Summary of FEI CO - Yahoo! Finance

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This Annual Report on Form 10-K 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, 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 corporate reorganization; any statements of factors that may affect our 2013 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 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 2013."
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 Annual Report on Form 10-K 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-Q and 8-K filed with, or furnished to, the SEC. You also should read the section entitled "Risk Factors" included in Part I, Item 1A. of this Annual Report on Form 10-K 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 applications and solutions for industry and science. 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. Beginning with the first quarter of 2013, we intend to change our reporting segments as previously disclosed in an 8-K filed with the SEC on January 14, 2013.
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; stand-alone FIBs; and high-performance optical microscopes. TEMs provide the highest resolution images of samples and their internal structure, down to the atomic level. SEMs provide detailed images of the surface and shape of samples. Optical microscopes provide a wider field of view than SEMs and TEMs. DualBeams and FIBs image, manipulate, mill and deposit material for a variety of purposes, including preparation of samples for TEMs. Substantially all of these product categories are sold into all of our market segments. Individual models of our products are increasingly designed to provide specific solutions and applications in each of our market segments.
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 semiconductor integrated circuit manufacturing and related industries such as manufacturers of data storage equipment and other technologies. For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, increasing complexity in their materials such as high-k metal gates and low-k dielectrics and increasing device complexity such as 3D transistor architectures. Our products are used primarily in laboratories or near the fabrication line 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 functionality.

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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 enable scientific discovery and advancement for researchers and help manufacturers develop, analyze and produce advanced products. Our products are used in mining for automated mineralogy and we have opportunities in oil and gas exploration and laboratory analysis. Our products are also used in root cause failure analysis and quality control applications across a range of industries.
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 biologists to create detailed 3D reconstructions of complex biological structures such as proteins and viruses. Cellular biologists use our tools to correlate wide-field, lower resolution optical images with higher resolution electron microscope imaging. Our products are also used by drug researchers and 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.
SALES AND BACKLOG
Net sales increased to $891.7 million in 2012 compared to $826.4 million in 2011. This increase reflects increases in all of our market segments, except Life Sciences, as described more fully below.
At December 31, 2012, our total backlog was $424.8 million compared to $430.7 million at December 31, 2011. As discussed in the section entitled "Business" included in Part I, Item 1 of this Annual Report on Form 10-K, orders received in a particular period that cannot be built and shipped to the customer in that period represent backlog.
OUTLOOK FOR 2013
During 2012, we experienced revenue growth of 8% over 2011 and we expect another year of moderate growth in 2013. Our backlog has stabilized at just under 6 months of revenue at current run rates and we expect revenue and bookings growth to be approximately equal in the coming year.
In January 2013, we executed a business reorganization that divided our operations into two primary groups. The business groups are titled Industry and Science and beginning in 2013, we will report our revenue and earnings in two segments that align with these business groups. Service revenue will be reported as part of each group.
Electronics revenue was up in 2012. We expect the early part of 2013 to be below 2012 levels, but believe Electronics bookings and revenue will increase as the year progresses. The semiconductor capital equipment industry experienced a cyclical downturn at the end of 2012 and we expect it will continue in early to mid 2013. Because our equipment is used in laboratories for new process development and yield improvement, we are less affected by cyclical swings than some equipment suppliers, but the industry downturn does have some impact. As evidence, our Electronics bookings were up 2% in 2012 compared with an industry decline of 8%. For 2013, we expect to benefit from a cyclical recovery in the industry, the introduction of new products, and increasing demand for higher-resolution images from semiconductor customers as they invest in more advanced processes, which require more of our TEMs and DualBeams in particular. Revenue for the natural resources business was up in 2012 and we expect continued growth in 2013. This business serves mining, oil and gas companies with automated mineralogy solutions that help those companies improve yields and lower costs. We have new solutions for both laboratory and on-site applications that are in the early stages of penetration in these markets.
Our Materials Science segment experienced modest revenue growth in 2012, and we expect that to continue in 2013. Growth has primarily come from developing countries as these economies continue to invest in education infrastructure, offsetting potential weakness in the United States due to political uncertainty and a mixed economic picture in Europe. We also expect contributions from new products introduced in 2012 and others planned for release in 2013. Life Sciences 2012 bookings were consistent with 2011 while 2012 revenue declined compared with 2011 revenue. The timing of new product introductions and funding difficulties, especially in the U.S., limited growth in 2012. For 2013, we expect bookings and revenue to grow based on new correlative microscopy products for cell biology research and continued penetration of electron microscopy into structural biology applications.

