FEI's CEO Discusses Q3 2012 Results - Earnings Call Transcript

| About: FEI Company (FEIC)

Start Time: 17:04

End Time: 17:56

FEI Company (NASDAQ:FEIC)

Q3 2012 Earnings Call

October 30, 2012 5:00 pm ET

Executive

Fletcher Chamberlin – Treasurer & Communications Director

Raymond A. Link – Executive Vice President and Chief Financial Officer

Dr. Don R. Kania – President and Chief Executive Officer

Analysts

Zach Larkin – Stephens Inc.

Bill Ong – B. Riley & Company, Inc.

Joe Maxa – Dougherty & Company LLC

Tycho Peterson – JPMorgan

Mark Miller – Noble Financial Capital Markets

Patrick Ho – Stifel Nicolaus & Company, Inc.

David Duley – Steelhead Securities

Derik De Bruin – Bank of America/Merrill Lynch

Thomas Diffely – D. A. Davidson & Co.

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the FEI Third 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 30, October 2012.

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

Fletcher Chamberlin

Thank you, [Walento]. Good afternoon, ladies and gentlemen. As the operator said, I am Fletcher Chamberlin, FEI’s Treasurer and Communications Director. With me today at our headquarters in Oregon are, Don Kania, our President and CEO; and Ray Link, Executive Vice President and CFO. We appreciate your interest in FEI, and we especially appreciate and send our best wishes to our friends on the East Coast whose lives have been so disrupted in the last two days. We hope for a quick recovery.

We’ve again posted some slides under Events & Presentations in 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 the numbers and getting them recorded.

I would also remind you that we included supplemental table with the release containing substantial additional information at the back. While you are pulling up the slides and before we get into the presentations, we have the regular housekeeping matters to address.

This call contains forward-looking statements. To the extent that we discussed expectations about future orders, revenue, gross margins, operating, and restructuring expenses, non-operating income, our tax rate and earnings or expected market and business unit strategies and growth opportunities, plan, product introduction, expected government spending for research tools worldwide, or other future events and plans, those statements are considered forward-looking subject to risks and uncertainties that could cause our actual results to differ from the forward-looking statements made.

These and other risk factors are cited in today’s press release on slide two of the slides posted 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 those 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 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 website at www.fei.com.

I’ll now turn the call over to Ray to go through the financials. Don will then discuss our business and outlook and then we’ll be glad to take questions.

Raymond A. Link

Thank you, Fletcher and good afternoon everyone. We had a good quarter. Bookings and revenues set all-time records and revenue was up sequentially despite our normal seasonality. The book-to-bill ratio was above 1:1. Earnings were the highest for any third quarter and were above guidance.

Our gross margin of 47% was on target and keeps us on track towards our long-term goal of 50% by mid 2015. R&D spending increased in line with our plan as we continue to invest the new products and applications. We now have recorded 26 consecutive quarters of GAAP profits demonstrating consistency in varying economic environments.

Net bookings for the quarter were $223.3 million, up 6% from Q2 of this year. Changes in currency rates had a $4.3 million positive impact at our orders and backlog this quarter, compared with the third quarter of last year, bookings were up 20%. Of that total, organic growth contributed 16%, acquisitions added 7%, and the impact of foreign exchange subtracted 3%. The backlog at the end of the quarter was $425.2 million and represents just under six months of revenue at our current run rate.

Moving to side 4, third quarter revenue of $221.8 million was up 8% from a year ago and normally from the second quarter, compared with the year ago organic revenue growth was about 6.4%, acquisitions added 4.6% of revenue, and the impact of foreign exchange rates reduced revenue by 3%. Looking at the segments and comparing to the second quarter 2012, Material Science, Life Sciences and Service were all up and Electronics was down modestly.

Turning to slide 5, our revenues continue to be balanced geographically with continued strong growth in Asia. North American revenue was leveled with the second quarter, up 25% from last year’s third quarter, and made up 34% of the total.

Europe was up 37% from a relatively weak second quarter and down 14% from a strong quarter a year ago, and made up 29% of the total. Conversely, Japan and Asia together were down 17% from the record second quarter, but up 16% from a year ago and made up 37% of the total.

I remind everyone that when we refer to Europe on this call and in our public disclosures, it includes Western and Eastern Europe, the Middle East, Brazil, and other developing countries outside Asia.

Now, looking at slide 6, gross margins in the quarter were 47%, compared with 47.2% in the second quarter, and 44.4% a year ago. Compared with the second quarter, improved service margins and a small FX benefit from the stronger dollar offset us slightly less favorable product mix. Both product and service margins were up from a year ago and they were very similar to the second quarter.

For the fourth quarter, we expect our gross margin to be around 47%. As we have pointed out before, our gross margin is already up 900 basis points from 2008, given us confident that we can achieve our 50% goal by mid-2015.

Turning to slide 7, and moving down to income statement, operating expenses were $65.8 million, up less than 1% from the second quarter 2012. Operating expenses included $23.9 million, or 10.8% of sales for R&D as we continue to invest for growth in 2013 and beyond.

We are estimating total operating expenses to increase to approximately $69 million in the fourth quarter, exclusive of restructuring charges due to the full quarter impact of recent acquisitions. We are estimating restructuring cost of approximately $2 million in Q4.

