FEI Company (NASDAQ:FEIC)
NASDAQ OMX 27th Investor Program
December 7, 2011 09:15 AM ET
Ray Link - Executive Vice President & Chief Financial Officer
Okay, thank you very much. Before I start, I would like to just point out that everything we say is covered by our Safe Harbor Statements and I encourage you to take a look at our SEC filings, to take a look at the risks and uncertainties involved in any investment in FEI.
So quickly, who is FEI and what do we do? FEI is a scientific instrument company. We make tools for nanoscale imaging, based on electron microscopy as our primary technology. The products that we produce fall into three general areas. Transmission Electron Microscopes, which are very high end, very expensive, very high resolution. These are tools, where we can see, the individual spaces between atoms used for a variety of applications, from material science, life science, semi-conductor laboratories, and other fields. Our price range on these products is generally from about 700,000, all the way up to $7 million, with an average price of about 1.5 million. We are the market leaders, both in resolution and in revenue, in this particular product line.
Our DualBeam products combine, both an electron microscope and a focused ion beam, where the focused ion beam is used to do very high precision milling, so you can thin samples also look at the underside of samples, and flip them using a variety of applications, material science and its semi-conductors in particular.
And lastly, our Scanning Electron Microscopes, which are for the everyday electron microscope, which sell on average for about $400,000. In terms of marketing position, we are in number one, in both, Transmission Electron Microscopes and in DualBeams, which is a product that we actually invented.
We have many different applications for our products, both geographically and markets. And I’d like to just show you a couple of different pictures. This is President, Barrack Obama. He visited Intel, main designed fab, located just next to our facility, in Oregon. He was there about for about 2 hours, he had a nice speech and he spent about another 30 minutes, looking at their particular products underneath our microscope, we were pretty proud about that.
Another application in material science, this is Prof. Daniel Shechtman, who was recently awarded the Nobel Prize in Chemistry, for discovering quasicrystals, which was more a bit theoretical exercise, 15 to 20 years ago, when he first came up with the discovery, but he couldn’t prove them out, until he actually purchased an FEI Titan Microscope, which he credited, with one of the reasons for him winning the Nobel Prize. We were very happy and pleased with his discovery.
Another application, this is a helicopter delivering one of our electron microscopes, which is loaded with very sophisticated software, to an actual well sided Papua New Guinea. So people are actually using our tools at WellSites to analyze our core samplings, as a process called mud logging or surface logging, very exciting new business opportunity for the company. And lastly, here is a picture of the Shanghai Protein Science facility, where they pursued over a high end Titan Krios microscopes, are for life science applications.
So as a company, we’ve been working on building our end markets, trying to expand our global reach, and try to take this core technology, that historically had been used, primarily by professors at colleges and universities, and in semi-conductor manufacturing, few other areas. The areas in particular we’re looking at are life science applications and natural resources.
When we look at the company, we’re fairly well spread out, both end market in terms of revenue and by geography. Roughly, a third of our business is in what we call, research and industry. And research and industry includes both, the classic colleges and universities and national labs. It’s really a global business. We’re getting tremendous growth out of China, out of India, out of Brazil. Eastern Europe in the Middle East are off sending any weaknesses we’re seeing in the U.S. and in Europe.
Other pieces included in the research and industry, do include the natural resources, which is a new business for us. It’s more than double in revenue this year, it’s a very profitable segment for the company in terms of the gross profit margin. Largely because, it’s a low end tool loaded with very sophisticated software. We also sell to Industrial Corporations that are buying tools for their primary research labs to improve their products and processes, by a planned nanotechnology to do that.
Another piece of our business, that’s roughly a third of revenue is in the semi-conductor space. We call it electronics because it is both, semi-conductor and data storage. The vast portion of that revenue is in the semi-conductor lab space, where tools are used to help design next generation integrated circuits.
We have a small percent of our revenue in Data Storage which is an inline tool. I’ll talk a little bit more about that in a moment. Life sciences which is a little over 11% of our revenue, is also a relatively new market for FEI. It’s now $100 million revenue opportunity for the company. This year, we have really pioneered the use of using electron microscopes, for biological research, where traditionally people are using high end digital light microscopes, where they were limited by resolution. Now moving it into an electron microscope, they can do 3D imaging and get much more data and analysis and look at things at a much higher level or resolution.
