FEI Company Q2 2008 Earnings Call Transcript

Aug. 3.08 | About: FEI Company (FEIC)

FEI Company (NASDAQ:FEIC)

Q2 2008 Earnings Call Transcript

July 29, 2008 5:00 pm ET

Executives

Fletcher Chamberlin – IR

Don Kania President and CEO

Ray Link – EVP and CFO

Analysts

JoAnne Feeney – FTN Midwest Research

David Duley – Merriman Curhan Ford

Peter Kim – Deutsche Bank Securities

Mark Miller – Brean Murray Carret

Benjamin Pappas – D.A. Davidson

Bill Dezellem– Tieton Capital Management

Matt Petkun – D. A. Davidson & Co.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the FEI second quarter earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) This conference is being recorded today, Tuesday, July 29, 2008. At this time, I would like to turn the conference over to Mr. Fletcher Chamberlin. Please go ahead, sir.

Fletcher Chamberlin

Thank you, operator. Good afternoon, ladies and gentlemen. As the operator said, I’m Fletcher Chamberlin, FEI’s Treasurer and Investor Relations Director. With me today at our headquarters in Oregon are Don Kania, President and CEO, and Ray Link, EVP and Chief Financial Officer.

Before we begin our presentation, we have to do the regular housekeeping matters. This call contains forward-looking statements to the extent that we discuss expectations of our future corporate performance and guidance, customer orders or revenue growth, performance by product and market, margin improvement, market developments and opportunities, the competitive landscape, product and technological developments, product introductions and shipment schedules, the effects of future movements and exchange rates, cost savings and restructuring, changes in our effective tax rate and other future events or plans. Those statements are considered forward-looking, subject to risks and uncertainties that could cause our actual results to differ from the forward-looking statements made.

These risk factors are cited in today’s press release and 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 are available free of charge at the SEC’s website at www.sec.gov or our website or from FEI’s Investor Relations department at 503-726-7710. The company assumes no duty to update forward-looking statements set out in those documents or made on this call. This call is the property of FEI Company. It will be archived in the Investor Relations section of our corporate website at www.fei.com.

I will now turn the call over Ray for a review of our results and then Don will have some comments on our markets and the outlook.

Ray Link

Thanks, Fletcher, and good afternoon, everyone. Welcome to our second quarter call. I will go through the financial report and guidance in some detail and then turn the call back over to Don.

Bookings of 140.4 million were above our guidance and up 3% from last year’s second quarter. This is the highest second quarter bookings level in the company's history as growth in research and life science offset a weak semiconductor capital equipment market. We also see a seasonal decline in bookings between the first and second quarters and this year is not exception. Our service bookings in the first quarter usually include a number of annual contract renewals. Thus service bookings are normally down first the first to the second quarter as they were this year. Product bookings were up 1% sequentially and up 2% compared to last year. We maintained a backlog of just under $300 million.

Net sales for the quarter of $154 million were up 4% from last year’s second quarter and up 2% from the first quarter above our guidance range. Research and industry revenue was up 36% from last year’s second quarter, and up 2% from the first quarter. Life science revenue was up 92% from last year’s second quarter and up over 100% from the first quarter of 2008. Electronics revenue was down 19% from the first quarter and 38% from last year’s second quarter and it now represents less than 25% of revenue compared with 41% a year ago. Don will discuss our bookings and trends within each market in a moment.

Those of you who follow us regularly have heard us discuss the euro-dollar exchange rate on prior calls in connection with different line items and I want to repeat a simple overview first. The effect of a weaker dollar and stronger euro has a negative impact on FEI. With significant operations in Europe, we have more euro based expenses than revenue. The average euro dollar rate in the second quarter was 1.56 compared with 1.50 in the first quarter and the cumulative effect of a 20% decline in 18 months put significant pressure on our margins. We have a cash flow hedging program that mitigates short-term currency movements but it can only delay the impact of a multiyear trend such as the one we’ve seen with the U.S. dollar against the euro. Later in the call, we’ll discuss the steps we are taking with our restructuring programs to reduce costs and mitigate the impact of currency movement.

Gross profit margin declined from 39.1% in the first quarter to 38.1% in the second quarter, and 41.6% a year ago, primarily due to the ongoing dollar weakness and to product mix. The electronics business is our highest margin segment and it made up 24.5% of total revenue last quarter down from prior periods. Our cash flow hedging program generated gains of about 1.2 million less in the second quarter than the first.

Looking at our market segments, it is notable that our service and components gross margin improved for the second quarter in a row to 27%. We still have a way to go to hit our target, but are moving in the right direction. Electronics and life science margins also improved while margins in industry – research and industry margin declined due to a less favorable product mix and dollar weakness.

For Q3 we expect our gross margin will be up slightly compared to Q2 on somewhat lower revenue. Improved margins in research and industry are likely to offset the strong euro and lower earnings from our hedging programs. Looking beyond the third quarter, our preliminary view is for improved margins in the fourth quarter as revenue increases and the benefits from our restructuring program start to take hold.

