Item 1. Legal Proceedings
In the ordinary course of business, we are involved in various routine legal matters, either asserted or unasserted, and investigations incidental to the business. In the opinion of management, ultimate resolution of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
The following risks and uncertainties should be read carefully with the other information included in this quarterly report. If any of the risks described below occur, our business, financial condition, operating results and cash flows could be materially and adversely affected. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations and financial results. All references to years are to fiscal years.
Risks Related to Our Competition and Customers
Volatility in our customers’ industries and capital spending can have a direct and material impact on our business.
Our business depends upon the capital equipment expenditures of manufacturers of microelectronics, PCB’s, semiconductors, computers, wireless communications and other electronic products. The capital equipment market for the production of those products has historically been characterized by cyclical variations in capital equipment supply and demand. These sometimes sudden and severe cycles may result from a number of factors, including overall consumer and industrial spending and demand for electronic products that drive manufacturer production, as well as their capacity utilization, timing of new product introductions and demand for customers’ products, inventory levels relative to demand and access to affordable capital. The timing, severity and duration of these market cycles are difficult to predict. As a result, our business can vary significantly from quarter to quarter or year to year, as evidenced, for example, by the recent third quarter of 2018 compared to the third quarter of 2017.
Downturns particularly affect our profitability given the relative fixed cost structure of our business and the need to continually invest in product technology and support and service our products. For example, in the first and second quarters of fiscal 2017, we experienced a significant decline in orders due to reduced demand from PCB manufacturers that significantly impacted our results in the second and third fiscal quarters.
Our future success depends on our ability to expand into new markets.
Our future success depends in large part on our successful entry into new markets adjacent to our existing markets, such as high density interconnect, IC packaging, advanced wafer scribing, and other industrial and consumer electronics markets, including automotive, aerospace, medical and display. These markets are new to us and our success depends on our displacing entrenched competitors who are familiar with these markets and are known to customers. In many cases, we are attempting to enter or expand our presence in these new markets with newly introduced products that are not yet proven in the industry. In addition, in some cases we need to develop or expand our sales channels and customer relationships in order to execute on this strategy. We cannot provide assurance that we will succeed in gaining significant, or any, market share in these new markets. If we fail to successfully expand into these markets, we will have difficulty growing our business and may lose business to our competitors.
Substantial competition in markets in which we operate may result in price reductions, reduced profit margins and loss of market share.
We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Competitors with greater resources may better withstand periodic downturns, compete more effectively on the basis of price and technology, utilize better established sales channels and customer relationships, or more quickly enhance or develop new generations of products that compete with our products, in addition to other advantages. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We have also experienced new entrants to our markets offering aggressive price and payment terms in an attempt to gain market share. Some competitors, particularly in China, also develop low-cost products employing processes or technology developed by us. In addition, because we frequently price our products in U.S. dollars, a strong U.S. dollar can make our products less price-competitive outside of the United States to products priced in other currencies. We believe that to be competitive, we must continue to expend significant financial resources in order to invest in new product development and enhancements, among other things. We may not be able to compete successfully in the future and increased competition may result in price reductions, reduced profit margins and loss of market share.
Because our revenues largely depend on few customers, we have a greater degree of risk if we lose one of those customers or fail to win on new product designs.
We depend on a few significant customers for a large portion of our revenues. Our top ten customers accounted for approximately 47% of total net sales in 2017 and in the third quarter of 2018 they accounted for approximately 78% of total net sales. In the third quarter of 2018, one customer accounted for approximately 51% of our total quarterly net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in technologies or solutions used by customers, changes in products manufactured by customers or in end-user demand for those products, selection of suppliers other than us, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue and reduced demand from any single major customer. Also, our level of sales to several of our top customers depends on our winning new designs and features each product cycle, and there is no guarantee of future business based on past design wins. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. If we lose any of our significant customers, including as a result of any shipment delays due to heightened production levels, or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected.
Because our revenues are largely based on the sale of a small quantity of product units, our operating results could fluctuate significantly from quarter to quarter.
