Description
Filed with the SEC from Feb 09 to Feb 15:
FEI (FEIC)
Blue Harbor Group decreased its stake to 1,868,603 shares (5%) by selling 633,397 from Jan. 9 through Feb. 10 for prices that ranged from $42.00 to $46.64.
BUSINESS OVERVIEW
Overview
We were founded in 1971 and our shares began trading on The NASDAQ Stock Market in 1995. We are a leading supplier of scientific instruments for nanoscale imaging, analysis and prototyping to enable research, development and manufacturing in a range of industrial, academic and research institutional applications. We report our revenue based on a market-focused organization: the Electronics market segment, the Materials Science market segment (formerly Research and Industry), the Life Sciences market segment and the Service and Components market segment.
Our products include transmission electron microscopes, or TEMs; scanning electron microscopes, or SEMs; DualBeam systems which combine a SEM and a focused ion beam system, or FIB, on a single platform; and stand-alone FIBs.
Our DualBeam systems include models that have wafer handling capability and are purchased by semiconductor equipment manufacturers (“wafer-level DualBeam systems”) and models that have small stages and are sold to customers in several markets (“small-stage DualBeam systems”).
We have research and development and manufacturing operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; and Munich, Germany. Our sales and service operations are conducted in the United States (U.S.) and approximately 50 other countries around the world. We also sell our products through independent agents, distributors and representatives in additional countries.
The Electronics market segment consists of customers in the semiconductor equipment and related industries such as manufacturers of data storage equipment, solar panels and light-emitting diodes (“LEDs”). For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, the use of multiple layers of new materials such as copper and low-k dielectrics and increasing device complexity. Our products are used primarily in laboratories to speed new product development and increase yields by enabling 3D wafer metrology, defect analysis, root cause failure analysis and circuit edit for modifying device structures.
The Materials Science market segment includes universities, public and private research laboratories and customers in a wide range of industries, including natural resources (mining and oil and gas), petrochemicals, metals, automobiles, aerospace, and forensics. Growth in these markets is driven by global corporate and government funding for research and development in materials science and by development of new products and processes based on innovations in materials at the nanoscale. Our solutions provide researchers and manufacturers with atomic-level resolution images and permit development, analysis and production of advanced products. Our products are used in mining for automated mineralogy and we have opportunities in oil and gas exploration. Our products are also used in root cause failure analysis and quality control applications across a range of industries.
The Life Sciences market segment includes universities, government laboratories and research institutes engaged in biotech and life sciences applications, as well as pharmaceutical, biotech and medical device companies and hospitals. Our products’ ultra-high resolution imaging allows structural and cellular biologists and drug researchers to create detailed 3D reconstructions of complex biological structures. Our products are also used in particle analysis and a range of pathology and quality control applications.
The Service and Components market segment provides support for products and customers for the entire life cycle of a tool from installation through the warranty period, and after warranty period through contract coverage or on a time and materials basis. We believe strong technical support is an important part of the value proposition that we offer customers when a tool is sold. Our Service and Components market segment provides support across all markets and all regions.
Particle beam technologies—focused ion beams and electron beams. The emission and focusing of ions, which are positively or negatively charged atoms, or electrons from a source material, is fundamental to many of our products. Particle beams are accelerated and focused on a sample for purposes of high resolution imaging and sample processing. The fundamental properties of ion and electron beams permit them to perform various functions. The relatively low mass subatomic electrons interact with the sample and release secondary electrons. When collected, these secondary electrons can provide high quality images at nanometer-scale resolution. In previously thinned samples, collection of high energy electrons transmitted through the sample can yield image resolution at the atomic scale. The much greater mass ions dislodge surface particles, also resulting in displacement of secondary ions and electrons. Through the use of FIBs, the surface can be modified or milled with sub-micron precision by direct action of the ion beam or in combination with gases. Secondary electrons and ions may also be collected for imaging and compositional analysis. Our ion and electron beam technologies provide advanced capabilities and applications when coupled with our other core technologies.
Beam gas chemistry. Beam gas chemistry plays an important role in enabling our electron and ion beam based products to perform many tasks successfully. Beam gas chemistry involves the interaction of the primary ion beam with an injected gas near the surface of the sample. This interaction results in either the deposition of material or the enhanced removal of material from the sample. Both of these processes are critical to optimizing and expanding FIB and SEM applications. Our markets have growing needs for gas chemistry technologies, and we have aimed our development strategy at meeting these requirements.
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Deposition: Deposition of materials enables our FIBs to connect or isolate features electrically on, for example, an integrated circuit. A deposited layer of metal also can be used before FIB milling to protect surface features for more accurate cross-sectioning or sample preparation.
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Etching: The fast, clean and selective removal of material is the most important function of our FIBs. Our FIBs have the ability to mill specific types of material faster than other surrounding material. This process is called selective etching and is used to enhance image contrast or aid in the modification of various structures.
System automation and sample management. Drawing on our knowledge of application needs, and using robotics and image recognition and reconstruction software, we have developed automation capabilities that allow us to increase system performance, speed and precision. These capabilities have been especially important to our development efforts for in-line products and applications in the Electronics market segment and are expected to be increasingly important in emerging production and process control applications in the Materials Science and Life Sciences market segments. Two important areas where we have developed significant automation technologies are TEM sample preparation and 3D process control. TEMs are widely used in the semiconductor and data storage markets to obtain valuable high-resolution images of extremely small, even atomic-level, structures. TEM sample preparation has traditionally been a slow and difficult manual process. With our DualBeam systems and proprietary software, we have automated this process, significantly improving the sample consistency and overall throughput. Similarly, by automating 3D process control applications, we allow customers to acquire previously unobtainable subsurface process metrics directly from within the production line, improving process management.
Research and Development
We have research and development operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; Munich, Germany; and Brisbane, Australia.
Our research and development staff at December 31, 2011 consisted of 398 employees, including scientists, engineers, designer draftsmen, technicians and software developers.
In the last year, we introduced several new and improved products, including:
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the Vion plasma focused ion beam ("PFIB") system that is much faster than existing FIB technologies;
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the Versa 3D DualBeam system which provides high-resolution 3D imaging and analysis on a wide range of sample types;
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the Titan G2 80-200 with ChemiSTEM Technology, a new member of the Titan G2 series of scanning/transmission electron microscopes; and
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the QEMSCAN WellSite analysis solution that enhances the quality of mudlogging services for the oil and gas industry.
Additionally, we announced a partnership with the Knight Cancer Institute at Oregon Health and Science University ("OHSU") to create the OHSU/FEI Living Lab for Cell Biology that will provide researchers with several state-of-the-art electron microscopes to advance the understanding and treatment of complex diseases such as cancer and AIDS.
We also completed the acquisition of TILL Photonics of Munich, Germany in 2011, giving the Company a high-end digital light microscope for Life Science application. On January 9, 2012, we completed the acquisition of ASPEX Corporation of Delmont, Pennsylvania, which gives us a durable SEM for industrial applications.
We believe our knowledge of field emission technology and products incorporating focused ion beams remain critical to our performance in the focused charged particle beam business. Drawing on this technology, we have developed a number of product innovations, including:
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Enhancement in the S/TEM system platform with unprecedented stability coupled with new aberration correctors and monochromator technology, enabling sub-angstrom resolution;
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Enhanced robotics, processes and tool connectivity, enabling in-line sample lift-out and S/TEM imaging from semiconductor wafers for defect analysis and process control applications with new automation software that improves the quality and consistency of multiple site-specific samples;
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Advanced image processing hardware and software enabling high performance 3D tomographic, TEM-based imaging and advance cryogenic fixation technology and subsequent imaging of aqueous samples at cryo temperatures in a TEM for aqueous biological and colloidal polymer, pigment and nanoparticle samples;
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High-speed analytic characterization technology that includes the proprietary X-Field Emission Guns (“X-FEG”) ultra-high brightness electron source and Super-X, our new Energy Dispersive X-ray (“EDX”) detection system based on Silicon Drift Detector (“SDD”) technology; and
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Direct electron detector technology with improved quantum efficiency, capturing more information from a given electron dose, and accelerating the rate at which the signal-to-noise ratio improves over the exposure period.
From time to time, we engage in joint research and development projects with some of our customers and other parties. In Europe, our electron microscope development is conducted in collaboration with universities and research institutions, often supported by European Union research and development programs. We periodically have received public funds under Dutch government and European Union-funded research and development programs, and expect to continue to leverage these funding opportunities in the future. However, these funds can vary from year to year and we are not able to predict the amount of future funding. We also maintain other informal collaborative relationships with universities and other research institutions, and we work with several of our customers to evaluate new products.
The markets into which we sell our principal products are subject to rapid technological development, product innovation and competitive pressures. Consequently, we have expended substantial amounts of money on research and development. We generally intend to continue investing in research and development and believe that continued investment will be important to our ability to address the needs of our customers and to develop additional product offerings. Research and development efforts continue to be directed toward development of next generation product platforms, new applications, new ion and electron columns, beam chemistries and system automation. We believe these areas hold promise of yielding significant new products and existing product enhancements. Research and development efforts are subject to change due to product evolution and changing market needs. Often, these changes cannot be predicted.
Net research and development expense was $78.3 million in 2011 , $66.3 million in 2010 and $67.7 million in 2009 .
Manufacturing
We have manufacturing operations located in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; and Munich, Germany. Our manufacturing staff at December 31, 2011 consisted of 570 employees. Our system manufacturing operations consist largely of final assembly and the testing of finished products. Product performance is documented and validated with factory acceptance and selective customer witness acceptance tests before these products are shipped. We also fabricate electron and ion source materials and manufacture component products at our facilities in Oregon and the Czech Republic.
Although we currently use numerous vendors to supply parts, components and subassemblies for the manufacture and support of our products, some key parts may only be obtained from a single supplier or a limited group of suppliers. In particular, we rely on: VDL Enabling Technologies Group, AP Tech, Frencken Mechatronics B.V., Keller Technology and AZD Praha SRO for our supply of mechanical parts and subassemblies; Gatan, Inc. for critical accessory products; and Neways Electronics, N.V. for some of our electronic subassemblies. A portion of the subcomponents that make up the components and sub-assemblies supplied to us are proprietary in nature and are provided to our suppliers only from single sources. We monitor those parts subject to single or a limited source supply to seek to minimize factory down time due to unavailability of such parts, which could impact our ability to meet manufacturing schedules.