Moving down the income statement, the sum of R&D and SG&A expenses was 51 million, up 2% from Q1. We started the headcount reduction portion of our previously announced restructuring programs near the end of the quarter and will complete most of it during the third quarter. We are maintaining our commitment to R&D and expect that expense to grow a bit. We will continue to control spending going forward but not surprisingly we are seeing an increased shift in travel cost as the euro remains at high levels compared to the dollar and our Q3 marketing expenses will be affected by our costs of our two largest tradeshows of the year, SEMICON/West and Microscopy and Microanalysis. On a net basis, we expect a modest increase in operating expenses for the third quarter.

Amortization of purchased technology was $459,000 in the second quarter and we expect that level to continue barring any future acquisitions. Restructuring expenses of 2.3 million were somewhat below our early forecast due to timing. We expect that restructuring expenses will total about 5 million in the second half of 2008 with some spillover into 2009 and we expect to generate about 15 million in annual savings from those actions in the future.

Operating income was $4.9 million compared to $8.8 million in the first quarter. Excluding restructuring expenses, operating income would have been 7.2 million. Below the operating income line, other income was $1.5 million, down from $1.9 million in the first quarter. This change is primarily driven by lower net interest income, our investment portfolio and balance sheet currency losses. This line also includes $372,000 for the premium on the 146 million in zero coupon notes that were put to us on June 16. With that repayment, we have now used cash to pay off 195 million in debt since the beginning of the year. The decline in market interest earnings and our investments in less invested cash, we expect this line item to be approximately 500,000 in the third quarter.

The tax rate for the quarter was 24.5%. It was subject to the mix of income between our U.S. and our international operations and the total level of income and it can vary by quarter. We expect the rate to range from 25 to 35% in the third quarter. All this leads to net income of $4.9 million or $0.12 per share for the second quarter. Restructuring expenses accounted for a $0.05, so exchange restructuring our EPS was at the top end of our guidance range.

The fully diluted share count was 41.5 million shares during the quarter. The repayment of our zero coupon notes reduces that total share count by 5.5 million shares and that will be fully reflected in the average share count for the third quarter which we expect to be approximately 37.2 million. That total does not include 3.9 million shares attributable to our 2.875% convertible notes because their inclusion will be anti-dilutive at our current income levels.

Turning to the balance sheet, our total cash and investment positions, including restricted cash and long-term investments declined in the quarter from $436.8 million to $290.8 million due to the repayment of our convertible notes. Excluding the debt repayment, total cash and investments were up 2.8 million in the quarter. Receivable turns improved, inventory was essentially flat, and current liabilities decreased by 17 million in addition to the debt repayment. We also added to our potential liquidity in the quarter with the arrangement of a $100 million credit facility with a group of major banks. Even after the debt repayment and taking our auction rate securities into account, we continue to have ample liquidity to grow our business organically or through acquisitions. Capital spending in the quarter was $2.3 million compared to depreciation expense of $4.3million.

Now, I’ll turn it to the details of our guidance. We expect revenue to be in the range of 144 million to 150 million. Our third quarter is normally slower on a seasonal basis because of our university customer base and holidays in Europe. Bookings are expected to above 150 million with potential for upside depending on the timing of several large orders. Our GAAP earnings per share for the third quarter assuming a 30% tax rate are expected to be in the range of 0.04 to $0.09. Restructuring charges of approximately 1.5 to 2 million which are included in the GAAP guidance are estimated to reduce income in the quarter by approximately $0.04 per share.

For the fourth quarter, we expect higher bookings, higher revenue, better margins and higher earnings compared to the third quarter. This improvement is based on our strong product flow, expected improvement in bookings and the early positive impact of our restructuring program. We believe we are well positioned going into 2009.

With that, I’ll turn it over to Don.

Don Kania

Thank you, Ray, and good afternoon everyone.

The second quarter played out about as we expected. The environment remained positive for our research and life sciences businesses but challenging for electronics. After a record second quarter orders, we expect a pick up in the third quarter and in the second half of the year. Our positive outlook is based on the strength of our regional and market diversity, discussion with key customers and a growing pipeline of larger orders.

Now, I would like to discuss each of our markets, both regarding our results for the second quarter and the outlook for the rest of the year, and then I will give you an update on our restructuring program. Research and industry bookings in the second quarter were $57.1 million, up 46% from the first quarter and up 40% from last year’s second quarter. Demand grew globally with over 80% of our bookings coming from outside the United States. A significant portion of the orders came form-developing economies, reinforcing our view that our tools are seen as key infrastructure investments in these regions.

We announced today a second quarter multi tool order from India’s International Centre for Material Science. This is a good example of the global demand for our leadership tools. In addition, our outlook is bolstered by the flow of new products, our new extreme high performance SEM Magellan was announced at SEMICON/West. It will be shown for the first time at next weeks M&M show, a research and microscopy tradeshow in Albuquerque. Magellan along with Titan and Helios completes the key strategic goal for FEI technical leadership in all product categories. We are hopeful that this flagship product will have the same positive impact on our entire SEM product line as Titan has done in TEM.

At the end of June, we also introduced another extension of the Titan called the ETEM. This product Titan for chemists allows scientist to image chemistry in action in its natural environment, not one dictated by the microscope. Early adopters are using it to develop catalysts with environmental and economic benefit and to study nanomaterial processes such as nanotube growth.

