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FEI Company (NASDAQ:FEIC)

Q1 2010 Earnings Call Transcript

May 4, 2010 5:00 pm ET

Executives

Fletcher Chamberlin – Treasurer & IR Director

Ray Link – EVP & CFO

Don Kania – President & CEO

Analysts

Bill Ong – Merriman & Co.

David Luke – GC Research

Hari Chandra – Deutsche Bank

Satya Kumar – Credit Suisse

Jim Ricchiuti – Needham & Co.

Patrick Ho – Stifel Nicolaus

David Duley – Steelhead Securities

Mark Miller – Noble Financial

Ben Catholic – First Investors

Robert Weaver – Forest Investments

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the FEI first quarter earnings conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions) This conference is being recorded today, Tuesday, May 4, 2010.

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

Fletcher Chamberlin

Thank you, Damien. 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, Executive Vice President and Chief Financial Officer.

Before we begin our presentation, we have the regular housekeeping matters to address. 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, product and technological developments, product introductions and shipment schedules, the effects of future movements and the exchange rates, cost saving, timing and expensive restructuring, changes in our effective tax rate and other future plans and events, these 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 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 these documents. Copies are available free of charge on the SEC's Web site, at www.sec.gov, or on our Web site or from Investor Relations department at 503-726-7710. The company assumes no duty to update forward-looking statements set out in these 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. Good afternoon, everyone. I will go through the financial report and guidance in detail and then I’ll turn the call over to Don.

We had mixed results for the first quarter. Orders were very strong and gross margin improved by 130 basis points. Revenue was in line with expectations after adjusting for the effective currency changes. On the other hand, operating expenses were higher than planned and GAAP operating income was affected both by restructuring and our previously announced unusual bad debt write-off. Excluding the bad debt charge, earnings were within our guidance range. We now have recorded 16 consecutive quarters of GAAP profitability.

Turning now to the details, net bookings for the first quarter were $167.9 million, up 3% from the fourth quarter and up 29% from last year, an all-time record for first quarter and are third highest in company history. Gross bookings were $175.6 million and they were reduced by $7.7 million due to the revaluation of backlog for currency movement. The euro/dollar rate finished the quarter at $1.36 compared with the $1.43 at the end of the fourth quarter and that reduced the backlog value.

Even with the reduction the backlog at the end of the quarter was 373.4 million, another record high with approximately 90% scheduled for delivery within a year. Don will talk more in a moment about the cap position of our bookings and our market outlook.

Net sales of $149.1 million were down 3% compared with the fourth quarter and up 5% from last year’s first quarter. The seasonal revenue decline in the fourth quarter to the first quarter is not unusual for us. This year 4.1 million of the 5.4 million sequential declines were due to the effect of the currency rate changes during the quarter. Without the currency rate change we would have been well within our guidance range. Our guidance resume a euro/dollar rate of the $1.45 and the average rate for the quarter was $1.39.

Electronics revenue of $41.3 million was up 25% from the fourth quarter and up 41% from last year’s first quarter. Electronics revenue suffered less than the semiconductor capital industry as a whole in the downturn and we’re now seeing a similar upturn to other equivalent companies.

Electronics made up 28% of revenue in the current quarter compared with 41% at the cyclical peak second quarter of 2007 and up from the 21% level we recovered some since the fourth quarter of 2008. We also built backlog in Electronics in the first quarter and look for more growth as 2010 progresses.

Life Science revenue of $24.1 million, 16% of the total and was up 15% from last year’s first quarter and down 17% from the fourth quarter. We continue to expect significant quarter-to-quarter variability in Life Science bookings and revenue in the context of significant long run growth for FEI.

Research and industry revenue of $46.5 million made up 31% of the total and was down 17% from the fourth quarter and down 20% from last year's first quarter.

Service and components revenue was $37.2 million for the quarter, 3% from the fourth quarter and up 12% from last year’s first quarter. Service growth a year ago was sluggish and as a result we’re likely to see stronger year-over-year growth for rates and service in the next few quarters, particularly, as our Electronics customers renew service contracts.

Geographically, we continued our broad diversification with the US and Canada making up 31% of revenue for the quarter. Europe, including the Middle East, also made up 31% of the quarter. Asia, Japan and the rest of the world made up 38% of first quarter revenue, the first time this region has been our largest for single quarter. This reflects our progress and our strategic emphasis on expanding our presence in those markets in the last few years.

Gross profit margin for the first quarter improved to 39.7% from 38.4% in the fourth quarter. The increase was primarily driven by foreign exchange improvement and FEI’s margins generally improve with stronger dollar and weaker euro along with expected improvements in Life Science margin and continued to improve in some service.

We expect company-wide gross margins to improve to over 40% in the second quarter, and we believe we are on track to hit our goal of 42% gross margin by the fourth quarter of 2010. Our plan to hit that goal is based on several elements

Firstly, higher revenue. We have the backlog and we’re seeing the bookings rate to support this. Next, a larger percentage of higher margin Electronics shipments, we’ve seen the percentage bookings grow significantly and we’re beginning to see expansion in the Electronics revenue as well.

