Ultratech's (UTEK) CEO Art Zafiropoulo on Q3 2016 Results - Earnings Call Transcript

| About: Ultratech, Inc. (UTEK)

Ultratech, Inc. (NASDAQ:UTEK)

Q3 2016 Earnings Conference Call

October 20, 2016, 11:00 AM ET

Executives

Suzanne Schmidt - Blueshirt Group

Art Zafiropoulo - CEO

Bruce Wright - CFO

Analysts

Krish Sankar - Bank of America Merrill Lynch

Patrick Ho - Stifel Nicolaus

Tom Diffely - D.A. Davidson & Co.

Craig Ellis - B. Riley & Co.

Mark Miller - William Blair & Company

Operator

Good day, everyone and welcome to the Ultratech Third Quarter 2016 Earnings Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Suzanne Schmidt with Investor Relations. Please go ahead.

Suzanne Schmidt

Thank you, operator. Good morning, everyone, and thank you for joining us today to discuss Ultratech's financial results for the second quarter of 2016. A press release detailing our financial results was distributed this morning by Business Wire at approximately 6:00 AM Pacific Time and is available on Ultratech's website. A webcast replay will be available on the website for one week after today's call.

Joining me on today's call are Art Zafiropoulo, Chairman and Chief Executive Officer; and Bruce Wright, Senior Vice President of Finance and Chief Financial Officer. After management's opening remarks, we will open the call for your questions.

And with that, I will turn the call over to Art.

Art Zafiropoulo

Good morning and welcome to our third quarter conference call. During the course of this presentation, we'll make projections or forward-looking statements regarding future events and the financial performance of the company. We wish to caution you that such statements are just projections and the actual events can differ materially. We refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company's Annual Report filed on 10-K for the period ending February 26, 2016 and the quarterly report filed on 10-Q for the quarter ending July 2, 2016 filed as of July 29, 2016. These documents contain and identify important factors that could cause the actual results to differ materially.

The third quarter of 2016 saw some temporary moderation in our new systems bookings due to the digestion of our significant ramp in our recent shipments in the advanced packaging lithography product. We have also seen an increase in Laser anneal sales and the current production ramp at the 28-nanometer and 14-nanometer FinFET notes. Our sales in the third quarter were about the same as the previous quarter with annual sales rate of approximately $200 million per year.

We also improve several of our financial metrics in the third quarter which Bruce will discuss in his formal presentation. Regarding the moderation in our new system bookings, the advanced packaging products drop the bid and accounted for 58% of new system bookings. Laser anneal was 24%, inspection 9% and the nano products also 9%.

The book to Bill for new system orders in the quarter was 0.7 to 1. Geographically new system orders were greater China 67%, Southeast Asia 24%, Europe 7% and North America 2%. We expect that the Pacific Rim customers will continue to constitute a large percentage of our future business. Our Singapore factory which we started six years ago has been important segment of our strategy to better serve the Asian customers and resulting an increased market share in both the foundries and OSAT companies.

Our customers continue request delivery of systems with a short notice period. We have met their needs with continued quality systems and with 100% on-time delivery for the more than the past 18 months. We've implemented processes that have provided the successful strategy by utilizing a flexible manufacturing structure. We have referred to this as a unity platform which is a base for more than 80% of all systems shipped.

We measure quality based on our customer's acceptance cycle time and the cost of warranty. These metrics continue, we believe best-in class. This is not an easy task to achieve, but one that the entire Ultratech workforce executes exceptionally well. At the same time without our topline growth and increase gross margins we are rapidly reducing inventory. Now looking at each of our products we continue to see many significant trends for the LSA systems and growth both in a number of wafer passes.

Production of the 28-nanometer plainer structures and the FinFET devices with continued to drive our LSA ramp. We're also seeing a result out of 10-nanometer devices process and a small number of 7-nanometer FinFET engineering lots. Yield for the 14,16-nanometer FinFET structures have increased nicely and are in the 70% plus range with the 10-nanometer range in the 30 to 40% yield. With the strong ramp we are seeing several fabs well over 85% utilization.

