UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________________________________
FORM 10-K
_____________________________________________
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2013
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 000-22780
_____________________________________________
FEI COMPANY
(Exact name of registrant as specified in its charter)
_____________________________________________
| Oregon | 93-0621989 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 5350 NE Dawson Creek Drive, Hillsboro, Oregon | 97124-5793 | |
| (Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: 503-726-7500
Securities registered pursuant to Section 12(b) of the Act: Common Stock and associated Preferred Stock
Purchase Rights (currently attached to and trading only with the Common Stock)
Name of each exchange on which registered: NASDAQ Global Stock Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | x | Accelerated filer | o | |
| Non-accelerated filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No ý
The aggregate market value of the voting and non-voting common stock held by non-affiliates, computed by reference to the last sales price ($72.70) as reported by The NASDAQ Global Stock Market, as of the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2013), was $3,026,352,547.
The number of shares outstanding of the registrant’s Common Stock as of February 17, 2014 was 42,229,623 shares.
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Documents Incorporated by Reference
The Registrant has incorporated by reference into Part III of this Annual Report on Form 10-K portions of its Proxy Statement for its 2014 Annual Meeting of Shareholders to be filed within 120 days of the Registrant's fiscal year ended December 31, 2013 pursuant to Regulation 14A.
FEI COMPANY
2013 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
| Page | ||
| PART I | ||
| Item 1. | ||
| Item 1A. | ||
| Item 1B. | ||
| Item 2. | ||
| Item 3. | ||
| Item 4. | ||
| PART II | ||
| Item 5. | ||
| Item 6. | ||
| Item 7. | ||
| Item 7A. | ||
| Item 8. | ||
| Item 9. | ||
| Item 9A. | ||
| Item 9B. | ||
| PART III | ||
| Item 10. | ||
| Item 11. | ||
| Item 12. | ||
| Item 13. | ||
| Item 14. | ||
| PART IV | ||
| Item 15. | ||
1
PART I
Item 1. Business
Overview
We were founded in 1971 and incorporated in Oregon in the same year and our shares began trading on The NASDAQ Stock Market in 1995. We are a leading supplier of scientific instruments for nanoscale applications and solutions for industry and science. We report our revenue based on a group structure organization, which we categorize as the Industry Group and the Science Group.
Our products include transmission electron microscopes, or TEMs; scanning electron microscopes, or SEMs; DualBeamTM systems which combine a SEM and a focused ion beam system, or FIB, on a single platform; stand-alone FIBs; high-performance optical microscopes, three-dimensional modeling software, and service and components to support the products. TEMs provide the highest resolution images of samples and their internal structure, down to the atomic level. SEMs provide detailed images of the surface and shape of samples. Optical microscopes provide a wider field of view than SEMs and TEMs. DualBeams and FIBs image, manipulate, mill and deposit material for a variety of purposes, including preparation of samples for TEMs. Substantially all of these product categories are sold into all of our markets. Individual models of our products are increasingly designed to provide specific solutions and applications in each of our markets.
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; Munich, Germany; and Delmont, Pennsylvania; and software development in Bordeaux, France; and Brisbane, Australia. 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 Industry Group consists of customers in semiconductor integrated circuit manufacturing and related industries such as manufacturers of data storage equipment and other technologies, as well as customers in the natural resources industries including mining and oil and gas. The tools we develop for our Industry Group customers are generally aimed at improving their processes to increase overall yields, whether in a factory, at a mine or at an oil and gas rig. For the semiconductor market, our growth is driven by shrinking line widths and process nodes of 45 nanometers and smaller, increasing complexity in their materials such as high-k metal gates and low-k dielectrics and increasing device complexity such as 3D transistor architectures. Such products are used primarily in laboratories or near the fabrication line 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 functionality. For the natural resource market, our products are used to increase yields in mining through automated mineralogy and in oil and gas exploration and laboratory analysis. We also provide support for products and customers within this group for the entire life cycle of a tool from installation through the warranty period, and after the warranty period through contract coverage or on a time and materials basis.
The Science Group includes universities, public and private research laboratories and customers in a wide range of industries, including metals, automobiles, aerospace, and forensics. The tools we develop for our customers in the Science Group are generally aimed at the exploration and discovery of new materials and chemistries or solving for causes and cures of diseases. The tools are used in a laboratory and are generally not used in industrial applications. The Science Group also includes customers at universities, government laboratories and research institutes engaged in biotech and life sciences applications, as well as pharmaceutical, biotech and medical device companies and hospitals. Growth in these markets is driven by global corporate and government funding for research and development and by development of new products and processes based on innovations at the nanoscale. Our solutions enable scientific discovery and advancement for researchers and help manufacturers develop, analyze and produce advanced products. Our products are also used in root cause failure analysis and quality control applications across a range of industries. Our products’ ultra-high resolution imaging allows structural biologists to create detailed 3D reconstructions of complex biological structures such as proteins and viruses. Cellular biologists use our tools to correlate wide-field, lower resolution optical images with higher resolution electron microscope imaging. Our products are also used by drug researchers and in particle analysis and a range of pathology and quality control applications. We also provide support for products and customers within this group for the entire life cycle of a tool from installation through the warranty period, and after the warranty period through contract coverage or on a time and materials basis.
2
Core Technologies
We use several core technologies to deliver a range of value-added customer solutions. Our core technologies include:
| • | focused ion beams, which allow modification of structures in sub-micron geometries; |
| • | focused electron beams, which allow imaging, analysis and measurement of structures at sub-micron and even atomic levels; |
| • | beam gas chemistries, which increase the effectiveness of ion and electron beams and allow etching and deposition of materials on structures at sub-micron levels; |
| • | system automation and sample management tools, which provide faster access to data and improved ease of use for operators of our systems; |
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.
| • | 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. |
| • | 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 Industry Group and are expected to be increasingly important in emerging production and process control applications in the Science Group. 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.
3
Research and Development
We have research and development operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; Bordeaux, France; Munich, Germany; Delmont, Pennsylvania; and Brisbane, Australia.
Our research and development staff at December 31, 2013 consisted of 495 employees, including scientists, engineers, designer draftsmen, technicians and software developers.
In the last year, we introduced several new and improved products, including:
| • | the Tecnai Arctica TEM for structural biology research, which is part of a highly-automated workflow that enhances the speed and efficiency of analysis and increases productivity; |
| • | the Helios 1200AT DualBeam system which allows for extraction of ultrathin samples of targeted structures and defects and, when coupled with an automated FOUP (front opening universal pod) loader, can be located inside the semiconductor wafer fab; |
| • | the Scios and Helios 660 DualBeam systems that provide high-quality imaging and fast analysis over a broad range of samples; |
| • | new TEM tools which provide efficient and effective application-specific workflows for semiconductor manufacturing and scientific research: |
| ◦ | the Metrios TEM which is designed to provide customers in the semiconductor industry with improved throughput and lower cost-per-sample than other TEMs; |
| ◦ | the Talos TEM which combines high-resolution, high-throughput TEM imaging with fast, precise and quantitative energy dispersive x-ray analysis to deliver advanced analytical performance; and |
| ◦ | the Titan Themis which enables direct measurements of properties on the nanometer-length scale and electric fields even down to the atomic scale. |
| • | ExSolve, an automated, high-throughput sample preparation workflow for customers in the semiconductor industry to perform TEM analysis; and |
| • | the Tecnai Femto electron microscope which enables scientists to explore ultrafast events and processes that occur at the atomic and molecular spatial scale over time spans measured in femtoseconds. |
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:
| • | Enhancement in the scanning/transmission electron microscope ("S/TEM") system platform with powerful stability coupled with new aberration correctors and monochromator technology, enabling sub-angstrom resolution; |
| • | 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; |
| • | 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; |
| • | High-speed analytic characterization technology that includes the proprietary X-Field Emission Guns (“X-FEG”) ultra-high brightness electron source and Super-X, our Energy Dispersive X-ray (“EDX”) detection system based on Silicon Drift Detector (“SDD”) technology; and |
| • | 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, German 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.
4
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 $101.9 million in 2013, $95.0 million in 2012 and $78.3 million in 2011.
Manufacturing
We have manufacturing operations located in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; Delmont, Pennsylvania; and Munich, Germany. Our manufacturing staff at December 31, 2013 consisted of 752 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, NTS Group, Frencken Mechatronics B.V., Keller Technology and AZD Praha SRO for our supply of mechanical parts and subassemblies; Gatan, Inc., Edax Inc. and Bruker Corp. 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, 2013 consisted of 411 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.
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 18 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. Our service staff at December 31, 2013 consisted of 688 employees.
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.
5
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.
Due to the highly specialized nature of our products and technology, and because of the critical mass necessary to support a worldwide field service capability, FEI has a distinct advantage over competitors who can provide service to our installed base of systems. Some of our older, less sophisticated equipment, particularly for customers in the Science Group, 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.
Also see the section titled "Risk Factors" in Part I, Item 1A. of this Annual Report on Form 10-K.
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 297 patents in the U.S. and approximately 508 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 2014 to 2032.
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 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, 2013, we had 2,611 employees worldwide. Some of the 1,818 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 are not scheduled to 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. Purchase commitments may include letters of intent. Product backlog consists of all open orders meeting these criteria. Service 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, 2013 our total backlog was $473.5 million, compared to $424.8 million at December 31, 2012. At December 31, 2013, our backlog consisted of $349.3 million of products and $124.2 million related to service compared to product backlog of $327.9 million and service backlog of $96.9 million at December 31, 2012. Generally, at least 90% of our backlog is shippable within one year.
6
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. During 2013 and 2012, we experienced cancellations of $4.2 million and $4.0 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.
Geographic Revenue and Assets
The following table summarizes sales by geographic region (in thousands):
| Year Ended December 31, 2013 | |||||||||||||||
| U.S. and Canada | Europe | Asia-Pacific Region and Rest of World | Total | ||||||||||||
| Product sales | $ | 167,876 | $ | 205,857 | $ | 335,705 | $ | 709,438 | |||||||
| Service sales | 92,759 | 64,803 | 60,454 | 218,016 | |||||||||||
| Total sales | $ | 260,635 | $ | 270,660 | $ | 396,159 | $ | 927,454 | |||||||
Our long-lived assets were geographically located as follows (in thousands):
| December 31, 2013 | |||
| United States | $ | 77,639 | |
| The Netherlands | 65,570 | ||
| The Czech Republic | 22,950 | ||
| Other | 42,272 | ||
| Total | $ | 208,431 | |
See also Note 21 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional geographic and segment information.
Seasonality
Our history shows that our revenues and bookings normally peak in the fourth quarter as our customers spend funds remaining in their fiscal budgets. These seasonal trends can be offset by numerous other factors, including our introduction of new products, the overall economic cycle and the business cycles in the semiconductor industry.
Where You Can Find More Information
Our principal executive offices are located at 5350 NE Dawson Creek Drive, Hillsboro, Oregon 97124. Our website is at http://www.fei.com. We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended. We make available free of charge on our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. Our committee charters are also available free of charge on our website. You can inspect and copy our reports, proxy statements and other information filed with the SEC at the offices of the SEC’s Public Reference Room located at 100 F Street, NE, Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of Public Reference Rooms. The SEC also maintains an Internet website at http://www.sec.gov where you can obtain most of our SEC filings. You can also obtain copies of these materials free of charge by contacting our investor relations department at 503-726-7500.
7
Item 1A. Risk Factors
A description of the risks and uncertainties associated with our business is set forth below. You should carefully consider such risks and uncertainties, together with the other information contained in this Annual Report on Form 10-K and in our other public filings. If any of such risks and uncertainties actually occurs, our business, financial condition or operating results could differ materially from the plans, projections and other forward-looking statements included in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of this Annual Report on Form 10-K and elsewhere in this Annual Report on Form 10-K and in our other public filings and public disclosures. In addition, if any of the following risks and uncertainties, or if any other risks and uncertainties, actually occurs, our business, financial condition or operating results could be harmed substantially, which could cause the market price of our stock to decline, perhaps significantly.
We operate in highly competitive industries, and we cannot be certain that we will be able to compete successfully in such industries.
The industries in which we operate are intensely competitive. Established companies, both domestic and foreign, compete with us in each of our product lines. Some of our competitors have greater financial, engineering, manufacturing and marketing resources than we do and may price their products very aggressively. In addition, these competitors may be willing to operate at a less profitable level than at which we would expect to operate. Our significant competitors include, among others: JEOL Ltd., Carl Zeiss SMT A.G., Hitachi High Technologies Corporation and Tescan, a.s. In addition, some of our competitors have formed collaborative relationships and otherwise may cooperate with each other.
Our customers must make a substantial investment to install and integrate capital equipment into their laboratories and process applications. As a result, once a manufacturer has selected a particular vendor’s capital equipment, the manufacturer generally relies on that equipment for a specific production line or process control application and frequently will attempt to consolidate its other capital equipment requirements with the same vendor. Accordingly, if a particular customer selects a competitor’s capital equipment, we expect to experience difficulty selling to that customer for a significant period of time.
Our ability to compete successfully depends on a number of factors both within and outside of our control, including:
| • | price; |
| • | product quality; |
| • | breadth of product line; |
| • | system performance; |
| • | ease of use; |
| • | type and breadth of product applications; |
| • | cost of ownership; |
| • | global technical service and support; |
| • | success in developing or otherwise introducing new products; and |
| • | foreign currency fluctuations. |
We cannot be certain that we will be able to compete successfully on these or other factors, which could negatively impact our revenues, gross margins and net income in the future.
Because many of our shipments occur in the last month of a quarter, we are at risk of one or more transactions not being delivered according to forecast.
We have historically shipped approximately 70%-80% of our products in the last month of each quarter. In addition, we rely on a significant amount of turns business (revenue from tools booked and sold in the same quarter) in any given quarter. As any one sale may be significant to meeting our quarterly sales projection (as our average selling price for a tool is approximately $1 million), any slippage of shipments into a subsequent quarter may result in our not meeting our quarterly sales projection, which may adversely impact our results of operations for the quarter.
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Because we have significant operations outside of the U.S., we are subject to political, economic and other international conditions that could result in increased operating expenses and regulation of our products and increased difficulty in maintaining operating and financial controls.
Because a significant portion of our operations occur outside of the U.S., our revenues and expenses are impacted by foreign economic and regulatory conditions. Approximately 72%, 67% and 69% of our sales occurred outside the U.S. in 2013, 2012 and 2011, respectively. Our sales to China have grown considerably in recent years. We have manufacturing facilities in Brno, Czech Republic, Eindhoven, The Netherlands and Munich, Germany and sales offices in many other countries. Over 80% of our products are manufactured in Europe.
Moreover, we operate in over 50 countries, including in 25 with a direct presence. Some of our global operations are geographically isolated, are distant from corporate headquarters and/or have little infrastructure support. Therefore, maintaining and enforcing operating and financial controls can be difficult. Failure to maintain or enforce controls could have a material adverse effect on our control over service inventories, quality of service, customer relationships and financial reporting.
Our exposure to the business risks presented by foreign economies will increase to the extent we continue to expand our global operations. International operations will continue to subject us to a number of risks, including:
| • | longer sales cycles; |
| • | multiple, conflicting and changing governmental laws and regulations; |
| • | protectionist laws and business practices that favor local companies; |
| • | price and currency exchange rates and controls; |
| • | taxes and tariffs; |
| • | export restrictions; |
| • | difficulties in collecting accounts receivable; |
| • | travel and transportation difficulties resulting from actual or perceived health risks (e.g., avian or swine influenza); |
| • | changes in the regulatory environment in countries where we do business could lead to delays in the importation of products into those countries; |
| • | the implementation and administration of the Control of Electronic Information Products (often referred to as China RoHS) regulations could lead to delays in the importation of products into China; |
| • | European Union Regulation of Hazardous Substances (RoHS) which could create problems in manufacture and delivery of certain products in Europe; |
| • | political and economic instability (e.g. Mexican crimewave, unrest in Egypt, Greece and the Middle East); |
| • | risk of failure of internal controls and failure to detect unauthorized transactions; and |
| • | potential labor unrest. |
The industries in which we sell our products are cyclical, which may cause our results of operations to fluctuate.
Our business depends in large part on the capital expenditures of customers within our Industry Group and Science Group. See “Net Sales by Segment” included in Part II, Item 7 of this Annual Report on Form 10-K for additional information.
The largest part of the Industry Group is the semiconductor industry. This industry is cyclical and has experienced significant economic downturns at various times in the last decade. Such downturns have been characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity. A downturn in this industry, or the businesses of one or more of our customers, could have a material adverse effect on our business, prospects, financial condition and results of operations. During downturns, our sales and gross profit margins generally decline.
The Science Group is also affected by overall economic conditions, but is not as cyclical as the Industry Group.
A significant portion of our Science Group revenue is dependent on government investments in research and development of new technology. To the extent that governments, especially in Europe or the U.S., reduce their spending in response to budget deficits and debt limitations, demand for our products could be affected. To date, we have not seen an impact from such actions, although the U.S. government has indicated that it plans to reduce funding for research. The funding cycles for our customers tend to extend over multiple quarters and several countries have reaffirmed their commitment to scientific research, but the longer-term impact of potential government fiscal austerity measures on our growth rate cannot be determined at this time. In addition, institutional endowments and philanthropy, which are a source of funding of some customer purchases, are threatened by the muted recovery from the 2008 recession.
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As a capital equipment provider, our revenues depend in large part on the spending patterns of our customers, who could delay expenditures or cancel orders in reaction to variations in their businesses or general economic conditions. Because a high proportion of our costs are fixed, we have a limited ability to reduce expenses quickly in response to revenue shortfalls. In a prolonged economic downturn, we may not be able to reduce our significant fixed costs, such as manufacturing overhead, capital equipment or research and development costs, which may cause our gross margins to erode and our net loss to increase or earnings to decline.
Our acquisition and investment strategy subjects us to risks associated with evaluating and pursuing these opportunities and integrating these businesses.
In addition to our efforts to develop new technologies from internal sources, we may also seek to acquire new technologies or operations from external sources. On January 9, 2012 we acquired ASPEX Corporation of Delmont, Pennsylvania to expand our natural resources footprint and on July 9, 2012 we acquired certain assets of AP Tech, a sales and service agent in Korea. On August 1, 2012 we acquired Visualization Sciences Group of Bordeaux, France, which provides three-dimensional visualization software products and tools to a range of markets. On August 9, 2013 we acquired nanoTechnology Systems Pty. Ltd. of Melbourne, Australia, which previously operated as our exclusive distributor in Australia and New Zealand for approximately 10 years. We continue to work to integrate these new entities.
Acquisitions can involve numerous risks, including management issues and costs in connection with the integration of the operations and personnel, technologies and products of the acquired companies, legal and intellectual property issues, failure to properly integrate acquisitions, the possible write-downs of impaired assets and the potential loss of key employees of the acquired companies. The inability to effectively manage any of these risks could seriously harm our business. Additionally, difficulties in integrating our acquisitions into our internal control structure could result in a failure of our internal control over financial reporting, which, in turn, could create a material weakness.
To the extent we make investments in entities that we control, or have significant influence in, our financial results will reflect our proportionate share of the financial results of the entity.
We may suffer manufacturing capacity limitations on occasion and are planning expansion.
Recently, demand for our product has accelerated and as orders increase, we may not be able to ramp our manufacturing capacity and supply chain fast enough to keep pace with order intake for every product line offered. We recently experienced challenges regarding manufacturing capacity for our TEM products driven by rapid growth. As a consequence, our ability to realize revenue on orders may be delayed or, in some cases, reduced and we may suffer cancellations. In addition, the quality of the products we ship may suffer, damaging our reputation and future sales. Although we are planning expansion to address future capacity needs our failure to plan adequately or execute on those plans could constrain capacity in the future.
A portion of our manufacturing operations will be moved to a new leased facility in the middle of 2014 which may involve significant costs and risks of operational interruption and product quality.
We are planning to move our operations in the Czech Republic to a new leased facility beginning in the middle of 2014. Our current facility accounts for over half of the total product shipments each quarter. Moving product manufacturing includes, among others, the following risks:
| • | unanticipated additional costs connected to such moves; |
| • | delay or failure in being able to build the transferred product at the new sites; |
| • | unanticipated additional labor and materials costs related to such moves; |
| • | logistical issues arising from the moves; and |
| • | product quality falling short of the product standard when manufactured at the prior location. |
Any of these factors could cause us to miss product orders, cause a decline in product quality and completeness, damage our reputation, increase costs of goods sold or decrease revenue and gross margins.
If our customers cancel or reschedule orders or if an anticipated order for even one of our systems is not received in time to permit shipping during a certain fiscal period, our operating results for that fiscal period may fluctuate and our business and financial results for such period could be materially and adversely affected. Cancellation risks rise in periods of economic downturn.
Our customers are able to cancel or reschedule orders, generally with limited or no penalties, depending on the product’s stage of completion. The amount of purchase orders at any particular date, therefore, is not necessarily indicative of sales to be made in any given period. Our build cycle, or the time it takes us to build a product to customer specifications, typically ranges from one to six months. During this period, the customer may cancel the order, although generally we will be entitled to receive a cancellation fee based on the agreed-upon shipment schedule. The risks of cancellation are higher during times of economic downturn, such as the U.S. and global economies are presently experiencing. In addition, we derive a substantial portion of our net sales in any fiscal period from the sale of a relatively small number of high-priced systems, with a large portion in the last month of the quarter.
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Further, in some cases, our customers have to make changes to their facilities to accommodate the site requirements for our systems and may reschedule their orders because of the time required to complete these facility changes. This is particularly true of our high-performance TEMs. As a result, the timing of revenue recognition for a single transaction could have a material effect on our revenue and results of operations for a particular fiscal period. During 2013 and 2012, we experienced cancellations of $4.2 million and $4.0 million, respectively.
Due to these and other factors, our net revenues and results of operations have fluctuated in the past and are likely to fluctuate significantly in the future on a quarterly and annual basis. It is possible that in some future quarter or quarters our results of operations will be below the expectations of public market analysts or investors. In such event, the market price of our common stock may decline significantly.
Due to our extensive international operations and sales, we are exposed to foreign currency exchange rate risks that could adversely affect our revenues, gross margins and results of operations.
A significant portion of our sales and expenses are denominated in currencies other than the U.S. dollar, principally the euro and Czech Koruna. For 2013, 2012 and 2011, approximately 25% to 35% of our revenue was denominated in euros, while more than half of our expenses were denominated in euros, Czech Koruna, or other foreign currencies. Particularly as a result of this imbalance, changes in the exchange rate between the U.S. dollar and foreign currencies, principally the euro, Czech Koruna and Japanese Yen, can impact our revenues, gross margins, results of operations and cash flows. We undertake hedging transactions primarily to limit our exposure to changes in the dollar/euro and dollar/Czech Koruna exchange rates. The hedges are designed to protect us as the dollar weakens but also provide us with some flexibility if the dollar strengthens.
Achieving hedge designation is based on evaluating the effectiveness of the derivative contracts’ ability to mitigate the foreign currency exposure of the linked transaction. We are required to monitor the effectiveness of all new and open derivative contracts designated as hedges on a quarterly basis. Failure to meet the hedge accounting requirements could result in the requirement to record deferred and current realized and unrealized gains and losses into net income in the current period. This failure could result in significant fluctuations in operating results. In addition, we will continue to recognize unrealized gains and losses related to the changes in fair value of derivative contracts not designated as hedges in the current period net income. Accordingly, the related impact to operating results may be recognized in a different period than the foreign currency impact of the hedged transaction.
We also enter into foreign forward exchange contracts that are designed to partially mitigate the impact of specific cash, receivables or payables positions denominated in foreign currencies. See Note 23 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K and Part II, Item 7A., "Qualitative and Quantitative Disclosures About Market Risk" of this Annual Report on Form 10-K for additional information.
The recent extreme volatility of dollar/euro and dollar/Czech Koruna exchange rates can make it more difficult for us to deploy our hedging program and create effective hedges.
Current economic conditions may adversely affect our industry, business and results of operations.
The global economy is suffering an extended slowdown with a high rate of unemployment and the future economic climate may continue to be less favorable than that of the past. This slowdown has, and could further lead to, reduced consumer and business spending in the foreseeable future, including by our customers, and the purchasers of their products and services. If such spending continues to slow down or decrease, our industry, business and results of operations may be adversely impacted. Also, in times of economic distress, hardship, bankruptcy and insolvency among our customers could increase. This may make it more difficult to collect on receivables.
Gross margins on our products vary between product lines and markets and, accordingly, changes in product mix will affect our results of operations.
If a higher portion of our net sales in any given period have lower gross margins, our overall gross margins and earnings would be negatively affected. Sales to our semiconductor customers, which ultimately depends on consumers who buy electronic devices, is volatile but contributes, on average, a higher proportion of our gross margin. Any significant downturn in the market would have a negative impact on our overall performance.
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Our business is complex, and changes to the business may not achieve their desired benefits.
Our business is based on a myriad of technologies, encompassed in multiple different product lines, addressing various customers in a range of markets in different regions of the world. A business of our breadth and complexity requires significant management time, attention and resources. In addition, significant changes to our business, such as changes in manufacturing, operations, product lines, market focus or organizational structure or focus, can be distracting, time-consuming and expensive. These changes can have short-term adverse effects on our financial results. Moreover, we operate through various foreign subsidiaries that are subject to local corporate and labor laws. Specifically, the requirements that certain actions of our subsidiaries are subject to approval by local workers councils and supervisory boards could impair the company's ability to take various actions and could result in unanticipated additional expense and delays. In addition, the complexity of product lines and diversity of our customer base creates manufacturing planning and control challenges that may lead to higher costs of materials and labor, increased service costs, delayed shipments and excessive inventory. Failure to effectively manage these manufacturing issues may materially impact our financial position, results of operations or cash flow.
We rely on a limited number of suppliers to provide parts and components. Failure of any of these suppliers to provide us with quality products in a timely manner could negatively affect our revenues and results of operations.
Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business, including our ability to convert backlog into revenue. 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, NTS Group, Frencken Mechatronics B.V., Keller Technology and AZD Praha SRO for our supply of mechanical parts and subassemblies; Gatan, Inc., Edax Inc. and Bruker Corp. 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. In addition, some of our suppliers rely on sole suppliers. As a result of this concentration of key suppliers, our results of operations may be materially and adversely affected if we do not timely and cost-effectively receive a sufficient quantity of quality parts to meet our production requirements or if we are required to find alternative suppliers for these supplies. We may not be able to expand our supplier group or to reduce our dependence on single suppliers. If our suppliers are not able to meet our supply requirements, constraints may affect our ability to deliver products to customers in a timely manner, which could have an adverse effect on our results of operations. In addition, restrictions regulating the use of certain hazardous substances in electrical and electronic equipment in various jurisdictions may impact parts and component availability or our electronics suppliers’ ability to source parts and components in a timely and cost-effective manner. Overall, because we only have a few equipment suppliers, we may be more exposed to future cost increases for this equipment.
Our maintenance and repair revenue depends on our ability to reliably supply replacement parts and consumables to our customers and failure to deliver high quality parts and consumables in a timely manner could cause our business to suffer.
