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, 2014
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
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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. ¨
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 ($91.23) 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 29, 2014), was $3,828,065,720.
The number of shares outstanding of the registrant’s Common Stock as of February 16, 2015 was 41,815,937 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 2015 Annual Meeting of Shareholders to be filed within 120 days of the Registrant's fiscal year ended December 31, 2014 pursuant to Regulation 14A.
FEI COMPANY
2014 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 and related services 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 (“TEMs”); scanning electron microscopes (“SEMs”); DualBeamTM systems which combine a SEM and a focused ion beam system (“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. Most all of these product categories are sold into our various end 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”).
Our significant research and development and manufacturing operations are located in Hillsboro, Oregon; Eindhoven, The Netherlands; and Brno, Czech Republic; and our software development is managed principally from Bordeaux, France. 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 22 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 metrology for advanced process control, 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 and biotech companies. 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.
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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.
Research and Development
We have research and development operations in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; Bordeaux, France; Munich, Germany; Trondheim, Norway; and Canberra, Australia.
Our research and development staff at December 31, 2014 consisted of 483 employees, including scientists, engineers, designer draftsmen, technicians and software developers.
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In the last year, we introduced several new and improved products, including:
| • | the Titan Halo, a versatile mid-range Cryo TEM enabling structural and cell biology workflows; |
| • | the Talos 200S TEM system, bringing an efficient combination of resolution and throughput to research and industrial applications; |
| • | the ExSolve Wafer TEM Prep system, which provides our semiconductor customers with fully automated high-speed production of TEM lamella with sub-25nm thickness; |
| • | the Helios PFIB (Plasma FIB) system, combining leading-edge Plasma FIB and SEM capabilities for applications such as 3D packaging analysis, Failure Analysis and Large Area ‘Slice and View’; |
| • | the Teneo (mid-range) SEM, derived from our proven Scios dual beam and designed to serve the needs of research and industrial applications; |
| • | the Teneo VSTM provides novel Serial Block Face Imaging capability that combines mechanical sectioning with virtual sectioning using FEI's proprietary Multi-Energy Deconvolution to facilitate automated acquisition of large sample volumes at isotropic resolution; |
| • | the Helios G3 system, which continues the tradition of best-in-class dual beam performance for high-end applications across many markets and applications; |
| • | the Nano-EX MEMS heating holder for research and industrial TEM workflows, enabling faster time-to-data versus conventional “furnace heaters”; and |
| • | the Strain-14 analysis software package for semiconductor applications, which measures silicon strain with increased robustness and reduced noise versus previous solutions. |
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:
| • | improved SEM and FIB columns specifically focused on the workflow solutions that our tools resolve; |
| • | enhancements in the scanning/transmission electron microscope ("S/TEM") system platform with improved performance, greater sensitivity and higher resolution coupled with new aberration correctors and monochromator technology, enabling sub-angstrom resolution; |
| • | the addition of TEM Phase plate capability, providing improved contrast for structural biology samples; |
| • | enhanced robotics, processes and tool connectivity, enabling near-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 TEM and Dual Beam systems 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 key 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 research institutions, and we work with several of our customers to evaluate new products.
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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 $102.6 million in 2014, $101.9 million in 2013 and $95.0 million in 2012.
Manufacturing
We have manufacturing operations located in Hillsboro, Oregon; Eindhoven, The Netherlands; Brno, Czech Republic; and Munich, Germany. Our manufacturing staff at December 31, 2014 consisted of 760 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, Schneeberger AG, Prodrive Technologies and AZD Praha s.r.o. 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, 2014 consisted of 421 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, 2014 consisted of 708 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 our patents or other intellectual property rights. We own, solely or jointly, approximately 347 patents in the U.S. and approximately 624 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 2015 to 2034.
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 software may incorporate 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 capacities. The failure of these suppliers to continue to offer and develop software consistent with our development efforts could undermine our ability to deliver product applications.
Also see the section titled "Risk Factors" in Part I, Item 1A. of this Annual Report on Form 10-K.
Employees
At December 31, 2014, we had 2,660 employees worldwide. Some of the 1,904 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, 2014 our total backlog was $535.6 million, compared to $473.5 million in total backlog at December 31, 2013.
At December 31, 2014, our backlog consisted of $364.8 million of product backlog and $170.8 million of service backlog, compared to product backlog of $349.3 million and service backlog of $124.2 million at December 31, 2013. We estimate that currently, 85% to 90% of our backlog is billable within one year. Recently, we have seen a trend where our orders have longer lead times resulting in more orders scheduled for delivery of goods or services beyond 12 months. In addition, the size of individual orders has increased due to our customers ordering higher priced tools and multiple tool orders as well as multi-year service contracts. These factors may increase the volatility of our future revenue forecasts.
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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 2014 and 2013, we experienced cancellations of $10.1 million and $4.2 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 certain vendors. 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, 2014 | |||||||||||||||
| U.S. and Canada | Europe | Asia-Pacific Region and Rest of World | Total | ||||||||||||
| Product sales | $ | 207,623 | $ | 200,995 | $ | 314,048 | $ | 722,666 | |||||||
| Service sales | 97,966 | 66,799 | 68,849 | 233,614 | |||||||||||
| Total sales | $ | 305,589 | $ | 267,794 | $ | 382,897 | $ | 956,280 | |||||||
Our long-lived assets were geographically located as follows (in thousands):
| December 31, 2014 | |||
| United States | $ | 76,553 | |
| The Netherlands | 59,722 | ||
| The Czech Republic | 36,534 | ||
| Other | 58,073 | ||
| Total | $ | 230,882 | |
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.
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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.
To compete successfully, we must succeed in our R&D efforts, develop new products and production processes, and improve our existing products and processes ahead of competitors. Our R&D efforts are critical to our success and are aimed at solving complex problems, and we do not expect all of our projects to be successful. We may be unable to develop and market new products successfully, and the products we invest in and develop may not be well received by customers. Our R&D investments may not generate significant operating income or contribute to our future operating results for several years and such contributions may not meet our expectations or even cover the costs of such investments. Additionally, the products and technologies offered by others may affect demand for or pricing of our products. These types of events could negatively affect our competitive position and may reduce revenue, increase costs, lower gross margin percentages, or require us to impair our assets.
The identity and composition of our competitors may change as we increase our focus on application-specific workflows and new market opportunities, such as the oil and gas services sector. As we expand into new markets, we will face competition not only from our existing competitors, but also from other established competitors with stronger technological, marketing and sales positions in those markets.
Our customers must make a substantial investment to install and integrate capital equipment into their laboratories and process applications. For example, 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.
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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% 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 over $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.
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 68%, 72% and 67% of our sales occurred outside the U.S. and Canada in 2014, 2013 and 2012, respectively. 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 26 where we have a direct presence, and we are seeking to establish a direct presence in additional countries. 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; |
| • | business practices that we are prohibited from engaging in by the Foreign Corrupt Practices Act and other anti-corruption laws and regulations; |
| • | difficulties in collecting accounts receivable; |
| • | travel and transportation difficulties resulting from actual or perceived health risks; |
| • | changes in the regulatory environment in countries where we do business, which could lead to delays in the importation of products into those countries; |
| • | European Union Regulation of Hazardous Substances ("RoHS") which could create problems in manufacture and delivery of certain products in Europe; |
| • | the implementation and administration of the Control of Electronic Information Products (often referred to as China RoHS) regulations, which could lead to delays in the importation of products into China; |
| • | security concerns, such as armed conflict and civil or military unrest, political and economic instability and terrorist activity; |
| • | risk of failure of internal controls and failure to detect unauthorized transactions; and |
| • | differing employment practices and labor issues. |
The industries in which we sell our products are cyclical, which may cause our results of operations to fluctuate and changes in product demands from our customers may increase volatility and adversely impact our ability to forecast revenues.
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.
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The largest part of our Industry Group is revenue derived from 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. In addition, the continued adoption of our near-line product solutions, which involves the sale of higher priced tools and longer lead times, has increased the volatility of our sales to this industry and our ability to accurately forecast revenues.
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. 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. We have also seen a slowing of orders in China as their government has implemented new anti-corruption rules which has extended the time for institutions to place new orders, impacting our Science Group.
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 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 February 5, 2014 we acquired Lithicon AS, a provider of digital rock technology services and pore-scale micro computed tomography equipment to oil and gas companies worldwide.
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 controls 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.
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 uncertainty.
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. 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. 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.
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. During 2014 and 2013, we experienced cancellations of $10.1 million and $4.2 million, respectively. 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 and for other reasons. This is particularly true of our high-performance TEMs.
Our orders have longer lead times resulting in more orders scheduled for delivery of goods or services beyond 12 months, and the size of individual orders has increased due to our customers ordering higher priced tools and multiple tool orders as well as multi-year service contracts, which may increase the volatility of our future revenue.
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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 2014, 2013 and 2012, approximately 28%, 29% and 27% of our revenue was denominated in euros, respectively, while more than half of our expenses were denominated in euros, Czech koruna, yen 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 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 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 or to achieve the desired outcome.
Global economic conditions may adversely affect our industry, business and results of operations.
The future economic climate may be less favorable than that of the past. Any slowdown in global economic conditions has led, and could lead, to reduced consumer and business spending in the future, including by our customers and the purchasers of their products and services. If such spending slows down or decreases, 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.
Our gross margin improvement strategy is dependent on multiple factors that, if not achieved, could hinder our ability to reach our gross margin targets.
Our gross margins are dependent on many factors, some of which are not directly controlled by the company. These factors are:
| • | significant variation in our gross margin among products. Any substantial change in product mix could change our gross margin; |
| • | volatility of sales to our Industry Group customers contribute, on average, a higher proportion of our gross margin. Any significant downturn affecting these customers would have a negative impact on our gross margin; |
| • | pricing and acceptance of higher-margin new products; |
| • | realization of manufacturing efficiencies from our new facilities; |
| • | realization of material cost savings through migration of the supply chain to lower cost suppliers and re-engineering of existing products; |
| • | continued improvement in gross margins from our installed base; and |
| • | movements in foreign currency exchange rates and impact of hedging. |
Our inability to control any one of these factors could result in us not achieving our gross margin targets and could negatively impact our operating results.
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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, labor and other 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. Our products incorporate leading-edge technology, including both hardware and software components. Software may contain bugs that unexpectedly interfere with expected operations. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects, which may interfere with customer satisfaction, reduce sales opportunities, or affect gross margins. Failure to effectively manage these manufacturing and product testing issues may materially impact our financial position, results of operations or cash flow.
We rely on a limited number of suppliers to provide certain key 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, Schneeberger AG, Prodrive Technologies and AZD Praha s.r.o. 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 10,000 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.
Global privacy legislation, enforcement, and policy activity are rapidly expanding and creating a complex compliance environment. 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
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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. Costs to comply with and implement privacy-related and data protection measures could be significant. Our failure to comply with federal, state, or international privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others.
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.
In 2014, 2013 and 2012, our top 10 customers accounted for approximately 27%, 25%, and 22% of our total annual net revenue, respectively. One customer accounted for just over 10% of total annual net revenue during 2013 and no customers accounted for 10% or more of total annual net revenue in 2014 and 2012. 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.
Certain of our significant customers have adopted policies relating to sustainability, supply chain management, disaster recovery and other initiatives that may result in significant additional costs depending on the actions we must take in order to comply. Our failure to comply with such policies and initiatives could result in loss of customer contracts or relationships, resulting in significant harm to our business.
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 generally rely on patents, copyrights, trademarks and trade secret laws to establish and maintain proprietary rights in our technology, products and services. We incur significant costs to obtain and maintain patents and other intellectual property rights and to defend our intellectual property. We also rely on the laws of the U.S. and other countries where we develop, manufacture or sell products and services 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 and delivery of our services. We endeavor to protect these trade secrets, but the measures taken to protect them may be inadequate or ineffective. These risks may increase as we focus on application-specific workflows and certain market opportunities, such as those in the oil and gas services sector, where key aspects of our technology may be made publicly available to competitors and new market entrants.
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 68%, 72% and 67% of our sales occurred outside the U.S. in 2014, 2013 and 2012, 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.
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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 or other intellectual property rights covering a variety of technologies that may be included in some of our products and services. In addition, some of our customers may use our products for applications that are similar to those covered by these patents or other intellectual property rights. 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 or other intellectual property rights. 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, including non-practicing 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.
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, developing non-infringing technology 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, develop non-infringing technology 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.
Our exposure to risks associated with the use of intellectual property may be increased as a result of acquisitions due to our lower level of visibility into the development process with respect to such technology or the care taken to safeguard against infringement risk.
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 for which we have repurchased approximately 2.7 million shares to date. In June 2012, our Board of Directors approved the initiation of quarterly cash dividends to holders of our common stock. The declaration and payment of dividends to shareholders in the future is subject to the discretion of 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, consolidate sites, reduce costs and balance the effects of currency fluctuations on our financial results. These actions have included reductions of work-force, site consolidations, and migrating portions of our supply chain to dollar-linked contracts.
Restructuring has the potential to adversely affect our business, financial condition and results of operations due to 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 this paragraph.
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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.
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 future contracts, which could have a material adverse effect on our business and results of operations.