We expect this will lead to further capacity expansion in 2017. We believe this expansion will be primarily in a greater China region. For the advance packaging steppers were heading to a record shipment year. In the third quarter bookings were below our expectations due to the foundries and OSATs absorbing the large number of systems that was shipped in recent quarters. We expect a significant quantity of AP orders in the fourth quarter offsetting the third quarter number.

With the projected bookings this fulfills the first quarter production plan and some of the second quarter output. Virtually all the systems offer 300 millimeter fanout and copper pillar applications. Superfast 3D inspection has continued to expanding use case applications which should lead to future sales growth. We have our superfast 3D systems in production for NAND devices with more than 2 million wafer passes in the past year.

This is with only a couple of use cases, currently our customers are analyzing more than 30 potential new used cases and in your initial feedback is encouraging. We are quite excited with our 3D technology feel that the market will develop as an integrated inspection strategy where we can provide exceptional value for the customer by increasing yield at the lowest 3D inspection cost.

This technology requires complex algorithms which necessitate a large amount of testing and that takes a considerable amount of time so, the incubation period will be a little longer than we would have liked but we going to provide an integrated inspection solution that will be very important in the reduction of chip cost.

The last product area dimension is a nanotechnology space where our ILD2s are primarily used for R&D. We have now shipped over 500 systems. We are continuing to monitor several possible production uses for ALD in the non-semiconductor markets. Our scientists continue to make significant contributions and developing solutions in this field. We have increased our IP position with about 80 patents and patent pending in several different areas from hardware to processes.

The high brightness LED lithography Stepper business is expected to increase in 2017. The current competitive strategy used by many manufacturers has we believe reached a dead-end. Significant amount of rework from old use reduction steppers has impacted profitability by excessive rework which in some cases reaches 50% so; in general we see 2016 and 2017 as strong growth in both top line sales and EPS.

All in all we are on a way for successful 16 and early indications point to a continuation of proper growth in 2017. At this time Bruce will provide more color regarding the third quarter financials and guidance for the fourth quarter.

Bruce Wright

Thanks Art. I would now like to go through a brief analysis of our income statement and balance sheet for the quarter then we will have the teleconference operator open it up for your questions. As you heard from Art’s comments third quarter saw a sequential decrease in revenue about half of 1% compared to the second quarter of 2016 primarily reflecting less revenue from laser processing partially offset by more revenue from superfast inspection and high brightness LED.

Geographically revenue decreased sequentially from the second quarter of 2016 in Europe while increasing in North America and remaining essentially the same in Asia-Pacific. Demand for laser processing systems in the third quarter of 2016 accounted for about 12% of revenue and about 24% of new systems orders. Advanced packaging systems in the third quarter of 2016 accounted for about 49% of revenue and about 58% of new systems orders.

Nanotechnology systems which includes high brightness LEDs and ALD systems in the third quarter of 2016 accounted for about 7% of revenue and about 9% of new systems orders. Superfast inspection systems in the third quarter of 2016 accounted for about 11% of revenue and about 9% of new systems orders.

Gross margin in the third quarter of 2016 increased to about 48% from approximately 47% in the second quarter of 2016 primarily due to product mix. Turning now to a comparison of the third quarter of 2016 to the third quarter of 2015 revenue for the third quarter was $48.6 million up about 47% from $33.1 million for the same period a year ago. Ultratech had net income for the third quarter of $5.5 million or $0.20 per share diluted. This net income compares with a net loss of $6.1 million or negative $0.22 per share for the same quarter a year ago.

On a non-gap basis Ultratech had net income for the third quarter of $8 million or $.29 per share diluted. This non-gap net income compares with a non-gap net loss of $1.3 million or negative $0.05 per share for the same quarter a year ago. For the third quarter 2016 versus third quarter of 2015 comparison of revenue mix, systems revenue was up about 45% in the third quarter of 2016 and service, spares and license revenue was up about 53%.

For the third quarter of 2016 systems revenue accounted for approximately 79% of the total broken out a 72% from semiconductor and 7% from nanotechnology and service spares and license revenue for about 21%. Geographically revenue from Asia-Pacific for the third quarter of 2016 was $36.8 million up about 48% from the third quarter of 2015 and represented 76% of the company's total third quarter 2016 revenue.

