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FEIC > SEC Filings for FEIC > Form 10-Q on 1-Nov-2012All Recent SEC Filings

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Form 10-Q for FEI CO


1-Nov-2012

Quarterly Report


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

Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. You can identify these statements by the fact that they do not relate strictly to historical or current facts and use words such as "anticipate," "estimate," "expect," "will," "are expected," "project," "intend," "plan," "believe," "appear," "assume" and other words and terms of similar meaning. Such forward-looking statements include any statements regarding expectations of earnings, revenues, bookings, gross margins, operating and non-operating expenses, tax rates, net income, foreign currency rates, payment of dividends, funding opportunities or other financial items, as well as backlog, order levels and activity of our company as a whole or in particular markets; any statements of the plans, strategies and objectives of management for future operations, restructuring and outsourcing or insourcing initiatives; any statements of factors that may affect our 2012 operating results; any statements concerning proposed new products, services, developments, changes to our restructuring reserves, our competitive position, hiring levels, sales and bookings or anticipated performance of products or services; any statements related to acquisitions of other companies; any statements related to future capital expenditures; any statements related to the needs or expected growth or spending of our target markets; any statements concerning the effects of litigation, on our financial condition or otherwise; any statements concerning our effective tax rates, the resolution of any tax positions or use of tax assets; any statements concerning the effect of new accounting pronouncements on our financial position, results of operations or cash flows; any statements regarding future economic conditions or performance; any statements of belief; any statements of assumptions underlying any of the foregoing; and any statements made under the heading "Outlook for the Remainder of 2012." From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. The risks, uncertainties and assumptions referred to above include, but are not limited to, those discussed here and the risks discussed from time to time in our other public filings. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us as of the date of this report, and we assume no obligation to update these forward-looking statements. You are advised, however, to consult any further disclosures we make on related subjects in our Forms 10-K, 10-Q and 8-K filed with, or furnished to, the SEC. You also should read the section entitled "Risk Factors" included in Part II, Item 1A. of this Quarterly Report on Form 10-Q for factors that we believe could cause our actual results to differ materially from expected and historical results. Other factors could also adversely affect us. Summary of Products and Segments
We are a leading supplier of scientific instruments for nanoscale imaging, analysis and prototyping to enable research, development and manufacturing in a range of industrial, academic and research applications. We report our revenue based on a market-focused organization: the Electronics market segment, the Materials Science market segment, the Life Sciences market segment and the Service and Components market segment.
Our products include transmission electron microscopes, or TEMs; scanning electron microscopes, or SEMs; DualBeamTM systems which combine a SEM and a focused ion beam system, or FIB, on a single platform; and stand-alone FIBs. Our DualBeam systems include models that have wafer handling capability and are purchased by semiconductor equipment manufacturers ("wafer-level DualBeam systems") and models that have small stages and are sold to customers in several markets ("small-stage DualBeam systems").
We have research and development and manufacturing operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; Munich, Germany; and Delmont, Pennsylvania, and software development in Bordeaux, France and Brisbane, Australia. Our sales and service operations are conducted in the United States (U.S.) and approximately 50 other countries around the world. We also sell our products through independent agents, distributors and representatives in additional countries.
The Electronics market segment consists of customers in the semiconductor equipment and related industries such as manufacturers of data storage equipment, solar panels and light-emitting diodes ("LEDs"). For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, the use of multiple layers of new materials such as copper and low-k dielectrics and increasing device complexity. Our products are used primarily in laboratories to speed new product development and increase yields by enabling 3D wafer metrology, defect analysis, root cause failure analysis and circuit edit for modifying device structures. The Materials Science market segment includes universities, public and private research laboratories and customers in a wide range of industries, including natural resources (mining and oil and gas), petrochemicals, metals, automobiles, aerospace, and forensics. Growth in these markets is driven by global corporate and government funding for research and development in materials science and by development of new products and processes based on innovations in materials at the nanoscale. Our solutions provide researchers and manufacturers with atomic-level resolution images and permit development, analysis and production of advanced products. Our products are used in mining for automated mineralogy and we have opportunities in oil and gas exploration. Our products are also used in root cause failure analysis and quality control applications across a range of industries.


