FEI's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: FEI Company (FEIC)

FEI Company (NASDAQ:FEIC)

Q3 2011 Earnings Call

October 27, 2011 5:00 pm ET

Executives

Fletcher Chamberlin – Treasurer & Communications Director

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

Dr. Don R. Kania – President and Chief Executive Officer

Analysts

Patrick Ho – Stifel Nicolaus & Company, Inc.

Bill Ong – Ticonderoga Securities

Zach Larkin - Stephens

James Ricchiuti – Needham & Co.

Mark Miller – Noble Financial Capital Markets

Thomas Diffely – D. A. Davidson & Co.

Operator

Welcome to the FEI Third Quarter Earnings Conference Call. During today’s presentation, all participants 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, October 27, 2011.

It is now my pleasure to introduce our host for today, Mr. Fletcher Chamberlin. Please go ahead.

Fletcher Chamberlin

Thank you, Diane. Good afternoon, ladies and gentlemen. As Diane said, I am Fletcher Chamberlin, 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.

We’ve again posted some slides under the Events & Presentations section in the Investor Relations part of our website, fei.com. We will refer to these slides during today’s call. We hope that having these slides will make it easier for you to listen to our comments rather than just focusing on getting the numbers recorded.

While you are pulling up the slides and before we get into the presentations, we also have the regular housekeeping matters to address. This call contains forward-looking statements. To the extent that we discuss expectations about future corporate financial performance and goals, future customer orders, performance by product and market, the outlook for margins and revenue, market developments and opportunities, future product and technological developments, the effects of future movements in exchange rates, future hiring plans, expected government spending for research tools, our expected effective tax rate or 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 and other risk factors are cited in today’s press release on slide two of the slides posted on this call and in 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 of the SEC filings are available free of charge on the commissions website at sec.gov or on our website or from our Investor Relations Department at 503-726-7710.

The company assumes no duty to update the 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 website at www.fei.com.

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

Raymond A. Link

Thank you, Fletcher and good afternoon everyone. We had another very good quarter. Revenue was a record for the third quarter, our second highest ever in line with our guidance and up 34% from last year’s third quarter. Orders were solid at $186 million net of the currency impact on backlog and above $200 million at constant exchange rates and above the high end of our guidance range.

Gross margin was in line with our forecast and operating margins at 17% or up 5.5 percentage points from a year ago. EPS was the highest in our history and ahead of our guidance and consensus estimates. All of the growth in 2011 has been organic with no additions from acquisitions. We have now recorded 21 consecutive quarters of GAAP profits demonstrating consistency over the long-term. We returned $15 million to our shareholders during the quarter with open market share repurchases and net cash has increased since the beginning of the year.

Gross bookings for the quarter at constant currency rates from the end of the Q2 were $201.1 million and net bookings including the downward revaluation of the backlog and quarter end currency rates were $186.4 million.

At the end of Q3, the euro was $1.34 compared to $1.45 at the end of Q2. The weaker euro reduces the value of our euro denominated backlog when converted back to dollars.

When we look at our orders on a constant currency basis, orders for the second and third quarters were essentially equal. The good news is that a weaker euro also reduces our cost of good sold so that while our total backlog is down in dollar terms, the gross margins in backlog increases. In addition, new orders in Q3 continue to be booked with a higher gross profit margin than earlier quarters.

The backlog at the end of the quarter was $440.1 million and represents over six months of backlog at our current revenue run rate.

Moving to slide four, total revenue growth was led by both Research and Industry and Life Sciences. Research and industry revenue was $74.4 million making up 36% of the total. It was up 35% in the second quarter and up 45% from last years third quarter. That’s the highest quarterly total ever for this segment. The book-to-bill ratio of research and industry was 1.02.

Life sciences revenue of $30.2 million was also it’s highest quarterly total ever and made up 50% of the total. It was up 13% in the second quarter and up 65% from last year’s third quarter. For the first nine months of the year, life science revenue is up 42% from a comparable period a year ago. We expect to have over $100 million in life science revenue this year.

Electronics revenue of $56.6 million was down 35% from a record second quarter as expected, but it was up 29% from last year’s third quarter. They made up 28% of the total, a bit below the percentage in our long run bottom[ph].