Operating income for the quarter was $38.3 million, up 10% from last year’s third quarter and down only 2% from the second quarter of this year. Non-operating expenses were $1.8 million in the third quarter, compared to $1.3 million in the second quarter and $600,000 in last year’s third quarter. We expect non-operating expense to be around $1.5 million per quarter.

Our tax rate for the third quarter was 20.3% and we expect it to be approximately 20% in Q4. Net income was $29.2 million. EPS was $0.71 per diluted share above our guidance range and up 13% from last year’s third quarter. The weighted-average shares per diluted EPS in Q3 was $41.8 million, compared with $41.6 million in Q2 and $42 million in last year’s third quarter.

As you can see on slide 8, 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 including restricted cash and long-term investments was $359.8 million, down $60 million from the end of the second quarter.

Net cash after subtracting debt was $270.8 million or $7.11 per share. We used approximately $78 million in cash in the third quarter for two acquisitions and payment for our cross-licensing agreement, excluding those transactions, cash increased by $18 million. We also paid our first dividend in July, totaling $3 million.

Cash flow from operating activities was positive $16.2 million in the third quarter and $25.3 million so far this year. EBITDA was positive $45 million, equal to the second quarter and up 11% from the year-ago. Day sales outstanding were up modestly and inventory turnover was flat. Capital spending was $3.1 million and depreciation expense was $5.8 million.

If summary, revenues up sequentially in spite of or normal seasonal slow period, margins are solid and we generated substantial free cash flow, which we deploy to accelerate growth in margin improvement, investing acquisitions, and returned the portion to our shareholders.

With that, I’ll turn the call over to Don for comment about our markets and our outlook.

Dr. Don R. Kania

Thank you, Ray and good afternoon everyone. As Ray said, FEI had another good quarter in an uncertain macroeconomic environment, we continued to execute our strategy. We are growing our served available market organically via acquisitions and by expanding our geographic reach.

Orders were the highest total for any quarter in our history. Our geographic and market diversity continued to help us this quarter. Strong bookings in Europe offset sequential decline in North America and in Asia. Electronics and Material Science orders were up sequentially this quarter, offsetting a decline in Life Sciences and a small drop in Service.

Turning now to slide 9, we’ll review the bookings for the third quarter. The largest segment this quarter was Material Science, which set a record with $89.2 million in bookings, up 14% from the second quarter, and 18% from the third quarter last year. That growth was driven by a combination of our natural resources business, aspects, VSG, and strengthened Asia and Germany, offset by continued weakness in the United States in the traditional Material Science business.

We are expecting another strong quarter in Material Science bookings in quarter four. Booking for our Natural Resources business are up over 50% both for the third quarter and the year-to-date period. Orders have balanced between mining and oil and gas customers. We continue to learn the most effective applications for both our Laboratory and our WellSite products and helps to drive site-based adoption by the oil and gas industry.

We have additional mining products coming out in the next few months, which we believe will contribute to the rapid growth rate for this part of the business. Electronics bookings rebounded from a weak Q2 as forecasted, reaching $70.3 million. They were up 37% from Q2 and 74% from last year’s third quarter with strength from logic and foundry customers.

Our discussions with customers indicate that we should expect bookings to decrease in the fourth quarter, compared with the third quarter and last year’s fourth quarter. Longer-term, we expect to continue to increase our share of total industry spending as we see increasing demand for the applications that we serve. We expect continued variability on a quarterly basis as this business is a cyclical growth business.

We are being qualified to provide mission critical defect information in both memory and logic spaces, where our customers are raising one and other to bring 1x technology to the market. We are moving our Electronics business into what we have characterized as near-line applications. This provides the basis for continued above the industry average growth.

Life Sciences bookings of $15.5 million were down from a strong second quarter and the third quarter a year ago. As we have said before, we expect significant quarterly variability in Life Sciences, and we are expecting an increase in bookings in Q4.

Our pipeline at the end of Q3 is up significantly from the end of the second quarter. We have shown our two new correlative microscopy products to customers at recent trade shows and have a formal announcement plan for the ASCB show later this year. The reception has been very positive and we expect them to contribute to growth in 2013.

We received the major Titan Krios order this quarter from a new European Technology Institute that is also adding NMR and XRD tools. This is one more data point supporting our thesis that there is value in using these adjacent technologies with electron microscopy. We are also pleased by new publications from our customers on HIV, the chemistry of drug resistance and respiratory disease.

Third quarter bookings for Service and Components were down about 5% from second quarter, but up 8% from the prior year. Along with significant margin improvement, our service business continues its high single-digit growth rate and we expect that to continue into 2013.

Looking at geographic bookings on slide 10, Europe was strong this quarter with growth in Germany and Eastern Europe. Our total pipeline in Western and Eastern Europe is higher at the end of Q3 than it was at the end of Q2. We’re expecting sequential growth in bookings from Europe in the fourth quarter.

Bookings from Asia including Japan were down sequentially. In Japan, we recorded our second highest bookings quarter that’s only by the record set in the second quarter of this year. Business in China remains strong and our pipeline continues to grow. Orders in the United States were relatively weak, especially in Life Sciences and Material Science. Once again, we had more orders for science-based businesses from China than we had from the United States.

