UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

		(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to              .

Commission file number 0-16244

 

 

VEECO INSTRUMENTS INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware	11-2989601
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)
100 Sunnyside Boulevard, Suite B
Woodbury, New York	11797-2902
(Address of Principal Executive Offices)	(Zip Code)
Registrant’s telephone number, including area code: (516) 677-0200
Website: www.veeco.com

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check one):

Large accelerated filer o    Accelerated filer x    Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No x

30,728,321 shares of common stock, $0.01 par value per share, were outstanding as of the close of business on July 26, 2006.

 

 

SAFE HARBOR STATEMENT

This Quarterly Report on Form 10-Q (the “Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Discussions containing such forward-looking statements may be found in Items 2 and 3 hereof, as well as within this Report generally. In addition, when used in this Report, the words “believes,” “anticipates,” “expects,” “estimates,” “plans,” “intends,” and similar expressions are intended to identify forward-looking statements. All forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from projected results. These risks and uncertainties include, without limitation, the following:

·                  The cyclicality of the microelectronics industries we serve directly affects our business.

·                  We operate in an industry characterized by rapid technological change.

·                  We face significant competition.

·                  We depend on a limited number of customers that operate in highly concentrated industries.

·      Our quarterly operating results fluctuate significantly.

·                  We face securities class action and shareholder derivative lawsuits which could result in substantial costs, diversion of management’s attention and resources and negative publicity.

·                  Our acquisition strategy subjects us to risks associated with evaluating and pursuing these opportunities and integrating these businesses.

·                  Any difficulty or inability to attract, retain and motivate key employees could have a material adverse effect on our business.

·                  We are exposed to the risks of operating a global business and the requirement to comply with laws and regulations of various jurisdictions such as import/export controls, which may not apply to our non-U.S. competitors.

·                  We are subject to foreign currency exchange risks.

·                  Our success depends on protection of our intellectual property rights.

·                  We may be subject to claims of intellectual property infringement by others.

·                  We rely on a limited number of suppliers.

·                  Our outsourcing strategy could adversely affect our results of operations.

·                  Changes in accounting standards for stock-based compensation may adversely affect our stock price and our ability to attract, motivate and retain key employees.

·                  The implementation of a new information technology system may disrupt our operations.

·                  We may not obtain sufficient affordable funds to finance our future needs.

·                  We are subject to risks of non-compliance with environmental and safety regulations.

·                  We have adopted certain measures that may have anti-takeover effects which may make an acquisition of our company by another company more difficult.

·                  The other matters discussed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this Report and in the Annual Report on Form 10-K for the year ended December 31, 2005 of Veeco Instruments Inc. (“Veeco” or the “Company”).

2

---

 

Consequently, such forward-looking statements should be regarded solely as the Company’s current plans, estimates and beliefs. The Company does not undertake any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements.

Available Information

We file annual, quarterly and current reports, information statements and other information with the Securities and Exchange Commission (the “SEC”). The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

Internet Address

We maintain a website where additional information concerning our business and various upcoming events can be found. The address of our website is www.veeco.com. We provide a link on our website, under Investors — Financial Information — SEC Filings, through which investors can access our filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports. These filings are posted to our Internet site, as soon as reasonably practicable after we electronically file such material with the SEC.

3

 

VEECO INSTRUMENTS INC.

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):
	Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2006 and 2005
	Condensed Consolidated Statements of Operations for the Six Months Ended June 30, 2006 and 2005
	Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005
	Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits
SIGNATURES

 

4

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Veeco Instruments Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

 

		Three Months Ended June 30,
		2006			2005
Net sales		$	111,635		$	103,415
Cost of sales		61,923			59,989
Gross profit		49,712			43,426
Costs and expenses:
Selling, general and administrative expense		24,996			21,435
Research and development expense		15,252			15,863
Amortization expense		3,989			4,026
Other (income) expense, net		(132		)	70
Total operating expenses		44,105			41,394
Operating income		5,607			2,032
Interest expense, net		1,149			1,959
Income before income taxes		4,458			73
Income tax provision		1,433			522
Net income (loss)		$	3,025		$	(449	)
Net income (loss) per common share		$	0.10		$	(0.02	)
Diluted net income (loss) per common share		$	0.10		$	(0.02	)
Weighted average shares outstanding		30,322			29,863
Diluted weighted average shares outstanding		31,254			29,863

 

See accompanying notes.

5

---

 

Veeco Instruments Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

 

		Six Months Ended June 30,
		2006			2005
Net sales		$	205,553		$	197,265
Cost of sales		114,072			116,307
Gross profit		91,481			80,958
Costs and expenses:
Selling, general and administrative expense		46,326			41,606
Research and development expense		29,838			30,687
Amortization expense		8,004			8,516
Other expense (income), net		67			(28		)
Total operating expenses		84,235			80,781
Operating income		7,246			177
Interest expense, net		2,527			4,105
Gain on extinguishment of debt		(330		)	—
Income (loss) before income taxes		5,049			(3,928		)
Income tax provision		2,266			1,223
Net income (loss)		$	2,783		$	(5,151	)
Net income (loss) per common share		$	0.09		$	(0.17	)
Diluted net income (loss) per common share		$	0.09		$	(0.17	)
Weighted average shares outstanding		30,208			29,859
Diluted weighted average shares outstanding		30,946			29,859

 

See accompanying notes.