Sales, Marketing and Service
Sales, marketing and service operations are conducted in the U.S. and approximately 50 other countries around the world. We also sell our products through independent agents, distributors and representatives in additional countries.
Our sales and marketing staff at December 31, 2011 consisted of 326 employees, including account managers, direct salespersons, sales support management, administration, demo lab personnel, marketing support, product managers, product marketing engineers, applications specialists and technical writers. Applications specialists identify and develop new applications for our products. Our sales force and marketing efforts are organized through four geographic sales and services divisions: North America, Europe, the Asia-Pacific region and Japan. Our service staff at December 31, 2011 consisted of 577 employees.
We require sales representatives to have the technical expertise and understanding of the businesses of our principal and potential customers to meet the requirements for selling our products. Normally, a sales representative will have the knowledge of, and experience with, our products or similar products, markets or customers at the time the sales representative is hired. We also provide additional training to our sales force on an ongoing basis. Our marketing efforts include presentations at trade shows, advertising in trade journals, development of printed collateral materials, customer forums, public relations efforts in trade media and our website. In addition, our employees publish articles in scientific journals and make presentations at scientific conferences.
In a typical sale, our sales representatives provide a potential customer with information about our products, including specifications and performance data. The customer then often participates in a product demonstration at our facilities, using samples provided by the customer. The sales cycle for our systems typically ranges from three to 12 months, but can be longer when our customers are evaluating new applications of our technology.
Our products are sold generally with a 12 month warranty. Customers may purchase service contracts for our products of one year or more in duration after expiration of any warranty. We employ service engineers in each of the four regions in which we have sales and service divisions. We also contract with independent service representatives for product service in some foreign countries.
Competition
The markets for our products are highly competitive. Some of our competitors and potential competitors have greater financial, marketing and production resources than we do. In addition, some of our competitors have formed collaborative relationships and otherwise may cooperate with each other. Additionally, markets for our products are subject to constant change, due in part to evolving customer needs. As we respond to this change, the elements of competition as well as the specific competitors may change. Moreover, one or more of our competitors might achieve a technological advance that could put us at a competitive disadvantage.
Our significant competitors include, among others: JEOL Ltd., Carl Zeiss SMT A.G., Hitachi High Technologies Corporation and Tescan, a.s. We believe the key competitive factors are performance, range of features, reliability and price. We believe that we are competitive with respect to each of these factors. Our ability to remain competitive depends in part upon our success in developing new and enhanced systems and introducing these systems at competitive prices on a timely basis.
Our service business faces little significant third-party competition. Because of the highly specialized nature of our products and technology, and because of the critical mass necessary to support a worldwide field service capability, few competitors have emerged to provide service to our installed base of systems. Some of our older, less sophisticated equipment, particularly in the Materials Science market segment, is serviced by independent field service engineers who compete directly with us. We believe we will continue to provide most of the field service for our products.
Patents and Intellectual Property
We rely on a combination of trade secret protection (including use of nondisclosure agreements), trademarks, copyrights and patents to establish and protect our proprietary rights. These intellectual property rights may not have commercial value or may not be sufficiently broad to protect the aspect of our technology to which they relate or competitors may design around the patents. We own, solely or jointly, approximately 206 patents in the U.S. and approximately 371 patents outside of the U.S., many of which correspond to the U.S. patents. Further, we license additional patents from third parties. Our patents expire over a period of time from 2012 to 2030 .
Several of our competitors hold patents covering a variety of focused ion beam products and applications and methods of use of focused ion and electron beam products. Some of our customers may use our products for applications that are similar to those covered by these patents. As the number and sophistication of focused ion and electron beam products in the industry increase through the continued introduction of new products by us and others, and the functionality of these products further overlaps, manufacturers and users of ion and electron beam products may become increasingly subject to infringement claims.
We also depend on trade secrets used in the development and manufacture of our products. We endeavor to protect these trade secrets but the measures we have taken to protect these trade secrets may be inadequate or ineffective.
We claim trademarks on a number of our products and have registered some of these marks. Use of the registered and unregistered marks, however, may be subject to challenge with the potential consequence that we would have to cease using marks or pay fees for their use.
Our automation software incorporates software from third-party suppliers, which is licensed to end users along with our proprietary software. We depend on these outside software suppliers to continue to develop automation capacities. The failure of these suppliers to continue to offer and develop software consistent with our automation efforts could undermine our ability to deliver product applications.
Employees
At December 31, 2011 , we had 2,006 full-time equivalent, permanent employees and 68 temporary employees worldwide. Some of the 1,465 employees who are employed outside of the U.S. are covered by national, industry-wide agreements or national work regulations that govern various aspects of employment conditions and compensation. None of our U.S. employees are subject to collective bargaining agreements, and we have never experienced a work stoppage, slowdown or strike in any of our worldwide operations. We believe we maintain good employee relations.
Backlog
Orders received in a particular period that cannot be built and shipped to the customer in that period represent backlog. We only recognize backlog for purchase commitments for which the terms of the sale have been agreed upon, including price, configuration, options and payment terms. Product backlog consists of all open orders meeting these criteria. Service and Components backlog consists of open orders for service, unearned revenue on service contracts and open orders for spare parts. U.S. government backlog is limited to contracted amounts. In addition, some of the U.S. government backlog represents uncommitted funds. At December 31, 2011 , our total backlog was $430.7 million , compared to $471.9 million at December 31, 2010 . At December 31, 2011 , our backlog consisted of $343.3 million of products and $87.4 million related to Service and Components compared to product backlog of $390.6 million and Service and Components backlog of $81.3 million at December 31, 2010 .
Customers may cancel or delay delivery on previously placed orders, although our standard terms and conditions include penalties for cancellations made close to the scheduled delivery date. As a result, the timing of the receipt of orders or the shipment of products could have a significant impact on our backlog at any date. Historically, cancellations have been low. However, in the last two years, this long-standing trend changed somewhat and, as a result, our cancellation rates may increase in the future. During 2011 and 2010 , we experienced cancellations or de-bookings of $3.5 million and $2.7 million , respectively. From time to time, we have experienced difficulty in shipping our product from backlog due to single-sourcing issues and problems in securing electronic components from a certain vendor. In addition, product shipments have been extended due to delays in completing certain application development, by our customers pushing out shipments because their facilities are not ready to install our systems and by our own manufacturing delays due to the technical complexity of our products and supply chain issues. A significant portion of our backlog is denominated in currencies other than the U.S. dollar and, therefore, our reported backlog fluctuates, to an extent, as a result of foreign currency exchange rate movements. For these reasons, the amount of backlog at any date is not necessarily indicative of revenue to be recognized in future periods.
CEO BACKGROUND
Lawrence A. Bock is a nationally recognized business leader in nanotechnology, which is the broad market that FEI serves. He has served as a director of FEI since December 2004. He currently serves as a general partner in CW Ventures and a special limited partner to Lux Capital, two venture capital firms that focus on life sciences and nanotechnology companies. Mr. Bock’s most recent position in industry was with Nanosys, Inc., a nanotechnology platform and product development company, where he served as Executive Chairman from November 2004 through December 2006. Mr. Bock has more than 20 years’ experience in leadership in the pharmaceutical, life sciences and nanotechnology industries. He has co-founded over a dozen companies and served as Chief Executive Officer of six. He has served as a member of the President’s Export Council Subcommittee on Export Administration and a member of the Blue Ribbon Task Force on Nanotechnology. Mr. Bock serves on the Advisory Board and Technology Advisory Board of the NanoBusiness Alliance, as well as the Advisory Board of the Faculty of Chemistry of the University of California, Berkeley. Mr. Bock’s broad range of business skills and knowledge of the nanotechnology market provide valuable assistance to the Board in evaluating FEI’s markets, strategy and operations. In addition, Mr. Bock’s experiences with life sciences companies and the pharmaceutical industry enhance the knowledge of the Board, providing value to FEI as it continues to grow and explore opportunities in these market segments. Mr. Bock received a B.A. degree in Biochemistry from Bowdoin College and an M.B.A. degree from University of California, Los Angeles.
Arie Huijser brings to the board a strong background as the senior technologist and member of the executive team of Koninklijke Philips Electronics N.V. (“Philips”), the global electronics and consumer products group. At the time of his retirement from Philips in 2006, Dr. Huijser was an Executive Vice President of Philips, its Chief Technology Officer and a Member of the Board of its Management Board. In addition he has a strong understanding of FEI based on his service from 2007 to 2011 on the Supervisory Board of our Dutch subsidiary. Dr. Huijser started his career at Philips in 1970 and held various positions in the Research Laboratories before becoming Chief Technology Officer for the consumer electronics division in 1991. He held several senior technology roles in various parts of Philips, including roles in the television division, the Philips Multimedia Center and the semiconductor group. While serving at Philips, Dr. Huijser was influential in the development of the recordable compact disc and in optical lithography, which led to the founding of ASML Holding N.V., the global semiconductor equipment manufacturer. As a Dutch national, Dr. Huijser brings to the Board his understanding of the Netherlands, where FEI operates a key development and manufacturing center. His deep experience in managing large R&D organizations is helpful to the Board’s understanding of R&D management, which is an important function at FEI. Dr. Huijser holds a Bachelor of Science degree and Masters Degree, both in Technical Physics from Eindhoven Technical University and gained a Ph.D. in Applied Physics from the University of Twente in Netherlands.
