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Veeco Instruments Inc. (NASDAQ:VECO)

Q4 2007 Earnings Call

February 11, 2008 05:00 pm ET

Executives

Debra Wasser – VP of Corporate Communications and Investor Relations

John Peeler – CEO

Jack Ryan - CFO

Analysts

Bill Ong – American Technology Research

Joanne Feeney – FTN Midwest Securities Corp.

Timothy Arcuri – Citigroup

Mark Miskelly - JP Morgan

Matthew Petkun – D.A Davidson & Co.

Mark Miller – Brean Murray, Carret & Co.

Operator

Good day everyone and welcome to Veeco Instruments Fourth Quarter 2007 Results Conference Call. Today’s call is being recorded.

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

Debra Wasser

Thank you everyone for joining today at Fourth Quarter 2007 Results Conference Call. Joining me for today’s call are John Peeler, our Chief Executive Officer and Jack Ryan, our Chief Financial Officer.

Today’s earnings release was distributed at four p.m. this afternoon. If you have not yet seen the press release, please visit the veeco.com website or call 516-677-0200, extension 1305 to get a copy.

We have also prepared an overview of our financial results and segment breakdowns which can be found on the website as well. This call is being recorded by Veeco Instruments and is copyrighted material. It cannot be recorded or rebroadcast without Veeco’s expressed permission. Your participation implies consent to our taping. To the extent of this call discusses expectation about market condition, 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 our subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. This factors are discussed in the business description and management discussion in the analysis section of the company’s report on Form 10-K and annual report to shareholders in our subsequent for quarterly reports on Form 10-Q, current reports on Form 8-K and press releases. Veeco does not undertake any obligations to update any forward-looking statements including those made on these call to reflect future events or circumstances after the date of such statements.

During these calls, the management may address non-GAAP financial measures. Information regarding such non-GAAP financial measures, including reconciliations to GAAP measures of performance is available on our website.

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

John Peeler

Our agenda for this call is to review the fourth quarter and full year 2007 results, provide outlook and guidance for the first quarter and review activities that have been completed to improve Veeco’s performance. I will also cover market trends and strategies for our business, and provide guidance for 2008.

As we stated in our press release, Veeco reported fourth quarter revenue of $107 million, which is in line with our guidance of $1,422,012.00 million, revenues were down 13% form the fourth quarter of 2006, but up 9% on a sequential basis driven by increases in sales to all in-market except semiconductor.

Fourth quarters bookings of $115 million were at the high end of guidance, down slightly on a sequential basis after our strong third quarter level and up 5% compared with the fourth quarter of 2006. We have experience continued strength than LED wireless orders, which were again over $40 million including multi-unit orders and orders from several new customers in Asia.

Included in the strong LED wireless figure was $5 million in orders for solar applications. Data storage orders of approximately $36 million were flat versus the third quarter and up from the prior year trough of $21 million. Scientific research orders were down slightly versus the prior quarter. The only market which showed a significant bookings downturn was semiconductor which was down 12% sequentially.

Veeco’s earnings per share, excluding amortization and restructuring charges was $0.07 per share. This was ahead of our guidance range due to lower than expected operating spending levels and this has been a significant focus for us.

Veeco’s full year of 2007 performance was clearly a disappointment with revenues of $403 million, down 9% versus 2006, while we had strong 2007 revenue growth in LED wireless which was up 25%, and Scientific Research which was up 5%, data storage and semiconductor revenues were down 25% and 35% respectively. While we had made significant changes to our spending line in the last six months our 2007 EBITDA of $11 million was impacted by weak volumes and gross margin declines in several key businesses.

We are confident that 2008 will be a much improved year for Veeco on both the revenue and earnings lines. As stated in October, we have initiated a performance improvement program and we are pleased to have completed significant restructuring activities in the fourth quarter, which when combine with a stable overall business environment in most markets, sets the stage for a much better year.

I would like now to take a few minutes to review our activities to cut cost and improve performance. We have taken a 7.5% reduction in force, which has decreased our workforce by about a 100 people since July to 1216 employees at the end of the year. This represents an annualized savings of nearly $12 million. We are on track to consolidate our corporate headquarters into our Plainview, New York site by the end of this quarter, which we anticipate will have an annualized savings of $1.8 million.

While we have seen a recovery in our data storage business, we think it is appropriate to increase focus in this business to better reflect the realities of the end market. In 2007, Veeco was negatively impacted by the continued industry consolidation including TDK’S purchase of assets and HTFT’s factory consolidation, as well as, by slower unit growth rates per heads and drives compared to previous years.

Recent data from TrendFOCUS indicates that in film head production will grow at a 6% compound annual growth rate through 2011 and this is well below the double digit growth rating experienced in prior years.