6

---

 

Veeco Instruments Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(In thousands)

 

		June 30, 2006			December 31, 2005
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	116,029		$	124,499
Accounts receivable, less allowance for doubtful accounts of $2,306 in 2006 and $1,860 in 2005		88,673			89,230
Inventories		96,144			88,904
Prepaid expenses and other current assets		12,002			9,640
Deferred income taxes		3,309			2,870
Total current assets		316,157			315,143
Property, plant and equipment at cost, less accumulated depreciation of $83,984 in 2006 and $77,954 in 2005		72,317			69,806
Goodwill		99,622			99,622
Purchased technology, less accumulated amortization of $58,341 in 2006 and $51,992 in 2005		49,235			55,776
Other intangible assets, less accumulated amortization of $24,199 in 2006 and $22,274 in 2005		20,670			22,413
Other assets		6,054			5,100
Total assets		$	564,055		$	567,860
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable		$	38,129		$	31,289
Accrued expenses		46,848			51,169
Deferred profit		685			537
Income taxes payable		2,145			2,123
Current portion of long-term debt		387			375
Total current liabilities		88,194			85,493
Deferred income taxes		1,671			1,048
Long-term debt		209,008			229,205
Other non-current liabilities		3,374			3,527
Shareholders’ equity		261,808			248,587
Total liabilities and shareholders’ equity		$	564,055		$	567,860

 

See accompanying notes.

7

---

 

Veeco Instruments Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

		Six Months Ended June 30,
		2006			2005
Operating activities
Net income (loss)		$	2,783		$	(5,151	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		14,594			15,080
Deferred income taxes		303			(101		)
Gain on extinguishment of debt		(330		)	—
Compensation expense for share-based payments		721			—
(Gain) loss on sale of property plant and equipment		(16		)	83
Other		21			—
Changes in operating assets and liabilities:
Accounts receivable		2,659			6,281
Inventories		(6,354		)	8,975
Accounts payable		6,765			2,953
Accrued expenses, deferred profit and other current liabilities		(1,576		)	(2,428		)
Other, net		(2,827		)	(1,598		)
Net cash provided by operating activities		16,743			24,094
Investing activities
Capital expenditures		(9,570		)	(4,550		)
Payments for net assets of businesses acquired		(3,161		)	(15,038		)
Proceeds from sale of property, plant and equipment and assets held for sale		35			2,178
Net maturities of investments		(80		)	(41		)
Other		(500		)	—
Net cash used in investing activities		(13,276		)	(17,451		)
Financing activities
Proceeds from stock issuance		7,983			1,041
Repayments of long-term debt		(19,585		)	(176		)
Net cash (used in) provided by financing activities		(11,602		)	865
Effect of exchange rates on cash and cash equivalents		(335		)	1,572
Net change in cash and cash equivalents		(8,470		)	9,080
Cash and cash equivalents at beginning of period		124,499			100,276
Cash and cash equivalents at end of period		$	116,029		$	109,356

 

See accompanying notes.

 

8

 

VEECO INSTRUMENTS INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1—Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (consisting of normal recurring accruals) have been included. Operating results for the three and six months ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.  For further information, refer to the financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Earnings (Loss) Per Share

The following table sets forth the reconciliation of weighted average shares outstanding and diluted weighted average shares outstanding:

		Three months ended June 30,				Six months ended June 30,
		2006		2005		2006		2005
		(In thousands)
Weighted average shares outstanding		30,322		29,863		30,208		29,859
Dilutive effect of stock options and restricted stock awards		932		—		738		—
Dilutive weighted average shares outstanding		31,254		29,863		30,946		29,859

 

Net income and diluted net income per common share are computed using the weighted average number of common and common equivalent shares outstanding during the period. The effect of approximately 140,000 and 158,000 common equivalent shares for the three and six months ended June 30, 2005, respectively, were anti-dilutive, and therefore are not included in the weighted average shares outstanding.

In addition, the effect of the assumed conversion of subordinated convertible notes into approximately 5.2 million and 5.3 million common equivalent shares is antidilutive, and therefore is not included in the weighted shares outstanding for the three and six months ended June 30, 2006, respectively.  The effect of the assumed conversion of subordinated convertible notes into approximately 5.7 million common equivalent shares is antidilutive, and therefore is not included in the weighted average shares outstanding for the comparable prior year periods.