Geographic diversity remained strong with orders totaling more than $2 million or more from 15 different countries in the quarter. We continue to invest in expanding our geographic reach. We have opened sales and service offices in Dubai and Rio De Janeiro. This will reflects our belief in the ongoing potential of the markets in the Middle East and South America and are desire to tighten our connections with the customers in those regions.

Looking at Q4, we expect the U.S. and Europe to show sequential growth in the fourth quarter as our total pipeline is grown. We are trying to the prudent in assessing the trade-offs between traditional Q4 budget flush and the potential impact of the uncertainty due to possible U.S. sequestration in the New Year.

Slide 11 is a summary of our guidance for the fourth quarter of 2012. We expect revenue to be in the range from $223 million to $233 million. Bookings are expected to be at least $225 million. GAAP earnings per share expected to be in the range of $0.64 to $0.72, which includes restructuring cost estimated at $0.04 per share. If our fourth quarter revenue is within our guidance range, we have revenue growth for the full year of 7% to 8%, consistent with our earlier estimate of full-year revenue growth in the 6% to 9% range. Included in that target is the expectation that acquisitions will contribute approximately 4% and foreign exchange will reduce the revenue by approximately 3%.

Looking out over the next couple of quarters, in our Q4 guidance we believe we have taken a prudent perspective on the potential for year-end budget plus the Material Science and Life Sciences against the cyclical weakness in Electronics.

As we have commented in the past, our major electronics customers may delay investments for up to a few quarters, but the trend towards more complex and smaller nodes increases the demand for our tools over time. The trend is our client. Life Science remains volatile, but the increased pipeline in compelling new and existing products gives us confidence about the long-term growth. We expect to exit this year with a very strong finish.

Material science core will remain resilient when viewed on a global basis. The natural resource opportunity is real, and we expect the business will continue to grow. Our new acquisitions are beginning to benefit from being part of FEI and it’s expanding global sales and service organization.

Our Service remains at stable and growing profit centre for the company. I would also point out, the key parts of our growth strategy of our penetration to existing markets with new and innovative products and software. We are less dependent on overall market growth than we otherwise would be. I’m proud of the entire FEI team that has delivered the strong results. At all levels, we continue to grow with these new challenge.

With that operator, we are ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instruction) And our first question is from the line of Zach Larkin with Stephens. Please go ahead.

Zach Larkin – Stephens Inc.

Hey, good afternoon, gentlemen, congratulation on another great quarter.

Dr. Don R. Kania

Thank you, Zach.

Zach Larkin – Stephens Inc.

Hey, Don, I wondered if you could first talk a little bit about, more about the natural resources opportunity, I appreciated the color on the bookings. But I was wondering if there is any updates on, specifically the oil and gas opportunity and any of the negotiations going on with the large oil service firms and when we might have a little more clarity on the economic model there?

Dr. Don R. Kania

Yeah. I think we’re at the point now where we are in negotiations and they are taking a bit longer than we would like them too. But we’re learning the process of how you have to see a customer demand have that flow through to service providers and then have them close on our side. We have multiple negotiations in process right now.

And I think by the first quarter of next year when we come back with the fourth quarter results, I thinking we’ll be able to talk more quantitatively about those specific contracts at this point. So right now, this is really not a lot that we can highlight since we’re in negotiation. I’m pleased with the pipeline, the number of contract negotiations that are going on. I’m pleased with the customers that were talking with and it’s just taken a little longer than we’d like.

Zach Larkin – Stephens Inc.

Okay, thanks for that. And then you talked about some of the new products that you are looking at to further penetrate existing and target new opportunities as well. What are the biggest R&D initiatives are focuses that you’re back going on right now?

Dr. Don R. Kania

Particularly in the natural resources space or overall?

Zach Larkin – Stephens Inc.

Just broadly what’s the areas that are particularly most focused with what you’re seeing done?

Dr. Don R. Kania

Yeah, and I think in terms of this maybe I’ll reflect on what products you might be seeing over the next year or so is maybe a better way to think about it. We’ll have some products in the Lice Sciences segment. We talked about the optical and the electron products that are combined together with correlative microscopy. They were a lot this quarter.

I won’t be specific within the year, next year, but we will have some new TM products, which serve multiple marketplaces. We’ll continue to rollout, in fact this last quarter we rolled out another generation of DualBeam tools for the semiconductor industry both the small sample and large sample. You should continue to see that evolution driving forward.

And then in the natural resources space, we will take the technology that were pitching to our friends in oil and gas to the mines, where we also see compelling economic models that can drive adoption as well. So we have a parallel path there with both laboratory and size both on the mine side and on the oil and gas side.

Zach Larkin – Stephens Inc.

Thanks very much. Congrats again on a great quarter.

Dr. Don R. Kania

Thank you, sir.

Operator

Thank you. Our next question is from the line of Bill Ong with B. Riley & Company. Please go ahead.

Bill Ong – B. Riley & Company, Inc.

Good afternoon, gentlemen. Congratulations on another solid quarter and just great execution all year long.

