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FEI Company (NASDAQ:FEIC)

Q2 2012 Earnings Call

August 02, 2012 5:00 pm ET

Executives

Fletcher Chamberlin - Fletcher Chamberlin, Treasurer and Communications Director

Don Kania - President & CEO

Ray Link - EVP & CFO

Analysts

Zach Larkin - Stephens

Bill Ong - B. Riley

Joe Maxa - Dougherty & Company

Jim Ricchuiti - Needham & Company

Mark Miller - Noble Financial Capital Markets

Patrick Ho - Stifel Nicolaus

Tom Diffely - D.A. Davidson

Tycho Peterson - JPMorgan

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the FEI Second Quarter Earnings Conference Call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Thursday August 2, 2012.

I would now like to turn the conference over to our host, Mr. Fletcher Chamberlin. Please go ahead.

Fletcher Chamberlin

Thank you, Kelly. Good afternoon, ladies and gentlemen. As the operator said, I am Fletcher Chamberlin and 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 have again posted some slides on the Events & Presentations section of the Investor Relations part of our website, 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 into the presentations, we also have the regular housekeeping matters to address.

This call contains forward-looking statements. To the extent that we discussed expectations about future corporate financial performance and goals, expected gross margins, future customer orders, performance by product and market, the outlook for margins and revenue, market developments and opportunities, future product and technological developments, the effects of future movements in exchange rates, future hiring plans, expected government spending for research tools worldwide, integration of acquisitions, our expected effective tax rate, or other future events and plans, these statements are considered forward-looking subject to risks and uncertainties that could cause our actual results to differ from the forward-looking statements made.

These and other risk factors are cited in today's press release on slide two of the slides posted 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 commissions website at sec.gov, or on our website or from our Investor Relations Department at 503-726-7710.

The company assumes no duty to update forward-looking statements as 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 fei.com.

I'll now turn the call over to Don for a review of our orders, business and markets. Ray will then go through the financials, and Don will talk about the outlook and then we'll take questions.

Don Kania

Thank you, Fletcher, and good afternoon everyone. We had a strong quarter. Revenue and earnings were again at record levels. Our gross margin 47% and product margins exceeded 50%. That's ahead of our near-term plans and keeps us on track towards our long-run target of 50% overall by mid-2015.

R&D spending increased in line with our plans as we continued to invest in new products and applications, several of which we have announced in the last week. We continue to execute our strategy in each of our businesses. We are growing our served available market organically via acquisitions and by expanding our geographic reach.

Net orders were the highest total for any second quarter in our history and our third highest ever. Our geographic and market diversity was especially evident this quarter. As bookings in the United States increased substantially, offsetting sequential declines in Europe and Asia, which had been strong in the prior quarter.

Material Science and Life Sciences orders were up this quarter to near record levels after strength in electronics and service in the first quarter. We expect continued growth and margin improvement in the second half of the year.

We also generated substantial cash in the second quarter and paid our first ever dividend. In the third quarter, we completed two acquisitions. AP Tech in Korea, and Visualization Sciences Group, or VSG in France.

Turning now to slide four, we will review the bookings for the second quarter. The largest segment quarter was Material Science with $78 million in bookings. That's our third largest quarter ever for this segment and the largest in nearly three years. Orders were strong in the United States with a significant Titan service bookings.

After strong Q1 in Japan, Q2 was even stronger setting an all time record for Material Science orders by a substantial margin much through the dismay of our competitors. We also saw several high value tiny orders from China. We are expecting another strong Material Science bookings quarter in Q3.

Within the Material Science segment, bookings for our Natural Resources business were up significantly from last year's second quarter. As we discussed at the end of Q1, we have booked our first paying customers for the WellSite with a combination of commercial and development projects.

We are pursuing additional contracts while we continue to learn more about the value propositions for our customers and what it takes to enable near real time analysis in remote locations. Electronics bookings were down significantly as forecasted from the record levels of Q1. We had orders from most of the major companies in logic, memory and foundry.

Our discussions with the customers indicate that we should expect bookings to increase in Electronics in the third quarter, comparing with the second quarter and last year's third quarter. Key customers will be expanding their 2X node capacity and we expect to see orders for more advanced nodes as well.

