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Edited Transcript of VECO earnings conference call or presentation 4-Nov-19 10:00pm GMT

Q3 2019 Veeco Instruments Inc Earnings Call

PLAINVIEW Nov 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Veeco Instruments Inc earnings conference call or presentation Monday, November 4, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Bencivenga

Veeco Instruments Inc. - Head of IR

* Shubham Maheshwari

Veeco Instruments Inc. - Executive VP, CFO & COO

* William John Miller

Veeco Instruments Inc. - CEO & Director

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Conference Call Participants

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* Auguste Philip Richard

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Brian K. Lee

Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst

* David Duley

Steelhead Securities LLC - Managing Principal

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* Mark S. Miller

The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Veeco Instruments Inc. Corporate Hosted Q3 2019 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Anthony Bencivenga, Investor Relations. Please go ahead, sir.

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Anthony Bencivenga, Veeco Instruments Inc. - Head of IR [2]

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Thank you, and good afternoon, everyone. Joining me on the call today are Bill Miller, Veeco's Chief Executive Officer; and Sam Maheshwari, our Chief Operating Officer and Chief Financial Officer. 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 expressed permission. Your participation implies consent to our recording.

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 on 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 website.

And with that, I will turn the call over to Bill for his opening remarks.

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William John Miller, Veeco Instruments Inc. - CEO & Director [3]

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Thank you, Anthony. Good afternoon, everyone, and thank you for joining the call. I will first highlight some of our Q3 results, then provide an update to our transformation, and finally, give product and market updates.

Q3 revenue was $109 million, which was above the midpoint of our guidance. We achieved strong revenue in our front-end semi market, with shipments of our second production EUV mask blank system and revenue from multiple LSA systems. Additionally, sales of our ion beam products to the data storage market remained solid. Non-GAAP gross margin was 40.3%, which was higher than our guidance range, resulting from improved product mix on higher volume and well-managed expenses. We're happy to report non-GAAP operating income was $4 million, resulting in earnings per share of $0.05, marking a return to profitability. Our bookings were $115 million, which were driven by strength in both data storage and EUV mask blank markets.

Now I will provide an update on the company's transformation. The transformation will be completed in 2 phases: returning the company to profitability and driving growth. Phase 1, returning the company to profitability, is well underway and includes our MOCVD shift from the commodity LED markets to photonics and emerging applications, making general infrastructure reductions and rationalizing our product lines by reprioritizing R&D expenditures.

On our last earnings call, we alluded to slow-moving inventory. We also mentioned reducing expenses to improve profitability. We made progress in both areas. Sam will provide more details in a few minutes.

Phase 2 of our transformation, driving growth, is in the early stages. We are taking steps to grow our existing front-end semi, advanced packaging and data storage markets. In addition to growing in our current markets, we are investing in applications such as EUV mask blank production and compound semi applications with our MOCVD products. When we complete our transformation, we'll be a leaner and more focused company on a path to growth.

And now for our business update. The data storage market remained strong. Our Ion Beam Deposition, Ion Beam Etch, diamond-like carbon and mechanical products enable hard disk drive manufacturers to improve their areal density as they pursue lower cost per bit to compete with the solid-state storage. The next revolution in aerial density improvements is coming from energy-assisted magnetic recording, also known as HAMR or MAMR, which is expected to increase the number of manufacturing steps required to produce read/write heads. This is good news for Veeco.

A recent Mizuho report forecasted the cloud-based hyperscale data center market will grow at a 15% to 25% CAGR through 2025, with hard disk drives currently storing greater than 70% of total bits. Hard disk drives should remain an important contributor.

Seagate recently conducted an Analyst Day where they provided their technology road map, which relies on increasing areal density at an accelerated pace over the next decade. Consequently, drive storage will increase, and the average number of head per drive is forecasted to increase from 5 heads today to 10 heads by 2023. The data storage market will remain strong through 2020.

