Veeco Instruments Inc (VECO) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to Veeco Instruments third quarter 2006 results conference call. [OPERATOR INSTRUCTIONS] For opening remarks and introductions, I'd like to turn the conference over to Senior Vice President of Corporate Communications and Investor Relations, Ms. Debra Wasser.

Ms. Wasser, please go ahead, ma'am.

Thank you, Operator.

And thank you everyone for joining today's third quarter 2006 results conference call.

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

Today's earnings release was distributed at 4:30 p.m. this afternoon.

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.

For your additional information, we are posting our investor presentation to reflect third quarter 2006 results and we'll post it on our investor.com -- veeco.com Website shortly.

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 this call discusses expectations about market conditions, market acceptance and future sales of the Company's products, future disclosures, future earnings expectations or otherwise make 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 and Analysis sections of the Company's report on Form 10-K and annual report to shareholders.

During this 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 our Website.

This call is being Webcast live at the veeco.com Website and will be available four replay and archived for future reference.

The Company does not plan to update the information on this Webcast once it has been archived.

I'll now turn the call over to Ed.

Thank you, Deb, good afternoon and welcome to our third quarter financial conference call.

Today, we reported financial results for Q3 in line with our October p, preannouncement.

Revenue was was $112.4 million, a 12% increase over the $100 million reported in the third quarter of 2005.

Bookings were $114.8 million, up 36% from the $84.6 million reported in the third quarter of 2005.

Earnings before interest, taxes, amortization excluding certain charges, EBITDA, were $10.2 million, up 23% from the third quarter of '05.

Net income was $4.5 million or $0.14 per share on a GAAP basis, compared to net income of $1.6 million or $0.05 per share last year.

Excluding certain items, earnings per share were $0.19, compared to $0.14 last your.

All Veeco divisions and core products were profitable in Q3.

As previously reported, Veeco's third quarter results were impacted by a slowdown in our data storage customers' production ramps, which was accompanied by shipment delays from the third to the fourth quarter of some five systems, approximately $15 million in revenue.

As customers are clearly managing their quarterly cash and depreciation in a more conservative CapEx environment, none of these systems were cancelled or delayed beyond the quarter.

While we expect these delayed shipments to be revenue in our Q4 period, we also expect the data storage customers will continue to reassess their production ramps for Q4, as they reflect being one or two quarters ahead of their currently required CapEx requirements and as a result of their strong order rates in the first half of 2006.

So, our Q4 revenue guidance in tonight's release of $120 to $124 million assumes this slower production ramp in the fourth quarter.

Despite these quarterly delays, data storage remains a growth Veeco market, with revenue up 13% for the nine months, driven by industry requirements for increased areal density and double digit growth in consumer electronic drive applications requiring industry-wide continued investments in the combination of perpendicular head technology, the transition to smaller femto sliders, and the conversion to larger wafer size.

And we are early in these transitions.

We currently expect approximately $190 million of data storage revenue for the 2006 year.

Again, about 13% up from 2005 levels.

In LED wireless, Veeco's other double digit growth market, revenue was up 193% in Q3 and nine months revenue was up 34% compared to prior year.

As new consumer high brightness LED applications, such as backlighting small area LCD monitors and automotive applications emerge, we expect to end the year with approximately $85 million in LED wireless revenue, up about 35% for the year.

In total, the year-to-date nine month revenue for all of Veeco was up 7%, while orders are up 27%.

Year-to-date, EBITDA is up 50%.

Operating income has more than doubled for the nine months compared to the prior year.

And net income has increased to to $7.3 million from a loss of $3.6 million last year.

The improved profitability for our nine months performance is expected to continue in the fourth quarter and our expected year-end results.

Veeco's nine month gross margins improved 170 basis points to 43.8%.

We currently expect to end the year at approximately 44% gross margin, up from last year's 42.4%.

We currently expect year-end revenue to be approximately $440 million, up about 7% year-over-year.

So despite a weaker CapEx environment in the second half, we expect 2006 to be a growth year in revenue, in earnings and in orders.

Our focus on cost control, operational execution, cash generation, outsourcing and implementation of SAP across Veeco and the creation of standard hardware and software platforms on new Veeco products proceeds, as we strengthen our balance sheet, our cash and our operational performance.

To focus a moment on Q3 orders.

As expected Q3 orders were seasonally down sequentially but up 36% from prior Q3 of '05, with year-over-year order growth in all of our market segments.

Data storage was $45 million in orders, up 35% year-over-year.

High brightness LED wireless $29 million up 99% year-over-year.

Semiconductor $14 million, up 26% year-over-year.

And scientific research $26 million, up 4% year-over-year.

In total $115 million, up 36% year-over-year.

Q3 equipment orders grew 59%.

While metrology Q3 orders were up 7%.

We currently expect Q4 orders to be approximately $115 million plus or minus 5%, up from last year's $103 million.