North America had revenue of $7.9 million up about 47% from the third quarter of 2015 and represented 16% of the total and Europe had revenue of $3.7 million up about 39% and represented 8% of the total. Our top five customers for the quarter were advanced packaging, laser processing and superfast inspection customers from Asia-Pacific. Overall the top five customers accounted for about 69% of systems revenue.

Gross margin increased to 48% in the third quarter of 2016 compared with approximately 42.5% in the third quarter of 2015. This increase was due primarily to product mix and higher production volume. Looking at operating expenses in the third quarter of 2016 R&D as a percentage of revenue decreased to about 18% from approximately 26% a year ago. SG&A expenses decreased to approximately 24% of revenue down from about 34% a year ago.

Total operating expenses for the quarter decreased to about 43% of revenue from approximately 62% in the third quarter of 2015. Operating margin for the third quarter of 2016 was about 6% of revenue compared with about negative 19% for the third quarter of 2015. Interest and other income net remained essentially flat at about $300,000 compared with the third quarter of 2015.

The company recorded a tax benefit of about $2.5 million in the third quarter of 2016 principally due to a tax accrual lending through the statute of limitations. During the year quarterly income tax provisions are determined using an estimated effective tax rate for the entire year. This rate is based on the jurisdictional mix of earnings and has potential to fluctuate as business moves from one geographic region to another.

Turning now to a third quarter 2016 versus second quarter 2016 comparison of the balance sheet cash, cash equivalents and short-term investments increased by about $6 million during the third quarter to total about $267 million at September 30, 2016. No common shares were repurchased in our stock buyback plan during the third quarter of 2016. Accounts receivable increased about 3% during the third quarter to approximately $47 million on a shipment decrease of about 16% compared to the second quarter of 2016.

Inventories decreased during the third quarter by about 4% to approximately $52 million. Working capital increase to about $334 million or $12.45 per share at September 30, 2016. Book value per share at September 30, 2016 was $13.34 up from $13.06 at June 30, 2016. Now let's take a few minutes to look at the future from a financial perspective. At this point is very important to recall and underscore the safe harbor comments Art made at the beginning of the call Ultratech's markets and industry are highly cyclical and hard to predict and fully subject to the risks enumerated in the company's 10 Q's and 10K.

As a result any forward-looking statements are highly vulnerable to very sudden and significant changes risks and uncertainties. In addition Ultratech undertakes no obligations to update forward-looking projections, forecasts or estimates. And looking at current market conditions and their impact on the fourth quarter 2016 financial performance we believe that the fourth quarter will be about the same as the third quarter of 2016. We anticipate Ultratech's fourth quarter 2016 revenue will be sequentially flat up about 5% over the third quarter of 2016. Gross margin could be about the same as this third quarter of 2016 or slightly lower based on expected product mix. Operating expenses look to be about the same as in third quarter of 2016 with an increase in R&D due to more melt spending on laser processing and a decrease in SG&A due to no proxy contest expenses.

The tax rate has estimated to be in the low single digits. We anticipate being profitable in the fourth quarter of 2016 on both the gap and non-gap basis, cash flow for the fourth quarter of 2016 should be positive. Finally we would like to wrap up our formal remarks by reminding you of the Reg FD restrictions. In Ultratech the only three people authorized to talk to you about the company are Art Zafiropoulo, Chairman and Chief Executive Officer; me, Bruce Wright, Chief Financial Officer; and Suzanne Schmidt of The Blueshirt Group.

For any calls or questions after the teleconference call dealing with quantitative matters we will refer you back to the comments made during the teleconference call. That concludes our formal remarks and now we would like to open it up for your questions. Operator, would you please begin the polling.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] and we‘ll take our first question from Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar

Art, first one, the September quarter miss you said was because LSA tool probably looks like one LSA tool got pushed out due to the typhoon. So is it actually happening in Q4 or did it get pushed out beyond Q4?

Art Zafiropoulo

No actually only a portion of the tool which was a chamber to be shipped from Japan on a couple tools that we shipped. It couldn’t be shipped due to the monsoon so, wasn't a full system. The major impact in and that was advanced packaging in terms of the bookings for the quarter but in terms of sales it was, it was really a small portion of that was the laser chambers that are actually made in Japan.

Krish Sankar

And so those things are going to be shipped in Q4?