Our installed base of approximately 9,200 tools includes diverse products of varying ages, configurations, use cases, condition, and customer requirements and is dispersed in approximately 50 countries around the globe. Providing logistical support for delivery of spare parts and consumables to these tools, particularly the older tools, can be difficult. We have attempted to address the complexity of our maintenance and repair requirements, in part, through a remote diagnostics system that allows us to remotely access tools through a virtual private network. If we are unable to effectively manage and support the supply and delivery of spare parts and consumables to our customers we may damage our reputation and business.
Our business relies on various electronic data systems and their functioning is important to our business. Our business could be damaged if those systems fail or suffer a security breach or compromise.
We use a number of electronic data systems to help operate our business. If we are unable to maintain and safeguard our electronic data, our operating activities, financial reporting and intellectual property could be compromised, which may disrupt operations, harm our reputation and damage customer relationships. Further, we maintain personal information of our employees and a data breach that leads to the misuse or misappropriation of this information could cause the company to incur liability and damage our relationship with our employees and our reputation. Moreover, if we suffer an unauthorized intrusion into our own systems or the virtual private network providing for remote tool diagnostics at customer sites, we, or our customers, may suffer a loss of proprietary information that could create liability for us and undermine our business.
Further, if our systems are inaccessible for a period of time, it may compromise our ability to perform business functions in a timely manner. In addition, we are presently upgrading our main enterprise resource planning system, which if not completed on time and as planned, could result in cost overruns or limit our ability to manufacture and ship products as planned.
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We depend on certain business processes for order entry and failure to adhere to those processes could impair our ability to properly book and fulfill orders.
We use business processes, including automated systems, to enter and track customer orders. Failure to adhere to these processes could result in errors in bookings, discounts on tool sales and failure to meet our global export compliance obligations. Further, inaccurate bookings information could lead to delays in shipping and having to rework orders. These problems could, in turn, cause us to suffer reduced margins, delayed revenue and governmental fines and penalties.
Our sales contracts often require delivery of multiple elements with complex terms and conditions that may cause our quarterly results to fluctuate.
Our system sales contracts include multiple elements such as delivery of more than one system, installation obligations (sometimes for multiple tools), accessories and/or service contracts, as well as provisions for customer acceptance. Typically, we recognize revenue as the various elements are delivered to the customer or the related services are provided. However, certain of these contracts have complex terms and conditions or technical specifications that require us to deliver most, or sometimes all, elements under the contract before revenue can be recognized. This could result in a significant delay between production and delivery of products and when revenue is recognized, which may cause volatility in, or adversely impact, our quarterly results of operations and cash flows.
The loss of one or more of our key customers would result in the loss of significant net revenues.
A relatively small number of customers account for a large percentage of our net revenues, and one customer accounted for more than 10% of total annual net revenues during 2013. Our business will be seriously harmed if we do not generate as much revenue as we expect from these key customers, if we experience a loss of any of our key customers or if we suffer a substantial reduction in orders from these customers. Our ability to continue to generate revenues from our key customers will depend on our ability to introduce new products that are desirable to these customers.
We may not be able to enforce our intellectual property rights, especially in foreign countries, which could have a material adverse effect on our business.
Our success depends in large part on the protection of our proprietary rights. We incur significant costs to obtain and maintain patents and defend our intellectual property. We also rely on the laws of the U.S. and other countries where we develop, manufacture or sell products to protect our proprietary rights. We may not be successful in protecting these proprietary rights, these rights may not provide the competitive advantages that we expect or other parties may challenge, invalidate or circumvent these rights. More specifically, we depend on trade secrets used in the development and manufacture of our products. We endeavor to protect these trade secrets but the measures taken to protect these trade secrets may be inadequate or ineffective.
Further, our efforts to protect our intellectual property may be less effective in some countries where intellectual property rights are not as well protected as they are in the U.S. Many U.S. companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. Approximately 72%, 67% and 69% of our sales occurred outside the U.S. in 2013, 2012 and 2011, respectively, and if we fail to adequately protect our intellectual property rights in these countries, our business may be materially adversely affected.
Infringement of our proprietary rights could result in weakened capacity to compete for sales and increased litigation costs, both of which could have a material adverse effect on our business, product gross margins, prospects, financial condition and results of operations.
If third parties assert that we violate their intellectual property rights, our business and results of operations may be materially adversely affected.
Several of our competitors hold patents covering a variety of technologies that may be included in some of our products. In addition, some of our customers may use our products for applications that are similar to those covered by these patents. From time to time, we, and our respective customers, have received correspondence from our competitors claiming that some of our products, as sold by us or used by our customers, may be infringing one or more of these patents. Any claim of infringement from a third party, even one without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from running the business.
In addition, our competitors or other entities may assert infringement claims against us or our customers in the future with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. Additionally, if claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.
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If we become subject to additional infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, these potential infringement claims could have a material adverse effect on our business, prospects, financial condition and results of operations.
If we are unable to pay quarterly dividends or repurchase our stock at intended levels, our reputation and stock price may be harmed.
In September 2010, our Board of Directors approved a plan to repurchase up to a total of 4.0 million shares of our common stock. In June 2012, our Board of Directors approved the initiation of quarterly cash dividends to holders of our common stock. The indicated quarterly cash dividend is subject to declaration by our Board of Directors and capital availability. Dividends have been paid under this program each quarter since its inception in June 2012. The dividend and stock repurchase program may require the use of a significant portion of our cash earnings. As a result, we may not retain a sufficient amount of cash to fund our operations or finance future growth opportunities, new product development initiatives and unanticipated capital expenditures. Further, our Board of Directors may, at its discretion, decrease the intended level of dividends or entirely discontinue the payment of dividends at any time. The stock repurchase program does not have an expiration date and may be limited at any time. Our ability to pay dividends and repurchase stock will depend on our ability to generate sufficient cash flows from operations in the future. This ability may be subject to certain economic, financial, competitive and other factors that are beyond our control. Any failure to pay dividends or repurchase stock after we have announced our intention to do so may negatively impact our reputation and investor confidence in us and may negatively impact our stock price.
Restructuring activities may be disruptive to our business and financial performance. Any delay or failure by us to execute planned cost reductions could also be disruptive and could result in total costs and expenses that are greater than expected.
From time to time, we have engaged in various restructuring and infrastructure improvement programs in order to increase operational efficiency, reduce costs and balance the effects of currency fluctuations on our financial results. These actions have previously included reductions of work-force as well as the costs to migrate portions of our supply chain to dollar-linked contracts.
Restructuring has the potential to adversely affect our business, financial condition and results of operations in other respects as well. This includes potential disruption of manufacturing operations, our supply chain and other aspects of our business. Employee morale and productivity could also suffer and result in unintended employee attrition. Loss of sales, service and engineering talent, in particular, could damage our business. Restructuring requires substantial management time and attention and has the potential to divert management from other important work. Moreover, we could encounter delays in executing our plans, which could cause further disruption and additional unanticipated expense. Some of our employees work in areas, such as Europe and Asia, where workforce reductions are highly regulated, and this could slow the implementation of planned workforce reductions. Restructuring plans may also fail to achieve the stated aims for reasons similar to those described in the prior paragraph.
During the course of executing a restructuring, we could incur material non-cash charges such as write-downs of inventories or other tangible assets. We test our goodwill and other intangible assets for impairment annually or when an event occurs indicating the potential for impairment. If we record an impairment charge as a result of this analysis, it could have a material impact on our results of operations.
Because we do not have long-term contracts with our customers, our customers may stop purchasing our products at any time, which makes it difficult to forecast our results of operations and to plan expenditures accordingly.
We do not have long-term contracts with our customers. Accordingly:
| • | customers can stop purchasing our products at any time without penalty; |
| • | customers may cancel orders that they previously placed; |
| • | customers may purchase products from our competitors; |
| • | we are exposed to competitive pricing pressure on each order; and |
| • | customers are not required to make minimum purchases. |
If we do not succeed in obtaining new sales orders from new and existing customers, our results of operations will be negatively impacted.
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Many of our projects are funded under various government contracts and if we are found to have violated the terms of the government contracts or applicable statutes and regulations, we are subject to the risk of suspension or debarment from government contracting activities, which could have a material adverse effect on our business and results of operations.
Many of our projects are funded under various government contracts worldwide. Government contracts are subject to specific procurement regulations, contract provisions and requirements relating to the formation, administration, performance and accounting of these contracts. Many of these contracts include express or implied certifications of compliance with applicable laws and contract provisions. As a result of our government contracting, claims for civil or criminal fraud may be brought by the government for violations of these regulations, requirements or statutes. Further, if we fail to comply with any of these regulations, requirements or statutes, our existing government contracts could be terminated, we could be suspended or debarred from government contracting or subcontracting, including federally funded projects at the state level. If one or more of our government contracts are terminated for any reason, or if we are suspended from government work, we could suffer the loss of the contracts, which could have a material adverse effect on our business and results of operations.
Changes and fluctuations in government spending priorities could adversely affect our revenue.
Because a significant part of our overall business is generated either directly or indirectly as a result of worldwide federal and local government regulatory and infrastructure priorities, shifts in these priorities due to changes in policy imperatives or economic conditions or government administration, which are often unpredictable, may affect our revenues.
Political instability in key regions around the world, the U.S. government’s commitment to military related expenditures and current uncertainty around global sovereign debt put at risk federal discretionary spending, including spending on nanotechnology research programs and projects that are of particular importance to our business. Also, changes in U.S. Congressional appropriations practices could result in decreased funding for some of our customers. At the state and local levels, the need to compensate for reductions in federal matching funds, as well as financing of federal unfunded mandates, creates strong pressures to cut back on research expenditures as well. A potential reduction of federal funding may adversely affect our business. Moreover, due to the world-wide economic downturn, many state and national governments are seeing significant declines in tax revenue, while also seeing increased demand for services. This could reduce the money available to our potential customers from government funding sources that could be used to purchase our products and services.
We have long sales cycles for our systems, which may cause our results of operations to fluctuate.
Our sales cycle can be 18 months or longer and is unpredictable. Variations in the length of our sales cycle could cause our net sales and, therefore, our business, financial condition, results of operations, operating margins and cash flows, to fluctuate widely from period to period. These variations could be based on factors partially or completely outside of our control.
The length of time it takes us to complete a sale depends on many factors, including:
| • | the efforts of our sales force and our independent sales representatives; |
| • | changes in the composition of our sales force, including the departure of senior sales personnel; |
| • | the history of previous sales to a customer; |
| • | the complexity of the customer’s manufacturing processes; |
| • | the introduction, or announced introduction, of new products by our competitors; |
| • | the economic environment; |
| • | the internal technical capabilities and sophistication of the customer; and |
| • | the capital expenditure budget cycle of the customer. |
Our sales cycle also extends in situations where the sale involves developing new applications for a system or technology. As a result of these and a number of other factors that could influence sales cycles with particular customers, the period between initial contact with a potential customer and the time when we recognize revenue from that customer, if we ever do, may vary widely.
The loss of key management or our inability to attract and retain managerial, engineering and other technical personnel could have a material adverse effect on our business, financial condition and results of operations.
Attracting qualified personnel is difficult, and our recruiting efforts may not be successful. Specifically, our product generation efforts depend on hiring and retaining qualified engineers. The market for qualified engineers is very competitive. In addition, experienced management and technical, marketing and support personnel in the technology industry are in high demand, and competition for such talent is intense. The loss of key personnel, or our inability to attract key personnel, could have an adverse effect on our business, financial condition or results of operations.
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Our customers experience rapid technological changes, with which we must keep pace. We may be unable to properly ascertain new market needs, or introduce new products responsive to those needs, on a timely and cost-effective basis.
Customers in each of our Groups experience rapid technological change that requires new product introductions and enhancements. Our ability to remain competitive depends in large part on our ability to understand these changes and develop, in a timely and cost-effective manner, new and enhanced systems at competitive prices that respond to, and accurately predict, new market requirements. We may fail to ascertain and respond to the needs of our customers or fail to develop and introduce new and enhanced products that meet their needs, which could adversely affect our financial position. In addition, new product introductions or enhancements by competitors could cause a decline in our sales or a loss of market acceptance of our existing products. Increased competitive pressure also could lead to intensified price competition, resulting in lower margins, which could materially adversely affect our business, prospects, financial condition and results of operations.
Our success in developing, introducing and selling new and enhanced systems depends on a variety of factors, including:
| • | selection and development of product offerings; |
| • | timely and efficient completion of product design and development; |
| • | timely and efficient implementation of manufacturing processes; |
| • | effective sales, service and marketing functions; and |
| • | product performance. |
Because new product development commitments must be made well in advance of sales, new product decisions must anticipate both the future demand for products under development and the equipment required to produce such products. We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new products or in enhancing existing products. On occasion, certain product and application developments have taken longer than expected. These delays can have an adverse effect on product shipments and results of operations.
The process of developing new high technology capital equipment products and services is complex and uncertain, and failure to accurately anticipate customers’ changing needs and emerging technological trends, to complete engineering and development projects in a timely manner and to develop or obtain appropriate intellectual property could significantly harm our results of operations. We must make long-term investments and commit significant resources before knowing whether our predictions will result in products that the market will accept.
To the extent that a market does not develop for a new product, we may decide to discontinue or modify the product. These actions could involve significant costs and/or require us to take charges in future periods. If these products are accepted by the marketplace, sales of our new products may cannibalize sales of our existing products. Further, after a product is developed, we must be able to manufacture sufficient volume quickly and at low cost. To accomplish this objective, we must accurately forecast production volumes, mix of products and configurations that meet customer requirements. If we are not successful in making accurate forecasts, our business and results of operations could be significantly harmed.
We may have exposure to income tax rate fluctuations as well as to additional tax liabilities, which would impact our financial position.
As a corporation with operations both in the U.S. and abroad, we are subject to income taxes in both the U.S. and various foreign jurisdictions. Our effective tax rate is subject to significant fluctuation from one period to the next as the income tax rates for each year are a function of the following factors, among others:
| • | the effects of a mix of profits or losses earned by us and our subsidiaries in numerous foreign tax jurisdictions with a broad range of income tax rates; |
| • | our ability to utilize recorded deferred tax assets; |
| • | changes in uncertain tax positions, interest or penalties resulting from tax audits; and |
| • | changes in tax rates and laws or the interpretation of such laws. |
Changes in the mix of these items and other items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial results.
We are also subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the U.S. and various foreign jurisdictions.
We are regularly under audit by tax authorities with respect to both income and non-income taxes and may have exposure to additional tax liabilities as a result of these audits.
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Significant judgment is required in determining our provision for income taxes and other tax liabilities. Although we believe that our tax estimates are reasonable, we cannot assure you that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals.
Many of our current and planned products are highly complex and may contain defects or errors that can only be detected after installation, which may harm our reputation and damage our business.
Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us. As a result, we could have to replace certain components and/or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products and loss of sales, which would harm our business and adversely affect our revenues and profitability.
Some of our systems use hazardous gases and high voltage power supplies as well as emit x-rays, which, if not properly contained, could result in property damage, bodily injury and death.
A product safety failure, such as a hazardous gas release, high voltage power supply problem, x-ray leak or extreme pressure release, could result in substantial liability and could also significantly damage customer relationships and our reputation and disrupt future sales. Moreover, remediation could require redesign of the tools involved, creating additional expense, increasing tool costs and damaging sales. In addition, the matter could involve significant litigation that would divert management time and resources and cause unanticipated legal expense. Further, if such a leak problem or release involved violation of health and safety laws, we may suffer substantial fines and penalties in addition to the other damage suffered. Finally, failure to properly manage the regulatory requirements for shipment of dangerous products could cause delays in clearing customs and thereby cause delay or loss of revenue in any particular quarter.
Natural disasters, catastrophic events, terrorist acts and acts of war may seriously harm our business and revenues, costs and expenses and financial condition.
Our worldwide operations could be subject to earthquakes, volcanic eruptions, telecommunications failures, power interruptions, water shortages, closure of transport routes, tsunamis, floods, hurricanes, typhoons, fires, extreme weather conditions, medical epidemics or pandemics, terrorist acts, acts of war and other natural or manmade disasters or business interruptions. For many of these events we carry no insurance. The occurrence of any of these business disruptions could seriously harm our revenue and financial condition and increase our costs and expenses. The impact of such events could be disproportionately greater on us than on other companies as a result of our significant international presence. Our corporate headquarters, and a portion of our research and development activities, are located on the Pacific coast, and other critical business operations and some of our suppliers are located in Asia, near major earthquake faults. We rely on major logistics hubs, primarily in Europe, Asia and the U.S. to manufacture and distribute our products and to move products to customers in various regions. Our operations could be adversely affected if manufacturing, logistics or other operations in these locations are disrupted for any reason, including those described above. The ultimate impact on us, our significant suppliers and our general infrastructure of being consolidated in certain geographical areas is unknown, but our revenue, profitability and financial condition could suffer in the event of a catastrophic event.
Unforeseen health, safety and environmental costs could impact our future net earnings.
Some of our operations use substances that are regulated by various federal, state and international laws governing health, safety and the environment. We could be subject to liability if we do not handle these substances in compliance with safety standards for storage and transportation and applicable laws. We will record a liability for any costs related to health, safety or environmental remediation when we consider the costs to be probable and the amount of the costs can be reasonably estimated.
We may not be successful in obtaining the necessary export licenses to conduct operations abroad, and the U.S. Congress may prevent proposed sales to foreign customers.
We are subject to export control laws that limit which products we sell and where and to whom we sell our products. Moreover, export licenses are required from government agencies for some of our products and accessories in accordance with various statutory authorities, including U.S. statutes such as the Export Administration Act of 1979, the International Emergency Economic Powers Act of 1977, the Trading with the Enemy Act of 1917 and the Arms Export Control Act of 1976. Depending on the shipment, we are also subject to Dutch or Czech law regarding export controls and licensing requirements. We may not be successful in obtaining these necessary licenses in order to conduct business abroad. In addition, we may suffer from process failures that would cause us to violate export laws. Failure to comply with applicable export controls or the termination or significant limitation on our ability to export certain of our products would have an adverse effect on our business, results of operations and financial condition.
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Changes in accounting pronouncements or taxation rules or practices may affect how we conduct our business.
Changes in accounting pronouncements or taxation rules or practices can have a significant effect on our reported results. Other new accounting pronouncements or taxation rules and varying interpretations of accounting pronouncements or taxation practices have occurred and may occur in the future. New rules, changes to existing rules, if any, or the questioning of current practices may adversely affect our reported financial results or change the way we conduct our business.
Provisions of our charter documents, our shareholder rights plan and Oregon law could make it more difficult for a third party to acquire us, even if the offer may be considered beneficial by our shareholders.
Our articles of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our Board of Directors. Our Board of Directors has also adopted a shareholder rights plan, or “poison pill,” which would significantly dilute the ownership of a hostile acquirer. In addition, the Oregon Control Share Act and the Oregon Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the effect of lengthening the time required for a person to acquire control of us through a proxy contest or the election of a majority of our Board of Directors, may deter efforts to obtain control of us and may make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by our shareholder.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters is located in a facility we own in Hillsboro, Oregon. This facility totals approximately 180,000 square feet and houses a range of activities, including manufacturing, research and development, corporate finance and administration and sales and marketing and is primarily used by the Industry Group.
In the second quarter of 2013, we purchased facilities we had previously been leasing in Eindhoven, The Netherlands, consisting of 271,743 square feet. This facility is used for research and development, manufacturing, sales, marketing and administrative functions and is primarily used by the Science Group.
We maintain a manufacturing and development facility in Brno, Czech Republic, which consists of a total of 140,157 square feet of space, and is leased for approximately $150,000 per month. The lease has various expiration dates extending through 2018. We are planning to move our Czech operations to a new larger facility in the middle of 2014 and have a lease agreement with an initial 10-year term with multiple options to renew. The new facility will consist of approximately 290,000 square feet and lease payments of approximately $230,000 per month will begin in the middle of 2014.
We operate, in leased facilities, a software development and licensing business in Bordeaux, France, an optical microscopy business in Munich, Germany, and an electron microscopy business in Delmont, Pennslyvania. In Australia, we operate offices for sales, service and some research and development, in leased facilities, which directly support our Industry and Science Groups.
We also operate support offices for sales, service and some research and development in leased facilities in the People’s Republic of China, Japan, Hong Kong, Singapore, Korea, The Netherlands, Germany and the U.S., as well as other smaller offices in the other countries where we have direct sales and service operations. In some of these locations, we lease space directly.
We expect that our facilities arrangements will be adequate to meet our needs for the foreseeable future and, overall, believe we can meet increased demand for facilities that may be required to meet increased demand for our products. In addition, we believe that, if product demand increases, we can use outsourced manufacturing, additional manufacturing shifts and currently underutilized space as a means of adding capacity without increasing our direct investment in additional facilities.
Item 3. Legal Proceedings
We are involved in various legal proceedings and receive claims from time to time, arising in the normal course of our business activities, including claims for alleged infringement or violation of intellectual property rights.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Stock Prices, Issuances of Common Stock and Dividends
Our common stock is quoted on the NASDAQ Global Market under the symbol FEIC. The high and low intraday sales prices on the NASDAQ Global Market and cash dividends paid for the past two years were as follows:
| 2012 | High | Low | Dividend Paid | ||||||||
| Quarter 1 | $ | 49.75 | $ | 40.00 | $ | — | |||||
| Quarter 2 | 52.01 | 42.18 | — | ||||||||
| Quarter 3 | 56.48 | 45.23 | 0.08 | ||||||||
| Quarter 4 | 56.06 | 49.40 | 0.08 | ||||||||
| 2013 | High | Low | Dividend Paid | ||||||||
| Quarter 1 | $ | 65.29 | $ | 55.61 | $ | 0.08 | |||||
| Quarter 2 | 75.73 | 61.89 | 0.08 | ||||||||
| Quarter 3 | 88.86 | 71.04 | 0.12 | ||||||||
| Quarter 4 | 93.13 | 82.52 | 0.12 | ||||||||
The approximate number of beneficial shareholders and shareholders of record at February 10, 2014 was 28,666 and 66, respectively.
In June 2012 we announced our plan to initiate a quarterly dividend and dividends have been paid under this program each quarter since its inception in June 2012. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors. See also "Dividends to Shareholders" included in Part II, Item 7 of this Annual Report on Form 10-K for further discussion.
PEO Combination
On February 21, 1997, we acquired substantially all of the assets and liabilities of the electron optics business of Koninklijke Philips Electronics N.V. (the “PEO Combination”), in a transaction accounted for as a reverse acquisition. As part of the PEO Combination, we agreed to issue to Philips additional shares of our common stock whenever stock options that were outstanding on the date of the closing of the PEO Combination are exercised. Any such additional shares are issued at a rate of approximately 1.22 shares to Philips for each share issued on exercise of these options. We receive no additional consideration for these shares issued to Philips under this agreement. We did not issue any shares in 2013, 2012 or 2011 to Philips under this agreement. As of December 31, 2013, 165,000 shares of our common stock are potentially issuable and reserved for issuance as a result of this agreement.
Share Repurchases
A plan to repurchase up to a total of 4.0 million shares of our common stock was approved by our Board of Directors in September 2010, re-authorized in December 2012, and does not have an expiration date. The amount and timing of specific repurchases are subject to market conditions, applicable legal requirements and other factors. The purchases are funded from existing cash resources and may be suspended or discontinued at any time at our discretion without prior notice. No repurchases were made in the fourth quarter of 2013.
During 2012 we repurchased 20,500 shares for a total of $0.9 million or an average of $43.41 per share. We did not repurchase any shares during 2013. As of December 31, 2013, 2,119,800 shares remained available for purchase pursuant to this plan.
Equity Compensation Plans
Information regarding securities authorized for issuance under equity compensation plans will be included in the section titled “Securities Authorized for Issuance Under Equity Compensation Plans” in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
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Stock Performance Graph
The following line-graph presentation compares cumulative five-year shareholder returns on an indexed basis, assuming a $100 initial investment and reinvestment of dividends, of (a) FEI Company, (b) a broad-based equity market index, (c) an industry-specific index and (d) SIC 3826: Laboratory Analytical Instruments. The broad-based market index used is the NASDAQ Composite Index and the industry-specific index used is the NASDAQ Non-Financial Index.
Base Period | Indexed Returns Year Ended | ||||||||||||||||||||||
| Company/Index | 12/31/2008 | 12/31/2009 | 12/31/2010 | 12/31/2011 | 12/31/2012 | 12/31/2013 | |||||||||||||||||
| FEI Company | $ | 100.00 | $ | 123.86 | $ | 140.03 | $ | 216.22 | $ | 295.07 | $ | 478.06 | |||||||||||
| NASDAQ Composite | 100.00 | 145.34 | 171.70 | 170.34 | 200.57 | 281.14 | |||||||||||||||||
| NASDAQ Non-Financial | 100.00 | 155.48 | 184.14 | 183.90 | 215.54 | 301.97 | |||||||||||||||||
| SIC 3826 | 100.00 | 147.64 | 208.16 | 169.79 | 221.66 | 339.42 | |||||||||||||||||
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Item 6. Selected Financial Data
The selected consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included elsewhere in this Form 10-K.