I'll pause here for Jack Ryan's financial review comments and then return with market segment comments.

Jack?

Thank you, Ed.

For the three months ended September 30, 2006, sales were $112.4 million, an increase of 12% versus the 2005 third quarter.

As previously announced and as Ed has noted, Veeco's data storage customers who purchased a significant amount of new capital equipment from Veeco during the first half of 2006 have now indicated that they will absorb this equipment more slowly than originally anticipated.

As a result, approximately $15 million of equipment originally scheduled to ship, principally to data storage customers late in the third quarter, has been rescheduled to ship in the fourth quarter.

None of this equipment has been cancelled.

Compared to the third quarter of 2005, the 12% sales increase is due to a $22 million increase in process equipment.

Primarily attributable to the growth in MOCVD products.

Metrology sales were at $41 million, a decrease of $9.7 million versus the third quarter of 2005.

By market, sales were up compared to the prior year by 193% in LED wireless, 31% in semiconductor, but down 18% in research and 9% in data storage.

Sequentially, sales increased by $800,000 or 1%, primarily due to a $4 million increase in process equipment, attributable to $8.8 million increase in MOCVD and a $1.5 million increase in mechanical process equipment.

This was partially offset by a decline of $6.5 million in ion beam attributable to the slowdown of the Company's data storage customers' production ramps causing the shipment delays that we discussed.

Third quarter 2006 orders increased to $114.8 million, up 36% from the third quarter of 2005.

Gross profit was $47.9 million for the quarter or 42.6% of sales, compared to $44.3 million or 44.2% of sales for the third quarter 2005.

Our gross margin decrease resulted from the third quarter 2006 process equipment versus metrology sales mix, which was 64% process process equipment and 36% metrology.

Compared to the 2005 third quarter mix, which was 49% process process equipment and 51% metrology.

Metrology has gross margins that are roughly 12 gross margin points higher than process equipment, so this mix shift is significant.

In addition, we had a 50.3% gross margin in metrology in the third quarter of '06 compared to 52.6% in the third quarter of '05 due to lower sales volume.

Process equipment margins improved to 38.1% in the current quarter from 35.6% in the third quarter of '05.

This 2.5 margin point increase was largely due to a significant improvement in epitaxial gross margins, which were 29% in the third quarter of '06 versus 14% in the third quarter of '05.

This increase occurred in MOCVD products as a result of higher sales volume, continued cost reduction efforts and higher prices.

Gross margins at our mechanical process equipment business improved to 41.6%, up 17.7 gross margin points versus the third quarter of '05.

Attributable to higher sales volume and cost improvements resulting from the standardization of product platforms.

The improvement in process equipment gross margins has been a significant area of focus for Veeco in 2006.

SG&A was $22.3 million or 19.8% of sales, compared to $21.2 million or 21.2% of sales in the third quarter of '05, and $25 million in the second quarter of '06.

R&D expense totaled 15.7 million, an increase of 1.3 million for the third quarter of 2005, largely due to new product development in ion beam, specifically new PVD equipment, as well as next generation MOCVD tools.

R&D expense was 14% of sales in the third quarter of '06.

Overall operating expenses declined as a percentage of sales to 33.6%, compared to 36.0% in the third quarter of '05.

Amortization expense totaled $4 million in both third quarter of '06 and '05.

As previously announced, we intend to broaden our data storage product line with the development of a new high rate aluminum deposition tool, for introduction in 2007.

The Company has recently acquired a 19.9% interest in Fluens, which is a high rate aluminum deposition Company.

Common accounting standards require us to consolidate of this business as if we'd purchased it in full and then eliminate 80.1% of the results.

Accordingly, we have additional line items in our income statement.

There's $1.160 million charge to write-off purchase and process technology and a $1.207 million credit to income captioned in non-controlling interest, which effectively eliminates 80.1% of this frequency noted charge, as well as the Fluens operating loss.

Veeco's cash investment at this point in this company to date is $500,000.

Net interest expense for the third quarter of '06 totaled $1.1 million, compared to $1.8 million in the comparable 2005 quarter.

The decrease in interest expense is attributable to the rise in interest rates on investment funds over the past year and reduced interest expense resulting from repayment of $20 million of our convertible notes in the first quarter of this year.

Third quarter EBITDA totaled $10.2 million, compared with $8.3 million in the third quarter of 2005.

The improved EBITDA is primarily the result of the strong sales performance in process equipment.

Our MOCVD, or high brightness LED product line, returned to profitability this quarter with $1.2 million in EBITDA.

Veeco's third quarter 2006 GAAP net income was $4.5 million or $0.14 per share, compared to net income of $1.6 million or $0.05 per share in the third quarter 2005.

EPS, excluding certain charges in 2006 and amortization expense in both periods using a 35% tax rate for the quarter, was $0.19, compared to $0.14 for the third quarter 2005.

