FEI's CEO Presents at J.P. Morgan SMid Cap Conference (Transcript)

| About: FEI Company (FEIC)

FEI Company (NASDAQ:FEIC)

J.P. Morgan SMid Cap Conference Call

November 29, 2012 1:45 pm ET

Executives

Raymond A. Link – Executive Vice President and Chief Financial Officer

Analysts

Tycho W. Peterson – JPMorgan Securities LLC

Tycho W. Peterson – JPMorgan Securities LLC

Okay. Good afternoon. I’m Tycho Peterson from the life science tools and diagnostic group. It’s my pleasure to introduce our next company this afternoon FEI. Here to tell you a little bit more, let me turn it over to Ray Link.

Raymond A. Link

Thank you. We have a fairly small group today. So I’m going to go through the presentation relatively quickly, and leave more time for Q&A. I think that’s really there is more general interest. Quickly, we do have our recorded safe harbor statements. I encourage you to read that and read our SEC filings, which covers a lot of statements about future events.

What we do as a company at FEI? We leverage our core technology, which is electron microscopy into a number of end markets. We have three principal platforms and tools that we sell. The main thing that we’re trying to do with our main technology and tools is to add sample management, handling features, sample prep and add a lot of software to provide answers and data for end users. That’s where the market is really growing.

As a company, our investment thesis is that we are a growth company. We have leadership and technology. There’s secular growth opportunities in our core businesses. We have some emerging market opportunities for us particularly in natural resources and in life science.

We’ve been expanding our gross profit margins. We are at about 38% about three, four years ago, we are going to be somewhere in the mid-46% for this year, with a long-term target of 50% over the next couple of years. And we are trying to pay a little bit more attention to our cash. We’ve initiated dividend. We’ve done some opportunistic share buybacks. We’re doing some investments in new plant and equipment and we’ve done some M&A over the past year, all of it, which will hopefully add the overall shareholder value.

Bookings for the company, when people say, well, what’s your normalized growth rate? I will just point to this; it shows a 12% CAGR on bookings over the long period of time. Bookings can move around obviously from quarter-to-quarter. We sell fairly high value products, some products go for – upwards of $5 millions. So when you book a particular order, one quarter or the other can move around a little bit, but the long-term trend has been positive for bookings.

When we look at our segments and we run the business at an end market focus. Our electronics end market is semiconductors and data storage. In the environment we are in right now, it’s pretty much semiconductors, as you guys know the hard disk business has been really, really soft recently.

Material science is really our – is sort of our fundamental business where we started as a company, where a lot of sales initially started from and that’s colleges and universities, national labs, just looking at material and structures for better science. So big business, it is our lowest gross profit margin business, but it still has a growth opportunity long-term particularly in developing area.

Life science is an area that I’m particularly excited about. We introduced a couple of new products the other day; I’ll talk a little bit more about that. But this is really an area of growth for the company where researchers historically have not used electronic microscopy for analysis of both cell biology and structural biology. There is a move towards that; we are pioneer in that move. And then there is a couple of new products that will help that.

Service and components is a really nice business, we hardly ever talk about that. It’s post sale of warranty and maintenance and repair. Good business for us. It’s almost $200 million business for the company. It’s nice as a CFO to know, we start each quarter with about $50 million, pretty much tied up in revenue. It generates a significant cash flow and profits. It’s a lower gross profit margin, but there is really no R&D associated with that and limited sales associated with that.

I’d also like to point out that our material science segment includes a new area of growth for the company called natural resources where we are selling tools for both mining and oil and gas and that’s been an area of explosive growth for the company and a area of huge gross profit margin opportunity.

Looking by geography, and we get the questions a lot about what’s happening in Europe, what’s happening in U.S. in particular. And this sort of shows that where in our case, U.S. has been pretty soft, clearly, we have good semiconductor sales into the U.S., but the general material science, colleges and universities funding from NIH, things of that nature, no surprise has been difficult for the company. So we’ve seen bookings with challenges in the US.

Interestingly, in Europe, which has been a challenge had a great quarter last quarter, there may have been a little pent-up demand for that, but we did particularly well in Europe, in the – more in the Eastern Europe developing areas, Poland, Czech Republic, Romania. We actually do fairly well in Asia-Pacific.