Dr. Don R. Kania

Thank you, Bill.

Bill Ong – B. Riley & Company, Inc.

Now also move with revenue (inaudible) replacement cycle for electron microscope 2.5 to 3 years with each (inaudible) no change. Now that the Life Sciences business is about six to seven years old, this year’s replacement cycle pattern for Life Sciences and for that matter, any replacement cycle patterns for the industrial segment as well?

Dr. Don R. Kania

Okay, so we talk about replacement patterns. I’ll do my best to keep up with you and you push back wherever answers your question. In the Electronics segment, I think you spot on it, sort of a three-year replacement cycle. And I think the upside on that from the perspective of driving the business is getting pulled more and more, not just into process development, but also we’re seeing a more substantive pull into the defect space, which we see is an upside on current activity.

If we look at the Life Sciences space, I still think we’re in a cycle of innovation, so it’s going to be new things that drive the market not so much replacement, especially when we are trying to assess new customers. So I think that’s more about how quickly we can get those customers that either on the optical space to buy more electrons, which are correlated products or the NMR, XRD people with the Krios class products providing that capability.

And if we go to Material Science, I think we’re still on a relatively long scale there. The New World is about new acquisition, more or so than upgrades. And that is, places like China, Eastern Europe, Middle East, and South America will be a big kick around that. But we sort of talk about at seven-year cycle on that give or take a little bit. And natural resources, it’s all new to us, so I don’t think we are going to see a lot of refresh in that space. Does that answer the question?

Bill Ong – B. Riley & Company, Inc.

Yes, that’s quite helpful. And then my last question is, given the natural gas prices at near multi-year lows, and it seems that it’s just slowing down for electron microscopy because of that?

Dr. Don R. Kania

No, actually I think not, and I think the drive here is an economic one. The part of the reason that exploration has slowed some isn’t, right, the prices are depressed. But I think what all the oil companies see is the tremendous opportunity in both the oil part, the natural gas part to get a tremendous economic return. And where we intersect with this space is the ability to make the process of extraction less expensive.

And so I think we fall in line either with either side of this coin that is the exploitation of oil, which is still very economic, right, or the so-called fluids that come with it. And then on the natural gas side if you can make the wells more economic that is improved strategies for extraction, because you understand the rocks better and that just speeds into lowering the price point for making money on a given well. So we feel like the pull is strong, people want to understand the rocks better, it’s the wild west, because not much as known, and I think the opportunities continues to be tremendous for us.

Bill Ong – B. Riley & Company, Inc.

Okay. Thanks for the insight and nice job again.

Dr. Don R. Kania

Thank you, Bill. Sorry about the hankies. We should be sorry about the tiger.

Bill Ong – B. Riley & Company, Inc.

Yeah.

Operator

Thank you. Our next question is from the line of Joe Maxa with Dougherty & Company. Please go ahead.

Joe Maxa – Dougherty & Company LLC

Well, thank you. Don, you touched a little bit on beyond Q4 that’s helpful. Can you give us a little more color on what you may see in seasonality, core products or core business, but also the acquisitions, and how we should be thinking about as it relates to Q1?

Dr. Don R. Kania

Yeah, we’re not going to make any calls specifically on the quarter. But I would say overall is one shouldn’t expect the seasonality of FEI to shift in the meaningful way because of the acquisitions. And so for we continue to view as the strong quarter, three occasionally challenged though the team did a really great job in this Q3, because many of you who follow us understand that Q3 is a challenged quarter for us.

So I would say don’t expect any major changes X-macro issues, but who knows what that will be. We feel that again our theory geographic diversity, market diversity leading and we have best stuff is going to give us resilient to that or what happens and tremendous upside if we start to turn any real quarters particularly in the U.S.

Joseph A. Maxa – Dougherty & Company LLC

And then I find you hit again on the bookings expectations for the fourth quarter, where you see in the strength of the same place of the third quarter or will you see in that pickup in others?

Dr. Don R. Kania

I think, yeah, our call is electronic, so it will be softer in for, that wasn’t true, and that’s just based on our interactions with customers. And I think everyone else we expect some modest uptick and probably a strong uptick in Life Sciences and that’s the granularity of large systems orders and a relatively modest business right now.

Joseph A. Maxa – Dougherty & Company LLC

Very good; thank you.

Operator

Thank you. Our next question is from the line of Tycho Peterson with JPMorgan. Please go ahead.

Tycho Peterson – JPMorgan

Hey, thanks for taking my question. Maybe just a follow-up in that last break-down for the electrons business obviously good book-to-bill this quarter, it sounds like it will slow little bit in the near-term. I mean we’re seeing some cautious commentary and now telegraphing of cost cutting by some of the semi-companies obviously the trends as you’ll find in long-term things going to be fine. But do you think that there could be a couple of quarters of dislocation here and some of that is dial back, the CapEx?

Dr. Don R. Kania

Yeah, I think our thesis remains unchanged that we will find a quarter or two, where life is little soft, not disasters. But when we talked to our customers about the need over let’s say three, four quarter period as they drive to another node, we’re very confident that the business will continue to grow.

