HILLSBORO Oct 28, 2015 (Thomson StreetEvents) -- Edited Transcript of FEI Co earnings conference call or presentation Tuesday, October 27, 2015 at 9:00:00pm GMT
TEXT version of Transcript
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Corporate Participants
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* Jason Willey
FEI Company - Director of IR
* Tony Trunzo
FEI Company - EVP & CFO
* Don Kania
FEI Company - President & CEO
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Conference Call Participants
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* Tycho Peterson
JPMorgan - Analyst
* Patrick Ho
Stifel Nicolaus - Analyst
* Amanda Murphy
William Blair & Company - Analyst
* Weston Twigg
Pacific Crest Securities - Analyst
* Jim Ricchiuti
Needham & Company - Analyst
* Derik de Bruin
BofA Merrill Lynch - Analyst
* David Duley
Steelhead Securities LLP - Analyst
* Mark Miller
Benchmark Capital - Analyst
* Isaac Ro
Goldman Sachs - Analyst
* Jairam Nathan
Sidoti & Company - Analyst
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Presentation
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Operator [1]
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Greetings, and welcome to the FEI third-quarter 2015 earnings conference call.
(Operator Instructions)
As a reminder, this conference is being recorded. I would now like to turn the conference to your host, Mr. Jason Willey, Director of Investor Relations. Thank you, you may begin.
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Jason Willey, FEI Company - Director of IR [2]
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Thank you, and good afternoon, everyone. As Matt said, I am Jason Willey, FEI's Investor Relations Director. With me today at our headquarters in Oregon are Don Kania, our President and CEO; and Tony Trunzo, EVP and CFO. We have again posted slides under events and presentations in the investor relations portion of our website. Before we get to the presentation, we would like to remind everyone this call contains forward-looking statements that include guidance for revenue and earnings per share for the fourth quarter of 2015 and full-year 2015. To the extent that we discuss expectations about future orders, revenue growth, the timing of orders in revenue, gross margins, expenses, capital spending, or our tax rate and earnings, those statements are considered forward-looking and are subject to risks and uncertainties that could cause our actual results to differ from forward-looking statements made.
Risk factors that could affect these forward-looking statements are cited in today's press release in the slides posted for this call and in FEI's most recent 10-K, 10-Q, 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 FEI's Investor Relations Department at 503-726-2533. The Company assumes no duty to update forward-looking statements set out in these documents or made on this call. This call is the property of FEI Company. It will be archived in the investor relations section of our corporate website at www.FEI.com. I will now turn the call over to Tony to go through the financials. Don will then discuss our business and outlook. We will then be glad to take your questions.
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Tony Trunzo, FEI Company - EVP & CFO [3]
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Thank you, Jason, and good afternoon, everyone. As Jason mentioned, we posted slides on our website that provide additional detail on our financial performance for the quarter as well as our proposed acquisition of DCG Systems. Our third-quarter revenue was below the expectations we communicated on our Q2 call. This shortfall is primarily attributable to lower than expected revenue from our large semiconductor customers as the industry experiences a pause as it transitions nodes. Our science business was above our expectations in Q3 but was not able to offset the softness in industry. As a result, we saw lower than expected revenue which resulted in earnings below our guided range despite better gross margin and continued careful expense management. Our operating cash flow remained a solid $46 million in Q3. And year-to-date cash from operations of $135 million is up 86% with the comparable period in 2014. We returned $55 million in cash to shareholders in the form of dividend and share repurchases during the quarter.
Earlier today, we announced an agreement to acquire DCG Systems, a leading private company providing electrical failure analysis solutions to the semiconductor market for $160 million in cash. DCG generated $76 million of revenue in its fiscal year ended January 31, 2015, and has a gross margin profile similar to FEI's semiconductor business. We expect the deal to close by the end of 2015 pending regulatory approval and to be slightly accretive to our 2016 GAAP earnings per share. We will provide more color on DCG's contribution to our 2016 financial results when we report Q4 earnings and provide our full-year 2016 outlook in February. Returning to our Q3 results, revenue in the quarter was $213 million, down 2.4% on an organic basis compared with the third quarter of 2014. Revenue in Q3 was negatively impacted by approximately $10 million due to the stronger US dollar with the largest effect in our science segment.
