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Executives

Fletcher Chamberlin - Treasurer & IR Director

Ray Link - EVP & CFO

Don Kania - President & CEO

Analysts

Noah Huth - Merriman & Company

Jim Ricchiuti - Needham and Company

Mark Miller - Noble Financial

Peter Kim - Deutsche Bank

Patrick Ho - Stifel Nicolaus

David Wu - GC Research

FEI Co. (FEIC) Q2 2010 Earnings Call August 5, 2010 5:00 PM ET

Operator

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the FEI second 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) This conference is being recorded today Thursday August 5, 2010. I would now like to turn the conference over to Mr. Fletcher Chamberlin. Please 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, Executive Vice President 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 improvements, market developments and opportunities, 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 of 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 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 website 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 I’ll turn the call over to Don. We had a good quarter. Orders were very strong for the third quarter in a row, given us a record back log. Gross margins improved by more than 1% from the first quarter and last year’s second quarter.

Revenue was inline the expectation despite of moderating impact of the Euro/Dollar exchange rate that was lower than our guidance assumptions. Operating expenses excluding the restructuring were down.

GAAP EPS was $0.40 and earnings excluding restructuring had a significant one time tax benefit worked the high end of our guidance, ahead of consensus estimates and above both the first quarter and last year’s second quarter. We now have recoded 17 consecutive quarters of GAAP profitability.

Turning now to the details, net bookings for the second quarter were $175.1 million, up 4% from the first quarter and up 11% from last year. That’s an all time record for second quarter and the second highest for any quarter in the company’s history.

Gross bookings were a $185.1 million and were reduced by $9.9 million due to the re-valuation of the backlog for currency movements. The backlog at the end of quarter was $402.5 million, another record high. Don will talk more in a moment about the composition of the bookings and our market outlook.

Net sales of $146 million were down 2% compared with first quarter and up 4% from last year’s second quarter. This average currency rate have been the same in Q2 as in Q1, revenue would have been $5 million higher, up compared with first quarter.

Electronics revenue up $56.9 million or up 38% from the first quarter and up 76% from last year’s second quarter, the highest level since the second quarter of 2007. Book-to-bill ratio for electronics is 1.26 to 1 as we build backlog for electronics in second quarter and are looking for more revenue growth in the second half.

Life science revenue $14.6 million up 10% in the total and was down from last year’s second quarter and from the first quarter. However, orders were strong and the book-to-bill ratio for life science was 1.89 to 1. Research and industry revenue up $37.4 million made up 26% of the total and was down 19% from the first quarter and down 32% from last year’s strong second quarter which included significant shift into our large accounts order.

Service revenue up $37.1 million for the quarter, in level with the first quarter and up 12% from last year’s second quarter. Geographically we continued our broad diversification with North America making up about 32% of revenue for the quarter and Europe making up 31%.

Asia, Japan and the rest of the world continued to have very strong performance making up 37% at second quarter revenue reflecting a strategy expand our presence in those markets over the last few years. As expected gross profit margins improved for the third consecutive quarter to 41% from 39.7% in a first quarter and 38.4% in Q4, last year.

Inquiries was primarily driven by foreign exchange since FEI’s margin generally improve with stronger dollar and weaker euro along with the higher portion of higher margin electronics revenue and continued improvements and service.

Moving down the income statement, operating expenses excluding the restructuring was $47.2 million compared with $52.7 million in Q1 and $48.5 million in last years second quarter.

The first quarter this year included $2.1 million addition to our bad debt for Cambridge Global Services as discussed at length last quarter. Aside from that operating expenses were down from the first quarter about equally due to impact of foreign exchange and expense controls.

We remained focused on controlling spending and expect operating expenses excluding restructuring to remain below the 15 million in the third quarter. Restructuring expenses were 9.1 million in the quarter in line with our forecast compared with 914,000 in the first quarter.

They reduced earnings per share by $0.22. Restructuring expenses were primarily related to severance costs including the costs relating to the plan to move our remaining small DualBeam manufacturing and approximately 50 jobs from the Netherlands to the Czech Republic.

Most of the restructuring expense will have a cash impact as severance payments were made over the next 12 months. As we said when we made the announcement in April, we expect the manufacturing move from the Netherlands to the Czech Republic to reduce our cost by about $4.5 million per year once the move is completed.

