FEI (FEIC) Donald R. Kania on Q4 2015 Results - Earnings Call Transcript

| About: FEI Company (FEIC)

FEI Co. (NASDAQ:FEIC)

Q4 2015 Earnings Call

February 02, 2016 5:00 pm ET

Executives

Jason Willey - Sr. Director, Investor Relations and Corporate Development

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

Donald R. Kania - President, Chief Executive Officer & Director

Analysts

Joel Harrison Kaufman - Goldman Sachs & Co.

Patrick M. Baumann - JPMorgan Securities LLC

Patrick J. Ho - Stifel, Nicolaus & Co., Inc.

Anne M. Edelstein - Bank of America Merrill Lynch

Jim A. Ricchiuti - Needham & Co. LLC

Bryan Andrew Masuda - D.A. Davidson & Co.

Operator

Greetings and welcome to the FEI Company's Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.

I'd now like to turn the conference over to your host, Jason Willey, Senior Director of Investor Relations. Please go ahead.

Jason Willey - Sr. Director, Investor Relations and Corporate Development

Thank you operator, and good afternoon everyone. As the operator said, I'm Jason Willey, FEI's Senior Director of Investor Relations. With me today at our headquarters in Oregon are Don Kania, our President and CEO; and Tony Trunzo, EVP and CFO. We have again posted slides under Events & Presentations in the Investor Relations portion of our website.

Before we get to the presentation, we would like to remind everyone this call contains certain forward-looking statements that include guidance for revenue and earnings per share for the first quarter of 2016 and full-year 2016. To the extent that we discuss expectations about future orders, revenue growth, the timing of orders and revenue, gross margins, expenses, capital spending or our tax rate and earnings, those statements are considered forward-looking and are subject to risks and uncertainties that could cause our actual results to differ from the forward-looking statements made.

Risk factors that could affect these forward-looking statements are cited in today's press release, in the slides posted for 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 FEI's Investor Relations Department at 503-726-2533. 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 will now turn the call over to Tony to go through the financials. Don will then discuss our business and outlook. We will then be glad to take your questions.

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

Thank you Jason and good afternoon everyone. We finished 2015 on a strong note with record bookings, revenue, operating margin and earnings per share in the fourth quarter. Q4 revenue of $273 million included approximately $1 million of revenue from the DCG Systems acquisition that we completed in December. Q4 revenue grew 8.2% organically compared with Q4 last year as backlog in our Science segment converted to revenue.

Earnings per share of $1.17 in Q4 included $5.3 million of transaction cost and operating expenses associated with the DCG acquisition and overall DCG reduced EPS for the quarter by $0.07. Q4 operating margin of 21.4%, which included a negative 180-basis-point impact from DCG, also represented a quarterly record. Operating margin and EPS performance in Q4 highlight the earnings leverage inherent in our business.

For the full year of 2015, revenue of $930 million was up 2.6% on an organic basis compared with 2014 and GAAP earnings per share grew by 20% to $2.96. GAAP EPS has been impacted by a number of unusual items over the past two years including restructuring costs, the revaluation of intangible assets, tax benefits and acquisition costs that reduced EPS by $0.50 in 2014 and by $0.43 in 2015. Excluding these unusual items, earnings per share grew by 15% in 2015 and return on equity exceeded 15%. Science segment Q4 revenue was $163 million, up 12% on an organic basis compared with last year, driven by record life sciences revenue and improvements in material sciences following a slow start to the year. For the quarter Science revenue accounted for 60% of total revenue compared with 52% for all of 2015.

Our Industry segment reported revenue of $110 million, up 2.8% compared with last year's fourth quarter on an organic basis. Results in this segment were negatively impacted by the timing of migration to next generation process nodes in our semiconductor business. Revenue from our three largest semiconductor customers was under 30% of total semiconductor product revenue in Q4, well below the typical range of 40% to 50%. Although the service business performed well again in Q4 with revenue growing to $66 million, up 14% on an organic basis compared with Q4 last year. For the full year 2015, Service revenue was $244 million, up 11% on an organic basis.