Life Sciences bookings of $29.9 million were up 98% from the first quarter and 60% from last year's second quarter. It was a second highest for any quarter on record. Bookings were strong in China and Europe. Europe include two important multi-tool wins in France.

TILL Photonics contributed about 10% of the segment's orders. This is before our planned introduction for microscopy solutions due later this year. We expect another solid quarter from Life Sciences, in Q3.

Second quarter bookings for Service and Components were down from the first quarter on a normal seasonal basis as the number of annual contracts are renewed in the first quarter. Nonetheless, bookings were up 12% from last year's second quarter buoyed in part by our large three-year contract renewal from a major Middle Eastern customer. Along with significant margin improvement, our service business now has reported two quarters in a row of double digit annual bookings growth.

Looking at geographic bookings on slide five, the strength this quarter came in the united states as we said in the all times booking and we set an all times bookings record for the quarter in Japan.

Europe was down as expected from a good Q1. While Asia was down, China was very strong this quarter both, sequentially and annually. Geographic diversity remained strong with orders totaling $2 million or more from 11 different countries in the quarter.

Looking at Q3, we expect Asia and Europe to show sequential growth in the third quarter as our pipeline of potential orders has grown for both regions driven by emerging economies.

Turning away from the segment results, we have introduced two major new products in conjunction with this week's Annual Microscopy & Microanalysis Show. The Titan ETEM G2 extends the application of our leading Titan into chemistry with the ability to see dynamic processes as they happen at the nanoscale.

We have targeted developers of catalyst and energy products along with our traditional base of Material Science customers will find this capability especially powerful. FEI continues to lead and define new competitive frontiers. Starting with resolution, moving speed elemental analysis, and is now expand into chemistry and dynamic microscopy.

We also Verios XHR high resolution SEM, the successor to our leading edge Magellan. It allows very high resolution images at low voltage. With improved ease-of-use it will have applications in both, electronics and Material Science. A key element of advancing our strategy is acquisitions.

Looking at slide seven, we have completed two in the third quarter. We purchased the assets of our Korean distributor continuing our expansion to Asia and bringing us closer to important customers. The details were announced on July 9th.

Yesterday, we announced the acquisition of Visualization Sciences Group, or VSG in Bordeaux, France. The details are on slide 8. VSG provides high performance 3-D visualization software products and tools to a range in markets. Our customers have been asking for better tools to analyze the vast amounts of data our imaging systems create, particularly in the high growth segments of Life sciences and Natural Resources.

VSG is a substantial addition to our toolkit. Their products, technologies and development capability are expected to be applicable across all of our markets. We have completed four acquisitions in the last nine months, each aligned with our business strategy.

As a group, we expect they will help improve our gross margins, but will also add to our operating expenses, thus we expected they will have a slight positive impact on 2012 GAAP earnings, and a greater contribution to growth and earnings in 2013. They also reflect our commitment to deploy our cash to improve shareholder returns. This commitment is also highlighted by our initiation of the quarterly dividend.

With that, I will turn it over to Ray for a review of the numbers in the quarter and then I'll come back with our guidance and outlook.

Ray Link

Thank you, Don, and good afternoon everyone. We had a strong quarter and the numbers are straight-forward. The highlights on slide nine are revenue and earnings highest for any quarter in our history, bookings above our baseline guidance even after a downward adjustment for currency movement. GAAP earnings also above our guidance and we generated cash and our balance sheet remain strong giving us the ability to deploy cash as we did in the third quarter for acquisitions and our first ever dividend while still driving our goals of growth and margin improvement. We have now recorded 25 consecutive quarters of GAAP profits and it's really in consistent in varying economic environments.

Net bookings for the quarter were $210 million, up 3% from Q2 of 2011, and down 5% from Q1 record net order total. Changes in currency rate had a $7.1 million negative impact and our orders this quarter. If we take out the impact of currency on our backlog and just look at income orders in the quarter, orders are up 9% from a year ago and are essentially in level from Q1.

At the end of the latest quarter, the euro was $1.26, compared to $1.33 at the end of Q1, and I would remind that a strong dollar actually for FEI's margins and earnings. Although it lowers our backlog and revenue growth rates modestly. Our expenses go down faster than our revenue and earnings improve. The backlog at the end of the quarter was $423.6 million and represents just under six months of revenue at our current revenue run rate.

