Veeco Instruments Inc (VECO) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the Veeco 2nd quarter 2004 results conference call.

Today's call is being recorded.

For opening remarks and introductions, I would like to turn the conference over to Vice President of Investor Relations, Ms. Deborah Wasser.

Please go ahead, ma'am.

Thank you.

Welcome to our conference call reviewing our results for the 2nd quarter ended June 30, 2004.

Joining me today's call are Ed Braun, our Chairman and CEO and Jack Rein, our Chief Financial Officer.

Veeco announced our 2nd quarter results at 7:00 a.m. eastern time this morning.

If you haven't yet seen the press release, please visit the Veeco.com website or call 516-677-0200, extension 1403 to get a copy.

This call is being recorded by Veeco Instruments and is copyrighted material.

It cannot be recorded or rebroadcast without Veeco's express permission.

Your participation implies consent to our taping.

To the extent that this call discusses expectations about market conditions, market acceptance and future sales of the company's products, 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 in the analysis section of the company's report on form 10-K and annual reports to shareholders.

It is Veeco's policy to provide forward-looking guidance one quarter at a time.

However, due to our currently strong backlog and visibility through the end of the year, management is providing guidance for the remainder of 2004.

The company has no obligation to or intention of, providing multiple quarters of guidance in the future.

During this call, management may address non-GAAP financial measures.

Information regarding such non-GAAP financial measures, including reconcilliations to GAAP measures of performance is included in the press release and the financial tables distributed this morning.

This information is available on our website.

This call is being webcast live at the Veeco.com website and will be available for replay and archived for future reference.

The company does not plan to update the information on this webcast once it has been archived.

I would now like to turn the call over to Ed.

Thank you and good morning.

We're pleased to report that Veeco's 2nd quarter 2004 orders, revenue and earnings all exceeded the prior year, and the prior quarter, and met or exceeded our guidance as we continue to experience a multi-market recovery and increased demand from our core semiconductor compound semiconductor and data storage customers.

Veeco's 2nd quarter revenues of 102.9 million increased 9% sequentially from 94.5 million in the 1st quarter, and included revenue growth in both process equipment and metrology within Veeco.

Year-over-year revenue growth was up 40% compared to Q2 of 2003.

Revenue was above our guidance of 95 to 100 million.

Sequential revenue growth by market included growth in three of our core markets: data storage revenue was up 13% to 35.5 million, semiconductor revenue was up 17% to15.5 million, and wireless compound semiconductor was up 19% to 24.6 million, which includes our MOCVD for high brightness LED activity.

While scientific research was down 6% to 27.3 million for our total revenue of 102.9 million.

We continue to benefit from our market diversity, and we have maintained our balance between our core markets with data storage at 35% of revenue, compound semi-and semi-combined at 39% of our revenue, and scientific research at 26% of our Q2 revenue.

Geographically, revenue increased in North America, Europe, and APAC, and declined in Japan, with continued strong international penetration, 37% of our business was in North America, 30% in APAC, 18% in Europe, and 15% in Japan, showing continued strength in APAC.

Revenue included 21.3 million from newly acquired MOCVD and precision lapping businesses, and so we had revenue growth in Q2 year-over-year with and without the recent acquisitions.

For our orders, we had quite strong Q2 orders of 124.7 million, up 95% year-over-year, and up 7% sequentially.

At the top of our 120 to 125 million guidance for the quarter.

This was our strongest order performance in 14 quarters, book to bill was positive at 1.21 to 1.

Our backlog increased to 164 million dollars.

Sequential growth was aided by our market and product diversity and continued growth in customer demand, led by record semiconductor orders which were up 121% to 22.3 million, and included 13 automated AFM orders, and three multiple AFM system orders.

And record wireless compound semiconductor epitaxial deposition equipment orders driven by high demand for high brightness LEDs.

Compound semiconductor orders were up 31% to 51.1 million, and this included 33 epideposition system orders, including six multiple system orders, again driven by blue LED applications.

Data storage declined, as we had forecasted, was down 41% to 26.4 million after a very strong Q1 performance, and scientific research was up 8% to 24.9 million, again for total orders of about 125 million dollars.

High sequential order growth and high brightness LED and semiconductors reflected our market distribution where now our compound semiconductor and semiconductor together were 59% of our Q2 orders, wireless itself, which includes the LED activity was 41% within that 60%, and data storage was about 20%, and scientific research about 20%.

Again, very strong growth in both semi-and in compound-semi for the quarter.

Q2 orders included $43 million from recently acquired MOCVD and precision lapping activities, and again we had order growth both year-over-year with and without acquisitions.

The geographic sequential order growth included increases in North America, Japan, Europe, and a decline in APAC.

Q2 earnings.

EBITDA of 9.3 million was up 189% year-over-year, and up 24% sequentially.

GAAP EPS was 5 cents per share.

EPS excluding amortization was 15 cents per share above our 11 to 14 cent guidance.

Gross margins were 44.1%, up from 43.7% in Q1.

Our balance sheet remains strong, with $117 million in cash, up 5.6 million in the quarter.

So a strong growth quarter that included sequential and year-to-year increases in revenue, in orders, and in earnings.

Commenting on overall market conditions and the continued benefit of Veeco's diverse product and market strategy, our orders have increased 95% in the last 3 quarters, from 64 million to 125 million.