Overall gross margin in the quarter was 48.8% compared with 46.5% a year ago, driven by improved factory absorption due to strong volume as well as higher software revenue. Gross margin in the Science segment improved sequentially for the fourth consecutive quarter and company-wide gross margin improved by 2.3 percentage points despite the negative gross margin impact of lower semiconductor revenue mix.

Operating expenses were $74 million in Q4 compared with $82 million in Q4 2014. Quarterly expenses included a year-over-year currency benefit of approximately $6 million and $5.3 million of additional costs related to the acquisition of DCG. Excluding unusual items in each of this year and last year, operating expenses were approximately flat year-over-year.

Adjusted EBITDA for 2015 was $217 million, up 9% from 2014. Moving forward, we will provide an adjusted EBITDA reconciliation in our earnings press release to offer additional view into our operational performance given recent M&A activity.

Q4 cash from operations was $70 million and equaled to 145% of quarterly net income. During the quarter, we paid cash dividends of $12 million, invested $6.9 million in plant and equipment and repurchased 443,000 shares of our stock at an average price of $75.77 per share. Full year cash from operations of $204 million was up 43% compared to 2014 and represented 138% of annual net income excluding the non-cash benefit of the Q3 goodwill impairment charge.

During 2015, we repurchased 1.4 million shares of our stock and increased our quarterly dividend for the third consecutive year to an annualized level of $1.20 per share. Total returns to shareholders via dividends and repurchases were $153 million in 2015, equivalent to 75% of our cash flow from operations. At the end of 2015, we were over halfway through the 2 million share two-year repurchase plan we announced at our June investor event.

In December, we invested $162 million in the previously announced acquisition of DCG, expanding our footprint in a less cyclical semiconductor lab. The combination of FEI and DCG technologies offers us the opportunity to create unique workflows that connect electrical failure and physical fault analysis. This is an area of increasing emphasis as device shrinks become more challenging and logic and memory designs move to 3D.

Q4 revenue included $1 million attributable to DCG while Q4 operating expense includes transaction and integration costs in the amount of $3.8 million and ongoing operating expenses of $1.5 million. The net impact on Q4 results from the DCG transaction was a reduction in net income of $3 million or $0.07 a share.

For the full year 2016, DCG is expected to generate revenue of approximately $70 million. Adjustments required by purchase accounting rules will reduce reported net revenue by approximately $12 million in 2016, with the majority of these adjustments occurring during Q1. Taking into account the impact of purchase accounting, we expect reported revenue for DCG in the first quarter to be approximately $6 million. Including estimated purchase accounting adjustments and integration costs, DCG is expected to reduce Q1 GAAP EPS by approximately $0.11. In aggregate, we expect DCG to be approximately neutral to earnings for the last three quarters of the year on a GAAP basis.

We've not yet completed the final purchase price allocation for the transaction, but we currently expect full year amortization expense related to acquired intangibles to be approximately $5.5 million. We'll of course provide updates on DCG's performance and the impact on our full year financial results with our quarterly earnings reports through 2016.

As outlined in our June investor event, we are measuring our long-term performance across four metrics: organic revenue growth, operating margin, earnings per share growth, and return on equity. We previously communicated our outlook for organic revenue growth in the range of 5% to 9%. Based on revenue growth within this range, by 2019, we expect operating margin to reach 23% and return on equity to reach 20%. Over this period, earnings per share growth is expected to be in the range of 10% to 15% per year.

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

Donald R. Kania - President, Chief Executive Officer & Director

Thank you, Tony and good afternoon everyone. We ended 2015 with a strong quarter. In Q4, the book-to-bill was 1.08 to 1 driven by record Science orders. Fourth quarter orders were $294 million, up 11% on an organic basis compared with the fourth quarter of 2014. Backlog reached $591 million at the end of 2015. Excluding the impact of the DCG acquisition, backlog grew 8% from the end of 2014. For the full year, bookings were down 1.6% organically. The decline was due to a slow start in the year in the Science business, which finished the year on a record note and a cyclical fall off in the semiconductor market in the second half.