Stepping back for a moment and looking at the long term trends for this market, revenue from research and industry grew at a compound annual growth rate of 27% form 2004 to 2007. Now halfway through 2008, our revenues are up 30% on a year to year basis. Our investment in technology, customer solutions and channel are paying off.

Our second quarter electronics bookings of 27.6 million were down 45% from the first quarter 2008 and down 39% from second quarter a year ago. If we remove the contribution from the extremely volatile data storage segment, semiconductor orders have been running approximately $30 million in the last two quarters and were down 10% from the first quarter. Looking at the electronics market, demand for our product increases as the industry moves to 45 nanometer and smaller processes, expanding demand for TEMs and DualBeams that prepare TEM samples.

At SEMICON/West, we introduced TEMLink, a suite of connectivity tools to link our TEMs and DualBeams together in a proprietary basis, giving semiconductor laboratory customers lower cost and faster time to data. Also at the show, we announced Magellan. Its ability to achieve extremely high resolution with low sample damage is unique to FEI and a compelling value to our customers. We have shown it to a number of key customers and have received universally positive response. We expect to take share from our competitors as our customers move to new nodes. This is a new opportunity for FEI. Since we have negligible market share in a $100 million plus market for laboratory semiconductor SEM. We will have modest positive impact on bookings and revenue in the second half as we expect a significant increase in volume in 2009.

In the third quarter, we expect electronics bookings to increase driven by investment in technology as first half restrains on capital spending are removed, particularly from our largest customers. Our life science segment also had a strong booking quarter with a total of $21.7 million. That’s up 31% from Q1 and up 21% from last year’s second quarter. As we have said before, bookings in the segment will be uneven, but we believe the long run trend is very positive and we have been getting increased traction.

Response to the Titan Krios, our high end system for molecular biology that we introduced in the first quarter has been very positive and the pipeline continues to build. For example, we have booked our first Krios from China. It is outside the larger U.S. and European market.

In summary, bookings were on track for the second quarter. As we see the potential for improvement and we see potential for improvement in the second half of the year, our optimism for second half growth is based on global growth in research and life science and a rebound in the electronics business, all fuelled by our recent introductions of new products.

Let me spend a moment giving you an update on our restructuring programs. Our goals are two fold. First and foremost, lower cost. Second, we are aiming for a better currency balance between revenue and expenses to eliminate the risks associated with foreign exchange. As a reminder, 80 to 90% of our product is built in euro or euro linked locations and the weakness of the dollar continues to hurt our growth in operating margin.

The bulk of our headcount reductions are complete. We are in active negotiations with our major euro based suppliers to reduce costs and shift their sale to a dollar base, and have agreements on $19 million of our annualized target of $40 million of spending shift. We are also in active discussions with multiple outsourcing partners to manufacture our low end SEM products now made in our Czech Republic facility and to take our U.S. manufacturing facility in Hillsboro. The next step will be to move mid range products from the Netherlands to the Czech Republic, our low cost factory. This will free up resources to expand production of our high performance, higher margins tools in the Netherlands where we completed a small expansion in the second quarter, literally raising the roots to expand production of our high end TEM products

Titan, Titan Krios, Titan3 and ETEM.

Restructuring will have a small positive impact on our fourth quarter and we expect most of the positive results will flow into 2009 with full benefits by the end of the year. As we continue to execute on our strategy, our conviction about FEI’s positive long run prospects have increased for a number of reasons. One, we serve global growing markets where our products are seen as critical elements of infrastructure for economic growth. The global strength of this quarter’s research and life sciences bookings, the pipeline of large orders, and our view about the recovery and technology spending in electronics in the electronics market all reaffirm this conviction.

Two, we serve these markets with leadership technology incorporated into best in class product sold through an ever more capable global channel. The introduction of the Magellan establishes us as the technology leader in all of our product areas. And the continued rollout of Titan and Helios extensions confirms that we intend to maintain that leadership.

Three, our restructuring plans will create a more efficient, naturally hedged cost structure while maintaining our investment in our growth engine. And four, our strategy are supported by a strong capital structure to support our investments and realize long term growth for FEI. Repayment of the notes resulting in the reduction of our share count demonstrates our commitment to generating shareholder value.

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

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question and answer session. (Operator instructions) Our first question comes from the line of JoAnne Feeney with FTN. Please go ahead.

JoAnne Feeney – FTN Midwest Research

Thanks. Congratulations on a nice quarter, guys. I have a few questions about the rest of the year really. You had said earlier that you expected the third quarter revenue to look similar to the second quarter, and so I am wondering if you are putting back any of the usual seasonal decline, if some of the additional revenue you saw in the second quarter was pulled in, in your view from the third quarter, or has something changed about your outlook on the third quarter since we last spoke?

Don Kania

I think, JoAnne, what you are seeing are minor shifts in customer expectations on delivery. So, I wouldn’t read anything too fundamental into where we are at, and I think our guidance for revenues Q3 are pretty much in line as you say with the seasonality. So, I don’t think there is not a hidden message here.

JoAnne Feeney – FTN Midwest Research

And so you are tracking a number of these large orders you talked to us about before. Given that, would you sort of characterize the third quarter of this year as having a bit more of – bit more uncertainty than is typical?

Don Kania

You are referring to orders or revenue?

