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FEI Company (NASDAQ:FEIC)

Q4 2009 Earnings Call Transcript

February 3, 2010 5:00 pm ET

Executives

Fletcher Chamberlin – Treasurer and Communications Director

Ray Link – EVP and CFO

Don Kania – President and CEO

Analysts

Vis Valluri – Credit Suisse

Bill Ong – Merriman Curhan Ford & Co.

Hari Chandra Polavarapu – Deutsche Bank Securities

David Duley [ph]

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the FEI fourth quarter earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator instructions)

I would now like to turn the conference over to Mr. Fletcher Chamberlin. Go ahead, sir.

Fletcher Chamberlin

Thank you, operator. Good afternoon, ladies and gentlemen. As the operator said, I'm Fletcher Chamberlain, FEI's Treasurer and Communications Director. With me today at our headquarters in Oregon are Don Kania, our President and CEO; and Ray Link, EVP and Chief Financial Officer.

Before we begin our presentation, we have the regular housekeeping matters to take care of. This call contains forward-looking statements. To the extent that we discuss expectations about future corporate performance and guidance, customer orders, revenue growth, performance by product and market, margin improvement, market developments and opportunities, the competitive landscape, product and technological developments, product introductions and shipment schedules, the effects of future movements and exchange rates, cost savings and restructuring, changes in our effective tax rate or other future events and plans, those statements are considered forward-looking subject to risks and uncertainties that could cause our actual results to differ from the forward-looking statements made.

These risk factors are cited in more detail in today's press release and FEI's most recent 10-K, 10-Q and 8-K documents and other filings with the SEC. Investors are urged to read those documents. Copies are available free of charge on the SEC's Web site, at www.sec.gov, or on our Web site or from FEI's Investor Relations department at 503-726-7710. The company assumes no duty to update forward-looking statements set out in those documents or made on this call.

This call is the property of FEI Company. It will be archived in the Investor Relations section of our corporate Web site at www.fei.com.

I'll now turn the call over to Ray for a review of the financials, and then Don will comment on our markets and the business environment.

Ray Link

Thanks, Fletcher, and good afternoon everyone. I will go through the financial report and guidance in detail and then turn the call over to Don.

We had mixed results for the fourth quarter. We had strong orders and excellent cash generation but a disappointing gross margin, which impacted our earnings. While gross margins were up for all of 2009 compared with 2008 it was lower in the fourth quarter, and as a result earnings were near the low end of our guidance range.

On the other hand we had numerous very positive measures. The good bookings led to record revenue above the top end of our guidance. Cash flow from operations was a record for the year and the fourth quarter. Through the worst of the recession, we held our top line and now have 15 consecutive quarters of GAAP profitability. After our fourth quarter with the largest revenue in our history, we entered 2010 with a record backlog, a solid balance sheet, improving market conditions and a continuing commitment to improve operating margins. Those operating margin improvements for 2010, I might add, are directly tied to management incentive and employee profit sharing.

Turning now to the details, net bookings for the fourth quarter were $153.3 million, up 9% from the third quarter and up 6% from last year's fourth quarter. Gross booking were $172.5 million and were reduced by $3.7 million due to the revaluation of backlog for currency movements and a $5.5 million cancellation.

While the average euro/dollar rate was higher in the fourth quarter than the third reducing gross margins, it finished the fourth quarter at $1.43 compared with $1.46 at the end of the third quarter, and that reduced the backlog. Backlog at the end of the quarter was $354.6 million, a record high, with approximately 90% scheduled for delivery within a year. Don will talk more in a moment about the composition of our bookings and our market outlook.

Net sales of $154.4 million were up 10% compared with the third quarter sales and up 2% from last year’s fourth quarter. Net sales for the year of $577.3 million were down just 4% from 2008.

Electronics revenue of $33 million was up 4% from the third quarter and 2% from last year's fourth quarter. Full-year electronics revenue was down 17% from 2008 and 36% from 2007. Those are significant declines but are substantially smaller than most semiconductor capital equipment companies. Electronics made up 21% of revenue in the current quarter compared with 41% two years ago at the cyclical peak in the second quarter of 2007. We had good orders in electronics in the fourth quarter as the semiconductor capital equipment industry recovers.

Life science revenue of $29.1 million made up 19% of the total and was up 137% from the third quarter and 59% from last year’s fourth quarter. We continue to expect significant quarter-to-quarter variability in life sciences bookings and revenue in the context of significant long run growth for FEI. Full-year life science revenue was up 16% from 2008.