Changes and fluctuations in government spending priorities and procurement practices could adversely affect our revenue.
Because a significant part of our overall business is generated either directly or indirectly as a result of international, national 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.
In addition, procurement practices and procedures vary widely in the various jurisdictions where we conduct business and changes in these practices and procedures could cause delay in obtaining orders and revenue. The anti-corruption measures undertaken by the Chinese government in its procurement practices have caused some delay in orders and revenue from Chinese government-controlled or related entities and these orders and revenue may continue to be delayed to the extent that these anti-corruption measures continue to be undertaken by the Chinese government.
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.
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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 which is very competitive. In addition, experienced management and technical, sales, marketing and service 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.
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.
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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.
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. Also, our ability to recognize revenue that has been deferred on sales of new products could be negatively impacted if all conditions for revenue recognition are not met.
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, a product safety failure could involve significant litigation that would divert management time and resources and cause unanticipated legal expense. Further, if such a failure 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
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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 of our consolidation in certain geographical areas on us, our significant suppliers and our general infrastructure 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.
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. 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, 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 shareholders.
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 third quarter of 2014, we completed the move of our manufacturing and development facility in Brno, Czech Republic, to a new, larger facility in Brno consisting of approximately 290,000 square feet. We have a lease agreement with an initial 10-year term with lease payments of approximately $230,000 per month with multiple options to renew.
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In the second quarter of 2013, we purchased facilities we had previously been leasing in Eindhoven, The Netherlands, consisting of 271,743 square feet. These facilities are used for research and development, manufacturing, sales, marketing and administrative functions, primarily by the Science Group.
We operate, in leased facilities, a software development and licensing business in Bordeaux, France, and an optical microscopy business in Munich, Germany. We closed our facility in Delmont, Pennsylvania at the end of 2014. In Australia, we operate an office for sales, service and some research and development, in a leased facility, located in Canberra which directly supports our Industry and Science Groups. We closed our Melbourne and Brisbane offices in 2014.
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, Norway and the U.S., as well as other smaller offices in the other countries where we have direct sales and service operations. In the fourth quarter of 2014, we relocated our China office to a larger leased facility totaling 47,688 square feet that includes a demonstration facility, training lab and offices.
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 the 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:
| 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 | ||||||||
| 2014 | High | Low | Dividend Paid | ||||||||
| Quarter 1 | $ | 111.57 | $ | 85.31 | $ | 0.12 | |||||
| Quarter 2 | 106.91 | 76.22 | 0.12 | ||||||||
| Quarter 3 | 93.38 | 75.32 | 0.25 | ||||||||
| Quarter 4 | 93.30 | 72.74 | 0.25 | ||||||||
The approximate number of beneficial shareholders and shareholders of record at February 9, 2015 was 27,215 and 61, 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. 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 2014, 2013 or 2012 to Philips under this agreement. As of December 31, 2014, 165,000 shares of our common stock are potentially issuable and reserved for issuance as a result of this agreement. These shares have been included in our calculation of earnings per share for all periods presented.
Share Repurchases
During 2014, we repurchased 795,321 shares for a total of $62.5 million, or an average of $78.61 per share. We did not repurchase any shares in 2013. During 2012, we repurchased 20,500 shares for a total of $0.9 million, or an average of $43.41 per share.
The following table sets forth share repurchase information for the periods indicated:
Total Number of Shares Purchased(1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans | Maximum Number of Shares that May Yet Be Purchased Under the Plans | ||||||
| Period: | |||||||||
| September 29 - October 26, 2014 | 295,321 | $ | 75.20 | 295,321 | 1,324,479 | ||||
| October 27 - November 30, 2014 | — | — | — | 1,324,479 | |||||
| December 1 - 31, 2014 | — | — | — | 1,324,479 | |||||
| Total fourth quarter | 295,321 | $ | 75.20 | 295,321 | 1,324,479 | ||||
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(1) | On September 20, 2010, the Board of Directors announced a 4.0 million share stock repurchase program, reauthorized in December 2012. The stock repurchase program does not have an expiry 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. As of December 31, 2014, 1,324,479 shares remained available for purchase pursuant to this plan. See “Liquidity and Capital Resources Share Repurchase Plan” in Part I, Item 7 of this Annual Report on Form 10-K for further information. |
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 2015 Annual Meeting of Shareholders and is incorporated by reference herein.
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 | 12/31/2009 | 12/31/2010 | 12/31/2011 | 12/31/2012 | 12/31/2013 | 12/31/2014 | |||||||||||||||||
| FEI Company | $ | 100.00 | $ | 113.06 | $ | 174.57 | $ | 238.23 | $ | 385.97 | $ | 393.62 | |||||||||||
| NASDAQ Composite | 100.00 | 118.02 | 117.04 | 137.47 | 192.62 | 221.02 | |||||||||||||||||
| NASDAQ Non-Financial | 100.00 | 118.43 | 118.27 | 138.63 | 194.21 | 223.47 | |||||||||||||||||
| SIC 3826 | 100.00 | 142.97 | 140.53 | 156.28 | 237.10 | 257.47 | |||||||||||||||||
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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 December 31, | ||||||||||||||||||
| Statement of Operations Data | 2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||
| Net sales | $ | 956,280 | $ | 927,454 | $ | 891,738 | $ | 826,426 | $ | 634,222 | |||||||||
| Cost of sales | 508,125 | 488,669 | 476,108 | 459,060 | 364,958 | ||||||||||||||
| Gross profit | 448,155 | 438,785 | 415,630 | 367,366 | 269,264 | ||||||||||||||
Total operating expenses(1) | 318,754 | 282,597 | 267,543 | 240,315 | 213,806 | ||||||||||||||
| Operating income | 129,401 | 156,188 | 148,087 | 127,051 | 55,458 | ||||||||||||||
| Other expense, net | (2,471 | ) | (4,586 | ) | (7,539 | ) | (4,186 | ) | (3,236 | ) | |||||||||
| Income before income taxes | 126,930 | 151,602 | 140,548 | 122,865 | 52,222 | ||||||||||||||
Income tax expense (benefit)(2) | 21,866 | 24,929 | 25,628 | 19,228 | (1,326 | ) | |||||||||||||
| Net income | $ | 105,064 | $ | 126,673 | $ | 114,920 | $ | 103,637 | $ | 53,548 | |||||||||
| Basic net income per share | $ | 2.50 | $ | 3.13 | $ | 3.02 | $ | 2.70 | $ | 1.41 | |||||||||
| Diluted net income per share | $ | 2.47 | $ | 3.01 | $ | 2.80 | $ | 2.51 | $ | 1.34 | |||||||||
| Shares used in basic per share calculations | 41,969 | 40,446 | 38,065 | 38,384 | 38,083 | ||||||||||||||
| Shares used in diluted per share calculations | 42,528 | 42,395 | 41,728 | 42,047 | 41,737 | ||||||||||||||
| In thousands | December 31, | ||||||||||||||||||
| Balance Sheet Data | 2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||
| Cash and cash equivalents | $ | 300,507 | $ | 384,170 | $ | 266,302 | $ | 320,361 | $ | 277,617 | |||||||||
| Working capital | 527,973 | 657,126 | 486,830 | 519,284 | 493,518 | ||||||||||||||
| Total assets | 1,417,818 | 1,426,084 | 1,234,223 | 1,089,909 | 984,422 | ||||||||||||||
| Current portion of convertible debt | — | — | 89,010 | — | — | ||||||||||||||
| Convertible debt, net of current portion | — | — | — | 89,011 | 89,012 | ||||||||||||||
| Shareholders’ equity | 1,041,325 | 1,077,568 | 839,903 | 696,814 | 633,174 | ||||||||||||||
(1) Included in operating expenses was $18.5 million, $1.1 million, $2.9 million, $3.2 million and $11.1 million of restructuring, reorganization, relocation and severance in 2014, 2013, 2012, 2011 and 2010, 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) 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.
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.
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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 2015, revenue expectations for the first half and full year 2015, the impact of certain items on our results for these periods, including statements regarding our sources of revenue, our investments and expenditures, our effective tax rate, the location of our cash and cash equivalents, the level of profitability at which we expect to operate and the allocation of our resources and expenditures. Forward-looking statements may also be identified by words and phrases that refer to future expectations, such as “guidance”, “guiding”, “forecast”, “toward”, “plan”, “expect”, “are expected”, “is expected”, “will”, “projecting”, “look forward”, and other similar words and phrases. Factors that could affect such forward-looking statements include, but are not limited to: the global economic environment, in particular continued slower growth in China and emerging markets; lower than expected customer orders, including for recently-introduced products; potential weakness of the Science and Industry market segments, including continued weakness in the oil and gas sector of the Industry segment resulting from declining oil prices; fluctuations in foreign exchange rates, which can affect revenues, margins and the competitive pricing of our products; cyclical changes and increased volatility in the semiconductor industry, which is a major component of Industry market segment revenue; changes in backlog and the timing of shipments from backlog, which may create forecasting challenges; potential delayed or reduced governmental spending to support expected orders; potential disruption in the company's operations due to organizational changes; the relative mix of higher-margin and lower-margin products; potential for increased volatility and challenges in forecasting resulting from larger sales transactions, cancellations and rescheduling of orders by customers; 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, and risks associated with building and shipping a high percentage of the company’s quarterly revenue in the last month of the quarter; delays in meeting all accounting requirements for revenue recognition; the ongoing determination of the effectiveness of foreign exchange hedge transactions; the relative mix of U.S. and non-U.S. sales; 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 disruption in manufacturing or unexpected additional costs due to the transition from older to newer products; failure to achieve improved operational efficiency and other benefits from infrastructure investments and restructuring activities; changes to restructuring activities, including greater than estimated costs, or potential additional restructurings, realignments and reorganizations; 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 rates and laws, accounting rules regarding taxes or agreements with tax authorities; changes in trade policies and tariff regulations; changes in the regulatory environment in the nations where we do business; potential shipment or supply chain disruptions; 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 2014 AND OUTLOOK FOR 2015
During 2014, we experienced revenue growth of 3% over 2013, with growth in both our Industry and Science Group. We are forecasting continued growth in 2015, across both our Industry Group and our Science Group, based on expected 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 2014, but expect a weaker first quarter in 2015 due to the typical effects of seasonality in our markets and the expected timing of product shipments in response to customer requests. In addition, we expect to see a negative year-over-year impact from currency movements.
Within the Industry Group, our revenues grew in 2014 due to strength in the semiconductor equipment market. Our equipment is primarily used in laboratories for new process development and yield improvement. The increasing complexity and shrinking dimensions of the devices made by our customers have increased the demand for our DualBeams and high-resolution TEMs. In addition, we introduced products in the latter half of 2013 that have moved our tools closer to the production line. We believe sales to the semiconductor market will grow as our customers increase their focus on smaller and more complex structures and demand for our near-line products continues to develop. Given the structure of the semiconductor industry, with a small number of customers accounting for a large portion of the capital spend, we believe that we will continue to see quarter-to-quarter variability in revenue and customer orders. Our Industry Group also includes, to a much lesser extent, sales to companies in oil and gas and the mining markets. In 2014, revenue and orders in these markets were down significantly compared with 2013. Capital spending in the mining market remained depressed and the significant declines in oil prices in the second half of 2014 negatively impacted customer spending. We are focusing our efforts in the oil and gas market toward reservoir characterization and digital rock technology. We believe there are long term opportunities in these areas but we do not expect a material improvement in our revenues from the oil and gas market in 2015 based on current market conditions.
Within the Science Group, sales of our products for materials science research drive the largest portion of our revenues. These customers are globally dispersed and their spending is driven by varied economic and political factors. In 2014, revenue was down compared with 2013 due to decreased spending in several large Asian countries, partially offset by strong growth in North America. We expect growth in the materials science markets in 2015 as customer adoption of new products first introduced in 2013 continues to grow and emerging economies, such as China, continue to invest in their research, development and education infrastructure. Sales to researchers in structural biology showed significant growth in 2014. The primary driver of this growth has been increased penetration of electron microscopy into structural biology applications and adoption of our products by new customers. We expect these revenues to continue to grow as the market grows, and we increase our ability to serve existing customers and acquire new customers.
Gross margin increased by 70 basis points from 2012 to 2013 and declined by 40 basis points from 2013 to 2014. We are seeking to improve gross margin in 2015. In addition to increasing our proportion of newer, higher-margin products and application-specific products, we expect lower costs from continued sourcing improvements and efficiencies from our new facility in the Czech Republic.
Operating expenses are expected to remain relatively flat in 2015 as increased spending for research and development and higher stock-based compensation expense are offset by savings from our 2014 restructuring program and more favorable impact of foreign exchange rates on our expenses.
Our net income declined in 2014 principally as a result of the restructuring program we announced in June. Growth in our net income will primarily depend upon our ability to grow our revenue and deliver improvement in our gross margin.