A small sequential decline in revenue improved gross margins and increased restructuring expense lead to a decline in GAAP operating income for the second quarter at $3.5 million compared to $5.6 million in the first quarter and $6.6 million in last years second quarter.

Excluding the restructuring expenses operating income was $12.6 million or 8.6% of sales. That’s 94% above the first quarter level and 64% above last year’s second quarter operating income excluding restructuring expenses and the past level since the third quarter of 2007.

Adjusted operating income margin is the key element from the way we measure our performance. So we are pleased with those gains. Below the operating income line, total other expense was 900,000 compared with 600,000 in the first quarter and $1.5 million a year ago.

Lower interest income due to variable market interest rates will continue to keep that operating expense around $1 million for the next several quarters. We have noticed that several analyst models have included unusually low net operating expense and we would encourage anyone publish the model to clearly reflect the expected non operating expense.

We registered a net tax benefit in the quarter of $13.5 million due to the finalization of an advanced pricing agreement between the US and the Dutch tax authorities that we announced in June. Compared with the normalized rate at 27%, the tax benefits in this quarter have added $0.40 per share to GAAP income.

In addition to releasing substantial tax reserves for closure our Q2 P&L, we’re able to release reserves of only $12.5 million directed shareholders equity. At the completion of this agreement, we’re also able to finalize tax returns and are expectedly generated net cash tax cash refund of approximately $5 million over the next six to nine months.

All this lead to GAAP net income of $16.2 million or $0.40 per deluded share for the second quarter, excluding restructuring expense and using normalized 27% tax rate, net income would have been $8.5 million or $0.22 per share. The cash, the press release and the table reconciled in the GAAP result to this non-GAAP result and the press release tax contains reasons why we believe non-GAAP measures are useful to investors.

The diluted share account was $41.8 million in the quarter, this include 3.4 million shares attributable to our two and seven eights percent convertible notes which are now included in the count because they are dilutive at this income level. For people building models there is an interest debt add back in net income of approximately $600,000 net of tax to calculate the diluted EPS.

We expect our diluted share count to be approximately 41.5 million shares in Q3 and the interest add back will be approximately $500,000. Our balance sheet remained very strong, total cash and investments ended the quarter included restricted cash and long-term investments were $375.5 million and net cash was $284.6 million, up $23.8 million in the quarter.

Net cash at the end of the quarter was $7.46 per share. During the quarter we received full par value for our auction rate securities and paid off the associated short term debt, improving our liquidity around investment.

We also repurchased $9.1 million of our convertible notes and slightly invested par reducing the diluted share count by over 300,000 shares beginning in Q3. Operating cash flow is positive $25.1 million for the quarter.

Inventory was in level with the first quarter and down from last year’s second quarter and DSO’s improved sequentially as well as compared with year ago. Capital expenditures were $1.8 million for the quarter and depreciation expense was $4.2 million.

Turning now to our guidance. It assumed that euro rate of a $1.30, we expect revenue for Q2, choosing for Q3 to be in the range of $150 million to $155 million. Bookings are expected to be above $165 million. Gross margin is expected to be around 41%.

GAAP earnings per share are expected to be in the range of 22 to $0.26 non-GAAP EPS exclusive of restructuring charges, are expected to be in the range of 23 to $0.27. Restructuring charges are estimated at approximately $700,000 or $0.001 per share and the tax rate is expected to be approximately 27%.

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

Don Kania

Thank you Ray and good afternoon everyone. We are pleased with the progress we made in the second quarter in both orders and margins. Net orders were very strong at $175.1 million that’s the largest second quarter in our history by more than 10% and the second largest quarterly total ever. Topped by the third quarter of 2008 when we received the past order for over EUR 20 million.

Looking to 11% above last years second quarter and up 4% sequentially. With the first quarter orders of $167.9 and assuming we hit our guidance for Q3 we will have averaged over $167 million per quarter for the trailing 12 months.

Turning to our market segments the strongest part of our business was electronics. Where bookings up $71.6 million were more than double last years second quarter and up 27% in the first quarter.

It was the second largest electronics total ever exceeding the last cyclical peak in 2007. Our strong growth was a result of the recovery in the industry and the expanding demand for TEM and DualBeam to support processed developments ramps and excursion control in manufacturing.