Don R. Kania brings a wealth of business and technological experience to FEI. He has served as a director and our President and Chief Executive Officer since August 2006. Prior to coming to FEI, Dr. Kania held successively senior positions at Veeco Instruments Inc., a provider of metrology and process equipment solutions used by manufacturers in the data storage, semiconductor, wireless, lighting and solar industries. From July 2004 to July 2006, Dr. Kania was President and Chief Operating Officer of Veeco. From March 2003 to July 2004, Dr. Kania was President of that company. Prior to that, he was a Vice President and General Manager of Veeco’s Metrology Group, and before that, Chief Technology Officer. Dr. Kania was heavily involved in Veeco’s operations as well as mergers and acquisitions. Dr. Kania’s experiences in nanotechnology and the capital equipment markets allow him to offer valuable knowledge and experience to FEI’s Board. Before entering private industry, Dr. Kania was a senior manager at Lawrence Livermore National Laboratory where he directed the Advanced Microtechnology Program and worked in data storage and semiconductor industry applications, including in areas served by FEI; these specific experiences are helpful to the Board’s understanding of these markets and customer needs. In the early 1990’s, Dr. Kania was also a Research Director at Crystallume, a manufacturer of thin film diamond coatings and a customer of FEI. Before that, he worked as a researcher in the U.S. Department of Energy’s Los Alamos and Lawrence Livermore National Laboratories. Through these activities, Dr. Kania has gained an understanding of the needs of FEI’s customers in the research market segment, which allows him to offer insights to the Board. Dr. Kania is on the Advisory and Oversight Board of the California NanoSystems Institute; on the North American Board of Directors of SEMI, a global industry association serving the manufacturing supply chains for the microelectronic, display and photovoltaic industries; and on the board of directors of American Science & Engineering, Inc., which designs state-of-the-art x-ray imaging tools for security screening. He holds B.S., M.S. and Ph.D. degrees in Physics and Engineering from the University of Michigan.
Thomas F. Kelly is a technology industry veteran and provides the Board with nearly 30 years’ experience of finance and operations background in software firms ranging in size from start-ups to companies with billions of dollars of revenue. He has served on the FEI Board since 2003. He currently works with Trident Capital, a venture capital and private equity firm focused on software, health care, information technologies and clean technologies. He is currently serving on the board of directors of Fabrinet, a provider of precision optical, electro-mechanical and electronic manufacturing services to original equipment manufacturers of complex products such as optical communication components, modules and sub-systems, industrial lasers and sensors. He served as a director of Epicor Software Corporation, an enterprise software company, from January 2000 until January 2009. From February 2008 to January 2009, Mr. Kelly also served as President and Chief Executive Officer of Epicor. From June 2006 until February 2008, Mr. Kelly served as Chief Executive Officer and President of MontaVista Software, a provider of Linux-based development software. He also chaired the board of that group from June 2006 until December 2009. Mr. Kelly was President and Chief Executive Officer of Encentuate, Inc., an enterprise software company in 2006. From September 2004 until December 2005, Mr. Kelly was an entrepreneur-in-residence with Trident Capital. From January 2001 to September 2004, Mr. Kelly was Chairman and Chief Executive Officer of BlueStar Solutions, Inc., an enterprise resource planning software hosting company. From July 1998 through December 2000, Mr. Kelly was Chairman and Chief Executive Officer of Blaze Software, Inc., a provider of rules-based e-business software that enabled personalized interaction across an enterprise’s electronic contact points. From March 1996 through March 1998, Mr. Kelly was employed at Cirrus Logic, Inc., a provider of digital audio, video and high performance analog and mixed signal integrated circuits for consumer entertainment and industrial applications, as Executive Vice President and Chief Financial Officer, and then subsequently as Chief Operating Officer. Mr. Kelly held executive roles at Frame Technology Corporation, which was acquired by Adobe Systems, and also served as Chief Financial Officer at Cadence Design Systems. Mr. Kelly’s diversity of business experience – as a chief executive officer, a chief operating officer and a chief financial officer – brings a range of perspectives to the Board. Moreover, Mr. Kelly’s strong background in software businesses is helpful to the Board’s understanding of FEI’s product offerings which have increasing software content. In addition, Mr. Kelly’s extensive finance and accounting experience make him well-suited for our Audit Committee. Mr. Kelly qualifies as an “audit committee financial expert” as defined in the SEC’s rules and regulations and serves as chair of the Audit Committee. Mr. Kelly holds a B.S. degree in Economics from Santa Clara University.
Jan C. Lobbezoo brings to the Board significant international business and financial experience. He has served as a director of FEI since July 1999. Until December 2006, Mr. Lobbezoo was the Executive Vice President of Philips International B.V., with responsibility for financial oversight of several minority shareholdings of Koninklijke Philips Electronics N.V. and its affiliates (“Philips”). From May 1994 to September 2005, Mr. Lobbezoo was Executive Vice President and Chief Financial Officer of Philips Semiconductors International B.V. (now NXP Semiconductors). He joined Philips in 1970 and has served in a number of finance and control positions in Nigeria, South Africa and Scandinavia, as well as in the Netherlands. Mr. Lobbezoo is on the supervisory board of TMC, a Dutch high-technology secondment services company, quoted on Amsterdam Alternext Stock Exchange, as well as a member of the Supervisory Board of the SmarTrac Technology Group, a Dutch registered company and a leading supplier of high security RFID inlays, quoted in the Frankfurt Stock Exchange. He is also a member of the Supervisory Board and Chairman of the Audit Committee of ASM International NV, a company which manufactures equipment and materials used to produce semiconductor devices, quoted on Euronext Amsterdam and NASDAQ stock exchanges. He was a member of the board of Taiwan Semiconductor Manufacturing Company (TSMC) for 12 years until 2007, and remains its advisor, specifically in the areas of U.S. corporate governance, international reporting and financial review. Mr. Lobbezoo’s long experience in a senior finance role has been useful in particular in his service on the Audit Committee as he contributes significant finance and accounting knowledge to our Board. His experience as Chief Financial Officer of a major semiconductor manufacturer and as director of the world’s largest semiconductor foundry is helpful to the Board for the insights he is able to provide into the electronics industry and customer needs. Mr. Lobbezoo’s Dutch background is helpful in understanding cultural, organizational and other issues related to our workers in the Netherlands and in other areas of Europe. His other international experience, including his work in Asia, lends helpful perspective to the Board’s deliberations on international issues. Mr. Lobbezoo’s experience with U.S. GAAP and public company accounting is valuable to the Board’s consideration of financial matters, and he qualifies as an “audit committee financial expert” as defined in the SEC’s rules and regulations. Mr. Lobbezoo holds an M.A. degree in Business Economics from Erasmus University in Rotterdam, the Netherlands, and is a member of the Dutch Institute of Chartered Accountants (NIVRA).
Gerhard H. Parker is widely respected in the semiconductor industry for his very successful 40-plus year career. He has served as a director of FEI since July 2001 and the Chairman of the Board since 2009. Dr. Parker began his work in the semiconductor industry in 1969 at Intel and held successively senior positions with Intel until his retirement in 2001 as Executive Vice President of New Business Development. From 1991-1998, he was General Manager of the Manufacturing and Technology Group, where his responsibilities included technology development, systems manufacturing, components manufacturing and support functions at Intel. Prior to that, Dr. Parker was Manager of Technology Development, where he was instrumental in defining and managing Intel’s highly successful technology development methodology and leadership strategy. Before that, Dr. Parker was Director of Quality Assurance and was responsible for establishing quality control and reliability engineering functions within the manufacturing operations. From his varied experiences at Intel, Dr. Parker brings to the Board deep manufacturing and operational experience that includes knowledge of the application of FEI’s tools in the electronics market segment. In addition, Dr. Parker’s long experience as a senior executive at a global Fortune 100 company contributes to the Board’s consideration of a range of international business matters. He has valuable knowledge of the capital equipment business from his service on the board of Applied Materials, Inc. Dr. Parker is also a member of the board of Lattice Semiconductor Corporation. His service on other boards enables him to offer unique perspectives on strategy and governance to FEI. Mr. Parker holds B.S., M.S. and Ph.D. degrees in Electrical Engineering from the California Institute of Technology.
James T. Richardson is a 30-year veteran of the high-tech sector and has served as Chief Financial and Administrative Officer for five global technology companies ranging in size from $20 million to $300 million in annual revenue. He has served as a director of FEI since July 2003 and the Chairman of the Board from August 2006 to May 2009. Mr. Richardson served as Senior Vice President and Chief Financial Officer of the website analytics software firm, WebTrends Corporation, from July 1998 to May 2001. Prior to that, Mr. Richardson served from April 1994 to December 1998 as Senior Vice President of Corporate Operations and Chief Financial Officer of Network General, a security software company that merged with McAfee Associates Inc. in December 1997 to form Network Associates. Before Network General, from July 1992 to March 1994, Mr. Richardson served as Vice President of Finance and Administration and Chief Financial Officer of Logic Modeling Corporation, which merged with Synopsys Inc. in February 1994. Prior to that, he served as Vice President of Finance and Administration, Chief Financial Officer, Treasurer and Secretary of Advanced Logic Research from November 1989 to July 1992. ALR was a personal computer manufacturer. From 1977 to 1989, Mr. Richardson served in various positions with Floating Point Systems Inc., rising to the position of Vice President of Finance and Administration and Chief Financial Officer. Mr. Richardson’s experience in senior finance roles at several public companies is valuable to the Board’s consideration of financial matters, and he qualifies as an “audit committee financial expert” as defined in the SEC’s rules and regulations. His finance experience and leadership skills also enable him to make valuable contributions to our Audit Committee on which he serves. In addition, Mr. Richardson’s strong experience with software companies is helpful to the Board’s deliberations regarding new technologies as software is increasingly important to FEI’s business and strategy. Mr. Richardson currently serves as lead independent director of the board of directors of Digimarc Corporation, a supplier of secure personal identification systems. His work with other boards and his significant experience in corporate governance and administration offers helpful experience to the Board. Mr. Richardson received a B.A. degree in Finance and Accounting from Lewis & Clark College, an M.B.A. degree from the University of Portland and a J.D. degree from Lewis & Clark Law School.