During the fourth quarter, we took several important actions to right size our data storage business in light of the changing environment. We decided to reduce our product offerings in ALD and some PVD product lines. After a careful evaluation and discussions with our key customers, we have decided that the market payback for continuing to pursue these technologies did not match the Veeco resources require.

We are also consolidating our Fremont, California Data Storage R&D Center in to our Plainview, New York site in order to improve the effectiveness and reduce development times. These activities represented another $1.3 million in annual saving for Veeco.

As Jack will review more fully in a minute, we also recorded $16 million in order cancellations from data storage customers during the fourth quarter primarily related to these discontinued products. While we have made some difficult decisions this past quarter in our data storage business, we maintain our commitment to this market and our data storage customers.

Our data storage product line now represent those where we have very high share, technology leadership, and the best growth potential, and this includes ion beam etch and deposition, PVDI, DLCX and our new PVD high rate aluminum deposition tool, as well as our slider products.

These technologies are well aligned with our customers needs such as larger wafer size programs and lower cost of ownership tools.

I am pleased with what we have accomplished this past quarter to improve Veeco’s performance and I think it will set the stage for a much better 2008. I will now turn the call over to Jack to review the further details of our fourth quarter results, and to review our first quarter guidance. I will comeback afterwards to discuss our market outlook and some thoughts about 2008.

Jack Ryan

For the three months end of December 31, 2007 sales were $106.8 million up sequentially 9.3% but down to 13.2% versus the fourth quarter of 2006. The decrease versus 2006 was due to $10.3 million or 22.4% decrease in metrology sales, principally due to lower sales of automated AFM products to the semiconductor market. Process equipment sales was $71 million, a decrease of $5.9 million, it was 7.7% versus the fourth quarter of 2006 due to the lower sale of the ion beam products and the data storage market.

Fourth quarter 2007 orders improved to $114.9 million which is at the high end of our guidance, up 5.3% on the fourth quarter of 2006 but down 2.9% sequentially. Price equipment represented 68% of orders at $78.3 million and metrology represented 32% of orders at $36.6 million. Compared to fourth quarter of 2006, we experienced a 70% increase in data storage orders and a 35% increase in high brightness LED wireless orders, Veeco’s book to bill ratios was 1.08 to 1 for the quarter.

Backlog at December 31, 2007 was approximately $107.5 million. Fourth quarter 2007 backlog adjustment totaled $16.2 million primarily consisting of customer orders for the ALD and PVD multi target data storage product lines which were discontinued as part of the company’s previously announced restructuring plan. The associated restructuring charge of $10.6 million in the fourth quarter of 2007 consisted of $7.7 million of inventory and related accruals and fixed assets associated with these data storage product lines, as well as $2.9 million in personnel severance cost resulting from the company’s 7.5% reduction in employment.

Gross margin on a non-GAAP basis excluding the $4.8 million inventory charge for the noted discontinued products was $40.5 million or 37.9% of sales for the quarter up sequentially from 36.7% in the third quarter of ’07, but down compared to the 44.5% in the fourth quarter of 2006. Processes equipment gross margin was 37.2% up sequentially from 33.5% in the third quarter of ’07, but down from 40.4% in the fourth quarter of ’06. The 3.2 margin point decrease compared to the fourth quarter of ’06 was due to $5.9 million of lower sales volume associated with the data storage product.

Metrology had a 39.3% gross margin compared to 51.6% in the fourth quarter of ’06 mainly due to lower semiconductor and data storage sales volume, less favorable product mix and overhead absorption. In addition, there was a one time $800,000.00 charge that adversely impacted Metrology gross margins during this fourth quarter.

SG&A was $21.6 million or 20.2% of sales down compared to $24.2 million or 19.6% of sales in the fourth quarter of ’06 and $22.5 million in the third quarter of ’07. R&D expense totaled $14.8 million, a decrease of $1.5 million from the fourth quarter of ’06.

Overall, operating expenses excluding the restructuring related charges in amortization totaled $36.4 million or 34.1% of sales compared to $40.5 million in the fourth quarter of 2006 and our fourth quarter ’07 guidance of $40 million to $41 million. This decline was mainly attributable to reduction in compensation related expenses, lower travel and entertainment and depreciation in accordance with our overall cost reduction initiative, as well as third and fourth quarter adjustments of accrual estimates related to the accounts and fringe benefits.

Exclusive of these fourth quarter accruals, a more normalized operating expense level was approximately $39 million and this is the level that we have targeted in the first quarter of ’08. Amortization expense totaled $2 million in the fourth quarter of 2007 versus $4 million in the fourth quarter of 2006 and this decrease was mainly due to certain technology based intangibles becoming fully amortized during the second quarter of 2007.