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Net sales | $ | 956,280 | $ | 927,454 | $ | 891,738 | |||||
| Cost of sales | 508,125 | 488,669 | 476,108 | ||||||||
| Gross profit | 448,155 | 438,785 | 415,630 | ||||||||
| Research and development | 102,613 | 101,947 | 94,965 | ||||||||
| Selling, general and administrative | 197,682 | 179,560 | 169,719 | ||||||||
| Restructuring, reorganization, relocation and severance costs | 18,459 | 1,090 | 2,859 | ||||||||
| Operating income | 129,401 | 156,188 | 148,087 | ||||||||
| Other expense, net | (2,471 | ) | (4,586 | ) | (7,539 | ) | |||||
| Income before income taxes | 126,930 | 151,602 | 140,548 | ||||||||
| Income tax expense | 21,866 | 24,929 | 25,628 | ||||||||
| Net income | $ | 105,064 | $ | 126,673 | $ | 114,920 | |||||
The following table sets forth our statement of operations data as a percentage(1) of consolidated net sales:
| Year Ended December 31, | ||||||||
| 2014 | 2013 | 2012 | ||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of sales | 53.1 | 52.7 | 53.4 | |||||
| Gross profit | 46.9 | 47.3 | 46.6 | |||||
| Research and development | 10.7 | 11.0 | 10.6 | |||||
| Selling, general and administrative | 20.7 | 19.4 | 19.0 | |||||
| Restructuring, reorganization, relocation and severance costs | 1.9 | 0.1 | 0.3 | |||||
| Operating income | 13.5 | 16.8 | 16.6 | |||||
| Other expense, net | (0.3 | ) | (0.5 | ) | (0.8 | ) | ||
| Income before income taxes | 13.3 | 16.3 | 15.8 | |||||
| Income tax expense | 2.3 | 2.7 | 2.9 | |||||
| Net income | 11.0 | % | 13.7 | % | 12.9 | % | ||
(1) | Percentages may not add due to rounding. |
Net sales increased $28.8 million, or 3.1%, to $956.3 million in 2014 compared to $927.5 million in 2013 and increased $35.7 million, or 4.0%, in 2013 compared to $891.7 million in 2012.
Revenue from our recently acquired businesses increased net sales by $10.1 million, or 1.1%, in 2014 compared to 2013 and increased net sales by $15.2 million, or 1.7%, in 2013 compared to 2012.
Currency fluctuations decreased net sales by $10.3 million, or 1.1%, in 2014 compared to 2013 and decreased net sales by approximately $8.3 million, or 0.9%, in 2013 compared to 2012. Strengthening of the U.S. dollar against foreign currencies generally has the effect of decreasing net sales and backlog. See also "Foreign Currency Exchange Rate Risk" included in Part I, Item 7A. of this Annual Report on Form 10-K for further discussion of currency impact on our results of operations.
Other factors affecting net sales are discussed in more detail in the Net Sales by Segment discussion below.
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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 December 31, | ||||||||||||||||||||
| 2014 | 2013 | 2012 | ||||||||||||||||||
| Industry Group | $ | 450,198 | 47.1 | % | $ | 427,731 | 46.1 | % | $ | 433,424 | 48.6 | % | ||||||||
| Science Group | 506,082 | 52.9 | 499,723 | 53.9 | 458,314 | 51.4 | ||||||||||||||
| Consolidated net sales | $ | 956,280 | 100.0 | % | $ | 927,454 | 100.0 | % | $ | 891,738 | 100.0 | % | ||||||||
Industry Group
The $22.5 million, or 5.3%, increase in Industry Group sales in 2014 compared to 2013 was primarily due to increased sales to semiconductor customers, mainly as a result of their ongoing investment in advanced technologies and the continued adoption of our near-line product solutions, as well as overall growth in revenues from our installed base. This increase was partially offset by reduced demand for our products from oil and gas customers and continued weakness in the mining sector driven by lower commodity prices and a corresponding reduction in capital spending. We may continue to experience reduced future demand for our oil and gas solutions if global oil prices remain at multi-year lows. Currency fluctuations decreased Industry Group revenue by $2.6 million, or 0.6%, and revenue from acquired businesses increased Industry Group revenue by $7.6 million, or 1.8%, as compared to the prior year.
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.
Science Group
The $6.4 million, or 1.3%, increase in Science Group sales in 2014 compared to 2013 was primarily driven by increased revenue from high-end, high-resolution systems sold to our structural and cell biology customers globally and increased revenue from our installed base. Offsetting this was reduced demand in China due to new procurement regulations slowing down order flow and a reduced demand for our products in Japan due to the weakening of the Japanese yen against the U.S. dollar which made our products more expensive. Currency fluctuations decreased Science Group revenue by $7.6 million, or 1.5%, and revenue from acquired businesses increased Science Group revenue by $2.5 million, or 0.5%, as compared to the prior year.
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.
Net Sales by Geographic Region
A majority of our net sales are 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 December 31, | ||||||||||||||||||||
| 2014 | 2013 | 2012 | ||||||||||||||||||
| U.S. and Canada | $ | 305,589 | 32.0 | % | $ | 260,635 | 28.1 | % | $ | 291,720 | 32.7 | % | ||||||||
| Europe | 267,794 | 28.0 | 270,660 | 29.2 | 244,722 | 27.5 | ||||||||||||||
| Asia-Pacific Region and Rest of World | 382,897 | 40.0 | 396,159 | 42.7 | 355,296 | 39.8 | ||||||||||||||
| Consolidated net sales | $ | 956,280 | 100.0 | % | $ | 927,454 | 100.0 | % | $ | 891,738 | 100.0 | % | ||||||||
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U.S. and Canada
The $45.0 million, or 17.2%, increase in sales to the U.S. and Canada in 2014 compared to 2013 was primarily due to increased sales to customers engaged in semiconductor manufacturing, structural and cell biology research, and materials research. We also saw increased service revenue from our installed base.
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.
Europe
Our European region also includes Central America, South America, Africa (excluding South Africa), the Middle East and Russia.
The $2.9 million, or 1.1%, decrease in sales to Europe in 2014 compared to 2013 was primarily as a result of lower revenues from semiconductor manufacturing customers as their demand continues to shift to the Asia-Pacific region. We also saw a decrease in sales to our research customers, but this decline was offset by increased demand from our structural and cell biology customers as our solutions continue to gain acceptance within the scientific community. Currency fluctuations decreased sales to Europe by $2.6 million, or 1.0%, in 2014 compared to 2013.
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.
Asia-Pacific Region and Rest of World
The $13.3 million, or 3.3%, decrease in sales to the Asia-Pacific Region and Rest of World in 2014 compared to 2013 was due to a decline in sales to customers engaged in materials research activities. In particular, while demand for our products in China remains substantial, recent anti-corruption initiatives undertaken by the Chinese government have slowed funding and procurement by Chinese government-controlled or related entities, thus causing delays in orders and revenue from our Chinese customers. We have also experienced lower sales in Japan as the weakening of the Japanese yen against the US dollar has made our products more expensive. The decrease in sales to our materials research customers was offset by increased purchases by our semiconductor customers as the region continues to expand manufacturing capacity, as well as increased purchases by our structural and cell biology customers. Currency fluctuations decreased sales to this region by $7.5 million, or 1.9%, in 2014 compared to 2013.
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.
Cost of Sales and Gross Margin
Our gross margin (gross profit as a percentage of net sales) by segment was as follows:
| Year Ended December 31, | ||||||||
| 2014 | 2013 | 2012 | ||||||
| Industry Group | 51.1 | % | 52.1 | % | 50.8 | % | ||
| Science Group | 43.1 | 43.2 | 42.6 | |||||
| Overall | 46.9 | 47.3 | 46.6 | |||||
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 $19.5 million, or 4.0%, to $508.1 million in 2014 compared to $488.7 million in 2013, due primarily to higher sales volume and a change in product mix of systems sold. Currency fluctuations decreased cost of sales by $9.6 million and reduced gross margin by $0.7 million, or 0.4 percentage points, in 2014 compared to 2013.
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.
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Industry Group
The decrease in Industry Group gross margin in 2014 compared to 2013 was due primarily to change in product mix as we sold less comparatively higher resolution systems to semiconductor and oil and gas customers, which generally carry higher average margins, and incurred higher costs to support our near-line solutions. This was partially offset by higher maintenance and repair revenue derived from our installed base. The realignment plan announced in the second quarter of 2014 also decreased gross margins as we discontinued or de-emphasized certain product lines and reduced the value of excess inventory. Currency fluctuations decreased Industry Group gross margin by $0.6 million, or 0.2 percentage points, in 2014 compared to 2013.
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 revenue derived from our installed base. Currency fluctuations decreased Industry Group gross margin in 2013 compared to 2012 by $2.8 million, or 0.2 percentage points.
Science Group
The decrease in Science Group gross margin in 2014 compared to 2013 was due primarily to changes in product mix and increased competition, which reduced average selling prices for our lower-resolution systems, offset by higher margins on revenue from our installed base due to lower costs for parts and labor. The realignment plan announced in the second quarter of 2014 also decreased gross margins as we discontinued certain product lines and reduced the value of excess inventory. Currency fluctuations had an insignificant impact on Science Group gross margin in 2014 compared to 2013.
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.
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Gross spending | $ | 107,126 | $ | 107,291 | $ | 102,309 | |||||
| Less subsidies | (4,513 | ) | (5,344 | ) | (7,344 | ) | |||||
| Net expense | $ | 102,613 | $ | 101,947 | $ | 94,965 | |||||
R&D costs increased $0.7 million, or 0.7%, in 2014 compared to 2013 primarily due to a decrease in subsidies from European governments and inclusion of R&D costs from acquired businesses. This was offset partially by a decline in external project spending as well as reduced labor costs resulting from our realignment plan announced in the second quarter of 2014. Currency fluctuations decreased R&D costs by $0.9 million, or 0.8%, in 2014 compared to 2013.
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.
We anticipate investing 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 and currency fluctuations.
See also the Risk Factors included in Part I, Item 1A. of this Annual Report on Form 10-K for further discussion of R&D expense impact on our results of operations.
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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 $18.1 million, or 10.1%, in 2014 compared to 2013 primarily due to increased headcount, higher stock-based compensation cost, additional depreciation, site consolidation costs related to our realignment plan announced in the second quarter of 2014 and the inclusion of SG&A costs of our acquired companies. Currency fluctuations decreased SG&A costs by $1.0 million, or 0.6%, in 2014 compared to 2013.
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 businesses. Currency fluctuations increased SG&A costs by an insignificant amount in 2013 compared to 2012.
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
Second Quarter 2014 Realignment
During the second quarter of 2014, we implemented a resource realignment plan aimed at improving our operational efficiency by eliminating redundancies in sites and personnel resulting from recent acquisitions and expansion activities. We shifted our resources to growing regions, such as Asia, and potential growth markets, such as structural biology, oil and gas, near-line semiconductor processing and metals research, in order to better position us to pursue our growth strategy. The realignment plan activities included the consolidation of our three Australia sites in Canberra; the closure of our facility in Delmont, Pennsylvania and relocation of those operations to our new facility in the Czech Republic; relocation of our Japan demonstration facility to our Shanghai facility; selective reductions in staffing, relocations and compensation adjustments related to the foregoing activities and other realignment of management resources. Savings from the realignment plan are expected to be approximately $10.0 million on an annual basis.
The following table summarizes the costs incurred under our second quarter realignment plan:
| Year Ended | ||||
| Realignment Costs | December 31, 2014 | |||
| Inventory write-offs | $ | 1,627 | ||
| Acceleration of acquisition-related earn-out | 2,500 | |||
| Impairment and other asset write-offs | 3,973 | |||
| Restructuring activities | 17,128 | |||
| Total | $ | 25,228 | ||
First Quarter 2014 Restructuring
During the first quarter of 2014, we engaged in a restructuring plan principally aimed at consolidating our sales force in Europe. The $1.3 million cost incurred in implementing the restructuring plan primarily consisted of severance and other employee termination related costs, and was incurred during the first quarter of 2014. We do not expect to incur any additional costs under this plan. Savings from this plan are expected to be approximately $1.8 million on an annual basis.
Group Structure Reorganization
During the first quarter of 2013, we reorganized the company into a group structure in order to enable us to efficiently execute our growth strategy. The costs associated with the reorganization consisted primarily of severance costs and resulted in the termination of certain positions throughout the company. In anticipation of this reorganization, we incurred $2.9 million of costs during the fourth quarter of 2012, and recorded $1.1 million of severance costs during 2013, for a total cost of $4.0 million. We do not expect to incur any additional costs under this reorganization plan.
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.
Other Expense, Net
Other expense, net includes interest income, interest expense, foreign currency transaction gains and losses, bank fees and other miscellaneous items.
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Interest income represents interest earned on cash and cash equivalents and investments in marketable securities and totaled $0.9 million in 2014, $0.4 million in 2013 and $1.6 million in 2012. The increase in 2014 compared to 2013 was primarily due to mix in investment balances. The decrease in 2013 compared to 2012 was primarily due to lower investment balances and continued low interest rates.
Interest expense was $0.6 million for 2014, $1.9 million for 2013 and $4.1 million for 2012. Interest expense for 2013 and 2012 included interest expense related primarily to our 2.875% convertible notes, which converted to common stock on June 1, 2013.
Other, net primarily consists of foreign currency gains and losses on transactions and realized and unrealized gains and losses on the changes in fair value of derivative contracts entered into to hedge these transactions.
