Veeco Instruments Inc (VECO) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to the Veeco first quarter 2005 results conference call.

Today's call is being recorded.

For opening remarks and introductions, I would like to turn the conference over to the Vice President of Corporate Communications and Investor Relations, Miss Debra Wasser.

Please go ahead.

Good morning, thank you, Operator and thank you all for joining our conference call this morning.

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

Veeco announced our first quarter 2005 results 7:00 a.m. eastern time this morning.

If you haven't yet seen the Press Release please visit the Veeco.com web site or call 516-677-0200, Extension 1403 to get a copy.

We also announced that Veeco will be appearing in several important investor conferences during the month of May.

This call is being recorded by Veeco Instruments and is copyrighted material and cannot be recorded or rebroadcast without Veeco's express permission.

Your participation implies consent to our taping.

To the extent this call discusses expectations about market conditions, market acceptance and future sales of Company's products, future disclosures, future earnings expectations, or otherwise makes statements about the future, such statements are forward-looking and are subject to a number of risk and uncertainties that could cause actual results to different materially from the statements made.

These factors are discussed in the business description and management's discussion and analysis section of the Company's report on Form 10-K and annual report to shareholders.

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

Information regarding such non-GAAP financial measures, including reconciliation to GAAP measures of performance is available on the web site.

This call is webcast live at the Veeco.com web site and available for replay in archived for future reference.

The Company does not plan to update the information on the webcast once it's archived and I would know like to turn the call over to Ed.

Thank you, Deb.

Good morning.

Today we reported our first quarter 2005 results and we're pleased to report first quarter revenues and bookings above our guidance. and EBITDA profitability in line with our guidance and are on track with our stated 2005 margin and profit improvement plan.

Revenues were 93.9 million, up 3% from the first quarter of 2004 and above our guidance of 85 to 90 million.

Gross margins increased to 40%, compared to 37.5% in the fourth quarter of 2004, and in line with the guidance despite reduced sequential revenue.

Net GAAP loss was 4.7 million, or a loss of $0.16 per share.

Earnings excluding amortization and certain charges were a penny per diluted share, in line with the guidance of being in the range of zero to $0.02 per diluted share.

Bookings were $98.9 million, above our guidance of $85 to $90 million, and flat with Q4 of 99 million.

Veeco has now reported two sequential quarters of $99 million in overall bookings, increasing our backlog and supporting our outlook for a flat 2005 revenue year, with improved profitability.

Our improved profitability is resulting from staffing reductions taken in Q4 and some in Q1; and a series of material cost reductions, new product introductions and a favorable product mix change which we will see throughout 2005.

Namely, increased revenue of higher margin data storage products and a decreased revenue in lower margin, high brightness LED-MOCVD products, and stable revenue in high-margin metrology products.

All are in line with our previously stated goal of 2% per quarter gross margin improvement for each quarter of 2005.

Despite what we expect to be a flattish revenue for 2005 compared to 2004.

So the gross margin plan we previously spoke of called for a 40% gross margin in Q1; 42% in Q2; 44% in Q3; and ending the year with a 46% planned gross margin in Q4.

That's per the outline of our March call.

I'll highlight Q1 financials, our guidance for Q2.

I'll comment on market sector conditions and our continued outlook for the year.

Jack will review financials and we'd be pleased to answer your questions.

First the revenue again was $93.9 million, up 3% year-over-year and down 9% sequentially.

Sequentially, data storage was 25.6 million, down 14%.

Semiconductor was 17.4 million, up 14%, with record auto AFM revenue from semiconductor.

Wireless was 22.3 million, down 14%; and scientific research 28.6 million, down 10%.

Again, above the $85 to $90 million guidance for the quarter and including record quarterly auto AFM revenue of nearly $14 million.

Demonstrating continued strong acceptance of our auto AFM products from semiconductor users at 90 and 65 nanometer line applications.

We have the benefit of market diversity as we continued to have about 33% being the combined semiconductor wireless content.

Scientific research 30% of our revenue and data storage 27% of our revenue.

In the orders, orders for the quarter were 98.9 million.

Flat sequentially and down 15% year-over-year, reflecting a stable continued order rate with strength and data storage.

Data storage in the quarter was 45.3 million, up 26% with a book-to-bill of 1.77-to-1.

Wireless was 14 million, down 23%, a booked-to-bill of .63-to-1.

Semiconductor was 14.4 million, down 21% with book-to-bill of .83, similar to the industry.

And scientific research 25.2 million, down 6%.

So overall sequentially flat bookings of about 99 million, with an overall book-to-bill of 1.05 to one.

Again, this was above our guidance range of 85 to 90 million.

Our backlog increased to about $144 million.

Very strong data storage growth now for two quarters, two sequential quarters and we expect data storage growth to continue in the second quarter.

We expect high data storage orders in the second quarter.

