UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
__________________________________________________
FORM 10-K
| (Mark One) | |||||
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Fiscal Year Ended October 2 , 2021
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||
Commission File Number: 001-33962
___________________________________________________
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
(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 | Name of each exchange on which registered | ||||||
| (Nasdaq Global Select Market) | ||||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"). Yes ☐ No ☒
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 (§229.405 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.
| ☒ | 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of November 23, 2021, 24,690,975 shares of common stock were outstanding. The aggregate market value of the voting shares (based on the closing price reported on the NASDAQ Global Select Market on April 3, 2021) held by non-affiliates of the registrant was approximately $6,282,554,076 . For purposes of this calculation only, directors and executive officers of the registrant are deemed to be affiliates of the registrant.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the registrant's 2022 Annual Meeting of Stockholders are incorporated by reference into Part III of the Form 10-K to the extent stated herein. The Proxy Statement or an amended report on Form 10-K will be filed within 120 days of the registrant's fiscal year ended October 2, 2021.
TABLE OF CONTENTS
PART IV | |||||||||||
ITEM 15. | |||||||||||
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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This annual report contains certain forward-looking statements. These forward-looking statements include, without limitation, statements relating to:
•our pending merger with II-VI Incorporated (“II-VI”);
•expansion into, and financial returns from, new markets;
•maintenance and development of current and new customer relationships;
•enhancement of market position through existing or new technologies;
•timing of new product introductions and shipments;
•optimization of product mix;
•future trends in microelectronics, scientific and government programs, OEM components and instrumentation and materials processing;
•utilization of vertical integration;
•adoption of our products or lasers generally;
•applications and processes that will use lasers, including the suitability of our products;
•capitalization on market trends;
•alignment with current and new customer demands;
•positioning in the marketplace and gains of market share;
•design and development of products, services and solutions;
•control of supply chain and partners;
•protection of intellectual property rights;
•compliance with environmental and safety regulations;
•net sales and operating results, including the timing and impact on fiscal 2022 revenues of recoveries in investments;
•any potential increase in future demand in the microelectronics flat panel display market;
•the timing of any buildout of OLED manufacturing capacity;
•effect of global economic conditions, including in particular resulting from U.S. and Chinese trade policies;
•capital spending;
•order volumes;
•fluctuations in backlog, including potential for cancellation or rescheduling of orders;
•variations in stock price;
•growth in our operations;
•trends in our revenues, particularly as a result of seasonality;
•controlling our costs;
•sufficiency and management of cash, cash equivalents and investments;
•sales by geography;
•effect of legal claims;
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•expectations regarding the payment of future dividends;
•effect of competition on our financial results;
•plans with respect to leases;
•compliance with standards;
•effect of our internal controls;
•optimization of financial results;
•repatriation of funds;
•accounting for goodwill and intangible assets, inventory valuation, warranty reserves and taxes; and
•impact from our use of financial instruments.
In addition, we include forward-looking statements under the "Our Strategy" and "Future Trends" headings set forth below in the section titled "Business".
You can identify these and other forward-looking statements by the use of the words such as "may," "will," "could," "would," "should," "expects," "plans," "anticipates," "estimates," "intends," "potential," "projected," "continue," "our observation," or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.
Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below in the sections titled "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors." All forward-looking statements included in this 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.
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RISK FACTORS SUMMARY
You should carefully consider the information set forth under the heading "Risk Factors" in Item 1A of this report 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 pending merger with II-VI, including our requirement to comply with certain restrictions on our operations until closing, the possibility that the merger agreement with II-VI will be terminated or expire prior to the completion of the merger, diversion of management's attention, potential business uncertainty, including disruption of our relationships with third parties and employees, restrictions on our business activities and litigation related to the merger.
•Our business, financial condition and results of operations may 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 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.
•Disruption in our global supply chain could negatively impact our businesses.
•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.
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•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 completed or 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.
•As seen in recent actions of the governments of the United States and China, 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.
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PART I
ITEM 1. BUSINESS
GENERAL
Business Overview
We are one of the world's leading providers of laser solutions and optics for microelectronics, life sciences, industrial manufacturing, scientific and aerospace and defense markets. More than a provider of lasers, we deliver systems to the world's leading brands, innovators, and researchers, all backed with a global service and support network. 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 machine 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.
Income (loss) from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. Income (loss) 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 Corporate and other. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
We were originally incorporated in California on May 26, 1966 and reincorporated in Delaware on October 1, 1990. Our common stock is listed on the NASDAQ Global Select Market and we are a member of the Standard & Poor's MidCap 400 Index and the Russell 1000 Index.
Our fiscal year ends on the Saturday closest to September 30. Fiscal years 2021, 2020, and 2019 ended on October 2, October 3, and September 28, respectively, and are referred to in this annual report as fiscal 2021, fiscal 2020, and fiscal 2019 for convenience. Fiscal 2021 and 2019 each included 52 weeks and fiscal 2020 included 53 weeks.
Additional information about Coherent, Inc. (referred to herein as the Company, we, our, or Coherent) is available on our web site at www.coherent.com. We make available, free of charge on our web site, access to our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after we file or furnish them electronically with the Securities and Exchange Commission ("SEC"). Information contained on our web site is not part of this annual report or our other filings with the SEC. Any product, product name, process, or technology described in these materials is the property of Coherent.
RECENT EVENTS
Merger Agreements and Termination Fee
On January 18, 2021, we entered into an Agreement and Plan of Merger with Lumentum Holdings Inc. ("Lumentum"), Cheetah Acquisition Sub, Inc. ("Lumentum Merger Sub I") and Cheetah Acquisition Sub LLC ("Lumentum Merger Sub II"), pursuant to which we agreed to be acquired for $100.00 in cash per Coherent share and 1.1851 shares of Lumentum common stock per Coherent share. In light of unsolicited proposals received from each of MKS Instruments, Inc. and II-VI Incorporated ("II-VI"), on March 9, 2021, we entered into an Amended and Restated Agreement and Plan of Merger with Lumentum, Lumentum Merger Sub I and Lumentum Merger Sub II (the "Amended Lumentum Agreement"), pursuant to which we agreed to be acquired for $175.00 in cash per Coherent share and 1.0109 shares of Lumentum common stock per Coherent share.
On March 25, 2021, we terminated the Amended Lumentum Agreement and entered into an Agreement and Plan of Merger with II-VI and Watson Merger Sub Inc. ("II-VI Merger Sub") (the "II-VI Merger Agreement"), pursuant to which we agreed to be acquired for $220.00 in cash per Coherent share and 0.91 of a share of II-VI common stock per Coherent share. In
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connection with terminating the Amended Lumentum Agreement, we paid a termination fee of $217.6 million to Lumentum during our second quarter of fiscal 2021. The termination fee, in addition to other costs related to the merger agreements with Lumentum and II-VI, is included in merger and acquisition costs in our consolidated statements of operations.
Pursuant to the terms of the II-VI Merger Agreement, the acquisition of Coherent will be accomplished through a merger of II-VI Merger Sub with and into Coherent (the "Merger"), with Coherent surviving the Merger as a wholly owned subsidiary of II-VI.
Pursuant to the terms of the II-VI Merger Agreement, and subject to the terms and conditions set forth therein, at the effective time of the 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 II-VI, Coherent, or any direct or indirect wholly owned subsidiary of II-VI 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) $220.00 in cash, without interest, plus
(B) 0.91 of a validly issued, fully paid and non-assessable share of the common stock of II-VI.
The completion of Coherent's acquisition by II-VI is subject to customary closing conditions, including, among others, regulatory approvals in applicable jurisdictions including the United States, Germany, China and South Korea.
Coronavirus pandemic (COVID-19)
In December 2019, COVID-19 cases were 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 from time to time, 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 could negatively affect our revenue and results of operations. Each of the regions where we generate a majority of our revenue including Asia, Europe, and North America have been and may continue to be impacted by COVID-19 in the future. 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, in fiscal 2020 we compared 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 direct impacts to our bookings and net sales from COVID-19 and other factors. Using this criteria, we estimate that our sales for fiscal 2020 were negatively impacted by the COVID-19 pandemic by approximately $40.0 million. We believe the impact on fiscal 2021 sales was immaterial.
During fiscal 2020 and 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. Beginning in the fourth quarter of fiscal 2020 and continuing in 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, particularly in light of the recent Delta variant, 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 and Asia.
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 workforce 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 Sunnyvale, 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
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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 continue to experience various supply disruptions throughout the supply chain and are working closely with our supply base to mitigate or remove constraints as they become known. Supply constraints due to COVID-19 may impact the speed with which we are able to ramp up production if we experience strong demand on certain products. We also continue to face 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 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 and many of our key senior-level employees are members of the COVID Steering Committee.
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 could 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 "Risks Related to COVID-19 Pandemic" included under the heading "Risk Factors" in Item 1A of this annual report regarding the impact of COVID-19.
Goodwill and other impairment charges
Based on our internal projections and the preparation of our financial statements for the quarter ended April 4, 2020, and considering the then-expected decrease in demand due to the COVID-19 pandemic and other factors, we believed that the fair value of our ILS reporting unit might no longer have exceeded its carrying value and performed an interim goodwill impairment test on the ILS and OLS reporting units. Based on the estimated fair value of the ILS reporting unit, we recorded non-cash pre-tax goodwill impairment charges of $327.2 million in the quarter ended April 4, 2020. 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 related to the impairment of 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, in the quarter ended April 4, 2020. See Note 8, "Goodwill and Intangible Assets" and Note 11, "Leases" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
Restructuring
In June 2019, we internally 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. In conjunction with this consolidation, we recorded restructuring charges in fiscal 2019 of $19.7 million. The charges primarily related to write-offs of excess inventory, which is recorded in cost of sales, and estimated severance. We recorded charges of $1.1 million in fiscal 2020, primarily related to accelerated depreciation and
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project management consulting. We recorded no charges related to this project in fiscal 2021 as the project was completed in fiscal 2020.
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 did not incur material expenses in fiscal 2019 related to this project. In fiscal 2021 and 2020, we incurred costs of $0.1 million and $1.5 million, respectively, primarily related to accelerated depreciation, and completed the project in fiscal 2021.
In the fourth quarter of fiscal 2020, we began a restructuring program, as part of our good to great transformation, in our ILS segment which includes management reorganizations, the planned closure of multiple manufacturing sites, and the right-sizing of global sales, service, order admin, marketing communication, and certain administrative functions, among others. In the fourth quarter of fiscal 2020, we incurred costs of $2.6 million, primarily related to severance. In fiscal 2021, we incurred costs of $12.2 million, primarily related to write-offs of excess inventory, accruals for vendor commitments and warranty provisions, which are recorded in cost of sales, estimated severance, facility exit costs and accelerated depreciation.
See Note 19, "Restructuring Charges" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
Other
On April 19, 2021, we acquired Electro-Optics Technology, Inc. ("EOT") for approximately $29.3 million, excluding transaction costs. EOT is a 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. See Note 4, "Business Combinations" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
INDUSTRY BACKGROUND
The word "laser" is an acronym for "light amplification by stimulated emission of radiation." A laser emits an intense coherent beam of light with some unique and highly useful properties. Most importantly, a laser is orders of magnitude brighter than any lamp. As a result of its coherence, the beam can be focused to a very small and intense spot, useful for applications requiring very high power densities including welding and other materials processing procedures. The laser's high spatial resolution is also useful for microscopic imaging and inspection applications. Laser light can be monochromatic—all of the beam energy is confined to a narrow wavelength band.
There are many types of lasers and one way of classifying them is by the material or medium used to create the lasing action. This can be in the form of a gas, liquid, semiconductor, solid state crystal or fiber. Lasers can also be classified by their output wavelength: ultraviolet, visible, infrared or wavelength tunable. We manufacture all of these laser types. There are also many options in terms of pulsed output versus continuous wave, pulse duration, output power, beam dimensions, etc. In fact, each application has its own specific requirements in terms of laser performance. The broad technical depth at Coherent enables us to offer a diverse set of product lines characterized by lasers targeted at growth opportunities and key applications. In all cases, we aim to be the supplier of choice by offering a high-value combination of superior technical performance and high reliability.
Photonics has taken its place alongside electronics as a critical enabling technology for the twenty-first century. Photonics-based solutions are entrenched in a broad array of industries that include microelectronics, flat panel displays, machine tools, automotive, and medical diagnostics, with adoption continuing in ever more diverse applications. Growth in these applications stems from two sources. First, there are many applications where the laser is displacing conventional mechanical devices because it can do the job faster, better or more economically. Second, there are new applications where the laser is the enabling tool that makes the work possible, as in the conversion of amorphous silicon into poly crystalline silicon at low temperatures, where lasers are used in the manufacturing of high resolution rigid and flexible OLED displays found in the latest smartphones, tablets and laptop computers.
Key laser applications include: semiconductor inspection; manufacturing of advanced printed circuit boards ("PCBs"); flat panel display manufacturing; solar cell production; medical and bio-instrumentation; materials processing; metal cutting and welding; industrial process and quality control; marking; imaging and printing; graphic arts and display; and research and development. For example, ultraviolet ("UV") lasers are enabling the continuous move towards miniaturization, which drives innovation and growth in many markets. In addition, the advent of industrial grade ultrafast lasers continues to open up new applications for laser processing.
Coherent occupies a unique position in the industry thanks to the breadth and depth of our product and technology portfolio, which includes laser sources, critical or enabling photonics components and laser systems. Working closely with our customers we have developed specialized solutions that include lasers, delivery and process optics in complete assemblies (sub-
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systems), and for certain applications and markets we have also developed parts handling and automation to build complete laser systems.