Income Tax Expense
Our effective income tax rate of 17.2% for 2014 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 due to the lapse of statutes of limitation and the effective settlement of positions taken on prior year returns.
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 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, 2014, total unrecognized tax benefits were $21.8 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 totaled $5.0 million and $7.9 million, respectively, at December 31, 2014 and 2013. Valuation allowances on deferred tax assets totaled $4.4 million and $2.7 million as of December 31, 2014 and 2013, respectively. The increase is due to additional valuation allowance against net deferred tax assets recorded as part of the Lithicon acquisition. 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, 2014 consisted of $377.9 million of cash, cash equivalents, short-term restricted cash and short-term investments, $85.9 million in non-current investments, $38.4 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, 2014, $255.2 million of our $502.1 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 2020.
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, 2014.
In 2014, cash and cash equivalents and short-term restricted cash decreased $86.8 million to $316.2 million as of December 31, 2014 from $403.0 million as of December 31, 2013 primarily as a result of $65.0 million used for acquisition related activities, $62.5 million used for share repurchases, $49.5 million used for the purchase of property, plant and equipment, dividends paid on common stock of $31.1 million, an increase in restricted cash of $8.8 million, and a $25.4 million unfavorable effect from changes in exchange rate changes. The decrease was offset by $142.9 million provided by operations and $14.8 million of net proceeds from employee stock compensation plans.
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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. The increase was 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.
Accounts receivable increased $32.9 million to $227.4 million as of December 31, 2014 from $194.4 million as of December 31, 2013. This increase was primarily due to the timing of shipments and a decline in collections on orders recorded as revenue in the last quarter of 2014. The December 31, 2014 balance included an $11.5 million decrease related to fluctuations in currency exchange rates. Our days sales outstanding, calculated on a quarterly basis, was 78 days at December 31, 2014 and 67 days at December 31, 2013.
Inventories decreased $5.3 million to $176.4 million as of December 31, 2014 compared to $181.7 million as of December 31, 2013, mainly due to strengthening of the U.S. dollar and offset by inventory purchases to support our 2015 build plan. The December 31, 2014 balance included a $22.1 million decrease related to fluctuations in currency exchange rates. Our annualized inventory turnover rate, calculated on a quarterly basis, was 2.4 times for the quarter ended December 31, 2014 and 2.2 times for the quarter ended December 31, 2013.
Deferred tax assets, current and long term, net of deferred tax liabilities, decreased $2.9 million to $5.0 million as of December 31, 2014 compared to $7.9 million as of December 31, 2013 primarily from additional deferred tax liabilities for deferral of revenue and the utilization of research and development credits to offset current period taxes due.
Other current assets increased $7.2 million to $35.5 million as of December 31, 2014 compared to $28.3 million as of December 31, 2013, primarily due to an increase in VAT receivable and prepaid taxes associated with the intercompany transfer of assets.
Expenditures for property, plant and equipment of $49.5 million and transfers to fixed assets from inventories of $2.9 million in 2014 primarily consisted of payments for demonstration equipment and equipment related to our Brno facility, offset by $3.6 million of tax incentives granted in the Czech Republic for reaching targeted levels of investment.
Accounts payable increased $5.1 million to $78.3 million as of December 31, 2014 compared to $73.2 million as of December 31, 2013, primarily due to a company-wide initiative to expand vendor payment terms and increased amounts due to suppliers for products and development projects.
Accrued payroll liabilities decreased $6.5 million to $38.6 million as of December 31, 2014 compared to $45.1 million as of December 31, 2013, primarily due to timing of payments and reduced accruals for wages and taxes related to our employee incentive programs.
Net income taxes receivable increased $2.4 million to $4.1 million as of December 31, 2014 compared to $1.7 million as of December 31, 2013 primarily due to the accrual of current year taxes plus prepayment of taxes associated with the intercompany transfer of assets. Our receivable for income taxes of $9.4 million at December 31, 2014 is included as a component of other current assets.
Other Credit Facilities and Letters of Credit
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 Administrative Agent (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.
On July 3, 2014, we entered into the Third Amendment to Credit Agreement (the “Third Amendment”) with the Agent, various lenders (the “Lenders”) and certain other parties. Among other things, the Third Amendment amended the Credit Agreement to increase the permitted amount of restricted payments, subject to certain conditions and certain technical amendments.
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.
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The following table sets forth information related to guarantees and letters of credit (in thousands):
| December 31, 2014 | |||
| Guarantees and letters of credit outstanding | $ | 54,897 | |
| Amount secured by restricted cash deposits: | |||
| Current | $ | 15,698 | |
| Long-term | 38,369 | ||
| Total secured by restricted cash | $ | 54,067 | |
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 2014, we repurchased 795,321 shares for a total of $62.5 million, or an average of $78.61 per share. We did not repurchase any shares in 2013. During 2012, we repurchased 20,500 shares for a total of $0.9 million, or an average of $43.41 per share. As of December 31, 2014, 1,324,479 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. 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 and further increased to $0.25 per share of common stock declared in the second, third, and fourth quarters of 2014.
Dividends declared during the year ended December 31, 2014 were $36.4 million, and dividend payments during the year ended December 31, 2014 totaled $31.1 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, 2014 was as follows (in thousands):
| 2015 | 2016 and 2017 | 2018 and 2019 | 2020 and Beyond | Total | |||||||||||||||
| Letters of Credit and Bank Guarantees | 16,528 | 6,729 | 526 | 31,114 | 54,897 | ||||||||||||||
| Purchase Order Commitments | 92,669 | 59 | 549 | 95 | 93,372 | ||||||||||||||
| Pension Related Obligations | 158 | 230 | 283 | 4,207 | 4,878 | ||||||||||||||
| Deferred Compensation Liability | — | — | — | 7,400 | 7,400 | ||||||||||||||
| Operating Leases | 8,327 | 12,757 | 8,953 | 41,800 | 71,837 | ||||||||||||||
| Total | $ | 117,682 | $ | 19,775 | $ | 10,311 | $ | 84,616 | $ | 232,384 | |||||||||
We also have other liabilities of $21.8 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.
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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; |
| • | valuations of excess and obsolete inventory; |
| • | the lives and recoverability of equipment and other long-lived assets; |
| • | the valuation of goodwill; |
| • | restructuring, reorganization, relocation and severance costs; |
| • | tax valuation allowances and unrecognized tax benefits; |
| • | 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.
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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.
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 $6.3 million, $4.8 million and $2.7 million, respectively, in 2014, 2013 and 2012. Provision for service spare parts inventory valuation adjustment total $10.0 million, $8.6 million and $6.6 million, respectively, in 2014, 2013 and 2012.
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.
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 2014. No impairments related to our equipment or other long-lived assets were recognized during 2013 or 2012.
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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. We evaluate impairment using the guidance in 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 2014, 2013 and 2012.
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 additional information.
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. 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.
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.
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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.
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 statements of operations and financial position. The major foreign currencies in which we experience periodic fluctuations are the euro, the Czech koruna, and the Japanese yen. For the last three years 68%, 72% and 67% of our sales occurred outside the U.S. and Canada in 2014, 2013 and 2012, 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.
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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 average exchange rates during the period. The resulting translation adjustments decreased shareholders’ equity and comprehensive income in 2014 by $71.4 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 $96.3 million as of December 31, 2014. Holding other variables constant, if the U.S. dollar strengthened by 10% against all currencies that we translate, shareholders’ equity would decrease by approximately $86.0 million as of December 31, 2014.
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, 2014, the aggregate notional amount of our outstanding derivative contracts designated as cash flow hedges was $222.0 million. These contracts have varying maturities through the second quarter of 2016. The aggregate notional amount of our outstanding balance sheet-related derivative contracts at December 31, 2014 was $153.5 million, which contracts have varying maturities through the second quarter of 2016. 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, 2014 would increase by approximately $14.8 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 non-functional 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 foreign currency gain or loss from the hedged balance sheet position. Foreign currency losses recorded in other expense, inclusive of the impact of derivatives, totaled $1.8 million, $2.8 million and $5.7 million, respectively, in 2014, 2013 and 2012.
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 may extend, generally, up to 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 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 $7.9 million in 2014 in cost of sales related to hedge results, compared to realized losses of $0.8 million in 2013 and losses of $2.5 million in 2012. As of December 31, 2014, $2.4 million of 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 eighteen months as a result of the underlying hedged transactions also being recorded in net income. 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. We recorded in other income a $0.3 million loss in 2014, a $0.1 million loss in 2013, and an insignificant gain in 2012 as a result of hedge ineffectiveness.
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, 2014, 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.
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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, 2014, we held cash and cash equivalents of $300.5 million and short-term restricted cash of $15.7 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 $3.0 million assuming our cash and cash equivalent balances at December 31, 2014 remained constant and were earning at least 1% per annum, which, at December 31, 2014, 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, 2014, we held short-term fixed rate investments of $61.7 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 $0.6 million assuming our investment balances at December 31, 2014 remained constant and were earning at least 1% per annum, which, at December 31, 2014, 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, 2014 is as follows:
2014 (In thousands, except per share data) | 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||
| Net sales | $ | 226,264 | $ | 236,955 | $ | 227,756 | $ | 265,305 | |||||||
| Cost of sales | 119,940 | 127,104 | 119,175 | 141,906 | |||||||||||
| Gross profit | 106,324 | 109,851 | 108,581 | 123,399 | |||||||||||
Total operating expenses(1) | 75,439 | 79,036 | 82,474 | 81,805 | |||||||||||
| Operating income | 30,885 | 30,815 | 26,107 | 41,594 | |||||||||||
| Other expense, net | (270 | ) | (806 | ) | (831 | ) | (564 | ) | |||||||
| Income before income taxes | 30,615 | 30,009 | 25,276 | 41,030 | |||||||||||
| Income tax expense | 5,537 | 5,061 | 3,629 | 7,639 | |||||||||||
| Net income | $ | 25,078 | $ | 24,948 | $ | 21,647 | $ | 33,391 | |||||||
| Basic net income per share | $ | 0.59 | $ | 0.59 | $ | 0.52 | $ | 0.80 | |||||||
| Diluted net income per share | $ | 0.59 | $ | 0.59 | $ | 0.51 | $ | 0.79 | |||||||
| Shares used in basic per share calculation | 42,191 | 42,080 | 41,891 | 41,726 | |||||||||||
| Shares used in diluted per share calculation | 42,772 | 42,627 | 42,465 | 42,221 | |||||||||||
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(2) | 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 (benefit) | 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 | |||||||||||
(1) | Operating expenses in the first, second, third and fourth quarters of 2014 included $1.3 million, $2.2 million, $7.7 million, and $7.2 million, respectively, of restructuring, reorganization, relocation and severance expense. |
(2) | 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. |
39
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, 2014 and 2013, 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, 2014. 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, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 31, 2014, 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, 2014, 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, 23, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Portland, Oregon
February 23, 2015
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FEI Company and Subsidiaries
Consolidated Balance Sheets
(In thousands)
| December 31, | |||||||
| 2014 | 2013 | ||||||
| Assets | |||||||
| Current Assets: | |||||||
| Cash and cash equivalents | $ | 300,507 | $ | 384,170 | |||