Moving to slide 10, second quarter revenue of $221.5 was up 5% from a year ago and 2% from the first quarter, compared with the year ago about 2.5% of our revenue growth came from acquisitions offset by a 3% reduction due to changes in currency rates, compared with the first quarter, foreign exchange rates reduced revenue by about 1%, and there was no impact from M&A.

Sequential revenue growth was driven by Electronic segment, which was up 5% from the first quarter of 2012, and made up 37% of the total, and by Life Sciences, which was up 24% and made up 10% of the total.

Material Science was 6.5% from the first quarter, but had a book-to-bill ratio of 1.4, and our revenue growth in the next few quarters. Within this segment, natural resource s revenue was up over 20% from the quarter and up over 50% compared with last year's second quarter.

Service and Components revenue was up 16%, compared with last year and 1% compared with first. It continues to grow with our installed base.

Turning to the slide 11, our revenues continued to be balanced geographically with continued strong growth in Asia. North American revenue was up 9% from the first quarter and made up 34% of the total. Europe and the Middle East was down 25% from the first quarter and made up 21% of the total. Japan and Asia together were up 27% from last year's second quarter and up 16% from the first quarter and made up 45% of the total.

Now looking at slide 12, gross margin in the quarter was 47.2%, up from 45.1% in the first quarter. Product mix, higher volume, improved service margins benefit from the weakness of the euro and Czech krona, and continued gains from our expanded manufacturing at Czech Republic all helped gross margins in the latest quarter.

Product margins were above 50%, or service margins were 36.4%, compared with 33.4% in the first quarter and 30.9% in last year's second quarter. We successfully completed the transition of our Hillsborough manufacturing operations back from UCT in the second quarter and fully benefits from that move will begin to accrue in the fourth quarter once we finish shipping the inventory, we purchase from them.

Based on that move and our expected product mix, we are projecting gross margins in the third quarter to be around 47% with renewed improvement in the fourth quarter. We are now selling sites and a long run target we laid out at our June investor meeting in New York, 50% by the second quarter 2013. By way of historical comparison, I would like to point out that our gross margin is already up 900 basis points from Q2 of 2008 giving us confidence that we can make further improvement.

Turning to slide 13 and moving down income statement, operating expense were $65.4 million, up only 2% from 64 million in the quarter 2012. Operating expenses included 23.3 million or 10.5% of sales for R&D as we continue to invest for growth in 2013 and beyond.

Operating income for the quarter was $39.1 million, up 7% from the last year's second quarter and up 15% from the first quarter of this year. Non-operating expenses $1.3 million in the second quarter, compared with $2.1 million in the first quarter and $900,000 expensed in last year's second quarter. We expect non-operating expense to be around $1.5 million per quarter, so please use that in your models.

Our tax rate for the second quarter was 19.9% and we expect it to be approximately 20% in Q3 and Q4. Net income was $30.3 million or $0.74 per diluted share. That's above our guidance range 17% above the first and 19% from last year's first quarter.

The weighted average shares for diluted EPS in Q2 was $41.6 million, compared with $41.5 million in Q1 and $42.6 million in the last year’s second quarter.

As you can see on slide 14, our balance sheet remains very strong and we are deploying our cash to improve shareholder returns. Total cash and investments at the end of the quarter included a restricted cash and long-term investments was $419.8 million up $23.4 million from the end of Q1.

Net cash after subtracting debt was $330.8 million or $8.69 per share. We used the total of 67 million in the third quarter for the two acquisitions, but they did not affect our cash in the second quarter. We also paid our first dividend in July a little over $3 million in total. Cash flow from operating activities was positive $41.3 million in the second quarter. EBITDA was 45 million, compared with $39.2 million in the first quarter and $41.8 million in last year's second quarter.

Day sales outstanding improved modestly, but inventory turnover declined slightly. Capital spending was $5.4 million and depreciation expense was 5.4. In summary, revenues up, margins are higher and we generated substantial free cash, which are going to accelerate growth and margin improvement, invest in acquisitions and returning some of it to our shareholders.