Our revenue is up 63% in that same 3-quarter period from 63 million to 103 million, and our EBITDA has nearly tripled in these last 3 quarters from 3.3 million to 9.3 million.

We see continued strength in orders, and revenue through the 3rd and 4th quarters based on opportunities across data storage, semiconductor, wireless, and scientific research markets. 2004, 2005 demand is being driven by the combined growth of PCs, both in lab laptop, mobile and desktop, and the emergence of a new generation of high-growth wireless digital consumer electronic products like iPod, camera cellphones, video players, which represent the convergence of small format data storage microdrives with semiconductor technology, and with compound semiconductor blue/green high brightness LEDs, high resolution color displays, and high frequency devices, all which require the increased use of Veeco's process equipment whether it's MOCVD, or PVD or OBD, and Veeco's metrology which is the combination of AFM and optical interferometry, and we see this activity both at the research level and the production level.

The size of these emerging consumer electronic product markets is made evident when one considers that compared to the installed base of 500 million worldwide PCs, there are 1.5 billion hand-held cellphones and PDAs.

In fact, we throw away 300 million cellphones each year, and high-end camera cellphones have become a father's day gift.

The success of the new iPod class of product which this year will be about 5 million units is forecasted to grow to 15 million units in the next 3 years, and will be followed by portable video players containing higher capacity microdrives with high brightness color displays.

In addition to personal computer devices, new automotive applications requiring small format disk drives and solid state high brightness LEDs, and brighter color displays with wireless electronics are emerging to satisfy demand for more usable navigation systems, and fully featured entertainment systems to be available in 2005-2006 cars.

For both personal and automotive applications, solid state LEDs, and high frequency compound semiconductor electronics will lower power consumption and extend battery life.

These high-growth next generation consumer products require high density smaller format, smaller feature size, energy-efficient, high brightness and wireless high-capacity storage devices, and these will need to be manufactured in higher volumes at lower per unit costs incorporating new materials which reduce nanoscale dimensional tolerances, and which require next generation process equipment both for etch and deposition and metrology equipment for yield management.

So it appears to us that we are early in a multi-market, multi-year equipment growth opportunity.

Veeco's outlook, our strong backlog affords us an opportunity to have some added visibility, and therefore we're providing both the forecast for the 3rd quarter and the initial outlook for the 4th quarter as follows: In Q3, we currently forecast that 3rd quarter bookings will be up in the range of 125 to 130 million, and that 3rd quarter sales will be up in the range 105 to 110 million, and that the company currently forecasts that it will earn between 6 and 9 cents per share on a GAAP basis in the 3rd quarter, and between 15 and 18 cents per share, excluding amortization and using a 35% tax rate for the 3rd quarter.

As for the Q4 outlook, we currently expect 4th quarter sales to be up again in the range of 115 to 125 million.

Earnings between 20 and 25 cents per share on a GAAP basis, and between 29 cents and 34 cents per share, excluding amortization, on a pro forma basis.

Veeco plans to provide an updated 4th quarter forecast at the end of the 3rd quarter.

Jack will comment on financial results, and I'll return to discuss market sector performance.

Jack?

Thank you.

For the 3 months ended June 30th, 2004, sales were 102.9 million, an increase of 40% versus the 2003 2nd quarter.

The increase is attributable to 26.3 million dollar increase in price equipment products including 8.8 million from our New York process equipment group, 14.1 million from the compound semiconductor group, including TurboDisc, and 3.4 million from AII, the latter two businesses acquired in the 4th quarter of '03.

Metrology sales increased 8% to 42.3 million.

Our market sales are were up compared the prior year by 46%, and data storage 100% and compound semi-wireless 44% in semi-conductor and 5% in research.

Sequentially, sales increased 8.4 million and 9% primarily due to a $7.7 million increase in price of equipment, attributable to TurboDisc and New York process equipment.

Second quarter 2004 orders improved to 124.7 million, up 95% from the 2nd quarter of 2003.

Orders were up 7% sequentially from the 1st quarter 2004.

Gross profit was 45.3 million for the quarter, or 44.1% of sales compared to 32.8 million, or 44.6% of sales for the 2003 2nd quarter.

The decrease is principally due to the sales, mix shift to process equipment tools from metrology, price of equipment have lower average gross margins.

Process equipment sales represented 59% of total sales in the 2004 2nd quarter compared to 47% in the 2003 2nd quarter.

Sequentially, gross margins improved 4/10 of a percent from 43.7 in the 1st quarter of 2004, which excludes nonreturning acquisition-related charges for the 1st quarter that were discussed at last call.

SG&A was 21.8 million, or 21.2% of sales, compared to 17.9 million or 24.4% of sales in the 2nd quarter of '03.

The dollar increase is mostly due to the acquisitions in the 4th quarter of 2003, SG&A was up 1.7 million dollars sequentially principally due to selling expense and increases related to increased sales as well as consulting order course related to Sarbanes-Oxley for certification, relocation costs and bonus accruals which were not present in 2003.

R&D expense totaled 14.6 million, an increase of 2.9 million from the 2nd quarter of 2003.

Largely due to the TurboDisc and AII acquisitions.

Sequentially, R&D was up half a million dollars.

Primarily due to investments in both metrology and process equipment new products.