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The Life Sciences market segment includes universities, government laboratories and research institutes engaged in biotech and life sciences applications, as well as pharmaceutical, biotech and medical device companies and hospitals. Our products' ultra-high resolution imaging allows structural and cellular biologists and drug researchers to create detailed 3D reconstructions of complex biological structures. Our products are also used in particle analysis and a range of pathology and quality control applications.
The Service and Components market segment provides support for products and customers for the entire life cycle of a tool from installation through the warranty period, and after warranty period through contract coverage or on a time and materials basis. We believe strong technical support is an important part of the value proposition that we offer customers when a tool is sold. Our Service and Components market segment provides support across all markets and all regions.
Overview - Orders and Backlog
Orders received in a particular period that cannot be built and shipped to the customer in that period represent backlog. We only recognize backlog for purchase commitments for which the terms of the sale have been agreed upon, including price, configuration, options and payment terms. Product backlog consists of all open orders meeting these criteria. Service and Components backlog consists of open orders for service, unearned revenue on service contracts and open orders for spare parts. U.S. government backlog is limited to contracted amounts. In addition, some of the U.S. government backlog represents uncommitted funds. At September 30, 2012, our total backlog was $425.2 million, compared to $430.7 million at December 31, 2011. At September 30, 2012, our backlog consisted of $330.5 million of products and $94.7 million related to Service and Components compared to product backlog of $343.3 million and Service and Components backlog of $87.4 million at December 31, 2011.
Customers may cancel or delay delivery on previously placed orders, although our standard terms and conditions include penalties for cancellations made close to the scheduled delivery date. As a result, the timing of the receipt of orders or the shipment of products could have a significant impact on our backlog at any date. Historically, cancellations have been low. However, in the last two years, this long-standing trend changed somewhat and, as a result, our cancellation rates may increase in the future. During the first thirty-nine weeks of 2012 and all of 2011, we experienced cancellations of $1.4 million and $3.5 million, respectively. From time to time, we have experienced difficulty in shipping our product from backlog due to single-sourcing issues and problems in securing electronic components from a certain vendor. In addition, product shipments have been extended due to delays in completing certain application development, by our customers pushing out shipments because their facilities are not ready to install our systems and by our own manufacturing delays due to the technical complexity of our products and supply chain issues. A significant portion of our backlog is denominated in currencies other than the U.S. dollar and, therefore, our reported backlog fluctuates, to an extent, as a result of foreign currency exchange rate movements. For these reasons, the amount of backlog at any date is not necessarily indicative of revenue to be recognized in future periods.
Outlook for the Remainder of 2012
Revenue in the first three quarters of 2012 grew by 8% compared with the first three quarters of 2011. We expect year-over-year revenue growth in the fourth quarter of 2012 to be in the same range, driven in part by the additional revenue of ASPEX, FEI Korea and VSG. Gross margin in the first nine months of the year was 46.4%, and we expect fourth quarter margin to be at or above that level. Diluted earnings per share has averaged $0.69 for the first three quarters of 2012, and we expect fourth quarter results to be at or above that level.
Electronics revenue for the rest of 2012 is expected to be below the first three quarters of the year, and Electronics bookings are expected to slow based on the timing of orders from major customers. We expect overall bookings for Materials Science and Life Sciences products to maintain at current levels, driven by orders from Asia and developing economies, as more orders from these regions compensate for fewer orders in the U.S. and Europe. Life Sciences bookings and revenue progression will continue to vary by quarter because of the large size of some individual orders. Toward the end of the year, we expect to see some positive impact on Life Sciences from our strategic initiatives, including collaborative agreements on structural and cell biology and our 2011 acquisition of TILL Photonics. We expect growth in the natural resources business to continue to positively impact the Materials Science segment as sales of Natural Resources products contribute additional revenue and higher average gross margin.
Critical Accounting Policies and the Use of Estimates Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We believe the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain.
Management's Discussion and Analysis and Note 1 to the Consolidated Financial Statements in our 2011 Annual Report on Form 10-K describe the significant accounting estimates and policies used in preparation of the Consolidated Financial Statements. Actual results in these areas could differ from management's estimates. During the first thirty-nine weeks of 2012, there were no significant changes in our critical accounting policies or estimates from those reported in our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission on February 17, 2012.


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Results of Operations
The following tables set forth our statement of operations data, in absolute
dollars and as a percentage(1) of consolidated net sales (dollars in thousands):
                                      Thirteen Weeks Ended             Thirteen Weeks Ended
                                       September 30, 2012                October 2, 2011
Net sales                        $    221,785          100.0  %   $    205,335          100.0  %
Cost of sales                         117,629           53.0           114,110           55.6
Gross profit                          104,156           47.0            91,225           44.4
Research and development               23,908           10.8            19,212            9.4
Selling, general and
administrative                         41,931           18.9            37,051           18.0
Restructuring, reorganization,
relocation and severance                    -              -                47              -
Operating income                       38,317           17.3            34,915           17.0
Other expense, net                     (1,712 )         (0.8 )            (601 )         (0.3 )
Income before income taxes             36,605           16.5            34,314           16.7
Income tax expense                      7,447            3.4             8,137            4.0
Net income                       $     29,158           13.1  %   $     26,177           12.7  %


