VEECO INSTRUMENTS INC.

INDEX

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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)

See accompanying notes.

4

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

See accompanying notes.

5

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

See accompanying notes.

6

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

Non-Cash Items

During the three months ended March 31, 2005 and 2004,2006, the Company had non-cash items excluded from the Condensed Consolidated Statements of Cash Flows of approximately $1.5$0.5 million, and $0.0 million respectively, which consisted of the transfer of property, plantfixed assets to inventory and equipmentthe write-down of capitalized debt issuance costs related to extinguished debt. During the three months ended March 31, 2005, the Company had non-cash items of approximately $1.5 million, which consisted of the transfer of fixed assets to inventory.

See accompanying notes.

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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 accounting principlesU.S. generally accepted in the United Statesaccounting 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 months ended March 31, 2005,2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.2006. 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, 2004.2005.

Loss Per Share

Net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed using the weighted average number of common shares and common equivalent shares outstanding during the period.  The effect of approximately 197,000574,000 and 755,000197,000 common equivalent shares for the three months ended March 31, 2006 and 2005, respectively, were anti-dilutive, and 2004, respectively, andtherefore are not included in the weighted average shares outstanding.

In addition, the effect of the assumed conversion of subordinated convertible debentures into approximately 5.2 million and 5.7 million common equivalent shares is antidilutive for the three months ended March 31, 2006 and 2005, and 2004,respectively, and therefore is not included in the diluted weighted average shares outstanding.

TheStock-Based Compensation

As of March 31, 2006, the Company accountshad four stock option 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 discussed in Note 2. Prior to 2006, the Company accounted for itsthese 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.  Nointerpretations and generally, no compensation expense iswas reflected in net loss as all options granted under the stock optionthose plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net loss and net loss per share ifEffective January 1, 2006, the Company had applied the fair value recognition provisions, under which compensation expense would be recognized as incurred, of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

Reclassifications

Certain amounts in the 2004 consolidated financial statements have been reclassified to conform to the 2005 presentation.

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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. 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, of SFAS No. 123, to stock-based employee compensation.

Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs- an amendment to ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal,” as previously stated in ARB No. 43. In addition, this Statement requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement shall beare effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect that the adoption ofadopted this Statement will haveon January 1, 2006 and such adoption did not result in a significant impact on the Company’s consolidated financial position or results of operations.

8Note 2—Share-Based Payments

Option Plans

The Company has four stock option 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 (2,049,307 options are available for future grants as of March 31, 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 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. In October 2005, the Company granted 45,000 shares of restricted common stock, resulting in stock-based compensation expense of approximately $0.1 million or ($0.0) per common share for the three months ended March 31, 2006. These shares of restricted common stock vest over three years and will result in additional stock-based compensation expense of approximately $0.6 million.

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 provides 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”) provides 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.

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The Veeco Instruments Inc. 1994 Stock Option Plan for Outside Directors, as amended, (the “Directors’ Option Plan”), provides 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 March 31, 2006 under these plans.

In addition to the four plans, the Company assumed certain stock option plans and agreements relating to the merger in September 2001with 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 March 31, 2006, there are 208,093 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. 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 March 31, 2006, there are 9,438 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.

For the three months ended March 31, 2006, there were no new options granted. 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 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:

A summary of the Company’s stock option plans as of and for the three months ended March 31, 2006 is presented below:

The weighted-average grant date fair value of stock options granted for the three months ended March 31, 2005 was $7.39. The total intrinsic value of stock options exercised during the three months ended March 31, 2006 and 2005 was $0.4 million and $0.1 million, respectively.

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The following table summarizes information about stock options outstanding at March 31, 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 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.  Based on the Company’s implementation date for SFAS No. 123(R) of January 1, 2006, the Company will not incur future compensation expense of approximately $7.9 million in 2006 and $3.6 million in 2007.

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 domestic 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 December 31, 2005 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 March 31, 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.

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Note 3—Balance Sheet Information

Inventories

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

Accrued WarrantiesWarranty

The Company estimates the costs that may be incurred under the warranty it provides and recordsrecognizes 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 recordedrecognized 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

During the three months ended March 31, 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 threetwo separate reporting segments. The firstCompany merged the former Ion Beam and Mechanical Process Equipment segment called “ion beam and mechanical process equipment,”the Epitaxial Process Equipment segment into one reporting segment. The new Process Equipment segment combines the etch, deposition, and dicing and slicing products sold mostly to data storage customers. This segment includescustomers and the production facilities in Plainview, New York, Ft. Collins, Coloradomolecular beam epitaxy and Camarillo and Ventura, California. The second segment, called “epitaxial process equipment,” includes the Molecular Beam Epitaxy and Metal Organic Chemical Vapor Depositionmetal organic chemical vapor deposition products primarily sold to high brightness light emitting diode and wireless telecommunications customers. This segment includes the production facilities in Plainview, New York, Ft. Collins, Colorado, Camarillo, California, St. Paul, Minnesota and Somerset, New Jersey. The thirdMetrology segment called “metrology”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 the production facilities in Santa Barbara, California and Tucson, Arizona. Accordingly, the Company has restated segment information for the prior period presented.