In the front-end semiconductor market, we enabled the evolution to EUV lithography by providing Ion Beam Depositions that create mask blanks. EUV lithography allows more sophisticated chip designs to be made with fewer layers. The proof points for EUV market adoption continue to occur. According to TSMC, their EUV tools recently reached production maturity, with tool availability reaching targeted goals for high-volume production.

In fact, they recently announced their 7-nanometer-plus EUV lithography technology is delivering customer products to market in high volume. This EUV-enabled node provides 15% to 20% higher density and improved power consumption versus the same node without EUV. Demand for EUV lithography systems are strong, with ASML recently announcing orders for 23 systems in the third quarter.

Accordingly, we shipped our second production EUV mask blank system in Q3 and received an order for an additional system.

Another contributor to our front-end semiconductor results is our laser annealing product lines. Industry leaders such as Samsung and TSMC announced they are ready for production at 5 nanometers. Advanced nodes reduce device feature size and shrink overall area, driving significant performance improvements over prior nodes. As devices shrink, annealing requires higher temperatures for extremely short and precise durations. Our LSA product is ideally suited to meet these advanced requirements.

In Q3, we continued our progress and recognized revenue on another system at a leading-edge node. When our customers ramp and move into their next nodes, we are well positioned to increase our market share.

Now I will move to the compound semiconductor market, which includes photonics, 5G RF, power devices and advanced display applications. Veeco has a long history of technology leadership with our gallium nitride MOCVD systems. Our product portfolio includes a multiwafer system for blue-green mini and micro LEDs and a 200-millimeter single-wafer system for power applications. On top of that, we completed development and shipped a 300-millimeter fully automated single-wafer GaN cluster system to a leading-edge semiconductor fab. This system has exceptional uniformity and outstanding film quality.

I'm excited to share that we recently obtained acceptance from our customer on this tool. High-quality GaN film stacks are key enablers for emerging semiconductor applications, including 5G RF, blue-green micro LED and power electronics.

In addition to our GaN products, last quarter we announced the shipment of a beta version of our improved arsenide/phosphide MOCVD system optimized for photonics applications, including VCSELs, edge-emitting lasers, mini and micro LEDs and red, orange, yellow LEDs. This data is going well, and we are on target to receive customer acceptance in the next few quarters.

We have been even working closely with other customers as well to place another evaluation tool for VCSELs. When this market begins to grow, we hope to be well positioned and gain market share.

We are confident in our products' performance, and we are ready with best-in-class MOCVD technology solutions to address the needs of the Photonics, 5G RF, power and advanced display markets.

As we come toward the end of 2019, we made significant progress. We continue to ship into the EUV mask blank market. We completed development and shipped a 300-millimeter single-wafer GaN MOCVD system to a leading-edge semiconductor fab. We are making progress with our MOCVD beta system designed for photonics applications, including VCSELs. We made improvement to our next-generation advanced packaging lithography system. And we've made progress penetrating the sub-7 nanometer with our laser anneal product.

And lastly, we achieved non-GAAP profitabilities. Our gross margins continued to improve, and we expect to further improve the operating leverage of the company going forward.

With that, I'll turn it over to Sam for further details on the financials.

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [4]

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Thanks, Bill, and good afternoon, everyone. 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 on our website.

Q3 bookings were $115 million, and ending backlog grew to $279 million. As a reminder, beginning in 2020, we will discontinue providing bookings and backlog results.

Revenue for the quarter was $109 million, which was slightly above the midpoint of our guidance range. Scientific and industrial market made up 37% of total revenue, driven by ion beam systems shipment to our data storage customers as well as sales of ion beam sputtering systems to high-end optical coating customers. Front-end semi market was 31% of revenue, driven by shipment of our second production EUV mask blank system as well as sales of multiple laser annealing systems. LED lighting, display and compound semi was 22% of overall revenue and included shipment of our 300 mm single-wafer MOCVD system and service and upgrades for our LED customers.