For the first nine months of 2006, sales totaled $317.9 million or a 7% increase from 2005 due, primarily to the increase of $31 million in process equipment sales, which included significant increases of $11.9 million in MOCVD, $10.4 million in mechanical process equipment and $8.7 million in MVE.

Offsetting this increase was a reduction of $10.4 million in metrology sales.

Gross margin for the first nine months of 2006 was 43.8% of sales, compared to 42.1% for the comparable 2005 period.

Primarily due to the increase in sales volume, as well as continued cost reduction and improved supply chain management, which includes outsourcing.

SG&a increased to $68.6 million, compared to $62.8 million in the first nine months of 2005, primarily due to higher selling and commission expenses resulting from the increase in sales and the expansion of our Asia Pacific business.

We also increased incentive expense resulting from improved profitability, stock option expenses, as well as increased litigation related costs.

R&D expense totaled $45.6 million, an increase of $500,000 from 2005, primarily due to new product developments in ion beam and MOCVD products.

As a percentage of sales, R&D decreased to 15% during the first nine months of 2006, from 15% in the comparable 2005 period.

Amortization expense of $12 million in the first nine months of 2006 compared to $12.6 million in the 2005 comparable period and the change resulting from having fully amortized certain intangible assets of acquired companies.

Net interest expense of $3.6 million compared to $5.9 million in the comparable 2005 period due to the increase in interest rates over the past year on invested funds, as well as the reduction in interest expense resulting from the repayment of $20 million of our convertible notes in the first quarter.

EBITDA was $25.4 million for the nine months, compared to $16.9 million for the first nine months of 2005.

Veeco's nine month for the first nine months of 2005.

Veeco's nine month 2006 GAAP net income was $7.3 million or $0.23 a share, compared to a net loss of $3.6 million or $0.12 per share loss in the first nine months of 2005.

Earnings per diluted share, excluding certain items for the first nine months of 2006, were $0.46, compared to $0.24 in the comparable period of 2005.

The items excluded from this calculation are a charge for the write-off of purchase and process technology, as well as a gain on the $20 million convertible notes repurchased in 2006 as well as amortization expense in both periods.

Backlog at September 30, 2006 was approximately approximately $160 million.

With regard to outlook guidance, we are currently forecasting fourth quarter revenues in the range of $120 to $124 million.

And earnings per share between $0.11 and $0.17 per share on a GAAP basis.

And earnings per share between $0.18 and $0.22, excluding amortization of $4 million and assuming a 35% tax rate.

Gross margin should return to the 44% level of the first half of 2006.

And operating expenses should approximate 35% of sales as incentive program accruals are increased in the fourth quarter.

Veeco's bookings for the fourth quarter of 2006 are currently expected to be approximately approximately $115 million, plus or minus 5%.

On the balance sheet side, cash and equivalents totaled $126.6 million at September 30.

We are pleased that we generated $21.5 million of cash in the first nine months of 2006, excluding the $19.4 million repayment to repurchase $20 million of our subordinated debt.

Accounts receivable day sales outstanding for the quarter were at 69.7 days, down from 71.5 days at June 30, 2006.

Inventory increased $8.5 million to $104.7 million at September 30 from the June 30 levels, primarily due to the $15 million of shipments delayed to the fourth quarter.

Inventory turnover was 2.5 times for the quarter.

Capital expenditures were $2.9 million for the third quarter 2006 and $12.5 million for the nine months 2006 period.

Depreciation expense totaled $3.8 million in the third quarter of 2006 and $10.4 million for the first nine months.

Our balance sheet and cash positions of $126.6 million remain quite strong.

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

Thank you, Jack.

I'd like to review individual Veeco Markets, if I may, starting with our two strongest growth double digit market areas, which are data storage and high brightness LED.

Data storage revenue is up 13% year-to-date.

While data storage orders are up 34% year-to-date.

High brightness LED revenue is up 34% year-to-date.

And high brightness LED orders are up 93% year-to-date.

In data storage, our Q3 orders of $45 million were very much in line with our forecast and up 35% over prior year.

Revenue of $45 million was down 9% year-over-year, as a result of customer delayed shipments.

But despite a slower second half production ramp, this is still a very strong year-over-year growth segment, expecting to be up 13% for the year.

The industry is experiencing unit and revenue hard drive annual growth and seeing continued growth in mobile and consumer application drives.

And investing in continued growth in areal density, which is increasing about 30% to 40% to year and requiring the proliferation of perpendicular head technology, which is early in it's extension.

There is still below, less than 15% of all heads manufactured in 2006 will be of a perpendicular technology.

And the transition to femto smaller format, [thin] filled heads are proceeding.

And that impacts our mechanical processing slider groups in California and our nine months slider revenue is up 65%, that's lappers and saws.

And our orders for lappers and saws are up 39%.

So it's very early in the transition to larger wafer size across the entire industry.

And we see good acceptance of new Veeco Ion Beam Etch, Ion Beam Deposition, PVD and AFM products, as we continue to expand our data storage product line.