Art Zafiropoulo

Yes, they already shipped now. They are at the customer site now.

Krish Sankar

Got you. And then your guidance for December which is flat to up 5% sequentially, can you just tell us the different moving pieces which is it you expect to be up from September? Is it more AP, less LSA? Can you give us some color on that?

Art Zafiropoulo

Well, it’s definitely going to be more AP as we currently has scheduled and so we expect on the bookings sides stronger advanced packaging and so that should bounce back very nicely in the fourth quarter and then Bruce can talk about little bit about product mix for you.

Bruce Wright

Yes, we’re looking in addition for laser to have a stronger quarter in the fourth quarter sequentially so, those are the two drivers that we see that might be a little bit better superfast looks like it might be a little bit weaker so, there just some offsets going on there and ups and downs in slight ups and downs and unit volumes the cost across the product mix.

Krish Sankar

Got it, got it. And then two quick questions. One is do you expect book to bill to be 1 or greater than 1 in the December quarter. Then the second one is, Art, what do think of the timeline for memory to adopt advanced packaging or sign-out? Thank you.

Bruce Wright

The book to Bill we expect to be above one-to-one offsetting the decrease in Q3 and so a timing pattern for some major orders we're looking at considerable increase in the number of AP tools that we book which we, if we expect that we have high probability that the hard copy POs will come in and if they do which we expect will be booked at least through Q1 and now have a big impact in the book to Bill. And the second question again?

Krish Sankar

The memory adoption of advanced packaging or sign-out?

Bruce Wright

Yes, I it's hard to say we have no input other than people are looking at it so, we don't have any more guidance in that. We are also looking at TSV for image sensors and I'll be in Japan and next couple weeks talking to people about that but that's another real possibility to reduce the thickness of the mobile device by 1 millimeter they’ll have to begin to redesign and use TSC for packaging of image sensors so, that could trigger another step function and the increase of the eight advanced packaging market for us.

We strongly believe that we're gaining more and more market share and we are getting stronger and not just in Taiwan but in China we’ve recognize as a quality supplier meet and exceed specifications reliable products very high uptime and so that we are becoming stronger and I think a great deal of that is due to our location in Singapore and superb, talented people we have working there that have at least four year degrees and so that's out that, that operation is running very nicely as is this operation here for the laser processing technology product so, in general the operation is doing really well and we see the step function increasing it just timing issues really but the product portfolios bigger than it has been before so, book to bill looks stronger right now in Q4 and this should lead to we believe an increase in business in 2017.

Art Zafiropoulo

Yes, amplifying what Art said about how well the operation has performing at this point in meeting TSMC's high demand and accelerating demand on info products of course many, many companies were providing systems into that company and they came back to us with very complementary statements telling us that we were the only company that met the delivery schedule and the specs on what we promised them so, we're firing on all cylinders.

Krish Sankar

Thank you, guys. Thank you.

Operator

And we’ll go next to Patrick Ho with Stifel, Nicolaus.

Patrick Ho

Thank you very much. A few questions first on the advanced packaging side, Art, are you seeing a broader customer base in terms of bookings this time around versus say earlier this year when it was very concentrated with one or select few customers? Is it a much broader base as you go into 2017?

Bruce Wright

No, I think that the same major players that are in advanced technology are just expanding their advanced packaging or the bumping and wafer level processing so, the ones that are smaller companies and wire bonding are just don't have the capital and the resources and technology to expand so, it’s still the handful of the same people what we do see though for next year is a stronger increase in China so as opposed to in greater Asia we see it being very strong but I think we see additional upside in China from some of the successes would have so far and then moving to more advanced technologies that other Stepper companies and other companies cannot produce as we do.

Art Zafiropoulo

Patrick, you heard may make comments about how the advanced packaging guys in general every other year by just cycles it's about time for the OSATs to get back into their bicycle.

Patrick Ho

Great, that is helpful. Going to LSA for a second, Art, you talked about the past, the 7-nanometer node appears to be quote the next big node following a 28-nanometer node. At the same time at virtually all of the leading foundries, they are kind of combining 10 and 7-nanometers together where they can transition from 10 easily to the 7 nanometer node.