As a percentage of sales, R&D was 14.2%, compared to 16% in the 2nd quarter of 2003, and 14.9% in the 1st quarter of 2004.

Operating expenses declined as a percentage of sales to 35.4%, compared to 40.3% in the 2nd quarter of 2003, exclusive of amortization and restructuring charges.

Amortization expense totaled 4.6 million in the 2nd quarter of 2004, versus 3.2 million in the 2nd quarter of 2002.

It was approximately 1.4 million of additional amortization expense related to the TurboDisc and AII acquisitions.

Sequentially, amortization expense is $3 million less than the 1st quarter of '04.

Other income for the 2nd quarter was $355,000 and was related to foreign exchange gains and other miscellaneous items with no similar gains in the 2nd quarter of '03.

There were no restructuring expenses during the 2nd quarter of '04.

Restructuring costs total $800,000 in the 2003 2nd quarter.

Primarily due to severance related to cost reduction efforts.

Net interest expense is 2.2 million compared to 1.9 million in the comparable 2003 quarter, due to the reduction of interest income resulting from lower cash balances, a result of our 4th quarter acquisitions.

Second quarter EBITDA totaled 9.3 million, compared with 3.2 million in the 2003 2nd quarter.

Veeco's 2nd quarter 2004 net income was $1.6 million, or 5 cents per share, compared to a net loss of 1.1 million, or 4 cents a share in the 2nd quarter of 2003.

EPS, excluding amortization and restructuring for the quarter was 15 cents, compared to 3 cents for the 2003 2nd quarter, using a 35% tax rate.

The 6 months of 2004 sales total 197.4 million, or 42% increase from 2003, due primarily to an increase of $49.7 million in process equipment sales. 40.9 million of this increase was due to the 4th quarter '03 acquisitions of TurboDisc and AII.

Metrology sales increased 8.5 million from the 1st quarter, 1st half of 2003.

Gross margin for the 2004 1st 6 months was 43.2% of sales, excluding $1.5 million of nonreccurring charges taken in the 1st quarter of 2004 relating to capitalization of manufacturing process inventory for the 4th quarter '03 acquisitions.

Gross margin was 43.9% for the 1st 6 months of 2004, compared to 46% in 2003.

As previously noted, the decrease in 2004 margin is principally due to sales mix shift to process equipment tools from metrology, which have lower average gross margins.

In 2004 process equipment represented 58% of total sales versus 46% in the 1st 6 months of 2003.

SG&A was 42 million, up 7.1 million from 2003. 5.6 million of the increase in SG&A is due to the acquisitions made in the 4th quarter of 03, with the remaining 1.5 million due primarily to selling expense increases due to higher sales volumes.

As a percentage of sales, SG&A has decreased to 21.3% from 25% in 2003.

R&D expense totaled 28.6 million, an increase of 4.8 million from 2003. 3.9 million of the increase in R&D is due to the acquisitions with the remaining 700,000 increase targeted at new products in both equipment and metrology.

As a percentage of sales R&D has decreased to 14.5% in the 1st half of 2004 from 17.1% in 2003.

Amortization expense totaled 9.5 million in the 1st 6 months of 2004, versus 6.3 million in 2003 comparable period.

This was the result of approximately 3.2 million of additional amortization expense related to the acquisitions.

Other income of 600,000 for the 1st half of 2004 compared to 900,000 and was mostly due to foreign exchange gains and sale of excess assets.

There are no merger or restructuring costs for the 1st half of 2004.

Restructuring costs of 1.5 million during the 1st half of 2003 was primarily due to severance for layoffs that related to actions announced in the 4th quarter of 2002.

Net interest expense totaled 4.4 million dollars, compared to 3.7 in the comparable 2003 period, due to the reduction of interest income resulting from lower cash balances.

EBITDA was 16.7 million, compared to 6.2 million in the 1st half of 2003.

Veeco's 6 month 2004 net income was $900,000, or 3 cents per share, compared to a net loss of 2.8 million or 10 cents per share loss in the 1st half of 2003.

Earnings per diluted share excluding certain charges for the 1st half of 2004 were 26 cents compared to 6 cents in the 1st half of 2003.

The charges excluded from this calculation are amortization, acquisition, and restructuring costs.

Backlog at June 30th, 2004, was approximately 164 million.

In regard to the outlook, we currently forecasting 3rd quarter revenues in the range of 105 to 110 million, with a forecasted GAAP income per diluted share in the range of 6 to 9 cents, or earnings per share in the rate of 15 to 18 cents excluding amortizations costs of 4.4 million.

We expect gross margins to remain level in the 3rd quarter and to improve 1% in the 4th quarter.

With regard to the balance sheet, cash and equivalents totaled 117.4 million at June 30, 2004.

We are pleased that we generated 5.6 million in cash for the 2nd quarter, which was above plan.

Accounts receivable increased by 17.2 million from the 1st quarter to 93.4 million, due to the higher sales volumes and the timing of our sales.

VSOs were 62 days.

Inventory increased to 108.1 million at June 30th, up from 104.4 at March of 2004, due to the ramp in our compound semiconductor business.

Capital expenditures were 4.5 million for the 2nd quarter of 2004, and 5.9 million for the 6 month period.

Depreciation expense total 3.3 million in the 2nd quarter, and 6.4 million for the 1st half.

Our balance sheet and cash position of 117 million in cash remains quite strong.