Fourth quarter 2007 GAAP net loss was $9.4 million or $0.30 per share compared to net income of $7.6 million or $0.24 per share in the fourth quarter of 2006. Earnings per share excluding amortization expense, restructuring items and using a 35% tax rate for the quarter was $0.07 compared to $0.29 for the 2006 quarter.

For the full year 2007, sales totaled $402.5 million or an 8.7% decrease from 2006 principally from the weak data storage environment and the lower automated AFM sales in the semiconductor model.

For the full year 2007, orders declined 8.5% compared to last year, process equipment represented $305.6 million or 68% of the orders and Metrology was $146 million or 32% of the orders. Gross margin for 2007 on a non-GAAP basis excluding the $4.8 million inventory charge for discontinued products was 40.3% sales compared to 44% in 2006 primarily due to lower sales volume.

Metrology gross margins were 44.1% compared to 51.5% in 2006 as a result of lower sales volume of automated AFM and optical metrology products and less favorable product mix in AFM products. Process equipment margin was slightly lower compared to the prior year mainly due to the continued slow demand of ion beam products to the data storage customers.

Veeco’s MOCVD and MBE business significantly improved its gross margins from 30.4% in 2006 to 37.8% in 2007, which helped support the process equipment group’s profitability overall and a difficult data storage environment. SG&A was $90.4 million or 22.4% of sales in 2007 compared to 92.5% or 21% sales in 2006, R&D expense decreased $700,000.00 to $61.2 million in 2007, amortization expense totaled $10.3 million in 2007 versus $16 million in 2006.

The restructuring charge net of gains on our debt retirement, for the full year, the net charge was $11.9 million. Net interest expense totaled $3 million, a decrease of $1.3 million from the $4.3 million that we expensed in 2006 due to the repurchase of $56 million of our convertible notes during the first quarter of 2007.

Veeco’s 2007 GAAP net loss was $17.4 million or $0.56 per share compared to net income of $14.9 million or $0.48 per share in 2006. The 2007 GAAP net loss was impacted by income tax expense of $3.7 million primarily from foreign taxes compared to $5 million in 2006.

Earnings per diluted share excluding certain items for 2007 were $0.17 compared to $0.75 in 2006. The items excluded from these calculation are the gain on extinguishment of debt, restructuring an asset impairment, an inventory of gross and amortization expense, used a 35% tax rate in that calculation.

The outlook with regards to our guidance for the first quarter of 2008 is for revenues to be in the range of $98 million to $105 million with a GAAP loss per share of $0.19 to $0.09 and earnings per share between zero and $0.06 per share excluding amortization of $2 million and restructuring charges in the first quarter estimated at $3.6 million.

For non-GAAP EPS, we used a 35% tax rate. We currently expect the first quarter 2008 gross margin will improve by approximately one margin point to the 39% range. As noted earlier, we expect operating expenses to be approximately $39 million. This includes many of the cost savings that John spoke about such as the 7.5% head count reduction and T&E savings.

These are partially offset by accruals from planned bonus incentives and equity awards or variable incentive programs. The first quarter also is impacted by higher trends due to filings of 401-K and other items that are skewed for the first half of the year. First quarter 2008 orders are currently expected to be between $105 million to $112 million. The forecast’s sequential decline in orders from $115 million in the fourth quarter is a reflection of the normal seasonality in our scientific research market. For the full year 2008, we are anticipating revenue growth of approximately 10% based on our beginning backlog in our key market and customer current indications. Of course, this does not assume a significant decline in the general economy.

We are targeting sequential quarterly gross margin improvements during 2008 at a minimum of 1% per quarter with an average of 42% gross margin targeted for the full year. As far as operating spending goes, we will continue to contain spending and expected to decline quarterly as percentage of sales. So we are looking at 2008 as a recovery year.

Regarding our balance sheet, cash and equivalents totaled $117.1 million at December 31. We are pleased that we generated a $31.1 million of free cash flow for 2007, accounts receivable DSO’s for the fourth quarter was 63 days remaining flat in the September quarter, but well below industry averages of 79 days. During the quarter, inventory decreased by $7.1 million to $98.6 million with a turnout of 2.7 times. The decrease is primarily due to the write off of the inventory related to the discontinuance of certain data storage product lines. Capital expenditures were $2.2 million for the fourth quarter of 2007 and $9.1 million for the full year.