Science bookings were up 14% on an organic basis compared with record Q4 2014 levels. Orders were strong at both material science and life sciences customers. Cryo-EM adoption continues to accelerate as a growing set of new customers embrace our technology for determining molecular structure that has been inaccessible with other imaging modalities. In a growing number of transactions, we are displacing more traditional technologies such as x-ray crystallography.

We are excited by the increased number of publications and recognition of cryo-EM in the leading scientific journals. We are especially proud that in January, Nature Methods named cryo-EM as Method of the Year and 2015 saw numerous papers highlighting the ability to achieve new atomic resolution with our cryo-EM solutions.

Revenue and bookings from life sciences customers were at record levels in Q4 and in 2015. The current backlog is scheduled to ramp into revenue throughout 2016. In anticipation of strong shipment growth, we have expanded our manufacturing capacity. Looking ahead, we're actively involved in developing the opportunity for cryo-EM within the pharma industry. We see long-term potential around the ability to gather insights into molecular activity and then translate this information into insights around disease and the developments of drugs. Progress has been made at the NIH where a new study published in Science demonstrates an atomic resolution structure of the binding of a small molecular drug to a key protein in a cancer cell.

In the near-term, majority of cryo-EM sales are expected to remain within the academic and research community where there is ample opportunity for growth. Our material science bookings improved in each quarter of 2015. Material science remained a geographically diverse customer set with strength in the United States and China, a steady Europe and weak emerging markets.

In 2015, the weaker yen continued to put us at a competitive disadvantage in Japan. Industry orders were up 4.4% on an organic basis from Q4 2014 levels. Despite the year-over-year growth in Q4, industry orders in the second half of 2015 were well below the first half levels and fell short of our expectations entering the year.

Our largest semiconductor customers delayed the ramp of their 10-nanometer processes, which had a negative impact on our near-line solutions. Current conversations with customers indicate investment activity in leading edge node transitions will pick up in the back half of 2016. However, our visibility into the exact timing of this uptick remains limited. Therefore, we have incorporated a conservative view for this portion of our business into the full year 2016 outlook which we will outline momentarily.

We believe our position within the market remains strong in an area of an accelerating investment, which will enable us to meaningfully outgrow the overall industry spending as device and process complexity continues to build. The oil and gas market environment remains difficult. That said, we believe our oil and gas business found the floor in 2015. Our focus is centered on areas where we continue to see near term opportunity, primarily national oil companies and some majors.

In January, we introduced PerGeos, a software package aimed at helping geoscientists interpret and model the results from digital rock imagery to better understand how to maximize yield from hydrocarbon reservoirs. It provides the bridge from FEI's data and analysis to the real-world analysis of oil and gas reservoirs.

Moving to guidance, for the first quarter of 2016 reported revenue is expected to be in the range of $215 million to $225 million, with organic revenue expected to be flat to down 4%. The outlook reflects seasonal softness in our Science business, timing of backlog conversion in life sciences, and muted activity in the semiconductor market. GAAP EPS is expected to be in the range of $0.46 to $0.57. Estimates for Q1 and the full year assume an effective tax rate of approximately 21%.

As Tony indicated earlier for Q1, DCG is expected to add approximately $6 million in revenue and to reduce EPS by approximately $0.11. We expect sequential improvement in revenue and earnings throughout 2016. These expectations factor in a modest improvement in the semiconductor spending as the year progresses and accelerated conversion of the backlog in life sciences to revenue. Backlog of $591 million exiting 2015 provides significant visibility into our Science and service revenue in 2016.

For the full year 2016, organic revenue growth is expected to be in the range of 3.5% to 6.5%. Reported revenue is expected to be between $1.02 billion to $1.05 billion, up 10% and 13%, respectively, year-over-year. For the full year 2016, EBITDA is expected to be in the range of $235 million to $245 million. GAAP EPS is expected to be in the range of $3.55 to $3.70. DCG is expected to contribute revenue of approximately $60 million in 2016 reflecting a negative purchase accounting adjustment of approximately $12 million. DCG is expected to reduce full-year GAAP EPS by approximately $0.10.