Rest of the World has been strong for the company for some time, dropped down a little bit in Q3, no real big deal, no trend there. China, in particular has been very strong for FEI. But as a company, we are relatively well balanced, they are roughly a third, a third, a third, we’re seeing Asia-Pacific and Japan in total becoming a little bit more getting close to 40%.

As I said, emerging markets is a growth opportunity for the company. China is actually now our single largest market for our material science. So – where research money has been spent, we’re seeing more being spent in China. It’s a larger market for us than the U.S., now U.S. is still way larger in total. Now we’ve looked just for our material science research spending. China has taken up a lot of slack there.

Seen good growth in India, we just opened an office and are now going direct in Brazil. We also opened up an office in the Middle East, so we’re now direct in a couple of countries there. And we’re seeing, as I mentioned before, a pretty good growth opportunities in Eastern Europe.

We had a fairly substantial order last quarter from the Czech Republic. Now we actually have a lot of operations in the Czech Republic from our manufacturing, but it’s – been a relatively being small country from a revenue standpoint, but we are even seeing that turn around a little bit.

Our strategy is pretty simple. We would like to double our served available market by 2015. We see the biggest areas of growth. If we look at the chart here, in life sciences, which is the bottom gray sliver and then also in natural resources, which is second from the top, which was extremely small a couple of years ago, we did 10 million in revenue in 2010 in natural resources. We are seeing it growing significantly over the next three years.

From our strategy, in terms of how they do that. I will start with one that will probably grow at a slowest rate, but we will continue to grow, which is our material science, fundamental research, college and universities, national labs. The key here is really getting and developing channels and developing regions.

So we had spent a lot of time, effort and energy and going direct in China, we have over 80 employees in China. We're going to do the same in other areas. We’ve won the resolution were meaning that our tools are the highest level. Our Titan class product which sells for in this particular segment around $3 million; you can literally see the dark spaces between atoms.

So it’s really about what you can do with the tools, I can provide more information. We are going with a dynamic microscopy, which is measuring the times, fourth dimension, and we’ve introduced a new product recently that enable our customers to do that. So here, it’s really a story of building out your channel and developing areas to capture our on that growth.

Natural resources, relatively new business for the company, we see the SEM growing significantly to a $500 million SEM. It's really in three different distinct buckets and its key to really understand that, mining, which is basically a product known as an MLA, Mineral Liberation Analyzer, that's a relatively low-end scanning electron microscope loaded up with very sophisticated software that enables users to put samples in, determine not only what minerals may be in the sample, whether it’s gold, platinum, copper or whatever. But as important maybe even more important is how difficult it will be to liberate those minerals from the rock that’s embedded in.

So what this tool does is, it's effectively a yield optimizer for people that are running concentrated huge crushing operations that they basically take the rock and crush, I don’t know if you guys watch Gold Rush, I love that show, these guys are out in Alaska trying to do gold and we are selling to sophisticated customers that are buying electronic microscope.

So it is a very interesting business, very profitable business. We are the leaders in this by far. We have over 50 employees within FEI dedicated to natural resources and those people are primarily software engineers, app support and geologist. So we really are adding domain expertise to the team.

Next piece that I’m going to – if you go to the bottom is oil and gas labs that's where we are selling our DualBeam product, which is a product that includes a focused ion beam system as well as a relatively sophisticated SEM loaded with software called CLEM scan which is our own and proprietary software.

And we are selling it to people that run central labs for petroleum companies and they are basically taking shale, put it underneath the FIB, cutting it up and looking at the microscopic membranes to see the porosity of the structured to see whether or not it’s suitable for fracing.

And this has been a really good business for us, it almost didn't exist a couple of years ago and now we are selling tools that's – in upwards of $2 million per customer. So pretty good business for us.

And then the third piece is that which is in the middle, which is our newest product and this is a product that is automating what is know as mud logging or surface logging, and what mud logging is it’s essentially a technique where you look at the rocks that come out of the drill bed sitting right next to the drill bed, as you’re drilling for oil and gas.

Doing analysis of that, comparing that data with data that you get from, whirling techniques from other providers and using that to determine whether or not the drill is going in the right direction, whether it’s hitting the right stop and give the operator the right information to make a call on that particular site.

What’s interesting about this, it’s a very ruggedized tool, it’s about the size of this podium and a matter of fact it looks about a as sexy as this podium, you have no idea that it’s a sophisticated tool inside. They basically open up a draw there is a little technique that we put the material and it’s a called a puck, it’s looks a miniature hockey puck, slide it in, it does the analysis, gives the data out and it automates the process that was formally done by two geologists sitting (inaudible) microscopes literally logging down the information.

