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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________________________________
FORM 10-Q
___________________________________________________
(Mark One)
| | | | | | | | |
| ☒ | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended January 2, 2021
or
| | | | | | | | |
☐ | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-33962
COHERENT, INC.
| | | | | | | | |
| Delaware | | 94-1622541 |
| (State or other jurisdiction of | | (I.R.S. Employer |
| incorporation or organization) | | Identification No.) |
5100 Patrick Henry Drive, Santa Clara, California 95054
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (408) 764-4000
___________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | | | | |
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock, $0.01 par value | COHR | The NASDAQ Stock Market LLC |
| | Nasdaq Global Select Market |
__________________
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer," “accelerated filer", “smaller reporting company" and “emerging growth company" in Rule 12b-2 of the Exchange Act.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Large accelerated filer | ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | ☐ | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of registrant’s common stock, par value $.01 per share, on February 8, 2021 was 24,448,718.
COHERENT, INC.
INDEX
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included in or incorporated by reference in this quarterly report, other than statements of historical fact, are forward-looking statements. These statements are generally accompanied by words such as "trend," "may," "will," could," "would," "should," "expect," "plan," "anticipate," "rely," "believe," "estimate," "predict," "intend," "potential," "continue," "outlook," "forecast" or the negative of such terms, or other comparable terminology, including without limitation statements made under "Our Strategy" and in "Management’s Discussion and Analysis of Financial Condition and Results of Operations." Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Actual results of Coherent, Inc. (referred to herein as the Company, we, our or Coherent) may differ significantly from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the sections captioned "Our Strategy," "Risk Factors" and "Key Performance Indicators," as well as any other cautionary language in this quarterly report. All forward-looking statements included in the document are based on information available to us on the date hereof. We undertake no obligation to update these forward-looking statements as a result of events or circumstances or to reflect the occurrence of unanticipated events or non-occurrence of anticipated events, except to the extent required by law.
RISK FACTORS SUMMARY
You should carefully consider the information set forth below under the heading "Risk Factors" in Part II, Item 1A before deciding whether to invest in our securities. Below is a summary of the principal risks associated with an investment in our securities.
•We face risks related to our proposed acquisition by Lumentum Holdings Inc., including the possibility that the merger agreement is terminated prior to the completion of the merger, diversion of management’s attention, disruption of our relationship with third parties and employees, restrictions on our business activities and potential litigation related to the merger.
•Our business, financial condition and results of operations may continue to be materially adversely affected by the novel coronavirus ("COVID-19") pandemic and the related private and public sector responses to the pandemic.
•Our operating results and stock price have varied in the past and will continue to be subject to fluctuations based upon numerous factors, including those discussed under the heading "Risk Factors" in Part II, Item 1A and throughout this report.
•Our dependence on sole source or limited source suppliers for some of the key components and materials used in our products makes us susceptible to supply shortages or price fluctuations that could adversely affect our business, particularly our ability to meet our customers' delivery requirements.
•We participate in the microelectronics market, which requires significant research and development expenses to develop and maintain products and a failure to achieve market acceptance for our products could have a significant negative impact on our business and results of operations.
•We participate in the flat panel display market, which has a relatively limited number of end customer manufacturers. Our backlog, timing of net sales and results of operations could be negatively impacted in the event we face any significant periods with few or no orders or our customers reschedule or cancel orders.
•Some of our laser systems are complex in design and may contain defects that are not detected until deployed by our customers, which could increase our costs and reduce our net sales.
•Continued volatility in the advanced packaging and semiconductor manufacturing markets could adversely affect our business, financial condition and results of operations.
•Our future success depends on our ability to increase our sales volumes and decrease our costs to offset potential declines in the average selling prices of our products.
•We face risks associated with our worldwide operations and sales that could harm our financial condition and results of operations.
•We depend on skilled personnel to operate our business effectively, and if we are unable to retain existing or hire additional personnel when needed, or manage transitions among members of our leadership team, our ability to develop and sell our products could be harmed.
•The long sales cycles for many of our products may cause us to incur significant expenses without offsetting net sales.
•The markets in which we sell our products are intensely competitive and increased competition could cause reduced sales levels, reduced gross margins or the loss of market share.
•If we fail to accurately forecast component and material requirements for our products, we could incur additional costs and incur significant delays in shipments, which could result in a loss of customers.
•Our reliance on contract manufacturing and outsourcing may adversely impact our financial results and operations due to our decreased control over the performance and timing of certain aspects of our manufacturing.
•If we fail to effectively manage our growth or, alternatively, our spending during downturns, our business could be disrupted, which could harm our operating results.
•Our market is unpredictable and characterized by rapid technological changes and evolving standards demanding a significant investment in research and development, and, if we fail to address changing market conditions, our business and operating results will be harmed.
•Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers.
•Our and our customers' operations would be seriously harmed if our logistics or facilities or those of our suppliers, our customers' suppliers or our contract manufacturers were to experience catastrophic loss.
•We may not be able to integrate the business of future acquisitions successfully with our own, realize the anticipated benefits of such acquisitions or manage our expanded operations, any of which would adversely affect our results of operations.
•We may not find suitable acquisition candidates in the future and we may not be able to successfully integrate and manage acquired businesses. Any acquisitions we make could disrupt our business and harm our financial condition.
•Our increased level of indebtedness following our acquisition of Rofin-Sinar Technologies Inc. ("Rofin") could adversely affect us, including by decreasing our business flexibility, and will increase our borrowing costs.
•If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.
•Our cash and cash equivalents and short-term investments are managed through various banks around the world and volatility in the capital and credit market conditions could cause financial institutions to fail or materially harm service levels provided by such banks, both of which could have an adverse impact on our ability to timely access funds.
•We are exposed to credit risk and fluctuations in the market values of our investment portfolio.
•If we are unable to protect our proprietary technology, our competitive advantage could be harmed.
•Intellectual property related claims or litigation could be costly and divert the attention of our technical and management personnel. Adverse resolution of litigation may harm our operating results or financial condition.
•Our information systems are subject to attacks, interruptions and failures.
•Difficulties with our enterprise resource planning system and other parts of our global information technology system could harm our business and results of operation. If our network security measures are breached and unauthorized access is obtained to a customer's data or our data or our information technology systems, we may incur significant legal and financial exposure and liabilities.
•Changes in tax rates, tax liabilities or tax accounting rules could affect future results.
•Governmental regulations, including tariffs and duties, affecting the import or export of products could negatively affect our business, financial condition and results of operations.
•We use standard laboratory and manufacturing materials that could be considered hazardous and we could be liable for any damage or liability resulting from accidental environmental contamination or injury.
•Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.
•Failure to maintain effective internal controls may cause a loss of investor confidence in the reliability of our financial statements or cause us to delay filing our periodic reports with the SEC and adversely affect our stock price.
•We face particular privacy, data security and data protection risks due to laws and regulations regulating the protection or security of personal and other sensitive data.
•Violations of anti-bribery, anti-corruption, and/or international trade laws to which we are subject could negatively affect our business, financial condition and results of operations. Allegations thereof may entail significant distraction of management and allocation of resources in the investigation and remediation thereof, which could also negatively affect our business, financial condition and results of operations.
•Provisions of our charter documents and Delaware law, and our Change of Control and Leadership Change Severance Plan, may have anti-takeover effects that could prevent or delay a change in control.
•Our bylaws provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to utilize a different judicial forum for disputes with us or our directors, officers or employees.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except per share data)
| | | | | | | | | | | |
| | Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Net sales | $ | 326,053 | | | $ | 320,771 | |
| Cost of sales | 206,057 | | | 211,518 | |
| Gross profit | 119,996 | | | 109,253 | |
| Operating expenses: | | | |
| Research and development | 28,221 | | | 28,680 | |
| Selling, general and administrative | 74,228 | | | 68,551 | |
| | | |
| | | |
| Amortization of intangible assets | 597 | | | 1,432 | |
| Total operating expenses | 103,046 | | | 98,663 | |
| Income from operations | 16,950 | | | 10,590 | |
| Other income (expense): | | | |
| Interest income | 162 | | | 267 | |
| Interest expense | (4,477) | | | (4,094) | |
| Other—net | 2,026 | | | 793 | |
| Total other expense, net | (2,289) | | | (3,034) | |
| Income before income taxes | 14,661 | | | 7,556 | |
| Provision for income taxes | 14,517 | | | 1,763 | |
| Net income | $ | 144 | | | $ | 5,793 | |
| | | |
| Net income per share: | | | |
| Basic | $ | 0.01 | | | $ | 0.24 | |
| | | |
| Diluted | $ | 0.01 | | | $ | 0.24 | |
| | | |
| Shares used in computation: | | | |
| Basic | 24,264 | | | 23,971 | |
| Diluted | 24,455 | | | 24,160 | |
See Accompanying Notes to Condensed Consolidated Financial Statements.
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited; in thousands)
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Net income | $ | 144 | | | $ | 5,793 | |
Other comprehensive income: (1) | | | |
Translation adjustment, net of taxes (2) | 16,034 | | | 15,168 | |
Changes in unrealized losses on available-for-sale securities, net of taxes (3) | 3 | | | — | |
Defined benefit pension plans, net of taxes (4) | (318) | | | 132 | |
| Other comprehensive income, net of tax | 15,719 | | | 15,300 | |
| Comprehensive income | $ | 15,863 | | | $ | 21,093 | |
(1) Reclassification adjustments were not significant during the three months ended January 2, 2021 and December 28, 2019.
(2) Tax expenses of $5,267 and $1,235 were provided on translation adjustments during the three months ended January 2, 2021 and December 28, 2019, respectively.
(3) Tax expenses of $1 and $0 were provided on changes in unrealized gains on available-for-sale securities during the three months ended January 2, 2021 and December 28, 2019, respectively.
(4) Tax expenses (benefits) of $(63) and $33 were provided on changes in defined benefit pension plans for the three months ended January 2, 2021 and December 28, 2019, respectively.
See Accompanying Notes to Condensed Consolidated Financial Statements.
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except par value)
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| ASSETS | | | |
| Current assets: | | | |
| Cash and cash equivalents | $ | 508,214 | | | $ | 440,258 | |
| Restricted cash | 801 | | | 765 | |
| Short-term investments | 35,361 | | | 35,346 | |
Accounts receivable—net of allowances of $7,625 and $7,630, respectively | 226,199 | | | 220,289 | |
| Inventories | 416,381 | | | 426,756 | |
| Prepaid expenses and other assets | 91,814 | | | 88,250 | |
| | | |
| Total current assets | 1,278,770 | | | 1,211,664 | |
| Property and equipment, net | 260,207 | | | 245,678 | |
| Goodwill | 104,742 | | | 101,317 | |
| Intangible assets, net | 19,934 | | | 21,765 | |
| Non-current restricted cash | 4,661 | | | 4,497 | |
| Other assets | 221,322 | | | 242,575 | |
| Total assets | $ | 1,889,636 | | | $ | 1,827,496 | |
| | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
| Current liabilities: | | | |
| Short-term borrowings and current-portion of long-term obligations | $ | 17,136 | | | $ | 16,817 | |
| Accounts payable | 62,412 | | | 60,225 | |
| Income taxes payable | 6,561 | | | 6,861 | |
| Other current liabilities | 210,554 | | | 184,155 | |
| Total current liabilities | 296,663 | | | 268,058 | |
| Long-term obligations | 428,823 | | | 411,140 | |
| Other long-term liabilities | 212,272 | | | 221,074 | |
| Commitments and contingencies (Note 13) | | | |
| Stockholders' equity: | | | |
Common stock, Authorized—500,000 shares, par value 0.01 per share: | | | |
| | | |
Outstanding— 24,447 shares and 24,257 shares, respectively | 243 | | | 241 | |
| Additional paid-in capital | 89,064 | | | 80,275 | |
| Accumulated other comprehensive loss | (9,948) | | | (25,667) | |
| Retained earnings | 872,519 | | | 872,375 | |
| Total stockholders’ equity | 951,878 | | | 927,224 | |
| Total liabilities and stockholders’ equity | $ | 1,889,636 | | | $ | 1,827,496 | |
See Accompanying Notes to Condensed Consolidated Financial Statements.
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited; in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Common
Stock
Shares | | Common
Stock
Par
Value | | Add.
Paid-in
Capital | | Accum.
Other
Comp.
Income (Loss) | | Retained
Earnings | | Total |
| Balances, September 28, 2019 | 23,982 | | | $ | 238 | | | $ | 34,320 | | | $ | (36,336) | | | $ | 1,286,514 | | | $ | 1,284,736 | |
| Common stock issued under stock plans, net of shares withheld for employee taxes | 171 | | | 2 | | | (7,430) | | | — | | | — | | | (7,428) | |
| Stock-based compensation | — | | | — | | | 7,574 | | | — | | | — | | | 7,574 | |
| Net income | — | | | — | | | — | | | — | | | 5,793 | | | 5,793 | |
| Other comprehensive income, net of tax | — | | | — | | | — | | | 15,300 | | | — | | | 15,300 | |
| Balances, December 28, 2019 | 24,153 | | | $ | 240 | | | $ | 34,464 | | | $ | (21,036) | | | $ | 1,292,307 | | | $ | 1,305,975 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Common
Stock
Shares | | Common
Stock
Par
Value | | Add.
Paid-in
Capital | | Accum.
Other
Comp.
Income (Loss) | | Retained
Earnings | | Total |
| Balances, October 3, 2020 | 24,257 | | | $ | 241 | | | $ | 80,275 | | | $ | (25,667) | | | $ | 872,375 | | | $ | 927,224 | |
| Common stock issued under stock plans, net of shares withheld for employee taxes | 190 | | | 2 | | | (3,009) | | | — | | | — | | | (3,007) | |
| Stock-based compensation | — | | | — | | | 11,798 | | | — | | | — | | | 11,798 | |
| Net income | — | | | — | | | — | | | — | | | 144 | | | 144 | |
| Other comprehensive income, net of tax | — | | | — | | | — | | | 15,719 | | | — | | | 15,719 | |
| Balances, January 2, 2021 | 24,447 | | | $ | 243 | | | $ | 89,064 | | | $ | (9,948) | | | $ | 872,519 | | | $ | 951,878 | |
See Accompanying Notes to Condensed Consolidated Financial Statements.
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Cash flows from operating activities: | | | |
| Net income | $ | 144 | | | $ | 5,793 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | |
| Depreciation and amortization | 10,606 | | | 13,156 | |
| Amortization of intangible assets | 2,614 | | | 12,312 | |
| Deferred income taxes | 12,615 | | | (1,911) | |
| Amortization of debt issuance cost | 857 | | | 826 | |
| Stock-based compensation | 12,185 | | | 7,792 | |
| Non-cash restructuring charges | 3,509 | | | 599 | |
| Amortization of right of use assets | 4,427 | | | 4,104 | |
Other non-cash expense | 219 | | | 229 | |
| Changes in assets and liabilities, net of effect of acquisitions: | | | |
| Accounts receivable | (359) | | | 34,320 | |
| Inventories | 18,570 | | | (867) | |
| Prepaid expenses and other assets | (3,577) | | | (3,418) | |
| Other long-term assets | (2,071) | | | (3,471) | |
| Accounts payable | (912) | | | 789 | |
| Income taxes payable/receivable | 13,306 | | | (2,447) | |
| Operating lease liabilities | (4,090) | | | (3,877) | |
| Other current liabilities | 6,766 | | | (7,856) | |
| Other long-term liabilities | 122 | | | 3,968 | |
| Net cash provided by operating activities | 74,931 | | | 60,041 | |
| | | |
| Cash flows from investing activities: | | | |
| Purchases of property and equipment | (15,073) | | | (11,496) | |
| Proceeds from dispositions of property and equipment | 1,695 | | | 695 | |
| Proceeds from sales and maturities of available-for-sale securities | — | | | 120 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| Net cash used in investing activities | (13,378) | | | (10,681) | |
| | | |
| Cash flows from financing activities: | | | |
| Short-term borrowings | — | | | 12,144 | |
| Repayments of short-term borrowings | (468) | | | (12,238) | |
| Repayments of long-term borrowings | (2,104) | | | (1,956) | |
| | | |
| Issuance of common stock under employee stock option and purchase plans | 5,896 | | | 5,747 | |
| Net settlement of restricted common stock | (8,903) | | | (13,175) | |
| | | |
| | | |
| Net cash used in financing activities | (5,579) | | | (9,478) | |
| Effect of exchange rate changes on cash, cash equivalents and restricted cash | 12,182 | | | 4,035 | |
| Net increase in cash, cash equivalents and restricted cash | 68,156 | | | 43,917 | |
| Cash, cash equivalents and restricted cash, beginning of period | 445,520 | | | 318,661 | |
| Cash, cash equivalents and restricted cash, end of period | $ | 513,676 | | | $ | 362,578 | |
| | | |
| Non-cash investing and financing activities: | | | |
| Unpaid property and equipment purchases | $ | 6,914 | | | $ | 7,770 | |
| | | |
The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same amounts shown in the condensed consolidated statements of cash flows.
| | | | | | | | | | | |
| |
| | January 2, 2021 | | December 28, 2019 |
| Cash and cash equivalents | $ | 508,214 | | | $ | 349,592 | |
| Restricted cash, current | 801 | | | 728 | |
| Restricted cash, non-current | 4,661 | | | 12,258 | |
| Total cash, cash equivalents, and restricted cash shown in the condensed consolidated statement of cash flows | $ | 513,676 | | | $ | 362,578 | |
See Accompanying Notes to Condensed Consolidated Financial Statements.
COHERENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto filed by Coherent, Inc. on Form 10-K for the fiscal year ended October 3, 2020. In the opinion of management, all adjustments necessary for a fair presentation of financial condition and results of operation as of and for the periods presented have been made and include only normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year or any other interim periods. Our fiscal year ends on the Saturday closest to September 30 and our first fiscal quarter includes 13 weeks of operations in each fiscal year presented. Fiscal 2021 includes 52 weeks and fiscal 2020 includes 53 weeks.
The consolidated financial statements include the accounts of Coherent, Inc. and its direct and indirect subsidiaries (collectively, the "Company", "we", "our", "us" or "Coherent"). Intercompany balances and transactions have been eliminated.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The COVID-19 pandemic has significantly increased economic uncertainty and decreased demand for our products in many markets we serve, which could continue for an unknown period of time. In these circumstances, there may be developments outside of our control, including the length and extent of the COVID-19 outbreak, government-imposed measures and our ability to ship products and/or service installed products that may require us to adjust our operating plans. As such, given the dynamic nature of this situation, we cannot predict the future impacts of COVID-19 on our financial condition, results of operations or cash flows. However, it could have an adverse impact on our revenue as well as our overall profitability and may lead to an increase in inventory provisions, allowances for credit losses, and a volatile effective tax rate driven by changes in the mix of earnings across our markets.
2. RECENT ACCOUNTING STANDARDS
Adoption of New Accounting Pronouncement
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and a subsequent amendment, ASU 2018-19 (collectively, Topic 326). Topic 326 requires measurement and recognition of expected credit losses for financial assets held. We adopted ASU 2016-13 in the first quarter of fiscal 2021 with no material impact to our condensed consolidated financial statements.
With the adoption of Topic 326, we are now assessing whether unrealized losses have resulted from a credit loss or other factors. We believe none of our unrealized losses on available-for-sale investments were other-than temporary or were attributable to credit losses as of January 2, 2021 and October 3, 2020. We review our available-for-sale investments on a quarterly basis to identify a potential other-than-temporary impairment. We also do not have an intent to sell our investments and would not be required to sell them before they recover.
The adoption of Topic 326 did not significantly change our approach to the valuation of trade receivables. We determine whether there is an expected loss on our accounts receivable by reviewing all available data, including our customers' latest available financial statements, their credit standing and historical collection experience, as well as current and future market and economic conditions. As of January 2, 2021 and October 3, 2020, the allowance for credit losses on our trade receivables was $5.6 million and $5.4 million, respectively.
Recently Issued Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). Topic 848 provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (LIBOR) or by another reference rate expected to be discontinued. The guidance was effective beginning March 12, 2020 and can be applied prospectively through December 31, 2022. In January 2021, the FASB issued ASU 2021-01, “Reference Rate Reform - Scope,” which clarified the scope and application of the original guidance. We will adopt these standards when LIBOR is discontinued and do not expect them to have a material impact on our consolidated financial statements or related disclosures.
3. REVENUE RECOGNITION
Disaggregation of Revenue
Based on the information that our chief operating decision maker ("CODM") uses to manage the business, we disaggregate revenue by type and market application within each segment. No other level of disaggregation is required considering the type of products, customers, markets, contracts, duration of contracts, timing of transfer of control, and sales channels.
The following tables summarize revenue from contracts with customers (in thousands):
Sales by revenue type and segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| OEM Laser Sources | | Industrial Lasers & Systems | | OEM Laser Sources | | Industrial Lasers & Systems |
| Net sales: | | | | | | | |
Products(1) | $ | 125,577 | | | $ | 89,312 | | | $ | 109,836 | | | $ | 93,903 | |
Other product and service revenues(2) | 85,585 | | | 25,579 | | | 91,112 | | | 25,920 | |
| Total net sales | $ | 211,162 | | | $ | 114,891 | | | $ | 200,948 | | | $ | 119,823 | |
(1) Net sales primarily recognized at a point in time.
(2) Includes sales of spare parts, related accessories and other consumable parts as well as revenues from service agreements, of which $16.0 million and $14.4 million for the three months ended January 2, 2021 and December 28, 2019, respectively, were recognized over time.
Sales by market application and segment
| | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | |
| January 2, 2021 | | December 28, 2019 | |
| OEM Laser Sources | | Industrial Lasers & Systems | | OEM Laser Sources | | Industrial Lasers & Systems | |
| Net sales: | | | | | | | | |
| Microelectronics | $ | 128,173 | | | $ | 20,675 | | | $ | 114,893 | | | $ | 15,653 | | |
| Precision manufacturing | 11,859 | | | 69,591 | | | 10,395 | | | 77,977 | | |
| Instrumentation | 67,276 | | | 17,951 | | | 68,186 | | | 18,994 | | |
| Aerospace and defense | 3,854 | | | 6,674 | | | 7,474 | | | 7,199 | | |
| Total net sales | $ | 211,162 | | | $ | 114,891 | | | $ | 200,948 | | | $ | 119,823 | | |
See Note 19, "Segment and Geographic Information" for revenue disaggregation by reportable segment and geographic region.
Contract Balances
We record accounts receivable when we have an unconditional right to the consideration. Contract liabilities are recorded when cash payments are received or due in advance of performance. Contract liabilities consist of customer deposits and deferred revenue, where we have unsatisfied or partly satisfied performance obligations. Contract liabilities classified as
customer deposits are included in other current liabilities and contract liabilities classified as deferred revenue are included in other current liabilities or other long-term liabilities on our condensed consolidated balance sheets. Payment terms vary by customer.
A rollforward of our customer deposits and deferred revenue are as follows (in thousands):
| | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
Beginning balance (1) | $ | 56,339 | | | $ | 42,550 | |
| Additions to customer deposits and deferred revenue | 45,694 | | | 42,633 | |
| Amount of customer deposits and deferred revenue recognized in income | (42,081) | | | (40,360) | |
| Translation adjustments | 1,187 | | | 652 | |
Ending balance (2) | $ | 61,139 | | | $ | 45,475 | |
(1) Beginning customer deposits and deferred revenue as of October 3, 2020 include $42,715 of current portion and $13,624 of long-term portion. Beginning customer deposits and deferred revenue as of September 28, 2019 include $34,538 of current portion and $8,012 of long-term portion.
(2) Ending customer deposits and deferred revenue as of January 2, 2021 include $48,119 of current portion and $13,020 of long-term portion. Ending customer deposits and deferred revenue as of December 28, 2019 include $35,894 of current portion and $9,581 of long-term portion.
Remaining performance obligations represent the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied as of the end of the reporting period. The following table includes estimated revenue expected to be recognized in the future related to performance obligations for sales of maintenance agreements, extended warranties, installation and contracts with customer acceptance provisions included in customer deposits and deferred revenue as of January 2, 2021 (in thousands):
| | | | | | | | | | | | | | | | | |
| Remainder of fiscal 2021 | | Thereafter | | Total |
Performance obligations as of January 2, 2021 | $ | 45,524 | | | $ | 15,615 | | | $ | 61,139 | |
4. BUSINESS COMBINATIONS
Merger Agreement
On January 18, 2021, Coherent, Lumentum Holdings Inc. ("Lumentum"), Cheetah Acquisition Sub, Inc., a wholly owned subsidiary of Lumentum ("Merger Sub I"), and Cheetah Acquisition Sub LLC, a wholly owned subsidiary of Lumentum ("Merger Sub II"), entered into an Agreement and Plan of Merger (the "Lumentum Merger Agreement").