In summary, we expect a year of improved organic revenue growth in 2016 with a continuation of the strong earnings and cash generation delivered in 2015. Our current view for the year assumes flat to slightly up product revenue in our Industry Group and growth in product revenue in our Science Group, which is supported by our backlog and order pipeline in life sciences. In addition, we are expecting our service businesses to continue to grow at near historic rates. Revenue growth in 2016 is expected to be biased towards the second half of the year. High-end tool revenue in our Science Group is driven by our customers' facility readiness, and within our Industry Group semiconductor customer demand is expected to improve in the second half.

In closing, I would like to thank our employees for their hard work in driving a record fourth quarter results. I would also like to welcome all the DCG employees into the FEI family.

With that, operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from Isaac Ro from Goldman Sachs.

Joel Harrison Kaufman - Goldman Sachs & Co.

Thanks, guys. It's actually Joel in for Isaac. Just trying to get a better sense of why you guys are still bullish on cryo-EM in 2016, just given how long it takes some of these new high-end technologies to gain traction and find funding? And then maybe could you just help us understand the typical sales cycle of one of these placements?

Donald R. Kania - President, Chief Executive Officer & Director

Sure. I think the bullishness comes from as we look prior to 2016, customers were very, very effective in the United States at finding non-NIH funding to buy their tools. There was relatively limited funding in the area. They were able to get either the university funding, philanthropic funding in areas outside of the traditional funding routes. We see that continuing into 2016. But on top of that I think we're starting to see that the NIH is waking up that this is a technology change that's deserving of additional funding, and so I think within the U.S. we see both the existing opportunities for growth and perhaps additional opportunities for people to acquire our system.

We look outside the U.S., Germany has been very aggressive in this area over the year, and we expect that to continue. We see the UK aggressively investing and to some extent some other areas in Europe. And if we go over to China, they are very well funded to contribute to their development in the long term of a pharmaceutical industry and so we see that funding as robust as well.

Typical sales cycle traditionally in our high-end equipment like this can run as long as a year. But our experience has been, in areas where you have the hot technology topic, that cycle time can shorten up because people get very aggressive. And what you have is the high-end scientists who have significant sway with the funders and they may be either within the traditional government routes or within their local funding, or whether that state or university or philanthropic funding find themselves to be more effective. And we've seen a little bit of that pattern starting to happen where orders are closing more quickly, because people want to lock in slots so they can be generating their differentiated research products more quickly. Does that answer your question?

Joel Harrison Kaufman - Goldman Sachs & Co.

Yes, thank you. And then maybe just one on the service business; I think you guys have seen some nice sequential improvements in organic growth throughout the year. Maybe just dive into what exactly is driving that improvement and why you guys are still bullish on service in 2016 as well?

Donald R. Kania - President, Chief Executive Officer & Director

I think – well, the easiest way to be bullish is just to look at the track record in the business, which is growing linearly over multiple years, but there is a reason that we've been able to do that. One, you do have some installed base expansion, but at the same time we feel confident that will continue, because we've enhanced the management team, enhanced our product offerings such that we're able to serve our customer bases, because we've separated service for the Industrial Group and the Science Group. They have very different needs and very different requirements and very different ability to pay. And so in the past several years in particular we've focused on having offerings that are appropriate for the segment, which has allowed us to grow revenue and at the same time improve the gross margins in the business. So we've got a good backlog, we feel that the team is executing and we see no disruption to that pattern.

Joel Harrison Kaufman - Goldman Sachs & Co.

Perfect, thanks.

Operator

Thank you. Our next question comes from Tycho Peterson from JPMorgan.

Patrick M. Baumann - JPMorgan Securities LLC

Hey, guys, thanks. It's actually Patrick Baumann in for Tycho. Maybe just looking at the 23% long-term operating margin in 2019, can you maybe just talk through the key levers to get there? Maybe what gross margins will be that year and where on the P&L are you really going to drive that leverage?