In thousands, except per share amounts | Year Ended | ||||||||||||||||||
| Statement of Operations Data | 2013 | 2012 | 2011 | 2010 | 2009 | ||||||||||||||
| Net sales | $ | 927,454 | $ | 891,738 | $ | 826,426 | $ | 634,222 | $ | 577,344 | |||||||||
| Cost of sales | 488,669 | 476,108 | 459,060 | 364,958 | 347,840 | ||||||||||||||
| Gross profit | 438,785 | 415,630 | 367,366 | 269,264 | 229,504 | ||||||||||||||
Total operating expenses(1) | 282,597 | 267,543 | 240,315 | 213,806 | 197,882 | ||||||||||||||
| Operating income | 156,188 | 148,087 | 127,051 | 55,458 | 31,622 | ||||||||||||||
Other expense, net(2) | (4,586 | ) | (7,539 | ) | (4,186 | ) | (3,236 | ) | (3,961 | ) | |||||||||
| Income from continuing operations before income taxes | 151,602 | 140,548 | 122,865 | 52,222 | 27,661 | ||||||||||||||
Income tax expense (benefit)(3) | 24,929 | 25,628 | 19,228 | (1,326 | ) | 5,017 | |||||||||||||
| Net income | $ | 126,673 | $ | 114,920 | $ | 103,637 | $ | 53,548 | $ | 22,644 | |||||||||
| Basic net income per share | $ | 3.13 | $ | 3.02 | $ | 2.70 | $ | 1.41 | $ | 0.60 | |||||||||
| Diluted net income per share | $ | 3.01 | $ | 2.80 | $ | 2.51 | $ | 1.34 | $ | 0.60 | |||||||||
| Shares used in basic per share calculations | 40,446 | 38,065 | 38,384 | 38,083 | 37,537 | ||||||||||||||
| Shares used in diluted per share calculations | 42,395 | 41,728 | 42,047 | 41,737 | 37,905 | ||||||||||||||
| In thousands | December 31, | ||||||||||||||||||
| Balance Sheet Data | 2013 | 2012 | 2011 | 2010 | 2009 | ||||||||||||||
| Cash and cash equivalents | $ | 384,170 | $ | 266,302 | $ | 320,361 | $ | 277,617 | $ | 124,199 | |||||||||
| Working capital | 657,126 | 486,830 | 519,284 | 493,518 | 435,034 | ||||||||||||||
| Total assets | 1,426,084 | 1,234,223 | 1,089,909 | 984,422 | 953,969 | ||||||||||||||
| Short-term line of credit | — | — | — | — | 59,600 | ||||||||||||||
| Current portion of convertible debt | — | 89,010 | — | — | — | ||||||||||||||
| Convertible debt, net of current portion | — | — | 89,011 | 89,012 | 100,000 | ||||||||||||||
| Shareholders’ equity | 1,077,568 | 839,903 | 696,814 | 633,174 | 567,524 | ||||||||||||||
| 1. | Included in operating expenses was $1.1 million, $2.9 million, $3.2 million, $11.1 million and $3.5 million of restructuring, reorganization, relocation and severance in 2013, 2012, 2011, 2010 and 2009, respectively. Also included in operating expenses in 2011 is $5.3 million for a contingent litigation accrual matter and a $1.4 million impairment of certain intellectual property. |
| 2. | Included in other income (expense), net in 2009 were the following: |
| • | a $2.0 million gain on the early redemption of our 2.875% notes; |
| • | a $0.5 million net gain on our auction rate securities (“ARS”) and our put right with UBS AG (together with its affiliates, “UBS”) (the “Put Right”); 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. |
| 3. | Our 2011 tax provision reflected taxes on earnings 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. |
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Our 2010 tax provision reflected 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. 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.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This Annual Report on Form 10-K contains forward-looking statements that include guidance for revenue, earnings per share and bookings for the first quarter of 2014, revenue expectations for the first half and full year 2014, the impact of certain items on our results for these periods and assumptions about tax rates. Forward-looking statements may also be identified by words and phrases that refer to future expectations, such as “guidance”, “guiding”, “forecast”, “toward”, “plan”, “expect”, “expects”, “are expected”, “is expected”, “will”, “projecting”, “look forward” and other similar words and phrases. Factors that could affect these forward-looking statements include, but are not limited to, the global economic environment; lower than expected customer orders and potential weakness of the Science Group and Industry Group; lower than expected customer orders for recently-introduced new products; potential disruption in manufacturing or unexpected additional costs due to the transition from older to newer products; potential reduced governmental spending due to budget constraints and uncertainty around U.S. or other countries’ sovereign debt; potential disruption in the company’s operations due to organization changes; risks associated with building and shipping a high percentage of the company’s quarterly revenue in the last month of the quarter; cyclical changes in the data storage and semiconductor industries, which are the major components of Industry Group revenue; continued weakness in the mining industry, which is also a component of Industry Group revenue; limitations in our manufacturing capacity for certain products; problems in obtaining necessary product components in sufficient volumes on a timely basis from our supply chain; the relative mix of higher-margin and lower-margin products; risks associated with a high percentage of the company’s revenue coming from “turns” business, when the order for a product is placed by the customer in the same quarter as the planned shipment; fluctuations in foreign exchange rates, which can affect margins or the competitive pricing of our products; additional costs related to future merger and acquisition activity; failure of the company to achieve anticipated benefits of acquisitions and collaborations, including failure to achieve financial goals and integrate acquisitions successfully; reduced profitability due to failure to achieve or sustain margin improvement in service or product manufacturing; potential customer requests to defer planned shipments; increased competition and new product offerings from competitors; lower average sales prices and reduced margins on some product sales due to increased competition; failure of the company's products and technology, including new products, to find acceptance with customers; inability to deploy products as expected or delays in shipping products due to technical problems or barriers, especially with regard to recently introduced TEM products; bankruptcy or insolvency of customers or suppliers; changes in tax rate and laws, accounting rules regarding taxes or agreements with tax authorities; the ongoing determination of the effectiveness of foreign exchange hedge transactions; potential shipment or supply chain disruptions due to natural disasters or terrorist attacks; changes to or potential additional restructurings and reorganizations not presently anticipated; changes in trade policies and tariff regulations; changes in the regulatory environment in the nations where we do business; and additional selling, general and administrative or research and development expenses.
From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. The risks, uncertainties and assumptions referred to above include, but are not limited to, those discussed here and the risks discussed from time to time in our other public filings. All forward-looking statements included in this Annual Report on Form 10-K are based on information available to us as of the date of this report, and we assume no obligation to update these forward-looking statements. You are advised, however, to consult any further disclosures we make on related subjects in our Forms 10-Q and 8-K filed with, or furnished to, the SEC. You also should read the section titled “Risk Factors” included in Part I, Item 1A. of this Annual Report on Form 10-K for factors that we believe could cause our actual results to differ materially from expected and historical results. Other factors could also adversely affect us.
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OVERVIEW OF 2013 AND OUTLOOK FOR 2014
During 2013, we experienced revenue growth of 4% over 2012, with growth in our Science Group offsetting a slight decline in our Industry Group. We are forecasting continued growth in 2014, primarily in our Industry Group but also in our Science Group, based on anticipated conditions in each of our markets, the impact of new products that we have introduced in the last few years and our competitive positioning. We experienced a strong fourth quarter in 2013, but anticipate a weaker first quarter in 2014 due to the typical effects of seasonality in our markets and the expected timing of product shipments in response to customer requests.
Within the Industry Group, our revenues declined in 2013 primarily due to weakness in the semiconductor equipment market early in the year. This market strengthened in the latter half of the year and has continued to show strength entering 2014. Our equipment is primarily used in laboratories for new process development and yield improvement, and the increasing complexity and shrinking dimensions of the devices made by our customers have increased the demand of our DualBeams and high-resolution TEMs. In addition, we have introduced products in the latter half of 2013 that are intended to move our tools closer the production line. We believe sales to the semiconductor market will grow as this market continues to strengthen and demand for our latest products continues to develop.
Our Industry Group also includes, to a much lesser extent, sales to companies in the mining and oil and gas markets. In 2013, revenue was flat compared with 2012 and orders were down significantly. Mining companies sharply reduced their capital spending due to market conditions affecting their businesses and our wellsite-oriented products did not penetrate the oil and gas markets as we had anticipated. We are now focusing our efforts in the oil and gas markets toward reservoir characterization where we believe there are more significant opportunities. As part of this strategy, we recently acquired Lithicon AS, a provider of digital rock technology services and pore-scale micro computed tomography (µCT, or microCT) equipment to oil and gas companies worldwide. While we believe that this strategy will allow us to introduce new products and address new markets in 2014, we do not expect it to materially impact our revenues until after 2014.
Within the Science Group, sales of our products for materials science research drive the largest portion of our revenues. Growth in this area has come primarily from emerging countries, such as China, as these economies continue to invest in their research, development and education infrastructure. We expect continued growth to the extent that this trend continues in 2014 and from sales in the second half of 2014 of new products first introduced in 2013.
Sales to researchers in both cell and structural biology showed significant growth near the end of 2013 after two years of generally flat orders. The primary driver of this growth has been increased penetration of electron microscopy into structural biology applications and adoption of our products in correlative microscopy for cell biology. We expect these revenues to continue to grow as these markets, and our ability to address them and acquire new customers, grow.
Gross margin increased by 210 basis points from 2011 to 2012 and 70 basis points from 2012 to 2013. We are seeking continued gross margin improvement in 2014. In addition to increasing our proportion of newer, higher-margin products and application-specific products, we expect lower costs from continued sourcing improvements and initial production from our new leased facility in the Czech Republic, which is scheduled to open in the second half of 2014. We expect to incur approximately $4.0 million in restructuring costs in the second half of 2014 related to the relocation of this facility and related exit costs.
Operating expenses are expected to increase in 2014 primarily due to acquisitions, the increase in staff in sales and service personnel, increased spending for research and development, and higher stock-based compensation expense.
Our net income grew in 2013 principally as a result of the growth of our revenues, and to a lesser extent, improvement in our gross margins. Continued growth in our net income, apart from the costs associated with acquisitions and the restructuring, will depend upon these trends continuing.
Please review the risk factors described in Part I, Item 1A of this Annual Report on Form 10-K for the risk factors that could cause our results to vary from the outlook described above.
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RESULTS OF OPERATIONS
The following table sets forth our statement of operations data (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Net sales | $ | 927,454 | $ | 891,738 | $ | 826,426 | |||||
| Cost of sales | 488,669 | 476,108 | 459,060 | ||||||||
| Gross profit | 438,785 | 415,630 | 367,366 | ||||||||
| Research and development | 101,947 | 94,965 | 78,318 | ||||||||
| Selling, general and administrative | 179,560 | 169,719 | 158,782 | ||||||||
| Restructuring, reorganization, relocation and severance costs | 1,090 | 2,859 | 3,215 | ||||||||
| Operating income | 156,188 | 148,087 | 127,051 | ||||||||
| Other expense, net | (4,586 | ) | (7,539 | ) | (4,186 | ) | |||||
| Income before income taxes | 151,602 | 140,548 | 122,865 | ||||||||
| Income tax expense | 24,929 | 25,628 | 19,228 | ||||||||
| Net income | $ | 126,673 | $ | 114,920 | $ | 103,637 | |||||
The following table sets forth our statement of operations data as a percentage(1) of consolidated net sales:
| Year Ended | ||||||||
| 2013 | 2012 | 2011 | ||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of sales | 52.7 | 53.4 | 55.5 | |||||
| Gross profit | 47.3 | 46.6 | 44.5 | |||||
| Research and development | 11.0 | 10.6 | 9.5 | |||||
| Selling, general and administrative | 19.4 | 19.0 | 19.2 | |||||
| Restructuring, reorganization, relocation and severance costs | 0.1 | 0.3 | 0.4 | |||||
| Operating income | 16.8 | 16.6 | 15.4 | |||||
| Other expense, net | (0.5 | ) | (0.8 | ) | (0.5 | ) | ||
| Income before income taxes | 16.3 | 15.8 | 14.9 | |||||
| Income tax expense | 2.7 | 2.9 | 2.3 | |||||
| Net income | 13.7 | % | 12.9 | % | 12.5 | % | ||
(1) | Percentages may not add due to rounding. |
Net sales increased $35.7 million, or 4.0%, to $927.5 million in 2013 compared to $891.7 million in 2012 and increased $65.3 million, or 7.9%, in 2012 compared to $826.4 million in 2011. The factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below.
Currency fluctuations decreased net sales by $8.3 million, or 0.9%, in 2013 compared to 2012 and decreased net sales by approximately $18.6 million, or 2.3%, in 2012 compared to 2011 as approximately 72% and 67% of our net sales were denominated in foreign currencies that fluctuated against the U.S. dollar during 2013 and 2012, respectively. Strengthening of the U.S. dollar against these foreign currencies generally has the effect of decreasing net sales and backlog. See also "Foreign Currency Exchange Rate Risk" included in Item 7A. of this Annual Report on Form 10-K for further discussion of currency impact on our results of operations.
Revenue from acquired businesses increased net sales by $15.2 million, or 1.7%, in 2013 compared to 2012 and increased net sales by $23.2 million, or 2.8%, in 2012 compared to 2011.
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Net Sales by Segment
Net sales by market segment (in thousands) and as a percentage of net sales were as follows:
| Year Ended | ||||||||||||||||||||
| 2013 | 2012 | 2011 | ||||||||||||||||||
| Industry Group | $ | 427,731 | 46.1 | % | $ | 433,424 | 48.6 | % | $ | 376,533 | 45.6 | % | ||||||||
| Science Group | 499,723 | 53.9 | 458,314 | 51.4 | 449,893 | 54.4 | ||||||||||||||
| Consolidated net sales | $ | 927,454 | 100.0 | % | $ | 891,738 | 100.0 | % | $ | 826,426 | 100.0 | % | ||||||||
Industry Group
The $5.7 million, or 1.3%, decrease in Industry Group sales in 2013 compared to 2012 was primarily due to fewer sales to semiconductor customers as a result of their capital purchasing cycles and reduced demand for our products from mining customers due to lower commodity prices, especially for gold, platinum and copper. Currency fluctuations decreased Industry Group revenue by $4.1 million, or 1.0%, and revenue from acquired businesses increased revenue by $3.1 million, or 0.7%, as compared to the prior year.
The $56.9 million, or 15.1%, increase in Industry Group sales in 2012 compared to 2011 was primarily due to increased demand for certain products as the industry shifted to smaller semiconductor manufacturing process nodes. More generally, as our customers have migrated to higher resolution systems, we realized increased sales of products which have higher average selling prices as compared to our lower resolution products. Additionally, we saw increased sales from continued penetration in the oil and gas and mining industries and the inclusion of sales from acquired businesses. Currency fluctuations decreased Industry Group sales by $5.3 million, or 1.2%, and revenue from acquired businesses increased revenue by $16.3 million, or 2.0%, in 2012 as compared to 2011.
Science Group
The $41.4 million, or 9.0%, increase in Science Group sales in 2013 compared to 2012 was primarily driven by increased revenue from high-end, high-resolution systems sold to research and science customers globally, the full year inclusion of revenue from acquired businesses, and increased maintenance and repair revenue realized from year-over-year increases to our installed base. We saw increased sales to emerging countries as they expanded their scientific infrastructure. In addition, sales of our high-end, high-resolution systems for structural and cell biology applications increased over 2012. Currency fluctuations decreased Science Group sales by $4.1 million, or 0.9%, and revenue from acquired businesses increased revenue by $12.1 million, or 2.6%, as compared to the prior year.
The $8.4 million, or 1.9%, increase in Science Group sales in 2012 compared to 2011 was primarily driven by an increase in maintenance and repair revenue resulting from a larger installed base. Increased advanced research spending in Asia and the inclusion of product sales from acquired businesses also contributed to the increase. This was partially offset by a decrease in the number of high-end, high-resolution units sold to customers engaged in structural and cell biology research. Historically, we have seen significant volatility in the sale of high-end, high resolution tools for these customers and that may continue. Currency fluctuations decreased Science Group sales by $13.3 million, or 2.8%, and revenue from acquired businesses increased revenue by $6.9 million, or 0.8%, in 2012 compared to 2011.
Net Sales by Geographic Region
A significant portion of our net sales has been derived from customers outside of the U.S., which we expect to continue. The following table shows our net sales by geographic region (dollars in thousands):
| Year Ended | ||||||||||||||||||||
| 2013 | 2012 | 2011 | ||||||||||||||||||
| U.S. and Canada | $ | 260,635 | 28.1 | % | $ | 291,720 | 32.7 | % | $ | 257,244 | 31.1 | % | ||||||||
| Europe | 270,660 | 29.2 | 244,722 | 27.5 | 261,313 | 31.6 | ||||||||||||||
| Asia-Pacific Region and Rest of World | 396,159 | 42.7 | 355,296 | 39.8 | 307,869 | 37.3 | ||||||||||||||
| Consolidated net sales | $ | 927,454 | 100.0 | % | $ | 891,738 | 100.0 | % | $ | 826,426 | 100.0 | % | ||||||||
U.S. and Canada
The $31.1 million, or 10.7%, decrease in sales to the U.S. and Canada in 2013 compared to 2012 was primarily due to fewer sales to research customers and a decline within the semiconductor industry as demand shifted to the Asia-Pacific region.
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The $34.5 million, or 13.4%, increase in sales to the U.S. and Canada in 2012 compared to 2011 was primarily due to an increase in shipments to semiconductor customers, growth in sales to mining, oil and gas customers, an increase in maintenance and repair revenue on our installed base driven by continued organic growth, and the inclusion of revenue from acquired businesses.
Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $25.9 million, or 10.6%, increase in sales to Europe in 2013 compared to 2012 was primarily due to increased sales of high-end, high-resolution systems to Science Group customers and full-year inclusion of revenue from acquired businesses. Currency fluctuations increased sales to Europe by $8.1 million, or 3.0%, in 2013 compared to 2012.
The $16.6 million, or 6.3%, decrease in sales to Europe in 2012 compared to 2011 was primarily due to change in the mix of sales to the semiconductor industry as demand moved away from Europe and shifted to customers in the Asia-Pacific region, as well as a decrease in the number of high-end, high-resolution systems sold for structural and cell biology research. Currency fluctuations also decreased sales to Europe by $19.0 million, or 7.8%, in 2012 compared to 2011.
Asia-Pacific Region and Rest of World
The $40.9 million, or 11.5%, increase in sales to the Asia-Pacific Region and Rest of World in 2013 compared to 2012 was primarily driven by increased sales to Science Group customers, increased maintenance and repair revenue due to a larger installed base and increased sales to semiconductor customers as the region continues to expand manufacturing capacity. Currency fluctuations, specifically the weakening of the yen compared to the dollar, decreased sales to this region by $16.4 million, or 4.1%, in 2013 compared to 2012.
The $47.4 million, or 15.4%, increase in sales to the Asia-Pacific Region and Rest of World in 2012 compared to 2011 was primarily driven by increased sales to semiconductor customers and increased spending by our Science Group customers, as well as increased maintenance and repair revenue from acquired businesses. Despite the adverse impact of the weakening yen, overall currency fluctuations had an insignificant impact in 2012 compared to 2011.
Cost of Sales and Gross Margin
Our gross margin (gross profit as a percentage of net sales) by segment was as follows:
| Year Ended | ||||||||
| 2013 | 2012 | 2011 | ||||||
| Industry Group | 52.1 | % | 50.8 | % | 49.2 | % | ||
| Science Group | 43.2 | 42.6 | 40.5 | |||||
| Overall | 47.3 | 46.6 | 44.5 | |||||
Cost of sales includes manufacturing costs, such as materials, labor (both direct and indirect) and factory overhead, as well as all of the costs of our customer service function such as labor, materials, travel and overhead. The four primary drivers affecting gross margin include: product mix, operational efficiencies, competitive pricing pressure and currency movements.
Cost of sales increased $12.6 million, or 2.6%, to $488.7 million in 2013 compared to $476.1 million in 2012, primarily due to increased sales in our Science Group, offset somewhat by improved operating efficiencies in the manufacture of our high-end, high-resolution systems. Currency fluctuations decreased cost of sales by $1.7 million in 2013 compared to 2012. The net effect on our gross margin from currency fluctuations during 2013 compared to 2012 was a decrease of $6.0 million, or 0.3 percentage points.
Cost of sales increased $17.0 million, or 3.7%, to $476.1 million in 2012 compared to $459.1 million in 2011, primarily due to increased sales. Currency fluctuations reduced cost of sales by $24.7 million in 2012 compared to 2011. The net effect on our gross margin from currency fluctuations during 2012 compared to 2011 was an increase of $6.1 million, or 1.6 percentage points.
Increasing gross margins is a major focus of the Company. During 2013 we introduced the largest number of new products in a single year in the Company's history, all of which are designed to improve gross margins. While the impact on gross margins from new products introduced in 2013 was minor, we expect to yield improved margins over time as we ramp up volumes of the new products. In addition, we have an ongoing effort to reduce cost of goods sold which includes a number of initiatives such as better factory utilization, re-working of the supply chain, re-design of existing products and control of quality on parts costs which is reducing installation and warranty expense.
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Industry Group
The increase in Industry Group gross margin in 2013 compared to 2012 was due primarily to change in product mix as we sold more sample preparation solutions, which generally carry higher average margins, as well as an increase in margins on service and maintenance revenue. Currency fluctuations decreased Industry Group gross margin in 2013 compared to 2012 by $2.8 million, or 0.2 percentage points.
The increase in Industry Group gross margin in 2012 compared to 2011 was due primarily to an increased number of sample preparation and high-resolution systems sold which carried higher average margins. Maintenance and repair revenue increased due to an expansion of the installed base, operational efficiencies, and the inclusion of sales from acquired businesses. Currency fluctuations improved Industry Group gross margin in 2012 compared to 2011 by $4.0 million, or 1.4 percentage points.
Science Group
The increases in Science Group gross margin in 2013 compared to 2012 was primarily due to the inclusion of revenue from acquired businesses, increased sales of high-resolution systems which carried higher average margins, and increased maintenance and repair revenue. Currency fluctuations decreased Science Group gross margin in 2013 compared to 2012 by $3.2 million, or 0.3 percentage points.
The increase in Science Group gross margin in 2012 compared to 2011 was primarily due to materials cost savings realized in the manufacture of our high-resolution systems, and the inclusion of revenue from acquired business. We realized some operational cost savings as a result of manufacturing a higher percentage of products at our Brno, Czech Republic facility. Also contributing was increased maintenance and repair revenue due to a larger installed base, and increased margin on that revenue due to the more efficient use of resources. Currency fluctuations increased Science Group gross margin in 2012 compared to 2011 by $3.0 million, or 2.0 percentage points.
Research and Development Costs
Research and Development (“R&D”) costs include labor, materials, overhead and payments to third parties for research and development of new products and new software or enhancements to existing products and software and are expensed as incurred. We periodically receive funds from various organizations to subsidize our research and development. These funds are reported as an offset to research and development expense. During all periods we received subsidies from European governments for technological developments primarily for semiconductor and life sciences equipment.
R&D costs, net of subsidies, were as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Gross spending | $ | 107,291 | $ | 102,309 | $ | 83,612 | |||||
| Less subsidies | (5,344 | ) | (7,344 | ) | (5,294 | ) | |||||
| Net expense | $ | 101,947 | $ | 94,965 | $ | 78,318 | |||||
R&D costs increased in 2013 compared to 2012 primarily due to increased headcount and project spending focused on new product introductions and support of current growth opportunities. The full year inclusion of the R&D expense from our acquired businesses also contributed to the increase. The impact of currency fluctuations increased R&D costs by $1.5 million, or 1.5%, in 2013 compared to 2012.
R&D costs increased in 2012 compared to 2011 primarily due to increased headcount and project spending to support current growth opportunities, as well as the inclusion of the R&D expenses for our recently-acquired companies. Currency fluctuations reduced R&D costs by $5.1 million, or 5.3%, in 2012 compared to 2011.
We anticipate that we will invest between 10% and 11% of revenue in R&D for the foreseeable future. Accordingly, as revenues increase, we expect R&D expenditures will also increase. Actual future spending, however, will depend on market conditions.
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 $9.8 million, or 5.8%, in 2013 compared to 2012 primarily due to increased headcount, higher stock-based compensation cost associated with a higher stock price and the inclusion of SG&A costs of our acquired companies. Currency fluctuations increased SG&A costs by an insignificant amount in 2013 compared to 2012.
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SG&A costs increased $10.9 million, or 6.9%, in 2012 compared to 2011 primarily due to increased headcount, higher stock-based compensation cost associated with a higher stock price and more commissions paid as a result of increased sales. Also causing the increase was the inclusion of SG&A costs of our acquired companies, including amortization expense of the acquired intangibles, and the costs associated with executing the acquisitions. Currency fluctuations decreased SG&A costs by $4.9 million, or 2.8%, in 2012 compared to 2011.
Our acquired businesses tend to have higher SG&A costs as a proportion of revenue as compared to our core business.
Restructuring, Reorganization, Relocation and Severance
Group Structure Reorganization
In January 2013, we announced our intention to reorganize the company into a group structure in order to enable us to efficiently execute our growth strategy. The reorganization was completed in the first quarter of 2013. The costs associated with the reorganization include primarily severance costs and resulted in the termination of certain positions throughout the company. In anticipation of this reorganization, we incurred $2.9 million of severance costs during the fourth quarter of 2012. We recorded an additional $1.1 million of severance costs during 2013. We do not expect to incur any additional charges related to the reorganization.
The reduction in positions as a result of the group structure reorganization reduced operating expenses by approximately $3 million.
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 were terminating the arrangement and that we would transfer the manufacturing process back to FEI. The termination contract was signed during the fourth quarter of 2011 and the manufacturing process was transitioned back to FEI as of April 2, 2012. The costs associated with the termination of the outsourcing arrangement were accrued in the fourth quarter of 2011. No additional costs were incurred in 2012 or 2013 and we do not expect to incur any significant additional costs associated with the termination of this arrangement.
The insourcing of our manufacturing operations reduced manufacturing costs by approximately $2 million to $3 million.
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.
Information for costs related to the April 2010 restructuring plan is as follows (in thousands):
| Year Ended | |||||||||||||||
| Costs Incurred | 2013 | 2012 | 2011 | Life of Plan | |||||||||||
| Severance costs related to work force reduction and reorganization | $ | — | $ | — | $ | 184 | $ | 6,617 | |||||||
| Product line transfer, training of Brno employees and facility build-out in Brno | — | — | 963 | 1,835 | |||||||||||
| Total costs incurred | $ | — | $ | — | $ | 1,147 | $ | 8,452 | |||||||
All of the costs incurred resulted in cash expenditures. We do not expect to incur significant additional costs associated with this plan.
The actions related to our April 2010 restructuring plan reduced manufacturing costs and operating expenses and increased cash flow by approximately $4.5 million per year.
For information regarding the related accrued liability, see Note 14 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.
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Other Expense, Net
Other expense, net includes interest income, interest expense, foreign currency transaction gains and losses and other miscellaneous items.
Interest income represents interest earned on cash and cash equivalents and investments in marketable securities and totaled $0.4 million in 2013, $1.6 million in 2012 and $2.4 million in 2011. The decrease in 2013 compared to 2012 was primarily due to continued low interest rates and mix of investments. The decrease in 2012 compared to 2011 was primarily due to lower investment balances and continued low interest rates.
Interest expense for 2013, 2012 and 2011 included interest expense related primarily to our 2.875% convertible notes, which converted to common stock on June 1, 2013.
Income Tax Expense
Our effective income tax rate of 16.4% for 2013 reflected comparatively lower tax rates in foreign jurisdictions where we earn most of our profits. The tax provision also included a benefit for the reduction of unrecognized tax benefits relating to positions on prior year returns after completion of audits in various jurisdictions.
Our effective income tax rate of 18.2% for 2012 reflected comparatively lower tax rates in foreign jurisdictions where we earn most of our profits. The benefit of lower tax rates was partially offset by an increase in unrecognized tax benefits for positions taken on current and prior year returns.
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 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, 2013, total unrecognized tax benefits were $24.0 million and related primarily to uncertainty surrounding tax credits, transfer pricing and permanent establishment. All unrecognized tax benefits would decrease the effective tax rate if recognized.
Our net deferred tax assets (liabilities) totaled $7.9 million and ($0.3) million, respectively, at December 31, 2013 and 2012. Valuation allowances on deferred tax assets totaled $2.7 million and $2.1 million as of December 31, 2013 and 2012, 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, 2013 consisted of $511.2 million of cash, cash equivalents, short-term restricted cash and short-term investments, $47.3 million in non-current investments, $32.7 million of long-term restricted cash, $100.0 million available under revolving credit facilities, as well as potential future cash flows from operations. At December 31, 2013 $282.3 million of our $591.2 million in total cash, cash equivalents, restricted cash and investments including long-term restricted cash was located outside of the United States. Although we do not intend to do so, repatriation of these funds would subject us to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries where funds are held. Restricted cash relates to deposits to secure bank guarantees for customer prepayments that expire through 2019.
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, 2013.
In 2013, cash and cash equivalents and short-term restricted cash increased $122.2 million to $403.0 million as of December 31, 2013 from $280.8 million as of December 31, 2012 primarily as a result of $237.9 million provided by operations, $16.5 million of proceeds from the exercise of employee stock options and a $5.8 million favorable effect of exchange rate changes. These were offset by $2.7 million used for acquisition related activities, $46.8 million used in the net purchase of marketable securities, $62.4 million used for the purchase of property, plant and equipment and dividends paid on common stock of $16.2 million.
