Veeco Instruments Inc. Q3 2009 Earnings Call Transcript

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 |  About: Veeco Instruments Inc. (VECO)
by: SA Transcripts

Veeco Instruments Inc. (NASDAQ:VECO)

Q3 2009 Earnings Call

October 26, 2009 5:00 pm ET

Executives

Debra Wasser – Senior Vice President Corporate Communications & Investor Relations

John Peeler – Chief Executive Officer

Jack Ryan – Senior Vice President Finance, Corporate Controller

Analysts

Timothy Arcuri – Citi

Matt Petkun – D.A. Davidson & Company

Andrews Abrams – Avian Securities

Joanne Feeney – FTN Equity Capital Markets

Krish Sankar – Merrill Lynch

Bill Ong – Merriman, Curhan, Ford

Patrick Ho – Stifel Nicolaus

David Dooley – Steelhead Securities

Peter Wright – GC Research

Operator

Welcome to the Veeco third quarter 2009 earnings conference call. (Operator Instructions) For opening remarks and introductions, I would like to turn the conference over to the Senior Vice President of Corporate Communications & Investor Relations, Ms. Debra Wasser. Please go ahead.

Debra Wasser

Thank you operator and thank you all for joining today's call. Joining me today are John Peeler, our Chief Executive Officer and Jack Ryan, our Chief Financial Officer. Today's earning's release was distributed at 4:00 pm this afternoon and is available on Veeco’s website. Also posted on our site is a PowerPoint overview of our third quarter financial results.

As you have probably seen, today we announced that we have commenced an underwritten public offering of up to five million shares of Veeco common stock. The offering includes a 30 day option for the underwriter to purchase up to 750,000 additional shares to cover over-allotment if any. Veeco intends to use the proceeds for general corporate purchases. Due to SEC regulations we are prohibited from discussing this transaction any further on this conference call.

This call is being recorded by Veeco Instruments and is copyrighted material. It cannot be recorded or rebroadcast without Veeco's express permission. Your participation implies consent to our taping. To the extent that this call discusses expectations about market conditions, market acceptance and future sales of the company's products, future disclosures, future earnings expectations or otherwise makes statements about the future, such statements are forward-looking and are subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made.

These factors are discussed in the business description and management’s discussion and analysis sections of the company's report on form 10-K and annual report to shareholders and in our subsequent quarterly reports on form 10-Q, current reports on form 8-K and press releases.

Veeco does not undertake any obligation to update any forward-looking statements including those made on this call to reflect future events or circumstances after the date of such statements. 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.

I will now turn the call over to John for opening remarks.

John Peeler

Thanks Deb. Thank you all for joining us today. I am pleased to report that Veeco exceeded our third quarter guidance on every metric and that we returned to profitability.

Third quarter revenue was $99 million, well above our guidance of $80-88 million and gross margins increased over seven points sequentially to 41.4%. Veeco’s restructuring actions decreased operating expenses by 19% versus a year ago. We completed our factor consolidations ahead of plan and achieved our $80 million breakeven target. This drove Q3 EBITDA to $9 million, positive GAAP EPS of $0.04 and non-GAAP EPS of $0.16 all significantly head of our guidance.

Veeco’s cash balance increased $12 million sequentially resulting in a positive net cash position. We are executing to plan and we are doing what we said we would do. By business, LED and solar revenue was $53 million or 54% of Veeco’s total revenue. Data storage was $22 million or 22% of total and metrology was $24 million or 24% of total.

Despite the fact that revenue levels in both data storage and metrology remain well below historic levels, we are pleased that our cost reduction initiatives have enabled both businesses to return to profitability in the third quarter.

In data storage we completed our outsource manufacturing initiatives ahead of schedule. This business delivered $1.6 million of EBITDA and gross margin recovered to 40% in Q3. Metrology’s gross margins improved seven points sequentially to 42% and in addition we removed over $2 million in OpEx in the first nine months of this year. It is encouraging to confirm that our cost reduction plans are having a dramatic impact on Veeco’s bottom line performance.

Veeco’s third quarter 2009 bookings were $226 million, a record for our company up 150% compared to the prior year and 129% sequentially. This exceptional result was driven by $179 million in LED and solar bookings. We are proud of the progress we are making winning important business in MOCVD, CIGS solar and in MVE systems.