Depreciation expense totaled $3.4 million in the fourth quarter and $13.6 million for the full year. We improved our balance sheet during 2007 and in particular, reduced our outstanding debt by 30%. In addition, as previously reported we exchanged approximately $118.8 million of convertible notes for new notes, which we will not issue until the second quarter of 2012. As a result, our capital structure has been significantly improved during the year. I will now turn the call back over to John to discuss market outlook and to take your questions.

John Peeler

I would like to take a few moments to describe our strategic initiatives and the market trends impacting our outlook for 2008. Historically, we have presented the company as two product segments, process equipment in Metrology, and four TM markets. This combination ends up being a complex and matrix way of looking at Veeco. In my mind Veeco has three market focused businesses. First, our LED and solar process equipment business comprised of MOCBD and MBE technologies. Second, our data storage process equipment business comprised of our ion beam and slider technologies. And third, our Metrology business. Going forward, we will report our process equipment business in two segments, LED and solar process equipment, and data storage process equipment. And we will report revenue bookings, and profitability information for each. We will of course continue to report results for our metrology business.

We have posted some historical data on these three businesses on the website and you will see that the numbers are not that different from the end-market breakdowns used in the past. We believe that this is a much simpler way to look at Veeco with our core technologies aligned with their primary end-markets. We also see these three businesses as having different strategies for growth and profit improvement and believe that this segmentation will make it simpler for you to model the company and track our progress and execution.

Veeco’s Senior Management is focused on allocating our resources to best drive growth in financial performance such as where to invest more and where to cut back, and it is taking actions to build and improve each of these three businesses. I will now take a few minutes to outline our focus areas and our market outlook for each business.

In LED and solar process equipment, we believe that the company has an exceptional multi-year growth opportunity. Revenues in this business were $94 million in 2006, an increase of 23% to a $116 million in 2007. Orders were up to 37% from $120 million in 2006 to $164 million in 2007.

In 2007, we launched our new TurboDisc K-series in MOCVD platform for Gallium nitride based Blue-Green LED’s and our first K465 systems are now receiving customer field acceptance. We also introduce our E475 or arsenic phosphite red, orange and yellow LED’s and triple junction solar cells, that we believe that we have increased our MOCVD market share based upon orders from 20% to about 35% during 2007. We are particularly pleased that while we remain the number of two supplier, we have penetrated several top tier account where our competitors holds the install base. We continue to enhance our MOCVD systems, and develop new products to improve throughput efficiency and the ultimate value of the LEDs produced.

We expect continued strong order patterns in the LED market given the broadening adoption of LED. The overall LED market is forecasted to growth from $4.2 billion in 2006 to $9.4 billion in 2011, which as an 18% compounded annual growth rate.

Some applications are forecasted to grow at much higher rates, for example, LED’s for architectural and retail lighting are forecasted to grow nearly 40% over the next several years. Our customers are seeing increased penetration in exterior as well as interior automotive lighting and a recent strategy analytics survey estimated that this market alone could be worth a billion dollars by 2014.

LED’s are also experiencing increased adoption in laptop backlighting, with the industry players expecting growth at the expense of traditional CCFL solutions. In a recent article stated that LED makers from Taiwan project that the cost of LED backlight units, which rank to 1.5 times that of CCFL’s during 2008. Apple’s new McBook Air which features an LED back-lit display is also expected to help push the growth of LED backlighting applications.

About $20 million of our 2007 MOCVD and MBE orders were for solar applications. Our E475 MOCVD system with 50% more throughput than the competition is helping to manufactures some of the world’s most efficient low cost 3-5 solar cells for satellite and terrestrial applications. In addition, we think thin film signal market offers a very promising growth opportunity for Veeco, given the potential for increased efficiency and lower cost panels than silicon. Given the tremendous growth opportunities we see in LED and Solar, we will increase our R&D spend in MOCVD and MBE technology by about 40% in 2008.

In data storage we had a very challenging 2007. Data storage process equipment revenues declined from a $175 million in 2006 to a $136 million in 2007. Here, we have a more mature market with modest growth opportunities and are focusing on areas where we deliver compelling products that address new data storage technologies or that provides significant economic benefits to our customers. We are exiting those product lines that lack compelling customer benefits and differentiation, and as we do this, we are also simplifying the business and reducing the cost by moving from four to three R&D sites and improving our manufacturing efficiency with increased source information and increased outsourcing.

Our customer’s larger wafer formats require retooling in greater than 50% of the process steps and we have aligned our products to address this important transition. While our first half starts out slowly, we own significant backlog to fuel revenue and profit recovery in our data storage business in the second half of 2008.

Our third business is Metrology, where revenues declined from a $172 million in 2006 to $150 million in 2007, primarily due to the declines in semiconductor and data storage markets. In 2008, we are focused on growing the instruments business with new product enhancements for our AFM and optical instrument lines, and we have already started to see traction from our efforts. In the fourth quarter, we booked a record number of piezo tube products over 30 of our newly released Innova STM systems and a record 60-plus Dektak 150, and in fact our nanobio AFM in optical business, each reported bookings increases in every quarter of 2007.