Research and industry revenue of $56.3 million made up 36% of the total and was down 9% from the third quarter and 16% from last year's fourth quarter. Full-year revenue was down just 3% from 2008.

Service revenue was $36 million for the quarter. It was up 2% from the third quarter and up 7% from last year’s fourth quarter. For the year, it was level with 2008.

Geographically, we continued our broad diversification with the US and Canada making up 36% of revenue for the quarter and 34% for the year. Europe, including the Middle East, made up 31% of the quarter and 37% for the year. Asia and rest of the world made up 33% of the fourth quarter revenue and 29% of the full-year revenue.

The gross profit margin for the year was up from 39.1% in 2008 to 39.8% in 2009, but the fourth quarter was disappointing 38.4%. There were several reasons for the lower gross margin, including a small impact from currency movement, but the key factor was the lower margins in our life science business. That segment had 29.5% gross margins in the fourth quarter compared with 37.7% in 2008 and 37.6% in the first three quarters of 2009. The lower-than-forecasted gross margins were a result of higher costs on several early Titan units plus lower margins on some mid-range products shipped in the quarter.

Our backlog has higher margins and we are well on our way to addressing the cost issues. So we expect life science margins to improve starting in the first quarter.

We expect company-wide margins to improve in the 39% range in the first quarter, and we believe we are on track to get our 42% gross margin targets in the fourth quarter of 2010. Our plan to hit that goal is based on several elements, higher revenue, a larger percentage of higher margin electronics, higher life science margins as we move down the manufacturing learning curve and ship more favorably-priced units from our backlog, and a continued improvement in operations and supply chain including the ongoing transition of some manufacturing to lower cost locations.

In the short term, the dollar has strengthened and that will help. We can’t plan for currency rates to stay stable, but we use the recent strength in the dollar to put some hedges in place that will help protect our margins should the dollar weaken later.

Moving down the income statement, operating expenses were $50.3 million compared with $47.5 million in Q3 and $48.8 million in the last year’s fourth quarter. Foreign exchange fluctuations caused about $1 million of this sequential increase and $3 million in the year-over-year increase. We also saw higher sales commission, including agent commissions to go along with the increased revenue in Q4.

Restructuring expenses were $826,000 in the quarter compared with $600,000 in the third quarter. That reduced earnings per share by $0.02. The bulk of the restructuring expenses in Q4 were related to requalification of vendors as we shipped some of our supply chain from European base to Asia to reduce costs and to retain a better currency balance. We expect this line to increase to around $1.2 million in the first quarter.

Operating income, which is a key measure on how we manage the business, increased to $9 million compared to $7.9 million in the third quarter and $11.2 million in last year's fourth quarter. The operating margin was 5.8% compared with 5.6% in Q3 '09. For the full year, operating margin was 5.5% compared with 5.2% last year.

Below the operating income line, total other expense was $1.3 million compared with $800,000 in the third quarter and $1 million a year ago. Substantially lower interest income due to very low market interest rates continue to depress non-operating income and is likely to keep the non-operating expense around $1 million for the next several quarters.

The tax rate was 14.0% for the quarter compared with 14.5% in the third quarter. The rate declined due to the allocation of income by legal entity. We expect the Q1 rate to be approximately 22%. All of this leads to GAAP net income of $6.0 million or $0.17 per share for the fourth quarter within our guidance range and compared to $6.1 million in the third quarter and $7.3 million a year ago.

The fully diluted share count was 38.2 million in the quarter, and we expect the share count will grow only modestly in the next few quarters.

Our balance sheet remains very strong, and we again increased our liquidity in the current quarter. Total cash and investments at the end of the quarter, including restricted cash and long-term investments was $429 million and net cash was $269.4 million or $7.05 per share.

Net cash increased $36.3 million from the end of Q3 and $65.1 million during the year. Operating cash flow was $45.5 million for the quarter and $78.2 million for all of 2009, up 43% from last year. Receivables and inventories both declined during the quarter, giving us lower DSOs and higher inventory turns. Capital expenditures were $4.1 million for the quarter and $13.4 million for the year. Depreciation expense was $4.5 million for the quarter and $17.1 for the year.

Turning now to our guidance; it assumes a euro rate of $1.45, which is close to the rate at the beginning of the quarter. First quarter is normally somewhat weaker for us on a seasonal basis, but with our solid backlog we expect Q1 revenue to be in a range of $150 million to $156 million. Bookings which are normally down on a seasonal basis from Q4 to Q1 are expected to be above $145 million. GAAP earnings per share for the quarter are expected to be in a range of $0.15 to $0.20, including restructuring charges of approximately $0.02 to $0.03 per share.