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Our Service and Components business grows mostly with the expansion of our installed base and is expected to continue that growth in 2013. Gross margin increased by 210 basis points from 2011 to 2012, and we expect continued gross margin improvement in 2013. In addition to increasing our proportion of newer, higher-margin products and application-specific products, we expect lower costs from increased production volume in the Czech Republic and continued sourcing improvements, including the full-year impact of termination of a manufacturing services agreement in Hillsboro.
Operating expenses are expected to increase in 2013 due to acquisitions, the increase in staff in customer-facing parts of the company to manage our growth and increased spending for research and development. We expect to continue to report a net expense for other income (expense), net, due to low market interest earned on our investments and the impact of currency costs. Global foreign exchange rates could have a significant impact on our results. In general, a stronger U.S. dollar compared with the euro will reduce our revenue growth rate and improve our operating income, while a weaker dollar has the opposite effect. In addition, a weaker yen compared to the dollar could reduce our margins modestly. We expect our overall effective tax rate to stabilize and we are estimating that it will be around 20% for 2013.
In recent years, our sales to customers in China have grown and will continue to be an area of focus for us in 2013.
Please see the risk factors listed in Part I, Item 1A. of this Annual Report on Form 10-K for the risk factors that could cause our results to vary from this Outlook for 2013.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data (in thousands):

                                                        Year Ended December 31,
                                                 2012            2011            2010
Net sales                                    $   891,738     $   826,426     $   634,222
Cost of sales                                    476,108         459,060         364,958
Gross profit                                     415,630         367,366         269,264
Research and development                          94,965          78,318          66,274
Selling, general and administrative              169,719         158,782         136,465
Restructuring, reorganization, relocation
and severance costs                                2,859           3,215          11,067
Operating income                                 148,087         127,051          55,458
Other expense, net                                (7,539 )        (4,186 )        (3,236 )
Income before income taxes                       140,548         122,865          52,222
Income tax expense (benefit)                      25,628          19,228          (1,326 )
Net income                                   $   114,920     $   103,637     $    53,548

The following table sets forth our statement of operations data as a percentage(1) of consolidated net sales:

                                                        Year Ended December 31,
                                                 2012            2011            2010
Net sales                                         100.0  %        100.0  %        100.0  %
Cost of sales                                      53.4            55.5            57.5
Gross profit                                       46.6            44.5            42.5
Research and development                           10.6             9.5            10.4
Selling, general and administrative                19.0            19.2            21.5
Restructuring, reorganization, relocation
and severance costs                                 0.3             0.4             1.7
Operating income                                   16.6            15.4             8.7
Other expense, net                                 (0.8 )          (0.5 )          (0.5 )
Income before income taxes                         15.8            14.9             8.2
Income tax expense (benefit)                        2.9             2.3            (0.2 )
Net income                                         12.9  %         12.5  %          8.4  %

(1) Percentages may not add due to rounding.

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Net sales increased $65.3 million, or 7.9%, to $891.7 million in 2012 compared to $826.4 million in 2011 and increased $192.2 million, or 30.3%, in 2011 compared to $634.2 million in 2010. The factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below. Currency fluctuations decreased net sales by $18.6 million in 2012 compared to 2011 and decreased net sales by approximately $22.4 million in 2011 compared to 2010 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. See also "Foreign Currency Exchange Rate Risk" included in Item 7A. of this Annual Report on Form 10-K for further discussion of currency impact on our results of operations. Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were as follows:

                                            Year Ended December 31,
                               2012                   2011                   2010
Electronics            $ 293,132     32.9 %   $ 259,730     31.4 %   $ 222,795     35.1 %
Materials Science        315,502     35.4       292,092     35.4       182,430     28.8
Life Sciences             82,862      9.3       102,777     12.4        74,555     11.8
Service and Components   200,242     22.4       171,827     20.8       154,442     24.3
Consolidated net sales $ 891,738    100.0 %   $ 826,426    100.0 %   $ 634,222    100.0 %

Electronics
The $33.4 million, or 12.9%, increase in Electronics sales in 2012 compared to 2011 was primarily due to increased demand for certain products as the industry shifts to smaller semiconductor manufacturing process 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, both of which have higher average selling prices than SEM products. Currency fluctuations decreased Electronics sales by $1.7 million as compared to the prior year.
The $36.9 million, or 16.6%, increase in Electronics sales in 2011 compared to 2010 was primarily due to an increase in semiconductor and data storage company capital spending for capacity expansion and new process development. We realized increases in unit sales of our wafer-level and small DualBeam products. In addition, currency fluctuations increased Electronics sales by $5.4 million as compared to the prior year.
Materials Science
The $23.4 million, or 8.0%, increase in Materials Science sales in 2012 compared to 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 by $9.1 million in 2012 compared to 2011.
The $109.7 million, or 60.1%, increase in Materials Science sales in 2011 compared to 2010 was primarily due to strong sales of our high-end TEMs as a result of increased spending in research institutions. We generally see our customers shifting from SEM-based tools to TEM-based tools as the demand to image on an increasingly small scale continues. The increase also reflects continued investment in education infrastructure in developing countries like Korea and China as well as increasing demand for our evolving line of natural resources product offerings. Currency fluctuations increased Materials Science sales by $7.7 million in 2011 compared to 2010. Life Sciences
The $19.9 million, or 19.4%, decrease, in Life Sciences sales in 2012 compared to 2011 was primarily due to a decrease in the number of high-end TEM units sold during the period. The Life Sciences market is heavily dependent on government funding for research grants and this funding has been under pressure, resulting in fewer large awards for FEI class of tools. 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 by $3.0 million in 2012 compared to 2011.
The $28.2 million, or 37.9%, increase in Life Sciences sales in 2011 compared to 2010 was primarily due to an increase in the number of high-end TEM units sold during the period due in part to increased penetration in electron microscopy in Life Sciences research. Currency fluctuations increased Life Sciences sales by $4.1 million in 2011 compared to 2010.

