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FEIC > SEC Filings for FEIC > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for FEI CO


2-May-2013

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," "is 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; and any statements of assumptions underlying any of the foregoing.
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 titled "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 applications and solutions for industry and science. We report our revenue based on a group structure organization: the Industry Group and the Science Group. 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 Industry Group consists of customers in semiconductor integrated circuit manufacturing and related industries such as manufacturers of data storage equipment and other technologies, as well as customers in the natural resources industries including mining and oil and gas. Our industrial customers generally use our tools to improve their processes to increase overall yields whether in a factory or at a mine or oil and gas rig. 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. For the natural resource market, our products are also used in mining for automated mineralogy and we have opportunities in oil and gas exploration and laboratory analysis. We also provide support for products and customers within this group for the entire life cycle of a tool from installation through the warranty period, and after the warranty period through contract coverage or on a time and materials basis.


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The Science market segment includes universities, public and private research laboratories and customers in a wide range of industries, including metals, automobiles, aerospace, and forensics. Our customers in the Science market generally use our tools for exploration and discovery of new materials and chemistries or to solve for causes and cures of diseases. The tools are used in a laboratory and are generally not used in industrial applications. It also 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. Growth in these markets is driven by global corporate and government funding for research and development and by development of new products and processes based on innovations at the nanoscale. Our solutions enable scientific discovery and advancement for researchers and help manufacturers develop, analyze and produce advanced products. Our products are also used in root cause failure analysis and quality control applications across a range of industries. 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. We also provide support for products and customers within this group for the entire life cycle of a tool from installation through the warranty period, and after the warranty period through contract coverage or on a time and materials basis.
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. Purchase commitments may include letters of intent. Product backlog consists of all open orders meeting these criteria. Service 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 March 31, 2013, our total backlog was $434.2 million, compared to $424.8 million at December 31, 2012. At March 31, 2013, our backlog consisted of $332.2 million of products and $102.0 million related to service compared to product backlog of $327.9 million and service backlog of $96.9 million at December 31, 2012. Generally, at least 90% of our backlog is shippable within one year.
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 thirteen weeks of 2013 and all of 2012, we experienced cancellations of $0.2 million and $4.0 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.
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 2012 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 thirteen weeks of 2013, 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, 2012, which was filed with the Securities and Exchange Commission on February 20, 2013.


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Results of Operations
The following table sets 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
                                         March 31, 2013                   April 1, 2012
Net sales                        $    221,189          100.0  %   $    217,555          100.0  %
Cost of sales                         118,638           53.6           119,444           54.9
Gross profit                          102,551           46.4            98,111           45.1
Research and development               24,809           11.2            22,722           10.4
Selling, general and
administrative                         43,524           19.7            41,323           19.0
Restructuring, reorganization,
relocation and severance                  695            0.3                 -              -
Operating income                       33,523           15.2            34,066           15.7
Other expense, net                     (1,505 )         (0.7 )          (2,063 )         (0.9 )
Income before income taxes             32,018           14.5            32,003           14.7
Income tax expense                      5,217            2.4             6,336            2.9
Net income                       $     26,801           12.1  %   $     25,667           11.8  %


___________________________


(1) Percentages may not add due to rounding.

Net Sales
Net sales increased $3.6 million, or 1.7%, to $221.2 million in the thirteen week period ended March 31, 2013 (the first quarter of 2013) compared to $217.6 million in the thirteen week period ended April 1, 2012 (the first quarter of 2012). Inclusion of two acquisitions completed in the first quarter of 2012 accounted for 2.9% of growth while currency fluctuations reduced growth by 2.2% compared to a year ago. The factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below.
Currency fluctuations decreased net sales during the thirteen week period ended March 31, 2013 compared to the same period of 2012 as approximately 69% 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. Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were as follows:

                                  Thirteen Weeks Ended
                          March 31, 2013         April 1, 2012
Industry               $  99,064     44.8 %   $ 111,686     51.3 %
Science                  122,125     55.2       105,869     48.7
Consolidated net sales $ 221,189    100.0 %   $ 217,555    100.0 %

Industry
The $12.6 million, or 11.3%, decrease in Industry sales in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily due to fewer large wafer-level DualBeam systems sold to the semiconductor industry resulting from the cyclical nature of the capital purchasing cycle. Currency fluctuations also decreased Industry revenue by 1% in the thirteen week period ended March 31, 2013 compared to the same period of 2012. Science
The $16.3 million, or 15.4%, increase in Science sales in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily driven by increased global technology spending mainly in developing countries and the inclusion of product sales from Visualization Sciences Group ("VSG"), which we acquired on August 1, 2012. Currency fluctuations decreased Science revenue by 3.5% in the thirteen week period ended March 31, 2013 compared to the same period of 2012.


