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

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Form 10-Q for FEI CO


2-Aug-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 June 30, 2013, our total backlog was $449.5 million, compared to $424.8 million at December 31, 2012. At June 30, 2013, our backlog consisted of $329.0 million of products and $120.5 million related to service compared to product backlog of $327.9 million and service backlog of $96.9 million at December 31, 2012. A large Industry customer renewed a multi-year service agreement, thereby significantly increasing service bookings in the quarter. 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 twenty-six 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.
Outlook for the Remainder of 2013
We expect revenue in the second half of the year will be greater than revenue in the first half of the year, with very modest growth in the third quarter and more significant growth in the fourth quarter. We continue to expect modest revenue growth for the full year 2013 compared with 2012, but at a somewhat slower rate than expected at the beginning of the year. Our rate of incoming orders has been generally as expected, but a portion of these orders has remained in our backlog, as a somewhat larger-than-expected portion of the orders have been for products with long delivery schedules. In addition, we have announced several significant new products and have begun to receive orders for them, with scheduled delivery dates in the fourth quarter or 2014. Our backlog of unfilled orders increased by $24.7 million in the first half of 2013, and we expect an additional increase in the backlog in the third quarter.
In the Science segment, the Materials Science business has showed steady growth, with continued strength in markets outside the U.S. Revenue and bookings for the Life Sciences business in the first half of 2013 were below the levels of the first half of 2012, but the business has a significant pipeline of potential orders heading into the second half of 2013.
In the Industry segment, the Electronics business is beginning to see cyclical industry recovery and we expect that to continue in the second half. We also expect to continue to benefit from increased demand for our products over the mid- to long-term as semiconductor companies continue to shrink the dimensions of their products, develop new structures and use new materials. The Natural Resources business has had a relatively weak first half of 2013 and we expect that to continue in the second half of the year. Mining customers have curtailed their capital spending due to lower commodity prices and global uncertainty. Our solutions for oil & gas customers continue to generate significant interest, but volume adoption has been slower than originally planned.


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On a geographic basis, we have continued to see relative strength in our business in Asia, including China, and we expect that trend to continue. Our gross margin was 46.4% in the first quarter and improved to 48.0% in the second quarter. On a quarterly basis in the short-term, we expect fluctuation in that range based on product mix and volume. Longer-term on an annual basis, we expect to continue the trend of improvement we have seen in recent years. We spent over 11% of sales on research and development in the first half of the year, and we expect to continue aggressive R&D spending in the second half, as we introduce numerous new products. Operating expenses will increase modestly, in part because of marketing and branding related to the new products. As a result of these factors, we expect income for all of 2013 to be above 2012, assuming the expected revenue increase in the fourth quarter. 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 twenty-six 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.
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
                                         June 30, 2013                     July 1, 2012
Net sales                        $    222,478          100.0  %   $    221,452          100.0  %
Cost of sales                         115,581           52.0           117,023           52.8
Gross profit                          106,897           48.0           104,429           47.2
Research and development               25,413           11.4            23,306           10.5
Selling, general and
administrative                         42,639           19.2            42,045           19.0
Restructuring, reorganization,
relocation and severance                  395            0.2                 -              -
Operating income                       38,450           17.3            39,078           17.6
Other expense, net                     (1,452 )         (0.7 )          (1,255 )         (0.6 )
Income before income taxes             36,998           16.6            37,823           17.1
Income tax expense                      7,005            3.1             7,530            3.4
Net income                       $     29,993           13.5  %   $     30,293           13.7  %


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                                       Twenty-Six Weeks Ended            Twenty-Six Weeks Ended
                                           June 30, 2013                      July 1, 2012
Net sales                          $     443,667         100.0  %   $     439,007           100.0  %
Cost of sales                            234,219          52.8            236,467            53.9
Gross profit                             209,448          47.2            202,540            46.1
Research and development                  50,222          11.3             46,028            10.5
Selling, general and
administrative                            86,163          19.4             83,368            19.0
Restructuring, reorganization,
relocation and severance                   1,090           0.2                  -               -
Operating income                          71,973          16.2             73,144            16.7
Other expense, net                        (2,957 )        (0.7 )           (3,318 )          (0.8 )
Income before income taxes                69,016          15.6             69,826            15.9
Income tax expense                        12,222           2.8             13,866             3.2
Net income                         $      56,794          12.8  %   $      55,960            12.7  %


___________________________


(1) Percentages may not add due to rounding.

