Veeco's Customers Don't Want to Buy

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If you want to witness the cyclical nature of equipment purchases by hard drive manufacturers, semiconductor makers, and LED manufacturers, you need only follow Veeco Instruments (Nasdaq: VECO) for a couple of years. These types of customers purchase Veeco equipment that is used for depositing thin films of material and for measuring the characteristics of the films, but not with any regularity. Their purchases come in bursts followed by periods when they would rather let moths eat holes in their dollar bills than pass them to Veeco.

Circumstances involving these vagaries and Veeco's scientific research customers gelled to produce a lackluster third quarter for Veeco. Revenue totaled $97.7 million, down 13% from a year ago, and the net loss was $5.7 million, or $0.18 per share. The data storage and semiconductor markets were weak, but the high-brightness LED/wireless and scientific research customers were in buy mode.

Hopefully things will look better a year or so down the road if its data storage and semiconductor customers manage to come out of their spending slumber, but in the meantime there are things to fret about. Here are three.

• Gross margin plummeted from more than 42% in Q2 to just 36.7%. Management claims the drop was due to issues relating to delivery of beta versions of new products and that it should improve in Q4. Let's hope they're right.
• While management expects to exit this year with a strong backlog of orders, it expects the first half of 2008 to be slow because of the continued reluctance of its data storage customers to spend. A glance at the stock chart shows that a lot of investors aren't waiting around for the hoped-for recovery.
• Veeco admitted during the conference call that some of its semiconductor customers have adopted alternate technology in place of its atomic force microscopes.

On the bright side, Veeco has received $5 million of orders for its solar deposition equipment. Given the interest in solar power, this part of the business will be worth watching.

Unfortunately, Veeco is similar to a lot of the smaller toolmakers, such as Mattson (Nasdaq: MTSN), Nanometrics (Nasdaq: NANO), and Semitool (Nasdaq: SMTL), in that it either struggles to price its equipment high enough to have a decent gross margin or it can't control operating expenses well enough to generate an acceptable operating margin. Veeco suffered from both of these ills this quarter.

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