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

Sure, yeah, it's Tony, Patrick. The last couple of quarters if you look at kind of where we've executed, we've been able to get into the pretty high teens with gross margins not quite at 50% on a continuous basis. To get to 23%, we're going to have to see gross margin expansion to the point where it's consistently north of 50%, not a ton north of 50%, but in the low-50%s. And there's a couple of places that comes from. We have been successful over the last couple of years in driving some meaningful millions of dollars out of our supply chain. We have gotten I think more focused in terms of value-based pricing and making sure that where we have a competitive edge we are able to translate that into better margin for us, and fundamentally the mix of the business should start to trend in a more favorable direction as well, because not all of our businesses have the same margins, and those that are growing the fastest tend to have somewhat higher margins.

And then on the operating expenses, we're not going to see operating leverage out of R&D because that's the lifeblood of this company. You might see a little bit in terms of sales overhead, but we're going to have growth in sales. But there is an opportunity and I've seen this and been involved in companies that have done this for many years where if you can grow your organic revenue in the mid- to high-single digits, you can grow your operating expenses somewhere between two-thirds and three-quarters that rate. And getting to the 23% is going to require us to be able to grow inside that range to get that operating leverage. But it's really once you get below the gross margin improvement in those items I talked about, it's really operating efficiency.

Patrick M. Baumann - JPMorgan Securities LLC

All right, great. And then just thinking long-term, maybe you could provide some perspective on how you're thinking about capital allocation during that time. I mean are you still thinking – at the Analyst Day, I think, you said 100% of free cash flow return to shareholders, then on that same vein maybe just priorities of cash still being kind of a mix of share repurchases and M&A?

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

Yes, I think this isn't a company that's going to drive all of the value creation off the balance sheet by returning capital to shareholders. We will return the majority, if not all, of our U.S. free cash flow to shareholders. Anything beyond that, I think, we bias clearly toward M&A. We see M&A opportunities out there and I think DCG is a great example of the type of M&A we'd like to be doing. We'd be happy to take on leverage for good strategic M&A, but I wouldn't expect to see us take on any meaningful amount of leverage to take capital off the table.

And then we've got a chunk of cash in Europe that today we would probably not pull back to do share buyback. There's not a lot of logic to that, particularly given the M&A opportunities that we see outside the U.S., but fundamentally the U.S. free cash flow, I think, it is by and large going to find its way back into the hands of shareholders between dividends and share repurchase.

Patrick M. Baumann - JPMorgan Securities LLC

All right. And then maybe if I could sneak one last one in. Maybe just looking at 1Q guidance, a bit slower start to the year than we were expecting. Maybe just kind of talk to the slower backlog conversion in life science, what's driving that delay?

Donald R. Kania - President, Chief Executive Officer & Director

The long conversion is primarily driven – if you look at the growth driver which is life sciences' room readiness for the sophisticated cryo schools and as we commented in your earlier question, right, that the conversion cycle is for the orders that were placed earlier, now going to revenue because we have facility readiness, we had a great order flow in Q4, but that's going to take sort of the tail end of the year to fill that out as people get ready to receive it. So that's the major driver on that side.

So we've always had longer revenue conversion in Science than in Industry. And then in the Industry side right now we're in a slow period, so we're just going to have to wait a little bit for our customers to wake up and spend a little more, which we fully expect to happen this year. Though I'll reiterate the fact we've been prudent with our view of revenue growth in that segment in the new year.

Patrick M. Baumann - JPMorgan Securities LLC

All right, great. Thanks for taking the questions, guys.

Operator

Thank you. Our next question comes from Patrick Ho from Stifel.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc.

Thank you very much. Don, with the growing traction for the cryo-EM with the academics and the research side of things, what's the key inflection point you will be looking for when pharma adoption starts to occur? What do we need to see that will get that segment I guess accepting or taking tools from you guys?