Service and components revenue was $44.1 million for the quarter up 4% in the second quarter and up 11% from last year’s third quarter. This profitable and steady segment of our business is up 12% on a year-to-date basis. Service margins rebounded from the second quarter levels of 34.5%.

Turning to slide five, our revenues for the quarter were balanced geographically with North America making up 30%, Europe and the Middle East making up 36%, and Asia, Japan and the rest of the world at 34%.

Now looking at slide six, gross margins in the quarter was 44.4% above the 43.5% level of last year’s third quarter and below the 45.3% recorded in the second quarter. Factors that drove the sequential decline included somewhat less favorable product mix and slightly lower volume offset by continued gains from our expanded manufacturing in the Czech Republic. Life sciences, electronic, and service each recorded sequential increases in gross margins.

Turning to slide seven and moving down the income statement, operating expenses excluding restructuring were $56.3 million, down from $58.4 million in Q4 and up from $48.3 million in the last year’s third quarter. Year-over-year operating expenses grew 16% while revenue grew by 34% given a significant operating leverage. R&D expenses grew 21% compared with last year as we made investments to build the growth in 2012 and beyond.

We had 2,016 employees at the end of the quarter, up 3% for the quarter and 11% from a year ago compared with the expected annual revenue growth rate of around 30%

Restructuring expenses were insignificant in the quarter compared with $783,000 in the second quarter and we expect them to remain low in Q4. Operating income for the third quarter was $34.9 million or 17% of revenue in the range of our long-term model at 16% to 19%.

This quarter compares with operating income of $36.5 million in the second quarter and $17.6 million in the last year’s third quarter. Below the operating income line, total other expense was 601,000 compares with 893,000 in the second quarter and $1.1 million a year ago. We expect non-operating expense will be between $500,000 and $1 million for the next several quarters.

The tax rate for Q3 was 23.7% compared with 26.9% in Q2 and our guidance rate of 26%. The rate in Q3 was below forecast due to foreign tax credits.

For Q4, our normalized rate is projected at 24%. However, we are awaiting final approval from the Dutch government to use a 5% tax rate on the bulk of our Dutch income.

We hope to reach resolution in the next six months and when we do, our long-term effective rate would drop to around 22%. In addition, when the ruling is completed, we will have a large one-time tax benefit of approximately $12 million to $16 million. For modeling purposes, we recommend that you use a 24% rate for Q4.

This led to GAAP net income of $26.2 million or $0.63 per diluted share for the third quarter. That compares to earnings in the second quarter of $26.1 million or $0.62 per diluted share and $11.9 million or $0.30 per diluted share a year ago.

During Q3, we repurchased $1.65 million shares of common stock for $50 million at an average cost of $30.19. This reduced our weighted shares used to compute diluted EPS from $42.6 million in Q2 to $40 million in Q3; both amounts include $3 million shares attributable to our convertible notes. We are projecting that the weighted average shares to be used for diluted EPS in Q4 will drop to around $41.4 million representing a decrease of 3% since Q2 or about $0.02 per share benefit in Q4 compared to Q2.

As you can see on slide eight, our balance sheet and cash flow remain very strong. Total cash and investments at the end of the quarter and kind of restricted cash and long-term investments was $435.7 million, and net cash after subtracting that was $346.7 million, down $35.6 million in the quarter after the share repurchase and up $11.7 million since the beginning of the year. Net cash at the end of the quarter was $9.23 per share. Days sales outstanding were the lowest for third quarter in the last decade. EBITDA was $40.5 million in the quarter, compared with $41.8 million in the second quarter and $22.4 million in the last year’s third quarter.

Slide nine is the summary of our guidance. We expect revenue for Q4 to be in the range of $205 million to $215 million. Earnings per share with a 24% tax rate are expected to be in the range of $0.60 to $0.65. We are guiding Q4 bookings to be around $200 million.

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

Dr. Don R. Kania

Thank you, Ray and good afternoon everyone. It was another very good quarter. We delivered record earnings for the fourth quarter in a row reaching $2.31 per share on $800 million in revenue for the last 12 months. For the third quarter, orders in revenue were in line with our guidance. We saw year-over-year and sequential gains in bookings and revenue for research and industry and life sciences, offsetting the expected declines in electronics.