Richard H. Wills brings extensive experience in marketing, product development and product line management, coupled with a global perspective, to the Board. He has served as a director of FEI since February 2009. Mr. Wills joined Tektronix, an Oregon based company, in 1979 and held a variety of positions, including key international roles, during his tenure there. In 1993 and 1994, he held the position of Worldwide Director of Marketing for the Measurement Business Division. During these years, his team started building a foundation for more extensive global marketing. His team established marketing centers in Europe, the Pacific and the U.S., and improved linkages with Japan and the rest of the world. In 1997, he was named President of European Operations, where he was responsible for all European activities, including sales, marketing, manufacturing and logistics. As President of European Operations, he was charged with building Tektronix’s sales and marketing presence in Europe, the company’s largest market outside the United States. Mr. Wills moved to the European post from his role as the company’s President of the Americas Operations, one of the three operational units established by Tektronix to accelerate growth in key international markets. In January 2000, he was named President and Chief Executive Officer of the company and was elected to its board of directors. In September 2001, he was elected Chairman of the Board. Tektronix was acquired by Danaher Corporation, a leading diversified industrial company, in late 2007. Mr. Wills remained Chairman of Tektronix until June 2008. Mr. Wills’ recent experience as Chief Executive Officer of a substantial capital equipment manufacturer brings a valuable perspective to the Board. His positions in sales and marketing are helpful to consideration of those issues, as is his international experience. His operations background also adds to the Board’s understanding of operational and manufacturing issues. Prior to joining Tektronix, Mr. Wills spent six years in the U.S. Air Force in various assignments in the United States and Europe. Mr. Wills holds a degree in Computer Systems from Linfield College and an M.B.A. from the University of Oregon.
MANAGEMENT DISCUSSION FROM LATEST 10K
SUMMARY OF PRODUCTS AND SEGMENTS
We are a leading supplier of scientific instruments for nanoscale imaging, analysis and prototyping to enable research, development and manufacturing in a range of industrial, academic and research institutional applications. We report our revenue based on a market-focused organization: the Electronics market segment, the Materials Science market segment (formerly Research and Industry), the Life Sciences market segment and the Service and Components market segment.
Our products include transmission electron microscopes, or TEMs; scanning electron microscopes, or SEMs; DualBeam systems which combine a SEM and a focused ion beam system, or FIB, on a single platform; and stand-alone FIBs.
Our DualBeam systems include models that have wafer handling capability and are purchased by semiconductor equipment manufacturers (“wafer-level DualBeam systems”) and models that have small stages and are sold to customers in several markets (“small-stage DualBeam systems”).
We have research and development and manufacturing operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; and Munich, Germany. Our sales and service operations are conducted in the United States (U.S.) and approximately 50 other countries around the world. We also sell our products through independent agents, distributors and representatives in additional countries.
The Electronics market segment consists of customers in the semiconductor equipment and related industries such as manufacturers of data storage equipment, solar panels and light-emitting diodes (“LEDs”). For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, the use of multiple layers of new materials such as copper and low-k dielectrics and increasing device complexity. Our products are used primarily in laboratories to speed new product development and increase yields by enabling 3D wafer metrology, defect analysis, root cause failure analysis and circuit edit for modifying device structures.
The Materials Science market segment includes universities, public and private research laboratories and customers in a wide range of industries, including natural resources (mining and oil and gas), petrochemicals, metals, automobiles, aerospace, and forensics. Growth in these markets is driven by global corporate and government funding for research and development in materials science and by development of new products and processes based on innovations in materials at the nanoscale. Our solutions provide researchers and manufacturers with atomic-level resolution images and permit development, analysis and production of advanced products. Our products are used in mining for automated mineralogy and we have opportunities in oil and gas exploration. Our products are also used in root cause failure analysis and quality control applications across a range of industries.
The Life Sciences market segment includes universities, government laboratories and research institutes engaged in biotech and life sciences applications, as well as pharmaceutical, biotech and medical device companies and hospitals. Our products’ ultra-high resolution imaging allows structural and cellular biologists and drug researchers to create detailed 3D reconstructions of complex biological structures. Our products are also used in particle analysis and a range of pathology and quality control applications.
The Service and Components market segment provides support for products and customers for the entire life cycle of a tool from installation through the warranty period, and after warranty period through contract coverage or on a time and materials basis. We believe strong technical support is an important part of the value proposition that we offer customers when a tool is sold. Our Service and Components market segment provides support across all markets and all regions.
SALES AND BACKLOG
Net sales increased to $826.4 million in 2011 compared to $634.2 million in 2010 . This increase reflects increases in all of our market segments as described more fully below.
At December 31, 2011 , our total backlog was $430.7 million compared to $471.9 million at December 31, 2010 . As discussed in the section entitled “Business” included in Part I, Item 1 of this Annual Report on Form 10-K, orders received in a particular period that cannot be built and shipped to the customer in that period represent backlog.
OUTLOOK FOR 2012
We begin 2012 coming off a record year for FEI. During 2011, we experienced revenue growth of 30% and nearly doubled net income from 2010. This was driven primarily by strong demand for our products and a large backlog at the end 2010, which grew by over 20% from 2009. Looking forward to 2012, we expect growth to moderate as our backlog at the end of 2011 is lower than at the end of 2010, but still represents approximately six months of revenue at the current run rate.
Electronics revenue was up in 2011, despite the uncertainty in demand for some end user products made by semiconductor and data storage producers. We do not have a clear view of the semiconductor industry's prospects for all of 2012. Based on our current view, demand for the first half of 2012 is consistent with the levels achieved in 2011. We are attaining an increased share of overall spending by semiconductor customers as they invest in more advanced processes, which require more of our TEMs and DualBeams in particular.
We expect developing countries including China to drive 2012 sales growth in our Materials Science segment as these economies continue to invest in education infrastructure but at a slower pace than seen in 2011, offsetting potential weakness in Europe and the United States. We also expect the Materials Science segment to benefit from an increasing demand for our evolving line of Natural Resources product offerings.
As the use of electron microscopy in Life Sciences applications continues to grow, we expect continued growth in our Life Sciences segment in 2012, though at a somewhat slower pace than the growth experienced in 2011. In the second half of 2011, we signed collaborative agreements with the Oregon Health Sciences University and the National Institutes of Health. Both of those agreements are expected to contribute to the long-run growth of our Life Sciences business.
Our Service and Components business grows with the expansion of our installed base and is expected to continue that growth in 2012.
The acquisitions of TILL Photonics and ASPEX Corporation were strategic in nature and are not expected to have a significant impact on our earnings in 2012, although we estimate they will add approximately $25 million in revenue.
Our goal is to continue to increase our gross margin during 2012. In addition to increasing our proportion of higher margin products, we expect lower costs from increased production volume in the Czech Republic and continued sourcing improvements including the termination of a manufacturing services agreement in Hillsboro. The insourcing of these manufacturing operations is expected to reduce manufacturing costs by approximately $2 million to $3 million per year when fully implemented.
Operating expenses are expected to increase in 2012 due to the increase in staff in customer-facing parts of the company to manage our growth in 2011 and increased spend in research and development. We expect to continue to report a net expense for other income (expense), net, due to low market interest earned on our investments and the impact of currency costs. Global foreign exchange rates could have a significant impact on our results. In general, a stronger U.S. dollar compared with the euro will reduce our revenue growth rate and improve our operating income, while a weaker dollar has the opposite effect. We expect our overall effective tax rate to stabilize and we are estimating that it will be around 22% for 2012.
Electronics
The increase in Electronics gross margin in 2011 compared to 2010 was due primarily to increased demand for our higher-margin small DualBeams, as well as abnormally low gross margins in the prior year period as we worked through orders that were priced in late 2009 and early 2010 when we were under greater pricing pressure. We also realized product cost savings related to our consolidation of the manufacturing of our small DualBeam products at our Brno, Czech Republic facility. Currency fluctuations improved Electronics gross margin in 2011 compared to 2010 by 1.3 percentage points.
The increase in Electronics gross margin in 2010 compared to 2009 was primarily due to currency fluctuations, which increased the gross margin by 2.4 percentage points. In addition, we sold more of our higher-margin small DualBeam systems in 2010 compared to 2009 and faced less pricing pressure in 2010 compared to 2009 . These factors were partially offset by the shipment of orders in the first quarter of 2010 that were priced during the cyclical downturn in 2009 , which was a more competitive pricing environment. Later quarters of 2010 realized improved pricing as compared to 2009 as the sales priced during the more competitive environment of 2009 were shipped in previous quarters. Also offsetting the improvements in 2010 was a decrease in gross margin related to inventory adjustments to write down certain older inventory. These adjustments reduced gross margin by $1.0 million, or 0.5 percentage points.
Materials Science
The increase in Materials Science gross margin in 2011 compared to 2010 was primarily due to an increase in the number of small DualBeam and high-end TEM units sold, as well as growth in sales of our higher-margin natural resources products. We also realized product cost savings related to the consolidation of the manufacturing of our small DualBeam products and a portion of our mid-range TEMs at our Brno, Czech Republic facility. Currency fluctuations impacted Materials Science gross margin in 2011 compared to 2010 by a 0.9 percentage point increase .
Gross margins for Materials Science declined in 2010 compared to 2009 primarily due to a shift in product mix away from small DualBeam and higher-end TEM units. The decline in Materials Science gross margins was partially offset by the positive impact of currency fluctuations in 2010 compared to 2009 , which increased gross margins by 0.9 percentage points.
Life Sciences
The increase in Life Sciences gross margin in 2011 compared to 2010 was primarily due to an increase in the number of high-end TEM units sold. This was partially offset by currency fluctuations which increased Life Sciences gross margin in 2011 compared to 2010 by 0.8 percentage points.
Gross margins for Life Sciences improved in 2010 compared to 2009 due to increased sales of our higher-margin TEM products. Additionally, currency fluctuations increased Life Sciences gross margins by 1.1 percentage points in 2010 compared to 2009 .
Service and Components
The decrease in Service and Components gross margin in 2011 compared to 2010 was primarily due to an increase in employee incentive compensation. Currency fluctuations impacted Service and Components gross margin in 2011 compared to 2010 by a 0.1 percentage point decrease .