Donald R. Kania - President, Chief Executive Officer & Director

Two comments. One, we have sold a couple tools to the pharma guys directly, so some people are taking a serious look on their owner and partnerships. We think at least this year is a time where pharma and we expect to be able to talk about some collaborative efforts here in the not-too-distant future invest time and effort into trying to quantify the benefits that they might see from engaging in cryo-EM more specifically. Then I think we just have to let that play out. So give us at least a year of runway here – or them to have a chance to evaluate its significance. And then after that, I think, if the answer is yes, I think, what we'll start to see is an evaluation on their part or indication on their part how they want to access that capability, whether it's through contract research organizations, adopted internally, continue academic partnerships. I don't think they know or we know at this point in time how that will all play out, but this is a year where we'll learn a tremendous about that opportunity.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc.

Great, that's helpful. And moving to the semiconductor side of things, obviously we've seen the push-outs from 10 nanometers on your near-line solutions into 2016. Can you give like some of the color or the variables that help each of the specific customers determine how many I guess near-line solutions they will take? I guess what I'm trying to get at, as we move from 10 nanometers to 7 nanometers eventually, is it inherently for me to assume that you will see an increase in near-line solutions that will be taken by these customers as the complexities increase or I guess what are some of the variables that determine how many of these solutions each customer takes.

Donald R. Kania - President, Chief Executive Officer & Director

Okay. So, first and foremost, we're still in a customer-specific world of deployment, so it will vary by customer and, of course, I'm not going to give any details on any specific customer. But as we go to 10 nanometers, we expect as we've seen with previous nodes an increase in number of samples, which then ultimately drives an increase in the amount of equipment they need to acquire. As we get our first looks at 7 nanometers, clearly additional complexity is coming into play. There is the typical shrink, so there's a typical three-dimensional aspects, but in addition, we're also seeing across devices, Intel talked about this that they're starting to integrate more varied structures onto the same chip, which is an additional relatively large complication as well and that's I think oriented mostly around power savings in devices. And so, every layer of complexity is a good thing, obviously, we believe for FEI and it has been historically. So, we expect that trend from 10 nanometers to 7 nanometers to continue in terms of increased need for FEI's equipment to both develop and then to ramp those processes into production.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc.

Great. Thank you.

Operator

Thank you. Our next question comes from Derik De Bruin from Bank of America Merrill Lynch.

Anne M. Edelstein - Bank of America Merrill Lynch

Great. Thanks. It's Anne in for Derik. So, congrats on the Q4 results, looks like life sciences flowing through there quite nicely. Just a question on the semiconductor business, I mean there's bit of a push and pull, it seems like on the one hand there is back half optimism but on the other hand you have one of your largest customers that recently abstained from providing 2016 CapEx guidance. So, maybe how do those sorts of obstacles factor into your guidance?

Donald R. Kania - President, Chief Executive Officer & Director

Sure. Well, it's no mystery that Samsung doesn't give capital guidance at this point. And there's a tendency for them to be flexible in whatever numbers they do talk about publicly relative to what they actually do. If you just want to look at the top three spenders, I think we've got significant capital uptakes indicated by two out of the three with one withholding their cards at this point in time. We feel like we have a pretty good idea within that customer base, the needs over time. We also feel we don't have a good indication of the specific timing of when that will happen. And so as a result, in the guidance that we've given you today, we took a conservative view about the timing of orders and revenue, particularly revenue within the year and we reserve the right to update that as we get more visibility.

Typically, in this industry as we roll past Chinese New Year, which we've just entered, out of the Asian customers, we will start to get better visibility as we go into the March-April timeframe and we'll be able to give you updates either at our next earnings call or certainly by Investor Day, whether we're seeing any additional opportunities coming into the year that we feel confident that we could forecast. So I think that's the mode we're in right now. It's going to happen. It's a question of when and we want to make sure before we add it to our view on the year that we have a very good indication for those customers it will happen.