JoAnne Feeney – FTN Midwest Research

Sorry, I was thinking of revenue, but if you feel like addressing both, that might be –

Don Kania

I think we are comfortable with the revenue forecast that we’ve given for the third quarter and thus stated we will stand by those numbers. On the booking side, I think we’ll stand by our mantra of we are tracking a number of large orders and they will close at some point. We closed a few in the second quarter and we are expecting that process to continue through the end of the year.

JoAnne Feeney – FTN Midwest Research

Okay. And then if I could, just a question on the gross margins. So Ray, you’ve probably done this exercise a few different ways, but if you could imagine the reorganization of the supply chain magically being done and all that stuff out of inventory, what would be – could you isolate for us the impact on gross margin just of the euro effect and when we might see it released once you are done with all that?

Ray Link

There is a big – really, that’s hard to judge because there is a question what do you compare it to. If you are just comparing it to Q1, the dollar was up about or down I should say about 3%. So, that has some impact on COGS, it has some impact on operating expenses. A large measure of what we are trying to do with our whole restructuring is to fundamentally lower cost to get them out of higher cost regions into lower cost regions with the second benefit being currency. So, I really can’t give you a specific answer on what if we moved all the supply chain just to get that out of dollars, that’s hard to compare. I think we are really targeting just true COGS reduction, and ultimately better balance of currency.

Don Kania

JoAnne, if I could, there other way to come back to this same question, but it integrates all the activities into it is that if you look at our guidance that we’ve given for margins over the next 18 months, with a 18 month target of 45 and a one year target of 43 from the announcement of restructuring. So, I think that’s really the best thing to latch on to in terms of gross margin motion.

JoAnne Feeney – FTN Midwest Research

Okay, and so you are still comfortable with that given the decline from last quarter gross margin and you still feel like you are on track to meet that model?

Don Kania

Yes, we are.

Ray Link

Yeah. And I think we – a perfect situation to look at, JoAnne, is that a lot of what we shipped in the second quarter are deals that we priced in the third and fourth quarter of last year, and some of them were priced in the first quarter but a lot of the larger deals that really can drive margins one way or the other, and those were quoted when the dollar was around 1.40-ish or so, and we moved up very rapidly, particularly in the first quarter and even into the second quarter to the current level of around 1.57. Those deals are largely flushed in through the system, so the deals we are quoting today are quoted at the current exchange rates. So, we don’t have the sort of hit deals or bad deals. Those are still nice deals but lower margins deals that had an impact on currency; those are starting to flushing through.

JoAnne Feeney – FTN Midwest Research

And so that’s why you think that the third quarter gross margin will improve a bit despite the fact that more of the hedges are coming off?

Ray Link

Absolutely. Absolutely. We can identify clearly deals that came about this quarter from a shipment standpoint that were priced sometime ago. Those are largely going away and we do see just overall better mix of products in aggregate, particularly in our research business that we feel pretty good that margins should be at least as good or better even though revenue is down slightly, and yes, we will have slightly better hedging gains.

JoAnne Feeney – FTN Midwest Research

And are you counting on electronics becoming a larger portion of sales when you come up with that conclusion about gross margins?

Ray Link

Not really, no.

JoAnne Feeney

Okay. Terrific, thanks.

Operator

Thank you. And our next question comes from the line of David Duley with Merriman Curhan Ford. Please go ahead.

David Duley – Merriman Curhan Ford

Yes, good afternoon. A couple of questions from me. First is a clarifier, Ray, you guys don’t give kind of a pro forma EPS number, but what I thought I heard and read is the $0.12 plus $0.05 from the restructuring, so that would roughly give you a pro forma number of 17?

Ray Link

That’s correct. Yeah, we don’t give non-GAAP guidance. We just give the pieces, and you add them together.

David Duley – Merriman Curhan Ford

Okay. I just wanted to make sure. And another clarifier, the $15 million savings you expect from your restructuring, would that be coming out of operating expenses or improvement in gross margins or what bucket would we throw that 15 million into whenever it does come?

Ray Link

Ultimately it will all come into operating income, but a good chunk of it comes into gross profit margins.

David Duley – Merriman Curhan Ford

Okay. Do you have a percentage, is it roughly 70/30, 50/50, or –

Ray Link

Yeah, considerably more than half of the improvement will be in gross margins.

David Duley – Merriman Curhan Ford

Okay. And just another clarifying statement, I just wanted to understand a little bit more about the order guidance, how many of these large 10, $15 million orders, the big ticket jumbo orders, whatever the threshold is that you like to define them as, how many of them are in your current quarter – in your outlook for your orders in the current quarter?

Ray Link

I’d characterize it as a few. We are not going to give you specific number on that. We have said in the past it is greater that 15, it continues to track that. The value continues to increase. So, we build in –

David Duley – Merriman Curhan Ford

A few multiple tool orders.

Ray Link

Yes.

David Duley – Merriman Curhan Ford

Okay. But there is not a – but the 150 million doesn’t include any of the big whoppers, like a 15 or a $20 million order?

Ray Link

I am not gong to comment on that.

David Duley – Merriman Curhan Ford

Would that be the type of – if you did close one of these, what kind of upside would we expect if you did close a big order?

Ray Link

I am not going to comment on that, Dave.

David Duley – Merriman Curhan Ford

Okay. One final thing is, and I hope you comment on this one –

Ray Link

We can stay here all afternoon.