                                       Thirty-Nine Weeks Ended            Thirty-Nine Weeks Ended
                                         September 30, 2012                   October 2, 2011
Net sales                          $     660,792          100.0  %   $     613,436            100.0  %
Cost of sales                            354,096           53.6            340,612             55.5
Gross profit                             306,696           46.4            272,824             44.5
Research and development                  69,936           10.6             56,771              9.3
Selling, general and
administrative                           125,299           19.0            111,607             18.2
Restructuring, reorganization,
relocation and severance                       -              -              1,115              0.2
Operating income                         111,461           16.9            103,331             16.8
Other expense, net                        (5,030 )         (0.8 )           (1,716 )           (0.3 )
Income before income taxes               106,431           16.1            101,615             16.6
Income tax expense                        21,313            3.2             27,066              4.4
Net income                         $      85,118           12.9  %   $      74,549             12.2  %


___________________________


(1) Percentages may not add due to rounding.

Net Sales
Net sales increased $16.5 million, or 8.0%, to $221.8 million in the thirteen week period ended September 30, 2012 (the third quarter of 2012) compared to $205.3 million in the thirteen week period ended October 2, 2011 (the third quarter of 2011). Net sales increased $47.4 million, or 7.7%, to $660.8 million in the thirty-nine week period ended September 30, 2012 compared to $613.4 million in the thirty-nine week period ended October 2, 2011. The factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below.
The strengthening of the dollar during the third quarter of 2012 decreased net sales for the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 as approximately 67% of our net sales were denominated in foreign currencies that fluctuated against the U.S. dollar. Strengthening of the U.S. dollar against these foreign currencies generally has the effect of decreasing net sales and backlog.


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Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were
as follows:
                                    Thirteen Weeks Ended
                         September 30, 2012        October 2, 2011
Electronics            $     76,923     34.7 %   $  56,589     27.6 %
Materials Science            72,267     32.6        74,450     36.2
Life Sciences                23,169     10.4        30,216     14.7
Service and Components       49,426     22.3        44,080     21.5
Consolidated net sales $    221,785    100.0 %   $ 205,335    100.0 %


                                  Thirty-Nine Weeks Ended
                         September 30, 2012        October 2, 2011
Electronics            $    236,317     35.8 %   $ 204,927     33.4 %
Materials Science           213,963     32.4       200,245     32.6
Life Sciences                64,067      9.6        81,011     13.2
Service and Components      146,445     22.2       127,253     20.8
Consolidated net sales $    660,792    100.0 %   $ 613,436    100.0 %

Electronics
The $20.3 million, or 35.9%, increase and the $31.4 million, or 15.3%, increase, respectively, in Electronics sales in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily due to increased demand for certain products as the industry shifts to smaller nodes. As our customers migrate from SEM-based to more TEM-based lab analysis, we realize increases in unit sales of our TEM products as well as our small DualBeam products. Currency fluctuations decreased Electronics sales compared to the same periods of 2011.
Materials Science
The $2.2 million, or 2.9%, decrease in Materials Science sales in the thirteen week period ended September 30, 2012 compared to the same period of 2011 was primarily due to a change in product mix and the timing of shipments as well as the impact of currency fluctuations which decreased Materials Science sales compared to the same period of 2011. The $13.7 million, or 6.9%, increase in Materials Science sales in the thirty-nine week period ended September 30, 2012 compared to the same period of 2011 was primarily due to increased advanced research spending in Asia and the inclusion of product sales from ASPEX Corporation ("ASPEX"), which we acquired January 9, 2012, and from Visualization Sciences Group ("VSG"), which we acquired on August 1, 2012. Also contributing to the increase was growth in sales to our natural resources customers driven by continued penetration in the oil and gas and mining industries. This was partially offset by currency fluctuations, which decreased Materials Science sales compared to the same period of 2011. Life Sciences
The $7.0 million, or 23.3%, decrease and the $16.9 million, or 20.9%, decrease, respectively, in Life Sciences sales in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily due to a decrease in the number of high-end TEM units sold during the period. Historically, we have seen significant volatility in the sale of high-end TEMs for Life Sciences and that may continue. Additionally, currency fluctuations decreased Life Sciences sales compared to the same periods of 2011. Service and Components
The $5.3 million, or 12.1%, increase and the $19.2 million, or 15.1%, increase, respectively, in Service and Components sales in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were due primarily to a larger install base and the inclusion of service revenue for our ASPEX product line as well as service revenue from our Korean subsidiary resulting from the acquisition of certain assets of AP Tech, which occurred on July 9, 2012. This was partially offset by currency fluctuations, which decreased Service and Components sales compared to the same periods of 2011.


