FEI Company's Management Presents at NASDAQ OMX 29th Investor Program Conference (Transcript)

| About: FEI Company (FEIC)
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FEI Company (NASDAQ:FEIC) NASDAQ OMX 29th Investor Program Conference December 4, 2012 5:45 AM ET


Raymond A. Link - EVP and CFO


Unidentified Analyst

Thank you. The next company presenting is FEI, a leading diversified scientific instruments company and a premier provider of electron and ion-beam microscopes and solutions. Presenting for us today is the company’s Executive Vice President and Chief Financial Officer, Raymond Link. Ray?

Raymond A. Link

Thank you, Marian and thank you all for attending. Like everyone else, I will spend a moment on our Safe Harbor statement. I’d like to encourage everyone to read our SEC filings. We will be making a number of forward-looking statements today. So please take a look at the filings and read our Safe Harbor statement.

So who or what is FEI? FEI is a nanoscale imaging Company that uses both electron and ion-beam microscopy as our core technology. Fundamentally our products fall into three main categories, Transmission Electron Microscopes where we have the world’s leading tool called Titan that can see down to the dark spaces between the atoms. Scanning Electron Microscopes where we have a broad range of product offerings and DualBeams systems that include both a focused ion-beam to enable you to manipulate, thin down, add materials whatever to your sample and then also look at it with a scanning electron beam.

As a Company we take our core technology and leverage it through a work flow solutions to provide our customers with an easier way to handle their samples and then more important to actually get the data that they desire seamlessly. So it’s really all about a work flow solution. This is what really differentiates FEI from its competitors where we spend an enormous amount of our R&D effort on the front-end and the back-end, everything in the middle the tool itself is something that is a relatively stable platform and where you get additional value from both the customers and from a profitability standpoint is making it easier to use and given them the answers to the problems that they’re looking to solve.

Our investment thesis is fairly straightforward. Our goal is to double our served available market over the next five years. We have technological leadership; we’re adding work flow solutions to that. We deal in a diversified end markets and as well as diversified economies, we have a specific goal to further enhance our sales channel and efforts into the emerging markets that have been a very large growth driver for the Company over the past few years. We’ve used our cash, we believe wisely, we’re fairly large generator of free cash flow on annual basis. We’ve done four acquisitions in the past year, primarily tuck-in investments to further leverage our growth opportunities. We’ve done some share buybacks and have a share buyback program in place and we initiated dividend about six months ago.

Our growth on a long-term basis measured over the past dozen or so years has a compound growth rate of around 12%, I think its as what is our future rate going to be and I just like to point you our past where we’ve been fairly consistent year-over-year with good growth, even during the huge downturn in 2008 to 2009, FEI’s revenue only dropped 3.6% and we actually had slightly more operating profit in ’09 versus ’08, so we’ve been able to weather the storms.

We sell into a number of end markets and we’re fairly well diversified. The electronics market space represents roughly a third of our revenue and in that space, it’s principally to semiconductor companies. We’re in the semiconductor lab as oppose to the fabs, so we really don’t have much to do with capacity issues that all has to do with developing of next generation semiconductor chips. We do have a very small portion of our business to data storage, the fellows from Seagate were here just before, FEI was presenting today and that’s a very small part of our business and that is actually a production related tool that we sell with the vast, vast majority we sell into electronics is in the semiconductor lab.

Material science is kind of the core base of our business and that’s where most all companies that make electron microscopes compete and also where we as a Company started with some of our risk way back. That’s basically sell into college and universities and national lab is very much of a global sale and I will talk more about where we get our revenues on that. Embedded in the material science numbers is an emerging opportunity for FEI, which is a natural resources, it’s still a relatively small percent of our revenue. But we believe it has a lot of legs and it could be a big growth driver both into revenue and into profitability.

Life science is a relatively new market for FEI. We started in earnest on this about six years ago. It’s currently approximately $100 million of revenue for the Company. It’s an area of significant growth. I will talk more about this in a few more slides, but its an area where historically -researchers were not using our type of tools and the switch has taken place over the past couple of years and we’ve done a couple of things to accelerate that where we believe our growth and profitability will continue to move forward.

Service and components is a great business. It’s essentially post sale warranty and aftermarket support, parts and brake fix type business for the Company. As a CFO I love the Company because I know starting the quarter, we have almost $50 million in backlog, it’s a recurrent revenue, its not a high gross profit margin, but it’s a very high operating profit margin business because we invest no R&D and that essentially we have a no sales cost associated with that because its generally sold as part of the tool and we have the initial sale and in cases where that’s not the situation, usually we get a service contract once the initial 12-month warranty expires.