Geographically, we demonstrated our diversity with strength in the United States and Japan this quarter following a very strong second quarter for Europe and Asia. Our strategy of geographic and market diversity is a cornerstone of our strong results.

Turning to our geographic bookings in slide 10, orders for the quarter were, again well diversified regionally with 39% in the bookings from North America, 25% from Europe and the Middle East and 36% from Asia including Japan. Electronics bookings were strong in the United States both research and industry and life sciences bookings were particularly strong in Asia. As we said, records for research orders from Japan and life sciences orders from the rest of Asia.

By country, China and Japan recorded our second and third largest order totals for the quarter after the United States. In China that reflects the countries continued investment in scientific infrastructure. In Japan its result of our improved competitive position against the domestic competition.

Our success in Japan and Asia is a direct result of the investment we have made to strength our channels.

In the US, orders improve from the first half in research and life sciences as we expected and our pipeline remain strong. We believe longer-term US budget uncertainty continues to meet demand, but we do not foresee a significant fall off from current levels.

From a broad perspective only about 5% of our total orders are funded by US government agencies such as NIH, NIST and NSF. As a result, the current view of modest cuts in those agency budgets would not have a major impact on our overall order rate.

Looking at slide 11, you can see that the largest booking segment in the quarter was research and industry at $75.8 million or 41% of the total, that’s up 17% from Q2. The global reach of this business is highlighted by the fact that both Japanese and Chinese research orders were larger than US research orders in the quarter. We also received orders for $2 million or more from 10 different countries.

Having been first in best in resolution, we have established clear leadership in the next material science frontier analytics that is not just seeing them, but identifying them. During the quarter, we made another product introduction to advance our technology leadership in material analysis. We released the latest version of our flagship TEM, the Titan G2 80-200, which incorporates our revolutionary ChemiSTEM analytical technology.

This new top of the market product is positioned above the fast selling Osiris, the mid range analytical TEM offering with bookings have doubled from 2010 levels. We also introduced the Versa 3D mid range DualBeam, which has greater flexibility and sample use and configurability than any other product on the market. That flexibility is particularly useful for the wide range of applications we see from our customers and the research market.

In addition, we were honored by the comments of Dr. Daniel Shechtman, the winner of the 2011 Nobel Prize in Chemistry for the discovery of quasicrystals. He was quoted as saying that Titan Microscope, which is considered the most advanced of its field, is a high-resolution electron microscope that can easily detect atoms and is used for discoveries. He went on to say that discovery would have been virtually impossible without the Titan Microscope. We are proud work with and be associated with Dr. Shechtman and many other leading researchers around the world.

Natural resources is reported in our researching and Industry segment. It has strong quarter resulting in orders up over 50% for the first nine months of this year as compared to last year. Last week, we also marked a major milestone for this business with the introduction of our QEMSCAN WellSite solution for service logging and oil and gas industry. We have successfully completed the first of our three joint development agreements for this new product and are moving into commercialization. The product will be shown for the first time at the Society of Petroleum Engineers trade show on Monday in Denver in coordination with Halliburton, the $18 billion global Oil and Gas Services Company.

Turning now to life sciences, orders are up $25.7 million were up 37% from Q2 and 40% from last year’s third quarter. Bookings were again strong in China for this business.

In September, we announced our living lab for Cell Biology, a technology development agreement with the Knight Cancer Institute at Oregon Health Sciences University. This agreement will be an important part of our development of correlated microscopy for Cell Biology, linking light microscopes with electron microscopy.

FEI’s employees will be working together with the world-class cancer researchers such as Dr. Joe Gray, a renowned cancer and genomic researcher recently recruited from Lawrence Berkeley National Laboratory.

We are also continuing to work on the development of a living lab for structural biology, which will be a collaboration with a major research institution to further develop the credibility, capability and complementary nature of electron microscopy with the large market for established techniques of nuclear magnetic residence and X-ray Diffraction for structural biology research.

We expect to announce the second living lab before year-end. Both are important for continuing our momentum in Life Sciences and important to expanding our served available market. As forecasted electronic orders were down from a new record level of $76.1 million in Q2 to $40.3 million in this quarter. Orders were strong in North America and weak in the rest of the world.

