FEI's CEO Discusses Q4 2011 Results - Earnings Call Transcript

| About: FEI Company (FEIC)

FEI Company (NASDAQ:FEIC)

Q4 2011 Earnings Call

February 8, 2012 05:00 p.m. 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.

Joe Maxa – Dougherty & Company

Zach Larkin – Stephens Inc.

James Ricchiuti – Needham & Co.

Mark Miller – Noble Financial Capital Markets

Thomas Diffely – D. A. Davidson & Co.

Operator

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the FEI Fourth Quarter Earnings Conference Call. During today’s presentation all parties will be in a listen-only mode and following the presentation, the conference will be open for questions.

[Operator Instructions] This conference is being recorded today, February 8, 2012 and I would now like to turn the conference over to Fletcher Chamberlin. Please go ahead.

Fletcher Chamberlin

Thank you, Douglas. Good afternoon ladies and gentlemen. As the operator 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 Events & Presentations in the Investor Relations part of our website, www.fei.com. We will refer to these slides during today’s call. We hope 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 to the presentations, we also have the regular housekeeping matters to address. This call contains forward-looking statements. To the extent that we discuss expectations of our future corporate financial performance and goals, future customer orders, performance by product in the market, the outlook for margins and revenue, market developments and opportunities, future product and technology developments, the effects of future movements in exchange rates, future hiring plans, expected government spending for research tools, expected tax rate and 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 and other risk factors are cited in today’s press release on slide two of the slides posted with 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 commission’s website at sec.gov, on our website or from our 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 website at www.fei.com.

I’ll now turn the call over to Don for a review of our execution against our strategies, a view of our markets and the business environment and then Ray will go through the numbers in detail.

Raymond A. Link

Thank you, Fletcher. Good afternoon everyone. 2011 was a transformational year for FEI. Successful execution of our strategy generated record revenue earnings and cash flow. In 2012 we plan to continue investing to further our growth to expand our margins and to effectively use our cash. For the year revenue grew 30%, gross margin increased by 200 basis points, operating margins increased by 670 basis points, net income group by 94%, and cash flow from operations grew by 35%.

Since 2006 revenue has grown at a compound annual growth rate of 12% per year, essentially all organically. Gross margin has grown by 350 basis points. Operating margin has increased by over 1000 basis points. Net income is up over five times and cash flow from operations is up over four times.

We finished the year with a strong fourth quarter. Revenue was up 14%. GAAP earnings were up 36% and non-GAAP earnings were up 19% from last year’s strong fourth quarter. Ray will provide all the details in a moment.

Last June, we outlined our strategic plans to continue our growth by doubling our served available market by 2014. Indeed we expect all of our markets to grow. But in addition we seek the opportunity to expand it to market served by adjacent technologies. In particular we identified opportunities in life sciences and natural resources that are outside of our traditional electron microscopy market. We’ve taken important steps in the last few months toward executing our plan.

In life sciences our strategy has two components, structural biology and cell biology. We have established an important collaboration in each area. In cell biology, the living lab with Knight Cancer Institute at Oregon Health Sciences University was announced in September.

In structural biology we have signed a cooperative research and development agreement in December with the National Institutes of Health. Under this agreement our team will be working together with NIH experts in adjacent technologies to target important scientific discoveries that could be used in electron microscopy.

These agreements are important investments in our life sciences strategy and are a foundation for future growth. We added another key building block in November with the acquisition of TILL Photonics of Munich, Germany. TILL gives us the performance light microscope component of our correlated microscopy solution, the seamless combination of light and electron microscopy.

FEI now owns the critical components of our cell biology strategy. In aggregate FEI has made substantial progress in expanding our served available market in life sciences.

In natural resources we announced our WellSite solution for service logging for conventional wells and the completion of joint development agreements in Papua New Guinea with Halliburton and in the Persian Gulf with Maersk Oil. We continue our third development with GEOLOG in Europe with the program that is targeted at applications in shale.

In January, we also acquired the hardware manufacturer for the WellSite product, ASPEX Corporation of Pittsburg, Pennsylvania. The ASPEX’s extreme product is a robust and rugged SEM that forms the microscope part of the WellSite solution. 2012 is the year of commercialization of our WellSite solution.