In MOCVD Veeco has been selected the supplier of choice for an important Korean TV manufacturer. We also received orders from other customers in Korea, Taiwan and China as they ramp production of LEDs for laptop and TV backlighting. Today we announced that Sanan, China’s leading LED manufacturer, has selected Veeco’s equipment for their latest capacity expansion.

In North America, we penetrated two key illumination customers, Philips Lumileds and Bridgelux, of winning their production ramp business. In total we received multi-unit orders from eight LED customers in Q3. We believe Veeco is gaining share by penetrating key accounts around the world particularly in China and Korea.

In solar we booked a $15 million order for FastFlex CIGS deposition tools from groups out of China and a separate multi-million dollar repeat order for CIGS components from an important U.S. customer.

While data storage orders remained weak at $17 million we are currently experiencing modest increased quoting activity with customer interest in both capacity and technology purchases. Metrology orders were $29 million, up 27% sequentially due to new product traction particularly for our Dimension Icon AFM where we reported increased adoption and strong sales. In addition, our Bioscope Catalyst AFM is performing well with our life science win rates improving dramatically since this product was introduced in March. This is the second quarter in a row of increased metrology bookings and we experienced somewhat improved business conditions across the board in scientific research, Industrial and semiconductor.

We are starting to see higher quoting activity for our automated AFMs from semiconductor and data storage customers and we are working to expand our industrial rep network to sell more optical metrology products.

By business segment, our $226 million in total Veeco third quarter orders were 80% LED and solar, 7% data storage and 13% metrology.

I will now hand the call over to Jack for some additional financial commentary.

Jack Ryan

Thank you John. Good afternoon. Third quarter 2009 sales were $98.9 million compared to $115.7 million for the third quarter of 2008. LED and solar process equipment experienced a $12 million or 29.2% increase in revenues primarily attributable to an increase in demand for high process LED Backlighting applications.

Data storage process equipment experienced a $21.5 million or 49.8% decline in sales primarily due to customers continuing to tightly control capital spending. Metrology sales declined $7.2 million or 23% due to the slowdown in data storage, semiconductor and industrial markets.

Bookings were a record $225.6 million with $179.2 million coming from our LED and solar process equipment segment. Our book to bill ratio was 2.28 to one for the quarter. Backlog at September 30, 2009 was approximately $286.5 million, up $126.3 million from June 30, 2009 period. Third quarter backlog adjustments approximate $400,000.

Gross profit was $40.9 million or 41.4% of sales for the quarter up compared to 39.8% in the third quarter of 2008 and up sequentially from 33.9% in the second quarter of 2009. On a sequential basis gross margin percentage was favorably impacted by the increase in sales volumes. The increase in gross margin percentage compared to the third quarter of 2008 principally resulted from material cost savings, the impact of manufacturing and overhead cost reductions associated with the reduction in workforce and outsourcing, favorable product mix and a $900,000 in the third quarter of 2008 inventory charge related to new acquisition accounting.

LED and solar process equipment gross margins were 41.7% up compared to 36% in the third quarter of 2008 due to increased sales volume, better product pricing and improved product costs associated with the outsourcing and improved purchasing related to our MOCVD high brightness LED tools.

As noted, the prior year period included a reduction in LED and solar gross profit of $900,00 related to the acquisition of Mill Lane. Data storage process equipment gross margins remained flat despite a 50% decrease in sales volume as a result of cost reductions and improved product mix. Metrology had a 42% gross margin, down from 44.9% in the third quarter of 2008 primarily due to lower sales volumes.

SG&A was $21 million or 21.3% of sales compared to $23.6 million or 20.4% of sales in the third quarter of 2008. The approximate $2.6 million or 11% decrease was due to lower salary and related expenses resulting from the personnel reductions taken as part of the 2008 restructuring plan as well as cost saving initiatives resulting in less occupancy, travel and entertainment, marketing and other operating expenses.

R&D expense totaled $13.7 million a decrease of $1.6 million from the third quarter of 2008 primarily due to a more focused approach to metrology and data storage product development which was partially offset by the continuation of investment in higher growth LED and solar opportunities.

Overall, operating expenses excluding restructuring and amortization charges totaled $34.5 million or 34.8% of sales compared to $38.7 million or 33.4% of sales for the third quarter of 2008. We continue to maintain a focus on all spending categories in order to enhance our profitability. Amortization expense totaled $1.8 million in the third quarter of 2009, down from $3.1 million in the third quarter of 2008 primarily due to lower intangible asset levels. During the third quarter of 2009 there was a restructuring charge of approximately $1.2 million consisting of personnel severance and related costs resulting from the previously announced reduction in workforce.