Just given that type of dynamic, is it imperative that you guys get into the 10-nanometer node so it becomes an easier transition when the industry migrates to 7-nanometers or do you believe that you could just get yourself inserted with LSA on the 7-nanometer node alone?

Bruce Wright

I’d say it’s both of that we're currently in the 10-nanometer node but the 7-nanometer node or the extended 10 calling at seven is exhibiting significant parasitics in the transistors and so that’s going require a different set of solutions that the 10- nanometer doesn't require so, there will be some modifications in the toolset at seven but most of the toolset will be there however the volume at 10 will be rather small so, we are as I mentioned earlier in the formal part of my presentation.

We're seeing a better yield in 10 than we saw earlier, we are running 10 at several sites and we are running samples and engineering fairly large, lots of engineering samples at seven, so that we also in one account are looking at the melt step at seven again because of parasitic. But we will pencil it in at five and we will be delivering in the next several weeks systems for melt to leading semiconductor larger customers and so we talked about the flying spot technology will share more of that at our Analyst Day next month.

So I think that we're on the way and so that next year the growth we're looking for is certainly increase in LSA sub-melt and the beginning toward the end of the year of the melt technology taking home will be shipping essentially EVAL systems early on and we expect then the results initially are quite encouraging, we now are working in the integration phase with our customers in terms of technology both at seven and five nanometers.

Patrick Ho

Great. And final question from me on the inspection side, it's obviously taking a little bit longer to get traction than you've anticipated as the 3D NAND industry starts to make its migration to the 64 layer devices, is that where you see the penetration point or is it probably the next generation after that where you see higher volume adoption?

Art Zafiropoulo

We see it really now it's 48 and certainly getting more important as you get to more and more layers, so that as you increase the layers, the demand becomes greater, there's some common – common requirements for 4864 and higher in terms of films and stress related to them but as you get to vertical dimension in more and more layers, it becomes a nightmare for lithography. So we think that the lithography becomes essentially more important as you increase the tower, the layers in this hotel that they're building and it gets more and more difficult and the budget gets less and less.

So we think that the – that the future demand will be greater in lithography as steps increase and will be equally important with the various films that create stress at the 48 and above. So the big problem here is that we've seen as I mentioned earlier more than 30 steps that people have identified that one can use this technology to improve their process control and subsequent yield and what is taking is a great deal of time running tests and running tests as much as they can.

The amount of wafers they run is extremely large and they just want to get more data before they implement this in their production lines, I just don't want to make any premature steps and mistakes, so we have run actually 2.5 million wafer passes in the past year on vertical 3D NAND and so that that's growing very nicely and as I mentioned, we penetrated the logic market at a significant player that will see expansion next year with. But in general, the gestation period is taking longer due to the testing and the complex algorithms that need to be generated and reworked.

So it's taking a lot longer but I'm encouraged by the number of steps and the continued support from our customer base in both the memory and now growing logic but especially the memory area could be very big for. So that's a place that I'm hoping that we get more diversification of our product portfolio into the memory space through the inspection area.

Patrick Ho

Great. Thank you very much.

Art Zafiropoulo

Thank you.

Operator

We will go next to Tom Diffely with D. A. Davidson. Mr. Diffely your line is open. Please check your mute button.

Tom Diffely

I'm sorry, can you hear me now?

Art Zafiropoulo

Yes.

Tom Diffely

So just repeating onto that last question, when you look at the 3D NAND market in the long-term, do you think your biggest opportunity is on the inspection side or is it on the advanced packaging side when they go to the high density multichip modules?

Art Zafiropoulo

I think it's on the inspection side, I think that business is going to be bigger than on the packaging side, I think the packaging side will decent and let's say that could have an incremental increase of maybe 30%, 40%, 50% and that was really impact of our business however if they move as we expect them to in time and inspection that product has very nice gross margins and also it has the capability of significant quantities.

To put this in perspective that currently at 100,000 wafer starts and a vertical NAND factory at 100,000 starts they've identified as I mentioned 30 steps and in each step, the sampling would be required one to eight tools and depending upon the process window, so there will be sampling of each of these steps more frequently when the data indicates that there is a change, a dramatic change or shift compared to the process window. So if you look at that and you have some factories running several hundred thousand wafer starts per month the serve market, the market on 3D could be substantial.