Higher Life Science and Research margins will also contribute as we move down the manufacturing learning curve and ship more favorably-priced units from our backlog. We saw the expected margin expansion in Life Science this quarter, and lastly, continued improvement in operations and the supply chain and the purchasing improvements we’ve made worked our way through the procurement cycle and through inventory.

In the short term, the dollar has remained relatively strong for most of the last few months and that will help. We’re largely hedged against currency movements for both the second and third quarters of 2010 so any further weakening in the euro will not significantly improve our profitability in the short run.

Moving down the income statement, operating expenses excluding restructuring were $52.7 million compared with $49.5 million in Q4 and $49.6 million in last year’s first quarter. Largest part of the increase was a 2.1 billion addition to our bad debt reserve that we announced on March 30 and that reduced EPS by $0.05.

Pass-through company name Cambridge Global Services purchased three systems through a set aside program on behalf of U.S. Federal Agency and a prime contractor. We have delivered the systems to our end user government customers. Government agency and its contractors have paid Cambridge but Cambridge has not paid us.

We’ve super payment and our action is one of several suits that have been filed by other scientific equipment companies against Cambridge were similar Federal government-related purchases. The rest of the operating expense increase came from a number of items including increased sales commission and higher than planned R&D project spending. We remain focused on control in spending and expect operating expenses excluding restructuring to drop back to approximately 50 million in the second quarter.

Restructuring expenses were $914,000 in the quarter compared with $826,000 in the fourth quarter, reduced earnings per share by $0.02. Restructuring expenses in Q1 are related to severance costs and the reclassification of vendors as we ship our supply chain from European base to Asia to reduce costs and to retain a better currency balance.

We announced on April 12 that we plan to move the remaining small DualBeam manufacturing and approximately 50 jobs from the Netherlands to the Czech Republic. We expect approximately 9 million of expense with that move and other restructuring activities primarily for severance in the second quarter. We currently expect restructuring expense of approximately (inaudible) in the quarter in the second half of the year.

As we said when we announced the manufacturing move on April 12 we expect to reduce our costs by about $4.5 million per year once the move is completed. We will see those benefits beginning in 2011 and they are expected to being an addition to the improvements that we have underway to get to our 42% gross profit margin target by the end of this year.

Small sequential decline in revenue, improved gross margins and increased operating expenses led to a decline in operating income for the first quarter to 5.6 million compared to 9 million in the fourth quarter and 8.1 million in last year’s first quarter.

Below the operating income line, total other expense was $600,000 compared with $1.3 million in the fourth quarter and $300,000 a year ago. Lower interest income due to the very low market interest rates are likely to keep non-operating expense around $1 million for the next several quarters.

Tax rate was 17.1% for the quarter compared with 14% in the fourth quarter. The rate remained below due to the allocation of income by legal entity. We expect the normal Q2 rate to be approximately 25%. All of this leads to GAAP net income of $4.1 million or $0.11 per share for the first quarter. The additional bad debt expense was a $0.05 charge and restructuring costs were $0.02 charge.

The fully diluted share count was 38.3 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. Total cash and investments at the end of the quarter, including restricted cash and long-term investments was $408 million and net cash was $260.8 million or $6.88 per share

Net cash decreased $8.7 million from the end of Q4 and increased $58.7 million from a year ago. 4.7 million of the sequential cash decline was relating to currency changes.

Operating cash flow was positive $2.3 million for the quarter and the first quarter is normally seasonal low and we do expect considerable cash generation for the full year.

Inventory turnover improved in the fourth quarter and last year’s first quarter and DSOs improved from a year ago. Capital expenditures were $2.6 million for the quarter and depreciation expense was $4.3 million.

Turning now to our guidance; it assumes a euro rate of $1.35. We expect revenue for Q1 to be in the range of $145 million to $150 million. The weaker euro reduces revenue but improves margins and lowers operating expense.

Bookings which are normally down on a seasonal basis from Q1 to Q2 are expected to be above $160 million, which would then be another quarterly record. Gross margin is expected to be above 40%. Earnings per share exclusive of restructuring charges are expected to be in a range of $0.18 to $0.23. Restructuring charges primarily related to severance costs, including those related to our small DualBeam move are expected to be approximately 9 million or $0.23 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. Net orders were very strong at $167.9 million. That’s the largest first quarter in our history by more than 10% and the third largest quarterly total ever.

Fourth quarter of $163.3 million and assuming we hit our guidance for Q2 will have three quarters in a row of bookings above $160 million. FEI strategy is driving success of the global economic recovery.

In addition, the gross margin on the booked orders in the last two quarters have increased steadily from a low point in the third quarter of last year when the market was particularly difficult. Net increase is due in part to the expansion of the higher margin Electronics segment and to growing orders for FEI’s new products.

Turning now to our market segments. Strongest part of our business was the Electronics segment where bookings of $56.4 million were up 70% from last year and 13% from the fourth quarter. It was the largest electronics bookings quarter since 2004. Our Electronics business did not decline as precipitously of the semiconductor capital equipment industry during the downturn and we’re now fully participating in the recovery.

Semiconductor industry is investing in new nodes and materials. They need our next generation tools to make that transition, particularly, as 22 nanometer line widths appear on the horizon. Our growth is building on the momentum for the expanded use of TEMs from leading logic and memory companies to support process development, RAMs and excursion control and manufacturing.