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In 2012, cash and cash equivalents and short-term restricted cash decreased $62.1 million to $280.8 million as of December 31, 2012 from $342.9 million as of December 31, 2011 primarily as a result of $93.4 million used for acquisition related activities, $39.4 million used in the net purchase of marketable securities, $22.1 million used for the purchase of property, plant and equipment, $15.0 million used for a cross-license of intellectual property, and dividends paid on common stock of $6.1 million. These factors were partially offset by $85.0 million provided by operations, $13.1 million of proceeds from the exercise of employee stock options and a $0.5 million favorable effect of exchange rate changes.
Accounts receivable decreased $16.8 million to $194.4 million as of December 31, 2013 from $211.2 million as of December 31, 2012. This decrease was primarily due to increased collection efforts and the timing of shipments. The December 31, 2013 balance included a $3.2 million decrease related to fluctuations in currency exchange rates. Our days sales outstanding, calculated on a quarterly basis, was 67 days at December 31, 2013 and 83 days at December 31, 2012.
Inventories decreased $10.8 million to $181.7 million as of December 31, 2013 compared to $192.5 million as of December 31, 2012, due mainly to increased sales volumes. The December 31, 2013 balance included a $0.6 million increase related to fluctuations in currency exchange rates. Our annualized inventory turnover rate, calculated on a quarterly basis, was 2.2 times for the quarter ended December 31, 2013 and 1.9 times for the quarter ended December 31, 2012.
Net deferred tax assets (liabilities), current and long term, increased $8.3 million to $7.9 million as of December 31, 2013 compared to ($0.3) million as of December 31, 2012 primarily due to a decrease in liabilities relating to deferred revenue and intangible assets plus a decrease in liabilities for unrecognized tax benefits recorded against deferred tax asset carryforwards.
Other current assets decreased $1.0 million to $28.3 million as of December 31, 2013 compared to $29.3 million as of December 31, 2012, primarily due to a decrease in our current income taxes receivable, offset partially by increases in prepaid commissions and local taxes.
Expenditures for property, plant and equipment of $62.4 million and transfers to fixed assets from inventories of $11.1 million in 2013 primarily consisted of expenditures for the purchase of our facilities in Eindhoven, payments for equipment related to the build-out of the new leased Brno facility and demonstration equipment.
Accrued payroll liabilities increased $6.0 million to $45.1 million as of December 31, 2013 compared to $39.1 million as of December 31, 2012, primarily due to the timing of payments and increased payroll taxes in certain foreign jurisdictions.
Net income taxes receivable decreased $5.3 million to $1.7 million as of December 31, 2013 compared to $7.0 million as of December 31, 2012 primarily due to the accrual of current year taxes plus the receipt of refunds after settlement of audits in the U.S. Our receivable for income taxes of $6.3 million at December 31, 2013 is included as a component of other current assets.
Other 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. The credit agreement expires in 2016-04-01. 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 December 31, 2013.
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 sheets.
The following table sets forth information related to guarantees and letters of credit (in thousands):
| December 31, 2013 | |||
| Guarantees and letters of credit outstanding | $ | 51,892 | |
| Amount secured by restricted cash deposits: | |||
| Current | $ | 18,798 | |
| Long-term | 32,718 | ||
| Total secured by restricted cash | $ | 51,516 | |
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Share Repurchase Plan
A plan to repurchase up to a total of 4.0 million shares of our common stock was approved by our Board of Directors in September 2010, re-authorized in December 2012, and does not have an expiration date. The amount and timing of specific repurchases are subject to market conditions, applicable legal requirements and other factors. The purchases are funded from existing cash resources and may be suspended or discontinued at any time at our discretion without prior notice.
During 2012 we repurchased 20,500 shares for a total of $0.9 million, or an average of $43.41 per share and during 2011 we repurchased 1,654,000 shares for a total of $50.0 million, or an average of $30.19 per share. We did not repurchase any shares during 2013. As of December 31, 2013, 2,119,800 shares remained available for purchase pursuant to this plan.
Dividends to Shareholders
In June 2012 we announced our plan to initiate a quarterly dividend and our Board of Directors has declared dividends each quarter since the plan's inception. Cash dividends of $0.08 per share of common stock were declared in the first quarter of 2013. This was increased to $0.12 per share of common stock declared in the second, third, and fourth quarters of 2013. Total dividends declared during the year ended December 31, 2013 were $18.1 million, and dividend payments during the year ended December 31, 2013 totaled $16.2 million. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors.
CONTRACTUAL PAYMENT OBLIGATIONS
A summary of our contractual commitments and obligations as of December 31, 2013 was as follows (in thousands):
| 2014 | 2015 and 2016 | 2017 and 2018 | 2019 and Beyond | Total | |||||||||||||||
| Letters of Credit and Bank Guarantees | 18,460 | 5,749 | 772 | 26,911 | 51,892 | ||||||||||||||
| Purchase Order Commitments | 81,009 | 140 | — | — | 81,149 | ||||||||||||||
| Pension Related Obligations | 63 | 194 | 221 | 3,424 | 3,902 | ||||||||||||||
| Deferred Compensation Liability | — | — | — | 5,287 | 5,287 | ||||||||||||||
| Operating Leases | 10,997 | 15,054 | 10,614 | 48,722 | 85,387 | ||||||||||||||
| Total | $ | 110,529 | $ | 21,137 | $ | 11,607 | $ | 84,344 | $ | 227,617 | |||||||||
We also have other liabilities of 24.0 million relating to additional uncertain tax positions. However, as we are unable to reliably estimate the timing of future payments related to these additional uncertain tax positions, we have excluded this amount from the table above.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
RECENTLY ISSUED ACCOUNTING GUIDANCE
See Note 2 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of recently issued accounting guidance.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period.
Significant accounting policies and estimates underlying the accompanying consolidated financial statements include:
| • | the timing of revenue recognition; |
| • | the allowance for doubtful accounts; |
| • | valuations of excess and obsolete inventory; |
| • | the lives and recoverability of equipment and other long-lived assets such as goodwill; |
| • | the valuations of intangible assets; |
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| • | restructuring, reorganization, relocation and severance costs; |
| • | tax valuation allowances and unrecognized tax benefits; |
| • | warranty liabilities; |
| • | stock-based compensation; and |
| • | accounting for derivatives. |
It is reasonably possible that management's estimates may change in the future.
Revenue Recognition
We recognize revenue when persuasive evidence of a contractual agreement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed and determinable, and collectability is reasonably assured.
For products demonstrated to meet our published specifications, revenue is recognized when the title to the product and the risks and rewards of ownership pass to the customer. For products produced according to a particular customer’s specifications, revenue is recognized when the product meets the customer’s specifications and when the title and the risks and rewards of ownership have passed to the customer. In each case, the portion of revenue related to installation, of which the estimated fair value is generally 4% of the net revenue of the transaction, is deferred until such installation at the customer site and final customer acceptance are completed. For new applications of our products where performance cannot be assured prior to meeting specifications at the customer's installation site, no revenue is recognized until such specifications are met.
We enter into arrangements with customers whereby they purchase products, accessories and service contracts from us at the same time. For sales arrangements containing multiple elements (products or services), revenue relating to the undelivered elements is deferred at the estimated selling price of the element as determined using the sales price hierarchy established in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification ("ASC") 605-25. To be considered a separate element, the deliverable in question must represent a separate element under the accounting guidance and fulfill the following criteria: the delivered item or items must have value to the customer on a standalone basis; and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transactions is deferred until all elements are delivered.
For sales arrangements that contain multiple deliverables (products or services), to the extent that the deliverables within a multiple-element arrangement are not accounted for pursuant to other accounting standards, revenue is allocated among the deliverables using the selling price hierarchy established in ASC 605-25 to determine the selling price of each deliverable. The selling price hierarchy allows for the use of an estimated selling price (“ESP”) to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”). We determine the selling price in multiple-element arrangements using VSOE or TPE if available. VSOE is determined based on the price charged for the same deliverable when sold separately and TPE is established based on the price charged by our competitors or third parties for the same deliverable. If we are unable to determine the selling price because VSOE or TPE does not exist, we determine ESP for the purposes of allocating total arrangement consideration among the elements by considering several internal and external factors such as, but not limited to, historical sales of similar products, costs incurred to manufacture the product and normal profit margins from the sale of similar products, geographical considerations and overall pricing practices.
These factors are subject to change as we modify our pricing practices and such changes could result in changes to determination of VSOE, TPE and ESP, which could result in our future revenue recognition from multiple-element arrangements being materially different than our results in the current period.
Generally, revenue from all elements in a multiple-element arrangement is recognized within 18 months of the shipment of the first item in the arrangement.
We provide maintenance and support services under renewable, term maintenance agreements. Maintenance and support fee revenue is recognized ratably over the contractual term, which is generally 12 months, and commences from the start date.
Revenue from time and materials-based service arrangements is recognized as the service is performed. Spare parts revenue is generally recognized upon shipment.
Deferred revenue represents customer deposits on equipment orders, orders awaiting customer acceptance and prepaid service contract revenue. Deferred revenue is recognized in accordance with our revenue recognition policies described above.
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Allowance for Doubtful Accounts
The allowance for doubtful accounts is estimated based on collection experience and known trends with current customers. The large number of entities comprising our customer base and their dispersion across many different industries and geographies somewhat mitigates our credit risk exposure and the magnitude of our allowance for doubtful accounts. Our estimates of the allowance for doubtful accounts are reviewed and updated on a quarterly basis. Changes to the reserve may occur based upon changes in revenue levels and associated balances in accounts receivable and estimated changes in individual customers’ credit quality. Write-offs include amounts written off for specifically identified bad debts. Historically, we have not incurred significant write-offs of accounts receivable, however, an individual loss could be significant due to the relative size of our sales transactions.
Activity within our accounts receivable allowance was as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Balance, beginning of period | $ | 2,718 | $ | 5,553 | $ | 5,685 | |||||
| Expense (reversal) | 473 | (154 | ) | (18 | ) | ||||||
| Write-offs | (263 | ) | (2,732 | ) | (25 | ) | |||||
| Translation adjustments | 41 | 51 | (89 | ) | |||||||
| Balance, end of period | $ | 2,969 | $ | 2,718 | $ | 5,553 | |||||
Valuation of Excess and Obsolete Inventory
Inventories are stated at the lower of cost or market, with cost determined by standard cost methods, which approximate the first-in, first-out method. Inventory costs include material, labor and manufacturing overhead. Service inventories that exceed the estimated requirements for the next 12 months based on recent usage levels are reported as a long-term asset. Management has established inventory reserves based on estimates of excess and/or obsolete current and non-current inventory.
Manufacturing inventory is reviewed for obsolescence and excess quantities on a quarterly basis, based on estimated future use of quantities on hand, which is determined based on past usage, planned changes to products and known trends in markets and technology. Changes in support plans or technology could have a significant impact on obsolescence.
To support our world-wide service operations, we maintain service spare parts inventory, which consists of both consumable and repairable spare parts. Consumable service spare parts are used within our service business to replace worn or damaged parts in a system during a service call and are generally classified in current inventory as our stock of this inventory turns relatively quickly. However, if there has been no recent usage for a consumable service spare part, but the part is still necessary to support systems under service contracts, the part is considered to be non-current and included within non-current inventories within our consolidated balance sheet. Consumables are charged to cost of goods sold when issued during the service call.
We also maintain a substantial supply of repairable and reusable spare parts for possible use in future repairs and customer field service of our install base. We have classified this inventory as a long-term asset given these parts can be repaired and reused in the service business over many years. As these service parts age over the related product group’s post-production service life, we reduce the net carrying value of our repairable and consumable spare part inventory to account for the excess that builds over the service life. The post-production service life of our systems is generally eight years and, at the end of the service life, the carrying value for these parts is reduced to zero. We also perform periodic monitoring of our installed base for premature or increased end of service life events. If required, we expense, through cost of goods sold, the remaining net carrying value of any related spare parts inventory in the period incurred.
Provision for manufacturing inventory valuation adjustments total $4.8 million, $2.7 million and $4.2 million, respectively, in 2013, 2012 and 2011. Provision for service spare parts inventory valuation adjustment total $8.6 million, $6.6 million and $6.6 million, respectively, in 2013, 2012 and 2011.
Lives and Recoverability of Equipment and Other Long-Lived Assets
We evaluate the remaining life and recoverability of equipment and other assets that are to be held and used, including purchased technology and other intangible assets with finite useful lives, at least annually and whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If there is an indication of impairment, we prepare an estimate of future, undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying value of the asset, we adjust the carrying amount of the asset to its estimated fair value. Long lived assets to be disposed of by sale are valued at the lower of book value or fair value less cost to sell.
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We estimate the fair value of an intangible asset or asset group using the income approach and internally developed discounted cash flow models. These models include, among others, the following assumptions: projections of revenue and expenses and related cash flows based on assumed long-term growth rates and demand trends; estimated royalty, income tax, and attrition rates; and estimated discount rates. We base these assumptions on our historical data and experience, third-party appraisals, industry projections, micro and macro general economic condition projections, and our expectations.
See Note 9 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual report on Form 10-K for information on impairments recognized in 2011. No impairments related to our equipment or other long-lived assets were recognized during 2013 or 2012.
Goodwill
Goodwill represents the excess purchase price over fair value of net assets acquired. Goodwill and other identifiable intangible assets with indefinite useful lives are not amortized, but instead, are tested for impairment at least annually during the fourth quarter. In 2011, we adopted ASU 2011-08, "Intangibles - Goodwill and Other (Topic 350), Testing Goodwill for Impairment", which allows an entity to perform a qualitative assessment of the fair value of its reporting units before calculating the fair value of the reporting unit in step one of the two-step goodwill impairment model. We perform our goodwill impairment analysis at the component level, which is defined as one level below our operating segments. If, through the qualitative assessment, the entity determines that it is more likely than not that a reporting unit's fair value is greater than its carrying value, the remaining impairment steps would be unnecessary.
If there are indicators that goodwill has been impaired and thus the two-step goodwill impairment model is necessary, step 1 is to determine the fair value of each reporting unit and compare it to the reporting unit's carrying value. Fair value is determined based on the present value of estimated cash flows using available information regarding expected cash flows of each reporting unit, discount rates and the expected long-term cash flow growth rates. Discount rates are determined based on the cost of capital for the reporting unit. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value. The implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, an impairment loss equal to the difference will be recorded. No impairments were identified in our annual impairment analysis during the fourth quarter of 2013, 2012 and 2011.
Restructuring, Reorganization, Relocation and Severance Costs
Restructuring, reorganization, relocation and severance costs are recognized and recorded at fair value as incurred. Such costs include severance and other costs related to employee terminations as well as facility costs related to future abandonment of various leased office and manufacturing sites. Also included are certain period costs to move our existing supply chain, as well as migration of certain IT systems to new platforms. Changes in our estimates could occur, and have occurred, due to fluctuations in exchange rates, the sublease of unused space, unanticipated voluntary departures before severance was required and unanticipated redeployment of employees to vacant positions.
See Note 14 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.
Income Taxes
We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. We record a valuation allowance to reduce deferred tax assets to the amount expected to “more likely than not” be realized in our future tax returns. Should we determine that we would not be able to realize all or part of our remaining net deferred tax assets in the future, increases to the valuation allowance for deferred tax assets may be required. Conversely, if we determine that certain tax assets that have been reserved for may be realized in the future, we may reduce our valuation allowance in future periods.
In the ordinary course of business, there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate or effective settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. When applicable, associated interest and penalties have been recognized as a component of income tax expense.
34
Unrecognized tax benefits relate mainly to uncertainty surrounding various tax credits, transfer pricing and permanent establishment in foreign jurisdictions. Included in the liabilities for unrecognized tax benefits were accruals for interest and penalties. If recognized, the total unrecognized tax benefits would have an impact on the effective tax rate.
See Note 13 of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.
Warranty Liabilities
Our products generally carry a one-year warranty. A reserve is established at the time of sale to cover estimated warranty costs and certain commitments for product upgrades as a component of cost of sales on our consolidated statements of operations. Our estimate of warranty cost is primarily based on our history of warranty repairs and maintenance, as applied to systems currently under warranty. For our new products without a history of known warranty costs, we estimate the expected costs based on our experience with similar product lines and technology. While most new products are extensions of existing technology, the estimate could change if new products require a significantly different level of repair and maintenance than similar products have required in the past. Our estimated warranty costs are reviewed and updated on a quarterly basis. Changes to the reserve occur as volume, product mix and warranty costs fluctuate.
Stock-Based Compensation
We measure and recognize compensation expense for all stock-based payment awards granted to our employees and directors, including employee stock options, non-vested stock and stock purchases related to our employee share purchase plan based on the estimated fair value of the award on the grant date. We utilize the Black-Scholes valuation model for valuing our stock option awards.
The use of the Black-Scholes valuation model to estimate the fair value of stock option awards requires us to make judgments on assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates at the time they are made, but these estimates involve inherent uncertainties and the determination of expense could be materially different in the future.
We amortize stock-based compensation expense on a straight-line basis over the vesting period of the individual award with estimated forfeitures considered. Vesting periods are generally four years. The exercise price of issued options equals the grant date fair value of the underlying shares and the options generally have a legal life of seven years.
Compensation expense is only recognized on awards that ultimately vest. Therefore, we have reduced the compensation expense to be recognized over the vesting period for anticipated future forfeitures. Forfeiture estimates are based on historical forfeiture patterns. We update our forfeiture estimates quarterly and recognize any changes to accumulated compensation expense in the period of change. If actual forfeitures differ significantly from our estimates, our results of operations could be materially impacted.
Derivatives
We use a combination of forward contracts, zero cost collar contracts, option contracts and other instruments to hedge certain anticipated foreign currency exchange transactions. When specific hedge criteria have been met, changes in fair values of hedge contracts relating to anticipated transactions are recorded in other comprehensive income rather than net income until the underlying hedged transaction affects net income. One of the criteria for this accounting treatment is that the hedge contract amounts should not be in excess of specifically identified anticipated transactions. By their nature, our estimates of anticipated transactions may fluctuate over time and may ultimately vary from actual transactions. When anticipated transaction estimates or actual transaction amounts decrease below hedged levels, or when the timing of transactions changes significantly, we reclassify a portion of the cumulative changes in fair values of the related hedge contracts from other comprehensive income to other income (expense) during the quarter in which such changes occur.
We also use foreign forward exchange contracts to mitigate the foreign currency exchange impact of our cash, receivables and payables denominated in foreign currencies. These derivatives do not meet the criteria for hedge accounting and, accordingly, changes in the fair value are recognized in net income in the current period.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Rate Risk
A large portion of our business is conducted outside of the U.S. through a number of foreign subsidiaries. Each of the foreign subsidiaries keeps its accounting records in its respective local currency. These local-currency-denominated accounting records are translated at exchange rates that fluctuate up or down from period to period and consequently affect our consolidated results of operations and financial position. The major foreign currencies in which we experience periodic fluctuations are the euro, the Czech koruna, the Japanese yen and the British pound sterling. For the last three years 72%, 67% and 69% of our sales occurred outside the U.S. in 2013, 2012 and 2011, respectively.
In addition, because of our substantial research, development and manufacturing operations in Europe, we incur a greater proportion of our costs in Europe than the revenue we derive from sales in that geographic region. Our raw materials, labor and other manufacturing costs are primarily denominated in U.S. dollars, euros and Czech korunas. This situation negatively affects our gross margins and results of operations when the dollar weakens in relation to the euro or koruna. A strengthening of the dollar in relation to the euro or koruna would have a net positive effect on our gross margins and results of operations. Movement of Asian currencies in relation to the dollar and euro can also affect our reported sales and results of operations because we derive more revenue than we incur costs from the Asia-Pacific region. In addition, several of our competitors are based in Japan and a weakening of the Japanese yen has the effect of lowering their prices relative to ours.
Assets and liabilities of foreign subsidiaries are translated using the exchange rates in effect at the balance sheet date. Revenues and expenses are translated using the average exchange rate during the period. The resulting translation adjustments increased shareholders’ equity and comprehensive income in 2013 by $10.0 million. Holding other variables constant, if the U.S. dollar weakened by 10% against all currencies that we translate, shareholders’ equity would increase by approximately $67.3 million as of December 31, 2013. Holding other variables constant, if the U.S. dollar strengthened by 10% against all currencies that we translate, shareholders’ equity would decrease by approximately $55.1 million as of December 31, 2013.
Risk Mitigation
We use derivatives to mitigate financial exposure resulting from fluctuations in foreign currency exchange rates. When specific hedge criteria have been met, changes in fair values of hedge contracts relating to anticipated transactions are recorded in other comprehensive income rather than net income until the underlying hedged transaction affects net income. Changes in fair value for derivatives not designated as hedging instruments are recognized in net income in the current period. As of December 31, 2013, the aggregate notional amount of our outstanding derivative contracts designated as cash flow hedges was $208.4 million. These contracts have varying maturities through the second quarter of 2015. The aggregate notional amount of our outstanding balance sheet-related derivative contracts at December 31, 2013 was $172.9 million, which contracts have varying maturities through the first quarter of 2014. We do not enter into derivative financial instruments for speculative purposes.
Holding other variables constant, if the U.S. dollar weakened by 10%, the market value of our foreign currency contracts outstanding as of December 31, 2013 would increase by approximately $23.8 million. The increase in value relating to the forward sale or purchase contracts would, however, be substantially offset by the revaluation of the transactions being hedged. A 10% increase in the U.S. dollar relative to the hedged currencies would have a similar, but negative, effect on the value of our foreign currency contracts, substantially offset again by the revaluation of the transactions being hedged.
Balance Sheet Related
We attempt to mitigate our currency exposures for recorded transactions by using forward exchange contracts to reduce the risk that our future cash flows will be adversely affected by changes in exchange rates. We enter into forward sale or purchase contracts for foreign currencies to hedge specific cash, receivables or payables positions denominated in foreign currencies. Changes in fair value of derivatives entered into to mitigate the foreign exchange risks related to these balance sheet items are recorded in other expense currently together with the transaction gain or loss from the hedged balance sheet position.
The hedging transactions we undertake are intended to limit our exposure to changes in the dollar/euro exchange rate. Foreign currency losses recorded in other expense, inclusive of the impact of derivatives, totaled $2.8 million, $5.7 million and $2.2 million, respectively, in 2013, 2012 and 2011.
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Cash Flow Hedges
We use zero cost collar contracts and option contracts to hedge certain anticipated foreign currency exchange transactions. The foreign exchange hedging structure is set up, generally, on a twenty-four month time horizon. The hedging transactions we undertake primarily limit our exposure to changes in the U.S. dollar/euro and the U.S. dollar/Czech koruna exchange rate. The zero cost collar contract hedges are designed to protect us as the U.S. dollar weakens, but also provide us with some flexibility if the dollar strengthens.
These derivatives meet the criteria to be designated as hedges and, accordingly, we record the change in fair value of the effective portion of these hedge contracts relating to anticipated transactions in other comprehensive income rather than net income until the underlying hedged transaction affects net income. We recognized realized losses of $0.8 million in 2013 in cost of sales related to hedge results, compared to realized losses of $2.5 million in 2012 and gains of $3.6 million in 2011. As of December 31, 2013, $1.3 million of deferred unrealized net losses on outstanding derivatives have been recorded in other comprehensive income and are expected to be reclassified to net income during the next twenty-four months as a result of the underlying hedged transactions also being recorded in net income. We recorded in other income a $0.1 million loss in 2013, an insignificant gain in 2012, and gains of $0.1 million in 2011 as a result of currency volatility. We continually monitor our hedge positions and forecasted transactions and, in the event changes to our forecast occur, we may have dedesignations of our cash flow hedges in the future. Additionally, given the volatility in the global currency markets, the effectiveness attributed to these hedges may decrease or, in some instances, may result in dedesignation as a cash flow hedge, which would require us to record a charge in other expense in the period of ineffectiveness or dedesignation.
Interest Rate Risk
Our exposure to market risk for changes in interest rates primarily relates to our investments. Since we had no variable interest rate debt outstanding at December 31, 2013, our interest expense is relatively fixed and not affected by changes in interest rates. In the event we issue any new debt in the future, increases in interest rates will increase the interest expense associated with the debt.
The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This objective is accomplished by making diversified investments, consisting only of investment grade securities.
Cash, Cash Equivalents and Restricted Cash
As of December 31, 2013, we held cash and cash equivalents of $384.2 million and short-term restricted cash of $18.8 million that consisted of cash and other highly liquid marketable securities with maturities of three months or less at the date of acquisition. Declines of interest rates over time would reduce our interest income from our highly liquid short-term investments. A decrease in interest rates of one percentage point would cause a corresponding decrease in annual interest income of approximately $3.8 million assuming our cash and cash equivalent balances at December 31, 2013 remained constant and were earning at least 1% per annum, which, at December 31, 2013, they were not. Due to the nature of our highly liquid cash equivalents, an increase in interest rates would not materially change the fair market value of our cash and cash equivalents.
Fixed Rate Debt Securities
As of December 31, 2013, we held short-term fixed rate investments of $108.2 million that consisted of marketable debt securities, certificates of deposit, commercial paper and government-backed securities. These investments are recorded on our balance sheet as available-for-sale securities at fair value based on quoted market prices. Unrealized gains/losses resulting from changes in the fair value are recorded, net of tax, in shareholders’ equity as a component of accumulated other comprehensive income (loss). Interest rate fluctuations impact the fair value of these investments, however, given our ability to hold these investments until maturity or until the unrealized losses recover, we do not expect these fluctuations to have a material impact on our results of operations, financial position or cash flows.
Declines in interest rates over time would reduce our interest income from our short-term investments, as our short-term portfolio is re-invested at current market interest rates. A decrease in interest rates of one percentage point would cause a corresponding decrease in our annual interest income from these items of approximately $1.1 million assuming our investment balances at December 31, 2013 remained constant and were earning at least 1% per annum, which, at December 31, 2013, they were not.