Third quarter of 2009 GAAP net income was $1.3 million or $0.04 per share compared to a net loss of $2.4 million $0.08 loss per share in the third quarter of 2008. This was well ahead of our guidance which was a loss of $0.25 to a loss of $0.13. The improvement was due to higher than forecasted sales and related profits. Earnings per share for the quarter excluding restructuring charges, amortization expense, equity compensation and non-cash interest and utilizing a 35% tax rate was $0.16, well ahead of our guidance which had a range of a $0.02 loss to $0.05 profit.

With regard to our outlook our forecast for the fourth quarter of 2009 is for revenues to be in a range of $120-130 million with earnings per share between $0.25 and $0.35 on a GAAP basis and $0.29 to $0.35 on a non-GAAP basis. Non-GAAP EPS excludes charges of $300,000 related to restructuring actions previously announced, amortization of $1.9 million, non-cash equity compensation of $2.9 million and non-cash interest of $700,000 and using a 35% tax rate.

We forecast gross margins will improve in the fourth quarter on a sequential basis to between 43-44% as a result of increased sales volume and improved mix. We anticipated an increase in fourth quarter operating spending in a range of $38-40 million compared to $34.5 million in the third quarter. The increase is principally due to profit sharing, bonus and commission, reinstatement of salaries as well as temporary help for the MOCVD ramp. Approximately half of this increase is above a normalized spending rate since most of Veeco’s annual profit and related incentive compensation is skewed to the fourth quarter. A more normalized operating spending level at the $120-130 million quarterly revenue level would be between $37-38 million a quarter.

Regarding our balance sheet, cash and equivalents totaled $109.4 million at September 30th. We improved our cash position by $12 million during the third quarter. Inventory decreased by $3.5 million to $75 million with a turnover of 3.1 times. This reduction was mainly due to systems shipments and the impact of continued outsourcing in MOCVD and data storage process equipment as well as continued inventory reduction initiatives in metrology.

We also had a $15.2 million increase in customer deposits associated with our higher level awards. Accounts receivable increased by $32 million primarily due to the higher sales level of MOCVD tools during the latter part of the quarter. This resulted in DSO of 59 days for the quarter versus comparable companies at 66 days.

Capital expenditures were $1.5 million for the quarter and depreciation expense totaled $3.4 million for the third quarter. We are pleased with the progress we have made in continuing to improve our working capital and cash position while increasing our sales and profits.

I will now turn the call back over to John.

John Peeler

Thanks Jack. So as Jack detailed, Veeco’s restructuring activities and dramatic top line recovery are combining to drive higher profitability for our company. Based on Q4 revenue guidance of $120-130 million our revised 2009 revenue forecast is $353-363 million. While 2009 revenue will still be down about 18% compared to 2008, this is very respectable performance during an unprecedented economic downturn.

Looking forward we believe that our backlog positions us very well heading into 2010. We continue to experience a high level of customer demand for our K465 MOCVD systems due to their industry leading productivity and low cost of ownership and are ramping up our manufacturing capacity to be able to ship more than 30 tools in the fourth quarter and more than 45 tools in the first quarter of 2010.

We are managing our slot plans and customer delivery schedules to ensure that our lead times remain under six months and we have sufficient capacity coming on line to keep them within this timeframe. We have 100% on time systems delivery for MOCVD systems on a year-to-date basis. The variable model we have designed with two outsourced partners gives us a lot of flexibility to scale manufacturing up and down as required by the market without bringing a lot of additional cost directly to Veeco. Given the large number of potential MOCVD multi-tool orders it is challenging to predict quarterly booking trends. Quoting activity remains well above historic levels with a large number of customers evaluating the purchase of multiple systems.

While we are not providing specific Q4 order guidance, we currently expect Veeco will have a positive fourth quarter book to bill ratio. This guidance reflects our belief that while the LED business order intake will likely be lumpy the overall trends in this business remain extremely favorable. As we look towards the future we believe the LED industry is at the beginning of a multi-year MOCVD tool investment cycle as LEDs increase their penetration in laptop and TV backlighting and gain momentum for general illumination. Market estimates for MOCVD are very broad but the average analyst estimate is in excess of 350 tools in 2011 or the equivalent of nearly $1 billion [ham].