Science posted Q3 revenue of $107 million, down 4.5% on an organic basis compared with last year as revenues declined slightly in each of our three major geographic regions. Our industry segment reported revenue of $105 million, essentially flat with last year's third quarter on an organic basis. At our semiconductor customers, contributions from smaller regional accounts helped offset slow activity from large customers. Overall, semiconductor revenue was approximately $10 million lower than what we expected entering the quarter. The current slowdown in orders and revenue is directly related to the slower than expected transition to 10 nanometer production. We expect this dynamic to persist into the first part of 2016, but it does not impact our view of the long-term market growth opportunity for FEI as we continue to invest in innovative solutions for our semiconductor customers.
Service revenue grew 11% on an organic basis in Q3 compared with the comparable period in 2014. Both of our business segments saw revenue and gross margin expansion in service. We view service as a strategically important source of recurring revenue with consistent growth and good margin, and we intend to continue investing in these offerings and capabilities moving forward. Gross margin in the quarter was 49.1% compared with 47.7% a year ago. The primary drivers of the increase were foreign currency movements and improved service margin in both of our science and industry segments. In Q3, we had two large unusual items that had a meaningful net negative impact on our earnings. We booked a $24 million after-tax impairment of goodwill and long-lived assets associated with our oil and gas business. The impairment reflects the effect of lower oil prices and the resulting impact on FEI's near-term opportunity in this market. The impairment had a $0.58 negative impact on Q3 earnings per share.
The secondary of impact relates to a tax benefit arising from the recognition of previously uncertain tax positions. This benefit reduced our reported tax expense for Q3 by $6.1 million or $0.15 per share. Our normalized tax rate for Q3 excluding these benefits was approximately 20%. Together, the asset impairment and tax items reduced our third-quarter earnings per share by $0.44. Our operating expenses remained well-controlled in the period. Expenses, excluding the asset impairment in restructuring related items, were $67 million in Q3 compared with $75 million in Q3 of 2014 and $66 million in the second quarter of this year. We remain focused on cost containment while continuing to make the necessary investments to position the Company for long-term growth. Q3 cash flow from operations was $46 million, and we ended the quarter with $500 million in cash and investments.
During the quarter, we paid dividends of $12 million and repurchased 545,000 shares of our common stock at an average price of $77.41 per share. At the end of Q3, we have repurchased an additional 300,000 shares at an average price of $74.96 per share. Year to date, we have repurchased over 1.2 million shares and have 1.1 million shares remaining under our current buyback authorization. These capital return activities and our proposed acquisition of DCG speak to the commitment we made it our June investor event to return a meaningful amount of free cash generation to shareholders while targeting strategic acquisitions. With that, I'll turn the call over to Don for his comments.
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Don Kania, FEI Company - President & CEO [4]
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Thank you, Tony, and good afternoon, everyone. Our science business performed ahead of our expectations in Q3 but the slowdown in the semiconductor market yielded revenue before below forecast. Bookings followed an identical pattern to revenue in Q3 and were $234 million yielding a book-to-bill ratio of 1.1 to 1. On an organic basis, orders were down 8.9% compared with the third quarter of 2014. We saw a pick-up in science orders and slower demand for our large semiconductor customers. Science orders were driven by continued strong demand for cryoEM solutions for structural biology and continued improved activity from material science customers compared with the first half of 2015. We exited Q3 with the backlog of $562 million, up 4.3% compared with Q3 of 2014. Industry orders were down 26% on an organic basis from the record of Q3 2014.
We are seeing slower activity from our largest semiconductor customers as they work through their timing of their 10 nanometer ramp. This dynamic negatively impacted our Q3 orders in revenue and will negatively impact Q4 as well. The impact is most evident in our near-line solutions which are often sold in bundles for in excess of $10 million each. As we have highlighted, our near-line solutions are more closely tied to volume manufacturing and the timing of specific customer projects. As we look past the current market conditions, we remain confident in the expanding role and market leadership of both our lab and near-line solutions as they enable customers to tackle increasing complexity of design and manufacturing at smaller nodes. Our confidence in the market opportunity is reflected in our decision to expand our semiconductor offering with the acquisition of DCG.