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Item 8. Financial Statements and Supplementary Data
Unaudited quarterly financial data for each of the eight quarters in the two-year period ended December 31, 2013 is as follows:
2013 (In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
| Net sales | $ | 221,189 | $ | 222,478 | $ | 218,496 | $ | 265,291 | |||||||
| Cost of sales | 118,638 | 115,581 | 113,751 | 140,699 | |||||||||||
| Gross profit | 102,551 | 106,897 | 104,745 | 124,592 | |||||||||||
Total operating expenses(1) | 69,028 | 68,447 | 70,743 | 74,379 | |||||||||||
| Operating income | 33,523 | 38,450 | 34,002 | 50,213 | |||||||||||
| Other expense, net | (1,505 | ) | (1,452 | ) | (661 | ) | (968 | ) | |||||||
| Income before income taxes | 32,018 | 36,998 | 33,341 | 49,245 | |||||||||||
| Income tax expense | 5,217 | 7,005 | 4,735 | 7,972 | |||||||||||
| Net income | $ | 26,801 | $ | 29,993 | $ | 28,606 | $ | 41,273 | |||||||
| Basic net income per share | $ | 0.70 | $ | 0.76 | $ | 0.69 | $ | 0.98 | |||||||
| Diluted net income per share | $ | 0.65 | $ | 0.72 | $ | 0.67 | $ | 0.97 | |||||||
| Shares used in basic per share calculation | 38,522 | 39,496 | 41,750 | 41,963 | |||||||||||
| Shares used in diluted per share calculation | 42,136 | 42,281 | 42,455 | 42,591 | |||||||||||
2012 (In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
| Net sales | $ | 217,555 | $ | 221,452 | $ | 221,785 | $ | 230,946 | |||||||
| Cost of sales | 119,444 | 117,023 | 117,629 | 122,012 | |||||||||||
| Gross profit | 98,111 | 104,429 | 104,156 | 108,934 | |||||||||||
Total operating expenses(2) | 64,045 | 65,351 | 65,839 | 72,308 | |||||||||||
| Operating income | 34,066 | 39,078 | 38,317 | 36,626 | |||||||||||
| Other expense, net | (2,063 | ) | (1,255 | ) | (1,712 | ) | (2,509 | ) | |||||||
| Income before income taxes | 32,003 | 37,823 | 36,605 | 34,117 | |||||||||||
| Income tax expense (benefit) | 6,336 | 7,530 | 7,447 | 4,315 | |||||||||||
| Net income | $ | 25,667 | $ | 30,293 | $ | 29,158 | $ | 29,802 | |||||||
| Basic net income per share | $ | 0.68 | $ | 0.80 | $ | 0.76 | $ | 0.78 | |||||||
| Diluted net income per share | $ | 0.63 | $ | 0.74 | $ | 0.71 | $ | 0.72 | |||||||
| Shares used in basic per share calculation | 37,886 | 37,993 | 38,082 | 38,295 | |||||||||||
| Shares used in diluted per share calculation | 41,518 | 41,614 | 41,771 | 41,897 | |||||||||||
| (1) | Operating expenses in the first and second quarters of 2013 included $0.7 million and $0.4 million, respectively, of restructuring, reorganization, relocation and severance expense. |
| (2) | Operating expenses in the fourth quarter of 2012 included $2.9 million of restructuring, reorganization, relocation and severance expense. |
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
FEI Company:
We have audited the accompanying consolidated balance sheets of FEI Company and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three‑year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FEI Company and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FEI Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February, 21, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Portland, Oregon
February 21, 2014
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FEI Company and Subsidiaries
Consolidated Balance Sheets
(In thousands)
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Assets | |||||||
| Current Assets: | |||||||
| Cash and cash equivalents | $ | 384,170 | $ | 266,302 | |||
| Short-term investments in marketable securities | 108,191 | 79,532 | |||||
| Short-term restricted cash | 18,798 | 14,522 | |||||
| Receivables, net of allowances for doubtful accounts of $2,969 and $2,718 | 194,418 | 211,160 | |||||
| Inventories | 181,725 | 192,540 | |||||
| Deferred tax assets | 15,114 | 12,245 | |||||
| Other current assets | 28,324 | 29,332 | |||||
| Total current assets | 930,740 | 805,633 | |||||
| Non-current investments in marketable securities | 47,278 | 29,179 | |||||
| Long-term restricted cash | 32,718 | 27,425 | |||||
| Property, plant and equipment, net of accumulated depreciation of $125,405 and $121,560 | 157,829 | 109,872 | |||||
| Intangible assets, net of accumulated amortization of $19,385 and $10,984 | 47,197 | 51,499 | |||||
| Goodwill | 136,152 | 131,320 | |||||
| Deferred tax assets | 1,751 | 5,092 | |||||
| Non-current inventories | 62,104 | 65,116 | |||||
| Other assets, net | 10,315 | 9,087 | |||||
| Total Assets | $ | 1,426,084 | $ | 1,234,223 | |||
| Liabilities and Shareholders’ Equity | |||||||
| Current Liabilities: | |||||||
| Accounts payable | $ | 73,247 | $ | 54,847 | |||
| Accrued payroll liabilities | 45,146 | 39,100 | |||||
| Accrued warranty reserves | 12,705 | 12,049 | |||||
| Short-term deferred revenue | 91,563 | 74,736 | |||||
| Income taxes payable | 4,579 | 1,343 | |||||
| Convertible debt | — | 89,010 | |||||
| Other current liabilities | 46,374 | 47,718 | |||||
| Total current liabilities | 273,614 | 318,803 | |||||
| Long-term deferred revenue | 30,744 | 26,668 | |||||
| Deferred tax liabilities | 8,931 | 17,588 | |||||
| Other liabilities | 35,227 | 31,261 | |||||
| Commitments and contingencies | |||||||
| Shareholders’ Equity: | |||||||
| Preferred stock - 500 shares authorized; none issued and outstanding | — | — | |||||
| Common stock - 70,000 shares authorized; 42,136 and 38,478 shares issued and outstanding, no par value | 637,482 | 516,907 | |||||
| Retained earnings | 392,958 | 284,440 | |||||
| Accumulated other comprehensive income | 47,128 | 38,556 | |||||
| Total Shareholders’ Equity | 1,077,568 | 839,903 | |||||
| Total Liabilities and Shareholders’ Equity | $ | 1,426,084 | $ | 1,234,223 | |||
See accompanying Notes to the Consolidated Financial Statements.
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FEI Company and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Net sales: | |||||||||||
| Products | $ | 709,438 | $ | 691,496 | $ | 654,599 | |||||
| Service | 218,016 | 200,242 | 171,827 | ||||||||
| Total net sales | 927,454 | 891,738 | 826,426 | ||||||||
| Cost of sales: | |||||||||||
| Products | 352,630 | 347,224 | 344,575 | ||||||||
| Service | 136,039 | 128,884 | 114,485 | ||||||||
| Total cost of sales | 488,669 | 476,108 | 459,060 | ||||||||
| Gross profit | 438,785 | 415,630 | 367,366 | ||||||||
| Operating expenses: | |||||||||||
| Research and development | 101,947 | 94,965 | 78,318 | ||||||||
| Selling, general and administrative | 179,560 | 169,719 | 158,782 | ||||||||
| Restructuring, reorganization, relocation and severance | 1,090 | 2,859 | 3,215 | ||||||||
| Total operating expenses | 282,597 | 267,543 | 240,315 | ||||||||
| Operating income | 156,188 | 148,087 | 127,051 | ||||||||
| Other expense: | |||||||||||
| Interest income | 428 | 1,606 | 2,361 | ||||||||
| Interest expense | (1,890 | ) | (4,098 | ) | (4,037 | ) | |||||
| Other, net | (3,124 | ) | (5,047 | ) | (2,510 | ) | |||||
| Total other expense, net | (4,586 | ) | (7,539 | ) | (4,186 | ) | |||||
| Income before income taxes | 151,602 | 140,548 | 122,865 | ||||||||
| Income tax expense | 24,929 | 25,628 | 19,228 | ||||||||
| Net income | $ | 126,673 | $ | 114,920 | $ | 103,637 | |||||
| Basic net income per share | $ | 3.13 | $ | 3.02 | $ | 2.70 | |||||
| Diluted net income per share | $ | 3.01 | $ | 2.80 | $ | 2.51 | |||||
| Cash dividends declared per share | $ | 0.44 | $ | 0.24 | $ | — | |||||
| Shares used in per share calculations: | |||||||||||
| Basic | 40,446 | 38,065 | 38,384 | ||||||||
| Diluted | 42,395 | 41,728 | 42,047 | ||||||||
See accompanying Notes to the Consolidated Financial Statements.
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FEI Company and Subsidiaries
Consolidated Statements of Comprehensive Income
(In thousands)
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Net income | $ | 126,673 | $ | 114,920 | $ | 103,637 | |||||
| Other comprehensive income, net of taxes: | |||||||||||
| Change in cumulative translation adjustment | 9,975 | 9,922 | (20,022 | ) | |||||||
| Change in unrealized (loss) gain on available-for-sale securities | (15 | ) | (14 | ) | 23 | ||||||
| Change in minimum pension liability | 267 | (796 | ) | — | |||||||
| Changes due to cash flow hedging instruments: | |||||||||||
| Net (loss) gain on hedge instruments | (2,492 | ) | 2,487 | (910 | ) | ||||||
| Reclassification to net income of previously deferred losses (gains) related to hedge derivatives instruments | 837 | 2,502 | (3,641 | ) | |||||||
| Comprehensive income | $ | 135,245 | $ | 129,021 | $ | 79,087 | |||||
See accompanying Notes to the Consolidated Financial Statements.
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FEI Company and Subsidiaries
Consolidated Statements of Shareholders’ Equity
For The Years Ended December 31, 2013, 2012 and 2011
(In thousands)
| Common Stock | Retained Earnings | Accumulated Other Comprehensive Income | Total Shareholders’ Equity | |||||||||||||||
| Shares | Amount | |||||||||||||||||
| Balance at December 31, 2010 | 38,280 | $ | 509,145 | $ | 75,024 | $ | 49,005 | $ | 633,174 | |||||||||
| Net income | — | — | 103,637 | — | 103,637 | |||||||||||||
| Employee purchases of common stock through employee share purchase plan | 212 | 5,458 | — | — | 5,458 | |||||||||||||
| Restricted shares issued and stock options exercised related to employee stock-based compensation plans | 1,133 | 18,854 | — | — | 18,854 | |||||||||||||
| Stock-based compensation expense | — | 11,111 | — | — | 11,111 | |||||||||||||
| Restricted stock unit taxes for net share settlement | (105 | ) | (3,789 | ) | — | — | (3,789 | ) | ||||||||||
| Repurchase of common stock | (1,654 | ) | (50,000 | ) | — | — | (50,000 | ) | ||||||||||
| Tax benefit of non-qualified stock option exercises and restricted stock unit vests | — | 2,918 | — | — | 2,918 | |||||||||||||
| Conversion of convertible debt | — | 1 | — | — | 1 | |||||||||||||
| Translation adjustment | — | — | — | (20,022 | ) | (20,022 | ) | |||||||||||
| Unrealized gain on available for sale securities | — | — | — | 23 | 23 | |||||||||||||
| Net adjustment for fair value of hedge derivatives | — | — | — | (4,551 | ) | (4,551 | ) | |||||||||||
| Balance at December 31, 2011 | 37,866 | 493,698 | 178,661 | 24,455 | 696,814 | |||||||||||||
| Net income | — | — | 114,920 | — | 114,920 | |||||||||||||
| Employee purchases of common stock through employee share purchase plan | 195 | 7,007 | — | — | 7,007 | |||||||||||||
| Restricted shares issued and stock options exercised related to employee stock-based compensation plans | 551 | 5,714 | — | — | 5,714 | |||||||||||||
| Stock-based compensation expense | — | 14,154 | — | — | 14,154 | |||||||||||||
| Restricted stock unit taxes for net share settlement | (113 | ) | (5,913 | ) | — | — | (5,913 | ) | ||||||||||
| Repurchase of common stock | (21 | ) | (891 | ) | — | — | (891 | ) | ||||||||||
| Tax benefit of non-qualified stock option exercises and restricted stock unit vests | — | 3,137 | — | — | 3,137 | |||||||||||||
| Conversion of convertible debt | — | 1 | — | — | 1 | |||||||||||||
| Translation adjustment | — | — | — | 9,922 | 9,922 | |||||||||||||
| Unrealized gain on available for sale securities | — | — | — | (14 | ) | (14 | ) | |||||||||||
| Dividends declared on common stock ($0.24 per share) | — | — | (9,141 | ) | — | (9,141 | ) | |||||||||||
| Minimum pension liability, net of taxes | — | — | — | (796 | ) | (796 | ) | |||||||||||
| Net adjustment for fair value of hedge derivatives | — | — | — | 4,989 | 4,989 | |||||||||||||
| Balance at December 31, 2012 | 38,478 | 516,907 | 284,440 | 38,556 | 839,903 | |||||||||||||
| Net income | — | — | 126,673 | — | 126,673 | |||||||||||||
| Employee purchases of common stock through employee share purchase plan | 163 | 8,618 | — | — | 8,618 | |||||||||||||
| Restricted shares issued and stock options exercised related to employee stock-based compensation plans | 574 | 7,927 | — | — | 7,927 | |||||||||||||
| Stock-based compensation expense | — | 18,327 | — | — | 18,327 | |||||||||||||
| Restricted stock unit taxes for net share settlement | (109 | ) | (9,658 | ) | — | — | (9,658 | ) | ||||||||||
| Tax benefit of non-qualified stock option exercises and restricted stock unit vests | — | 6,424 | — | — | 6,424 | |||||||||||||
| Conversion of convertible debt | 3,030 | 88,937 | — | — | 88,937 | |||||||||||||
| Translation adjustment | — | — | — | 9,975 | 9,975 | |||||||||||||
| Unrealized loss on available for sale securities | — | — | — | (15 | ) | (15 | ) | |||||||||||
| Dividends declared on common stock ($0.44 per share) | — | — | (18,155 | ) | — | (18,155 | ) | |||||||||||
| Minimum pension liability, net of taxes | — | — | — | 267 | 267 | |||||||||||||
| Net adjustment for fair value of hedge derivatives | — | — | — | (1,655 | ) | (1,655 | ) | |||||||||||
| Balance at December 31, 2013 | 42,136 | $ | 637,482 | $ | 392,958 | $ | 47,128 | $ | 1,077,568 | |||||||||
See accompanying Notes to the Consolidated Financial Statements.
43
FEI Company and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 126,673 | $ | 114,920 | $ | 103,637 | |||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation | 23,693 | 22,814 | 18,931 | ||||||||
| Amortization | 10,568 | 5,852 | 2,054 | ||||||||
| Stock-based compensation | 18,327 | 14,154 | 11,111 | ||||||||
| Asset impairments and write-offs of intangible assets | — | — | 1,434 | ||||||||
| Other | 27 | 9 | 3 | ||||||||
| Income taxes payable (receivable), net | 13,066 | (3,979 | ) | 6,908 | |||||||
| Deferred income taxes | (6,743 | ) | 2,350 | (5,175 | ) | ||||||
| Decrease (increase), net of acquisitions, in: | |||||||||||
| Receivables | 12,982 | (22,077 | ) | (5,389 | ) | ||||||
| Inventories | 1,486 | (24,309 | ) | (42,337 | ) | ||||||
| Other assets | 3,781 | (2,949 | ) | (11,072 | ) | ||||||
| Increase (decrease), net of acquisitions, in: | |||||||||||
| Accounts payable | 18,553 | 397 | 1,324 | ||||||||
| Accrued payroll liabilities | 5,429 | (12,685 | ) | 15,832 | |||||||
| Accrued warranty reserves | 660 | 176 | 3,077 | ||||||||
| Deferred revenue | 13,285 | (4,703 | ) | (8,544 | ) | ||||||
| Accrued restructuring, reorganization, relocation and severance | (2,628 | ) | 397 | (2,860 | ) | ||||||
| Other liabilities | (1,211 | ) | (5,413 | ) | 13,784 | ||||||
| Net cash provided by operating activities | 237,948 | 84,954 | 102,718 | ||||||||
| Cash flows from investing activities: | |||||||||||
| (Increase) decrease in restricted cash | (7,894 | ) | 25,083 | (5,059 | ) | ||||||
| Acquisition of property, plant and equipment | (62,414 | ) | (22,111 | ) | (13,775 | ) | |||||
| Payments for acquisitions, net of cash acquired | (2,694 | ) | (93,368 | ) | (14,050 | ) | |||||
| Purchase of investments in marketable securities | (227,119 | ) | (173,908 | ) | (146,571 | ) | |||||
| Redemption of investments in marketable securities | 180,332 | 134,478 | 159,520 | ||||||||
| Other | (2,710 | ) | (10,874 | ) | (992 | ) | |||||
| Net cash used in investing activities | (122,499 | ) | (140,700 | ) | (20,927 | ) | |||||
| Cash flows from financing activities: | |||||||||||
| Dividends paid on common stock | (16,191 | ) | (6,095 | ) | — | ||||||
| Redemption of 2.875% convertible note | (73 | ) | — | — | |||||||
| Withholding taxes paid on issuance of vested restricted stock units | (9,658 | ) | (5,913 | ) | (3,789 | ) | |||||
| Proceeds from exercise of stock options and employee stock purchases | 16,545 | 13,131 | 24,382 | ||||||||
| Excess tax benefit for share based payment arrangements | 6,010 | 2,873 | 1,425 | ||||||||
| Repurchases of common stock | — | (891 | ) | (50,000 | ) | ||||||
| Other financing activities | — | (1,869 | ) | (1,367 | ) | ||||||
| Net cash (used in) provided by financing activities | (3,367 | ) | 1,236 | (29,349 | ) | ||||||
| Effect of exchange rate changes | 5,786 | 451 | (9,698 | ) | |||||||
| Increase (decrease) in cash and cash equivalents | 117,868 | (54,059 | ) | 42,744 | |||||||
| Cash and cash equivalents: | |||||||||||
| Beginning of period | 266,302 | 320,361 | 277,617 | ||||||||
| End of period | $ | 384,170 | $ | 266,302 | $ | 320,361 | |||||
| Supplemental Cash Flow Information: | |||||||||||
| Cash paid for income taxes, net | $ | 10,917 | $ | 23,802 | $ | 9,391 | |||||
| Cash paid for interest | 1,322 | 3,559 | 3,539 | ||||||||
| Increase in fixed assets related to transfers with inventories | 11,091 | 21,239 | 9,034 | ||||||||
| Increase in goodwill from acquisition-related liabilities | — | — | 3,456 | ||||||||
| Dividends declared but not paid | 5,011 | 3,046 | — | ||||||||
| Conversion of 2.875% convertible notes | 88,937 | — | — | ||||||||
| Accrued purchases of plant and equipment | 1,014 | 1,120 | 1,099 | ||||||||
See accompanying Notes to the Consolidated Financial Statements.
44
FEI COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
| NOTE 1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Nature of Business
We are a leading supplier of scientific instruments for nanoscale applications and solutions for industry and science. We report our revenue based on a group structure organization, which we categorize as the Industry Group and the Science Group.
Our products include transmission electron microscopes, or TEMs; scanning electron microscopes, or SEMs; DualBeamTM systems which combine a SEM and a focused ion beam system, or FIB, on a single platform; stand-alone FIBs; high-performance optical microscopes, three-dimensional modeling software, and service and components to support the products. TEMs provide the highest resolution images of samples and their internal structure, down to the atomic level. SEMs provide detailed images of the surface and shape of samples. Optical microscopes provide a wider field of view than SEMs and TEMs. DualBeams and FIBs image, manipulate, mill and deposit material for a variety of purposes, including preparation of samples for TEMs. Substantially all of these product categories are sold into all of our markets. Individual models of our products are increasingly designed to provide specific solutions and applications in each of our markets.
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; Munich, Germany; and Delmont, Pennsylvania; and software development in Bordeaux, France; and Brisbane, Australia. 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.
Basis of Presentation
The consolidated financial statements include the accounts of FEI Company and our wholly-owned subsidiaries (collectively, “FEI”). All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates in Financial Reporting
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period.
Significant accounting policies and estimates underlying the accompanying consolidated financial statements include:
| • | the timing of revenue recognition; |
| • | the allowance for doubtful accounts; |
| • | valuations of excess and obsolete inventory; |
| • | the lives and recoverability of equipment and other long-lived assets such as goodwill; |
| • | the valuations of intangible assets; |
| • | restructuring, reorganization, relocation and severance costs; |
| • | tax valuation allowances and unrecognized tax benefits; |
| • | warranty liabilities; |
| • | stock-based compensation; and |
| • | accounting for derivatives. |
It is reasonably possible that management's estimates may change in the future.
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Concentration of Credit Risk
Instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, short-term investments and receivables. Our investment policy limits investments with any one issuer to 10% or less of the total investment portfolio, with the exception of money market funds and securities issued by the U.S. government or its agencies which may comprise up to 100% of the total investment portfolio. Our exposure to credit risk concentrations within our receivables balance is limited due to the large number of entities comprising our customer base and their dispersion across many different industries and geographies.
Dependence on Key Suppliers
Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business, including our ability to convert backlog into revenue. 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, NTS Group, Frencken Mechatronics B.V., Keller Technology and AZD Praha SRO for our supply of mechanical parts and subassemblies; Gatan, Inc., Edax Inc. and Bruker Corp. 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.
As a result of this concentration of key suppliers, our results of operations may be materially and adversely affected if we do not timely and cost-effectively receive a sufficient quantity of quality parts to meet our production requirements or if we are required to find alternative suppliers for these supplies. We may not be able to expand our supplier group or to reduce our dependence on single suppliers. If our suppliers are not able to meet our supply requirements, constraints may affect our ability to deliver products to customers in a timely manner, which could have an adverse effect on our results of operations. In addition, restrictions regulating the use of certain hazardous substances in electrical and electronic equipment in various jurisdictions may impact parts and component availability or our electronics suppliers’ ability to source parts and components in a timely and cost-effective manner. Overall, because we only have a few equipment suppliers, we may be more exposed to future cost increases for this equipment.
Cash and Cash Equivalents
Cash and cash equivalents include cash deposits in banks, money market funds and other highly liquid marketable securities with maturities of three months or less at the date of acquisition.
Restricted Cash
Our restricted cash balances are held in deposit accounts with banks that have issued guarantees and letters of credit to our customers for system sales transactions and customer advance deposits relating to prepayments for service contracts, mainly in Europe and Asia. This restricted cash can be drawn on by the bank if goods are not delivered or services are not properly performed. In addition, while the restricted cash is held in the bank it is earning interest. Given these deposit accounts require satisfaction of conditions other than a withdrawal demand for us to receive a return of principal, are interest bearing and are held for extended periods of time, we have concluded these balances are similar in nature to our other investments and that inclusion in investing activities on our statement of cash flows is appropriate and consistent with our treatment of other investments. 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 sheets.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is estimated based on collection experience and known trends with current customers. The large number of entities comprising our customer base and their dispersion across many different industries and geographies somewhat mitigates our credit risk exposure and the magnitude of our allowance for doubtful accounts. Our estimates of the allowance for doubtful accounts are reviewed and updated on a quarterly basis. Changes to the reserve may occur based upon changes in revenue levels and associated balances in accounts receivable and estimated changes in individual customers’ credit quality. Write-offs include amounts written off for specifically identified bad debts. Historically, we have not incurred significant write-offs of accounts receivable, however, an individual loss could be significant due to the relative size of our sales transactions.
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Activity within our accounts receivable allowance was as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Balance, beginning of period | $ | 2,718 | $ | 5,553 | $ | 5,685 | |||||
| Expense (reversal) | 473 | (154 | ) | (18 | ) | ||||||
| Write-offs | (263 | ) | (2,732 | ) | (25 | ) | |||||
| Translation adjustments | 41 | 51 | (89 | ) | |||||||
| Balance, end of period | $ | 2,969 | $ | 2,718 | $ | 5,553 | |||||
Investments
Our investments include marketable debt securities, certificates of deposit, commercial paper and government-backed securities with maturities greater than 90 days at the time of purchase. These investments are recorded on our balance sheet as available-for-sale securities at fair value based on quoted market prices. Unrealized gains/losses resulting from changes in the fair value are recorded, net of tax, in shareholders’ equity as a component of accumulated other comprehensive income (loss).
Certain long-term investments included in non-current investments in marketable securities consisted of mutual fund shares held to offset liabilities to participants in the Company's deferred compensation plan. The investments are classified as long-term because the related deferred compensation liabilities are not expected to be paid within the next year. These investments are classified as trading securities and are recorded at fair value with unrealized gains and losses reported in operating expenses, which are offset against gains and losses resulting from changes in corresponding deferred compensation liabilities to participants (see Note 7 the Notes to the Consolidated Financial Statements). Investments for which it is not practical to estimate fair value are included at cost and primarily consist of investments in privately-held companies.
Realized gains and losses on all investments are recorded on the specific identification method and are included in interest income (expense) or other income (expense) in the period incurred. Investments with maturities greater than 12 months from the balance sheet date are classified as non-current investments, unless they are expected to be liquidated within the next 12 months; in which case, the investment is classified as current.
Inventories
Inventories are stated at the lower of cost or market, with cost determined by standard cost methods, which approximate the first-in, first-out method. Inventory costs include material, labor and manufacturing overhead. Service inventories that exceed the estimated requirements for the next 12 months based on recent usage levels are reported as a long-term asset. Management has established inventory reserves based on estimates of excess and/or obsolete current and non-current inventory.
Manufacturing inventory is reviewed for obsolescence and excess quantities on a quarterly basis, based on estimated future use of quantities on hand, which is determined based on past usage, planned changes to products and known trends in markets and technology. Changes in support plans or technology could have a significant impact on obsolescence.
To support our world-wide service operations, we maintain service spare parts inventory, which consists of both consumable and repairable spare parts. Consumable service spare parts are used within our service business to replace worn or damaged parts in a system during a service call and are generally classified in current inventory as our stock of this inventory turns relatively quickly. However, if there has been no recent usage for a consumable service spare part, but the part is still necessary to support systems under service contracts, the part is considered to be non-current and included within non-current inventories within our consolidated balance sheet. Consumables are charged to cost of goods sold when issued during the service call.
We also maintain a substantial supply of repairable and reusable spare parts for possible use in future repairs and customer field service of our install base. We have classified this inventory as a long-term asset given these parts can be repaired and reused in the service business over many years.
As these service parts age over the related product group’s post-production service life, we reduce the net carrying value of our repairable and consumable spare part inventory to account for the excess that builds over the service life. The post-production service life of our systems is generally eight years and, at the end of the service life, the carrying value for these parts is reduced to zero. We also perform periodic monitoring of our installed base for premature or increased end of service life events. If required, we expense, through cost of goods sold, the remaining net carrying value of any related spare parts inventory in the period incurred.
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Income Taxes
We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. We record a valuation allowance to reduce deferred tax assets to the amount expected to “more likely than not” be realized in our future tax returns. Should we determine that we would not be able to realize all or part of our remaining net deferred tax assets in the future, increases to the valuation allowance for deferred tax assets may be required. Conversely, if we determine that certain tax assets that have been reserved for may be realized in the future, we may reduce our valuation allowance in future periods.
In the ordinary course of business, there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate or effective settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. When applicable, associated interest and penalties have been recognized as a component of income tax expense.
Unrecognized tax benefits relate mainly to uncertainty surrounding various tax credits, transfer pricing and permanent establishment in foreign jurisdictions. Included in the liabilities for unrecognized tax benefits were accruals for interest and penalties. If recognized, the total unrecognized tax benefits would have an impact on the effective tax rate. See Note 13 of the Notes to the Consolidated Financial Statements for additional information.
Property, Plant and Equipment
Land is stated at cost. Buildings and improvements are stated at cost and depreciated over estimated useful lives of approximately 40 years using the straight-line method. Leasehold improvements are amortized over the shorter of their economic lives or the lease term. Machinery and equipment, including systems used in production and research and development activities, are stated at cost and depreciated over estimated useful lives of approximately three to seven years using the straight-line method.
Demonstration systems consist primarily of internally manufactured products and related accessories that we use for marketing purposes in our demonstration laboratories (“NanoPorts”) or for trade shows. These systems are long lived in nature and are recorded as a component of property, plant and equipment. The proceeds expected to be realized when the systems are sold is estimated and the net cost is depreciated using the straight-line method over their expected useful lives of approximately three to seven years with the expense being reflected as a component of selling, general and administrative. If sold, the net book value of the system is recorded as a component of cost of good sold.