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 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
•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, and 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 merger and acquisition costs. 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 expansion 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 are 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 as well as 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 markets, which were realigned as follows beginning in fiscal 2021:
•Microelectronics (which captures the 3 sub-markets of Display, Semiconductor, and Advanced Packaging & Interconnect);
•Precision Manufacturing;
•Instrumentation (which captures the 3 sub-markets of Bio-Instrumentation, Therapeutics & Research); and
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•Aerospace & Defense
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 and 2019 have been restated to these market applications.
The following table sets forth, for the periods indicated, the percentages of total net sales by market application:
| Fiscal 2021 | Fiscal 2020 | Fiscal 2019 | ||||||||||||||||||
| Percentage of total net sales | Percentage of total net sales | Percentage of total net sales | ||||||||||||||||||
| Consolidated: | ||||||||||||||||||||
| Microelectronics | 44.7 | % | 43.8 | % | 44.2 | % | ||||||||||||||
| Precision manufacturing | 26.8 | % | 27.3 | % | 28.3 | % | ||||||||||||||
| Instrumentation | 25.2 | % | 24.5 | % | 23.6 | % | ||||||||||||||
| Aerospace and defense | 3.3 | % | 4.4 | % | 3.9 | % | ||||||||||||||
| Total | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||||||
Microelectronics
Nowhere is the trend towards miniaturization and higher performance more prevalent than in the Microelectronics market where smartphones, tablets, personal computers, televisions, and wearables are driving advances in displays, integrated circuits, and PCBs. In response to market demands and consumer expectations, semiconductor and device manufacturers are continually seeking to improve their process and design technologies in order to manufacture smaller, more powerful, and more reliable devices at lower cost. New laser applications and new laser technologies are a key element in delivering higher resolution and higher precision at lower manufacturing cost.
We participate in three sub-markets in the microelectronics industry: (1) flat panel display manufacturing, (2) semiconductor front-end manufacturing, and (3) advanced packaging and interconnects.
Microelectronics—flat panel display manufacturing
The high-volume consumer market is driving the production of flat panel displays in applications such as mobile phones, tablets, laptop computers, televisions and wearables. There are multiple types of established displays, liquid crystal display ("LCD") and organic light emitting diodes ("OLED"), as well as emerging displays (MicroLED), each based on different technologies. All of these technologies utilize laser applications in their manufacturing process to enable improved yields, higher process speed, improved battery life, lower cost and/or superior display brightness, resolution and refresh rates.
Several display types require a high-density pattern of silicon thin film transistors. If this silicon is polycrystalline as opposed to amorphous, the display performance is greatly enhanced. Excimer-based processes, such as excimer laser annealing ("ELA") enable high-volume production of low-temperature polysilicon ("LTPS") on conventional glass substrates as well as flexible displays based on plastic substrates. Our excimer lasers provide a unique solution for LTPS because they are the only industrial-grade excimer lasers optimized for this application. The current state-of-the-art product for this application is our Vyper excimer laser and Linebeam systems. These systems deliver power ranges of 1200W to 3600W, enabling a critical manufacturing process step on substrate sizes, currently, up to Generation 6. These systems are integral to the manufacturing process on all leading LTPS-based smartphone displays and hold the potential for deployment in a variety of screens, including tablet, laptop, automotive displays, and OLED television. Excimer-based LTPS is also enabling flexible OLED displays which have undergone rapid growth as they have been adopted into smartphones.
An emerging technology related to flat panel displays is MicroLED technology. The appeal of MicroLED is reduced electrical consumption for improved battery life and higher absolute brightness relative to OLED. We are continuing to accelerate our efforts and investments in UV MicroLED manufacturing solutions to help our customers develop the laser processes of record, so we can, in turn, develop the laser-based capital equipment systems needed for mass production.
We see a co-existence of two technologies in the years to come, one being flexible OLED which will remain the dominant choice for mobile applications in the long term, and also in MicroLED which may become the preferred technology in large diagonal high end television, and devices such as watches or future smart glasses where brightness is a key advantage and
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battery size is at a premium. We believe we are well positioned to remain the laser solutions display industry leader for all display technologies.
A modern flat panel display incorporates a number of different layers, some of which are thin films that need to be cut or structured. As film thicknesses decrease over time, lasers are becoming the tool of choice to process these materials. Our DIAMOND CO2 and Rapid series ultrafast lasers are used for cutting flat panel display films.
We have developed a proprietary technology for cutting brittle materials such as glass and sapphire without debris and with zero kerf called SMART CleaveTM, which is used for cutting brittle materials used in displays. This technology uses ultrafast lasers coupled with proprietary optics.
Our AVIA, Rapid, Monaco, and DIAMOND CO2 lasers are also used in other production processes for flat panel displays. These processes include drilling, cutting, patterning, marking, and yield improvement.
While the timing and adoption rate of an emerging display technology such as ‘micro’ LED (µLED) is difficult to gauge, it is likely to make use of both similar technologies such as a LTPS backplane, as well as new ones, e.g. new versions of laser lift-off (LLO) and laser induced forward transfer (LIFT). We expect that this will represent an expanding market opportunity into new display form factors for laser-based processes.
Microelectronics—semiconductor front-end manufacturing
The term "front-end" refers to the production of semiconductor devices which occurs prior to packaging.
As semiconductor device geometries decrease in size, devices become increasingly susceptible to smaller defects during each phase of the manufacturing process and these defects can negatively impact yield. One of the semiconductor industry's responses to the increasing vulnerability of semiconductor devices to smaller defects has been to use defect detection and inspection techniques that are closely linked to the manufacturing process.
Detecting defects is only the first step in preventing their recurrence. Once found, defects must be examined in order to identify their size, shape and the process step in which the defect occurred. This examination is called defect classification. Identification of the sources of defects in the lengthy and complex semiconductor manufacturing process has become essential for maintaining high yield production. Semiconductor manufacturing has become an around-the-clock operation and it is important for products used for inspection, measurement and testing to be reliable and to have long lifetimes. Our Azure, Paladin, Excimer, Ion, and OPSL lasers are used to detect and characterize defects in semiconductor chips.
Microelectronics—advanced packaging and interconnects
After a wafer is patterned, there are then a host of other processes, referred to as back-end processing, which finally result in a packaged encapsulated silicon chip. Ultimately, these chips are then assembled into finished products. The advent of high-speed logic and high-memory content devices has caused chip manufacturers to look for alternative technologies and materials to improve performance as well as reduce process costs. This search includes new types of materials, such as low-k and thinner silicon. Our AVIA, Rapid, Monaco, and Matrix lasers provide economical methods of cutting and scribing these wafers while delivering higher yields than traditional mechanical methods.
There are similar trends in chip packaging and PCB manufacturing, that is the requirement for more compact packaging and denser interconnects. In many cases, lasers present enabling technologies. For instance, lasers are now the only economically practical method for drilling blind microvias in chip substrates and in both rigid and flexible PCBs. These microvias provide for the tiny interconnects that are essential for enabling high-density circuitry commonly used in smartphones, tablets, and advanced computing systems. Our DIAMOND CO2 and AVIA diode pumped solid state ("DPSS") lasers are the leading lasers in this application. The ability of these lasers to operate at very high repetition rates translates into faster drilling speeds and increased throughput in microvia processing applications. In addition, multi-layer circuit boards require more flexible production methods than conventional printing technologies can offer, which has led to widespread adoption of laser direct imaging ("LDI"). Our Paladin laser is used for this application.
We also offer market-leading solutions for laser marking of wafers and ICs, such as our PowerLine laser sub-systems.
Precision Manufacturing
Beginning in fiscal 2021, we increased our focus on Precision Manufacturing, a subset of the Materials Processing market, which demands more precision and control than other parts of the laser material processing market, and targeted our R&D and our manufacturing capabilities towards new products that will serve higher margin, defendable markets. Examples include medical device manufacturing, semiconductor wafer marking, and precision welding. Within the Precision Manufacturing area we participate at three levels: components, laser sources and laser systems. In the components space, we
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plan to introduce a whole new category of laser diode products that will allow us to address new applications and customers, dramatically increasing the size of our servable market.
In fiscal 2021, we primarily supported five sub-markets in the materials processing industry: (1) automotive, (2) machine tools, (3) medical device, (4) materials processing components and (5) consumer goods, as well as a number of smaller sub-markets. Our sales to this highly diverse set of markets include components, laser sources, laser diagnostic equipment, and complete laser systems. At a high level, the drivers for laser deployment within the materials processing sub-market are faster processing with higher yields, processing of new and novel materials, and more environmentally friendly processes, all with higher precision. With the broadest product portfolio in the laser industry, we offer solutions for almost any application on any material to our customers. The most common applications include cutting, welding, joining, drilling, perforating, scribing, engraving, and marking.
Lasers are used in a number of applications in the automotive sub-market, from fine processing of high precision parts to marking, as well as cutting of metals and welding large components such as gear boxes and car bodies for customers including OEMs and their customers. With the increasing production of electric vehicles, lasers are also playing a key role in the manufacture and welding of batteries used in these vehicles. We serve this market with a number of our products including ultrafast, DPSS, CO2, diode and ARM fiber lasers as well as systems in the areas of marking, scribing, cutting and welding.
We serve the machine tools sub-market with components, laser sources, and systems in applications including cutting, welding, marking, and additive manufacturing. We offer fiber lasers with different performance points in terms of power levels and beam profiles to address specific applications. During the past 12 months we have chosen to focus on specific lasers and processes including single mode lasers and advanced beam shaping options, e.g. the ARM advanced high power fiber laser where the beam parameters can be optimized to deliver higher quality welds with a wide variety of metals which translate into higher customer yields and enables more cost efficient designs. As a fully vertically integrated fiber and laser diode supplier, we are able to produce all key components in-house. Other products include our full line up of CO2 lasers, DPSS, and ultrafast lasers.
The medical device sub-market is characterized by its need for high precision manufacturing with high levels of quality control which lends itself very well to laser manufacturing. Applications include fine cutting and welding in addition to high quality and specialized marking. We serve this sub-market with a number of lasers as well as a portfolio of systems.
In the consumer goods sub-market, we serve a large variety of applications in various industries, such as packaging, digital printing, jewelry, textiles, security, and consumer electronics. We serve these industries with a broad offering of our products from lasers to laser tools. As a consequence, this market represents a stable and growing opportunity for us.
In summary, we serve the materials processing market with a very broad product portfolio. Laser sources include the Diamond series mid-power CO2 lasers; the DC series of high power CO2 lasers; Highlight FL high power ARM fiber lasers; the DF series of high power diode laser systems; the COMPACT, MINI and EVOLUTION series of low and mid power diode lasers; the AViA, Matrix, Flare, and Helios DPSS lasers; and the Monaco and Rapid series of ultrafast lasers. Laser tools include the Performance, Select and Integral series of manual welding systems; the Exact, UW and MPS series of modular and highly configurable laser processing systems; the EasyMark, EasyJewel, LabelMarker Advanced and Combiline laser marking systems; and the META laser cutting tools. Laser sub-systems, i.e. laser sources combined with software, beam delivery, processing heads, process monitoring, pattern recognition and vision, include the PowerLine series for marking; the StarFiber for welding and cutting; the PWS welding system; the QFS laser scribing system; and the StarShape CO2 laser-based systems.
Instrumentation
Instrumentation is one of our more mature commercial applications. Representative applications within this market include bio-instrumentation, medical OEMs and scientific and research applications. We also support the laser-based instrumentation market with a range of laser-related components and power and energy measurement products.
Bio-instrumentation
Laser applications for bio-instrumentation include confocal microscopy for biological imaging that allows researchers and clinicians to visualize cellular and subcellular structures and processes with an incredible amount of detail; DNA sequencing where lasers provide automation and data acquisition rates that would be impossible by any other method; drug discovery—genomic and proteomic analyses that enable drug discovery to proceed at very high throughput rates; flow cytometry for analyzing and sorting single cells or populations of cells in a heterogeneous mixture, including blood samples; and Raman spectroscopy which enables chemical analysis in a wide range of commercial applications. Our OBIS, Flare, Galaxy, Sapphire, BioRay, Genesis and CellX lasers are used in several bio-instrumentation applications.
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Medical therapy
We sell a variety of components and lasers to medical laser companies for use in clinical applications such as ophthalmology, aesthetic, surgical, therapeutic and dentistry. Our DIAMOND series CO2 lasers are widely used in dental, aesthetic and surgical markets. We have a leading position in Lasik and photorefractive keratectomy surgery methods with our ExciStar XS excimer laser platform. We also provide ultrafast lasers for use in cataract surgery and optical fibers for surgical applications.
The unique ability of our optically pumped semiconductor lasers ("OPSL") technology to match a wavelength to an application has led to the development of a high-power yellow (577nm) laser for the treatment of eye related diseases, such as Age Related Macular Degeneration and retinal diseases associated with diabetes. Other applications where our OBIS, Genesis and Sapphire series of lasers are used include the retinal scanning market in diagnostic imaging systems as well as new ground breaking in-vivo imaging.
Scientific and Research
We are widely recognized as a technology innovator and the scientific market has historically provided an ideal "test market" for our leading-edge innovations. These have included ultrafast lasers, DPSS lasers, continuous-wave ("CW") systems, excimer lasers and water-cooled ion gas lasers. Our portfolio of lasers that address the scientific research market is broad and includes our Acuity, Chameleon, Chameleon Discovery, COMPexPro, Astrella, Revolution, Fidelity, Legend, Libra, Monaco, Vitara, Mephisto, Mira, Genesis and Verdi lasers. Many of the innovations and products pioneered in the scientific marketplace have become commercial successes for both our OEM customers and us.