In the auto AFM side of metrology, we believe our new insight 3D auto AFM will give Veeco some 2008 bookings growth in an otherwise unexciting semiconductor market. Current capex plans indicate that 80% of payout spending in 2008 will be for 65 and 45 nanometer applications. With three times the throughput and two times the measurement accuracy and precision of our previous AFM’s, insight represents an entirely new approach for semiconductor 3D metrology. We are receiving significant interest in demos and samples coming from countries throughout the US, Asia, Japan, and Europe. Our two betas in the field are performing quite well; one is a reference tool and the other in a production environment for 45 nm. In addition to new products to drive growth were also moving to increase use of lean manufacturing and driving operational excellence in our metrology services organization.

Lastly, but certainly not the least, we have strengthened our leadership team in this important Veeco business. As we have announced two weeks ago, we have hired Mark Munch as our new Executive Vice President in Metrology. He brings the details to Veeco deep scientific technical and product development experience and is comfortable managing a multi product, multi market business.

As we stated in our press release, we currently expect 2008 to be a better year for Veeco; while we always faced unpredictability in our end markets, our 2008 goal is for revenue growth at a minimum of 10%. When you look at this reporting to our new segmentation, we are modeling 20% to 25% growth for LED and solar process equipments, 0% to 5 % growth for data storage process equipment, and 5% to 7% growth for metrology. So as we said back in October, the first half of 2008 will have a modestly improved revenue when compared with the second half of 2007 as we face a trough period in data storage revenue, but we expect 2008 to be a recovery year for Veeco overall in terms of revenue growth and improved profitability.

As Jack discussed, while 2008 operating spending is currently expected to increase in absolute dollars due to necessary budgeting for raises, incentive compensation and other variable cost, our significant cost-cutting actions and continued cost-containment focus will allow us to decrease our operating spending as the percentage of sales by 200-basis points from about 38% in 2007 to about 36% in 2008; while simultaneously investing in the future growth of Veeco as I had just outlined.

We are continuing to improve our gross margins through better pricing of global supply chain initiative and outsourcing and as Jack stated we currently expect gross margins to increase each quarter in 2008 as we bring up revenues.

Now that I have been here for about seven months, I believe we are on the right track to transition Veeco’s business model over the coming months and years. Our goal is to align the company to higher growth opportunities and to deliver steadier revenue increases and profit improvement.

Thank you for your patience during our prepared remark. Operator we would like to now start the Q & A session.

Question and Answer Session

Operator

(Operator instructions)

We will take our first question from Bill Ong with American Technology Research.

Bill Ong – American Technology Research

In the MOCVD bookings that you saw, is it mostly by the demand of the Red Orange LED application or more towards the blue green gallium nitrite applications, and how do you see others will play out? Are you expecting these strong bookings deposit and so you accelerate your run off into 2009?

John Peeler

First of all the strength is really across both types of LED’s. We have not seen anything to indicate a pause at this time, but it has happened before in the market and it certainly could happen again. We do enter the year with strong backlog, so we believe we can deliver good results even if there is pause but we have not seen that.

Bill Ong – American Technology Research

Do you have a sense of the market share for 2007 right now?

John Peeler

We have tracked the bookings wins and losses versus our competition as we have gone through 2007 and we think on a bookings basis that we have come from about 20% to about 35%. Revenue has clearly lagged the bookings, but we think booking is a good leading indicator for the future.

Bill Ong – American Technology Research

Okay and then my last question is on your 2008 revenue guidance, you are expecting data storage be flat of 5% given the Capex for Seagate and Western Digital is kind of flattish in the backend of your load, if that is that, even the flat of 5% is too optimistic maybe some comfort on why you think you may do a little bit better this year?

John Peeler

Comfort really comes from the fact that we entered the year with a strong backlog and we have multiple customers going to eight-inch wafer size and we have both backlog as well as anticipated additional orders for this new technology; so even in a fairly tough capex environment, we think we can deliver at least the bottom of that range and perhaps better.

Operator

Our next question comes from Joanne Feeney with FTN Midwest.

Joanne Feeney – FTN Midwest Securities Corp

A couple of questions on the HP-LED world, could you give us an update on your gross margin over there. You were making some steady improvements, has that been continuing?

Jack Ryan

Yes we have made improvements and I think I indicated that in my comment that we had gone from I think with a 30% gross margin to almost 39% gross margin during the course of 2007, and as John and I both indicated, we have expectations that our gross margin will continue improve in the coming 2008 year.