With our customer list including over 80% of the world’s key LED manufacturers, Veeco is extremely well positioned to capitalize on this sizeable growth opportunity. We continue to make investments to improve yield and capitalize on our systems cost of ownership advantage. We see a meaningful inflection point in the decision making process of global LED manufacturers who are beginning to evaluate tool purchases more upon their demanding requirements for mass production rather than on installed base legacy.

We believe that our Turbo Disk technology is the most extendable, offering the industry’s highest productivity, excellent brightness and uniformity, lowest cost of ownership and a seamless transition between 2, 4, 6 and 8 inch wafers. As the only fully automated MOCVD system on the market today we are focusing on gaining traction, satisfying our customers and winning share. We possess a multi-year technology roadmap which has been developed with our customers to drive a 4X reduction in FE costs and enable solid state lighting and we are significantly increasing our R&D spending to drive this roadmap.

In solar, Veeco is seeing strong interest in our systems for manufacturing CIGS solar cells and we believe Veeco is well positioned to capture share in this market. News from the CIGS industry has been very positive in recent months with Solar Grow reporting 12% module efficiency on a 1 meter square module, Ascent at 11.7% on flexible modules, Dow announcing CIGS based solar shingles and Global Solar reporting 15% efficiency at the cell level.

Solar Grow, an important customer recently spoke at our technical conference held in conjunction with the Europe TV show commenting that while CIGS might not be the first thin film technology to market it has the potential to be the best given its low manufacturing cost and high cell efficiencies. We believe that Veeco is uniquely positioned to deliver CIGS process equipment systems with compelling advantages including flexible stainless steel and glass, complete systems for Moly CIGS and PCO steps and thermal deposition for higher efficiency and lower cost production. In particular we believe that our thermal co-evaporation approach for the CIGS absorber layer will help drive lower materials costs and reduced capital costs for CIGS manufacturers.

Using Greentech Media and our own internal forecast we concurrently believe that CIGS deposition represents a total available equipment market in excess of $600 million in 2011. Business conditions in data storage and metrology appear to be improving from the trough levels we experienced earlier in the year. We remain cautious on data storage segment as our customers continue to tightly manage their CapEx. We are staying close to our customer technology roadmaps and poised to benefit from future capacity additions. We will carefully manage this business for sustained profitability through industry cycles.

In metrology we are revitalizing the business with new products that expand the market, hit growth niches and take share. We have strengthened our direct and indirect sales channel to increase win rates and penetration in the industrial markets and we are targeting growth applications such as alternative energy, life sciences and medical. Incremental volume in this business will drive higher profitability as a result of our successful cost reduction efforts.

At the onset of the recession we put goals in place to emerge from the downturn in a position of strength and we are gratified to achieve these goals. We executed our factor consolidation ahead of plan, achieved an $80 million breakeven level in Q3, generated cash through the down cycle, reported the best order quarter in our history and are delivering compelling new products in all three businesses.

So in summary, we believe that Veeco is well positioned to capitalize on the explosive growth in the LED and solar markets and we see incremental growth upside from the data storage and metrology businesses from both end market recovery and our new products. We have strong customer relationships and are aligned on technology roadmaps across our businesses.

Lastly, as you can see from today’s results and our fourth quarter guidance, Veeco’s restructuring, outsourced manufacturing and spending discipline are driving significant growth and a highly leveraged earnings model heading into 2010. Thank you for your patience during our prepared remarks. Operator we would like to start the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Timothy Arcuri – Citi.

Timothy Arcuri – Citi

First of all, how do you gauge how much of your current bookings in LED could be sort of double ordering if any of it is? Is it even possible any of it could be? How do you gauge how much of it is due to sort of an arms race with your customers to basically sort of keep up with each other and how much of it is sort of based on real demand?

John Peeler

We don’t see any evidence of double ordering. Our orders are coming from a broad variety of customers. Some of them are lighting. A lot of them are display and backlighting opportunities. I think at the beginning of this year Samsung ran the first commercial for an LED TV, at least the first one that I saw, and that got a huge amount of interest in the industry and all the TV manufacturers are driving for this. I don’t believe there is double ordering. I do believe there is a huge ramp up to satisfy the demand here. I also think we are seeing increased activity in lighting. You look at the deals we announced this quarter and there is ongoing activity there. When we look at things, this looks like a multi-year market expansion and we think it is very healthy.

Timothy Arcuri – Citi

How much of your orders are for lighting? How much of your LED bookings are for lighting? There was another big section to the order you booked this quarter I think that is still kind of out there from that particular Korean maker. Will the remainder of that booking all be done by the end of December?