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

Don Kania

Thanks, Ray, Slide 15 is a summary of our guidance for the third 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 third quarter and the third consecutive quarterly record.

Earnings per share expected to be in the range of $0.63 to $0.70. Our guidance for Q3 reflects a normal seasonal pattern for FEI. After the normal seasonal decline in the third quarter, we expect to finish the year with a strong four quarter.

We project second half revenue and earnings will be above the first half totals. We are maintaining our estimate for revenue for the full year compared with 2011 in the 6% to 9% range. Included in that target is the expectation that acquisitions will contribute approximately 4% to that growth and foreign exchange will reduce the amount of growth by approximately 3% assuming foreign exchange rates stay about where they are now.

As we continue to execute our strategy, FEI will continue to grow improve margins invest in the future and generate and deploy for our shareholders. I'm proud of the entire FEI team that has delivered these strong results.

With that operator, we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Zach Larkin with Stephens. Please go ahead.

Zach Larkin - Stephens

First off, Don, I wondered if you can maybe talk about the VSG acquisition and give us a little bit of insight into how quickly can you integrate a product set like that and get it out to your customers. What's the process like to go out and actually get that to the market in Adel, Delaware so to speak.

Don Kania

Right. Effectively, we are using pieces of VSG does today in our products. The story is much is touch more complicated than that, but that's the effective results, so that is an important piece of our Life Sciences products for example. That's something (Inaudible).

In addition, we can relatively quickly integrate the additional capabilities that they have in visualization into what we do, because this is simply add-on software to the platform in the longer term though the really benefit will be integrating two pieces of the puzzle.

One, they are software platforms as they exist, but number two really leveraging off of the large group of software engineers that we've acquired in the acquisition and getting a bit more focused on what FEI needs in their solutions for customers overall. That will take a bit longer. That's more than a year sort of progression, so short-term, it's already there.

We'll get benefit. We'll also get a little bit of benefit from our larger global reach in terms of channel that's selling their product. Though not a primary motivation for the acquisition, and then part two, making sure that their expertise is integrated into our solution roadmaps for FEI little bit longer term there.

Zach Larkin - Stephens

Thanks very much. As you kind of look at these acquisitions, you look to get more software, more imaging capabilities overall in product portfolio are there any specific markets or applications that you are looking at or working to get into that has maybe been brought on by these acquisitions or serendipitously develops.

Don Kania

No comment on that at this point. I think the thing to focus on is for where VSG fits into what FEI does today, and that's going to be the big win that we see right now. They do participate in lots of other marketplaces. I think that's really a TBD.

Zach Larkin - Stephens

Okay. Then one final question. Ray, could you quantify how much of the margin benefit in the quarter was attributed to the lower euro?

Ray Link

We got close to 1.5 of the benefit that was from the euro and Czech krona.

Operator

Our next question comes from the line of Bill Ong with B. Riley. Please go ahead.

Bill Ong - B. Riley

In general terms, on the lease agreements, are these weekly or even daily rental terms or is it some type of minimal like three months, and so what I'm really getting at the term of agreements are relatively short. It becomes R&D expense, but it's longer. It could be treated as a capital budget, which requires a more lengthier approval process, so just some thoughts on that.

Ray Link

Number one, were not going to disclose details of contracts, but our goal is to longer term commitments from customers, because it's obviously expensive to move the equipment to a particular site, so that's inherent in any deal.

Don Kania

I will, Ray, comment on. This is close to the P&L.

Ray Link

I think bill is referring to how they look at, whether it's…

Bill Ong - B. Riley

Yes.

Ray Link

I think early on, Bill, the length of term we are looking at, my guess it's probably not going to be a CapEx. I think that it takes a bit more of OpEx expenditure regardless.

Bill Ong - B. Riley

That's helpful. That' makes it easier to get the valuation. Then my follow-up question is that. If this leasing model is successful in oil and gas. Do you see leasing opportunities and industrials are even smaller reps that would like to have GMK buildings, but maybe limited by $1 million capital cost?

Ray Link

We keep our eyes to that, particularly and say in the Material Science, but what we typically find even if a customer approaches us for a leasing arrangement. The typically do not follow through and convert to a purchase before the end of the process.