Joanne Feeney – FTN Midwest Securities Corp

And so if I understand, the outlook for the process equipment in HP-LED, you were remarking I think John that you saw an external source of about an 8% on an annual growth rate forecasted for the next few years, you are forecasting growth in that segment of 20% or better for 2008, is that because either you expect to take share or you just see this year as a particular year, which capacities constrained in that market?

John Peeler

First of all Joanne, I meant 18% as the kind of overall LED market growth, on the other hand a lot of the segments are growing at 40 or more percent growth, so our growth is based on a couple of things, being able to address the higher growth segments as well as really entering the year with a very strong backlog and a 37% bookings growth last year really positions us for a very good revenue growth this year, so we are confident we are going to keep growing above 20% in this market.

Joanne Feeney – FTN Midwest Securities Corp

Do you have any sense of the state of capacity utilization in this segment?

Jack Ryan

All we know is what our customers tell us by buying additional units and we have seen a good ramp on bookings, we do not know a whole lot more than that.

Joanne Feeney – FTN Midwest Securities Corp

Okay and then on the Metrology side do you see, I mean that is obviously traditionally been an area where gross margin is much higher and with auto AFM kind of waiting to see a ramp with the recovery of semiconductors; is there anything else that might go on within that segment that could bring up gross margins or are there other new products that you see bringing up gross margins through this year?

John Peeler

There are, first of all in the instrument side we are anticipating a growth year. Our new and other product line has a better gross margin than prior products so the new products we expect to pull up the gross margin and we are also working on our operational effectiveness. We have added Mark Munch who we are very glad is with us, and we believe that the combination of products put some growth and some improvement in our operations will drive the gross margins on the instrument side and of course on the auto AFM side, we had a real tough revenue year last year. We believe the new insight product will help to produce a better growth year this year and that will produce better gross margins.

Joanne Feeney – FTN Midwest Securities Corp

And so in the past Metrology has been just so much better in terms of growth margins and process equipment, today they are almost even; so is it the case that the potential in those two segments is more balanced now than traditionally and with the only exception perhaps being the auto AFM product?

John Peeler

First of all, on the Metrology side, the instruments continue to be much higher gross margin than the process equipment, so we expect that to continue as well as to get improved gross margins in the instrument side. The auto side has pulled everything down this last year, so I expect Metrology over the average to operate at significantly better gross margins than process equipments maybe 8 to 10 points better.

Joanne Feeney – FTN Midwest Securities Corp

Okay and then finally, any signs from your customers of an economic downturn? Are you seeing anything concrete that would suggest a slow down across the board here?

Jack Ryan

We are not; I think the data storage market news is pretty much out there with good announcements, solid end market announcements from Seagate and WD, and we are not seeing any other signs other than continued very tough semiconductor market.

Operator

Our next question is from Timothy Arcuri with Citigroup.

Timothy Arcuri – Citigroup

Couple of things, first of all John can you give us some update with respect to the potentially pending competition in the MOCVD space; there is a big process tool vendor that has talked about getting into that space, do you see any new entrance in that space?

Jack Ryan

Well, I think we have long said that this was an attractive market and we would not be surprised if anyone else entered this market and that certainly maybe the case. We do believe there are some significant barriers to entry based on the complexities of the technology and the installed base of Veeco and Asteron, so I do not have any new news, but we will continue to stay on our toes, build our products to be better and work on next generation products.

Timothy Arcuri – Citigroup

John on that point, if you look at the valuation of your primary peer in that space, it would imply that you are getting one buy-in Veeco will be getting the entire rest of the business basically for free if you kind of comp up to what they are giving value just on the MOCVD business; as you kind of look at the valuation that the market is paying for the LED space, what sort of strategical turnout, over the long term do you think exist for the other businesses because right now the market does not seem to be giving you any credit whatsoever for anything beyond just your LED market.

John Peeler

We are thinking of a couple of things that we are working on, first of all we just announced that a more clear way to present the company which is actually the way we manage it, which we think will improve visibility in each of the businesses and hopefully that will result in getting a realistic value for the businesses going forward.

Secondly, we announced the new approach to providing the segmentation of each because each of these businesses has good opportunities and good potential in its own right, but they each need different things to maximize their value going forward.

In high brightness LED and solar, it is continued investment really coming out with the next generation products, building the revenue, gaining share and growing. And in Metrology, as I outlined it is different and in data storage is different, yes, so we are working to get the full value and development of each of these businesses and if the market has not seen that yet, it probably will in a while.

