%, probably about the same in Taiwan at about 90% and similarly in Korea.

I think where we've seen it fall off a little bit is the tier 2 and 3 in China going to about 70%, so the rates are still quite high if you're looking at the productive tools.

We have seen customers turning off old tools that they bought in 2008 or 2009 where they just can't compete at today's pricing levels.

And we think that will actually ultimately turn into a replacement cycle and help our business.

Great, thank you.

We'll take our next question from Mike Ritzenhaler with Piper Jaffray.

Good afternoon, John, just a quick question maybe actually a follow-up on PSP.

Is it fair to say that the revenue synergies from geographically expanding that business has been in line with your expectation, or has it been a pleasant surprise?

Its probably been a little maybe pleasant surprise a little better than in line.

I think we brought a global sales organization that could cover certain countries where PSP had no coverage.

Additionally we have a lot of service personnel around the world, so that really was the largest synergy we are expecting, and I think it's working well.

Thanks for that.

On the gross margin outlook, Sam, I'm wondering about the -- last quarter you guys had talked about the mix shift toward new tools and better margins with the orders that you were taking and I'm wondering if -- how that manifested itself in the gross margin outlook maybe just being 50 basis points above where it was guided for Q2.

We're still seeing that shift but maybe just at a slower pace or maybe more color around that particular piece of guidance would be helpful, thanks.

Gross margins continue to improve.

It really is a matter of some of the factors that we talked about in the past.

One of them is cost reduction.

We are quite pleased with the progress we made in the cost reduction side, and then as we negotiate those lower prices with our suppliers and then that product begins to show itself on the P&L, so that has an impact on the gross margin side.

And on the booking side, and we continue to see a situation where our pricing is improving and that also has an effect on the overall gross margin.

Of course it takes about six months from the time of booking to the time of shipment and revenue that it plays out on the P&L.

So overall, what's going on here is a unique margin expansion on the back of a very strong product along with a very successful cost reduction program.

And then on top of it, we also have operational leverage going on, so it's just helping gross margin from multiple perspectives.

That makes sense, thank you.

We'll take our next question from Steven Chin with UBS.

Hi, guys, thanks for taking the question.

Just looking at the Taiwan MOCVD market, sounds like you think about a quarter of those MOCVDs can be upgraded.

Can you just give color on how big that install base would be roughly?

Well, when we've looked at the overall market, first of all, in Taiwan as you know, Taiwan built its LED industry really ahead of most of the other regions or really all of the other regions, so it tends to have a fairly good percentage of older tools.

When we look across the world and at older tools which are no longer cost effective, it's probably in the range of 300 to maybe 325 K465 equivalents.

And I'm not saying these are K465 reactors.

That's just kind of the equivalent number.

Many of these tools are not Veeco's because they were sold before Veeco really gained a lot of its market share, but it's a sizeable number of tools that are available for replacement.

And we believe that will happen.

Got it, thank you.

And then just looking at the balance sheet you guys have a lot of cash and sounds like you're pretty confident in the business moving forward, so just curious if you're considering doing a stock buyback now, especially with the stock here in the mid 20s.

Steven, this is Sam.

So we have talked about this previously also.

We continue to evaluate the deployment of capital for the greatest long term benefit for our business and our shareholders.

First and foremost the priority for our cash is to fund organic growth initiatives including working capital and R&D, and then we are also looking at both an organic growth opportunity and/or return capital to the shareholders.

So we continue to evaluate these alternatives, and what I can say is that obviously, if we had something approved our Board we would have shared that with you.

So at this time I would say that we continue to evaluate those alternatives and we would make decisions -- we will let you know the decisions as they are made.

Thank you.

We'll take our next question from Patrick Ho with Stifel.

Thank you very much.

John, in your comments about the $1 billion TAM by I believe you said 2019, how much of it incrementally is from these replacements that you talked about that gets you to that TAM?

Is that like 20%, 25% or just a larger number than I'm projecting?

We actually when we put that TAM together we were much more conservative on the replacement cycle, and we thought there was about 5% a year going into that.

We think the opportunity is bigger now, but we haven't quantified it into that number, so I'd say that number could go up.

Fair enough.

Going back to an early question about the competitive landscape, given some of the commentary by your main competitor and some of the qualification issues that they're having, do you believe aside from the current market pull and adoption of EPIK are you seeing incremental pull that may be going your way because of the competitor's internal issues?

Well, I think our customers can always reverse decisions or change decisions.

We've been building the product at a rapid rate.

There's been a lot of pull for our product and a lot of demand.

The product works great, and it's proven to be easy to transition to from the current product.

It is very high reliability and really working well, so I think it has a tremendous future here, and the turbo disc technology has a lot of inherent advantages in this marketplace.