We watch in other industrial areas, where this might be appropriate. For example, mining and elsewhere. I think at this point in time, we don't see the appetite for that as well as we do in oil and gas, but we'll continue to monitor and (Inaudible) in that particular way.

Operator

Our next question comes from Joe Maxa with Dougherty & Company. Please go ahead.

Joe Maxa - Dougherty & Company

Question regarding the government funded and also been pretty weak in the U.S. as of late, but pretty good orders this last quarter. Can you give us an update on your current thoughts?

Ray Link

Our thoughts haven't changed. I think, we've been pretty consistent in our view that the U.S. has been at modest level and we expect that to maintain with perhaps some upside when our customers get better visibility to whatever budgets they are going to have, a small upside, so I think that's our view of the U.S. I'll walk around the world we're here.

In Europe, we be okay we think, buoyed the emerging parts of that region as we characterize it, and Northern Europe being, again, consistent I think. Okay, and Southern Europe being very difficult, but the net of it all will be small growth opportunity there, continues because of the emerging markets and then.

Then Asia, we still feel very strong about. Particularly, China, the big driver in the region. It will continue to invest predominantly independent of any kind of economic cycles that they see. They believe in their five-year plans and commitments to investment in infrastructure of which we're put into and we think that continues unabated, no matter what short-term economics up and downs they see.

Joe Maxa - Dougherty & Company

Thank you. On the Electronics business, can you break out the semi versus your data storage?

Ray Link

Yes. Data Storage was vanishingly small, such that he usually we know that number by heart.

Don Kania

Data Storage was less than 10% of the Electronics' orders. It usually averages around 10%, but jumps around, and this one happen to be underpinned, so it wasn't zero, but it was small.

Joe Maxa - Dougherty & Company

Then what are the outlook in that segment?

Don Kania

I think the best word to use is episodic. When those customers are ready to buy some stuff, they come to us, we're very much designed into the two major manufactures that exist today and we certainly have close relationships with them, but there's only two people manufacturing those Thin-Film Head and we have some visibility to what's coming down, but timing is extremely difficult to call, and I think as we've grown in the semiconductor space, it's certainly business but it's not as consequential as these semiconductor customers that we serve.

Operator

Our next question comes from the line of Jim Ricchuiti with Needham & Company. Please go ahead.

Jim Ricchuiti - Needham & Company

Don, I missed your comment about Life Science. Do you expect the bookings to be up sequentially in that business again this quarter?

Ray Link

We didn't guide. I think specifically to it being up, but we said they would be good next quarter. I think I know you've noted that Q1 was particularly weak, and I think we've had a nice rebound in Q2. We don't expect any kind of retrenchment to Q1 levels. Again, it's very difficult in that business with large individual orders, which can move around a bit, but we feel like the pipeline is maturing, we're back where we think we need to be in this business, so I would say they'll be good next quarter.

Jim Ricchuiti - Needham & Company

Great. I was curious about the margins that you generated in that market this quarter. Was that a function of the volume or was it also a very favorable mix that drove those margins?

Ray Link

More of a mix, Jim. That particular business unit had more high end system shipped in the quarter that typically have a higher margin.

Operator

Our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead.

Unidentified Analyst

This is Ramesh (Inaudible) in for Tycho. Thanks for taking the question. Congrats on the quarter. Just to touch on Europe again. Europe obviously, revenues down, orders also challenged. Did you see a gradual worsening through the quarter, and was that in any way surprise to your expectations? Then as you look in next quarter, the quarter after that, what gives you some comfort in the pipeline that things couldn't deteriorate further?

Ray Link

What I would caution people not to do is to look at changes between quarters and try to draw straight lines on them for FEI. We had significant volatility quarter-to-quarter in each of our segments.

Our view of Europe is as I described earlier, it's going to be okay, and what we based that on primarily is a review of our pipeline, so the tool that we use very carefully and we look for inflection points in that.\

Looking at the segmentation of that pipeline by sub-geographies, we see that there are regions that continue to offer more opportunity and flattening in Europe all the Europe or the euro zone as a whole, and the differentiation being north to south, so we're not running in panic from Europe, I think, as others may have indicated, and I think we have the advantage to some extent of being a large-priced product which have long pipelines and they are traditionally funded before the process beings.