We derive a substantial portion of our revenue from the sale of a relatively small quantity of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:
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the timing of orders and terms or acceptance of product shipments by our customers;
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the mix of products and services that we sell in a given quarter;
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timing and market acceptance of our new product introductions; and
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delays or problems in the planned introduction of new products, or in the performance of any such products following delivery to customers.
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As a result of these risks, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance.
Increased pressure on price may result in pricing concessions, extended payment terms and decreased margins.
We have experienced and continue to experience pricing pressure from both competitors and customers in the sale of our products. Pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced or lower-cost products. In addition, we may agree to pricing concessions or extended payment terms with our customers in connection with expanding into new markets or gaining volume orders, or to improve our customer cost of ownership in highly competitive applications. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and price-based competition.
Risks Related to Our Supply Chain and Production
Limitations on our ability to rapidly change our production capacity in a cost effective manner could result in lower gross margins during sudden downturns and an inability to meet demand in sudden upturns.
To meet rapid changes in demand, such as we have experienced recently, we must effectively manage our resources and production capacity. During periods of decreasing demand for our products, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our supply chain. Our ability to timely and effectively reduce our costs in response to rapid downturns is limited by the fixed nature of many of our expenses in the near term, by our need to continue investing in product technology and support and service our products, and by our need to have sufficient production capacity and supply available to respond to sudden increases in demand. Conversely, when upturns occur, we may have difficulty rapidly and effectively increasing our manufacturing capacity or procuring sufficient materials to meet sudden increases in customer demand, which could result in shipping delays or the loss of business to our competitors and harm to our relationships with our customers. If we are not able to timely and cost effectively adapt to changes in our business environment, our business, financial condition or results of operations may be materially and adversely affected.
Our reliance on critical suppliers for key components could lead to production and service interruptions and shortages.
We use a wide range of components from numerous suppliers in the manufacturing of our products, including custom electronic, laser, optical and mechanical components. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. However, some key parts are available only from a single supplier or a limited group of suppliers in the short term. In addition, some of the lasers we use in our products are difficult to manufacture, and as a result we may not receive an adequate supply of lasers in a timely fashion to fill orders. Operations at our suppliers’ facilities are subject to disruption or discontinuation for a variety of reasons, including changes in business relationships, competition, financial difficulties, work stoppages, fire, natural disasters, customer prioritization, component end of life decisions or other causes. Any such disruption or discontinuation to our suppliers’ operations could interrupt or reduce our manufacturing activities and delay delivery of our products, any or all of which could materially and adversely affect our results of operations. This risk is particularly acute when we rely on a single or a limited group of suppliers. In addition, during periods of increased demand for our products, there is a heightened risk that one or more of our suppliers may not meet our increased demand requirements, adversely affecting our ability to fulfill orders and win business with our customers.
We may be unable to timely deliver certain products made by contract manufacturers.
We have arrangements with contract manufacturers to complete the manufacturing of certain of our product subcomponents. Any significant interruption in our contract manufacturers’ ability to provide quality manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, financial difficulties, natural disasters, delay or interruption in the receipt of inventory, or other causes could result in reduced manufacturing quality or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our business. Additionally, should a contract manufacturer no longer be able to perform for any reason or we need to add a contract manufacturer, it may require substantial time and resources, including the potential of incurring substantial cost, to replace or add the associated manufacturing capabilities, which could materially and adversely affect our business.
We may incur charges for excess or obsolete inventory as a result of having to forecast product demand without firm orders.
To effectively compete, we must deliver products on schedules required by our customers. Management forecasts demand, both in type and amount of products, for us to timely meet customer delivery schedules. We use these forecasts to purchase inventory in advance of our receiving firm customer orders. We also order materials based on our technology roadmap, which represents management’s assessment of technology we will utilize in new product developments. Certain types of inventory, such as lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast, we may have excessive working capital and slow-turning inventory. In addition, we may incur material charges for excess and obsolete inventory if we cannot sell the inventory. Also, if we alter our technology or product development strategy, we may have unusable inventory, which may also result in material accounting charges. For example, during the first quarter of 2018, we recorded approximately $6.0 million of charges in cost of sales for inventory written off associated with discontinued products.