With our leadership position in the lab, we have grown with increased share of spending over the cycle. As our strategic engagement expands with our customers, we see that technical demand for shrinking devices and 3G structures will continue to increase the demand for TEMs and dual beams for the foreseeable future.

Finally, our service bookings were up 14% compared with the third quarter of last year and 9% for the first three quarters of the year. Looking forward, a stronger second half for both Research and Life Sciences is developing as we planned. The global nature of these businesses, infrastructure spending in emerging economies, the continued commitment by northern European countries to upgrade their universal infrastructure in our innovative products all point to continued growth.

We are expecting another strong booking quarter for our research business in Q4. We also expect sequential increase in bookings for electronics. We have significantly strengthen our position in the market through the last cycle leading logic, memory and foundry customers are continuing to develop new nodes and FEI share of spend continues to expand.

I’d like to take a moment to comment on our order guidance for the fourth quarter of approximately $200 million. There are two important factors to consider one we have a number of pending multi-million dollar orders primarily in electronics and Life Sciences where the timing is uncertain at this point. And two we are not counting on a very large year-end budget flesh in our guidance.

We are building our plans for next year and we’re not yet in a position to forecast 2012. But we do see opportunities for growth and margin improvement. We continue to focus on key factors for expansion of our served available market and long-term growth.

In natural resources initiating the move from development agreements to commercial offerings in the oil and gas market, in Life Sciences the development of our living labs to expand our served market in cell biology and structural biology

In Research further expansion of our technology leadership to help the next Nobel Prize winner. While we continue to expand our channel around the globe. In electronics building on the market leadership to exploit the expanding share of spend and team effort a continue drive towards our goal of 47.5% gross margins in Q4 of 2012.

Through development and introduction of higher margin new products continue expanded manufacturing in the Czech Republic and other operations and supply chain improvements. As we continue to grow, we’re generating cash consistently. We have been opportunistic borrowers of our stock, this quarters we took – this quarter we took a major step towards returning cash to our shareholders in the form of a $50 million share repurchase.

While at the same time maintaining a very solid balance sheet to support potential M&A. We appreciate your attention, we are confident that our diversified market and geographic strategy will continue to service well in whatever macro economic environment lies ahead. We remain relentlessly optimistic about the future as we continue towards our goal of doubling our served available market by 2014.

I want to take this opportunity to express my thanks to the company’s employees for applying their tremendous talent and skills to grow FEI. With that operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Patrick Ho from Stifel Nicolaus. Please go ahead.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Thanks a lot and congrats on another nice quarter. Don, in terms of the natural resources business, now that you have this official agreement with Halliburton, can you broadly speak about how an agreement like this could spur others to I guess, one, beta and how you could turn additional ones into also commercial agreements?

Dr. Don R. Kania

Okay. I want to be real clear on everything here so. We have not announced a commercial agreement with Halliburton at this point. But we do have – we are co-announcing the offering of the service and you can find it on Halliburton’s website and it will be more formalized come Monday at the show. And I'm going to actually be there as well. We – there is no exclusivity involved in any discussions with them at this point and I would say you have to stay tuned on the other, the outputs of the other agreements over the next few weeks to a month and but one should expect to see further announcements as we go forward.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Right. Moving over to the electronic side of things, obviously you know there is a lot of volatility in the market, but I know -- we have discussed it in the past, can you discuss the potential opportunities with the foundries given that they are becoming I think more process technology centric than they have been in the past with the move to smaller nodes and with more foundries pushing one another. Can you just discuss your penetration with that customer segment?

Dr. Don R. Kania

Sure. And you’ve captured the essence of it. As the global foundries in particular entered the space, they’re pushing harder and harder on the smaller nodes to show differentiation against the likes of TSMC, for example. And so what we’re seeing in response is a broader based and a more strategic investment from a company like TSMC in advanced technology that FEI provides to support not only development, but ramps and we believe over time in fact extrusion control. So it’s a growing opportunity for FEI relative to investment by the whole foundry space in the past.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. And final question from me, and I guess for you or Ray. I know in the past, you talked about having your R&D percentage go up, particularly as you enter next year. One, can you just reaffirm that? Secondly, are there specific business segments that you’re particularly going to focus that R&D or is it going to broad based across all your businesses?

