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

Results of Operations.

Three Months Ended June 30, 2002 and 2001

        Net sales of $77.3 million for the three months ended June 30, 2002, represent a decrease of $34.8 million, or 31%, from the 2001 comparable period sales of $112.1 million, resulting principally from a decrease in sales of process equipment products. Sales in the U.S., Europe, Japan and Asia Pacific, accounted for 36%, 21%, 18% and 25%, respectively, of the Company's net sales for the three months ended June 30, 2002. Sales in the U.S. decreased 56% from the comparable 2001 period due to a 67% decline in U.S. process equipment sales, particularly for sales of optical filter deposition products to the telecommunications industry, as well as a 27% decrease in U.S. metrology sales. Sales in Europe and Asia Pacific increased 32% and 81%, respectively. The increase in Europe is principally a result of $3.7 million of sales of molecular beam epitaxy (MBE) equipment produced by Veeco's Applied Epi subsidiary, which was acquired by the Company in September 2001. The increase in Asia Pacific is principally a result of an increase in etch and deposition equipment sales to the data storage industry, as well as an increase of $6.5 million in sales of optical metrology products. Sales in Japan decreased 49% from the 2001 comparable period, due primarily to declines in sales in both etch and deposition and optical filter deposition products. The Company believes that there will continue to be quarter-to-quarter variations in the geographic concentration of sales.

        Process equipment sales of $36.9 million for the three months ended June 30, 2002, decreased by $36.3 million, or 50%, from the comparable 2001 period. The decrease in process equipment sales has resulted from a decline in sales of optical filter deposition equipment to the telecommunications industry, as well as a decrease in sales to the data storage industry. Metrology sales of $40.4 million for the three months ended June 30, 2002, increased slightly (4%) from the comparable prior period sales of $38.9 million.

        Veeco received $78.2 million of orders during the three months ended June 30, 2002, a 3% decrease compared to $80.3 million of orders for the comparable 2001 period. Process equipment orders decreased 8% to $37.1 million, due to a decline in orders from optical telecommunications and data storage customers. Veeco's Ion Tech subsidiary had a decrease of $2.3 million, or 25%, in orders from the comparable 2001 period. Etch and deposition equipment orders decreased 19% to $25.2 million from $31.2 million for the comparable 2001 period. Metrology orders increased slightly (2%) to $41.1 million. The Company's book/bill ratio for the second quarter of 2002 was 1.01.

        The order and sales declines are a result of the general economic slowdown that has had a very significant impact on the telecommunications, data storage and semiconductor markets that the Company serves.

        The Company's backlog generally consists of product orders for which a purchase order has been received and which are scheduled for shipment within twelve months. Veeco schedules production of its systems based on order backlog and customer commitments. Because certain of the Company's orders require products to be shipped in the same quarter in which the order was received, and due to possible changes in delivery schedules, cancellations of orders and delays in shipment, the Company does not believe that the level of backlog at any point in time is an accurate indicator of the Company's future performance. Due to the current weak business environment, the Company may experience cancellation and/or rescheduling of orders.

        Gross profit, as a percentage of net sales decreased to 45.5%, for the second quarter of 2002, from 47.4% for the comparable 2001 period. The decline is attributable to the decrease in sales volume of process equipment products.

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        Selling, general and administrative expenses of $19.3 million for the three months ended June 30, 2002, decreased by approximately $1.4 million from the 2001 comparable period due principally to cost reductions implemented by the Company in the fourth quarter of 2001 and the first quarter of 2002, as well as a decrease in selling and commission expenses as a result of the decreased sales volume. The decrease is partially offset by the selling, general and administrative expenses of Veeco's Applied Epi and TM Microscopes ("TM") subsidiaries, which were acquired in the third quarter of 2001, and thus had no comparable spending in the second quarter of 2001.

        Research and development expenses of $13.9 million for the three months ended June 30, 2002, decreased by approximately $0.9 million, or 6%, from the comparable period of 2001, due primarily to cost reduction efforts implemented by the Company in the fourth quarter of 2001 and the first quarter of 2002.

        Amortization expense totaled $3.2 million in the three months ended June 30, 2002 compared with $0.9 million in 2001. The increase is due primarily to the intangible assets acquired in connection with the acquisitions of Applied Epi and TM, offset in part by $0.4 million of reduced amortization expense related to the accounting requirement to no longer amortize goodwill, effective January 1, 2002, in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill is to be reviewed annually for impairment. As of January 1, 2002, no impairment exists.