Advanced packaging, MEMS & RF Filter market made up 10% of overall revenue, reflecting continued softness in this market. By region, rest of the world, which includes Japan, Taiwan, Korea and Southeast Asia, was 41% of overall revenue, driven by our EUV mask blank system sales, data storage products as well as our LSA product sales.

U.S. was 25% and included sales to the data storage market. And EMEA was 18% of overall revenue driven by sales to scientific and industrial customers. Lastly, China was 16% of overall revenue, driven by LSA product shipments to foundries.

Now turning to non-GAAP operating results. Gross margin of 40.3% was a 2 percentage point sequential improvement from Q2 driven by improved product mix, higher volume and lower expenses. OpEx for the quarter was $40 million and roughly in line with where we expected it to be. We continue to take actions to reduce infrastructure cost as well as rationalize ongoing investment in certain product lines. As a result, we expect OpEx to reduce in the coming quarters. Our target is to eliminate approximately $16 million from the current run rate on an annualized basis or about $4 million per quarter. We expect the reductions to be fully realized by Q3 of 2020.

Tax expense for the quarter was $0.2 million. Net income came in at $2.6 million, with EPS of $0.05 on a diluted share count of 48 million shares.

Now moving to the balance sheet and cash flow highlights. We ended the quarter with the cash and short-term investments of $232 million, which included $42 million of cash held offshore. Cash flow from operations was negative $15 million due to biannual interest payments on our debt and an increase in contract assets on the balance sheet.

The increase in contract assets is driven by an uninvoiced tools shipment, which was recorded as per SEC revenue recognition rules. Inventory declined $235 million. We have made progress reducing overall inventory. However, a portion of the inventory is slow moving, which was related to LED business and certain other products. We believe the slow-moving inventory is no more than $25 million, and we are pursuing steps to sell this inventory. Long-term debt on the balance sheet was recorded at $297 million, representing the carrying value of $345 million in convertible notes. And lastly, our CapEx during the quarter was $1.7 million.

Now turning to Q4 guidance. Q4 revenue is expected between $100 million and $120 million, with non-GAAP gross margin between 39% and 41%. We expect non-GAAP OpEx to be around $39 million. GAAP EPS is expected between a loss of $0.32 and a loss of $0.10 per diluted share. Non-GAAP EPS is expected between a loss of $0.03 and $0.18 per diluted share.

And now for some additional color beyond Q4. At this time, based on our current visibility, we see Q1 '20 similar to Q4 '19. Additionally, as I mentioned earlier, we expect OpEx to decline towards our target of $36 million per quarter by Q3 of 2020 at current revenue levels.

And with that, Bill and I will be happy to take your questions. Operator, please open the line.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Patrick Ho of Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [2]

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Nice work on the quarter getting back to non-GAAP profitability. Bill, maybe my first question in terms of the LSA business. You mentioned that you saw some strength there. Is it for the same application that you have won previously, and you're just seeing increased capacity buy? Or have you broadened it out to additional applications, and that's why you're seeing the strength?

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William John Miller, Veeco Instruments Inc. - CEO & Director [3]

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I think it's actually both, Patrick. It's -- we saw some order activity and business activity as that node ramps, and we're also working with that customer on their next node, where we will have an opportunity to broaden out beyond the 1 application to 2 or 3 applications.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [4]

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Great. And as my follow-up (inaudible) target of $4 million a quarter. Are those additional facility consolidation? Or how can I characterize what type of OpEx cuts these will be?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [5]

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Sure, Patrick. This is Sam. I'll take your question there. So what is happening there is we have been working on a number of products and product development efforts. So there is a little bit of facilities and administrative-oriented [refining] and optimization that we are going to be working through. But a larger portion of the reduction is going to come from the R&D line, and that is really driven by optimizing and reducing consultants, contractors and project material-related spending as a number of our products are getting towards the late stages in terms of their development cycles.