The increase in the Service and Components gross margin in 2010 compared to 2009 was primarily due to incremental contract revenue, as well as increased time and material sales as customers, primarily in the Electronics segment, prepare for increased demand and capacity improvements. In addition, a flat cost structure and operating efficiencies also contributed to the margin increase .
Selling, General and Administrative Costs
Selling, general and administrative (“SG&A”) costs include labor, travel, outside services and overhead incurred in our sales, marketing, management and administrative support functions. SG&A costs also include sales commissions paid to our employees as well as to our agents.
SG&A costs were $158.8 million ( 19.2% of net sales) in 2011 , $136.5 million ( 21.5% of net sales) in 2010 and $126.7 million ( 22.0% of net sales) in 2009 .
SG&A costs increased in 2011 compared to 2010 primarily due to increased commissions driven by the increase in revenue and increased employee incentive compensation, as well as an impairment charge of $1.4 million to write off the unamortized value of intellectual property and a $5.3 million charge for contingent litigation accruals. This activity was partially offset by a decrease in bad debt write-offs. In the first quarter of 2010 , we recorded a $2.1 million charge to fully write off amounts receivable from one customer. Currency fluctuations increased SG&A costs by $3.9 million in 2011 compared to 2010 .
The increase in SG&A costs in 2010 compared to 2009 was primarily due to increased internal and agent sales commissions, primarily in Asia, as revenue from Asia increased and the proportion of agent sales is larger in Asia than any other region. In addition, SG&A costs in 2010 included a $1.9 million increase in bad debt expense compared to 2009 for receivables owed to us by Cambridge Global Services. These factors were partially offset by lower legal and accounting costs and decreases in amortization of purchased intangible assets. Currency fluctuations decreased SG&A costs by $1.0 million in 2010 compared to 2009 .
Restructuring, Reorganization, Relocation and Severance
Manufacturing Transfer
In 2008 we entered into an arrangement to outsource aspects of our manufacturing processes. In 2011, we notified our largest contract manufacturer, accounting for approximately 10% of our revenue, that we plan to terminate the arrangement and to take over the manufacturing process. The termination contract was signed during the fourth quarter of 2011 and will be executed during the first quarter of 2012. We incurred $2.1 million of costs associated with the termination of the outsourcing arrangement.
The insourcing of our manufacturing operations is expected to reduce manufacturing costs by approximately $2 million to $3 million per year when fully implemented.
April 2010 Restructuring
On April 12, 2010, we announced a restructuring program to consolidate the manufacturing of our small DualBeam product line by relocating manufacturing activities currently performed at our facility in Eindhoven, The Netherlands to our facility in Brno, Czech Republic. The balance of our small DualBeam product line is already based in Brno. The move, which has been substantially completed, resulted in severance costs, costs to transfer the product line, costs to train Brno employees and costs to build-out the existing Brno facility to add capacity for the additional small DualBeam production. In addition to the product line move, the April 2010 restructuring plan involved organizational changes designed to improve the efficiency of our finance, research and development and other corporate programs and improve our market focus. Costs incurred in connection with this plan were related to the consolidation of the manufacturing of our small DualBeam product line in Brno.
Other Expense, Net
Other expense, net includes interest income, interest expense, foreign currency gains and losses and other miscellaneous items.
Interest income represents interest earned on cash and cash equivalents and investments in marketable securities and totaled $2.4 million in 2011 , $2.6 million in 2010 and $2.9 million in 2009 . The decrease in 2011 compared to 2010 was primarily due to lower market interest rates. The decrease in 2010 compared to 2009 was primarily due to the use of $10.9 million of cash for the repayment of debt in 2010 and lower market interest rates.
Interest expense for 2011 , 2010 and 2009 included interest expense related to our 2.875% convertible notes.
The amortization of capitalized note issuance costs related to our convertible note issuances is also included as a component of interest expense. Interest expense in 2010 and 2009 included $0.1 million and $0.3 million, respectively, related to the write-off of note issuance costs in connection with the early redemption of a total of $11.0 million and $15.0 million, respectively, of our 2.875% convertible notes.
Assuming no additional note repurchases, amortization of our remaining convertible note issuance costs will total approximately $0.1 million per quarter through the second quarter of 2013.
Other, net primarily consists of foreign currency gains and losses on transactions and realized and unrealized gains and losses on the changes in fair value of derivative contracts entered into to hedge these transactions.
Other, net in 2011 of $2.5 million expense resulted primarily from volatility in market exchange rates and increased volatility in our hedges.
Other, net in 2010 included a $0.1 million gain on the early redemption of a portion of our 2.875% convertible notes.
Other, net in 2009 included a $2.0 million gain on the early redemption of our 2.875% notes and a $1.3 million charge for cash flow hedge ineffectiveness, foreign currency gains and losses on transactions and realized and unrealized gains and losses on the changes in fair value of derivative contracts entered into to hedge these transactions.
Income Tax Expense
Our effective income tax rate of 15.6% for 2011 reflected taxes accrued in the U.S. and foreign jurisdictions, and included a $12.4 million benefit relating to an agreement with The Netherlands to tax profits from intellectual property at a reduced rate. This benefit was partially offset by an increase of unrecognized tax benefits for positions taken on current and prior year returns.
Our income tax benefit of $1.3 million in 2010 primarily resulted from benefits related to the release of valuation allowance recorded against U.S. deferred tax assets and liabilities for unrecognized tax benefits, offset by taxes accrued in both the U.S. and foreign tax jurisdictions.
In June 2010 , as a result of a mutual agreement between the U.S. and The Netherlands taxing authorities regarding various transfer pricing issues related to our operations, we released valuation allowance and tax reserves of approximately $47.9 million, of which $12.5 million was recorded as a benefit to shareholder’s equity. The remaining $35.4 million of tax benefit was offset by tax expense of $18.1 million to recognize the impact of our new transfer pricing methodology in prior periods.
Our effective income tax rate of 18.1% for 2009 reflected taxes accrued in foreign jurisdictions, reduced by a tax benefit of $3.9 million related to the release of valuation allowance recorded against net operating loss deferred tax assets utilized to offset income earned in the U.S. The tax rate also reflected the release of tax liabilities totaling $1.3 million due to the lapses of statutes of limitations and effective settlements with tax authorities.
Our effective tax rate may differ from the U.S. federal statutory tax rate primarily as a result of the effects of state and foreign income taxes, research and development tax credits earned in the U.S. and foreign jurisdictions, adjustments to our unrecognized tax benefits and our ability or inability to utilize various carry forward tax items. In addition, our effective income tax rate may be affected by changes in statutory tax rates and laws in the U.S. and foreign jurisdictions and other factors.
As of December 31, 2011 , total unrecognized tax benefits were $16.0 million and related primarily to uncertainty surrounding tax credits and permanent establishment. All unrecognized tax benefits would decrease the effective tax rate if recognized.
Our net deferred tax assets totaled $13.2 million and $8.4 million , respectively, at December 31, 2011 and 2010 . Valuation allowances on deferred tax assets totaled $2.2 million and $2.1 million as of December 31, 2011 and 2010 , respectively. We continue to record a valuation allowance against a portion of U.S. and foreign deferred tax assets, as we do not believe it is more likely than not that we will be able to utilize the deferred tax assets in future periods.
LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity and Capital Resources
Our sources of liquidity and capital resources as of December 31, 2011 consisted of $359.1 million of cash, cash equivalents, short-term restricted cash and short-term investments, $53.3 million in non-current investments, $43.7 million of long-term restricted cash, $100.0 million available under revolving credit facilities, as well as potential future cash flows from operations. $191.9 million of our $456.1 million in total cash, cash equivalents, restricted cash and investments, are held outside of the United States. Restricted cash relates to deposits to secure bank guarantees for customer prepayments that expire through 2016 .
We believe that we have sufficient cash resources and available credit lines to meet our expected operational and capital needs for at least the next twelve months from December 31, 2011 .
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Summary of Products and Segments
We are a leading supplier of instruments for nanoscale imaging, analysis and prototyping to enable research, development and manufacturing in a range of industrial, academic and research institutional applications. We report our revenue based on a market-focused organization: the Electronics market segment, the Research and Industry market segment, the Life Sciences market segment and the Service and Components market segment.
Our products include focused ion beam systems, or FIBs; scanning electron microscopes, or SEMs; transmission electron microscopes, or TEMs; and DualBeam systems, which combine a FIB and SEM on a single platform.
Our DualBeam systems include models that have wafer handling capability and are purchased by semiconductor and data storage manufacturers (“wafer-level DualBeam systems”) and models that have small stages and are sold to customers in several markets (“small-stage DualBeam systems”).
The Electronics market segment consists of customers in the semiconductor, data storage and related industries such as manufacturers of solar panels and light-emitting diodes. For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, the use of multiple layers of new materials such as copper and low-k dielectrics and increasing device complexity. Our products are used primarily in laboratories to speed new product development and increase yields by enabling 3D wafer metrology, defect analysis, root cause failure analysis and circuit edit for modifying device structures. In the data storage market, our products offer 3D metrology for thin film head processing and root cause failure analysis. Factors affecting our business include advances in perpendicular recording head technology, such as rapidly increasing storage densities that require smaller recording heads, thinner geometries and materials that increase the complexity of device structures.
The Research and Industry market segment includes universities, public and private research laboratories and customers in a wide range of industries, including automobiles, aerospace, forensics, metals, mining, oil and gas and petrochemicals. Growth in these markets is driven by global corporate and government funding for research and development in materials science and by development of new products and processes based on innovations in materials at the nanoscale. Our solutions provide researchers and manufacturers with atomic-level resolution images and permit development, analysis and production of advanced products. Our products are also used in mineral concentration analysis, root cause failure analysis and quality control applications.