        During the three months ended June 30, 2002, the Company recorded a restructuring charge of $1.1 million. This charge includes severance related costs for approximately 30 employees, which included both management and manufacturing employees, located in each of the Company's process equipment group and the Minnesota metrology facility. As of June 30, 2002, approximately $0.2 million has been expended and approximately $0.9 million remains accrued.

        Other (income) expense, net, for the three months ended June 30, 2002, decreased $0.5 million from the comparable 2001 period due to the decrease in foreign currency exchange losses.

        Interest expense, net, of $1.5 million for the three months ended June 30, 2002 increased $1.9 million from the comparable 2001 period as a direct result of the issuance of $220.0 million of 4.125% convertible subordinated notes, which occurred in December 2001 and January 2002.

        Income taxes for the three months ended June 30, 2002, amounted to a $1.9 million income tax benefit, or 53% of loss before income taxes, as compared to a $5.4 million income tax provision, or 34% of income before income taxes, for the same period of 2001. The higher than statutory effective benefit rate of 53% in 2002 is a result of the impact of R&D tax credits along with foreign tax benefits.

        Quarterly information for the three months ended June 30, 2001, has been restated from that previously filed on the Quarterly Report on Form 10-Q for such period, due to the required accounting to reflect the discontinued operations of the Company's industrial measurement segment, which was recorded in the quarter ended December 31, 2001.

Six Months Ended June 30, 2002 and 2001

        Net sales were $157.5 million for the six months ended June 30, 2002, representing a decrease of approximately $80.0 million, or 34%, from the comparable 2001 period. The decrease is primarily a result of a decrease in process equipment sales. Sales in the U.S., Europe, Japan and Asia Pacific accounted for 46%, 17%, 17% and 20%, respectively, of the Company's net sales for the six months ended June 30, 2002. Sales in the U.S. decreased by 47%, principally as a result of decreased process equipment sales of optical filter deposition products to the telecommunications industry, as well as a decline in sales to the data storage industry. Metrology sales also decreased, primarily as a result of a decline in sales to customers in the semiconductor industry. Sales in Europe remained relatively flat when compared to the comparable 2001 period. Sales in Japan decreased by 49%, primarily as a result of decreases in process equipment sales, as well as decreased metrology sales from the comparable

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2001 period. Asia Pacific sales increased by 45% principally as a result of a 78% increase in process equipment sales, primarily from sales of etch and deposition equipment to data storage customers. Metrology sales for Asia Pacific also increased by 32% from the prior period, as a result of increased sales of optical metrology products.

        Process equipment sales were $81.8 million for the six months ended June 30, 2002, a decrease of approximately $71.8 million, or 47%, from the comparable 2001 period. The decrease is primarily due to a decrease in process equipment sales of $89.3 million to the telecommunications and data storage industries, offset in part by sales of $17.5 million of MBE equipment produced by Veeco's Applied Epi subsidiary. Metrology sales for the six months ended June 30, 2002, were $75.7 million, a decrease of approximately $8.2 million, or 10%, compared to the comparable 2001 period, reflecting a 9% drop in sales of AFMs and a 13% decline in optical metrology sales.

        Veeco received $148.5 million of orders for the six months ended June 30, 2002, a 22% decrease compared to $190.5 million of orders in the comparable 2001 period. Process equipment orders decreased 33% to $75.6 million, principally reflecting decreases in both telecommunications and data storage orders. Metrology orders decreased 6% to $72.9 million, reflecting a decrease in AFM orders. The book/bill ratio for the six months ended June 30, 2002 was 0.94.

        Gross profit for the six months ended June 30, 2002, as a percentage of net sales decreased to 43.8%, from 47.1% for the comparable 2001 period. The decline from the prior period is primarily attributable to the volume decrease in process equipment sales, in particular optical filter deposition products to the telecommunications industry.

        Selling, general and administrative expenses of $38.4 million for the six months ended June 30, 2002, represent a decrease of approximately $3.5 million, or 8%, from the comparable 2001 period, due principally to a decrease in selling and commission expense in response to the decreased sales volume, as well as cost reduction efforts implemented by the Company in the fourth quarter of 2001 and the first quarter of 2002. The decrease is partially offset by the selling, general and administrative expenses of Applied Epi and TM subsidiaries, which were acquired by the Company in the third quarter of 2001, and thus had no comparable spending in the first six months of 2001.