| Short-term investments in marketable securities | 61,688 | 108,191 | |||||
| Short-term restricted cash | 15,698 | 18,798 | |||||
| Receivables, net of allowances for doubtful accounts of $2,990 and $2,969 | 227,354 | 194,418 | |||||
| Inventories | 176,440 | 181,725 | |||||
| Deferred tax assets | 8,225 | 15,114 | |||||
| Other current assets | 35,503 | 28,324 | |||||
| Total current assets | 825,415 | 930,740 | |||||
| Non-current investments in marketable securities | 85,865 | 47,278 | |||||
| Long-term restricted cash | 38,369 | 32,718 | |||||
| Property, plant and equipment, net of accumulated depreciation of $132,807 and $125,405 | 163,794 | 157,829 | |||||
| Intangible assets, net of accumulated amortization of $28,930 and $19,385 | 54,111 | 47,197 | |||||
| Goodwill | 170,773 | 136,152 | |||||
| Deferred tax assets | 6,605 | 1,751 | |||||
| Non-current inventories | 50,731 | 62,104 | |||||
| Other assets, net | 22,155 | 10,315 | |||||
| Total Assets | $ | 1,417,818 | $ | 1,426,084 | |||
| Liabilities and Shareholders’ Equity | |||||||
| Current Liabilities: | |||||||
| Accounts payable | $ | 78,308 | $ | 73,247 | |||
| Accrued payroll liabilities | 38,599 | 45,146 | |||||
| Accrued warranty reserves | 13,005 | 12,705 | |||||
| Short-term deferred revenue | 96,924 | 91,563 | |||||
| Income taxes payable | 5,299 | 4,579 | |||||
| Accrued restructuring, reorganization, relocation and severance | 9,161 | 50 | |||||
| Other current liabilities | 56,146 | 46,324 | |||||
| Total current liabilities | 297,442 | 273,614 | |||||
| Long-term deferred revenue | 34,021 | 30,744 | |||||
| Deferred tax liabilities | 9,576 | 8,931 | |||||
| Other liabilities | 35,454 | 35,227 | |||||
| Commitments and contingencies | |||||||
| Shareholders’ Equity: | |||||||
| Preferred stock - 500 shares authorized; none issued and outstanding | — | — | |||||
| Common stock - 70,000 shares authorized; 41,797 and 42,136 shares issued and outstanding, no par value | 607,250 | 637,482 | |||||
| Retained earnings | 461,586 | 392,958 | |||||
| Accumulated other comprehensive (loss) income | (27,511 | ) | 47,128 | ||||
| Total Shareholders’ Equity | 1,041,325 | 1,077,568 | |||||
| Total Liabilities and Shareholders’ Equity | $ | 1,417,818 | $ | 1,426,084 | |||
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Net sales: | |||||||||||
| Products | $ | 722,666 | $ | 709,438 | $ | 691,496 | |||||
| Service | 233,614 | 218,016 | 200,242 | ||||||||
| Total net sales | 956,280 | 927,454 | 891,738 | ||||||||
| Cost of sales: | |||||||||||
| Products | 369,043 | 352,630 | 347,224 | ||||||||
| Service | 139,082 | 136,039 | 128,884 | ||||||||
| Total cost of sales | 508,125 | 488,669 | 476,108 | ||||||||
| Gross profit | 448,155 | 438,785 | 415,630 | ||||||||
| Operating expenses: | |||||||||||
| Research and development | 102,613 | 101,947 | 94,965 | ||||||||
| Selling, general and administrative | 197,682 | 179,560 | 169,719 | ||||||||
| Restructuring, reorganization, relocation and severance | 18,459 | 1,090 | 2,859 | ||||||||
| Total operating expenses | 318,754 | 282,597 | 267,543 | ||||||||
| Operating income | 129,401 | 156,188 | 148,087 | ||||||||
| Other expense: | |||||||||||
| Interest income | 897 | 428 | 1,606 | ||||||||
| Interest expense | (600 | ) | (1,890 | ) | (4,098 | ) | |||||
| Other, net | (2,768 | ) | (3,124 | ) | (5,047 | ) | |||||
| Total other expense, net | (2,471 | ) | (4,586 | ) | (7,539 | ) | |||||
| Income before income taxes | 126,930 | 151,602 | 140,548 | ||||||||
| Income tax expense | 21,866 | 24,929 | 25,628 | ||||||||
| Net income | $ | 105,064 | $ | 126,673 | $ | 114,920 | |||||
| Basic net income per share | $ | 2.50 | $ | 3.13 | $ | 3.02 | |||||
| Diluted net income per share | $ | 2.47 | $ | 3.01 | $ | 2.80 | |||||
| Cash dividends declared per share | $ | 0.87 | $ | 0.44 | $ | 0.24 | |||||
| Shares used in per share calculations: | |||||||||||
| Basic | 41,969 | 40,446 | 38,065 | ||||||||
| Diluted | 42,528 | 42,395 | 41,728 | ||||||||
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Net income | $ | 105,064 | $ | 126,673 | $ | 114,920 | |||||
| Other comprehensive income, net of taxes: | |||||||||||
| Change in cumulative translation adjustment | (71,406 | ) | 9,975 | 9,922 | |||||||
| Change in unrealized loss on available-for-sale securities | (27 | ) | (15 | ) | (14 | ) | |||||
| Change in minimum pension liability | (246 | ) | 267 | (796 | ) | ||||||
| Changes due to cash flow hedging instruments: | |||||||||||
| Net (loss) gain on hedge instruments | (11,050 | ) | (2,492 | ) | 2,487 | ||||||
| Reclassification to net income of previously deferred losses related to hedge derivatives instruments | 8,090 | 837 | 2,502 | ||||||||
| Comprehensive income | $ | 30,425 | $ | 135,245 | $ | 129,021 | |||||
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, 2014, 2013 and 2012
(In thousands)
| Common Stock | Retained Earnings | Accumulated Other Comprehensive Income | Total Shareholders’ Equity | |||||||||||||||
| Shares | Amount | |||||||||||||||||
| 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 gain 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 | |||||||||||||
| Net income | — | — | 105,064 | — | 105,064 | |||||||||||||
| Employee purchases of common stock through employee share purchase plan | 139 | 9,862 | — | — | 9,862 | |||||||||||||
| Restricted shares issued and stock options exercised related to employee stock-based compensation plans | 433 | 4,736 | — | — | 4,736 | |||||||||||||
| Stock-based compensation expense | — | 23,132 | — | — | 23,132 | |||||||||||||
| Restricted stock unit taxes for net share settlement | (116 | ) | (9,965 | ) | — | — | (9,965 | ) | ||||||||||
| Repurchase of common stock | (795 | ) | (62,523 | ) | — | — | (62,523 | ) | ||||||||||
| Tax benefit of non-qualified stock option exercises and restricted stock unit vests | — | 4,526 | — | — | 4,526 | |||||||||||||
| Translation adjustment | — | — | — | (71,406 | ) | (71,406 | ) | |||||||||||
| Unrealized loss on available for sale securities | — | — | — | (27 | ) | (27 | ) | |||||||||||
| Dividends declared on common stock ($0.87 per share) | — | — | (36,436 | ) | — | (36,436 | ) | |||||||||||
| Minimum pension liability, net of taxes | — | — | — | (246 | ) | (246 | ) | |||||||||||
| Net adjustment for fair value of hedge derivatives | — | — | — | (2,960 | ) | (2,960 | ) | |||||||||||
| Balance at December 31, 2014 | 41,797 | $ | 607,250 | $ | 461,586 | $ | (27,511 | ) | $ | 1,041,325 | ||||||||
See accompanying Notes to the Consolidated Financial Statements.
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FEI Company and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | 105,064 | $ | 126,673 | $ | 114,920 | |||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation | 29,042 | 23,693 | 22,814 | ||||||||
| Amortization | 14,290 | 10,568 | 5,852 | ||||||||
| Stock-based compensation | 23,132 | 18,327 | 14,154 | ||||||||
| Asset impairments, write-offs of intangible assets and other | 1,457 | 27 | 9 | ||||||||
| Income taxes (receivable) payable, net | (5,336 | ) | 13,066 | (3,979 | ) | ||||||
| Deferred income taxes | 2,615 | (6,743 | ) | 2,350 | |||||||
| Decrease (increase), net of acquisitions, in: | |||||||||||
| Receivables | (41,526 | ) | 12,982 | (22,077 | ) | ||||||
| Inventories | (23,376 | ) | 1,486 | (24,309 | ) | ||||||
| Other assets | (1,809 | ) | 3,781 | (2,949 | ) | ||||||
| Increase (decrease), net of acquisitions, in: | |||||||||||
| Accounts payable | 11,794 | 18,553 | 397 | ||||||||
| Accrued payroll liabilities | (4,310 | ) | 5,429 | (12,685 | ) | ||||||
| Accrued warranty reserves | 835 | 660 | 176 | ||||||||
| Deferred revenue | 18,584 | 19,181 | (18 | ) | |||||||
| Accrued restructuring, reorganization, relocation and severance | 9,969 | (2,628 | ) | 397 | |||||||
| Other liabilities | 2,484 | (7,107 | ) | (10,098 | ) | ||||||
| Net cash provided by operating activities | 142,909 | 237,948 | 84,954 | ||||||||
| Cash flows from investing activities: | |||||||||||
| (Increase) decrease in restricted cash | (8,766 | ) | (7,894 | ) | 25,083 | ||||||
| Acquisition of property, plant and equipment | (49,481 | ) | (62,414 | ) | (22,111 | ) | |||||
| Payments for acquisitions, net of cash acquired | (65,049 | ) | (2,694 | ) | (93,368 | ) | |||||
| Purchase of investments in marketable securities | (227,256 | ) | (227,119 | ) | (173,908 | ) | |||||
| Redemption of investments in marketable securities | 235,054 | 180,332 | 134,478 | ||||||||
| Other investing activities | (1,317 | ) | (2,710 | ) | (10,874 | ) | |||||
| Net cash used in investing activities | (116,815 | ) | (122,499 | ) | (140,700 | ) | |||||
| Cash flows from financing activities: | |||||||||||
| Dividends paid on common stock | (31,062 | ) | (16,191 | ) | (6,095 | ) | |||||
| Redemption of 2.875% convertible note | — | (73 | ) | — | |||||||
| Withholding taxes paid on issuance of vested restricted stock units | (9,969 | ) | (9,658 | ) | (5,913 | ) | |||||
| Proceeds from exercise of stock options and employee stock purchases | 14,771 | 16,545 | 13,131 | ||||||||
| Excess tax benefit for share based payment arrangements | 4,381 | 6,010 | 2,873 | ||||||||
| Repurchases of common stock | (62,523 | ) | — | (891 | ) | ||||||
| Other financing activities | — | — | (1,869 | ) | |||||||
| Net cash (used in) provided by financing activities | (84,402 | ) | (3,367 | ) | 1,236 | ||||||
| Effect of exchange rate changes | (25,355 | ) | 5,786 | 451 | |||||||
| (Decrease) increase in cash and cash equivalents | (83,663 | ) | 117,868 | (54,059 | ) | ||||||
| Cash and cash equivalents: | |||||||||||
| Beginning of period | 384,170 | 266,302 | 320,361 | ||||||||
| End of period | $ | 300,507 | $ | 384,170 | $ | 266,302 | |||||
| Supplemental Cash Flow Information: | |||||||||||
| Cash paid for income taxes, net | $ | 16,983 | $ | 10,917 | $ | 23,802 | |||||
| Cash paid for interest | 326 | 1,322 | 3,559 | ||||||||
| Increase in fixed assets related to transfers with inventories | 2,914 | 11,091 | 21,239 | ||||||||
| Dividends declared but not paid | 10,385 | 5,011 | 3,046 | ||||||||
| Conversion of 2.875% convertible notes | — | 88,937 | — | ||||||||
| Accrued purchases of plant and equipment | 700 | 1,014 | 1,120 | ||||||||
See accompanying Notes to the Consolidated Financial Statements.
45
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 and related services 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 (“TEMs”); scanning electron microscopes (“SEMs”); DualBeamTM systems which combine a SEM and a focused ion beam system (“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”).
Our significant research and development and manufacturing operations are located in Hillsboro, Oregon; Eindhoven, The Netherlands; and Brno, Czech Republic; and our software development is managed principally from Bordeaux, France. 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; |
| • | valuations of excess and obsolete inventory; |
| • | the lives and recoverability of equipment and other long-lived assets; |
| • | the valuation of goodwill; |
| • | restructuring, reorganization, relocation and severance costs; |
| • | tax valuation allowances and unrecognized tax benefits; |
| • | stock-based compensation; and |
| • | accounting for derivatives. |
It is reasonably possible that management's estimates may change in the future.
Reclassifications
Certain reclassifications to prior year consolidated financial statements have been made to conform to current period presentation. These reclassifications had no effect on our consolidated statements of operations.
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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, Schneeberger AG, Prodrive Technologies and AZD Praha s.r.o. 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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Balance, beginning of period | $ | 2,969 | $ | 2,718 | $ | 5,553 | |||||
| Expense (reversal) | 402 | 473 | (154 | ) | |||||||
| Write-offs | (85 | ) | (263 | ) | (2,732 | ) | |||||
| Translation adjustments | (296 | ) | 41 | 51 | |||||||
| Balance, end of period | $ | 2,990 | $ | 2,969 | $ | 2,718 | |||||
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.
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 $6.3 million, $4.8 million and $2.7 million, respectively, in 2014, 2013 and 2012. Provision for service spare parts inventory valuation adjustment total $10.0 million, $8.6 million and $6.6 million, respectively, in 2014, 2013 and 2012.
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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 included in Part II, Item 8 of this Annual Report on Form 10-K 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 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 goods sold.
Other fixed assets include computer software and hardware, automobiles and furniture 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 goods sold.
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 included in Part II, Item 8 of this Annual Report on Form 10-K for additional information on impairments recognized in 2014. 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. We evaluate impairment using the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Update ("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 2014, 2013 and 2012.
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 additional information.
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.
50
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 the FASB Accounting Standards Codification (“ASC”) 605-25, Revenue Recognition. 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.
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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 2014, 2013 and 2012, we received subsidies of $4.5 million, $5.3 million and $7.3 million, respectively, from European governments for technological developments primarily for semiconductor and life sciences equipment.
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 $3.4 million, $4.1 million and $3.9 million in 2014, 2013 and 2012, 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. 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.
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 functional currency. These accounting records are translated at exchange rates that fluctuate up or down from period to period and consequently affect our consolidated statements 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.
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| NOTE 2. | NEW ACCOUNTING PRONOUNCEMENTS |
ASU 2014-15
On August 27, 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. The update provides US GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in this update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. We will evaluate the going concern considerations in this ASU, however, at the current period, management does not believe that it has met conditions which would subject these consolidated financial statements for additional disclosure.