So we are pretty bullish on this as a long term opportunity. It’s a leasing model and that we will work with the service providers for BP’s and Exxon’s and Shell’s, et cetera. They like to tagger on a daily rate, so they try to get our product more out of variable cost model. So we are at least in it to them and least intervals between three months and 12 months. So revenue will ramp a little bit slower, but great profit margins, this whole segment of our business is a 60% or so gross profit margin opportunity for the company growing very rapidly.

I think I really covered most of this slide and the opportunity here and what we are doing. It really has all to do with work flow automation particularly in the mining and in the oil and gas on-site situations. The piece that we have for the labs is just more data analysis given people information on whether or not the rocks will work for fracking.

Electronics is an area that as we look into 2013, I am sure you are hearing this from a lot other companies, it's an area that it's going to be challenge the growth. Many semiconductor capital equipment companies clearly are looking at down years. In our case, we are not that pessimistic. We are not making a call yet on 2013, I’d like to point that out. But we sell into the laboratory space, so we are really an R&D spent.

And what our tools do is they help people running the labs to analyze the structures and determine defect analysis for semiconductor devices. And in the past the devices were at 65 nanometer; you really didn’t have to use as sophisticated of a toolset. As device structures continue to shrink and once you get below about 32 nanometer, you’re really in a situation where you cannot use old toolset, you have to use a higher performance transmission electron microscope.

You are interested not only in looking at the structures inside, you are also interested in the chemistries as you go forward using many more chemistries to build semiconductor devices and they are layering this stuff down a couple atoms thick. So it is really important to know where the germanium and the phosphate stops and the silica starts, et cetera.

So getting the data, being able to analyze that is key and to do that you're going to need a TEM, a transmission electronic microscope. And in order to get the samples into a TEM, you need a focused ion beam or DualBeam system, both of which we have a large market share and have a very commanding position in the semiconductor space.

So the key here is as structure gets smaller, it’s good for FEI. So it's basically the takeaway from this – our presentation on the semiconductor space. Yes, there is going to be some ups and downs in the overall market trend, but the trend is still good for FEI, devices are going to get smaller, just look at the iPhone 5, I mean, that thing is so darn small, it is unbelievable how thin it is. And the only way to get smaller devices is buy our tools. So we are a net winner with smaller and faster devices.

And lastly on the semiconductor piece, I would like to point out that we will have some volatility with the market, but our volatility is about half of the overall semiconductor capital equipment spending, the reason for that once again we are in next-generation devices, so they tend not to cut that as much as they do with capacities. So capacity is going to be down, they will just stop ordering from Applied Materials and ASML, but they will hopefully continue to order from FEI.

Next piece is life science, and I'm really excited about life science because we just introduced two new products on Monday. And what is happening in life science for many, many years, particularly in cell biology, researchers were not using our types of tools, they were using light microscopes, they want to look at their samples in a live native state, they don’t want to kill it.

So what they are used to working with – and moving into an electron microscope, first of all, it’s expensive, it’s difficult to put the samples in; you kill the sample, lots of bad things happen. So we had a lot of things to overcome to really develop this market. We pioneered techniques to take and flash freeze samples and move them quickly into an electron microscope. But it still didn't address the part on the front end that researchers like to start with a wet sample -- like to start using a light microscope.

So the key to this business is really tying the two tools together and what is known as a correlative workflow. So we acquired a company in Munich, Germany, a year ago called TILL Photonics, has super cool high end digital light microscopes. The goal was to develop a product that would work with our existing electron microscopes, you can work with one, quickly tag your sample, move it seamlessly into an electron microscope and then basically Google Earth down on that area of interest that you are looking at a particular cell.

So the two products that we introduced on Monday, one is called iCorr, the other one is called CorrSight. They can argue about the names of these, but they are what they are. Corrsight is a standalone light microscope that would develop our operation and it works in conjunction with our TEM, sells for around $250,000. It has a number of modules that can be added to that, fairly high gross profit margin opportunity.

The other tool called iCorr is a bolt-on to our existing TEM. So we have a fairly large install base of Tecnai transmission electron microscopes that we sold to cell biologists over the years. This is a bolt-on tool that will add a light microscope right into that. It sells also for about $250,000 and because it’s an accessory, it has very, let me just say very favorable gross profit margin.