In the failure analysis market, FEI's position has focused on physical failure analysis. The DCG acquisition will add electrical failure analysis to our lab portfolio, and like FEI, DCG is a market leader in its space. Electrical failure analysis is a key part of helping semiconductor customers identify and characterize critical process defects. DCG brings to FEI optical, thermal, and nano-probing solutions that often fit adjacent to FEI's physical failure analysis tools in the semiconductor lab workflow. We see the combined offering providing significant time to data and efficiency advantages for our customers who are seeing increasing physical and electrical defect challenges as nodes shrink below 14 nanometers. The transaction will solidify and expand FEI's position as a leading provider of defect solutions within the less cyclical semiconductor lab.
Spending in oil and gas industry continues to adjust the significantly lower commodity prices, which as Tony mentioned, cause a reevaluation of the carrying value of our assets in our oil and gas business. In Q3, we saw another quarter of improved activity with significantly higher bookings compared with Q3 of 2014. During the quarter, we closed a significant transaction with the University of Wyoming consisting of Digital Rock software and equipment that included multiple units of our new helical scan microCT tool. These solutions will help researchers gain insight into multi-phase flow in unconventional and conventional oil and gas reservoirs. We are concentrating our sales and marketing efforts on national oil companies, particularly in the Middle East. This segment of the market continues to make investments as they keep their production levels high. As a result, we see a growing pipeline of software and services opportunities.
We have multiple ongoing Digital Rock Services projects in the region, each with the potential for significant expansion in 2016. Science bookings were up 16% on organic basis compared with Q3 of 2014 and up significantly from the beginning of the year. We see this order momentum continuing into Q4 driven by both material science and life sciences customers. We continue to build backlog in this business with a growing content of high-end tools. These high-end tools tend to have slower conversions from bookings to revenues as customer facility improvements are typically required. At our material science customers, we see strength in the United States while the pace of activity in certain Asian and European markets remain slow. China continues to show improvement as we received another multi-tool order from a major university.
Along with the strength in high-end tools, we are seeing good traction with our newer products -- newer product offerings including our Halo mid-range TEM and Teneo SEM. The structural biology community continues to embrace electron microscopy as an important tool for resolving critical questions around protein structure. Our customers continue to publish important new results highlighting the unique capabilities of cryoEM. Recent publications of note include a high resolution structure of the spliceosome at 3.6-angstroms from Tsinghua University and the editorial article in Nature entitled -- The Revolution Will Not Be Crystallized, describing the revolutionary impact of cryoEM on structural biology. Publications of this kind are a key catalyst for market expansion as customers and their funders pursue approvals to fund new tools.
Following record life sciences customer orders in Q2, we had another strong quarter including a second order from a pharma company. We are encouraged by the accelerating interest from this industry. There are ongoing discussions about creating an industry funded consortium for cryoEM in both Europe and the United States. We believe these consortiums will play a valuable role in defining the important pharma problems that cryoEM can solve. We seek consortiums of academic pharma and FEI as the key step to expand cryoEM beyond the academic market. In addition to ongoing activity in the US and Europe, we expect China to strategically expand its investment in cryoEM as they focus on developing a pharma industry and associated enabling science capabilities.
North American orders for the third quarter were up 11% year over year driven by significantly higher activity from our science customers. Orders in Europe were down 17% year over year reflecting the weak euro. Asia declined 28% year over year with weakness in both industry and science markets. We continue to see improved activity levels in China compared with last year as transaction processes are running at a smoother pace than we saw through much of 2014. Moving to our guidance for the fourth quarter, we expect revenue to be in the range of $260 million to $275 million, which implies an organic revenue growth of 2% to 7.5% compared with Q4 of 2014. This includes our view of continued softness in our semiconductor business reducing revenues from our previous expectations. Assuming a tax rate of approximately 20%, EPS for Q4 is expected to be in the range of $1.05 to $1.20, a record result for the Company.
For the full-year 2015, we expect organic revenue growth to be in the range of 1% to 2.5% compared with 2014. GAAP EPS for 2015 is expected to be in the range of $2.85 to $3 per share. This range includes the Q3 asset impairment expense and tax benefit which in aggregate reduced full-year EPS by $0.44. In summary, in Q3 we had good performance throughout the business with the exception of slower activity at our semiconductor customers. We expect the continuation of these general trends in Q4 with expanded contribution from our science group driving record earnings in the fourth quarter.
We are focused on executing on the capital allocation plan we outlined at our June investor event. In the third quarter, we stepped up our return of capital to shareholders and today announced our acquisition of DCG, expanding our semiconductor lab footprint by adding a leader in electrical failure analysis. We have begun our 2016 planning process and remain on track to deliver on more timed long-term objectives for operating margin, earnings growth, and return on equity when we report our Q4 results in early 2016. With that operator, we are now ready for questions.