At this point, we will turn to Ed for some additional comments and your questions.

Thank you, Jack.

I'll briefly talk about some of the markets, and then we'll be pleased to take your questions.

Let me provide some highlights.

In wireless compound semiconductor where again, the Q2 booking increased 31% to a record 51 million, driven by demand for Veeco's MOCVD, and MBE epitaxial deposition equipment, which is required for the manufacture of high brightness gallion nitride blue/green LEDs, here we see continued growth opportunities in cellphones that contain both high brightness, blue/white LEDs for keyboard and color display back lighting, as well as high frequency galium arsenide devices and fully featured camera cellphones will soon include white LEDs for flesh.

Cellphone sales are expected to nearly double to 750 million units by 2008, and contain 30 compound semiconductor devices per phone.

LED back lighting is now being extended to larger color display applications including mobile PC monitors and flat panel TVs.

And new automotive applications include forward headlights, fog lights, instrument panels where high brightness long life bulbs and lower power consumption are becoming more important.

High resolution, high brightness stadium displays, LED traffic lights, new architectural lighting applications, are the entry applications to the much larger worldwide general illumination future market that is now attracting people like Lumalens, Osran, Cree, Jellcorp and others.

In this sector, Veeco is rapidly becoming the leading equipment supplier offering both a combination of MOCVD and MBE epitaxial systems which determine device functionality and brightness, and Veeco's metrology equipment to improve manufacturing view.

So compound semi, which has become quite important to us this year had a 1st half orders of 90 million and a 1st half revenue of 45 million.

In semiconductor, bookings increased 121% sequentially to a record of 22.3 million, reflecting acceptance of both our auto AFM, and optical metrology products, as well as some orders for I&B process equipment for mask applications.

Veeco has the broadest line of 3D AFM non-destructive metrology solutions for etch, CMP, CD, and lithography applications at 110 and 90-nanometer feature sizes, and is extendible to 65 and 45-nanometers.

First half semiconductor orders were 32 million, up 70% over prior year, and revenue was 29 million, up 30% over prior year.

In data storage, Veeco clearly offers the industry's broadest line of etch deposition precision lapping, and metrology tools, both for wafer and slider applications.

Data storage customers are currently upgrading their capacity and adding new technology for the completion of the 60 gigabyte ramp, and for next year's 120-gigabyte introduction, and for continued research for perpendicular heads required for the 2006 timeframe which will likely require new magnetic materials, and we've announced a new dedicated development team within Veeco to address new deposition tool development incorporating PVD, AOD, IBD and other technologies likely required for perpendicular head manufacturing.

The combination of single digit annual PC growth and the emergence of high growth consumer electronics with embedded hard drive storage such as iPod, MP3, video players, game boxes, auto navigation, present a new multi-year data storage industry growth opportunity.

This year, there will be 300 million hard drives produced, including about 30 million for consumer electronics, which are forecasted to grow to over 600 million hard drives, of which 250 million will be consumer drives by the year 2010.

So in data storage, our 1st half orders of 71 million were up 45% versus the prior year and our 1st half revenue of 67 million was up 54%.

And lastly, in scientific research, in that sector, our orders are were up 8% sequentially.

Here we provide research AFM, and optical interferometry to material science, life science, and university research customers.

Veeco's research AFM scanning probe microscopes continue to be the industry standard for atomic imaging and molecular manipulation and our new lower end, lower price AFMs have allowed penetration of the entry level AFM business for university and research markets, allowing us to broaden the base of AFM and nanotech users.

First half scientific research revenue was about 56 million and orders were about 48 million, essentially flat to prior year.

Operator, we would be pleased to take questions.

Thank you very much.

The question-and-answer session will be conducted electronically, so if you would like to ask a question, please signal by pressing star, 1 on your telephone at this time.

If you are using a speakerphone, please make sure your mute button is turned off to allow your signal to reach our equipment.

Again, that is star, 1 to ask a question.

We'll here first from David Duley of Merriman.

Yes, good morning.

I was wondering if you could talk a little more about the MOCVD business, and it has grown sequentially several quarters dramatically, and I was wondering how sustainable you thought this current order rate was.

Yes, it has had double-digit growth now for some number of quarters.

We see continued strength, Dave, in the fact that the applications are -- there's a wave of applications that seem apparent to us.

You know, the first one was certainly back lighting for keyboard and small color displays.

Now we're seeing back lighting for computer screens and flat panel TVs, we're seeing new automotive applications.

Indeed all solid state lighting in some cars in the '05 timeframe, and architectural lighting, which is really the beginning of general illumination.

So I think we see, you know, continued strength here.

You know, this will be like our other markets, a market that has some cyclicality to it.

So, you know, and none of these markets should we expect an endless quarter-over-quarter improvement.

Rather, we should expect a rather positive trendline year-over-year for some 2 or 3 year period.

Okay, and in the disk drive area, I think your orders were down sequentially.

Could you talk about what you thought might have caused that, and apparently you have an outlook there that that's going to recover since your order guidance is pretty robust.

So could you talk about what's going on in that business?

And finally for me, just a comment on the growth margins.

What would be the outlook in the 3rd and the 4th quarter.

I guess I heard Jack say flat and then up 1%.

What's the key metrics to move that needle both up and down?

Thank you.