We look back at the last recessionary period, and we did pretty well through that as well, but we look at the data. We pay attention to the macro, but ultimately when we give our guidance, we look at what our sales people are telling us, what our pipeline is tell us and what our prospect was for the next quarter is tell us.

Unidentified Analyst

Then you mentioned that TILL contributed about 10% of orders in Life Sciences. Now that you have their company and those assets there, has your view changed in terms of the opportunity for TILL to be more of a focus and correlative microscopy versus maybe even a standalone product and sort of optical?

Ray Link

We stand by our initial strategy, which is the correlated products, and we've done some pre-release activity with our correlated products and we're seeing some very, very positive response to those and those will be formally introduced in the fourth quarter, so I would say we're paying attention to perhaps these other opportunities, but our efforts are laser-like focused on the correlated solutions.

Operator

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

Mark Miller - Noble Financial Capital Markets

Let me also add my congratulations to your results. I'm just wondering currency impact on sales and earnings this quarter?

Ray Link

On sales, Mark, it was small, actually only about 1% relative to Q1. Overall margin as I said earlier, it was good or under 1.5% of the gains, so slightly more than half our gain. Relatively Q1 was currency, and earnings per share little less than half.

Mark Miller - Noble Financial Capital Markets

In terms of the Electronic segment, people received have been doing well, because of the transition in the fabs to the 28-nanometers. Are we now coming to an end of that or is that going to get back or there's 29-nanometers coming on shortly?

Don Kania

From the FEI perspective it's I guess the 2X nodes where X is less than 5, are the strong contributors and we are also seeing 1X node activity, so that's the leading indicator. That will be more important as we exit this year and move into next year.

Mark Miller - Noble Financial Capital Markets

So, we are expecting sequential improvement in Electronic sales and orders. Is that correct? Sales, we don't comment, but on the order front, yeah we expected an improvement.

Operator

Our next question comes from the line of Derik de Bruin with Bank of America. Please go ahead.

Unidentified Analyst

Hi. Good afternoon .it's Thank you for the questions. A follow up question on Europe think you are mentioning basically expecting a sequential improvement, so just wanted to know if there was any particular segment that was likely to outperform as there was going to be evenly distributed across the board.

Don Kania

I think what we was we expect it to be about equal to last quarter, in that range. I think we guided up meaningfully. Nonetheless, we think Europe will be fine. Europe is typically dominated by Life Sciences, Material Sciences transaction not a lot of semi left in that space right now, so those are areas that we'll continue to from our perspective move forward strongly through Q3 on the order front.

Unidentified Analyst

Okay. I may have missed this, but any incremental updates in terms of the relationship with the lab would then age, or I guess any clarity on when we can see another publication there?

Don Kania

Our customers here are very sensitive, more so that we are about new products, but I think that I can comment that the pipeline is really quite robust for meaningful publications to be coming out.

Recently, there was a release via NPR on a recent publication on HIV, which was correlated with the AIDS, Big international HIV meeting. That was pretty new. I know we actually\, but all is new in my head right now, but I do know that there is a sequence of papers and preparation, which as you know are a good leading indicator of what will happen in the future, and I will remind everyone that we are pleased when we look at our pipeline that we see according to our thesis practioners generally are trying to do structural biology whether it's with NMR, XRD appearing more in that pipeline and we see that as a very encouraging trend for the future.

Operator

Our next question comes from Patrick Ho with Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

Don when you looked at Life Sciences business, I know correlated solutions are still in the early stages, but you guys have been able to maintain a pretty high level in challenging environment for a lot of your comparable Life Science.

Can you just give a little bit of color what's helping to keep your Life Sciences business at these higher levels relative to some of the peers out there?

Don Kania

Yes. I think a big piece of the puzzle here is the fact that we are still generally bringing what seem from the Life Sciences perspective is new capability, and that market segment really now becoming to understand the utility (Inaudible) are correlated stuff and our DualBeam in the space and that's come by working closely with our academic customers and partners, so I think that's why we are different and I was a scientist many, many years ago, when budgets get tough people I think focus and more what's going to make them different than their competitors and s they become I think a little bit more open to taking risk, and because we are new, we are more risky, but then our partnerships help reduce that risk, because if you have credible scientist from the NIH, from the Oregon Health Sciences university from institute, writing papers and describing new insights that they are able to achieve.