Dr. Don R. Kania

Okay. Part one, yes, we intend to move towards our 11% target or R&D spend into 2012. So you should expect to see that dollar spend rise and we will end up preferentially investing a bit more in those segments that we consider high growth, which should be the Natural Resources segment and the Life Sciences segment.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. Thanks a lot guys.

Dr. Don R. Kania

Thank you, Patrick.

Operator

Thank you. And our next question comes from the line of Bill Ong from Ticonderoga Securities. Please go ahead.

Bill Ong – Ticonderoga Securities

Yeah. Good afternoon gentlemen, congratulations another great quarter.

Dr. Don R. Kania

Thanks Bill.

Bill Ong – Ticonderoga Securities

My question is on the natural resources. I understand that the business model is leasing electron microscopes to oil and gas rigs. So in your market forecasting you had in the Analyst Day, how many electron microscopes would you need to have at hand to support the 3,700 or so oil rigs world wide.

Dr. Don R. Kania

Okay.

Bill Ong – Ticonderoga Securities

And if it is a leasing model, is it going to be similar to like a car rental model, we have a fleet of microscopes out in Europe or North Africa to support the business, just want to get a better understanding how you’re going to recognize revenue going forward?

Dr. Don R. Kania

Okay I will defer to Ray the revenue recognition part; let me describe the model to you. Essentially what the plan is for FEI to provide basically a small processing laboratory and they’re typically built into something like a shipping container you might be familiar with which has air conditioning and power conditioning on it.

FEI would provide that and the service support for that. A company like Halliburton or another services company would provide onsite support facilitization for that and so it’s really a model where by we provide one set of equipment because it’s not only the microscope, there is sample prep involved in the process.

So we would provide those to a services company who would then lease that as part of typically a much broader package of services to an oil company and then support it on the rig. So if you think there’s about 3,500 oils going world wide, you need the number of units to support the fraction of those that adopt the technology over time, and you have to realize that there is some inefficiency in the system, whereby as things move from site to site, then you can basically move the same system from one vendor to another.

So we will see how that develops over time but the model is pretty much one per site give or take some efficiency factor. Do we believe we will penetrate all 3,700, we don’t think that’s a possibility. But the question that we are still trying to answer is, what fraction of those can we penetrate, and then how quickly can we do that? Time will tell? And Ray can talk about the revenue model.

Raymond A. Link

Yeah, Bill. How we’re going to do this from a revenue standpoint; it is a leasing model and we are still fine tuning it but we are looking at either a monthly, quarterly or annual. There will be some incentives to go to annual, the initial discussions, it seems like the quarterly is sort of the sweet spot and that’s how it will be done. So first, we’ll have it for a 90-day period and then they can return it back; now hopefully what they will do is they will just (inaudible) move it to another site and we’ll continue the lease.

Bill Ong – Ticonderoga Securities

Okay, that is helpful. So I guess you’d be getting the business from let’s say Halliburton, so to speak, so Halliburton gets the dollar – a piece of that dollar back to you, something like that?

Raymond A. Link

That’s a fair characterization.

Bill Ong – Ticonderoga Securities

Okay, great. And then my last question is, how many beta sites do you have in the field right now in oil and gas?

Dr. Don R. Kania

We have two ongoing; we had three and that one is now completed and now we are going to the commercialization phase as I described and stay tuned for the rest.

Bill Ong – Ticonderoga Securities

Okay, thanks. And I’m sorry, one more, in mining how many revenues – how much – how many dollars of revenue have you recognized in mining? Ballpark?

Dr. Don R. Kania

Mining is a just a work layer. Mining is strictly an equipment sale at this point. So anything we sold to date in the mining has been you know buy the equipment or buy a service contract.

Raymond A. Link

And we don’t break that out yet, Bill, it’s included in our research industry segment. It is one of the many factors that are driving that, the higher revenue levels, and I will say just to be fair that it looks like we’ll more than double revenue from last year.

Bill Ong – Ticonderoga Securities

Okay, thanks so much. Nice job everyone.

Dr. Don R. Kania

Thanks again.