I'll do those in sort of the reverse order, and Jack will comment separately on gross margins.

Gross margins, you know, which have been improving quarter-upon-quarter, and I think will continue to do so 2nd half versus 1st half, are very sensitive to the mix of equipment and metrology.

You know, metrology has a higher gross margin than process equipment and we're in a year where process equipment is growing much more rapidly than metrology, and we planned the year on sort of a 60/40, equipment and metrology mix.

We're more likely certainly in the 2nd half to be seeing a 70/30 equipment metrology mix.

So even though the revenues are higher and the cost reduction programs are in place there's some pressure on margins that are due entirely to the mix of equipment and metrology.

But I think you'll see gains in margin 2nd half versus 1st half.

In data storage -- you know, in your first question, your other question, you know, in the 1st quarter we saw very strong orders in data storage, all five stenfeld head manufacturers bought multiple Veeco systems.

So in the 2nd quarter, we saw multiple orders coming from LED manufacturers.

You know, so each quarter, we tend to see the highlight of some multi orders in a particular sector.

In Q3, I think we'll see an improvement.

Some of the data storage orders we were chasing for Q2 have fallen into Q3, so we see an uptick in data storage orders in Q3, and probably a flattish, because performance was so high LED, MOCVD order content in Q3.

Some improvement in compound semiconductor, and overall orders up a little bit.

Thank you.

Our next question comes from Robert Mare of Needham & Company.

Congratulations on a nice numbers.

Thank you.

You would you give us a little bit of geographic color?

We've heard from some other people in similar industries of some particular strength in Japan, and weakness in other areas.

Maybe you could give us your sort of view of the world?

Well, in -- you know, we're unusual, Robert, as you know, because of our diverse product and market mix, so I'll kind of answer by market.

In this last quarter, Japan was strong, we had multiple AFM orders from Japan, in a prior quarter and in both quarters we had multiple customer orders in MOCVD, LED, both from Taiwan and from China.

We also had some strong orders from North America in this recent quarter on LED, MOCVD activity.

I think as you know there are sort of two groups of high brightness LED manufacturers.

There are the Tawainese, Chinese manufacturers, mostly aiming at the lower cost LEDs, and then there are the higher-end high performance LED manufacturers, North America and Europe.

So we see a good balance.

We don't see, as others might have reported, a hole in China for the 2nd half of the year.

You know, I think Japan will continue to be strong.

I think China will be strong for us in LEDs, and North American LED and data storage customers will also be strong.

So I see sort of a continuation to our geographic mix.

The cost of the diversity of the product.

Okay.

Good.

And another question.

When you purchased the assets from Emcore, one of the advantages of Veeco owning it as compared to Emcore was the fact that you don't compete with your customer base.

Have you seen any share gains?

Obviously your numbers are quite good in MOCVDs.

Is part of that through share gain, or is there more share gain to come?

What's sort of the -- where are you in terms of growing that business and changing that business from what it was under Emcore?

That's been a big positive.

We said when we made the acquisition, as you have described, that there were a lot of customers who were restraining themselves from buying MOCVD equipment from Emcore, because they were -- they considered them competitors, and they look forward to Veeco as an equipment company not competing with them in devices.

So we have seen a gain in market share.

Both from the point of view that older existing Emcore customers have a deeper relationship with Veeco than that had with Emcore.

They're sharing strategic road maps with us, they're letting us do modifications to the equipment that they were doing themselves, and there's a new class of customers who think, you know, who just refuse to buy from Emcore because of competitive reasons, who are now buying from Veeco.

So if you look at the last quarter there's $50 million, which a combination of MOCVD orders and MBE, is about 40 some-odd million of MOCVD alone, and I think if I remember correctly, Axtron's recent quarter was, I think, 30 million in orders.

So the 50-50 share has been disturbed, and Veeco has now increased its market share relative to Axtron.

Any -- last question.

Any relevant or interesting new customer wins in any of the product lines, or any changes in market share worth noting?

Well, the strength in orders overall, data storage, semi, and compound semi has really been on the benefit of penetrating all of the large accounts, and I think we've done better in these last 2 or 3 quarters penetrating the leaders both in compound semi, semi, and data storage.

Okay.

Thanks again.

Our next question comes from Mark Miller of Hoefer Arnett.

Congratulations on another solid quarter plus having the guts to stick your neck out in the 4th quarter.

Not a lot of people are doing that.

Just a question.

Talked to a couple of CEOs at companies recently, and they surprised me, because they were telling me that they thought the long dormant opticle fiber market, there might be some life it in next year.

I'm wondering if you see that.

God bless you.

Now, no, I don't.

The optical market is -- has been, you know, very quiet, has been reduced to sort of 2 or 3 spector I&B and deposition systems per quarter IM sources that are running about $20 million a year.

Mark, and we have not seen a change to that.

And in fact I fact, I think that with Y-Max, a lot of the fiber to the home opportunity will be accommodated by wireless connections to the home.

And so there will be certainly fiber within 10 miles of the home, but I think that last mile collection to the -- connection to the home, you know, could -- you know, could be more wireless than fiber.

And I think this just confirms with what you mentioned previously, but we've also talked to a couple of other people who supply equipment at data storage, and they said they did see some pushouts this quarter, but they were given assurances by a couple of firms who were pushing out that these orders would come back if not in the September quarter, December quarter.