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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 table shows our net
sales by geographic region (dollars in thousands):
                                                 Thirteen Weeks Ended
                                         March 31, 2013         April 1, 2012
U.S. and Canada                       $  68,709     31.1 %   $  69,073     31.7 %
Europe                                   65,673     29.7        63,006     29.0
Asia-Pacific Region and Rest of World    86,807     39.2        85,476     39.3
Consolidated net sales                $ 221,189    100.0 %   $ 217,555    100.0 %

U.S. and Canada
The $0.4 million, or 0.5%, decrease in sales to the U.S. and Canada in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily due to declines in sales to Science customers, partially offset by modest growth in sales to Industry customers. Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $2.7 million, or 4.2%, increase in sales to Europe in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily due to the inclusion of revenue from VSG which was acquired on August 1, 2012. Currency fluctuations decreased revenue to Europe by 0.6% in the thirteen week period ended March 31, 2013 compared to the same period of 2012. Asia-Pacific Region and Rest of World
The $1.3 million, or 1.6%, increase in sales to the Asia-Pacific Region and Rest of World in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily driven by growth of sales to our Science customers in Japan. Currency fluctuations decreased revenue to this region by 5.4% in the thirteen week period ended March 31, 2013 compared to the same period of 2012. 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
         March 31, 2013     April 1, 2012
Industry         51.0 %             50.7 %
Science          42.6               39.2
Overall          46.4               45.1

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), operational efficiencies, competitive pricing pressure and currency movements.
Cost of sales decreased $0.8 million, or 0.7%, to $118.6 million in the thirteen week period ended March 31, 2013 compared to $119.4 million in the comparable period of 2012 on slightly higher revenue, primarily due to improved operating efficiencies. Currency fluctuations decreased cost of sales by 0.6% in the thirteen week period ended March 31, 2013 compared to the same period of 2012. Currency fluctuations, specifically the weakening of the yen compared to the dollar, reduced our gross margins by 0.7 percentage points during the thirteen week period ended March 31, 2013 compared to the same period of 2012. Industry
The slight increase in Industry gross margin during the thirteen week period ended March 31, 2013 compared to the same period of 2012 was due primarily to the introduction of the next generation of our small-stage DualBeam systems which are more competitive in the market and also reflect the benefit of cost reduction efforts. This increase was partially offset by currency fluctuations which decreased Industry gross margin by 0.2 percentage points in the thirteen week period ended March 31, 2013 compared to the same period of 2012.


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Science
The increase in Science gross margin in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was due primarily the introduction of the next generation of our small-stage DualBeam systems which are more competitive in the market and also reflect the benefit of cost reduction efforts. The acquisition of VSG, which has higher margin products, during the third quarter of 2012 also positively impacted margins for this segment. Further, we experienced improvement in our margins due to improved operational efficiencies. Currency fluctuations, notably the impact of the weakening yen, decreased Science gross margin by 1.2 percentage points in the thirteen week period ended March 31, 2013 compared to the same period of 2012. Research and Development Costs
Research and Development ("R&D") costs include labor, materials, overhead and payments to third parties for research and development of new products and new software or enhancements to existing products and software and are expensed as incurred. We periodically receive funds from various organizations to subsidize our research and development. These funds are reported as an offset to research and development expense. During the 2013 and 2012 periods, we received subsidies from European governments for technological developments for semiconductor and life sciences equipment.
R&D costs, net of subsidies, were as follows (in thousands):

Thirteen Weeks Ended
                 March 31,      April 1,
                   2013           2012
Gross spending $    26,131     $ 24,329
Less subsidies      (1,322 )     (1,607 )
Net expense    $    24,809     $ 22,722