We also announced the introduction of our MAPS software which allows numerous high-resolution microscope images to be fixed together into a larger field of view and allows one to easily navigate to and zoom into a particular section of an image. The MAPS software is a key component in workflow solutions in Life Sciences and natural resources where large field high-resolution data sets are required.

FEI continues as a technology leader in electron microscopy at software, particularly the manipulation and analysis of large three dimensional data sets is growing in importance in our workflow solutions for these markets.

Turning now to slide four and the bookings for the fourth quarter in each of our markets, the largest segment this quarter was Electronics at $72.5 million, up 80% from the third quarter and near the record set in last year’s fourth quarter.

Orders were over $250 million for the year. The key semiconductor customers expanded their investments for new notes containing finer features, new materials and more complex structures. Business from data storage customers was good in the fourth quarter after being almost non-existent in prior quarters. We expect bookings for electronics to remain strong in the first half of 2012 as leading semiconductor customers invest further.

The second largest segment in the fourth quarter was Material Science. We have changed the name of this segment from Research and Industry to better reflect what our customers in this segment do. The segment also includes our emerging natural resources business. Material Science bookings were down modestly from the third quarter and last year’s fourth quarter. Business continued to be particularly strong in Asia with weakness in the U.S. Material Science service from China were at record levels and greater than orders from United States for the quarter and for the full year. We also saw strength in Korea and Brazil.

For the year, bookings in our Material Science segment were up 15% to an all-time record. Bookings for natural resources were up over 40% for the year and 30% from a strong fourth quarter a year ago, both records. The bulk of the business has come from mining companies with no contribution at this time from the WellSite product.

We continue to see laboratory business from oil and gas companies, especially related to unconventional sources. Life Science’s booking is at $19.5 million in the quarter were down from last year and the third quarter. As we have said in the past this segment can be variable in its bookings pattern because of the large size of individual orders. We remain very positive about the prospects for our Life Sciences business, especially in the context of the strategic announcements I mentioned earlier. Orders were flat from year-to-year as the next set of adopters in our pipeline and we expect strong Life Sciences bookings in the first half of 2012.

Fourth quarter bookings for service and components were also down slightly from the third quarter and last year. For the year, service and components bookings were up 6% in line with our expectations. We expect a normal sequential increase in service bookings in the first quarter as the number annual contracts are renewed early in the year.

Looking at geographic bookings on slide five, we had another very strong quarter in Asia including Japan which strengthened Electronics and Material Science. Asian bookings made up a record 51% of the total. They were up 55% from the third quarter and up 33% from last year’s fourth quarter. Bookings for the year from China were up 24% over 2010, making it our second largest country market in each of the last two years.

Geographic diversity remains strong with orders totaling more than $2 million or more from 15 different countries in the quarter. On the year, records were set in Asia as well as in Europe supported by strength in Eastern Europe.

With that, I’ll turn the call over to Ray for a review of the fourth quarter number and then I’ll close the call with some comments on our outlook.

Raymond A. Link

Thanks, Don. There are a number of moving parts in the quarter and I’ll go through them in detail. It was another good quarter. Looking first at slide six, you can see revenue at $213 million was the highest for any quarter in our history. Bookings were above our guidance both before and after the adjustments to the backlog for currency movement. GAAP earnings were well ahead of guidance and non-GAAP earnings were right in the middle of guidance and cash flow from operations was very strong once again. We have now reported 23 consecutive quarters of GAAP profit demonstrating consistency over the long term.

Gross bookings for the quarter at constant currency rate from the end of Q3 were $212 million and net bookings including the downward revaluation of the backlog at quarter end currency rates were $203.6 million, up 9% from Q3 net order total. At the end of Q4, the euro was $1.29 compared to $1.34 at the end of Q3. The weaker euro reduces the value of our euro denominated backlog when converted back to dollars. The back log at the end of the quarter was $430.7 million and represents approximately six months of revenue at our current run rate.

Moving to slide seven, fourth quarter revenue was up 14% from a year ago and 4% in the third quarter. Sequential revenue growth was reduced by another $5.6 million due to currency movements during the quarter. Revenue growth was driven by our Material Science segment which was up 23% sequentially and 94% from last year’s fourth quarter. The natural resources part of this segment more than doubled for both the fourth quarter and the full year and the scientific research part was also up substantially.