Now this is going to take time, so that I don't see the equivalent growth in the AP area for the potential growth in the new inspection, so in terms of dollars, I expect that the potential market is larger in inspection however we certainly have a stronger position in AP and very, very tough competition in inspection. So both areas are important but I think the upside potential is greater in inspection now whether we get it or not is another story but we have a higher probability certainly to get the lithography portion of the AP business in inspection. I hope that's not too cloudy.

Tom Diffely

That's great information. I appreciate that. So when you look at the Chinese market, there has been a lot of international companies come in there and you're seeing a lot of growth, what are you seeing on this domestic market, with the domestic in-house players?

Art Zafiropoulo

In China?

Tom Diffely

In China, yes.

Art Zafiropoulo

Yes we're very – I mean again if I look at the laser technology for junction formation, we literally have 100%, so as the ramp continues in 28 nanometers and below, we expect to be a dominant player in China so as the growth occurs, which we think the next several years there will be significant growth in new fabs. We expect to be in a very strong position there in China based on our previous work that we've done there and the performance of our systems.

As I mentioned, we literally have 100% of that market currently in the junction formation area multiple step junction formation area and that currently beginning to ramp their 28 nanometers, the yields are getting better, so they're making real progress in that area and I expect them to be a pretty dominant player in the mobile space, in the IoT area.

So as we roll on in the cost of transistors the node 28 being the lowest-cost transistors, they should really begin to ramp that up and I expect to take a decent market share. It's little bit more difficult in membrane and the advanced packaging part of our business although we're making really progress there.

There is local companies that are supported, subsidized by the government but once we get to more advanced packaging these companies are not capable of getting that the process requirements that the industry needs, so as we go down to smaller nodes 28 down to the FinFETs and packaging those nodes, we become stronger based on our technical capability.

So in total, our future looks very bright in China that they mainly based on technology as opposed to relationships of pricing, we have truly the leading technology that they can use today and we think growing tomorrow.

Tom Diffely

Okay, great. And then earlier, Art, you mentioned that the ALD systems you are starting to look at some production systems that are non-semi. Just curious what type of production systems will that be? What kind of end market products is that serving?

Art Zafiropoulo

Well they've got to be quite simple and low cost because of these markets can't afford the depreciation that the semiconductor industry normally does. So they have to be inexpensive systems, they have to be unique and I wanted to stress that we're inventing a lot of good things both in hardware and in processes and those processes will be again do not all non-semiconductor they are some semiconductor work that we're doing, one I just go for Tangent for a second here, we're doing some great work with IMEC on selective deposition with ALD.

I mean world-class work that we're doing and so that is going to help the semi industry but I'm not going to participate in

production, we will have to develop the process and the technology and we have a lot of IP in that area and but in terms of the other work we're doing in non-semiconductor, it is a huge range of applications and I don't like it any specific one right now but as we make more progress we will certainly let all of you know.

Tom Diffely

Okay. And then finally, Bruce, on the margin front, is it simply just a matter of when advanced packaging is a higher percentage the margins are going up versus LSA?

Bruce Wright

By and large yes because those are the two most significant slices of the revenue contribution pie and you're correct when you say that the AP margins are greater than the LP margins as we see growth in Superfast though, the margin story is going to be more and more dependent on that because Superfast probably has the best margin of all three of the product groups, it's just small absolute dollars right now but watch out for that one in the future.

Tom Diffely

Okay. Thanks for your time today.

Operator

And we will go next to Craig Ellis with B. Riley.

Craig Ellis

Thanks for taking the question. Art, I thought I heard you say in your prepared remarks that fab utilization at 16 and 14 was running near 80% and so that would lead to capacity adds next year. One, was that the case? Two, if that is the case, how significant would those adds be and what does that mean for Ultratech?

Art Zafiropoulo

Yes it's hard to figure that out right now but let me just share with you that, there are some fabs actually running over 90% and we know now that there is new factories being built in China and for expansion but most of these other factories that have high utilization is not much room within that factory they can expand to.

So that puts a little bit of a damper in expansion within that factory unless they move things out and as likelihood that they'll start changing the location and positioning of their tools to increase the output of those factories.