Pursuant to the terms of the Lumentum Merger Agreement, the acquisition of Coherent will be accomplished through a merger of Merger Sub I with and into Coherent (the "First Merger"), with Coherent surviving the First Merger, followed by a merger of Coherent with and into Merger Sub II, with Merger Sub II continuing as the surviving entity.
Pursuant to the terms of the Lumentum Merger Agreement, and subject to the terms and conditions set forth therein, at the effective time of the First Merger (the "Effective Time"), each share of the common stock of Coherent (the "Coherent Common Stock") issued and outstanding immediately prior to the Effective Time (other than (x) shares of Coherent Common Stock owned by Lumentum, Coherent, or any direct or indirect wholly owned subsidiary of Lumentum or Coherent or (y) shares of Coherent Common Stock owned by stockholders who have properly exercised and perfected appraisal rights under Delaware law, in each case immediately prior to the Effective Time), will be cancelled and extinguished and automatically converted into the right to receive the following consideration:
(A) $100.00 in cash, without interest, plus
(B) 1.1851 validly issued, fully paid and non-assessable shares of the common stock of Lumentum, par value $0.001 per share.
The completion of Coherent's acquisition by Lumentum is subject to customary closing conditions, including the approval of both parties' stockholders and regulatory approvals.
On February 4, 2021, MKS Instruments, Inc. ("MKS") made an unsolicited proposal to acquire Coherent in a cash and stock transaction. Under the terms of MKS' proposal, each share of Coherent common stock would be exchanged for $115.00 in cash and 0.7473 of a share of MKS common stock at the completion of the transaction, subject to customary closing conditions, including receipt of U.S. and foreign antitrust approvals and stockholder approvals. Coherent's board of directors is evaluating MKS' proposal and has not made a determination as to whether it is superior to the Lumentum transaction under the terms of the Lumentum Merger Agreement. After consulting with its financial and legal advisors, however, Coherent's board of directors has determined that MKS' proposal could lead to a transaction that is superior to its pending transaction with Lumentum and, accordingly, Coherent has determined to engage in discussions with MKS to further evaluate the comparative benefits and risks of MKS' proposed transaction relative to Coherent's pending transaction with Lumentum, including the near and long term financial opportunities of each transaction, the expected completion timing of each transaction, and the closing risks associated with each transaction.
Pending acquisition
On July 31, 2020, we reached an agreement to purchase Electro-optics Technology, Inc. ("EOT"), a highly specialized U.S.-based components company, which we expect will enable us to vertically integrate and improve the performance of our directed energy amplifier technology. We expect the acquisition to close in the second or third quarter of fiscal 2021, after receiving all regulatory approvals.
5. FAIR VALUES
We have not changed our valuation techniques in measuring the fair value of any financial assets and liabilities during the period. We recognize transfers between levels within the fair value hierarchy, if any, at the end of each quarter. There were no transfers between levels during the periods presented. As of January 2, 2021 and October 3, 2020, we had one investment carried on a cost basis. If we were to fair value this investment, it would be based upon Level 3 inputs. This investment is not considered material to our condensed consolidated financial statements.
We measure the fair value of outstanding debt obligations for disclosure purposes on a recurring basis. As of January 2, 2021, the current and long-term portion of long-term obligations of $7.1 million and $428.8 million, respectively, are reported at amortized cost. As of October 3, 2020, the current and long-term portion of long-term obligations of $6.8 million and $411.1 million, respectively, are reported at amortized cost. These outstanding obligations are classified as Level 2 as they are not actively traded and are valued using a discounted cash flow model that uses observable market inputs. Based on the discounted cash flow model, the fair value of the outstanding debt approximates amortized cost.
Financial assets and liabilities measured at fair value as of January 2, 2021 and October 3, 2020 are summarized below (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Aggregate Fair Value | | Quoted Prices
in Active
Markets for
Identical
Assets | | Significant
Other
Observable
Inputs | | Aggregate Fair Value | | Quoted Prices
in Active
Markets for
Identical
Assets | | Significant
Other
Observable
Inputs |
| | January 2, 2021 | | October 3, 2020 |
| | | | | (Level 1) | | (Level 2) | | | | (Level 1) | | (Level 2) |
| Assets: | | | | | | | | | | | | |
| Cash equivalents: | | | | | | | | | | | | |
| Money market fund deposits | | $ | 40,328 | | | $ | 40,328 | | | $ | — | | | $ | 36,646 | | | $ | 36,646 | | | $ | — | |
| Certificates of deposit | | 59,571 | | | 59,571 | | | — | | | 56,191 | | | 56,191 | | | — | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Short-term investments: | | | | | | | | | | | | |
U.S. Treasury and agency obligations (1) | | 35,361 | | | — | | | 35,361 | | | 35,346 | | | — | | | 35,346 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Prepaid and other assets: | | | | | | | | | | | | |
Foreign currency contracts (2) | | 2,387 | | | — | | | 2,387 | | | 812 | | | — | | | 812 | |
Money market fund deposits — Deferred comp and supplemental plan (3) | | 515 | | | 515 | | | — | | | 203 | | | 203 | | | — | |
Mutual funds — Deferred comp and supplemental plan (3) | | 23,877 | | | 23,877 | | | — | | | 22,778 | | | 22,778 | | | — | |
| Total | | $ | 162,039 | | | $ | 124,291 | | | $ | 37,748 | | | $ | 151,976 | | | $ | 115,818 | | | $ | 36,158 | |
| | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | |
| Other current liabilities: | | | | | | | | | | | | |
Foreign currency contracts (2) | | (1,865) | | | — | | | (1,865) | | | (2,811) | | | — | | | (2,811) | |
| | | | | | | | | | | | |
| Total | | $ | 160,174 | | | $ | 124,291 | | | $ | 35,883 | | | $ | 149,165 | | | $ | 115,818 | | | $ | 33,347 | |
___________________________________________________
(1) Valuations are based upon quoted market prices in active markets involving similar assets. The market inputs used to value these instruments generally consist of market yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Pricing sources include industry standard data providers, security master files from large financial institutions, and other third party sources which are input into a distribution-curve-based algorithm to determine a daily market value. This creates a "consensus price" or a weighted average price for each security.
(2) The principal market in which we execute our foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. See Note 7, "Derivative Instruments and Hedging Activities."
(3) The fair value of mutual funds is determined based on quoted market prices. Securities traded on a national exchange are stated at the last reported sales price on the day of valuation; other securities traded in over-the-counter markets and listed securities for which no sale was reported on that date are stated as the last quoted bid price.
6. SHORT-TERM INVESTMENTS
We consider all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Investments classified as available-for-sale are reported at fair value with unrealized gains and losses, net of related income taxes, recorded as a separate component of other comprehensive income ("OCI") in stockholders’ equity until realized. Interest and amortization of premiums and discounts for debt securities are included in interest income. Gains and losses on securities sold are determined based on the specific identification method and are included in other income (expense).
Cash, cash equivalents and short-term investments consist of the following (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| | January 2, 2021 |
| | Cost Basis | | Unrealized
Gains | | Unrealized
Losses | | Fair Value |
| Cash and cash equivalents | $ | 508,214 | | | $ | — | | | $ | — | | | $ | 508,214 | |
| | | | | | | | |
| Short-term investments: | | | | | | | |
| Available-for-sale securities: | | | | | | | |
| | | | | | | |
| U.S. Treasury and agency obligations | $ | 35,257 | | | $ | 104 | | | $ | — | | | $ | 35,361 | |
| | | | | | | |
| | | | | | | |
| Total short-term investments | $ | 35,257 | | | $ | 104 | | | $ | — | | | $ | 35,361 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | October 3, 2020 |
| | Cost Basis | | Unrealized
Gains | | Unrealized
Losses | | Fair Value |
| Cash and cash equivalents | $ | 440,258 | | | $ | — | | | $ | — | | | $ | 440,258 | |
| | | | | | | | |
| Short-term investments: | | | | | | | |
| Available-for-sale securities: | | | | | | | |
| | | | | | | |
| U.S. Treasury and agency obligations | $ | 35,311 | | | $ | 36 | | | $ | (1) | | | $ | 35,346 | |
| | | | | | | |
| Total short-term investments | $ | 35,311 | | | $ | 36 | | | $ | (1) | | | $ | 35,346 | |
There were $0.1 million and less than $0.1 million of unrealized gains and losses at January 2, 2021 and October 3, 2020, respectively. None of the $1,000 in unrealized losses at October 3, 2020 were considered to be other-than-temporary impairments.
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, Japanese Yen, South Korean Won, Singapore Dollar and Chinese Renminbi. As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading purposes. The credit risk amounts represent our gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency rates at each respective date.
Non-Designated Derivatives
The total outstanding notional contract and fair value asset (liability) amounts of non-designated hedge contracts, with maximum maturity of two months, are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| | U.S. Notional Contract Value | | U.S. Fair Value |
| | January 2, 2021 | | October 3, 2020 | | January 2, 2021 | | October 3, 2020 |
| Foreign currency hedge contracts | | | | | | | |
| Purchase | $ | 119,775 | | | $ | 169,206 | | | $ | 2,387 | | | $ | (1,802) | |
| Sell | $ | (121,575) | | | $ | (166,813) | | | $ | (1,865) | | | $ | (197) | |
The fair value of our derivative instruments is included in prepaid expenses and other assets and in other current liabilities in our Condensed Consolidated Balance Sheets. See Note 5, "Fair Values."
During the three months ended January 2, 2021 and December 28, 2019, we recognized losses of $1.1 million and $0.5 million, respectively, in other income (expense) for derivative instruments not designated as hedging instruments.
Master Netting Arrangements
To mitigate credit risk in derivative transactions, we enter into master netting arrangements that allow each counterparty in the arrangements to net settle amounts of multiple and separate derivative transactions under certain conditions. We present the fair value of derivative assets and liabilities within our condensed consolidated balance sheet on a gross basis even when derivative transactions are subject to master netting arrangements and may otherwise qualify for net presentation. The impact of netting derivative assets and liabilities is not material to our financial position for any of the periods presented. Our derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by us or the counterparties.
8. GOODWILL AND INTANGIBLE ASSETS
During the quarter ended January 2, 2021, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment. We will conduct our annual goodwill testing during the fourth fiscal quarter.
See Note 8, "Goodwill and Intangible Assets" to the Company’s audited consolidated financial statements and notes thereto for the year ended October 3, 2020 included in the Company’s Annual Report on Form 10-K for discussion of the non-cash pre-tax charges we recorded in the quarter ended April 4, 2020 related to the goodwill, intangible assets, property, plant and equipment and ROU assets of the ILS reporting unit of $327.2 million, $33.9 million, $85.6 million and $1.8 million, respectively.
The changes in the carrying amount of goodwill, all of which is in the OLS segment, for the period from October 3, 2020 to January 2, 2021 are as follows (in thousands):
| | | | | | |
| | OEM Laser Sources | |
| Balance as of October 3, 2020 | $ | 101,317 | | |
| | |
| | |
| Translation adjustments | 3,425 | | |
| Balance as of January 2, 2021 | $ | 104,742 | | |
Components of our amortizable intangible assets are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| | Gross
Carrying
Amount | | Accumulated
Amortization | | Net | | Gross
Carrying
Amount | | Accumulated
Amortization | | Net |
| Existing technology | $ | 38,737 | | | $ | (31,547) | | | $ | 7,190 | | | $ | 46,547 | | | $ | (37,630) | | | $ | 8,917 | |
| Customer relationships | 23,245 | | | (11,769) | | | 11,476 | | | 24,388 | | | (12,923) | | | 11,465 | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Production know-how | 2,300 | | | (1,032) | | | 1,268 | | | 2,300 | | | (917) | | | 1,383 | |
| | | | | | | | | | | |
| Total | $ | 64,282 | | | $ | (44,348) | | | $ | 19,934 | | | $ | 73,235 | | | $ | (51,470) | | | $ | 21,765 | |
For accounting purposes, when an intangible asset is fully amortized, it is removed from the disclosure schedule.
Amortization expense for intangible assets for the three months ended January 2, 2021 and December 28, 2019 was $2.6 million and $12.3 million, respectively. The change in the accumulated amortization also includes $1.8 million (increase) and $2.8 million (increase) of foreign exchange impact for the three months ended January 2, 2021 and December 28, 2019, respectively.
At January 2, 2021, estimated amortization expense for the remainder of fiscal 2021, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):
| | | | | |
| | Estimated Amortization
Expense |
| 2021 (remainder) | $ | 7,632 | |
| 2022 | 3,373 | |
| 2023 | 2,779 | |
| 2024 | 1,997 | |
| 2025 | 1,996 | |
| 2026 | 1,997 | |
| Thereafter | 160 | |
| Total | $ | 19,934 | |
9. BALANCE SHEET DETAILS
Inventories consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| Purchased parts and assemblies | $ | 115,580 | | | $ | 116,957 | |
| Work-in-process | 170,934 | | | 173,871 | |
| Finished goods | 129,867 | | | 135,928 | |
| Total inventories | $ | 416,381 | | | $ | 426,756 | |
Prepaid expenses and other assets consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| Prepaid and refundable income taxes | $ | 36,775 | | | $ | 50,548 | |
| Other taxes receivable | 11,644 | | | 13,006 | |
| Prepaid expenses and other assets | 43,395 | | | 24,696 | |
| Total prepaid expenses and other assets | $ | 91,814 | | | $ | 88,250 | |
Other assets consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| Assets related to deferred compensation arrangements | $ | 31,105 | | | $ | 39,720 | |
| Deferred tax assets | 89,921 | | | 102,028 | |
| Right of use assets, net - operating leases (See Note 11) | 84,488 | | | 85,905 | |
| Right of use assets, net - finance leases (See Note 11) | 588 | | | 656 | |
| Other assets | 15,220 | | | 14,266 | |
| Total other assets | $ | 221,322 | | | $ | 242,575 | |
Other current liabilities consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| Accrued payroll and benefits | $ | 71,083 | | | $ | 54,211 | |
| Operating lease liability, current (See Note 11) | 16,492 | | | 15,366 | |
| Finance lease liability, current (See Note 11) | 369 | | | 399 | |
| Deferred revenue | 35,357 | | | 32,998 | |
| Warranty reserve | 34,489 | | | 35,032 | |
| Accrued expenses and other | 40,002 | | | 36,432 | |
| Customer deposits | 12,762 | | | 9,717 | |
| Total other current liabilities | $ | 210,554 | | | $ | 184,155 | |
Components of the reserve for warranty costs during the first three months of fiscal 2021 and 2020 were as follows (in thousands):
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Beginning balance | $ | 35,032 | | | $ | 36,460 | |
| Additions related to current period sales | 7,484 | | | 10,310 | |
| Warranty costs incurred in the current period | (9,217) | | | (10,972) | |
| | | |
| Adjustments to accruals related to foreign exchange and other | 1,190 | | | 126 | |
| Ending balance | $ | 34,489 | | | $ | 35,924 | |
Other long-term liabilities consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| Long-term taxes payable | $ | 15,627 | | | $ | 15,374 | |
| Operating lease liability, long-term (See Note 11) | 73,634 | | | 75,264 | |
| Finance lease liability, long-term (See Note 11) | 125 | | | 178 | |
| Deferred compensation | 34,110 | | | 42,854 | |
| Defined benefit plan liabilities | 48,113 | | | 45,810 | |
| Deferred tax liabilities | 16,820 | | | 15,721 | |
| Deferred revenue | 13,020 | | | 13,624 | |
| Asset retirement obligations liability | 6,055 | | | 5,892 | |
| Other long-term liabilities | 4,768 | | | 6,357 | |
| Total other long-term liabilities | $ | 212,272 | | | $ | 221,074 | |
10. BORROWINGS
On December 21, 2020, Coherent LaserSystems GmbH & Co. KG entered into a loan agreement with Commerzbank for borrowings of up to 24 million Euros, to be drawn down by October 29, 2021, to finance a portion of the construction of a new facility in Germany. The term of the loan is 10 years and borrowings bear interest at 1.55% per annum. As of January 2, 2021, no amounts have been withdrawn under this loan facility. The loan agreement contains customary affirmative loan covenants.
On November 7, 2016 (the "Closing Date"), we entered into a Credit Agreement by and among us, Coherent Holding BV & Co. K.G. (formerly Coherent Holding GmbH), as borrower (the "Borrower"), and certain of our direct and indirect subsidiaries from time to time party thereto, as guarantors, the lenders from time to time party thereto, Barclays Bank PLC, as administrative agent and an L/C Issuer, Bank of America, N.A., as an L/C Issuer, and MUFG Union Bank, N.A., as an L/C Issuer (the "Initial Credit Agreement" and, as amended by the Amendments (defined below), the "Credit Agreement"). The Initial Credit Agreement provided for a 670.0 million Euro senior secured term loan facility (the "Euro Term Loan") and a $100.0 million senior secured revolving credit facility (the "Revolving Credit Facility") with a $30.0 million letter of
credit sublimit and a $10.0 million swing line sublimit, in each case, which may be increased from time to time pursuant to an incremental feature set forth in the Credit Agreement. The Initial Credit Agreement was amended on May 8, 2017 (the "First Amendment") to reduce the interest rate margins applicable to the Euro Term Loan and was amended again on July 5, 2017 (the "Second Amendment" and, together with the First Amendment, the "Amendments") to make certain technical changes in connection with the conversion of the Borrower from a German company with limited liability to a German limited partnership.
The Credit Agreement contains customary mandatory prepayment provisions. The Borrower has the right to prepay loans under the Credit Agreement in whole or in part at any time without premium or penalty, subject to customary breakage costs. Revolving loans may be borrowed, repaid and reborrowed until the fifth anniversary of the Closing Date, at which time all outstanding revolving loans must be repaid. The Euro Term Loan matures on the seventh anniversary of the Closing Date (in the first quarter of fiscal 2024), at which time all outstanding principal and accrued and unpaid interest on the Euro Term Loan must be repaid.
As of January 2, 2021, the outstanding principal amount of the Euro Term Loan was 356.5 million Euros. As of January 2, 2021, the outstanding amount of the Revolving Credit Facility was $10.0 million plus a 10.0 million Euro letter of credit.
Loans under the Credit Agreement bear interest, at the Borrower’s option, at a rate equal to either (i)(x) in the case of calculations with respect to U.S. Dollars or certain other alternative currencies, the London interbank offered rate ("LIBOR") or (y) in the case of calculations with respect to the Euro, the euro interbank offered rate ("EURIBOR" and, together with LIBOR), the "Eurocurrency Rate") or (ii) a base rate (the "Base Rate") equal to the highest of (x) the federal funds rate, plus 0.50%, (y) the prime rate then in effect and (z) the Eurocurrency Rate for loans denominated in U.S. Dollars applicable to a one-month interest period, plus 1.0%, in each case, plus an applicable margin that is subject to adjustment pursuant to a pricing grid based on consolidated total gross leverage ratio. At January 2, 2021, the applicable margin for Euro Term Loans borrowed as Eurocurrency Rate loans was 2.25% per annum and as Base Rate loans was 1.25%. The applicable margin for revolving loans borrowed as Eurocurrency Rate loans was 4.25% per annum and as Base Rate loans was 3.25% per annum. Interest on Base Rate Loans is payable quarterly in arrears. Interest on Eurocurrency Rate loans is payable at the end of the applicable interest period (or at three month intervals if the interest period exceeds three months).
The Credit Agreement requires the Borrower to make scheduled quarterly payments on the Euro Term Loan of 0.25% of the original principal amount of the Euro Term Loan, with any remaining principal payable at maturity. A commitment fee accrues on any unused portion of the revolving loan commitments under the Credit Agreement at a rate of 0.375% or 0.5% depending on the consolidated total gross leverage ratio at any time of determination. The Borrower is also obligated to pay other customary fees for a credit facility of this size and type.
On the Closing Date, we and certain of our direct and indirect subsidiaries, as guarantors, provided an unconditional guaranty of all obligations of the Borrower and the other loan parties arising under the Credit Agreement, the other loan documents and under swap contracts and treasury management agreements with the lenders or their affiliates (with certain limited exceptions). The Borrower and the guarantors have also granted security interests in substantially all of their assets to secure such obligations.
The Credit Agreement contains customary affirmative and negative covenants, including covenants limiting the ability of us and our subsidiaries to, among other things, incur debt, grant liens, make investments, make certain restricted payments, transact with affiliates, and sell assets. The Credit Agreement also requires us and our subsidiaries to maintain a senior secured net leverage ratio as of the last day of each fiscal quarter of less than or equal to 3.50 to 1.00. We were in compliance with all covenants at January 2, 2021.
We incurred $28.5 million of debt issuance costs related to the Euro Term Loan and $0.5 million of debt issuance costs to the original lenders related to the First Amendment, which are included in short-term borrowings and current portion of long-term obligations and long-term obligations in the condensed consolidated balance sheets and will be amortized to interest expense over the seven year life of the Euro Term Loan using the effective interest method, adjusted to accelerate amortization related to voluntary repayments. We incurred $2.3 million of debt issuance costs in connection with the Revolving Credit Facility which were capitalized and included in prepaid expenses and other assets in the condensed consolidated balance sheets and will be amortized to interest expense using the straight-line method over the contractual term of five years of the Revolving Credit Facility.
Additional sources of cash available to us were international currency lines of credit and bank credit facilities totaling $17.0 million as of January 2, 2021, of which $14.4 million was unused and available. These unsecured international credit
facilities were used in Europe during the first three months of fiscal 2021. As of January 2, 2021, we had utilized $2.6 million of the international credit facilities as guarantees in Europe.
Short-term borrowings and current portion of long-term obligations consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
Current portion of Euro Term Loan (1) | $ | 5,218 | | | $ | 4,970 | |
1.3% Term loan due 2024 | 1,535 | | | 1,465 | |
1.0% State of Connecticut term loan due 2023 | 383 | | | 382 | |
| | | |
| | | |
| Line of credit borrowings | 10,000 | | | 10,000 | |
| Total short-term borrowings and current portion of long-term obligations | $ | 17,136 | | | $ | 16,817 | |
(1) Net of debt issuance costs of $3.0 million and $2.9 million at January 2, 2021 and October 3, 2020, respectively.
Long-term obligations consist of the following (in thousands):
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
Euro Term Loan due 2024 (1) | $ | 424,053 | | | $ | 406,099 | |
1.3% Term loan due 2024 | 4,220 | | | 4,395 | |
1.0% State of Connecticut term loan due 2023 | 550 | | | 646 | |
| | | |
| | | |
| Total long-term obligations | $ | 428,823 | | | $ | 411,140 | |
(1) Net of debt issuance costs of $5.4 million and $5.9 million at January 2, 2021 and October 3, 2020, respectively.
Contractual maturities of our debt obligations, excluding line of credit borrowings, as of January 2, 2021 are as follows (in thousands):
| | | | | |
| | Amount |
| 2021 (remainder) | $ | 7,609 | |
| 2022 | 10,140 | |
| 2023 | 10,024 | |
| 2024 | 416,620 | |
| |
| |
| |
| Total | $ | 444,393 | |
11. LEASES
We determine if an arrangement contains a lease at inception for arrangements with an initial term of more than 12 months, and classify it as either a finance or operating lease. We lease certain real and personal property from unrelated third parties under non-cancellable operating leases that expire at various dates through fiscal 2032. These operating leases are mainly for administrative offices, research-and-development and manufacturing facilities, as well as sales offices in various countries around the world. Certain leases require us to pay property taxes, insurance and routine maintenance, and include escalation clauses. Many leases include one or more options to renew. We assume renewals in our determination of the lease term when the renewals are deemed to be reasonably assured at lease commencement. We have also entered into various finance leases to obtain servers and certain other equipment for our operations. These arrangements are typically for three to six years. Our assets, liabilities and lease costs related to finance leases are immaterial.
As the rates implicit in our leases are not readily determinable, we use incremental borrowing rates based on the information available at the commencement date in determining the present value of future lease payments. We consider both the credit rating and the length of the lease when calculating the incremental borrowing rate. We combine lease and non-lease components into a single lease component for both our operating and finance leases.
For the purpose of lease liability measurement, we consider only payments that are fixed and determinable at the time of commencement. Any variable payments that depend on an index or rate are expensed as incurred.
We generally recognize sublease income on a straight-line basis over the sublease term.