The electronics revenue for the fourth quarter of $54.8 million was down 3% from the third quarter as we had expected. The book-to-bill ratio for electronics was 1.32 to 1, and we expect revenue growth for this segment in the first quarter of 2012.

Life Science’s Q4 revenue was down sequentially from the record level in the third quarter, but up 24% from last year’s fourth quarter. Life Science’s revenue for the full year was over $100 million for the first time and was up 38% from 2010.

Service and components revenue was up 10% for the fourth quarter compared with last year and 11% for the full year. That’s the best annual growth we have seen in that segment in the past decade.

Turning to slide eight, our revenues for the quarter are well balanced geographically. Asia and Japan made up 40% of revenues in the quarter, Europe and the Middle East made up 32%, and North America made up 28%.

Now looking at slide nine, gross margin in the quarter was 44.4%, in line with the third quarter and our expectation. We are pleased with that performance in light of its significant mix shift in the quarter. Our electronics business made up only 26% of revenue in this year’s fourth quarter compared with 43% in the fourth quarter a year ago.

The currency higher volume, improved service margin, and continued gains from our expanded manufacturing in the Czech Republic helped gross margins in the latest quarter offsetting the significant mix shift. Gross margin in the first quarter of 2012 is expected to improve from the Q4 levels and we believe we are on track to reach our stated goal of a 47.5% gross margin in the fourth quarter of 2012.

Turning to slide 10 and moving down the income statement, operating expenses are a bit complex. Total expenses on a GAAP basis were $70.8 million. That includes $8.8 million of expenses for unusual items in the fourth quarter. Those items include $5.3 million for our estimates to settle a long running patent dispute and $1.4 million to write down the value of certain intangible assets due to a change in our technology roadmap.

These two charges are included in SG&A expenses. Restructuring expenses totaled $2.1 million and relate to an early termination of a manufacturing service contract at our Hillsborough facility. We expect that termination to contribute to gross margin improvement in the second half of 2012. Without these items SG&A expense would have been $40.4 million. Total operating expense would be $62 million and restructuring expense would have been zero.

Reported GAAP operating income for the quarter was $23.7 million excluding the items I just discussed non-GAAP operating income would have been $32.6 million. Non-operating expense was $2.5 million in the fourth quarter compared with a $600,000 loss in the third quarter and in last year’s fourth quarter. The unusual volatility in currency rates during the quarter caused larger than normal balance sheet translation losses. On a GAAP basis we recorded a net tax benefit in the quarter of $ 7.8 million.

During the quarter we received permission from the Dutch tax authorities to apply their Innovation Box tax treatment to an income attributable to intellectual property for our Dutch operations. An important benefit of the innovation batch approval is that we now expect our overall tax rate during 2012 to be approximately 22% compared with around 27% prior to the approval.

Adjusting for the benefit from the Innovation Box for periods prior to the fourth quarter of 2011 and applying an appropriate tax expense to the operating expense adjustment mentioned previously, yields of non-GAAP tax expense was $4.7 million for the fourth quarter. GAAP net income was $29.1 million or $0.72 per share. After the excluded items and a tax impact, non-GAAP income was $25.4 million or $0.63 per share in the middle of our guidance range. The weighted average shares for diluted EPS in Q4 was $41.3 million, a decrease of 2% in Q3 and 3% in Q2 as a result of our share repurchases during the third quarter. We do not buy shares in the open market and the fourth quarter.

As you can see on slide 11, our balance sheet and cash flow remain very strong. Total cash and investments at the end of the quarter included restricted cash in long-term investments was $456.1 million, up $20.4 million from the end of the third quarter. That’s after spending $14 million to purchase TILL Photonics.

Net cash after subtracting debt was $367.1 million, up $32.3 million since the beginning even after the TILL acquisition and the purchase of $50 million of shares in the third quarter. Net cash at the end of the quarter was $9.70 per share.

Cash flow from operating activities was $48.6 million in the fourth quarter and over $100 million for the full year. Free cash flow after subtracting net capital expenditures was $87.6 million or $2.31 per share. Day’s sales outstanding were at the lowest in a decade and inventory turnover improved in the quarter.

With that, I’ll turn the call back to Don for guidance and comments about the outlook.