We have a large installed base of scientific lasers which are used in a wide range of applications spanning virtually every branch of science and engineering. These applications include biology and life science, engineering, chemistry and physics. Many of these applications require the use of ultrafast lasers that enable the generation of pulses short enough to be measured in femto- or attoseconds (10-15 to 10-18 seconds). Because of these very short pulse durations, ultrafast lasers enable the study of fundamental physical and chemical processes with temporal resolution unachievable with any other tool. These lasers also deliver very high peak power and large bandwidths, which can be used to study many different areas. Some of these are now finding their way into mainstream applications, such as microscopy or materials processing. The use of ultrafast lasers such as the Chameleon, Fidelity and Monaco in microscopy is now a common occurrence in bio-imaging labs, and they have become a crucial tool in modern neuroscience research.
Aerospace and defense
In fiscal 2021, we began disclosing aerospace and defense as a separate market application. Previously, this was included in our OEM Components and Instrumentation market application in fiscal 2020. We serve the aerospace and defense markets with components and laser sources in a number of applications including Directed Energy weapons, as well as technology for target designation and countermeasures. Additional areas include fiber optic gyroscopes, specialty large diameter optics and entire telescope payloads for intelligence, surveillance & reconnaissance. In particular, directed energy has seen rapid growth in the last couple of years, driven largely by the promise of being able to deter and repel asymmetrical threats such as drones in an effective and economical manner.
FUTURE TRENDS
Microelectronics
Lasers are widely used in mass production microelectronics applications largely because they enable entirely new manufacturing and testing capabilities that cannot be realized any other way. These laser-based fabrication and testing methods provide a level of precision, typically on a micrometer and nanometer level, that is unique, fast and touch free, delivers superior end products, increases yields, and/or reduces production costs. We anticipate this trend to continue, driven primarily by the increasing sophistication and miniaturization of consumer electronic goods, resulting in increasing demand for better displays, more bandwidth and memory, and all packaged into devices which are lighter, thinner and consume less power. We believe that we are well positioned to continue to capitalize on the current market trends.
Excimer-based LTPS is a key technology in the production of high resolution rigid and flexible OLED displays as well as future display technologies.
Another key technology related to flat panel displays is that of the emerging MicroLED technology. The appeal of MicroLED is reduced electrical consumption for improved battery life and higher absolute brightness relative to OLED. We are continuing to accelerate our efforts and investments in excimer laser-based MicroLED processes to help our customers develop the laser processes of record, creating a laser-based capital equipment market for mass production.
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Demand for CO2, Avia, Matrix, Rapid, Monaco, Helios and direct diode lasers provides solutions for related flat panel display touch panel, film cutting, light guide technology, repair and frit welding applications.
The trend for thinner and lighter devices is impacting the glass substrates used in today's mobile devices requiring thinner glass with higher degrees of mechanical strength and scratch resistance. Mechanical means of cutting these glass and sapphire pieces are no longer adequate to meet future requirements and we expect lasers to play an increased role. Our CO2, Monaco and Rapid lasers together with our proprietary SmartCleave technology are well positioned to take advantage of this trend.
These same lasers, plus Monaco, Rapid, and CO2 are also widely adopted for back end Advanced Packaging and Interconnect (API) applications. With dimension roadmaps showing a decade of dimension shrink on PCBs, interconnects, Silicon scribe widths and wafer thickness, and driven by developments such as 5G, we believe that our portfolio of lasers aligns well with these demands as well as new processes that could be enabled by our lasers, to meet the increasing demands and decreasing tolerances of these markets.
Semiconductor devices look set to continue shrinking device geometries, as well as expanding vertically into new 3D structures. Such development requires sophisticated testing in order to enhance yields. We believe our many UV laser sources (such as Azure, Paladin, Avia, Rapid, ExiStar, and OPSL) will continue to find increasing adoption, since their unique optical properties align well with the demands of a nanometer scale world. The semiconductor capital equipment market remains strong, and we are anticipating this trend continuing in fiscal 2022. Furthermore, we also believe we will benefit from further adoption of sophisticated semiconductor testing techniques.
While we experienced a softening of the demand in fiscal 2019 and fiscal 2020, we experienced a resumption of investment in OLED manufacturing capacity in fiscal 2021. It is difficult to precisely determine the timing and impact of this OLED investment on our fiscal 2022 and longer term revenues even as additional vendors ramp their OLED production rates.
Precision Manufacturing
The materials processing market is the most diverse of all the markets we serve and a large cross section of our products are used in this market. In fiscal 2021, we began to focus on Precision Manufacturing, a subset of the Materials Processing market, where we participate well both in terms of market share and margins on three levels of components, laser sources and laser systems. We are concentrating our R&D and our manufacturing capabilities towards new products that will serve higher margin, defendable markets. We sell components, laser sources and complete laser systems. There are many drivers at play, but at a high level they involve faster processing with higher yields, processing of new materials, more environmentally friendly processes and higher precision.
The automotive industry is undergoing rapid changes that present opportunities for further use of lasers. Trends such as using new materials to develop lighter cars and emission-reduced electric vehicles require new processes for welding, cutting and drilling. We believe this will lead to further adoption of lasers and tools based on high power fiber and diode lasers, as well as ultrafast and CO2 lasers. In particular, we believe our ARM laser technology offers competitive advantages versus alternative solutions especially in the rapidly growing area of battery welding and manufacturing.
We expect to see select opportunities for our products in the machine tools industry in a variety of broad-based applications including newer applications such as laser cladding and heat treatment.
In the consumer goods market, we serve a large variety of applications in various industries, such as packaging, digital printing, jewelry, textiles, security and consumer electronics. We serve these industries with a broad offering of our products from lasers to laser tools. As a consequence, this market represents a stable and growing opportunity for us.
We supply the medical device market with a variety of lasers and laser systems in applications such as fine cutting and welding as well as marking. This market is set to continue to grow in the foreseeable future as the population becomes older and advanced medical procedures spread outside the traditional markets in US, Europe and Japan.
Instrumentation
Instrumentation is one of our more mature commercial applications. Representative applications within this market include bio-instrumentation, medical therapy, and scientific and research applications.
We are an OEM supplier to the bio instrumentation market which includes flow cytometry, microscopy and DNA sequencing, all of which are enjoying solid growth on a worldwide basis with some local variations. In this field, our OPSL technology gives us differentiated products at a number of important wavelengths. This advantage coupled with strong focus on meeting our customers' demands for more compact and cost effective sources as well as integrated laser sub-systems has resulted in growth for us in this market and we expect that to continue.
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In the medical therapy market, we are an OEM laser supplier to medical system manufacturers in a number of clinical segments. In this area, we see stable business with several opportunities for growth. We supply excimer lasers used in refractive eye surgery and are actively involved in further developments in laser vision correction. We also have opportunities in dental procedures for both hard and soft tissue applications, with greatly improved patient comfort and outcome. In the area of retinal treatment, photocoagulation based on our Genesis OPSL yellow lasers are being used since the wavelength is particularly suitable for the treatment of blood vessels. We are an OEM supplier of CO2 and semiconductor lasers to the major manufacturers of equipment used in the latest aesthetic procedures.
Worldwide scientific funding is expected to remain relatively stable, with some regions growing and others holding their current level. Potential growth areas include the strong push in neuroscience to better understand how the brain functions. Lasers play a very important role in imaging brain structure as well as tracking activity using techniques such as optogenetics. We believe that our current and upcoming products are well positioned to take advantage of the growing scientific interest and funding in this area. In physics and chemistry applications, our recent product introductions of high performance and industrially hardened ultrafast products have been very well received. While this is a very competitive market, we expect that our new products will position us for growth.
Aerospace and defense
Governments have made and continue to make investments in the development of directed energy systems, both offensive and defensive. We have a number of product offerings which support these development efforts. A key differentiator for us in this market is having a U.S.-based supply chain for all critical components, many of which are vertically integrated within Coherent, which we believe is advantageous to serve this market. Our U.S. Defense customers have made it clear that a secure, U.S.-based supply chain is and will be required moving forward. Our fabrication process includes epitaxial growth for our own laser diodes and packaged diodes in the U.S. and we also supply the specialty single mode amplifier fiber, critical for every directed energy amplifier. We own several other businesses that make critical components and in April 2021, we completed the purchase of 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.
MARKET APPLICATIONS
We design, manufacture and market lasers, laser tools, precision optics and related accessories for a diverse group of customers. The following table lists our major markets and the Coherent technologies serving these markets, based on our market applications in fiscal 2021.*
| Market | Application | Technology | |||||||||
| Microelectronics | Flat panel display | CO, CO2 DPSS Excimer Ultrafast Semiconductor Laser Sub-systems | |||||||||
| Semiconductor front-end | CO2 DPSS OPSL Ion Laser Sub-systems | ||||||||||
| Advanced packaging and interconnects | CO, CO2 DPSS Excimer Ultrafast Laser Sub-systems | ||||||||||
| Precision Manufacturing | Automotive | CO2 ARM Fiber Laser Systems/ Laser Sub-systems Ultrafast | |||||||||
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| Market | Application | Technology | |||||||||
| Machine Tools | CO2 ARM Fiber DPSS Ultrafast Laser Systems/ Laser Sub-systems | ||||||||||
| Medical Device | CO2 DPSS Fiber Ultrafast Excimer Laser Systems/ Laser Sub-systems Components | ||||||||||
| Consumer Goods | CO2 Fiber DPSS Ultrafast Laser Systems/ Laser Sub-systems | ||||||||||
| Instrumentation | Bio-Instrumentation | DPSS OPSL Ultrafast Semiconductor | |||||||||
| Medical therapy (OEM) | CO, CO2 DPSS Ultrafast Excimer OPSL Semiconductor Components | ||||||||||
| Scientific and research | CO, CO2 DPSS Excimer OPSL Ultrafast | ||||||||||
| Defense and aerospace | Defense and aerospace applications | Fiber Laser Amplifiers Semiconductor Components | |||||||||
| *Coherent sells its laser measurement and control products into a number of these applications. | |||||||||||
In addition to the products we provide, we invest routinely in the core technologies needed to create substantial differentiation for our products in the marketplace. Our semiconductor, crystal, fiber and large form factor optics facilities all maintain an external customer base providing value-added solutions. We direct significant engineering efforts to produce unique solutions targeted for internal consumption. These investments, once integrated into our broader product portfolio, provide our customers with uniquely differentiated solutions and the opportunity to substantially enhance the performance, reliability and capability of the products we offer.
TECHNOLOGIES
Diode-pumped solid-state lasers (DPSS)
DPSS lasers use semiconductor lasers to pump a crystal to produce a laser beam. By changing the energy, optical components and the types of crystals used in the laser, different wavelengths and types of laser light can be produced.
The efficiency, reliability, longevity and relatively low cost of DPSS lasers make them ideally suited for a wide range of OEM and end-user applications, particularly those requiring 24-hour operations. Our DPSS systems are compact and self-contained sealed units. Unlike conventional tools and other lasers, our DPSS lasers require minimal maintenance since they do
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not have internal controls or components that require adjusting and cleaning to maintain consistency. They are also less affected by environmental changes in temperature and humidity, which can alter alignment and inhibit performance in many systems.
We manufacture a variety of DPSS laser types for different applications including semiconductor inspection; advanced packaging and interconnects; laser pumping; spectroscopy; bio-agent detection; DNA sequencing; drug discovery; flow cytometry; entertainment lighting (display); medical; rapid prototyping and marking, welding, engraving, cutting and drilling.
Fiber Lasers, Fiber Components and Fiber Assemblies
Fiber lasers use semiconductor lasers to pump a doped optical fiber to produce a laser beam. The unique features of a fiber laser make them suitable for producing high power, continuous wave laser beams. Our emphasis is on the design and manufacture of highly differentiated fiber lasers that provide advantages and/or are enabling in certain applications. For example, our ARM laser offers dynamically adjustable beam profiles that improve welding results compared to standard fiber lasers and is able to weld new composite materials.
We are one of the world's leading OEM suppliers of Active Fiber for fiber lasers - selected for our combination of high performance and consistent quality. In addition, we are a volume supplier of Specialty Passive Fiber, High Power Fiber Cables, Fiber Switches, Fiber-to-Fiber Couplers, as well as fiber laser amplifiers for directed energy applications. In addition, many of the fiber components offered in the broader market, such as Fiber Bragg Gratings and Fiber Combiners, have our fiber components in them.
Gas lasers (CO, CO2, Excimer, Ion)
The breadth of our gas laser portfolio is industry leading, encompassing CO, CO2, excimer and ion laser technologies. Gas lasers derive their name from the use of one or more gases as a lasing medium. They collectively span an extremely diverse and useful wavelength range, from the very deep ultraviolet to the far infrared. This diverse range of available wavelengths, coupled with high optical output power, and an abundance of other attractive characteristics, makes gas lasers extremely useful and popular for a variety of microelectronics, scientific, therapeutic and materials processing applications. For example, the CO2 and CO lasers are unique in their ability to process non-metal materials.
Optically Pumped Semiconductor Lasers ("OPSL")
Our OPSL platform is a surface emitting semiconductor laser that is energized or pumped by a semiconductor laser. The use of optical pumping circumvents inherent power scaling limitations of electrically pumped lasers, enabling very high powered devices. A wide range of wavelengths can be achieved by varying the semiconductor materials used in the device and changing the frequency of the laser beam using techniques common in solid state lasers. The platform leverages high reliability technologies developed for telecommunications and produces a compact, rugged, high power, single-mode laser.