We were pleased with the strong demand from leading edge logic and memory companies. Demand for DualBeam tools remains very strong including our new Helios 1,200 wafer level tool and the new Helios 450 small phased tool. There were additional orders for the Titan TEM, Tecnai Osiris and the Magellan SEM.

In addition the, disk drive business remain strong in the quarter and made up around 20% of the electronics bookings.

We may see some moderation electronic bookings in the third quarter, we believe the overall outlook for the industry is good as it renews it investments in new factories through 2012.

In addition to industry strength, our exceptional performance is driven by a focus strategy, a strong product portfolio that is matched to our customer’s needs. Research & Industry bookings of 40.4 million for the quarter was slightly below the first quarter and down from last year’s second quarter.

The bulk of our 9.9 million reductions in booking due to revaluation of the backlog occurred here. Our research pipeline continues to be very solid and we expect bookings growth in research in the second half of the year.

Our research business continues to be driven by infrastructure spending around the world, as countries build their economy through the long term. This quarter included significant orders from China, Brazil, Poland, Germany, Hungary and Spain.

Even with the discussion of fiscal austerity in Europe, we see increase commitments of scientific research there. For example, in France, President Sarkozy has re-affirmed their research funding through 2012, and is allocated towards larger projects which is good for FEI.

In Germany, the university’s excellence program targets improving the competitive position of their university system and is also funded through 2012.

And in Brussels, the European Commission announced a EUR 6.4 billion investment for research & innovation. Our European research bookings were up over 90% in the second quarter, compared with the first quarter and we expect order growth from Europe and the segment from the third quarter

Orders at Life Sciences are $27.5 million were up 56% from Q1 and down 10% from last year’s record second quarter. This week at the annual microscopy and micro analysis trade show we introduced the set of software application for life sciences research.

One package connects optical and electron microscopy into a simplified work flow, bridging electron microscopy to the much larger world using advanced optical microscopes.

The other three all address the creation and management and analysis of large three dimensional datasets generated by Krios. The software packages are consistent with our strategy of providing high margin, application specific complete solutions in growing markets.

This month another important paper was published by a leading German research team using the Titan Krios. This one was about the dynamics of ribosomes which are the protein making machines of cells; it was published by a team from the Max Planck Plant Institute from the Journal Nature, which editorialized that the work was seminal.

This work and other research are establishing the unquestioned value of the Krios life sciences. We expect to stimulate the demand for Krios as we move from early adopters to the broader life science market.

Ultimately the ability to understand the structure of complex biological machinery at the atomic level will open avenues for the development of therapeutics and diagnostics for the treatment of disease.

Finally, as expected our service booking were seasonally down in the quarter compared with the first quarter. But they were up slightly from last year’s second quarter.

Geographically, we had record orders in Asia including Japan, which made up 40% of the total and was up 9% from the first quarter and up 23% from last year. The strength reflects both the positive electronics market and our investment expanding our presence in the region.

North America made up 33% of the booking and Europe totaled 27%. Looking forward, we are expecting bookings in the third quarter to be greater than $165 million. We expect order strength and research and solid orders in electronics and life sciences to keep the order rate in the range of recent quarters. This will give us a book-to-bill ratio of greater than one-to-one for nine of the last 10 quarters.

We normally see a seasonal slow down in revenue in the third quarter, but this year our guidance for modest sequential increase in the revenue. We expect revenue and earnings growth for the fourth quarter, a seasonally strong period for us.

The manufacturing transition of the Small DualBeam line will be a vehicle to expand capacity and ramp revenue with variable costs. We are also making other selective investments to expand capacity to support revenue growth. Increased revenue will have a positive impact on gross and operating margins.

We expect with confidence to reach our goal of 42% gross margins and double digit operating margins in the fourth quarter. Our margin expansion plan is supported by our large backlog, higher total revenue, strong electronics revenue, a reasonable foreign exchange environment and operating improvements.

As a result we continue to expect that 2010 will be a growth year for FEI. We are also laying the ground work for continued improvement in 2011 with ongoing investments in technology, new products and continued operating recruitments.

With that operator, we are now ready for questions.

Question-and-Answer Session

Operator

Our first question comes from the line of Bill Ong with Merriman & Company, please go ahead.