We recently announced the addition to the Helios small DualBeam line also saw very good demand. (inaudible) our manufacturing capacity in the near-term.

Our new product flow continues with strong interest and key placements in the Helios 1200 Wafer level DualBeam and a Tecnai Osiris high speed analytical TEM.

With the Magellan, we’re increasing our penetration to the SEM portion of the market where we have historically had negligible market share. This quarter we booked more Magellan than in all of last year with new placements and follow-on orders from established customers.

We’re well positioned with the strong product line of focus strategy and take advantage of the industry trends and the improving environment. In addition, we’re benefiting from the strength in a disk drive business which added around 25% of this quarter’s electronics booking, double last year’s first quarter.

Looking forward in electronics, we expect continued strong orders in the second quarter. Visibility has limited but we remain cautiously optimistic on the second half of the year.

Research and industry bookings of $41.9 million for the quarter were up 6% compared with last year’s first quarter. They were down 28% from the fourth quarter but the sequential decline is smaller than we have seen in the last four years. Our research pipeline continues to be solid and we expect significant sequential bookings growth in Q2.

We had a particularly strong quarter for research in Japan with three Titan P [ph] and orders in the homeland of our major competitors. U.S. research bookings were flat with the fourth quarter. Our research and industry business continues to be driven by infrastructure spending around the world as companies build their economies for the long-term. For example, this quarter included significant orders from China, Romania, Poland, Germany, Hungary and France.

Orders in Life Sciences of $17.7 million were up 14% from Q4 and down 8% from last year’s first quarter.

This morning we issued a press release about publication and the prestigious life science journal Cell, by our customer Professor Hung Zhou and his colleagues at UCLA and the California Nanosystems Institute. They achieved atomic resolution of viruses and solution for the first time ever using a Titan Krios. This paper show that the Krios can provide (inaudible) unattainable Life Sciences information that exceeds the capability of established tool such as x-ray crystallography and NMR.

We expect this achievement will stimulate additional interest in the Krios for Life Science research. Ultimately, the ability to understand the structure of viruses and other complex biological machinery and solution at the atomic level will open up avenues for the development of therapeutics and diagnostics for the treatment of disease.

Global stimulus orders were under $10 million for the quarter as U.S. releases were bias toward smaller value brands and thus had less impact on FEI.

We expect global stimulus bookings for 2010 to be greater than 2009 and with additional orders coming in 2011.

Finally, our servicing and components bookings were seasonally strong in the quarter, up 31% from the fourth quarter and up 34% from a somewhat to do level in last year’s first quarter.

We normally see a sequential increase in the service orders in the first quarter as customers renew annual service contract. This year that seasonal strength was augmented by a three-year service contract renewal from a large electronics customer. Thus we’re expecting somewhat larger than normal seasonal decline in the bookings for service in the second quarter.

As FEI comes up with strong order quarter we’re expecting bookings in the second quarter to be greater than $160 million. Achieving that goal make it the largest second quarter bookings total in our history.

Bookings strength has been supported by positive reception of our new products in the marketplace. In addition for the excellent Magellan bookings I mentioned earlier, we’re pleased with the positive response of the Helios DualBeam series, Helios 1200 Full Wafer DualBeam and the Tecnai Osiris.

A key challenge for us is the speed in which we can transfer our record backlog interrupted. In the near-term, we’re finding the customers at all three of our markets have ordered products for delivery and advanced their facility readiness facing revenue growth.

We expect the facility this year is to work themselves out over the next couple of quarters. The rapid increase in bookings in the Electronics market has also pushed out our own lead times for certain products, which has limited our ability to increase revenue. We expect this will be resolved by the end of the quarter.

Along with our announcement to move small DualBeam manufacturing to the Czech Republic that Ray described we’ve also implemented the strategically important in terms of the organization and resource reallocation to improve our ability to bring customer focus solutions to our markets and do it faster.

As we more and more to providing differentiated application specific solution to targeted markets rather than standalone hardware our goal to increase both our growth rate and our margin. The changes we made an important step on that road.

As we look at the remainder of 2010 we’re on track for margin expansion for the reasons that Ray outlined. Increase revenue, higher margins and the backlog, stronger dollar and our associated hedging program to protect our physician and continue to improving on our operations and supply chain. Also we’re looking for meaningful revenue growth in the second half of the year as the Electronics segment will continue with significant growth this year. Life Sciences will continue to cycle adoption for the Krios aided by significant scientific results from our customers and continued worldwide infrastructure spending on the nano technology.

Finally, our balance sheet remains rock solid and gives us the opportunities to explore acquisitions. As a result we continue to expect 2010 will be a growth year for FEI with improving margins as we lay the ground work for continued improvement in 2011 with the move of some manufacturing for the Netherlands to the Czech Republic.

Before we go to questions I want to remind everyone that we’re planning our annual investor meeting for this year on Friday, May 21, at 10 A.M. in New York. If you like to attend please contact Fletcher at the e-mail address or phone number on today’s press release.

With that operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question is from the line of Bill Ong with Merriman & Co. Please go ahead.