Increasing regulations or environmental requirements on our product components could negatively affect our ability to sell our products or source materials.
Many countries, including the United States, China and those in the European Union, have implemented directives that restrict the sale of new electrical and electronic equipment containing certain hazardous substances and require disclosures if certain metals used in products are not from a conflict-free source. The directives could restrict our ability to sell our products in certain countries and affect sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products. In addition, our reputation could suffer if we are required to disclose that metals in our products are not from conflict-free sources.
Risks Related to Our Organization
Our significant international trade subjects us to greater risks.
International shipments accounted for 90% of net shipments in 2017, with 84% of our net shipments to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. In addition, we obtain supplies through an international supply chain. Our non-U.S. sales and purchases are subject to risks inherent in international trade, many of which are outside our control and include the following:
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periodic local or geographic economic downturns;
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price and currency exchange controls;
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fluctuation in the relative values of currencies;
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difficulty in repatriating money, whether as a result of tax laws or otherwise;
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difficulties protecting intellectual property;
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shipping delays and disruptions, including as a result of border controls;
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changes in trading policies, regulatory requirements, export control regulations, tariffs and other barriers, or the termination or renegotiation of existing trade agreements; and
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difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.
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Our success could be negatively impacted if we fail to effectively control, oversee and direct foreign subsidiaries and their operations.
We have significant foreign operations and subsidiaries, including manufacturing facilities in Singapore and China, research and application development facilities in France, China and Korea, and sales and service offices in various countries. Under our globalization strategy, we intend to increase our foreign operations in the future. Operating in multiple countries requires us to understand and comply with many different laws, infrastructures, ways of doing business, cultural customs and language. We are also more exposed to local labor disputes, potential corruption, and noncompliance with labor laws and other laws governing employees. Additionally, the human resources and the systems our foreign entities use can be vastly different. Having substantial international operations also increases the complexity of managing our financial reporting and internal controls and procedures, and effective communications across time zones. If we are unable to manage these risks effectively, it could negatively affect our operating performance and our reputation.
The complications associated with the implementation and modification of our globalization strategy may result in a substantial amount of management effort, cost and uncertainty.
We continue to implement and expand our globalization strategy, in which we are moving certain operational resources and capabilities to countries in Asia. As part of this strategy, we opened a manufacturing facility in Singapore in 2010, which is now our primary system manufacturing facility. We also acquired Topwin, a Chinese manufacturer of laser-based systems, in January 2015. In 2016, we opened an applications development center in Korea in order to increase responsiveness and access to local customers.
Our globalization strategy subjects us to a variety of complexities and risks, many of which may divert a substantial amount of management’s time. These risks include:
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designing facilities we can scale for future expansion, replicating current processes and bringing new facilities up to full operation;
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unpredictable costs, redundancy costs and cost overruns for developing facilities and acquiring equipment;
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building local management teams, technical personnel and other staff for functions that we have not previously conducted outside of the United States;
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technical obstacles such as poor production or process yield and loss of quality control during the ramp of a new facility;
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re-qualifications and other procedures that our customers may require;
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our ability to bring up local suppliers to meet our quality and cycle-time needs;
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our ability to ship timely or incur costs associated with export control restrictions of certain of our technologies;
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our ability to reduce costs in the United States;
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rapidly changing business conditions that may require us to change or abandon plans before we fully implement them; and
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challenges posed by distance and differences in language and culture.
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These and other factors could delay the continuing development, expansion and implementation of our strategy, as well as decrease our gross margins, delay shipments and deliveries, cause us to lose sales, require us to write off investments already made, damage our reputation and harm our business, financial condition and results of operations. If we decide to change our globalization strategy, we may incur charges for certain costs incurred. For example, we announced restructuring plans in 2015 and 2017 that led to the impairment of associated leasehold improvements and other assets for several of our facilities. The estimated future liability associated with these lease commitments was accrued net of estimated sublease rental income. However, to the extent the property is vacated or payments are not made by the sublessee, we will incur the full amounts of the ongoing lease obligation.