The components of operating lease costs (in thousands), lease term (in years) and discount rate are as follows:
| | | | | | | | | | | |
| Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Operating lease cost | $ | 5,344 | | | $ | 5,023 | |
Variable lease cost | 329 | | | 376 | |
| Short-term lease cost | 11 | | | 130 | |
| Sublease income | (2) | | | (32) | |
| Total lease cost | $ | 5,682 | | | $ | 5,497 | |
| | | | | | | | | | | |
| January 2, 2021 | | December 28, 2019 |
| Weighted average remaining lease term | 7.6 | | 8.3 |
| Weighted average discount rate | 4.9 | % | | 4.8 | % |
Supplemental cash flow information related to leases are as follows (in thousands):
| | | | | | | | | | | |
| Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Operating cash outflows from operating leases | $ | 5,023 | | | $ | 4,887 | |
| ROU assets obtained in exchange for new operating lease liabilities | 853 | | | 1,996 | |
See Note 9, "Balance Sheet Details" for supplemental balance sheet information related to leases.
As of January 2, 2021, maturities of our operating lease liabilities, which do not include short-term leases and variable lease payments, are as follows (in thousands):
| | | | | |
| | Operating Leases |
| 2021 (remainder) | $ | 15,257 | |
| 2022 | 18,673 | |
| 2023 | 16,124 | |
| 2024 | 12,456 | |
| 2025 | 11,143 | |
| 2026 and thereafter | 37,219 | |
| Total minimum lease payments | 110,872 | |
| Amounts representing interest | (20,746) | |
| Present value of total lease liabilities | $ | 90,126 | |
12. STOCK-BASED COMPENSATION
Fair Value of Stock Compensation
We recognize compensation expense for all share-based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis per tranche over the respective requisite service period of the awards.
Determining Fair Value
The fair values of shares purchased under the Employee Stock Purchase Plan ("ESPP") for the three months ended January 2, 2021 and December 28, 2019, respectively, were estimated using the following weighted-average assumptions:
| | | | | | | | | | | |
| Employee Stock Purchase Plan |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Expected life in years | 0.5 | | 0.5 |
| Volatility | 53.5 | % | | 47.1 | % |
| Risk-free interest rate | 0.11 | % | | 1.84 | % |
| Expected dividend yield | — | % | | — | % |
| Weighted average fair value per share | $ | 36.67 | | | $ | 43.54 | |
We grant performance restricted stock units to officers and certain employees. The performance restricted stock unit agreements provide for the award of performance units with each unit representing the right to receive one share of our common stock to be issued after the applicable award vesting period. The final number of units awarded, if any, for these performance grants will be determined as of the vesting dates, based upon our total shareholder return over the performance period compared to the applicable Russell Index and could range from no units to a maximum of twice the initial award units.
The weighted average fair value for the performance units granted for the three months ended January 2, 2021 and December 28, 2019 was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
| | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Risk-free interest rate | 0.2 | % | | 1.6 | % |
| Volatility | 51.7 | % | | 47.2 | % |
| Weighted average fair value per share | $ | 119.54 | | | $ | 190.86 | |
We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period of approximately 3 years, with no adjustment in future periods based upon the actual shareholder return over the performance period.
In addition, during fiscal 2020, we granted performance restricted stock unit awards to certain employees with vesting based on goals related to free cash flow target amounts, with the initial fair value determined based on our closing stock price on the date of grant. Such awards were granted to serve as a performance incentive with a pay-for-performance forward-looking free cash flow target for the fiscal year in recognition of the impact of the COVID-19 pandemic. The number of shares issuable under these performance units upon satisfaction of the free cash flow performance criteria was capped at 100% of target. The total stock-based compensation of these awards was adjusted based on the level of achievement of free cash flow. These awards vested, in the three months ended January 2, 2021, at 100% of target.
Stock Compensation Expense
The following table shows total stock-based compensation expense and related tax benefits included in the condensed consolidated statements of operations for the three months ended January 2, 2021 and December 28, 2019 (in thousands):
| | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Cost of sales | $ | 2,272 | | | $ | 1,182 | |
| Research and development | 1,199 | | | 561 | |
| Selling, general and administrative | 8,714 | | | 6,049 | |
| Income tax benefit | (1,572) | | | (856) | |
| $ | 10,613 | | | $ | 6,936 | |
During the three months ended January 2, 2021, $1.9 million of stock-based compensation cost was capitalized as part of inventory for all stock plans, $2.3 million was amortized into cost of sales and $2.4 million remained in inventory at January 2, 2021. During the three months ended December 28, 2019, $1.0 million of stock-based compensation cost was capitalized as part of inventory for all stock plans, $1.2 million was amortized into cost of sales and $1.2 million remained in inventory at December 28, 2019.
At January 2, 2021, the total compensation cost related to unvested stock-based awards granted to employees under our stock plans but not yet recognized was approximately $63.8 million. We do not estimate forfeitures and account for them as they occur. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.8 years.
Stock Awards Activity
The following table summarizes the activity of our time-based and performance-based restricted stock units for the first three months of fiscal 2021 (in thousands, except per share amounts):
| | | | | | | | | | | | | | | | | | | | | | | |
| Time Based Restricted Stock Units | | Performance Restricted Stock Units |
| Number of
Shares | | Weighted
Average
Grant Date
Fair Value | | Number of
Shares | | Weighted
Average
Grant Date
Fair Value |
| Nonvested stock at October 3, 2020 | 419 | | | $ | 144.87 | | | 136 | | | $ | 177.54 | |
| Granted | 244 | | | 121.23 | | | 64 | | | 119.43 | |
Vested (1) | (196) | | | 147.56 | | | (12) | | | 118.45 | |
| Forfeited | (3) | | | 138.92 | | | (30) | | | 315.05 | |
| Nonvested stock at January 2, 2021 | 464 | | | $ | 131.34 | | | 158 | | | $ | 131.90 | |
(1) Service-based restricted stock units vested during the fiscal year. Performance-based restricted stock units included at 100% of target goal. Under the terms of the market based awards, the recipient may earn between 0% and 200% of the award. Under the terms of the performance-based awards based on free cash flow targets, the recipient may earn between 0% and 100% of the award.
13. COMMITMENTS AND CONTINGENCIES
Indemnifications
In the normal course of business, we enter into agreements that contain a variety of representations and warranties and provide for general indemnification. Exposure under these agreements is unknown because claims may be made against us in the future and we may record charges in the future as a result of these indemnification obligations. As of January 2, 2021, we did not have any material indemnification claims that were probable or reasonably possible.
Legal Proceedings
We are subject to legal claims and litigation arising in the ordinary course of business, such as contract-related, product sales and servicing, real estate, product liability, regulatory matters, employment or intellectual property claims.
Although we do not expect that such claims and litigation will ultimately have a material adverse effect on our consolidated financial position, results of operations or cash flows, an adverse result in one or more matters could negatively affect our results in the period in which they occur, or in future periods.
The United States and many foreign governments impose tariffs and duties on the import and export of certain products we sell and purchase. From time to time our customs compliance, product classifications, duty calculations and payments are reviewed or audited by government agencies. Any adverse result in such a review or audit could negatively affect our results in the period in which they occur, or in future periods.
German authorities are currently investigating an export compliance matter involving one of our German subsidiaries involving four former employees (whose employment was terminated following our discovery of this matter). While under
German law the subsidiary can be held liable for certain infringements by its employees of German export control laws, we believe that this matter involves less than approximately 1.5 million Euros in transactions in the period currently under investigation and do not believe that the final resolution of this matter will be material to our consolidated financial position, results of operations or cash flows. However, the German government investigation is ongoing and it is possible that substantial payments, fines, penalties or damages could result. Even though we do not currently expect this matter to be material to our consolidated financial position, results of operations or cash flows, circumstances could change as the investigation progresses.
14. STOCK REPURCHASES
On October 28, 2018, our board of directors authorized a stock repurchase program authorizing the Company to repurchase up to $250.0 million of our common stock through December 31, 2019, with a limit of no more than $75.0 million per quarter. During fiscal 2019, we repurchased and retired 603,828 shares of outstanding common stock under this program at an average price of $128.20 per share for a total of $77.4 million. We made no repurchases under the program during fiscal 2020 and the program expired on December 31, 2019.
On February 5, 2020, our board of directors authorized a stock repurchase program authorizing the Company to repurchase up to $100.0 million of our common stock through January 31, 2021.We made no repurchases under the program and the program expired on January 31, 2021.
15. EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data):
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Weighted average shares outstanding—basic | 24,264 | | | 23,971 | |
| Dilutive effect of employee stock awards | 191 | | | 189 | |
| Weighted average shares outstanding—diluted | 24,455 | | | 24,160 | |
| | | |
| Net income | $ | 144 | | | $ | 5,793 | |
A total of 2,184 and 9,876 potentially dilutive securities have been excluded from the diluted share calculation for the three months ended January 2, 2021 and December 28, 2019, respectively, as their effect was anti-dilutive.
16. OTHER INCOME (EXPENSE)
Other income (expense) is as follows (in thousands):
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Foreign exchange loss | $ | (994) | | | $ | (1,034) | |
| Gain on deferred compensation investments, net | 2,242 | | | 2,232 | |
| Other | 778 | | | (405) | |
| Other—net | $ | 2,026 | | | $ | 793 | |
17. INCOME TAXES
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discrete to the period.
Our effective tax rate on income before income taxes for the three months ended January 2, 2021 of 99.0% was higher than the U.S. federal tax rate of 21.0% primarily due to the establishment of valuation allowances for certain foreign deferred tax assets, the impact of income subject to foreign tax rates that are higher than the U.S. tax rates, the deferred taxes on foreign earnings not considered permanently reinvested, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under Internal Revenue Code Section 162(m). These amounts are partially offset by the benefit of federal research and development tax credits and our Singapore tax exemption.
We assess our ability to realize our net deferred tax assets on a quarterly basis and establish a valuation allowance if it is more-likely-than-not that some portion of the deferred tax assets will not be realized. Although several factors may be considered for assessing the need for a valuation allowance, a 12-quarter cumulative loss is generally viewed as a primary factor based on the weight given to historical results versus projections. In Germany we have an "Organschaft" arrangement among our German entities in which the annual profit and loss results are ultimately pooled at the parent level of Coherent Holding B.V. & Co. KG. During the first quarter of fiscal 2021, our German pooled results reflected a loss and we now have a cumulative loss position for the last 12 quarters. Due to the weight of objectively verifiable negative evidence, we believe that it is now more likely-than-not that our German Organschaft group’s deferred tax assets will not be realized as of first quarter of fiscal 2021. Accordingly, we have recorded a valuation allowance of approximately $7.0 million related to these deferred tax assets. It is reasonably possible that significant positive evidence may become available to reach a conclusion that a significant portion of the valuation allowance will no longer be needed, and if so, we may release our valuation allowance in the future.
Our effective tax rate on income before income taxes for the three months ended December 28, 2019 of 23.3% was higher than the U.S. federal tax rate of 21.0% primarily due to the impact of income subject to foreign tax rates that are higher than the U.S. tax rates, an accrual for foreign withholding taxes on certain current year foreign earnings not considered permanently reinvested, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under Internal Revenue Code Section 162(m). These amounts are partially offset by the net excess tax benefits from restricted stock unit vesting, the benefit of federal research and development tax credits, the benefit of certain tax audit settlements and our Singapore tax exemption.
18. DEFINED BENEFIT PLANS
For the three months ended January 2, 2021 and December 28, 2019, net periodic cost under our defined benefit plans was $0.2 million and $0.8 million, respectively. The service cost component of net periodic costs is included in selling, general and administrative ("SG&A") expenses, and the interest costs, net actuarial (gain) loss and other components are included in Other—net in the condensed consolidated statements of operations.
19. SEGMENT AND GEOGRAPHIC INFORMATION
We are organized into two reporting segments, OEM Laser Sources ("OLS") and Industrial Lasers & Systems ("ILS"), based upon our organizational structure and how the CODM receives and utilizes information provided to allocate resources and make decisions. This segmentation reflects the go-to-market strategies and synergies for our broad portfolio of laser technologies and products. While both segments deliver cost-effective, highly reliable photonics solutions, the OLS business segment is focused on high performance laser sources and complex optical sub-systems, typically used in microelectronics manufacturing, medical diagnostics and therapeutic applications, as well as in scientific research. Our ILS business segment delivers high performance laser sources, sub-systems and tools primarily used for industrial laser materials processing, serving important end markets like automotive, machine tools, consumer goods, and medical device manufacturing as well as applications in aerospace and defense.
We have identified OLS and ILS as operating segments for which discrete financial information is available. Both units have dedicated engineering, manufacturing, product business management and product line management functions. A small portion of our outside revenue is attributable to projects and recently developed products for which a segment has not yet been determined. The associated direct and indirect costs are presented in the category of Corporate and other, along with other corporate costs as described below.
Our Chief Executive Officer has been identified as the CODM, as he assesses the performance of the segments and decides how to allocate resources to the segments. Income from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. Assets by segment are not a measure used to assess the performance of the company by the CODM and thus are not reported in our disclosures. Income from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate certain operating expenses to our operating segments and we manage them at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain management, finance, legal and human resources) and are included in the results below under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
The following table provides net sales and income from operations for our operating segments and a reconciliation of our total income from operations to income before income taxes (in thousands):
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Net sales: | | | |
| OEM Laser Sources | $ | 211,162 | | | $ | 200,948 | |
| Industrial Lasers & Systems | 114,891 | | | 119,823 | |
| Total net sales | $ | 326,053 | | | $ | 320,771 | |
| | | |
| Income from operations: | | | |
| OEM Laser Sources | $ | 49,416 | | | $ | 47,708 | |
| Industrial Lasers & Systems | (7,912) | | | (20,300) | |
| Corporate and other | (24,554) | | | (16,818) | |
| Total income from operations | 16,950 | | | 10,590 | |
| Total other expense, net | (2,289) | | | (3,034) | |
| Income before income taxes | $ | 14,661 | | | $ | 7,556 | |
Geographic Information
Our foreign operations consist primarily of manufacturing facilities and sales offices in Europe and Asia-Pacific. Sales, marketing and customer service activities are conducted through sales subsidiaries throughout the world. Geographic sales information for the three months ended January 2, 2021 and December 28, 2019 is based on the location of the end customer.
Sales to unaffiliated customers are as follows (in thousands):
| | | | | | | | | | | |
| | Three Months Ended |
| SALES | January 2, 2021 | | December 28, 2019 |
| United States | $ | 71,527 | | | $ | 77,885 | |
| Foreign countries: | | | |
| South Korea | 71,838 | | | 60,056 | |
| China | 61,459 | | | 58,588 | |
| Japan | 23,339 | | | 22,351 | |
| Asia-Pacific, other | 27,411 | | | 22,162 | |
| Germany | 29,285 | | | 30,445 | |
| Europe, other | 28,531 | | | 34,513 | |
| Rest of World | 12,663 | | | 14,771 | |
| Total foreign countries sales | 254,526 | | | 242,886 | |
| Total sales | $ | 326,053 | | | $ | 320,771 | |
Major Customers
We had one customer during the three months ended January 2, 2021 and December 28, 2019 that accounted for 18.9% and 17.6% of net sales, respectively. This customer purchased primarily from our OLS segment.
We had one customer that accounted for 24.8% and 24.2% of accounts receivable at January 2, 2021 and October 3, 2020, respectively. This customer purchased primarily from our OLS segment.
20. RESTRUCTURING CHARGES
In June 2019, we announced our plans to exit a portion of our high power fiber laser ("HPFL") business and consolidate all HPFL manufacturing and engineering functions in our Tampere, Finland facility by transferring certain HPFL activities from our Hamburg, Germany facility. We recorded charges related to this project in the first quarter of fiscal 2020 of $0.6 million, primarily related to accelerated depreciation and project management consulting.
We also vacated our leased facility in Santa Clara at the end of the lease term on July 31, 2020 and combined operations into our owned Santa Clara headquarters. We incurred costs in the first quarter of fiscal 2020 of $0.2 million, primarily related to accelerated depreciation. We also incurred costs in the first quarter of fiscal 2020 of $0.1 million for other projects.
In the fourth quarter of fiscal 2020, we began a restructuring program in our ILS segment which includes management reorganizations, the planned closure of certain manufacturing sites, and the right-sizing of global sales, service, order admin, marketing communication and certain administrative functions, among others. In the first quarter of fiscal 2021, we incurred costs of $5.4 million, primarily related to write-offs of excess inventory and accruals for vendor commitments, which are recorded in cost of sales, accelerated depreciation and estimated severance.
The following table presents our current liability as accrued on our balance sheets for restructuring charges. The table sets forth an analysis of the components of the restructuring charges and payments and other deductions made against the accrual for the first quarters of fiscal 2021 and 2020 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Severance Related | | Asset Write-Offs | | Other | | Total |
| Balances, October 3, 2020 | $ | 2,611 | | | $ | — | | | $ | 230 | | | $ | 2,841 | |
| Provision | 819 | | | 3,509 | | | 1,055 | | | 5,383 | |
| Payments and other | (555) | | | (3,509) | | | (281) | | | (4,345) | |
| Balances, January 2, 2021 | $ | 2,875 | | | $ | — | | | $ | 1,004 | | | $ | 3,879 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Severance Related | | Asset Write-Offs | | Other | | Total |
| Balances, September 28, 2019 | $ | 8,279 | | | $ | — | | | $ | 215 | | | $ | 8,494 | |
| Provision | 54 | | | 599 | | | 280 | | | 933 | |
| Payments and other | (658) | | | (599) | | | (275) | | | (1,532) | |
| Balances, December 28, 2019 | $ | 7,675 | | | $ | — | | | $ | 220 | | | $ | 7,895 | |
At January 2, 2021, $3.9 million of accrued severance related and other costs were included in other current liabilities. The severance, asset write-offs for inventory, accruals for vendor commitments, accelerated depreciation and other costs in the first quarter of fiscal 2021 primarily related to the restructuring program that began in the fourth quarter of fiscal 2020. The asset write-offs for accelerated depreciation and other costs in the first quarter of fiscal 2020 primarily related to the exit of a portion of our HPFL business in Hamburg, Germany, and costs to vacate our leased facility in Santa Clara and combine operations into our owned Santa Clara headquarters.
By segment, $5.4 million of restructuring costs were incurred in the ILS segment in the three months ended January 2, 2021. In the three months ended December 28, 2019, $0.7 million of the restructuring costs were incurred in the ILS segment and $0.2 million were incurred in the OLS segment. Restructuring charges are recorded in cost of sales, research and development and selling, general and administrative expenses in our condensed consolidated statements of operations.
21. SUBSEQUENT EVENTS
See Note 4, "Business Combinations" for a description of the Lumentum Merger Agreement entered into on January 18, 2021, between Coherent, Lumentum, Merger Sub I and Merger Sub II.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
COMPANY OVERVIEW
BUSINESS BACKGROUND
We are one of the world’s leading providers of lasers, laser-based technologies and laser-based system solutions in a broad range of commercial, industrial and scientific applications. We design, manufacture, service and market lasers and related accessories for a diverse group of customers. Since inception in 1966, we have grown through internal expansion and through strategic acquisitions of complementary businesses, technologies, intellectual property, manufacturing processes and product offerings.
We are organized into two reporting segments: OEM Laser Sources ("OLS") and Industrial Lasers & Systems ("ILS"), based on the organizational structure of the company and how the chief operating decision maker ("CODM") receives and utilizes information provided to allocate resources and make decisions. This segmentation reflects the go-to-market strategies and synergies for our broad portfolio of laser technologies and products. While both segments deliver cost-effective, highly reliable photonics solutions, the OLS business segment is focused on high performance laser sources and complex optical sub-systems typically used in microelectronics manufacturing, medical diagnostics and therapeutic applications, as well as in scientific research. Our ILS business segment delivers high performance laser sources, sub-systems and tools primarily used for industrial laser materials processing, serving important end markets like automotive, machine tool, consumer goods, and medical device manufacturing as well as applications in aerospace and defense.
Income from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. Income from operations represents the sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate certain operating expenses to our operating segments and we manage them at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain management, finance, legal and human resources) and are included in Corporate and other. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
SIGNIFICANT EVENTS
Merger Agreement
On January 18, 2021, Coherent, Lumentum Holdings Inc., Cheetah Acquisition Sub, Inc., a wholly owned subsidiary of Lumentum ("Merger Sub I"), and Cheetah Acquisition Sub LLC, a wholly owned subsidiary of Lumentum ("Merger Sub II"), entered into an Agreement and Plan of Merger (the "Lumentum Merger Agreement").
Pursuant to the terms of the Lumentum Merger Agreement, the acquisition of Coherent will be accomplished through a merger of Merger Sub I with and into Coherent (the "First Merger"), with Coherent surviving the First Merger, followed by a merger of Coherent with and into Merger Sub II, with Merger Sub II continuing as the surviving entity.
Pursuant to the terms of the Lumentum Merger Agreement, and subject to the terms and conditions set forth therein, at the effective time of the First Merger (the "Effective Time"), each share of the common stock of Coherent (the "Coherent Common Stock") issued and outstanding immediately prior to the Effective Time (other than (x) shares of Coherent Common Stock owned by Lumentum, Coherent, or any direct or indirect wholly owned subsidiary of Lumentum or Coherent or (y) shares of Coherent Common Stock owned by stockholders who have properly exercised and perfected appraisal rights under Delaware law, in each case immediately prior to the Effective Time), will be cancelled and extinguished and automatically converted into the right to receive the following consideration:
(A) $100.00 in cash, without interest, plus
(B) 1.1851 validly issued, fully paid and non-assessable shares of the common stock of Lumentum, par value $0.001 per share.
The completion of Coherent's acquisition by Lumentum is subject to customary closing conditions, including the approval of both parties' stockholders and regulatory approvals.
On February 4, 2021, MKS Instruments, Inc. ("MKS") made an unsolicited proposal to acquire Coherent in a cash and stock transaction. Under the terms of MKS' proposal, each share of Coherent common stock would be exchanged for $115.00 in cash and 0.7473 of a share of MKS common stock at the completion of the transaction, subject to customary closing conditions, including receipt of U.S. and foreign antitrust approvals and stockholder approvals. Coherent's board of directors is evaluating MKS' proposal and has not made a determination as to whether it is superior to the Lumentum transaction under the terms of the Lumentum Merger Agreement. After consulting with its financial and legal advisors, however, Coherent's board of directors has determined that MKS' proposal could lead to a transaction that is superior to its pending transaction with Lumentum and, accordingly, Coherent has determined to engage in discussions with MKS to further evaluate the comparative benefits and risks of MKS' proposed transaction relative to Coherent's pending transaction with Lumentum, including the near and long term financial opportunities of each transaction, the expected completion timing of each transaction, and the closing risks associated with each transaction. There can be no assurances that Coherent will conclude that the transaction proposed by MKS is superior to Coherent's pending transaction with Lumentum and Coherent investors are encouraged to await a final determination from Coherent's board of directors. Notwithstanding its receipt of MKS' proposal and pending discussions between Coherent and MKS, Coherent's board of directors continues to recommend Coherent's merger agreement with Lumentum to its stockholders. Coherent's board of directors is not modifying or withdrawing its recommendation with respect to the Lumentum merger agreement and the Lumentum merger at this time, or proposing to do so, and is not making any recommendation with respect to MKS' proposal at this time.
MARKET APPLICATIONS
Our products address a broad range of applications that, beginning in the first quarter of fiscal 2021, we group into the following markets: Microelectronics, Precision Manufacturing, Instrumentation, and Aerospace and Defense. Net sales by market application for fiscal 2020 have been restated to these market applications.
OUR STRATEGY
We strive to develop innovative and proprietary products and solutions that meet the needs of our customers and that are based on our core expertise in lasers and optical technologies. In pursuit of our strategy, we intend to:
•Effect our Good to Great Transformation—Since our incorporation, we have developed critical technology and have built this company into a multinational corporation and a leader in the photonics industry. We are engaged in a multi-pronged and multi-year transformation focusing on all aspects of our company. Namely, we are working to:
•Transform the operational efficiency of all our processes;
•Reduce the complexity of our portfolio;
•Focus our investments on growth opportunities; and
•Enhance the focus and alignment with our customers even further
•Streamline our manufacturing structure and improve our cost structure—We are focusing on optimizing the mix of products that we manufacture internally and externally. We expect to further utilize vertical integration where our internal manufacturing process is considered proprietary and seek to leverage external sources when the capabilities and cost structure are well developed and on a path towards commoditization.
•Focus on long-term improvement of adjusted EBITDA, in dollars and as a percentage of net sales, drive free cash flow and gross margin as a percentage of sales—We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock-based compensation expense, restructuring costs and certain other non-operating income and expense items, such as costs related to our acquisitions. Key initiatives to reach our goals for EBITDA and gross margin improvements include utilization of our manufacturing locations in Asia, optimizing our supply chain and continued leveraging of our infrastructure. Our focus on free cash flow is to generate cash over the long term as it is essential to maintaining a healthy business and providing funds to help fuel growth.