Noah Huth - Merriman & Company

This is Noah Huth speaking on behalf of Bill Ong. I never said you reported very strong contribution to revenue in the electronic segment this quarter at 57 million, however compared to the fourth quarter of 2009, your gross margins are slightly lower at 49% despite the weaker Euro that’s been fairly as now. Were there any sort of change in pricing during the quarter to achieve these numbers or pressure that you saw?

Don Kania

Yeah. I think with the way to look at that is I think we did a good job in electronics and it was a good strong piece of business. Overall, if you look at the details, research and life sciences margin were a little bit lower and that was really a reflection of product mix and shipments. So the overall March was a little bit lower than that previous period.

Noah Huth - Merriman & Company

And then also going on to the quarter, you gave guidance of a 150 million to 155 million and it appears that previous peaks of revenues number have been right around that same $150 million level, has there been some sort of structural limitation to that number or is it possible for higher numbers in the future with increased capacity?

Ray Link

I think there’s two points. We have the seasonal issues that always faces in the third quarter on revenue with a large European content of our business that and a large academic content. Typically, that’s a slow period for those pieces of our business. And then, we’ve also. I think we talked about this in the last call. The demand for our new products particularly the DualBeam products has caused us to invest more in ramping those products up and using our transition of manufacturing from the Netherlands to the Czech Republic.

And so, you’ll start to see the real effect of those in the fourth quarter, as we commented earlier.

Operator

And our next question comes from the line of Jim Ricchiuti, Needham & Company. Please go ahead sir.

Jim Ricchiuti - Needham and Company

I was just wondering if you can comment on the research and scientific market in terms of what you are seeing relating to stimulus and you guys have given some indication in the past about how much you feel is still globally. And maybe you could talk a little bit about that? Thank you.

Don Kania

Okay, in the current period we saw under 5% of the order flow come from stimulus. So stimulus overall our view is it smaller than we expected in the beginning, and it’s spread out over more time so less of a bulk. But as we look into Q3 we expect to see a rebound in stimulus content. So you know sort of this transaction by transaction right now in terms of its impact.

But overall probably less, if you go back a year and half ago we started this less than expected, they have spreads their grand surround in smaller quantities which is not good for us if you downsize the average quantity and the timing has taken three times as long as we probably initially anticipated for the orders to be placed.

Jim Ricchiuti - Needham and Company

How should we think about the activity in this area from stimulus in 2011? Clearly some of it has been pushed out, is it also a case where may be some of the spending you identified may not come through?

Ray Link

Yeah, I think our expectations are lower right now, there’ll be some orders swapping into ‘11 I think and probably more of it on the revenue side swapping into ‘11. So I think that’s part of their characterization.

Jim Ricchiuti - Needham and Company

Okay and just with respect to the electronics portion of the business. You have had some very strong bookings clearly. Assuming some moderation in Q3 and don’t know if you can talk a little bit about where you might be seeing that I am just curious if you are seeing much in the way of visibility in orders in Q4 in this area?

Don Kania

Yes, let me start the last piece. I think we have probably more than we have had in the past. I think at least the recent past, we do have some visibility before as people talk about, my fab is going to come online, explaining time, we need to place orders, here so the tools are in place with right point in time so I would say generally better visibility than we have had in recent memories on that front and I think our view, we [cut off] very very strong quarters, so I don’t think anybody should read any negative into the fact that orders might be down a bit off of as we said we had exceeded the run rates of the last cyclical peak, recent the total record was the small back in ‘04 and I think that was probably data storage driven in the company so, I think we feel actually really strongly positioned with the product portfolio we have, and we are just enjoying the fact that the industry is doing well and we really do believe that we are seeing the transition as we talk about for a couple of years now with people needing more CEM and the supporting DualBeam’s to create those samples that are imaged there to support these finer feature sizes that are used in manufacturing.

So the trend lines are pretty much all gone in our favor I think probably the one if you put all the pieces together the demand there has been so strong that’s where the DualBeam manufacturing has been the area of great focus for us to ramp capacity there to beat the needs of our customers who are, shall we say relentless in their demands get the tools as quickly as possible.

Jim Ricchiuti - Needham and Company

Okay and just on the slowing your [seen] and its again I’d characterize it kind of given the strong quarters you have had I was just curious if its in any particular area, for instance in the data storage are you still seeing good signs of investment there or is that beginning to slow down a bit?