David Duley – Merriman Curhan Ford

Well – and you know, I’ll just want to use your math. The orders in the second half would be greater than the first, but since it was 140 and 150 and you just guided to 150, that could mean Q4 is down. Is that what you are trying to telling us?

Ray Link

Not at all. What I think we are trying to tell you is we think second half is up, there’s probably some uncertainty in timing on some orders of substance and whether they show up in three or four, you should say three is up a little bit. We guided to at least 10 million up, and the second half up overall from the first half. So, I think we are trying to send a message of uncertainty in timing but optimism.

David Duley – Merriman Curhan Ford

Okay. And Ray, final question from me is the tax rate for this upcoming quarter, what did you say that should be again?

Ray Link

I think you should model 30%. We are giving a fairly broad range. Our GAAP earnings are down in Q3 and restructuring kind of moves the tax rate around a lot, but I’d be comfortable with a 30% tax rate.

David Duley – Merriman Curhan Ford

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Peter Kim with Deutsche Bank. Please go ahead.

Peter Kim – Deutsche Bank Securities

Hi. Thanks for taking my questions. I wanted to ask about your – again on your outlook here, you talked about your semi was expected to be stronger in the second half, and yet everybody knows that semi’s margins are stronger but you didn’t expect semis to contribute to your margin improvement. I was wondering if you could kind of talk around that point, why wouldn’t semis, if there is upside from semis in 3Q, why wouldn’t it have an impact on margins.

Don Kania

Because the margin impact was costing me revenue, so I think what we are trying to indicate is we are more optimistic on the order book in Q3, and I think a good fraction of that we converted to revenues in Q4, so that would be an advantage there.

Peter Kim – Deutsche Bank Securities

So, when you talk about these jumbo orders, are most jumbo orders around the semi space, or are there other segments like research and development that have jumbo orders?

Don Kania

They cut across all categories. And let’s just be clear, jumbo order or whatever, that’s not our jargon, but it’s really multi tool orders. That’s a trend we’ve seen growing over the past couple of years is that there’s been more and more buying of groups of tools as opposed to individual tools, and that plays well to our technology leadership which often bring along, particularly in the SEM space, until the introduction of Magellan and relatively what were a relatively weaker product line. So, that was the advantage for us overall.

Peter Kim – Deutsche Bank Securities

So, are you looking for Magellan to contribute to your semi’s business in the second half of the year?

Don Kania

Only in a relatively – it will, but it will be relatively modest this year. As customers buy their first tools, they typically take three to six months to really work through them and then as they transition to smaller nodes, again we are more nodally driven that volume driven, they will invest in, in a number of tools to staff their factories.

Peter Kim – Deutsche Bank Securities

All right. Last point, you’ve suffered – obviously, we’ve had the last four, five quarters have been very strong, euro appreciation in those periods. And usually there is some level of expectation that if that trend were to reverse that you would see your margins come back. But now that you are moving most of your manufacturing, I was wondering will the leverage from the currency effects reversing not be as strong as they were coming into these four, five quarters of strong euro?

Don Kania

I think, Pete, our goal – let’s take a high level view and then we can come back to a shorter term view. Our goal is not to be in a position where FEI is playing the currencies. Our goal is to get lower cost and that goes back to our European traditions of supporting European supplier base which has become even a more expensive supplier base. So, we are going to move out of the euro zone, we are going to move out of the euro to the dollar, and that’s our primary goal, lower cost and better natural hedge within the company. I think I will turn it over for Ray in terms of the short term fluctuations in the currency, I think that Ray is better equipped to answer that question.

Ray Link

Yeah, but even today, everybody is all excited because the dollar is at a three month high. It’s is 155.50. That’s currently off from the average rate of 157 for Q2. So, that kind of movement and the noise level, we are more concerned with major movement in the dollar, and we don’t play the currency game. I don’t believe that the dollar is going to strengthen dramatically when we have half a trillion dollar deficit. It is hard to imagine that to turn around. But as Don said, our goal is to get out of that and have a more natural balance. It is unhealthy for a company to have, 80, 90% of its cost in a currency where it only has 40% of so of its revenue.

Peter Kim – Deutsche Bank Securities

I agree. But that has been the case for the last four, five years for FEI. And only recently you’ve taken these steps to move some of the cost out of European based cost – euro cost base.

Ray Link

That’s not totally accurate. We had a better balance several years back on currencies and the movement has actually gone away from us a bit. The research business which is more global and also back in the 2002, 2003 timeframe, we actually moved some production from the U.S. to Europe. In retrospect, obviously, we’d like to bring that decision back, but we are more on balance today than we’ve been.

Peter Kim – Deutsche Bank Securities

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Mark Miller with Brean Murray. Please go ahead.

Mark Miller – Brean Murray Carret

Congratulations on your bookings and another record quarter. Did you provide any data on your service margins? I mean is that some way long or we started to add a couple of quarters for those to start to come up?

Don Kania

Well, we did see some improvement, Mark. We went from 24.7 a year ago, 26.1 in Q1 and 27% in Q2, and that’s something that we are going to hopefully continue that trend. Service margins grow much more gradual simply because you’ve got embedded contracts that are out there in some periods, in some cases even greater than a year, and – but some are concentrated and we see that continue to grow.