Our OPSL products are well suited to a wide range of applications, including the bio-instrumentation, therapeutics and graphic arts and display markets.
Semiconductor lasers
High power edge emitting semiconductor diode lasers use the same principles as widely-used CD and DVD lasers, but produce significantly higher power levels. The advantages of this type of laser include smaller size, longer life, enhanced reliability and greater efficiency. We manufacture a wide range of discrete semiconductor laser products with wavelengths ranging from 650nm to over 1000nm and output powers ranging from 1W to over 100W, with highly integrated products in the kW range. These products are available in a variety of industry standard form factors including the following: bare die, packaged and fiber coupled single emitters and bars, monolithic stacks and fully integrated modules with microprocessor controlled units that contain power supplies and active coolers.
Our semiconductor lasers are used internally as the pump lasers in DPSS, fiber and OPSL products that are manufactured by us, as well as a wide variety of external medical, OEM, defense and industrial applications, including aesthetic (hair removal, cosmetic dentistry), graphic arts, counter measures, rangefinders, target designators, cladding, hardening, brazing and welding.
Ultrafast ("UF") Lasers
UF lasers are lasers generating light pulses with durations of femtoseconds (10-15 seconds) to a few tens of picoseconds (10-12 seconds). These types of lasers are used for medical, advanced microelectronics and materials processing applications as well as scientific research. UF laser oscillators generate a train of pulses at 50-100 MHz, with peak powers of tens of kilowatts, and UF laser amplifiers generate pulses at 1-2000 kHz, with peak powers up to several Terawatts.
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The extremely short duration of UF laser pulses enables temporally resolving fast events like the dynamics of atoms or electrons. In addition, the high peak power enables so-called non-linear effects where several photons can be absorbed by a molecule at the same time. This type of process enables applications like multi-photon excitation microscopy or ablation of materials with high precision and minimal thermal damage. The use of our ultrafast lasers in applications outside science continued to grow as it offers unparalleled quality of results, particularly in microelectronics and materials processing applications.
Integrated Laser Solutions: Systems and Sub-systems
In most cases, our lasers are integrated into machine tools or systems to perform a specific task, e.g. manufacturing of electronic components or performing a procedure on a patient. Inside the system the laser is typically combined with delivery optics and beam steering devices, such as scanning galvanometers, to deliver the laser beam to the workpiece.
In addition to offering laser sources, we also offer solutions comprising beam delivery optics, mechanics and control electronics including software. We believe that these 'sub-systems' allow us to leverage our expertise in laser processing and optical design into superior solutions for our customers, with applications that can offer higher value and/or faster time to market. We have developed proprietary hardware, firmware and software in this area. Laser sub-systems often include vision systems, process monitoring and monitoring of the system itself. Our sub-system products include: PowerLine series for marking; the StarFiber for welding and cutting; the PWS welding system; the QFS laser scribing system; and the StarShape CO2 laser-based systems.
In select cases we also offer complete laser systems which include the laser sub-system as well as a material handling capability inside a class 1 laser safety enclosure, ready to be used in production or development environments. Our laser systems products include: the Performance, Select and Integral series of manual welding systems; the Exact, UW and MPS series of modular and highly configurable laser processing systems; the EasyMark, EasyJewel, LabelMarker Advanced and Combiline laser marking systems; the META laser cutting tools; and the PWS mini welding system.
SALES AND MARKETING
We primarily market our products in the United States through a direct sales force. We sell internationally through direct sales personnel located in Canada, China, France, Germany, Israel, Italy, Japan, the Netherlands, South Korea, Singapore, Spain, Taiwan, and the United Kingdom, as well as through independent representatives in certain jurisdictions around the world. Our foreign sales are made principally to customers in South Korea, China, Germany, Japan, as well as other European and Asia-Pacific countries. Foreign sales accounted for 77% of our net sales in fiscal 2021, 76% of our net sales in fiscal 2020, and 76% of our net sales in fiscal 2019. Sales made to independent representatives and distributors are generally priced in U.S. Dollars. A large portion of foreign sales that we make directly to customers are priced in local currencies and are therefore subject to currency exchange fluctuations. Foreign sales are also subject to other normal risks of foreign operations such as protective tariffs, export and import controls, and political instability.
We had one customer, Advanced Process Systems Corporation, who contributed more than 10% of revenue during each of fiscal 2021, 2020, and 2019.
To support our sales efforts we maintain and continue to invest in a number of applications centers around the world, where our applications experts work closely with customers on developing laser processes to meet their manufacturing needs. The applications span a wide range, but are mostly centered around the materials processing and microelectronics markets. Locations include several facilities in the US, Europe, and Asia.
We maintain customer support and/or field service staff in major markets within the United States, Canada, Europe, Japan, China, Singapore, South Korea, Taiwan, Vietnam, and other Asia-Pacific countries. This organization works closely with customers, customer groups and independent representatives in servicing equipment, training customers to use our products and exploring additional applications of our technologies.
We typically provide parts and service warranties on our lasers, laser-based systems, optical and laser components and related accessories and services. The length of warranties offered on our products and services varies, but primarily ranges from 12 to 24 months. Warranty reserves, as reflected on our consolidated balance sheets, have generally been sufficient to cover product warranty repair and replacement costs. The weighted average warranty period covered in our reserve is approximately 15 to 18 months.
MANUFACTURING
Since the acquisition of Rofin in fiscal 2017, we have implemented strategies to improve operating leverage, to execute synergies and to enhance our customers' experience. For example, 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
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transferring certain HPFL activities from our Hamburg, Germany facility. In fiscal 2020, we reorganized our reporting structure so that all business units now report to our Executive Vice President and Chief Operating Officer. Common policies and guidelines have been communicated, key management and operating processes have been implemented and ERP systems deployed at Rofin's sites in Asia, North America, and Europe, including all significant manufacturing sites, consistent with the rest of Coherent.
Strategies
One of our core manufacturing strategies is to tightly control our supply of key parts, components, sub-assemblies, and outsourcing partners. We utilize vertical integration when we have proprietary internal capabilities that are not cost-effectively available from external sources. We believe this is essential to maintaining high quality products and enable rapid development and deployment of new products and technologies. We are committed to providing customers with products manufactured at the highest level of quality and reliability by continuously improving our quality management system and adhering to processes that are International Organization for Standardization ("ISO") certified at our principal manufacturing sites.
Our commitment to Operational Excellence and continuous improvement is at the core of our Coherent Lean culture aimed at creating value for our customers. Our culture of continuous improvement is driven throughout all operations by embracing and developing a common culture of learning. Our passion for operational excellence is embedded in all operations by continually teaching our teams how to identify waste, leveraging proven problem solving tools, standardizing our manufacturing systems and empowering our employees to drive change through best practice sharing or Kaizen events.
Committed to quality and customer satisfaction, we design and produce many of our own components and sub-assemblies in order to retain quality and performance control. We have also outsourced certain components, sub-assemblies and finished goods where we can maintain our high quality standards while improving our cost structure.
As part of our strategy to increase our market share and customer support in Asia as well as our continuing efforts to manage costs, we continue to transfer the production of targeted products to our Singapore and Malaysia factories. Our increased tube refurbishment capacity in our South Korea operations has allowed us to reduce service response time, carry strategic inventory, and provide benefits to us and to our customers throughout the APAC region. Our Asia material sourcing strategy driven by our International Procurement Office in Singapore continues to expand, which has enabled us to leverage spend and reduce material costs on a global basis.
We have designed and implemented proprietary manufacturing tools, equipment and techniques in an effort to provide products that differentiate us from our competitors. These proprietary manufacturing techniques are utilized in a number of our product lines including our gas laser production, crystal growth, beam alignment as well as the wafer growth for our semiconductor, optically pumped semiconductor laser product family and fiber component and fiber laser product family.
Raw materials or sub-components required in the manufacturing process are generally available from several sources. However, we currently purchase several key components and materials, including exotic materials, crystals and optics, used in the manufacture of our products from sole source or limited source suppliers. We also purchase assemblies and turnkey solutions from contract manufacturers based on our proprietary designs. We rely on our own production and design capability to manufacture and specify certain strategic components, crystals, fibers, semiconductor lasers, lasers and laser-based systems.
For a discussion of the importance to our business of, and the risks attendant to sourcing, see "Risk Factors" in Item 1A — "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."
Operations
Our products are manufactured at our sites in California, Oregon, Arizona, Michigan, New Jersey, Connecticut, and New Hampshire in the U.S.; Germany, Scotland, Finland, Sweden, Switzerland, and Spain in Europe; and South Korea, China, Singapore, and Malaysia in Asia. In addition, we also use contract manufacturers in southeast Asia, Eastern Europe and the United States for the production of certain assemblies and turnkey solutions.
Our ion gas lasers, a portion of our DPSS lasers that are used in microelectronics, scientific research and materials processing applications, semiconductor lasers, OPS lasers, ultrafast scientific lasers, defense-related water-cooled stacks, passively cooled fiber coupled bars and single emitters are manufactured at our Santa Clara, California site. Our laser diode module products, laser instrumentation products, test and measurement equipment products are manufactured in Wilsonville, Oregon and Singapore. We manufacture exotic crystals in Mount Olive, New Jersey and Koblenz, Germany. We manufacture passive fibers in our Salem, New Hampshire facility. Our low power CO2 and CO gas lasers are manufactured in Bloomfield,
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Connecticut. We manufacture a portion of our DPSS lasers used in microelectronics and OEM components and instrumentation applications in Lübeck, Germany and Singapore. We manufacture a portion of our DPSS lasers used in microelectronics, OEM components and instrumentation and materials processing applications in Kaiserslautern, Germany. Our excimer gas laser products are manufactured in Göttingen, Germany and we refurbish excimer tubes at our manufacturing sites in An-Seong, South Korea.
We manufacture the fiber-based lasers and a portion of our DPSS lasers used in microelectronics and scientific research applications in Glasgow, Scotland. Our facility in Sunnyvale, California grows the aluminum-free materials that are incorporated into our semiconductor lasers. Our facility in Richmond, California manufactures high performance optical components and assemblies for the aerospace and defense industries as well as large form optics for astronomical observatories and our own Linebeam excimer laser annealing systems. We manufacture fiber and free space Faraday rotators and isolators critical to a wide range of lasers in Traverse City, Michigan. We manufacture and test high-power CO2, solid-state and fiber laser macro products in Hamburg, Germany; Plymouth, Michigan; East Granby, Connecticut; and Tampere, Finland. Our laser marking products are manufactured and tested in Gilching, Germany and Singapore. Our micro application products are manufactured and tested in Gilching, Germany; Tampere, Finland; Plymouth, Michigan; and Belp, Switzerland. Our diode laser products are manufactured and tested in Mainz and Freiburg, Germany. We completed the closure of our Tucson, Arizona operation in the first half of fiscal 2021 and completed the closure of our Nanjing, China operation in the fourth quarter of fiscal 2021. Anodization of our Slab laser electrodes is performed in Overath, Germany. Our fiber optics and beam delivery systems are manufactured and tested in Molndal, Sweden. Our specialty fibers and fiber-based components for defense amplifiers and fiber optic gyroscopes are manufactured in East Granby, Connecticut and Salem, New Hampshire. Optical engines for fiber lasers, fiber lasers modules and wafer material are designed and manufactured in Tampere, Finland. We manufacture critical components for diode lasers in Monrovia, California.
We have transferred several products and sub-assemblies for manufacture and repairs to our Singapore and Malaysia facilities and are continuing to transfer additional product manufacturing to these facilities as part of our worldwide manufacturing cost reduction strategy.
Coherent is committed to meeting internationally standards for the design, manufacture and service of products to industry-based requirements. All primary facilities are certified to ISO 9001 whereas others hold multiple certifications based upon the markets they serve including ISO 13485, ISO 14001, ISO 17025, ISO 45001 and/or ISO 50001.
INTELLECTUAL PROPERTY
We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. As of October 2, 2021, we held approximately 890 U.S. and foreign patents, which expire in calendar years 2021 through 2040 (depending on the payment of maintenance fees) and we have approximately 195 additional pending patent applications that have been filed. The issued patents cover various products in all of the major markets that we serve.
Some of our products are designed to include intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to aspects of our products, processes and services. While we have generally been able to obtain such licenses on commercially reasonable terms in the past, there is no guarantee that such licenses could be obtained on reasonable terms in the future or at all.
For a discussion of the importance to our business of, and the risks attendant to intellectual property rights, see "Risk Factors" in Item 1A — "If we are unable to protect our proprietary technology, our competitive advantage could be harmed" and "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."
COMPETITION
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 Holdings Inc., 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. In addition, from time to time our customers may also decide to vertically integrate and build their own photonics products. We compete globally based on our broad product offering, reliability, cost, and performance advantages for the widest range of commercial and scientific research applications. Other considerations by our customers include warranty, global service and support and distribution.
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BACKLOG
At fiscal 2021 year-end, our backlog of orders scheduled for shipment (within one year) was $717.1 million compared to $548.0 million at fiscal 2020 year-end. By segment, backlog for OLS was $426.0 million and $354.5 million at fiscal 2021 and 2020 year-ends, respectively. Backlog for ILS was $291.1 million and $193.5 million at fiscal 2021 and 2020 year-ends, respectively. The increase in OLS backlog from fiscal 2020 to fiscal 2021 year-end was primarily due to higher orders for excimer laser annealing systems for the flat panel display market as well as higher orders for service. The increase in ILS backlog from fiscal 2020 to fiscal 2021 year-end was primarily due to higher orders in the precision manufacturing market. Orders used to compute backlog are generally cancellable and, depending on the notice period, are subject to rescheduling by our customers. We have not historically experienced a significant rate of cancellation or rescheduling, however the rate of cancellations or rescheduling may increase in the future. In the first quarter of fiscal 2019, one customer cancelled three purchase orders which included orders shippable within 12 months from fiscal 2018 year-end of $38.2 million and were included in backlog as of fiscal 2018 year-end. We reached agreement with this customer for compensation for such cancellation in the first quarter of fiscal 2019.
