Veeco Instruments Inc. — Q1 2017 Form 10-Q
Business context and period. Veeco designs and sells thin-film process equipment used in manufacturing LEDs, displays, power electronics, semiconductor-related devices, scientific and industrial products, and data-storage products. This unaudited filing covers the three months ended March 31, 2017, compared with the same period in 2016. Amounts below are in U.S. dollars; financial-statement figures are converted from thousands to millions where indicated.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $94.4 million | $78.0 million |
| Gross profit / gross margin | $34.2 million / 36% | $32.0 million / 41% |
| Operating income (loss) | $(5.8) million | $(15.3) million |
| Net income (loss) | $1.1 million | $(15.5) million |
| Diluted earnings (loss) per share | $0.03 | $(0.40) |
| Cash from (used in) operating activities | $6.3 million | $(18.8) million |
- Sales rose 21% year over year. Gross margin fell to 36% from 41%, which management attributed principally to product and regional sales mix and temporary effects from manufacturing consolidation.
- Operating expenses declined 15% to $40.0 million, primarily reflecting lower R&D spending following the reduction in ALD development investment and lower related costs. Restructuring expense was $1.3 million; asset impairment expense was $0.5 million.
- Q1 2017 net income included a $10.3 million income tax benefit despite a $9.2 million pretax loss. The benefit included U.S. tax effects associated with convertible-note accounting and a $6.3 million benefit from reassessing a foreign tax incentive position and related tax assets. The filing says the benefit related to the notes will not recur in future years.
- Cash and cash equivalents were $423.7 million and short-term investments were $258.2 million at March 31, for combined liquidity of $681.9 million, versus $344.2 million at December 31, 2016. The increase largely reflects net proceeds from the convertible notes issuance.
- Operating cash flow was positive $6.3 million, compared with cash use of $18.8 million a year earlier. Investing cash flow was negative $195.9 million, primarily due to purchases of short-term investments; financing cash flow was positive $335.8 million, primarily from the notes issuance.
- Veeco issued $345.0 million principal amount of 2.70% convertible senior unsecured notes, receiving approximately $335.8 million net proceeds. The notes mature January 2023. Their March 31 balance-sheet carrying value was $267.4 million, reflecting a substantial unamortized debt discount and issuance costs; total balance-sheet debt, including the mortgage and current portion, was approximately $268.5 million.
- Current assets were $822.4 million and current liabilities $132.8 million at March 31. Purchase commitments totaled $81.5 million, substantially all due within one year. Management stated it expected cash, investments, and operating cash flow to cover the next 12 months’ needs, including the anticipated Ultratech cash payment and note interest.
Material changes and business trends
- Lighting, Display & Power Electronics sales increased 136% year over year to $54.2 million, driven by improved LED conditions and demand for larger TV displays and fine-pitch digital signage. China sales rose to $40.3 million from $8.8 million, largely reflecting this market’s growth.
- Advanced Packaging, MEMS & RF sales declined 50% to $11.6 million; Data Storage sales declined 20% to $13.6 million. Scientific & Industrial sales were approximately flat at $15.1 million.
- Orders increased to $107.3 million from $61.6 million; the book-to-bill ratio was 1.1 versus 0.8. Backlog was $221.1 million at March 31, compared with $209.2 million at year-end. The company recorded $0.8 million of backlog adjustments for orders no longer meeting booking criteria.
- R&D expense fell 32% to $15.0 million, primarily due to reduced investment in ALD technology and cost-reduction actions. Veeco said its 2016 streamlining and ALD actions affected approximately 75 employees in total.
Outlook, transactions, and risks
- No formal numerical revenue or earnings guidance is provided. Management said MOCVD sales have the potential to be higher in the second half of 2017 than in the first half, citing improved LED demand and increased MOCVD backlog.
- Veeco expected to incur an additional $2 million to $4 million of restructuring costs over the next few quarters and approximately $5 million to $10 million of 2017 capital expenditures related to facility consolidation.
- Veeco agreed to acquire Ultratech for $21.75 in cash plus 0.2675 Veeco shares per Ultratech share. The filing estimated total transaction value at approximately $820 million and enterprise value at approximately $553 million, and expected closing in Q2 2017, subject to shareholder, regulatory, and other customary approvals.
- Two purported Ultratech shareholder class actions filed in March challenged aspects of the merger process and proxy disclosures and sought injunctive and monetary relief. Veeco said it believed the suits were without merit; outcomes and potential losses could not yet be reasonably estimated. Further merger-related suits could be filed.
- Key disclosed risks include cyclical and volatile end markets, customer and geographic concentration, reliance on government incentives for some MOCVD demand, order and revenue timing, cancellable backlog, competition and rapid technology change, supplier dependence, international operations, and the ability to complete and integrate the Ultratech acquisition.
- Interest-rate sensitivity: Veeco estimated that a 100-basis-point increase would reduce the fair value of its $258.2 million investment portfolio by approximately $0.8 million. Management said a 10% foreign-exchange-rate change would have an immaterial operating impact, as most non-U.S. sales are denominated in U.S. dollars.
- Management reported disclosure controls and procedures were effective as of March 31, 2017, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the improvement in LED demand, MOCVD orders, and backlog translated into the anticipated second-half 2017 sales, and whether backlog was converted without cancellations or further adjustments.
- Whether gross margins recovered from the 36% Q1 level as product mix and manufacturing consolidation effects changed.
- The sustainability of reported net income, given the operating loss and significant tax benefit, and the amount of non-cash interest expense associated with the convertible notes.
- The final funding, closing conditions, integration costs, and realized benefits of the Ultratech acquisition, including developments in the shareholder litigation.
- Execution and cost of the restructuring and facility consolidation, along with the timing and size of the $81.5 million purchase commitments.
- Potential dilution or cash settlement under the convertible notes and the company’s ability to meet scheduled interest and principal obligations.