Mark Miller – Brean Murray Carret

I was wondering too, have you seen any response. I thought I read something that drove or someone from (inaudible) response to one of your new products, I believe it was the Phenom, maybe I am wrong here, but have you seen any response to any recent new product like the Phenom or Magellan from your competitors?

Don Kania

Okay. So, let’s just go – let’s go through the list of new products, how’s that? I will start with ETEM, we are clearly the leader there. There is no fundamental competitor in the world in that segment right now. TEMLink which is linked (inaudible) it’s really a semi space play or – and data storage, but it links the DualBeams in a proprietary way through our TEM. So, our competitors have nothing like that and we think the value that it delivers to customers makes us highly differentiated and obviously locks the customers into our toolset.

As we talk about Magellan, our position is much to our customers dismay that – our competitors dismay, it’s vastly superior to anything that they are offering today in terms of resolution capabilities and the ability to image at levels which is more and more important for many applications, including life sciences, material science and biology. And on the Phenom class front, the low priced product, yes, that’s a space that’s been getting populated. I think we are still early in the game in that whole thing. Joe [ph] has one out there, Hitachi has had one out there. So, we are watching that pretty carefully. I don’t think it has had an effect at this point, but I think that’s going to be– how that market ultimately gets defined will be a process that we will watch over the next year or so.

Mark Miller – Brean Murray Carret

Finally, SanDisk posted a loss last week and announced that it was slowing down on certain capital expenditure in projects, and this came as a surprise. Of course, the flash memory a few years ago really propelled capital spending. I am just wondering in terms of your electronic segment, how exposed you are to the flash memory chip producers?

Don Kania

Our thesis remains that we are less sensitive to those pieces of the puzzle than we are to the relentless drive to shrink the product. We are very technology driven and if you listen to the commentary carefully, we try to emphasize that. The reason we are optimistic about the second half is tech buys have been held up. I think we described in the first quarter call that we – people have one to two quarters where they can hold off on tech buys, but if you want to stay in the game, you can’t do it much longer than that. So, that’s what we feel the second half will be much stronger for us. So, yes, you’ll see some vagaries in some of the players, but I think our larger customers have all indicated to us that sometime in the second half that they will start to spend on these technology pieces.

Mark Miller – Brean Murray Carret

Thank you.

Operator

Thank you. Our next question comes from the line of Benjamin Pappas with D.A. Davidson. Please go ahead. Benjamin, your line is open. If you are on mute, please unmute.

Benjamin Pappas – D.A. Davidson

Hi, guys. Ben Pappas calling in for Matt Petkun. I just wanted to follow in with a couple questions regarding Magellan. What’s the total opportunity here in terms of (inaudible) market share. And also if you’ve given any commentary on the margins for Magellan, that would be great?

Don Kania

Okay. So, Magellan, as we described just a few minutes ago, in the semiconductor area, we think it is a 100 million plus market, probably at least equaled in the research and life sciences market, so a couple of 100 million plus. We are not going to give a market share target for that at this point though we think with a highly differentiated product that we can do pretty well through ’09 in terms of growing the business. So, it will have a meaningful impact on the company. By way of reminder, this is also our – has always been our weakest segment, and so it’s really quite – it’s not going to cannibalize existing business, this will be really new business for the company .

Benjamin Pappas – D.A. Davidson

Okay, great. And the margins, I mean is it higher than what you’ve experienced in the past in this segment, lower, kind of –

Don Kania

Semiconductor class margins.

Benjamin Pappas – D.A. Davidson

Okay, great. And then the restructuring fees, I just wanted to tag on that. I think you said that some amount would trickle into Q1, how should we model for the back half of the year and into the beginning of the year?

Ray Link

Well, we are looking at somewhere around a 1.5 million to 2 million for Q3 and about 5 million in total for the second half of the year. So, 3 to 3.5 million for Q4. We are not providing details just for Q1 in terms of where that would be, but it won’t be super significant, let’s just put it that way.

Benjamin – D.A. Davidson

Okay, fair enough guys. Thanks a lot.

Operator

Thank you. Our next question comes from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Bill Dezellem – Tieton Capital Management

Hi, thank you. I wanted to circle back to the Titan first of all. Would you please bring us up to date in terms of the activity level there? With the success that you’ve had over the last couple of years, do you see that pipeline getting smaller, or with success would that be getting more success when the pipeline is actually expanding? That’s the first question. And the second question is relative to the Phenom, would you please bring us up to date in terms of where you are at sales wise and when that product is really going to be fully on the market and selling and what your expectations are for 2009, please?

Ray Link

Okay. Let’s comment on the Titan pipeline first. If you take a step back, I want to remind everybody our strategy is we have two things that work for us in terms of – people get concerned about market saturation. And so number one is we have the base Titan which we introduced in ’05, really started selling strongly in ’06. But the geographic diversity there helps us a lot. So, we sell in the first world, Europe, North America first, and we then we see a lot of traction as we go into the third world, or the emerging world, places like India, China, etc.

In addition, fundamental to our strategy is to make application specific variants of the tools, so a core Titan. We add on to that an environment enclosure, that’s Titan3. We add a chemistry enclosure, that becomes ETEM. We add onto that a refrigerator and some automation and that becomes Krios. And so those open up new market opportunities that flow forward. So, the net result for us has been a strengthening pipeline as we look forward around the Titan product and we feel very good about that.