Overview - Orders and Backlog
Orders received in a particular period that cannot be built and shipped to the customer in that period represent backlog. We only recognize backlog for purchase commitments for which the terms of the sale have been agreed upon, including price, configuration, options and payment terms. Product backlog consists of all open orders meeting these criteria. Service and Components backlog consists of open orders for service, unearned revenue on service contracts and open orders for spare parts. U.S. government backlog is limited to contracted amounts. In addition, some of the U.S. government backlog represents uncommitted funds. At October 2, 2011 , our total backlog was $440.1 million , compared to $471.9 million at December 31, 2010 . At October 2, 2011 , our backlog consisted of $348.2 million related to products and $91.9 million related to Service and Components compared to product backlog of $390.6 million and Service and Components backlog of $81.3 million at December 31, 2010 .
Customers may cancel or delay delivery on previously placed orders, although our standard terms and conditions include penalties for cancellations made close to the scheduled delivery date. As a result, the timing of the receipt of orders or the shipment of products could have a significant impact on our backlog at any date. Historically, cancellations have been low. However, in the last two years, this long-standing trend changed somewhat and, as a result, our cancellation rates may increase in the future. During the first thirty-nine weeks of 2011 and all of 2010 , we experienced cancellations or de-bookings of $0.4 million and $2.7 million , respectively. From time to time, we have experienced difficulty in shipping our product from backlog due to single-sourcing issues and problems in securing electronic components from a certain vendor. In addition, product shipments have been extended due to delays in completing certain application development, by our customers pushing out shipments because their facilities are not ready to install our systems and by our own manufacturing delays due to the technical complexity of our products and supply chain issues. A significant portion of our backlog is denominated in currencies other than the U.S. dollar and, therefore, our reported backlog fluctuates, to an extent, as a result of foreign currency exchange rate movements. For these reasons, the amount of backlog at any date is not necessarily indicative of revenue to be recognized in future periods.
Outlook for the Remainder of 2011
Our backlog of unfilled orders remains consistent with prior periods and our rate of incoming orders for the first three quarters of 2011 has been above the comparable period in 2010. As a result, we expect revenue levels in the fourth quarter of 2011 to be at or above the quarterly average of $204.5 million recorded in the first three quarters of the year, assuming relatively similar exchange rates. We expect revenue growth in the fourth quarter which should yield annual growth of approximately 30% for 2011 over 2010.
Gross margin was 44.5% in the first three quarters of 2011, an increase over 2009 and 2010 gross margins. Given relatively consistent exchange rates, we expect gross margin to be at approximately the same level in the fourth quarter of the year.
Research and development expenses are expected to increase in the quarter as we invest in new product development. Other operating expenses are also expected to rise compared with the third quarter.
As a result of these factors, we forecast full year earnings for 2011 to be above 2010 levels, and fourth quarter earnings to be approximately equal to third quarter earnings.
Critical Accounting Policies and the Use of Estimates
Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We believe the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain.
Management’s Discussion and Analysis and Note 1 to the Consolidated Financial Statements in our 2010 Annual Report on Form 10-K describe the significant accounting estimates and policies used in preparation of the Consolidated Financial Statements. Actual results in these areas could differ from management’s estimates. During the first thirty-nine weeks of 2011 , there were no significant changes in our critical accounting policies or estimates from those reported in our Annual Report on Form 10-K for the year ended December 31, 2010 , filed with the SEC on February 18, 2011 .
Electronics
The $12.6 million , or 28.7% , increase and the $62.8 million , or 44.2% , increase , respectively, in Electronics sales in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were primarily due to continued strong spending in leading edge technologies for development and the continued overall strength of the semiconductor and related markets. The volume of small DualBeam and wafer dual beam units sold in the first thirteen and thirty-nine weeks of 2011 increased compared to the same periods of 2010 primarily due to strong semiconductor capital equipment spending. In general, we see our customers' demand shifting to TEM-specific tools, which have higher resolutions, as the requirements to image on an increasingly small scale continue. Currency fluctuations increased Electronics sales by $1.9 million and $4.8 million , respectively, during the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 .
Research and Industry
The $23.3 million , or 45.5% , increase and the $65.1 million , or 48.2% , increase , respectively, in Research and Industry sales in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were primarily due to strong sales of our high-end TEMs as a result of increased spending in research markets. In general, we see customer demand shifting to buying more TEM-specific tools, which have higher resolutions, as the requirements to image on an increasingly small scale continue. The increase also reflects continued investment in education infrastructure in emerging markets in Asia as well as increasing demand for our evolving line of natural resources product offerings. Currency fluctuations increased Research and Industry sales by $3.6 million and $8.0 million , respectively, during the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 .
Life Sciences
The $11.9 million , or 65.4% , increase and the $24.0 million , or 42.2% , increase , respectively, in Life Sciences sales in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were primarily due to an increase in the number of high-end TEM units sold during the periods. Currency fluctuations increased Life Sciences sales by $2.1 million and $4.3 million , respectively, during the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 .
Service and Components
The $4.5 million , or 11.4% , increase and the $13.3 million , or 11.7% , increase , respectively, in Service and Components sales in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were due primarily to a larger install base. Currency fluctuations increased Service and Components sales by $2.0 million and $5.0 million , respectively, during the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 .
Electronics
The increases in Electronics gross margin in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were due primarily to increased demand for our higher-margin small DualBeams , as well as lower gross margin sales in the prior year period as we worked through orders that were priced in late 2009 and early 2010 when we were under greater pricing pressure. We also realized product cost savings related to our consolidation of the manufacturing of our small DualBeam products at our Brno, Czech Republic facility. Currency fluctuations impacted Electronics gross margin in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 by a 1.8 percentage point increase and a 2.1 percentage point increase , respectively.
Research and Industry
The decrease in Research and Industry gross margin in the thirteen week period ended October 2, 2011 compared to the same period of 2010 was primarily due to lower margins on TEM units sold. The increase in Research and Industry gross margin in the thirty-nine week period ended October 2, 2011 compared to the same period of 2010 was primarily due to an increase in the number of small DualBeam and high-end TEM units sold, as well as growth in sales of our higher-margin natural resources products. We also realized product cost savings related to the consolidation of the manufacturing of our small DualBeam products at our Brno, Czech Republic facility. Currency fluctuations impacted Research and Industry gross margin in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 by a 1.5 percentage point increase and a 1.7 percentage point increase , respectively.
Life Sciences
The increases in Life Sciences gross margin in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 were primarily due to an increase in the number of high-end TEM units sold. Currency fluctuations impacted Life Sciences gross margin in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the same periods of 2010 by a 0.9 percentage point increase and a 1.1 percentage point increase , respectively.
Service and Components
The Service and Components gross margin in the thirteen week period ended October 2, 2011 remained relatively consistent with the same period of 2010 . The decrease in Service and Components gross margin in the thirty-nine week period ended October 2, 2011 was due to increased costs in Japan as the work flow for our service employees in Japan was interrupted by the earthquake, tsunami and nuclear power plant crisis which occurred during the first quarter of 2011 . Currency fluctuations impacted Service and Components gross margin in the thirteen week period ended October 2, 2011 compared to the same period of 2010 by a 0.1 percentage point decrease and were insignificant in the thirty-nine week period ended October 2, 2011 compared to the same period of 2010 .
Selling, General and Administrative Costs
Selling, general and administrative (“SG&A”) costs include labor, travel, outside services and overhead incurred in our sales, marketing, management and administrative support functions. SG&A costs also include sales commissions paid to our employees as well as to our agents.
SG&A costs increased $4.7 million to $37.1 million ( 18.0% of net sales) in the thirteen week period ended October 2, 2011 compared to $32.4 million ( 21.2% of net sales) in the thirteen week period ended October 3, 2010 primarily due to increased commissions driven by our increase in revenue, and increased employee incentive compensation.
SG&A costs increased $12.0 million to $111.6 million ( 18.2% of net sales) in the thirty-nine week period ended October 2, 2011 compared to $99.6 million ( 22.2% of net sales) in the thirty-nine week period ended October 3, 2010 primarily due to increased commissions driven by the increase in revenue, and increased employee incentive compensation, partially offset by a decrease in bad debt write-offs. In the first quarter of 2010 , we recorded a $2.1 million charge to fully write off amounts receivable from one customer.
SG&A as a percentage of net sales decreased in the thirteen and thirty-nine week periods ended October 2, 2011 compared to the comparable periods of 2010 as a result of efficiencies gained as revenue increased at a faster rate than operating expenses. This was partially driven by the move of the small DualBeam product line to Brno, Czech Republic.
Restructuring, Reorganization, Relocation and Severance
On April 12, 2010, we announced a restructuring program to consolidate the manufacturing of our small DualBeam product line by relocating manufacturing activities currently performed at our facility in Eindhoven, The Netherlands to our facility in Brno, Czech Republic. The balance of our small DualBeam product line is already based in Brno. The move, which has been substantially completed, resulted in severance costs, costs to transfer the product line, costs to train Brno employees and costs to build-out the existing Brno facility to add capacity for the additional small DualBeam production. In addition to the product line move, the April 2010 restructuring plan involved organizational changes designed to improve the efficiency of our finance, research and development and other corporate programs and improve our market focus. Costs incurred in connection with this plan in the thirteen and thirty-nine week periods ended October 2, 2011 related to the consolidation of the manufacturing of our small DualBeam product line in Brno.
Income Tax Expense
Our effective income tax rate of 26.6% for the thirty-nine week period ended October 2, 2011 reflected taxes accrued in the U.S. and foreign jurisdictions. These amounts were partially offset by approximately $2.8 million of benefit related to additional tax credits generated in prior years.
Our income tax benefit of approximately $8.1 million for the thirty-nine week period ended October 3, 2010 primarily resulted from benefits related to the release of the valuation allowance recorded against U.S. deferred tax assets and liabilities for unrecognized tax benefits, offset by taxes accrued in both the U.S. and foreign tax jurisdictions.
In June 2010 , we received confirmation that the U.S. and The Netherlands taxing authorities had entered into a mutual agreement with us on various transfer pricing issues related to our operations. We had previously provided valuation allowances against U.S. deferred tax assets and tax reserves related to the uncertainty surrounding sources of future U.S. income and the outcome of the negotiations between the taxing authorities.