Don R. Kania

Thanks, Ray. Slide 12 is a summary of our guidance for the first quarter of 2012. We expect revenue to be in the range of $210 million to $220 million. Bookings are expected to be at least $210 million, which if achieved will be a record for our first quarter. Earnings per share expected to be in the range of $0.60 to $0.65.

After transformative growth in 2011, we expect FTI to organically grow in 2012. The acquisitions of TILL and ASPEX are strategic in nature and will not have a significant defect on the bottom line. Both add approximately $25 million in annual revenue. Electronics will continue to increase its share spend by our customers, Material Science will be okay with potential weakness in the U.S. and parts of Europe offset by continued global investment.

Natural resources will continue its penetration in the labs of mining and oil and gas companies and we’ll see its first revenue from the WellSite solution. Life Sciences will continue the growth we have seen already and will begin to reap the benefits of our living lab investments. We are on track to reach our goal of our gross margin of 47.5% by the fourth quarter of 2012. In addition to increasing our proportion of higher margin products, we expect lower costs from increased volume from the Czech Republic, continued sourcing improvement and the end of manufacturing services agreement in Hillsborough.

Our plan is to continue growth, improve margins and generate cash. For the cash in our balance sheet, we will continue to target M&A and be opportunistic buyers of our stock. I am proud of the entire FTI team and the leaders we have assembled to deliver the excellent results in 2011. We are again planning a New York Investor Day this spring when you will have an opportunity to meet more members of the management team and learn more about our strategies for growth and margin improvement. The meeting will be on June 7 and you will receive an invitation shortly. We hope to see you there.

With that operator, we are ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line from Patrick Ho with Stifel Nicolaus. Please go ahead.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Thank you very much, and congrats guys for a really good year. Don, if you look at your revenue outlook for the March quarter, can you give a little color on the type of mix because it’s incorrect, usually Electronics is a little softer in the first quarter of the year. How does the mix shake out for March?

Don R. Kania

Yes, I think probably a better thing given the times that we’re in is to look at the flow of orders and usually we try to convert those orders in Electronics a little faster. So I think it’s quite fair to expect that the mix in Electronics will be up a bit from what we saw in the fourth quarter which had an unusually large amount of that Material Science, Mat Science business. So, yeah, Electronic is up, and I think the other stuff will fill up the space.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. Going back to Life Sciences business and the traction you’re starting to gain there, how are you able to, I guess, manage the supply chain especially for those type of customers where the problems begin if I am correct, they typically had a little bit of a longer lead time. How are you able to manage I guess the order inflow as well as the shipments for that business segment?

Don R. Kania

Yeah. Well, in terms of managing the build of the product, it’s – I don’t know the exact number, but it’s 85% tight, and so we ship out large mix of those every quarter, and so managing that aspect of the inventory is pretty modest. And then the mixing in the Life Science specific components for use is actually pretty straightforward. Then matching – we just try to manufacturing the build up to the customer’s expected delivery in the bigger picture in life.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. Final question from me in terms of the oil and natural resources business that you are building there, can you give us some update on, I guess some of the non-traditional, are we going to see datas in 2012 or it’s just something that’s still kind of a working progress on the non-traditional side of things?

Don R. Kania

In other words the unconventional oil and gas?

Patrick Ho – Stifel Nicolaus & Company, Inc.

Yeah, yeah, exactly, yes.

Don R. Kania

Yeah. In unconventional, we are doing a test. You really see two things right now, number one, we’re already selling equipment into oil and gas companies that have an interest in understanding from the scientific or technical side shales. And so, we have major oil companies that are customers of our equipment, but that sits in a laboratory. With GEOLOG which is the largest private service logging company in the world out of Italy, especially headquartered in Italy we are actually doing a measurements related to shale extraction. And I really can't say any more on that, but the first two were on conventional, the third is working on shale, and so this really two trends are going to evolve through the year. One is we expect continued business from the development side, that is the understanding of how the shales work and then I think part two was towards the end of the year there is a chance we’ll see some traction in the shale side, perhaps from the services, but that’s going to be a small component of ‘12. That’s hopefully a bigger play in ‘13.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. Thanks a lot guys.

Don R. Kania

Thank you sir.

Operator

Our next question comes from the line of Joe Maxa with Dougherty & Company.

Joe Maxa – Dougherty & Company

Thank you very much and congrats on a nice quarter.

Don R. Kania

Thanks Joe.