I think that's the road that we are on, which is maybe different than other companies driven by consumables, more worried about transferring that money to you paying for salaries as opposed to paying for the consumable with aspects of equipment, so maybe that's the differentiation.

Patrick Ho - Stifel Nicolaus

You mentioned that Japan was up this quarter and highlighted some of your share gains and improvements in that region. That region obviously, you've had the same competitors there. What's been their response? Are you seeing any increase in pricing pressures as they are trying stem, their share losses versus your presence there?

Ray Link

We try to be very strategic when we go after particularly large orders in Japan, which is the bulk of the wins that drive our business there. And, highlighting our value, taking advantage of the beneficial currency situation we are with the strong yen, weak euro. That's what an ideal situation for us.

I think we can go. We have been going in and winning at good pricing for FEI, but it all comes down. In the end, if we don't have a better mousetrap than our competitors, we won't get an audience in Japan, so that differentiation being better is important and then being attentive to putting together a right kind of deal and taking advantage of the environment that we are in for good wins. That's the formula that's worked well for us.

Patrick Ho - Stifel Nicolaus

Great. Final question for me maybe for Ray in terms of the transition back to Hillsborough in terms of manufacturing. You mentioned it will be fully integrated and fully recognized in the business model by the December quarter. What's the potential incremental benefit in terms of on the gross margin line as it's being recognized in Q4?

Ray Link

Yes. That's a fair question, Patrick. We haven't actually broken that out specifically that piece. It's meaningful. It's less than four percentage point, but it's meaningful.

Operator

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

Tom Diffely - D.A. Davidson

Yes. Good afternoon. First quick on the Electronics business. The falls in Q2 an expected rebound in Q3, does that represent push outs or there's always just kind of a whole and the lumpiness of your parent?

Don Kania

You're talking about orders here?

Tom Diffely - D.A. Davidson

Orders, yes.

Don Kania

I think the push-out on orders is kind of a concept we don't look at. As we come into the quarter, we look at what the forecast looks like. I would say that, if we take a big deal, we look at the big picture, all the data that we have comes back to the we described our business to everyone, which is we may see some rearrangement quarter-to-quarter in terms of either orders or revenue for maybe one to two quarters, but ultimately our position in the technology food chain is becoming more important and more essential whether you are trying to ramp a product or ramp a line, you need the FEI stuff.

We really look at this business very transactionally, so we've got the trend in from that perspective and then look what the big customers are doing and that's the flow of business. Obviously, we're calling three up from two. We're obviously not seeing headwinds, perhaps the other people had described, but again we sit in a different place in the industry.

Tom Diffely - D.A. Davidson

When a company or customer builds a new fab and he come to you for that initial order, what's your timing then and where does it typical trend as far as delivery of equipment over the next few quarters?

Don Kania

It will vary a fair amount by customer depending on the magnitude, but in terms of our lead times, we try even on a most complicated equipment to be able to delivering approximately a quarter, but that means we're building the forecast, which is based upon our strong relationships with our large customers, because some of those products have larger lead times. If you look at the observations in our revenue relative to our observations in orders, they one attracts the other by [order]. That's our cycle of life these days.

On bigger projects that maybe a little bit different. There may be a longer time between orders and shipments and that's really based on customer requirements. Again, if you're feeling that a clean factory, we like to think that the first thing you order is the litho equipment and the second thing you order is an FEI tool, because it's going to qualify everything else that goes into that factory.

Tom Diffely - D.A. Davidson

Okay. When you look at some of these large 1X fabs, do you think 2012 kind of build the backlog and in 2013 is the revenue?

Don Kania

That's probably a good statement at a high level from where we sit today.

Tom Diffely - D.A. Davidson

Okay. Then moving on to the Life Sciences business, can you give us your view on how you think that evolution is going? Versus what happened in the Research Materials business a few years ago? Is the adoption rate pretty similar of your goals, yes.

