3 Takeaways From Veeco Instruments' Earnings Report

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Veeco Instruments, Inc. (NASDAQ: VECO) is an interesting stock for tech and value investors alike. The company operates in exciting industries, making industrial machines for manufacturers of semiconductors, RF filters, microelectronics, lasers, and LED lighting -- all strong growth markets -- yet Veeco's stock has struggled over the past year. The company's price of $18.30 as of this writing sits well below its 52-week high of $34.38, though it has spiked off the lows recently.

The story of Veeco is somewhat complicated. It purchased lithography systems maker Ultratech last May, has been the subject of several patent lawsuits, and faces an evolving competitive landscape. Things seemed to stabilize recently, but is a turnaround really underway?

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Growth

During its fourth-quarter report on Feb. 12, management was keen to point out six straight quarters of revenue growth, while also projecting continued revenue growth in the first quarter of 2018 to $140 million-$165 million, with the midpoint being above the fourth quarter's $143.4 million.

Veeco also noted bookings grew for the third consecutive quarter to $179 million, while backlog grew for the sixth consecutive quarter, to $334 million. Management also noted it expects its overall end markets to grow 50% by 2020, from $1.2 billion last year to $1.8 billion.

Despite these positives, Veeco's current revenue run rate sits well below its peak from 2011 (even with the Ultratech purchase), with gross margin sharply below that year as well.

That's because Veeco operates in a cyclical industry that is also marked by technological transitions and varying degrees of competition. In particular, the company has been dinged by rising Chinese competition in its main segment of LED manufacturing, which made up 58% of of sales in 2017.

International lawsuits

Unfortunately for Veeco, Chinese manufacturers, most notably Advanced Micro-Fabrication Equipment (AMEC), have developed their businesses, catching up to Veeco's technology in producing the metal organic chemical vapor deposition (MOCVD) systems that Veeco had dominated in recent years. China is also where most LED manufacturing takes place.

Veeco filed a patent infringement lawsuit in early 2017 against German supplier SGL Group, which supplies parts to AMEC and other MOCVD manufacturers. However, the move seemed to backfire when AMEC filed a lawsuit against Veeco in a Chinese court. Veeco's stock plunged in early December on news that a Chinese court had blocked some of its business in China, but recovered when the three parties agreed to settle the various disputes on Feb. 8.

The settlement will allow Veeco to resume its sales into China, though the company will also have to compete with AMEC, and the terms of the deal (such as any up-front or licensing payments) were not disclosed. Unsurprisingly, the company's margins on its Chinese sales are now much lower than overall margins. Of the new agreement, management said during the fourth-quarter conference call with analysts, "Clearly, we're not going to go back to where we were, where we were the only player in town. There's going to be a two-company competitive [dynamic] in the market, and we'll battle it out."

Trying to diversify

In light of increasing competition and weakness in its LED segment, Veeco sought to diversify into more non-LED segments by purchasing Ultratech last year. Management noted the benefits of supplier cost discounts, combining both companies' enterprise resource planning systems, and cross-selling opportunities, all of which should strengthen the company's front-end semiconductor and advanced packaging segments. Management also noted sales to manufacturers of emerging technologies such as MRAM memory and vertical-cavity surface-emitting lasers, which are used in optical communications and LIDAR systems for the burgeoning self-driving car industry.

Management expects the merger to help these smaller (and more profitable) segments grow from 9% of revenue each to 15%-20% of revenue in 2018, with the core LED market decreasing to 40%-50% of total revenue.

Bright skies ahead?

In its latest earnings report, Veeco Instruments showed some improvement over its dismal 2017, but investors will have to wait to see if it can return to prior levels of profitability. With its overall end markets growing at a healthy pace and the company showing slow sequential improvements, recent signs are good, but investors aren't out of the woods just yet.

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Billy Duberstein has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.