I guess that's basically what you said, is that correct?

Yeah, we had forecasted, you know, after a 100% increase in Q1 orders in data storage that there would be some down -- a downturn in orders, and there were in Q2, and you've described correctly, you know, within data storage, there are always inventory adjustments and capacity adjustments, so some of this stuff that was pushed out from Q2 has already landed in Q3, and I think the 2nd half will be better than the 1st half, equal to or better than the 1st half in data storage, so, you know within despite movement quarter to quarter it will be quite a good growth year for Veeco data storage in '04.

Innovex, which supplies media deposition equipment surprised us a couple of weeks ago.

They said that CA was pushing to accelerate delivery of some of their perpendicular media tools.

Do you see perpendicular getting hotter right now in terms of time schedule?

Well, the -- for us, the perpendicular component will be in the head, since we don't run any media tools, and I think you're right.

I think that they've already begun work on the media for perpendicular recording, and they are just beginning to do that research and development for the heads.

The heads will require a whole new host of new magnetic materials, and so we do see that as an important '05, '06 head deposition equipment opportunity.

Thank you.

We'll take our next question from Brett Hodess of Merrill Lynch.

Good morning, Ed.

Good morning.

A couple of questions.

Again on the HP LED market, since it is such a big piece of the business today, you said you 33 systems ordered in the quarter.

Can you give us a little color about, you know, how broad that customer base is ordering those 33 systems, and what do you think the potential is for some of those customers competing with each other versus having different application markets?

Yeah, that's -- Brett, you know, unlike semiconductor, which has become a very efficient industry with a handful of very large foundries and device makers, LEDs is very inefficient.

There are probably 50 customers that we're selling MOCVD MD.

I mean, a very large number of customers, and even though there were, you know, multiple orders from 6 major companies, there were individual orders from a dozen companies.

And if I look at the Q3-Q4 prospect list, even in the absence of forecasted large buys, there are probably 20 or 30 customers in each quarter, so we -- it's a very broad industry investment, both China, Taiwan, and North America and Europe, that is somewhat inefficient, which is good for the equipment supplier, and lots of people jockeying around for market share, and a lot of investment money that's there, and, you know, there likely won't be a consolidation of that sector for a couple of years.

Ed, do you know if those bigger customers, are they typically going after the same end market, or do they have different applications they go after?

The larger customers, I hesitate -- you know, I'm mention only the names that they allow to, you know, Isram and Lumilos allowed their names to be mentioned.

They are, you know, the larger people like Isram and Lumilos are going a after different market.

They're going after automotive, high performance, high ASP, LEDs, large screen display, general illumination, architectural lighting, automotive applications, whereas for the most part, the 50 or so Taiwanese, Chinese manufacturers are going after back lighting for keyboard, cellphone, small color display.

So you have sort of multiple segments of that market that are being invested in.

And then next question.

In the research side, the seasonal pick up in 2Q, I'm wondering in the past, you've a bit talked about I think that system is where you get most of your nanotech business.

Is -- how is the nanotech portion of research trending at this time?

It probably is staying at sort of a 30 or 40% content, and I think nanotech is now, you know, correctly seen as having a contribution to information technology, so I mean certainly we see semiconductor, LED, and data storage feature sizes not only below 90-nanometer, but some as low as 20-nanometers, so its fair to recognize that as nanotech content, so probably when you combine our nanotech content in semi and data storage and compound semi with life sciences, it's probably approaching 50 or 60% content within the company.

Okay.

And then finally, a little earlier in the Q&A, you mentioned that data storage might see an uptick in 3Q and that the MOCVD probably flat after the 2Q.

The semi side was pretty strong in the the quarter just ended.

Do you think that continues to grow in orders in 3Q?

I think it will be, you know, it had -- it will be flat only because the -- it's hard to -- to compete with -- we had both very strong order AFM, some deposition equipment, and some opticle sales to that sector in Q2, at a very high level, I think a record level for us, so I would be pleased if it was sort of flattish.

Very good.

Thank you.

We'll here next from Mark Fitzgerald from Bank of America.

Thanks.

Can you give us what the -- in the backlog what semis is as a percentage of the backlog?

Mark, I don't think we do that.

Okay.

The question I'm kind of leading up to is given what's going on in the semiconductor base at this point with wafer starts being pulled back, how comfortable are you in terms of backlog being solid at this point, that we're not going to facing some pushouts and therefore I'm wondering how comfortable you are in terms of going out 2 quarters with your forecast?

Well, the forecast, as we stated, the 2-quarter forecast is based entirely on the fact that we have this $164 million of backlog.

We have not seen any extensions in semiconductor.

I mean, most of our semiconductor backlog is auto AFM, and auto AFM is, you know, so important to 90 and 65-nanometer metrology, that those people would take those AFMs as rapidly as we could deliver them.

Okay.

Fair enough.

And just also wanted to thank you for the forecast and GAAP at this point.

I think that's very helpful.

You're welcome.

I would mention also, Mark, that with regard to backlog, we do, in the compound semi area, have a reasonable level of the customer deposits, so that makes us feel comfortable that those are secure orders, that they're not cancelable.

Probably at a third in some cases of the purchase prices in deposit.

And we'll take our next question from Ali Irani of CIBC World Markets.

Yes, good morning, gentlemen.