Don Kania

Well data storage is a hard call, because ask me next week and you might get a different answer, they are very volatile in their forecasting so we feel like there is still some strength there in demand, and already seen some transaction activity earlier in this quarter in that segment, so you know I would say if you want to separate logic memory and data storage I think we are seeing activity in all the areas, its just we are coming off a very very strong quarter and I think we gave proven guidance, what’s going to happen in the sector, quarter-to-quarter. But there is no fall off in memory or logic that we could identify.

Operator

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

Mark Miller - Noble Financial

Well, if you can provide us, what signs has been choppy? Do you expect that continue to be choppy? I know you are expecting you had [few] orders last quarter but what’s producing those choppiness?

Don Kania

Mark, we’re running into 25 to totally be 27 this quarter and the high end product in that segment trials will go for 5 million to 6 million. So one or two moves around makes a big difference in the quarterly performance. So it’s just granularity that drives the choppiness.

Mark Miller - Noble Financial

Service margins. How you feel you be doing on that looking forward. You’ve done a good job improving them.

Ray Link

You’re absolutely right. Our service business has really done a great job. If we look at how that’s trended over the past three quarters where 30.6% a year ago, we’re 32.3 last quarter, 34.4 this quarter. I wouldn’t really look for any more tremendous growth. Our original goal is to get into the mid 30, lower to mid 30’s. So we are there. There is still actions that are being done in our service business part of standardization it’s one of them but I think if you look to model service, somewhere in the range of where we’ve been in the past two quarters, that’s probably a safe assumption up for the near term.

Mark Miller - Noble Financial

That was 34.4 for this quarter?

Ray Link

With that said for anyone in our service business who is listening at the call. You guys did a great job and keep it going. We want more.

Mark Miller - Noble Financial

Was that 30.4 for this quarter?

Ray Link

30% for this quarter.

Mark Miller - Noble Financial

Its 30% for this quarter.

Ray Link

34 I can’t read.

Mark Miller - Noble Financial

So it was 34%. And drives were 27% a year, your electronic bookings last quarter are correct.

Ray Link

20%

Mark Miller - Noble Financial

20%. Somebody has reported, I know (Inaudible) reported some push-outs. But that’s more for production equipment. You haven’t had any inklings of that from the drive, guys have you?

Don Kania

No push outs and I would say if you literally week by week, did you know I have been around these customers for a long time, their view, this is the time of year when their views gets very volatile. I would say generally we are positive. Our view today is pretty positive view for the second half in their storage.

Operator

Our next question comes from the line of Peter Kim with Deutsche Bank. Please go ahead sir.

Peter Kim - Deutsche Bank

I want to ask about the lead times for your DualBeam products. What’s the current lead time now? Is that improving as you increased your capacity there?

Don Kania

Lead times depends on who you are, we are allocating slots to more important customers in this time period. Other than that you are looking at earliest of first quarter slot maybe and you start looking at Q1.

Peter Kim - Deutsche Bank

So your ramping capacity to meet increased demand, your expectations for your capacity expansion. What kind of percentage of expansion are you looking at? Do you have a timeline for that?

Don Kania

We don’t talk specifically about that amount of expansion. That the timeline as we are ramping in this quarter, you will see the effects of revenue growth in the next quarter and because what we are using is the, we are going to be downsizing in operation in Netherlands and ramping operations in Czech Republic. As we get visibility into ‘11 we can make judgments about whether to hold the Netherlands up longer or less time to make us to balance the transition and grow the Czech Republic operation to meet demand. So we are just holing up and how long we keep the capacity inflation, we can do that, a very low cost. It just give us a little more visibility but certainly if you are listening what I said at the beginning, we are pretty much booked through the year start selling up the Q1, life is pretty good for this set of products right now.

Peter Kim - Deutsche Bank

So revenue was pretty strong, yes very strong growth in the current quarter. And I was wondering are you running at capacity and electronics for the DualBeam for the electronic segment and so we shouldn’t expect to see a significant increase in revenue from the electronics component in Q3?

Don Kania

I think both of those re give our take of our right.

Peter Kim - Deutsche Bank

Okay. Lastly, I wanted to ask about, just two more question; one, with regards to the life sciences you had a press release about software upgrades and I was wondering will that be a meaningful contributor to revenues and software for life science provider, a stronger margin, when I book those?