        Research and development expenses of $27.3 million for the six months ended June 30, 2002, represent a decrease of approximately $2.7 million, or 9%, from the comparable period of 2001, as a result of the cost reduction efforts implemented by the Company in the fourth quarter of 2001 and the first quarter of 2002.

        During the six months ended June 30, 2002, the Company incurred restructuring charges of $1.9 million in connection with a reduction in work force announced in the fourth quarter of 2001 and the first quarter of 2002. This charge includes severance related costs for approximately 90 employees which included both management and manufacturing employees located at each of the Company's process equipment operations and Minnesota metrology facility. As of June 30, 2002, approximately $0.7 million has been expended and approximately $1.2 million remains accrued. During the year ended December 31, 2001, the Company recorded restructuring charges of approximately $20.0 million in response to the significant downturn in the telecommunications industry and the overall weak business environment. These charges consisted of a $13.6 million write-off of inventory related to order cancellations and the rationalization of certain product lines, $3.0 million related to personnel and business relocation costs and $3.4 million related to the write-down of long-lived assets. The $3.0 million charge for personnel and business relocation costs principally related to plant consolidations and a workforce reduction of approximately 230 employees, which included both management and manufacturing employees located in all operations of the Company. As of June 30, 2002, approximately $2.2 million of the $3.0 million charge for relocation and termination benefits has been paid and approximately $0.8 million remains accrued.

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        Amortization expense totaled $6.9 million in the six months ended June 30, 2002 compared with $2.3 million in 2001 period, due to the acquisition of intangible assets discussed in the three-month results. This amount is offset in part by $0.8 million of reduced amortization expense related to the accounting requirement to no longer amortize goodwill, effective January 1, 2002, in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill is to be reviewed annually for impairment. As of January 1, 2002, no impairment exists.

        Other (income) expense, net, for the six months ended June 30, 2002, decreased $1.9 million from the comparable 2001 period due to the foreign currency exchange losses experienced in the first quarter of 2001, which did not occur in 2002.

        Interest expense, net, of $3.0 million for the six months ended June 30, 2002, increased $4.1 million from the comparable 2001 period as a direct result of the issuance of $220.0 million of 4.125% convertible subordinated notes, which occurred in December 2001 and January 2002.

        Income taxes for the six months ended June 30, 2002, amounted to a $3.5 million income tax benefit, or 42% of loss before income taxes, as compared to a $12.6 million income tax provision, or 35% of income before income taxes, for the same period of 2001.

        Quarterly information for the six months ended June 30, 2001, has been restated from that previously filed on the Quarterly Report on Form 10-Q for such period, due to the required accounting to reflect the discontinued operations of the Company's industrial measurement segment, which was recorded in the quarter ended December 31, 2001.

Critical Accounting Policies

        General:     Veeco's discussion and analysis of its financial condition and results of operations are based upon Veeco's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Veeco to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, management evaluates its estimates and judgments, including those related to derivatives, bad debts, inventories, intangible assets, income taxes, warranty obligations, restructuring costs and contingent litigation. Management bases its estimates and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company considers certain accounting policies related to revenue recognition, the valuation of inventories, the impairment of goodwill and intangible assets and derivatives to be critical policies due to the estimation processes involved in each.

        Revenue Recognition:     The Company recognizes revenue when persuasive evidence of an arrangement exists, the price of goods or services being sold is fixed or determinable and collectibility is reasonably assured. For products produced according to the Company's published specifications, where no installation is required or installation is deemed perfunctory and no substantive customer acceptance provisions exist, revenue is recognized when title passes to the customer, generally upon shipment. For products produced according to a particular customer's specifications, revenue is recognized when the product has been tested and it has been demonstrated that it meets the customer's specifications and title passes to the customer. The amount of revenue recorded is reduced by the amount of any customer retention (generally 10% to 20%), which is not payable by the customer until installation is completed and final customer acceptance is achieved. Installation is not deemed to be essential to the functionality of the equipment since installation does not involve significant changes to the features or capabilities of the equipment or building complex interfaces and connections. In addition, the equipment could be installed by the customer or other vendors and generally the cost of installation approximates only 1% to 2% of the sales value of the related equipment. For new applications of the

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Company's existing products, for new products or for products with substantive customer acceptance provisions where performance cannot be fully assessed prior to meeting customer specifications at the customer site, revenue is recognized upon completion of installation and receipt of final customer acceptance. Service and maintenance contract revenues are recorded as deferred revenue, which is included in other accrued expenses, and recognized as revenue on a straight-line basis over the service period of the related contract. The Company provides for warranty costs at the time the related revenue is recognized.