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Questions and Answers
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Operator [1]
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(Operator Instructions)
Our first question comes from the line of Tycho Peterson from JPMorgan.
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Tycho Peterson, JPMorgan - Analyst [2]
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Hello, thanks. Don, I'm wondering if you can maybe just talk a little bit on the outlook on the semi side and maybe go back to the beginning of this year. Obviously, there was a hope for some improvement in the back half of the year. Maybe just talk about your thoughts going forward here, how long you think things remain depressed on that side.
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Don Kania, FEI Company - President & CEO [3]
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It's clearly a pause and not with classic cyclical downturn in the transition from 14, 17 to 10 nanometers. And as we watch that play forward and we look into 2016, we've identified multiple significant investments by our customers that need to happen within that timeframe. The timing is going to be uncertain by a few quarters and where we stand today, we're probably tickling the bottom in three and four here, and probably should see some minor improvement in the new year but when things really pick up, it's difficult to make the call on right now. So I think we're just going to have to stay tuned a little bit longer on that front.
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Tycho Peterson, JPMorgan - Analyst [4]
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Okay. If we think about next year, you've put out 5% to 9% long-term growth targets at the analyst day. You're coming off two years of 1% to 3% growth. Can you maybe help us build the case for the acceleration next year?
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Don Kania, FEI Company - President & CEO [5]
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Well I think clearly in the science side, we've got accelerating in material science and life sciences in the orders up 16% year on year, a good thing that's been happening. Even oil and gas showed improvement this quarter accelerating orders year on year as well. I think the other piece of the puzzle is we expect strength next year. It's just a question of timing in semiconductor. As you add those up, we have the opportunity to have strong growth, and I don't think I'll comment any deeper than that. Looking back on this year right now, if you listen to our talk through, basically $30 million to $40 million moved out of the year which represents 3% to 4% of growth because of the slowdown in semi so you add that back in to where we're at, you're kind of in range. That's just the arithmetic. The fact of the matter is the semi slowed down. Our market position hasn't changed one bit. And we'll just let that flow into 2016.
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Tycho Peterson, JPMorgan - Analyst [6]
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And then just one last one on semi. With DCG, you're increasing your exposure there. I guess why increase the exposure to the cyclical part of the business or is that a less cyclical asset that you're tacking on?
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Don Kania, FEI Company - President & CEO [7]
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It's actually a less cyclical asset. It's a laboratory-based asset similar to where we were before near line. And going back to that comment about semi coming up short in 2015, our view is we had forecasted some near-line tool activity, so let's call it $40 million, represents four tool sets that didn't flow through the system this year. DCG laboratory base is right next to our stuff. We see some great opportunities to link up the data flows for those in the workflows. They're a market leader. We're a market leader. It's the right thing to do and it will have great returns for the Company. So the right thing for us to do to improve the financial performance overall.
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Tycho Peterson, JPMorgan - Analyst [8]
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Okay. Thank you.
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Operator [9]
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Our next question comes from the line of Patrick Ho from Stifel.
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Patrick Ho, Stifel Nicolaus - Analyst [10]
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Thank you very much. Don, maybe just related first on the semiconductor side of things, and I think clearly the weakness on the foundry side. Bigger picture, how do you see advancements for your near-line workflow solution from memory customers particularly as that industry transitions to 3D nan?
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Don Kania, FEI Company - President & CEO [11]
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Clearly, everybody who is either in the transition or attempting manufacturing for 3D is either testing or utilizing our near-line workflows. So I would argue generally seen as important to critical for both development and more and more required in manufacturing to make those processes work effectively in the factory. So it's a little bit behind the transitions that we've seen on the logic side but everybody who's doing it is an FEI customer.
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Patrick Ho, Stifel Nicolaus - Analyst [12]
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Great, that's helpful. And maybe my follow-up question also on the semiconductor side. With your acquisition of DCG, is that primarily a target for -- or the acquisition rationale a target for the advanced packaging market particularly as a lot of those applications start to gain traction over the next several years?