Other fixed assets include computer software and hardware, automobiles and furnitures and fixtures. These assets are stated at cost and are depreciated over estimated useful lives of approximately three to seven years. Maintenance and repairs are expensed as incurred.
On occasion, we loan systems to customers on a temporary basis while they wait for their tool to be manufactured or for evaluation. These systems are included in our finished goods inventories and the lending/evaluation periods are typically for a time period of less than one year. The sale of disposable products or services is not typically included in these arrangements. Any expense associated with these systems is recorded as a component of cost of sales.
Additionally, we lease systems to customers as operating or sales-type leases where we are the lessor. Under the operating method, rental revenue is recognized over the lease period. The leased asset is depreciated over the life of the lease. In addition to the depreciation charge, maintenance costs and the cost of any other services rendered under the provision of the lease that pertain to the current accounting period are charged to expense. Under the sales-type method, revenue is recorded upfront with interest income recorded over the life of the lease. The related costs are recorded upfront to match the sales revenue.
Lives and Recoverability of Equipment and Other Long-Lived Assets
We evaluate the remaining life and recoverability of equipment and other assets that are to be held and used, including purchased technology and other intangible assets with finite useful lives, at least annually and whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If there is an indication of impairment, we prepare an estimate of future, undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying value of the asset, we adjust the carrying amount of the asset to its estimated fair value. Long lived assets to be disposed of by sale are valued at the lower of book value or fair value less cost to sell.
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We estimate the fair value of an intangible asset or asset group using the income approach and internally developed discounted cash flow models. These models include, among others, the following assumptions: projections of revenue and expenses and related cash flows based on assumed long-term growth rates and demand trends; estimated royalty, income tax, and attrition rates; and estimated discount rates. We base these assumptions on our historical data and experience, third-party appraisals, industry projections, micro and macro general economic condition projections, and our expectations.
See Note 9 of the Notes to the Consolidated Financial Statements for information on impairments recognized in 2011. No impairments related to our equipment or other long-lived assets were recognized during 2013 or 2012.
Goodwill
Goodwill represents the excess purchase price over fair value of net assets acquired. Goodwill and other identifiable intangible assets with indefinite useful lives are not amortized, but instead, are tested for impairment at least annually during the fourth quarter. In 2011, we adopted ASU 2011-08, "Intangibles - Goodwill and Other (Topic 350), Testing Goodwill for Impairment", which allows an entity to perform a qualitative assessment of the fair value of its reporting units before calculating the fair value of the reporting unit in step one of the two-step goodwill impairment model. We perform our goodwill impairment analysis at the component level, which is defined as one level below our operating segments. If, through the qualitative assessment, the entity determines that it is more likely than not that a reporting unit's fair value is greater than its carrying value, the remaining impairment steps would be unnecessary.
If there are indicators that goodwill has been impaired and thus the two-step goodwill impairment model is necessary, step 1 is to determine the fair value of each reporting unit and compare it to the reporting unit's carrying value. Fair value is determined based on the present value of estimated cash flows using available information regarding expected cash flows of each reporting unit, discount rates and the expected long-term cash flow growth rates. Discount rates are determined based on the cost of capital for the reporting unit. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired and no further testing is performed. The second step is performed if the carrying value exceeds the fair value. The implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, an impairment loss equal to the difference will be recorded. No impairments were identified in our annual impairment analysis during the fourth quarter of 2013, 2012 and 2011.
Derivatives
We use a combination of forward contracts, zero cost collar contracts, option contracts and other instruments to hedge certain anticipated foreign currency exchange transactions. When specific hedge criteria have been met, changes in fair values of hedge contracts relating to anticipated transactions are recorded in other comprehensive income rather than net income until the underlying hedged transaction affects net income. One of the criteria for this accounting treatment is that the hedge contract amounts should not be in excess of specifically identified anticipated transactions. By their nature, our estimates of anticipated transactions may fluctuate over time and may ultimately vary from actual transactions. When anticipated transaction estimates or actual transaction amounts decrease below hedged levels, or when the timing of transactions changes significantly, we reclassify a portion of the cumulative changes in fair values of the related hedge contracts from other comprehensive income to other income (expense) during the quarter in which such changes occur.
We also use foreign forward exchange contracts to mitigate the foreign currency exchange impact of our cash, receivables and payables denominated in foreign currencies. These derivatives do not meet the criteria for hedge accounting and, accordingly, changes in the fair value are recognized in net income in the current period.
Segment Reporting
We have determined that we operate in two reportable operating segments: Industry Group and Science Group. There are no differences between the accounting policies used for our business segments compared to those used on a consolidated basis.
Revenue Recognition
We recognize revenue when persuasive evidence of a contractual agreement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed and determinable, and collectability is reasonably assured.
For products demonstrated to meet our published specifications, revenue is recognized when the title to the product and the risks and rewards of ownership pass to the customer. For products produced according to a particular customer’s specifications, revenue is recognized when the product meets the customer’s specifications and when the title and the risks and rewards of ownership have passed to the customer. In each case, the portion of revenue related to installation, of which the estimated fair value is generally 4% of the net revenue of the transaction, is deferred until such installation at the customer site and final customer acceptance are completed. For new applications of our products where performance cannot be assured prior to meeting specifications at the customer's installation site, no revenue is recognized until such specifications are met.
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We enter into arrangements with customers whereby they purchase products, accessories and service contracts from us at the same time. For sales arrangements containing multiple elements (products or services), revenue relating to the undelivered elements is deferred at the estimated selling price of the element as determined using the sales price hierarchy established in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification ("ASC") 605-25. To be considered a separate element, the deliverable in question must represent a separate element under the accounting guidance and fulfill the following criteria: the delivered item or items must have value to the customer on a standalone basis; and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transactions is deferred until all elements are delivered.
For sales arrangements that contain multiple deliverables (products or services), to the extent that the deliverables within a multiple-element arrangement are not accounted for pursuant to other accounting standards, revenue is allocated among the deliverables using the selling price hierarchy established in ASC 605-25 to determine the selling price of each deliverable. The selling price hierarchy allows for the use of an estimated selling price (“ESP”) to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”). We determine the selling price in multiple-element arrangements using VSOE or TPE if available. VSOE is determined based on the price charged for the same deliverable when sold separately and TPE is established based on the price charged by our competitors or third parties for the same deliverable. If we are unable to determine the selling price because VSOE or TPE does not exist, we determine ESP for the purposes of allocating total arrangement consideration among the elements by considering several internal and external factors such as, but not limited to, historical sales of similar products, costs incurred to manufacture the product and normal profit margins from the sale of similar products, geographical considerations and overall pricing practices.
These factors are subject to change as we modify our pricing practices and such changes could result in changes to determination of VSOE, TPE and ESP, which could result in our future revenue recognition from multiple-element arrangements being materially different than our results in the current period.
Generally, revenue from all elements in a multiple-element arrangement is recognized within 18 months of the shipment of the first item in the arrangement.
We provide maintenance and support services under renewable, term maintenance agreements. Maintenance and support fee revenue is recognized ratably over the contractual term, which is generally 12 months, and commences from the start date.
Revenue from time and materials-based service arrangements is recognized as the service is performed. Spare parts revenue is generally recognized upon shipment.
Deferred Revenue
Deferred revenue represents customer deposits on equipment orders, orders awaiting customer acceptance and prepaid service contract revenue. Deferred revenue is recognized in accordance with our revenue recognition policies described above.
Warranty Liabilities
Our products generally carry a one-year warranty. A reserve is established at the time of sale to cover estimated warranty costs and certain commitments for product upgrades as a component of cost of sales on our consolidated statements of operations. Our estimate of warranty cost is primarily based on our history of warranty repairs and maintenance, as applied to systems currently under warranty. For our new products without a history of known warranty costs, we estimate the expected costs based on our experience with similar product lines and technology. While most new products are extensions of existing technology, the estimate could change if new products require a significantly different level of repair and maintenance than similar products have required in the past. Our estimated warranty costs are reviewed and updated on a quarterly basis. Changes to the reserve occur as volume, product mix and warranty costs fluctuate.
Research and Development Costs
Research and Development (“R&D”) costs include labor, materials, overhead and payments to third parties for research and development of new products and new software or enhancements to existing products and software and are expensed as incurred. We periodically receive funds from various organizations to subsidize our research and development. These funds are reported as an offset to research and development expense. During the 2013, 2012 and 2011 periods, we received subsidies of $5.3 million, $7.3 million and $5.3 million, respectively, from European governments for technological developments primarily for semiconductor and life sciences equipment.
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Advertising Costs
Advertising costs are expensed as incurred and are included as a component of selling, general and administrative costs on our consolidated statements of operations. Advertising expense totaled $4.1 million, $3.9 million and $3.2 million in 2013, 2012 and 2011, respectively.
Restructuring, Reorganization, Relocation and Severance Costs
Restructuring, reorganization, relocation and severance costs are recognized and recorded at fair value as incurred. Such costs include severance and other costs related to employee terminations as well as facility costs related to future abandonment of various leased office and manufacturing sites. Also included are certain period costs to move our existing supply chain, as well as migration of certain IT systems to new platforms. Changes in our estimates could occur, and have occurred, due to fluctuations in exchange rates, the sublease of unused space, unanticipated voluntary departures before severance was required and unanticipated redeployment of employees to vacant positions. See Note 14 of the Notes to the Consolidated Financial Statements for additional information.
Stock-Based Compensation
We measure and recognize compensation expense for all stock-based payment awards granted to our employees and directors, including employee stock options, non-vested stock and stock purchases related to our employee share purchase plan based on the estimated fair value of the award on the grant date. We utilize the Black-Scholes valuation model for valuing our stock option awards.
The use of the Black-Scholes valuation model to estimate the fair value of stock option awards requires us to make judgments on assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates at the time they are made, but these estimates involve inherent uncertainties and the determination of expense could be materially different in the future.
We amortize stock-based compensation expense on a straight-line basis over the vesting period of the individual award with estimated forfeitures considered. Vesting periods are generally four years. The exercise price of issued options equals the grant date fair value of the underlying shares and the options generally have a legal life of seven years.
Compensation expense is only recognized on awards that ultimately vest. Therefore, we have reduced the compensation expense to be recognized over the vesting period for anticipated future forfeitures. Forfeiture estimates are based on historical forfeiture patterns. We update our forfeiture estimates quarterly and recognize any changes to accumulated compensation expense in the period of change. If actual forfeitures differ significantly from our estimates, our results of operations could be materially impacted.
Foreign Currency Translation
A large portion of our business is conducted outside of the U.S. through a number of foreign subsidiaries. Each of the foreign subsidiaries keeps its accounting records in its respective local currency. These local-currency-denominated accounting records are translated at exchange rates that fluctuate up or down from period to period and consequently affect our consolidated results of operations and financial position.
Assets and liabilities of foreign subsidiaries denominated in a foreign currency, where the local currency is the functional currency, are translated to U.S. dollars at the exchange rate in effect on the respective balance sheet date. Gains and losses resulting from the translation of assets, liabilities and equity are included in accumulated other comprehensive income on the consolidated balance sheet. Transactions representing revenues, costs and expenses are translated using an average rate of exchange for the period, and the related gains and losses are reported as other income (expense) on our consolidated statement of operations.
Reclassifications
Certain items previously reported in the Consolidated Balance Sheet have been reclassified to conform to current year financial statement presentation. These reclassifications had no effect on our results of operation, financial position, or cash flows.
| NOTE 2. | NEW ACCOUNTING PRONOUNCEMENTS |
ASU 2013-02
In February 2013, the FASB issued ASU No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" which added new disclosure requirements for items reclassified out of accumulated other comprehensive income. ASU No. 2013-02 effectively replaced the requirements previously outlined in ASU 2011-05 and ASU 2011-12.
ASU 2013-02 was adopted prospectively beginning in 2013. As ASU 2013-02 relates to disclosure requirements only, the adoption of this guidance did not have an impact on our financial position, results of operations or cash flows.
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ASU 2013-11
In July 2013, the FASB issued ASU No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” which provides explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective for annual periods, and interim periods within those years, beginning after December 15, 2013. We early adopted this guidance and it did not have a material effect on our financial statements.
| NOTE 3. | EARNINGS PER SHARE |
Following is a reconciliation of basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts):
| Year Ended | ||||||||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | ||||||||||||||||||||||||||||||
Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | ||||||||||||||||||||||||
| Basic EPS | $ | 126,673 | 40,446 | $ | 3.13 | $ | 114,920 | 38,065 | $ | 3.02 | $ | 103,637 | 38,384 | $ | 2.70 | |||||||||||||||||
| Dilutive effect of 2.875% convertible debt | 780 | 1,287 | (0.08 | ) | 1,819 | 3,033 | (0.18 | ) | 1,808 | 3,033 | (0.15 | ) | ||||||||||||||||||||
| Dilutive effect of stock options, restricted stock units, and shares issuable to Philips | — | 662 | (0.04 | ) | — | 630 | (0.04 | ) | — | 630 | (0.04 | ) | ||||||||||||||||||||
| Diluted EPS | $ | 127,453 | 42,395 | $ | 3.01 | $ | 116,739 | 41,728 | $ | 2.80 | $ | 105,445 | 42,047 | $ | 2.51 | |||||||||||||||||
The following table sets forth the schedule of anti-dilutive securities excluded from the computation of diluted EPS (number of shares, in thousands):
| Year Ended | ||||||||
| 2013 | 2012 | 2011 | ||||||
| Stock options | 142 | 279 | 358 | |||||
| Restricted stock units | 33 | 59 | 322 | |||||
| NOTE 4. | CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT |
The following table illustrates the disclosure of changes in the balances of each component of accumulated other comprehensive income ("AOCI"), as well as details the effect of reclassifications out of AOCI on the line items in the Consolidated Statements of Operations by component (net of tax, in thousands):
| Year Ended December 31, 2013 | |||||||||||||||||||
| Foreign Currency Items | Unrealized Gains and Losses on Available-for-Sale Securities | Defined Benefit Pension Items | Gains and Losses on Cash Flow Hedges | Total | |||||||||||||||
| Beginning Balance | $ | 38,890 | $ | 4 | $ | (819 | ) | $ | 481 | $ | 38,556 | ||||||||
| Other comprehensive income before reclassifications | 9,975 | (15 | ) | 267 | (2,492 | ) | 7,735 | ||||||||||||
| Amounts reclassified from AOCI to: | |||||||||||||||||||
| Revenue | — | — | — | (33 | ) | (33 | ) | ||||||||||||
| Cost of goods sold | — | — | — | 790 | 790 | ||||||||||||||
| Other income (expense) | — | — | — | 80 | 80 | ||||||||||||||
| Total reclassifications out of AOCI | — | — | — | 837 | 837 | ||||||||||||||
| Net current period other comprehensive income | 9,975 | (15 | ) | 267 | (1,655 | ) | 8,572 | ||||||||||||
| Ending balance | $ | 48,865 | $ | (11 | ) | $ | (552 | ) | $ | (1,174 | ) | $ | 47,128 | ||||||
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| NOTE 5. | FACTORING OF ACCOUNTS RECEIVABLE |
In 2013, we entered into agreements under which we sold a total of $9.9 million of our accounts receivable at a discount to unrelated third party financiers without recourse. The transfers qualified for sales treatment and, accordingly, discounts related to the sale of the receivables, which were immaterial, were recorded on our Consolidated Statements of Operations as other expense. We sold no accounts receivable under these agreements during 2012.
| NOTE 6. | INVENTORIES |
Inventories consisted of the following (in thousands):
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Raw materials and assembled parts | $ | 61,235 | $ | 67,985 | |||
| Service inventories, estimated current requirements | 15,197 | 15,898 | |||||
| Work-in-process | 75,883 | 81,104 | |||||
| Finished goods | 29,410 | 27,553 | |||||
| Total current inventories | $ | 181,725 | $ | 192,540 | |||
| Non-current inventories | $ | 62,104 | $ | 65,116 | |||
| NOTE 7. | INVESTMENTS |
Investments held consisted of the following (in thousands):
| December 31, 2013 | |||||||||||||||
Amortized cost | Unrealized gains | Unrealized losses | Estimated fair value | ||||||||||||
| Available for sale marketable securities: | |||||||||||||||
| U.S. treasury notes | $ | 10,130 | $ | — | $ | (2 | ) | $ | 10,128 | ||||||
Agency bonds(1) | 37,996 | — | (35 | ) | 37,961 | ||||||||||
| Commercial paper | 39,987 | — | — | 39,987 | |||||||||||
| Certificates of deposit | 7,786 | — | — | 7,786 | |||||||||||
| Municipal bonds | 49,296 | 24 | (1 | ) | 49,319 | ||||||||||
| Corporate bond | 5,002 | — | (1 | ) | 5,001 | ||||||||||
| Total available for sale marketable securities | 150,197 | 24 | (39 | ) | 150,182 | ||||||||||
| Trading Securities: | |||||||||||||||
| Equity securities - mutual funds | 5,287 | — | — | 5,287 | |||||||||||
Cost Method Investments(2) | 608 | — | — | 608 | |||||||||||
| Total Investments | $ | 156,092 | $ | 24 | $ | (39 | ) | $ | 156,077 | ||||||
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| December 31, 2012 | |||||||||||||||
Amortized cost | Unrealized gains | Unrealized losses | Estimated fair value | ||||||||||||
| Available for sale marketable securities: | |||||||||||||||
| U.S. treasury notes | $ | 60,785 | $ | 4 | $ | (3 | ) | $ | 60,786 | ||||||
Agency bonds(1) | 31,153 | 4 | — | 31,157 | |||||||||||
| Commercial paper | 5,000 | — | — | 5,000 | |||||||||||
| Certificates of deposit | 5,494 | — | — | 5,494 | |||||||||||
| Municipal bonds | 3,227 | 1 | — | 3,228 | |||||||||||
| Total available for sale marketable securities | 105,659 | 9 | (3 | ) | 105,665 | ||||||||||
| Trading Securities: | |||||||||||||||
| Equity securities - mutual funds | 3,046 | — | — | 3,046 | |||||||||||
Cost Method Investments(2) | 608 | — | — | 608 | |||||||||||
| Total Investments | $ | 109,313 | $ | 9 | $ | (3 | ) | $ | 109,319 | ||||||
(1) | Agency bonds are securities backed by U.S. government-sponsored entities. |
(2) | Investments for which it is not practical to estimate fair value are included at cost and primarily consist of investments in privately-held companies. |
Realized gains and losses on sales of marketable debt securities were insignificant in 2013, 2012 and 2011.
We review available for sale investments in debt and equity securities for other than temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. In the evaluation of whether an impairment is “other-than-temporary,” we consider our ability and intent to hold the investment until the market price recovers, the reasons for the impairment, compliance with our investment policy, the severity and duration of the impairment and expected future performance. Unrealized losses on our corporate notes and bonds and government-backed securities are mainly due to interest rate movements, and no unrealized losses of any significance existed for a period in excess of 12 months. Our investments classified as trading securities, such as assets related to our deferred compensation plan, are carried on the balance sheet at fair value.
For investments in small privately-held companies, which are recorded at cost, it is often not practical to estimate fair value. In order to assess whether impairments exist that are “other-than-temporary,” we reviewed recent interim financial statements and held discussions with these entities’ management about their current financial conditions and future economic outlooks. We also considered our willingness to support future funding requirements as well as our intention and/or ability to hold these investments long-term. At December 31, 2013 and 2012, we had $0.6 million in cost-method investments on our balance sheet. Refer to Note 22 the Notes to the Consolidated Financial Statements for additional information.
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Investments were included in the following captions on the balance sheet as follows (in thousands):
| December 31, 2013 | December 31, 2012 | ||||||||||||||||||||||||||||||
| Short-term investments | Long-term investments | Other assets | Total | Short-term investments | Long-term investments | Other assets | Total | ||||||||||||||||||||||||
| Available for sale marketable securities: | |||||||||||||||||||||||||||||||
| U.S. treasury notes | $ | 10,128 | $ | — | $ | — | $ | 10,128 | $ | 60,786 | $ | — | $ | — | $ | 60,786 | |||||||||||||||
| Agency bonds | 10,995 | 26,966 | — | 37,961 | 10,148 | 21,009 | — | 31,157 | |||||||||||||||||||||||
| Commercial paper | 39,987 | — | — | 39,987 | 5,000 | — | — | 5,000 | |||||||||||||||||||||||
| Certificates of deposit | 5,802 | 1,984 | — | 7,786 | 3,598 | 1,896 | — | 5,494 | |||||||||||||||||||||||
| Municipal bonds | 41,279 | 8,040 | — | 49,319 | — | 3,228 | — | 3,228 | |||||||||||||||||||||||
| Corporate bond | — | 5,001 | — | 5,001 | — | — | — | — | |||||||||||||||||||||||
| Total fixed maturity securities | 108,191 | 41,991 | — | 150,182 | 79,532 | 26,133 | — | 105,665 | |||||||||||||||||||||||
| Trading Securities: | |||||||||||||||||||||||||||||||
| Equity securities - mutual funds | — | 5,287 | — | 5,287 | — | 3,046 | — | 3,046 | |||||||||||||||||||||||
| Cost Method Investments | — | — | 608 | 608 | — | — | 608 | 608 | |||||||||||||||||||||||
| Total Investments | $ | 108,191 | $ | 47,278 | $ | 608 | $ | 156,077 | $ | 79,532 | $ | 29,179 | $ | 608 | $ | 109,319 | |||||||||||||||
Contractual maturities or expected liquidation dates of available-for-sale fixed maturity securities at December 31, 2013 were as follows (in thousands):
| Amortized Cost | Fair Value | ||||||
| Due in 1 year or less | $ | 108,183 | $ | 108,191 | |||
| Due in 1-5 years | 42,014 | 41,991 | |||||
| Total | $ | 150,197 | $ | 150,182 | |||
| NOTE 8. | PROPERTY, PLANT AND EQUIPMENT |
Property, plant and equipment consisted of the following (in thousands):
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Land | $ | 25,535 | $ | 7,806 | |||
| Buildings and improvements | 36,778 | 21,645 | |||||
| Leasehold improvements | 23,948 | 16,503 | |||||
| Machinery and equipment | 103,180 | 108,982 | |||||
| Demonstration systems | 44,700 | 29,986 | |||||
| Other fixed assets | 49,093 | 46,510 | |||||
| Gross property, plant and equipment | 283,234 | 231,432 | |||||
| Accumulated depreciation | (125,405 | ) | (121,560 | ) | |||
| Total property, plant and equipment, net | $ | 157,829 | $ | 109,872 | |||
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| NOTE 9. | GOODWILL AND OTHER INTANGIBLE ASSETS |
Goodwill
The roll-forward of activity related to our goodwill was as follows (in thousands):
| Year Ended | |||||||
| 2013 | 2012 | ||||||
| Balance, beginning of period | $ | 131,320 | $ | 58,053 | |||
| Additions | 3,268 | 69,398 | |||||
| Goodwill adjustments | 1,564 | 3,869 | |||||
| Balance, end of period | $ | 136,152 | $ | 131,320 | |||
Additions to goodwill represent goodwill from an acquisition made during the period. Adjustments to goodwill include translation adjustments resulting from a portion of our goodwill being recorded on the books of our foreign subsidiaries as well as an adjustment related to the finalization of the purchase price allocation of the acquisition of ASPEX Corporation in 2012.
Acquisition of nanoTechnology Systems Pty. Ltd.
On August 9, 2013, we acquired 100% of the outstanding shares of nanoTechnology Systems Pty. Ltd. (NTS) of Melbourne, Australia, which had operated as our exclusive distributor in Australia and New Zealand for approximately 10 years. The total purchase price of the acquisition was approximately $3.6 million.
No pro forma or disclosure has been provided for this acquisition as it is insignificant.
Other Intangible Assets
Patents, trademarks and other are amortized under the straight-line method over their estimated useful lives of 2 to 15 years. Customer relationships are amortized under the straight-line method over their estimated useful lives of 5 to 10 years. Developed technology is amortized under the straight-line method over the estimated useful life of the related technology, which ranges from 5.5 to 10 years. Note issuance costs were amortized over the life of the related debt, which was 7 years.
Asset Impairment Charges
As part of our annual impairment test of long-lived intangible assets performed in the fourth quarter of 2011, we determined that the carrying value of certain intellectual property was not recoverable as we no longer intend to use the associated technology. As a result, we recorded an impairment charge of $1.4 million to write-off the remaining net book value of the intellectual property. The impairment loss is recorded within the selling, general and administrative expense line of our Consolidated Statements of Operations and is reported under the Science Group. There were no impairment charges recorded during 2013 or 2012.
The gross amount of our other intangible assets and the related accumulated amortization were as follows (in thousands):
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Patents, trademarks and other | $ | 24,327 | $ | 22,047 | |||
| Accumulated amortization | (9,296 | ) | (5,743 | ) | |||
| Net patents, trademarks and other | 15,031 | 16,304 | |||||
| Customer relationships | 21,650 | 20,305 | |||||
| Accumulated amortization | (3,547 | ) | (1,171 | ) | |||
| Net customer relationships | 18,103 | 19,134 | |||||
| Developed technology | 18,161 | 17,686 | |||||
| Accumulated amortization | (4,098 | ) | (1,771 | ) | |||
| Net developed technology | 14,063 | 15,915 | |||||
| Note issuance costs | 2,445 | 2,445 | |||||
| Accumulated amortization | (2,445 | ) | (2,299 | ) | |||
| Net note issuance costs | — | 146 | |||||
| Total intangible assets included in other long-term assets | $ | 47,197 | $ | 51,499 | |||
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Amortization expense was as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Patents, trademarks and other | $ | 3,553 | $ | 1,993 | $ | 1,342 | |||||
| Customer relationships | 2,376 | 1,168 | 3 | ||||||||
| Developed technology | 2,327 | 1,716 | 55 | ||||||||
| Note issuance costs | 146 | 350 | 350 | ||||||||
| Total amortization expense | $ | 8,402 | $ | 5,227 | $ | 1,750 | |||||
Expected amortization, without consideration for foreign currency effects, is as follows over the next five years and thereafter (in thousands):
Patents, Trademarks and Other | Customer Relationships | Developed Technology | Total | ||||||||||||
| 2014 | $ | 3,234 | $ | 2,420 | $ | 2,291 | $ | 7,945 | |||||||
| 2015 | 3,019 | 2,420 | 2,291 | 7,730 | |||||||||||
| 2016 | 2,757 | 2,420 | 2,291 | 7,468 | |||||||||||
| 2017 | 2,214 | 2,072 | 2,010 | 6,296 | |||||||||||
| 2018 | 1,646 | 1,988 | 1,847 | 5,481 | |||||||||||
| Thereafter | 2,161 | 6,783 | 3,333 | 12,277 | |||||||||||
| Total future amortization expense | $ | 15,031 | $ | 18,103 | $ | 14,063 | $ | 47,197 | |||||||
| NOTE 10. | CREDIT FACILITIES AND RESTRICTED CASH |
Multibank Credit Agreement
We have a multibank credit agreement (the “Credit Agreement”), which provides for a $100.0 million secured revolving credit facility, including a $50.0 million subfacility for the issuance of letters of credit. The credit agreement expires in April 2016. We may, upon notice to JPMorgan Chase Bank, N.A. (the “Agent”), 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. In connection with this loan agreement, we incurred loan origination fees which are being amortized as additional interest expense over the term of the loan.