In LED wireless, we experienced our fourth sequentially strong MOCVD booking quarter in the September quarter.

In this sector, Q3 orders of $29 million were up 99% year-over-year.

Q3 revenue of $27.7 million was up 193% year-over-year.

And it's important to note that our MOCVD business unit achieved profitability in Q3.

We are early in the growth of blue, green, and white LED's for emerging applications, such as backlighting of small area LCD monitors, automotive applications, headlights and running lights in addition to interior living, as well as architectural lighting and high resolution displays.

This sector has our highest year-to-date revenue in order growth rate, with orders likely to exceed exceed $100 million for the year.

And this remains a strong, multiyear growth opportunity for Veeco, with new MOCVD tools required for higher levels of LED brightness and improved uniformity.

In semiconductor, Q3 orders of $14.2 million were up 26% year-over-year.

And revenue of $16 million was up 31% year-over-year.

And this continues to be a combination of our auto AFM as well as table top atomic force microscope and optical metrology and an occasional deposition system for [mask] or specialty applications.

We will continue to expand our auto AFM product line for 65 nanometer applications in etch, CMP and lithography applications.

And lastly in our scientific research segment, Q3 orders of $26.1 million were up 4% year-over-year.

Q3 revenue of $23.3 million was down 18% year-over-year.

And this segment includes our broad line of high margin atomic force microscope and optical metrology products for university, material science and emerging life science applications.

We intend to increase both application support to new applications for end, new product R&D focus, so as to grow this profitable segment in 2007.

Operator, we would be pleased to take questions now.

Thank you. [OPERATOR INSTRUCTIONS] We'll hear first from Daniel Berenbaum, Susquehanna Financial.

Hi, guys, thanks for taking my call.

Let me ask a question about LED and about what you think the curve of that business will be?

If I heard you right, you said it looks like orders will be over over $100 million this year.

That doesn't look that difficult given this quarter's strength.

So maybe you can elaborate a little bit on what you think the order ramp in that space will be?

And then longer term, in terms of LED capital investment, how do you think about expected CapEx in the space?

Is there a way that you size the business, the way that you size your business?

And maybe you could help us sort of understand how we should think about that moving forward a little bit further into the future?

Yes.

Dan, the last four quarters have been around -- MOCVD by itself or high brightness, blue-green or white LED's, the order rate has been $21 million, $19, $20 million, $23 million in this last quarter.

Compared to the first quarters of last year were $9 million, $7 million, and $4 million.

So we've had a big step function increase now with four quarters running at, let me call it, this rate of $85 million in MOCVD and probably $100 million a year when you add in $25 or $30 million of MBE.

So that's a big growth rate, step function growth, from '06 -- from '05 to '06.

I think it stays at these current levels for some number of quarters, with an expectation that somewhere in '07, small area LCD backlighting feeds into LCD TV backlighting and additional automotive applications.

And so I would expect on, a multiyear basis, to see not quite the high growth rate we're seeing this year but growth rates of 20% to 30% in CapEx as LCD TV becomes reality.

But so in the short-term then you'd expect order levels -- order rates to stay sort of around where they are now?

Yes.

I think $20 to $25 million per quarter, which is mostly small area monitors, some backlighting, some architectural lighting and some automotive applications.

And they really haven't started sampling the 30" and 40" LCD TV screens, which represents a huge increase.

And so that increase could be over 30% a year, and I would expect that to start to be visible, let's say, in mid-'07.

So then maybe on that sort of 20% to 30% growth rate longer term that you talked about, how do you sort of arrive at that?

Is that from looking purely at the end markets and assuming that the capital intensity there stays constant or are you looking specifically to investments by some of the larger players?

It's really the CapEx required for the next large step, which is backlighting the LCD TV's.

It ignores further growth in architectural lighting and it certainly ignores the very high growth rate somewhere in the, let me call it, the '08 to the 2010 timeframe for solid state lighting, which is itself a $12 to $14 billion business.

So I think you see waves of 20% 30%, 40% growth opportunities coming over the next three or four years.

Okay, great.

Thanks.

We'll move on to Brett Hodess, Merrill Lynch.

I was wondering if you could talk a little bit about the gross margin progression?

It's been sort of in the 44% range, good year-over-year improvement but now with a mix shift more towards HB-LED for awhile, perhaps and process tools being up as a percentage of revenues and then whatever internal programs you have on new products and whatnot to get costs down, are we going to see more progression going forward or do we stabilize for awhile ?

How do you see that?

I think in the fourth quarter we go back to a, as Jack said, something above 44% gross margin in improvement over the third quarter, which was largely impacted by less than expected revenue and a very high equipment mix.

I think we see -- so we'll end the year at about a 44% gross margin up from a 42% gross margin in '05.