•Leverage our technology portfolio and application engineering to lead the proliferation of photonics into broader markets—We will continue to identify opportunities in which our technology portfolio and application engineering can be used to offer innovative solutions and gain access to new markets.
•Optimize our leadership position in existing markets—There are a number of markets where we have historically been at the forefront of technological development and product deployment and from which we have derived a substantial portion of our revenues. We plan to optimize our financial returns from these markets.
•Maintain and develop additional strong collaborative customer and industry relationships—We believe that the Coherent brand name and reputation for product quality, technical performance and customer satisfaction will help us to further develop our loyal customer base. We plan to maintain our current customer relationships and develop new ones with customers who are industry leaders and work together with these customers to design and develop innovative product systems and solutions as they develop new technologies.
•Develop and acquire new technologies and market share—We will continue to enhance our market position through our existing technologies and develop new technologies through our internal research and development efforts, as well as through the acquisition of additional complementary technologies, intellectual property, manufacturing processes and product offerings.
•Focus on our core end markets—While we are organized around our two segments of OLS and ILS, we also take a holistic approach to aligning and driving our business to focus on our four core end markets, which have been realigned as follows beginning in fiscal 2021:
•Microelectronics (which captures the 3 sub-markets of Display, Semiconductor, and Advanced Packaging & Interconnect);
•Instrumentation (which captures the 3 sub-markets of Bio-Instrumentation, Therapeutics & Research);
•Precision Manufacturing; and
•Aerospace & Defense.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, business combinations, accounting for long-lived assets (including goodwill and intangible assets), inventory valuation, warranty reserves and accounting for income taxes. See Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for our fiscal year ended October 3, 2020.
KEY PERFORMANCE INDICATORS
Below is a summary of some of the quantitative performance indicators (as defined below) that are evaluated by management to assess our financial performance. Some of the indicators are non-GAAP measures and should not be considered as an alternative to any other measure for determining operating performance or liquidity that is calculated in accordance with generally accepted accounting principles.
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | | | |
| | January 2, 2021 | | December 28, 2019 | | Change | | % Change |
| | (Dollars in thousands) |
| Net sales—OEM Laser Sources | $ | 211,162 | | | $ | 200,948 | | | $ | 10,214 | | | 5.1 | % |
| Net sales—Industrial Lasers & Systems | $ | 114,891 | | | $ | 119,823 | | | $ | (4,932) | | | (4.1) | % |
| Gross profit as a percentage of net sales—OEM Laser Sources | 45.2 | % | | 46.8 | % | | (1.6) | % | | N/A |
| Gross profit as a percentage of net sales—Industrial Lasers & Systems | 23.0 | % | | 13.5 | % | | 9.5 | % | | N/A |
| Research and development as a percentage of net sales | 8.6 | % | | 8.9 | % | | (0.3) | % | | N/A |
| Income before income taxes | $ | 14,661 | | | $ | 7,556 | | | $ | 7,105 | | | 94.0 | % |
| Net cash provided by operating activities | $ | 74,931 | | | $ | 60,041 | | | $ | 14,890 | | | 24.8 | % |
| Free cash flow | $ | 59,858 | | | $ | 48,545 | | | $ | 11,313 | | | 23.3 | % |
| Days sales outstanding in receivables | 62 | | | 66 | | | (4) | | | N/A |
| Annualized first quarter inventory turns | 2.0 | | | 1.9 | | | 0.1 | | | N/A |
| Net income as a percentage of net sales | 0.0 | % | | 1.8 | % | | (1.8) | % | | N/A |
| Adjusted EBITDA as a percentage of net sales | 15.3 | % | | 14.3 | % | | 1.0 | % | | N/A |
Net Sales
Net sales include sales of lasers, laser systems, related accessories and services. Net sales for the first quarter of fiscal 2021 increased 5.1% in our OLS segment and decreased 4.1% in our ILS segment from the same quarter one year ago. For a description of the reasons for changes in net sales refer to the "Results of Operations" section of this quarterly report.
Gross Profit as a Percentage of Net Sales
Gross profit as a percentage of net sales ("gross profit percentage") is calculated as gross profit for the period divided by net sales for the period. Gross profit percentage in the first quarter of fiscal 2021 decreased to 45.2% from 46.8% in our OLS segment and increased to 23.0% from 13.5% in our ILS segment as compared to the same quarter one year ago. For a description of the reasons for changes in gross profit refer to the "Results of Operations" section of this quarterly report.
Research and Development as a Percentage of Net Sales
Research and development as a percentage of net sales ("R&D percentage") is calculated as research and development expense for the period divided by net sales for the period. Management considers R&D percentage to be an important indicator in managing our business as investing in new technologies is a key to future growth. R&D percentage decreased to 8.6% for the first quarter of fiscal 2021 from 8.9% for the same quarter one year ago. For a description of the reasons for changes in R&D spending refer to the "Results of Operations" section of this quarterly report.
Net Cash Provided by Operating Activities
Net cash provided by operating activities as reflected on our Condensed Consolidated Statements of Cash Flows primarily represents the excess of cash collected from billings to our customers and other receipts over cash paid to our vendors for expenses and inventory purchases to run our business. We believe that cash flows from operations is an important performance indicator because cash generation over the long term is essential to maintaining a healthy business and providing funds to help fuel growth. For a description of the reasons for changes in net cash provided by operating activities refer to the "Liquidity and Capital Resources" section of this quarterly report.
Free Cash Flow
Free cash flow represents net cash provided by operating activities reduced by purchases of property and equipment, both as reflected on our Condensed Consolidated Statements of Cash Flows. We believe that free cash flow is an important performance indicator because it is a measure of cash generation after accounting for cash outflows to support operations and maintain capital assets. Cash generation over the long term is essential to maintaining a healthy business and providing funds to help fuel growth. For a description of the reasons for changes in free cash flow refer to the "Liquidity and Capital Resources"
section of this quarterly report, where we discuss the reasons for changes in net cash provided by operating and investing activities.
Days Sales Outstanding in Receivables
We calculate days sales outstanding ("DSO") in receivables as net receivables at the end of the period divided by net sales during the period and then multiplied by the number of days in the period, using 90 days for quarters. DSO in receivables indicates how well we are managing our collection of receivables, with lower DSO in receivables resulting in higher working capital availability. The more money we have tied up in receivables, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our DSO in receivables for the first quarter of fiscal 2021 decreased to 62 days from 66 days compared to the same quarter one year ago. The decrease was primarily due to improved collections of receivables for ELA tools used in the Asian flat panel display market and improved linearity with a lower concentration of sales in the last month of the quarter. These ELA tools are our highest priced products, so any changes in collection timing will have a more significant impact on overall DSO.
Annualized First Quarter Inventory Turns
We calculate annualized first quarter inventory turns as the cost of sales during the first quarter annualized and divided by net inventories at the end of the first quarter. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. Our annualized inventory turns for the first quarter of fiscal 2021 increased to 2.0 turns from 1.9 turns compared to the same quarter a year ago primarily due to higher flat panel display shipments in our OLS segment and higher inventory write-offs for restructuring programs partially offset by lower intangibles amortization in cost of goods sold as a result of the impairment charges recorded in the second quarter of fiscal 2020. Although our annualized inventory turns are lower than our historical turns primarily due to shifts in demand, we continue to carefully manage our inventory levels in anticipation of expected increased demand from our customers over the next 12 to 18 months.
Adjusted EBITDA as a Percentage of Net Sales
We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock-based compensation expense, restructuring costs and certain other non-operating income and expense items, such as costs related to our acquisitions. Key initiatives to reach our goals for EBITDA improvements include utilization of our manufacturing locations in Asia, optimizing our supply chain and continued leveraging of our infrastructure.
We utilize a number of different financial measures, both GAAP and non-GAAP, such as free cash flow and adjusted EBITDA as a percentage of net sales, in analyzing and assessing our overall business performance, for making operating decisions and for forecasting and planning future periods. We consider the use of non-GAAP financial measures helpful in assessing our current financial performance and ongoing operations. While we use non-GAAP financial measures as a tool to enhance our understanding of certain aspects of our financial performance, we do not consider these measures to be a substitute for, or superior to, the information provided by GAAP financial measures. We provide free cash flow and adjusted EBITDA as a percentage of sales in order to enhance investors’ understanding of our ongoing operations. These measures are used by some investors when assessing our performance.
Below is the reconciliation of our net cash provided by operating activities to our free cash flow:
| | | | | | | | | | | | |
| | Three Months Ended | |
| | January 2, 2021 | | December 28, 2019 | |
| Net cash provided by operating activities | $ | 74,931 | | | $ | 60,041 | | |
| Less: Purchases of property and equipment | 15,073 | | | 11,496 | | |
| Free cash flow | $ | 59,858 | | | $ | 48,545 | | |
| | | | |
Below is the reconciliation of our net income as a percentage of net sales to our adjusted EBITDA as a percentage of net sales:
| | | | | | | | | | | | |
| | Three Months Ended | |
| | January 2, 2021 | | December 28, 2019 | |
| Net income as a percentage of net sales | 0.0 | % | | 1.8 | % | |
| Income tax expense | 4.5 | % | | 0.6 | % | |
| Interest and other income (expense), net | 1.4 | % | | 1.7 | % | |
| Depreciation and amortization | 4.0 | % | | 7.9 | % | |
| Restructuring charges and other | 1.7 | % | | 0.3 | % | |
| | | | |
| Impairment (asset recoveries) and other charges | 0.0 | % | | (0.4) | % | |
| Stock-based compensation | 3.7 | % | | 2.4 | % | |
| Adjusted EBITDA as a percentage of net sales | 15.3 | % | | 14.3 | % | |
SIGNIFICANT EVENTS
Merger Agreement
See Item II "COMPANY OVERVIEW" for a description of the Merger Agreement entered into on January 18, 2021, between Coherent, Lumentum, Merger Sub I and Merger Sub II.
Coronavirus pandemic (COVID-19)
In December 2019, a novel coronavirus disease ("COVID-19") was reported, and in January 2020, the World Health Organization ("WHO") declared it a Public Health Emergency of International Concern. On February 28, 2020, the WHO raised its assessment of the COVID-19 threat from high to very high at a global level due to the continued increase in the number of cases and affected countries, and on March 11, 2020, the WHO characterized COVID-19 as a pandemic. In an effort to contain COVID-19 or slow its spread, governments around the world have enacted various measures, including orders to close all businesses not deemed "essential," isolate residents in their homes or places of residence, and practice social distancing at and away from work. These actions and the global health crisis caused by COVID-19 will continue to negatively impact global business activity, which will continue to negatively affect our revenue and results of operations. Each of the areas where we generate a majority of our revenue including Asia, Europe and North America have been and will continue to be impacted by COVID-19. The timing and extent of impact related to COVID-19 varies by country and region.
In determining the impact of the COVID-19 pandemic in relation to our net sales, we compare our actual results to our most recently published forecast and the net sales guidance range communicated in our quarterly earnings call. This forecast has been adjusted for known impacts to our bookings and net sales from COVID-19 and other factors. Using this criteria, we estimate that our sales for the following fiscal quarters were further negatively impacted by the COVID-19 pandemic: (i) for the second quarter of fiscal 2020 — $31.0 million, (ii) for the third quarter of fiscal 2020 — $9.0 million, (iii) for the fourth quarter of fiscal 2020 — an immaterial amount, and (iv) for the first quarter of fiscal 2021 — an immaterial amount. The effect of COVID-19 as forecasted and as further experienced was most significant in Asia during the second quarter of fiscal 2020 and began impacting Europe and North America only later in the second quarter of fiscal 2020 as the virus spread globally. In the third quarter of fiscal 2020, the global economic effect of the COVID-19 pandemic was less significant, though continued to be high in certain regions. While we believe that COVID-19 was a partial cause of the decline in revenue in the second quarter of fiscal 2020, we also had lower shipments related to ELA tools in the flat panel display market and lower shipments in materials processing applications in the second quarter of fiscal 2020 that were mostly unrelated to COVID-19.
During fiscal 2020 and continuing into the first quarter of fiscal 2021, the global demand environment was uncertain at times given the effects of COVID-19 on many businesses, including manufacturing facilities and customer confidence around the world. While we saw a partial recovery in order volumes in China in the latter half of March and the third quarter of fiscal 2020, this coincided with declining bookings in other regions, particularly in North America, and to a lesser extent in Europe and other countries in Asia. In the fourth quarter of fiscal 2020 and the first quarter of fiscal 2021, we saw global demand recover in all regions and begin to return to a more normalized demand trend. However, we cannot predict future resurgences of COVID-19 and the impact that it may have on future demand for our products and services, particularly given the recent shutdown measures taken in certain countries in Europe.
Currently, our major production facilities in Europe, Southeast Asia and the United States remain open. At all of our locations, we have transitioned from business continuity plans to return-to-operations plans while continuing to maintain high standards of employee safety and sanitization protocols. Our Return to Operations Plans have a phased approach with the primary focus on employee safety, with a continuing requirement for "working from home" for other members of our work force wherever possible. We have vertically integrated manufacturing, and many of the components produced at certain of our facilities supply other company facilities, are single sourced internally and are not available from third-party suppliers (for example our semiconductor diodes are manufactured in Santa Clara, California). While we do maintain a safety stock of critical components at our various locations, the scope, timing and duration of various government restrictions to address the COVID-19 pandemic could impact our internal supply chain. We have implemented certain policy changes to help support our employees impacted by COVID-19. These measures have and will continue to increase the cost of our operations but the magnitude and length of time of this impact is difficult to quantify at this time and may continue to be difficult to estimate in the future. If our sales are reduced for an extended period or if our production output falls because of government restrictions, we may be required to reduce payroll-related costs and other expenses in the future through layoffs or furloughs, even though we have not done so to date.
We have not experienced significant supply disruption from third-party component suppliers but if we experience strong demand in certain products, COVID-19 may impact the speed in which we are able to ramp up production due to supply chain constraints. However, we continue to face some supply chain constraints primarily related to logistics, including available air cargo space and higher freight rates. Available cargo space on flights between the U.S. and Europe, and Europe and Asia has been and remains limited as a result of the impact from COVID-19 and government and business responses to it, and this has increased shipping time and costs. In addition, shipments between countries have been more severely impacted by COVID-19 and we are experiencing delays due to additional checks at border crossings, including within Europe and Asia. There has also been sporadic restrictions on individual travel between certain states in the United States of America as well. Government actions related to COVID-19 come on the heels of increasing trade tensions between the United States and China, which may continue. We believe we have the ability to meet the near-term demand for our products, but the situation is fluid and subject to change.
We continue to monitor the rapidly evolving conditions and circumstances as well as guidance from international and domestic authorities, including public health authorities, and we may need to take additional actions based on their recommendations. There is considerable uncertainty regarding the impact on our business stemming from current measures and potential future measures that could restrict access to our facilities, limit our manufacturing and support operations and place restrictions on our workforce, customers and suppliers. The measures implemented by various authorities related to the COVID-19 outbreak have caused us to change our business practices including those related to where employees work, the distance between employees in our facilities, limitations on in-person meetings between employees and with customers, suppliers, service providers, and stakeholders as well as restrictions on some shipping activities, business travel to domestic and international locations or to attend trade shows, investor conferences and other events. In March of 2020, we formed a COVID Steering Committee to, among other things, propose, discuss, and implement best practices in response to COVID-19. The COVID Steering Committee meets weekly and more often if required. All of our executive officers are members of the COVID Steering Committee as are many key senior-level employees.
The COVID-19 pandemic has significantly increased worldwide and regional economic uncertainty and decreased demand for our products in many markets we serve, which could continue for an unknown period of time. In these circumstances, there may be developments outside of our control, including the length and extent of the COVID-19 outbreak, government-imposed measures and our ability to ship as well as install products and/or service installed products that may require us to adjust our operating plans. As such, given the dynamic nature of this situation, we cannot estimate with certainty the future impacts of COVID-19 on our financial condition, results of operations or cash flows. However, we do expect that it could have an adverse impact on our revenue as well as our overall profitability and may lead to an increase in inventory provisions, allowances for credit losses, and a volatile effective tax rate driven by changes in the mix of earnings across our markets.
See the additional Risk Factor included in Part II-Item 1A of this quarterly report regarding the impact of COVID-19.
Restructuring
In June 2019, we announced our plans to exit a portion of our HPFL business and consolidate all HPFL manufacturing and engineering functions in our Tampere, Finland facility by transferring certain HPFL activities from our Hamburg, Germany facility. We recorded charges related to this project in the first quarter of fiscal 2020 of $0.6 million, primarily related to accelerated depreciation and project management consulting.
We also vacated our leased facility in Santa Clara at the end of the lease term on July 31, 2020 and combined operations into our owned Santa Clara headquarters. We incurred costs in the first quarter of fiscal 2020 of $0.2 million, primarily related to accelerated depreciation. We also incurred costs in the first quarter of fiscal 2020 of $0.1 million for other projects.
In the fourth quarter of fiscal 2020, we began a restructuring program in our ILS segment which includes management reorganizations, the planned closure of certain manufacturing sites, and the right-sizing of global sales, service, order admin, marketing communication and certain administrative functions, among others. In the first quarter of fiscal 2021, we incurred costs of $5.4 million, primarily related to write-offs of excess inventory and accruals for vendor commitments, which is recorded in cost of sales, and estimated severance.
See Note 20, "Restructuring Charges" in the Notes to Condensed Consolidated Financial Statements.
RESULTS OF OPERATIONS
CONSOLIDATED SUMMARY
The following table sets forth, for the periods indicated, the percentage of total net sales represented by the line items reflected in our condensed consolidated statements of operations:
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| Net sales | 100.0 | % | | 100.0 | % |
| Cost of sales | 63.2 | % | | 65.9 | % |
| Gross profit | 36.8 | % | | 34.1 | % |
| Operating expenses: | | | |
| Research and development | 8.6 | % | | 8.9 | % |
| Selling, general and administrative | 22.8 | % | | 21.4 | % |
| | | |
| Amortization of intangible assets | 0.2 | % | | 0.5 | % |
| Total operating expenses | 31.6 | % | | 30.8 | % |
| Income from operations | 5.2 | % | | 3.3 | % |
| Other expense, net | (0.7) | % | | (0.9) | % |
| Income before income taxes | 4.5 | % | | 2.4 | % |
| Provision for income taxes | 4.5 | % | | 0.6 | % |
| Net income | 0.0 | % | | 1.8 | % |
Net income for the first quarter of fiscal 2021 was $0.1 million ($0.01 per diluted share). This included $10.6 million of after-tax stock-based compensation expense, $4.5 million of after-tax restructuring costs, $2.3 million of after-tax amortization of intangible assets, $8.6 million non-recurring income tax net charge and $0.6 million of excess tax charge for employee stock-based compensation. Net income for the first quarter of fiscal 2020 was $5.8 million ($0.24 per diluted share). This included $8.9 million of after-tax amortization of intangible assets, $6.9 million of after-tax stock-based compensation expense, $0.7 million of after-tax restructuring costs, $1.1 million of benefit from amounts received from a legal settlement on a resolved asset recovery matter and $0.7 million of excess tax benefits for employee stock-based compensation.
NET SALES
Market Application
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Amount | | Percentage
of total
net sales | | Amount | | Percentage
of total
net sales |
| Consolidated: | | | | | | | |
| Microelectronics | $ | 148,848 | | | 45.7 | % | | $ | 130,546 | | | 40.7 | % |
| Precision manufacturing | 81,450 | | | 25.0 | % | | 88,372 | | | 27.5 | % |
| Instrumentation | 85,227 | | | 26.1 | % | | 87,180 | | | 27.2 | % |
| Aerospace and defense | 10,528 | | | 3.2 | % | | 14,673 | | | 4.6 | % |
| Total | $ | 326,053 | | | 100.0 | % | | $ | 320,771 | | | 100.0 | % |
Net sales for the first quarter of fiscal 2021 increased by $5.3 million, or 2%, compared to the first quarter of fiscal 2020, with increases in the microelectronics market partially offset by decreases in the precision manufacturing, aerospace and defense and instrumentation markets. We believe that we are well-positioned with our laser-based technology to benefit from technology proliferation in rapid growth areas such as 5G, flexible OLED and MicroLED. In addition, we believe the market for laser-based medical instrumentation, devices and procedures will continue to grow with the aging population around the globe. We also anticipate that technology advances will result in increased defense spending.
The increase in the microelectronics market of $18.3 million, or 14%, was primarily due to increased shipments for flat panel display (higher shipments related to ELA tools used in the flat panel display market offset by lower revenues from consumable service parts) and advanced packaging applications. In microelectronics, we expect future increases in ELA tool shipments as Asian manufacturers improve yields and ramp manufacturing as indicated by the fact that we have received new orders for these products in our first quarter of fiscal 2021. In addition, it is expected that the handset market will transition to 5G technology. This technology requires more power from the battery which we expect will result in the handset manufacturers having to decide between shorter talk times or placement of larger batteries in existing form factors. Since OLED displays are much thinner than liquid crystal displays (LCD), we believe 5G will increase demand for OLED displays to accommodate larger batteries. In addition, we are seeing demand for laser solutions for MicroLED production. We believe that these technological demands will allow us to continue to maintain a leadership position in flat panel display applications. We are also seeing higher demand for semiconductor applications driven by continuous strength in cloud computing and data centers as well as in advanced packaging applications driven by 5G demand for smaller geometry, better power management and next generation printed circuit boards.
The decrease in the precision manufacturing market of $6.9 million, or 8%, was primarily due to decreased sales in machine tools materials processing applications. An index which often correlates to materials processing sales is the Purchasing Managers Index (PMI). PMI is a measure of the prevailing economic trends in manufacturing. The manufacturing PMI for the US, Germany and Japan has continued to rise over our last few fiscal quarters, with the US and Germany posting 6 year and 3 year highs, respectively, in December 2020. The rising PMIs are slightly tempered with a slowing down in the rise of production along with rising prices. We see automotive production returning to pre-COVID-19 levels and expect increased demand in the second quarter of fiscal 2021 and beyond. Conversely, we anticipate some near-term weakness in medical device manufacturing as elective surgeries have declined again as COVID-19 cases increase. The timing for our recovery in some portions of this market remains uncertain.
Sales in the aerospace and defense market decreased $4.1 million, or 28%, primarily due to lower optics shipments in defense and aerospace applications. We anticipate the defense market, especially amplifiers for directed energy and specialty optics for aerospace, to be a multi-year growth opportunity for us.
The decrease in the instrumentation market of $2.0 million, or 2%, was due primarily to lower shipments for biomedical instrumentation applications. We supply lasers and optical systems for biomedical instrumentation applications and our lasers have been used in diagnostic instruments in applications including gene sequencing, biomarker identification and vaccine development. We expect demand in the scientific and government program applications to continue to fluctuate from quarter to quarter.
Segments
We are organized into two reportable operating segments: OLS and ILS. While both segments deliver cost-effective, highly reliable photonics solutions, OLS is focused on high performance laser sources and complex optical sub-systems, typically used in microelectronics manufacturing, medical diagnostics and therapeutic applications, as well as in scientific research. ILS
delivers high performance laser sources, sub-systems and tools primarily used for industrial laser materials processing, serving important end markets like automotive, machine tool, consumer goods, and medical device manufacturing as well as applications in aerospace and defense.
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Amount | | Percentage
of total
net sales | | Amount | | Percentage
of total
net sales |
| Consolidated: | | | | | | | |
| OEM Laser Sources (OLS) | $ | 211,162 | | | 64.8 | % | | $ | 200,948 | | | 62.6 | % |
| Industrial Lasers & Systems (ILS) | 114,891 | | | 35.2 | % | | 119,823 | | | 37.4 | % |
| Total | $ | 326,053 | | | 100.0 | % | | $ | 320,771 | | | 100.0 | % |
Net sales for the first quarter of fiscal 2021 increased by $5.3 million, or 2%, compared to the first quarter of fiscal 2020, with increases of $10.2 million, or 5%, in our OLS segment partially offset by decreases of $4.9 million, or 4%, in our ILS segment.
The increase in our OLS segment sales was primarily due to higher demand for flat panel display applications, with higher shipments of ELA tools partially offset by lower revenues from consumable service parts, as well as higher shipments for applications in the precision manufacturing market. The increased sales were partially offset by lower shipments for applications in the aerospace and defense market.
The decrease in our ILS segment sales was primarily due to lower sales to the precision manufacturing market, primarily for machine tools applications, partially offset by higher sales for advanced packaging applications within the microelectronics market.