So we are excited about this, we think there will be good pent-up demand from the existing install base and then further it will enable us to grow our cell biology piece of our light microscope of our life science business. The other piece of our life science business is structural biology and what we are working there is a – in effort with NIH for – we have our in Maryland running next to tools from Brooker and other companies that make NMR and x-ray diffraction to show how electron microscopy can work very well in conjunction with researchers and other techniques. So we are pretty excited overall about our life science business on a go forward basis.

Past year has been pretty active for the company, we did actually do four acquisitions, I guess, TILL is a year and a month ago, but that was the first major one we did. It wasn't all that large of a company or that expensive, but it was really key to enabling us to develop the correlative workflow for our life sciences business.

ASPEX is a manufacturer of ruggedized SEMs that was really key for our natural resources business because that is the platform that we are using for our on-site tool. AP Tech was our distributor in Korea, and that was a no-brainer, they became fairly large distributor for us. Korea is a very important market; obviously, there is a couple of very important customers there, so that one made all the sense in the world.

And then recently we acquired VSG, which is a software provider, super cool company, based in Bordeaux. So if you're going to acquire somebody you might as well buy them in good places. But seriously, VSG has got about 85 employees, dedicated to software development. About 70% of revenue is in natural resources, the balances in life sciences. They have a who’s who of customers, a great company little company, obviously the software business, high gross profit margins.

I'm not going to go over the financial summary in detail. Here you can see that we've had improving results year-over-year, year-to-date this year, we’re on track to be somewhere around just shy of 900 million in revenue. And if you just take our guidance on EPS, it will be somewhere in the $2.70 or so good. So, good EPS growth year-over-year, good revenue growth and good gross profit margin expansion.

Q3 was a very good quarter for the company, it’s generally a tough quarter because of our large amount of customers that are involved in colleges and universities. In effect we've got a lot of European operations, but nevertheless we did a good revenue, we did have record bookings, gross margin were 47%, earnings per share $0.71 above Street consensus. Good quarter from cash generation. ex all our one-time acquisitions that we did during the quarter.

A strong balance sheet, good cash flow year-over-year, improving free cash flow per share probably it will be down a little bit this year, just simply because we're doing a little bit more, not only in growth, but also doing a little bit more in fixed asset acquisitions this year. So we’ll see how 2012 ends up. But our plan is for that to reaccelerate as we go forward.

Business model, as I mentioned long-term targeted margins, 50% up from 46.5% or so this year. Four main drivers there, new products, software, COGS down initiatives primarily on a supply chain. We are a largely an integrator so we pretty much design the sub components, other people make them, but there is lots of opportunities for COGS reduction there.

And then lastly is just overall process and manufacture improvements at the company, the main one being that we are building a new plant in the Czech Republic where we have a plant already, so it’s actually three different plants in three different locations and it is highly inefficient, so we expect to get some efficiencies out of that when that’s up and running early 2015.

Guidance for Q4, pretty straightforward, we are expecting bookings to be about 225 million that would be an all-time high. Same with revenues, it will be an all-time high as well. Gross margin about 47% and earnings per share, we are expecting to have about 2 million or so in restructuring expenses this quarter. So even with that GAAP EPS somewhere $0.60 – $0.72.

So with that, I will it open it up for questions. And thanks again for attending.

Question-and-Answer Session

Tycho W. Peterson – JPMorgan Securities LLC

Great. I will kick it off with a couple and obviously people want to jump in just raise your hand. First, maybe part of what you are highlighting here is the move into lateral or adjacent markets. Can you talk a little bit about how mix will change as you push into these customers? You have highlighted software, you highlighted the service business. How do you see the portfolio changing in terms of mix in terms of consumables, recurring revenues as you move into some of these other customers? And talk about the visibility within some of these other markets. Do you have better visibility as you move beyond the core kind of semiconductor based?

Raymond A. Link

I think we have to almost looking at it market by market because the mix will change a bit. Our life science mix is still predominately going to be TEM, mid and high range TEM coupled with light microscopes and they will be – I wouldn’t call it a true consumable piece, but there will be more accessories sold into that, which were higher gross profit margins. In our electronics, business we are seeing a mix change from STMs to DualBeams and TEMs, which is very good for FEI because we have a higher market share in those and they are higher price point products and higher gross profit margin products. So we see a very favorable mix in the semiconductor space.