Data storage orders, again, were $45 million, a recent record, and included multimillion dollar orders from all five leading thin film (ph) head manufacturers.

So market diversity helped us in the order side, with 46% of our orders being data storage; 29% being the combination of semiconductor wireless; and 25% coming from the scientific research.

The EBITDA 2.6 million, in line with our guidance, below Q4 in the prior year.

Gross margins -- a very important program within Veeco -- were in line with the guidance, 40%; above Q4, which was 37.5%, and include 30% gross margin in process equipment, which was the combination of ion beam coming in 36% gross margin, and epitaxial equipment coming in at 22% gross margin.

And metrology continued to have high margins, 52% for the quarter.

Operating expense was $35 million, or 37%.

We slightly reduced our head count in epitaxial equipment during the quarter, about 30 people.

Inventory was $106 million, down 4.4 million from the previous quarter.

Accounts receivable stayed at 65 days.

Cash was slightly positive, with operations generating slightly over $15 million, and we paid acquisition earn-outs about $15 million in the quarter.

Our balance sheet remains strong with $107 million in cash.

Our outlook for the June quarter -- we see continued data storage booking strength and overall stable revenue, with continued emphasis on improving profitability throughout Veeco.

In Q2, we expect orders and revenue to be between $90 and $95 million.

We see continued gross margin improvement to 42% total gross margin expected in Q2.

Earnings, excluding amortization, to be between $0.04 and $0.07 per share, and a loss of $0.06 and $0.10 a share on a GAAP basis.

We remain focused on our top priority for 2005 -- improving Veeco's overall profitability.

Our outlook for 2005 reflects a relatively flat revenue year with a product mix change that increases gross margin with sales higher in data storage, lower in epitaxial equipment and stable in metrology products in the '05 year.

In addition, Veeco's fourth quarter spending reductions are now impacting the increased gross margins we witnessed in Q1.

Our comment on market sectors starting with data storage, in data storage we had orders up 26% in the quarter, which followed a 91% increase in the fourth quarter.

Record orders of $45 million included Veeco ion beam slider optical metrology and auto AFM buys, again, multimillion dollar orders from all five leading hard drive manufacturers, including the first data storage purchase of a X3D auto AFM for metrology applications at Pulltip (ph).

Drive manufacturers are reporting approximately 90% utilization rates in wafer fab and nearly 100% utilization rates in slider backend factories.

Many have announced planned capital spending increases, intended in '05.

Clearly we see the small format one-inch consumer drive are forecasting to have continued 30% growth rates over the 2005-2006 timeframe.

These are in iPod MP3, DVD, TV recorders, game, home entertainment boxes, and soon high-end cell phone applications.

We see both capacity buys and technology aerial density improvement activity for new perpendicular heads expected to be in production in late 2006 or early 2007.

As handheld microdrives will approach 60 to 80 gigabyte capacity and desktop will approach 500 gigabyte to one terabyte in the '07 timeframe.

This really, to satisfy digital video downloaded TV storage applications, with 10 drives expected per home in the '07-'08 timeframe.

Overall industry drive revenue and drive units are growing year-over-year, with industry forecast as high as 20% growth for 2005.

Heads per driver increasing with 2005 forecasted growth up 20% in heads to 900 million thin film heads required in 2005, up from 740 million in 2004.

This strong Veeco data storage order trend is expected to continue into the June quarter.

As major drive manufacturers continue their announced expansions and increase capital spending.

Our equipment backlogs for plain view and ion beam products for Tucson and metrology and for Veeco, CA slider process equipment, precision lapping and slicing, now extend to Q3 in backlog.

We expect a 20% 2005 revenue growth in data storage within Veeco.

In our semiconductor sector first quarter orders of 14.4 million included multiple auto AFM orders from two customers and record auto AFM revenue in the quarter.

So despite our earlier expectations of an industry-wide semi-CapEx softening, we see continued worldwide acceptance of our auto AFM and wafer fab for 90 and 65-nanometer applications where utilization rates remain higher than the rest of the industry.

In general, our AFM sales will be paced by deployment of 90 and 65-nanometer lines in 2005 and 2006.

KLA, a key competitor, has withdrawn their AFM product and has returned beta sites so that our competitor position is strengthened.

Veeco has, indeed, the broadest line of 3-D AFM non-destructive metrology solutions.

Our goal is to continue to be a step ahead of the industry at 90-65 and eventually 45-nanometer applications.

The top 10 semiconductor device manufacturers have all at least one or two AFMs in line and wafer fab applications with over 250 systems installed.

We see a total available market going forward of as many as 10 AFMs per fab and we've launched new systems for specific applications in etch, CMP, CD control and photo lithography applications.

In addition, we're making progress in our tip development road map for 45 and 25-nanometer applications.

In LED wireless, our first quarter orders of 14 million reflected an overall industry downturn.

We expect a revenue decline in 2005 as mobile cell phone growth has slowed and Taiwan and China clearly have continued to have excess capacity.