We are a well balanced geography. We – at one point of time we’re about a third, third, third, but with the growth in developing areas particularly in China and in India we’re seeing our rest of the world, part of our pie continued to grow approximately 40% of our revenue is in Asia and developing areas, Europe and U.S. are approximately about 30% each.

As I mentioned earlier, growth is for the company comes from a number of areas, but emerging markets have been just fantastic for FEI. We made significant investments over the past several years to improve our sales and service support in developing regions, particularly in China and it’s really paid off well. Right now China spends more money at FEI than the U.S. spends FEI for the material science portion of our business. So the fundamental colleges and university build out of the educational infrastructure, we see that very, very strong in China and that is now our number one market for those particular type of tools.

We see developing emerging regions being at over 30% of our revenue in the out years, it was 45% in 2011, up from 36% in 2005. So significant opportunities for the Company, we continue to expand there, we’ve opened up offices in Brazil and in the Middle East in the past year and we’ll be looking for further opportunities for that in India in the future.

Our strategy as I said earlier is to double our served available markets. So when we look at the overall market, the total TEM in nanoscale imaging is somewhere around about $8 billion. When you break it down in terms of how much is spent in electron microscopy, it’s about $2 billion, $2.4 billion currently. We see the ability for FEI to double that SAM by adding features to our tools, adding software where we can take more of the share of spend in the overall nanoscale imaging. Take it from adjacent technologies, into our type of technology. The areas of biggest growth at the very bottom of this slide you can see that the Life Science is the area we think will grow the largest, we’ve introduced couple of new products recently, which I will talk about in a few more slides.

And the other area of significant growth is natural resources, which is the second part of the bar from the top, very small in 2011. We did about $29 million in revenue last year and that 2010 we did $10 million of revenue, we’re projecting that to be somewhere north of 30%, growth rate on a go forward basis. So we see significant opportunities in both mining and in Oil & Gas.

So taking a look at the end markets we’ll start with our research market which is our core piece of our business, roughly about a third of our revenue on any given year. It is once again sales of tools to colleges and universities and national labs, its very much a global spend and this is really been an area where there’s been confusion by the investment community, because there’s almost always a bare case that well spending is going to be bad with NIH in the U.S. and Europe is tough shape, so they’re not going to spend. So therefore the conclusion is that this is going to be a down business for FEI. And that was very much the mood of investors in 2011. In fact, this part of our business grew by $90 million in 2011 versus 2010. It was the largest portion of growth in absolute dollars from the Company between 2011 and 2010. Where we see growth again is in developing areas. The U.S. clearly is going to be weak. No one knows what’s going to happen in Washington on a day-to-day basis. Europe, Europe isn’t as bad as people think. We see growth opportunities particularly in Eastern Europe, we’re getting orders from Romania, from Poland, from the Czech Republic, even at Western Europe, Germany has been relatively strong for the Company. We’ve even had sales in the past six months in Spain where they have actually already paid for it. So it’s not as bleak as people may think.

The rest of the world particularly China, developing areas continue to be very, very strong for the Company. So while we’re not making a call yet on 2013, our view overall on the research space is clearly more optimistic than most people would think. We have a few initiatives as well to introduce some new products mid-year 2013, most of those have to do with more simplification of the product portfolio, a reduction of our cost of goods sold, so it’s an area for margin improvement for the Company over the next couple of years.

The new frontier is Dynamic Microscopy adding time, the fourth to mention, so people want to know time development as part of the resolution of the sample that they’re looking at, we introduced a new product relatively – recently that will help researchers do that. As I said, embedded in the material science segment is our Natural Resource’s offering. And when we look at this we’re extremely enthusiastic about the opportunity for FEI in this space. It was largely a space that we had limited sales to kind of a one-off situation, excuse me – historically and now when we look at the market, we see an opportunity for $500 million SAM by 2015. And if we break it into three different buckets, mining is the area that we have most of our current revenue associated in the space.