With that I will turn the call over to Don for some additional comments.

Don Kania

Thank you, Ray, and good afternoon, everyone. First, let’s step back and look at 2009 as a whole. Then I will talk about the specifics of what we saw in the markets in the fourth quarter and the outlook for 2010.

We are reasonably pleased with 2009, given the difficult economic environment. With bookings down 3% and revenue down 4%, we were able to increase operating margins. During the middle of the year, we saw increasingly aggressive pricing from our competitors and we responded with our strong product portfolio netting a gain in market share.

Electronics bookings were down 7%, a much stronger performance in the semiconductor capital equipment industry as a whole, and electronics ended on a positive note. Life sciences and research & industry bookings were flat despite the weak economy; and geographically in 2009, our Asian business was up about 6% despite the weakness in electronics. European bookings were flat and US business was down because of the electronics market and order delays as customers waited to see if they would receive stimulus funding.

We continued our investment in new products with significant releases in the second half of the year. In the fourth quarter, we saw the pricing environment improve along with the normal seasonal uptick in orders. We had a positive book-to-bill for the quarter and the year. We entered 2010 in a much stronger position than a year ago.

Turning to the specifics of the quarter; gross margin was 38.4% below our expectations. As Ray said, the major issue was in our life sciences business where we had several shipments with unique configurations that have been priced aggressively in the very early stages of the product, which drove unexpectedly higher costs in the quarter. We have new General Manager for that division and we are on track for margin rebound in the first quarter.

Gross orders of $172.5 million and net orders of a $163.3 million were the third highest in the company’s history, and our pipeline continues to build in all markets. We were gratified that we saw the normal positive seasonal strength despite the low level of US stimulus orders.

Our geographic and market diversity was once again crucial to our results as Asian and Japanese bookings were solid following the third quarter strength in Europe and the United States. We also saw very good business in our electronics and life sciences markets offsetting lower bookings in research & industry.

Orders from US stimulus funding were weak, making up less than 5% of the bookings in the quarter compared with over 10% in the third quarter. Agencies have not met their own target dates for releasing grants. The funding is still there and we estimate that less than 25% of the relevant science-based stimulus funding has been spent so far. We continue to expect to get our unfair share of stimulus purchases and expect stimulus orders in Q1 and for the remainder of the year.

Turning now to our market segments; even though it was down from the very high levels of the third quarter and last year’s fourth quarter, research & industry remained our largest single segment with bookings of $58.2 million or 35% of the total. Governments around the world are continuing their investment in science infrastructure as a way to build their economies.

Bookings were strong in Asia, reflecting our ongoing strategic commitments to build our research and life sciences businesses in that part of the world. We are also pleased with significant orders from institutes in Germany, Spain, China and the United States.

For Q1 of 2010, we are looking for growth in research & industry bookings as the positive benefits of continued global investments and some already-funded US stimulus projects are expected to offset any concerns in areas of government debt and deficits.

Gross orders in life sciences were $21 million, up 85% from Q3 and 21% from last year’s fourth quarter. As Ray mentioned, we did have a cancellation of $5.5 million. It came from a life sciences institute who decided to change their strategic direction and cancel a project that was scheduled for delivery in 2011. So the net life sciences bookings were $15.5 million, up 36% from Q3.

This strength was spread broadly around the world. Meanwhile, the earlier adopters of Krios are beginning to generate important scientific results. As the systems capabilities penetrate the research community and most of the stimulus funding is released, we see an ongoing opportunity in life sciences, but quarterly bookings will continue to fluctuate.

Electronic bookings of $49.9 million were up 122% from the third quarter and 125% from last year’s fourth quarter. Our electronics business did not decline as much as the semiconductor capital equipment industry during the downturn, but we are seeing its upswing as it recovers.

Semiconductor industry is investing in new nodes and materials, and they need next generation tools to make that transition, particularly to 22 nanometer line widths. We are seeing building momentum for the expanded use of TEMs from leading logic and memory companies. With the Magellan SEM, our new Helios 1200 DualBeam, and the introduction of high-speed analytics from the Tecnai Osiris we are well positioned to take advantage of the improving environment. In addition, the disk drive business will likely increase investment during the year. Nonetheless, we expect first quarter orders to fall off sequentially from the very strong fourth quarter. Finally, our servicing and components bookings were up 12% from the third quarter and up 24% from last year’s fourth quarter, another sign of improving prospects for FEI.