John Peeler

First of all, we don’t have a good split out between lighting and backlighting but I can tell you if you look at our press releases Lumiled is a focus on lighting. Bridgelux is focused on lighting and Sanan does both lighting as well as backlighting type of applications. Just from the three that were public, there are three lighting customers there.

We have a very disciplined order process. We put things on the books when we have the full criteria that makes it an order where it can ship within a year. Usually obviously much, much sooner than that. We have a committed purchase from the customer. So we clearly hope to win some substantial additional business from key customers and I expect we will do that as we go forward. We are not predicting forward bookings guidance so we are not predicting what might show up in Q4 versus Q1. It is just really tricky to do that.

Timothy Arcuri – Citi

Of what you know that you booked this quarter there is more to it than just that. I am wondering, as of the end of December will all of what you know you are going to get be in backlog by the end of December?

John Peeler

I don’t know. We have booked a big chunk of business and there is more to come. It is hard to predict what is Q4 and what is Q1.

Operator

The next question comes from the line of Matt Petkun – D.A. Davidson & Company.

Matt Petkun – D.A. Davidson & Company

First, Jack your material says the share count you are using for next quarter is 33.5 million in the guidance. Is that including the convertible notes? The converted 27 and change?

Jack Ryan

No, it does not include the convertible notes. We have a Treasury Method of accounting for that because we have the option to pay it back with cash.

Matt Petkun – D.A. Davidson & Company

On the CIGS solar side of the business, you had booked a large order I believe was [Dan] Metal at the beginning of this year. Can you update us in terms of what is going on there. My understanding was given the progress you might have some opportunity for follow-on business there.

John Peeler

I believe it is entirely possible to get follow-on business. We are building the systems now and casting them and expect to ship in Q1 and Q2 with revenue in Q2 2010. Projects are going very well. We also after that one in group that business and are very happy with our solar systems performance.

Matt Petkun – D.A. Davidson & Company

You commented just about the flexibility and the potential for customers to shift wafer sizes. If you had to guess at the end of next year what percentage of your customers would still be using 2 inch wafers, and I know a lot of that is out of your control, but what are you hearing and what does it look like to you in terms of the actual wafer transition progress out there?

John Peeler

Most of the customers are still on 2 inches. Some are starting to go to 4. Some are experimenting with 6. I think that is going to be a process that is hard to estimate the timing. I think the important thing to note is due to our Turbo Disk technology whatever size disk is there we get more runs per day in than the competitive units and we have a significant productivity advantage at all wafer sizes. We are willing to work with them and help them move up but most people are still running at 2 inches and will slowly jump to 4 or 6 probably with some pilot lines first and improve the technology and get it working really well and probably on a bigger way once they get their back end processing converted to 6.

So the one thing we wanted to make sure of is we are not a varier in this process, we don’t’ slow it down and we don’t complicate their purchases by having to buy a system that is one way or the other.

Matt Petkun – D.A. Davidson & Company

Our math says wafer size transitions don’t increase area that much. Are you getting pressure to expand your reactor size?

John Peeler

They don’t increase area that much. They reduce edge effects and improve the back end processing efficiency. We clearly have a roadmap of new technologies that we will roll out over time. We worked with our best customers to define that roadmap and some day there may be a larger reactor. That is one approach to improving and there are others also.

Operator

The next question comes from the line of Andrews Abrams – Avian Securities.

Andrews Abrams – Avian Securities

Breakdown of captive versus merchant in your MOCVD business, can you give us some color there as to who is buying and what percentage that might represent to you?

Jack Ryan

On MOCVD most of the companies don’t make their own equipment. Almost everybody in the market buys equipment from Veeco or Axtron or [Nepon]. So the vast majority of the business is non-internal.

Andrews Abrams – Avian Securities

On your drive business, you kind of indicated things were at least conversations were getting better. Some of the drive guys have started talking about their CapEx for next year increasing. Have you seen anything kind of leaning in that direction or is it still kind of just polite conversation?

John Peeler

We have seen more quoting. We have seen some desire to look at both capacity expansion, of course we have been selling technology deals for the last couple of quarters, but we have seen more quoting and it looks as there may be some capacity expansion. Over the last year we have moved this business to a much more variable cost model and really improved our operating efficiency. So we have got it where it is making money at still a very depressed level of business. A little pickup here I think will do great things for this business. The market is encouraging if you look at the Seagate announcements or the WD announcements or Intel’s announcements on processors I think there is a bit of good news out there.