Material science probably no change on that, probably the same mix and it’s pretty well balanced SEMs, TEMs. And then in natural resources that’s clearly a software business even though we are selling hardware, it’s really software that drives it because it really have a fairly low performing SEM, but it has to be rugged. So the increased SEM sales that will be in a much higher price point and gross margin because we will have a lot more software embedded coupled with our VSG acquisitions, we will have more and more software into the natural resources space.

So on a recurring revenue, we will get more because we will have more software, we will have more recurring revenue, because we will have a leasing model in our natural resources. We will have accessories in our life science business and we are actually looking at our service business to see what we can do there to expand beyond a great fix model, can we add more value added services, can we do more support those things we can do and service to grow that as well. So I think those covers the main part of your question.

Tycho W. Peterson – JPMorgan Securities LLC

And maybe can you talk a little bit about how you run things from an R&D standpoint? And in other words, is it one central R&D organization that you leverage into each new vertical or is it more…?

Raymond A. Link

We have a common R&D organization, but it’s spread on most of the geographies. It’s not like they’re all sitting in the U.S. or in Ireland. We have people doing R&D in U.S., in Ireland. Actually we’re doing more and more in Czech Republic. And we do try to leverage it across the end markets and across the platforms, that’s one of the beauties of FEI where we have a lot of those contained markets and what appears to be a lot of different products. But it’s the same chassis.

It’s sort of like building cars and you just kind of tweak it by geographies. So our primary products and technology do get leveraged across all end markets and all the different platforms. So that’s an advantage, and we take the R&D once again more on the end market focused. So we try to drive that to build each of our businesses.

Tycho W. Peterson – JPMorgan Securities LLC

And maybe just jumping into some questions on divisions. For electronics, for example, you talked a lot about shrinking feature sizes as you transition toward TEM-based imaging. How do you feel about the competitive dynamics there? How do you think about the sustainability as you move closer to the production line? And also, how do you think about the cadence of new products cycles from your customers? I mean, are we at the point now where we won't see new cell phones every 12 months but that could actually get extended as the market becomes more saturated? How do you think about those?

Raymond A. Link

Yeah, yeah, I’ll start with the competitors first, we always worry about competitors, but frankly, we’re now in a pretty good position there and are pretty far ahead of them. And we loose the all sorts of questions about that, but it’s more just on situations where our major customers don’t want us to be feel that they are single sourcing. So we loose them to just kind of whole requirements for dual sourcing, but on the semiconductor space particularly in the TEM and small DualBeam even though, we have competitors that make those products really have a pretty good position there.

As far as the velocity of change of products, we are getting – really pulled hard to accelerate some development and some new products. Even though some times I wonder when this all going to end, devices just continue to get smaller and the leading guys who are leading the charge on that have a vested interest to keep their positions there. So we think there will be more product and there will be more product announcements from FEI addressing that space particularly to get what we would call near aligned to get not out of the – we won’t be actually in the fab, but to be as close as possible for quick throughput.

Tycho W. Peterson – JPMorgan Securities LLC

Go ahead.

Unidentified Analyst

Can you just chat about your software development? Is that all done in-house? Or are you depending on acquiring that or do you outsource that to software Google’s around the world?

Raymond A. Link

Most is done in-house. It’s not like we have a big software group in India or something like that. We do outsource some pieces of our software, but most is actually developed in-house and we did that largely through acquisitions, our software for natural resources was through two companies we acquired in Brisbane. They were competitors of one another, (inaudible) Queensland University, we’ve heard them about 3.5 years ago. And as a company, even though we sell hardware, almost half of our R&D’s teams are software engineers, so software is really what drives it. So there is a lot of this internal software driving the tools. There is something like 7 million lines of code that drives our high-end Titan Krios microscope. So there is a lot of software and tools.

Unidentified Analyst

On life sciences, which is a new segment for you, when do you think you would – when do you hope to see the tractions sort of the inflection that this is going to be promising business for you?

Raymond A. Link

Yeah, it’s close to $100 million business now. But I am hoping that 2013, 2014 will really be break out years where we can really start seeing some acceleration. You may not see any revenue in this but some acceleration in bookings where we start becoming more predictable, that is pretty lumping now, we have one quarter $25 million, next quarter it will be $15 million. What I would like to see is consistently quarters of $30 million or better on an ongoing basis and I think the key to that is the correlated workflow coupled with more adoption of our high-end Titan Krios. And we might need a little bit better government funding situation for that to happen, so we will see how 2013 shakes out.