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Net Sales by Geographic Region
A significant portion of our net sales has been derived from customers outside
of the U.S., which we expect to continue. The following tables show our net
sales by geographic region (dollars in thousands):
                                                   Thirteen Weeks Ended
                                        September 30, 2012        October 2, 2011
U.S. and Canada                       $     75,590     34.1 %   $  60,408     29.4 %
Europe                                      64,390     29.0        74,529     36.3
Asia-Pacific Region and Rest of World       81,805     36.9        70,398     34.3
Consolidated net sales                $    221,785    100.0 %   $ 205,335    100.0 %


                                                 Thirty-Nine Weeks Ended
                                        September 30, 2012        October 2, 2011
U.S. and Canada                       $    220,067     33.3 %   $ 198,213     32.3 %
Europe                                     174,408     26.4       191,840     31.3
Asia-Pacific Region and Rest of World      266,317     40.3       223,383     36.4
Consolidated net sales                $    660,792    100.0 %   $ 613,436    100.0 %

U.S. and Canada
The $15.2 million, or 25.1%, increase and the $21.9 million, or 11.0%, increase, respectively, in sales to the U.S. and Canada in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily due to an increase in shipments to semiconductor customers as well as growth in sales to our natural resources customers. Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $10.1 million, or 13.6%, decrease and the $17.4 million, or 9.1%, decrease, respectively, in sales to Europe in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily due to a shift in the mix of semiconductor sales away from European customers to Asian customers, as well as a decrease in the number of high-end TEM units sold in our Life Sciences segment. Currency fluctuations also decreased sales to Europe compared to the same periods of 2011. Asia-Pacific Region and Rest of World
The $11.4 million, or 16.2%, increase and the $42.9 million, or 19.2%, increase, respectively, in sales to the Asia-Pacific Region and Rest of World in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily driven by increased spending in the semiconductor industry as well as increased advanced research spending by our Materials Science customers. Currency fluctuations negatively impacted sales to this region in the thirteen week period ended September 30, 2012 and increased sales to this region in the thirty-nine week period ended September 30, 2012 compared to the same periods of 2011.
Cost of Sales and Gross Margin
Our gross margin (gross profit as a percentage of net sales) by segment was as follows:

                                           Thirteen Weeks Ended                       Thirty-Nine Weeks Ended
                                  September 30, 2012      October 2, 2011     September 30, 2012       October 2, 2011
Electronics                                 55.3 %                 54.3 %              54.5 %                   52.5 %
Materials Science                           47.2                   40.9                46.4                     42.9
Life Sciences                               40.4                   49.1                41.6                     46.3
Service and Components                      36.7                   34.5                35.5                     32.8
Overall                                     47.0                   44.4                46.4                     44.5

Cost of sales includes manufacturing costs, such as materials, labor (both direct and indirect) and factory overhead, as well as all of the costs of our customer service function such as labor, materials, travel and overhead. The five primary drivers affecting gross margin include: product mix (including the effect of price competition), volume, cost reduction efforts, competitive pricing pressure and currency movements.


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Cost of sales increased $3.5 million, or 3.1%, to $117.6 million in the thirteen week period ended September 30, 2012 compared to $114.1 million in the thirteen week period ended October 2, 2011 and increased $13.5 million, or 4.0%, to $354.1 million in the thirty-nine week period ended September 30, 2012 compared to $340.6 million in the comparable period of 2011, primarily due to increased sales. Currency fluctuations reduced cost of sales in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011.
The strengthening of the dollar during the third quarter of 2012 positively impacted our gross margin for the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011. This benefit was partially offset by hedge losses.
Electronics
The increases in Electronics gross margin during the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were due primarily to an increased number of high-end TEM units sold and improved margins on those high-end TEMs. Electronics gross margin also benefited from a stronger dollar in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011. Materials Science
The increase in Materials Science gross margin in the thirteen week period ended September 30, 2012 compared to the same period of 2011 was primarily because our higher-margin natural resources products comprised a larger proportion of revenue for this segment. Additionally, the acquisition of VSG during the third quarter of 2012 positively impacted margins for this segment.
The increase in the thirty-nine week period ended September 30, 2012 compared to the same period of 2011 was because our higher-margin natural resources products comprised a larger proportion of revenue for this segment. The acquisition of VSG during the third quarter of 2012 also positively impacted margins for this segment. We continue to realize some operational cost savings for our TEM product line resulting from manufacturing a higher percentage of products at our Brno, Czech Republic facility. As the move was substantially complete in the second quarter of 2011, the cost savings effect of the transfer is diminishing on a year-over-year comparison basis. Materials Science gross margins also benefited from a stronger dollar in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011. Life Sciences
The decreases in Life Sciences gross margin in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011 were primarily due to a decrease in the number of high-end TEM units sold. This was partially offset by an increase in Life Sciences gross margin driven by a stronger dollar in the thirteen and thirty-nine week periods ended September 30, 2012 compared to the same periods of 2011. Service and Components
The increases in Service and Components gross margin in the thirteen and . . .

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