SEASONALITY
We have historically generally experienced decreased revenue in the first fiscal quarter compared to other quarters in our fiscal year due to the impact of time off and business closures at our facilities and those of many of our customers due to year-end holidays. For example, over the past 10 years, excluding certain recovery years, our first fiscal quarter revenues have ranged 2%-17% below the fourth quarter of the prior fiscal years. This historical pattern should not be considered a reliable indicator of the Company's future net sales or financial performance.
EMPLOYEES
Our workforce is distributed globally over 24 countries. As of fiscal 2021 year-end, we had approximately 5,085 employees worldwide, with approximately 830 located in the Asia-Pacific region, 2,608 in the EMEA region, and 1,647 in the Americas region. Of our total workforce, approximately 640 employees are involved in research and development; 3,293 employees are involved in operations, manufacturing, service and quality assurance; and 1,152 employees are involved in sales, order administration, marketing, finance, information technology, general management and other administrative functions. Our success will depend in large part upon our ability to attract and retain employees. We face competition in this regard from other companies, research and academic institutions, government entities and other organizations. We consider our relations with our employees to be good.
Our human capital is governed by various federal, state and local regulations. We monitor all key employment activities, such as hiring, termination and pay practices to ensure compliance with established regulations across the world. We embrace diversity and inclusion and strive to provide an environment rich with diverse skills, backgrounds and perspectives. Within the United States we conduct a yearly review of employees and establish hiring goals for minority, female, disabled and military veteran candidates. Our recruitment programs are regionally focused and hiring is done at a local level to ensure compliance with specific regulations. To ensure diversity within our workforce we advertise job openings and source candidates broadly to attract a diverse candidate pool. As a leader in our industry we are able to attract a strong candidate pool and have been successful in filing vacancies to ensure business continuity. In fiscal 2021 we had 635 new hires, 280 of which were within the EMEA region, 282 of which were within the Americas region and 73 of which were in the Asia-Pacific region. During fiscal 2020, we also conducted a worldwide organizational health survey designed to assess employee engagement, leadership, work environment and culture. We had a response rate of 77% of our total worldwide employee base, which is one indicator of a high-level of employee engagement.
We track and report internally on key talent metrics including workforce demographics, talent pipeline, diversity data, and engagement of our employees. We believe in investing in professional development programs to ensure we provide opportunities for individuals to advance their careers either in a technical track or move to a leadership position. We offer many of our in-class training programs digitally so that more employees can benefit from self-development during a period when many of our employees are working remotely. Additional focus is placed on the development of our future leaders and we leverage a talent review process where high-potential and high-performing employees are assessed for future leadership roles as part of our succession management process for critical leadership positions. As employee turnover is an indicator of employee satisfaction we closely monitor turnover globally and benchmark locally. Coherent has a very stable and committed workforce. This translates into very low voluntary turnover when compared to benchmark data. Our 12 month rolling average for voluntary turnover at the end of fiscal 2021 stood at 5.3%, substantially less than benchmark data. Our employee average tenure globally is more than 10 years.
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ACQUISITIONS
On April 19, 2021, we acquired EOT for approximately $29.3 million, excluding transaction costs. EOT is a 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.
On October 5, 2018, we acquired privately held Ondax for approximately $12.0 million, excluding transaction costs. Ondax develops and produces photonic components which are used on an OEM basis by the laser industry as well as incorporated into its own stabilized lasers and Raman Spectroscopy systems.
On October 5, 2018, we acquired certain assets of Quantum for approximately $7.0 million, excluding transaction costs.
Please refer to Note 4, "Business Combinations" of Notes to Consolidated Financial Statements under Item 8 of this annual report for further discussion of recent acquisitions completed.
RESTRUCTURINGS AND CONSOLIDATION
In June 2019, we internally 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. In conjunction with this announcement, we recorded restructuring charges in fiscal 2019 of $19.7 million. The charges primarily related to write-offs of excess inventory, which is recorded in cost of sales, and estimated severance. We recorded charges of $1.1 million in fiscal 2020, primarily related to accelerated depreciation and project management consulting. We recorded no charges related to this project in fiscal 2021 as the project was completed in fiscal 2020.
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 did not incur material expenses in fiscal 2019 related to this project. In fiscal 2021 and 2020, we incurred costs of $0.1 million and $1.5 million, respectively, primarily related to accelerated depreciation and completed the project in fiscal 2021.
In the fourth quarter of fiscal 2020, we began a restructuring program in our ILS segment which includes management reorganizations, the planned closure of multiple manufacturing sites, and the right-sizing of global sales, service, order admin, marketing communication and certain administrative functions, among others. In the fourth quarter of fiscal 2020, we incurred costs of $2.6 million, primarily related to severance. In fiscal 2021, we incurred costs of $12.2 million, primarily related to write-offs of excess inventory, accruals for vendor commitments and warranty provisions, which are recorded in cost of sales, estimated severance, facility exit costs and accelerated depreciation.
See Note 19, "Restructuring Charges" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
GOVERNMENT REGULATION
We are required to comply, and it is our policy to comply, with numerous regulations that are normal and customary to businesses in our industry and that operate in our markets and operating locations. These regulations relate to, among other things, healthcare, environmental protection, antitrust, anti-corruption, marketing, fraud and abuse (including anti-kickback and false claims laws), export control, product safety and efficacy, employment, privacy, governmental contracts and regulatory matters specific to the defense industry and other areas.
Environmental Regulation
Our operations are subject to various federal, state, local and foreign environmental regulations relating to the use, storage, handling and disposal of regulated materials, chemicals, various radioactive materials and certain waste products. In the United States, we are subject to the federal regulation and control of the Environmental Protection Agency. Comparable authorities are involved in other countries. We also face increasing complexity in our product design and procurement operations due to the evolving nature of environmental compliance regulations and standards, as well as specific customer compliance requirements. We expect all operations to meet the legal and regulatory environmental requirements and believe that compliance with those regulations will not have a material adverse effect on our capital expenditures, earnings and competitive and financial position.
Although we believe that our safety procedures for using, handling, storing and disposing of such materials comply with the standards required by federal and state laws and regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials. 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.
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We further discuss the impact of environmental regulation under "Risk Factors" in Item 1A — "Compliance or the failure to comply with current and future environmental regulations could cause us significant expense."
Regulatory Compliance
Lasers that are manufactured or sold in the United States are classified under the applicable rules and regulations of the Center for Devices and Radiological Health ("CDRH") of the U.S. Food and Drug Administration ("FDA"). A similar classification system is applied in the European markets.
CDRH regulations require a self-certification procedure pursuant to which a manufacturer must submit a filing to the CDRH with respect to each product incorporating a laser, make periodic reports of sales and purchases, and comply with product labeling standards, product safety and design features and informational requirements. The CDRH is empowered to seek fines and other remedies for violations of their requirements. We believe that our products are in material compliance with the applicable rules and regulations of CDRH relating to lasers manufactured or sold in the United States.
In addition, certain portions of our business contract with numerous U.S. government agencies and entities or with entities whose projects are funded therefrom. We also contract with similar government authorities outside of the U.S., subject in all cases to applicable law. Consequently, we must comply with and are affected by regulations relating to the formation, administration, and performance of such U.S. government and other contracts governing such matters.
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 Export Administration Regulations ("EAR") administered by the Department of Commerce’s Bureau of Industry and Security, 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 the International Traffic in Arms Regulations ("ITAR") administered by the Department of State’s Directorate of Defense Trade Controls, require a license prior to any export, re-export, or deemed export. Certain of our products are subject to the EAR and/or the ITAR. Products and the associated technical data developed and manufactured in our foreign locations are subject to export controls of the applicable foreign nation. We further discuss the impact of such regulations under "Risk Factors" in Item 1A – "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 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 U.S. Foreign Corrupt Practices Act (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. We further discuss the impact of such regulations under "Risk Factors" in Item 1A – "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."
Aspects of our operations and business are subject to privacy, data security and data protection regulations, which impact the way we use and handle data and operate our products and services. We further discuss the impact of such regulations under "Risk Factors" in Item 1A – "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."
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ITEM 1A. 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" and the risks described elsewhere in this annual 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 PENDING MERGER WITH II-VI
Our pending merger with II-VI may be delayed or not occur at all for a variety of reasons, including the possibility that the II-VI Merger Agreement is terminated or expires prior to the consummation of the acquisition.
On March 25, 2021, we entered into the II-VI Merger Agreement, pursuant to which we agreed to be acquired for $220.00 in cash per Coherent share and 0.91 of a share of II-VI common stock per Coherent share. On June 24, 2021, II-VI and Coherent held special meetings of their shareholders and stockholders, respectively, at which all proposals relating to the II-VI Merger Agreement were approved.
Completion of the Merger is subject to customary closing conditions, including (i) the absence of certain legal impediments and (ii) regulatory approvals in applicable jurisdictions including the United States, Germany, China and South Korea. Many of the conditions to completion of the Merger are not within either our or II-VI's control, and we cannot predict when or if these conditions will be satisfied (or waived, as applicable).
The II-VI Merger Agreement contains customary mutual termination rights for us and II-VI, including if the Merger is not completed by December 25, 2021 (subject to automatic extension first to March 25, 2022, then to June 25, 2022 and finally to September 25, 2022, in each case, to the extent the regulatory closing conditions remain outstanding).
The II-VI Merger Agreement also contains customary termination rights for the benefit of each party, including if the other party breaches its representations, warranties or covenants under the II-VI 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).
In light of the foregoing, the Merger may not be completed or may not be completed as quickly as expected.
Failure to complete the Merger 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 Merger will be consummated;
•we paid a termination fee of $217.6 million to Lumentum in connection with the termination of the Amended Lumentum Agreement for which we will have received little or no benefit if the Merger is not consummated;
•we have incurred, and will continue to incur, significant expenses for professional services in connection with the Merger for which we will have received little or no benefit if the Merger is not consummated;
•we have incurred significant expenses, including the costs of settlement, in connection with litigation against us and our directors and officers in connection with the Merger for which we will have received little or no benefit if the Merger is not consummated; and
•failure to consummate the Merger may result in negative publicity and/or give a negative impression of us in the investment community or business community generally.
The Merger 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 Merger, which may have a negative impact on our ongoing business. Uncertainty regarding the outcome of the Merger 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 Merger could also adversely affect our ability to recruit and retain key personnel and other employees. The pendency of the Merger may also result in negative publicity and a
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negative impression of us in the financial markets, and has resulted in, and may result in additional, litigation against us and our directors and officers. Such litigation may be distracting to management and has required us to incur, and may require us to incur additional, significant costs. Such litigation could result in the Merger being delayed and/or enjoined by a court of competent jurisdiction, which could prevent the Merger 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 II-VI Merger Agreement is in effect, we are subject to certain interim covenants.
While the II-VI 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 Merger. The interim operating covenants require us to obtain II-VI's consent (such consent not to be unreasonably conditioned, withheld or delayed) prior to taking certain actions, which requirement could significantly impact our operating results and ongoing business.
After the Merger, our stockholders will have a significantly lower ownership and voting interest in II-VI than they currently have in Coherent and will exercise less influence over management.
Coherent and II-VI estimate that, as of immediately following completion of the Merger, holders of Coherent common stock immediately prior to the Merger will hold approximately 14% of the combined company (based on fully diluted shares outstanding of the combined company as of September 30, 2021). Consequently, former Coherent stockholders will have less influence over the management and policies of II-VI than they currently have over the management and policies of Coherent.
The rights of our stockholders will change as a result of the Merger.
The rights of Coherent stockholders are governed by Delaware law and by the charter and bylaws of Coherent. If the Merger is completed, Coherent stockholders will become holders of II-VI common stock, and their rights will be governed by Pennsylvania law and the charter and bylaws of II-VI. Coherent stockholders will, therefore, have different rights after becoming II-VI stockholders due to differences in governing law and between the Coherent governing documents and the II-VI governing documents.
After completion of the Merger, II-VI may fail to realize the anticipated benefits and cost savings of the Merger, which could adversely affect the value of II-VI common stock.
The success of the Merger will depend, in part, on II-VI's ability to realize the anticipated benefits and cost savings from combining the businesses of II-VI and Coherent. The anticipated benefits and cost savings of the Merger 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 II-VI, 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 Merger 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 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 could 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, the severity and transmission rate of variants of the virus, new medical and other information that may emerge concerning COVID-19, the effectiveness of vaccines, 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 continuing actions and guidance provided by the U.S. and European governments.
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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" in "Item 7. 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;
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•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 ("the Tax 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;
•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;
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•continued government spending on defense-related and scientific research projects where we are a vendor or 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 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, aluminum, and magnesium,
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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, California, Belgium and Germany, 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.
Disruption in our global supply chain could negatively impact our businesses.