ASU 2014-09
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard will become effective for us on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
| 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 December 31, | ||||||||||||||||||||||||||||||||
| 2014 | 2013 | 2012 | ||||||||||||||||||||||||||||||
Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | Net Income | Shares | Per Share Amount | ||||||||||||||||||||||||
| Basic EPS | $ | 105,064 | 41,969 | $ | 2.50 | $ | 126,673 | 40,446 | $ | 3.13 | $ | 114,920 | 38,065 | $ | 3.02 | |||||||||||||||||
| Dilutive effect of 2.875% convertible debt | — | — | — | 780 | 1,287 | (0.08 | ) | 1,819 | 3,033 | (0.18 | ) | |||||||||||||||||||||
| Dilutive effect of stock options, restricted stock units, and shares issuable to Philips | — | 559 | (0.03 | ) | — | 662 | (0.04 | ) | — | 630 | (0.04 | ) | ||||||||||||||||||||
| Diluted EPS | $ | 105,064 | 42,528 | $ | 2.47 | $ | 127,453 | 42,395 | $ | 3.01 | $ | 116,739 | 41,728 | $ | 2.80 | |||||||||||||||||
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 December 31, | ||||||||
| 2014 | 2013 | 2012 | ||||||
| Stock options | 271 | 142 | 279 | |||||
| Restricted stock units | 6 | 33 | 59 | |||||
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| NOTE 4. | CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT |
The following tables illustrate 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 our consolidated statements of operations by component (net of tax, in thousands):
| Year Ended December 31, 2014 | |||||||||||||||||||
| 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 | $ | 48,865 | $ | (11 | ) | $ | (552 | ) | $ | (1,174 | ) | $ | 47,128 | ||||||
| Other comprehensive income before reclassifications | (71,406 | ) | (27 | ) | (246 | ) | (11,050 | ) | (82,729 | ) | |||||||||
| Amounts reclassified from AOCI to: | |||||||||||||||||||
| Revenue | — | — | — | (176 | ) | (176 | ) | ||||||||||||
| Cost of goods sold | — | — | — | 7,930 | 7,930 | ||||||||||||||
| Other income (expense) | — | — | — | 336 | 336 | ||||||||||||||
| Total reclassifications out of AOCI | — | — | — | 8,090 | 8,090 | ||||||||||||||
| Net current period other comprehensive income | (71,406 | ) | (27 | ) | (246 | ) | (2,960 | ) | (74,639 | ) | |||||||||
| Ending balance | $ | (22,541 | ) | $ | (38 | ) | $ | (798 | ) | $ | (4,134 | ) | $ | (27,511 | ) | ||||
| 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 | ||||||
| NOTE 5. | FACTORING OF ACCOUNTS RECEIVABLE |
In 2014 and 2013, we entered into agreements under which we sold a total of $7.8 million and $9.9 million, respectively, 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.
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| NOTE 6. | INVENTORIES |
Inventories consisted of the following (in thousands):
| December 31, | |||||||
| 2014 | 2013 | ||||||
| Raw materials and assembled parts | $ | 61,644 | $ | 61,235 | |||
| Service inventories, estimated current requirements | 12,398 | 15,197 | |||||
| Work-in-process | 76,402 | 75,883 | |||||
| Finished goods | 25,996 | 29,410 | |||||
| Total current inventories | $ | 176,440 | $ | 181,725 | |||
| Non-current inventories | $ | 50,731 | $ | 62,104 | |||
| NOTE 7. | INVESTMENTS |
Investments held consisted of the following (in thousands):
| December 31, 2014 | |||||||||||||||
Amortized cost | Unrealized gains | Unrealized losses | Estimated fair value | ||||||||||||
| Available for sale marketable securities: | |||||||||||||||
| U.S. treasury notes | $ | 17,609 | $ | 1 | $ | (2 | ) | $ | 17,608 | ||||||
Agency bonds(1) | 52,014 | — | (63 | ) | 51,951 | ||||||||||
| Commercial paper | 13,500 | — | — | 13,500 | |||||||||||
| Certificates of deposit | 19,122 | — | — | 19,122 | |||||||||||
| Municipal bonds | 27,112 | 10 | (3 | ) | 27,119 | ||||||||||
| Corporate bond | 10,909 | 3 | (10 | ) | 10,902 | ||||||||||
| Total available for sale marketable securities | 140,266 | 14 | (78 | ) | 140,202 | ||||||||||
| Trading Securities: | |||||||||||||||
| Equity securities - mutual funds | 7,351 | — | — | 7,351 | |||||||||||
Cost Method Investments(2) | 608 | — | — | 608 | |||||||||||
| Total Investments | $ | 148,225 | $ | 14 | $ | (78 | ) | $ | 148,161 | ||||||
| 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 bonds | 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 | ||||||
(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. |
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Realized gains and losses on sales of marketable debt securities were insignificant in 2014, 2013 and 2012.
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, 2014 and 2013, we had $0.6 million in cost-method investments on our balance sheet. Refer to Note 22 in the Notes to the Consolidated Financial Statements for additional information.
Investments were included in the following captions on the balance sheet as follows (in thousands):
| December 31, 2014 | December 31, 2013 | ||||||||||||||||||||||||||||||
| 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 | $ | — | $ | 17,608 | $ | — | $ | 17,608 | $ | 10,128 | $ | — | $ | — | $ | 10,128 | |||||||||||||||
| Agency bonds | 9,996 | 41,955 | — | 51,951 | 10,995 | 26,966 | — | 37,961 | |||||||||||||||||||||||
| Commercial paper | 13,500 | — | — | 13,500 | 39,987 | — | — | 39,987 | |||||||||||||||||||||||
| Certificates of deposit | 5,750 | 13,372 | — | 19,122 | 5,802 | 1,984 | — | 7,786 | |||||||||||||||||||||||
| Municipal bonds | 25,407 | 1,712 | — | 27,119 | 41,279 | 8,040 | — | 49,319 | |||||||||||||||||||||||
| Corporate bonds | 7,035 | 3,867 | — | 10,902 | — | 5,001 | — | 5,001 | |||||||||||||||||||||||
| Total fixed maturity securities | 61,688 | 78,514 | — | 140,202 | 108,191 | 41,991 | — | 150,182 | |||||||||||||||||||||||
| Trading Securities: | |||||||||||||||||||||||||||||||
| Equity securities - mutual funds | — | 7,351 | — | 7,351 | — | 5,287 | — | 5,287 | |||||||||||||||||||||||
| Cost Method Investments | — | — | 608 | 608 | — | — | 608 | 608 | |||||||||||||||||||||||
| Total Investments | $ | 61,688 | $ | 85,865 | $ | 608 | $ | 148,161 | $ | 108,191 | $ | 47,278 | $ | 608 | $ | 156,077 | |||||||||||||||
Contractual maturities or expected liquidation dates of available-for-sale fixed maturity securities at December 31, 2014 were as follows (in thousands):
| Amortized Cost | Fair Value | ||||||
| Due in 1 year or less | $ | 61,679 | $ | 61,688 | |||
| Due in 1-5 years | 78,587 | 78,514 | |||||
| Total | $ | 140,266 | $ | 140,202 | |||
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| NOTE 8. | PROPERTY, PLANT AND EQUIPMENT |
Property, plant and equipment consisted of the following (in thousands):
| December 31, | |||||||
| 2014 | 2013 | ||||||
| Land | $ | 23,440 | $ | 25,535 | |||
| Buildings and improvements | 35,269 | 36,778 | |||||
| Leasehold improvements | 42,836 | 23,948 | |||||
| Machinery and equipment | 95,977 | 103,180 | |||||
| Demonstration systems | 47,693 | 44,700 | |||||
| Other fixed assets | 51,386 | 49,093 | |||||
| Gross property, plant and equipment | 296,601 | 283,234 | |||||
| Accumulated depreciation | (132,807 | ) | (125,405 | ) | |||
| Total property, plant and equipment, net | $ | 163,794 | $ | 157,829 | |||
| NOTE 9. | GOODWILL AND OTHER INTANGIBLE ASSETS |
Goodwill
The roll-forward of activity related to our goodwill was as follows (in thousands):
| Year Ended December 31, | |||||||
| 2014 | 2013 | ||||||
| Balance, beginning of period | $ | 136,152 | $ | 131,320 | |||
| Additions | 46,880 | 3,268 | |||||
| Goodwill adjustments | (12,259 | ) | 1,564 | ||||
| Balance, end of period | $ | 170,773 | $ | 136,152 | |||
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 minor adjustments made for the finalization of the purchase price allocations.
Acquisition of Lithicon AS
On February 5, 2014 we acquired 100% of the outstanding shares of Lithicon AS (“Lithicon”), which has operations in Norway and 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, plus an adjustment for the change in final closing accounts of $0.4 million. We paid $0.4 million in transaction costs which were expensed as incurred within the selling, general and administrative expense line of our consolidated statements of operations. The total purchase price was allocated to the net tangible and intangible assets acquired based on their preliminary fair values as of February 5, 2014. The fair value of net tangible assets acquired was $7.7 million and the fair value of net intangible assets acquired was $22.0 million, which consisted of $18.6 million in developed technology, $2.2 million of customer relationships and $1.2 million of purchased backlog. Including an increase to net deferred tax liabilities of $8.1 million, the excess of the purchase price over the fair value of the net assets acquired was $46.9 million, which was recorded as goodwill in the Industry Group. In 2014, the acquired business contributed $6.9 million of revenue and a net loss of $5.0 million to our consolidated financial results.
The goodwill arising from the acquisition of Lithicon is primarily related to expected future cash flows from expansion of our product offerings in the oil and gas market to include digital rock services, as well as synergies from the introduction of the microCT product to the existing FEI product suite.
The acquired developed technology, customer relationships and purchased backlog will be amortized over a period of 10 years, 5 years and 2 years, respectively.
No pro forma financial information has been provided for this acquisition as it is insignificant.
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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.
Other Intangible Assets
Patents, trademarks and other are amortized using the straight-line method over their estimated useful lives of 2 to 10 years. Customer relationships are amortized using the straight-line method over their estimated useful lives of 5 to 10 years. Developed technology is amortized using 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 2014, we determined that the carrying value of one of our trademarks was not recoverable as we no longer intend to use the trademark. As a result, we recorded an impairment charge of $0.3 million to write-off the remaining net book value of the trademark within the selling, general and administrative expense line of our consolidated statements of operations. Additionally, as a result of the implementation of our second quarter realignment plan in 2014, we also recorded impairment charges of $0.6 million related to the write-down of developed technology that we do not intend to use after 2014. These costs are also recorded within the selling, general and administrative expense line of our consolidated statements of operations. Both impairment losses are reported under the Industry Group. There were no impairment charges recorded during 2013 or 2012.
For information regarding the second quarter realignment plan, 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.
The gross amount of our other intangible assets and the related accumulated amortization were as follows (in thousands):
| December 31, | |||||||
| 2014 | 2013 | ||||||
| Patents, trademarks and other | $ | 25,333 | $ | 24,327 | |||
| Accumulated amortization | (12,805 | ) | (9,296 | ) | |||
| Net patents, trademarks and other | 12,528 | 15,031 | |||||
| Customer relationships | 21,739 | 21,650 | |||||
| Accumulated amortization | (5,863 | ) | (3,547 | ) | |||
| Net customer relationships | 15,876 | 18,103 | |||||
| Developed technology | 33,525 | 18,161 | |||||
| Accumulated amortization | (7,818 | ) | (4,098 | ) | |||
| Net developed technology | 25,707 | 14,063 | |||||
| Note issuance costs | 2,445 | 2,445 | |||||
| Accumulated amortization | (2,445 | ) | (2,445 | ) | |||
| Net note issuance costs | — | — | |||||
| Total intangible assets included in other long-term assets | $ | 54,111 | $ | 47,197 | |||
Amortization expense was as follows (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Patents, trademarks and other | $ | 5,965 | $ | 3,553 | $ | 1,993 | |||||
| Customer relationships | 2,317 | 2,376 | 1,168 | ||||||||
| Developed technology | 3,720 | 2,327 | 1,716 | ||||||||
| Note issuance costs | — | 146 | 350 | ||||||||
| Total amortization expense | $ | 12,002 | $ | 8,402 | $ | 5,227 | |||||
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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 | ||||||||||||
| 2015 | $ | 3,572 | $ | 2,619 | $ | 3,804 | $ | 9,995 | |||||||
| 2016 | 2,882 | 2,619 | 3,804 | 9,305 | |||||||||||
| 2017 | 2,406 | 2,272 | 3,557 | 8,235 | |||||||||||
| 2018 | 1,588 | 2,198 | 3,093 | 6,879 | |||||||||||
| 2019 | 1,279 | 1,756 | 2,496 | 5,531 | |||||||||||
| Thereafter | 801 | 4,412 | 8,953 | 14,166 | |||||||||||
| Total future amortization expense | $ | 12,528 | $ | 15,876 | $ | 25,707 | $ | 54,111 | |||||||
| 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 Administrative Agent (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.
On July 3, 2014, we entered into the Third Amendment to Credit Agreement (the “Third Amendment”) with the Agent, various lenders (the “Lenders”) and certain other parties. Among other things, the Third Amendment amended the Credit Agreement to increase the permitted amount of restricted payments, subject to certain conditions and certain technical amendments.
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 LIBOR 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 1.50% and 2.50%, 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.
As of December 31, 2014, 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.