Now, if I remember, the other question is on Phenom. We haven’t been giving a lot of details on that, and what we’ll describe is that we’ve been – we are in the process of building our global distribution network. We have – since it is a much lower price point product, we are developing distribution for that product where we have some strength in Europe and North America, and we are expanding both and also expanding into what we call the independent channel around the world. And we remain steadfast in our target of – we see $40 million run rate exiting ’09, that’s the color we’ve given at this point. And we are going to standby that, and we’ll – as it becomes really meaningful, we’ll make further comments.

Bill Dezellem – Tieton Capital Management

The 40 million is actually the run rate at the end of ’09, calendar ’09 total sales level?

Ray Link

Correct.

Bill Dezellem – Tieton Capital Management

Great, thank you.

Operator

Thank you. (Operator instructions) Our next question is a follow up question from the line of David Duley with Merriman Curhan Ford. Please go ahead.

David Duley – Merriman Curhan Ford

Yeah. I was just coming back for one final clarification. You said, Don, in your prepared remarks you talked about the sequential movement in the nanoelectronic sales line or was it the bookings line, could you just repeat what you said there, because you kind of framed what the semi business was without the disk drive business and that’s an important data point?

Don Kania

Yeah. I think the way to think about it is we’ve been running about a $30 million run rate without data storage.

Ray Link

Bookings.

Don Kania

Bookings, thank you, Ray. Revenues, actually I don’t have that on top off my head, so we can get that for you in a second. That’s really what’s important I think in terms of the forward look in the business.

David Duley – Merriman Curhan Ford

Okay. So, we can look at the last two quarters of bookings in that market and basically the change in the decline there was mainly driven by the disk drive business?

Ray Link

That is, yeah, right.

Don Kania

(inaudible)

David Duley – Merriman Curhan Ford

From 50 to 27 million, that is a pretty big fall off. What you are kind of saying is semi was down like 10% and the rest of that decline, the other 35% was disk drives.

Ray Link

Right. And for us disk drive is very, very volatile.

David Duley – Merriman Curhan Ford

Right. Okay. That was it for me. I just wanted to make sure.

Ray Link

Well, thanks, Dave.

Operator

Thank you. And our next question is a follow up question from the line of JoAnne Feeney with FTN, Please go ahead.

JoAnne Feeney – FTN Midwest Research

Yeah, thanks. Just to clarify the order outlook that you are seeing, you remarked and somebody else addressed this, do you expect the second half orders to be higher than the first? And now you’ve also given us guidance on the third quarter being 150 or better. But I though I heard you say that we should expect the fourth quarter orders to be an improvement along with revenue, EPS and gross margins from the thirds quarter, but it sound like your second quarter – sorry, second half orders are going to be where you expect them to be considerably higher than the first half, is that sequential picture correct?

Ray Link

The only thing I would caution you Joanne, I think is you gave the substance of a strong second half on your order front is our view. The only thing I would spin in to that is watch the timing. Some of these larger orders, it is difficult to call three or four, and that becomes – it’s more of a timing that a total issue.

JoAnne Feeney – FTN Midwest Research

And then one other – okay, and then one other housekeeping question on the tax rate, so should – how far out should we be thinking about that 30% rate applying, is that just for this quarter or should we be using that going forward?

Don Kania

(inaudible)

Ray Link

JoAnne, I am going to come back to the order and then I will answer your tax question. I think if you take Q3 guidance at 150 and ignore the upside which is where we have timing issues on the multi tool orders, and assume that we just did 150 in Q3, we would be comfortable that Q4 then would be greater. Now it is the timing of some of those multi-tool orders ultimately fall into Q3, it is hard to make a call on Q4. But I think that will give you some color on how we are viewing the second half.

JoAnne Feeney – FTN Midwest Research

Okay, that’s a good clarification. Thanks, Ray.

Ray Link

Okay. And then on the tax rate, the model for the year, I think if you look just for the total year, a range of somewhere around 25% is a pretty good number. For Q4 at this point based on the color we’ve already given, we are anticipating Q4 profitability to be higher, therefore the tax rate is lower. It is kind of a nice thing about the FEI model, the higher the income, the lower the tax rate.

JoAnne Feeney – FTN Midwest Research

Okay. And so you – in the press release, it was noted that part of the reason for the 30% tax rate this quarter had to do with restructuring.

Ray Link

Yeah, the restructuring is a larger potion of our – is a bigger component of costs at a lower level of income and also the mix of which geography it is paid out of FEI, whether U.S. or European has a dramatic impact on our overall effective rate.

JoAnne Feeney – FTN Midwest Research

Okay. But we are more thinking about that $0.04 difference between your GAAP guidance and your estimate of the restructuring charges. So, it sounds like only a $0.02 you are coming through the actual restructuring charge and some of it is being accounted for by the tax, is that right?

Ray Link

On the guidance, we are assuming a 30% rate on the restructuring. So, we used a million – a mid point of the 1.5 million and the 2 million, 1.7 million at 70% and divide by 37 million shares, you should come up with about $0.04.

JoAnne Feeney – FTN Midwest Research

Okay, got it. Thank you very much.