Share-Based Compensation

As of June 30, 2006, the Company has stock option and restricted stock plans, which are described more fully in Note 2. In addition, the Company assumed certain stock option plans and agreements in connection with various acquisitions, as also discussed in Note 2. Prior to 2006, the Company accounted for these stock option plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and generally, no compensation expense was reflected in net income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, supersedes APB No. 25 and amends SFAS No. 95, Statement of Cash Flows.  Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees and non-employee directors, including grants of stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.  SFAS No. 123(R) was adopted using the modified prospective method of application, which requires

9

---

 

Veeco to recognize compensation expense on a prospective basis. Therefore, prior period financial statements have not been restated. Under this method, in addition to reflecting compensation expense for new share-based awards, expense is also recognized to reflect the remaining service period of awards that had been included in the pro forma disclosures in prior periods.  SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under previous accounting literature, which  has the effect of reducing consolidated cash flows from operations and increasing cash flows from financing activities in periods after adoption. For the three and six months ended June 30, 2006, the Company did not recognize any amount of consolidated financing cash flows for such excess tax deductions.

Total share-based compensation expense is attributable to the remaining requisite service periods of stock options and restricted common stock awards. For the three and six months ended June 30, 2006, the Company granted 146,200 stock options and 198,250 restricted common stock awards to its directors, officers and employees. As a result of adopting SFAS No. 123(R), the Company’s net income for the three and six months ended June 30, 2006 was $0.2 million and $0.3 million lower, respectively,  than if it had continued to account for share-based compensation under APB No. 25. Net income per common share and diluted net income per common share for the three and six months ended June 30, 2006, are less than $0.01 and $0.01 lower, respectively, than if the Company had continued to account for share-based compensation under APB No. 25. As of June 30, 2006, the total unrecognized compensation cost related to nonvested stock awards and option awards is $5.1 million and $1.8 million, respectively, and the related weighted average period over which it is expected that such unrecognized compensation costs will be recognized is approximately 2.5 years for the nonvested stock awards and 2.4 years for option awards. Future share-based compensation expense will depend on levels of share-based awards granted in the future and, therefore, cannot be predicted at this time.

 Prior to the Company’s adoption of SFAS No. 123(R), SFAS No. 123 required that the Company provide pro forma information regarding net loss and loss per share as if compensation cost for the Company’s stock-based awards had been determined in accordance with the fair value method prescribed therein. In accordance with SFAS No. 123, the following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions, under which compensation expense would be recognized as incurred, to stock-based employee compensation.

		Three months ended June 30, 2005			Six months ended June 30, 2005
		(In thousands, except per share amounts)
Net loss, as reported		$	(449	)	$	(5,151	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(21,192		)	(25,216		)
Pro forma net loss		$	(21,641	)	$	(30,367	)
Net loss per common share:
Net loss and diluted net loss per common share, as reported		$	(0.02	)	$	(0.17	)
Net loss and diluted net loss per common share, pro forma		$	(0.72	)	$	(1.02	)

 

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes.  FIN 48 clarifies the accounting and disclosure for income taxes by defining the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority.  It also provides guidance on derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  The Company is currently assessing the impact of FIN 48 on its consolidated financial position and results of operations.

10

---

 

Note 2—Share-Based Payments

Stock Option and Restricted Stock Plans

The Company has several stock option and restricted stock plans. The Veeco Instruments Inc. 2000 Stock Incentive Plan, as amended, (the “2000 Plan”), was approved by the Board of Directors and shareholders in May 2000. The 2000 Plan provides for the grant to officers and key employees of up to 8,530,000 options (1,776,524 options are available for future grants as of June 30, 2006) to purchase shares of common stock of the Company. Stock options granted pursuant to the 2000 Plan expire after seven years and generally become exercisable over a three-year period following the grant date. However, grants made under the 2000 Plan between June 17, 2005 and December 23, 2005 became exercisable on or before December 31, 2005, and are subject to a resale restriction which provides that the shares issuable upon exercise of the option may not be transferred prior to the second anniversary of the option grant date. In addition, the 2000 Plan provides for automatic annual grants of 5,000 shares of restricted stock to each member of the Board of Directors of the Company who is not an employee of the Company.  Up to 1,700,000 of the awards authorized under the 2000 Plan may be issued in the form of restricted stock (1,456,750 shares are available for future grants as of June 30, 2006). In June 2006, the Company granted 158,250 shares of restricted common stock to key employees, which vest over three years, and in May 2006, granted 40,000 shares of restricted common stock to the non-employee members of the Board of Directors, which vest over a period of one year.

A summary of the Company’s restricted stock awards as of June 30, 2006, is presented below:

 

 

The Veeco Instruments Inc. 2000 Stock Option Plan for Non-Officer Employees (the “Non-Officer Plan”) was approved by the Board of Directors in October 2000. The Non-Officer Plan provided for the grant of stock options to non-officer employees to purchase shares of common stock of the Company. Stock options granted pursuant to the Non-Officer Plan become exercisable over a three-year period following the grant date and expire after seven years.

The Veeco Instruments Inc. Amended and Restated 1992 Employees’ Stock Option Plan (the “1992 Plan”) provided for the grant to officers and key employees of stock options to purchase shares of common stock of the Company. Stock options granted pursuant to the 1992 Plan become exercisable over a three-year period following the grant date and expire after ten years.

The Veeco Instruments Inc. 1994 Stock Option Plan for Outside Directors, as amended, (the “Directors’ Option Plan”), provided for automatic annual grants of stock options to each member of the Board of Directors of the Company who is not an employee of the Company. Such options are exercisable immediately and expire after ten years.