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Operator [6]

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(Operator Instructions) We'll take our next question from Brian Lee of Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [7]

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Sam, maybe first just on the out quarter guidance, always appreciative when you give a bit more forward color. Just want to clarify, when you say similar -- Q1 similar to Q4, that's top line and gross margin? I guess that would be a first part of the question.

And then I suppose you'd start to see some of the OpEx reduction coming in in Q1 as well, as you get some portion toward that $4 million quarterly reduction?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [8]

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Yes. Thanks, Brian. Yes, I think you have a good understanding there. My color in terms of Q1 trending similar to Q4 is in fact around gross margin and top line, like you just said. And then in terms of OpEx, as I said, we are targeting up to -- targeting $36 million by Q3 of 2020. So in a linear fashion or in some sort of a staircase down, the spending in Q1 is expected to be lower than Q4. We won't hit all the way to $36 million by Q1, but it's expected to be lower than Q4.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [9]

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Okay. Fair enough. That's helpful. And then maybe just one more modeling one. The -- I might have missed this, but the cash flow from operations in the quarter was negative mid-teens number. Can you kind of outline what was going on there? I didn't see anything meaningfully off from a working capital perspective, and I know the inventory is kind of staying in the same range. Can you tell us what the drivers were there, and then what we should be thinking about for cash flow in 4Q?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [10]

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Sure. So I covered that a little bit in my prepared remarks, Brian. So what happened is as you look at the accounts receivable line, you see that. But then there is another line, which is the contract assets line. And essentially, what that is, is it went up by about $10 million or so quarter-over-quarter, and that's for following the revenue recognition rules. We shipped the tool to a Japanese customer, and we are following the Japanese business practice where the tool is shipped, but then we invoice the customer only when the tool has been received by the customer, installed and then accepted by the customer. At that time, we invoice the customer. But following the GAAP rules here, when we ship it, we recognize the revenue, and we record it as contract asset.

So essentially, it is kind of an uninvoiced accounts receivable. So when you add that to the accounts receivable line, you would see that overall, call it, proxy accounts receivable, including the true AR and the contract asset, it's gone up. And that is in line with our growth here. So that is where a significant amount of cash went in terms of cash flow from operations.

The second piece I would like to highlight or provide some color is that in our business, cash kind of moves from quarter to quarter. It is lumpy, depending upon the timing of the machine shipments and the proportion of the machines that ship in third month versus first month of the quarter and some of those factors.

So if you put all of that together, essentially, this quarter in Q3, we consumed cash, but in Q2 we generated cash. In Q1, we consumed cash. And in Q1 and Q2, we were also generating operating income loss. So I expect Q4, with that type of a background, essentially, what I'm trying to say is cash is lumpy in our business. And in Q4, I'm expecting cash to be neutral to positive from here on compared to Q3.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [11]

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Okay. Great. Appreciate the color. And then maybe just one on the product side. The VCSEL opportunity, it sounds like last quarter, you had the customer take the beta tool. It sounds like you have 1 more customer lined up for beta tool, if I heard you right. Do you anticipate that that occurs in 2019? Or is that a 2020 event? And then I guess given the 6- to 12-month beta conversion cycle you've talked about in the past, is it fair to assume there really isn't a P&L impact from VCSEL tools until probably 2021?

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William John Miller, Veeco Instruments Inc. - CEO & Director [12]

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Yes. Sure, Brian. Just to -- just follow-up on your question. We did say that we shipped 1 arsenide phosphide tool to a customer as a beta eval agreement. That's actually going very well. We've actually turned the tool over to the customer, and they're actually putting it through its paces and going through the qualification process. I would expect that to revenue early to -- excuse me, early 2020 in the first quarter, second quarter of '20.

I did not say that we have a second beta customer. We are working with a number of customers trying to close an agreement or a commercial sale and have not been successful with that to date. Obviously, that's a very high focus for the company and remains as such. And I think your final point was will it have a material impact on -- was it 2019 P&L? The answer is no, it will not.