The next LED growth opportunity lies in the area of large area flat panel LCD TVs and emerging automotive lighting applications, both expected in 2006, along with new cell phone introductions that are capable of downloading a music content and video content expected later this year.

The LED market is forecasted to double from 3.5 billion to 7 billion in the next five years.

Driven by blue, green and white LED penetration evolving from keypad and color display to 20 and 40-inch flat panel TVs.

Automotive tail light, turn signals and interior lighting, and eventually headlight applications.

Specialty lighting for buildings, bridges, museums, airports, and high resolution signs.

And eventually, in 2008 to 2010, to general illumination allowing a penetration of a $12 billion worldwide lighting market toward the end of the decade.

Veeco will use 2005 to improve gross margin in our epitaxial products; to improve product reliability; to reduce our warranty costs; and to introduce the Ganzilla II, a new product to be introduced in mid year; and to be profitable by the fourth quarter and prepare for growth in 2006.

In scientific research, our orders declined 6% in the first quarter to 25.2 million.

We see continued strength in our profitable optical and AFM metrology products, in material science and life science and nano tech material applications.

We'll introduce new metrology products for extended applications in the second half of 2005 to grow this profitable Veeco segment.

I'll pause here for Jack to comment on financial comments and then we'll come back for comments and your questions, Jack?

Thank you, Ed.

The three month ended March 31, 2005 sales were $93.9 million, representing a 3% increase from the first quarter 2004.

Increase is attributable to a $1.9 million increase in metrology sales, including 2.7 million from AFM offset by reduction in optical metrology sales of 800,000, and an increase of 1.1 million in process equipment, including an $8.6 million increase in epitaxial equipment, partially offset by a reduction in sales of 7.5 million from the ion beam and mechanical segment.

Market sales up, compared to prior year, by 30% in semiconductor and 31% [inaudible] wireless; down by 19% in data storage and 2% in research.

Sequentially, sales decreased 9.1 million, or 9% due to a 2.6 million decrease in ion beam and mechanical, a 4.6 million decrease in epitaxial, and a $1.9 million decrease in metrology sales.

First quarter 2005 orders were $98.9 million, down 15% from the first quarter 2004 and equal to the fourth quarter of 2004.

Gross profit was $37.5 million for the quarter, or 40% of sales, compared to 36.8 million, or 40.5% of sales in the first quarter 2004.

The first quarter 2004 gross margins were 38.3 million, or 42.1% of sales, excluding a $1.5 million charge related to the capitalization of manufacturing profit inventory.

We added to acquisition accounting of the [Inaudible] and Aii acquisitions.

The reduction in gross margin in the current quarter is primarily attributable to the epitaxial profit equipment margin declines, resulting from certain warranty issues in the [inaudible] CBD product line market and the tool mix in MBE.

Sequentially, gross margins improved 2% from 38% to 40%, as both profit equipment and metrology gross margins increased in the quarter.

We believe that gross margins will continue to improve in the second quarter of '05 and will improve in each quarter of 2005 due to improved pricing in new products, reduced warranty expense, as well as material cost reduction initiatives.

We expect the second quarter 2005 gross margin to improve by 2%.

The improvement in the margin in the second quarter that we are forecasting is for all segments, but is most significant in process equipment.

We expect ion beam and mechanical process equipment to improve to 40% from the current 36% as result of ion beam increases of approximately 35%, as well as cost reduction completed in our slider business.

While we anticipate a reduction in epitaxial process equipment sales, we believe there will be a margin improvement in the business due to the better supply chain management and reduced warranty expense.

Metrology gross margin should improve, as well, due to better product mix.

Selling, general and administrative expenses were 20.2 million, or 21.5% of sales versus 19.9 or 21.9% in the first quarter 2004.

SG&A was down 1.2 million sequentially, principally due to lower selling commission expenses resulting from lower sales.

We expect a modest increase in operating expenses in the second quarter '05, due to increased profitability that will result in an increase in intensive compensation accruals .

R&D expense totaled 14.8 million, an increase of 800,000 from the first quarter 2004 and flat sequentially.

The increase occurred principally in process equipment and more specifically in MOCVD, where a new Ganzilla product, as Ed mentioned, is being introduced in the third quarter 2005.

As a percentage of sales, R&D was 15.8% compared to 15.4% in the first quarter 2004 and 14.4% in the fourth quarter of 2004.

Overall, operating expenses as a percentage of sales were 37.2%, up slightly from 37% in the first quarter of '04. [Inaudible] expense totaled 4.5 million in the first quarter 2005 versus 4.[inaudible] first quarter 2004.

Other income for the first quarter of $98,000 was related to rental income or sub-leased facility space, compared to income of $286,000 for the first quarter 2004.

We added principally to foreign exchange.

That interest expense was flat at 2.1 million compared to 2.2 million in the first quarter of 2004.