Bill Ong – Merriman & Co.

Yes, hi, Good afternoon, gentlemen. Just some accounting questions. The bad debt expense of $2.1 million, is that included in R&D or SG&A or somewhere else?

Don Kania

It’s in SG&A.

Bill Ong – Merriman & Co.

Okay and what type of tax rate can we expect going forward?

Don Kania

I would use 25% there. Realistically, it can still vary, but I think that’s the safe number to use.

Bill Ong – Merriman & Co.

Okay. And then on your bookings given that your results of $168 million and guidance $160 million, it’s fairly safe to assume revenue should be at the $160 million plus run rate in the second half?

Don Kania

We don’t I mean too specific about that, but the run rates, obviously, should start to converge at some around those levels as we get into the second half of the year. So that’s a reasonable observation. So we’re not giving a specific second half forecast.

Bill Ong – Merriman & Co.

Fair enough. And then my last question is, if you kind of look from 2005 to 2010 projections, the CAGR growth rate during those five years is about 8%, recognizing the financial downturn that happened recently. Given your markets are somewhat mature, but you do have emerging growth in Life Science, what type of CAGR can we expect, say, in the next five years?

Don Kania

I think in excess of 10% and the way we view that is somewhat mature market in the research area is still going to grow because we think there’s opportunity there and we’ll help grow that by expanding the customer base. We talked in the past about introducing TEM tools that will appeal to chemists more so than the traditional material science that we do. So that’s the way we can help grow that market. (inaudible) will take a long as we grow our installed base.

Electronics were coming off a cyclical low and though I’m not fully subscribe to the theory that the so-called super cycle, I do believe that we’re going to have a good year this year and as people start to invest in new fabs, which they haven’t for quite a while, we’ll see some good extended growth in the Electronics businesses. I think Life Sciences got some; we’re really on that process. The NMR and markets that we can start to now access, in our estimates are in the $500 million to the $1 billion scale that we don’t really address directly today. I think take pieces of those markets at relatively high gross rates. That segment has been growing for I think like 20% CAGR for over the past few years. So I think you combine those together you see an excess of 10% growth rate for us over the next two years.

Bill Ong – Merriman & Co.

Great. Thank you very much, gentlemen.

Don Kania

Thank you, Bill.

Operator

Our next question is from the line of David Luke with GC Research. Please go ahead.

David Luke – GC Research

My first question really comes to, when I look at the gross margin on Electronics, which has been rising rapidly, I guess those gross margin weakness in Q1 must be a result of those bookings during the weak period of 2009. And I was just wondering when are we out of those that have a low gross margin backlog?

Don Kania

Yes, I think your observation is correct that we took some business at lower gross margin in the Q2, Q3 timeframe, that’s revenue-ing now and we expect those margins to uptick next quarter. I’d highlight a little bit further that’s if you know it’s a lot of the new product discussion that we had, involve products that serve the Electronics segment and all of those come with superior gross margins and the segment has been producing over the past couple of quarters.

David Luke – GC Research

How quickly do you think we’ll get back to the sort of 50% gross margin that we’ve seen in the past out of the Electronics segment?

Don Kania

I think the way I’ll answer that is we expect to see continuous improvement in the gross margins in that segment over the next few quarters’ right through the end of the year. So you should expect to see continued improvement in that segment.

David Luke – GC Research

The other thing I was wondering is now that Greece and Spain have been such a wonderful headline stuff. If you look at your business in Europe, how much of the Research business comes out of the weaker countries as opposed to the Germany’s and the France’s and the UK’s?

Don Kania

By weaker countries you mean the –

David Luke – GC Research

The so-called eight.

Don Kania

I think our business that we do in those regions we’re forecasting in the near future is modest to vanishingly small. I think the virtuous thing for us we did get some nice orders from Spain in the past few quarters, but those are in place and just to remind you those in the research area orders aren’t typically placed until funding is located. So we feel pretty confident in that piece of the backlog that we have as well and we checked. So it’s not going to have a big tremendous driver at all, as we look forward. And those countries that have weathered better in Eastern Europe, have also been, as we highlight, I think in the last couple of calls as well.

Source of strength and actually that continued this last quarter with more orders there. So Europe has got a broader-based and it did for FEI even a year ago. It’s moved better than Germany, France, England, and other Nordic countries and now we’re seeing more traction in Eastern Europe, where we have some developing economies that are investing in the future.

David Luke – GC Research

One last question is in terms of hedge, I guess the exchange rate currently is almost $1.30 on Euro. When do we see the impact of that with the hedge I guess that’s just the delayed action? Assuming exchange rate continues at a $1.30 level, when do we see the effect on you?

Ray Link

We will see some benefit in Q2 and Q3. How we run our programs here as we look longer-term and do have contracts in place to offset while swing and we will have some contracts that will cost us some money, which is built into our Q2 forecast. But, as we move into Q4 and beyond, on a longer-term basis, FEI is certainly better off at Euro 1.30 or weaker.

David Luke – GC Research

Okay, thank you.

Operator

Our next question is from the line of Hari Chandra with Deutsche Bank. Please go ahead.