Don Kania

Okay so overall yes there will be obviously their software products will be strong contributors to margin. And the other piece I think is you should view these not too much as individual revenue generators but their part of their total solutions that we provide and so it gives us both differentiation and a way to expand the market for customers who want that total solution piece of the puzzle. It will be good driver, these things are like $50,000 products they can get a sense. But we see the leverage that comes from them is highly differentiating the FEI’s total solution that we completed in this space, further distancing us from our competitors.

Operator

Our next question comes from the line of Patrick Ho with Stifel Nicolaus, please go ahead.

Patrick Ho - Stifel Nicolaus

Thanks a lot. Don, I understand the seasonality with 3Q but can you just give me a little color in terms of you had really strong booking quarters well above the current revenue rate, when do those I guess orders start hitting the revenue line and could be possibly see as it get down the real one big step of quarter when a lot of those I guess orders hit revenues?

Don Kania

I think what we’re indicating is that you should expect a Q4 revenues will be up over Q3 but we’re not being specific about that. We just have to wait for our next conference call for us to give you the guidance on that,

Patrick Ho - Stifel Nicolaus

I guess than just, I guess I don’t want the specifics but is there a timing issue on when I guess these orders hit cause I’m just trying to figure out I guess lead times or cycle times.

Don Kania

There’s two feet to the puzzle. I think in electronics, we’ve talked about capacity limitations on the flip side and the research class market which is research and life sciences rather that’s been driven revenue movements there have been driven by timing of the customer’s timing and the delivery of those tools. So we expect that to start to happen Q4 in moving into 2011.

What I’m certainly attacking the revenue to believe that FEI is focused on ramping revenues to meet our run rates in revenue.

Patrick Ho - Stifel Nicolaus

I’m just trying to reconcile cause you had really, really great orders for the last several quarters. I’m just trying to figure out when they all start hitting the revenue line. I expect that I guess some of it to hit in Q3 but it sounds like we’re getting close to when a lot of those big orders, not big orders but the good enough orders numbers you’re proposing that they start hitting in Q4 and beyond. At least can I assume that?

Don Kania

Yes you can. We’re very [specific] about that in our formal comments that we expect revenues to be up, both revenues and growth in operating margins to be up in the fourth quarter.

Patrick Ho - Stifel Nicolaus

And then, on the gross margin, it looks like you guys are making the progress to their 42% gross margin target. You are now getting some additional headwinds from other factors. Does that also contribute to that 42% or does that provide potential upside?

Don Kania

I think the way you should look at it is our confidence level is increasing at 42% and let’s just see where the cards fall as we go into Q2.

Patrick Ho - Stifel Nicolaus

Okay, great and final question from me, I know we have talked about this but just the natural resources in mining opportunity, can you give us an update on how that’s going and do you see 2011 as when you start seeing I guess meaningful revenues from that business segment?

Patrick Ho - Stifel Nicolaus

Right, there are two major pieces of natural resources. One is the mineral’s business which has been the more long standing business. We are trying to move more broadly and it serves first the precious metals area, we are trying to serve more customers there and then move more into the base metals role for an expansion of that market place. The other very early market for us is oil and gas. We are in the process of trying to establish some beta test with some key customers in that space. There will be the service providers to establish a value proposition for using our software and hardware tools at oil sites. So I think our guidance is still early, I would say as we learn more we get more excited about the opportunity and I think if things go according to plan you should expect to hear more details from us early in 2011 and talking more exclusively about the opportunity, still too small right now.

Operator

Next question comes from the line of David Wu with GC Research. Please go ahead.

David Wu - GC Research

Just quick question, clarification rather, comments about the Q3. The fact that you are seasonally better than your seasonal Q3 as a function of research and industry, those shipments are moving up and I guess the life science and electronics are probably going to be sequentially down, right. So the met is your less than highest gross margin product is moving out which is why the gross margins doesn’t pop until Q4 when you get a more regular mix of electronics there? Did I get it right?