And I’m not trying to give that, we have any visibility into the one or two any detail right. It’s really just watching the customers understanding what they’re pushing around in response to their near-term market need. So you see the capacity players they can applied in KLA. They’ll have a very different response to this environment than FEI will.

Tycho Peterson – JPMorgan

Okay. And then in Life Sciences, can you talk a little bit about how you are thinking about the correlative microscopy products, it sounds like you could get a little bit contribution in the fourth quarter from those, and how do you think about the rollout?

Dr. Don R. Kania

Yeah, I don’t think we’ll see much in for, we’ll really roll on the product, there we might see some orders or limited, I’m not sure what were taken in terms of slots. But that takes a little time to build momentum. We still are relatively expensive tool, so the bicycles have, some period of months built into them some people to get their orders in place and follow their procedures. But we see the upside is meaningful and it’s strictly complementary to the structural biology activity with the Krios class product.

So we think 2013 could be a very good year for these products. And just by way of reminder, there essentially a combination of some of the film technology in existing FEI platform. So they are not major new platform investments from that perspective, so we feel confidence, the robust and ready for primetime. And the customer, I’m really pleased with the customer feedback when we did informal shows that rollout at a couple of shows that we show people how the product look like and there was a tremendous amount of interest, it looks like we hit in that sweet spot in the demand in this correlated space.

Tycho Peterson – JPMorgan

Okay. And then just one last one on the macro, I mean in Europe obviously bookings were strong, just talk your visibility and how sustainably you think some of those trends are?

Dr. Don R. Kania

Yeah, what we commented on, we tried to comment a little bit on this, talk about our pipeline, because for us that’s the best leading indicator. And even though we had a strong quarter in Europe, the pipeline is still continued to grow. So Europe again, when we do Europe, it includes Europe as everybody would describe, but we said right out Eastern Europe and then it does include some of the high growth regions flow through there just because of the way we’ve reported to the Middle East, South America, flown through that.

So we think it’s pretty robust going into the New Year. Obviously, South remains weak, but we would call Northern Europe is okay, and Eastern Europe continues to be strong. And I think with the, the office opening in Brazil is the real indication of our belief and we’ve already seen some good flow of business out of that region, so geographic diversity is the strength, particularly in these times.

Tycho Peterson – JPMorgan

Great. Thank you.

Operator

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

Mark Miller – Noble Financial Capital Markets

Congratulations on your quarter. I just want to explore a little bit more on the electronic softness, which you said to the extent for a couple of quarters. I’m just wondering how sense of your, because the projections I’ve been saying for new fab construction and new construction products are down significantly next year. I’m just wondering how that affects you versus just it could be in the new nodes and existing trends?

Dr. Don R. Kania

Yeah, Mark, we are down by new nodes. The new fab construction is a good thing and that’s part of the game, but predominately to have the capacity to either develop or execute and particularly anything associated with 1X puts a strong demand on FEI equipment, in a growing demand relative to previous node. So again, our thoughts are they can shift around a little bit, but unless the industry, the big players, the obvious big players in the industry give up on the shrink model, until that happens, FEI is going to be in good step.

Mark Miller – Noble Financial Capital Markets

It’s my next question. As you know, there has been a lot of promotion or a lot of concern, we’ve seen a lot of money going into ASML, which bought Cymer. To me that’s maximum concern that and you will be lithography certainly facing challenges, and that would be for the 14 nanometer node. I’m just wondering if that would get delayed, what type of impact would that have on you?

Raymond A. Link

So I think there is two sides of that question, one is the, you believe it will get delayed even if EUV comes up shorter. And I would argue probably not. I feel just do it another way and spend more money on developing multiple pattering approaches that can be robust enough for the critical layers. I think the economics is too compelling to be a slave to the technology. I do agree with you though that, the companies have identified risk on EUV coming online and whether it’s at 14 or 10. I think it’s still open. I think 14 happens no matter what happens to EUV. So within the window of visibility, of this class of discussion, I think we are in good shape.

Mark Miller – Noble Financial Capital Markets

And just two questions. First of all, I missed how much the new acquisitions impacted your sales last quarter?

Dr. Don R. Kania

Last quarter, Mark, it was about $3.4 million.

Mark Miller – Noble Financial Capital Markets

Okay.

Dr. Don R. Kania

But we say new acquisition next time we are talking about the right thing in the third quarter.

Mark Miller – Noble Financial Capital Markets

Okay. And I’m sorry, was again, what was the figure?

Dr. Don R. Kania

$3.4 million approximately and that’s the two that we completed in the quarter. We only had partial quarter benefit from them.

Mark Miller – Noble Financial Capital Markets

And then again…

Dr. Don R. Kania

Sorry, go ahead, Mark.

Mark Miller – Noble Financial Capital Markets

China, what’s your feeling there? That seems, it’s still be hanging in there for you guys. You haven’t seen any slowing, or what’s your feeling you are getting from China?

Raymond A. Link

We love China and it’s robust and we expect it to continue to be a source of strength for the company. Remember most of our customers in China are on the science-based side. Those are funded predominantly out of the government to take a long view and they will continue the investment. And that happened during the great recession and we have no expectation that minor changes in the growth rate will affect their investment in scientific infrastructure.