And I would look for another 150 basis points improvement in '07 as you continue to get growth in gross margin and equipment, which this year went from 35% to 39% gross margin and metrology, which went from 51% to 52%.

But we'll be impacted, as you've indicated, by the equipment metrology mix in '07 and the current booking mix of equipment and metrology.

So I think you see steady continuous growth in margin but maybe not the 200 or 300 basis points a year.

Maybe something like 150 basis points a year going forward.

Okay, and then the second question I had was on the HB-LED side, there's been a lot of consolidation in Taiwan lately announced.

Given what you just said about the growth rate, does that help or hinder you do you think in terms of a number of your customers combining it to say one bigger Company?

Net-net it helps, Brett.

I think the -- we were very concerned two years ago that the credit-worthiness of these disparate small companies was a problem.

Today, they are becoming quite large.

We're seeing multiple buys from five or six of these companies during a quarter or two.

Their balance sheets are better.

They're more stable and they are still the area of high growth in the industry in comparison to the Tier 1 accounts, which I think start to buy equipment next year.

So, I think even though there's been consolidation in Taiwan, we see steady growth in Taiwan, in Korea and in China with a more stable customer base in terms of their own balance sheets.

And then just one final one.

On scientific research, usually at year-end you get some of a year-end spend out of people that have budgets in that scientific research area.

Does that look like the case this December quarter?

Yes, so our forecast for the fourth quarter includes an expected bump up, as is seasonally expected, in scientific research, metrology, and I very much hope our sales team is listening.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS] We'll go next to Robert Maire, Needham & Company.

In terms of data storage head technology, has there been any sort of change in terms of next generation?

And sort of where are we in terms of length of time at generation and all of that?

I'm just trying to gauge, are we running at similar cycles or is this sort of a different thing?

And related to that, we've heard different discussions of capital intensity on the semiconductor side.

Given that there has been a little consolidation on the data storage side, do you see any change in capital intensity in that part of the industry?

Yes, Robert, I -- the data storage industry is on a steeper capital intensity curve than semiconductor is currently.

Semiconductor has become so efficient and it has gone through a lot of its increased capital intensity.

Whereas data storage, because of perpendicular and femto and larger wafer size, it is really experiencing very much higher capital intensity growth, currently at 8% expected to go north of 10%.

So we're going to see good CapEx expansion in data storage in total.

And there are now some third party market research firms that are beginning to describe more accurately that there's a $4 billion equipment opportunity in data storage.

So there's a lot of growth.

And Veeco this year will do something less than than $200 million in that $4 billion, so there's a lot of growth opportunity for us to expand our product line and to grow in the markets we're in.

With relation to your question on perpendicular, we're very early in this transition, so 15% of all heads manufactured in '06 will be perpendicular.

Everyone has a perpendicular program but it's the minority of their heads they're shipping.

And that's expected to be 30% in '07, 60% in '08 and near 90% in '09.

So, it's got another three or four year growth in perpendicular proliferation and I would expect in the '07/'08 timeframe, mostly the '08 timeframe.

You've asked about the next leg of areal density growth and it's something called heat assisted in film heads, which have a laser component.

And two or three major manufacturers have announced development in that next generation, which probably begins to be fed into R&D and pilot production in the '08 timeframe.

So you have yet another leg of areal density growth coming three or four or five years from now, which are required to keep flash at arms length in terms of price performance.

Just a follow-on to understand that a little further if I could.

If I look at sort of a spending curve as being somewhat of a bell shaped curve or the capital spending associated with recording heads starting off slow and then picking up and then slowing back down, is a bell curve sort of the way to look at it?

Or is it more of a wedge-shaped curve where it falls off more rapidly on the trailing edge?

And if I were to try and pick a peak, given that we're only given 15% of the way into that curve, does that sort of peak of spending on vertical technology occur in '07, '08, or obviously it leads the manufacturing peak a bit?

Well, the bell shaped curve is a good way to think of it but the bell shaped curves overlap, Robert.

So, if the industry continues to increase areal density 30% or 40% a year, which it's been doing for the last three or four years, it allows Veeco, as it has, it has allowed Veeco 30% annual revenue growth for the last three or four years.

Because those bell shaped curves three or four years because those bell shaped curves are not discrete with a valley between them.

Rather, they overlap.

Understood.

They have -- it's sort of like an inclined sine wave. but I'm just trying to understand where the sort of near term -- or where would you expect a near term term sort of peak in business?

Well, if you look at IVC I think is or Coglin & Associates has done an attempt at market research for CapEx for hard drive and reports that it's $3.6 billion this year, up from $2.87 billion in '06.

And it will be almost $5 billion in '09.

So it's increasing from about an 8% or 9% of revenue CapEx to 11% of revenue going forward.

So it's becoming a more capital intensive industry.

And I think we're going to see continue to see an opportunity, certainly for Veeco, to continue to grow over 20% to year in data storage CapEx.

Got it.

Okay, that clarifies it, thank you.