Timothy Arcuri – Citigroup

Okay I guess last thing for me, it looks like if you are look at your data storage guidance it looks like basically you are kind of flat lining revenue in the kind of mid-30 range, off of your Q4 booking numbers or are you just kind of assuming that revenue flat lines basically at were the bookings were in Q4, so that kind of being the case; A, do you think that the seasonality in storage is gone and B, we are kind of bouncing along a perpetual bottom here, is there any strategic alternative for that business so that if you even wanted to get rid of it, would it be a product sale or are those products too intertwined with what you do in other parts of the business that you could not outright sell that business?

John Peeler

So first of all on the data storage market, the fourth quarter orders where significantly up from the fourth quarter of last year, so if you look at the order trend, the order trend is improving, the revenue trend does lag the order trend, so based on that it gives us a tough revenue trend in data storage for the first half of 2008, but based on the orders that we have been getting and the backlog that we have, we do believe there is a good recovery in the second half.

I would like to think the cyclicality of data storage went away, but there is a long history here that would probably prevent me from drawing that conclusion. So the business, the bookings provide some good insight that we do have a good future here. We have taken a lot of cost out of the business, we have simplified it, we have made it easier to run with less sites; so we do think it is a good business.

There is some synergy across our businesses and to data storage, we sell Metrology, and we sell MB products and some cross selling to data storage into other markets. So we do think there are synergies between the business, we are working to get more leverage in our supply chain in some of the areas to get more out of that, and as far as strategic alternative, we are focused on building the business and getting it back to profitability making a healthy business.

Operator

Next we will go to Mark Miskelly with JP Morgan

Mark Miskelly - JP Morgan

A few question, first of all, I appreciate the newly introduced format for reporting going forward, in tem of judging how you form to your mile posting with respect of segments and taking that one step further as far as data storage, can you maybe just help us understand how your customers are reacting; obviously, you have already talked about the cancellations in term of what you have done with the PVD and LED, but can you talk about their response in terms of, do you see the response in terms of realizing how really focused you guys are in terms of improving the profitability of your data storage business; are they going to work with you more as partners rather than try to beat you over the head on your existing business for continual price declines?

John Peeler

You know Mark the reaction of our customers has actually been quite good; and first of all we did not surprise any of them, we have been working with our customers since early in the fall, as well as up through the last week to talk to our top customers understand best where they really valued us and versus where we were selling them products that were kind of ‘me too’ products and maybe where we had entered the market late or did not have compelling technology or just did no align with what they really saw as their high-value products.

So we have a good understanding of where they needed us and wanted us to be. We went through a process of where we were potentially going to exit product lines of working with our customers carefully to do that and I think that is very important. I have seen companies cut product lines and surprise customers and do tremendous damage. In the past, we were very careful not to do that and not to leave our customers high and dry.

So this was a carefully worked plan over the prior months to get to a situation that worked for our customers and worked for us. As I have talked to them and our other senior management have talked to the customers, it has been well received, they are looking for us to improve our efficiencies to use more Asian sourcing, to be a more efficient company, so they have been very positive about the changes we are making and feel that it actually aligns with their very competitive environments.

The $16 million of backlog reduction was really worked carefully. This was not the we sent them a letter and they responded and cut orders, this was a jointly worked plan with our customers and I think we will work more closely together going forward, so I think we feel good about what we did here and it was hard to do, but I think it was the right thing for the company and will be better for us and our customers in the future.

Mark Miskelly -JP Morgan

Okay I appreciate that and then, I may have missed it, but Jack or John did you see what the quantifiable reduction in that business will mean in terms of as we look forward to 2008 in terms of comparison how much of the LED and PVD divestiture hold out revenue on a quarterly basis for 2007?

Jack Ryan

You know on the revenue side our 0% to 5% growth assume those product lines are going; so the numbers we have issued as far as going forward growth include the impact of this cancelled product lines.

Mark Miskelly - JP Morgan

You are not going to give us what it was on a quarterly basis for the four quarters of 2007 those respective product lines being cancelled?

Jack Ryan

We do not have that on our fingertips frankly; it was not a terribly meaningful number.

Mark Miskelly - JP Morgan

If we could shift gears to HP-LED, I just want to get a sense in terms of the visibility around the 20% to 25% revenue growth for this year and getting back to the earlier question, is it more fun to inverse it back and load in them, and the reason I ask that is just because of the Olympics, how much of the Olympics is having an impact here?

John Peeler

First of all, we had a very solid bookings year in 2007. We are beginning to ship the new systems, we have gotten acceptance of our first 465; so the revenue is not back and loaded, it is a loaded throughout the year in a fairly uniform way, and actually as we talked about it, there was kind of a first half trough in data storage, the high brightness LED business is making up for that in a pretty big way to get us where we have ended up to. It is not back and loaded, but there is a lot of backlog to ship so we are comfortable in our numbers.