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Operator [13]

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Our next question comes from the David Duley from Steelhead Securities.

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David Duley, Steelhead Securities LLC - Managing Principal [14]

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I guess the first question is on the backlog. Could you give us some idea about the relative breakout of the backlog? And it's -- I guess it's more than a couple of quarters now. Is there any way that you might deaccelerate the delivery of this backlog?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [15]

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Sure, David. This is Sam here. So we've been growing backlog, although the pace of growth of backlog has moderated, and what has happened is we've been shipping tools. The reason for a significant growth in backlog, say, 6 months or 9 months back was really driven by EUV tools and a lot of bookings in the data storage side of the business.

In that part of our business, the lead times run anywhere from 9 months all the way up to 12 months. So we just started shipping EUV tools beginning 1 tool in Q2, and we shipped another tool in Q3. And we now are in a position that we keep on servicing this demand at a measured pace however customers are able to digest this demand and how we are able to supply these orders. So that is the reason backlog has been growing.

Going forward, I hope that our book-to-bill remains greater than 1. Again, we are doing pretty good in Q3. We did greater than 1.0 in terms of book-to-bill. So it's always a good situation or a good setup for us that we are increasing the revenue, and at the same time, our book-to-bill is greater than 1. So that's the setup where we are, how we are entering 2020 and seems to be a good setup for us.

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David Duley, Steelhead Securities LLC - Managing Principal [16]

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And can you give us the rough breakout of -- within the 4 segments that you report? Or any sort of idea of the relative size of the pieces, just for reference point?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [17]

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Sure. Yes. Generally, we do not provide it quantitatively, the breakout of the backlog by the 4 segments we report. However, I would say that the backlog contribution of front-end semi and scientific, industrial, and data storage segments, those 2 segments are very strong in our revenue results for the recent quarter and similarly is the case as you look at our Q3 ending backlog.

I would say that the advanced packaging segment in terms of our backlog makeup is weak. And then the lighting display and compound semi sector is also I would say, somewhat on the weak side. We are trying to penetrate a number of opportunities in power semi. And also you know about our commentary on the VCSEL side and certain other arsenic phosphide applications, including edge-emitting lasers and photonics-related applications.

So with all of that, we are providing our progress there, but the backlog is weak. And similarly, in the advanced packaging, the backlog continues to remain weak, driven largely by the smartphone unit-related softness. There is a little bit of an improvement in this, in the smartphone-driven business in Q3, but overall, I would characterize it as still soft.

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William John Miller, Veeco Instruments Inc. - CEO & Director [18]

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I guess I would just add, David, that the advanced packaging market does work on more of a book and turn. So we wouldn't expect to be carrying a large backlog there, but...

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David Duley, Steelhead Securities LLC - Managing Principal [19]

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Okay. Very helpful color. Now could you help us understand perhaps what the EUV opportunity -- incremental opportunity -- might be next year or the next couple of years, however you'd like to characterize it? So that we can understand what sort of growth driver this is for the overall business.

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William John Miller, Veeco Instruments Inc. - CEO & Director [20]

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Yes. We have been kind of working with our customer to understand that model. It is a bit of a challenge to model it out. It varies pretty significantly, obviously based on the number of EUV steps, the lifetime of a mask blank, the yield of mask blanks, and obviously the number of tape-outs or applications that are using EUV can really cause this number to move around a lot.

But we've -- well, we've been booking business at kind of around in the $40 million, $50 million kind of range this year. We're expecting it to be in that -- about that size range next year, caveated by those 4 or 5 variables that I just mentioned to you. So I think the number could move around a fair amount.

ASML is continuing. I think they are going to ship 26 systems this year, 30 next year. The demand is real. The demand is there. We'll have to keep monitoring it to see how this industry matures here. But I -- we're sizing it in that $40 million to $50 million range next year.