Unidentified Analyst

But do you feel that the existing product line allows you to do that or do you need another?

Raymond A. Link

No, I am comfortable with the existing product line now.

Unidentified Analyst

Okay.

Raymond A. Link

…as of Monday.

Unidentified Analyst

As of Monday?

Raymond A. Link

Yeah, it’s right. Prior to that I would say, no. That’s really a major issue to get to that point.

Tycho W. Peterson – JPMorgan Securities LLC

Just to maybe follow up on that, I mean we're obviously in a world of finite and probably shrinking research dollars from a government perspective. How do you think about that? Are you able to buck the trend with some of this innovation? And how do you view this technology as kind of stacking up to NMR and XRD and some of these other kind of high-end technologies, are they complementary or competitive?

Raymond A. Link

I would say, we’re complementing each other, but at some point those will become competitive, there is a limited amount of funding available. And I think we’re actually in a better position than the other guys because those are the tools they’ve been using, and ours is sort of the new sexy guy in the town. So I think from that standpoint, we’re a little bit better positioned perhaps than others and we are still very bullish on this.

When you look at what still needs to be accomplished, there is no cure for cancer, there is no cure Alzheimer’s, there is no cure AIDS, really and there is an insatiable demand for healthcare to improve. and it’s only going to happen in the lab and it’s only going to happen really going to the next level of exploration and we believe that our tools offer that.

Tycho W. Peterson – JPMorgan Securities LLC

Do the new correlative microscopy products impact the Living Lab initiative at all

Raymond A. Link

It’s part of the impact.

Tycho W. Peterson – JPMorgan Securities LLC

It’s part of it?

Raymond A. Link

Yeah.

Tycho W. Peterson – JPMorgan Securities LLC

Okay.

Raymond A. Link

As a matter of fact we’ve been working hand and glove with Living Lab as – I wouldn’t call it joint venture, it’s a partnership with Oregon Health & Science University, which is based in Portland, which is where we’re based. It is part of the Knight Cancer Research Institute where Phil Knight, the founder of Nike, wrote a check for $240 million to build the latest and greatest research center in the world to help cure cancer. So we are working hand-in-hand with them to develop this correlative workflow as they view that as really a key to helping them unlock the mysteries of cancer.

Unidentified Analyst

Do you have any patents or intellectual property that are core to the company and if so what are they?

Raymond A. Link

Well, we have a lot of patents, we have a lot of IP, but the – it’s really – it’s more in the IP than I would say in the patents and it’s just more in terms of how you run the whole business than any one thing. The core IP in electron microscope has all expired years ago. So it’s not like we will have the patent on electron microscope, it was invented in 1931. So it’s essentially an old tool. But it’s really combining the hardware and the software and the know-how and lots of things together to do that.

So, what are the real barriers to entry? There’s probably huge barriers to entry from somebody starting from scratch. It’s really what are the barriers for our competitors to do what we’re doing. And when I look at it, we’re spending more in R&D dollars than our three next biggest competitors combined. So I think, we’re making an investment on that – that it’s more – we’re spending $100 million, we don't think they spent $100 million between the three of them. So that’s the main thing.

Tycho W. Peterson – JPMorgan Securities LLC

Maybe just one on the natural resources business. How do you think about the build out there? Are we in kind of an early trialing period here? Or do you see broader conversion once some of your customers start to adopt and the word spreads?

Raymond A. Link

I think when I look at natural resources, on the mining side, we are well into adoption there. It’s a proven technique. And now the issue there is taking it from the central lab to the field. So there is a big opportunity there, we’re working with a potential customer who was doing a huge mine in Mongolia, and they have a real difficulty getting throughput back to their central labs, so they want something on-site. So we see that as a big opportunity.

So central lab, mining, it is proving we are there. In oil and gas, for their central labs I would say that’s just at the beginning stage, that companies are starting to buy that and well site is – we are still at that – we are still pioneers there.

Unidentified Analyst

Your views on any changes in the China demand picture or changes in priorities with the government changeover?

Raymond A. Link

Yeah, we’re still very bullish on the China. We’re hearing good things. Their government is committed to increasing R&D spend. They are moving monies around, but I still think they have a big commitment to building out their education infrastructure and most of what we sell in the China is for material science, we are selling life science as well very little in the other areas, but we do see China to be an area of growth and expect China to be pretty good in 2013 and beyond.