Another important piece of the company is our services business, which is 22% of revenue. It’s primarily post warranty maintenance and repair, it grows with the overall growth of the installed base, is very predictable business, long lead time, long life cycle. People who buy the products, they are expensive products and average year products sell for about $1.1 million. A high percentage of the products turn into service contracts, once the warranty expires. The value of the service contract is roughly about 4% and people generally, have a line service for about 5 year or so. Every time we sell a tool, we get recurring revenue screen from that tool, from our services business.
Geographically, we are fairly well distributed, we are a U.S company. Although, we do have significant manufacturing in Europe, both in the Netherlands and in the Czech Republic, roughly 30% of our revenue, 30 to 33% of our revenue is North America. And also the same amount in Europe. The largest portion or our revenue on a go forward basis is in Asia, particularly in the growing areas in China and in India.
From a gross standpoint, we’ve been a pretty nice growth company over the years. We track back to, even though we were formed in 1971, we released 1998, as the main starting point as we did a major acquisition at the point in time, that really is the FEI, as it exists today. So our compound revenue growth rate on bookings which ultimately correlates the revenue, has been 12%. And our recent bookings have been running roughly around about $200 million a quarter, that moves up or down a little bit with currency movements, because we do have backlog based in Euros. And depending how the Euros doing, weaker or stronger, we have to revalue the backlog which comes through as either a gain or loss in bookings and recently with a weaker Euro values coming down. It’s actually a good thing for FEI because as a company, we are actually short Euros, and that we have more manufacturing cost in Europe than we have revenue. So please continue with what you’re doing and make the Euro weaker, and it would actually be good for FEI. I don’t know whether it’s good for everyone else, but it’s good for FEI.
And looking at where we do see growth, I mentioned that developing regions are a significant portion of our growth, And we go back a couple of years ago, we had about 42% of our revenue and what we defined is developing areas, which is Asia, ex-Japan, Middle East and Eastern Europe and now it’s over 50%. So, we’re pretty happy with the growth on that. And we expect it to continue and continue to get pass 50%, as we go forward.
Looking at the overall total available market, we define it as nanoscale imaging. And clearly there are lots of techniques used to do nanoscale imaging ranging from electron microscopy, where we are at a high-end digital light microscopes, to XRD and NMR and sophisticated software. So right now, when we look at it, the instrument portion of the sand, the 1.5 million that excludes services is where we are currently planned. We have over 40% market share in that piece. Going forward we like to take that serve available market from the billion 5 to $3 billion over the next three years. And, how we do that and how we planned to do that, is to use our technology in adjoining areas, particularly in life sciences and in natural resources by either building or acquiring different little pieces of our business to move forward. For example, in life sciences, the key there is combining both high-end digital light microscopes with electron microscopes, so you could literally put in a wet sample of a cell, image it, and move the data into an electron microscope or you can do 3D modeling and see, a lot more data and get a lot more resolution. To do that, you would need to have a high-end digital light microscope. And in our case, we just completed an acquisition 3 weeks ago, called TILL Photonics, based in Munich, Germany. And secondly you need software to move that digital image, over and we announced on Monday, a new software product that we developed internally called MAPS to do that.
And likes in natural resource is the key there, because it combines both hardware and software, so you can address the needs of both mine operators and WellSite operators, where they can use our tool to help them to get the data they need to do, their mining, or drilling much more effectively. So we stack up our served available market by end market 2011 versus 2014, you can see the differences there, with the main growth really being in our life sciences business going forward.
Let’s talk about our electronics market, which is our semi-conductor and data storage, roughly a third of our revenue in this particular area. Quarter of a billion or so, plus or minus revenue, most of it is in the semi-conductor space and the real key here, and why we feel we’re going to win and why we feel comfortable, with the fact that we’re in this business, because there is always a lot of concern about this cycle and what’s going on, and with semi-conductor capital spending. We really play in the semi-conductor lab space. And where we play and where we’re going to win is, as semi-conductor labs expand, which they are doing as percent of revenue, more and more of that spend is moving from tools of our competitors, and the tools of FEI has a very strong position.