Our global operations expose us to a greater variety of natural disasters and political and social strife, each of which could directly impact our properties, operations and personnel.
Our business and operating results could be impacted, directly or indirectly, by natural disasters, outbreaks of infectious disease, military action, international conflicts, terrorist activities, civil unrest and associated political instability and policy changes. Many of our facilities, including our Portland, Oregon headquarters, are in areas with known earthquake risk. Some of these events or circumstances may also result in heightened security concerns with respect to domestic and international travel and commerce, which may further affect our business and operating results. In particular, we are subject to the following additional risks:
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recent and potential future tightening of immigration and travel controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities, our ability to attract, hire and retain new non-U.S. employees in such facilities or our ability to bring our non-U.S. employees into the United States for business related activities;
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more frequent instances of shipping delays; and
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our customers or suppliers may experience financial difficulties or cease operations.
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Our acquisition activities could result in operational disruptions, integration difficulties and other complications.
We may acquire or make significant investments in other businesses with complementary products, services or technologies, such as our January 2015 acquisition of Topwin and our August 2016 acquisition of Visicon. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:
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increased costs in connection with integration of personnel, operations, technologies and products of the acquired businesses;
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difficulties in implementation of our enterprise resource planning (ERP) system into the acquired company’s operations;
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diversion of management’s attention from other operational matters;
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the potential loss of key employees of the acquired company;
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lack of synergy or inability to realize expected synergies resulting from the acquisition;
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the inability to successfully enter new markets expected to result from the acquisition;
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acquired assets becoming impaired as a result of technological advancements or worse-than-expected performance by the acquired company;
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establishing satisfactory internal controls and accounting practices at the acquired company;
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difficulties implementing internal manufacturing processes at the acquired company;
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achieving our anticipated financial and operational performance for the acquired company or the performance of the combined company following the transaction; and
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acquiring unanticipated liabilities for which we will not be indemnified.
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Furthermore, the accounting for an acquisition could result in significant charges resulting from amortization or write-off of intangible assets and goodwill we acquire. Our inability to effectively manage these risks or lower levels of revenue, profitability or cash flows for acquired businesses and assets could result in our inability to realize the anticipated benefits of an acquisition on a timely basis, or at all, and materially and adversely affect our business, financial condition and results of operations. In addition, all acquisition transaction costs must be expensed as incurred rather than capitalized, which may have a material adverse effect on our results of operations. For example, in the fourth quarter of 2017 we recognized an impairment charge of $9 million related to goodwill and acquired intangibles.
The means by which we finance an acquisition may also significantly affect our business or the value of our common stock. If we issue common stock to pay for an acquisition, the ownership percentage of our existing shareholders will be diluted and the value of the shares held by our existing shareholders could decrease. If we use cash on hand to pay for an acquisition, the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. If we borrow funds in connection with an acquisition, we would be required to use cash to service the debt and to comply with financial and other covenants, which may reduce our flexibility.
Our business and reputation could be negatively impacted by cyber-attacks and other security breaches.
We electronically store sensitive data, including intellectual property, and our customers’, suppliers’ and business partners’ proprietary business information, and our employees’ personally identifiable information. The secure maintenance and transmission of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other actions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, disrupt our operations and damage our reputation, which could adversely affect our business, revenues and competitive position.
Our success depends, in part, on hiring and retaining key personnel.
Our continued success depends in part upon the services of our key managerial, financial and technical personnel. The loss of key personnel, or our inability to attract, assimilate and retain qualified personnel, could result in the loss of customers, inhibit our ability to operate and grow our business and otherwise have a material adverse effect on our business and results of operations. We have previously had to, and may in the future have to, impose salary reductions on employees during economic downturns in an effort to maintain our financial position. On several occasions in recent years, executives and other employees have received limited or no annual bonuses due to our financial performance relative to the performance parameters in our annual bonus plans. These events may have an adverse effect on employee loyalty and may make it more difficult for us to attract and retain key personnel. Competition for qualified personnel in the industries and locations in which we compete for talent is intense, and we may not be successful in attracting and retaining qualified personnel. We may incur significant costs in our efforts to recruit and retain key personnel, which could affect our financial position and results of operations.