Mark Miskelly - JP Morgan

Okay and did you comment as far as the 20% to 25% gross target, how much of that is based on the contribution from the new products in solar or soon to be announced new products in solar or does it even include?

John Peeler

It is really a combination of our high brightness LED and solar products with a little bit to wireless out of those businesses. It is mainly high brightness LED and solar, we have booked about 20 million of solar in 2007, probably shipped about 10 million of revenue of that, so the solar growth is probably nominally about equivalent in a percentage point to the LED growth; so it is both of those markets are exciting markets and growing together.

Mark Miskelly - JP Morgan

Okay just lastly, I know it is kind of a loaded question but Dr. Munch has only been there for a few week, but John when you worked with Dr. Munch, have you kind of recognized Metrology as having the same type of opportunity as maybe data storage where there can be some realignment or refocus in efforts that you could implement over the next 6 to 12 months?

John Peeler

Well first of all Dr. Munch has been here only four days maybe five days including today, him and I spent a lot of time together before he joined the company to make sure this was going to work for both sides; but I think he has seen the opportunity in the business and her has seen that we can make this business operate better and improve the growth and the effectiveness and I am sure he will be working on that in the coming months.

I have spent a good bit of time over the last couple of months working with that business myself and we do believe there are opportunities to improve our growth rate as well as to improve our gross margin and our predictability so we can get a good business and we can do good things with it and I think Dr. Munch is exactly the right guy to lead that to the next level.

Operator

The next question will come from Matt Petkun with D.A Davidson & Co.

Matthew Petkun – D.A Davidson & Co.

Couple of questions for me, first John what do you see in terms of wafer-size transitions in the data storage market and when you look at the implied economics of a shift in the wafer-size, how does that color your view of a market that you think will grow at only 6% gigahertz, industry resources suggest will grow at only 6% gigahertz in and on of itself.

John Peeler

For the wafer-sized changes, we have major multiple customers planning to go larger wafer sizes, generally they will not throw out their existing equipment but they will add 8-inch equipment going forward as they need new capacity and so that presents a significant capital opportunity over a few years. The end market of 6% does not naturally, exactly tie to the capital equipment growth market because there are increased efficiencies in the use of capital, the move to film to sliders, getting more heads on a wafer all make for a more efficient operations, so over the long run we would expect capital to grow at a slightly less rate than the end market rate but we think there is a big opportunity.

We do see our customers being very careful with their capital spending and very efficiency oriented, so what we have tried to do with our product lines here is really focus on the ones that align with the technology change or the economic change for our customers so we do think there is a good opportunity here but it is not going to come as a giant wave of dollars, it is going to come as customers start with 8-inch, get their pilot lines up and running, and then the capacity. So we think it givers some good growth going forward and we see that really starting a second half for 2008 there is always some potential, they will pull some of that forward.

Matthew Petkun – D.A Davidson & Co.

Okay and then Jack you mentioned opex for Q1 of $39 million roughly; was that including your amortization of intangibles?

John Ryan

No, it is exclusive of that.

Matthew Petkun – D.A Davidson & Co.

So you guys should be running at a higher rate than you have for the last couple of quarters and you mentioned some of the increases there but will come back to the level that we saw in Q4 or?

John Ryan

We do have some variable compensation that we did not have in 2007 when there was very little in way of the intensive bonus for management that will be impacting 2008.

Operator

Our next question comes from Mark Miller with Brean Murray.

Mark Miller – Brean Murray, Carret & Co.

I was wondering if you could break out just for the high brightness LED orders this quarter and last quarter and say you were going with no solar included?

John Peeler

No I think we are not prepared to provide anymore granularity on that area.

Mark Miller – Brean Murray, Carret & Co.

Would it be accurate to say your orders declined sequentially just based on high brightness orders from the Third Quarter?

John Peeler

No. I would say that the third quarter or fourth quarter are probably similar in terms of solar orders I do not think that is a corrective function.

Mark Miller – Brean Murray, Carret & Co.

Okay finally your competitors working in with universal display on the development or equipment for OLB, do you have anything in align for that there has been some fairly, I know several years away but so many numbers of people are jumping into this market and they feel like to be eventually a replacement for some of the LED applications.

John Peeler

No we are at least in our MOCVD business we are not working on Led’s where we have seen some Metrology sales in some other price sales but not MOCBD.

Well I want to thank you for joining us today, so operator that concludes the call.

Operator

Thank you. That does conclude this presentation, we appreciate everybody’s participation, have a good day.

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Source: Veeco Instruments Inc. Q4 2007 Earnings Call Transcript
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