Mark Miller – Noble Financial Capital Markets

Thank you.

Dr. Don R. Kania

Mark, and correct, reading by writing better, a $3.9 million, that $3.4 million.

Mark Miller – Noble Financial Capital Markets

Okay. Thank you, Ray.

Operator

Thank you. Our next question is from the line of Patrick Ho with Stifel Nicolaus. Please go ahead

Patrick Ho – Stifel Nicolaus & Company, Inc.

Thank you very much. Don, maybe first for you in terms of the semiconductor capital equipment business and I know, I think we’ve both seen how volatile that can be. But our longer-term trend has been that we reuse of tools particularly on the manufacturing side of things given that you are not directly on the manufacturing like how much of reuse do you see that ship makers using for your types of tools, particularly in the process development side of things?

Dr. Don R. Kania

Reuse is going to be small to non-existent. The reason I have to upgrade the tools is that meets the precision and accuracy requirements of the smaller nodes, we have to reengineer the equipment to achieve higher levels of performance. We do offer upgrades occasionally, so there is really, we give the customer two steps usually, if you buy the tool, there is an upgrade path then you get, buy a new tool. And we’ve had that in place for about a cycle unchanged right now. And we believe that model will continue.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Okay, great.

Dr. Don R. Kania

Minimal for us.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. That’s really helpful on that end. Ray, a question in terms of the margins I was look forward particularly for 2013 in you path 250% gross margins, (inaudible) at this time the margin improvements, excluding any, I guess in the macro economy if things continue to come back, that’s the biggest variable for you guys internally?

Raymond A. Link

Yeah, overall margins, the two variables that matter the most in the short-term are product mix and currency. And product mix is dominated by how much we have on higher-end tools, particularly our DualBeam products and our higher-end TDMs that traditionally have better margins. Although we’re seeing great margin in our natural resources products, which are more midrange price products.

In terms of things that are controllable by us clearly more operations improvement and we have a number of items that we are tracking and working on that. Each one is relatively small, but collectively will get us to our long-term targets of 50% by mid-2015. New products are also a key element to that end. Don covered the number of the items in R&D and new products that we are looking at introducing over the next 6 to 12 months and new products generally have pretty favorable margins.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great. And I guess maybe just as a follow-up to that, do you believe you’ve done the majority of the work I guess on the manufacturing side of things, or supply chain that you mentioned is product mix comparables on a gold?

Raymond A. Link

As much as our ops people have done a good job, there is still lots of room for improvement in supply chain, a lots of room for benefit, when we look at out total COGS purchased components are 75% of our total COGS. So that’s the area of focus. We are pretty much more of an integrator. We design a lot of this component. Other people may come to our factory, we bolt them together at software tested et cetera. So if we really want to improve margins long-term, it really is a new product COGS redesign and working supply chain.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Okay great. Maybe a final question for you Don in terms of some of the new markets that you guys or maybe not new markets, but some of the new products that you mentioned that you’re introducing for some other marketplaces. How much are you able to leverage from I guess existing technology that you have in-house, because it sounds like a lot of the stuff that you guys have are in developed with the well side technology that something that can be very applicable to mining. How much are you doing that for some of the other products and other marketplaces within the company?

Dr. Don R. Kania

In other example would be the aspect product, which we purchased. How long it’s – Ray?

Raymond A. Link

January.

Dr. Don R. Kania

Yeah, January. Obviously it’s part of the platform for national resource business but also it’s a heck of a standalone SEM for industrial applications. And so that’s our thesis is reuse, reuse, reuse, repackage for new markets. So Life Sciences products are very similar to the products we sell to the Material Science customers except the cryogenics that we had on to it.

And it makes it also possible for us to expand our product offerings and from a price point performance, price point perspective relatively easily. So we like the model and we’ll see. I don’t want to comment too much further on the details of 13 product lines. But I think we have some very exciting product lines for 13.

Patrick Ho – Stifel Nicolaus & Company, Inc.

Great, thanks a lot guys.

Operator

Thank you. Our next question is from the line of David Duley with Steelhead Securities. Please go ahead.

David Duley – Steelhead Securities

Thanks for taking my question and nice quarter. Just a couple of questions from me, Ray, could you talk about I think you mentioned the increase in operating expense just a little bit more color is that I think you said $69 million is that a permanent increase or what we should expect going forward?

Raymond A. Link

Yeah, you should think of the $69 million as sort of the run rate that we’re going to be at plus or minus currency and a few other items. But the main difference on the ramp is we did two acquisitions in the quarter, we only had a partial COGS, should be partial OpEx and both of those when we roll that in and also roll in hopefully somewhere incremental sale, which will have more selling commissions et cetera. It gets up to the $69 million run rate.

David Duley – Steelhead Securities

Most of that increased than sequentially is from having the full quarter of the acquisitions?

Raymond A. Link

That’s the biggest component, but there is some incremental spend in selling in a little incremental spend in R&D. The third quarter is generally a good quarter for us in an OpEx standpoint and to tough quarter from revenue, although we did post record revenue. But we have a little bit more OpEx in the fourth quarter than we do on the third quarter just naturally, now too far on vacations they’re not traveling and we’re not using consultant et cetera.