Joe Maxa – Dougherty & Company

Question on, I just want to talk a little bit more about the geographic mix pretty strong in Asia pacific, a little weaker in North America than normal. Are you seeing the funding environment being a big issue, and what do we expect in North America going forward. We are going to see a big back up.

Don R. Kania

I think typically in the fourth quarter, particularly in our businesses that do research, so both research and lifestyle, you have a tendency historically to see what we would call budget flush. People approaching the end of their years and they spend a way a little bit extra because to use it or lose it. I think this quarter what we saw particularly in United States was very little budget flush. And so I think we are sort of at a static mode of spent there. So, as I said in my comment in the material science area, you know, we are not expecting the U.S. to be a big mover in ’12. I think the U.S. carries on and it will be okay, it’s the rest of the world that carries a day in that segment overall.

And then in Asia and in China has been a wonderful thing. Its run-rate in the fourth quarter we are getting that $100 million level. Its round eighth of the business of the company and that trajectory we remain optimistic about. And then the other piece of the puzzle I think in Asia in terms of its big share this quarter was in fact a lot of the electronics business that we saw within that region. You combine those together it’s a strong growth.

In the research type businesses, particularly material science and then [indiscernible] electronics that had a good quarter that region of the world has carried the day.

Joe Maxa – Dougherty & Company

You did mention a bit of pent up demand in material sciences last quarter. Do you think we peaked there?

Don R. Kania

I don’t know if it’s – I think this is sort of this is a – we don’t have peaks. I think it’s going to carry on and we said off late that this is going to be a modest by our standards growth rate business and I think this carries on. We will see the usual kinds of seasonalities and some give and takes, but I think it carries on. We still see Eastern Europe as an area of continued investment. We see China as being strong or starting to see places like South America, Brazil, I commented on being strong as well. So the big plan, there are still lots of pieces to the puzzle.

Joe Maxa – Dougherty & Company

On the electronics side you talked, obviously there are some positive comments during the market the whole from MySpace, but would you expect to see growth in that segment or meaningful growth this year?

Don R. Kania

I think we will comment on ’12 growth overall. I think that we feel very good about the first half of the year. That’s where we have visibility. Most of our knowledge and we really rely on customer interactions and in our interactions with particularly our largest spenders is coming back very positive for the first half of ’12. Second half we are just not going to comment on.

Joe Maxa – Dougherty & Company

Okay, and one for Ray on the SG&A line. You take out the one timers, was that a reasonable number to look at for next year or is that bit high going into the first part.

Raymond A. Link

I think if you look at the Q4 run-rate if you strip out everything we are around $62 million. That’s a reasonable method to start looking at 2012.

Joe Maxa – Dougherty & Company

Okay.

Raymond A. Link

One other thing to thank you, David Dugan our controller whispered in my ear also they certainly talk about we do have the two new companies that rolled in. At TILL we acquired late in December so there is very little cost in SG&A for that then we will have a full year of that and we will have a full year of aspects. They are relatively small so they will be a little trend up from the 62 [indiscernible].

Joe Maxa – Dougherty & Company

All right. Very good. Thank you.

Operator

Our next question comes from the line of Zach Larkin with Stephens Inc. Please go ahead.

Zach Larkin – Stephens Inc.

Hey, good afternoon gentlemen. Thanks for taking my call. First off, I wondered if you could talk a little bit about some of the order flows and was there anything that's been particular in the quarter that may be was surprising to you that was a little bit off of what you would have stop going into the quarter.

Don R. Kania

I think the one area in terms of off was – and I think I should look back at our last transcript and when we guided we did mentioned that we were concerned there might not be this budget flush in research and in fact I think that’s pretty much things of past, but because I think people are concerned about their budgets in the ’12 in the U.S. that people just are trying to hold on the money to pay for people and it will be a little more conservative with respect to funding, spending on equipment in the near terms. So, our sense is we have reached a level there and it’s the level is going to be stable and maybe if we ever get more certainty about where the budgets are going to go it might pick up. But we are not planning on that. Our forward view of growth for FEI in ’12 assumes that we are sort of static in the U.S.

Joe Maxa – Dougherty & Company

Okay. And then as we look into 2012, you’ve already talked a fair bit about the natural resources and Life Sciences opportunities, but are there any specific signs on the road that we should look for from you guys by way of potential announcements or things like that to say, hey, things are really moving along as anticipated or how should we think about that?