We'll hear next from David Duley with Merriman.

Good afternoon.

I was wondering, when I look at the revenue guidance that you -- or the revenue guidance in fourth quarter and I look at my third quarter numbers that you just reported.

I look at my disk drive expectations and I took about $27 million out of my revenue for both third and fourth quarter.

And that's because of the guidance statements that you've made.

And you've said that nothing has been cancelled.

So, my question is when would we pick up the $27 million that I took out of my model for the second half of the year?

And those numbers were based on your annual guidance.

The earlier annual guidance.

Correct.

Yes, so the reason the numbers come down that $20 some odd million is it's really -- it's a combination of two things or three things, if I may.

Some $15 million of delayed revenue went from Q3 to Q4.

But if you listened to my comments, I think there's going to be another adjustment coming from data storage in Q4 that maybe -- $10 million that was in our original slot plan for Q4 will be moved into Q1, so remember that.

The Q3 miss just moves from one quarter to another., so you could ignore it for a year-end consideration.

But another $10 million moves out of the year based on expected slip age of another quarter delay in Q4.

And now you have to add to that the fact that, if you remember, in Q3, we were looking at order guidance that was $115 to $130 and that came in at $115.

So, $15 million of that, I don't know what to call it, the miss or below the top of guidance booking has to be added to the $10 million that's slipping out from Q4 to Q1, so that $15 plus $10 is your $25 million.

So you're saying it was not -- even though people had it forecasted in their revenue numbers you didn't actually have the order for it?

No.

The $25 million consists of second half orders that are clearly going to be less than what we thought they were a quarter ago and $10 million in revenue that comes out of Q4 and goes into Q1.

That's why your model is adding up to those numbers.

Okay.

So I the point is, some revenue that we initially expected based on your revenue guidance for the year is going to go away.

But some of it is going to spill into the first quarter and I'm trying to figure out what's going to go away and what's going to actually be recognized.

Well, I think I'm going to let you do the model, David.

Fourth quarter, there might be 10 quarters that goes forward, but you got to look at the -- most telling is to look at the order rates in the second half of the year compared to the first half of the year.

And that's down -- we did $270 million in orders in the first half and we're going to do about $230, $235 in the second half.

So that has to at some point impact expected revenue.

Well one way to turn it around is, typically, a good revenue projection for you is your last two quarters of order rates.

And let's just say it's $115 and $120, $117.

So that would be an indicator that Q1, based on your last two quarters of order rates, would be $117.

But you have a backlog of $27 million of orders that have been cancelled or pushed or as you have said have been pushed.

So some of that revenue has to actually be recognized, otherwise it's a cancellation.

Correct?

No.

I think there's only about $10 million.

So you're right.

One way to do a model is to take the sort of the six-month run rate of orders and add to it the backlog expectation for the coming quarters.

And you're within $10 million, David, of a model that works.

Okay.

One other question I have is, with guided revenues up a little bit sequentially here between the third quarter and the fourth quarter but I think the EPS numbers right in line with where we were on the third quarter and I may have missed some of your prepared remarks.

Could you let us know what 00 on an up revenue number, why we're seeing GAAP EPS come out roughly the same place?

As the earlier expectation.

It's up from Q3 to Q4 but again, it's currently being influenced by the fact that not our ideal 60/40 equipment to metrology mix but a mix that's more like 64/36.

You're running a little higher equipment mix than the optimum gross margin mix.

So, even though revenue is going to go up and gross margins are going to go up, I think that's what I heard you say, our GAAP EPS is going to stay, what you said, $0.19 to something?

Well, both GAAP and non-GAAP EPS or EBITDA, if you will, will be influenced by the fact that you're going to be seeing a period of slightly higher equipment content than the earlier quarters.

Thanks.

And again, you're correct.

We are improving gross margin both in equipment and in metrology, but as Jack said, there's a -- one is at a 40% level and one is at a 52% level.

So as you have richer equipment mixes, you have a little bit of a price to pay at the EBITDA line.

We'll hear next from Matt Petkun, D.A. Davidson.

Hi, good afternoon.

Just speaking about the guidance for a second here.

Jack?

The variance between GAAP and non-GAAP guidance obviously incorporates the amortization.

Why would it be $0.07 at the bottom end of the range and only $0.05 at the top end of the range?

You mean why is it $0.05?

Well --.

Well your guidance is $0.11 to $0.17 and then if you are to add $0.07 back for that amortization, you get to the $0.18, which is the bottom end of your non-GAAP guidance but only $0.22.

We only have to do the tax rate.

And I could walk you through that offline.

Okay.

But that's the major reason.

So, at the high end you would expect that a higher tax rate then?

Yes.

Okay.

And then, did you say what depreciation and amortization was in the quarter again?

Yes, we did give that number.

CapEx was $2.9 million for the quarter and depreciation was was $3.8 million.

Okay.