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Don Kania, FEI Company - President & CEO [13]
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That's a piece of the puzzle that we obviously didn't refer to in the discussion of the acquisition but yes, there's a piece there and clearly over time, we've seen the complexity in semiconductor manufacturing continue to push further down the chain, and DCG brings some great capabilities around packaging opportunities in the relatively near term. And so that would be something quite new for FEI.
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Patrick Ho, Stifel Nicolaus - Analyst [14]
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Great. Thank you very much.
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Operator [15]
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Our next question comes from the line of Amanda Murphy from William Blair.
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Amanda Murphy, William Blair & Company - Analyst [16]
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Hello, good afternoon, guys. Just a question on the semi side perhaps for us non-semi folks. Could you just give us, taking a step back kind of frame out the issues in terms of moving to 10 nanometers. I'm assuming there is CapEx issues but is there anything sentimental that's driving delays to get a sense of the major puts and takes there. And then my second question to you is, I think last quarter you had some good results in memory, so can you help us think about memory this quarter relative to logic how that side performed?
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Don Kania, FEI Company - President & CEO [17]
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In our view, there's two pieces of the puzzle on the semiconductor market and its transition to 10 nanometer. There's an economic piece, which is the amount of capital investment that the semiconductor manufacturers are willing to make and balance that, and there are certain companies I think are paying far more attention to their balance sheets now than they have traditionally and slowed their transition. And there is a technical aspect of it, which is -- feeds very well into what FEI does perfectly well which is the challenges of yield ramp on these technically more sophisticated structures.
So it's our view that the combination of two, the economics as well as the technical challenges. The industry has effectively decided to stretch out the transition to the smaller nodes that's pushed some of the activities we described out a little bit in time which means from 2015 into 2016. It's our view that they will occur in 2016. Difficult for us to comment on specific timing at this point. The other part of your question referring to memory logic kind of balance, sort of the memory logic foundry, probably the weakest part is logic, and foundry of late which memory okay in the middle there. But we see memory more as a earlier than the logic components or the foundry components in terms of adoption.
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Amanda Murphy, William Blair & Company - Analyst [18]
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And I guess another one for Tony. I think, Tony, when you came in you talked about thinking about guidance and how to set that in terms of looking at a bottom subtype model, and I realize that obviously it's hard to predict exactly, but maybe you could just kind of help us frame out now that you've been there a few months, how you're thinking about setting guidance in the context of all these moving parts. Obviously, it's -- we've had some stuff pushed out so it would be helpful to just kind of get a sense of how you're thinking about that going forward.
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Tony Trunzo, FEI Company - EVP & CFO [19]
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Sure. As Don indicated, it's too early for us to have anything to say with any granularity about 2016. What I can say is at this point in our process we put a bottoms up front end on our entire budgeting process for the year, and I think it resulted in a level of awareness and understanding of just how we get to the results that we're getting to. And I think it highlighted for the team an opportunity for them to state their case about what they saw as the opportunities and challenges in their business. And as we go through a couple more revs in the process, we're going to continue to refine that. But fundamentally for 2016, there's a much more meaningful aspect of bottoms up. And in terms of what that means for guidance, from my perspective it sort of distributes the ownership for execution throughout the Company which is clearly an objective. And I would expect that it will result in hopefully some more accuracy in terms of us at the most senior levels of the Company getting multiple layers of feed-in in terms of information as we vector on the guidance.
I don't think that -- and I look at what was done before I showed up here. It was excellent work. The fact that we're going to come in this year below what our initial -- the ranges overlap a little bit but the fact that our new range is somewhat below our old range for the year, it's really point specific and that's an extremely difficult thing in an industry where you do have these cycles and these fairly quick movements up and down. As Don identified, there are fewer than a handful of transactions that represent the difference between where we are today and where we were a couple of months ago. And they haven't gone away; they've just been delayed. That part of forecasting is going to continue to be a challenge in certain parts of our business.
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Amanda Murphy, William Blair & Company - Analyst [20]
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Got it. Okay. Makes sense. Thank you.
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Operator [21]
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Our next question comes from the line Weston Twigg from Pacific Crest.
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Weston Twigg, Pacific Crest Securities - Analyst [22]
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Yes, hi, thanks. Just wanted to ask on the 10 nanometer transition as a relates to near line, are you getting any new or at least meaningful new customers at 10 nanometer that didn't really participate at the 14, 16 nanometer node? And is there any impact from re-use from customers that did buy near-line systems at the 16 or 14 nanometer node?