And then again the new factories and when they will be ready and when they will start delivering need to have tools delivered to them so but we feel overall that this year was a big transitional year for LSA due to the FinFET's and the difficulties there, so this year's transitional and we're expecting next year to grow above where we are this year, which is an okay year.

But we want to get back on track toward our numbers that we had in early years not quite reaching next year but beginning to get closer to those numbers that we reached early on three and four years ago. So we're expecting to see growth in that area and then toward the end of the year begin to see some revenue and the melt area primarily driving into the seven and five nanometer needs.

But all now we're encouraged by all the things that we're dealing with right now, I think the one that's the hardest to call is the inspection area due to the amount of testing that's required and the complex algorithms that that need to be generated. So that's an area that we're still learning and working at, we actually have more knowledge base on the LSA and the AP.

It's a matter of really the facilities being ready on LSA primarily in China where we're very strong and AP as Bruce said probably would get stronger on the OSATs next year and we see the level of interesting quotes are increasing in the OSAT area.

Craig Ellis

That's very helpful. I appreciate that. And then the follow-up is for Bruce and it relates to the prior questioner. With respect to gross margins, it looks like the underlying dynamics in the business are setting up for growth next year. So if that were to be the case, would gross margin dynamics simply be a function of mix or is there a volume component to gross margin? And if so, how does that compare to the mix dynamics that we have seen impact the business quite favorably this year?

Bruce Wright

There is absolutely a volume component to the margins and our breakeven run rate revenue run rate right now is around $43 million, so we're above that and the impact is two-fold not only on gross margins but on cash and you're seeing that as we've gotten above the breakeven point Ultratech historically has and continues to just be a cash generator and we're bringing that to the bottom line.

We added cash again this quarter, so the impact on margins has to do with absorption in the factory which is even more important than just a product mix or seeing the impact as we've gone through the first three quarters of 2016 to where the gross margin has increased that's because we've been seeing top line growth, we've been seeing high components to the revenue contribution from AP which as we commented on earlier has very good gross margins and better absorption.

So those are the two main factors that impact gross margins and we're looking as Art said with growth not only as I gave modest sequential growth in the fourth quarter but going into next year we're looking for gross margin improvement as a result of both of those components.

Art Zafiropoulo

Yes if I could get some color on the cash, we just had a board meeting this week obviously and we spend a lot of time talking about the use of cash and so we've looked at all the alternatives including the current $100 million buyback that we have done about $40 million on that, so we continue to look at where is the best use of cash and every single thing that you can think about, we're looking at in the best interest of the investors.

So I want to assure everybody that we're not just sitting back at counting money, we're looking as the best way for our shareholders and to grow the company and or provide money back to them in several different ways. So we're looking at this and currently we still have that open $60 million out of the 100 and we will use that at the proper time and we continue to look at that at every board meeting and we discuss it with a number of our important investors ongoing and we listen to them very carefully and take it very seriously on the use of cash.

Bruce Wright

Recall also that we do have 10b5-1 program in place.

Craig Ellis

Can you provide any color, Art, on the way the Board assesses the priorities for cash use and the degree to which those priorities will change from time to time as industry conditions or as Company specific conditions change?

Art Zafiropoulo

Sure. I think that as I mentioned we look at all potential areas, we look at investor inputs and any comments they make or data they give us, we also look at outside consultants, we look at banks to get analysis, we look at every possible conceivable bit of information we can share with the board, so that the board can make the decisions that are necessary based on the facts are available.

So data is very important to us, so we look at lots of sources of data and then we look at the timing of where we are, what our objectives are short-term, mid-term and it ranges the full gamut from dividends, stock buyback it looks at acquisitions, it's whole host of things, it is a full portfolio of use of cash and all of those are looked at and discussed at these meetings and as I mentioned before we take it very seriously.

And we will find ways in which to add value for shareholders, at the same time one has to be understanding that we are in a very volatile business and our customers expect us to have a strong balance sheet to be around to support them and so while and it's getting more and more difficult with some of these companies in a weak position they're at and we just don't want to deal with the second and third tier companies forever and the big guys out there want us to be self-sufficient to give them more product needs, so whether it would be service, whether it would be process information, whether regardless what it is and discounting.