Don Kania

I think it's a little bit different here, because we have the additional. It a barrier. The additional barrier brining something new to new customers, whereas in the Titan penetration. We are the selling the same old customers the better thing, so that's why in the past, when you look at Titan, the implementation of Titan, we really didn't make a lot of hay or whatever key customer relationships from these leading lab type of rate. We didn't need to.

Here we thought those were important to get the news out more credible and more quickly that this in fact is a relevant tool to do structural biology research, to do cellular research, so it's a little bit more difficult from that perspective and we are pleased with the results of this last quarter and we feel pretty good about the guidance we gave for next quarter in terms of order flow. We think that traction is happening.

Tom Diffely - D.A. Davidson

Okay. Would you expect the adoption of multi-year period to be a bit slower than because of the lack of familiarity with the customers?

Don Kania

You could argue one or two ways. Yes. There's a lack of similarity. Two, once it becomes obvious that the utility is there, there's a pent-up demand for something new, a new way to do things that in fact it could accelerate.

Tom Diffely - D.A. Davidson

Then the [wealth] side business, earlier you said something along the lines of kind of a near real time analysis. What does that mean exactly?

Don Kania

That's just our description. It's approximately hour from rocks to data.

Patrick Ho - Stifel Nicolaus

Still two of the other on-site?

Don Kania

Absolutely, there was no change. We're trying to be more compact and distinct in our descriptions of what we do.

Patrick Ho - Stifel Nicolaus

Then final one for Ray. I missed something what you said about your expectations for OpEx for the near quarter? If you could just maybe repeat that quickly?

Ray Link

There will be minor movements in OpEx. One, we'll have continuation with R&D spend. In the fourth quarter assuming we make our second half targets with higher revenue, you should expect to see a little bit more so on expenses associated with that, and then in addition I'd like to remind everyone in their models that we have two new companies to roll in, which is the impact from both, ESG and AP Tech you will see and they are relatively small, but you'll see some upward movement in OpEx.

Operator

We have a follow-up question from the line of Jim Ricchuiti with Needham & Company. Please go ahead.

Jim Ricchuiti - Needham & Company

Yes. You gave some growth rates for the natural resources market. I was wondering if you might give us the dollar number in terms of the revenues. I know it's small, but we're all kind of tracking that.

Ray Link

Yes. We're not really giving that out right now. As we said, we wanted to wait for it to get a little bigger, so give us another quarter or two, we'll give you another data point.

Jim Ricchuiti - Needham & Company

Question on ESG. I know again, it's a small company, but are their revenues concentrated in any one particular vertical right now?

Ray Link

The do have a lot of revenue in the Oil and Gas segment.

Jim Ricchuiti - Needham & Company

Okay, so that does tie in with what you are doing there. And beyond that, any other concentration in any other verticals they described?

Don Kania

Life Science would be second.

Jim Ricchuiti - Needham & Company

Thanks. Congrats. On the quarter.

Operator

Thank you. And we also have a follow-up question from the line of Tycho Peterson with JPMorgan. Please go ahead.

Tycho Peterson - JPMorgan

Actually my question was already asked, so I'm all set. Thanks very much and great quarter.

Ray Link

Operator

We have a question from the line of Mark Miller with Noble Financial Capital Markets. Please go ahead. Your next question is a follow-up question from the line of Patrick Ho with Stifel Nicolaus. Please go ahead.

Patrick Ho - Stifel Nicolaus

Thank you. Also related to VSG. Is there any seasonality in their business that will be reflected in future quarters?

Ray Link

That's a great question, Patrick. First of all, I'd like to remind everybody we just completed the acquisition yesterday, so I have a partial quarter and there what is the third fiscal quarter for everybody else is the quarter we are currently and is their softer quarter, and that's largely due to their European exposure.

Operator

(Operator Instructions). There are no further questions in the queue. At this time, I'd now like to turn the conference back over to management for closing remarks.

Fletcher Chamberlin

Thank you very much, everyone for listening in and this is Fletcher. Call me if you have further questions. I will be available. Ray and Don are going to move into employee meeting pretty quickly, but I'm available today and tomorrow.

Thanks very much we appreciate your interest.

Operator

Thank you. Ladies and gentlemen, that concludes the FEI second quarter earnings conference call. We would like to thank you thank you for your participation. You may now disconnection.

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