The Non-Officer Plan, the 1992 Plan and the Directors’ Option Plan have been frozen; and, thus, there are no options available for future grant as of June 30, 2006 under these plans.

In addition to the plans described above, the Company assumed certain stock option plans and agreements relating to the merger in September 2001 with Applied Epi, Inc. (“Applied Epi”). These stock option plans do not have options available for future grants and expire after ten years from the date of grant. Options granted under two of the plans vested over three years and options granted under one of the plans vested immediately. As of June 30, 2006, there are 200,477 options outstanding under the various Applied Epi plans. In addition, Veeco assumed certain warrants related to Applied Epi, which were in effect prior to the merger with Veeco. These warrants expired in February 2006.

In May 2000, the Company assumed certain stock option plans and agreements related to CVC, Inc. and Commonwealth Scientific Corporation, a subsidiary of CVC, Inc., which were in effect prior to the merger with Veeco.

11

---

 

These plans do not have options available for future grants, the options granted thereunder generally vested over a three to five year period and expire five to ten years from the date of grant. As of June 30, 2006, there are 7,251 options outstanding under the various CVC, Inc. and Commonwealth Scientific Corporation plans.

With the adoption of SFAS No. 123(R) on January 1, 2006, the Company is required to record the fair value of stock-based compensation awards as an expense. In order to determine the fair value of stock options on the date of grant, the Company applies the Black-Scholes option-pricing model. Inherent in the model are assumptions related to expected stock-price volatility, option life, risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility and option life assumptions require a level of judgment which make them critical accounting estimates.

Beginning in the fourth quarter of 2005, the Company used an expected stock-price volatility assumption that is a combination of both historical and implied volatilities of the underlying stock, which are obtained from public data sources. Prior to that time, the Company based this assumption solely on historical volatility.

With regard to the weighted-average option life assumption, the Company considers the exercise behavior of past grants and models the pattern of aggregate exercises.

The fair value of each option granted during the three and six months ended June 30, 2006, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

Weighted-average expected stock-price volatility		40%
Weighted-average expected option life		3 years
Average risk-free interest rate		4.99%
Average dividend yield		0%

 

The fair value of each option grant that was unvested as of January 1, 2006, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

Weighted-average expected stock-price volatility		60%
Weighted-average expected option life		4 years
Average risk-free interest rate		3.64%
Average dividend yield		0%

 

A summary of the Company’s stock option plans as of and for the six months ended June 30, 2006, is presented below:

 

The weighted-average grant date fair value of stock options granted for the three and six months ended June 30, 2006 was $7.61.  The weighted-average grant date fair value of stock options granted for the three and six months ended June 30, 2005 was $8.05 and $7.99,  respectively.  The total intrinsic value of stock options exercised during the three and six months ended June 30, 2006 was $2.8 million and $3.2 million, respectively.  The total intrinsic value of stock options exercised during the three and six months ended June 30, 2005 was less than $0.1 million and $0.1 million, respectively.

12

---

 

The following table summarizes information about stock options outstanding at June 30, 2006:

 

On April 12, 2005, the Compensation Committee (the “Committee”) of the Company’s Board of Directors approved the acceleration of vesting for unvested, out-of-the-money stock options granted under the Company’s stock option plans prior to September 1, 2004.  An option was considered out-of-the-money if the option exercise price was greater than the closing price of the Company’s common stock on the NASDAQ National Market on April 11, 2005 ($15.26), the last trading day before the Committee approved the acceleration.  As a result of this action, options to purchase approximately 2,522,000 shares of the Company’s common stock became immediately exercisable, including options held by the Company’s executive officers to purchase approximately 852,000 shares of common stock.  The weighted average exercise price of the options for which vesting was accelerated was $21.24.

The purpose of the accelerated vesting was to avoid future compensation expense of approximately $7.9 million in 2006 and $3.6 million in 2007 associated with these options that the Company would otherwise recognize in its Consolidated Statements of Operations upon the adoption of SFAS No. 123(R) (see Note 1).  In addition, many of these options had exercise prices significantly in excess of current market values and were not providing an effective means of employee retention and incentive compensation.

Employee Stock Purchase Plan

Under the Veeco Instruments Inc. Amended and Restated Employee Stock Purchase Plan (the “ESP Plan”), the Company is authorized to issue up to 2,000,000 shares of common stock to its full-time U.S. employees, nearly all of whom are eligible to participate. Under the terms of the ESP Plan, employees can choose to have up to 10% of their annual base earnings withheld to purchase the Company’s common stock. The purchase price of the stock as of June 30, 2006 was 95% of the end-of-offering period market price and qualifies as a noncompensatory employee stock purchase plan under Section 423 of the Internal Revenue Code.

Shares Reserved for Future Issuance

As of June 30, 2006, the Company has reserved the following shares for future issuance related to:

 

Preferred Stock

The Board of Directors of the Company has authority under the Company’s Certificate of Incorporation to issue shares of preferred stock with voting and economic rights to be determined by the Board or Directors.