The Credit Agreement contains quarterly commitment fees that vary based on borrowings outstanding.
The revolving loans under the Credit Agreement will generally bear interest, at our option, at either (i) the alternate base rate, which is defined as a rate per annum equal to the higher of (a) the Prime Rate in effect on such day, (b) the Federal Funds Effective Rate in effect on such day plus 1/2 of 1%, and (c) the LIBO Rate for an Interest Period of one month plus 1.50%, or (ii) a floating per annum rate based on LIBOR (based on one, two, three or six-month interest periods) plus a margin equal to between 1.00% and 2.00%, depending on our leverage ratio as of the fiscal quarter most recently ended. A default interest rate shall apply on all obligations during an event of default under the Credit Agreement, at a rate per annum equal to 2.00% above the applicable interest rate. Revolving loans may be borrowed, repaid and reborrowed and voluntarily prepaid at any time without premium or penalty.
The obligations under the Credit Agreement are guaranteed by our present and future material domestic subsidiaries. In addition, obligations outstanding under the Credit Agreement are secured by substantially all of our assets and the assets of our material domestic subsidiaries.
The Credit Agreement contains customary covenants for a credit facility of this size and type, that include, among others, covenants that limit our ability to incur indebtedness, create liens, merge or consolidate, dispose of assets, make investments, enter into swap agreements, pay dividends or make distributions, enter into transactions with affiliates, enter into restrictive agreements and enter into sale and leaseback transactions. The Credit Agreement provides for financial covenants that require us to maintain a minimum interest coverage ratio and limit the maximum leverage that we can maintain at any one time.
The Credit Agreement contains customary events of default for a credit facility of this size and type that include, among others, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross-defaults to certain other material indebtedness, bankruptcy and insolvency defaults, material judgments defaults, defaults for the occurrence of certain ERISA events and change of control defaults. The occurrence of an event of default could result in an acceleration of the obligations under the Credit Agreement.
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As of December 31, 2013, there were no revolving loans or letters of credit outstanding under the Credit Agreement, we were in compliance with all covenants and we were not in default under the Credit Agreement.
Restricted Cash
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 sheets.
The following table sets forth information related to guarantees and letters of credit (in thousands):
| December 31, 2013 | |||
| Guarantees and letters of credit outstanding | $ | 51,892 | |
| Amount secured by restricted cash deposits: | |||
| Current | $ | 18,798 | |
| Long-term | 32,718 | ||
| Total secured by restricted cash | $ | 51,516 | |
| NOTE 11. | WARRANTY RESERVES |
The following is a summary of warranty reserve activity (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Balance, beginning of period | $ | 12,049 | $ | 11,683 | $ | 8,648 | |||||
| Reductions for warranty costs incurred | (13,058 | ) | (11,958 | ) | (8,991 | ) | |||||
| Warranties issued | 13,677 | 12,302 | 12,229 | ||||||||
| Translation and changes in estimates | 37 | 22 | (203 | ) | |||||||
| Balance, end of period | $ | 12,705 | $ | 12,049 | $ | 11,683 | |||||
| NOTE 12. | CONVERTIBLE NOTES |
2.875% Convertible Subordinated Notes
On May 19, 2006, we issued $115.0 million aggregate principal amount of convertible subordinated notes with an interest rate of 2.875%, payable semi-annually. The notes were due on June 1, 2013, and were subordinated to all previously existing and future senior indebtedness, and effectively subordinated to all indebtedness and other liabilities of our subsidiaries. The cost of this transaction, including underwriting discounts and commissions and offering expenses, totaled $3.1 million and was recorded on our balance sheet in other long-term assets and amortized over the life of the notes. The amortization of these costs totals $0.1 million per quarter and is reflected as additional interest expense in our Consolidated Statements of Operations through the date of conversion.
Prior to conversion, we redeemed the following amounts of our 2.875% Convertible Subordinated Notes:
| Date | Amount Redeemed | Redemption Price | Redemption Discount | Related Note Issuance Costs Written Off | |||||||||||
| February 2009 | $ | 15,000,000 | 86.50 | % | $ | 2,025,000 | $ | 250,154 | |||||||
| June 24, 2010 | 7,940,000 | 98.90 | 89,325 | 90,904 | |||||||||||
| June 29, 2010 | 1,200,000 | 99.00 | 12,000 | 13,703 | |||||||||||
| July 8, 2010 | 1,848,000 | 99.25 | 13,860 | 20,546 | |||||||||||
| Total for 2010 | 10,988,000 | 115,185 | 125,153 | ||||||||||||
| Total | $ | 25,988,000 | $ | 2,140,185 | $ | 375,307 | |||||||||
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Additionally, during 2012, one of our note holders converted a $1,000 note into 34 shares of FEI common stock and in 2011, one of our note holders converted a $1,000 note into 34 shares of FEI common stock.
Debt Conversion
On June 1, 2013, the remaining $89.0 million of these notes were due. Prior to maturity, holders of $88.9 million of these notes converted their notes into 3.0 million shares of FEI common stock. At maturity, holders of $0.1 million of these notes did not elect to convert into FEI common stock and those notes were settled with a cash payment.
| NOTE 13. | INCOME TAXES |
Income before income taxes included the following components (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| U.S. | $ | 32,549 | $ | 26,640 | $ | 14,189 | |||||
| Foreign | 119,053 | 113,908 | 108,676 | ||||||||
| Total | $ | 151,602 | $ | 140,548 | $ | 122,865 | |||||
Income tax expense consisted of the following (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Current: | |||||||||||
| Federal | $ | (851 | ) | $ | 8,173 | $ | 7,767 | ||||
| State | 419 | 475 | 395 | ||||||||
| Foreign | 16,513 | 13,870 | 18,559 | ||||||||
| Total current income tax expense | 16,081 | 22,518 | 26,721 | ||||||||
| U.S. deferred expense (benefit) | 12,645 | 4,285 | (6,266 | ) | |||||||
| Foreign deferred benefit | (3,797 | ) | (1,175 | ) | (1,227 | ) | |||||
| Income tax expense | $ | 24,929 | $ | 25,628 | $ | 19,228 | |||||
The effective income tax rate applied to net income varied from the U.S. federal statutory rate due to the following (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Tax expense at U.S. federal statutory rates | $ | 53,061 | $ | 49,192 | $ | 43,003 | |||||
| Increase (decrease) resulting from: | |||||||||||
| State income taxes, net of federal benefit | 857 | 1,126 | 723 | ||||||||
| Foreign tax benefit | (25,263 | ) | (26,181 | ) | (20,515 | ) | |||||
| Research and experimentation benefit | (5,966 | ) | (758 | ) | (2,908 | ) | |||||
| Foreign tax credit benefit | (2,152 | ) | (2,738 | ) | (4,465 | ) | |||||
| Tax audit settlements and lapses of statutes of limitations | (70 | ) | (439 | ) | (509 | ) | |||||
| Stock compensation | 2,658 | 2,134 | 1,683 | ||||||||
| Non-deductible items | 2,132 | 3,100 | 1,597 | ||||||||
| Other | (328 | ) | 192 | 619 | |||||||
| Income tax expense | $ | 24,929 | $ | 25,628 | $ | 19,228 | |||||
Our 2013 tax expense reflected comparatively lower tax rates in foreign jurisdictions where we earn most of our profits. The tax provision also included a benefit for the reduction of unrecognized tax benefits relating to positions on prior year returns after completion of audits in various jurisdictions.
Current taxes payable were reduced for excess tax benefits recorded to common stock and related to stock compensation of $6.4 million, $3.1 million and $2.9 million, respectively, in 2013, 2012 and 2011.
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Deferred Income Taxes
Net deferred tax assets (liabilities) were classified on the balance sheet as follows (in thousands):
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Deferred tax assets – current | $ | 15,114 | $ | 12,245 | |||
| Deferred tax assets – non-current | 1,751 | 5,092 | |||||
| Deferred tax liabilities – current | (9 | ) | (93 | ) | |||
| Deferred tax liabilities – non-current | (8,931 | ) | (17,588 | ) | |||
| Net deferred tax assets (liabilities) | $ | 7,925 | $ | (344 | ) | ||
| Valuation allowance | $ | 2,723 | $ | 2,081 | |||
The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and deferred tax liabilities were as follows (in thousands):
| December 31, | |||||||
| 2013 | 2012 | ||||||
| Deferred tax assets: | |||||||
| Accrued liabilities and reserves | $ | 15,804 | $ | 13,239 | |||
| Revenue recognition | 340 | 3,707 | |||||
| Tax credit and loss carryforwards | 8,063 | 8,497 | |||||
| Fixed assets and intangibles | 546 | 765 | |||||
| Unrealized investment | 765 | 2,538 | |||||
| Stock compensation | 2,151 | 1,815 | |||||
| Other assets | 1,501 | 665 | |||||
| Gross deferred tax assets | 29,170 | 31,226 | |||||
| Valuation allowance | (2,723 | ) | (2,081 | ) | |||
| Net deferred tax assets | 26,447 | 29,145 | |||||
| Deferred tax liabilities: | |||||||
| Fixed assets and intangibles | (17,965 | ) | (20,697 | ) | |||
| Revenue recognition | (19 | ) | (4,991 | ) | |||
| Other liabilities | (538 | ) | (3,801 | ) | |||
| Total deferred tax liabilities | (18,522 | ) | (29,489 | ) | |||
| Net deferred tax assets (liabilities) | $ | 7,925 | $ | (344 | ) | ||
Deferred tax benefit of $1.1 million, $3.0 million and $3.0 million was recorded in other comprehensive income in 2013, 2012 and 2011, respectively.
As of December 31, 2013 and 2012, our valuation allowance on deferred tax assets totaled $2.7 million and $2.1 million, respectively. In assessing the realizability of deferred tax assets, we utilize a more likely than not standard. If it is determined that it is “more likely than not” that deferred tax assets will not be realized, a valuation allowance must be established against the deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, historical operating performance, projected future taxable income and tax planning strategies in making this assessment.
U.S. net operating loss carryforwards as of December 31,2013 were $0.2 million and expire in 2031. Foreign net operating loss carryforwards as of December 31, 2013 were $14.6 million and do not expire.
U.S. research and development tax credit carryforwards as of December 31, 2013 were $2.9 million and expire between 2014 and 2033. Foreign research and development tax credit carryforwards as of December 31, 2013 were $0.2 million and do not expire. Alternative minimum tax credit carryforwards as of December 31, 2013 were $0.7 million and do not expire.
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As of December 31, 2013, U.S. income taxes have not been provided for approximately $331.3 million of cumulative undistributed earnings of several non-U.S. subsidiaries, as our current intention is to reinvest these earnings indefinitely outside the U.S. Foreign tax provisions have been provided for these cumulative undistributed earnings. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Similarly, we have not provided deferred taxes on the cumulative translation adjustment related to those non-U.S. subsidiaries.
Unrecognized Tax Benefits and Other Tax Contingencies
A rollforward of our unrecognized tax benefits, including interest and penalties, was as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Unrecognized tax benefits, beginning of period | $ | 25,135 | $ | 16,041 | $ | 7,156 | |||||
| Increases for tax positions taken in current period | 1,197 | — | 542 | ||||||||
| Increases for tax positions taken in prior periods | 1,701 | 9,965 | 10,502 | ||||||||
| Decreases for tax positions taken in prior periods | (3,997 | ) | (620 | ) | (1,723 | ) | |||||
| Decreases for lapses in statutes of limitations | (70 | ) | (251 | ) | (436 | ) | |||||
| Unrecognized tax benefits, end of period | $ | 23,966 | $ | 25,135 | $ | 16,041 | |||||
During 2013, we effectively settled matters with the Internal Revenue Service and certain foreign jurisdictions. The result of effective settlements was a reduction of $3.7 million of unrecognized tax benefits, all of which resulted in a tax benefit. This reduction was offset by accruals for positions taken on current and prior year tax returns and related mainly to uncertainty surrounding transfer pricing and permanent establishment.
Non-current unrecognized tax benefits as of December 31, 2013 and 2012 of $23.8 million and $15.7 million were classified on the balance sheet as a component of Other Liabilities.
The entire balance of unrecognized tax benefits, if recognized, would reduce our effective tax rate. We believe it is reasonably possible that our unrecognized tax benefits could decrease, in the next 12 months, between zero and $4.0 million due to lapses of statutes of limitations and as the result of settlements with taxing authorities.
We recognize interest and penalties related to unrecognized tax benefits in income tax expense. The liability for unrecognized tax benefits included accruals for interest and penalties of $3.7 million and $2.0 million as of December 31, 2013 and 2012, respectively.
Tax expense included the following relating to interest and penalties (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Benefit for lapses of statutes of limitations and settlement with taxing authorities | $ | (24 | ) | $ | (88 | ) | $ | (124 | ) | ||
| Accruals for current and prior periods | 1,698 | 652 | 293 | ||||||||
| Total interest and penalties | $ | 1,674 | $ | 564 | $ | 169 | |||||
For our major tax jurisdictions, the following years were open for examination by the tax authorities as of December 31, 2013:
| Jurisdiction | Open Tax Years | |
| U.S. | 2010 and forward | |
| The Netherlands | 2011 and forward | |
| Czech Republic | 2011 and forward | |
| NOTE 14. | RESTRUCTURING, REORGANIZATION, RELOCATION AND SEVERANCE |
Group Structure Reorganization
In January 2013, we announced our intention to reorganize the company into a group structure in order to enable us to efficiently execute our growth strategy. The reorganization was completed in the first quarter of 2013. The costs associated with the reorganization include primarily severance costs and resulted in the termination of certain positions throughout the company. In anticipation of this reorganization, we incurred $2.9 million of severance costs during the fourth quarter of 2012. We recorded an additional 1.1 million of severance costs during 2013. We do not expect to incur any additional charges related to the reorganization.
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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 were terminating the arrangement and that we would transfer the manufacturing process back to FEI. The termination contract was signed during the fourth quarter of 2011 and the manufacturing process was transitioned back to FEI as of April 2, 2012. The costs associated with the termination of the outsourcing arrangement were accrued in the fourth quarter of 2011. No additional costs were incurred in 2012 or 2013 and we do not expect to incur any significant additional costs associated with the termination of this arrangement.
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.
Information for costs related to the April 2010 restructuring plan is as follows (in thousands):
| Year Ended | |||||||||||||||
| Costs Incurred | 2013 | 2012 | 2011 | Life of Plan | |||||||||||
| Severance costs related to work force reduction and reorganization | $ | — | $ | — | $ | 184 | $ | 6,617 | |||||||
| Product line transfer, training of Brno employees and facility build-out in Brno | — | — | 963 | 1,835 | |||||||||||
| Total costs incurred | $ | — | $ | — | $ | 1,147 | $ | 8,452 | |||||||
All of the costs incurred resulted in cash expenditures. We do not expect to incur significant additional costs associated with this plan.
Restructuring, Reorganization, Relocation and Severance Accrual
The following tables summarize the charges, expenditures, write-offs and adjustments related to our restructuring, reorganization, relocation and severance accrual (in thousands):
| Year Ended December 31, 2013 | Group Structure Reorganization | Total | |||||
| Beginning accrued liability | $ | 2,692 | $ | 2,692 | |||
| Charged to expense, net | 1,090 | 1,090 | |||||
| Expenditures | (3,782 | ) | (3,782 | ) | |||
| Write-offs and adjustments | 50 | 50 | |||||
| Ending accrued liability | $ | 50 | $ | 50 | |||
| Year Ended December 31, 2012 | Severance, outplacement and related benefits for terminated employees | Manufacturing Transfer | Group Structure Reorganization | Total | |||||||||||
| Beginning accrued liability | $ | 113 | $ | 2,100 | $ | — | $ | 2,213 | |||||||
| Charged to expense, net | — | — | 2,859 | 2,859 | |||||||||||
| Expenditures | — | (2,100 | ) | (254 | ) | (2,354 | ) | ||||||||
| Write-offs and adjustments | (113 | ) | — | 87 | (26 | ) | |||||||||
| Ending accrued liability | $ | — | $ | — | $ | 2,692 | $ | 2,692 | |||||||
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| Year Ended December 31, 2011 | Product line transfer and training of Brno employees | Severance, outplacement and related benefits for terminated employees | IT system upgrades | Abandoned leases, leasehold improvements and facilities | Manufacturing Transfer | Total | |||||||||||||||||
| Beginning accrued liability | $ | — | $ | 4,832 | $ | 20 | $ | 32 | $ | — | $ | 4,884 | |||||||||||
| Charged to expense, net | 963 | 184 | — | (32 | ) | 2,100 | 3,215 | ||||||||||||||||
| Expenditures | (963 | ) | (5,083 | ) | — | — | — | (6,046 | ) | ||||||||||||||
| Write-offs and adjustments | — | 180 | (20 | ) | — | — | 160 | ||||||||||||||||
| Ending accrued liability | $ | — | $ | 113 | $ | — | $ | — | $ | 2,100 | $ | 2,213 | |||||||||||
| NOTE 15. | COMMITMENTS AND CONTINGENCIES |
From time to time, we may be a party to litigation arising in the ordinary course of business. Currently, we are not a party to any litigation that we believe would have a material adverse effect on our financial position, results of operations or cash flows.
Purchase Obligations
We have commitments under non-cancelable purchase orders, primarily relating to inventory, totaling $81.1 million at December 31, 2013. These commitments expire at various times through the second quarter of 2016.
| NOTE 16. | LEASE OBLIGATIONS |
We have operating leases for various vehicles and equipment, as well as for certain of our manufacturing and administrative facilities that extend through 2033. The facilities lease agreements generally provide for payment of base rental amounts plus our share of property taxes and common area costs as well as renewal options at current market rates.
Rent expense is recognized on a straight-line basis over the term of the lease. Rent expense was $7.4 million in 2013, $8.5 million in 2012 and $7.5 million in 2011.
The approximate future minimum rental payments due under these agreements as of December 31, 2013, were as follows (in thousands):
| Minimum Rental Payment | |||
| 2014 | $ | 10,997 | |
| 2015 | 8,171 | ||
| 2016 | 6,883 | ||
| 2017 | 5,803 | ||
| 2018 | 4,811 | ||
| Thereafter | 48,722 | ||
| Total | $ | 85,387 | |
| NOTE 17. | SHAREHOLDERS’ EQUITY |
Preferred Stock Rights Plan
On July 21, 2005, the Board of Directors adopted a Preferred Stock Rights Plan. Pursuant to the Preferred Stock Rights Plan, we distributed Rights as a dividend at the rate of one Right for each share of our common stock held by shareholders of record as of the close of business on August 12, 2005. The Rights expire on August 12, 2015, unless redeemed or exchanged.
The Rights are not exercisable until the earlier of: (1) 10 days (or such later date as may be determined by the Board of Directors) following an announcement that a person or group has acquired beneficial ownership of 20% of our common stock or (2) 10 days (or such later date as may be determined by the Board of Directors) following the announcement of a tender offer which would result in a person or group obtaining beneficial ownership of 20% or more of our outstanding common stock, subject to certain exceptions (the earlier of such dates being called the Distribution Date). The Rights are initially exercisable for one-thousandth of a share of our Series A Preferred Stock at a price of $120 per one-thousandth share, subject to adjustment. However, if: (1) after the Distribution Date we are acquired in certain types of transactions, or (2) any person or group (with limited exceptions) acquires beneficial ownership of 20% of our common stock, then holders of Rights (other than the 20% holder) will be entitled to receive, upon exercise of the Right, common stock (or in case we are completely acquired, common stock of the acquirer) having a market value of two times the exercise price of the Right. Philips Business Electronics International B.V., or any of its affiliates, shall not be considered for the 20% calculation so long as it does not acquire 30% or more of our common shares.
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We are entitled to redeem the Rights, for $0.001 per Right, at the discretion of the Board of Directors, until certain specified times. We may also require the exchange of Rights, at a rate of one share of common stock for each Right, under certain circumstances. We also have the ability to amend the Rights, subject to certain limitations.
PEO Combination
On February 21, 1997, we acquired substantially all of the assets and liabilities of the electron optics business of Koninklijke Philips Electronics N.V. (the “PEO Combination”), in a transaction accounted for as a reverse acquisition. As part of the PEO Combination, we agreed to issue to Philips additional shares of our common stock whenever stock options that were outstanding on the date of the closing of the PEO Combination are exercised. Any such additional shares are issued at a rate of approximately 1.22 shares to Philips for each share issued on exercise of these options. We receive no additional consideration for these shares issued to Philips under this agreement. We did not issue any shares in 2013, 2012 or 2011 to Philips under this agreement. As of December 31, 2013, 165,000 shares of our common stock are potentially issuable and reserved for issuance as a result of this agreement.
Share Repurchases
A plan to repurchase up to a total of 4.0 million shares of our common stock was approved by our Board of Directors in September 2010, re-authorized in December 2012, and does not have an expiration date. The amount and timing of specific repurchases are subject to market conditions, applicable legal requirements and other factors. The purchases are funded from existing cash resources and may be suspended or discontinued at any time at our discretion without prior notice.
During 2012 we repurchased 20,500 shares for a total of $0.9 million, or an average of $43.41 per share and during 2011 we repurchased 1,654,000 shares for a total of $50.0 million, or an average of $30.19 per share. We did not repurchase any shares during 2013. As of December 31, 2013, 2,119,800 shares remained available for purchase pursuant to this plan.
Dividends to Shareholders
In June 2012 we announced our plan to initiate a quarterly dividend and our Board has declared dividends each quarter since the plan's inception. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors.
| NOTE 18. | STOCK-BASED COMPENSATION |
Employee Share Purchase Plan
In 1998, we implemented an Employee Share Purchase Plan (“ESPP”). At our 2013 Annual Meeting of Shareholders, which was held on May 9, 2013, our shareholders approved an amendment to our Employee Share Purchase Plan to increase the number of shares of our common stock reserved for issuance under the plan from 3,700,000 to 3,950,000.
Under the ESPP, employees may elect to have compensation withheld and placed in a designated stock subscription account for purchase of FEI common stock. Each ESPP offering period consists of one six-month purchase period. The purchase price in a purchase period is set at a 15% discount to the lower of the market price on either the first day of the applicable offering period or the purchase date. The ESPP allows a maximum purchase of 500 shares per six-month offering period.
A total of 163,143 shares were purchased pursuant to the ESPP during 2013 at a weighted average purchase price of $52.60 per share, which represented a weighted average discount of $27.36 per share compared to the fair market value of our common stock on the dates of purchase. At December 31, 2013, 911,568 shares of our common stock remained available for purchase and were reserved for issuance under the ESPP.
1995 Stock Incentive Plan
Also at our 2013 Annual Meeting of Shareholders, our shareholders approved an amendment to our 1995 Stock Incentive Plan (the “1995 Plan”) to increase the number of shares of our common stock reserved for issuance under the plan from 10,750,000 to 11,000,000.
We maintain stock incentive plans for selected directors, officers, employees and certain other parties that allow the Board of Directors to grant options (incentive and nonqualified), stock and cash bonuses, stock appreciation rights, restricted stock units (“RSUs”), performance RSUs and restricted shares. The Board of Directors’ ability to grant options under the 1995 Plan will terminate, if the plan is not amended, when all shares reserved for issuance have been issued and all restrictions on such shares have lapsed, or earlier, at the discretion of the Board of Directors.
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The following table sets forth certain information regarding the 1995 Plan:
| December 31, 2013 | ||
| Shares available for grant | 1,998,881 | |
| Shares of common stock reserved for issuance | 3,487,290 | |
The following table sets forth certain information regarding all options outstanding and exercisable:
| December 31, 2013 | |||||||
| Options Outstanding | Options Exercisable | ||||||
| Number | 751,853 | 232,828 | |||||
| Weighted average exercise price | $ | 50.18 | $ | 31.80 | |||
| Aggregate intrinsic value | $ 29.5 million | $ 13.4 million | |||||
| Weighted average remaining contractual term | 5.1 years | 3.8 years | |||||
The following table sets forth certain information regarding all RSUs nonvested and expected to vest:
| December 31, 2013 | |||||||
| RSUs Nonvested | RSUs Expected to Vest | ||||||
| Number | 745,060 | 637,692 | |||||
| Weighted average grant date per share fair value | $ | 57.60 | $ | 56.75 | |||
| Aggregate intrinsic value | $ 65.8 million | $ 57.0 million | |||||
| Weighted average remaining term to vest | 1.7 years | 1.6 years | |||||
As of December 31, 2013, unrecognized stock-based compensation related to outstanding, but unvested stock options and RSUs was $47.7 million, which will be recognized over the weighted average remaining vesting period of 2 years.
Activity under these plans was as follows (share amounts in thousands):
| Year Ended December 31, 2013 | ||||||
| Shares Subject to Options | Weighted Average Exercise Price | |||||
| Balance, beginning of period | 870 | $ | 35.81 | |||
| Granted | 198 | 82.11 | ||||
| Forfeited | (47 | ) | 37.38 | |||
| Expired | (4 | ) | 15.56 | |||
| Exercised | (265 | ) | 29.69 | |||
| Balance, end of period | 752 | 50.18 | ||||
| Year Ended December 31, 2013 | ||||||
| Restricted Stock Units | Weighted Average Grant Date Per Share Fair Value | |||||
| Balance, beginning of period | 871 | $ | 41.69 | |||
| Granted | 244 | 83.58 | ||||
| Forfeited | (61 | ) | 41.14 | |||
| Vested | (309 | ) | 37.00 | |||
| Balance, end of period | 745 | 57.60 | ||||
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Stock-Based Compensation Expense
Certain information regarding our stock-based compensation was as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Weighted average grant-date fair value of stock options granted | $ | 16,283 | $ | 12,279 | $ | 11,703 | |||||
| Weighted average grant-date fair value of restricted stock units | 20,415 | 20,461 | 15,499 | ||||||||
| Total intrinsic value of stock options exercised | 13,169 | 6,293 | 10,550 | ||||||||
| Fair value of restricted stock units vested | 11,452 | 9,113 | 8,120 | ||||||||
| Cash received from stock options exercised and shares purchased under all stock-based arrangements | 16,545 | 13,131 | 24,382 | ||||||||
| Tax benefit realized for stock options | 6,495 | 3,137 | 2,918 | ||||||||
Our stock-based compensation expense was included in our Consolidated Statements of Operations as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Cost of sales | $ | 2,427 | $ | 1,858 | $ | 1,511 | |||||
| Research and development | 2,156 | 1,903 | 1,873 | ||||||||
| Selling, general and administrative | 13,744 | 10,393 | 7,727 | ||||||||
| Total stock-based compensation | $ | 18,327 | $ | 14,154 | $ | 11,111 | |||||
Stock-based compensation costs related to inventory or fixed assets were not significant in the years ended December 31, 2013, 2012 and 2011.