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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, 2014 | |||
| Guarantees and letters of credit outstanding | $ | 54,897 | |
| Amount secured by restricted cash deposits: | |||
| Current | $ | 15,698 | |
| Long-term | 38,369 | ||
| Total secured by restricted cash | $ | 54,067 | |
| NOTE 11. | WARRANTY RESERVES |
The following is a summary of warranty reserve activity (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Balance, beginning of period | $ | 12,705 | $ | 12,049 | $ | 11,683 | |||||
| Reductions for warranty costs incurred | (14,051 | ) | (13,058 | ) | (11,958 | ) | |||||
| Warranties issued | 14,846 | 13,677 | 12,302 | ||||||||
| Translation and changes in estimates | (495 | ) | 37 | 22 | |||||||
| Balance, end of period | $ | 13,005 | $ | 12,705 | $ | 12,049 | |||||
| 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 | |||||||||
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.
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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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| U.S. | $ | 27,832 | $ | 32,549 | $ | 26,640 | |||||
| Foreign | 99,098 | 119,053 | 113,908 | ||||||||
| Total | $ | 126,930 | $ | 151,602 | $ | 140,548 | |||||
Income tax expense consisted of the following (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Current: | |||||||||||
| Federal | $ | 3,088 | $ | (851 | ) | $ | 8,173 | ||||
| State | 861 | 419 | 475 | ||||||||
| Foreign | 11,127 | 16,513 | 13,870 | ||||||||
| Total current income tax expense | 15,076 | 16,081 | 22,518 | ||||||||
| U.S. deferred expense (benefit) | 7,174 | 12,645 | 4,285 | ||||||||
| Foreign deferred benefit | (384 | ) | (3,797 | ) | (1,175 | ) | |||||
| Income tax expense | $ | 21,866 | $ | 24,929 | $ | 25,628 | |||||
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Tax expense at U.S. federal statutory rates | $ | 44,425 | $ | 53,061 | $ | 49,192 | |||||
| Increase (decrease) resulting from: | |||||||||||
| State income taxes, net of federal benefit | 861 | 857 | 1,126 | ||||||||
| Foreign tax benefit | (22,307 | ) | (25,263 | ) | (26,181 | ) | |||||
| Research and experimentation benefit | (2,785 | ) | (5,966 | ) | (758 | ) | |||||
| Foreign tax credit benefit | (1,490 | ) | (2,152 | ) | (2,738 | ) | |||||
| Tax audit settlements and lapses of statutes of limitations | (2,869 | ) | (70 | ) | (439 | ) | |||||
| Stock compensation | 2,940 | 2,658 | 2,134 | ||||||||
| Non-deductible items | 3,524 | 2,132 | 3,100 | ||||||||
| Release of valuation allowance | (454 | ) | — | — | |||||||
| Other | 21 | (328 | ) | 192 | |||||||
| Income tax expense | $ | 21,866 | $ | 24,929 | $ | 25,628 | |||||
Our 2014 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 due to the lapse of statutes of limitation and the effective settlement of positions taken on prior year returns.
Current taxes payable were reduced for excess tax benefits recorded to common stock and related to stock compensation of $4.5 million, $6.4 million and $3.1 million, respectively, in 2014, 2013 and 2012.
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Deferred Income Taxes
Net deferred tax assets were classified on the balance sheet as follows (in thousands):
| December 31, | |||||||
| 2014 | 2013 | ||||||
| Deferred tax assets – current | $ | 8,225 | $ | 15,114 | |||
| Deferred tax assets – non-current | 6,605 | 1,751 | |||||
| Deferred tax liabilities – current | (218 | ) | (9 | ) | |||
| Deferred tax liabilities – non-current | (9,576 | ) | (8,931 | ) | |||
| Net deferred tax assets | $ | 5,036 | $ | 7,925 | |||
| Valuation allowance | $ | 4,350 | $ | 2,723 | |||
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, | |||||||
| 2014 | 2013 | ||||||
| Deferred tax assets: | |||||||
| Accrued liabilities and reserves | $ | 14,941 | $ | 15,804 | |||
| Revenue recognition | — | 340 | |||||
| Tax credit and loss carryforwards | 7,437 | 8,063 | |||||
| Fixed assets and intangibles | — | 546 | |||||
| Unrealized losses | 2,219 | 765 | |||||
| Stock compensation | 3,278 | 2,151 | |||||
| Other assets | 4,775 | 1,501 | |||||
| Gross deferred tax assets | 32,650 | 29,170 | |||||
| Valuation allowance | (4,350 | ) | (2,723 | ) | |||
| Net deferred tax assets | 28,300 | 26,447 | |||||
| Deferred tax liabilities: | |||||||
| Fixed assets and intangibles | (18,004 | ) | (17,965 | ) | |||
| Revenue recognition | (2,800 | ) | (19 | ) | |||
| Other liabilities | (2,460 | ) | (538 | ) | |||
| Total deferred tax liabilities | (23,264 | ) | (18,522 | ) | |||
| Net deferred tax assets | $ | 5,036 | $ | 7,925 | |||
Deferred tax benefit of $2.6 million, $1.1 million and $3.0 million was recorded in other comprehensive income in 2014, 2013 and 2012, respectively.
As of December 31, 2014 and 2013, our valuation allowance on deferred tax assets totaled $4.4 million and $2.7 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.
Foreign net operating loss carryforwards as of December 31, 2014 were $20.7 million and do not expire.
State research and development tax credit carryforwards as of December 31, 2014 were $1.2 million and expire between 2015 and 2019.
During 2014, we placed in service fixed assets at our new facility in Brno which qualified for approximately $3.6 million of investment tax credits. We have elected to apply the deferral method of accounting for these credits and have reduced the depreciable basis in the related fixed assets. The credits can be used to offset future taxes payable over a fixed base amount each year, and have been classified on the balance sheet as a component of other assets, net as of December 31, 2014.
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As of December 31, 2014, U.S. income taxes have not been provided for approximately $381.9 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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Unrecognized tax benefits, beginning of period | $ | 23,966 | $ | 25,135 | $ | 16,041 | |||||
| Increases for tax positions taken in current period | — | 1,197 | — | ||||||||
| Increases for tax positions taken in prior periods | 2,081 | 1,701 | 9,965 | ||||||||
| Decreases for tax positions taken in prior periods | (1,419 | ) | (3,997 | ) | (620 | ) | |||||
| Decreases for lapses in statutes of limitations | (2,869 | ) | (70 | ) | (251 | ) | |||||
| Unrecognized tax benefits, end of period | $ | 21,759 | $ | 23,966 | $ | 25,135 | |||||
During 2014, we reduced unrecognized tax benefits by $2.9 million due to a lapse in a US statute of limitation. We also effectively settled matters with tax authorities in certain foreign jurisdictions in which we operate. The result of effective settlements was a reduction of $1.2 million of unrecognized tax benefits. 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, 2014 and 2013 of $21.8 million and $23.8 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 $6.5 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 $3.1 million and $3.7 million as of December 31, 2014 and 2013, respectively.
Tax expense included the following relating to interest and penalties (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Benefit for lapses of statutes of limitations and settlement with taxing authorities | $ | (202 | ) | $ | (24 | ) | $ | (88 | ) | ||
| (Benefit) Accruals for current and prior periods | (405 | ) | 1,698 | 652 | |||||||
| Total interest and penalties | $ | (607 | ) | $ | 1,674 | $ | 564 | ||||
For our major tax jurisdictions, the following years were open for examination by the tax authorities as of December 31, 2014:
| Jurisdiction | Open Tax Years | |
| U.S. | 2011 and forward | |
| The Netherlands | 2011 and forward | |
| Czech Republic | 2012 and forward | |
| NOTE 14. | RESTRUCTURING, REORGANIZATION, RELOCATION AND SEVERANCE |
Second Quarter 2014 Realignment
During the second quarter of 2014, we implemented a resource realignment plan aimed at improving our operational efficiency by eliminating redundancies in sites and personnel resulting from recent acquisitions and expansion activities. We shifted our resources to growing regions, such as Asia, and potential growth markets, such as structural biology, oil and gas, near-line semiconductor processing and metals research, in order to better position us to pursue our growth strategy. The realignment plan activities included the consolidation of our three Australia sites in Canberra; the closure of our facility in Delmont, Pennsylvania and relocation of those operations to our new facility in the Czech Republic; relocation of our Japan demonstration facility to our
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Shanghai facility; selective reductions in staffing, relocations and compensation adjustments related to the foregoing activities and other realignment of management resources. Savings from the realignment plan are expected to be approximately $10.0 million on an annual basis.
The following table summarizes the costs incurred under our second quarter realignment plan:
| Year Ended | |||
| Realignment Costs | December 31, 2014 | ||
| Inventory write-offs | $ | 1,627 | |
| Acceleration of acquisition-related earn-out | 2,500 | ||
| Impairment and other asset write-offs | 3,973 | ||
| Restructuring activities | 17,128 | ||
| Total | $ | 25,228 | |
These costs have been recorded in our consolidated statements of operations as follows:
| Year Ended | |||
| Statement of Operations Classification | December 31, 2014 | ||
| Cost of sales | $ | 1,627 | |
| Selling, general and administrative | 6,473 | ||
| Restructuring, reorganization and relocation | 17,128 | ||
| Total | $ | 25,228 | |
First Quarter 2014 Restructuring
During the first quarter of 2014, we engaged in a restructuring plan principally aimed at consolidating our sales force in Europe. The $1.3 million cost incurred in implementing the restructuring plan primarily consisted of severance and other employee termination related costs, and was incurred during the first quarter of 2014. We do not expect to incur any additional costs under this plan. Savings from this plan are expected to be approximately $1.8 million on an annual basis.
Group Structure Reorganization
During the first quarter of 2013, we reorganized the company into a group structure in order to enable us to efficiently execute our growth strategy. The costs associated with the reorganization consisted primarily of severance costs and resulted in the termination of certain positions throughout the company. In anticipation of this reorganization, we incurred $2.9 million of costs during the fourth quarter of 2012, and recorded $1.1 million of severance costs during 2013, for a total cost of $4.0 million. We do not expect to incur any additional costs under this reorganization 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, 2014 | Second Quarter 2014 Realignment | First Quarter 2014 Restructuring | Group Structure Reorganization | Total | |||||||||||
| Beginning accrued liability | $ | — | $ | — | $ | 50 | $ | 50 | |||||||
| Charged to expense, net | 17,128 | 1,331 | — | 18,459 | |||||||||||
| Expenditures | (7,553 | ) | (1,327 | ) | (50 | ) | (8,930 | ) | |||||||
Write-offs and adjustments | (414 | ) | (4 | ) | — | (418 | ) | ||||||||
| Ending accrued liability | $ | 9,161 | $ | — | $ | — | $ | 9,161 | |||||||
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| Year Ended December 31, 2013 | Group Structure Organization | 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 | |||
| 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 $93.4 million at December 31, 2014. These commitments expire at various times through the first quarter of 2020.
| 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 2034. 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 $9.5 million in 2014, $7.4 million in 2013 and $8.5 million in 2012.
The approximate future minimum rental payments due under these agreements as of December 31, 2014, were as follows (in thousands):
| Minimum Rental Payment | |||
| 2015 | $ | 8,327 | |
| 2016 | 6,926 | ||
| 2017 | 5,831 | ||
| 2018 | 4,926 | ||
| 2019 | 4,027 | ||
| Thereafter | 41,800 | ||
| Total | $ | 71,837 | |
| 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.
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.
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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 2014, 2013 or 2012 to Philips under this agreement. As of December 31, 2014, 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 2014, we repurchased 795,321 shares for a total of $62.5 million, or an average of $78.61 per share. We did not repurchase any shares in 2013. During 2012, we repurchased 20,500 shares for a total of $0.9 million, or an average of $43.41 per share. As of December 31, 2014, 1,324,479 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 2014 Annual Meeting of Shareholders, which was held on May 8, 2014, 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 3,950,000 to 4,200,000.
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 139,696 shares were purchased pursuant to the ESPP during 2014 at a weighted average purchase price of $70.60 per share, which represented a weighted average discount of $12.46 per share compared to the fair market value of our common stock on the dates of purchase. At December 31, 2014, 1,021,872 shares of our common stock remained available for purchase and were reserved for issuance under the ESPP.
1995 Stock Incentive Plan
Also at our 2014 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 11,000,000 to 11,250,000.
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, 2014 | ||
| Shares available for grant | 1,916,974 | |
| Shares of common stock reserved for issuance | 3,301,988 | |
The following table sets forth certain information regarding all options outstanding and exercisable:
| December 31, 2014 | |||||||
| Options Outstanding | Options Exercisable | ||||||
| Number | 808,484 | 310,649 | |||||
| Weighted average exercise price | $ | 61.27 | $ | 44.52 | |||
| Aggregate intrinsic value | $ 23.6 million | $ 14.2 million | |||||
| Weighted average remaining contractual term | 4.9 years | 3.8 years | |||||
The following table sets forth certain information regarding all RSUs nonvested and expected to vest:
| December 31, 2014 | |||||||
| RSUs Nonvested | RSUs Expected to Vest | ||||||
| Number | 578,530 | 507,013 | |||||
| Weighted average grant date per share fair value | $ | 69.72 | $ | 69.03 | |||
| Aggregate intrinsic value | $ 52.1 million | $ 45.8 million | |||||
| Weighted average remaining term to vest | 1.5 years | 1.5 years | |||||
As of December 31, 2014, unrecognized stock-based compensation related to outstanding, but unvested stock options and RSUs was $42.8 million, which will be recognized over the weighted average remaining vesting period of 1.9 years.