And then kind of looking towards next year or maybe -- I'm very impressed by the 29% margins that you got in the MOCVD business.

And I'm just wondering how much of that is coming from the volumes that you're seeing?

Obviously, a significant top line growth there.

And then how much of that is just kind of baseline improvement in margins as you kind of price these things for the improved cost structure?

And perhaps if you're running more like at a $20 million run rate in the Epi business, what would the gross margins be?

Well, the most of the improvement -- Jack is looking for some numbers but I'll just comment in the meantime.

Most of the gross margin improvement I think comes from the fact that with the newer tools, the ASP's have gotten better.

The cost reduction and warranty expense has been very effective, so the warranty cost is greatly reduced.

And as we said earlier, we expect it to end the year at sort of this 29% or 30% gross margin.

And we expected the newer tools, which are in the R&D pipeline now to be introduced in the middle of '07, will have closer to a 40% gross margin.

Okay.

So even if we were to see revenues, not that they are likely to fall off for any significant period of time, but even if we were to see them turn back towards where they had been in prior quarters we would still see a nice uptick in that line item?

Yes.

The margin improvement is permanent because it's basic improvement in the product.

Right.

The other question is, because this is such a growth area, we don't want to be fearful of increased revenue hurting our total margin.

And as long as we get that margin in '07 up to a number like 40% then we'll be very happy with the impact of the higher revenue.

Okay, thanks so much.

We'll go next to Timothy Arcuri with Citigroup.

Hi, guys.

Couple things.

The first thing, Ed, I'm just looking at the revenue relative to the bookings and it looks like, I know you don't want to give guidance for March, but it looks like revenue is not going to decline.

If it's down, it isn't going to be down that much.

Is that the right way to think about March?

My track record for revenue guidance was so sterling in the fourth quarter that I think I'm going to take the fifth and I'm going to allow myself this quarter's execution before we give guidance in the first quarter.

Yes, of course.

But Tim, you're a little high.

Yes, okay.

And then Jack, did you say backlog is $160?

Yes.

What was it last quarter?

Well, it grew a little bit because we had $115 and $112.

Right.

So it should be about $3 million -- backlog grew about $3 million in the quarter.

There were some -- there were no -- I looked this morning at cancellations, cancellations, which are adjustments to orders, were less than $1 million in the quarter.

So, really about $3 million.

Okay, that's what I was after.

And then if I look at the semi's business, and if I'm generous in terms of what you're going to do in terms of the revenue for the fourth quarter, it's actually down year-over-year for semi's and that's in a big up year for semi's.

What's going on there?

Well, we had some backlog.

Did you factor in backlog into your semi fourth quarter expectation?

Yes, but you have to print -- even to get it flat, you have to double revenue sequentially.

Yes, I think it's -- I'm looking at the most recent slide show, which I think Deb put up on the Internet, shows semiconductor ending the year at, you're right, Tim, ending the year at $65 million, compared to $69 million last year.

So it's down a couple million dollars and mostly it's because where -- this has become such a small sector with high ASP units, that one or two units influence quarter to quarter.

And I think in the year, we're sort of waiting for our own Veeco next generation AFM tool, which has a very significant increase of throughput, which comes out in 2007.

And that will more drive Veeco's semiconductor sector next year.

But you're right.

I think we probably are underperforming the semiconductor market in '06.

Yes, okay.

I would agree.

And then I guess lastly, on inventories.

What do you think happens to inventory in the fourth quarter, Jack?

We're hopeful that it's going to go down to below the level of the second quarter.

Okay.

So, you still think that you could be close to three turns by the end of the year?

Yes.

It seems like it should be higher than that given the work you've done on the GaNzilla and some of the programs already underway.

Some sections of our business, in fact GaNzilla is a good example.

GaNzilla turned six times in this most recent quarter, so you're right.

We are making -- we're not seeing progress.

It's not uniform across the Company and that's what we're working towards.

But it's very encouraging.

Jack commented correctly.

In those areas where outsourcing is or has proceeded for a longer period of time, we're getting very high inventory turns.

Thanks a lot.

We'll hear next from Mark Miller, Brean Murray.

As discussed previously, I guess there's some people who believe that maybe this is just a temporary pause in data storage orders.

But I know at least one of your customers, Seagate, has made notice that beginning in fiscal '08 that their spending is going to be roughly 8% to 8.5% of sales, which with the current consensus revenue forecast indicates at best we'll breakeven, at least in terms of what Seagate is going to spending and worst it's going to be significantly declined.

I'm just wondering how do you reckon with this and do you really believe things will rebound next year in the second half in data storage if Seagate does something like they've been talking about?

I think that if you look at -- certainly, we've had year-over-year growth for three or four years.

And even if you look at the $45 million booking rate that we just experienced in data storage CapEx, compared to a previous trough, that's a very decent number.

So we do see that even though the quarter to quarter variances are significant, the troughs are getting higher and the peaks are getting higher.