Operator

Thank you. And our next question comes from the line of Zach Larkin from Stephens. Please go ahead.

Zach Larkin - Stephens

Hey gentlemen, congrats on the quarter. Thanks for taking my call.

Dr. Don R. Kania

Any time.

Zach Larkin - Stephens

First question; I wondered if you guys could talk a little bit more about 4Q and kind of the distribution of reps among the segments and whether you expect it to be fairly similar to what we saw this quarter, if there is going to be any obvious big swings going in to the fourth quarter.

Raymond A. Link

This is Ray. We don’t really get into that level of granularity, but I will try to help you out a little bit. It depends obviously whether the high-end or the low-end of our guidance but we certainly have a lot of pent up demand in our Research and Industry Segment. So the revenue that you saw for this quarter which was very strong, we could easily surpass that in Q4. And pretty much everybody else would be up or down a little bit and it really depends, if you look in Electronics, a tool here or tool there can move the needle on that as well as with Life Sciences. But most of the revenue growth assuming we are at the high end of the guidance would be incrementally out of our Research And Industry group.

Zach Larkin - Stephens

Okay, thanks, thanks, thanks very much. That’s very helpful. Then also wondered as we look at the Electronics business you gave some good color on these moves to smaller nodes and how that’s going to help drive demand. Do you guys have a sense for – as people are moving to this, is there kind of a velocity of demand going on where not only are we expanding into additional foundries but also seeing more equipment purchases per lab as people move to these lower architectures and if you could give some color on that?

Raymond A. Link

What you described is true. What we’re seeing in the cutting edge customers who are already discussing things like sub-20 nanometer nodes with us that the amount of spend at those node is higher than the amount of spend we saw at larger feature sizes.

And so we expect that trend to continue not only as those companies move to say 14 nanometers, but as well as other customers start to enter that sub 20 nanometer realm, so we were really pleased with that trend and we see that as a secular growth driver for that segment.

Zach Larkin - Stephens

Okay. Thanks very much, guys. Congrats again.

Dr. Don R. Kania

Thank you.

Operator

Thank you. And our next question comes from the line of Jim Ricchiuti from Needham & Co. Please go ahead.

James Ricchiuti – Needham & Co.

Hi, thanks. Good afternoon. Just with respect to the electronics bookings in the quarter, you’re guiding I think sequentially higher, but you have a fairly low hurdle here, but I guess what I wanted to dig a little deeper into Don, as you talked a little bit about some multimillion dollar orders, can you give us in just kind of broad terms the nature of those orders? Are these orders that you have been tracking that you thought might have been awarded in Q3 slipped, are these orders that you’ve been tracking and are thinking that it could be awarded in Q4?

Dr. Don R. Kania

It’s more the later. What we’re seeing is a couple of orders where we’re tracking to customer expectations and these are – when you get to these larger order range with our electronics customers is typically for both DualBeams and TEMs and a solution this, the whole solution package for them. And it really becomes now a question of timing and to be blunt oftentimes the price negotiation issue where they try to, you know the game in capital equipment. And so that’s why we’ve been, we’d say, we feel it’s going to be up, and it’s – we’ve been a little prudent, I think in trying to forecast in detail all these transactions closing, because we’re going to take high road on profitability and not trying to force things into the quarter.

James Ricchiuti – Needham & Co.

Got it. And can you talk a little bit about the decision to change source some of the semi-related DualBeams in Hillsboro?

Dr. Don R. Kania

It’s [encounter] to what you guys are being doing?

Raymond A. Link

Oh, UCT yeah, okay this is a pretty simple story. It’s in fact fully aligned to what we’re trying do, which is to be more profitable in higher margins. The UCT team did a fine job in building product for us its been 10%, been a good thing and but at the end of the day, when we did the analysis and we ran enough volume through it, they really just wasn’t enough margin benefit to share and we feel that by transitioning that manufacturing back to FEI and we’re going to be make more money, we’re going to improve our margins, and that’s the fundamental behind the decision.

James Ricchiuti – Needham & Co.

Okay. And just one more question, if I may, just with respect to the research market, you clearly had a very strong bookings quarter and kind of the go strong booking quarter in the US and is there any sense among your research customers that they are uneasy about their spending environment and may be move things up a little bit or is that probably not practical given the lead times in the equipment.