Sound likes the diversification strategy is working.

Just to clarify on something and not to leave a false impression.

It seems to me that URA had some orders that are strengthening are really driven by the new applications at the 90-nanometer, 65-nanometer mode, and I was hoping you could give us some color around that rather than the decline in wafter starts at the older nodes, the 180, the 250, the 350-nanometer where we're seeing demissions and wafer starts slow down, and I'm hoping with that that you can give us a sense of the broadening of the discussions that you're having with customers for the 65-nanometer node, their more pilot work efforts there, and then I have a follow-up question for you.

Thank you.

Yeah.

I mean, due to the fact that our, I mean you're absolutely right.

Due to the fact that you know, for Veeco's case, we don't sell process equipment to the semiconductor industry.

We sell mainly the automatic -- auto AFM for 90 and 65-nanometer metrology projects and I think as everyone knows, the metrology content changes drastically when one goes from 120-nanometer to 90 and then reducing to 35, in that you simply need more AFM inline metrology tools at etch CMP lithography to keep your process equipment running to specification and to improve yields.

So today where there are probably 1 or 2 AFMs, Veeco AFMs in every one of the top 10 semiconductor device fabs, and as they fully deploy 90 and 65-nanometers, they have estimated they'll need between 5 and 10 AFMs per fab at those same etch CMP lithography points, and so, you know, that's probably a $250 million to $300 million opportunity over the next 4 years

Ed, you talked about the AFM market for so long.

Do you think that maybe perhaps us as an analytic community are a little bit sceptical about this ramp?

You mentioned just now that you're customers are estimating 5 to 10 per fab.

Are they actually giving you RFPs or requests for quotes at this point for the 300 millimeter projects that are beginning to take shape?

Are you getting some visibility that that talk is translating to at least the quot level?

Well, it's beyond the quote.

If you look at the 2 or 3, although we say there's 1 or 2 per fab right now, those people, those 2 or 3 manufacturers who are actually beginning to process 65-nanometer feature sizes have as many as 5 AFMs.

It's just a handful of them, but there are a handful that have 5 AFMs in the fab.

And this is in individual fabs?

Yes.

And inline?

Yes.

Now, when you look at the competition for the AFMs, there has obviously been a lot of talk about new entrance coming into the market.

Could you update us with that, and whether it's slowing your customers' appetite for your tools, and whether you're seeing some other types of technology for the same applications being considered by the customers, or is the decision at this point made that AFMs will be part of the 300 millimeter inlines ramping up?

I think it's the latter.

I think, you know, the entrance of KLA to the AFM product area is sort of a reconfirmation that this must be a business, and KLA has introduced sort of an entry level 1D AFM for etch measurement, and there are a couple of beta sites in the field.

It appears not to be a 3 dimensional machine, and doesn't seem to be designed for 65 or 40-nanometers, and doesn't seem to be designed for lithography and mask, CMP and lithography applications.

So a more limited product offering, but from a very powerful company, who I think have sort of have reconfirmed that there is indeed an AFM opportunity at 90 and 65-nanometers.

Has it changed any of the pricing discussions you've had with customers or has it materially impacted any business that you would have gotten and is now being dual sourced, be it just for the etch applications?

No, no, and no.

We've not lost any orders, pricing hasn't changed, and, you know, the appetite for AFM, I think, just continues to grow.

Right.

Thank you very much.

Next we'll here from Graham Tanaka of Tanaka Capital.

Yea, good quarter.

I was going to ask you -- those were great questions on AFM entry by KLA.

Have you heard of anybody else being interested the market?

Really the only alternative?

Yeah, Graham, remember that also unique to Veeco is the fact that we are, you know, a $120 million AFM company that extends itself over research AFM as well as production AFM, and so there are competitors on both sides and the research AFM, tabletop business if you will, where the ASPs are 150,000 to 200,000.

There's probably 10 manufacturers.

I mean Veeco is a very large player, but there have been a lot of people entering the research AFM business in a small way.

There are no big name, except for Seiko.

Seiko is a research AFM provider, and I don't know that there's anybody else entering in the auto AFM area.

The other thing I was wondering, just how the acquisitions were going now that they've been digested, relative to expectations, and what are the growth expectations?

They're looking pretty exciting, one of them, at least.

Well, in November, when we completed the TurboDisc, and the advanced imaging applications, we said that they would be about a $90 million revenue contribution combined to our 2004 result, and they would be accretive.

I guess they're going to north of 100, with -- with probably a different mix.

TurboDisc is higher than we had estimated, and advanced imaging is probably a little less than we had estimated for the year, but both are strong contributors to the '04 and '05 year.

Integration is going very, very well.

We're seeing new markets for advanced imaging products.

This last quarter, although I would say their advanced imaging orders were very, very modest, they did include some orders outside of the Seagate activity and we'll see more of that I think in Q3 and Q4, but the big winner certainly has been TurboDisc, where, you know, in November that was a division within Emcore that was having about $5 million of quarterly orders, and just completed a $40 million order too.

So that's an unusual growth, and I think it will continue for the next 2 or 3 quarters.

Great.

Congratulations.

Thank you.

Next we'll hear from Matt Petkun of D.A.

Davidson and Company.

Hi Ed, or maybe this is question for you, Jack.