 

13

---

 

Note 3—Balance Sheet Information

Inventories

Inventories have been determined by lower of cost (principally first-in, first-out) or market.  Inventories consist of:

 

 

Accrued Warranty

The Company estimates the costs that may be incurred under the warranty it provides and recognizes a liability in the amount of such costs at the time the related revenue is recognized.  Factors that affect the Company’s warranty liability include product failure rates, material usage and labor costs incurred in correcting product failures during the warranty period.  The Company periodically assesses the adequacy of its recognized warranty liability and adjusts the amount as necessary.  Changes in the Company’s warranty liability during the period are as follows:

 

 

Note 4—Segment Information

As of January 1, 2006, the Company changed its management structure in a manner that caused the composition of its reportable segments to change. The Company currently manages the business, reviews operating results and assesses performance, as well as allocates resources, based upon two separate reporting segments. The Company merged the former Ion Beam and Mechanical Process Equipment segment and the Epitaxial Process Equipment segment into one reporting segment. The new Process Equipment segment combines the etch, deposition, dicing and slicing products sold mostly to data storage customers and the molecular beam epitaxy and metal organic chemical vapor deposition products primarily sold to high brightness light emitting diode and wireless telecommunications customers. This segment includes production facilities in Plainview, New York, Ft. Collins, Colorado, Camarillo, California, St. Paul, Minnesota and Somerset, New Jersey. The Metrology segment remains unchanged and represents equipment that is used to provide critical surface measurements on products such as semiconductor devices and thin film magnetic heads and includes Veeco’s broad line of atomic force microscopes, optical interferometers and stylus profilers sold to semiconductor customers, data storage customers and thousands of research facilities and scientific centers. This segment includes production facilities in Santa Barbara, California and Tucson, Arizona.  Accordingly, the Company has restated segment information for the prior periods presented.

The Company evaluates the performance of its reportable segments based on income or loss from operations before interest, income taxes and amortization (“EBITA”). The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Items excluded from segment profit primarily consist of interest, amortization, income taxes, corporate expenses, as well as other unusual charges for purchased in-process technology, restructuring and asset impairment charges and merger-related costs. Corporate expenses are comprised primarily of general and administrative expenses.

 

14

The following tables present certain data pertaining to the reportable product segments of the Company and a reconciliation of EBITA to income (loss) before income taxes for the three and six months ended June 30, 2006 and 2005, and goodwill and total assets as of June 30, 2006 and December 31, 2005 (in thousands):

 

		Process Equipment			Metrology			Unallocated Corporate Amount			Total
Three Months Ended June 30, 2006
Net sales		$	67,361		$	44,274		$	—		$	111,635
Income (loss) before interest, taxes, amortization and certain items (EBITA)		7,801			6,316			(4,521		)	9,596
Interest expense, net		—			—			1,149			1,149
Amortization expense		3,288			441			260			3,989
Income (loss) before income taxes		4,513			5,875			(5,930		)	4,458
Three Months Ended June 30, 2005
Net sales		$	61,157		$	42,258		$	—		$	103,415
Income (loss) before interest, taxes, amortization and certain items (EBITA)		2,269			6,517			(2,728		)	6,058
Interest expense, net		—			—			1,959			1,959
Amortization expense		3,294			457			275			4,026
(Loss) income before income taxes		(1,025		)	6,060			(4,962		)	73
Six Months Ended June 30, 2006
Net sales		$	120,552		$	85,001		$	—		$	205,553
Income (loss) before interest, taxes, amortization and certain items (EBITA)		9,677			11,928			(6,355		)	15,250
Interest expense, net		—			—			2,527			2,527
Amortization expense		6,576			895			533			8,004
Other items		—			—			(330		)	(330		)
Income (loss) before income taxes		3,101			11,033			(9,085		)	5,049
Six Months Ended June 30, 2005
Net sales		$	111,519		$	85,746		$	—		$	197,265
(Loss) income before interest, taxes, amortization and certain items (EBITA)		(433		)	14,279			(5,153		)	8,693
Interest expense, net		—			—			4,105			4,105
Amortization expense		6,888			1,038			590			8,516
(Loss) income before income taxes		(7,321		)	13,241			(9,848		)	(3,928		)

 

15

---

 

 

		Process Equipment			Metrology			Unallocated Corporate Amount			Total
As of June 30, 2006
Goodwill		$	70,254		$	29,368		$	—		$	99,622
Total assets		297,035			136,903			130,117			564,055
As of December 31, 2005
Goodwill		$	70,254		$	29,368		$	—		$	99,622
Total assets		300,617			132,928			134,315			567,860

 

Corporate total assets are comprised principally of cash at June 30, 2006 and December 31, 2005.

Note 5—Comprehensive Income (Loss)

Total comprehensive income (loss) was $4.0 million and $4.5 million for the three and six months ended June 30, 2006, and ($2.4) million and ($8.7) million for the three and six months ended 2005, respectively. The Company’s comprehensive income (loss) is comprised of net income (loss) and foreign currency translation adjustments.