Andrews Abrams – Avian Securities

If you look at that business from a time standpoint, from when you get orders until delivery time comes to the drive manufacturer what would you say your timing is now that you have kind of switched your model?

John Peeler

The switching the model hasn’t really changed the timing and it is a 3-6 month lead time. It depends whether we have any inventory or not. It is a build to order business though so it is not a stocking type of business. It is build to order. Kind of standard process equipment with lead times 3-6 months.

Operator

The next question comes from the line of Joanne Feeney – FTN Equity Capital Markets.

Joanne Feeney – FTN Equity Capital Markets

A question perhaps you could help us understand what you see today of penetration of the available market. So perhaps you could give us a hint as to what percentage of the top 10 LED manufacturers have placed orders with you since the first quarter and how much do you think they represent of the total market for this year and next year?

John Peeler

Let me give you a couple of angles on that. We have penetrated over 80% of the key LED suppliers. How much of the top ten…what was the second part of your question?

Joanne Feeney – FTN Equity Capital Markets

How much of the total market do the top ten represent because I think it is probably changing with the increase in activity in Asia at this point.

John Peeler

I don’t have those figures at hand. I think we have about 30% share and I believe that on an order basis we think we have been gaining share. I think we are doing very well and we are doing very well in China, Korea, the U.S. So I think we are pretty excited about what the future looks like here.

Joanne Feeney – FTN Equity Capital Markets

Has there been any pickup in activity in Europe at this point or is it pretty much Asia and the U.S.?

John Peeler

We have seen some pickup in Europe. We are seeing pickup now in all regions although Asia moved first on the recovery. We have seen some pickup in all areas.

Joanne Feeney – FTN Equity Capital Markets

On the gross margin side, you have made a number of changes in the supply chain and I am wondering how much that can add to gross margins specifically on the LED side and I would imagine it is going to take a little bit of time for those changes to work through your inventory of products. What kind of evolution would we expect in gross margin on the LED side? Have we reached a peak or can we still improve over the next couple of quarters and continue to build like this?

John Peeler

I think there is still some good potential for performance improvement. We have gone to a much more global sourcing model so we are buying materials in low cost regions, creating a dual outsourced partner gave them both some incentives to really manage their costs. Of course, as volumes go up we get better overhead absorption and we talked about more than 30 units in Q4 and more than 45 in Q1 so that will drive some good improvement. Obviously we are buying in volume so there is a lot of things. I think we had talked about a longer term model for Veeco 45-46% gross margin and we are moving towards that. We made I think great progress in our Q4 projections. It has been a long time since we have been able to project a quarter like this.

Operator

The next question comes from the line of Krish Sankar – Merrill Lynch.

Krish Sankar – Merrill Lynch

Can you tell us in terms of the book to bill for next quarter can you give more granularity by segment?

John Peeler

We really haven’t announced that. I don’t believe we can. We did give a revenue range of $120-130 million and we expect bookings to be better than 130. There is a wide range around that. Things are lumpy. It is hard to say. We did deliver a substantial sequential growth in metrology bookings this quarter. That was good to see. That is two quarters in a row. In data storage we were a little bit down from last quarter but way ahead of the Q1 trough. So we could see good things happen there. There is tremendous interest in this LED and solar area. It is exciting to see these markets move.

Krish Sankar – Merrill Lynch

Given the fact there are a limited number of MOCVD vendors are there any concerns with your customers regarding the limited number of suppliers? Are your customers asking you for any kind of exclusivity in response to giving large orders?

John Peeler

There are two main suppliers and [Nepon] Sansu in this business. Many customers want to have two suppliers. Most customers want to have two suppliers and many are switch kind of large volume from one supplier and a lesser volume from the other. Some places we are the lead and some places Axtron is the lead. They are making sure they have supply though. They are visiting our factories. They are checking out what we are doing. They are very engaged to make sure they don’t have supply limitations and we are doing a really good job for them. One of the things I mentioned earlier is we have 100% on time delivery for our systems. So we have become very focused on meeting our commitments. Beating our commitments and making sure the customers can see when they get a commitment for us it gets met. That is going very well.

Krish Sankar – Merrill Lynch

You said you can do over 45 units in Q1 next year. What do you think the maximum number of units Veeco can supply next year in 2010?