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Service and Components
The $28.4 million, or 16.5%, increase in Service and Components sales in 2012 compared to 2011 was 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 by $4.8 million in 2012 compared to 2011.
The $17.4 million, or 11.3%, increase in Service and Components sales in 2011 compared to 2010 was due primarily to a larger install base and improved market conditions in the semiconductor industry, which contributed to an increase in service contracts. Currency fluctuations increased Service and Components sales by $5.2 million in 2011 compared to 2010. 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 table shows our net sales by geographic region (dollars in thousands):

                                               Year Ended December 31,
                            2012                         2011                         2010
U.S. and Canada  $   291,720         32.7 %   $   257,244         31.1 %   $   204,002         32.2 %
Europe               244,722         27.5         261,313         31.6         207,394         32.7
Asia-Pacific
Region and Rest
of World             355,296         39.8         307,869         37.3         222,826         35.1
Consolidated net
sales            $   891,738        100.0 %   $   826,426        100.0 %   $   634,222        100.0 %

U.S. and Canada
The $34.5 million, or 13.4%, increase in sales to the U.S. and Canada in 2012 compared to 2011 was primarily due to an increase in shipments to semiconductor customers, growth in sales to our natural resources customers, and an increase in service revenues driven by continued organic growth, expansion of our install base and the inclusion of service revenue for our ASPEX product line. The $53.2 million, or 26.1%, increase in sales to the U.S. and Canada in 2011 compared to 2010 was primarily due to continued strong semiconductor capital equipment spending and an increase in Life Sciences sales related to an increase in high-end TEM units sold.
Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $16.6 million, or 6.3%, decrease in sales to Europe in 2012 compared to 2011 was 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 by $19.0 million in 2012 compared to 2011. The $53.9 million, or 26.0%, increase in sales to Europe in 2011 compared to 2010 was primarily due to increased semiconductor capital equipment spending and continued improvement in spending by research institutions. Currency fluctuations increased sales to Europe by $10.4 million in 2011 compared to 2010.
Asia-Pacific Region and Rest of World
The $47.4 million, or 15.4%, increase in sales to the Asia-Pacific Region and Rest of World in 2012 compared to 2011 was primarily driven by increased spending in the semiconductor industry and increased advanced research spending by our Materials Science customers as well as increased service revenue driven by the inclusion of service revenue from our Korean subsidiary. Sales to customers in China also helped drive the increase. Despite the adverse impact of the weakening yen, overall currency fluctuations increased sales to this region by $0.4 million in 2012 compared to 2011.
The $85.0 million, or 38.2%, increase in sales to the Asia-Pacific Region and Rest of World in 2011 compared to 2010 was primarily driven by the strengthening economy, additional investment in educational infrastructure in emerging Asian economies and increased spending by research institutions in Materials Science and Life Sciences. Currency fluctuations increased sales to this region by $12.0 million in 2011 compared to 2010.

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Cost of Sales and Gross Margin
Our gross margin (gross profit as a percentage of net sales) by segment was as
follows:
                          Year Ended December 31,
                         2012         2011      2010
Electronics              54.1 %       52.8 %   50.2 %
Materials Science        47.6         43.1     41.0
Life Sciences            42.9         45.8     41.0
Service and Components   35.6         33.4     33.7
Overall                  46.6         44.5     42.5

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.
Cost of sales increased $17.0 million, or 3.7%, to $476.1 million in 2012 compared to $459.1 million in 2011, primarily due to increased sales. Currency fluctuations reduced cost of sales by $24.7 million in 2012 compared to 2011. The net effect on our gross margin from currency fluctuations during 2012 compared to 2011 was an increase of $6.1 million, or 1.6 percentage points. Cost of sales increased $94.1 million, or 25.8%, to $459.1 million in 2011 compared to $365.0 million in 2010 primarily due to increased sales. The impact of currency fluctuations on cost of sales was an increase cost of sales by $6.0 million in 2011 compared to 2010. The net effect on our gross margin from currency fluctuations during 2011 compared to 2010 was an increase of $16.4 million, or 0.8 percentage points. Electronics
The increase in Electronics gross margin in 2012 compared to 2011 was due primarily to an increased number of high-end TEM units sold and improved margins on those high-end TEMs. Currency fluctuations improved Electronics gross margin in 2012 compared to 2011 by 0.5 percentage points.
The increase in Electronics gross margin in 2011 compared to 2010 was due primarily to increased demand for our higher-margin small DualBeams, as well as abnormally low gross margins in the prior year as we worked through orders that were priced in late 2009 and early 2010 when we were under greater pricing pressure. We also realized product cost savings related to our consolidation of the manufacturing of our small DualBeam products at our Brno, Czech Republic facility. Currency fluctuations improved Electronics gross margin in 2011 compared to 2010 by 1.3 percentage points. Materials Science . . .