The products we sell are sourced from a wide variety of domestic and international vendors, and any future disruption in our supply chain or inability to find qualified vendors and access products that meet requisite quality and safety standards in a timely and efficient manner could adversely impact our businesses. The loss or disruption of such supply arrangements for any reason, including for issues such as COVID-19 or other health epidemics or pandemics, labor disputes, loss or impairment of key manufacturing sites, inability to procure sufficient raw materials, quality control issues, ethical sourcing issues, a supplier’s financial distress, natural disasters, looting, vandalism or acts of war or terrorism, trade sanctions or other external factors over
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which we have no control, could interrupt product supply and, if not effectively managed and remedied, have a material adverse impact on our business operations, financial condition and results of operations.
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 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 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;
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•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, laser components 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 fiscal 2021, 2020 and 2019, 77%, 76%, and 76%, 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 Germany and 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
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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, dips in the manufacturing Purchasing Managers Index as well as the Institute for Supply Management 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 Merger. 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.
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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. 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, Novanta Inc., nLIGHT, Inc., II-VI, 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.
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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.
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.
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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 (particularly the rolling blackouts recently experienced in China), 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 completed or 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.
Acquisition 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. If 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 Electro-Optics Technology in April 2021 and Rofin in November 2016, as well as asset purchases, and we continue to evaluate
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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 ended 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 October 2, 2021, 351.5 million Euros were outstanding under the Euro Term Loan. As of October 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 repaid outstanding borrowings on October 29, 2021 and on November 5, 2021, the Revolving Credit Facility terminated. In connection with the termination of our Revolving Credit Facility, on October 29, 2021, we entered into a 10.0 million Euro letter of credit facility, rolled our existing letter of credit into that facility and deposited 10.5 million Euros with Barclays as cash collateral to secure the payment obligations under such facility. We may incur additional indebtedness in the future by 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
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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.
Certain of our financial arrangements, including our Credit Agreement, are made at variable rates that use interbank offered rates, or IBORs, including the Euro Interbank Offered Rate, or EURIBOR and the London Interbank Offered Rate, or LIBOR (or metrics derived from or related to LIBOR), as a benchmark for establishing the interest rate. IBORs are or have been reformed, may cease to be available or may be declared to be no longer representative of the underlying market and economic realities. In such a case IBORs and specifically LIBOR may need to be replaced with a replacement rate. While EURIBOR is the subject of reform, in March 2021, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to cease or otherwise declare as no longer representative certain LIBOR settings on December 31, 2021 and the remainder of the U.S. dollar LIBOR settings on June 30, 2023. At this time, we cannot predict how markets will respond to reform or the proposed alternative rates or the effect of any changes to IBORs or the discontinuation or non-representativeness of LIBOR. New methods of calculating IBORs that may be established or the establishment of alternative reference rates could have an adverse impact on the market value for or value of IBOR-linked securities, loans and other financial obligations or extensions of credit held by or due to us. Changes in market interest rates may influence our financing costs, returns on financial investments and the valuation of derivative contracts and could reduce our earnings and cash flows. There is no guarantee that a transition from IBORs and specifically LIBOR to an alternative will not result in financial market disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have an adverse effect on our business, financial condition, and results of operations.
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,
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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 "Item 7A. 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;
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•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 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;
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•the resolution of transfer pricing issues through the Competent Authority process between South Korea, Germany and the United States arising from the German tax audits for fiscal 2011-2016 and South Korean tax audits for fiscal 2014-2017;
•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 and two-pillar solution addressing the digitalization of the global economy implemented by the Organization for Economic Co-operation and Development ("OECD") as well as an OECD-led global minimum corporate tax rate, and President Biden's various proposals to increase the U.S. corporate income tax rates and increase U.S. taxation on foreign earnings;
•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 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
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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, the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive and the Waste Electrical and Electronic Equipment Directive enacted in the European Union, which regulate the use of certain hazardous
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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
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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, global supply chain issues, 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,
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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 Item 9A "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 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
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ITEM 2. PROPERTIES
Our corporate headquarters is located in Santa Clara, California. At fiscal 2021 year-end, our principal manufacturing locations were as follows (all acreage and square footage is approximate) (unless otherwise indicated, each property is utilized jointly by our two segments):
| Description | Use | Term* | ||||||||||||||||||
| Santa Clara, CA | 8.5 acres of land, 200,000 square feet | Corporate headquarters, manufacturing, R&D | Owned | |||||||||||||||||
| Richmond, CA (2) | several buildings totaling 68,635 square feet | Office, manufacturing, R&D | Leased through November 2029 | |||||||||||||||||
| Sunnyvale, CA (1) | two buildings totaling 28,299 square feet | Office, manufacturing, R&D | Leased through December 2023 | |||||||||||||||||
| Bloomfield, CT (1) | 88,396 square feet | Office, manufacturing, R&D | Leased through February 2027 | |||||||||||||||||
| East Granby, CT (1) | 68,135 square feet | Office, manufacturing, R&D | Leased through January 2027 | |||||||||||||||||
| Plymouth, MI (1) | 54,080 square feet | Office, manufacturing, R&D | Leased through May 2024 | |||||||||||||||||
| Mount Olive, NJ (2) | 88,000 square feet | Office, manufacturing, R&D | Leased through June 2028 | |||||||||||||||||
| Tampere, Finland (1) | 4.9 acres of land, 50,074 square feet | Office, manufacturing, R&D | Owned | |||||||||||||||||
| Gilching, Germany (1) | 4.2 acres of land, 125,012 square feet | Office, manufacturing, R&D | Owned | |||||||||||||||||
| Göttingen, Germany (2) | 14.2 acres of land, several buildings totaling 211,648 square feet | Office, manufacturing, R&D | Owned | |||||||||||||||||
| Lübeck, Germany (2) | several buildings totaling 89,761 square feet | Office, manufacturing, R&D | Leased through December 2024 | |||||||||||||||||
| Lübeck, Germany (2) | 7.4 acres of land, 147,446 square feet | Future office, manufacturing, R&D | Owned (expected occupancy beginning in Q2 fiscal 2022) | |||||||||||||||||
| Mainz, Germany (1) | 1.2 acres of land, 46,984 square feet | Office, manufacturing, R&D | Owned | |||||||||||||||||
| Mainz, Germany (1) | several buildings totaling 46,193 square feet | Office, manufacturing, R&D | Leased primarily through September 2024 | |||||||||||||||||
| Glasgow, Scotland (2) | 2.0 acres of land, 68,220 square feet | Office, manufacturing, R&D | Owned | |||||||||||||||||
| Kallang Sector, Singapore | 42,722 square feet | Office, manufacturing | Leased through January 2027 | |||||||||||||||||
| An-Seong, South Korea (2) | 60,257 square feet | Office, manufacturing | Leased through October 2027 | |||||||||||||||||
_________________________________________
(1)This facility is utilized primarily by our ILS operating segment.
(2)This facility is utilized primarily by our OLS operating segment.
* We currently plan to renew leases on buildings as they expire, as necessary.
We maintain other manufacturing, sales and service offices under varying leases expiring from fiscal 2022 through 2029 in Belgium, Canada, China, France, Germany, Israel, Italy, Japan, Malaysia, the Netherlands, South Korea, Spain, Sweden, Switzerland, Taiwan, the United Kingdom, the United States and Vietnam.
We consider our facilities to be both suitable and adequate to provide for current and near-term requirements and that the productive capacity in our facilities is substantially being utilized or we have plans to utilize it.
ITEM 3. LEGAL PROCEEDINGS
Information with respect to this item may be found in Note 13, "Commitments and Contingencies" in the Notes to Consolidated Financial Statements in Item 8 of this report and is incorporated herein by reference.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the NASDAQ Global Select Market exchange with the ticker symbol of COHR.
The number of stockholders of record as of November 23, 2021 was 426. While we paid a cash dividend in fiscal 2013 and may elect to pay dividends in the future, we have no present intention to declare cash dividends. The credit agreement includes certain restrictions on our ability to pay cash dividends.
There were no sales of unregistered securities in fiscal 2021.
Refer to Note 14 "Stock Repurchases" of our Notes to Consolidated Financial Statements under Item 8 of this annual report for discussion on repurchases during fiscal 2021, 2020 and 2019.
COMPANY STOCK PRICE PERFORMANCE
The following graph shows a five-year comparison of cumulative total stockholder return, calculated on a dividend reinvestment basis and based on a $100 investment, from October 1, 2016 through October 2, 2021 comparing the return on our common stock with the Russell 1000 Index and the Nasdaq Composite Index. The stock price performance shown on the following graph is not necessarily indicative of future price performance.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN AMONG COHERENT, INC.,
THE RUSSELL 1000 INDEX AND THE NASDAQ COMPOSITE INDEX
| INDEXED RETURNS | |||||||||||||||||||||||||||||||||||
| Base Period | Years Ending | ||||||||||||||||||||||||||||||||||
| Company Name / Index | 10/1/2016 | 9/30/2017 | 9/29/2018 | 9/28/2019 | 10/3/2020 | 10/2/2021 | |||||||||||||||||||||||||||||
| Coherent, Inc. | 100 | 212.75 | 155.77 | 137.09 | 99.51 | 228.98 | |||||||||||||||||||||||||||||
| Russell 1000 Index | 100 | 118.54 | 139.60 | 144.24 | 167.87 | 222.82 | |||||||||||||||||||||||||||||
| Nasdaq Composite Index | 100 | 123.68 | 154.82 | 154.46 | 217.58 | 288.09 | |||||||||||||||||||||||||||||
The information contained above under the caption "Company Stock Price Performance" shall not be deemed to be "soliciting material" or to be "filed" with the SEC, nor will such information be incorporated by reference into any future SEC filing except to the extent that we specifically incorporate it by reference into such filing.
ITEM 6. [RESERVED]
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes included under Item 8 of this annual report. This discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in Item 1A,"Risk Factors" and elsewhere in this annual report. Please see the discussion of forward-looking statements at the beginning of this annual report under "Special Note Regarding Forward-Looking Statements."
We have applied the FAST Act Modernization and Simplification of Regulation S-K, which limits the discussion to the two most recent fiscal years. This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for fiscal 2021 and fiscal 2020. For the comparison of fiscal 2020 and fiscal 2019, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of our 2020 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on December 1, 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.
| Fiscal | |||||||||||
| 2021 | 2020 | ||||||||||
| Net Sales—OEM Laser Sources | $ | 913,636 | $ | 758,929 | |||||||
| Net Sales—Industrial Lasers & Systems | $ | 573,832 | $ | 470,070 | |||||||
| Gross Profit as a Percentage of Net Sales—OEM Laser Sources | 45.4 | % | 46.0 | % | |||||||
| Gross Profit as a Percentage of Net Sales—Industrial Lasers & Systems | 28.2 | % | 14.5 | % | |||||||
| Research and Development Expenses as a Percentage of Net Sales | 8.4 | % | 9.4 | % | |||||||
| Loss Before Income Taxes | $ | (115,538) | $ | (442,723) | |||||||
| Net Cash Provided by Operating Activities | $ | 72,938 | $ | 206,907 | |||||||
| Free Cash Flow | $ | (9,625) | $ | 141,988 | |||||||
| Days Sales Outstanding in Receivables | 60 | 65 | |||||||||
| Annualized Fourth Quarter Inventory Turns | 2.4 | 1.9 | |||||||||
| Net Loss as a Percentage of Net Sales | (7.2) | % | (33.7) | % | |||||||
| Adjusted EBITDA as a Percentage of Net Sales | 17.3 | % | 12.3 | % | |||||||
Definitions and analysis of these performance indicators are as follows:
Net Sales
Net sales include sales of lasers, laser systems, laser components, related accessories and services. Net sales for fiscal 2021 increased 20.4% in our OLS segment and increased 22.1% in our ILS segment from fiscal 2020. For a description of the reasons for changes in net sales refer to the "Results of Operations" section below.
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 for OLS decreased to 45.4% in fiscal 2021 from 46.0% in fiscal 2020. Gross profit percentage for ILS increased to 28.2% in fiscal 2021 from 14.5% in fiscal 2020. For a description of the reasons for changes in gross profit refer to the "Results of Operations" section below.
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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 8.4% in fiscal 2021 from 9.4% in fiscal 2020. For a description of the reasons for changes in R&D spending refer to the "Results of Operations" section below.
Net Cash Provided by Operating Activities
Net cash provided by operating activities as reflected on our 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. Net cash provided by operating activities in fiscal 2021 was unfavorably impacted by merger and acquisition costs, including our payment of a termination fee of $217.6 million to Lumentum. For a description of the reasons for changes in Net Cash Provided by Operating Activities refer to the "Liquidity and Capital Resources" section below.
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 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. Free cash flow in fiscal 2021 was unfavorably impacted by merger and acquisition costs, including our payment of a termination fee of $217.6 million to Lumentum. For a description of the reasons for changes in free cash flow refer to the "Liquidity and Capital Resources" section below, 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 a 360 day year. 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 fiscal 2021 improved to 60 days as compared to 65 days in fiscal 2020. This improvement was primarily due to increased collections of past due receivables, primarily in China, Japan and Europe, improved linearity with a lower concentration of sales in September 2021 compared to September 2020 and the favorable impact of foreign exchange rates.
Annualized Fourth Quarter Inventory Turns
We calculate annualized fourth quarter inventory turns as cost of sales during the fourth quarter annualized and divided by net inventories at the end of the fourth 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 fourth quarter inventory turns for fiscal 2021 increased to 2.4 turns from 1.9 turns in fiscal 2020 primarily due to lower inventory levels, primarily in our OLS segment, due to higher flat panel display shipments and higher service parts demand partially offset by lower inventory provisions for excess and obsolete inventory in certain ILS business units and improved manufacturing absorption in both segments.