        Inventory Valuation:     Inventories are stated at the lower of cost (principally first-in, first-out method) or market. Management evaluates the need to record adjustments for impairment of inventory on a quarterly basis. The Company's policy is to assess the valuation of all inventories, including raw materials, work-in-progress, finished goods and spare parts. Obsolete inventory or inventory in excess of management's estimated usage for the next 18 to 24 month's requirements is written-down to its estimated market value, if less than its cost. Inherent in the estimates of market value are management's estimates related to Veeco's future manufacturing schedules, customer demand, technological and/or market obsolescence, possible alternative uses and ultimate realization of excess inventory.

        Goodwill and Intangible Asset Impairment:     The Company has significant intangible assets related to goodwill and other acquired intangibles. In assessing the recoverability of the Company's goodwill and other intangible assets, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. Changes in strategy and/or market conditions could significantly impact these assumptions, and thus Veeco may be required, during the annual review process, to record an impairment charge for these assets in accordance with SFAS No. 142.

        Derivatives:     During the six months ended June 30, 2002, the Company used derivative financial instruments to minimize the impact of foreign exchange rate changes on earnings and cash flows. In the normal course of business, operations are exposed to fluctuations in foreign exchange rates. In order to reduce the effect of fluctuating foreign currencies on short-term foreign currency-denominated intercompany balances and other known foreign currency exposures, the Company enters into monthly forward contracts (which during the six months ended June 30, 2002, included a majority of the Company's foreign subsidiaries). The Company does not use derivative financial instruments for trading or speculative purposes. The Company's forward contracts do not subject it to material risks due to exchange rate movements because gains and losses on these contracts are intended to offset exchange gains and losses on the underlying assets and liabilities; both the forward contracts and the underlying assets and liabilities are marked-to-market through earnings .

Liquidity and Capital Resources

        Cash flows used in operations were $2.7 million for the six months ended June 30, 2002, as compared to cash flows from operations of $8.4 million for the comparable 2001 period. Net income adjusted for non-cash items provided operating cash flows of $3.6 million for the six months ended June 30, 2002 compared to $41.5 million for the comparable 2001 period. The amount of net income adjusted for non-cash items for the six months ended June 30, 2002 was offset by an increase in working capital of $6.2 million. Accounts receivable for the six months ended June 30, 2002 decreased by $19.1 million, primarily as a result of the decrease in sales volume from the fourth quarter of 2001. Deferred gross profit for the six months ended June 30, 2002 decreased by $7.8 million, primarily as a result of revenue recognition on tools that received final customer acceptance. Accrued expenses and other current liabilities decreased $17.2 million, primarily as a result of income tax payments made by the Company's Japanese subsidiary, and various other tax payments made in the first six months of 2002 related to sales and foreign taxes. In addition, accrued expenses decreased as a result of bonuses

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paid in the first quarter of 2002 and the decrease in accrued commission expense and customer deposits related to the decline in sales volume and orders.

        Cash flows from investing activities of $3.1 million for the six months ended June 30, 2002, are a result of the proceeds from the sale of the Company's industrial measurement business of $3.7 million, which closed in May 2002, proceeds from the sale of property, plant and equipment of $1.8 million and maturities of long-term investments of $1.8 million, offset by capital expenditures of $4.2 million.

        In December 2001, the Company issued $200.0 million of 4.125% convertible subordinated notes, and in January 2002, the Company issued an additional $20.0 million of those notes pursuant to the exercise of an over-allotment option.

        In connection with the subordinated notes issuance in December 2001 and January 2002, the Company purchased approximately $25.9 million of U.S. government securities, which have been pledged to the trustee under the indenture as security for the exclusive benefit of the holders of the notes. These securities will be sufficient to provide for the payment in full of the first six scheduled interest payments due on the notes and represent restricted investments. The first interest payment was made on June 21, 2002 in the amount of $4.5 million.

        Funds from operations, the use of proceeds received from the issuance of the subordinated notes in connection with the exercise of the over-allotment option in January 2002 and the maturities of long-term investments were used to pay for capital expenditures and the scheduled repayment of long-term debt.

        At June 30, 2002, Veeco's contractual cash obligations and commitments relating to its debt obligations and lease payments are as follows (in thousands):

        The Company believes that existing cash balances together with cash generated from operations and amounts available under the Company's $100.0 million credit facility will be sufficient to meet the Company's projected working capital and other cash flow requirements for the next twelve months.