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FEIC > SEC Filings for FEIC > Form 10-Q on 1-Aug-2014All Recent SEC Filings

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Form 10-Q for FEI CO


1-Aug-2014

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 include guidance for revenue, earnings per share and bookings for the third quarter of 2014, revenue expectations for the remainder of 2014, the impact of certain items on our results for these periods and assumptions about tax rates. Factors that could affect these forward-looking statements include, but are not limited to: the global economic environment; lower than expected customer orders, including for recently-introduced products; potential weakness of the Science and Industry market segments; potential disruption in manufacturing or unexpected additional costs due to the transition from older to newer products; potential delayed or reduced governmental spending to support expected orders; potential disruption in the company's operations due to organizational changes; cyclical changes in the semiconductor industry, which is a major component of Industry market segment revenue; the relative mix of higher-margin and lower-margin products; potential for increased volatility resulting from larger sales transactions; risks associated with a high percentage of the company's revenue coming from "turns" business, when the order for a product is placed by the customer in the same quarter as the planned shipment, and risks associated with building and shipping a high percentage of the company's quarterly revenue in the last month of the quarter; delays in meeting all accounting requirements for revenue recognition; fluctuations in foreign exchange rates, which can affect margins or the competitive pricing of our products; additional costs related to future merger and acquisition activity; failure of the company to achieve anticipated benefits of acquisitions and collaborations, including failure to achieve financial goals and integrate acquisitions successfully; reduced profitability due to failure to achieve or sustain margin improvement in service or product manufacturing; failure to achieve improved operational efficiency and other benefits from infrastructure investments and restructuring activities; changes to current restructuring activities, including greater than estimated costs, or potential additional restructurings and reorganizations; potential customer cancellations or requests to defer planned shipments; changes in backlog and the timing of shipments from backlog; inability to deploy products as expected or delays in shipping products due to technical problems or barriers, especially with regard to recently introduced TEM products; potential shipment or supply chain disruptions; and additional selling, general and administrative or research and development expenses.
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 and related services 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 ("TEMs"); scanning electron microscopes ("SEMs"); DualBeamTM systems which combine a SEM and a focused ion beam system ("FIB") on a single platform; stand-alone FIBs; high-performance optical microscopes, three-dimensional modeling software, and service and components to support the products. 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 markets. Individual models of our products are increasingly designed to provide specific solutions and applications in each of our markets.
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").
Our significant research and development and manufacturing operations are located in Hillsboro, Oregon; Eindhoven, The Netherlands; and Brno, Czech Republic; and our software development is managed principally from Bordeaux, France. 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.


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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. The tools we develop for our Industry Group customers are generally aimed at improving their processes to increase overall yields, whether in a factory, at a mine or at an 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. Such 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 used to increase yields in mining through automated mineralogy and 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.
The Science Group includes universities, public and private research laboratories and customers in a wide range of industries, including metals, automobiles, aerospace, and forensics. The tools we develop for our customers in the Science Group are generally aimed at the exploration and discovery of new materials and chemistries or solving for causes and cures of diseases. The tools are used in a laboratory and are generally not used in industrial applications. The Science Group also includes customers at 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 are not scheduled to 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 29, 2014, our total backlog was $516.7 million, compared to $473.5 million in total backlog at December 31, 2013.
At June 29, 2014, our backlog consisted of $373.2 million of products and $143.5 million related to service, compared to product backlog of $349.3 million and service backlog of $124.2 million at December 31, 2013. Generally, at least 90% of our backlog is shippable within one year. Recently, we have seen a trend where our orders have longer lead times resulting in less backlog shippable in the near quarter and more in one quarter out. In addition, the size of individual orders has increased due to our customers ordering higher priced tools and multiple tool orders as well as multi-year service contracts. These factors may increase the volatility of our future revenue forecasts. 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. There were no cancellations during the first twenty-six weeks of 2014 and we experienced cancellations of $4.2 million during all of 2013. 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.