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 merger and acquisition costs. 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
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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:
| Fiscal | |||||||||||
| 2021 | 2020 | ||||||||||
Net cash provided by operating activities | $ | 72,938 | $ | 206,907 | |||||||
Less: Purchases of property and equipment | 82,563 | 64,919 | |||||||||
| Free cash flow | $ | (9,625) | $ | 141,988 | |||||||
Below is the reconciliation of our net income (loss) as percentage of net sales to our adjusted EBITDA as a percentage of net sales:
| Fiscal | |||||||||||
| 2021 | 2020 | ||||||||||
| Net income (loss) as a percentage of net sales | (7.2) | % | (33.7) | % | |||||||
| Income tax benefit | (0.5) | % | (2.3) | % | |||||||
| Interest and other income (expense), net | 1.4 | % | 1.5 | % | |||||||
| Depreciation and amortization | 3.7 | % | 6.3 | % | |||||||
| Purchase accounting step-up | 0.1 | % | — | % | |||||||
| Restructuring charges and other | 1.2 | % | 0.3 | % | |||||||
| Merger and acquisition costs | 15.8 | % | — | % | |||||||
| Goodwill and other impairment charges | — | % | 36.6 | % | |||||||
| Stock-based compensation | 2.8 | % | 3.6 | % | |||||||
| Adjusted EBITDA as a percentage of net sales | 17.3 | % | 12.3 | % | |||||||
SIGNIFICANT EVENTS
Merger Agreement and related fees
See "Recent Events - Merger Agreement and Termination Fee" in Item 1 of this report for a description of the Agreement and Plan of Merger we entered into on January 18, 2021, and the Amended Lumentum Agreement we entered into on March 9, 2021 with Lumentum, Lumentum Merger Sub I and Lumentum Merger Sub II, the termination of the Amended Lumentum Agreement and the payment of a termination fee to Lumentum in the second quarter of fiscal 2021, as well as the II-VI Merger Agreement we entered into with II-VI and II-VI Merger Sub on March 25, 2021.
The termination fee, in addition to other costs related to the merger agreements is included in merger and acquisition costs in our consolidated statements of operations.
Coronavirus pandemic (COVID-19)
In December 2019, COVID-19 cases were 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 from time to time, 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 could negatively affect our revenue and results of operations. Each of the regions where we generate a majority of our revenue including Asia, Europe, and North America have been and may continue to be impacted by COVID-19 in the future. 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, in fiscal 2020 we compared our actual results to our most recently published forecast and the net sales guidance range communicated in our quarterly earnings call.
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This forecast has been adjusted for known direct impacts to our bookings and net sales from COVID-19 and other factors. Using this criteria, we estimate that our sales for fiscal 2020 were negatively impacted by the COVID-19 pandemic by approximately $40.0 million. We believe the impact on fiscal 2021 sales was immaterial.
During fiscal 2020 and 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. Beginning in the fourth quarter of fiscal 2020 and continuing in 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, particularly in light of the recent Delta variant, 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 and Asia.
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 workforce 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 Sunnyvale, 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 continue to experience various supply disruptions throughout the supply chain and are working closely with our supply base to mitigate or remove constraints as they become known. Supply constraints due to COVID-19 may impact the speed with which we are able to ramp up production if we experience strong demand on certain products. We also continue to face 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 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 and many of our key senior-level employees are members of the COVID Steering Committee.
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 could lead to an increase in inventory
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provisions, allowances for credit losses, and a volatile effective tax rate driven by changes in the mix of earnings across our markets.
See "Risks Related to COVID-19 Pandemic" included under the heading "Risk Factors" in Item 1A of this annual report regarding the impact of COVID-19.
Goodwill and other impairment charges
Based on our internal projections and the preparation of our financial statements for the quarter ended April 4, 2020, and considering the then-expected decrease in demand due to the COVID-19 pandemic and other factors, we believed that the fair value of our ILS reporting unit might no longer have exceeded its carrying value and performed an interim goodwill impairment test on the ILS and OLS reporting units. Based on the estimated fair value of the ILS reporting unit, we recorded non-cash pre-tax goodwill impairment charges of $327.2 million in the quarter ended April 4, 2020. 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 right of use ("ROU") assets as of April 4, 2020 and recorded non-cash pre-tax charges 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, in the quarter ended April 4, 2020. See Note 8, "Goodwill and Intangible Assets" and Note 11, "Leases" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
Restructuring
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. In conjunction with this announcement, we recorded restructuring charges in fiscal 2019 of $19.7 million. The charges primarily related to write-offs of excess inventory, which is recorded in cost of sales, and estimated severance. We recorded charges of $1.1 million in fiscal 2020, primarily related to accelerated depreciation and project management consulting. We recorded no charges related to this project in fiscal 2021 as the project was completed in fiscal 2020.
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 did not incur material expenses in fiscal 2019 related to this project. In fiscal 2021 and 2020, we incurred costs of $0.1 million and $1.5 million, respectively, primarily related to accelerated depreciation, and completed the project in fiscal 2021.
In the fourth quarter of fiscal 2020, we began a restructuring program in our ILS segment which includes management reorganizations, the planned closure of multiple manufacturing sites, and the right-sizing of global sales, service, order admin, marketing communication and certain administrative functions, among others. In fiscal 2020, we incurred costs of $2.6 million, primarily related to severance. In fiscal 2021, we incurred costs of $12.2 million, primarily related to write-offs of excess inventory, accruals for vendor commitments and warranty provisions, which are recorded in cost of sales, estimated severance, facility exit costs and accelerated depreciation.
See Note 19, "Restructuring Charges" in the Notes to Consolidated Financial Statements under Item 8 of this annual report for further discussion of the restructuring charges.
Acquisitions
On April 19, 2021, we acquired Electro-Optics Technology, Inc. ("EOT") for approximately $29.3 million, excluding transaction costs. EOT is a 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. See Note 4, "Business Combinations" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
RESULTS OF OPERATIONS—FISCAL 2021 AND 2020
Fiscal 2021 consisted of 52 weeks and fiscal 2020 consisted of 53 weeks.
Consolidated Summary
The following table sets forth, for the years indicated, the percentage of total net sales represented by the line items reflected in our consolidated statements of operations:
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| Fiscal | |||||||||||
| 2021 | 2020 | ||||||||||
| (As a percentage of net sales) | |||||||||||
| Net sales | 100.0 | % | 100.0 | % | |||||||
| Cost of sales | 61.8 | % | 66.6 | % | |||||||
| Gross profit | 38.2 | % | 33.4 | % | |||||||
| Operating expenses: | |||||||||||
| Research and development | 8.4 | % | 9.4 | % | |||||||
| Selling, general and administrative | 20.4 | % | 22.0 | % | |||||||
| Merger and acquisition costs | 15.8 | % | — | % | |||||||
| Goodwill and other impairment charges | — | % | 36.7 | % | |||||||
| Amortization of intangible assets | 0.2 | % | 0.3 | % | |||||||
| Total operating expenses | 44.8 | % | 68.4 | % | |||||||
| Loss from operations | (6.6) | % | (35.0) | % | |||||||
| Other income (expense), net | (1.2) | % | (1.0) | % | |||||||
| Loss before income taxes | (7.8) | % | (36.0) | % | |||||||
| Benefit from income taxes | (0.6) | % | (2.3) | % | |||||||
| Net loss | (7.2) | % | (33.7) | % | |||||||
Net loss for fiscal 2021 was $106.8 million ($4.38 per diluted share). This included after tax charges of $182.3 million for merger and acquisition costs (primarily due to a termination fee of $217.6 million paid to Lumentum), $36.0 million of after-tax stock-based compensation expense, $10.4 million of after-tax restructuring costs, $9.3 million of after-tax amortization of intangible assets, $5.3 million of after-tax losses on the dissolution of our OR Laser operations, $1.1 million of purchase accounting step-up and $13.1 million non-recurring income tax net expense.
Net loss for fiscal 2020 was $414.1 million ($17.18 per diluted share). This included after tax charges of $423.2 million for goodwill and other impairment, $39.1 million of after-tax stock-based compensation expense, $21.9 million of after-tax amortization of intangible assets, $2.1 million of after-tax restructuring costs (net of the gain on the sale-leaseback of our Hamburg facility), $0.7 million after-tax of accelerated compensation for our former CEO, $0.6 million non-recurring income tax net expense and $0.9 million of excess tax benefit for employee stock-based compensation.
Backlog
Backlog represents orders which we expect to be shipped within 12 months and the current portion of service contracts. Orders used to compute backlog are generally cancellable and, depending on the notice period, are subject to rescheduling by our customers without substantial penalties. We have not historically experienced a significant rate of cancellation or rescheduling, however the rate of cancellations or rescheduling may increase in the future.
We had a backlog of orders shippable within 12 months of $717.1 million at October 2, 2021.
Net Sales
Market Application
The following table sets forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands):
| Fiscal 2021 | Fiscal 2020 | ||||||||||||||||||||||
| Amount | Percentage of total net sales | Amount | Percentage of total net sales | ||||||||||||||||||||
| Microelectronics | $ | 664,535 | 44.7 | % | $ | 538,535 | 43.8 | % | |||||||||||||||
| Precision manufacturing | 399,049 | 26.8 | % | 335,750 | 27.3 | % | |||||||||||||||||
| Instrumentation | 374,075 | 25.2 | % | 300,321 | 24.5 | % | |||||||||||||||||
| Aerospace and defense | 49,809 | 3.3 | % | 54,393 | 4.4 | % | |||||||||||||||||
| Total | $ | 1,487,468 | 100.0 | % | $ | 1,228,999 | 100.0 | % | |||||||||||||||
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During fiscal 2021, net sales increased by $258.5 million, or 21%, compared to fiscal 2020, with increases in the microelectronics, instrumentation and precision manufacturing markets partially offset by decreases in the aerospace and defense market. The increase included higher net sales due to the negative impact in fiscal 2020 of approximately $40.0 million from COVID-19 shelter-in place orders and/or delays in restarting non-essential manufacturing activity at many of our customers, primarily in the precision manufacturing, instrumentation and aerospace and defense markets. In fiscal 2020, we continued to experience weaker demand in the microelectronics and materials processing markets. We finished fiscal 2021 with a positive book-to-bill ratio, in all four end-markets, and increased backlog levels compared to fiscal 2020 across all end-markets. Entering fiscal 2022, 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 globally.
During fiscal 2021, microelectronics sales increased $126.0 million, or 23%, compared to fiscal 2020 primarily due to increased shipments for flat panel display (higher shipments related to ELA tools used in the flat panel display market and higher revenues from consumable service parts), advanced packaging and semiconductor applications, and partially due to the negative impact of COVID-19 in fiscal 2020. 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 fiscal 2021 and we expect many of these orders to ship in fiscal 2022. In addition, it is expected that the handset market will continue to transition to 5G and newer technologies over time. 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 pilot 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, somewhat tempered by rolling blackouts in China. Demand is being 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.
Precision manufacturing sales increased $63.3 million, or 19%, during fiscal 2021 primarily due to increased sales in materials processing components and automotive applications, partially offset by lower shipments for machine tools applications. The increase in fiscal 2021 was partially due to the negative impact of COVID-19 in fiscal 2020, which was not an impact in fiscal 2021. The Purchasing Managers Index ("PMI") is a measure of the prevailing economic trends in manufacturing, and often correlates to materials processing sales. The manufacturing PMI for the U.S. and Germany rose in the first few quarters of fiscal 2021, with the U.S. and Germany hitting near record levels, followed by a slight reduction in the fourth quarter of fiscal 2021. The fourth quarter PMI reduction was partially due to supply chain pressures from extended lead time, rapidly rising materials prices and recent power supply problems in China. In addition, we saw customer demand for automobiles and production return to pre-COVID-19 levels. Although unfavorably impacted by the global semiconductor chip shortage, we expect continued strong demand for laser based welding products, especially for battery applications in EVs (Electronic Vehicles). Medical device manufacturing had record orders in fiscal 2021, with increases in the U.S., China and Europe.
The increase in the instrumentation market of $73.8 million, or 25%, during fiscal 2021 was primarily due to higher shipments for biomedical instrumentation and scientific applications, as scientific applications shipments were negatively impacted by COVID-19 in fiscal 2020 due to closures of universities as a result of COVID-19 shelter-in-place orders, as well as higher shipments for medical 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.
Sales in the aerospace and defense market decreased $4.6 million, or 8%, during fiscal 2021 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 timing for shipments of our higher average selling price ELA tools in the flat panel display market has historically fluctuated and is expected to continue to fluctuate from quarter-to-quarter due to customer scheduling, market conditions, our ability to manufacture these products and/or availability of critical component parts and supplies. As a result, the timing to convert orders for these products to net sales will likely fluctuate from quarter-to-quarter.
We have historically generally experienced decreased net sales in the first fiscal quarter compared to other quarters in our fiscal year due to the impact of time off and business closures at our facilities and those of many of our customers due to year-
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end holidays. For example, over the past 10 years, excluding certain recovery years, our first fiscal quarter net sales have ranged 2%-17% below the fourth quarter of the prior fiscal years.
In fiscal 2021 and 2020, one customer accounted for 16% and 17%, respectively, of net sales.
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 machine tools primarily used for industrial laser materials processing, serving important end markets like automotive, machine tools, consumer goods and medical device manufacturing.