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

And Anne, it's Tony. I'd make a couple of other comments. I will refer you back to a comment that we made on the conference call – at the beginning of the call when we were sharing our thoughts. Typically, the sort of top few customers make up half of our revenue base in this business. Over the last couple of quarters, we have done a remarkable job I think in developing our relationships and sales opportunities in what we call the regional accounts, of which there are many. And that has formed the basis for us to continue to have more success in this business than we otherwise might have expected given the downturn. The other comment that I'd make is in respect of the importance of our tools to 10 nanometer and 7 nanometer ramp, it's our expectation that whatever you see in terms of overall semiconductor capital equipment spending, we should see performance ahead of that in terms of growth. So, if you have a flat overall semiconductor capital spending market, we would expect to see growth in that kind of market.

Anne M. Edelstein - Bank of America Merrill Lynch

Okay. Great. And then, maybe just a follow-up in terms of the longer term margin guidance; can you just talk about the variability of your cost structure as it pertains to the semiconductor side of the business, if that is slower coming through or faster?

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

So, as it pertains to the semiconductor side of the business? Well, when you look at our manufacturing, we've got – the vast majority of our cost of goods is in materials. It's much more of an assembly operation than it is a manufacturing operation. Our capital intensity is relatively low, so where we tend to drive benefit is through the supply chain and I mentioned in response to an earlier question, that's been an ongoing area of focus. Some of our near near-line tools are made here in Hillsboro and I think in terms of factory absorption, you will see – I think there's likely to be significant improvement from the levels that we have now. I don't anticipate that you are going to see, over the time horizon we are talking about, any real exposure in terms of having a factory absorption work. Don, do you...

Donald R. Kania - President, Chief Executive Officer & Director

The other thing we do is we do move resources around when we have an underutilized factory. So even though, as Tony highlighted, manufacturing, labor content in our product is relatively modest, we always strive to use it efficiently and effectively. And whether it's deploying some of those resources into the field or into other factories, that's what we do to make sure that we have efficient utilization of the dollars associated with those resources.

Anne M. Edelstein - Bank of America Merrill Lynch

Great. Thanks for all the color guys.

Operator

Our next question comes from Jim Ricchiuti from Needham & Co.

Jim A. Ricchiuti - Needham & Co. LLC

Thank you. Good afternoon. I caught most of the commentary I think regarding the semi market, but I may have missed some of the color you gave on the Science segment. Don or Tony, are you anticipating that to be somewhat back-end loaded as well just given the conversion cycle there; is that what you are suggesting for the year?

Donald R. Kania - President, Chief Executive Officer & Director

Right. I think we expected to have a sequentially increasing profile through the year with a modest start and we recognize that, but we also see the slots and we also understand when people are willing to accept the tools for revenue. That's why we feel pretty confident on that base for the 2016 organic growth guidance numbers.

Jim A. Ricchiuti - Needham & Co. LLC

Okay. And Don, could you just talk a little bit about what you are seeing just because of the concerns in China, just in that scientific related infrastructure business? Is that holding up for you?

Donald R. Kania - President, Chief Executive Officer & Director

Yeah China, last quarter in Science had a very good quarter and we've continued to see kind of the transition as we go back 18 months or so when we started to see the anticorruption having impact on the ability or the willingness for people to transact large orders. That seems to be going away and maybe there's a little bit of sense here of stimulus that's in the sense of please go spend the money. We're seeing that return to sort of normal levels that we saw earlier and so we expect China to be a growth engine in the new year. In addition, we've seen some of the regional semi accounts start to spend in China. Based on their renewed interest in developing a domestic industry, they're going about a little different this time, not so much cutting edge, but nonetheless we're finding that some of these smaller players in China have the resources and the interest to acquire our equipment, so it's a nice adder to the China environment. So, China seems good. The Shanghai Stock Exchange can do what it does, what all stock exchanges do, but there is seemingly in the government a relentless pursuit of developing this infrastructure, particularly in the life science side, but material science continues to help (39:16) pharmaceutical industry to have world-class scientific infrastructure to hone their talent around, so feels good.