And the way to look at this, is looking at the -- if you look at the process steps and the current resolution, right now the main resolution is around 65 nanometers. As semi-conductor gates get smaller and smaller, they move from a SEM environment, Scanning Electron Microscope environment to a Transmission Electron Microscope environment. And why that’s important and why that’s needed is that the technology in the TEM, has a much higher resolution and can solve the problems that semi-conductor manufacturers have in developing the next generation chips. And this is great for FEI, because the price of an SCM, is roughly $400,000. We have a number 3 or so market position in SEM’s to a TEM, where we have a number one market position, where the price of a TEM is roughly 1.5 million, see it more than triple the price. And when you buy a TEM, you also need a FIB, a focused ion beam or dual beam product, which we also have a very strong product offering. And that product sells for about a million dollars, so you substitute spending 400,000 or 500,000 with someone else to spending about $2.5 million hopefully with FEI.
So as we track on smaller to 28 and 32 nanometer, you’re pretty much moving most of your process steps into a TEM environment. And as you get below into the next next generation chips, as some of the major manufacturers are looking into 15 nanometer and below, you’re a whole entity and environment. So that is very very good news, for FEI, and at leads us to be very comfortable that this is a good viable business for the company.
Let’s move to our research market. Our research market is really 3 different markets combined under one reporting entity. The majority of our research market is colleges and universities and national labs that are doing material science research. The growth of this business is mostly in developing areas. China is now moved from to being our second largest market by countries marginally, a research market is largely China, trying to improve its educational infrastructure by building new universities, building out Nano technology centers to try to attract back the PhD’s who left China to America and other places, so that they can bring them back and improve their educational infrastructure.
We’re also seeing tremendous opportunities in the Middle East. Two of our top three largest single sales orders were to customers in the Middle East, for education and infrastructure. We’re also seeing good growth in India, in Brazil and Eastern Europe. Poland in particular, has been very very strong. Obviously the areas, that have been a little soft, U.S. and Europe, Western Europe have been a little bit slower. There is a big concern about overall U.S government funding, through NIH, that that could be cut, we do expect it to be cut. Most people are thinking that it will be cut about 3%, from overall spending.
The concern is how they can impact FEI of our total revenue less than 5% of our consolidated revenue is relying on US government fund directly or indirectly if your looking at our research business that applies to about 15% so 85% of our research business is outside of US government funding so we feel pretty comfortable in fact our research business is actually our largest growing business this year relative to last year and our overall revenues are projected to be up somewhere around about 30% for the year. So, once again the real opportunity here is really developing areas particularly China is just a fantastic customer, we did a lot of investment in China over the past 5 years to build our own infrastructure there on the sales and services supports side. So, we feel pretty comfortable there and we do believe we are the number one provider of electron microscopes to that market.
Life Science is a fantastic opportunity for the company. We really just started on this business about 8 years ago in 2005 where we were still a sub $40 million business. We have been growing fairly rapidly and what has really changed this is that we have been successful and convincing of life scientist to use electron microscopes for research that they are trying to do and the key to winning business here is getting with the major thought leaders, getting the major research papers and having people prove about theories that they used to believe and to change that theory and another to have better data for example there has been a complete rethinking of the age virus that the people have analyzed data using one of our electron microscope. So, we are pretty proud of this and pretty happy with what is going on here and now with the acquisition of TILL Photonics we have high-end digital light microscopes and with the announcement of our MAPS software we have the correlative work flow. So, this is an area that we are expecting significant long-term growth and we’re also expecting significant margin improvement because as you combine those technologies together provided with the software. This becomes a very compelling business from the profitability standpoint. So, currently we are in mostly structural biology which is the analysis of proteins and we are moving into cell biology and as I said the key to that is high-end digital light microscopes coupled with a correlative workflow.
This is the slide under we recently completed acquisition of TILL Photonics in Munich. It is relatively small company, they have been limited by channel we’re very excited to have them part of FEI and it was essentially a technology buy and we are excited about combining the two and moving forward with our correlative workflow. And our last end market that were super super excited about is natural resources. This is a business that is very very new to FEI. We really just started in this about 3 years ago and we started at it when we were selling relatively low-end scanning electron microscopes in conjunction with the software out of Brisbane in Australia and we finally realized that there was a real business here when we had a customer in South Africa that ended up purchasing 13 of our systems which is just a lot of systems to be purchased at any one point in time. So, we suddenly did little bit more work on this and realized that there was real opportunity long term here, we ultimately acquired our software provider in Australia combined the two companies and now sell a complete solution which is a relatively low-end SCM, but vulnerably [ph] very sophisticated software.