R&D costs increased in the thirteen week period ended March 31, 2013 compared to the same period of 2012 primarily due to increased headcount and project spending to support current growth opportunities, as well as the inclusion of the R&D expenses for VSG which was acquired on August 1, 2012. The impact of currency fluctuations on R&D costs was insignificant in the thirteen week period ended March 31, 2013 compared to the same period of 2012.
We anticipate that we will invest between 10% and 11% of revenue in R&D for the foreseeable future. Accordingly, as revenues increase, we currently anticipate that R&D expenditures will also increase. Actual future spending, however, will depend on market conditions.
Selling, General and Administrative Costs Selling, general and administrative ("SG&A") costs include labor, travel, outside services and overhead incurred in our sales, marketing, management and administrative support functions. SG&A costs also include sales commissions paid to our employees as well as to our agents.
SG&A costs increased $2.2 million, or 5.3%, to $43.5 million in the thirteen week period ended March 31, 2013 compared to $41.3 million in the thirteen week period ended April 1, 2012 primarily due to increased headcount and the inclusion of SG&A costs of our recently acquired companies, including amortization expense of the acquired intangibles, and the costs associated with integrating the acquisitions. The impact of currency fluctuations on SG&A costs was insignificant in thirteen week period ended March 31, 2013 compared to the same period in 2012.
Restructuring, Reorganization, Relocation and Severance Group Structure Reorganization
In January 2013, we announced our intention to reorganize the company into a group structure in order to enable us to efficiently execute our growth strategy. The reorganization was completed in the first quarter of 2013. The costs associated with the reorganization include primarily severance costs and resulted in the termination of certain positions throughout the company. In anticipation of this reorganization, we incurred $2.9 million of severance costs during the fourth quarter of 2012 and $0.7 million of severance costs and anticipate $0.6 million in additional charges in the second quarter of 2013. All of the costs related to this plan are expected to result in cash expenditures and we currently expect the total cost of the reorganization to be approximately $4.2 million.
The reduction in positions as a result of the group structure reorganization is expected to reduce operating expenses by approximately $3 million per year when fully implemented.


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For information regarding the related accrued liability, see Note 12 of the Condensed Notes to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Other Expense, Net
Other expense, net includes interest income, interest expense, foreign currency gains and losses and other miscellaneous items.
Interest income represents interest earned on cash and cash equivalents and investments in marketable securities and totaled $0.1 million in the thirteen week period ended March 31, 2013 and $0.6 million in the comparable period of 2012. The decrease in the thirteen week period ended March 31, 2013 compared to the same period of 2012 was primarily due to lower investment balances and continued low interest rates.
Interest expense was $0.8 million in the thirteen week period ended March 31, 2013 and $1.1 million in the comparable period of 2012 and included interest expense related to our 2.875% convertible notes.
Other, net primarily consists of foreign currency gains and losses on transactions and realized and unrealized gains and losses on the changes in fair value of derivative contracts entered into to hedge these transactions. Other, net was a net expense of $0.8 million in the thirteen week period ended March 31, 2013 and was a net expense of $1.6 million in the comparable period of 2012.
Income Tax Expense
Our effective income tax rates for the thirteen week periods ended March 31, 2013 and April 1, 2012 were 16.3% and 19.8%, respectively, and reflected taxes accrued in the U.S. and foreign jurisdictions. The tax rate in the current quarter is lower due to U.S. research and experimentation tax credits generated in 2012 and recognized in conjunction with the extension of legislation enacted in January 2013.
Our effective tax rate may differ from the U.S. federal statutory tax rate primarily as a result of the effects of state and foreign income taxes, research and development tax credits earned in the U.S. and foreign jurisdictions, adjustments to our unrecognized tax benefits and our ability or inability to utilize various carry forward tax items. In addition, our effective income tax rate may be affected by changes in statutory tax rates and laws in the U.S. and foreign jurisdictions and other factors.
As of March 31, 2013, total unrecognized tax benefits were $25.5 million and related primarily to uncertainty surrounding tax credits and permanent establishment. All unrecognized tax benefits would decrease the effective tax rate if recognized.
Our net deferred tax assets (liabilities) totaled $1.1 million and ($0.3) million, respectively, at March 31, 2013 and December 31, 2012. Valuation allowances on deferred tax assets totaled $2.0 million and $2.1 million as of March 31, 2013 and December 31, 2012, respectively. We continue to record a valuation allowance against a portion of U.S. and foreign deferred tax assets, as we do not believe it is more likely than not that we will be able to utilize the deferred tax assets in future periods. Liquidity and Capital Resources
Sources of Liquidity and Capital Resources Our sources of liquidity and capital resources as of March 31, 2013 consisted of $383.5 million of cash, cash equivalents, short-term restricted cash and short-term investments, $28.2 million in non-current investments, $29.9 million of long-term restricted cash, $100.0 million available under revolving credit facilities, as well as potential future cash flows from operations.
$179.3 million of our $441.6 million in total cash, cash equivalents, restricted . . .

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