So all those factors are looked at and in terms of our decisions as to the use of cash but at this point we know we have a lot of cash and so we are not just sitting on it and as we move forward, we will find good ways to use it for the best interest of the shareholders.

Craig Ellis

Got it, thanks guys.

Operator

And we will take our final question today from Mark Miller with Benchmark Company.

Mark Miller

Thank you. Just wondering if you could estimate next year the number of sales of LSA tools for advanced node versus 28 nanometer and older nodes?

Art Zafiropoulo

I really at this moment, I really couldn't do that. I would say that I could give you some general thoughts. I'd say that the 28 nanometer probably will be the most, the greatest percent right behind that will be FinFET.

And then I think there may be some work at 40 nanometer smaller amount and then of course maybe a small amount from that on the melt but I think right now that the 28 nanometer will probably be at this moment the largest portion percent wise and next down still significant will be FinFET.

Mark Miller

Okay. You mentioned you are expecting an improvement in the high brightness LED area because the reduction steppers are having problems with rework. It has already announced starting in June they were seeing after a couple of soft quarters in orders a resurgent in their orders and I'm just wondering why is there – it doesn't seem like, it seems like this is more, it doesn’t seem like...

Art Zafiropoulo

I think question let me kind of give touch on the high brightness area little bit, the steppers they're using are in many cases 20 years old and they just are having severe problems in depth of focus. They were made for semiconductor use and so it is creating a great deal of rework and so our steppers were made specifically for high brightness and so the rework in some cases I mentioned is up to 50%.

And they're trying to get cost out of their line and this is one of the areas that they have identified, so that's a good news is that we've seen increase, now I should share with you the bad news is that margins are terrible and so typically the margins are in the mid-30% range and so I have mixed feelings and I'm happy that business may be increasing, I'm not so happy about the gross margins because the industry is extremely difficult and competitive in pricing.

So sometimes they punish themselves and by the incorrect tool just because of pricing, so at this stage, we see an increase but I'm going to try to hold the line in pricing more to try get margins up a little bit better and so that's my dilemma but I just want to share with you that we may see some business that share increasing rather substantially may be based on if they are willing to pay the price.

If they're not willing to pay the price then, we just won't move forward, we have too many other things to do and I should mention that these machines are made in Singapore and all our people are cross trained between advanced packaging lithography and the steppers for high brightness LED. So the question is you know do I want to use people to build high advanced packaging or high brightness LED.

So at this stage, we're going to carefully analyze that and make decisions on pricing based on what's in the best interest in earnings per share and in valuation of our company.

Mark Miller

You mentioned you had bought back 40 million in shares to date. What was your cash flow from operations? Did you buy back any shares this prior quarter?

Art Zafiropoulo

No we did not.

Mark Miller

And cash flow from operations, do you have that? It looks like it was...

Bruce Wright

And that was about $7 million.

Mark Miller

Okay. And then finally, Taiwan Semiconductor made some comments about info being a volume production and it is a fairly big thing there maybe $100 million in revenues. Is that an opportunity for you? They are talking about cost reductions and yield improvements?

Art Zafiropoulo

Well it's pretty public knowledge where I think everyone knows about this through the Taiwan government really every week has the public company providing information as to what they are buying and if you look at the past year or so, you'll see that TSMC has spent a lot of money with Ultratech and since they're not buying very many systems, LSA systems from us, it's lithography.

So I would then lead to the conclusion that we are the dominant player and they're back in for their copper pillar and the wafer fan out. So we believe that we are the dominant player in this phase, we mentioned that, we literally own this market and so with that, I would then take the next step and say that we literally own the backend at TSMC.

Mark Miller

Thank you.

Operator

And at this time, I would like to turn the conference back over to Art Zafiropoulo for additional or closing remarks.

Art Zafiropoulo

Thank you. We would like to remind everyone that our analyst meeting will be held again this year at our corporate headquarters in San Jose, California on November 15 beginning this morning at 9 AM, we look forward and seeing you at this meeting, we will provide more information that will help in projections of our expectations for the next several quarters.

Please contact Suzanne Schmidt of The Blueshirt Group or refer to our website. With that, I want to thank you very much for participating in our call today.

Operator

Again, that does conclude today's presentation. We thank you for your participation.

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