In February 2016, we announced a reorganization and restructuring, which resulted in site closures in Montreal, Canada, Napa and Sunnyvale, California, and reductions in headcount in all functions and geographies. Additionally, we have replaced key executives. These events may adversely disrupt operating activities, may negatively affect employee morale and loyalty, and may make it more difficult to retain or rehire key personnel.
Risks Related to Technology
We may be unable to keep up with rapid technological changes in our markets, which could result in customers purchasing less of our products.
The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes and the requirements of current and potential customers. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We may not be able to identify, develop, manufacture, market or support new or enhanced products on a timely basis, if at all. If our competitors introduce new or enhanced products, or alternative technologies, our customers may defer, change or cancel orders for our existing products or cease purchasing our products altogether. Further, our new products may not gain timely market acceptance, and we may not be able to respond effectively to product announcements by competitors, technology changes or emerging industry standards. If we are unable to develop new or enhanced products to address customer requirements, technology changes or new industry standards on a timely basis, if our new or enhanced products are not accepted by the market, or if our customers adopt alternative technologies, our business, financial condition and results of operations may be adversely affected due to loss of market share or due to concentrations in impacted areas.
Our industry requires continued investment in research and development, and we may fail to optimally allocate our resources in this area.
The intense competition in our industry requires us to continue to invest in research and development. If we fail to invest sufficiently in research and development, our products could become obsolete or less attractive to our current and potential customers. Because of our need to maintain our research and development spending levels, our operating margins could be materially decreased if our net sales decline. In addition, our emphasis on research and development and technological innovation could cause our operating costs to increase in the future, and research and development expenses to increase as a percentage of total operating expenses and as a percentage of net sales.
We may be unable to realize growth opportunities if we cannot strengthen our marketing and channel capabilities.
The laser microfabrication industry is comprised of broad sets of markets and applications and presents significant opportunities for growth. In order to access these growth opportunities, we are strengthening our approach from customer-centric to market-based. We have reorganized into a functional structure and hired a Vice President of Marketing to drive improved process and disciplines across the organization. We believe our ability to successfully access and compete in these broader markets partially depends on our successful development of new marketing capabilities, sales and distribution channel access and customer relationships. Our inability to do so would limit our growth opportunities and profitability. In addition, any new strategy may cause disruption and ultimately prove unsuccessful.
Because our products are highly complex, we may experience quality control issues that could result in decreased sales and harm our reputation.
Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us. Our strategy to leverage proprietary laser technology to create competitive advantage may increase the probability and impact of this risks. As a result, we may have to replace certain components or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products, loss of sales and increased expenses and warranty costs.
Risks Related to Legal Matters
Our business depends on proprietary rights that may be difficult to protect, and the loss of any proprietary rights could affect our ability to compete effectively.
Our success depends significantly upon the protection of our proprietary rights. We attempt to protect our proprietary rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. Although we incur substantial costs to obtain and maintain patents and to defend our intellectual property rights, we may be unsuccessful in protecting these rights. Additionally, our proprietary rights may not provide the competitive advantages we expect, or other parties may challenge, invalidate or circumvent these rights.
We rely upon the laws of the United States and foreign countries where we develop, manufacture or sell our products to protect our proprietary rights. However, our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. For example, the patent prosecution and enforcement system within China is less mature than the systems in other jurisdictions and therefore we may be limited in our ability to enforce our rights. This disadvantage would likely be compounded by the challenge of any enforcement attempts by us as a foreign entity seeking protection against a Chinese company infringing on our proprietary rights in China. If we fail to adequately protect our intellectual property abroad, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins.
Our products may subject us to intellectual property infringement claims that could increase our costs and restrict our ability to do business.
Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. Competitors or others have asserted in the past, and may assert in the future, infringement claims against our customers or us with respect to current or future products or uses. These assertions may result in costly litigation, and if claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.
If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms, or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.
As a global company, we are subject to adverse fluctuations in our effective taxes due to tax audits, changes in tax law, certain preferential tax concessions, and other regulatory requirements.
Our tax liabilities may fluctuate from one period to the next because we operate in numerous tax jurisdictions with a broad range of income tax rates and regulations. Further, we are also periodically under audit by United States and foreign tax authorities and may have exposure to additional tax liabilities as a result. Although we believe our tax estimates are reasonable, the final outcome of tax audits and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made. For example, in 2018 we recorded an expense of $1.7 million for a value added tax and duty audit by the South Korean government. This audit is ongoing as of the third quarter of 2018.
We benefit from a tax incentive program in Singapore pursuant to which we paid no Singapore income tax with respect to our manufacturing income. The incentive period ends June 30, 2021 and is conditioned on achieving certain business and investment levels. If we do not achieve these criteria, we may lose the incentive benefits. We are subject to laws in various jurisdictions related to export/import compliance. Failure to comply or inconsistency in application could have an adverse impact on our ability to timely serve customers and/or results from operations.
We have tax losses and tax credits with remaining lives between 5 and 20 years. Due to a history of losses, as of December 30, 2017, we maintain a full valuation allowance on our deferred tax assets. We intend to continue maintaining a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Given our current earnings levels and anticipated future earnings, we believe that there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. A release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. The exact timing and amount of the valuation allowance release are subject to the levels of profitability that we are able to actually achieve and the weight of positive and negative evidence regarding the potential realizability of the deferred balances.
The Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law in the U.S. on December 22, 2017. We continue to evaluate the impact the new legislation will have on the Condensed Consolidated Financial Statements. While not limited to the following, we believe the following risks exist:
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Rule-making and additional technical guidance from the Department of Treasury, the FASB, and other relevant rule-making bodies continues to evolve and is likely to impact the treatment of the impact of the Tax Act.
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The Company’s assessment remains ongoing; therefore, the final impact of the Tax Reform may differ due to changes in interpretations, assumptions and we are not able to fully quantify the impact on the Condensed Consolidated Financial Statements at this time.
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Reaction to the new regulations by states and international trading partners is not yet clear, and could have a material impact on our business and results from operations.
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The change in statutory tax rates in the U.S. also impacts the gross values of the deferred tax assets before consideration of the valuation allowance, and assuming a release of the valuation allowance in the future, or utilization of these tax assets, the associated assets would be realized at the new, lower rate.
Risks Related to Financial Matters
If we cannot meet our liquidity needs, we may not have sufficient working capital to continue our business operations.
We may require greater working capital to operate than similar size businesses in many other industries. At
December 30, 2017
, we had working capital of
$169.2 million
, including
$99.1 million
in cash, cash equivalents and short-term investments. Our operating cash flows were negative for most quarters since September 2013. If we have continued decreases in cash, increases in production levels, an increase in slow-moving or obsolete inventory, or a combination of these circumstances, among others, we may need additional working capital for receivables and inventory. In addition, most of our contracts to acquire inventory represent purchase commitments. As a result, if we experience lower than anticipated demand for our products, in many cases we could not avoid the cost of purchasing the associated inventory.
While we have a credit facility in place, if we fail to meet the covenants in our credit facility or our lenders fail to fund, access to the facility may be limited or the facility may become unavailable altogether. Losses, such as those experienced in the second and third quarters of 2017, negatively impact our ability to maintain compliance with these covenants.
We have initiated restructuring activities, and as a result we have incurred and will continue to incur costs, some of which require cash outlays. To the extent actual costs exceed estimated costs, liquidity and results of operations could be materially and adversely affected.
If we have a material decrease in working capital, or require additional working capital to operate or require additional liquidity, and we do not have available credit or other funds and are unable to obtain financing on acceptable terms, or at all, our business and our ability to fully fund operations could be materially and adversely affected.