GROSS PROFIT
Consolidated
Our gross profit percentage increased by 2.7% to 36.8% in the first quarter of fiscal 2021 from 34.1% in the first quarter of fiscal 2020.
The 2.7% increase in gross profit percentage during the first quarter of fiscal 2021 included 2.8% lower amortization of intangibles primarily due to the impairment of ILS intangibles in the second quarter of fiscal 2020 and a 1.3% unfavorable impact of higher restructuring costs, primarily related to the write-off of inventories, accelerated depreciation and severance costs in the first quarter of fiscal 2021 due to our planned closure of certain manufacturing sites. Excluding the 1.5% favorable net impact of lower intangibles amortization and higher restructuring costs, gross profit percentage increased 1.2% compared to the first quarter of fiscal 2020 primarily due to lower warranty costs (1.1%) and lower other costs (0.7%) partially offset by unfavorable product margins (0.3%) and higher stock-based compensation (0.3%) as a percentage of sales. The lower warranty and installation costs as a percentage of sales were due to fewer warranty events, particularly for our HPFL products sold in China, as well as for fiber components in ILS and decreased warranty events in the instrumentation and microelectronics markets within OLS. Other costs, excluding restructuring provisions, were lower primarily due to lower inventory provisions for excess and obsolete inventory costs in certain OLS and ILS business units. Unfavorable product margins in OLS as a result of lower margins (both mix and average selling prices) for flat panel display systems in our microelectronics market and the unfavorable impact of the stronger Euro as well as unfavorable absorption of manufacturing costs were partially offset by favorable product margins in ILS due to higher capitalized variances resulting from lower sales volumes as well as lower manufacturing and service costs due to the impact of restructuring plans initiated in prior periods.
Our gross profit percentage has been and will continue to be affected by a variety of factors including the impact of COVID-19, shipment volumes, product mix, pricing on volume orders, our ability to manufacture advanced and more complex products, manufacturing efficiencies, excess and obsolete inventory write-downs, warranty costs, amortization of intangibles, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, commodity prices and foreign currency fluctuations against the U.S. Dollar, particularly the recent volatility of the Euro and to a lesser extent, the Japanese Yen and South Korean Won. Our gross profit in future quarters will continue to be favorably
impacted by lower amortization and depreciation as a result of the impairments of long-lived assets in our ILS segment in the second quarter of fiscal 2020. We have embarked on a number of internal strategic initiatives and are expecting that the impact of those will include continued improvement of our gross margins during the remainder of calendar 2021.
OEM Laser Sources
The gross profit percentage in our OLS segment decreased by 1.6% to 45.2% in the first quarter of fiscal 2021 from 46.8% in the first quarter of fiscal 2020.
The 1.6% decrease in gross profit percentage during the first quarter of fiscal 2021 was primarily due to unfavorable product margins (3.4%) as a result of the unfavorable impact of lower margins (both mix of product and service revenues and average selling prices) for flat panel display systems in our microelectronics market and the unfavorable impact of the stronger Euro as well as unfavorable absorption of manufacturing costs. The unfavorable product costs were partially offset by lower other costs (1.0%) primarily due to lower inventory provisions for excess and obsolete inventory in certain business units and lower warranty costs (0.8%) as a percentage of sales due to decreased warranty events in the instrumentation and microelectronics markets.
Industrial Lasers & Systems
The gross profit percentage in our ILS segment increased by 9.5% to 23.0% in the first quarter of fiscal 2021 from 13.5% in the first quarter of fiscal 2020.
The 9.5% increase in gross profit percentage during the first quarter of fiscal 2021 included 7.3% lower amortization of intangibles due to the impairment of ILS intangibles in the second quarter of fiscal 2020 and a 4.0% unfavorable impact of higher restructuring costs, primarily related to the write-off of inventories, accelerated depreciation and severance costs in the first quarter of fiscal 2021 due to our planned closure of certain manufacturing sites. Excluding the net 3.3% favorable impact of lower intangibles amortization and higher restructuring costs, gross profit percentage increased 6.2% compared to the first quarter of fiscal 2020 primarily due to favorable product costs (4.8%) and lower warranty and installation costs (1.5%) as a percentage of sales due to fewer warranty events, particularly for our HPFL products sold in China, and for fiber components products, partially offset by higher other costs (0.1%). Product costs, net of restructuring costs, were favorable primarily due to higher capitalized variances resulting from lower sales volumes as well as lower manufacturing and service costs due to the impact of restructuring plans initiated in prior periods.
OPERATING EXPENSES:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| January 2, 2021 | | December 28, 2019 |
| Amount | | Percentage of
total net sales | | Amount | | Percentage of
total net sales |
| (Dollars in thousands) |
| Research and development | $ | 28,221 | | | 8.6 | % | | $ | 28,680 | | | 8.9 | % |
| Selling, general and administrative | 74,228 | | | 22.8 | % | | 68,551 | | | 21.4 | % |
| | | | | | | |
| | | | | | | |
| Amortization of intangible assets | 597 | | | 0.2 | % | | 1,432 | | | 0.5 | % |
| Total operating expenses | $ | 103,046 | | | 31.6 | % | | $ | 98,663 | | | 30.8 | % |
Research and development
Research and development ("R&D") expenses decreased $0.5 million, or 2%, during the first quarter of fiscal 2021 compared to the same quarter one year ago. The decrease was primarily due to $0.6 million lower headcount expenses as well as $0.6 million lower spending on materials net of the impact of lower customer reimbursements. The lower headcount expenses were due to the impact of headcount reductions and the timing of vacations partially offset by the unfavorable impact of foreign exchange rates and higher variable compensation. Partially offsetting the decreases, was $0.6 million higher stock-based compensation expense due to increased grants to employees and $0.1 million higher charges for increases in deferred compensation plan liabilities.
On a segment basis as compared to the prior year period, OLS R&D spending decreased $0.1 million with lower spending on materials and headcount offset by the unfavorable impact of foreign exchange rates. ILS R&D spending decreased $1.1 million
primarily due to lower spending for headcount and materials partially offset by the unfavorable impact of foreign exchange rates. Corporate and other R&D spending increased $0.7 million primarily due to higher stock-based compensation expense and higher charges for increases in deferred compensation plan liabilities.
Selling, general and administrative
Selling, general and administrative ("SG&A") expenses increased $5.7 million, or 8%, during the first quarter of fiscal 2021 compared to the same quarter one year ago. The increase was primarily due to $3.1 million higher spending on headcount and $2.7 million higher stock-based compensation expense partially offset by $0.1 million lower other variable spending. The $3.1 million higher spending on headcount was primarily due to higher variable compensation, the unfavorable impact of foreign exchange rates and higher severance and restructuring costs partially offset by the impact of lower headcount. The $2.7 million higher stock-based compensation expense is primarily due to increased equity grants to our employees, including our executives. The $0.1 million lower variable spending included lower travel and other discretionary spending due to COVID-19 and lower depreciation expense due to the impairment of ILS long-lived assets in the second quarter of fiscal 2020 offset by higher consulting on special projects, the impact of a benefit in first quarter of fiscal 2020 of $1.4 million due to amounts received from a legal settlement on a resolved asset recovery matter and the unfavorable impact of foreign exchange rates.
On a segment basis as compared to the prior year period, OLS SG&A expenses decreased $0.3 million primarily due to lower variable spending on travel and other discretionary spending partially offset by higher headcount spending and the unfavorable impact of foreign exchange rates. ILS SG&A spending decreased $0.2 million primarily due to lower headcount spending including the impact of lower headcount and lower variable spending on travel and depreciation partially offset by the prior year settlement on the resolved asset recovery matter and unfavorable impact of foreign exchange rates. Corporate and other SG&A spending increased $6.2 million primarily due to higher stock-based compensation expense, higher headcount spending (including higher variable compensation) and higher consulting fees.
Amortization of intangible assets
Amortization of intangible assets decreased $0.8 million in the three months ended January 2, 2021 compared to the same period last year. The decrease was primarily due to the impairment of ILS intangibles in the second quarter of fiscal 2020 and the completion of the amortization of certain intangibles from acquisitions partially offset by the unfavorable impact of foreign exchange rates.
OTHER INCOME (EXPENSE) — NET
Other income (expense), net, decreased by $0.7 million to an expense of $2.3 million in the first quarter of fiscal 2021 from an expense of $3.0 million in the first quarter of fiscal 2020. The decrease in net other expense was primarily due to a $0.5 million higher benefit from non-service pension income.
INCOME TAXES
Our effective tax rate on income before income taxes for the three months ended January 2, 2021 of 99.0% was higher than the U.S. federal tax rate of 21.0% primarily due to the establishment of valuation allowances for certain foreign deferred tax assets, the impact of income subject to foreign tax rates that are higher than the U.S. tax rates, the deferred taxes on foreign earnings not considered permanently reinvested, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under Internal Revenue Code Section 162(m). These amounts are partially offset by the benefit of federal research and development tax credits and our Singapore tax exemption.
We assess our ability to realize our net deferred tax assets on a quarterly basis and establish a valuation allowance if it is more-likely-than-not that some portion of the deferred tax assets will not be realized. Although several factors may be considered for assessing the need for a valuation allowance, a 12-quarter cumulative loss is generally viewed as a primary factor based on the weight given to historical results versus projections. In Germany we have an "Organschaft" arrangement among our German entities in which the annual profit and loss results are ultimately pooled at the parent level of Coherent Holding B.V. & Co. KG. During the first quarter of fiscal 2021, our German pooled results reflected a loss and we now have a cumulative loss position for the last 12 quarters. Due to the weight of objectively verifiable negative evidence, we believe that it is now more likely-than-not that our German Organschaft group’s deferred tax assets will not be realized as of first quarter of fiscal 2021. Accordingly, we have recorded a valuation allowance of approximately $7.0 million related to these deferred tax assets. It is reasonably possible that significant positive evidence may become available to reach a conclusion that a significant portion of the valuation allowance will no longer be needed, and if so, we may release our valuation allowance in the future.
Our effective tax rate on income before income taxes for the three months ended December 28, 2019 of 23.3% was higher than the U.S. federal tax rate of 21.0% primarily due to the impact of income subject to foreign tax rates that are higher than the U.S. tax rates, an accrual for foreign withholding taxes on certain current year foreign earnings not considered permanently reinvested, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under Internal Revenue Code Section 162(m). These amounts are partially offset by the net excess tax benefits from restricted stock unit vesting, the benefit of federal research and development tax credits, the benefit of certain tax audit settlements and our Singapore tax exemption.
LIQUIDITY AND CAPITAL RESOURCES
At January 2, 2021, we had assets classified as cash and cash equivalents and short-term investments, in an aggregate amount of $543.6 million, compared to $475.6 million at October 3, 2020. In addition, at January 2, 2021, we had $5.5 million of restricted cash. At January 2, 2021, approximately $403.2 million of our cash and securities was held in certain of our foreign subsidiaries and branches, $380.0 million of which was denominated in currencies other than the U.S. Dollar. Our current plans do not demonstrate a need for these funds to support our domestic operations. If, however, a portion of these funds are needed for and distributed to our operations in the United States, we may be subject to additional foreign withholding taxes and certain state taxes. The amount of the U.S. and foreign taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated. We historically asserted our intention to indefinitely reinvest foreign earnings. As a result of the enactment of the Tax Act and certain income tax treaty updates, we no longer consider foreign earnings to be indefinitely reinvested in our foreign subsidiaries. We actively monitor the third-party depository institutions that hold these assets, primarily focusing on the safety of principal and secondarily maximizing yield on these assets. We diversify our cash and cash equivalents and investments among various financial institutions, money market funds, sovereign debt and other securities in order to reduce our exposure should any one of these financial institutions or financial instruments fail or encounter difficulties. To date, we have not experienced any material loss or lack of access to our invested cash, cash equivalents or short-term investments. However, we can provide no assurances that access to our invested cash, cash equivalents or short-term investments will not be impacted by adverse conditions in the financial markets. To date, we have had sufficient liquidity to manage the financial impact of COVID-19. However, we can provide no assurance that this will continue to be the case if the impact of COVID-19 is prolonged or if there is an extended impact on us or the economy in general. Further, COVID-19 has caused significant uncertainty and volatility in the credit markets. If our liquidity or access to capital becomes significantly constrained, or if costs of capital increase significantly due to the impact of COVID-19 as result of a volatility in the capital markets, a reduction in our creditworthiness or other factors, then our financial condition, results of operations and cash flows could be materially adversely affected.
See "Part I, Item 3. Quantitative and Qualitative Disclosures About Market Risk" below for more information about risks and trends related to foreign currencies.
Sources and Uses of Cash
Historically, our primary source of cash has been provided by operations. Other sources of cash in the past few fiscal years include proceeds from our Euro Term Loan used to finance our acquisition of Rofin, proceeds received from the sale of our stock through our employee stock purchase plan as well as borrowings under our Revolving Credit Facility. Our historical uses of cash have primarily been for acquisitions of businesses and technologies, capital expenditures, the repurchase of our common stock and debt issuance costs. Supplemental information pertaining to our historical sources and uses of cash is presented as follows and should be read in conjunction with our condensed consolidated statements of cash flows and the notes to condensed consolidated financial statements:
| | | | | | | | | | | |
| | Three Months Ended |
| | January 2, 2021 | | December 28, 2019 |
| | (in thousands) |
| Net cash provided by operating activities | $ | 74,931 | | | $ | 60,041 | |
| | | |
| | | |
| Issuance of shares under employee stock plans | 5,896 | | | 5,747 | |
| Net settlement of restricted common stock | (8,903) | | | (13,175) | |
| | | |
| Borrowings (repayments), net | (2,572) | | | (2,050) | |
| Purchases of property and equipment | (15,073) | | | (11,496) | |
Net cash provided by operating activities increased by $14.9 million for the first three months of fiscal 2021 compared to the same period one year ago. The increase in cash provided by operating activities was primarily due to higher cash flows from deferred taxes, taxes payable, inventories and accrued payroll partially offset by lower cash flows from accounts receivable and lower net income including non-cash adjustments. In order to support our liquidity during the pandemic, we are proactively taking measures to increase available cash on hand, including, but not limited to, reducing discretionary spending for operating and capital expenses. To further support our liquidity, we elected to defer the payment of our employer portion of social security taxes beginning in April 2020 and through the end of the calendar year, which we expect to pay in equal installments in the first quarters of fiscal 2022 and 2023, as provided for under the CARES Act. We believe that our existing cash, cash equivalents and short term investments combined with cash to be provided by operating activities and amounts available under our Revolving Credit Facility will be adequate to cover our working capital needs and planned capital expenditures for at least the next 12 months to the extent such items are known or are reasonably determinable based on current business and market conditions, including consideration of the impact of COVID-19. However, we may elect to finance certain of our capital expenditure requirements through other sources of capital. We continue to follow our strategy to further strengthen our financial position by using available cash flow to fund operations.
We intend to continue to consider acquisition opportunities at valuations we believe are reasonable based upon market conditions. However, we cannot accurately predict the timing, size and success of our acquisition efforts or our associated potential capital commitments. Furthermore, we cannot assure you that we will be able to acquire businesses on terms acceptable to us. We expect to fund future acquisitions, if any, through existing cash balances and cash flows from operations and additional borrowings (as in our acquisition of Rofin). If required, we will consider the issuance of securities. The extent to which we will be willing or able to use our common stock to make acquisitions will depend on its market value at the time and the willingness of potential sellers to accept it as full or partial payment. On July 31, 2020, we reached an agreement to purchase Electro-optics Technology, Inc., a highly specialized U.S.-based components company, which will enable us to vertically integrate and improve the performance of our directed energy amplifier technology. We expect the acquisition to close in the second or third quarter of fiscal 2021, after we clear all regulatory requirements. We do not believe this acquisition will have a material impact on our liquidity or capital resources.
In fiscal 2020, we made debt principal payments of $7.5 million, recorded interest expense on the Euro Term Loan of $12.3 million and recorded $3.3 million amortization of debt issuance costs. In fiscal 2020, we recorded interest expense related to our Revolving Credit Facility of $0.6 million.
In the first three months of fiscal 2021, we made debt principal payments of $2.0 million, recorded interest expense on the Euro Term Loan of $3.2 million and recorded $0.9 million amortization of debt issuance costs. In the first three months of fiscal 2021, we recorded interest expense related to our Revolving Credit Facility of $0.1 million.
On October 28, 2018, our board of directors authorized a stock repurchase program authorizing the Company to repurchase up to $250.0 million of our common stock through December 31, 2019, with a limit of no more than $75.0 million per quarter. During fiscal 2019, we repurchased and retired 603,828 shares of outstanding common stock under this program at an average price of $128.20 per share for a total of $77.4 million. We made no repurchases under the program during fiscal 2020 and the program expired on December 31, 2019. On February 5, 2020, our board of directors authorized a stock repurchase program authorizing the Company to repurchase up to $100.0 million of our common stock through January 31, 2021. We made no repurchases under the program, which expired January 31, 2021. See Note 14, "Stock Repurchases" in the Notes to Condensed Consolidated Financial Statements.
On December 21, 2020, Coherent LaserSystems GmbH & Co. KG entered into a loan agreement with Commerzbank for borrowings of up to 24 million Euros, to be drawn down by October 29, 2021, to finance a portion of the construction of a new facility in Germany. As of January 2, 2021, no amounts have been withdrawn under this loan facility.
Additional sources of cash available to us, in addition to the amounts available under the Revolving Credit Facility, were international currency lines of credit and bank credit facilities totaling $17.0 million as of January 2, 2021, of which $14.4 million was unused and available. These unsecured international credit facilities were used in Europe during the first three months of fiscal 2021. As of January 2, 2021, we had utilized $2.6 million of the international credit facilities as guarantees in Europe.
Our ratio of current assets to current liabilities decreased to 4.3:1 at January 2, 2021 compared to 4.5:1 October 3, 2020. The decrease in our ratio was primarily due to higher other current liabilities partially offset by increases in our ratio due to higher cash and cash-equivalents. Our cash and cash equivalents, short-term investments and working capital are as follows:
| | | | | | | | | | | |
| | January 2, 2021 | | October 3, 2020 |
| | (in thousands) |
| Cash and cash equivalents | $ | 508,214 | | | $ | 440,258 | |
| Short-term investments | 35,361 | | | 35,346 | |
| Working capital | 982,107 | | | 943,606 | |
Contractual Obligations and Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements as defined under Regulation S-K of the Securities Act of 1933. Information regarding our contractual obligations is provided in Item 7 "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended October 3, 2020. There have been no material changes in contractual obligations outside of the ordinary course of business since October 3, 2020. Information regarding our other financial commitments at January 2, 2021 is provided in the Notes to Condensed Consolidated Financial Statements in this report.
Changes in Financial Condition
Cash provided by operating activities during the first three months of fiscal 2021 was $74.9 million, which included cash provided by operating assets and liabilities of $27.8 million (primarily lower inventories and higher income taxes payable and accrued payroll partially offset by payments made for lease liabilities and higher prepaid assets), depreciation and amortization of $13.2 million, net increases in deferred tax assets of $12.6 million, stock-based compensation expense of $12.2 million, amortization of operating ROU assets of $4.4 million, non-cash restructuring charges of $3.5 million, amortization of debt issuance cost of $0.9 million and net income of $0.1 million. Cash provided by operating activities during the first three months of fiscal 2020 was $60.0 million, which included depreciation and amortization of $25.5 million, cash provided by operating assets and liabilities of $17.1 million (primarily lower accounts receivable net of lower accrued payroll, payments made for lease liabilities, lower other accruals, higher prepaid assets and lower income taxes payable), stock-based compensation expense of $7.8 million, net income of $5.8 million, amortization of operating ROU assets of $4.1 million, amortization of debt issuance cost of $0.8 million and non-cash restructuring charges of $0.6 million partially offset by net increases in deferred tax assets of $1.9 million.
Cash used in investing activities during the first three months of fiscal 2021 was $13.4 million, which included $13.4 million, net of proceeds from dispositions, used to acquire property and equipment and purchase and upgrade buildings. Cash used in investing activities during the first three months of fiscal 2020 was $10.7 million, which included $10.8 million, net of proceeds from dispositions, used to acquire property and equipment and purchase and upgrade buildings partially offset by $0.1 million in net sales of available-for-sale securities.
Cash used in financing activities during the first three months of fiscal 2021 was $5.6 million, which included $8.9 million in outflows due to net settlement of restricted stock units and $2.6 million net debt payments partially offset by $5.9 million generated from our employee stock option and purchase plans. Cash used in financing activities during the first three months of fiscal 2020 was $9.5 million, which included $13.2 million in outflows due to net settlement of restricted stock units and $2.1 million net debt payments partially offset by $5.7 million generated from our employee stock option and purchase plans.
Changes in exchange rates during the first three months of fiscal 2021 resulted in an increase in cash balances of $12.2 million. Changes in exchange rates during the first three months of fiscal 2020 resulted in an increase in cash balances of $4.0 million.
RECENT ACCOUNTING STANDARDS
See Note 2, "Recent Accounting Standards" in the Notes to Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our condensed consolidated financial position, results of operations and cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk disclosures
We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
Interest rate sensitivity
A portion of our investment portfolio is composed of fixed income securities. These securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately (whether due to changes in overall market rates or credit worthiness of the issuers of our individual securities) and uniformly by 10% from levels at January 2, 2021, the fair value of the portfolio, based on quoted market prices in active markets involving similar assets, would decline by an immaterial amount due to their short-term maturities. We have the ability to generally hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. If necessary, we may sell short-term investments prior to maturity to meet our liquidity needs.
At January 2, 2021, the fair value of our available-for-sale debt securities was $35.4 million, all of which was classified short-term investments. Gross unrealized gains on available-for-sale debt securities were $104,000 at January 2, 2021.
We are exposed to market risks related to fluctuations in interest rates related to our Euro Term Loan. As of January 2, 2021, we owed $437.7 million on this loan with an interest rate of 3.0% as of January 2, 2021. We performed a sensitivity analysis on the outstanding portion of our debt obligation as of January 2, 2021. Should the current average interest rate increase or decrease by 10%, the resulting annual increase or decrease to interest expense would be approximately $1.3 million as of January 2, 2021.
Foreign currency exchange risk
We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, the Japanese Yen, the South Korean Won, the Singapore Dollar and the Chinese Renminbi. Additionally we have operations in different countries around the world with costs incurred in the foregoing currencies and other local currencies, such as British Pound Sterling, Malaysian Ringgit, Swiss Franc, Taiwan Dollar, Swedish Krona, Canadian Dollar and Vietnamese Dong. As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. For example, because of our significant manufacturing operations in Europe and resulting expenses and costs, a weakening Euro is advantageous and a strengthening Euro is disadvantageous to our financial results. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for trading purposes.
We do not anticipate any material adverse effect on our condensed consolidated financial position, results of operations or cash flows resulting from the use of these instruments. There can be no assurance that these strategies will be effective or that transaction losses can be minimized or forecasted accurately. While we model currency valuations and fluctuations, these may not ultimately be accurate. If a financial counterparty to any of our hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, we may experience material financial losses. In the current economic environment, the risk of failure of a financial party remains high.
A hypothetical 10% change in foreign currency rates on our forward contracts would not have a material impact on our results of operations, cash flows or financial position. For example, a 10% change in the Euro as of October 3, 2020 would amount to less than a 0.25% change on our consolidated balance sheet.
At January 2, 2021, approximately $403.2 million of our cash, cash equivalents and short-term investments were held outside the U.S. in certain of our foreign operations, $380.0 million of which was denominated in currencies other than the U.S. dollar.
See Note 7, "Derivative Instruments and Hedging Activities" in Notes to Condensed Consolidated Financial Statements for further discussion of our derivatives and hedging activities.
ITEM 4. CONTROLS AND PROCEDURES
Management’s Evaluation of Disclosure Controls and Procedures
We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as of January 2, 2021 ("Evaluation Date"). The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective in providing reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the three months ended January 2, 2021.
Inherent Limitations over Internal Control
Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, 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. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item may be found in Note 13, "Commitments and Contingencies" in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report and is incorporated herein by reference.
ITEM 1A. RISK FACTORS
RISK FACTORS
You should carefully consider the followings risks when considering an investment in our common stock. These risks could materially affect our business, results of operations or financial condition, cause the trading price of our common stock to decline materially or cause our actual results to differ materially from those expected or those expressed in any forward-looking statements made by us. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under "Forward-Looking Statements" of our Annual Report on Form 10-K for the fiscal year ended October 3, 2020 and the risks described elsewhere in this quarterly report. Additionally, these risks and uncertainties described herein are not the only ones facing us. Other events that we do not currently anticipate or that we currently deem immaterial also may affect our business, results of operations or financial condition.