As a result of the mutual agreement, we released valuation allowance and tax reserves of approximately $47.9 million, of which $12.5 million was recorded as a benefit to shareholder's equity. The remaining $35.4 million of tax benefit was offset by tax expense of $18.1 million to recognize the impact of our new transfer pricing methodology in prior periods.
Our effective tax rate may differ from the U.S. federal statutory tax rate primarily as a result of the effects of state and foreign income taxes, research and experimentation tax credits earned in the U.S. and foreign jurisdictions, adjustments to our unrecognized tax benefits and our ability or inability to utilize various carry forward tax items. In addition, our effective income tax rate may be affected by changes in statutory tax rates and laws in the U.S. and foreign jurisdictions and other factors.
As of October 2, 2011 , unrecognized tax benefits totaled $16.3 million and related primarily to uncertainty surrounding transfer pricing, tax credits and permanent establishment. All unrecognized tax benefits would decrease the effective tax rate if recognized.
Our net deferred tax assets totaled $16.5 million and $8.4 million , respectively, at October 2, 2011 and December 31, 2010 . Valuation allowances on deferred tax assets totaled $1.9 million and $2.1 million as of October 2, 2011 and December 31, 2010 , respectively. We continue to record a valuation allowance against a portion of U.S. deferred tax assets, as we do not believe it is more likely than not that we will be able to utilize the deferred tax assets in future periods.
Liquidity and Capital Resources
Sources of Liquidity and Capital Resources
Our sources of liquidity and capital resources as of October 2, 2011 consisted of $354.0 million of cash, cash equivalents, short-term restricted cash and short-term investments, $40.2 million in non-current investments, $41.5 million of long-term restricted cash, $100.0 million available under revolving credit facilities, as well as potential future cash flows from operations. Restricted cash relates to deposits to secure bank guarantees for customer prepayments that expire through 2016 .
We believe that we have sufficient cash resources and available credit lines to meet our expected operational and capital needs for at least the next twelve months from October 2, 2011 .
In the thirty-nine week period ended October 2, 2011 , cash and cash equivalents and short-term restricted cash increased $15.6 million to $315.3 million as of October 2, 2011 from $299.7 million as of December 31, 2010 primarily as a result of $52.8 million provided by operations, $20.2 million of proceeds from the exercise of employee stock options and $3.5 million used for the net redemption of marketable securities. These factors were partially offset by repurchases of common stock of $50.0 million , a $0.2 million unfavorable effect of exchange rate changes and $9.1 million used for the purchase of property, plant and equipment.
In the thirty-nine week period ended October 3, 2010 , cash and cash equivalents and short-term restricted cash increased $115.9 million to $257.2 million as of October 3, 2010 from $141.3 million as of December 31, 2009 primarily as a result of $22.6 million provided by operations, $98.9 million from the redemption of auction rate securities, $5.3 million of proceeds from the exercise of employee stock options and the net redemption of $80.7 million of marketable securities. These factors were partially offset by $5.3 million used for the purchase of property, plant and equipment, $59.6 million of repayments on our UBS line of credit, $10.9 million used for the early redemption of $11.0 million par value of our 2.875% convertible subordinated notes and a $6.4 million unfavorable effect of exchange rate changes.
Accounts receivable increased $17.4 million to $200.7 million as of October 2, 2011 from $183.3 million as of December 31, 2010 . This increase was primarily driven by a corresponding increase in sales and was partially impacted by the timing of customer payments. The October 2, 2011 balance included a $0.3 million decrease related to fluctuations in currency exchange rates. Our days sales outstanding, calculated on a quarterly basis, was 89 days at October 2, 2011 and 90 days at December 31, 2010 .
Inventories increased $35.6 million to $191.6 million as of October 2, 2011 compared to $156.0 million as of December 31, 2010 , to support our planned ramp up of shipments in 2011 . The October 2, 2011 balance included a $0.1 million decrease related to fluctuations in currency exchange rates. Our annualized inventory turnover rate, calculated on a quarterly basis, was 2.3 times for the quarter ended October 2, 2011 and 2.4 times for the quarter ended October 3, 2010 .
Deferred tax assets, current and long term, net of deferred tax liabilities increased $8.1 million to $16.5 million as of October 2, 2011 compared to $8.4 million as of December 31, 2010 primarily due to an increase in deferred tax assets for tax credits.
Other current assets increased $8.3 million to $31.4 million as of October 2, 2011 compared to $23.1 million as of December 31, 2010 , primarily due to an increase in our current income taxes receivable.
Expenditures for property, plant and equipment of $9.1 million and transfers to fixed assets from inventories of $2.6 million in the thirty-nine week period ended October 2, 2011 primarily consisted of expenditures for demonstration systems and computer hardware and software. We expect to continue to invest in capital equipment, demonstration systems and R&D equipment for applications development. We estimate our total capital expenditures in 2011 to be approximately $20 million, primarily for the development and introduction of new products, demonstration equipment and upgrades and incremental improvements to our enterprise resource planning (“ERP”) system.
Accrued payroll liabilities increased $7.3 million to $39.1 million as of October 2, 2011 compared to $31.8 million as of December 31, 2010 , primarily due to accruals of employee incentive compensation.
Income taxes payable increased $22.4 million to $26.1 million as of October 2, 2011 compared to $3.7 million as of December 31, 2010 primarily due to accruals for U.S. and foreign taxes on current period income. Our receivable for income taxes of $7.2 million at October 2, 2011 is included as a component of other current assets.
Credit Facilities and Letters of Credit
We have a $100.0 million secured revolving credit facility, including a $50.0 million subfacility for the issuance of letters of credit. We may, upon notice to JPMorgan Chase Bank, N.A., request to increase the revolving loan commitments by an aggregate amount of up to $50.0 million with new or additional commitments subject only to the consent of the lender(s) providing the new or additional commitments, for a total secured credit facility of up to $150.0 million . There were no amounts outstanding under this facility as of October 2, 2011 .
We also have a ÂĄ50.0 million unsecured and uncommitted bank borrowing facility in Japan and various limited facilities in select foreign countries. No amounts were outstanding under any of these facilities as of October 2, 2011 .
We mitigate credit risk by transacting with highly rated counterparties. We have evaluated the credit and non-performance risks associated with our lenders and believe them to be insignificant.
As part of our contracts with certain customers, we are required to provide letters of credit or bank guarantees which these customers can draw against in the event we do not perform in accordance with our contractual obligations. Restricted cash balances securing bank guarantees that expire within 12 months of the balance sheet date are recorded as a current asset on our consolidated balance sheets. Restricted cash balances securing bank guarantees that expire beyond 12 months from the balance sheet date are recorded as long-term restricted cash on our consolidated balance sheet.
CONF CALL
Fletcher Chamberlin
Thank you, Douglas. 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 Chief Financial Officer.
We’ve again posted some slides under Events & Presentations in the Investor Relations part of our website, www.fei.com. We will refer to these slides during today’s call. We hope having these slides will make it easier for you to listen to our comments rather than just focusing on getting the numbers recorded.
While you are pulling up the slides and before we get to the presentations, we also have the regular housekeeping matters to address. This call contains forward-looking statements. To the extent that we discuss expectations of our future corporate financial performance and goals, future customer orders, performance by product in the market, the outlook for margins and revenue, market developments and opportunities, future product and technology developments, the effects of future movements in exchange rates, future hiring plans, expected government spending for research tools, expected tax rate and 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 with this call and in FEI’s most recent 10-K, 10-Q and 8-K documents and other filings with the SEC. Investors are urged to read these documents. Copies of the SEC filings are available free of charge on the commission’s website at sec.gov, 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 corporate website at www.fei.com.
I’ll now turn the call over to Don for a review of our execution against our strategies, a view of our markets and the business environment and then Ray will go through the numbers in detail.
Raymond A. Link
Thank you, Fletcher. Good afternoon everyone. 2011 was a transformational year for FEI. Successful execution of our strategy generated record revenue earnings and cash flow. In 2012 we plan to continue investing to further our growth to expand our margins and to effectively use our cash. For the year revenue grew 30%, gross margin increased by 200 basis points, operating margins increased by 670 basis points, net income group by 94%, and cash flow from operations grew by 35%.
Since 2006 revenue has grown at a compound annual growth rate of 12% per year, essentially all organically. Gross margin has grown by 350 basis points. Operating margin has increased by over 1000 basis points. Net income is up over five times and cash flow from operations is up over four times.
We finished the year with a strong fourth quarter. Revenue was up 14%. GAAP earnings were up 36% and non-GAAP earnings were up 19% from last year’s strong fourth quarter. Ray will provide all the details in a moment.
Last June, we outlined our strategic plans to continue our growth by doubling our served available market by 2014. Indeed we expect all of our markets to grow. But in addition we seek the opportunity to expand it to market served by adjacent technologies. In particular we identified opportunities in life sciences and natural resources that are outside of our traditional electron microscopy market. We’ve taken important steps in the last few months toward executing our plan.
In life sciences our strategy has two components, structural biology and cell biology. We have established an important collaboration in each area. In cell biology, the living lab with Knight Cancer Institute at Oregon Health Sciences University was announced in September.
In structural biology we have signed a cooperative research and development agreement in December with the National Institutes of Health. Under this agreement our team will be working together with NIH experts in adjacent technologies to target important scientific discoveries that could be used in electron microscopy.
These agreements are important investments in our life sciences strategy and are a foundation for future growth. We added another key building block in November with the acquisition of TILL Photonics of Munich, Germany. TILL gives us the performance light microscope component of our correlated microscopy solution, the seamless combination of light and electron microscopy.
FEI now owns the critical components of our cell biology strategy. In aggregate FEI has made substantial progress in expanding our served available market in life sciences.
In natural resources we announced our WellSite solution for service logging for conventional wells and the completion of joint development agreements in Papua New Guinea with Halliburton and in the Persian Gulf with Maersk Oil. We continue our third development with GEOLOG in Europe with the program that is targeted at applications in shale.
In January, we also acquired the hardware manufacturer for the WellSite product, ASPEX Corporation of Pittsburg, Pennsylvania. The ASPEX’s extreme product is a robust and rugged SEM that forms the microscope part of the WellSite solution. 2012 is the year of commercialization of our WellSite solution.