Now looking forward to 2010; our high-margin electronics markets are in an upturn and continue to strengthen and increase the demands for our products. Our product positions remain very strong with the release of new Titans, the new Tecnai Osiris, the Wafer DualBeam and proprietary cameras and detectors with more to come in 2010.

Stimulus funding will positively affect the life sciences and research markets. Life sciences will continue with the cycle of adoption of the Krios. Our balance sheet remains rock solid and gives the opportunity for us to explore accretive acquisitions, and we entered the year with a substantial backlog.

As a result, 2010 will be a growth year for FEI with a 42% gross margin target for the fourth quarter. 2009 was a challenging for FEI and its employees. We have to work harder and smarter just to stay in place, and I am proud of the way the FEI team has responded to the challenges of last year. I want to acknowledge and thank all of them and we expect to enjoy a more prosperous 2010.

With that operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator instructions) Our first question comes from Satya Kumar. Go ahead please.

Vis Valluri – Credit Suisse

Yes, hi. This is Vis Valluri for Satya. How much was the disk drive orders in the December quarter?

Don Kania

How much was the disk drive orders? It was in a range of – we will give a rough range – I think within the range of about $10 million.

Vis Valluri – Credit Suisse

Okay. And how do you see – your semi orders were down 6.8% for calendar year '09, and with CapEx expected to grow over like 50% in ‘10. How do you expect this segment to grow? You said, it's going to be down quarter over quarter, but for the year, what do you project for this?

Don Kania

The way we are describing is we expect it certainly to be up for the year but we are not at this point seeing it as reaching the peak levels that we saw back in earlier time frames.

Vis Valluri

Okay. With regards to stimulus spending – it looks like the fourth quarter, the stimulus spending didn't kick in as expected. What gives you the confidence that in the first quarter or even in the first half that stimulus spending is going to increase?

Don Kania

Specifically on the first quarter, those opportunities that were including in our forecast are already funded and so the moneys were allocated in previous periods and now they will be investing those funds. So that’s the basis. We don’t have any unfunded activity at our forecast. As we talk to the agencies, clearly, they need to move forward with spending the money. So we get the same kind of information we had in Q4, if you remember, there were dates identified for additional funding releases, which the agencies missed. We get new information that those release dates are approaching again and we remain optimistic that those funds will be released.

Vis Valluri

Okay. Thank you.

Operator

Thank you very much. Our next question comes from the line of Bill Ong. Go ahead please.

Bill Ong – Merriman Curhan Ford & Co.

Yes, hi. Good afternoon, gentlemen. Many of the college universities have been facing these budget cuts given the current climate. In your current discussions with university labs, have any clean tech projects been curtailed outside of stimulus? And how has that impacted your business?

Don Kania

You are asking specifically about clean tech projects or projects overall?

Bill Ong – Merriman Curhan Ford & Co.

Projects overall, but clean tech – because I know that a lot of the new projects are clean tech. So whatever level detail you have would be greatly appreciated.

Don Kania

I think this is an area we're watchful on because I think we are all concerned, and it is now just potentially a US phenomenon, but to date we really can’t identify any particular activity that has been curtailed because of restrictions on budgets. So we watch, we remain wary of it, but when I probe specifically with the sales force, it may affect timing at times, but it hasn’t reflected affected transactions. So that’s true globally and that’s also true in anything that are close to, you might say, clean tech kinds of activity as well.

Bill Ong – Merriman Curhan Ford & Co.

Okay. In your discussions, have you seen budgets being flat this year in 2010? Or, plus or minus, any color on how the budget trends are taking place this year?

Don Kania

Most of the things you see [ph] is a good example, as you're seeing operating spending squeezes going on with people, but if you –- just to remind everyone, the capital funds usually flow from institutes or federal government areas. So the stimulus and the typical NIHs of the world in the United States, so that flow seems to be okay, and in fact, when we look at the Q4 orders we were really quite pleased that on a global basis we saw that the fourth quarter uptick that you typically see on a seasonal basis which indicates to us that things remain relatively healthy. When we look forward from Q3, that was one of the areas that we were concerned about potentially that maybe the economic environment might affect that. Well, we saw a very strong order flow in the quarter overall. So we remain optimistic on that from.

Bill Ong – Merriman Curhan Ford & Co.

Okay. Thanks. That's helpful.

Operator

Thank you very much. Our next question comes from the line Hari Chandra. Go ahead please.

Hari Chandra Polavarapu – Deutsche Bank Securities

Yes, thank you. I wanted to touch upon the gross margin issues. You did indicate it's because of the Titan aggressive pricing and also mid-range products. It looks like based on the guidance that you give for the first quarter – it looks like these will linger into Q1 and beyond?