Hari Chandra – Deutsche Bank

Thank you. Can you just quantify what percentage of your 2009 sales were from stimulus related spending, both in the U.S. and international and how do you see that trending up in this year?

Don Kania

We never have been overly specific, but it was in the range of, I’ll say 40-ish million I believe last year and I’m looking at Fletcher to help me out with that.

Fletcher Chamberlin

Including outside the U.S.?

Don Kania

Global stimulus.

Fletcher Chamberlin

Bookings.

Don Kania

Yes, bookings, we’re talking about future. And we expect that the uptick this year with some tail into 11.

Hari Chandra – Deutsche Bank

Can you just elaborate a little bit on the weakness you’ve seen in the Life Sciences and R&D in the current quarter?

Don Kania

Yes, I think in the research areas this is quite tradition. You get a good spike in fourth quarter. People spend out their budgets than annual budgets. And then we see a low in Q1, that’s a pretty typical seasonal pattern. And as we guided we expect a pretty strong recovery and research in Q1, which is also not unusual to say. On the Life Sciences area I think we’re dealing with some of the granularity as we highlighted before we have a few number of large dollar transactions in that business. So, it will move around from quarter-to-quarter.

Ray Link

Like to add to that also, a year ago, we had our large order in Saudi Arabia that was both Research and the Life Science. So the year-to-year comparison (inaudible) significant revenue in Q1 and Q2.

Hari Chandra – Deutsche Bank

And on the office guidance of $50 million. Is it only because of the bad debt expense being out or is that the run rate that we should look to?

Ray Link

That’s a run rate you should look to. We have spending controls in place. We look at a little benefit from the weaker Euro and we’re fully expecting not to have a recurrence of the bad debt charge in Q2.

Hari Chandra – Deutsche Bank

Okay, thank you.

Operator

Our next question comes from the line of Satya Kumar with Credit Suisse. Please go ahead.

Satya Kumar – Credit Suisse

Yes, hi, thanks. I just wanted to understand a little bit, it sounds like in Q2, and we should not expect the benefit from the currency because of the hedging. But in steady state for every $0.05 decline in the euro, could you remind us what the benefit the gross margins and operating margins are?

Ray Link

Sure. We will get some benefit in Q2. So I want to put that on the table. We won’t get the full benefit because we do have some currency contracts that will offset some of that that we put in place in the second half of last year when the euro was significantly stronger. The general rule of thumb is that for any movement impacts our revenue about $400,000 and we saw that this past quarter where we had slightly under a $0.10 movement in our revenue and constant currency decline about 4.1 million. And the same calculus on operating expenses is that normally a penny movement is somewhere between $150,000 and $200,000 reduction on a non-hedge situation. But on longer-term basis especially as we get into Q4 and beyond we should receive the full benefit.

Satya Kumar – Credit Suisse

And I just wanted to confirm that the 42% gross margin outlook for Q4 embed is $1.35 exchange rate?

Ray Link

The 42% margin at $1.35 is definitely our target.

Satya Kumar – Credit Suisse

How will OpEx trend in the second half assuming revenues get somewhere in the ballpark of the low $160 million type levels in the back half of the year?

Ray Link

OpEx, if I understood the question, OpEx really won’t track up much. It will track up a little bit because the commissions related to those incremental sales. Assume there was 10 million of incremental revenue there will be several $100,000 of incremental commission.

Satya Kumar – Credit Suisse

Are you willing to talk to a potential target operating margin level at 42% gross margins?

Ray Link

We’re targeting above 10%.

Satya Kumar – Credit Suisse

Okay. You mentioned that you saw some increases in lead times for some of your products. I was wondering if you could elaborate on what products are the increase lead times and what type of increase in lead times we are talking about. I’m trying to get a sense of whether for FEI book-to-build can approach parity at some point.

Don Kania

I think the major limiting factor right now is in the new Helios. We call it X50 Series. We were pleasantly surprised. In fact, going through the cycle internally, we expanded the build plan, we raised our forecast, again, expanded the build plan. And we got to the third time we found that in Q2 we just couldn’t expand the build plan any more. As I have said we expect that to get rectified in the later quarters of the year. And certainly before we exit the year I hate to talk book-to-build because it’s going to be speaking the orders but I think $160 million in the latter half of the year per quarter is achievable.

Satya Kumar – Credit Suisse

If I can squeeze in one last question, as you look at the bookings pipeline in the second half of the year, is the right way to think about the business in the back half or are you seeing any pull-ins of orders in the Research segment just given the macro issues in Europe?

Don Kania

I would say until the last point the pull in of orders I don’t think we see any evidence for that. And I think if we look in the Research segment globally, if anything we still see (inaudible) in the U.S. I think the spend waiting for all the stimulus noise to settle out. We’ll get additional orders from that which we'll revenue subsequent to the orders. But I think we don’t sense there’s any shift in the environment overall. That’s business is in good shape and continues to flow so. No concern there.

All in fact, I think we remain optimistic; we got some new products going to be coming out in that segment as well. I think Research is in good shape, as we comment about Electronics, we’re bullish on Electronics. Second half, of course, anybody has real visibility, but nonetheless, our optimism is getting a little more traction as we go forward, believing it will have good flow in the second half of orders as well.