We also announced the introduction of our MAPS software which allows numerous high-resolution microscope images to be fixed together into a larger field of view and allows one to easily navigate to and zoom into a particular section of an image. The MAPS software is a key component in workflow solutions in Life Sciences and natural resources where large field high-resolution data sets are required.
FEI continues as a technology leader in electron microscopy at software, particularly the manipulation and analysis of large three dimensional data sets is growing in importance in our workflow solutions for these markets.
Turning now to slide four and the bookings for the fourth quarter in each of our markets, the largest segment this quarter was Electronics at $72.5 million, up 80% from the third quarter and near the record set in last year’s fourth quarter.
Orders were over $250 million for the year. The key semiconductor customers expanded their investments for new notes containing finer features, new materials and more complex structures. Business from data storage customers was good in the fourth quarter after being almost non-existent in prior quarters. We expect bookings for electronics to remain strong in the first half of 2012 as leading semiconductor customers invest further.
The second largest segment in the fourth quarter was Material Science. We have changed the name of this segment from Research and Industry to better reflect what our customers in this segment do. The segment also includes our emerging natural resources business. Material Science bookings were down modestly from the third quarter and last year’s fourth quarter. Business continued to be particularly strong in Asia with weakness in the U.S. Material Science service from China were at record levels and greater than orders from United States for the quarter and for the full year. We also saw strength in Korea and Brazil.
For the year, bookings in our Material Science segment were up 15% to an all-time record. Bookings for natural resources were up over 40% for the year and 30% from a strong fourth quarter a year ago, both records. The bulk of the business has come from mining companies with no contribution at this time from the WellSite product.
We continue to see laboratory business from oil and gas companies, especially related to unconventional sources. Life Science’s booking is at $19.5 million in the quarter were down from last year and the third quarter. As we have said in the past this segment can be variable in its bookings pattern because of the large size of individual orders. We remain very positive about the prospects for our Life Sciences business, especially in the context of the strategic announcements I mentioned earlier. Orders were flat from year-to-year as the next set of adopters in our pipeline and we expect strong Life Sciences bookings in the first half of 2012.
Fourth quarter bookings for service and components were also down slightly from the third quarter and last year. For the year, service and components bookings were up 6% in line with our expectations. We expect a normal sequential increase in service bookings in the first quarter as the number annual contracts are renewed early in the year.
Looking at geographic bookings on slide five, we had another very strong quarter in Asia including Japan which strengthened Electronics and Material Science. Asian bookings made up a record 51% of the total. They were up 55% from the third quarter and up 33% from last year’s fourth quarter. Bookings for the year from China were up 24% over 2010, making it our second largest country market in each of the last two years.
Geographic diversity remains strong with orders totaling more than $2 million or more from 15 different countries in the quarter. On the year, records were set in Asia as well as in Europe supported by strength in Eastern Europe.
With that, I’ll turn the call over to Ray for a review of the fourth quarter number and then I’ll close the call with some comments on our outlook.
Raymond A. Link
Thanks, Don. There are a number of moving parts in the quarter and I’ll go through them in detail. It was another good quarter. Looking first at slide six, you can see revenue at $213 million was the highest for any quarter in our history. Bookings were above our guidance both before and after the adjustments to the backlog for currency movement. GAAP earnings were well ahead of guidance and non-GAAP earnings were right in the middle of guidance and cash flow from operations was very strong once again. We have now reported 23 consecutive quarters of GAAP profit demonstrating consistency over the long term.
Gross bookings for the quarter at constant currency rate from the end of Q3 were $212 million and net bookings including the downward revaluation of the backlog at quarter end currency rates were $203.6 million, up 9% from Q3 net order total. At the end of Q4, the euro was $1.29 compared to $1.34 at the end of Q3. The weaker euro reduces the value of our euro denominated backlog when converted back to dollars. The back log at the end of the quarter was $430.7 million and represents approximately six months of revenue at our current run rate.
Moving to slide seven, fourth quarter revenue was up 14% from a year ago and 4% in the third quarter. Sequential revenue growth was reduced by another $5.6 million due to currency movements during the quarter. Revenue growth was driven by our Material Science segment which was up 23% sequentially and 94% from last year’s fourth quarter. The natural resources part of this segment more than doubled for both the fourth quarter and the full year and the scientific research part was also up substantially.
The electronics revenue for the fourth quarter of $54.8 million was down 3% from the third quarter as we had expected. The book-to-bill ratio for electronics was 1.32 to 1, and we expect revenue growth for this segment in the first quarter of 2012.
Life Science’s Q4 revenue was down sequentially from the record level in the third quarter, but up 24% from last year’s fourth quarter. Life Science’s revenue for the full year was over $100 million for the first time and was up 38% from 2010.
Service and components revenue was up 10% for the fourth quarter compared with last year and 11% for the full year. That’s the best annual growth we have seen in that segment in the past decade.
Turning to slide eight, our revenues for the quarter are well balanced geographically. Asia and Japan made up 40% of revenues in the quarter, Europe and the Middle East made up 32%, and North America made up 28%.
Now looking at slide nine, gross margin in the quarter was 44.4%, in line with the third quarter and our expectation. We are pleased with that performance in light of its significant mix shift in the quarter. Our electronics business made up only 26% of revenue in this year’s fourth quarter compared with 43% in the fourth quarter a year ago.
The currency higher volume, improved service margin, and continued gains from our expanded manufacturing in the Czech Republic helped gross margins in the latest quarter offsetting the significant mix shift. Gross margin in the first quarter of 2012 is expected to improve from the Q4 levels and we believe we are on track to reach our stated goal of a 47.5% gross margin in the fourth quarter of 2012.
Turning to slide 10 and moving down the income statement, operating expenses are a bit complex. Total expenses on a GAAP basis were $70.8 million. That includes $8.8 million of expenses for unusual items in the fourth quarter. Those items include $5.3 million for our estimates to settle a long running patent dispute and $1.4 million to write down the value of certain intangible assets due to a change in our technology roadmap.
These two charges are included in SG&A expenses. Restructuring expenses totaled $2.1 million and relate to an early termination of a manufacturing service contract at our Hillsborough facility. We expect that termination to contribute to gross margin improvement in the second half of 2012. Without these items SG&A expense would have been $40.4 million. Total operating expense would be $62 million and restructuring expense would have been zero.
Reported GAAP operating income for the quarter was $23.7 million excluding the items I just discussed non-GAAP operating income would have been $32.6 million. Non-operating expense was $2.5 million in the fourth quarter compared with a $600,000 loss in the third quarter and in last year’s fourth quarter. The unusual volatility in currency rates during the quarter caused larger than normal balance sheet translation losses. On a GAAP basis we recorded a net tax benefit in the quarter of $ 7.8 million.
During the quarter we received permission from the Dutch tax authorities to apply their Innovation Box tax treatment to an income attributable to intellectual property for our Dutch operations. An important benefit of the innovation batch approval is that we now expect our overall tax rate during 2012 to be approximately 22% compared with around 27% prior to the approval.
Adjusting for the benefit from the Innovation Box for periods prior to the fourth quarter of 2011 and applying an appropriate tax expense to the operating expense adjustment mentioned previously, yields of non-GAAP tax expense was $4.7 million for the fourth quarter. GAAP net income was $29.1 million or $0.72 per share. After the excluded items and a tax impact, non-GAAP income was $25.4 million or $0.63 per share in the middle of our guidance range. The weighted average shares for diluted EPS in Q4 was $41.3 million, a decrease of 2% in Q3 and 3% in Q2 as a result of our share repurchases during the third quarter. We do not buy shares in the open market and the fourth quarter.
As you can see on slide 11, our balance sheet and cash flow remain very strong. Total cash and investments at the end of the quarter included restricted cash in long-term investments was $456.1 million, up $20.4 million from the end of the third quarter. That’s after spending $14 million to purchase TILL Photonics.
Net cash after subtracting debt was $367.1 million, up $32.3 million since the beginning even after the TILL acquisition and the purchase of $50 million of shares in the third quarter. Net cash at the end of the quarter was $9.70 per share.
Cash flow from operating activities was $48.6 million in the fourth quarter and over $100 million for the full year. Free cash flow after subtracting net capital expenditures was $87.6 million or $2.31 per share. Day’s sales outstanding were at the lowest in a decade and inventory turnover improved in the quarter.
With that, I’ll turn the call back to Don for guidance and comments about the outlook.
Don R. Kania
Thanks, Ray. Slide 12 is a summary of our guidance for the first quarter of 2012. We expect revenue to be in the range of $210 million to $220 million. Bookings are expected to be at least $210 million, which if achieved will be a record for our first quarter. Earnings per share expected to be in the range of $0.60 to $0.65.
After transformative growth in 2011, we expect FTI to organically grow in 2012. The acquisitions of TILL and ASPEX are strategic in nature and will not have a significant defect on the bottom line. Both add approximately $25 million in annual revenue. Electronics will continue to increase its share spend by our customers, Material Science will be okay with potential weakness in the U.S. and parts of Europe offset by continued global investment.
Natural resources will continue its penetration in the labs of mining and oil and gas companies and we’ll see its first revenue from the WellSite solution. Life Sciences will continue the growth we have seen already and will begin to reap the benefits of our living lab investments. We are on track to reach our goal of our gross margin of 47.5% by the fourth quarter of 2012. In addition to increasing our proportion of higher margin products, we expect lower costs from increased volume from the Czech Republic, continued sourcing improvement and the end of manufacturing services agreement in Hillsborough.
Our plan is to continue growth, improve margins and generate cash. For the cash in our balance sheet, we will continue to target M&A and be opportunistic buyers of our stock. I am proud of the entire FTI team and the leaders we have assembled to deliver the excellent results in 2011. We are again planning a New York Investor Day this spring when you will have an opportunity to meet more members of the management team and learn more about our strategies for growth and margin improvement. The meeting will be on June 7 and you will receive an invitation shortly. We hope to see you there.
With that operator, we are ready for questions.
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Fund Letters