And I think that's proving out especially as we've scaled the reactors to larger sizes that our technology scales exceptionally well.

Great.

Thank you very much.

Thanks, Patrick.

We'll take our next question from Brian Lee with Goldman Sachs.

Hi, guys, thanks for taking the questions.

And apologize if you already commented on these but had two around the China exposure here, just maybe one housekeeping one for you Sam.

How much of the backlog is based in China?

I think you mentioned close to $300 million of backlog as of the end of Q2.

And then as a follow-up to that, you guys mentioned the weakness in bookings from that region, but are you seeing delays in shipment timing or any chatter around that owing to some of the weakness in the fundamentals and capital availability that you cited?

Thanks.

Thanks, Brian.

In terms of our backlog, we typically do not provide backlog breakdown by region; however, if you look at our market and geography data, our revenue generally range between 50% to 55% or in that percentage in that range in China, so it would be fair to assume that the backlog is roughly in the same range without giving you a specific number.

So there is significant backlog from China.

Now also keep in mind when we book business from China, we obtain a meaningful amount of cash as deposit and then most of the business is on line of credit, or LC, so essentially our financial risk is significantly reduced in terms of shipment.

These are bank guaranteed LCs so that helps our business in terms of assuring there's not a lot of risk in collecting that cash, if that's what you were trying to ask.

Yes, no, I guess what I've seen in the past is and I appreciate that you guys take anywhere close to 30% of final sales price in terms of up front deposits, so it does de- risk your bookings relative to peers.

We've seen that in prior cycles, but wondering if some of the capital availability issues are actually leading to some of your customers wanting to delay shipment timing because they don't have the additional 60% to 70% of funds that they may need to ultimately cover to get the bookings to move to them in terms of shipments.

So, no, we are not seeing that on the other end because a lot of the backlog is related to EPIK.

We are seeing requests for further accelerating that so on the shipment side we are not seeing any deceleration of shipment.

That comment applied mostly in terms of challenges, in terms of accessing credit or capital applied mostly toward booking.

Okay, thanks for the clarification.

Thanks, Brian.

We'll take our next question from Mark Miller with The Benchmark Company.

Thank you for taking my question.

I was just wondering, you talk a lot about replacements and are any of the recent orders you received you feel are replacing tools, or is still that fairly small?

The recent orders have been really new fab expansions, no significant amount of replacements at this point.

You received a large order at the end of last year, and I'm just wondering is that being impacted by any of the conditions that you discussed or is that staging as you expected?

I think it's going out exactly as expected, and in general there's been pull to go faster more than anything else, so it's -- I think it's happening right on plan for us.

Just one final question.

You mentioned that the Tier 1 in China and Taiwan were 90%.

What about Korea?

Is that similar?

It is.

There is variation, and there is -- there are some unproductive tools in Korea also.

But the Tier 1s are relatively up there around 90%, some a little higher some a little lower.

Thank you very much.

Thanks, Mark.

We'll take our next question from Mark Heller with CLSA

Thanks for taking my question.

Just a few follow-ups at this point.

Sam, of the $55 million deferred revenue, how much is expected to drop in Q3?

We will take some of those tools and convert them into revenue, and at this point we are not adding to the deferred revenue bucket, because most of the tools that we ship now are getting recognized as revenue upon shipment.

So what I can say to you is that it's going to come down over time.

Most of these should get recognized by the time the year ends.

And as I've said previously, we gave the deferred revenue guidance because we had just released a new product, and it was difficult for the street to understand the activity level going on in the Company.

So respectfully I think I would decline to provide the guidance, Mark.

Okay and then is there any way to quantify the breadth of customers like how many customers were buying the 465i versus how many customers are buying Max Bright and like how many customers that you're seeing today buying EPIK?

I'm just wondering if your customer base is maintaining itself or shrinking as maybe some of the weaker players fall out of the market?

Well the customer base with the customer consolidation, the number of substantial orders per quarter now is two to four customers in a typical quarter here, and whereas if we go back three or four years it would be 15 to 20.

So there are substantially fewer players down to a number of companies that are striving to be world class leaders.

I think that makes the business more lumpy, and that will continue as we serve a smaller customer base.

I think regarding EPIK, when we look at the orders, it's over 80% of our orders now I would say in MOCVD, so the market has moved quickly to purchases of EPIK, more quickly than past product transitions that we've seen.

And I would add to that that EPIK really enables our customers to compete effectively in this low price end device market, so that's why we are seeing a pretty significant pull on EPIK.

Thank you.

Okay.

With that, we will close off the Q&A session.

Thank you for joining us.

Look forward to seeing you in the coming weeks and months.

Thank you.

Thanks.

That concludes today's presentation.

Thank you for your participation.