Satya Kumar – Credit Suisse

All right, thank you.

Ray Link

Thank you, Satya.

Operator

Our next question is from the line of Jim Ricchiuti with Needham & Co. Please go ahead.

Jim Ricchiuti – Needham & Co.

Thanks, good afternoon. Looks like you’re expecting a pickup in your Service and Component revenues beginning in the June quarter and I assume continuing into the second half of the year. I wonder if you can talk a little about how we should think about the gross margins in that segment of the business. Should we assume that that picks up from Q1 levels, which look a little bit lower than you’d expect?

Ray Link

Yes, Jim, this is Ray. I think what we’re trying to say there might be a little bit of confusion on the Service business. Service business had a great quarter and on a year-over-year it was up about 12%, it was only up about 3% relative to the fourth quarter. And I think what we’re trying to say is that our year-over-year comparisons are going to look fairly robust because we had really flow service revenue particularly in the first half of last year. What happened was that service contracts to some extent are a variable cost, so lab managers, whether they are in semiconductor or college or universities when the financial crisis hit, drop the service contracts, went to time and material, as the year progress, they realize they’re actually better off on service contracts, which is I think one of the reasons why we had very strong booking in Service coupled with we had a very large three-year booking from a major customer. I think as we look into Q2 and beyond we will see modest growth relative to Q1. There will be strong growth year-over-year of at least still close to double-digits modest relatively to Q1.

Margins were actually excellent in Service. In Q1, it was 32.3%, up from 29.1% last quarter. And frankly, 32.3% for Service and Component is above our target. And we will be very happy with 32.3% margins on a go-forward basis. With that said if anybody from a Service and Operations (inaudible) you need to do better.

Jim Ricchiuti – Needham & Co.

Okay. Thanks for clarifying, Ray. If we think about your OpEx for Q2, clearly your SG&A is going to be down. Will the currency effect also impact your R&D where that will be down sequentially?

Ray Link

R&D should be down on currency. That’s correct.

Jim Ricchiuti – Needham & Co.

Okay. And just in terms of thinking about bookings and Q2, if we think about $160 million bookings number, it sounds like you’re expecting fairly significant increase in Research, and I guess, Service and Components you think will be down sequentially. Electronics given the strength in Q1, I would expect that’s going to be difficult to maintain that kind of momentum. And then would you anticipate your Life Science bookings would be up?

Don Kania

I think Electronics we expect to be something sideways.

Jim Ricchiuti – Needham & Co.

Okay.

Don Kania

In the quarter. And the Life Science is let’s just say sideways there too and again, that’s the granularity thing that makes it hard to make that call. But those two sideways Service down, obviously, and Research up.

Jim Ricchiuti – Needham & Co.

Okay. And you guys may have touched on this, but just in the Life Science market, do you feel that the issues now with Krios are behind you? You may have touched on this already. I apologize if you did, but in terms of the margin impact we should see less and less of that in Q2 and certainly much less in Q3?

Ray Link

Exactly. You should see positive margin momentum going forward as we burn through those early units that we shipped last couple of quarters.

Jim Ricchiuti – Needham & Co.

Okay, thanks very much.

Ray Link

Thank you.

Operator

Our next question is from the line of Patrick Ho with Stifel Nicolaus. Please go ahead.

Patrick Ho – Stifel Nicolaus

Thank you very much. Don and Ray, just given some of your exposure to the European market as well as the shift in manufacturing, interruptions in air travel earlier this month? Has there been any impact at all for you guys as you make that switch or in terms of deliveries of tools?

Don Kania

The biggest impact was personal for Ray and we were both in Europe when it happened because 40 hours to get from Amsterdam to Portland, Oregon. But in terms of the operation, no, the impact is negligible on the quarter. We’re watchful though. I will highlight that it occurs at the end of the quarter when there’s, as you know, we’re back end loaded in one of our shipments, it could have a negative effect on performance during the period. But in terms of what happen to-date there is no effect at all.

Patrick Ho – Stifel Nicolaus

Great. Good to hear. In terms of this manufacturing shift, how much of it are you going to have in terms of duplicate costs in the near-term? And the reason I’m asking is you guys are still posting growth in margins through the year. So it seems you guys have a pretty good control of this manufacturing. What is the offset, I guess, the duplicate costs and when (inaudible)?

Ray Link

Patrick, this is Ray, you cut out a little bit but I think the question was the costs as we transition the small DualBeam product line. The answer to that is there’s a little bit but it is not really significant. We already have a factory in the Czech Republic, the Czech Republic’s already making some of our lower as small DualBeam product line. So those costs are really built in.

Patrick Ho – Stifel Nicolaus

Great. Final question in terms of revenue outlook as we (inaudible) the year. Given your strong (inaudible) look for the June (inaudible) three-quarters worth of really strong bookings, when do you expect (inaudible) to turn into revenue, is it a 6 month to 12 month kind of cycle or is it 3 month to 6 month type of cycle where the revenues could start showing up in the second half of this year?

Ray Link

You broke up a little bit, but I think the comment is we had a good bookings around, we’ve been doing 160, and we may do it again in Q2, when do revenues approach those levels. And I think our comment right now is for the second half.