John Peeler

We have the ability to continue to ramp. We can ramp substantially beyond 45 and we do have plans to ramp beyond 45. I won’t say you can add 50% more units every quarter but we will really ramp to meet the needs. We have really good outsourcing partners. We have really good teamwork. They are experienced. They know how to build this type of equipment and I just don’t see a limitation. It may take us a couple of months to respond to something really big but we don’t feel capacity limited. We don’t believe we have lost business on lead time. We are very happy with our expansion. You will note I said more than 30 and more than 45 systems in Q1. We have got a good record of doing well here.

Operator

The next question comes from the line of Bill Ong – Merriman, Curhan, Ford.

Bill Ong – Merriman, Curhan, Ford

Excluding the LED solar business for now what kind of seasonality can we expect in 2010 and do you expect Q1 to be slightly better than seasonality and maybe just how LED solar will play out in the coming quarters and years.

John Peeler

Data storage is really going to depend on a little bit of data storage market recovery and going back to some basic capacity expansion. The announcements we saw said that should happen and we will see. The metrology, the trend there is less seasonality although in metrology Q3 has historically been a weak bookings quarter for Veeco and yet we delivered a substantial sequential increase. In metrology what is really paying off for us is a couple of years of hard work on the new product pipeline. The products are coming out. They are exceptional products. Our win rates are increasing and I think we are taking share. That I expect we will continue to do that. We have historically had seasonality for solid orders in Q4 and then a little bit of fall off in Q1.

In solar there is one important factor and that is we have been building systems but we haven’t shipped them and we are not going to take revenue until we get full acceptance in the factory. Their big systems, the new CIGS system weighs 8 tons. It has to be shipped on a ship so we add about six weeks of transit time versus our traditional air shipping. The point I am going to get to is we have been seeing revenue in solar from our sources business but not substantial revenue on the systems side. We will start to see that ramp up a little bit in Q1 and more in Q2.

We are going to count on next year being a bigger contributor to solar systems revenue that we really don’t have this year. We do have $30 million of backlog going into the year. I think that is going to give us a boost in the solar area and what we have seen in the solar trade shows and things is CIGS is really gaining momentum. A lot of companies that went after other technologies like a more silicon are flipping because the efficiencies are just too low and CIGS is gaining momentum. The Dow announcement of the solar shingle was pretty exciting to see. We have known about that for a couple of years but to actually see it come out as a real announcement from them was exciting because it just represents a huge opportunity and you can’t do it with crystalline silicone solar cells or other technologies. It is a CIGS application.

Operator

The next question comes from the line of Patrick Ho – Stifel Nicolaus.

Patrick Ho – Stifel Nicolaus

In terms of the LED ramp in orders over the next few quarters I think you characterized how the ramp has been in Q3 and how it is going to trend in Q4. Can you give just a little color on whether those are from repeat customers or are you going to see new customers in Q4?

John Peeler

We have been seeing both. We have had follow-on orders from large follow-on orders from current customers. We have had customers that were more Axtron focused that chose us for their next generation after a head-to-head battle and we penetrated new customers. So we have some of the mix there and I think we will see that trend continue. I clearly expect to get more orders from people that have ordered from us in the past. As customers get to use our systems and get experience with them they really have some great performance approvals.

Patrick Ho – Stifel Nicolaus

As a follow-up on that in terms of share gains, in your head-to-head battles with Axtron, what would you characterize as the biggest differentiator that allows you to gain share? Is it something technology wise or is it your ability to ramp or get systems faster to your customers, which could be an advantage as well?

John Peeler

The Turbo Disk technology is proprietary technology. It has unique attributes. It doesn’t have a particle problem. It doesn’t have to be cleaned. The systems don’t have to be cleaned between runs. So our systems are automated. You get more runs per day. You get an economic model when you look at what you get out of the system versus the cost that is just better. So it is productivity and cost of ownership. Customers really value that and our systems are also very flexible in terms of being able to meet the customer specific process requirements. There is a lot of ability to change our system parameters. So our customers like that and they like working with Veeco. We have heard that some of the other suppliers aren’t very flexible. They like the way we work.

Patrick Ho – Stifel Nicolaus

On the solar side of things, given that the overall industry remained relatively weak do you believe that is an advantage for CIGS adoption or could that also delay the market traction or acceptance of CIGS as we enter 2010 and beyond?

John Peeler

The overall market has been down. The European subsidies have been cut. Clearly that is hurting everybody. At the same time, I think it is an advantage for CIGS because it is enabling people to have a little bit of time to get up to speed with new factories. People are building large CIGS factories. The economics are improving. I think there will be a shake out with some of the other technologies.