Note 6—Other Matters

As of June 30, 2006, the Company has outstanding $200.0 million of 4.125% convertible subordinated notes.  During the first quarter of 2006, the Company repurchased $20.0 million of its notes, reducing the amount outstanding from $220.0 million to $200.0 million.  The repurchase amount was $19.5 million in cash, of which $19.4 million related to principal and $0.1 million related to accrued interest.  As a result of the repurchase, the Company recorded a gain from the early extinguishment of debt in the amount of $0.6 million, offset by a $0.3 million proportionate reduction in the related deferred financing costs for a net gain of $0.3 million.

In conjunction with a cost reduction plan announced by the Company in October 2005, the Company recognized a restructuring charge of approximately $1.2 million in the fourth quarter of 2005. The $1.2 million charge consisted of personnel severance costs for approximately 37 employees which included management, administration and manufacturing employees located at the Company’s Plainview, New York, Camarillo, California and Somerset, New Jersey Process Equipment operations and the Santa Barbara, California Metrology operations. As of June 30, 2006, approximately $1.0 million has been paid and approximately $0.2 million remains in accrued expenses. The Company expects to pay the remainder by the fourth quarter of 2006.

A reconciliation of the liability for the 2005 restructuring charge for severance costs is as follows (in millions):

 

Note 7—Business Acquisition and Related Party Transaction

In May 2006, Veeco invested $0.5 million to purchase 19.9% of the common stock of Fluens Corporation (“Fluens”).  Approximately 31% of Fluens is owned by a Vice President of Veeco.  Veeco and Fluens plan to jointly develop a next-generation process for high-rate deposition of aluminum oxide for data storage applications.  If this development is successful and upon the satisfaction of certain additional conditions by May 2009, Veeco will be obligated to purchase the balance of the outstanding stock of Fluens for $3.0 million and pay an earn-out.  In April 2006, Veeco issued a $0.8 million purchase order to Fluens for a reactive sputtering deposition system.  Veeco had advanced approximately $0.4 million against this purchase order as of June 30, 2006.

 

16

---

Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Summary:

Veeco designs, manufactures, markets and services a broad line of equipment primarily used by manufacturers in the data storage, scientific and industrial research, semiconductor, high-brightness light emitting diode (“HB-LED”) and wireless industries. These industries help create a wide range of information age products such as computer integrated circuits, personal computers, hard disk drives, network servers, digital cameras, wireless phones, TV set-top boxes, personal music/video players and personal digital assistants. The Company’s broad line of products features leading edge technology and allows customers to improve time-to-market of their next generation products. Veeco’s products are also enabling advancements in the growing fields of nanoscience, nanobiology and other areas of scientific and industrial research.

The Company currently manages the business, reviews operating results and assesses performance, as well as allocates resources, based upon two separate reporting segments.  As of January 1, 2006, the Company merged the former Ion Beam and Mechanical Process Equipment segment and the Epitaxial Process Equipment segment into one reporting segment. The new Process Equipment segment combines the etch, deposition, dicing and slicing products sold mostly to data storage customers and the molecular beam epitaxy (“MBE”) and metal organic chemical vapor deposition (“MOCVD”) products primarily sold to HB-LED and wireless telecommunications customers. The Metrology segment remains unchanged and represents equipment that is used to provide critical surface measurements on products such as semiconductor devices and thin film magnetic heads and includes Veeco’s broad line of atomic force microscopes (“AFMs”), optical interferometers and stylus profilers sold to semiconductor customers, data storage customers and thousands of research facilities and scientific centers. This equipment allows customers to monitor their products throughout the manufacturing process in order to improve yields, reduce costs and improve product quality. The Company’s metrology solutions are also key research instruments used by many universities, scientific laboratories and industrial applications.

Veeco currently maintains manufacturing facilities in Arizona, California, Colorado, Minnesota, New Jersey and New York, with sales and service locations around the world.  Each of Veeco’s products is currently manufactured in only one location, as management believes that the technological know-how and precision needed to make each of the Company’s products requires specialized expertise.

Highlights of the Second Quarter of 2006:

·                  Revenue was $111.6 million, an 8% increase over the second quarter of 2005.

·                  Orders were $143.2 million, up 21% from the second quarter of 2005.

·                  Gross margin was 44.5%, up from 42.0% for the second quarter of 2005.

·                  Net income was $3.0 million, or $0.10 per share, compared to a loss of ($0.4) million, or ($0.02) per share, in the second quarter of 2005.

Highlights of the First Half of 2006:

·                  Revenue was $205.6 million, a 4% increase over the first half of 2005.

·                  Orders were $269.9 million, up 24% from the comparable 2005 period.

·                  Gross margin was 44.5%, up from 41.0% for the first half of 2005.

·                  Net income was $2.8 million, or $0.9 per share, compared to a loss of ($5.2) million, or ($0.17) per share in the comparable prior year period.

 

17

---

Current Business Conditions/Outlook:

In the first half of 2006, Veeco’s revenues were $205.6 million, up $8.3 million from $197.3 million in the first six months of 2005.  Operating income for the first half of 2006 was $7.2 million, compared to $0.2 million in the prior year period.  Net income for the first six months of 2006 was $2.8 million, or diluted net income of $0.09 per share, compared to a net loss of ($5.2) million, or diluted net loss of ($0.17) per share, for the first six months of 2005.