Dr. Don R. Kania

I think if we just take to the US you know one that’s been a relatively muted environment for us. We file a lot of our peers and there is been a lot of doom and gloom talk about like in our agent things like that. Where it’s such a – when we look at the data it’s just the small part of our business overall, so we don’t see that as a big negative. If any thing, we’d show some conservatives in the bookings going forward, because if you look at our history always Q4, we see a pretty good budget flush people look at their budgets. Say, I got to spend this money I’m going to lose it so they spend it out. We’re just not sure what is going to happen so we’ve taken a little more cautious approach on that, but you know, when I talk the researchers I interact with our customers they are not so challenge on ‘11, but they look for they get. We just like to see more certainty just like Ray and I would like to see more certainty on our government (inaudible) so they can make their decisions.

James Ricchiuti – Needham & Co.

Okay, thanks a lot.

Operator

Thank you. And our next question comes from the line of Mark Miller from Noble Financial. Please go ahead.

Mark Miller – Noble Financial Capital Markets

Hi, guys, congratulations.

Dr. Don R. Kania

Thanks Mark.

Mark Miller – Noble Financial Capital Markets

Just was wondering talking to some people about three dimensional chips and through the silicon vias and there was some thought that would be coming on stronger to second half of next year and people now feel that that might be pumped in into 2013 and I think you had noted that was an opportunity for your equipment and I'm just wondering what your visibility about this?

Dr. Don R. Kania

Right, we introduced – I think it was last quarter product called the Vion, which is our high speed milling tool which actually takes – some of our customers have been using our dual beam tools to look at through the silicon vias and milling for essentially 24 hours to get the data that they want and we’ve been able to reduce that by a factor of 10 at least and so we (inaudible) and I think we sold another unit recently. So we are early in the Vion testing of the adoption that for the analysis through silicon vias. So we feel like we are there with the right product, right time and we will watch it develop over the next year or too.

Mark Miller – Noble Financial Capital Markets

Just wondering if you can comment about in terms of the order linearity of this quarter. I'm sorry in the September quarter?

Dr. Don R. Kania

In the September quarter (inaudible) each other gone. You know it wasn’t – you didn’t feel – if you’re thinking you worked in other quarters, I’d say no.

Raymond A. Link

It’s a normal Q3.

Dr. Don R. Kania

Yeah, normal. Yeah Q3 has always looked challenge for us, because one of our customers are in holiday for August, lot of our employees are on holiday for August because of the European continent, the traditions there. But we didn’t feel like it was out of the ordinary.

Mark Miller – Noble Financial Capital Markets

And then I apologize if I missed this, if you can just talk about first of all your margin improvement in service and the sequential decline in SG&A expenses?

Raymond A. Link

I’ll take the SG&A first. There’s a couple reason for that; one, we had a slightly favorable currency benefit that’s got a big impact. Second, we had in Q2, we’ve realized that we were tracking at a higher level of profitability and we accrued incentive compensation, which is paid after the end of the year, but we had a pickup in Q2 we had to sort of retroactively go back to the full six months and record our margin expense. So we had certainly higher charge in Q2.

And then in Q3, we have lower sales commission, because we have lower revenue, but we also have lower sales commissions, because more of our sales were direct versus through agents and there is a much higher commission associated when we go through agents. So those were the combined factors for the decline in SG&A.

And then with respect to service; service traditionally has a pretty good third quarter and we have a lot of contracts there, contract case and when the customers are gone, (inaudible) recognized when you have less cost, there is a little bit of a pickup there and frankly the guys in service are doing a great job and marching forward with a lot of initiatives and moving a relatively small but they all count. And we had some incremental of revenue in service, which also helps.

Mark Miller – Noble Financial Capital Markets

Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Tom Diffely from D. A. Davidson. Please go ahead.

Thomas Diffely – D. A. Davidson & Co.

Yeah. Good afternoon. Another question on the Electronics business, historically you guys have done quite well in this new fab construction and in near-term we’ve got some push outs of some orders. But on a long-term basis over the next couple of years have you seen change in the projected number of new fabs started to come on line?