Don R. Kania

Yeah, I think what we’ll do is we’ll prudently update you as we get these quarterly calls about – I think the thing I will want to highlight as they happen and these will take some time is to do with the commercialization of the WellSite solution. So we get paying customers instead of them will question.

Joe Maxa – Dougherty & Company

Okay. Thank you very much.

Don R. Kania

Sure.

Operator

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

James Ricchiuti – Needham & Co.

Hi, thanks. Good afternoon.

Don R. Kania

Hi, Jim.

James Ricchiuti – Needham & Co.

Question I had, Don, just with respect to the comments you made a little earlier just about the – it sounds like a stronger visibility in the Electronics business in the first half of the year. I wonder if you could comment on the visibility you have in terms of shipments in your other major markets as you look out into the second half of the year. I mean, it almost sounds like you’re suggesting a stronger first half, but it – I just want to get a better understanding of how you’re viewing shipments in this – in the other markets in the second half?

Don R. Kania

I think the most important thing we takeaway is, no, we are not commenting anything about strong first half versus second half. I think what we’re commenting on is we have a lot better visibility in the first half and we’re making no comments about the second half at this point. But we feel pretty good about the first half in terms of Electronics being strong. We think Life Sciences will be strong as compare, we think Material Science carries on, it’s kind of a record year in that segment. So we feel like that’s going to be good as well, and the other piece of the puzzle seem to hold together pretty well. So I – bullish is maybe not the right term, but we feel good about first half of this year and we’re just not making any comments on the second half.

James Ricchiuti – Needham & Co.

Okay, fair enough. And just on the newer areas that you’re focusing on structural biology, same biology, should we think about that is potentially being a meaningful contributor in 2013 or is that still kind of early.

Don R. Kania

Yeah, I think it’s for 2013?

James Ricchiuti – Needham & Co.

Yeah. I’m just – given you sort of -?

Don R. Kania

Yeah. And the answer is we should expect to see something worthy of a discussion in ’13 from the combination of the acquisition of TILL and move forward based upon our investment in the two laboratories, the one at Oregon Health Sciences University FEI NIH and start with – there are some purchase there.

James Ricchiuti – Needham & Co.

And on these agreements, can – maybe you could talk a little bit about the significance of the NIH agreement, how significant is that do you think?

Don R. Kania

We think it’s actually very, very significant, and I participated in some of the activities and one of the important things for us was that we’re really freeing a new technology into a marketplace that, I think it’s $500 million to $800 million a year, people spending on these adjacent technologies. And we wanted to be sure that we had real engagement from the practitioners of those technologies who would understand their limits, understand the science of what’s important, and how we would fit into that. And I was so impressed with the enthusiastic response that we got from the NIH scientists who are world class in their abilities in these other technologies. We think that this is really going to catalyze a lot of the – lot of traction for us over time in structural biology. So my comment is it’s very important. When you have the best mines in the world that are buying other people stuffs and this is very interesting that we want to work together with you to see if this all works together better, it’s to me a good leading indicator.

James Ricchiuti – Needham & Co.

Okay. Perfect. Thanks very much.

Operator

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

Mark Miller – Noble Financial Capital Markets

Let me add my congratulations to your results again, this will be coming on handed.

Don R. Kania

Thanks.

Mark Miller – Noble Financial Capital Markets

Just you mentioned that data storage favorably impact your electronics bookings and we all know about the targets, one in Thailand. Was not a significant part in the increase in data storage bookings?

Don R. Kania

It was a piece of it. I think what was interesting to us, Mark, was that every major manufacturer of thin films had made a purchase in the quarter and I can’t remember last time that happened. I mean obviously we haven’t gotten a lot of orders from data storage for three, four quarters. But this quarter everybody teed up. Yes, there was an impact of the floods and we received some unfortunate benefit from that, but we’re going to help WD get a past tense has weakened our part of that. But everybody else contributed to the floorboards and day stores as well. So I think there is another bit of technology activity going on.

Mark Miller – Noble Financial Capital Markets

Can we look at R&D spending, it really went up significantly during the first and fourth quarter, the trend going to continue this year.