Stock-Based Compensation Assumptions
The following weighted average assumptions were used in determining fair value pursuant to the Black-Scholes option pricing model:
| Year Ended | ||||||||
| 2013 | 2012 | 2011 | ||||||
| Risk-free interest rate | 0.07% - 1.72% | 0.13% - 0.81% | 0.06% - 2.02% | |||||
| Dividend yield | 0.44% - 0.59% | 0% - 0.72% | — | % | ||||
| Expected term: | ||||||||
| Option plans | 3.1 - 5.1 years | 5.3 - 5.5 years | 5.5 - 5.7 years | |||||
| Employee share purchase plan | 6 months | 6 months | 6 months | |||||
| Volatility | 23% - 43% | 36% - 55% | 36% - 55% | |||||
| Discount for post vesting restrictions | — | % | — | % | — | % | ||
The risk-free rate used is based on the U.S. Treasury yield over the expected term of the options granted. The expected term for options is estimated based on historical exercise data and for the ESPP, it is based on the life of the purchase period. The expected volatility is calculated based on the historical volatility of our common stock.
| NOTE 19. | EMPLOYEE BENEFIT PLANS |
Pension Plans
Employee retirement plans have been established in some foreign countries in accordance with the legal requirements and customs in the countries involved. The majority of employees in Europe and Asia are covered by defined benefit, multi-employer or defined contribution pension plans. The benefits provided by these plans are based primarily on years of service and employees’ compensation near retirement. Employees in the U.S. are covered by a profit sharing 401(k) plan, which is a defined contribution plan.
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Employees in The Netherlands participate with other companies in making collectively-bargained payments to the Metal-Electro Industry pension fund. We are responsible for the employer contributions to this fund, but are not obligated to make additional payments to cover any underfunded portions. Pension costs relating to this multi-employer plan were $6.5 million, $5.6 million and $4.7 million in 2013, 2012 and 2011, respectively.
Outside the U.S. and The Netherlands, employees are covered under various defined contribution and defined benefit plans as required by local law.
Plan costs for our defined contribution plans outside the U.S. and The Netherlands totaled $3.6 million in 2013, $3.6 million in 2012 and $2.2 million in 2011.
Profit Share and Variable Compensation Programs
We maintain an Employee Profit Share Plan and a Management Variable Compensation Plan for management-level employees to reward achievement of corporate and individual objectives. The Compensation Committee of the Board of Directors generally determines the structure of the overall incentive program at the beginning of each year. In setting the structure and the amount of the overall target incentive pool, the Compensation Committee considers potential size of the pool in relation to our earnings and other financial estimates, the achievability of the corporate targets under the plan, historical payouts under the plan and other factors. The total cost of these plans was $12.8 million in 2013, $13.2 million in 2012 and $24.7 million in 2011.
Profit Sharing 401(k) Plan
We maintain a profit sharing 401(k) plan that covers substantially all U.S. employees. Employees may elect to defer a portion of their compensation, and we may contribute an amount approved by the Board of Directors. We match 100% of employee contributions to the 401(k) plan up to 3% of each employee’s eligible compensation. Employees must meet certain requirements to be eligible for the matching contribution. We contributed $2.1 million in 2013, $1.8 million in 2012 and $1.5 million in 2011 to this plan. Our 401(k) plan does not allow for the investment in shares of our common stock.
Deferred Compensation Plan
We maintain a deferred compensation plan (the “Plan”), which permits certain employees to defer payment of a portion of their annual compensation. We do not match deferrals or make any additional contributions to the Plan. Distributions from the Plan are generally payable as a lump sum payment or in multi-year installments as directed by the participant according to the Plan provisions. Undistributed amounts under the Plan are subject to the claims of our creditors. As of December 31, 2013 and 2012, the invested amounts under the Plan totaled $5.3 million and $3.0 million, respectively, and were recorded on our balance sheets as non-current investments in marketable securities and as a long-term liability to recognize undistributed amounts due to employees.
| NOTE 20. | RELATED-PARTY ACTIVITY |
Related parties with which we had transactions during 2013 were as follows:
| • | one of the members of our Board of Directors serves on the Board of Directors of Applied Materials, Inc. and Lattice Semiconductor Corporation; |
| • | our Chief Financial Officer is on the Board of Directors of Cascade Microtech, Inc.; |
| • | one of the members of our Board of Directors serves on the Supervisory Board of TMC BV; and |
| • | our Chief Executive Officer is on the Board of Trustees for the Oregon Health and Science University Foundation. |
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Transactions with these related parties were as follows (in thousands):
| Year Ended | |||||||||||
| Sales to Related Parties | 2013 | 2012 | 2011 | ||||||||
| Product sales: | |||||||||||
| Applied Materials, Inc. | $ | 4,656 | $ | 981 | $ | 3,594 | |||||
| Lattice Semiconductor Corporation | 5 | — | 122 | ||||||||
| Cascade Microtech, Inc. | — | 4 | — | ||||||||
| Oregon Health and Science University | 555 | — | — | ||||||||
| Total product sales to related parties | 5,216 | 985 | 3,716 | ||||||||
| Service sales: | |||||||||||
| Applied Materials, Inc. | 719 | 554 | 459 | ||||||||
| Lattice Semiconductor Corporation | 12 | — | — | ||||||||
| Cascade Microtech, Inc. | 33 | 33 | 39 | ||||||||
| Oregon Health and Science University | 85 | — | — | ||||||||
| Total service sales to related parties | 849 | 587 | 498 | ||||||||
| Total sales to related parties | $ | 6,065 | $ | 1,572 | $ | 4,214 | |||||
| Purchases from Related Parties | |||||||||||
| TMC BV | $ | 580 | $ | 127 | $ | 109 | |||||
| Cascade Microtech, Inc. | — | — | 1 | ||||||||
| Oregon Health and Science University | 353 | — | — | ||||||||
| Total purchases from related parties | $ | 933 | $ | 127 | $ | 110 | |||||
Amounts due from (to) related parties were as follows (in thousands):
| December 31, 2013 | |||
| Applied Materials, Inc. | $ | 46 | |
| Cascade Microtech, Inc. | 8 | ||
| Oregon Health and Science University | 1 | ||
| TMC BV | (403 | ) | |
| Due to related parties, net | $ | (348 | ) |
| NOTE 21. | SEGMENT AND GEOGRAPHIC INFORMATION |
Segment Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer.
Beginning with the first quarter of 2013, we reorganized our corporate structure. We currently report our segments based on a group structure organization. Our segments are the Industry Group and the Science Group.
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The following tables summarize various financial amounts for each of our business segments (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Sales to External Customers: | |||||||||||
| Industry Group | $ | 427,731 | $ | 433,424 | $ | 376,533 | |||||
| Science Group | 499,723 | 458,314 | 449,893 | ||||||||
| Total | $ | 927,454 | $ | 891,738 | $ | 826,426 | |||||
| Gross Profit: | |||||||||||
| Industry Group | $ | 222,675 | $ | 220,267 | $ | 185,156 | |||||
| Science Group | 216,110 | 195,363 | 182,210 | ||||||||
| Total | $ | 438,785 | $ | 415,630 | $ | 367,366 | |||||
| December 31, 2013 | December 31, 2012 | ||||||
| Goodwill: | |||||||
| Industry Group | $ | 51,532 | $ | 53,572 | |||
| Science Group | 84,620 | 77,748 | |||||
| Total | $ | 136,152 | $ | 131,320 | |||
| Total Assets: | |||||||
| Industry Group | $ | 297,987 | $ | 293,115 | |||
| Science Group | 365,571 | 401,795 | |||||
| Corporate and Eliminations | 762,526 | 539,313 | |||||
| Total | $ | 1,426,084 | $ | 1,234,223 | |||
Market segment disclosures are presented to the gross profit level as this is the primary performance measure for which the segment general managers are responsible. Selling, general and administrative, research and development and other operating expenses are managed and reported at the corporate level and, given allocation to the market segments would be arbitrary, have not been allocated to the market segments. See our Consolidated Statements of Operations for reconciliations from gross profit to income before income taxes. These reconciling items are not included in the measure of profit and loss for each reportable segment.
In 2013 one customer in our Industry segment represented approximately $96.0 million, or 10.4%, in total sales. None of our customers represented 10% or more of our total sales during 2012 or 2011.
Geographical Information
A significant portion of our net sales has been derived from customers outside of the U.S., which we expect to continue. We evaluate geographical performance for three regions: U.S. and Canada, Europe and the Asia-Pacific Region and Rest of World. Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The following table summarizes sales by geographic region (in thousands):
| Year Ended | |||||||||||||||||||||||||||||
| 2013 | 2012 | 2011 | |||||||||||||||||||||||||||
| Product Sales | Service Sales | Total | Product Sales | Service Sales | Total | Product Sales | Service Sales | Total | |||||||||||||||||||||
| U.S. and Canada | $ | 167,876 | $ | 92,759 | $ | 260,635 | $ | 200,778 | $ | 90,942 | $ | 291,720 | $ | 179,126 | $ | 78,118 | $ | 257,244 | |||||||||||
| Europe | 205,857 | 64,803 | 270,660 | 185,598 | 59,124 | 244,722 | 206,994 | 54,319 | 261,313 | ||||||||||||||||||||
| Asia-Pacific Region and Rest of World | 335,705 | 60,454 | 396,159 | 305,120 | 50,176 | 355,296 | 268,479 | 39,390 | 307,869 | ||||||||||||||||||||
| Consolidated net sales | $ | 709,438 | $ | 218,016 | $ | 927,454 | $ | 691,496 | $ | 200,242 | $ | 891,738 | $ | 654,599 | $ | 171,827 | $ | 826,426 | |||||||||||
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Our long-lived assets were geographically located as follows (in thousands):
| December 31, 2013 | December 31, 2012 | ||||||
| United States | $ | 77,639 | $ | 74,319 | |||
| The Netherlands | 65,570 | 32,679 | |||||
| The Czech Republic | 22,950 | 12,019 | |||||
| Other | 42,272 | 46,258 | |||||
| Total | $ | 208,431 | $ | 165,275 | |||
| NOTE 22. | FAIR VALUE MEASUREMENTS OF ASSETS AND LIABILITIES |
Factors used in determining the fair value of our financial assets and liabilities are summarized into three broad categories:
| • | Level 1 – quoted prices in active markets for identical securities as of the reporting date; |
| • | Level 2 – other significant directly or indirectly observable inputs, including quoted prices for similar securities, interest rates, prepayment speeds and credit risk; and |
| • | Level 3 – significant inputs that are generally less observable than objective sources, including our own assumptions in determining fair value. |
The factors or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.
Following are the disclosures related to the fair value of our financial assets and (liabilities) (in thousands):
| December 31, 2013 | Level 1 | Level 2 | Level 3 | Total | ||||||||
| Available for sale marketable securities: | ||||||||||||
| U.S. treasury notes | $ | 10,128 | $ | — | $ | — | $ | 10,128 | ||||
| Agency bonds | — | 37,961 | — | 37,961 | ||||||||
| Commercial paper | — | 39,987 | — | 39,987 | ||||||||
| Certificates of deposit | — | 7,786 | — | 7,786 | ||||||||
| Municipal bonds | — | 49,319 | — | 49,319 | ||||||||
| Corporate bond | — | 5,001 | — | 5,001 | ||||||||
| Trading securities: | ||||||||||||
| Equity securities – mutual funds | 5,287 | — | — | 5,287 | ||||||||
| Derivative contracts, net | — | (1,113 | ) | — | (1,113 | ) | ||||||
| Total | $ | 15,415 | $ | 138,941 | $ | — | $ | 154,356 | ||||
| December 31, 2012 | Level 1 | Level 2 | Level 3 | Total | ||||||||
| Available for sale marketable securities: | ||||||||||||
| U.S. treasury notes | $ | 60,786 | $ | — | $ | — | $ | 60,786 | ||||
| Agency bonds | — | 31,157 | — | 31,157 | ||||||||
| Commercial paper | — | 5,000 | — | 5,000 | ||||||||
| Certificates of deposit | — | 5,494 | — | 5,494 | ||||||||
| Municipal bonds | — | 3,228 | — | 3,228 | ||||||||
| Trading securities: | ||||||||||||
| Equity securities – mutual funds | 3,046 | — | — | 3,046 | ||||||||
| Derivative contracts, net | — | 1,655 | — | 1,655 | ||||||||
| Total | $ | 63,832 | $ | 46,534 | $ | — | $ | 110,366 | ||||
Agency bonds are securities backed by U.S. government-sponsored entities.
We use an income approach to value the assets and liabilities for outstanding derivative contracts using current market information as of the reporting date, such as spot rates, interest rate differentials and implied volatility.
There were no transfers between fair value categories or changes to our valuation techniques during the year ended December 31, 2013.
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We believe the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and other current liabilities are a reasonable approximation of the fair value of those financial instruments because of the nature of the underlying transactions and the short-term maturities involved.
| NOTE 23. | DERIVATIVE INSTRUMENTS |
In the normal course of business, we are exposed to foreign currency risk and we use derivatives to mitigate financial exposure from movements in foreign currency exchange rates.
The aggregate notional amount of outstanding derivative contracts were as follows (in thousands):
| December 31, 2013 | December 31, 2012 | ||||||
| Cash flow hedges | $ | 208,446 | $ | 165,000 | |||
| Balance sheet hedges | 172,947 | 225,924 | |||||
| Total outstanding derivative contracts | $ | 381,393 | $ | 390,924 | |||
The outstanding contracts at December 31, 2013 have varying maturities through the second quarter of 2015. We do not enter into derivative financial instruments for speculative purposes.
We attempt to mitigate derivative credit risk by transacting with highly rated counterparties. We have evaluated the credit and nonperformance risks associated with our derivative counterparties and believe them to be insignificant and not warranting a credit adjustment at December 31, 2013. In addition, there are no credit contingent features in our derivative instruments.
Balance Sheet Related
In countries outside of the U.S., we transact business in U.S. dollars and in various other currencies. We attempt to mitigate our currency exposures for recorded transactions by using forward exchange contracts to reduce the risk that our future cash flows will be adversely affected by changes in exchange rates. We enter into forward sale or purchase contracts for foreign currencies to economically hedge specific cash, receivables or payables positions denominated in foreign currencies.
Changes in fair value of derivatives entered into to mitigate the foreign exchange risks related to these balance sheet items are recorded in other income (expense) together with the transaction gain or loss from the respective balance sheet position as follows (in thousands):
| Year Ended | |||||||||||
| 2013 | 2012 | 2011 | |||||||||
| Foreign currency loss, inclusive of the impact of derivatives | $ | (2,808 | ) | $ | (5,675 | ) | $ | (2,222 | ) | ||
Cash Flow Hedges
We use zero cost collar contracts and option contracts to hedge certain anticipated foreign currency exchange transactions. The foreign exchange hedging structure is set up, generally, on a twenty-four month time horizon. The hedging transactions we undertake primarily limit our exposure to changes in the U.S. dollar/euro and the U.S. dollar/Czech koruna exchange rate. The zero cost collar contract hedges are designed to protect us as the U.S. dollar weakens, but also provide us with some flexibility if the dollar strengthens.
These derivatives meet the criteria to be designated as hedges and, accordingly, we record the change in fair value of the effective portion of these hedge contracts relating to anticipated transactions in other comprehensive income rather than net income until the underlying hedged transaction affects net income. Gains and losses resulting from the ineffective portion of the hedge contracts, if any, are recognized as a component of net income. Gains and losses related to cash flow derivative contracts not designated as hedging instruments are recorded as a component of net income.
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Summary
Our derivative instruments are subject to master netting arrangements and are presented net in our balance sheet. We do not have any financial collateral related to these netting arrangements. The effect of these netting arrangements on our balance sheet is as follows (in thousands):
| Offsetting of Derivative Assets | Offsetting of Derivative Liabilities | ||||||||||||||||||
| December 31, 2013 | Gross Amounts of Recognized Assets | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in Other Current Assets | Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in Other Current Liabilities | |||||||||||||
| Foreign exchange contracts designated as hedging instruments | $ | — | $ | — | $ | — | $ | 4,362 | $ | (3,042 | ) | $ | 1,320 | ||||||
| Foreign exchange contracts not designated as hedging instruments | 2,171 | (698 | ) | 1,473 | 2,916 | (1,650 | ) | 1,266 | |||||||||||
| Total | $ | 2,171 | $ | (698 | ) | $ | 1,473 | $ | 7,278 | $ | (4,692 | ) | $ | 2,586 | |||||
| Offsetting of Derivative Assets | Offsetting of Derivative Liabilities | ||||||||||||||||||
| December 31, 2012 | Gross Amounts of Recognized Assets | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in Other Current Assets | Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Balance Sheet | Net Amounts Presented in Other Current Liabilities | |||||||||||||
| Foreign exchange contracts designated as hedging instruments | $ | 3,019 | $ | (1,492 | ) | $ | 1,527 | $ | — | $ | — | $ | — | ||||||
| Foreign exchange contracts not designated as hedging instruments | 2,725 | (1,589 | ) | 1,136 | 4,289 | (3,281 | ) | 1,008 | |||||||||||
| Total | $ | 5,744 | $ | (3,081 | ) | $ | 2,663 | $ | 4,289 | $ | (3,281 | ) | $ | 1,008 | |||||
The effect of derivative instruments was as follows (in thousands):
| Year Ended | |||||||||||
| Foreign Exchange Contracts in Cash Flow Hedging Relationships | 2013 | 2012 | 2011 | ||||||||
| Amount of gain/(loss): | |||||||||||
| Recognized in OCI (effective portion) | $ | (1,934 | ) | $ | 8,032 | $ | 108 | ||||
| Reclassified from accumulated OCI into revenue (effective portion) | 33 | — | — | ||||||||
| Reclassified from accumulated OCI into cost of sales (effective portion) | (790 | ) | (2,511 | ) | 3,558 | ||||||
| Recognized in other, net (ineffective portion and amount excluded from effectiveness testing) | (80 | ) | 9 | 83 | |||||||
| Foreign Exchange Contracts Not in Cash Flow Hedging Relationships | |||||||||||
| Amount of gain/(loss): | |||||||||||
| Recognized in other, net | $ | (4,802 | ) | $ | (4,882 | ) | $ | (6,181 | ) | ||
The unrealized losses at December 31, 2013 are expected to be reclassified to net income during the next twenty-four months as a result of the underlying hedged transactions also being recorded in net income.
| NOTE 24. | SUBSEQUENT EVENT |
On February 5, 2014, we acquired 100% of the outstanding shares of Lithicon AS of Trondheim, Norway and Canberra, Australia. Lithicon provides digital rock technology services and pore-scale micro computed tomography (microCT) equipment to oil and gas companies. In conjunction with the acquisition we have obtained the helical scan microCT product and associated software from the Australian National University, through a licensing and development agreement. The total purchase price of the acquisition was $68.0 million. As of the date of this filing, the allocation of the purchase price is in process and, accordingly, the applicable disclosures cannot be made and the acquisition is not significant for the purposes of pro-forma disclosures.
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation and under the supervision of our President and Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our most recent fiscal year that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, we used the criteria set forth in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment using those criteria, our management concluded that, as of December 31, 2013, our internal control over financial reporting was effective.
KPMG LLP has audited this assessment of our internal control over financial reporting and their report is included below.
Inherent Limitations on Effectiveness of Controls
Our management, including the CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
FEI Company:
We have audited FEI Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). FEI Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, FEI Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FEI Company and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013, and our report dated February 21, 2014 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Portland, Oregon
February 21, 2014
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Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers of the Registrant and Corporate Governance Matters
Information required by this item will be included under the captions Governance, Code of Ethics, Proposal No. 1 Election of Directors, Meetings and Committees of the Board of Directors, Executive Officers, Membership of the Audit Committee and Section 16(a) Beneficial Ownership Reporting Compliance in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
On September 9, 2003, we adopted a code of business conduct and ethics that applies to all directors, officers and employees. We posted our code of business conduct and ethics on our website at www.fei.com. We intend to disclose any amendment to the provisions of the code of business conduct and ethics that apply specifically to directors or executive officers by posting such information on our website. We intend to disclose any waiver to the provisions of the code of business conduct and ethics that apply specifically to directors or executive officers by filing such information on a Current Report on Form 8-K with the SEC, to the extent such filing is required by the NASDAQ Global Market’s listing requirements; otherwise, we will disclose such waiver by posting such information on our website.
Item 11. Executive Compensation
Information required by this item will be included under the captions Director Compensation, Executive Compensation, Compensation Discussion and Analysis for Named Executive Officers, Compensation Committee Report, Summary Compensation Table, Grants of Plan-Based Awards for Fiscal Year Ended 2013, Outstanding Equity Awards at Fiscal Year End for Fiscal Year Ended 2013, Option Exercises and Stock Vested for Fiscal Year Ended 2013, Nonqualified Deferred Compensation for Fiscal Year Ended 2013, Potential Payments Upon Termination of Employment and Compensation Committee Interlocks and Insider Participation in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item will be included under the captions Security Ownership of Certain Beneficial Owners and Management and Securities Authorized for Issuance Under Equity Compensation Plans in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions and Director Independence
Information required by this item will be included under the captions Certain Relationships and Related Transactions and Director Independence in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
Item 14. Principal Accounting Fees and Services
Information required by this item will be included under the caption Proposal No. 4 Advisory Approval on the Appointment of Public Accounting Firm in our Proxy Statement for our 2014 Annual Meeting of Shareholders and is incorporated by reference herein.
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PART IV
Item 15. Financial Statement Schedules and Exhibits
Financial Statements and Schedules
The Consolidated Financial Statements, together with the report thereon of our independent registered public accounting firm, are included on the pages indicated below:
| Page | |
There are no schedules required to be filed herewith.
Exhibits
The following exhibits are filed herewith and this list is intended to constitute the exhibit index. A plus sign (+) beside the exhibit number indicates the exhibits containing a management contract, compensatory plan or arrangement, which are required to be identified in this report.
| Exhibit No. | Description |
3.1 (6) | Third Amended and Restated Articles of Incorporation |
3.2 (8) | Articles of Amendment to the Third Amended and Restated Articles of Incorporation |
3.3 (12) | Amended and Restated Bylaws, as amended on November 14, 2012 |
4.1 (8) | Preferred Stock Rights Agreement dated July 21, 2005, between FEI and Mellon Investor Services, LLC |
10.1+ (17) | 1995 Stock Incentive Plan, as amended |
10.2+ (2) | 1995 Supplemental Stock Incentive Plan |
10.3+ (5) | Form of Nonstatutory Stock Option Agreement |
10.4+ (17) | Employee Share Purchase Plan, as amended |
10.5+ (10) | Amended and Restated Executive Change of Control and Severance Agreement by and between Dr. Don Kania and FEI Company |
10.6+ (3) | FEI Company Nonqualified Deferred Compensation Plan, as amended |
10.7 (4) | Lease Agreement, dated December 11, 2002, by and among FEI, Technologicky Park Brno, a.s. and FEI Czech Republic, s.r.o. |
10.8 (1) | Deed of Sale, Purchase and Delivery by and between the Company, Daro Vastgoed B.V. in liquidation and Stichting Daro Vastgoed, dated June 6, 2013 |
| 10.9+ | Form of Indemnity Agreement for Directors and Executive Officers of FEI |
10.10+ (7) | Description of Compensation of Non-Employee Directors |
10.11+ (16) | 2011 and 2012 FEI Management Variable Compensation Plan Program Summary Description |
10.12 (11) | Credit Agreement, dated as of June 4, 2008, by and among FEI Company, the Guarantors party thereto from time to time, JPMorgan Chase Bank, N.A., as Administrative Agent, J.P. Morgan Europe Limited, as Alternative Currency Agent, and each of the Lenders party thereto from time to time |
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10.13 (11) | Security and Pledge Agreement, dated as of June 4, 2008, by and among FEI Company, the Guarantors party thereto from time to time and JPMorgan Chase Bank, N.A., as Administrative Agent |
10.14 (14) | First Amendment to Credit Agreement, Security and Pledge Agreement and Disclosure Letter, dated as of March 3, 2009, by and among FEI Company, the Guarantors identified on the signature pages thereto, the Lenders identified on the signature pages thereto and JPMorgan Chase Bank, N.A., as Administrative Agent |
10.15+ (10) | Amended and Restated Form of Executive Change of Control and Severance Agreement for Benjamin Loh, Raymond Link and Bradley Thies |
10.16 (15) | Second Amendment to Credit Agreement, Security and Pledge Agreement and Disclosure Letter, dated as of April 26, 2011, by and among FEI Company, the Guarantors identified on the signature pages thereto, the Lenders identified on the signature pages thereto and JPMorgan Chase Bank, N.A., as Administrative Agent |
10.17 (9) | Agreement on Future Lease Agreement and on Rights and Duties in Connection with Acquisition and Development by and between CTP Property X, spol. s r.o. and FEI Czech Republic s.r.o. dated June 4, 2012 |
10.18 (9) | Form of Lease Agreement by and between CTP Property X, spol. s r.o. and FEI Czech Republic s.r.o. |
14 (13) | Code of Business Conduct and Ethics |
| 21 | Subsidiaries |
| 23.1 | Consent of KPMG LLP |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of The Sarbanes-Oxley Act of 2002 |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of The Sarbanes-Oxley Act of 2002 |
| 32.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 |
| 32.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 |
| 101.INS | XBRL Instance Document |
| 101.SCH | XBRL Taxonomy Extension Schema Document |
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document |
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document |
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
| (1) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013. |
| (2) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1995. |
| (3) | Incorporated by reference to our Registration Statement on Form S-3, filed on April 23, 2001. |
| (4) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002. |
| (5) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2009. |
| (6) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 28, 2003. |
| (7) | Incorporated by reference to our Annual report on Form 10-K for the year ended December 31, 2012. |
| (8) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 27, 2005. |
| (9) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 6, 2012. |
| (10) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2011. |
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| (11) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 10, 2008. |
| (12) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 15, 2012. |
| (13) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 2, 2010. |
| (14) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 5, 2009. |
| (15) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on April 27, 2011. |
| (16) | Incorporated by reference to our Current Reports on Form 8-K filed with the Securities and Exchange Commission on December 20, 2010 and December 16, 2011. |
| (17) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 9, 2013. |
The certifications attached as Exhibits 32.1 and 32.2 that accompany this Annual Report on Form 10-K are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of FEI Company under the Securities Act, or the Securities Exchange Act of 1934, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any general incorporation language contained in such filing.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: February 21, 2014 | FEI COMPANY | |
| By | /s/ DON R. KANIA | |
| Don R. Kania | ||
| Director, President and | ||
| Chief Executive Officer | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 21, 2014:
| Signature | Title |
| /s/ DON R. KANIA | |
| Don R. Kania | Director, President and Chief Executive Officer (Principal Executive Officer) |
| /s/ RAYMOND A. LINK | |
| Raymond A. Link | Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |
| /s/ HOMA BAHRAMI | |
| Homa Bahrami | Director |
| /s/ ARIE HUIJSER | |
| Arie Huijser | Director |
| /s/ THOMAS F. KELLY | |
| Thomas F. Kelly | Director |
| /s/ JAN C. LOBBEZOO | |
| Jan C. Lobbezoo | Director |
| /s/ JAMI K. NACHTSHEIM | |
| Jami K. Nachtsheim | Director |
| /s/ GERHARD H. PARKER | |
| Gerhard H. Parker | Director |
| /s/ JAMES T. RICHARDSON | |
| James T. Richardson | Director |
| /s/ RICHARD H. WILLS | |
| Richard H. Wills | Director |
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