Veeco’s orders for the first half of 2006 were $269.9 million, reflecting double digit market growth in data storage and in HB-LED/wireless. Within the strong order rate, Veeco’s data storage orders increased 34% from the prior year period to $141.8 million.  Another area of strength was in HB-LED/wireless, which reported orders of $51.7 million, up 90% from the prior year period.  The strong order rate for the first half of 2006 reflects market growth in embedded storage for consumer electronic applications, the hard drive industry’s investment in capacity requirements as well as technology changes such as perpendicular recording, and the beginning of HB-LED backlighting for emerging applications such as personal computers and flat panel televisions.

Veeco is continuing its strategy for growth as well as its focus on improving profitability and gross margin performance.  For the remainder of 2006, the Company has planned significant new product introductions in both the Process Equipment and Metrology business units, which are expected to provide an opportunity for revenue growth. Veeco has forecasted that 2006 revenues will grow by approximately 11-13% over  2005 to $455-$465 million.  In addition, consumer spending on many types of electronics has increased and various worldwide regions, such as the Asia-Pacific region, are experiencing growth. The Company reviews a number of indicators to predict the strength of its markets going forward, including plant utilization trends, capacity requirements and capital spending trends.  Many of these trends have remained positive through the current year.  However, Veeco currently anticipates its orders in the third quarter will decrease from the strong second quarter rate due to the seasonal buying patterns that the Company has experienced in recent years.  The Company believes that orders will recover again in the fourth quarter.

Technology changes are continuing in all of Veeco’s markets: the continued increase of 80 GB hard drives and investment in 120 GB hard drives in data storage; the increased use of “mini” drives in consumer electronic applications; the increased use of Veeco’s automated AFMs for 65 nanometer and below semiconductor applications; the opportunity for Veeco’s MOCVD and MBE products to further penetrate the emerging wireless and HB-LED markets. Veeco believes that these changes, together with the continued funding of nanoscience research, will prompt customers to seek the Company’s next-generation solutions to address their manufacturing and technology challenges.

The Company’s goal is to continue to increase gross margins in 2006, with improvements in both Process Equipment and Metrology. Veeco has forecasted that gross margins will increase from 42.4% in 2005 to approximately 45% in 2006 and has already realized gross margins of 44.5% for the first half of the year. Veeco anticipates that progress in this area will continue to come from increased sales volume, the introduction of new products with higher gross margins, and better supply chain management, including outsourcing of new products and development of common hardware and software platforms.

 

18

---

Results of Operations:

Three Months Ended June 30, 2006 and 2005

The following tables show selected items of Veeco’s Consolidated Statements of Operations, percentages of sales and comparisons between the three months ended June 30, 2006 and 2005 and the analysis of sales and orders for the same periods by segment, industry and regions (in thousands):

 

		Three Months ended June 30,										Dollar
		2006					2005					Change
Net sales		$	111,635		100.0	%	$	103,415		100.0	%	$	8,220
Cost of sales		61,923			55.5		59,989			58.0		1,934
Gross profit		49,712			44.5		43,426			42.0		6,286
Operating expenses:
Selling, general and administrative expense		24,996			22.4		21,435			20.7		3,561
Research and development expense		15,252			13.7		15,863			15.3		(611		)
Amortization expense		3,989			3.5		4,026			3.9		(37		)
Other (income) expense, net		(132		)	(0.1	)	70			0.1		(202		)
Total operating expenses		44,105			39.5		41,394			40.0		2,711
Operating income		5,607			5.0		2,032			2.0		3,575
Interest expense, net		1,149			1.0		1,959			1.9		(810		)
Income before income taxes		4,458			4.0		73			0.1		4,385
Income tax provision		1,433			1.3		522			0.5		911
Net income (loss)		$	3,025		2.7	%	$	(449	)	(0.4	)%	$	3,474

 

		Sales											Orders
		Three Months ended June 30,						Dollar and Percentage					Three Months ended June 30,						Dollar and Percentage					Book to Bill Ratio
		2006			2005			Change Year to Year					2006			2005			Change Year to Year					2006		2005
Segment Analysis
Process Equipment		$	67,361		$	61,157		$	6,204		10.1	%	$	94,309		$	68,387		$	25,922		37.9	%	1.40		1.12
Metrology		44,274			42,258			2,016			4.8		48,899			50,166			(1,267		)	(2.5	)	1.10		1.19
Total		$	111,635		$	103,415		$	8,220		7.9	%	$	143,208		$	118,553		$	24,655		20.8	%	1.28		1.15
Industry Analysis
Data Storage		$	53,105		$	47,370		$	5,735		12.1	%	$	71,446		$	60,391		$	11,055		18.3	%	1.35		1.27
HB-LED/wireless		18,424			13,905			4,519			32.5		27,405			13,278			14,127			106.4		1.49		0.95
Semiconductor		12,448			16,896			(4,448		)	(26.3	)	19,997			18,966			1,031			5.4		1.61		1.12
Research and Industrial		27,658			25,244			2,414			9.6		24,360			25,918			(1,558		)	(6.0	)	0.88		1.03
Total		$	111,635		$	103,415		$	8,220		7.9	%	$	143,208		$	118,553		$	24,655		20.8	%	1.28		1.15
Regional Analysis
US		$	32,244		$	29,842		$	2,402		8.0	%	$	51,812		$	31,360		$	20,452		65.2	%	1.61		1.05
Europe		16,095			23,006			(6,911		)	(30.0	)	9,648			22,728			(13,080		)	(57.6	)	0.60		0.99
Japan		11,297			20,769			(9,472		)	(45.6	)	19,596			19,060			536			2.8		1.73		0.92
Asia-Pacific		51,999			29,798			22,201			74.5		62,152			45,405			16,747			36.9		1.20		1.52
Total		$	111,635		$	103,415		$	8,220		7.9	%	$	143,208		$	118,553		$	24,655		20.8	%	1.28		1.15