The following table sets forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands):
| Fiscal 2021 | Fiscal 2020 | ||||||||||||||||||||||
| Amount | Percentage of total net sales | Amount | Percentage of total net sales | ||||||||||||||||||||
| OEM Laser Sources (OLS) | $ | 913,636 | 61.4 | % | $ | 758,929 | 61.8 | % | |||||||||||||||
| Industrial Lasers & Systems (ILS) | 573,832 | 38.6 | % | 470,070 | 38.2 | % | |||||||||||||||||
| Total | $ | 1,487,468 | 100.0 | % | $ | 1,228,999 | 100.0 | % | |||||||||||||||
Net sales for fiscal 2021 increased $258.5 million, or 21%, compared to fiscal 2020, with increases of $154.7 million, or 20%, in our OLS segment and increases of $103.8 million, or 22%, in our ILS segment. The fiscal 2021 increases in both OLS and ILS segment sales included increases due to the favorable impact of foreign exchange rates.
The increase in our OLS segment sales in fiscal 2021, including higher sales due to the negative impact of COVID-19 in fiscal 2020 of approximately $26.0 million, was primarily due to higher demand for flat panel display applications, with higher revenues from consumable service parts and higher shipments of ELA tools, as well as higher shipments for biomedical instrumentation and scientific applications in the instrumentation market, semiconductor applications in the microelectronics market and applications in the precision manufacturing market. The increased sales were partially offset by lower shipments for applications in the aerospace and defense market.
The increase in our ILS segment sales from fiscal 2020 to fiscal 2021, including higher sales due to the negative impact of COVID-19 in fiscal 2020 of approximately $14.0 million, was primarily due to higher sales to the precision manufacturing market, primarily for materials processing components and automotive applications, higher sales for advanced packaging applications within the microelectronics market and higher sales to the instrumentation market.
Gross Profit
Consolidated
Our gross profit percentage increased by 4.8% to 38.2% in fiscal 2021 from 33.4% in fiscal 2020. The increase included 1.6% lower amortization of intangibles primarily due to the impairment of ILS intangibles in the second quarter of fiscal 2020, a 0.5% unfavorable impact of higher restructuring costs, primarily related to the write-off of inventories, severance costs, warranty costs, facility exit costs and accelerated depreciation in fiscal 2021 due to our planned closure of multiple manufacturing sites, a 0.1% unfavorable impact due to purchase accounting adjustments (inventory step-up in other costs) related to our acquisition of EOT in April 2021 and 0.1% higher stock-based compensation expense. Excluding the 0.9% favorable net impact of lower intangibles amortization, higher restructuring costs, higher purchase accounting adjustments and higher stock-based compensation expense, gross profit percentage increased 3.9% compared to fiscal 2020 primarily due to lower other costs (2.4%) and lower warranty costs (1.5%). Product margins were flat year over year as a percentage of sales. Other costs, excluding restructuring provisions, were lower primarily due to lower inventory provisions for excess and obsolete inventory in certain OLS and ILS business units in fiscal 2021 compared to fiscal 2020. The higher excess and obsolete charges in fiscal 2020 were primarily due to the impact of worldwide economic uncertainties on our demand forecasts due to COVID-19. 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. Although total product margins were flat, unfavorable product margins in OLS resulted from unfavorable mix and average selling prices and the unfavorable impact of the stronger Euro,
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which were partially offset by favorable mix and pricing for fiber components and global tools products in ILS. In both segments, the unfavorable impact of lower capitalized variances resulting from higher sales volumes were partially offset by the favorable absorption of manufacturing costs.
Our gross profit percentage has been and will continue to be affected by a variety of factors including the impact of 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, supply chain shortages, 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.
OEM Laser Sources
Our OLS gross profit percentage decreased by 0.6% to 45.4% in fiscal 2021 from 46.0% in fiscal 2020 and included a 0.2% unfavorable impact due to purchase accounting adjustments (0.2% of inventory step-up in other costs) related to our acquisition of EOT in April 2021. The decrease was primarily due to unfavorable product margins (2.1%) (both mix of product and service revenues and lower average selling prices) and the unfavorable impact of the stronger Euro against the U.S. Dollar. In addition, the unfavorable impact of lower capitalized variances resulting from higher sales volumes net of the favorable absorption of manufacturing costs negatively impacted our gross profit percentage. The unfavorable product costs were partially offset by lower warranty costs (0.8%) due to decreased warranty events in the instrumentation and microelectronics markets and lower other costs (0.7%) primarily due to lower inventory provisions for excess and obsolete inventory in certain business units as a percentage of sales partially offset by the unfavorable impact of EOT purchase accounting adjustments.
Industrial Lasers & Systems
Our ILS gross profit percentage increased by 13.7% to 28.2% in fiscal 2021 from 14.5% in fiscal 2020. The increase included 4.2% lower amortization of intangibles 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, severance, warranty and facility exit costs, and accelerated depreciation in fiscal 2021 due to our planned closure of multiple manufacturing sites. Excluding the net 2.9% favorable impact of lower intangibles amortization and higher restructuring costs, gross profit percentage increased 10.8% compared to fiscal 2020 primarily due to lower other costs (5.2%) due to lower provisions for excess and obsolete inventory, favorable product costs (3.5%) and lower warranty and installation costs (2.1%) as a percentage of sales due to fewer warranty events, particularly for our HPFL products sold in China, and for fiber components products. The higher excess and obsolete charges in fiscal 2020 were primarily due to the impact of worldwide economic uncertainties on our demand forecasts due to COVID-19. Product costs, net of restructuring costs, were favorable primarily due to the favorable absorption of manufacturing costs including the impact of restructuring plans initiated in prior periods and favorable mix and pricing for fiber components and global tools products partially offset by the unfavorable impact of lower capitalized variances resulting from higher sales volumes.
Operating Expenses
The following table sets forth, for the periods indicated, the amount of operating expenses and their relative percentages of total net sales by the line items reflected in our consolidated statement of operations (dollars in thousands):
| Fiscal 2021 | Fiscal 2020 | ||||||||||||||||||||||
| Amount | Percentage of total net sales | Amount | Percentage of total net sales | ||||||||||||||||||||
| (Dollars in thousands) | |||||||||||||||||||||||
| Research and development | $ | 124,266 | 8.4 | % | $ | 115,578 | 9.4 | % | |||||||||||||||
| Selling, general and administrative | 303,863 | 20.4 | % | 270,464 | 22.0 | % | |||||||||||||||||
| Merger and acquisition costs | 236,047 | 15.8 | % | — | — | % | |||||||||||||||||
| Impairment and other charges | — | — | % | 451,025 | 36.7 | % | |||||||||||||||||
| Amortization of intangible assets | 2,877 | 0.2 | % | 3,987 | 0.3 | % | |||||||||||||||||
| Total operating expenses | $ | 667,053 | 44.8 | % | $ | 841,054 | 68.4 | % | |||||||||||||||
Research and development
Fiscal 2021 research and development ("R&D") expenses increased $8.7 million, or 8%, from fiscal 2020, but decreased to 8.4% of sales, compared to 9.4% in fiscal 2020. The increase in R&D expenses was primarily due to $6.8 million higher
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employee-related spending, $1.2 million incremental spending due to the acquisition of EOT in April 2021 and $0.9 million higher charges for increases in deferred compensation plan liabilities. Partially offsetting the increases were $0.1 million lower spending on materials net of the impact of lower customer reimbursements and $0.1 million lower stock-based compensation expense. The higher employee-related spending was primarily due to higher variable compensation, the unfavorable impact of foreign exchange rates and higher severance costs partially offset by the impact of an extra week in fiscal 2020.
On a segment basis as compared to fiscal 2020, OLS R&D spending increased $6.1 million in fiscal 2021 with higher employee-related spending, the unfavorable impact of foreign exchange rates and incremental spending from the acquisition of EOT partially offset by lower net spending on materials. ILS R&D spending increased $1.8 million primarily due to higher employee-related spending and the unfavorable impact of foreign exchange rates partially offset by lower net spending on materials. Corporate and other R&D spending increased $0.8 million primarily due to higher charges for increases in deferred compensation plan liabilities partially offset by lower stock-based compensation expense.
Selling, general and administrative
Fiscal 2021 selling, general and administrative ("SG&A") expenses increased $33.4 million, or 12%, from fiscal 2020. The increase was primarily due to $31.3 million higher employee-related spending, $3.3 million higher other variable spending, $2.9 million higher charges for increases in deferred compensation plan liabilities and $1.6 million incremental spending due to the acquisition of EOT in April 2021, partially offset by $5.7 million lower stock-based compensation expense. The $31.3 million higher employee-related spending was primarily due to higher variable compensation, the unfavorable impact of foreign exchange rates and higher sales commissions partially offset by the impact of an extra week in fiscal 2020, the impact of lower headcount and lower costs related to the retirement of and transition of our former CEO to special advisor status. The $3.3 million higher other variable spending included higher consulting on special projects, the non-recurrence of a gain on the sale-leaseback of our Hamburg facility in fiscal 2020, the unfavorable impact of foreign exchange rates, the impact of a benefit in fiscal 2020 of amounts received from a $1.4 million legal settlement on a resolved asset recovery matter and higher sales rep commissions partially offset by lower travel and other discretionary spending due to COVID-19 and lower bad debts expense. The $5.7 million lower stock-based compensation expense is primarily due to lower accounting acceleration charges for equity grants for our former CEO and other executives partially offset by increased equity grants to our employees, including our executives.
On a segment basis as compared to fiscal 2020, OLS SG&A expenses increased $14.6 million primarily due to higher employee-related spending, the unfavorable impact of foreign exchange rates and the acquisition of EOT partially offset by lower variable spending on travel and other discretionary spending. ILS SG&A spending increased $12.3 million primarily due to higher employee-related spending including the favorable impact of lower headcount, the unfavorable impact of foreign exchange rates, the prior year gain on the sale-leaseback of our Hamburg facility and the prior year settlement on the resolved asset recovery matter partially offset by lower variable spending on travel and other discretionary spending. Corporate and other SG&A spending increased $6.5 million primarily due to higher employee-related spending (including higher variable compensation), higher charges for increases in deferred compensation plan liabilities and higher consulting fees partially offset by lower stock-based compensation expense, lower costs related to the retirement of our former CEO.
Merger and acquisition costs
In fiscal 2021, we recorded $236.0 million in merger and acquisition costs, including $217.6 million paid to Lumentum as a termination fee, as well as costs for investment banking, legal and other consultants related to our merger agreements with Lumentum and II-VI and other acquisition-related costs.
Goodwill and other impairment charges
In fiscal 2020, we recorded non-cash pre-tax goodwill impairment charges of $327.2 million related to our ILS segment to operating expense in our results of operations. In addition, we recorded non-cash pre-tax charges related to the impairment of 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. See Note 8, "Goodwill and Intangible Assets" in the Notes to Consolidated Financial Statements and Note 11, "Leases" in the Notes to Consolidated Financial Statements under Item 8 of this annual report.
In fiscal 2019, we invested 3.0 million Euros ($3.4 million) in 3D-Micromac AG, a private company in Germany. The investment is included in other assets and is being carried on a cost basis. During fiscal 2020, we determined that our investment became impaired and wrote it down to its fair value. As a result, we recorded a non-cash impairment charge of $2.5 million to operating expense in our results of operations in fiscal 2020.
Amortization of intangible assets
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Amortization of intangible assets decreased $1.1 million, or 28%, from fiscal 2020 to fiscal 2021 primarily due to the impairment of ILS intangibles in fiscal 2020 and the completion of the amortization of certain intangibles from acquisitions partially offset by the unfavorable impact of foreign exchange rates and the acquisition of EOT in April 2021.
Other income (expense), net
Other income (expense), net, increased by $4.8 million to other expense of $17.3 million in fiscal 2021 from other expense of $12.5 million in fiscal 2020. The higher expenses were primarily due to the $5.3 million non-recurring translation adjustment related to the dissolution of our OR Laser operations, $1.5 million higher foreign exchange losses, $1.0 million higher interest expense due to the unfavorable impact of foreign exchange rates and $0.6 million lower interest income partially offset by $3.7 million higher gains, net of expenses, on our deferred compensation plan assets.
Income taxes
Our effective tax rate on loss before income taxes for fiscal 2021 of 7.6% was lower than the U.S. federal tax rate of 21%. Our effective tax rate benefit for fiscal 2021 was unfavorably impacted primarily due to the establishment of valuation allowances on certain deferred tax assets, income in foreign jurisdictions subject to tax rates that are higher than the U.S. tax rates, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under Internal Revenue Code Section 162(m) and the deferred taxes on foreign earnings not considered permanently reinvested, partially offset by the benefit of federal research and development tax credits, our Singapore tax exemption and the benefit of our FDII deduction.
Our results reflect the payment of a termination fee to Lumentum of $217.6 million in the second quarter of fiscal 2021. This amount was deducted for book purposes in the current year and treated as a future deductible expense for tax purposes in accordance with our accounting policy.
Our effective tax rate on loss before income taxes for fiscal 2020 of 6.5% was lower than the U.S. federal tax rate of 21%. Our effective tax rate benefit for fiscal 2020 was unfavorably impacted primarily due to the impairment of goodwill that is not deductible for tax purposes and the establishment of valuation allowances for certain deferred tax assets. These unfavorable impacts were partially offset primarily from the release of unrecognized tax benefits net of settlements and competent authority offsets and losses in foreign jurisdictions subject to tax rates that are higher than the U.S. tax rates.
In September 2021, Coherent Singapore received an amended Pioneer Status tax exemption from the Singapore authorities effective from fiscal 2022 through fiscal 2026. The tax holiday continues to be conditional upon our meeting certain revenue, business spending and employment thresholds. The impact of this tax exemption decreased Coherent Singapore income taxes by approximately $3.7 million and $2.6 million in fiscal 2021 and 2020, respectively. The benefits of the tax holiday on net income per dilute