RISKS RELATED TO OUR PROPOSED ACQUISITION BY LUMENTUM
Our proposed acquisition may be delayed or not occur at all for a variety of reasons, including the possibility that the Merger Agreement is terminated prior to the consummation of the acquisition, which could result in a termination fee being payable by us.
On January 18, 2021, we entered into an Agreement and Plan of Merger (the "Merger Agreement"), with Lumentum Holdings Inc. ("Lumentum"), Cheetah Acquisition Sub, Inc. ("Merger Sub I"), a wholly owned subsidiary of Lumentum, and Cheetah Acquisition Sub LLC ("Merger Sub II"), a wholly owned subsidiary of Lumentum. Pursuant to the terms of the Merger Agreement, the acquisition of Coherent will be accomplished through a merger of Merger Sub I with and into Coherent (the "First Merger"), with Coherent surviving the First Merger, followed by a merger of Coherent with and into Merger Sub II, with Merger Sub II continuing as the surviving entity (taken together with the First Merger, the "Mergers"). Completion of the Mergers is subject to customary closing conditions, including (i) the absence of certain legal impediments, (ii) the expiration or termination of the required waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (iii) antitrust approvals in other applicable jurisdictions, including China and South Korea, (iv) the effectiveness of a registration statement on Form S-4 registering the shares of Lumentum common stock to be issued in connection with the First Merger, (v) approval by the holders of a majority of the outstanding shares of Lumentum common stock and Coherent common stock, and (vi) the receipt by us of a closing tax opinion. Many of the conditions to completion of the Mergers are not within either our or Lumentum’s control, and we cannot predict when or if these conditions will be satisfied (or waived, as applicable). The Merger Agreement contains customary mutual termination rights for us and Lumentum, including if the First Merger is not completed by October 19, 2021 (subject to automatic extension first to January 19, 2022, April 19, 2022 and then to July 19, 2022, in each case, to the extent the regulatory closing conditions remain outstanding).
The Merger Agreement also contains customary termination rights for the benefit of each party, including (i) if the board of directors of the other party changes its recommendation, (ii) if the board of directors of the other party authorizes entry into a definitive agreement relating to a superior proposal, and (iii) if the other party breaches its representations, warranties or covenants under the Merger Agreement in a way that would result in a failure of the other party’s condition to closing being satisfied (subject to certain procedures and cure periods).
On February 4, 2021, MKS Instruments, Inc. ("MKS") made an unsolicited proposal to acquire Coherent in a cash and stock transaction. Under the terms of MKS' proposal, each share of Coherent common stock would be exchanged for $115.00 in cash and 0.7473 of a share of MKS common stock at the completion of the transaction, subject to customary closing conditions, including receipt of U.S. and foreign antitrust approvals and stockholder approvals. Coherent's board of directors is evaluating MKS' proposal and has not made a determination as to whether it is superior to the Lumentum transaction under the terms of the Lumentum Merger Agreement. After consulting with its financial and legal advisors, however, Coherent's board of directors has determined that MKS' proposal could lead to a transaction that is superior to its pending transaction with Lumentum and, accordingly, Coherent has determined to engage in discussions with MKS to further evaluate the comparative benefits and risks of MKS' proposed transaction relative to Coherent's pending transaction with Lumentum, including the near and long term financial opportunities of each transaction, the expected completion timing of each transaction, and the closing risks associated with each transaction. There can be no assurances that Coherent will conclude that the transaction proposed by
MKS is superior to Coherent's pending transaction with Lumentum and Coherent investors are encouraged to await a final determination from Coherent's board of directors. Notwithstanding its receipt of MKS' proposal and pending discussions between Coherent and MKS, Coherent's board of directors continues to recommend Coherent's merger agreement with Lumentum to its stockholders. Coherent's board of directors is not modifying or withdrawing its recommendation with respect to the Lumentum merger agreement and the Lumentum merger at this time, or proposing to do so, and is not making any recommendation with respect to MKS' proposal at this time.
In light of the foregoing, the Mergers may not be completed or may not be completed as quickly as expected.
Failure to complete the Mergers could adversely affect our business and the market price of our common stock in a number of ways, including:
•the market price of our common stock may decline to the extent that the current market price reflects an assumption that the Mergers will be consummated;
•if the Merger Agreement is terminated under certain circumstances specified in the Merger Agreement (including termination by us to accept a superior proposal), we would be required to pay Lumentum a termination fee of $217.6 million and $25 million in expenses as payment for Lumentum’s costs and expenses in connection with the Merger Agreement;
•we have incurred, and will continue to incur, significant expenses for professional services in connection with the Mergers for which we will have received little or no benefit if the Mergers are not consummated; and
•failure to consummate the Mergers may result in negative publicity and/or give a negative impression of us in the investment community or business community generally.
The Mergers could divert management’s attention, disrupt our relationships with third parties and employees and result in negative publicity or legal proceedings, any of which could negatively impact our operating results and ongoing business.
We have expended, and continue to expend, significant management time and resources in an effort to complete the Mergers, which may have a negative impact on our ongoing business. Uncertainty regarding the outcome of the Mergers and our future could disrupt our business relationships with our existing and potential customers, suppliers, vendors, landlords and other business partners, who may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. Uncertainty regarding the outcome of the Mergers could also adversely affect our ability to recruit and retain key personnel and other employees. The pendency of the Mergers may also result in negative publicity and a negative impression of us in the financial markets, and may result in potential litigation against us and our directors and officers. Such litigation may be distracting to management and may require us to incur significant costs. Such litigation could result in the Mergers being delayed and/or enjoined by a court of competent jurisdiction, which could prevent the Mergers from becoming effective. The occurrence of any of these events individually or in combination could have a material and adverse effect on our business, financial condition and results of operations.
While the Merger Agreement is in effect, we are subject to certain interim covenants.
While the Merger Agreement is in effect, we are subject to customary interim operating covenants and must generally operate our business in the ordinary course, subject to certain exceptions. These restrictions could prevent us from pursuing certain business opportunities that may arise prior to the consummation of the Mergers. The interim operating covenants require us to obtain Lumentum’s consent (such consent not to be unreasonably conditioned, withheld or delayed) prior to taking certain actions, which requirement could significantly impact Coherent’s operating results and ongoing business.
After the Mergers, our stockholders will have a significantly lower ownership and voting interest in Lumentum than they
currently have in Coherent and will exercise less influence over management.
Coherent and Lumentum estimate that, as of immediately following completion of the First Merger, holders of Coherent common stock immediately prior to the First Merger will hold approximately 27% of the combined company. Consequently, former Coherent stockholders will have less influence over the management and policies of Lumentum than they currently have over the management and policies of Coherent.
After completion of the Mergers, Lumentum may fail to realize the anticipated benefits and cost savings of the Mergers,
which could adversely affect the value of Lumentum common stock.
The success of the Mergers will depend, in part, on Lumentum’s ability to realize the anticipated benefits and cost savings from combining the businesses of Lumentum and Coherent. The anticipated benefits and cost savings of the Mergers may not be realized fully or at all, may take longer to realize than expected or could have other adverse effects that we do not currently foresee. The integration process may, for us and Lumentum, result in the loss of key employees, the disruption of ongoing businesses or inconsistencies in standards, controls, procedures and policies. There could be potential unknown liabilities and
unforeseen expenses associated with the Mergers that were not discovered in the course of performing due diligence.
Additionally, the integration will require significant time and focus from management following the acquisition which may
disrupt the business of the combined company.
RISKS RELATED TO COVID-19 PANDEMIC
Our business, financial condition and results of operations may continue to be materially adversely affected by the COVID-19 pandemic and the related private and public sector responses to the pandemic.
The full extent to which the COVID-19 pandemic will impact our financial condition and operating results will depend on future developments that are highly uncertain and cannot be accurately predicted, including COVID-19 infections intensifying or returning in various geographic areas as is currently happening in Europe and the United States, new medical and other information that may emerge concerning COVID-19, and the actions by governmental entities or others to address it, contain it or treat its impact.
COVID-19 poses the risk that we or our employees, suppliers, distributors, customers and others may be restricted or prevented from conducting business activities for indefinite or intermittent periods of time, including as a result of employee health and safety concerns, shutdowns, shelter-in-place ("SiP") orders, travel restrictions and other actions and restrictions that may be prudent or required by governmental authorities. Even after governmental entities have lifted SiP orders, there is a risk that such orders will be reinstated, making it difficult to predict the long term financial impact of this virus on the Company. Examples of this have been seen across the globe, including most recently in the actions by several European governments.
To date, many (but not all) of our business operations and those of our suppliers, distributors and customers have been classified as essential or otherwise permitted to operate in jurisdictions in which facility closures have been mandated; however, we can give no assurance that this will not change in the future or that we, our suppliers, distributors and customers will continue to be permitted to conduct business in each of the jurisdictions in which we operate.
In addition, we have modified our business practices for the continued health and safety of our employees - including, among other things, implementing a remote work policy to the fullest extent possible, a limited travel policy, the distribution of and mandatory wearing of personal protection equipment, reorganizing and adjusting the timing of manufacturing personnel shifts, temperature monitoring for entering our facilities, and a social distancing policy - and we may take further actions, or be required to take further actions, that are in the best interests of our employees. Our suppliers, distributors and customers have also implemented such measures, which has resulted in, and we expect it will continue to result in, disruptions or delays and higher costs. The implementation of health and safety practices by us or our suppliers, distributors or customers could impact customer demand, supplier deliveries, our productivity, and costs, which could have a material adverse impact on our business, financial condition and results of operations.
While we currently believe we have sufficient liquidity to manage the financial impact of the COVID-19 pandemic, we can give no assurance that this will continue to be the case if the pandemic is prolonged or if there is an extended impact on us or the economy generally. Further, the pandemic has caused significant uncertainty and volatility in the credit markets. If our liquidity or access to capital becomes significantly constrained, or if costs of capital increase significantly as result of volatility in the capital markets, a reduction in our creditworthiness or other factors, then our financial condition, results of operations and cash flows could be materially adversely affected.
We have invested and will continue to invest significant time and resources in managing the impact of the COVID-19 pandemic on our business. Our focus on managing and mitigating such impact may cause us to divert or delay the application of resources toward existing or new initiatives or investments, which could have a material adverse impact on our results of operations.
Please refer to "Coronavirus pandemic (COVID-19)" under "Significant Events" "Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations" for additional discussion of the risks related to the COVID-19 pandemic and its impact on the Company.
COMPANY AND OPERATIONAL RISKS
Our operating results and stock price have varied in the past and will continue to be subject to fluctuations in the future based upon numerous factors, including those discussed in this Item 1A and throughout this report.
Our operating results, including net sales, operating expenses, net income (loss) and adjusted EBITDA in dollars and as a percentage of net sales, as well as our stock price, have varied in the past and may vary significantly from quarter to quarter and from year to year in the future. We believe a number of factors, many of which are outside of our control, could cause these variations and make them difficult to predict, including:
•general economic uncertainties in the macroeconomic and local economies facing us, our customers and the markets we serve, particularly as COVID-19 continues to adversely affect the global economy;
•impact of government economic policies on macroeconomic conditions, such as recently instituted, proposed or threatened changes in trade policies by the U.S. and any corresponding retaliatory actions by affected countries, in particular with respect to China, as well as trade restrictions instituted by the Japanese government affecting the export to South Korea of certain products and materials used in the manufacture of flat panel displays and in the semiconductor industry;
•fluctuations in demand for our products or downturns in the industries that we serve, particularly the continued build-out of "phase 2" of the capacity for the manufacture of OLED and the increased use of the installed base of our products in such manufacturing;
•the ability of our suppliers, both internal and external, to produce and deliver components and parts, including sole or limited source components, in a timely manner, in the quantity, quality and prices desired;
•the timing of receipt of bookings and the timing of and our ability to ultimately convert bookings to net sales;
•the concentration of a significant amount of our backlog, and resultant net sales, with a few customers in the Microelectronics market;
•rescheduling of shipments or cancellation of orders by our customers;
•fluctuations in our product mix;
•the ability of our customers' other suppliers to provide sufficient material to support our customers' products;
•currency fluctuations and stability, in particular the Euro, the Japanese Yen, the South Korean Won, the Chinese RMB and the U.S. Dollar as compared to other currencies;
•commodity pricing;
•interpretation and impact of the U.S. Tax Cuts and Jobs Act and the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act" and any additional related newly enacted laws);
•introductions of new products and product enhancements by our competitors, entry of new competitors into our markets, pricing pressures and other competitive factors;
•the increasing focus by companies in China to vertically integrate and consolidate their supply chains fully with products manufactured in China;
•our ability to develop, introduce, manufacture and ship new and enhanced products in a timely manner without defects;
•our ability to manage our manufacturing capacity across our diverse product lines and that of our suppliers, including our ability to successfully expand our manufacturing capacity in various locations around the world;
•our ability to successfully and fully integrate acquisitions into our operations and management;
•our ability to successfully internally transfer the manufacturing of products and related operations as part of our integration and internal reorganization efforts and to realize anticipated benefits (including savings) therefrom;
•our reliance on contract manufacturing;
•our reliance in part upon the ability of our OEM customers to develop and sell systems that incorporate our laser products;
•our customers' ability to manage their susceptibility to adverse economic conditions;
•the rate of market acceptance of our new products;
•the ability of our customers to pay for our products;
•expenses associated with acquisition-related activities, including the costs of acquiring businesses or technologies;
•seasonal sales trends;
•jurisdictional capital and currency controls negatively impacting our ability to move funds from or to an applicable jurisdiction;
•access to applicable credit markets by us, our customers and their end customers;
•the impact of rising Chinese consumer debt and eroding consumer confidence and spending in China;
•delays or reductions in customer purchases of our products in anticipation of the introduction of new and enhanced products by us or our competitors;
•our ability to control expenses;
•the level of capital spending of our customers;
•potential excess and/or obsolescence of our inventory;
•costs and timing of adhering to current and developing governmental regulations and reviews relating to our products and business, including import and export regulations in multiple jurisdictions;
•impairment of goodwill, intangible assets and other long-lived assets;
•our ability to meet our expectations and forecasts and those of public market analysts and investors;
•the availability of research funding by governments with regard to our customers in the scientific business, such as universities;
•continued government spending on defense-related and scientific research projects where we are a vendor directly or as a subcontractor;
•maintenance of supply relating to products sold to the government on terms which we would prefer not to accept;
•changes in policy, interpretations, or challenges to the allowability of costs incurred under government cost accounting standards;
•changes in the method of determining the London Interbank Offered Rate ("LIBOR"), the Euro Interbank Offered Rate ("EURIBOR"), or the replacement of LIBOR or EURIBOR with an alternative reference rate, may adversely affect interest rates on our outstanding variable rate indebtedness;
•our ability and the ability of our contractual counterparts to comply with the terms of our contracts;
•damage to our reputation as a result of coverage in social media, Internet blogs or other media outlets;
•managing our and other parties' compliance with contracts in multiple languages and jurisdictions;
•managing our internal and third party sales representatives and distributors, including compliance with all applicable laws;
•costs, expenses and damages arising from litigation;
•the impact of market fluctuations on assets and liabilities in our deferred compensation plans;
•costs associated with designing around or payment of licensing fees associated with issued patents in our fields of business;
•individual employees intentionally or negligently failing to comply with our internal controls;
•government support of alternative energy industries, such as solar;
•negative impacts related to the United Kingdom's withdrawal from the European Union, or "Brexit" including uncertainties regarding the terms of applicable trade treaties between the United Kingdom and other countries, particularly with regard to any potential negative effects on our sales from our Glasgow, Scotland facility to other jurisdictions and purchases of supplies from outside the United Kingdom by such facility;
•negative impacts related to the recent independence movement in Catalonia, Spain, particularly with regard to holding and operating some of our foreign entities in an efficient manner from a tax, business and legal perspective;
•negative impacts related to government instability in any jurisdiction in which we operate;
•the future impact of legislation, rulemaking, and changes in accounting, tax, defense procurement and export policies; and
•distraction of management related to acquisition, integration or divestment activities.
In addition, we often recognize a substantial portion of our sales in the last month of our fiscal quarters. Our expenses for any given quarter are typically based on expected sales, and if sales are below expectations in any given quarter, the adverse impact of the shortfall on our operating results may be magnified by our inability to adjust spending quickly enough to compensate for the shortfall. We also base our manufacturing on our forecasted product mix for the quarter. If the actual product mix varies significantly from our forecast, we may not be able to fill some orders during that quarter, which would result in delays in the shipment of our products. Accordingly, variations in timing of sales, particularly for our higher priced, higher margin products, can cause significant fluctuations in quarterly operating results.
Due to these and other factors, we believe that quarter-to-quarter and year-to-year comparisons of our historical operating results may not be meaningful. You should not rely on our results for any quarter or year as an indication of our future performance. Our operating results in future quarters and years may be below public market analysts' or investors' expectations, which would likely cause the price of our stock to fall. In addition, over the past several years, U.S. and global equity markets have experienced significant price and volume fluctuations that have affected the stock prices of many technology companies both in and outside our industry, and the ongoing COVID-19 pandemic could exacerbate such fluctuations. There has not always been a direct correlation between this volatility and the performance of particular companies subject to these stock price fluctuations. These factors, as well as general economic and political conditions or investors' concerns regarding the credibility of corporate financial statements, may have a material adverse effect on the market price of our stock in the future.
We depend on sole source or limited source suppliers, as well as on our own production capabilities, for some of the key components and materials, including exotic materials, certain cutting-edge optics and crystals, used in our products, which makes us susceptible to supply shortages or price fluctuations that could adversely affect our business, particularly our ability to meet our customers' delivery requirements.
We currently purchase several key components and materials used in the manufacture of our products from sole source or limited source suppliers. From time-to-time our customers require us to ramp up production and/or accelerate delivery schedules of our products, and our key suppliers may not have the ability to increase their production in line with our customers'
demands. This can become acute during times of high growth in our customers' businesses. Our failure to timely receive these key components and materials would likely cause delays in the shipment of our products, which would likely negatively impact both our customers and our business. Some of these suppliers are relatively small private companies that may discontinue their operations at any time and may be particularly susceptible to prevailing economic conditions. Some of our suppliers are located in regions susceptible to natural and man-made disasters, such as Thailand which has experienced severe flooding, Japan which has experienced earthquakes, tsunamis and a resulting nuclear disaster, and the Eastern part of the United States and California which have experienced severe flooding, wildfires and/or power loss. In addition, our suppliers have been adversely affected by the COVID-19 pandemic and the related imposition of government restrictions to mitigate the spread of the virus. We typically purchase our components and materials through purchase orders or agreed upon terms and conditions, and we do not have guaranteed supply arrangements with many of these suppliers. For certain long-lead time supplies or in order to lock-in pricing, we may be obligated to place non-cancellable purchase orders or otherwise assume liability for a large amount of the ordered supplies, which limits our ability to adjust down our inventory liability in the event of market downturns or other customer cancellations or rescheduling of their purchase orders for our products.
Some of our products, particularly in the flat panel display industry, require designs and specifications that are at the cutting-edge of available technologies and change frequently to meet rapidly evolving market demands. By their very nature, the types of components used in such products can be difficult and unpredictable to manufacture and may only be available from a single supplier, which increases the risk that we may not obtain such components in a timely manner. Identifying alternative sources of supply for certain components could be difficult and costly, result in management distraction in assisting our current and future suppliers to meet our and our customers' technical requirements, and cause delays in shipments of our products while we identify, evaluate and test the products of alternative suppliers. Any such delay in shipment would result in a delay or cancellation of our ability to convert such order into revenues. Furthermore, financial or other difficulties faced by these suppliers or significant changes in demand for these components or materials could limit their availability. We continue to consolidate our supply base and move supplier locations. When we transition locations, we may increase our inventory of such products as a "safety stock" during the transition, which may cause the amount of inventory reflected on our balance sheet to increase. Additionally, many of our customers rely on sole source suppliers. In the event of a disruption of our customers' supply chain, orders from our customers could decrease or be delayed.
Like most other multinational companies, we are also highly dependent upon the ability to ship products to customers and to receive shipments of supplies from suppliers. The COVID-19 pandemic and resulting government policies have resulted in variable limitations on our ability to receive supplies and ship our products to customers. In the event of a disruption in the worldwide or regional shipping infrastructure, our access to supplies and our ability to deliver products to customers would correspondingly be negatively impacted. Any such disruption would likely materially and adversely affect our operating results and financial condition.
Any interruption or delay in the supply of any of these components or materials, or the inability to obtain these components and materials from alternate sources at acceptable prices and within a reasonable amount of time, or our failure to properly manage these moves, would impair our ability to meet scheduled product deliveries to our customers and could cause customers to cancel orders. Furthermore, we have historically relied exclusively on our own production capability to manufacture certain strategic components, crystals, semiconductor lasers, fiber, lasers and laser-based systems. We also manufacture certain large format optics. Because we manufacture, package and test these components, products and systems at our own facilities, and such components, products and systems are not readily available from other sources, any interruption in manufacturing would adversely affect our business. Since many of our products have lengthy qualification periods, our ability to introduce multiple suppliers for parts may be limited. In addition, our failure to achieve adequate manufacturing yields of these items at our manufacturing facilities may materially and adversely affect our operating results and financial condition.
We participate in the microelectronics market, which requires significant research and development expenses to develop and maintain products and a failure to achieve market acceptance for our products could have a significant negative impact on our business and results of operations.
The microelectronics market is characterized by rapid technological change, frequent product introductions, the volatility of product supply and demand, changing customer requirements and evolving industry standards. The nature of this market requires significant research and development expenses to participate, with substantial resources invested in advance of material sales of our products to our customers in this market. Additionally, our product offerings may become obsolete given the frequent introduction of alternative technologies. In the event either our customers' or our products fail to gain market acceptance, or the microelectronics market fails to grow, it would likely have a significant negative effect on our business and results of operations.
We participate in the flat panel display market, which has a relatively limited number of end customer manufacturers. Our backlog, timing of net sales and results of operations could be negatively impacted in the event we face any significant periods with few or no orders or our customers reschedule or cancel orders.
In the flat panel display market, it is unclear when the timing will be, or whether it will occur at all, for any further build-out of fabs for the manufacture of OLED screens, and there are a relatively limited number of manufacturers who are the end customers for our annealing products. In the first quarter of fiscal 2021, Advanced Process Systems Corporation, an integrator in the flat panel display market based in South Korea, contributed more than 10% of our revenue. Given macroeconomic conditions, varying consumer demand and technical process limitations at manufacturers, we may see fluctuations in orders, including periods with no or few orders, and our customers may seek to reschedule or cancel orders. For example, in the fourth quarter of fiscal 2018, a customer requested a change of delivery date resulting in a significant order being rescheduled from the first to the second quarter of fiscal 2019. In addition, in the first quarter of fiscal 2019, one customer cancelled three purchase orders which included backlog shippable within 12 months of $38.2 million as well as some additional orders which were unscheduled.
These larger flat panel-related systems have large average selling prices. Any significant periods with few or no orders or any rescheduling or canceling of such orders by our customers will likely have a significant impact on our quarterly or annual net sales and results of operations and could negatively impact inventory values and backlog. Additionally, challenges in meeting evolving technological requirements for these complex products by us and our suppliers could result in delays in shipments and rescheduled or cancelled orders by our customers. This could negatively impact our backlog, timing of net sales and results of operations.
Some of our laser systems are complex in design and may contain defects that are not detected until deployed by our customers, which could increase our costs and reduce our net sales.
Lasers and laser systems are inherently complex in design and require ongoing regular maintenance. The manufacture of our lasers, laser products and laser systems involves a highly complex and precise process. As a result of the technological complexity of our products, in particular our excimer laser annealing tools used in the flat panel display market, changes in our or our suppliers' manufacturing processes or the inadvertent use of defective materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve and maintain our projected yields or product reliability, our business, operating results, financial condition and customer relationships would be adversely affected. We provide warranties on a majority of our product sales, and reserves for estimated warranty costs are recorded during the period of sale. The determination of such reserves requires us to make estimates of failure rates and expected costs to repair or replace the products under warranty. We typically establish warranty reserves based on historical warranty costs for each product line. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to cost of sales may be required in future periods which could have an adverse effect on our results of operations.
Our customers may discover defects in our products after the products have been fully deployed and operated, including under the end user's peak stress conditions. In addition, some of our products are combined with products from other vendors, which may contain defects. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to identify and fix defects or other problems, we could experience, among other things:
•loss of customers or orders;
•increased costs of product returns and warranty expenses;
•damage to our brand reputation;
•failure to attract new customers or achieve market acceptance;
•diversion of development, engineering and manufacturing resources; and
•legal actions by our customers and/or their end users.
