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FEIC > SEC Filings for FEIC > Form 10-Q on 1-Nov-2013All Recent SEC Filings

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Form 10-Q for FEI CO


1-Nov-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. In particular, the section "Outlook for the Remainder of 2013" also contains forward-looking statements and assumptions subject to risks and uncertainties. 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, which we categorize as 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.
Our acquisitions have accelerated the growth in service backlog as we assume the service business of companies which we have acquired, with the growth in service backlog primarily located in the Asia-Pacific region and Australia. At September 29, 2013 our total backlog was $482.0 million, compared to $424.8 million at December 31, 2012. At September 29, 2013, our backlog consisted of $355.8 million of products and $126.2 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 thirty-nine weeks of 2013 and all of 2012, we experienced cancellations of $3.9 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
This section 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.
Based on an expanded backlog and reasonable order prospects, we expect revenue growth in the fourth quarter. As a result, we continue to expect modest revenue growth for the full year 2013 compared with 2012. The book-to-bill ratio in the third quarter was 1.15-to-1 and the backlog at the end of the quarter was $482.0 million, an increase of $32.5 million in the quarter and $57.2 million since the beginning of 2013.
In the Science segment, the Materials Science business has been steady, with continued strength in markets outside the U.S. Bookings for the Life Sciences business were strong in the third quarter.


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In the Industry segment, the Electronics business is beginning to see cyclical industry recovery and we expect that to continue in the next several quarters. 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 three quarters of 2013. We saw modest sequential improvement in the third quarter and expect that to continue in the fourth quarter. Mining customers have curtailed their capital spending due to lower commodity prices and global uncertainty. Our solutions for oil and gas customers continue to generate significant interest, but volume adoption has been slower than originally planned, and we are re-orienting the business toward other potential opportunities within this industry. On a geographic basis, we have continued to see relative strength in our business in Asia, including China, tied largely to continued growth in emerging markets and we expect that trend to continue.
Our gross margin was 47.9% in the third quarter and 47.4% for the first nine months of the year. While we expect fluctuation based on product mix and volume, we expect the fourth quarter gross margin to be in the same range as the first nine months of 2013. We spent over 11% of sales on research and development in the first three quarters of the year, and we expect to increase research and development spending in the fourth quarter. We expect operating expenses to 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 thirty-nine 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
                                       September 29, 2013          September 30, 2012
Net sales                           $    218,496     100.0  %   $    221,785     100.0  %
Cost of sales                            113,751      52.1           117,629      53.0
Gross profit                             104,745      47.9           104,156      47.0
Research and development                  25,397      11.6            23,908      10.8
Selling, general and administrative       45,346      20.8            41,931      18.9
Operating income                          34,002      15.6            38,317      17.3
Other expense, net                          (661 )    (0.3 )          (1,712 )    (0.8 )
Income before income taxes                33,341      15.3            36,605      16.5
Income tax expense                         4,735       2.2             7,447       3.4
Net income                          $     28,606      13.1  %   $     29,158      13.1  %


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                                       Thirty-Nine Weeks Ended            Thirty-Nine Weeks Ended
                                         September 29, 2013                 September 30, 2012
Net sales                          $     662,163          100.0  %   $     660,792            100.0  %
Cost of sales                            347,970           52.6            354,096             53.6
Gross profit                             314,193           47.4            306,696             46.4
Research and development                  75,619           11.4             69,936             10.6
Selling, general and
administrative                           131,509           19.9            125,299             19.0
Restructuring, reorganization,
relocation and severance                   1,090            0.2                  -                -
Operating income                         105,975           16.0            111,461             16.9
Other expense, net                        (3,618 )         (0.5 )           (5,030 )           (0.8 )
Income before income taxes               102,357           15.5            106,431             16.1
Income tax expense                        16,957            2.6             21,313              3.2
Net income                         $      85,400           12.9  %   $      85,118             12.9  %


___________________________


(1) Percentages may not add due to rounding.

Net Sales
Net sales decreased $3.3 million, or 1.5%, to $218.5 million in the thirteen week period ended September 29, 2013 (the third quarter of 2013) compared to $221.8 million in the thirteen week period ended September 30, 2012 (the third quarter of 2012). Inclusion of one acquisition completed in the third quarter of 2013 accounted for 0.3% of growth in net sales for the thirteen week period ended September 29, 2013 while currency fluctuations increased net sales by 0.9% for the same period compared to a year ago.
Net sales increased $1.4 million, or 0.2%, to $662.2 million in the thirty-nine week period ended September 29, 2013 compared to $660.8 million in the thirty-nine week period ended September 30, 2012. Inclusion of two acquisitions in the third quarter of 2012 and one acquisition in the third quarter of 2013 accounted for 2.1% of growth in the thirty-nine week period ended September 29, 2013 while currency fluctuations reduced growth by 0.1% for the same period compared to a year ago.
During the thirteen and thirty-nine week periods ended September 29, 2013 approximately 70% 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
                         September 29, 2013        September 30, 2012
Industry               $    103,627     47.4 %   $    112,804     50.9 %
Science                     114,869     52.6          108,981     49.1
Consolidated net sales $    218,496    100.0 %   $    221,785    100.0 %