 

Net sales of $111.6 million for the second quarter of 2006 were up $8.2 million compared to the second quarter of 2005. By segment, process equipment sales were up $6.2 million or 10.1%. The increase in process equipment sales is primarily due to an increase in sales to data storage customers driven by an increase in the production of data storage devices.  Metrology sales increased $2.0 million primarily due to increased AFM sales to the research and industrial markets.  By region, net sales increased by 74.5% and 8.0% in Asia-Pacific and the U.S., respectively, while sales in Japan and Europe declined by 45.6% and 30.0%, respectively. The Company believes that there will continue to be quarter-to-quarter variations in the geographic distribution of sales.

 

19

---

Orders of $143.2 million for the second quarter of 2006 increased by $24.7 million, or 20.8%, from the comparable 2005 period. By segment, the 37.9% increase in process equipment orders was primarily driven by continued market growth in the data storage and HB-LED/wireless sectors reflecting growth in embedded storage in consumer electronics, continued investment in perpendicular recording technology, and HB-LED backlighting of small area flat panel displays. The 2.5% decrease in metrology orders was due to a $4.5 million decrease in orders for optical metrology products, partially offset by a $3.2 million increase in orders for AFM products.

The Company’s book-to-bill ratio for the second quarter of 2006, which is calculated by dividing orders received in a given time period by revenue recognized in the same time period was 1.28.  The Company’s backlog as of June 30, 2006 is $159.1 million, compared to $114.1 million as of December 31, 2005. During the quarter ended June 30, 2006, the Company experienced backlog adjustments and order cancellations of $10.5 million, primarily in the HB-LED/wireless industry for MOCVD products.  The Company also experienced rescheduling of order delivery dates by customers.  Due to changing business conditions and customer requirements, the Company may continue to experience cancellations and/or rescheduling of orders.

Gross profit for the quarter ended June 30, 2006, was 44.5%, as compared to 42.0% in the second quarter of 2005.  Process equipment gross margins increased from 36.7% to 40.3%, primarily due to an increase in sales volume of $6.2 million, favorable product mix, cost reductions and improved supply chain management, which included outsourcing in this segment.  Metrology gross margins increased to 51.0% from 49.7%, principally due to higher sales volume and favorable product mix of optical metrology products.

Selling, general and administrative expenses were $25.0 million, or 22.4% of sales in the second quarter of 2006, compared with $21.4 million, or 20.7%, in the comparable prior year period.  The $3.6 million increase is primarily attributable to annual incentive compensation related expenses, including stock options, restricted shares, severance and cash incentives as well as annual salary increases.  In addition, selling, general and administrative expenses increased due to litigation related expenses for the securities class action and consolidated derivative action lawsuits  as well as expansion of field sales and marketing personnel to support the Company’s new product introductions and the Company’s Asia-Pacific operations.

Research and development expense totaled $15.3 million in the second quarter of 2006, a decrease of $0.6 million from the second quarter of 2005, primarily due to the timing of new product development efforts in AFM and MOCVD.  As a percentage of sales, research and development decreased in the second quarter of 2006 to 13.7% from 15.3% for the comparable prior year period.

Amortization expense remained flat at $4.0 million in the second quarter of 2006 compared with the second quarter of 2005.

Net interest expense in the second quarter of 2006 was $1.1 million compared to $2.0 million in the second quarter of 2005.  This reduction was due to an increase in interest rates and higher cash balances invested during the second quarter of 2006 compared to the comparable prior year period, as well as the reduction in interest expense related to the early extinguishment of debt.

Income tax provision for the quarter ended June 30, 2006 was $1.4 million compared to $0.5 million in the second quarter of 2005. The 2006 provision for income taxes included $1.1 million relating to Veeco’s foreign operations which continue to be profitable and $0.3 million relating to the Company’s domestic operations.  Due to significant domestic net operating losses, which are fully reserved by a valuation allowance, Veeco’s domestic operations are not expected to incur significant income taxes for the foreseeable future. The 2005 provision for income taxes of $0.5 million related to Veeco’s foreign operations, which were profitable.

20