Because of the strength that you're seeing from the MOCVD business, can you update us about your expectations for the earn-out feature of the acquisition acquisition there?

I believe it was -- I don't know if it's 20 million in total for fiscal '05.

Twenty million, we're going to be very pleased to pay the 20 million.

And will it be in cash or stock, and can you kind of highlight how the payments might go over the next couple of years?

It will be in cash at our option.

It will be in cash, and it will probably be paid in this current -- I should say 2005 1st quarter.

And it will be -- the nice thing about it is it will mean the acquisition will still have been done for less than one-time sales

Very good.

And then Ed, as you kind of look out over the next couple of years, you've highlighted some high growth new markets for you, especially enabled by the HP LED market, and some of those end markets are automotive potentially interior lighting, and those aren't markets that one might normally associate with high margin business.

How do you see your gross margin profile going especially with that in the mix, and could you -- do you see pricing pressure longer term in that market, and perhaps, you know, what could that do to your overall gross margin profile moving out maybe 2 or 3 years?

Well, I think the -- you know, the brand new consumer product growth that we see, iPod, game boxes, PDAs, cellphones that could contain one inch or half inch drives, and automotive applications, represent, you know, at a factory level almost a doubling of wafers, if you look into compound semiconductor wireless and data storage activity.

So this is a very big opportunity, and I think, you know, the consumer products -- you may see a shift at some of our customers become the larger consumer names, you know, rather than the traditional computer manufacturers, but I don't fear that, you know, their margins are going to damage us.

What I'm more concerned about is the mix within Veeco of process equipment and metrology will continue to be a big influence as to our blended gross margin, and so it is important that in each of these markets we start to provide more and more metrology solutions in data storage, in compound semiconductor, in LEDs, for these growth opportunities, so that we have, you know, a more traditional mix of Veeco process equipment and Veeco metrology so that our margins, you know, are closer to 50% going forward.

Okay.

But you would assume or hoped that you could maintain your historic process equipment gross margins going out the next couple of years serving these markets?

I think we have to improve them.

We're not so happy with our process equipment gross margins relative to metrology, and, you know, Jack and I have always said that in these next 2 or 3 quarters, need to see a couple of percentage point increase in process equipment, and sort of a maintenance of the decent margins that we get in metrology, and need to watch the blend.

Okay.

And then my final question, I think would be kind ever in line with that.

When you look out of the next couple of quarters and you talk about talk about some cost control measures and gross margin goals, what do you see from a facility standpoint.

I know you made a couple of acquisitions last year that give gave you some new facilities, and what do you expect you can do in terms of fixed costs and reducing fixed costs going forward?

Well, I think, you know, in the immediate future, the -- certainly the capacity that we have in compound semiconductor, which is the major -- one of the major acquisitions, we're going to need those facilities, so I don't see any real reduction there.

We have, as you probably know, taken out two factories, and two other sites at the end of -- or the beginning of 2003, so I think that we -- considering the ramp that we have in orders right now, I think consolidation of facilities in the immediate future is not something that we see happening.

But what we are doing, and I think we've just started, and we've not yet seen the margin benefit, is better supplier management.

The company now is organized around sort of three supersites: data storage, a compound semiconductor, and a metrology supersite, where we're now buying materials for the combination of all of our equipment groups.

And the combination of our metrology factories.

So we will see some purchase -- favorable purchase price variance, and just collective buying, and as Jack said, we're starting to fill both the New Jersey factory and the St. Paul factory with MOCVD equipment that we can build in two factories to accommodate this ramp.

They will soon have an 80 or $90 million backlog in MOCVD.

Okay.

Thank you.

And we'll move on now to Ben Ping of Prudential Equity Group.

Hi, good morning.

A couple of questions.

Can you take about what the backlog is in terms of service?

How much service is in your backlog?

And also for the AFMs, can you comment on kind of the mix between how many tools you guys are selling into production, and how many are for R&D?

I'm not sure that we break out.

The service runs 20 to 25% of our revenue.

Okay.

So I would guess that its backlog content probably reflects that.

Okay.

In terms of AFM, you know, we have 7,000 research AFMs in the world, and probably 200 auto AFMs in the world, and, you know, so -- and in terms of the revenue, there's probably about -- this year there will probably be about 80 million in auto AFM -- I'm sorry, in research AFM -- 80 million in research AFM revenue, and about 45 million in auto AFM revenue, just to give you some sizing.

Okay, and in terms of the research, the research part of your business, the expectation is that that should pick up seasonally?

Yeah, but you know, I think of its a -- I think in the next year or two, that's going to be sort of a GNP growth.

I think we -- a lot of investment has been made in nanotech research in life sciences and we need a year or two for that to reach the Fortune 100, Fortune 500 and so I think of scientific research which over its lifetime has grown sort of high single digit GNP-like growth rates, and that probably accurately allows you to model it over the next two or three years.

Is that what's the primary driver for the north American business?

No.

What is there in North America?

Data storage and LEDs.

Okay.

Okay.

Perfect.

Thank you very much.

Operator we'll take one more question.

Actually that was our last question, so I'll turn it back to you for any additional and closing remarks.

Great timing.

I want to thank you all for your attendance, and we look forward to a positive and productive Q3, and we will talk to you after the 3rd quarter.

Thank you all.

That will conclude today's conference call.

Thank you, everyone, for your participation.

You may now disconnect.