Operator

Thank you. And our next question is a follow up question from the line of Benjamin Pappas with D.A. Davidson. Please go ahead.

Matt Petkun – D. A. Davidson & Co.

Hi, there. It’s actually Matt Petkun now in for Ben Pappas. Sorry, I was – I am back from the dead. Couple of questions. Don, have you seen anything especially outside of the nanoelectronics worth commenting on from a macro economic perspective in terms of how your engagements with customers have been over the last couple months and as you’ve look for the back half of the year?

Don Kania

Yeah. I think we made a comment, actually. We’re – I forgot where I was last – at our analyst day. I think people, if you spend too much time in New York City, no offence, and in the U.S., you miss out a lot of the optimism that exists in Russia and China, India, places that are quite well off financially, are investing in the future. And if you think about our research and industry orders, the increases there and where those increases have taken place, I think this speaks to the strength of the global economy. I think in the semiconductor world, I think we all sort of hear the same story of muted near term view. I think we are differentiated on the basis of being technology driven more so than volume driven, so thus we believe we will pick up in the second half. I don’t hear a lot of just macroeconomic human gloom around our business segment at this point. We listen very carefully, but –

Matt Petkun – D. A. Davidson & Co.

Great. And then another question for Ray. I know, Ray, that you guys have sort of started down the path exploring the notion of more leased space sales with al least some of your customers. Can you share at all with us about how that’s playing out in this environment and if you see that really becoming a growing portion of FEI’s opportunity over the next couple of years?

Ray Link

You know, I think we – I don’t think it’s going to be ever huge portion of our business. We do a lot of quote on leases and it ultimately keeps deals in play for us. And many times where we think it is gong to end up being a leased transaction, it ultimately does not. We don’t really break out on any quarter basis how much we have in leases but it’s just another tool to help our salesmen close deals.

Matt Petkun – D. A. Davidson & Co.

And any sense, when your customers – probably a small portion of your customers’ purchases are being financed by a third party, but if there are any of those, are you seeing any changes in their ability to finance purchases?

Ray Link

Haven’t really seen any change on that. There really isn’t that much of that.

Matt Petkun – D. A. Davidson & Co.

Okay, that’s what I thought. Well, thanks so much.

Ray Link

Welcome back from the dead.

Matt Petkun – D. A. Davidson & Co.

Yeah, thank you, and thanks for taking my questions.

Operator

Thank you. Our next question is a follow question from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Bill Dezellem – Tieton Capital Management

Thank you. Would you please spend some time discussing the press release that you put out just immediately before the call. I don’t know about others on the call, I haven’t had time to absorb and since you are here give us the importance of this and why it was a press release (inaudible)?

Don Kania

Okay. It is important for several reasons. It is an announcement of a multi tool order to a key materials science research center in India. It is an important one because the receiver of the tool is very influential in the Indian political scene, and Professor Rao is incredibly important in directing the future of funding of this type of activity in India. (inaudible) India has announced that it is quintupling in 2008 its spending in the nanotech area versus 2007. So, we think the win and the person who is leading that win speaks wells for the opportunity for FEI in India in the future, and it is just another one of many opportunities we see around the globe for these nano centers to be populated with FEI product.

Bill Dezellem – Tieton Capital Management

And you say you are quintupling spending, does that imply that you have additional opportunities in India for this calendar year?

Don Kania

I am not going to comment on the timing within a year or not, but we believe over time the investment in this area in India will benefit FEI.

Bill Dezellem – Tieton Capital Management

Maybe I will try the question slightly differently. Do you feel in the first half of ’08 that India’s nanotech spending is five fold greater than it was in the first half of 2007?

Don Kania

What I commented in general typically that there is a timeline between the announcement – a significant timeline between the announced and increased funding and flow of orders to our products and that can be anywhere from nine months to longer than a year.

Bill Dezellem – Tieton Capital Management

Great, thank you.

Operator

Our next question is a follow question from the line of Mark Miller with Brean Murray Carret. Please go ahead.

Mark Miller – Brean Murray Carret

Just wanted to make sure the order growth you are projecting in the second half of the year, is that due to several factors such as recently introduced products, seasonal effects, anything else?

Don Kania

New products, strengthening of the buys from the semiconductor customers, those are two fundamental drivers underneath just what’s been and I think a bit missed by everybody is this strong growth we’ve seen in research and the life sciences area, that we expect that to continue. So, you’ve got strong growth there, improving growth in the electronics segment, and you dump all that together and we feel pretty good about the second half.

Mark Miller – Brean Murray Carret

Thank you.

Operator

(Operator instructions) One moment please for the next question. I am showing there is no further question in the queue, I will turn it back over to management for any closing remarks.

Don Kania

Well, I just like to certainly thank everyone who has shown interest in the company, we appreciate that. And all the employees listening, we appreciate the great work that you’ve done as well, and we look forward to speaking with everyone at our next quarter conference call. Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude today’s FEI second quarter earnings conference call. If you like to listen to a replay of today’s call, please dial 303-590-3000 or 800-405-2236, enter the pass code of 11117189. Again those number are 303-590-3000 or 800-405-2236, enter the pass code of 11117189. AT&T would like to thank you for your participation, you may now disconnect.

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