Veeco's first quarter 2005 operating profit before amortization was $2.6 million, compared to $4.7 million in first quarter 2004, including the purpose accounting adjustments of 1.5 million in the prior year quarter.

Veeco's 2005 GAAP net loss was $4.7 million, or $0.16 loss per share compared to a net loss of $2.7 million, or $0.09 loss per share in the first quarter 2004.

Backlog at March 31, 2005, was approximately $144 million.

With regard to guidance, we are currently forecasting second quarter revenues in the range of 90 to 95 million, with forecasted GAAP loss per share in the range of $0.06 to $0.10 per share.

Our earnings per share, excluding amortization cost of $0.04 to $0.07.

Amortization is expected to be approximately $4.1 million in the second quarter.

Balance sheet and cash and cash equivalents totaled 100.7 million at March 31, 2005 and we're quite pleased we generated $400,000 in cash during the first quarter 2005, despite making payments of $15.1 million for earn-outs relating to two acquisitions.

Accounts receivable decreased by 13.2 million from December 2004 due to lower sales volumes, while DSOs remain 65 days, an excellent level compared to industry norms of 79 days.

Inventory decreased $4.4 million to $106.2 from 110.6 at December 2004, due principally to a reduction in both epitaxial process equipment and metrology inventories.

Inventory returns remained at two times.

CapEx expenditures were at $1.8 million first quarter 2005 and depreciation expense totaled $3.2 million.

Our balance sheet and cash position of nearly $101 million remain strong.

At this point we'll return to Ed for additional comments and your questions.

Thank you, Jack.

Overall Veeco's market diversity coupled to our technology leadership in segments that are critical to the growth of new digital wireless consumer electronics are an important part of our strategy, including embedded hard drives, wireless, high brightness LED, 90 and 65-nanometer semiconductor devices , and nano material applications.

All of these opportunities, I think, position us to benefit from high potential growth opportunities of new consumer electronic products and the converged technology that we're all seeing in the '05-'06-'07 timeframe.

So we feel good about achieving our goals for '05 and we feel good about the growth opportunities that consumer electronics and converged technologies will allow us in the '06-'07 timeframe.

Operator we'd be pleased to take questions.

Thank you, sir. [Operator instructions.] Our first question comes from Timothy Arcuri of Smith Barney.

Hi, guys.

This is actually Dan Berenbaum for Tim.

Couple of questions.

One on orders and one on gross margins.

In the data storage orders category, and correct me if I'm wrong here, maybe you commented on this already, it looks like the order increase was driven mostly by metrology.

Given the fact you're talking about very high utilization in the head fabs, is there some reason why they -- the customers wouldn't order more process equipment in the coming quarters?

Do you have any visibility on that?

Secondly, on the epitaxial gross margins, it looks like those gross margins were actually down sequentially and I assume that's due to the revenue increase, but could you comment a little more specifically on the gross margin improvement plan there?

Sure.

Dan, no, the -- I'm sorry if we gave the implication the data storage order strength was in metrology.

We did mention that it included in X 3-D.

It was the first auto AFM they purchased.

But no, the $45 million of orders in data storage were quite broad and they were included -- ion beam etch and ion beam deposition and slider process equipment, as well as metrology.

It wasn't largely metrology.

But it was very broad, in that it included all of Veeco's products.

But we do expect going forward to continue to see metrology and process equipment participation in high order rates coming from data storage.

In terms of the gross margin plan we gave a lot of information in the last call -- in the March call -- and you're absolutely correct, we said, you know, we're going to improve our gross margin two percentage points per quarter and 40% was the goal for the first quarter and we achieved it, despite the fact that -- we also gave guidance actually per business segment.

We said that ion beam and mechanical equipment would start, we thought, about 36% gross margin, and they did.

We said that epitaxial equipment, we thought , would start with about a 25% gross margin, and it actually came in at 22%.

So it is a little lower than the original plan.

Volume was an impact there, and also just getting the newer orders at higher gross margins might take a little more time.

We did see reduction in warranty costs, but we're probably lagging a little bit in the gross margin improvement intended in epitaxial equipment, but we intend to end the year above 33% as we originally outlined in epitaxial equipment.

In metrology, we said first quarter would be 52% gross margin and it was.

Those rolled up to 40% gross margin right on plan, with two of the business segments being exactly on plan; and one lagging slightly, but making good progress in reducing costs.

Okay, so then if I could ask a quick follow-up on the LED.

When do you think the orders are going to, I realize this is a little bit of a broader question, but when do you think the orders will help you out there to catch back up to your gross margin plan?

Yeah.

Dan, I think, Tim sort of mentioned in his report this morning, I think, we've always said that the, you know, this next wave of order increase, which comes from flat panel TV and automotive applications, I really expect to be a very late '05, early '06, event.

Okay.

Which would put, you know, pressure on our gross margin plan, but so be it.

We're going to have to reduce costs as we are.