We have a product called an MLA, Mineral Liberation Analyzer that we sell to mining companies it’s used at their central labs. It does essentially two things. You take samples from the field, bring it to the lab, run it through our tool, it will tell them whether or not the elements that they’re looking for is in the sample, it is gold, platinum, copper whatever they’re looking for, that’s relatively easy, and many different techniques can do that. But what our tool does through and overly a very sophisticated software, it will tell them what the expected yield will be from that, how difficult it is to liberate the gold or platinum or whatever from the rock that is embedded in, so it’s a way that they can fine-tune their concentrators to maximize through yields. So if you think about it, it’s a yield management tool for MineSite operators.

The next frontier here is to take that same tool and put it on a -- take that same technology and put it on a ruggedized platform and enable that tool to actually go out in to field. We are working with a major MineSite operator in Mongolia and they have a significant problem because the time that it takes for them to extract the sample, sent it to the lab and get the data back because of the difficulties of transportation in Mongolia really makes the process a little bit redundant. So they are anxious to have a tool that’s very rugged to be onsite to do that.

We have actually worked with a partner and have since acquired our partner called ASPEX a company in Pittsburgh, Pennsylvania that develop a very rugged ice scanning electron microscope initially for the Navy that was used on aircraft careers, it had to do a couple of things. It had to withstand humidity and salt and lots of other nasty things that you have on aircraft carriers, but it also had to pass to four toot drop test and believe me if you drop any of our other tools off a four foot print platform, you have a major problem. This particular tool survives that and its great for ruggedized use and we’ve already taken that tool which is the middle part pf the slide here, into a WellSite solution where we’ve taken this ruggedized platform and loaded in this proprietary software, called QEMSCANE, shipped it out to operators of drilling operations for oil & gas. It sits next to the drill and it analyses the rocks as it’s coming out, and it effectively automates a process known as mud logging or surface logging, so we have this very ruggedized tool, it looks a bit like the podium that I’m standing in front of has a drawer, you open up the draw you put the sample in and shut the drawer or push a button gives a lot more data out and they were able to receive in the past. In the past a process was done manually, where two geologist would effectively look at samples with old cell light microscopes and log down the data, take that data compare it to the data that they get from (indiscernible) and then make decisions on the viability of that particular WellSite. It’s a brand new product for FEI. We just introduced it. We’re just starting to get revenue and opportunities in the field. We had a press release on Monday talking about new customer buying the particular tool. Optimistic about this, it’s a slow revenue growth model, so I’d like to caution people on that because it’s a leasing model.

We effectively will be working with WellSite operators, the people like Halliburton and Weatherford and people that -- a type of business where they will lease the tool from us and then include it into a daily rate which they charge the owner of the well. So, we’re very optimistic about this long term because it’s a leasing model, the revenue ramps are a little bit slower but it is a very high gross profit margin opportunity for the Company.

And the third piece of our natural resources segment is the Oil & Gas Lab; and this is a very exciting opportunity for the Company because it’s a high value add, and it’s also a high revenue and gross profit margin opportunity. What's happening here is we’re selling a suite of tools both a scanning electron microscope loaded with the QEMSCAN software coupled with that a DualBeam system that enables the lab operator to actually look at the rocks, slice it up with an ion-beam and then analyze the microscopic membranes for the porosity to determine whether or not it will be suitable for shale and suitable for fracking.

So this is a very interesting opportunity for the Company. It ends-up being a sale of over $2 million per site when we sell them. I encourage people to take a look at Whiting Petroleum, on their website if you go to videos; then go to core lab, they actually have a video. We didn’t even know they were doing this. Where they have their lab manager talking about the brand new tools he purchased. He does not mention FEI, but he mentions the name of the tools and in front of -- and he’s sitting in front of the FEI logo and he talks about how wondering if it to use this technology for helping them analyze structures of shale.

So fundamentally when we look at this business we see large opportunities for growth somewhere in the north of 30% of revenue growth. We’ve got some proven systems. We have proven customers that already is a viable business, it’s seeing very good gross profit margin business because it’s essentially selling lower-end tools embedded with very sophisticated software that we’ve developed over the years. We’ve also done some acquisitions to help accelerate in this particular area, and we believe we have a very nice proprietary position in this space and it’s an area that is clearly a return on investment sale for the Company.

Moving to electronics which is principally a sale’s to semiconductor companies. It’s generally for the [bleeding] and leading edge semiconductor companies to help them develop the next generation chipset. And what's happening in this space right now is all are good for FEI. Smaller devices, more complex structures to so called 3D FinFET structures, many more chemistries added to developing a semiconductor device are all and good for FEI.