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David Duley, Steelhead Securities LLC - Managing Principal [21]

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And since you had the relative orders this year, that's kind of what you would expect for revenue next year, just to be clear?

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William John Miller, Veeco Instruments Inc. - CEO & Director [22]

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Yes. Yes.

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David Duley, Steelhead Securities LLC - Managing Principal [23]

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Final thing from me. I guess it's a little bit of a follow-on from Patrick's question on the LSA business. I know you've penetrated at least 1 customer at an advanced node. Did you mention that you have now 2 customers at advanced nodes, or, I guess 10 nanometers or 14 nanometers and below, however you'd like to characterize the advanced node?

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William John Miller, Veeco Instruments Inc. - CEO & Director [24]

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Yes, David. That's actually a great clarifying question. Actually, on Patrick's question, I was kicking myself for not mentioning that. So thank you for bringing that up.

We do have a second customer, and I would say an advance node is 7 nanometer or better. And we are working with a second customer as well. So we're -- and each of those customers today, we have 1 application. And at the next node, we are working to qualify a second or a third application at each of those customers. I wouldn't expect that node to be of significant volume for another few years out though.

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David Duley, Steelhead Securities LLC - Managing Principal [25]

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Okay. And just a final question for me. I'm sorry, I keep rambling. But the overall TAM of the annealing market, do you have a number there on an annual basis so we can just understand what the overall potential opportunity is?

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William John Miller, Veeco Instruments Inc. - CEO & Director [26]

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I would say that's about $100 million opportunity.

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Operator [27]

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Our next question comes from Gus Richard of Northland.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [28]

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Just a little bit of color on the MOCVD market. You had a nice step-up in the quarter, and I was just wondering if you could just give us a little sense of whether that was RF, or that was more power.

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William John Miller, Veeco Instruments Inc. - CEO & Director [29]

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Yes. Thanks, Gus. Good question. In my prepared remarks, I did mention that we have shipped, and the customer has accepted, a 300-millimeter single-wafer gallium nitride cluster tool. That -- it does make up probably most of that step-up that you're seeing in MOCVD.

The end application is pretty confidential, but I would say that the GaN tool is capable for RF 5G as well as micro LED blue-green applications as well as power.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [30]

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Okay. And is this in a development environment, or is it in a -- moving into a production environment?

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William John Miller, Veeco Instruments Inc. - CEO & Director [31]

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Today it's in, I would call it, a development pilot production, maybe, environment, and we are working with the customer to see how this application matures.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [32]

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Got it. And then on the drive business, that's running quite strongly, it's still fine beam etch and depth. Is it better for you if it's MAMR? Or is it better for you if it's HAMR?

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William John Miller, Veeco Instruments Inc. - CEO & Director [33]

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We're actually pretty, pretty agnostic either way.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [34]

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Got it. And are you seeing multiple customers ramp energy-enhanced heads (inaudible) recording?

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William John Miller, Veeco Instruments Inc. - CEO & Director [35]

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Yes. Yes, we're seeing -- we are seeing a number of customers have had a HAMR and MAMR programs going on for years, maybe even coming up to a decade, I've been involved in various programs with many of these customers. So they each have their own integration schemes, but they're all actively, actively working it.

But I think it's really important because historically, in the last 5 years, 6 years, the CAGR of areal density growth has been less than 10%. With HAMR or MAMR, they can increase that areal density growth to over 20%, and that's when they can really start driving performance and cost per bit down to stay competitive with other memory storage types.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [36]

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Right. And it -- okay. And then that were -- where -- what inning would you say we're in, in terms of the upgrade to enhanced -- energy-enhanced recording? Are we first inning? 10th inning? Late innings? What would you say?

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William John Miller, Veeco Instruments Inc. - CEO & Director [37]

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I would say -- yes, I would say this is a very long baseball game. We've been in it for a long time. But if -- I would say we're very much in the early innings. I think Seagate has said that they've shipped -- I can't remember the number of drives. But not very many drives, but they're -- but just starting to ship.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [38]

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Got it. And then the last...