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Outlook for the Remainder of 2014
Based on our current backlog of unfilled orders, our pipeline of potential orders, conditions in each of our markets, the impact of new products that we have introduced in the last few years and our strategies and competitive positioning, we expect revenue to increase in the second half compared with the first half of 2014. For all of 2014, we expect revenue to grow compared to 2013. Within the Industry Group, we expect growth in the semiconductor business. Our equipment has been used primarily in laboratories for new process development and yield improvement, and the increasing complexity and shrinking dimensions of the devices made by our customers have increased the demand for our workflow solutions. In addition, we have introduced products that are intended to move our tools closer to the production line. We believe our volume will increase in part due to demand for those products. Within the overall context of growth, the timing of orders and revenue growth from quarter to quarter will depend on capital spending commitments by major customers.
Our Industry Group also includes, to a much lesser extent, sales to companies in the mining and oil and gas markets. Orders from mining company customers remain constrained due to market conditions affecting their business. We continue to reorient our oil and gas business toward reservoir characterization where we believe there is substantial opportunity. As part of that strategy, in the first quarter of 2014 we acquired Lithicon AS, a provider of digital rock technology services and pore-scale micro computed tomography (ÁCT, or microCT) equipment to oil and gas companies worldwide, and we have begun the integration of Lithicon with our existing operations for oil and gas customers. While we believe this strategy will better position us to introduce new products and address new markets, we do not expect it to materially impact our revenues until after 2014. In addition, we are experiencing a decline in revenue from customers in mining and we are de-emphasizing our products for mining.
Within the Science Group, sales of our products to customers engaged in materials research have historically driven the largest portion of revenues. Sales to these customers were relatively weak in the first quarter but orders recovered somewhat in the second quarter. We expect improved revenue performance in the second half of 2014. In addition, we also expect increasing contribution in the second half from new products introduced last year.
Sales to customers engaged in structural and cell biology research were up in the first half of 2014 compared with last year, continuing the growth that developed at the end of 2013. The primary driver of this growth has been increased penetration of electron microscopy into structural biology applications and adoption of our products in correlative microscopy for cell biology. While we may experience variation from quarter to quarter, we expect revenues from customers in the biological sciences to continue to grow. Gross margin decreased by 50 basis points from the first half of 2013 to the first half 2014. The decrease was principally caused by inventory write-offs related to our realignment activities and to a certain number of orders that had lower margins. We are seeking continued gross margin improvement in 2014. In addition to increasing our proportion of newer, higher-margin products and higher-margin application-specific products, we expect lower costs from continued sourcing improvements and initial production from our new leased facility in the Czech Republic, which is scheduled to open in the third quarter of 2014.
Operating expenses are expected to increase in the second half of 2014 due to recent acquisitions, the increase of sales and service personnel, increased spending for research and development and higher stock-based compensation expense. We will also incur additional costs of approximately $18 million as part of our realignment plan announced in the second quarter of 2014 and moving costs associated with our new facility in the Czech Republic. These realignment expenses are expected to reduce operating expenses by approximately $10 million annually beginning in 2015.
Growth in net income for the remainder of 2014 will be primarily dependent on expected increases in revenue and further improvements in gross margin, although it will be impacted by the realignment expenses previously discussed. Please see the risk factors listed in Part II, Item 1A. of this Quarterly Report on Form 10-Q for the risk factors that could cause our results to vary from this Outlook for the remainder of 2014.
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 2013 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 2014, 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, 2013, which was filed with the Securities and Exchange Commission on February 21, 2014.


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Results of Operations
The following tables set forth our statement of operations data, in absolute
dollars and as a percentage(1) of consolidated net sales (dollars in thousands):
                                      Thirteen Weeks Ended             Thirteen Weeks Ended
                                         June 29, 2014                    June 30, 2013
Net sales                        $    236,955          100.0  %   $    222,478          100.0  %
Cost of sales                         127,104           53.6           115,581           52.0
Gross profit                          109,851           46.4           106,897           48.0
Research and development               26,221           11.1            25,413           11.4
Selling, general and
administrative                         50,587           21.3            42,639           19.2
Restructuring, reorganization,
relocation and severance                2,228            0.9               395            0.2
Operating income                       30,815           13.0            38,450           17.3
Other expense, net                       (806 )         (0.3 )          (1,452 )         (0.7 )
Income before income taxes             30,009           12.7            36,998           16.6
Income tax expense                      5,061            2.1             7,005            3.1
Net income                       $     24,948           10.5  %   $     29,993           13.5  %


                                       Twenty-Six Weeks Ended            Twenty-Six Weeks Ended
                                           June 29, 2014                     June 30, 2013
Net sales                          $     463,220         100.0  %   $     443,667           100.0  %
Cost of sales                            247,044          53.3            234,219            52.8
Gross profit                             216,176          46.7            209,448            47.2
Research and development                  51,866          11.2             50,222            11.3
Selling, general and
administrative                            99,050          21.4             86,163            19.4
Restructuring, reorganization,
relocation and severance                   3,559           0.8              1,090             0.2
Operating income                          61,701          13.3             71,973            16.2
Other expense, net                        (1,076 )        (0.2 )           (2,957 )          (0.7 )
Income before income taxes                60,625          13.1             69,016            15.6
Income tax expense                        10,599           2.3             12,222             2.8
Net income                         $      50,026          10.8  %   $      56,794            12.8  %


___________________________


(1) Percentages may not add due to rounding.