If we take a look at the process steps that a person goes through to build a semiconductor device. When you’re in the 65 nanometer level you could essentially use an old line scanning electron microscope to analyze the device and do the analysis that you needed to do. We made those. We still make those. We still sell to those. What's interesting about that though is you generally would sell an SEM on a standalone basis. An SEM for a semiconductor customer would be somewhere around $0.5 million to $1 million depending on the particular product they would buy and what features they’d buy. So let’s just say its $750,000.

As devices shrink, as you start getting below 32 nanometer and get into even to 15 nanometer, you move out of an SEM environment meaning that you do not have the capability to analyze the structures with that type of tool and you move into a TEM environment, a Transmission Electron Microscope. This is good for FEI because we are the leading provider of TEMs for the semiconductor space. We have a product called a Tecnai OSIRIS which is an analytical high throughput TEM that provides not only information on the structure, but also about the chemistries of where they’re located. If you think about how are they building semiconductor devices? They’re using multiple chemistries.

They’re layering the stuff down a couple of atoms thick, so they need to know where the silicon stops and where the germanium begins etcetra, etcetrta begins et cetera, et cetera. So, as you get smaller, more complex, more chemistries, you move into a TEM environment. A TEM sells for somewhere between $1.2 million and $2 million. So, it’s about double the ASP of an SEM. In addition when you buy a TEM you need to buy a DualBeam or Focused Ion-Beam or a FIB system. We are the leading provider of those systems. We actually invented that product for the semiconductor space and when you buy a TEM you often buy one, often two DualBeams which each sell for about $1.2 million. So the share of spend as device structures get smaller to FEI increases measurably.

So where and not and we’re not making any calls on 2013 at this point in time, but whether or not there’s a downturn in semiconductor spending or whatever, we still believe that we are really well positioned relative to other semiconductor equivalent manufactures because of our positioning in the semiconductor lab. But we look at how we’ve done over the years. Our volatility is about half of what it is for a semiconductor capital equipment. I am only talking about the electronics portion of FEI.

FEI in total is very well balanced as I mentioned earlier, but our volatility in the semiconductor space is about half of that, and we believe that it will be even less on a go forward basis. So, we’re pretty happy with our positioning. We’re extremely excited about smaller devices. We’re getting pulled even more and more so by the semiconductor companies to have higher throughput faster TEM prep tools, so we expected to have some new product flow introductions over the next 12 months or so.

And then lastly is our Life Science Business, and this is an area that I am extremely excited about. It’s still relatively small about 10% of our revenue, so slightly under $100 million opportunity currently for FEI. 2012 has really been a year of investment for the Company. We did a couple of things. Let me just backup for a moment.

Historically researchers were not using our type of toolset for life science applications. And the principle reason for that is particular Cell biologist, who like to start out with a wet live sample and it’s difficult to use that in an electron microscope because it kills it or it evaporates it so it makes it difficult. So over the years we developed techniques to flash free samples in a cryogenic state of liquid nitrogen temperatures where they could take a live sample, freeze it instantaneously, move it into our tool and then you could slice it up to 3D modeling and understand the structures.

There are a couple of important things that happened with our tool over the years. One, we are the first Company to isolate the OSIRIS virus. Our tools I should say – the researchers did the work. Our tools were the ones that were first to isolate the OSIRIS virus. Our tools were also the first to disprove some of the common views of the AIDS virus. So it’s really important for researchers more and more to move out of the old style toolset that they were working with into ours.

There’s a magazine called Cell, which I’m sure its Cell, I am sure all of you subscribed to, which talks about the use of electron microscopy and we’ve been on the cover of that more recently than LeBron James have been on the cover of Sports Illustrated. So we’re getting a lot of good press out of how electron microscopy is pioneering lice science applications.

But with that said, we still were missing pieces. At the front end we missed -- we’re missing a high-end digital light microscope. And when you think about light microscopes you probably think about your old science labs. That’s not the case anymore. They’re really high-end for us in tools. We acquired a Company in Munich, Germany a year ago. Worked all those past year and we’ve introduced two new products a week ago. One of them is a standalone light microscope that is integrated with our toolset in a workflow called correlated microscopy, so you could start with your wet sample, do your analysis, find the area of interest, take that and stick it into the electron microscope, effectively do a Google earth down and see orders of magnitude in better resolution. And we also introduced a new product called iCorr which is a bolt-on accessory to our existing toolset. So people that have already purchased one of our TEMs can now purchase this as an add on accessory and have an integrated workflow. So very, very excited about that.