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William John Miller, Veeco Instruments Inc. - CEO & Director [39]

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Very early innings.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [40]

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Yes. The last one for me, in terms of your litho offering, what's the competitive environment in China and elsewhere?

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William John Miller, Veeco Instruments Inc. - CEO & Director [41]

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We do see some competitors in China. Most of our business -- a lot of our business for our advanced packaging lithography is not in China today. It's really at the larger IDMs and OSATs predominantly in Taiwan, where we still maintain, we think, a very strong market share.

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Auguste Philip Richard, Northland Capital Markets, Research Division - MD & Senior Research Analyst [42]

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Okay. And is it for -- just what are the applications driving it? Is it fan-out high-bandwidth memory? Is it flip chip? Can you give a little bit of color there as well?

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William John Miller, Veeco Instruments Inc. - CEO & Director [43]

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Sure. I would say, Gus, we've had some success with high-bandwidth memory this year, having winning a key memory customer there. We've also seen some order activity this year from OSATs, for GPUs and AI-type applications. We have not seen a lot of follow-on activity in fan-out wafer-level packaging. As Sam mentioned, in the smartphone market, the AP lithography, there's a lot -- fair amount of excess capacity that need to be worked down.

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Operator [44]

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(Operator Instructions) And we'll take our next question from Mark Miller of The Benchmark Company.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [45]

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When we're talking about your backlog, I'm trying to break that down. You said that the AP was fairly weak in terms of the backlog distribution. Does that mean if you would look at the margins of the tools and backlog, they'd be somewhat lower? Or about the same and what you had last quarter?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [46]

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Mark, I think margin profile -- I assume you're saying gross margins. The margin profile versus the backlog situation, they're quite different, in the sense for the advanced packaging business, the way that industry works, at least for our products there, is that we get very -- well, I would say, low lead times. And when I say lead times, meaning from the time we get the order to the time we ship the tool. And that typically for advanced packaging side is 3, 4, maybe maximum 5 months. And I was just contrasting there that compared -- compare that to the EUV and data storage industry, we get upwards of 8 or 9 months or even 10 months.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [47]

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So you're projecting a $3 million lower in terms of non-GAAP OpEx by the third quarter of next year. How does that break out between COGS and expenses, operating expenses?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [48]

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Mark, that is largely related to OpEx.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [49]

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Okay. So most of it. And is that split equally between R&D and SG&A?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [50]

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Correct. And a little bit more towards -- skewed more towards R&D than SG&A.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Technology & Hardware Analyst [51]

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All right. Tax next year, 10% tax rate, 8% tax rate? What can we model?

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Shubham Maheshwari, Veeco Instruments Inc. - Executive VP, CFO & COO [52]

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So from a modeling perspective for taxes, we have about $280 million in U.S. NOLs. So really, percentage tax doesn't really work for our P&L. We pay very small amount of taxes because of the NOL position. You could model anywhere from $0.5 million to $1 million of taxes for non-GAAP purposes a quarter. So it could be $2 million to $4 million of taxes per year.

And we really do not pay taxes in the U.S. Whatever taxes these are, that is really driven by the taxes we pay in foreign jurisdictions and depending upon which specific jurisdiction the sale is and what the tax rates in those countries are, that's why it varies. But we really aren't paying taxes in the U.S. due to the NOL position.

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Operator [53]

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It appears there are no further questions at this time. I'd like to turn the conference back to Bill Miller for closing remarks. Please go ahead, sir.

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William John Miller, Veeco Instruments Inc. - CEO & Director [54]

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Yes. So we're excited that we got back to non-GAAP profitability, and we look forward to meeting with you again next quarter to discuss our progress. Thank you.

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Operator [55]

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This concludes today's call. Thank you for your participation. You may now disconnect.