Okay.

Great, thanks.

We'll now go to Andrew Suthven (ph.) Northeast Research.

I was hoping to revisit the question the previous gentleman asked and that was: Box balancing into the second quarter, gross margins that are expected to be 42%.

You gave guidance at the ion beam, you expect that to be about 40%.

Help me out with the epi and metrology.

We will see ion beam and process and mechanical process group increase, well above it's 36% performance in the first quarter.

In the second quarter.

Yeah.

I think Jack mentioned 40%.

Yes.

But we have two squares with a blank in it, epi and metrology.

Metrology will move up above 52%, as it was in the first quarter.

So it will gain, probably, a percent or two in gross margin in the second quarter.

So will epi.

Okay.

Ed, I think on the last call you mentioned that the Plain View facility was getting pretty close to being fully utilized on the capacity basis, and that there were only a few slots left.

I was wondering if you could give us some -- the latest and greatest there?

Yeah.

Probably fully booked, I think, for Q3; there's still room in Q4.

We said on the call, they're working one shift, so one of the things we're looking at, if there's a way to deliver some of that product in Q4 and Q3, we could go to an extended manufacturing shift in that facility.

In the second half of the year.

Okay.

Then I have a sort of just industry question for you.

From what I gather, the metrology -- AFM and scanning probe microscopy markets are growing at double digit growth rates and I was curious as to why the guidance is, for 2005, is 3% to 5%?

Do you think you're losing share or what is behind that?

That was a nice piece, incidentally, your write-up on the markets.

Thank you.

I think you were right about the 20% expected growth in metrology overall.

But that's probably aligned to growth, both in semiconductor, data storage, industrial research and scientific research.

As we break that number down, we're clearly seeing double digit growth in auto AFM for semiconductor.

We're now seeing double digit growth in metrology for data storage, but we still see single digit growth in life science and scientific research.

Until we get some new products introduced that penetrate those markets.

Okay.

We'll have metrology growth overall that will be higher, but largely driven this year by our growth in semi and data storage.

Okay.

And, then, Ganzilla II, that's still on track to be released in -- or in production in the -- in the third quarter?

Yes.

And that will be a big improvement in brightness, in uniformity, run-to-run, wafer-to-wafer -- to help people who have a pretty serious binning problem right now because they don't get good uniformity across the run.

Hopefully, it will lower the cost of ownership of MOCVD by having some enhancements in it.

Okay.

Then, Jack, I have a question for you.

Just sort of on a guidance basis, going forward, what should we be using as a tax rate?

Well, we, for a -- on the pro forma basis we show a 35% tax rate.

But on a GAAP basis?

On a GAAP basis, we're running about $1 million a quarter for foreign taxes.

You probably know we--

Uh-huh.

-- have NOL, so we don't have to record U.S. taxes, even after we turn profitable until we fully utilize the deferred tax asset that was reserved in the end of 2004.

What -- when I think about the effective tax rate for all your foreign sales, what number should I use?

25%.

25%?

Yeah.

Okay.

Good enough.

Thank you very much.

Thank you.

We'll go next to Robert Reitsas (ph), Bear Stearns.

Mr. Reitsas (ph) your line is open, please go ahead.

We'll move on to Robert Maire, Needham.

Okay.

A couple of questions.

Could you tell us where you think we are in the current upgrade cycle in the data storage industry, how far along and when the next upgrade cycle is?

Just your view?

Yes, Robert.

I commented that we're seeing both capacity increases in wafer and slider, you know, for the 80-120 gigabyte platter size, but we're also seeing R&D for perpendicular recording heads, which are in development and will reach manufacturing in the late '06, early '07 timeframe.

Probably coincident with the 160, 180 gigabyte platters.

So we're seeing, businesses healthy because it's both the capacity expansion of existing drives; largely the under 1.8-inch drives, including the 1-inch drive, and development of -- for aerial density that's required for the 1-inch drive to penetrate these consumer electronics with a higher capacity.

I think we'll see '05 will really largely be about capacity getting microdrives into deployment and '06, '07 could be helped by a generational trend -- or change to higher aerial density perpendicular heads.

Okay.

Great.

In terms of your re-organization of your turbo disc operation.

You gave us some detail on that, maybe a little more granularity as to, you know, where you are in your timetable and are your views roughly the same?

In terms of gross margin?

Where we can get to?

In that area?

Yeah.

I think you know as I commented earlier, that we continue to expect gross margins to be 32, 33% at the end of the year.

Despite rather sluggish revenue in '05.

Better revenue in '06.

That will help the gross margins.

We will have a new product introduced in June, and that will help, and we are doing very well in reducing what were high warranty costs in the '04 timeframe.

So basically that restructuring is going along more or less as planned?

It's on track, despite the fact, Robert, the gross margin in the first quarter was one or two percentage points lower than where we wanted it to be.

Okay.