Net Sales
Net sales increased $1.0 million, or 0.5%, to $222.5 million in the thirteen week period ended June 30, 2013 (the second quarter of 2013) compared to $221.5 million in the thirteen week period ended July 1, 2012 (the second quarter of 2012). Inclusion of two acquisitions completed in the third quarter of 2012 accounted for 3.5% of growth in the thirteen week period ended June 30, 2013 while currency fluctuations reduced growth by 1.1% for the same period compared to a year ago.
Net sales increased $4.7 million, or 1.1%, to $443.7 million in the twenty-six week period ended June 30, 2013 compared to $439.0 million in the twenty-six week period ended July 1, 2012. Inclusion of two acquisitions completed in the third quarter of 2012 accounted for 3.1% of growth in the twenty-six week period ended June 30, 2013 while currency fluctuations reduced growth by 1.3% for the same period compared to a year ago.
The strengthening of the dollar during the second quarter of 2013 decreased net sales for the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 as approximately 71% 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. The factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below. Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were as follows:

                                  Thirteen Weeks Ended
                          June 30, 2013           July 1, 2012
Industry               $ 103,702     46.6 %   $ 117,353     53.0 %
Science                  118,776     53.4       104,099     47.0
Consolidated net sales $ 222,478    100.0 %   $ 221,452    100.0 %


                                 Twenty-Six Weeks Ended
                          June 30, 2013           July 1, 2012
Industry               $ 202,766     45.7 %   $ 229,039     52.2 %
Science                  240,901     54.3       209,968     47.8
Consolidated net sales $ 443,667    100.0 %   $ 439,007    100.0 %


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Industry
The $13.7 million, or 11.6%, decrease and the $26.3 million, or 11.5%, decrease, respectively, in Industry sales in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily due to fewer large wafer-level DualBeam systems sold to semiconductor customers resulting from the cyclical nature of the capital purchasing cycle. This was partially offset by an increase in revenue from our natural resources customers due to sales of new products. Currency fluctuations also decreased Industry sales by 1.1 and 0.9 percentage points, respectively, in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012.
Science
The $14.7 million, or 14.1%, increase and the $30.9 million, or 14.7%, increase, respectively, in Science sales in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily driven by increased global technology spending on our small DualBeam products, mainly in developing countries and the inclusion of $5.3 million in revenue from acquired product lines. These increases were partially offset by currency fluctuations which decreased Science sales by 1.2 and 1.8 percentage points, respectively, in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012.
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
                                         June 30, 2013           July 1, 2012
U.S. and Canada                       $  61,413     27.6 %   $  75,404     34.1 %
Europe                                   70,538     31.7        47,012     21.2
Asia-Pacific Region and Rest of World    90,527     40.7        99,036     44.7
Consolidated net sales                $ 222,478    100.0 %   $ 221,452    100.0 %


                                                Twenty-Six Weeks Ended
                                         June 30, 2013           July 1, 2012
U.S. and Canada                       $ 130,122     29.3 %   $ 144,477     32.9 %
Europe                                  136,211     30.7       110,018     25.1
Asia-Pacific Region and Rest of World   177,334     40.0       184,512     42.0
Consolidated net sales                $ 443,667    100.0 %   $ 439,007    100.0 %

U.S. and Canada
The $14.0 million, or 18.6%, decrease and the $14.4 million, or 9.9%, decrease, respectively, in sales to the U.S. and Canada in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily due to declines in sales to Science customers. Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $23.5 million, or 50.0%, increase and the $26.2 million, or 23.8%, increase, respectively, in sales to Europe in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily due to an increase in the number of high-end TEM units sold as well as the inclusion of revenue from acquired product lines. Currency fluctuations increased sales to Europe by 1.4% and 0.4%, respectively, during the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012. Asia-Pacific Region and Rest of World
The $8.5 million, or 8.6%, decrease and the $7.2 million, or 3.9%, decrease, respectively, in sales to the Asia-Pacific Region and Rest of World in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily driven by the cyclical nature of the electronics business in Asia. Currency fluctuations, specifically the weakening of the yen compared to the dollar, decreased sales to this region by 3.8% and 4.5%, respectively, during the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012.


Table of Contents

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             Twenty-Six Weeks Ended
         June 30, 2013     July 1, 2012    June 30, 2013     July 1, 2012
Industry        51.9 %            51.1 %          51.4 %           50.9 %
Science         44.7              42.8            43.6             41.0
Overall         48.0              47.2            47.2             46.1

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 $1.4 million, or 1.2%, to $115.6 million in the thirteen week period ended June 30, 2013 compared to $117.0 million in the thirteen week period ended July 1, 2012 and decreased $2.2 million, or 1.0%, to $234.2 million in the twenty-six week period ended June 30, 2013 compared to $236.5 million in the comparable period of 2012, primarily due to decreased sales in our Industry group and improved operating efficiencies in our SDB and TEM product lines. Currency fluctuations reduced cost of sales by 0.4 percentage points in both the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012.
Currency fluctuations, primarily the strengthening of the U.S dollar, reduced our gross margins by 0.5 and 0.6 percentage points, respectively, during the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012.
Industry
The increases in Industry gross margin during the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily due to an increase in the number of high-end TEM units sold as well as an increase in margins for our Service business. These increases were partially offset by currency fluctuations which decreased Industry gross margins by 0.6 and 0.5 percentage points, respectively, in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012. Science
The increases in Science gross margin in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods of 2012 were primarily due to the inclusion of higher margin software products. Currency fluctuations, primarily the strengthening of the U.S dollar, reduced Science gross margins by 0.4 and 0.8 percentage points, respectively, in the thirteen and twenty-six week periods ended June 30, 2013 compared to the same periods 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 primarily for semiconductor and life sciences equipment. . . .

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