9The 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. Costs 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.

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The $2.8 million charge for personnel costs includes severance related costs for approximately 10737 employees which included management, administration and manufacturing employees located at the Company’s Plainview, New York, and Camarillo, California, ion beam and mechanical process equipment operations, the Somerset, New Jersey Process Equipment operations and St. Paul, Minnesota epitaxial process equipment operations, the Santa Barbara, California and Tucson, Arizona metrology facilities, the sales and service offices located in France, England and Singapore, and the corporate offices in Woodbury, New York.Metrology operations. As of March 31, 2005,2006, approximately $1.9$0.7 million has been paid and approximately $0.9$0.5 million remains accrued.in accrued expenses. The remainder is expected to be paid by the fourth quarter of 2005.

The $0.8 million charge for costs related to the internal investigation of improper accounting transactions at the Company’s TurboDisc business unit include accounting, legal and other auditing fees performed by external consultants who assisted with the investigation. As of March 31, 2005, $0.7 million remained accrued and will be paid by the second quarter of 2005.2006.

A reconciliation of the liability for the 2005 restructuring and other charges during 2004charge for severance and investigation costs is as follows (in millions):

Note 7—Subsequent EventsEvent and Related Party Transaction

On April 12, 2005, the Compensation Committee (the “Committee”)In May 2006, Veeco invested $0.5 million to purchase 19.9% of the Company’s Board of Directors approved the acceleration of vesting of unvested, out-of-the-money stock options granted prior to September 1, 2004 under Veeco’s stock option plans.  An option was considered “out-of-the-money” if the option exercise price was greater than the closing price of Veeco’s common stock onof Fluens Corporation (“Fluens”).  Approximately 31% of Fluens is owned by a Vice President and General Manager 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 NASDAQ National Market on April 11, 2005 ($15.26),satisfaction of certain additional conditions, Veeco will be obligated to buy the last trading day before the Committee approved the acceleration.  As a result of this action, options to purchase approximately 2,549,000 shares of Veeco’s common stock became immediately exercisable, including options held by Veeco’s executive officers to purchase approximately 852,000 shares.  The weighted average exercise pricebalance of the options accelerated was $21.25.outstanding stock of Fluens for $3.0 million plus 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 $0.1 million against this purchase order in March 2006.

The purpose of the accelerated vesting is to eliminate future compensation expense that Veeco would otherwise recognize in its statement of operations with respect to these accelerated options upon the adoption by Veeco of SFAS 123(R).  In addition, because many of these options have exercise prices significantly in excess of current market values, they were not providing an effective means of employee retention and incentive compensation.  The future compensation expense that will be avoided, based on Veeco’s implementation date for SFAS 123R of January 1, 2006, is approximately $8.4 million in 2006 and $3.9 million in 2007.

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Current Business Conditions/Outlook:

In the first quarter of 2005,2006, Veeco reported sales of $93.9 million, a 3% increase from the $90.9 million reported in theflat compared with prior year first quarter of 2004.  Revenuessales. As anticipated, revenues were down sequentially as anticipated from the $103.0$112.8 million reported in the fourth quarter of 2004.  2005, as a result of the Company’s low order rate of $84.6 million during the third quarter of 2005.

Veeco’s first quarter 20052006 bookings of $98.9were $126.7 million, reflected increased demand from ourreflecting double digit market growth in data storage customers who are currently investingand in capacity expansions for consumer micro-drive applications and advanced development programs for next generation TFMHs.  Data storageHB-LED/wireless. First quarter orders increased 26% sequentially to $45.3 million –were the highest quarterly level the Company has experienced in severalfive years. Within the  strong order rate, Veeco’s data storage orders increased 55% from the prior year to a record $70.4 million. Another area of strength was in HB-LED/wireless, which reported orders of $24.3 million, up 74% from the prior year. The strong first quarter 2006 order rate 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 flat panel televisions.