If you could, maybe, provide us a little comment on the LED market?

Obviously, we went through a little bit of a, I guess, capacity issue for a while there.

And where you think we are in terms of the LEDs for lighting or other applications?

It seems, maybe, we've hit a little bit of a weak spot in here, I'm not quite sure.

I think we're in a transition where cell phone growth has slowed, and flat panel TV and projection TV and automotive applications haven't fully blossomed yet.

People have introduced products, mostly for shipment in late '05 timeframe.

So I think we'll see a couple more quarters of industry downturn, and, then, late '05, early '06, we'll see a rather dramatic pick up as 20-inch and 40-inch and projection TV are backlit with white LEDs and there will be four or five cars on the market with all solid state lighting.

And phones could surprise us and come back, because there are, even now, people talking about downloading TV and video into cell phones, which might require larger screens and better back lighting.

It is also interesting that the iPod is talking about becoming a cell phone and MP3s talking about becoming cell phones and cell phones are talking about becoming MP3s.

I think we could see '05 growth we didn't expect later in the year in cell phones as well.

Okay.

Very good.

One last, quick question.

In terms of KLA's withdrawal from the AFM market, have you heard anything as to what they're doing there?

Just withdrawing the product to come back later on with an upgraded product?

Or, any sense as to what's happening over there?

The limited G-2 we have comes largely from the group of analysts who are watching this along with us and the comments are that they've withdrawn the product and taken all of the beta sites back and taken it off the web site and no longer quoting it for sale.

They have told people this is an important market sector and they'd hope to have a product a year from now.

We'll be back.

Got it, thanks.

Thank you.

Our next question comes from JoAnne Feeney, Punk Ziegel.

Good morning, guys.

Congratulations on the orders and reps.

I just had a couple of questions about the introduction of the new GaNzilla II system.

Do you have any figures for us on the gross margins you expect?

Specifically from that system, is there a change in the design in the build process that gives you confidence about that gross margin?

Yes.

That build of materials has been cost reduced.

Performance has been enhanced and probably will have the ability to have slightly higher ASPs because it will have brighter films and lower cost of ownership, even at a higher selling price, the cost of ownership to the end-user will be lower and I think it can have 35-40% gross margins.

Okay.

Then.

[Inaudible].

-- over to the metrology side.

As the industry ramps up, finishes 90 nanometers and gets into 65 nanometers are you seeing new applications for auto AFMs or are you seeing the introduction of some of your systems into some of the consortia that are exploring new uses for it?

Can you tell us anything about possible new applications?

Yes.

The applications at 65 nanometers and beyond continue to be etch, CMP, photo lithography steps.

Where a fab would want to be able to look at more sites and more wafers at each of those critical steps and go to, you know, five to 10 AFMs per fab, rather than one or two per fab.

So, as the line with a -- shrinks, the content of AFM and indeed the content of all advanced metrology in those fabs will increase.

So we already see some consortia companies using four or five AFMs per fab as opposed to one or two a year ago.

I think we'll see more at 70 and 45 nanometers.

Okay.

And then, finally, just back to your operating expenses.

With the release of the GaNzilla II system, obviously, you had some increase in R&D expenses to get that ready.

Is that something that you will care to speculate on how we meet see the percentage of R&D expense go down over the next few quarters?

I don't -- I think we're going to continue to spend, the R&D spending is over a longer time period than one or two quarters to get a product.

So -- I'm not sure you could expect to see, you know, bumps and values in R&D coinciding with product introductions.

You know I think we want to continue to spend 14% or 15% in R&D overall to have year-over-year new product introductions.

We have said we'd like to try to take a couple of percent per quarter out of operating spending going forward.

I would expect to see that in sort of the Q3-Q4 timeframe.

You're saying, then, that's primarily going to come out of SG&A?

Yes.

Okay.

Then the other gains we're looking for are in the gross margins?

Yes.

Okay.

Thanks a lot.

Next is Brett Hodess, Merrill Lynch.

Good morning.

Ed, I got three questions: The first one is, if you look at the data storage in the auto AFMs those are the highest ticket items and they have higher gross margins.

They also tend to take, I think longer for revenue recognition, so does that imply that in the second half we should see an acceleration in revenue and gross margins?

As those things start to hit revenue recognition?

Yes.

You're right.

Datar storage and auto AFM, in fact, are the two increased backlog portions of the Veeco slot plan going forward, where, as I spoke about already being booked into Q3, and that's clearly the case in auto AFM, and in data storage, where the margins can expect to be increased during the year and you're also correct that those tend to be bifurcated sales because they have lengthed customer acceptance requirements, and you'll see increased revenue and margins from both of those areas in the Q3-Q4 time frame.

And that will be a little quicker pace, do you think, than what we've been seeing now, since, you know ,some of that delayed revenue recognition?

Yeah.

Also, if you look at the book-to-bill, you know, in the first quarter we were still really shipping data storage product from the third quarter of last year, where we had low order rates.