The occurrence of any one or more of the foregoing factors could seriously harm our business, financial condition and results of operations.
Continued volatility in the advanced packaging and semiconductor manufacturing markets could adversely affect our business, financial condition and results of operations.
A portion of our net sales in the microelectronics market depends on the demand for our products by advanced packaging applications and semiconductor equipment companies. These markets have historically been characterized by sudden and severe cyclical variations in product supply and demand, which have often severely affected the demand for semiconductor manufacturing equipment, including laser-based tools and systems. The timing, severity and duration of these market cycles are difficult to predict, especially during the ongoing COVID-19 pandemic, and we may not be able to respond effectively to these cycles. The continuing uncertainty in these markets severely limits our ability to predict our business prospects or financial results in these markets.
During industry downturns, our net sales from these markets may decline suddenly and significantly. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in next-generation product technology and to support and service our products. In addition, due to the relatively long manufacturing lead times for some of the systems and subsystems we sell to these markets, we may incur expenditures or purchase raw materials or components for products we cannot sell. Accordingly, downturns in the semiconductor capital equipment market may materially harm our operating results. Conversely, when upturns in these markets occur, we must be able to rapidly and effectively increase our manufacturing capacity to meet increases in customer demand that may be extremely rapid, and if we fail to do so we may lose business to our competitors and our relationships with our customers may be harmed.
Our future success depends on our ability to increase our sales volumes and decrease our costs to offset potential declines in the average selling prices of our products and, if we are unable to realize greater sales volumes and lower costs, our operating results may suffer.
Our ability to increase our sales volume and our future success depends on the continued growth of the markets for lasers, laser systems and related accessories, as well as our ability to identify, in advance, emerging markets for laser-based systems and to manage our manufacturing capacity to meet customer demands. We cannot assure you that we will be able to successfully identify, on a timely basis, new high-growth markets in the future. Moreover, we cannot assure you that new markets will develop for our products or our customers' products, or that our technology or pricing will enable such markets to develop. Future demand for our products is uncertain and will depend to a great degree on continued technological development and the introduction of new or enhanced products. If this does not continue, sales of our products may decline and our business will be harmed.
We have in the past experienced decreases in the average selling prices ("ASPs") of some of our products. As competing products become more widely available or lower-cost products come to market, the ASPs of our products may decrease. If we are unable to offset any decrease in our ASPs by increasing our sales volumes, our net sales will decline. In addition, to maintain our gross margins, we must continue to reduce the cost of manufacturing our products while maintaining their high quality. From time to time, our products, like many complex technological products, may fail in greater frequency than anticipated. This can lead to further charges, which can result in higher costs, lower gross margins and lower operating results. Furthermore, as ASPs of our current products decline, we must develop and introduce new products and product enhancements with higher margins. If we cannot maintain our gross margins, our operating results could be seriously harmed, particularly if the ASPs of our products decrease significantly.
We face risks associated with our worldwide operations and sales that could harm our financial condition and results of operations.
For the three months ended January 2, 2021, 78% of our net sales were derived from customers outside of the United States. For fiscal 2020, 2019 and 2018, 76%, 76% and 84%, respectively, of our net sales were derived from customers outside of the United States. We anticipate that international sales, particularly in Asia, will continue to account for a significant portion of our net sales in the foreseeable future.
A global economic slowdown or a natural disaster could have a negative effect on various international markets in which we operate, such as the earthquake, tsunami and resulting nuclear disaster in Japan and the flooding in Thailand. Such a slowdown may cause us to reduce our presence in certain countries, which may negatively affect the overall level of business in such countries. Our international sales are primarily through our direct sales force. Additionally, some international sales are made through international distributors and representatives. Currently, the COVID-19 pandemic is having a significant adverse effect on the global economy, which is affecting the various markets in which we operate.
Our international operations and sales are subject to a number of risks, including:
•compliance with applicable import/export regulations, tariffs and trade barriers, including recently instituted or proposed changes in trade policies by the U.S. and any corresponding retaliatory actions by affected countries, in particular with respect to China;
•longer accounts receivable collection periods;
•the impact of recessions and other economic conditions in economies outside the United States, including, for example, recent dips in the manufacturing Purchasing Managers’ Index ("PMI") as well as the Institute of Supply Management ("ISM") data in the Eurozone, in particular in Germany;
•unexpected changes in regulatory requirements and compliance with applicable regulatory requirements;
•product certification requirements;
•environmental regulations;
•reduced protection for intellectual property rights in some countries;
•potentially adverse tax consequences;
•political and economic instability, such as the current situation between the governments of Japan and South Korea, which has led to the imposition of trade restrictions by the Japanese government affecting the export to South Korea of certain products and materials used in the manufacture of flat panel displays and in the semiconductor industry;
•compliance with applicable United States and foreign anti-corruption laws;
•less than favorable contract terms;
•reduced ability to enforce contractual obligations;
•cultural and management differences;
•reliance in some jurisdictions on third party sales channel partners;
•preference for locally produced products; and
•shipping and other logistics complications.
Our business could also be impacted by international conflicts, terrorist and military activity including, in particular, any such conflicts on the Korean peninsula, civil unrest and pandemics, any of which could cause a slowdown in customer orders, cause customer order cancellations or negatively impact availability of supplies or limit our ability to timely service our installed base of products.
We are also subject to the risks of fluctuating foreign currency exchange rates, which could materially adversely affect the sales price of our products in foreign markets, as well as the costs and expenses of our international subsidiaries, particularly if we have a significant amount of manufacturing costs denominated in one currency, e.g. the Euro, compared to the sales of those same products to customers denominated in another currency, e.g. the U.S. Dollar. While we use forward exchange contracts and other risk management techniques to hedge our foreign currency exposure, we remain exposed to the economic risks of foreign currency fluctuations.
We depend on skilled personnel to operate our business effectively in a rapidly changing market, and if we are unable to retain existing or hire additional personnel when needed, or manage transitions among members of our leadership team, our ability to develop and sell our products could be harmed.
Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future, including the time preceding the closing of the Mergers. Recruiting and retaining highly skilled personnel in certain functions continues to be difficult. At certain locations where we operate, the cost of living is extremely
high and it may be difficult to retain key employees and management at a reasonable cost. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, which could adversely affect our growth and our business.
Our future success depends upon the continued services of our executive officers and other key engineering, sales, marketing, manufacturing and support personnel, as well as our ability to effectively transition to their successors. Most recently, we appointed a new President and Chief Executive Officer in April 2020, at which time our former President and CEO, who had served in such position since 2002, transitioned to the role of special advisor to the Company. Any future changes to our executive and senior management teams, including hires or departures, could cause further disruption to our business and have a negative impact on our operating performance, while these operational areas are in transition. We can provide no assurance that we will be able to find suitable successors to key roles as transitions occur or that any identified successor will be successfully integrated into our management team. Our inability to do so, or to retain other key employees or effectively transition to their successors, or any delay in filling any such positions, could harm our business and our results of operations.
The long sales cycles for many of our products may cause us to incur significant expenses without offsetting net sales.
Customers often view the purchase of our products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our products before making a decision to purchase them, resulting in a lengthy initial sales cycle. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses to customize our products to the customers' needs. We may also expend significant management efforts, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our products. As a result, these long sales cycles may cause us to incur significant expenses without ever receiving net sales to offset such expenses.
The markets in which we sell our products are intensely competitive and increased competition could cause reduced sales levels, reduced gross margins or the loss of market share.
Competition in the various photonics markets in which we provide products is very intense. We compete against a number of large public and private companies, including IPG Photonics Corporation, Lumentum, MKS Instruments, Inc., Novanta Inc., nLIGHT, Inc., II-VI Incorporated, Wuhan Raycus Fiber Laser Technologies Co., Ltd, and Trumpf GmbH, as well as other smaller companies. Some of our competitors are large companies that have significant financial, technical, marketing and other resources. These competitors may be able to devote greater resources than we can to the development, promotion, sale and support of their products. Some of our competitors are much better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines. Any of these acquisitions could give our competitors a strategic advantage. Any business combinations or mergers among our competitors, forming larger companies with greater resources, could result in increased competition, price reductions, reduced margins or loss of market share, any of which could materially and adversely affect our business, results of operations and financial condition.
Additional competitors may enter the markets in which we serve, both foreign and domestic, and we are likely to compete with new companies in the future. For example, in recent years there have been a growing number of companies in China that, in some cases aided by government subsidies, are targeting our markets and are exerting significant price pressure in certain of our product markets, in particular the HPFL products used in the metal cutting market in China, which led to our decision to exit this market. These companies will likely in the future be able to expand into broader product markets, which may result in additional competitive pressures on us. We may also encounter potential customers that, due to existing relationships with our competitors, are committed to the products offered by these competitors. Further, our current or potential customers may determine to develop and produce products for their own use which are competitive to our products. Such vertical integration could reduce the market opportunity for our products. As a result of the foregoing factors, we expect that competitive pressures may result in price reductions, reduced margins, loss of sales and loss of market share. In addition, in markets where there are a limited number of customers, competition is particularly intense.
If we fail to accurately forecast component and material requirements for our products, we could incur additional costs and incur significant delays in shipments, which could result in a loss of customers.
We use rolling forecasts based on anticipated product orders and material requirements planning systems to determine our product requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. We depend on our suppliers for most of our product components and materials. Lead times for components and materials that we order vary significantly and depend on factors including the specific supplier requirements, the size of the order, contract terms and current market demand for components. For substantial
increases in our sales levels of certain products, some of our suppliers may need at least nine months lead-time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt and delay delivery of our products to our customers. We expect that the volatility and uncertainty created by the COVID-19 pandemic in the markets we serve will exacerbate these issues, and any of these occurrences would negatively impact our net sales, business or operating results.
Our reliance on contract manufacturing and outsourcing may adversely impact our financial results and operations due to our decreased control over the performance and timing of certain aspects of our manufacturing.
Our manufacturing strategy includes partnering with contract manufacturers to outsource non-core sub-assemblies and less complex turnkey products, including some performed at international sites located in Asia and Eastern Europe. Our ability to resume internal manufacturing operations for certain products and components in a timely manner may be eliminated. The cost, quality, performance and availability of contract manufacturing operations are and will be essential to the successful production and sale of many of our products. Our financial condition or results of operation could be adversely impacted if any contract manufacturer or other supplier is unable for any reason, including as a result of the COVID-19 pandemic and the negative effect it is having on the global economy, to meet our cost, quality, performance, and availability standards. We may not be able to provide contract manufacturers with product volumes that are high enough to achieve sufficient cost savings. If shipments fall below forecasted levels, we may incur increased costs or be required to take ownership of the inventory. Also, our ability to control the quality of products produced by contract manufacturers may be limited and quality issues may not be resolved in a timely manner, which could adversely impact our financial condition or results of operations.
If we fail to effectively manage our growth or, alternatively, our spending during downturns, our business could be disrupted, which could harm our operating results.
Growth in sales, combined with the challenges of managing geographically dispersed operations, can place a significant strain on our management systems and resources, and our anticipated growth in future operations could continue to place such a strain. The failure to effectively manage our growth could disrupt our business and harm our operating results. Our ability to successfully offer our products and implement our business plan in evolving markets requires an effective planning and management process. In economic downturns, we must effectively manage our spending and operations to ensure our competitive position during the downturn, as well as our future opportunities when the economy improves, remain intact. The failure to effectively manage our spending and operations could disrupt our business and harm our operating results.
Our market is unpredictable and characterized by rapid technological changes and evolving standards demanding a significant investment in research and development, and, if we fail to address changing market conditions, our business and operating results will be harmed.
The photonics industry is characterized by extensive research and development, rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. Because this industry is subject to rapid change, it is difficult to predict its potential size or future growth rate. Our success in generating net sales in this industry will depend on, among other things:
•maintaining and enhancing our relationships with our customers;
•the education of potential end-user customers about the benefits of lasers and laser systems; and
•our ability to accurately predict and develop our products to meet industry standards.
We cannot assure you that our expenditures for research and development will result in the introduction of new products or, if such products are introduced, that those products will achieve sufficient market acceptance or to generate sales to offset the costs of development. Our failure to address rapid technological changes in our markets could adversely affect our business and results of operations.
Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers.
Our current products address a broad range of commercial and scientific research applications in the photonics markets. We cannot assure you that the market for these applications will continue to generate significant or consistent demand for our products. Demand for our products could be significantly diminished by disrupting technologies or products that replace them or render them obsolete. Furthermore, the new and enhanced products in certain markets generally continue to be smaller in size and have lower ASPs, and therefore, we have to sell more units to maintain revenue levels. Accordingly, we must continue to invest in research and development in order to develop competitive products. Ongoing restrictions resulting from the COVID-19 pandemic have had a negative impact on the work on some of our research and development programs due to the inability of some personnel being able to work in applicable regional labs.
Our future success depends on our ability to anticipate our customers' needs and develop products that address those needs. Introduction of new products and product enhancements will require that we effectively transfer production processes from research and development to manufacturing and coordinate our efforts with those of our suppliers to achieve volume production rapidly. If we fail to transfer production processes effectively, develop product enhancements or introduce new products in sufficient quantities to meet the needs of our customers as scheduled, our net sales may be reduced and our business may be harmed.
Our and our customers' operations would be seriously harmed if our logistics or facilities or those of our suppliers, our customers' suppliers or our contract manufacturers were to experience catastrophic loss.
Our operations, logistics and facilities and those of our customers, suppliers and contract manufacturers could be subject to a catastrophic loss from fire, flood, earthquake, volcanic eruption, work stoppages, power outages, acts of war, pandemics such as COVID-19, energy shortages, theft of assets, other natural disasters or terrorist activity. A substantial portion of our research and development activities, manufacturing, our corporate headquarters and other critical business operations are located near major earthquake faults in Santa Clara, California, an area with a history of seismic events. Any such loss or detrimental impact to any of our operations, logistics or facilities could disrupt our operations, delay production, shipments and net sales and result in large expenses to repair or replace the facility. While we have obtained insurance to cover most potential losses, after reviewing the costs and limitations associated with earthquake insurance, we have decided not to procure such insurance. We believe that this decision is consistent with decisions reached by numerous other companies located nearby. We cannot assure you that our existing insurance coverage will be adequate against all other possible losses.
ACQUISITION RISKS
We may not be able to integrate the business of future acquisitions successfully with our own, realize the anticipated benefits of such acquisitions or manage our expanded operations, any of which would adversely affect our results of operations.
Integration efforts are costly due to the large number of processes, policies, procedures, locations, operations, technologies and systems to be integrated, including purchasing, accounting and finance, sales, service, operations, payroll, pricing, marketing and employee benefits. Integration expenses could, particularly in the short term, exceed the savings we expect to achieve from the elimination of duplicative expenses and the realization of economies of scale, which could result in significant charges to earnings that we cannot currently quantify. Potential difficulties that we may encounter as part of the integration process include the following:
•the inability to successfully combine our business with the acquired company in a manner that permits the combined company to achieve the full synergies and other benefits anticipated to result from the merger;
•complexities associated with managing the combined businesses, including difficulty addressing possible differences in corporate cultures and management philosophies and the challenge of integrating products, services, complex and different information technology systems (including different Enterprise Management Systems), control and compliance processes, technology, networks and other assets of each of the companies in a cohesive manner;
•diversion of the attention of our management;
•the disruption of, or the loss of momentum in, our business; and
•inconsistencies in standards, controls, procedures or policies.
Any of the foregoing could adversely affect our ability to maintain relationships with customers, suppliers, employees and other constituencies or our ability to achieve the anticipated benefits of the merger, or could reduce our earnings or otherwise adversely affect our business and financial results. For example, in the fourth quarter of fiscal 2018, difficulties in implementing our Enterprise Management Systems at one of our manufacturing sites located in Germany, which was historically part of our prior acquisition of Rofin, resulted in a shortage of manufacturing parts and shippable inventory to meet demands, resulting in a reduction of revenue for that quarter. If similar difficulties arise in the future and we are unable to resolve them in a timely manner, we may experience a shortage of parts and inventory or otherwise be unable to meet demand, which could have a material adverse impact on our results of operations.
Following an acquisition, the size and complexity of the business of the combined company could increase significantly. Our future success depends, in part, upon our ability to manage this expanded business, which could pose substantial challenges for management, including challenges related to the management and monitoring of new operations and associated increased costs and complexity. The execution of these consolidation projects could result in temporary loss of productivity or operational efficiency, interruptions in manufacturing or other unforeseen challenges while the projects are ongoing. Moreover, there can be no assurances that we will be successful in realizing the anticipated savings in connection with these consolidations or with our broader efforts to manage our expanded business or that we will realize the expected synergies and benefits anticipated from the merger.
Historically, acquisitions have been an important element of our strategy. However, we may not find suitable acquisition candidates in the future and we may not be able to successfully integrate and manage acquired businesses. Any acquisitions we make could disrupt our business and harm our financial condition.
We have in the past made both large and smaller strategic acquisitions of other corporations and entities, including Ondax in October 2018, OR Laser in March 2018 and Rofin in November 2016, as well as asset purchases, and we continue to evaluate potential strategic acquisitions of complementary companies, products and technologies. In the event of any future acquisitions, we could:
•issue stock that would dilute our current stockholders' percentage ownership;
•pay cash that would decrease our working capital;
•incur debt;
•assume liabilities; or
•incur expenses related to impairment of goodwill and other long-lived assets, as we incurred in the quarter ending April 4, 2020 totaling $451.0 million.
Acquisitions also involve numerous risks, including:
•problems combining the acquired operations, systems, technologies or products;
•an inability to realize expected operating efficiencies or product integration benefits;
•difficulties in coordinating and integrating geographically separated personnel, organizations, systems and facilities;
•difficulties integrating business cultures;
•unanticipated costs or liabilities, including the costs associated with improving the internal controls of the acquired company;
•diversion of management's attention from our core businesses;
•adverse effects on existing business relationships with suppliers and customers;
•potential loss of key employees, particularly those of the purchased organizations;
•incurring unforeseen obligations or liabilities in connection with acquisitions; and
•the failure to complete acquisitions even after signing definitive agreements which, among other things, would result in the expensing of potentially significant professional fees and other charges in the period in which the acquisition or negotiations are terminated.
We cannot assure you that we will be able to successfully identify appropriate acquisition candidates, to integrate any businesses, products, technologies or personnel that we might acquire in the future or achieve the anticipated benefits of such transactions, which may harm our business.
FINANCIAL RISKS
Our indebtedness following the Rofin merger is substantially greater than our indebtedness prior to the merger. This increased level of indebtedness could adversely affect us, including by decreasing our business flexibility, and will increase our borrowing costs.
In November 2016, we entered into a credit agreement (the "Credit Agreement"), which provided for a 670.0 million Euro term loan (the "Euro Term Loan"), all of which was drawn, and a $100.0 million revolving credit facility (the "Revolving Credit Facility"), under which a 10 million Euro letter of credit was issued. As of January 2, 2021, 356.5 million Euros were outstanding under the Euro Term Loan. As of January 2, 2021, the Revolving Credit Facility had been used for guarantees of 10.0 million Euros as well as borrowings of $10.0 million. We may incur additional indebtedness in the future by accessing the Revolving Credit Facility and/or entering into new financing arrangements. Our ability to pay interest and repay the principal of our current indebtedness is dependent upon our ability to manage our business operations and the ongoing interest rate environment. There can be no assurance that we will be able to manage any of these risks successfully.
The Credit Agreement contains customary affirmative covenants, including covenants regarding the payment of taxes and other obligations, maintenance of insurance, reporting requirements and compliance with applicable laws and regulations, and negative covenants, including covenants limiting the ability of us and our subsidiaries to, among other things, incur debt, grant liens, make investments, make certain restricted payments, transact with affiliates, and sell assets. The Credit Agreement also requires us and our subsidiaries to maintain a senior secured net leverage ratio as of the last day of each fiscal quarter of less of than or equal to 3.50 to 1.00. The Credit Agreement contains customary events of default that include, among other things, payment defaults, cross defaults with certain other indebtedness, violation of covenants, inaccuracy of representations and warranties in any material respect, change in control of us and Coherent Holding BV & Co. K.G. (formerly Coherent Holding GmbH), judgment defaults, and bankruptcy and insolvency events. If an event of default exists, the lenders may require the immediate payment of all obligations and exercise certain other rights and remedies provided for under the Credit Agreement, the other loan documents and applicable law. The acceleration of such obligations is automatic upon the occurrence of a bankruptcy and insolvency event of default. There can be no assurance that we will have sufficient financial resources or we will be able to arrange financing to repay our borrowings at such time.
Our substantially increased indebtedness and higher debt-to-equity ratio as a result of the Rofin merger in comparison to that prior to the merger will have the effect, among other things, of reducing our flexibility to respond to changing business and economic conditions and will increase our borrowing costs. In addition, the amount of cash required to service our increased indebtedness levels and thus the demands on our cash resources will be greater than the amount of cash flows required to service our indebtedness or that of Rofin individually prior to the merger. The increased levels of indebtedness could also reduce funds available for our investments in product development as well as capital expenditures, dividends, share repurchases and other activities and may create competitive disadvantages for us relative to other companies with lower debt levels.
If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.
Under accounting principles generally accepted in the United States, we review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered in determining whether a change in circumstances indicating that the carrying value of our goodwill or other intangible assets may not be recoverable include declines in our stock price and market capitalization or future cash flows projections. A decline in our stock price, or any other adverse change in market conditions, particularly if such change has the effect of changing one of the critical assumptions or estimates we used to calculate the estimated fair value of our reporting units, could result in a change to the estimation of fair value that could result in an impairment charge. Any such material charges, whether related to goodwill or purchased intangible assets, may have a material negative impact on our financial and operating results. For example, in the quarter ended April 4, 2020, the worldwide spread of COVID-19 created significant volatility, uncertainty and disruption to the global economy, representing an indicator to test our goodwill for impairment. As a result of that test, we recorded a non-cash pre-tax charge, in the quarter ended April 4, 2020, related to the ILS reporting unit of $327.2 million, reducing the goodwill balance of the reporting unit to zero. In
addition, we performed impairment tests on the long-lived assets allocated to the asset group of the ILS reporting unit, including intangible assets, property, plant and equipment and ROU assets as of April 4, 2020 and recorded non-cash pre-tax charges, in the quarter ended April 4, 2020, related to the impairment intangible assets, property, plant and equipment and ROU assets of the ILS reporting unit of $33.9 million, $85.6 million and $1.8 million, respectively.
Our cash and cash equivalents and short-term investments are managed through various banks around the world and volatility in the capital and credit market conditions could cause financial institutions to fail or materially harm service levels provided by such banks, both of which could have an adverse impact on our ability to timely access funds.
World capital and credit markets have been and may continue to experience volatility and disruption. In some cases, the markets have exerted downward pressure on stock prices and credit capacity for certain issuers, as well as pressured the solvency of some financial institutions. These financial institutions, including banks, have had difficulty timely performing regular services and in some cases have failed or otherwise been largely taken over by governments. We maintain our cash, cash equivalents and short-term investments with a number of financial institutions around the world. Should some or all of these financial institutions fail or otherwise be unable to timely perform requested services, we would likely have limited ability to timely access our cash deposited with such institutions, or, in extreme circumstances the failure of such institutions could cause us to be unable to access cash for the foreseeable future. If we are unable to quickly access our funds when we need them, we may need to increase the use of our existing credit lines or access more expensive credit, if available. If we are unable to access our cash or if we access existing or additional credit or are unable to access additional credit, it could have a negative impact on our operations, including our reported net income. In addition, the willingness of financial institutions to continue to accept our cash deposits will impact our ability to diversify our investment risk among institutions.
We are exposed to credit risk and fluctuations in the market values of our investment portfolio.
Although we have not recognized any material losses on our cash, cash equivalents and short-term investments, future declines in their market values could have a material adverse effect on our financial condition and operating results. Given the global nature of our business, we have investments both domestically and internationally. There has recently been growing pressure on the creditworthiness of sovereign nations, particularly in Europe where a significant portion of our cash, cash equivalents and short-term investments are invested, which results in corresponding pressure on the valuation of the securities issued by such nations. Additionally, our overall investment portfolio is often concentrated in government-issued securities such as U.S. Treasury securities and government agencies, corporate notes, commercial paper and money market funds. Credit ratings and pricing of these investments can be negatively impacted by liquidity, credit deterioration or losses, financial results, or other factors. Additionally, liquidity issues or political actions by sovereign nations could result in decreased values for our investments in certain government securities. As a result, the value or liquidity of our cash, cash equivalents and short-term investments could decline or become materially impaired, which could have a material adverse effect on our financial condition and operating results. See "Part I, Item 3. Quantitative and Qualitative Disclosures about Market Risk."