In 2006, Veeco implemented an active plan to improve the Company’s profitability in 2005.  This plan is based both on headcount reductions which were taken in the fourth quarter of 2004,continuing its strategy for growth as well as aits focus on improving profitability and gross margin performance. For the remainder of 2006, the Company currently anticipates positive market conditions across core markets (data storage, HB-LED/wireless, semiconductor and scientific research), which, combined with significant new product mix expectationintroductions expected from both the Process Equipment and Metrology business units, should provide an opportunity for 2005revenue growth. Veeco has forecasted that revenues that should leadwill grow 8-10% in 2006 to $440-$450 million. In addition, consumer spending on many types of electronics has increased gross margins.and various worldwide regions, such as the Asia Pacific region, are experiencing growth. The Company currently expects higher 2005 revenues in data storage products, lower 2005 revenues in epitaxial equipment productsreviews a number of indicators to predict the strength of its markets going forward. These include plant utilization trends, capacity requirements and stability in its metrology revenues as compared to 2004.  This revenue mix as well as other planned actions are expected to result in increased gross margins for each subsequent quartercapital spending trends. At the beginning of 2005 and for the year as a whole compared with 2004.

2006, many of these trends appear positive.

Technology changes are continuing in all of Veeco’s markets: the continued rampincrease of 80 GB hard drives and investment in 120 GB hard drives in data storage and investmentsstorage; the increased use of “mini” drives in next generation drives (120GB);consumer electronic applications; the increased use of Veeco’s automated AFMs for sub 13065 nanometer and below semiconductor applications; the opportunity for Veeco’s MOCVD and MBE systemsproducts to further penetrate the emerging wireless and HB-LED and wireless markets; andmarkets. Veeco believes that these changes, together with the continued funding of nanoscience research, whichwill prompt our customers to seek our next-generation solutions to address their manufacturing and technology challenges.

The Company’s goal is one driver of Veeco’s scientific research business.  While Veeco’s customers remain cautious regarding capital spending, they are also placing orders for Veecoto continue to increase gross margins in 2006, with improvements in both Process Equipment and MetrologyMetrology. Veeco has forecasted that gross margins will increase three percentage points from 42% in 2005 to approximately 45% in 2006. Veeco anticipates that progress in this area will continue to come from the introduction of new products that enable their next generation products.  Veeco remains well positioned to provide leadership technologies for growth applications in semiconductor, data storage, HB-LED/wireless and scientific research.

Recent Events:

Internal Accounting Investigation; Restatement of 2004 Financial Results

On February 11, 2005, Veeco announced the postponement of the release of audited results for the fourth quarter and year ended December 31, 2004, pending completion of an internal investigation of improper accounting transactions at its TurboDisc business unit. Veeco acquired the assets of TurboDisc in November 2003. The investigation focused principally on the value of inventory, accounts payable and certain liabilities,with higher gross margins, as well as certain revenue transactionsactivities such as better supply chain management, including outsourcing of TurboDisc. The investigation was commenced after Veeco’s internal audit staffnew products and corporate financial management discovered improper accounting transactions in the coursedevelopment of a Veeco internal auditcommon hardware and transitioning the business to Veeco’s SAP accounting system during the fourth quarter of 2004. The Audit Committee of the Company’s Board of Directors supervised the accounting investigation and authorized Veeco’s outside counsel, Kaye Scholer LLP, to hire Jefferson Wells International to perform forensics and accounting reconstruction work as part of the investigation. The investigation has been completed. The investigation concluded that the improper accounting entries were made by a single individual at TurboDisc whose employment had been terminated prior to the commencement of the investigation, and that there was no evidence found of embezzlement or diversion of corporate assets.software platforms.

The results of the investigation led to the restatement of financial statements previously issued for the first three quarterly periods of 2004 and related six and nine month periods ended June 30, 2004 and September 30, 2004. The cumulative restatement included a $10.2 million adjustment to pre-tax earnings, comprised of $8.1 million in adjustments relating to inventory, accruals and accounts payable and $2.1 million in adjustments relating to revenue recognition issues. Veeco has made a number of personnel changes to strengthen the management of the epitaxial process equipment group and the TurboDisc business unit since the discovery of the accounting issues that gave rise to the investigation, including the replacement of the General Manager of the epitaxial process equipment group, creation of the positions of General Manager of the TurboDisc business unit, General Manager of the St. Paul business unit, Group Controller of the epitaxial process equipment group and the appointment of a new controller of the TurboDisc business unit.

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Results of Operations:

Three Months Ended March 31, 20052006 and 20042005

The following tables show selected items of Veeco’s Consolidated Statements of Operations, percentages of sales and comparisons between the three months ended March 31, 20052006 and 20042005 and the analysis of sales and orders for the same periods between our segments, industriesby segment, industry and regions (in thousands):