David Duley – Steelhead Securities

Okay. And then when you step back and look at the electronics business, Don, do you have an idea about how much your TEM is increasing and as I guess go to these new line applications and I guess that’s related with going from 28 nanometer to 14 nanometer, how are we would like to characterize. Can you help us understand how much bigger your market is?

Dr. Don R. Kania

We get that question we constantly referred back to the last cycle, which we grew by 30% from cycle-to-cycle. It’s probably not that aggressive going forward, but it’s certainly a double-digit potential for growth and revenues, which we highlighted at the Investor Day class activity. So the market I think is up to a couple hundred million new stuff that will access over the next years and that’s meaningful to business right now is run rate just under $300 million. So we feel quite excited about the business.

David Duley – Steelhead Securities

Okay. And you mentioned the growth in the pipeline in Europe. I was just curious, what the key driver of that? Is that just macroeconomic conditions are getting better or this is specific to FEI product lines?

Dr. Don R. Kania

I thought of its macro getting better. I think remember we tried the highlight the geographic diversity component of that reporting segment, but so those have South America, and those have Middle East, those have Eastern Europe. But also there was a France recently for example reemphasized its continuing investment in university infrastructure, those facts if we look specifically at the pipeline, France is growing pretty significantly in the past quarter, because lot of that money is now coming from look like it’s real, and so it moved into our further up our pipeline.

So we have pockets of continued investments, I think generally the U.S. has the dimmest view on investing for the long-term in scientific infrastructure right now, and the rest of the world to bit more robust, so we’re going to be a beneficiaries of that. And probably less affected by – its the frustration becomes the disaster, which I don’t expect it to the effect on FEI won’t be as pronounce it will be others who have had probably a little better market presence in the U.S., in the past year or so.

We’ve always commented it’s been very weak in the U.S. And I think it will go out almost two years now. It’s just been in tough marketplace. It’s just in the other large CapEx items in the U.S. I have not been well funded. So the rest of the world seems to be much, much more able to or as wherewithal to make those investments.

David Duley – Steelhead Securities

Okay. Final question from me is for the electronics revenue or the electronics booking, however, you can characterize it. Could you talk a little bit about which end markets were strong, was it memory or logic or foundry or anything along those lines?

Dr. Don R. Kania

In this last quarter?

David Duley – Steelhead Securities

Yeah.

Raymond A. Link

Yeah, I think logic was pretty strong as last quarter that’s probably the one.

Dr. Don R. Kania

And some foundry.

Raymond A. Link

Okay.

David Duley – Steelhead Securities

Okay. Thanks and nice quarter.

Dr. Don R. Kania

Thank you again.

Operator

Thank you. Our next question is from the line of Derik De Bruin with Bank of America. Please go ahead.

Derik De Bruin – Bank of America/Merrill Lynch

Hi, good afternoon.

Dr. Don R. Kania

Hi.

Derik De Bruin – Bank of America/Merrill Lynch

Hey, the revenue guidance for Q4, the $223 million of the $233 million, what’s the high-end and low-end, what’s the delta, we look at that?

Raymond A. Link

While we typically need $10 million range…

Derik De Bruin – Bank of America/Merrill Lynch

No, what happens to get you the low-end, what happens to get you towards the higher-end of range? Just want to know what’s rebuild? And then you talked about how much of the budget flush that you need to see? What you need to see? I’m just curious in terms of what’s built into your guidance?

Raymond A. Link

I’ll start maybe in real fashion. The budget flush is really in referencing the order flow, not really the revenue flow.

Derik De Bruin – Bank of America/Merrill Lynch

Got it, okay.

Raymond A. Link

So that was really around that. And then as we typically report it, we usually use the $10 million range. It’s always we will ship a lot of big systems in the quarter as you know we missed one or two, you guys are be really unhappy with us and we would be unhappy with ourselves. But there is always that risk that comes into a quarters and that’s set the range overall, so I think that’s the source of the guidance overall.

Dr. Don R. Kania

It really goes down to revenue recognition sooner than larger systems. And to some degree, we don’t have full control over those because can be revenue upon acceptance for the customer, revenue upon delivery to the customers site, things get hung up in custom. So we need to build in about a 5% buffer of the gold. So to get to the $233 million, everything flows nicely. Things go to the factory. We recognize revenue and things get under $223 million, what the best happened where we didn’t get revenue. So we have the orders we have the backlog in that really the question is just getting setup factory and also getting that recorded as revenue.

Derik De Bruin – Bank of America/Merrill Lynch

Great, that’s exactly I was look for. On the gross margin for Q4, the 47% numbers, it’s a little bit lower than the 47.5% you’re targeting, I assume that’s more FX and mix and some of that M&A you just recently did more sort of at the NOLs?

Raymond A. Link

Yeah, two comments. Number one, we haven’t given specific guidance, we just said around 47%. And number two, yes, all those comments you may do have effect on gross margin.

Derik De Bruin – Bank of America/Merrill Lynch

Great. And just finally this full year for the M&A impact on revenue percentage wise?

Dr. Don R. Kania

So far this year?