Our existing indebtedness may limit our business opportunities.
In the fourth quarter of 2017, we incurred $14.0 million of long-term indebtedness. This indebtedness is secured by our headquarters in Portland, Oregon. We also have a credit facility under which we may borrow up to a maximum of $30 million, subject to meeting certain availability requirements. This credit facility is secured by our non-real estate assets and nothing was outstanding under this agreement at
December 30, 2017
. We are required to comply with certain financial covenants under the debt agreements, including maintaining a certain level of earnings, a stated debt service coverage ratio and a specified level of certain types of liquid assets, as well as limiting our discretion to make capital expenditures or acquisitions. If we are unable to comply with the covenants in our debt agreements or make payments when due and the lender declares an event of default, the outstanding indebtedness would likely be immediately due and owing and the lenders could foreclose upon the collateral securing the debt.
Unfavorable currency exchange rate fluctuations could reduce our net sales abroad or cause us to incur losses on our forward exchange contracts.
Unfavorable currency fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to those customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, we could be forced to sell our products at a lower margin or at a net loss. A weak dollar may lead to impairment of inventories if costs begin to exceed selling prices as translated to the functional currency. In addition, some of our foreign sales are denominated in the currency of the country in which these products are sold and that currency could be less valuable at the time of receipt as a result of exchange rate fluctuations. From time to time, we enter into forward exchange contracts to hedge the value of accounts receivable primarily denominated in euros and other currencies. However, our efforts may not be adequate to protect us against significant currency fluctuations and such efforts may expose us to additional exchange rate risks, which could adversely affect our results of operations.
Impairment of Goodwill, Intangible and Long-Lived Assets
We held a total of
$5.5 million
in acquired intangible assets, net of accumulated amortization, and
$2.6 million
in goodwill at
December 30, 2017
. Consistent with the impairment recognized in the fourth quarter of 2017, events may occur or circumstances change such that the carrying value is not recoverable or it becomes more likely than not that the fair value of long-lived assets is reduced below the carrying value of the reporting unit, which could result in a further write-down of the fair-value of our assets. For example, the performance of our Topwin reporting unit did not meet expectations and, as a result, an impairment of goodwill and intangibles associated with that reporting unit was triggered in 2017, impacting consolidated earnings.
In addition, certain of our long-lived assets such as leasehold improvements, machinery, equipment, and loan and demo assets may experience impairment as a result of events such as the closure of sites, introduction of new products, decisions to exit certain products or markets, and changes in technology or changes in customer demand patterns. We depreciate long-lived assets and amortize intangible assets at levels we believe are adequate; however, an impairment of these assets could have a material adverse impact on our business, financial condition and results of operations. For example, due to the 2017 restructuring action,
$3.0 million
of leasehold improvements and related assets were impaired, impacting consolidated earnings.
An impairment of our investments could reduce our available liquidity.
Our investment portfolio is primarily comprised of commercial paper, debt securities issued by U.S. governmental agencies and money market securities. These investments are intended to be highly liquid and low risk. If the markets for these securities deteriorated for any reason, including as a result of a downgrade in the credit rating of U.S. government securities, the liquidity and value of these investments could be negatively affected, which could result in impairment charges and a material impact to our financial condition and results of operations. In addition, if our investments become illiquid or materially decrease in value, we may not have access to sufficient cash to meet or working capital and liquidity needs.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud and our stock price may be adversely affected.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed.
Although we are committed to continue to improve our internal control processes and we will continue to diligently and vigorously review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, any control system, regardless of how well designed, operated and evaluated, can provide only reasonable, not absolute, assurance that its objectives will be met. Therefore, we cannot be certain that in the future additional material weaknesses or significant deficiencies will not exist or otherwise be discovered. If such weaknesses or deficiencies occur, they could result in misstatements of our results of operations, additional restatements of our consolidated financial statements, a decline in our stock price and investor confidence, or other material effects on our business, reputation, financial condition or liquidity.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not Applicable.
Item 4. Mine Safety Disclosures
Not Applicable.