The other, I think, important trend we have seen other than just there is more interest in CIGS is that the efficiencies are coming up and you read the press releases on module efficiencies they are getting better and CIGS Has been done in a lab with 20% efficiencies whereas top customers are putting out 20% modules and that is at a 14-15% cell there is still five percentage points of huge additional level that can be driven and will be driven in coming year. So there is a lot of headroom for efficiency improvements.

The other thing we are seeing is that companies went after CIGS were sputtering early in the market because they thought it was more producible. Sputtering is an old technology that everybody was comfortable with. They were concerned with making thermal work. What is happening now is if you look at all the record efficiencies in the lab they all come from thermal co-evaporation and if you look at the companies that are announcing high efficiencies in the field they are the companies with thermal co-evaporation. So there is a shift to the approach we have taken and we think that our experience in this area and our experience providing thermal sources to these companies really gives us an advantage.

So I think that is a real benefit to us as we look forward. I guess the third factor I would add is the Asians have money. The Koreans and Chinese and Japanese there is a strong stepping forward of people with money to invest in this technology. Although things may have dried up in Europe boy the Asians are really taking the lead.

Operator

The next question comes from the line of David Dooley – Steelhead Securities.

David Dooley – Steelhead Securities

You talked about the increase in your manufacturing capacity for your LED tools. Is that managing your lead times at about six months? Is that what your metric was there a lead time of about six months?

John Peeler

We are trying to keep lead times below six months. We have been able to successfully do that. They are currently below six months and in special cases we can get people things earlier. Traditionally in this business they have been 4-6 months. We are focused on driving them down and doing that.

David Dooley – Steelhead Securities

What do you think the drop rate of gross margins on incremental revenue above $125 million will be?

Jack Ryan

We like to target sort of a 50% flow through at the gross margin line on an incremental sales basis.

David Dooley – Steelhead Securities

Do you expect disk drive orders to grow sequentially in Q4 or early next year?

John Peeler

We haven’t provided any kind of order guidance but when I read the Seagate or Western Digital guidance that looks pretty exciting to me. If they are talking about spending more CapEx that is a good sign. We did say there is more quoting activity but we don’t really have specific guidance.

David Dooley – Steelhead Securities

How much industry capacity do you think is being added in the LED space at this point? You kind of gave us a tool number you thought the industry would be in 2011 but just by however you want to measure it, number of wafers, LED, however you are looking at it, what sort of capacity increases is this backlighting opportunity driving for the overall industry?

John Peeler

I don’t think I have any specific numbers on the tip of my tongue. There is clearly a lot of capacity being added and there are a lot of analysts that have published data you can see what is coming out. I would look at some of those other reports.

Operator

The next question comes from the line of Peter Wright – GC Research.

Peter Wright – GC Research

I was hoping you could quantify your capacity ramp assuming more strategic thought goes into how big you build your internal capability for MOCVD. Where do you see yourself capping out internal capacity of how many systems you would want to build internally in the medium term, next 12-18 months? My second question is I was hoping you could give some color on the complexion of the follow-on offering if there is any inside participation.

John Peeler

I can’t take any questions related to the offering and will have to refer you to the offering materials for that. On the manufacturing capacity, the last few years we have relied on a very highly proficient outsourcing partner in the U.S. They were building most of the production, doing most of the building of our MOCVD systems and then we were testing them. What has changed is we moved to them building the entire system or entire systems and then we do testing at their facilities with their people and our people and during this expansion wave we also do testing at our sites.

So we are really just doing testing. We do help manage the supply chain, make sure we have the right vendors and the right suppliers and there is nothing in the supply chain that is going to limit us. So in addition to this company which has ramped substantially and done a great job for us, we have also been working with an Asian supplier to bring on capacity. They have been building units here in the U.S. with us to develop that capability and are now building units in Asia and we augment their capability with our people to make sure there is no quality glitch here. So we have a whole second manufacturer coming online. The figures I quoted don’t have a lot of output from that second manufacturer.

If we needed to double 45 to 90 we can do that. We are not going to let manufacturing limit us. We have been very careful about this. We have been very methodical. We have very experienced people working on it. It is not a limiting factor. We are going to go sell more and win more business.

So thank you all for joining us tonight. We really appreciate it. It is exciting to be here to have this type of quarter to announce. We will look forward to seeing you soon.

Operator

Thank you Sir. At this time you may disconnect.

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