Activity under these plans was as follows (share amounts in thousands):
| Year Ended December 31, 2014 | ||||||
| Shares Subject to Options | Weighted Average Exercise Price | |||||
| Balance, beginning of period | 752 | $ | 50.18 | |||
| Granted | 230 | 81.99 | ||||
| Forfeited | (31 | ) | 77.08 | |||
| Exercised | (143 | ) | 33.21 | |||
| Balance, end of period | 808 | 61.27 | ||||
| Year Ended December 31, 2014 | ||||||
| Restricted Stock Units | Weighted Average Grant Date Per Share Fair Value | |||||
| Balance, beginning of period | 737 | $ | 57.60 | |||
| Granted | 193 | 83.65 | ||||
| Forfeited | (61 | ) | 64.76 | |||
| Vested | (290 | ) | 49.44 | |||
| Balance, end of period | 579 | 69.72 | ||||
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Stock-Based Compensation Expense
Certain information regarding our stock-based compensation was as follows (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Weighted average grant-date fair value of stock options granted | $ | 18,856 | $ | 16,283 | $ | 12,279 | |||||
| Weighted average grant-date fair value of restricted stock units | 16,172 | 20,415 | 20,461 | ||||||||
| Total intrinsic value of stock options exercised | 8,730 | 13,169 | 6,293 | ||||||||
| Fair value of restricted stock units vested | 14,461 | 11,452 | 9,113 | ||||||||
| Cash received from stock options exercised and shares purchased under all stock-based arrangements | 14,771 | 16,545 | 13,131 | ||||||||
| Tax benefit realized for stock options | 4,526 | 6,495 | 3,137 | ||||||||
Our stock-based compensation expense was included in our consolidated statements of operations as follows (in thousands):
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Cost of sales | $ | 3,276 | $ | 2,427 | $ | 1,858 | |||||
| Research and development | 2,727 | 2,156 | 1,903 | ||||||||
| Selling, general and administrative | 17,129 | 13,744 | 10,393 | ||||||||
| Total stock-based compensation | $ | 23,132 | $ | 18,327 | $ | 14,154 | |||||
Stock-based compensation costs related to inventory or fixed assets were not significant in the years ended December 31, 2014, 2013 and 2012.
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 December 31, | |||||
| 2014 | 2013 | 2012 | |||
| Risk-free interest rate | 0.06% - 0.89% | 0.07% - 1.72% | 0.13% - 0.81% | ||
| Dividend yield | 0.48% - 1.22% | 0.44% - 0.59% | 0% - 0.72% | ||
| Expected term: | |||||
| RSU and option plans | 2.8 - 3.1 years | 3.1 - 5.1 years | 5.3 - 5.5 years | ||
| Employee share purchase plan | 6 months | 6 months | 6 months | ||
| Volatility | 29% - 34% | 23% - 43% | 36% - 55% | ||
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.
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 $6.6 million, $6.5 million and $5.6 million in 2014, 2013 and 2012, respectively.
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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 $3.3 million in 2014, $3.6 million in 2013 and $3.6 million in 2012. Due to the immateriality of our defined benefit pension plan costs, we have not included all required disclosures.
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 $9.1 million in 2014, $12.8 million in 2013 and $13.2 million in 2012.
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 2014, $2.1 million in 2013 and $1.8 million in 2012 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, 2014 and 2013, the invested amounts under the Plan totaled $7.4 million and $5.3 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 2014 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 Board of Directors of Electro Scientific Industries, 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 December 31, | |||||||||||
| Sales to Related Parties | 2014 | 2013 | 2012 | ||||||||
| Product sales: | |||||||||||
| Applied Materials, Inc. | $ | 2,706 | $ | 4,656 | $ | 981 | |||||
| Lattice Semiconductor Corporation | — | 5 | — | ||||||||
| Cascade Microtech, Inc. | — | — | 4 | ||||||||
| Electro Scientific Industries, Inc. | 390 | — | — | ||||||||
| Oregon Health and Science University | 364 | 555 | — | ||||||||
| Total product sales to related parties | 3,460 | 5,216 | 985 | ||||||||
| Service sales: | |||||||||||
| Applied Materials, Inc. | 829 | 719 | 554 | ||||||||
| Lattice Semiconductor Corporation | 12 | 12 | — | ||||||||
| Cascade Microtech, Inc. | 35 | 33 | 33 | ||||||||
| Oregon Health and Science University | 347 | 85 | — | ||||||||
| Total service sales to related parties | 1,223 | 849 | 587 | ||||||||
| Total sales to related parties | $ | 4,683 | $ | 6,065 | $ | 1,572 | |||||
| Purchases from Related Parties | |||||||||||
| TMC BV | $ | 2,348 | $ | 580 | $ | 127 | |||||
| Oregon Health and Science University | 119 | 353 | — | ||||||||
| Total purchases from related parties | $ | 2,467 | $ | 933 | $ | 127 | |||||
Amounts due from (to) related parties were as follows (in thousands):
| December 31, 2014 | |||
| Applied Materials, Inc. | $ | 74 | |
| Cascade Microtech, Inc. | 10 | ||
| Electro Scientific Industries, Inc. | 351 | ||
| Oregon Health and Science University | 209 | ||
| TMC BV | (324 | ) | |
| Due from related parties, net | $ | 320 | |
| 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.
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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Sales to External Customers: | |||||||||||
| Industry Group | $ | 450,198 | $ | 427,731 | $ | 433,424 | |||||
| Science Group | 506,082 | 499,723 | 458,314 | ||||||||
| Total | $ | 956,280 | $ | 927,454 | $ | 891,738 | |||||
| Gross Profit: | |||||||||||
| Industry Group | $ | 229,959 | $ | 222,675 | $ | 220,267 | |||||
| Science Group | 218,196 | 216,110 | 195,363 | ||||||||
| Total | $ | 448,155 | $ | 438,785 | $ | 415,630 | |||||
| December 31, 2014 | December 31, 2013 | ||||||
| Goodwill: | |||||||
| Industry Group | $ | 76,858 | $ | 51,532 | |||
| Science Group | 93,915 | 84,620 | |||||
| Total | $ | 170,773 | $ | 136,152 | |||
| Total Assets: | |||||||
| Industry Group | $ | 444,168 | $ | 297,987 | |||
| Science Group | 470,899 | 365,571 | |||||
| Corporate and Eliminations | 502,751 | 762,526 | |||||
| Total | $ | 1,417,818 | $ | 1,426,084 | |||
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, because allocation to the market segments would be arbitrary, have not been allocated to the market segments. See the 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 2014, 2013, and 2012 our top 10 customers accounted for approximately 27%, 25% and 22% of our total annual net revenue, respectively. One customer accounted for just over 10% of total annual net revenue during 2013 and no customers accounted for 10% or more of total annual net revenue in 2014 and 2012.
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 December 31, | |||||||||||||||||||||||||||||
| 2014 | 2013 | 2012 | |||||||||||||||||||||||||||
| Product Sales | Service Sales | Total | Product Sales | Service Sales | Total | Product Sales | Service Sales | Total | |||||||||||||||||||||
| U.S. and Canada | $ | 207,623 | $ | 97,966 | $ | 305,589 | $ | 167,876 | $ | 92,759 | $ | 260,635 | $ | 200,778 | $ | 90,942 | $ | 291,720 | |||||||||||
| Europe | 200,995 | 66,799 | 267,794 | 205,857 | 64,803 | 270,660 | 185,598 | 59,124 | 244,722 | ||||||||||||||||||||
| Asia-Pacific Region and Rest of World | 314,048 | 68,849 | 382,897 | 335,705 | 60,454 | 396,159 | 305,120 | 50,176 | 355,296 | ||||||||||||||||||||
| Consolidated net sales | $ | 722,666 | $ | 233,614 | $ | 956,280 | $ | 709,438 | $ | 218,016 | $ | 927,454 | $ | 691,496 | $ | 200,242 | $ | 891,738 | |||||||||||
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Our long-lived assets were geographically located as follows (in thousands):
| December 31, 2014 | December 31, 2013 | ||||||
| United States | $ | 76,553 | $ | 77,639 | |||
| The Netherlands | 59,722 | 65,570 | |||||
| The Czech Republic | 36,534 | 22,950 | |||||
| Other | 58,073 | 42,272 | |||||
| Total | $ | 230,882 | $ | 208,431 | |||
| 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, 2014 | Level 1 | Level 2 | Level 3 | Total | ||||||||
| Available for sale marketable securities: | ||||||||||||
| U.S. treasury notes | $ | 17,608 | $ | — | $ | — | $ | 17,608 | ||||
| Agency bonds | — | 51,951 | — | 51,951 | ||||||||
| Commercial paper | — | 13,500 | — | 13,500 | ||||||||
| Certificates of deposit | — | 19,122 | — | 19,122 | ||||||||
| Municipal bonds | — | 27,119 | — | 27,119 | ||||||||
| Corporate bond | — | 10,902 | — | 10,902 | ||||||||
| Trading securities: | ||||||||||||
| Equity securities – mutual funds | 7,351 | — | — | 7,351 | ||||||||
| Derivative contracts, net | — | (2,739 | ) | — | (2,739 | ) | ||||||
| Total | $ | 24,959 | $ | 119,855 | $ | — | $ | 144,814 | ||||
| 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 bonds | — | 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 | ||||
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, 2014.
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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, 2014 | December 31, 2013 | ||||||
| Cash flow hedges | $ | 222,000 | $ | 208,446 | |||
| Balance sheet hedges | 153,499 | 172,947 | |||||
| Total outstanding derivative contracts | $ | 375,499 | $ | 381,393 | |||
The outstanding contracts at December 31, 2014 have varying maturities through the second quarter of 2016. 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, 2014. 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 December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| Foreign currency loss, inclusive of the impact of derivatives | $ | (1,810 | ) | $ | (2,808 | ) | $ | (5,675 | ) | ||
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 may extend, generally, up to 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, 2014 | 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 | $ | — | $ | — | $ | — | $ | 3,283 | $ | (865 | ) | $ | 2,418 | ||||||
| Foreign exchange contracts not designated as hedging instruments | 2,456 | (670 | ) | 1,786 | 4,729 | (2,622 | ) | 2,107 | |||||||||||
| Total | $ | 2,456 | $ | (670 | ) | $ | 1,786 | $ | 8,012 | $ | (3,487 | ) | $ | 4,525 | |||||
| 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 | |||||
The effect of derivative instruments was as follows (in thousands):
| Year Ended December 31, | |||||||||||
| Foreign Exchange Contracts in Cash Flow Hedging Relationships | 2014 | 2013 | 2012 | ||||||||
| Amount of gain/(loss): | |||||||||||
| Recognized in OCI (effective portion) | $ | (6,631 | ) | $ | (1,934 | ) | $ | 8,032 | |||
| Reclassified from accumulated OCI into revenue (effective portion) | 176 | 33 | — | ||||||||
| Reclassified from accumulated OCI into cost of sales (effective portion) | (7,930 | ) | (790 | ) | (2,511 | ) | |||||
| Recognized in other, net (ineffective portion and amount excluded from effectiveness testing) | (336 | ) | (80 | ) | 9 | ||||||
| Foreign Exchange Contracts Not in Cash Flow Hedging Relationships | |||||||||||
| Amount of gain/(loss): | |||||||||||
| Recognized in other, net | $ | (6,532 | ) | $ | (4,802 | ) | $ | (4,882 | ) | ||
The unrealized losses at December 31, 2014 are expected to be reclassified to net income during the next eighteen months as a result of the underlying hedged transactions also being recorded in net income.
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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, 2014. 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, 2014, 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, 2014, 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, 2014, 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, 2014 and 2013, 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, 2014, and our report dated February 23, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Portland, Oregon
February 23, 2015
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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 Conduct, 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 2015 Annual Meeting of Shareholders and is incorporated by reference herein.
On September 9, 2003, we adopted a code of business conduct and ethics (“Code”) that applies to all directors, officers and employees and amended our Code in 2010 and again in February 2015. We have posted our Code on our website at www.fei.com. We intend to disclose any amendment to the provisions of our Code 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 our Code 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 2014, Outstanding Equity Awards at Fiscal Year End for Fiscal Year Ended 2014, Option Exercises and Stock Vested for Fiscal Year Ended 2014, Nonqualified Deferred Compensation for Fiscal Year Ended 2014, Potential Payments Upon Termination of Employment and Compensation Committee Interlocks and Insider Participation in our Proxy Statement for our 2015 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 2015 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 2015 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 2015 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 September 15, 2014 |
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) | 2014 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. |
10.19 (18) | Third Amendment to Credit Agreement, dated as of July 3, 2014, 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 |
14 (13) | Code of Conduct |
| 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, 2013. |
| (8) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 27, 2005. |
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| (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. |
| (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 September 15, 2014. |
| (13) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 12, 2015. |
| (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 13, 2013. |
| (17) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 8, 2014. |
| (18) | Incorporated by reference to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 3, 2014. |
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 23, 2015 | 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 23, 2015:
| 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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