Derik De Bruin – Bank of America/Merrill Lynch

Yeah, just all and what you’re looking for the full-year guidance, what’s embedded for M&A for the full-year guidance?

Raymond A. Link

Yeah, so give me a moment here, we have that. So our full-year, we expect acquisitions 4%, foreign exchange minus 3, overall 6% to 9%.

Derik De Bruin – Bank of America/Merrill Lynch

Right, great. Great, thanks a lot.

Operator

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

Thomas Diffely – D. A. Davidson & Co.

Yeah, good afternoon. So Don, specifically you mentioned Germany has been, some strength in Europe. But I was curious, would you characterize that German business has, you have normal business there whether any kind of one timers or large chunks of business that came through that may not repeat?

Dr. Don R. Kania

I think the way to characterize Germany has been a strong investor and it has been over several years. In fact, it’s been one of the top five buyers of our equipment for that kind of period of time. So something they do and they’ve been doing and there is no doubt, one of the strong economies of Europe and we feel good about the future and the past has been strong.

Thomas Diffely – D. A. Davidson & Co.

Okay. So no indications, any kind of macro concern there outside of just, what they have been living under for the last couple of years?

Dr. Don R. Kania

I think for everybody’s interest. The macro concern for us is predominantly by the U.S.

Thomas Diffely – D. A. Davidson & Co.

Okay.

Dr. Don R. Kania

And again our argument has been, the U.S. has been relatively weak, so the downside though would be meaningful, it’s not critical…

Thomas Diffely – D. A. Davidson & Co.

Yeah.

Dr. Don R. Kania

…to the future. And Europe seems with the balance of all the different sub segments that we describe, it’s going to be okay, that’s our point of view.

Thomas Diffely – D. A. Davidson & Co.

Okay. That sounds good. And also you’re talking more about the zero line applications, is there a specific process or insertion point for the near line, meaning there after a certain process and that you are making steps or I mean or is it just kind of a general as we move down the nodes we need more information about all the processes, right?

Dr. Don R. Kania

There is a hierarchy of process steps and I couldn’t rail that off the cuff right now. But if you go back to our Investor Day when Rudy talked about the business, he showed a chart which referred to when certain process steps become more relevant to what we do versus say, top down some or other approaches to it. So there is a cascade in fact, as you continue to shrink that more processes fall into the FEI camp versus the old way camp and that progresses over time, which is again comes back to why we think our cyclical growth business in this segment.

Thomas Diffely – D. A. Davidson & Co.

Okay, I just say simple as when we move to a 3D transistor out there, we need this type of technology going on?

Dr. Don R. Kania

I wish the world were so simple, and although 3D transistors are one of the ones on Moody’s chart that is in the TEM category.

Raymond A. Link

Yeah.

Thomas Diffely – D. A. Davidson & Co.

Okay. And then Ray, maybe you could give us a little information about what the actual FX impact on the margins was in the current quarter and whether that stable FX is required to get to your 50% in the year and half?

Raymond A. Link

The impact on FX is almost de minimis in the quarter. It was very small. The average rate was actually favorable meaning this dollar was a little bit stronger. But we shipped more in the third month of the quarter, so the effective rate was almost unchanged, a very small impact on FX.

Thomas Diffely – D. A. Davidson & Co.

Okay.

Raymond A. Link

And for our long-term targets, we believe in pretty clear on that stable OpEx rate that is assumed in that which is obviously not what’s going to happen. But we need to have rates somewhere in the general range that we’re talking about, the 130, 135 would be something beneficial to FEI.

Thomas Diffely – D. A. Davidson & Co.

Okay, all right. Thank you.

Operator

Thank you. (Operator Instructions) Our next question is a follow-up question from the line of Mark Miller with Noble Financial Capital Markets. Please go ahead.

Mark Miller – Noble Financial Capital Markets

Yeah, I think you mentioned in Europe, you’ve got a significant I thought it was from a single customer for tightened NMR and XRD. I’m just wondering if that was the case, what percent of total European orders that does represent?

Raymond A. Link

It was this many million, we’re flashing fingers at each other, it’s under 10%. Yeah.

Mark Miller – Noble Financial Capital Markets

It’s under 10% or $10 million, I’m sorry.

Raymond A. Link

We have under 10% of the European orders like.

Mark Miller – Noble Financial Capital Markets

Okay, thank you.

Raymond A. Link

Okay.

Dr. Don R. Kania

This will be a clear Mark too that we didn’t by NMR actually from us, they’ve got somebody else. We just sold them Titan Krios.

Raymond A. Link

We sold the electron microscope NMR, XRD and from other suppliers.

Dr. Don R. Kania

And they did buy within that order, can’t think it was couple of other tool, so it was 3/12 order.

Mark Miller – Noble Financial Capital Markets

Okay.

Operator

Thank you. There are no further questions at this time. I would like to pass the call back to management for closing remarks.

Dr. Don R. Kania

Thank you very much everyone. We appreciate your interest we hope you have a safe and happy Halloween and market is not too smoothie when they open tomorrow morning. Thanks very much.

Operator

Thank you. Ladies and gentlemen, this does conclude the FEI third quarter earnings conference call. We would like to thank you thank you for your participation. You may now disconnect.

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