Don Kania

What we're saying is – this is Don still – is specifically, we guided to around 39% next quarter in terms of gross margins and we have a target for 42% gross margins in Q4. So we believe that we are on the road because of a recovery in electronics, a little bit strengthening of the dollar that we are dealing with the issues in life sciences and those margins will rebound in Q1, and improving pricing environment and our supply chain improvements all getting momentum. So that should carry us through the year with improvements to 42% by Q4.

Hari Chandra Polavarapu – Deutsche Bank Securities

And the issues that you've seen with initial Titan shipments, would they also be applicable to the new products that you would be shipping in 2010, and hence lowering your earlier gross margin expectations?

Don Kania

So, also you should be clear. This is the Krios product, which is a Titan variant, so it's only the life science product that we're referring to. So we think we’ve worked through the bulk of the issues in this area in Q4 and took the pain in the quarter, which we are not happy about, but nonetheless it happened and we think that’s behind us as soon as we get to Q1.

Hari Chandra Polavarapu – Deutsche Bank Securities

And one last question on the stimulus spending, previously you indicated the average size of the grant is lower than previous expectations. So would it lower the – in terms of the mix shift towards the mid-range products which will again pressure your gross margins?

Don Kania

We have no new data. I wish we did because that would mean that funding had been released. So that’s an area we highlighted for concern, but we’re awaiting to see how those funds are moved forward. I think with the operational improvements that we’ve highlighted, certainly we'd prefer if they came out at higher dollar levels per grant, but nonetheless we feel that factoring that into our thinking through the year that we still can achieve our fourth quarter targets.

Hari Chandra Polavarapu – Deutsche Bank Securities

I might have missed this, but the tax guidance for 2010, does it stay at 28?

Ray Link

We just guided for the quarter and that's all we do guide. We guided at 22% for Q1.

Hari Chandra Polavarapu – Deutsche Bank Securities

Thank you.

Operator

Thank you very much. Our next question comes from the line of David Duley [ph]. Go ahead please.

David Duley

Yes, quick question on the gross margin. I guess I would have expected a little bit more of a snap back in the gross margins in Q1 given that your electronics bookings were so strong this year and that’s your highest quarter and that's your highest gross margin business and that's got a flow through in Q1. You won't have this – or maybe you can talk to this a little bit more, but it doesn't sound like you are going to have this issue with the Titan Krios in the life science market. So both of those things should be quite positive influences on the gross margin, yet it’s somewhat flattish. So what am I missing or what’s going to be down sequentially?

Don Kania

I think you are probably optimistic on the conversion from orders to revenue in electronics. It will run a little longer than a quarter on that. So I think you will see the bulk of that effect both in terms of the mix of the products and the content of revenues in Q2 as opposed to Q1.

David Duley

Why where the margins on those Titan Krios product below expectations? I think you probably took those orders some time ago and when you priced them you probably knew what the margin was, but it appears that it’s got you by surprise. So was there a problem with the product, so it didn’t come up and run like it supposed to, so it took extra engineering work. Why where they lower?

Don Kania

It was primarily configuration issues, number one, that we had to sell some special features on the products earlier on that became a burden on the manufacturing operations as we shipped the product and the costs associated with that ballooned, more than we had anticipated.

David Duley

Okay. As part of the order guidance for the upcoming quarter, I guess it’s down sequentially on the order front, but you anticipate stimulus orders being up, so I'm a little – can you help us with the moving parts with that math?

Don Kania

I'll help you with the math. I don’t think we guided stimulus orders up. We said there will still be a stimulus order content and less than 5% meant there wasn’t a lot. But we're taking the usual cautionary view on orders. Last quarter we guided above 150, so I would look at it in that context. Q1, we guided above 150, we beat that number, and we are guiding – if you just look at the guidance basis, we are actually guiding down less than seasonally, which is typically about 10%, 4 to 1, Q4 to Q1. So 145 we feel is a fairly reasonable point. We feel good about 145 plus.

David Duley

Okay. Thanks.

Operator

Thank you very much. (Operator instructions) At this time, I show no further questions. I'd like to turn the conference back over.

Don Kania

That completes our conference call. We appreciate everybody calling in. The operator will give the replay information and thank you very much for checking in.

Operator

Ladies and gentlemen, this concludes the FEI's fourth quarter earning conference call. This conference will be available for replay after 5:00 p.m. Eastern today through March 3, 2010 at midnight. You may access the replay system at any time by dialing 1-800-406-7325 and entering the access code 4199666. Thanks for your participation. You may now disconnect.

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