Those book-to-bill in data storage in the first quarter was almost 1.8 to 1.

We're going to see a pretty significant ramp in data storage revenue, Q2, Q3, Q4.

The second question I had was in the scientific research side, how important is the nanotech applications at this point, in terms of a driver for that business this year?

It's very exciting in development and ,you know, we mentioned, I think, a quarter ago we received a combined, niched grant with Dow and Veeco, working on nano materials, which are intended to be very high-strength, low-weight materials to be used in automotive applications, reducing the weight of a car by a couple of thousand pounds.

So it is very exciting in R&D right now and it will result, I think, in '06 products for people to test nano materials.

I think it's sort of '07-'08 revenue opportunity.

Okay.

And the last question I had was, you know, back on the auto AFMs for semiconductor fabs, if you're starting to move to a 5 plus units, let's say, per fab over the next two process generations, the semiconductors move out of the mid-teens revenue percentage it's been at for quite a while, with the high price and number of units that implies, could this become a 20% or 30% part of the business?

Yes.

And, again, we've guided that the '05 revenue in across total Veeco will be relatively flat to last year.

Right.

But the revenue expectation within Veeco for data storage and for semi, you know, is going to be clearly double digit growth.

Very good, thank you.

Our next question comes from Matt Petkun, D.A.

Davidson and Company.

Good morning.

Can you give us your head count for this quarter?

I don't know if I missed that.

1,280, Jack?

Yes.

1,280 people, after a modest reduction in MOCVD in the March quarter.

Okay.

And so you said 1,280, that's up from 1,261in the 10-K?

No.

It shouldn't be. [Inaudible.] Maybe including temporaries, or consultants, that aren't included in the 10-K.

But by our records, our head count was reduced 20-30 people in the quarter.

Okay, and, then, I think it was beginning in Q3 of last year, and obviously a lot has happened between then and now for the Company, but you had talked about a 10% reduction in expenses overall for the year, and some of that, is clouded now by mix shift and those types of things, but, we really doesn't appear that we've seen much of a reduction in op- X, especially in SG&A.

What can we expect for SG&A going forward?

As a percentage of sales?

It is a little cloud -- that's really a good question.

It's a little clouded because we took about 100 people out in Q4 and another 20 or 30 people out in Q1.

And you really see it more at the EBITDA line, because a lot of it is in cost of goods.

You know the 2% gross margin increase you saw in Q,1 and 2% you're going to see in Q2, has a lot to do with that head count reduction, as well.

So it's not, you're right, though, it's not all in operating spending, at least half of it is in cost of goods sold.

Okay.

But in Q3, when you kind of announced that you're going to start making the cuts, and you saw a number of pink slips go out in Q4, you were running on 97 million in sales.

You had costs of SG&A was 20.6%.

Now, on, you know, lower revenues, obviously some of that absorption, you're up to 21.5%.

So we've seen an absolute dollars increase in SG&A on lower sales.

Yes.

Some of that are the, you know , the slider division, where we added to Veeco, the MTI and Aii slider processing equipment group in Camarillo that doing very well.

If you look -- we'd have to dig a little deeper -- but if you look at the spending, the operating spending in Q4, was about 36 -- let me pull that for a moment.

Operating spending in Q4 was $36.2 million in Q4 of '04, and the operating spending that we just completed was 35 million.

So we're seeing a reduction in operating spending, but it is clouded by the fact that a lot of this head count is in cost of goods, as well as operations.

I think we'll try to model for you, maybe in the next call, some specific SG&A numbers.

Okay.

Are there any meaningful costs associated with the accounting review or litigation expenses in Q1that are incorporated into SG&A?

Jack should answer that.

There were, probably $500,000 related to those kind of activities.

Okay.

Thank you.

[Operator instructions.] We have a follow-up from Timothy Arcuri, Smith Barney.

Yeah, hi guys.

This is Dan again.

Actually, a follow-up on a couple of those questions.

To follow-up on the last question on SG&A, if we're looking at the $103 million in revenue Q4 where you had the 36.2 million in OpEX.

So if I were to have another, say, $103 million quarter in Q3 or Q4, could you talk about where you think OpEX would be total?

If we were to have the same revenue quarter two quarters out?

I hope that's a meaningful question.

We would like operating spending to be below that.

Okay.

But, any guidance, anymore specifics percentage-wise or dollar-wise?

Only that we would like to, again, in the second half of the year, take a couple of percent per quarter out of the operating spending compared to the first quarter.

Fair enough.

And, then, on the auto AFM, do you see that, you've gone now to saying maybe there's an opportunity for 10 per fab at 65 nanometer, I assume we're talking about 30,000 wafer start per month fabs.

Where do you see that plateauing?

I mean, is 10, now, kind of the plateau?

More importantly, where do you see that revenue segment for Veeco plateauing?