As I mentioned we’ve done a couple of acquisitions, spent a little over $100 million in the past 12 months or so. TILL was high-end digital light microscope. ASPEX was the rugged ice, SEM for our MineSite and WellSite Solutions, and VSG, Visualization Science Group is 3D modeling which, their 3D modeling takes output from our tools and does modeling from it, specifically in natural resources Oil & Gas and Life Science. And lastly we acquired our agent in Korea.

So financial summary, the data is all available out there. I am not going to spend a lot of time on this. I’ll leave a little bit of time for Q&A, but we’ve grown nicely over the past five years. Specific effaces on gross profit margin improvement. We still have initiatives in place that further grow that. We’re going to be up about 200 basis points year-over-year, and we have our long-term model to get to 50% over the next two and half years.

Q3 a good quarter, record revenue, record bookings, strong cash flow, strong earnings per share. Balance sheet is very strong. We have almost $400 million in cash. Net cash is $7.11 per share. Our free cash flow has been very strong and increasing year-over-year. In fact all those years that was equal to or exceeded our diluted earnings per share.

Business model plan is to get gross margins at 50%, that’s essentially by mid 2015. We’re building a new plant in the Czech Republic, where we already produced 60% of our output. But we think with the new plant which will be on line by 2015 will be another catalyst for our gross margin improvement. With that we expect operating income to continue to go up. We were grocery store margins not all that long ago at around 5% and growing to almost 17% year-to-date with the plan to get them over 20% over the next couple of years.

So with that I’ll open it up for any questions.

Question-and-Answer Session

Raymond A. Link

Yes, sir.

Unidentified Analyst


Raymond A. Link

Yeah, the question is, our gross profit margin expanded over the past couple of years were the key drivers to that. The single biggest one was focus and tie in everybody’s comp to gross profit margin improvement. And as a result everybody took it seriously, and it was mainly a function of new products, adding more solutions so we get a higher return on investment opportunity on sales. We’ve done a lot also on operations. We took a lot of products that were – we had a plant in Holland, moved most of those products out of Holland to the Czech Republic to get not only a lower labor rate, but also just a easier way to do business. You don’t have as many worker rules et cetera associated there. And we’ve really focused on some area, even our service business which was only 25% gross profit margin. We put in a lot of automation there to help drive that. We have the tools connected to the internet so we can do remote diagnostics. So we’ve grown the margin there from 25% to about 35% over the past three, four years. So, it’s a function of a lot of things, but the single biggest thing was focus.

A question in the back.

Unidentified Analyst

You talked about your TEM system and your focused ion-beam systems. What are your competitors doing in that market and how can you protect yourself going forward?

Raymond A. Link

We are protected from a variety of different areas, so it’s not a lot in patents per say we do have some, and we actually entered into a cross license agreement recently with Hitachi to solidify that situation. A lot of it really has to do with software. There is millions of line’s of software that drive this as a Company. We spent more in R&D than we believe our three largest competitors combined. We also have almost half of our R&D effort is in software. So it’s a function of some proprietary technology, some patents but not a lot. And we have over 200, 300 patents, but they’re not as important as it may seem; but software’s is a lot of it. There’s also a lot just in terms of the, how we run the business. We have the largest sales and service support. We have almost 850 people globally in sales and service, so a lot of it has to do with service as well. So it’s a combination of a lot of things that really protect the Company, so our position.

Question upfront.

Unidentified Analyst


Raymond A. Link

I’m sorry, I can't hear you.

Unidentified Analyst

Just have the question on the service and a couple around the business. What exactly services do you provide and [indiscernible] macro and what is the gross [indiscernible]?

Raymond A. Link

Sure. Our service business currently is largely post-warranty maintenance and repair. So, think about you buy a car and you take it off the lot, have a warranty for a while, after that you take it back for service and we sell service contracts and also time material contracts. We are – starting to do more value added services, we’re doing training to drive that up and also we’re looking at ways to further provide more value added service. We do think that will grow at a slower rate because it grows with the installed base. We have about 88500 tools worldwide installed. So service revenue grows more or less in line with the growth of the installed base. Also the more complex tool is the generally more expensive the service contracts. So I think this is a 7%, 8% type broad business, although in some instances it’s grown greater than that in the past.

And with that, I believe we’re concluded on time. So thank you for attending, I appreciate your interest.

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