Net Sales
Net sales increased $14.5 million, or 6.5%, to $237.0 million in the thirteen week period ended June 29, 2014 (the second quarter of 2014) compared to $222.5 million in the thirteen week period ended June 30, 2013 (the second quarter of 2013). Revenue from acquired businesses increased net sales by $3.1 million, or 1.4%, in the thirteen week period ended June 29, 2014 compared to the same period of 2013.
Net sales increased $19.6 million, or 4.4%, to $463.2 million in the twenty-six weeks ended June 29, 2014 compared to $443.7 million in the twenty-six weeks ended June 30, 2013. Revenue from acquired businesses increased net sales by $5.6 million, or 1.3%, in the twenty-six weeks ended June 29, 2014 compared to the same period of 2013.
Currency fluctuations decreased net sales by $0.4 million, or 0.2%, and increased net sales by $0.3 million, or 0.1%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013. Strengthening of the U.S. dollar against 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.


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Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were
as follows:
                                  Thirteen Weeks Ended
                          June 29, 2014          June 30, 2013
Industry Group         $ 127,225     53.7 %   $ 103,702     46.6 %
Science Group            109,730     46.3       118,776     53.4
Consolidated net sales $ 236,955    100.0 %   $ 222,478    100.0 %


                                 Twenty-Six Weeks Ended
                          June 29, 2014          June 30, 2013
Industry Group         $ 233,664     50.4 %   $ 202,766     45.7 %
Science Group            229,556     49.6       240,901     54.3
Consolidated net sales $ 463,220    100.0 %   $ 443,667    100.0 %

Industry Group
The $23.5 million, or 22.7%, increase and the $30.9 million, or 15.2%, increase, respectively, in Industry Group sales in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013 were primarily due to increased sales to semiconductor customers, mainly as a result of their ongoing investment in advanced technologies and the continued adoption of our near-line product solutions. This increase was partially offset by reduced demand for our products from oil and gas customers and continued weakness in the mining sector driven by lower commodity prices and a corresponding reduction in capital spending.
Currency fluctuations decreased Industry Group revenue by $1.2 million, or 1.1%, and by $1.2 million, or 0.6%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013. Revenue from acquired businesses increased Industry Group revenue by $2.1 million, or 2.0%, and by $3.1 million, or 1.5%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013. Science Group
The $9.0 million, or 7.6%, decrease and the $11.3 million, or 4.7%, decrease, respectively, in Science Group sales in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013 were primarily driven by decreased revenue from high-end, high-resolution systems sold to research and science customers globally. The decrease was partially offset by increased demand for our structural and cell biology applications solutions, and increased revenue from our installed base.
Currency fluctuations increased Science Group revenue by $0.8 million, or 0.7%, and increased Science Group revenue by $1.4 million, or 0.6%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013. Revenue from acquired businesses increased Science Group revenue by $1.0 million, or 0.8%, and increased Science Group revenue by $2.5 million, or 1.0%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013. Net Sales by Geographic Region
Most of our net sales are 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 29, 2014          June 30, 2013
U.S. and Canada                       $  80,463     34.0 %   $  61,413     27.6 %
Europe                                   63,561     26.8        70,538     31.7
Asia-Pacific Region and Rest of World    92,931     39.2        90,527     40.7
Consolidated net sales                $ 236,955    100.0 %   $ 222,478    100.0 %


Table of Contents

                                                Twenty-Six Weeks Ended
                                         June 29, 2014          June 30, 2013
U.S. and Canada                       $ 152,729     33.0 %   $ 130,122     29.3 %
Europe                                  130,603     28.2       136,211     30.7
Asia-Pacific Region and Rest of World   179,888     38.8       177,334     40.0
Consolidated net sales                $ 463,220    100.0 %   $ 443,667    100.0 %

U.S. and Canada
The $19.1 million, or 31.0%, increase and the $22.6 million, or 17.4%, increase, respectively, in sales to the U.S. and Canada in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013 were primarily due to increased sales to customers engaged in semiconductor manufacturing, structural and cell biology research, and materials research. We also saw increased service revenue from our installed base. Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
Sales to Europe decreased $7.0 million, or 9.9%, and decreased $5.6 million, or 4.1%, respectively, in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013, primarily as a result of lower revenues from semiconductor manufacturing customers as their demand shifts to the Asia-Pacific region. The decrease was offset by increased purchases from research customers in the thirteen week period, and by structural and cell biology customers in the twenty-six week period. Revenue from our installed base increased in both the thirteen and twenty-six week periods ended June 29, 2014. Currency fluctuations increased sales to Europe by $1.7 million, or 2.4%, and increased sales to Europe by $4.9 million, or 3.6%, respectively, during the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013.
Asia-Pacific Region and Rest of World
The $2.4 million, or 2.7%, increase and the $2.6 million, or 1.4%, increase, respectively, in sales to the Asia-Pacific Region and Rest of World in the thirteen and twenty-six week periods ended June 29, 2014 compared to the same periods of 2013 were largely due to increased purchases by our semiconductor customers as the region continues to expand manufacturing capacity. The increase was offset by declines in sales to customers engaged in research activities in . . .

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