I think that 10 per fab is a good guideline we're getting from the semiconductor device world, that has to do with the throughput, that coincides with the current throughput of an AFM, which has been increased in the last year from maybe 10 wafers an hour to 20 wafers an hour for certain applications -- and that's helped some of the growth.

But that same semiconductor community would tell us if we could make that tool easier to use, and get to 40 wafers an hour, then it would be deployed in an even greater fashion in a fab and you could get to, you know, possibly 15 systems per fab because they would just use it more in production.

Rather than high sample rate, which is what they're doing now.

So it is possible that that sector could be 25% of revenue going forward.

Okay.

Right now you don't really see it, plateauing anytime soon?

You see just continued growth?

No.

It won't plateau.

It will really be tied to the deployment of smaller feature size, so as more total semiconductor becomes 90 nanometers and 65 and 45 nanometers, then you're going to see further deployment of AFM in the fab.

Okay.

That's very helpful, thanks.

And our next question comes from Mark Fitzgerald, Bank of America.

If you look at it flat guidance for the year, that would mean that second half you'll have to grow mid-single digits on a quarterly basis.

Do you have the visibility, in terms of backlog, to do that?

Yes.

My comment, Mark, backlog is quite high now in data storage and auto AFM relative to where it was six-months ago.

You're right, that that to be flat for the year, we have to have some increased revenue in Q3 and Q4 that's coming from backlog.

Okay.

And if you look at the data storage business, historically pretty volatile, and I understand the second half looking pretty good at this point, what's the level of confidence that that can hold into 2006 for you?

I have many of the same fears, Mark, that you have in the storage.

We're looking at a run of quarters here really very, very favorable with very high Capex improvement, you probably read the same as we have, three or four or five.

All of the major thin film head manufacturers, unlike semiconductor, have all gone back to their boards and in the last two months, and increased their Capex spending for '05 and '06.

And, you know ,they're pushing us for delivery as rapidly as we can complete the tools and we're very much wanting to do that because we have the same certain that, you know, historically this is an industry that has a history of overbuying.

And to the extent that that's happening, we want to ship the stuff as quickly as possible.

Also, I think I mentioned -- I'm also, I think I mentioned on previous calls, this very high growth rate that I think is indeed multi-year growth in data storage comes from consumer electronics.

Consumer electronics, themselves, are a volatile growth opportunity on top of a volatile business.

So I think that volatility is a serious thing that we need to watch, and I think we want to ship this stuff to data storage as quickly as they can accept it.

But it certainly is multi-quarter, Mark.

Is there any major technology transition 2006 that even if the capacity thing were to be a problem, that they'd have to go ahead and do?

Yes.

That's perpendicular recording.

For them tho get to the -- and the smaller drive formats, restore the aerial density concern.

All of them need to get that 1-inch drive to a 10, 20 gigabyte capacity and for that to happen the aerial density has to be increased because you only have 1 inch space of media.

Perpendicular recording is the next leg of technology that will replace GMR and TMR and we're beginning to see that in advance development now.

So even in a slower capacity period, in '06, we will see technology buys for perpendicular recording.

And, then, one last question.

Can you identify any seasonality in your disk drive business, historically?

Historically and you've made this observation before.

You know Q1 is always a big order period.

You know, now Q2 is a -- Q2 looks like a very good order book as well.

I think, you know, right now, what we're hearing from all of them is wanting us to be a strategic supplier to keep up with the capacity expansion that's '05-'06 in their mind and giving us more information as they can about the growth of consumer electronics.

I think more the volatility going forward will not necessarily be a seasonality issue, as much as it will be the acceptance of all of these new consumer electronics with embedded storage.

Okay.

Thank you.

Thank you.

And we also have a follow up from Andrew Suthven (ph.) Northeast Research.

Hi.

On the last conference call during the Q&A there was discussion about the sort of operating margin anticipated at the close of this fiscal year, being around 10%, with the 45% gross margin, and the 35 percentage points of operating expense.

Are -- where do you stand on that now?

Do you think that's still achievable?

Andrew that's a great last question.

Because I was concerned, also.

I think what we actually said was, 46% gross margin.

And 10 -- you're right -- 10% operating profit.

Remember we said gross margins through the year would be 40, 42, 44, and 46%.

Uh-huh.

Per quarter, ending at 46%.

We said at the end point we would expect improvement in EBITDA to 10% and that's exactly where we remain today.

So I would caution us--

so it's EBITDA not operating income?

No, EBITDA.

Take the "D" out.

Cool.

Let's not let the models run away beyond that, that's the end point for the fourth quarter of 46% gross margin and 10% EBITDA.

Good enough.

Thank you.

Operator, I think that's probably a good place to stop?

Okay.

Thank you, all and we look forward to our July call during which we'll report June results.

Thank you, all.

Once again, Ladies and Gentlemen, that does conclude today's conference.

We do appreciation your participation and you may now disconnect.