We sell in at three main areas and natural resources and the revenue here is still small, but more than doubled this year over last year and more importantly it is a very profitable from a gross profit margin standpoint. This is generally about 60% gross profit margin business where we sell through right now our mining operators with a product called Mineral Liberation Analysis lets say low in SCM, bundled with sophisticated software usually at the central lab with bringing samples from the field run them through it will tell them not only what is in the samples whether there is gold, platinum or copper or whatever we are looking at, but as important it will tell them how difficult it is to extract that mineral from the rock that is the liberation analysis part. So, if your running a concentrator which is a huge expensive piece of equipment that is used to separate the compounds which you are looking for, it is very expensive running that. You want to know what is your yield is going to be so it is really a yield analysis tool, a sort of applying some of the same logic that we had in developing our electronics business to our mining business. It has been a very well received product, good growth opportunities with the world wide shortage of commodities in the high commodity prices which they are pretty bullish about this.
The second area that we’re starting to get some revenue here is where we are selling fairly high and dual beam systems to oil companies and they are using this to analyze shale, so they are taking samples of shale put them in the tool, slicing them up with the ion beam looking at the structure to determine the porosity of the shale to see whether or not it is a candidate for fracking. So, we’re pretty bullish, obviously there is lot of discussion on about fracking, but it is certainly an area that is going to be further explored particularly in the United States with the abundance of natural gas we have there. So, we’re pretty bullish on that part of our business as well.
Third is a brand new product that we announced which is the on WellSite product called QEMSCAN which is a very rugged SCM that looks like an oversized bread box that essentially automates a process known as surface logging or mudlogging. There is a about a billion dollars a year spent in surface logging by oil service providers, it is a technique that they use to analyze the rocks that come out of the drill bed. It is a technology used in correlation with wireline which is something that has been pioneered by (inaudible). Infringing on that part, they’re doing their part and we’re just automating what is currently a very manual process. Literally, there is two geologists sitting in a hut right on the WellSite that have a light microscope and they are logging down what they see and telling the operator of the well which way to turn the drill bed based on the data that they see. So, we can replace two geologists with a very low-end technician that can just load samples then all year along and have reliable and consistent data coming out of our tool. It is a lathe [ph] model, the revenue will grow relatively slow overtime but it’s very profitable. So between those three different tool sets and hopefully, a fourth one to be announced in the 2012, we are really bullish on our natural resources opportunity.
So this shows the business strategies, so we’re pretty much in the lab now, next phase is to go onsite. We’re initially going with the WellSite because that’s where the demand is, and then down the road we’d like to go over to the same type of systems for mining operators, so that they can take the tool to the field there as well.
Completed 3 data tests for our WellSite all with flying colors, one in Papua New Guinea, one in the Persian Gulf, and another one it’s actually still on process in Italy. But the initial read on that has been very favorable as well.
Let’s take a peek at our financial results. We are pretty proud of this year, right now, we’ve made significantly more profits than in the first nine months, so we did it all last year, and last year was our best year by far in the history of the company. Our revenues this year projected to be up, somewhere around about 30%. Our gross margins improved fairly, dramatically. It’s a function of incremental revenue, a lot of work on cost reduction and some new products particularly, in life science, in electronics and in natural resources.
We are also very proud of the fact that we’re a fairly consistent performer. If you look back we have 22 consecutive quarters, of true GAAP profitability, unlike a lot of U.S companies that have a lot of non-GAAP items that they add back or some track, whatever. We just report on GAAP basis. We’ll provide supplemental information, so you can analyze it better, but just from a fewer GAAP basis, are 22 consecutive quarters of profitability. An increase in cash flow, year over year and increase in revenue over the past three years.
Another nice point is, when you look at how we did through the cycle, through the 2008 to 2009 time frame. Our revenues only dropped 3.6%, compared to most other equipment companies, who were down significantly more than that. And we actually made $0.01 more a share in 2009, than we did in 2008.