Raymond A. Link

You know we’re probably not the experts on that, and the answer will be, no. But I tried in the office every morning. I look at D1X going up over Intel and I’m just counting the days to – still happening with our equipment. So our view is, remains robust over that kind of time period there is no Electronics is going to do just fine and you know the fab construction will go forward. And probably the most weighty item on our minds around all this is 450 [win] is a big – actually a big opportunity we think for us. So we’re looking forward to that transition.

Thomas Diffely – D. A. Davidson & Co.

Okay. And then when you look at the other half of Electronics, the other portion of Electronics, the hard disk drive maybe a little update there and if you’re seeing impact from the Thailand disaster?

Raymond A. Link

Yeah. point one; I think we have record low this quarter in data storage orders, which is practically non-existing in the last quarter. Going forward we have told WD that we are ready and able and available to help them. They’ve expressed a need for help and they have a strategy to bring their manufacturing back up. No doubt there will be some replacement opportunity for FEI tools. The timing and the quantity are uncertain at this point.

Thomas Diffely – D. A. Davidson & Co.

Okay. On the – for some of the oil exploration, you talk a lot about the new leasing plan. Does that mean that the whole idea of actually selling the tools to that marketplace is not going to happen or they are going to happen in tandem?

Raymond A. Link

No, we will – for this, we have to be very – there is a particular application, which is WellSite measurement. We will not sell tools for that. There’s a particular microscope that goes with that package and the only way you can get their microscope packaged up with a sample prep is at least from one of FEI’s partners. If you are in mining or in other areas, you can buy equipment from us. So we’ve really – this is the space that prefer the leasing model.

Thomas Diffely – D. A. Davidson & Co.

Yeah.

Dr. Don R. Kania

This is well established, this is how business works in overtime. It will make us vastly more profitable.

Thomas Diffely – D. A. Davidson & Co.

Okay, great.

Dr. Don R. Kania

Taking out where you’re fracing, which is a last situation where people will (inaudible) we’ll continue to service in that markets with sales or tools.

Raymond A. Link

Yes absolutely.

Thomas Diffely – D. A. Davidson & Co.

Okay, good. And then just finally on the service part of the business, what is the relative end market exposure there. Is it more heavily weighted to either research or electronics?

Dr. Don R. Kania

I would say it’s probably not overly, it is not a big deal, but probably a little heavier in electronics, because they have a tendancy to buy contract and they want 724 short-term response to, it will be a dollar heavier than

Raymond A. Link

More heavier weighted towards electronics.

Thomas Diffely – D. A. Davidson & Co.

Okay.

Raymond A. Link

Yeah ultimately.

Dr. Don R. Kania

The economics make that better.

Thomas Diffely – D. A. Davidson & Co.

And do you ever see much of a variability there based on just the cycle?

Dr. Don R. Kania

Either The only variability we saw was during the last great recession where as you know people were turning equipment off, things shutting down, but that, but during a standard cycle now, they are still running, they still need to take care of it, they still need us to take care of your tools for.

Raymond A. Link

And even that slowed down less to the couple of quarters and came back for a quick on..

Dr. Don R. Kania

Yeah. I think (inaudible) I don’t have the exact date with me so, I apologize that I don’t have completely right, but more on the over the past five years, we may have only had one or two quarters where we didn’t have sequential increase to service revenue during that cycle.

Thomas Diffely – D. A. Davidson & Co.

Okay. And is the bookings components of that business heavier in the fourth quarter?

Dr. Don R. Kania

No, first quarter.

Thomas Diffely – D. A. Davidson & Co.

First quarter. Okay, all right. Thanks.

Dr. Don R. Kania

The annual contract renewals cock up and that’s like – and that’s a very consistent pattern in the company.

Thomas Diffely – D. A. Davidson & Co.

Okay. Thanks for your time.

Operator

(Operator Instructions) I am showing no further questions, you may continue.

Fletcher Chamberlin

Thank you very much everyone. We appreciate your attention. We are available for follow up calls. Give me a call first I think on (inaudible) So thanks very much.

Operator

Ladies and gentlemen, that does conclude the FEI third quarter earnings conference call. If you’d like to listen to today’s replay the phone number is 1-800-406-7325. Access number 4481618. Thank you for your participation. You may now disconnect, have a great day.

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