                                    Thirty-Nine Weeks Ended
                         September 29, 2013        September 30, 2012
Industry               $    306,393     46.3 %   $    341,843     51.7 %
Science                     355,770     53.7          318,949     48.3
Consolidated net sales $    662,163    100.0 %   $    660,792    100.0 %


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Industry
The $9.2 million, or 8.1%, decrease and the $35.5 million, or 10.4%, decrease, respectively, in Industry sales in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were primarily due to fewer TEMs sold to semiconductor customers resulting from the cyclical nature of their capital purchasing cycle. We also saw weakness in natural resources attributable to the cyclical nature of capital purchases in the mining sector. Currency fluctuations had no measurable impact and decreased 0.5%, respectively, in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012.
Science
The $5.9 million, or 5.4%, increase and the $36.8 million, or 11.5%, increase, respectively, in Science sales in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were primarily driven by improved service sales due to a higher installed base and the inclusion of revenue from our acquired businesses. Currency fluctuations increased Science sales by 1.6% for the thirteen-week period ended September 29, 2013 and had no measurable impact in the thirty-nine week period ended September 29, 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
                                        September 29, 2013        September 30, 2012
U.S. and Canada                       $     65,235     29.9 %   $     75,590     34.1 %
Europe                                      63,064     28.8           64,390     29.0
Asia-Pacific Region and Rest of World       90,197     41.3           81,805     36.9
Consolidated net sales                $    218,496    100.0 %   $    221,785    100.0 %


                                                   Thirty-Nine Weeks Ended
                                        September 29, 2013        September 30, 2012
U.S. and Canada                       $    195,357     29.5 %   $    220,067     33.3 %
Europe                                     199,275     30.1          174,408     26.4
Asia-Pacific Region and Rest of World      267,531     40.4          266,317     40.3
Consolidated net sales                $    662,163    100.0 %   $    660,792    100.0 %

U.S. and Canada
The $10.4 million, or 13.7%, decrease and the $24.7 million, or 11.2%, decrease, respectively, in sales to the U.S. and Canada in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were primarily due to fewer TEMs sold to semiconductor customers and general weakness in the U.S. due to cut-backs in U.S. government funding for Sciences. Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
Sales to Europe decreased $1.3 million, or 2.1%, and increased $24.9 million, or 14.3%, in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012, respectively. The quarter-to-date decrease was primarily due to fewer TEMs and wafer-level DualBeam systems sold to Science and Industry customers, respectively, which was partially offset by an increase in the number of small-stage DualBeam systems sold to customers in Industry as well as increases in service revenue and the inclusion of revenue from acquired product lines. Year-to-date sales to Europe increased due to an increase in the number of TEMs and small-stage DualBeam systems sold to customers in Industry and the inclusion of software revenue from our acquired product lines. Currency fluctuations increased sales to Europe by 4.4% and 1.8%, respectively, during the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012.


Table of Contents

Asia-Pacific Region and Rest of World
The $8.4 million, or 10.3%, increase and the $1.2 million, or 0.5%, increase, respectively, in sales to the Asia-Pacific Region and Rest of World in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were primarily driven quarter-to-date by increased sales of wafer-level DualBeam systems as Industry customers adopt next generation technology, and year-to-date by increased sales of TEMs to Science customers, offset by lower sales of small-stage DualBeam systems in Industry. Currency fluctuations, specifically the weakening of the yen compared to the dollar, decreased sales to this region by 5.1% and 4.7%, respectively, during the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods 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                       Thirty-Nine Weeks Ended
                                                                                                          September 30,
                                  September 29, 2013      September 30, 2012     September 29, 2013           2012
Industry                                    54.2 %                   52.1 %               52.4 %                51.3 %
Science                                     42.2                     41.6                 43.2                  41.2
Overall                                     47.9                     47.0                 47.4                  46.4

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 four primary drivers affecting gross margin include: product mix, operational efficiencies, competitive pricing pressure and currency movements.
Cost of sales decreased $3.9 million, or 3.3%, to $113.8 million in the thirteen week period ended September 29, 2013 compared to $117.6 million in the thirteen week period ended September 30, 2012 and decreased $6.1 million, or 1.7%, to $348.0 million in the thirty-nine week period ended September 29, 2013 compared to $354.1 million in the comparable period of 2012, primarily due to decreased sales in our Industry group and improved operating efficiencies in our small-stage DualBeam systems and TEM product lines. Currency fluctuations reduced cost of sales by 0.5% and 0.6% in both the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012. For the thirteen and thirty-nine week periods ended September 29, 2013 currency fluctuations increased our gross margins by 0.5% and decreased our gross margins by 0.2%, respectively, compared to the same periods of 2012. Industry
The increases in Industry gross margin percentage during the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were primarily due to an increase in the number of higher margin wafer-level DualBeam systems sold as well as an increase in margins for our Service business. Currency fluctuations increased gross margin by 1.1% and 0.4% points for the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012.
Science
The increases in Science gross margin in the thirteen and thirty-nine week periods ended September 29, 2013 compared to the same periods of 2012 were . . .

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