Jim A. Ricchiuti - Needham & Co. LLC

Okay. And just switching gears just with respect to DCG. Just putting aside the purchase accounting issues for Q1. Does that business have a similar cadence to your traditional lab business, in other words the way you're suggesting the outlook for this year. Is it similar in nature?

Donald R. Kania - President, Chief Executive Officer & Director

Yes. It actually has a smoother cadence. They have such long delivery times in the business that they have a tendency to fill out their slot plans over an extended period of time and they receive deference from the big customers I think based on their size that it allowed them to the requirements of longer order to delivery time than we or any of our peer larger semiconductor CapEx companies get. We think that will change over time, but it will look more like our lab business, but right now it's going to be less volatile than our lab business and certainly less volatile than our business overall in this segment.

Jim A. Ricchiuti - Needham & Co. LLC

Okay. Thanks very much.

Operator

Thank you. Our next question comes from Tom Diffely from D.A. Davidson.

Bryan Andrew Masuda - D.A. Davidson & Co.

Hey, guys. It's Andrew Masuda asking a question on behalf of Tom. First one is for Don, just geographically you gave some nice color on China, but outside of China, have the buying patterns from customers in other geographies changed relative to three months ago?

Donald R. Kania - President, Chief Executive Officer & Director

I don't know if I'd say three months ago, but I would say sort of in the Science business in particular the geographic description I think hasn't changed a lot, which is U.S. has been good, China is good, Europe is kind of okay, and then, the emerging world and Japan have been difficult. And to highlight that a little bit too, we think that's also impacted the seasonality that we see Q4 to Q1 transition, where as we looked at the data historically those emerging markets had done a lot to fill in those spaces as we transitioned across the calendar year. So, we don't see that changing, we don't expect that to change in the new year. We expect that to be the pattern that will stick with us. These foreign exchange and macroeconomic FX side got our customer base in those emerging markets pretty distracted and the FX in Japan is a big challenge against our entrenched competitors there.

Bryan Andrew Masuda - D.A. Davidson & Co.

Okay. And then just on the semiconductor side, you guys have provided a lot of nice detail on the foundry and logic portion, but what's your view on memory this year? Could you maybe talk about first half, second half and have you split it out between NAND and DRAM?

Donald R. Kania - President, Chief Executive Officer & Director

We're not going to go to that level. I think that's not how we track internally. So I know the market likes to track it that way, but we track it more by customer-by-customer basis given the limited set of customers, but I would then say in memory the move to 3D structures is a important driver for the utilization of FEI's technology. So we see a 3D NAND coming up. It's a big driver in some places like Toshiba, Micron, Samsung, that's an important trend that will be beneficial to us.

Bryan Andrew Masuda - D.A. Davidson & Co.

Okay. And then just on DCG, can you remind us broadly speaking how their customer base is segmented amongst foundry, logic and memory?

Donald R. Kania - President, Chief Executive Officer & Director

They certainly share the commonality in customers with FEI so there is almost a one-to-one on FEI's customers. In addition to that they have a bigger footprint in the fabless companies where they're used for quality assessment. We see that over time as an opportunity for us to give a broader based solution to that set of customers. So it's a longer term growth opportunity for the combination of FEI and DCG. In the short term they have got their customers. As I said we feel pretty good about their year and I think in the longer term the combination not only to the existing overlapping customers but to these newer customers I think we can really create some powerful solutions for them.

Bryan Andrew Masuda - D.A. Davidson & Co.

Okay. And final question for Tony, can you remind us how much of the cash on the balance sheet is onshore?

Anthony L. Trunzo - Chief Financial Officer & Executive Vice President

In the U.S. right now about 20% of our cash just post DCG and the share buyback from last year were at about 20% U.S. cash.

Bryan Andrew Masuda - D.A. Davidson & Co.

Okay, Thank you so much.

Operator

Thank you. At this time we have no further questions. I will turn the call back over to Jason Willey for closing comments.

Jason Willey - Sr. Director, Investor Relations and Corporate Development

Thank you everyone for their interest and we look forward to talking to you over the coming months. So good afternoon.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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