And I think it is becoming a more capital intensive market and we're helping ourselves by greatly broadening the product line.

I can point to PVD, ALD, Fluens, AFM for metrology, where Veeco will have probably $30 to $50 million of new revenue product opportunity in '07 that it didn't have in '06.

So, Veeco's growth is helped by the fact that we just are continuing to broaden our footprints in data storage but I think the CapEx is also growing.

And I don't -- while I have high regards for Seagate and Hitachi and all of the others, their ability to project accurately their capital is also sort of difficult.

Do you know anybody else besides Seagate who is kind of projecting that the second half of next year or in '08 that this year might be a peak year for capital spending for them?

No.

I think they all need to continue to fund perpendicular, they all need to go to a larger wafer size.

They are a little further down the pipeline in femto but they have to continue that.

We're seeing huge growth in saws and lapping.

These new perpendicular heads have much tighter tolerances and much greater shape control and we're seeing an improved interest in metrology because their advanced heads start life with a 30% yield.

So I think even though we continue to have to ponder the quarter to quarter variations, we feel very good about year-over-year CapEx growth in data storage.

Thank you.

We'll go next to Douglas Reid with Thomas Weisel Partners.

Thanks.

Most of my questions have been answered but I am curious if you can add a little bit more color on what you might be seeing in the automated AFM space?

Helping -- if you could, help me to understand how the competitive landscape has changed such that your overall outlook longer term, how that compares now for say what you expected from that area a few quarters ago?

Well, I think the opportunity for Veeco auto AFM and semiconductor, and I say in semiconductor because we have grown some market applications in data storage for our auto AFM that are becoming significant.

So the auto AFM business can be expected to grow within Veeco serving both semi and data storage.

But focusing on semi, I think the task is clear for us.

Ours is a 20 wafer an hour, 65 nanometer capable tool that would have higher revenue if we could make it 30 or 40 wafers an hour and keep developing tips down to 30 nanometers and that's the plan.

So when I look at it, I see it as a kind of a multiple use reference tool that's used in the fab that we may sell 40 or 50 of a year where we could probably increase that to 60 or 70 a year if we allowed people to use it in higher volumes at higher throughput.

And that's the plan.

Okay.

Also, you mentioned earlier some ASP increases.

Wondered if you could add a little more color, where they were and magnitudes?

Well that tool is probably close to a $2 million ASP today compared to $1.6 million a year ago, so we've added features to the tool.

At the higher throughput, that tool will probably be well over $2.2 million per copy, so we'll see ASP expansion as well.

And in the other tool categories?

You mean process equipment as well?

Yes.

Yes, we tend -- because the films are more difficult to make and people want higher yield than greater throughput, we enjoy sort of a positive creeping upward ASP in most of our products that are a value because the production rate is higher, the yields are better and so we do get a little appreciation in ASP.

And lastly, in terms of modeling R&D into '07, given the new products ramping so fourth, how should we think of that?

We would like to keep the total R&D spending sort of flat as a percentage of revenue.

And we have found pretty productive R&D pipeline for looking for the year, I think 14% for the year.

And it was a little higher than that last year, actually, 14.7%.

I think we can be very productive in R&D at a 14% R&D spend level.

Helpful.

Thanks.

We'll take our final question from Mark Fitzgerald, Bank of America Securities.

Thanks.

I was just curious on these acquisition or the investments you just did.

Is there any pressure to actually own the whole thing and take out the 100%?

That was the plan, Mark.

This is a multistep joint venture in an important technology for data storage, high rate aluminum.

And we have begun by making a minority investment while they developed the tool/ And the understanding is that as they fully develop the tool, we would buy the entire Company.

But it's a very small -- I think we said originally this was going to be $5, $10, $15 million investment.

I mean, the earn out would get you that level.

Yes.

That actual purchase price was $3.5 million.

Okay.

And then when you look down the technology road map here for the LED and the disk drive business, is there anything else that's kind of critical on the horizon like this aluminum tool that you feel you have to have that you have to bring in house?

There, we continue -- yes, there are.

And what we do -- we continue to work with these customers on their strategic road maps and to identify complementary areas that we can develop additional product to enhance our footprint both in data storage and LED.

But right now, they continue to be along the lines of either internally developed, like using our metrology technology more broadly in LED and in data storage, or these modest start-up investments, Mark, like the one you just described, in Fluens.

So, there's nothing on a short list that represents a significant acquisition requirement in the next couple years.

Okay.

Thank you.

Operator, thank you.

We're -- if I may, just make some closing comments.

We're pleased to see continued growth in revenue orders and profitability, both for the nine months year-to-date performance as well as our projected 2006 results.

And we continue to invest mostly internally in new equipment and metrology products, vital to our growth in our core markets.

And we look forward to speaking with all of you following our Q4 results.

Thank you.

Once again that does conclude our teleconference for today.

We would like to thank everyone for their participation.

Have a great afternoon.