Dr. Don R. Kania

We said yes, and we’re targeting at the 11% level, so you should think about that spend and touch with the addition of these other companies, there are some R&D contribution there. So yeah, we’ll see grow up a bit, I don’t think quite as dramatic as what we saw in ’11, but nonetheless that I think we’ve got a brand felt in as well.

Mark Miller – Noble Financial Capital Markets

And just finally, you are still being very positive on the 47.5% and you did mention some of the factors and I didn’t can personally catch them all. I know the Czech Republic world class were one of the drivers, what are the other drivers?

Don R. Kania

Well, I think the other one is by noteworthy is that we’re taking over manufacturing in our Hillsborough facility, that’s the most recent news. And we – Ray highlighted that there was a one-time payment to accelerate that separation and we will start to garner margin benefits from that in the third quarter and full benefit from that transfer in the fourth quarter. So you know that’s the piece of the puzzle that’s going to be building toward improving margins in Q4.

Mark Miller – Noble Financial Capital Markets

Just to go back to that what about new products? Are they significant part of the margin drivers?

Don R. Kania

Yeah, they are meaningful part of it and it’s actually quite gratifying to see when our new products roll out that the margin targets that we set for them are being achieved. So that’s great.

Mark Miller – Noble Financial Capital Markets

Thank you.

Operator

Our next question comes from the line of Thomas Diffely with D. A. Davidson & Co. Please go ahead.

Thomas Diffely – D. A. Davidson & Co.

Yeah, good afternoon. First a quick clarification. Did you say that two-one aspect is going to generate about $25 – add $25 million on the top line, but no impact to earnings?

Raymond A. Link

Correct.

Thomas Diffely – D. A. Davidson & Co.

Okay. And then you looking at the hard disk drive business, is that still mainly a DualBeam market for you? Is that the high margin DualBeam products?

Don R. Kania

Yeah, yeah, absolutely.

Thomas Diffely – D. A. Davidson & Co.

Okay.

Don R. Kania

Large wafer, what we call the large wafer dual beams.

Thomas Diffely – D. A. Davidson & Co.

Okay. And then I guess looking at the gross margin goal by the end of the year do you see that’s kind of linear and progression margins or is that you know certain things falling together in the second half and regular step function.

Don R. Kania

Obvious step function, but it will be back and loaded.

Thomas Diffely – D. A. Davidson & Co.

Okay. And then Ray if you could may be give us a still for what the impact of the weak Euro was both in the reported quarter and also what you expected to be in your guidance?

Raymond A. Link

In the quarter it had about $5.6 million reduction in revenue, reduced the back log by about $8 million or there about. We are looking right now in our guidance we are pretty much assuming we are going to be in the same general range that we are today. So rather than just picking numbers we have to live with all the day-to-day fluctuations just assume that it’s going to be the same general range. Clearly a stronger dollar help the FEI ultimately because it reduces some of our OpEx and includes our merge, but it does affect top line revenue growth a little bit.

Thomas Diffely – D. A. Davidson & Co.

Okay and finally Don, a couple of years ago you were going to increase gross margins by outsourcing R&D in the U.S. and today you are going to increase gross margins by insourcing, manufacturing in the U.S.

Don R. Kania

Yeah. We did that experiment and it failed, okay. I mean it’s really that and we found that by pretty straight forward, but rigorous analysis that you know we can build the product cheaper and I talked to other people who from this experiment in similar time scale that we did it and the integrating model that has been assembling large sub systems is a very good one. So test and integrate, outsource manufacturing. You seem to give up a little bit of value to do that and we don’t think that’s the right thing for us.

Thomas Diffely – D. A. Davidson & Co.

So I guess before this is done maybe you would get to some volume buying discounts, but that is – your volumes wasn’t coming through.

Don R. Kania

It wasn’t enough to overcome the margin stack of two people who wanted to make money.

Thomas Diffely – D. A. Davidson & Co.

Yeah, okay. All right, thank you.

Operator

[Operator Instructions] One moment please for our next question. And there are no further questions in queue. I would like to turn the call back over for closing remarks.

Fletcher Chamberlin

Okay, this is Fletcher. Thanks everybody. We appreciate your checking in and hope it’s useful. Give me a call, I’ll be available. Don and Ray are running into meeting, but we will be available for the next few days as well. Thanks very much for your attention.

Operator

Thank you 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 4501547. We like to thank you for your participation and you may now disconnect.

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