So taking a peek at Q3, Q3 was a good quarter for the company. Revenue 205 million, up 34%. Our third quarter traditionally is a down quarter, and that’s the function of our customer base and our concentration in Europe, etc, so it was down slightly from a revenue standpoint from Q2, but it was up from a profitability standpoint over the quarter, was our highest quarter ever, GAAP profits are $0.63.
We look at Q4, we guide on bookings revenue margin etc, or looking at bookings around 200 million are revenue, 205 to 215 million for at the high end that would be our highest ever. And earnings per share of $0.60 to $0.65 hit the high end again, that would be a record and that assumed the tax rate of 24%. One of the focus of the company has been gross margin improvement and revenue growth, those are the two key metrics by the way, that all of our incentive compensation programs both the (inaudible) employees and management are tied to. So that’s a major area of focus to the company.
So, we are pretty proud of the fact, we took margins up, from 38.4% in Q4 ‘09, to approximately 44.5%, where we expect to be this year and operating income grown from the, low to mid, single digit to around 17%, so a whole lot of focus on that as a company.
Our balance sheet, a very strong balance sheet, cash of 435 million, when we look at excess cash and we back out any cash that’s tied up in restricted cash deposits, or frozen offshore, we still believe we have well over a quarter billion dollars of excess cash. And as you can see from the prior chart, our pre-cash flow per share cash flow from operating activities and less capital expenditure has been increasing year over year.
So what are we going to do with cash, I get question asked a lot. It’s really 3 main things we’re looking at. Clearly, acquisitions that would fall into any one of the three areas we’re most interested in. Anything in life sciences, particularly having to do with correlated microscopy, we just completed the TILL acquisitions where we were comfortable there. Anything that can accelerate or improve our natural resources business that fits well with our technology, we’re very interested in.
And the third item would be anything having to deal with nanoscale imaging software, particularly software that can extract it either from our tools or from tools of similar technologies, would be very interesting for FEI, because those would be tremendous areas of growth and margin improvement. We’ve looked at debt reduction, we do have $89 million of a convertible debt on our balance sheet. It was a 115 million, so we whittled it away. Obviously, as the stock price went up, the value of the debt went up, so it’s very difficult for us to reduce there anymore, but if there were an opportunity to buy some of that back, we will try to do that in the open market, before it converts.
Share buy backs, we‘ve been fairly aggressive on that, we bought back $15 million of stock, mid way through the third quarter at around $30 a share, we were buying stock back before that, and on a go-forward basis, our view is to be opportunistic powers to, and a minimum offset and dilution from employee equity awards on a go-forward basis. So primarily would be little M&A, little share buyback, and see how we all go from there.
Business model, we have a fairly aggressive business model and we put here the prior long term target, because if that is model we put out a year ago, in terms of where we thought we would be and we pretty much achieved a 45% gross profit margin. We’ve more than achieved the operating income or operating income this year to year to date, through the first time month is 16.8%. As we look out a year from now, so the long term target there is really Q4 of 2012.
We’re looking to improve gross margins to 47.5% and the areas that we look to do that, there is a little bit of incremental revenue that we need to get there, but it’s primarily from new products. It’s also from how we manufacture our products. We are—joining the company not quite 7 years ago, and at that time we had multiple factories. We reduced the number of factories, but we still have a factory at Holland and at that time, a very small factory in the Czech Republic, we’ve been successful in moving a lot of our products, out of Holland to the Czech Republic, take advantage of the higher work hours and the lower labor costs. And that’s been a nice gross profit margin improvement. It will probably have close to 60% of our output in 2012, out of our factory in the Czech Republic so, a better balance and a better cost structure there.
Also working at supply chain, we manufacture all of our end product, but most of our costs are from purchase components that are sourced from around the world. We historically source a lot of our components from Western Europe and we’re moving more and more of our source into Asia, to lower the embedded labor cost, associated with that. We are also restructuring, how we do our factory in the U.S.
So with that the summary of the company, sector growth opportunities in emerging areas, and open up a few moments for Q&A.
And no questions, it’s like my employees in the Czech Republic, they never have any questions. I was told the reason for that as when it used to be controlled by the Soviet Union people had asked questions, got into trouble. That will not be the case here.
Well, thank you very much.