INTELLECTUAL PROPERTY AND CYBERSECURITY RISKS
If we are unable to protect our proprietary technology, our competitive advantage could be harmed.
Maintenance of intellectual property rights and the protection thereof is important to our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Our patent applications may not be approved, any patents that may be issued may not sufficiently protect our intellectual property and any issued patents may be challenged by third parties. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Further, we may be required to enforce our intellectual property or other proprietary rights through litigation, which, regardless of success, could result in substantial costs and diversion of management's attention. Additionally, there may be existing patents of which we are unaware that could be pertinent to our business and it is not possible for us to know whether there are patent applications pending that our products might infringe upon since these applications are often not publicly available until a patent is issued or published.
We have been and may, in the future, be subject to claims or litigation from third parties, for claims of infringement of their proprietary rights or to determine the scope and validity of our proprietary rights or the proprietary rights of competitors or other rights holders. These claims could result in costly litigation and the diversion of our technical and management personnel. Adverse resolution of litigation may harm our operating results or financial condition.
In recent years, there has been significant litigation in the United States and around the world involving patents and other intellectual property rights. This has been seen in our industry, for example in the concluded patent-related litigation between IMRA America, Inc. ("Imra") and IPG Photonics Corporation and in Imra's concluded patent-related litigation against two of our German subsidiaries. From time to time, like many other technology companies, we have received communications from other parties asserting the existence of patent rights, copyrights, trademark rights or other intellectual property rights which such third parties believe may cover certain of our products, processes, technologies or information. In the future, we may be a party to litigation to protect our intellectual property or as a result of an alleged infringement of others' intellectual property whether through direct claims or by way of indemnification claims of our customers, as, in some cases, we contractually agree to indemnify our customers against third-party infringement claims relating to our products. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages or invalidation of our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. In addition to paying possibly significant monetary damages, any potential intellectual property litigation could also force us to do one or more of the following:
• stop manufacturing, selling or using our products that use the infringed intellectual property;
•obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, although such license may not be available on reasonable terms, or at all; or
•redesign the products that use the technology.
If we are forced to take any of these actions or are otherwise a party to lawsuits of this nature, we may incur significant losses and our business may be seriously harmed. We do not have insurance to cover potential claims of this type.
Our information systems are subject to attacks, interruptions and failures.
As part of our day-to-day business, we store our data and certain data about our customers in our global information technology system. While our system is designed with access security, if a third party gains unauthorized access to our data, including any regarding our customers, such a security breach could expose us to a risk of loss of this information, loss of business, litigation and possible liability. Our security measures may be breached as a result of third-party action, including intentional misconduct by computer hackers, employee error, malfeasance or otherwise. Additionally, third parties may attempt to fraudulently induce employees or customers into disclosing sensitive information such as user names, passwords or other information in order to gain access to our customers' data or our data, including our intellectual property and other confidential business information, or our information technology systems. Because the techniques used to obtain unauthorized access, or to sabotage systems, change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any unauthorized access could result in a loss of confidence by our customers, damage our reputation, disrupt our business, lead to legal liability and negatively impact our future sales. Additionally, such actions could result in significant costs associated with loss of our intellectual property, impairment of our ability to conduct our operations, rebuilding our network and systems, prosecuting and defending litigation, responding to regulatory inquiries or actions, paying damages or taking other remedial steps.
Difficulties with our enterprise resource planning ("ERP") system and other parts of our global information technology system could harm our business and results of operation. If our network security measures are breached and unauthorized access is obtained to a customer's data or our data or our information technology systems, we may incur significant legal and financial exposure and liabilities.
Like many modern multinational corporations, we maintain a global information technology system, including software products licensed from third parties. Any system, network or Internet failures, misuse by system users, the hacking into or disruption caused by the unauthorized access by third parties or loss of license rights could disrupt our ability to timely and accurately manufacture and ship products or to report our financial information in compliance with the timelines mandated by the SEC. Any such failure, misuse, hacking, disruptions or loss would likely cause a diversion of management's attention from the underlying business and could harm our operations. In addition, a significant failure of our global information technology system could adversely affect our ability to complete an evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002.
LEGAL, TAX, REGULATORY AND COMPLIANCE RISKS
Changes in tax rates, tax liabilities or tax accounting rules could affect future results.
As a global company, we are subject to taxation in the United States and various other countries and jurisdictions. Significant judgment is required to determine our worldwide tax liabilities. A number of factors may affect our future effective tax rates including, but not limited to:
•interpretation and impact of the recently enacted and aforementioned U.S. tax laws, the Tax Act and the CARES Act;
•the establishment or release of valuation allowances against deferred tax assets may cause greater volatility in the effective tax rate;
•changes in our current and future global structure based on the Rofin acquisition and restructuring that involved significant movement of U.S. and foreign entities and our ability to maintain favorable tax treatment as a result of various Rofin restructuring efforts and business activities;
•the outcome of discussions with various tax authorities regarding intercompany transfer pricing arrangements;
•changes that involve other acquisitions, restructuring or an increased investment in technology outside of the United States to better align asset ownership and business functions with revenues and profits;
•changes in the composition of earnings in countries or states with differing tax rates;
•the resolution of issues arising from tax audits with various tax authorities, and in particular, the outcome of the German tax audits for fiscal 2011-2016 and the appeals of the South Korean fiscal 2014-2017 tax audits through the Competent Authority process between South Korea, Germany and the United States;
•adjustments to estimated taxes upon finalization of various tax returns;
•increases in expenses not deductible for tax purposes, including impairments of goodwill in connection with acquisitions;
•our ability to meet the eligibility requirements for tax holidays of limited time tax-advantage status and any challenges by tax authorities regarding the timing of benefits derived from those holidays;
•changes in available tax credits;
•changes in share-based compensation;
•changes in other tax laws or the interpretation of such tax laws, including the Base Erosion Profit Shifting action plan implemented by the Organization for Economic Co-operation and Development;
•changes in generally accepted accounting principles; and
•significant fluctuations in business activities due to the COVID-19 pandemic.
As indicated above, we are engaged in discussions with various tax authorities regarding the appropriate level of profitability for Coherent entities and this may result in changes to our worldwide tax liabilities. In addition, we are subject to regular examination of our income tax returns by the Internal Revenue Service ("IRS") and other tax authorities. We regularly assess the likelihood of favorable or unfavorable outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Although we believe our tax estimates are reasonable, there can be no assurance that any final determination will not be materially different from the treatment reflected in our historical income tax provisions and accruals, which could materially and adversely affect our operating results and financial condition.
From time to time the United States, foreign and state governments make substantive changes to tax rules and the application of rules to companies. For example, the Tax Act has a significant impact on the taxation of Coherent including the U.S. tax treatment of our foreign operations. The Tax Act is subject to further interpretation by the U.S. federal and state governments
and regulatory organizations, legislative updates or new regulations, or changes in accounting standards for income taxes. These actions may have a material impact on our financial results.
Governmental regulations, including tariffs and duties, affecting the import or export of products could negatively affect our business, financial condition and results of operations.
The United States, Germany, the European Union, the United Kingdom, China, South Korea, Japan and many other foreign governments impose tariffs and duties on the import and export of products, including some of those which we sell. In particular, given our worldwide operations, we pay duties on certain products when they are imported into the United States for repair work as well as on certain of our products which are manufactured by our foreign subsidiaries. These products can be subject to a duty on the product value.
Additionally, the United States and various foreign governments have imposed tariffs, controls, export license requirements and restrictions on the import or export of some technologies, especially those related to the power and performance of our products and encryption technology. From time to time, government agencies have proposed additional regulation of encryption technology, such as requiring the escrow and governmental recovery of private encryption keys. Governmental regulation of encryption technology and regulation of imports or exports, or our failure to obtain required import or export licenses or other approvals for our products, could harm our international and domestic sales and adversely affect our net sales.
Exports of certain of our products are subject to export controls imposed by the U.S. government and administered by the U.S. Departments of State and Commerce. In certain instances, these regulations may require pre-shipment authorization from the administering department. For products subject to the EAR, the requirement for a license is dependent on the type and end use of the product, the final destination, the identity of the end user and whether a license exception might apply. Virtually all exports of products subject to ITAR require a license. Certain of our products are subject to EAR and to ITAR. Products and the associated technical data developed and manufactured in our foreign locations are subject to export controls of the applicable foreign nation. Given the current global political climate, obtaining export licenses can be difficult and time-consuming and may result in substantial expenses and diversion of management’s attention. Failure (i) to obtain the required export licenses could reduce our revenue and/or (ii) to adequately address these directives could result in substantial payments, fines, penalties or damages - including the suspension or loss of our export privileges, any of which could have a material adverse effect on our business or financial position, results of operations, or cash flows. For example, German authorities are currently investigating an export compliance matter involving one of our German subsidiaries involving four former employees (whose employment was terminated following our discovery of this matter) and while we do not believe that the final resolution of this matter will be material to our consolidated financial position, results of operations or cash flows, the German government investigation is ongoing and it is possible that substantial payments, fines, penalties or damages could result.
The United States has recently instituted or proposed changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on imports into the United States including, in particular, on Chinese goods, economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the United States and other countries where we conduct our business. In addition, the Japanese government has recently instituted trade restrictions affecting the export to South Korea of certain products and materials used in the manufacture of flat panel displays and in the semiconductor industry. These policy changes and proposals could require time-consuming and expensive alterations to our business operations and may result in greater restrictions and economic disincentives on international trade, which could negatively impact our competitiveness in jurisdictions around the world as well as lead to an increase in costs in our supply chain. Given that we are a multinational corporation, with manufacturing located both in the United States and internationally, we may face additional susceptibility to negative impacts from these tariffs or change in trade policies regarding our inter-company trade practices. For example, we have recently seen a reduction in demand from our Chinese customers particularly in the materials processing space. Some of these customers are reevaluating expansion plans and delaying and, in limited cases, cancelling orders. In addition, new tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries, and certain foreign governments, including the Chinese government (which has imposed retaliatory tariffs on a range of U.S. goods including certain photonics products), some of which have instituted or are considering imposing trade sanctions on certain U.S. manufactured goods. Such changes by the United States and other countries have the potential to adversely impact U.S. and worldwide economic conditions, our industry and the global demand for our products, and as a result, could negatively affect our business, financial condition and results of operations.
As a multinational corporation, we may be subject to audits by tax, export and customs authorities, as well as other government agencies. Any future audits could lead to assessments that could have a material adverse effect on our business or financial position, results of operations, or cash flows.
We use standard laboratory and manufacturing materials that could be considered hazardous and we could be liable for any damage or liability resulting from accidental environmental contamination or injury.
Although most of our products do not incorporate hazardous or toxic materials and chemicals, some of the gases used in our excimer lasers and some of the liquid dyes used in some of our scientific laser products are highly toxic. In addition, our operations involve the use of standard laboratory and manufacturing materials that could be considered hazardous. Also, if a facility fire were to occur at our Sunnyvale, California site and were to spread to a reactor used to grow semiconductor wafers, it could release highly toxic emissions. We believe that our safety procedures for handling and disposing of such materials comply with all federal, state and offshore regulations and standards. However, the risk of accidental environmental contamination or injury from such materials cannot be entirely eliminated. In the event of such an accident involving such materials, we could be liable for damages and such liability could exceed the amount of our liability insurance coverage and the resources of our business which could have an adverse effect on our financial results or our business as a whole.
Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.
We are subject to a variety of federal, state, local and foreign environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing process or requiring design changes or recycling of products we manufacture. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of products we manufacture. In addition, such regulations could restrict our ability to expand our facilities or could require us to acquire costly equipment, or to incur other significant expenses to comply with environmental regulations, including expenses associated with the recall of any non-compliant product and the management of historical waste.
From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. We continue to evaluate the necessary steps for compliance with regulations as they are enacted. These regulations include, for example, the Registration, Evaluation, Authorization and Restriction of Chemical substances ("REACH"), the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive ("RoHS") and the Waste Electrical and Electronic Equipment Directive ("WEEE") enacted in the European Union, which regulate the use of certain hazardous substances in, and require the collection, reuse and recycling of waste from, certain products we manufacture. This and similar legislation that has been or is in the process of being enacted in Japan, China, South Korea and various states of the United States may require us to re-design our products to ensure compliance with the applicable standards, for example by requiring the use of different types of materials. These redesigns or alternative materials may detrimentally impact the performance of our products, add greater testing lead-times for product introductions or have other similar effects. We believe we comply with all such legislation where our products are sold, and we will continue to monitor these laws and the regulations being adopted under them to determine our responsibilities. In addition, we are monitoring legislation relating to the reduction of carbon emissions from industrial operations to determine whether we may be required to incur any additional material costs or expenses associated with our operations. We are not currently aware of any such material costs or expenses. The SEC has promulgated rules requiring disclosure regarding the use of certain "conflict minerals" mined from the Democratic Republic of Congo and adjoining countries and procedures regarding a manufacturer's efforts to prevent the sourcing of such minerals. The implementation of such rules has required us to incur additional expense and internal resources and may continue to do so in the future, particularly in the event that only a limited pool of suppliers are available to certify that products are free from "conflict minerals." Our failure to comply with any of the foregoing regulatory requirements or contractual obligations could result in our being directly or indirectly liable for costs, fines or penalties and third-party claims, and could jeopardize our ability to conduct business in the United States and foreign countries.
Failure to maintain effective internal controls may cause a loss of investor confidence in the reliability of our financial statements or cause us to delay filing our periodic reports with the SEC and adversely affect our stock price.
The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Although we test our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, our failure to maintain adequate internal controls over financial reporting could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements or a delay in our ability to timely file our periodic reports with the SEC, which ultimately could negatively impact our stock price.
We may face particular privacy, data security and data protection risks due to laws and regulations regulating the protection or security of personal and other sensitive data.
We may face particular privacy, data security and data protection risks due to laws and regulations regulating the protection or security of personal and other sensitive data, including in particular several laws and regulations that have recently been enacted or adopted or are likely to be enacted or adopted in the future. For instance, effective May 25, 2018, the European General Data Protection Regulation ("GDPR") imposed additional obligations and risk upon our business and increased substantially the penalties to which we could be subject in the event of any non-compliance. GDPR requires companies to satisfy requirements regarding the handling of personal data (generally, of EU residents), including its use, protection and the rights of affected persons regarding their data. Failure to comply with GDPR requirements could result in fines of up to 20 million Euro or 4% of global annual revenues, whichever is higher. We have taken extensive measures to ensure compliance with GDPR and to minimize the risk of incurring any penalties and we continue to adapt to the developing interpretation and enforcement of GDPR as well as emerging best practice standards. For example, we have introduced an international Data Protection Organization, a European Data Protection Policy, a system for Data Protection Management and Documentation and implemented an international Intra Group Data Transfer Agreement including the EU Standard Contractual Clauses. In addition, several other jurisdictions around the world have recently enacted privacy laws or regulations similar to GDPR. For instance, California enacted the California Consumer Privacy Act ("CCPA"), which became effective January 1, 2020 and which gives consumers many of the same rights as those available under GDPR. Several laws similar to the CCPA have been proposed in the United States at both the federal and state level. Like GDPR, other similar laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business.
Violations of anti-bribery, anti-corruption, and/or international trade laws to which we are subject could negatively affect our business, financial condition and results of operations.
We are subject to laws concerning our business operations and marketing activities in foreign countries where we conduct business. For example, we are subject to the FCPA, U.S. export control and trade sanction laws, and similar anti-corruption and international trade laws in certain foreign countries, such as the U.K. Bribery Act. The FCPA generally prohibits U.S. companies and their officers, directors, employees, and intermediaries from making improper payments to foreign officials for the purpose of obtaining or retaining business abroad or otherwise obtaining favorable treatment. The FCPA also requires that U.S. public companies maintain books and records that fairly and accurately reflect transactions and maintain an adequate system of internal accounting controls. There can be no assurance that our employees, contractors, sales channel partners and agents will not take actions in violation of our policies and procedures, which are designed to ensure compliance with such laws. Violations of such laws and/or our policies and procedures by our employees, contractors, sales channel partners and agents could result in sanctions including civil and criminal fines, disgorgement of profits and suspension or debarment of our ability to contract with government agencies or receive export licenses and could also result in the termination of our relationships with customers and suppliers as well as financial reporting problem which could negatively affect our business, financial condition and results of operations.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
Provisions of our charter documents and Delaware law, and our Change of Control and Leadership Change Severance Plan, may have anti-takeover effects that could prevent or delay a change in control.
Provisions of our certificate of incorporation and bylaws, as well as the terms of our Change of Control and Leadership Change Severance Plan, may discourage, delay or prevent a merger or acquisition, make a merger or acquisition more costly for a potential acquirer, or make removal of incumbent directors or officers more difficult. These provisions may discourage takeover attempts and bids for our common stock at a premium over the market price. These provisions include:
•the ability of our Board of Directors to alter our bylaws without stockholder approval;
•limiting the ability of stockholders to call special meetings; and
•establishing advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
We are subject to Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a merger, asset or stock sale or other transaction with an interested stockholder for a period of three years following the date such person became an interested stockholder, unless prior approval of our board of directors is obtained or as otherwise provided. These provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us without obtaining the prior approval of our board of directors, which may cause the market price of our common stock to decline. In addition, we have adopted a change of control severance plan, which provides for the payment of a cash severance benefit to each eligible employee based on the employee's position. If a change of control occurs, our successor or acquirer will be required to assume and agree to perform all of our obligations under the change of control severance plan which may discourage potential acquirers or result in a lower stock price.
Our bylaws provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a different forum for disputes with us or our directors, officers or employees.
Our bylaws provide that the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have jurisdiction, another state or federal court located within the State of Delaware) is the exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a duty (including any fiduciary duty) owed by any current or former director, officer, stockholder, employee or agent to us or our stockholders, (iii) any action asserting a claim arising out of or relating to any provision of the Delaware General Corporation Law or our certificate of incorporation or bylaws (each, as in effect from time to time) or as to which the Delaware General Corporation Law confers jurisdiction on the Court of Chancery of the State of Delaware, or (iv) any action asserting a claim governed by the internal affairs doctrine. Our bylaws also provide that the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. This choice of forum provision may limit a stockholder’s ability to bring a claim in a different judicial forum that such stockholder views as more favorable for such disputes which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provisions contained in our bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
GENERAL RISK FACTORS
Worldwide economic conditions and related uncertainties could negatively impact demand for our products and results of operations.
Volatility and disruption in the capital and credit markets, depressed consumer confidence, government economic policies, negative economic conditions, volatile corporate profits and reduced capital spending could negatively impact demand for our products. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, as well as effectively manage supply chain relationships, in the face of such conditions, including uncertainty regarding the ability of some of our suppliers to continue operations and provide us with uninterrupted supply flow. Our ability to maintain our research and development investments in our broad product offerings may be adversely impacted in the event that our future sales decline or remain flat. Spending and the timing thereof by consumers and businesses have a significant impact on our results and, where such spending is delayed or cancelled, it could have a material negative impact on our operating results. Global economic conditions have become more uncertain and challenging as the effects of the COVID-19 pandemic continue to have a significant adverse effect on the global economy. Weakness in our end markets has negatively impacted our bookings, net sales, gross margin and operating expenses, and, if it continues, would have a material adverse effect on our business, financial condition and results of operations.
Uncertainty in global fiscal policy has likely had an adverse impact on global financial markets and overall economic activity in recent years. Should this uncertain financial policy continue to occur or recur, it would likely continue to, and may in the future, negatively impact global economic activity. Any weakness in global economies would also likely have negative repercussions on U.S. and global credit and financial markets, and further exacerbate sovereign debt concerns in the European Union. All of these factors would likely adversely impact the global demand for our products and the performance of our investments, and would likely have a material adverse effect on our business, results of operations and financial condition.
Financial turmoil affecting the banking system and financial markets, as has occurred in recent years, could result in tighter credit markets and lower levels of liquidity in some financial markets. There could be a number of follow-on effects from a tightened credit environment on our business, including the insolvency of key suppliers or their inability to obtain credit to finance development and/or manufacture products resulting in product delays; inability of customers to obtain credit to finance
purchases of our products and/or customer insolvencies; and failure of financial institutions negatively impacting our treasury functions. In the event our customers are unable to obtain credit or otherwise pay for our shipped products it could significantly impact our ability to collect on our outstanding accounts receivable. Other income and expense also could vary materially from expectations depending on gains or losses realized on the sale or exchange of financial instruments; impairment charges resulting from revaluations of debt and equity securities and other investments; interest rates; cash balances; and changes in fair value of derivative instruments. Volatility in the financial markets and any overall economic uncertainty increase the risk that the actual amounts realized in the future on our financial instruments could differ significantly from the fair values currently assigned to them. Uncertainty about global economic conditions could also continue to increase the volatility of our stock price.
In addition, political and social turmoil related to international conflicts, terrorist acts, civil unrest and mass migration may put further pressure on economic conditions in the United States and the rest of the world. Unstable economic, political and social conditions make it difficult for our customers, our suppliers and us to accurately forecast and plan future business activities. If such conditions persist, our business, financial condition and results of operations could suffer. Additionally, unstable economic conditions can provide significant pressures and burdens on individuals, which could cause them to engage in inappropriate business conduct. See "Part I, Item 4. Controls and Procedures."
We are exposed to lawsuits in the normal course of business which could have a material adverse effect on our business, operating results, or financial condition.
We are exposed to lawsuits in the normal course of our business, including product liability claims, if personal injury, death or commercial losses occur from the use of our products. As a public company our stock price fluctuates for a variety of different reasons, some of which may be related to broader industry and/or market factors. As a result, from time-to-time we may be subject to the risk of litigation due to the fluctuation in stock price or other governance or market-related factors. While we typically maintain business insurance, including directors' and officers' policies, litigation can be expensive, lengthy, and disruptive to normal business operations, including the potential impact of indemnification obligations for individuals named in any such lawsuits. We may not, however, be able to secure insurance coverage on terms acceptable to us in the future. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit, including a recall or redesign of products if ultimately determined to be defective, could have a material adverse effect on our business, operating results, or financial condition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Sales of Unregistered Securities
Not applicable.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On February 5, 2020, we announced that our board of directors authorized a stock repurchase program authorizing the Company to repurchase up to $100.0 million of our common stock through January 31, 2021. No repurchases were made under the program which expired on January 31, 2021.
ITEM 6. EXHIBITS
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| | | | Incorporated by reference herein |
| Exhibit Numbers | | Description | | Form | | Exhibit No. | | Filing Date | | File No. |
| | | | | | | | | | |
| 2.1* | | | | 8-K | | 2.1 | | January 20, 2021 | | 001-33962 |
| | | | | | | | | | |
| 3.1 | | | | 8-K | | 3.1 | | January 19, 2021 | | 001-33962 |
| | | | | | | | | | |
| 10.1 | | | | 10-K/A | | 10.25 | | February 1, 2021 | | 001-33962 |
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| 31.1 | | | | | | | | | | |
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| 31.2 | | | | | | | | | | |
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| 32.1** | | | | | | | | | | |
| | | | | | | | | | | |
| 32.2** | | | | | | | | | | |
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| 101.INS | | Inline XBRL Instance Document | | | | | | | | |
| | | | | | | | | | |
| 101.SCH | | Inline XBRL Taxonomy Extension Schema | | | | | | | | |
| | | | | | | | | | |
| 101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase | | | | | | | | |
| | | | | | | | | | |
| 101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase | | | | | | | | |
| | | | | | | | | | |
| 101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase | | | | | | | | |
| | | | | | | | | | |
| 101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase | | | | | | | | |
| | | | | | | | | | |
| 104 | | Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101). | | | | | | | | |
* Certain schedules and exhibits have been omitted pursuant to Item 601(a)(5) of Regulation S-K. A copy of any omitted schedule or exhibit will be furnished supplementally to the SEC upon request.
** Furnished herewith.
COHERENT, INC.
SIGNATURES
Pursuant to the requirements 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.
| | | | | | | | | | | |
| | Coherent, Inc. |
| | (Registrant) |
| | |
| Date: | February 10, 2021 | /s/: | ANDREAS W. MATTES |
| | | Andreas W. Mattes |
| | | President and Chief Executive Officer |
| | | (Principal Executive Officer) |
| | | |
| Date: | February 10, 2021 | /s/: | KEVIN S. PALATNIK |
| | | Kevin S. Palatnik |
| | | Executive Vice President and Chief Financial Officer |
| | | (Principal Financial and Accounting Officer) |