Tycho W. Peterson – JPMorgan Securities LLC

You have alluded to a new fifth vertical I think. Can you just tell us, if you don't necessarily want to talk specifically about that, how you evaluate new verticals? How do you think about a return when you go into a new market?

Raymond A. Link

We are a long ways from figuring out which that is…

Tycho W. Peterson – JPMorgan Securities LLC

Okay.

Raymond A. Link

…so I’d like to state that – but we are constantly looking at what’s the next big market for the company. And the things we are trying to look for are customers that could benefit from nano-scale imaging. Therefore they might be using some other technique and not use ours, but ours maybe more suitable large markets people that buy capital and if they are – they buy more than just ones. So they just don’t buy one and park it in a lab and use it once a month or something like that.

So there is a few that are natural when you first think in a high level and then you just have to really analyze and do a lot of work on that still. So we haven’t made a decision, have not started an R&D initiative, we are still just in the – trying to figure out where we are going to place our bet and that’s what we did five years ago with Natural Resource and that – once we started getting into it, we actually – we are missing more pieces than we thought, but the key was software and ultimately a ruggedized SEM and we did those through acquisitions. Those are relatively small companies and relatively cheap amount of money.

Tycho W. Peterson – JPMorgan Securities LLC

Just as a follow-up on that, is there one…?

Raymond A. Link

Their idea has been looked at, that’s all.

Tycho W. Peterson – JPMorgan Securities LLC

Okay.

Raymond A. Link

There is no R&D being spent on the next vertical.

Tycho W. Peterson – JPMorgan Securities LLC

Okay.

Raymond A. Link

We’re probably a year or plus away on that.

Unidentified Analyst

When you do enter these verticals though, how do you think about the return, is it two or three years of overfunding, if you think about natural resources are you being overfunded for two to three years and then sort of get a real return on investment?

Raymond A. Link

Yeah, yeah, absolutely when you look at – our target R&D spent is around 11%, but with our new initiatives, it’s infinite. And with natural resources and we care – our General Manager there is great and he worries about making profits almost too much. We kept telling him, don’t worry about the profits yet, fill the business, what do we have to do. So there is going to be an investment, you’re going to loose money to start-up, and we try to think of this as a start up company.

So you’re going to have a start up company that’s going to be investing and loosing some money for x amount of time, but what’s the pay off going to be. And in our case it's not as great as you might think for a true start-up. We already have the manufacturer, we already have the infrastructure in place. It’s really just the R&D and the added support in the marketing.

Tycho W. Peterson – JPMorgan Securities LLC

And then from a capital deployment strategy obviously you highlighted you have done a number of bolt-ons, if you will. Should we think about from a capital deployment strategy, obviously a fairly balanced mix between the dividend and buybacks, but also -- and M&A, but also should we think about M&A focusing on technologies that can be easily bolted on or should we think about potentially broadening the portfolio a little bit?

Raymond A. Link

Yeah, that’s a fair question. I still think there is lot of opportunities and built-on, smaller tuck in technology that can really help a lot, we can help that company and that company would help FEI. So I think that’s really our first choice. We would love to be able to buy something that could add a couple 100 million of revenue and something that make complete sense that you guys wouldn’t say, scratch your heads over that with the nano-scale imaging. Those are kind of few and far between.

We do look at that, we’ve actually bid on some fairly substantial transactions over the past couple of years. We’re cautious bidders, so we did that win and that’s okay. There was some point, you got to just draw a line in the sand and move on. So we do look at larger situations when they come about, but I think it’s more or likely that they would be in the call it 50 million plus or minus range price in revenue wise, that seem to be where more of the stuff is.

Tycho W. Peterson – JPMorgan Securities LLC

Can we take one more?

Unidentified Analyst

If you are trying to do nano-scale imaging what other options are there from a technology standpoint than electronic microscopes?

Raymond A. Link

Well there is atomic force microscopy, also known as AFM, there is x-ray diffraction, there is fluorescent imaging. There is lot’s of other techniques that would fit in fairly nice within FEI. We probably wouldn’t do like NMR or something really big. That’s already well established, there is huge companies in that, but there is other techniques that would fit in with FEI.

Tycho Peterson

Great. Thank you.

Raymond A. Link

Okay. Thank you.

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