Patrick Ho – Stifel Nicolaus

Great, thanks a lot.

Operator

(Operator instructions) Our next question is from the line of David Duley with Steelhead Securities. Please go ahead.

David Duley – Steelhead Securities

Good afternoon. I was wondering are you a little bit surprised with the level of stimulus spending or ordering thus far and why it just seems like it’s at a pretty low level. And I was just wondering what might be the road blocks to make it go to a higher level?

Don Kania

Yes, we’re disappointed. I think the flow and I think the major impact from our perspective is ASPs are $1 million, right, that’s the company. So we need grants to be larger in size for people to be able to buy our equipment. And what we’ve seen is in some instances, a lot of that money that’s been released to-date flowing out to on average dollar basis therefore it just doesn’t drive business to our direction. But having said that our current view of 2010 and '11 it’s still a significant bump in the Research, Life Sciences areas to a meaningful add to orders in that period. But yes, we just (inaudible) I think so.

David Duley – Steelhead Securities

But, you still basically expect the money to come?

Don Kania

Yes, just government. Slower than what we wanted. If you are in charge you to spend all the money already, wouldn’t you do? I’m still waiting for my Street to get that.

David Duley – Steelhead Securities

Just another clarification question. What impact did the currency have on the gross margin line this quarter?

Don Kania

It had an impact of over 4 percentage points.

David Duley – Steelhead Securities

That was a favorable impact in the quarter?

Don Kania

Favorable impact, correct. Thank you.

David Duley – Steelhead Securities

Okay, that’s it for me. Thanks.

Ray Link

Thanks, David.

Operator

Our next question is from the line of Mark Miller with Noble Financial. Please go ahead.

Mark Miller – Noble Financial

Question about the two products, the types that are very successful products for you. Just wondering, at that time you thought there’s not a huge market, but what percent of the Titan market, and I don’t want to talk about the Krios, but the Titan market, do you feel it’s been sold into of your total available market?

Don Kania

I’ll be a little bit carefully here to so we’re clear. I think the Titan market that we sold into if we compare to its predecessor tool which was the Tech Nite [ph] to very small lever of penetration. That was I think it’s 800 units to 1,000 units if I remember correctly over seven year period, give or take a little bit, we still the former high end tool into. And to-date I think we announced the couple of quarters ago we had 100. So we think we’re still relatively early in that cycle. So I don’t expect that we’re seeing market saturation. But having said that FEI strategy is to basically take that base platform, add new capability to it, to attract new customers. The Krios is an example of that. And the ETEM, so called ETEM which is Titan for chemist is another variation on that theme. So we’re driving at it from two sides. One, there is people who buy TEMs that I think over time will still require Titan and two, we’re going to find new customers create tools that’s appealing to customers who haven’t bought TEM support.

Mark Miller – Noble Financial

Relative to understand what you’ve said it appears for all different variation of the Titan you probably saturated 10%, 15% of the market, which you feel might be the margin, is that –?

Don Kania

Right, long-term market place for it. It will take years, but absolutely.

Mark Miller – Noble Financial

The Magellan, I know, you seem make some progress there. It might have been a little slow maybe because of the recession. Any estimates for what the market size would be for that and (inaudible)?

Don Kania

Yes, I think not such electronics I mean we think $100 million plus place for on an annual basis for products in there, major competitor there is Hitachi, who I think we’re definitely taking some share away from in the process. So, the traction in the research side for that product is we’ve always expected would be behind it and we’re seeing traction there as well. But, right now, it’s primarily semiconductor story.

Mark Miller – Noble Financial

Thank you.

Don Kania

Welcome back Mark.

Operator

Our next question is from the line of Ben Catholic with First Investors. Please go ahead

Ben Catholic – First Investors

Yes, hi guys. Sorry if I missed this, but can you give us fair idea what the current impact negative was on the top-line? I think you said that you would have been within the guidance this quarter. Any idea of how much it impacts your guidance for the Q2?

Ray Link

Sure Ben, this is Ray. The impact on Q1 on constant currency relative to Q4 was $4.1 million. We are still in the currency rate similar to Q4’s rate, for our Q1 guidance, so if you add the $4.1 million we’re theoretically at a $153.1 million.

Ben Catholic – First Investors

Okay. And then so I could just use a math to figure it out for Q2, right?

Ray Link

And then on Q2 we’re guiding at a $135 rate, which seem like a good rate to use yesterday, tremendous change again today. And our average rate for Q1 was $139, so that’s roughly about $2 million.

Ben Catholic – First Investors

Okay, that’s helpful, thanks

Ray Link

3.2 to 2.

Ben Catholic – First Investors

And then if I just extrapolate that to the bookings number I mean I would assume on a constant currency bookings somewhere that 160 is pretty, pretty strong number then, right? Or that's assuming the $1.35?

Ray Link

With the record quarter for us for second quarter, it’s a little harder to extrapolate the currency changes the backlog because backlog, first of all, is much larger and the composition of backlog in terms of what currencies we’re billing in, it’s more significant. We have more currency that we sell into backlog than we manufacture it. So with that said, we had a $7.7 million I believe downward adjustment with the changes in the rates between Q4, Q1 and we’re looking if we were to close it right now, we’re about $0.06 lower, which is about the same delta the Q4 versus Q1 so with everything we’re constant would be maybe a $7 million ahead.