Don Kania

You are not too far off David. We don’t really breakout our targets by

And markets in our guidance but based on the count is that [non-paid] we have a very, very strong shipment quarter in Q2 in electronics. If you take our guidance into the mid points that means we are going to be up about $7 million on essentially constant currency and if your look at our life science and research business we are expecting them to be stronger in the quarter. And you’re right, those traditionally have slightly lower margins than the electronics, we are working to improve the margins with all respect the overall mix shift does make it a little bit of a drag to drive up margins on the incremental revenue. So, margin, dollars should be up operating expenses as I talked about it should be above the level and when you run through the models you should be able to come out with the EPS range that we gave higher the EPS we have for the second quarter.

David Wu - GC Research

Last question I have is actually I was surprised about hard drives, because those guys, both Western Digital and Seagate have lowered their expectations for Q3 in terms of the number of drives they are producing and I guess I got a sense that it has not affected the orders to you.

Don Kania

You should think of us more as technology driven. Fortunately, even though we do serve manufacturing in that segment, the kinds of tools that we’re selling to them are related to upgrading or new tools to serve higher aerial density production. That race isn’t going to stop.

Operator

Thank you. Our next questions is a follow-up question from the line of Mark Miller with Noble Financial. Please go ahead.

Mark Miller - Noble Financial

I’m just wondering the Magellan was a very important introduction for you and it’s been around for a while, have you seen significant pressure on the pricing of Magellan, currently compared to the when you introduced it?

Don Kania

Well, I don’t think so. We’re looking around the table here. I don’t think there’s any sense of routine pricing pressure and in fact as we commented in the last quarter, seen good volume movement with the product and good acceptance by particularly in the semi space of tool of records and then follow-on by. So we’re quite pleased with the progress of Magellan.

Ray Link

Yes I would echo that. We launched it just as the semi-conductor industry was starting to decline. So we didn’t have the growth in revenue in there initially we thought, but lately the order trends have been very fine.

Mark Miller - Noble Financial

I realized in this related product, have your competitors responded via pricing trend to compete with you in that area?

Don Kania

I think it’s the one area where we have highlighted competitive pressure is Hitachi particularly in Japan. If they want the business, they’ll do whatever it takes to get the business. We don’t chase them down around.

Mark Miller - Noble Financial

But that’s impacting you more in the Magellan area, product area?

Don Kania

It’s pretty well. Yes, they don’t have anything to stack up against the new DualBeams nor the 10’s. So we feel pretty good about that piece. What are you going to do? The competitor wants something and they’re going to cut price to get it well. We’re giving let them have the business.

Operator

Thank you. Our next questions is a follow up from the line of Peter Kim with Deutsche Bank.

Peter Kim - Deutsche Bank

So, kind of a philosophical question I guess. Looking at your backlog increasing, it has been increasing pretty strong over the last several years, as a matter of fact. But your revenue has lagged. And I think this issue has come up before. And I was just wondering, what are you guys comfortable with in terms of ramping up your capacity to kind of maybe reduce the build-up of the backlog?

Don Kania

I think the way probably you just think about it is to run a capital quick company with the nature of equipment that FEI build and sells. Six month backlog is a reasonable target for operating company. And so we are certainly well above that on any kind of run rate measure or guidance measures at this point in time but that’s clearly where we have to get it. And we will be comfortable with that level of capacity expansion which is pretty much all incremental additions to get to run at those levels.

Peter Kim - Deutsche Bank

I’m trying to also kind of gauge the sense of urgency. Do you feel like your products are differentiated enough that you could maintain an extended backlog and feel comfortable with that? Do you feel like you need to expand to meet your customer demands, and so you’re more aggressive about expansion plans?

Don Kania

I would say it’s the latter particularly with those products that serve our electronics customers. They are very, very time sensitive and so we are very, very focused on that particular activity using all the things we talked about in the call. So philosophically we need to ramp our capacity and we are very focused on it.

Operator

(Operator Instructions).

Fletcher Chamberlin

With that David, I think that is probably, there are no more questions.

Operator

There are no further questions in queue at this time.

Fletcher Chamberlin

Okay then we appreciate everybody being on the call. Give it is Ray or Don or me, call for follow-up if you have other questions. Thanks very much for being here.

Operator

Ladies and gentlemen that does conclude our conference for today. If you’d like to listen to a replay of today’s conference please dial 303-590-3030 or 800-406-7325 and enter the access code 4330802. I’d like to thank you for your participation and you many now disconnect.

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Source: FEI Co. Q2 2010 Earnings Call Transcript
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