Ben Catholic – First Investors

Okay, okay, great, thanks.

Operator

(Operator instructions) Our next question is from the line of Robert Weaver with Forest Investments. Please go ahead.

Robert Weaver – Forest Investments

Yes, hi, could you give me color on the types of acquisitions that you’re looking at in terms of size, what geographies, what technology areas you’re looking into, just trying to understand how you view that as part of strategy?

Ray Link

Right, okay, so, there’s really two major buckets to think about. One is we characterize as our core businesses, research, service and electronics. We would be looking at acquisitions that would improve the profitability essentially of those businesses overall. So primary bring something in, your accretive (inaudible) immediately and move the needle in terms of financial performance, the primary criteria there. When we look at the businesses in Life Science and Natural Resources, who are industrial segment, there we look at opportunities to move into adjacencies and expand our footprint in those two marketplaces. Go across the board primarily would be to do something that’s meaningful, $50, $100 million of revenue would be a nice working spot for us affordable, manageable by FEI, would make a change overall.

So I think that’s the landscape that we try to portray it. I think underneath that if we saw like we did, like with launches international resources which was a couple of small things that we tucked in and turned into a business we’re certainly open to those kinds of activities. One is given a blank sheet of paper say what you want to do, $100 million in revenue increasing sum for FEI and maybe a nice growth opportunity it would be adjacent to something in either Natural Resources or Life Science.

Robert Weaver – Forest Investments

Okay, thank you.

Ray Link

Certainly.

Operator

Our next question is from the line of Mark Miller with Noble Financial. Please go ahead

Mark Miller – Noble Financial

Are we going to focus on margins and you are projecting that margins are going to be moving up, and I am just wondering I assume some of that product mix with micro electronics, the others volume, but are there any constraints this quarter that we heard about. Some of the products are going at over maybe sold to lower margins because of the economic difficulties in previous quarters, also Krios ramp. Were there any constraints this quarter, in terms of significant constraints besides product mix and higher volumes that might also lift margins in the quarter ahead?

Don Kania

Yes, I think, this quarter we suffered a little bit, electronics is little over than we liked (inaudible) in the middle of last year. And as we commented earlier we expect that to accelerate over the next two quarters, as we start the revenue and more recently backlog orders. So I think that’s a fair statement on Q1, Q4, Q1, kind of going through that drop that came out of Q2, Q3 in terms of margin performance. And we’re accelerating out of that. We guided, we pumped up 0.5 this last quarter, and we’re guiding about 40 for the next quarter. And we’ve also mentioned just to give you some confidence as we look at that backlog from the Q3 to the Q1 timeframe the margins have improved significantly in the backlog orders, so we feel some confidence that not just words that will get the 42 in Q4.

Mark Miller – Noble Financial

Well, since I last looked at you’ve done a good job on the services, is there anything more there or are we kind of topping out at least momentarily on the service margin?

Don Kania

I think I gave our team there a real credit for big bump of it at the end of the year. It’s really highly that numbers probably not sustainable in the short-term, but, long run, it’s relentless, I mean it (inaudible) runs that business for us, put a lot of pressure and to continue improvements and there is room for improvement. So we should expect that continued flow, but I think we should give that team credit for Q, but don’t expect that to be the operational margin level in the next couple of quarters, but down the road for sure, we should hold those levels and exceed those levels.

Mark Miller – Noble Financial

Would it be harder to say those have risen maybe about 500 basis points over the last year, I recall where you’re at a year ago?

Ray Link

32.3 in Q1 versus 29.1 in Q4, so they have never been trending out.

Don Kania

And it’s been trending up if you look just the trend line over the past, so seven years that business has been trending upward.

Mark Miller – Noble Financial

Is that around 25% a year or just trying a little?

Ray Link

We are actually bottom closer on 25% a couple of years back and we are trending up, almost since our manager came up for us.

Mark Miller – Noble Financial

Well, good job.

Operator

(Operator instructions) At this time, I show there are no further questions. I would like to turn it back to management for any closing remarks.

Ray Link

Yes, I would l like to want to thank everybody for their interest in the call of FEI and then a reminder that we are going to have our Investors Meeting, Friday, May 21st A.M. in New York. Contact Fletcher will so introduce in just a second here, if you would like any more particulars on that meeting, so Fletcher.

Fletcher Chamberlin

The meeting is going to be at 1, Madison Avenue, 10:00 A.M., it will go, we will talk and do presentations with members of the management team, little past noon and then lunch will be available. We look forward to seeing you. Let me know by e-mail or by phone if you like to come. Thank you very much for being on the call. We appreciate it and look forward to seeing you in New York.

Operator

Ladies and gentlemen, if you would like to listen to a replay of today’s conference please dial 1-800-406-7325 or 303-590-3030 and entering the access code 428-5936 followed by the pound key. The replay will be available until June 4th 2010. This concludes our FEI Q1 earnings conference call. Thank you for your participation. You may now disconnect.

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