ITEM 1. BUSINESS
GENERAL
Spectra-Physics Lasers, Inc. (the "Company") is a leader in the design, development, manufacture and distribution of lasers and laser systems for a broad range of markets. The Company has been a pioneer in the laser industry and has developed a proprietary and patented portfolio of laser, optic and related manufacturing technologies. The Company offers two broad product lines: high power semiconductor-based lasers and laser-based systems (high power semiconductor lasers (HPSL) and semiconductor laser pumped solid state (SLPSS) lasers) and conventional lasers and laser-related products. The Company's high power semiconductor-based products range from semiconductor lasers, the basic engine, through semiconductor laser pumped lasers to end user systems. Through technological innovation, the Company is leading the transition to high power semiconductor-based lasers from conventional lasers such as gas, liquid and lamp pumped lasers. The Company has been at the forefront of high power semiconductor-based laser technology for the last 15 years and is leveraging its technical strengths to develop high power semiconductor-based lasers, which are generally more efficient, reliable, cost-effective and compact than conventional lasers. These lasers are enabling many new applications and replacing conventional lasers in existing applications in industrial, OEM and research and development markets. According to Strategies Unlimited, a market research firm, the use of high power semiconductor-based lasers is expected to increase approximately 20% to 40% annually over the next several years.
The Company is also a leading supplier of conventional lasers and laser-related products to industrial and research and development customers. These lasers, while based on older technology, have unique performance characteristics that make them the only current solution for certain demanding technical applications. According to Laser Focus World, the market for high power conventional lasers is expected to grow from $1.6 billion in 1998 to $1.8 billion in 1999. The Company's conventional products include ultrafast systems, amplifier systems, optical parametric oscillators, air and water-cooled ion lasers, high energy flash lamp pumped YAG lasers, optics and optical systems. The Company's strong market position and technology leadership in these conventional laser applications enhances its opportunity to expand its high growth semiconductor-based laser business by generating funds, capitalizing on strong customer relationships and leveraging its technological expertise.
The Company works closely with its customers to develop its products and is focused on providing innovative solutions to customer needs. To control critical aspects of product quality, significantly improve time-to-market, reduce costs and identify new applications, the Company has vertically integrated into strategic technologies. The Company sells its products to a wide range of customers for use in a variety of applications in markets such as materials processing, life sciences, research and development, printing and telecommunications. The Company's customers include 3D Systems, Becton Dickinson, DaiNippon Screen, Electro-Scientific Industries, ETEC, General Scanning, Haemonetics, IBM, Inspex, KLA/Tencor, Komag, Presstek, Rofin-Sinar, Seagate and Western Digital.
Spectra-Physics AB, a multinational corporation based in Sweden which is listed for trading on the Stockholm Stock Exchange, indirectly owns 80.4% of the Company's outstanding Common Stock. On February 22, 1999, shareholders of Spectra-Physics AB holding approximately 98.4% of the outstanding shares of Spectra-Physics AB tendered their shares to Thermo Instrument Systems Inc. (TIS), which shares were thereafter accepted by TIS for approximately $355 million. Accordingly, TIS now indirectly owns approximately 79.1% of the Company's outstanding common stock.
Prior to the Reorganization described below, the Company, Opto Power Corporation ("Opto Power") and Spectra-Physics Laser Data Systems, Inc. ("Laser Data"), together with various foreign subsidiaries of Spectra-Physics AB that conducted sales and technical support operations on their behalf, were operated as a functional group called the Lasers and Optics Group (collectively, the "Lasers and Optics Group"). In preparation for the Company's initial public offering, the Lasers and Optics Group was reorganized (the
"Reorganization") in October 1997 so that the assets and liabilities (including contractual rights and obligations) of the Lasers and Optics Group are now held by the Company. In connection with the Reorganization, the Company entered into certain agreements with Spectra-Physics AB or its subsidiaries relating to certain aspects of the ongoing relationships between them, such as administrative support services and distribution, facilities leasing, trademark and patent license arrangements. In December 1997, the Company also entered into a registration rights agreement with Spectra-Physics Holdings USA, Inc. ("Holdings"), a wholly-owned subsidiary of Spectra-Physics AB.
In December 1997, the Company completed an initial public offering of 2,400,000 shares of common stock, at an offering price of $10.00 per share. An additional 360,000 shares of common stock were sold in January 1998 in accordance with an overallotment option granted to the underwriters. The net proceeds from the sale of these shares was approximately $23.9 million.
STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
Certain information in this Annual Report on Form 10-K, including but not limited to the Management's Discussion and Analysis of Financial Condition and Results of Operations, may constitute forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934. Certain forward-looking statements can be identified by the use of forward-looking terminology such as, "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," "anticipates," or "hopeful," or the negative thereof or other comparable terminology, or by discussions of strategy, plans or intentions. Forward-looking statements involve risks and uncertainties, including those described in the Risk Factors section of Item 1 of this Annual Report on Form 10-K, which could cause actual results to be materially different than those in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company assumes no obligation to update such information.
RISK FACTORS
Fluctuations In Quarterly Operating Results
The Company's operating results have fluctuated significantly in the past and are expected to fluctuate in the future on a quarterly and annual basis as a result of a number of factors, many of which are beyond the Company's control. Results in any period could be affected by changes in market demand, competitive market conditions, market acceptance of new or existing products, fluctuations in foreign currency exchange rates, the cost and availability of components, the Company's ability to manufacture and ship products, the mix of the Company's customer base and sales channels, the mix of products sold, the Company's ability to expand its sales and marketing organization effectively, the Company's ability to attract and retain key technical and managerial employees and general economic conditions. Due to the foregoing factors, the Company's operating results in one or more future periods are expected to be subject to significant fluctuations. In the event such fluctuations result in the Company's financial performance being below the expectations of public market analysts and investors, the price of the Company's Common Stock would likely decline, perhaps substantially.
Sales to individual customers are often related to a customer's specific requirements, the timing of which is subject to change. From time to time, the Company has experienced accelerations and slowdowns in shipments to customers, causing changes in the sales level of a given quarter relative to both the preceding and subsequent quarters. A significant portion of the Company's sales are to customers in the research and development market. Sales into this market have historically varied from quarter-to-quarter due to seasonal fluctuations and governmental spending patterns. In addition, announcements by the Company or its competitors of new products or technologies could cause customers to defer purchases of the Company's existing products. In the event that anticipated orders from customers fail to materialize, or delivery schedules are deferred or canceled as a result of the above factors or other unanticipated factors, the Company's business, operating results and financial condition would be materially adversely affected. As a result, the
Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indicative of future performance.
The Company has experienced a trend in its sales whereby its fiscal fourth quarter net sales represent a disproportionate share of the Company's annual net sales and whereby the Company's first quarter net sales decline significantly compared to the fourth quarter of the prior fiscal year. The Company believes these sales patterns occur in part because of seasonal sales patterns related to customers' fiscal years and in part from the Company's incentive compensation plan which compensates employees based on annual results. The Company recognizes that the non-linear pattern of its shipments leads to inefficiencies in asset and employee utilization. The Company is taking steps to mitigate this sales trend, but this pattern is likely to continue in the near term.
Despite the fluctuations in its quarterly sales patterns, the Company's operating expenses are incurred on an approximately ratable basis. As a result, if expected sales are deferred for any reason, the Company's business, operating results and financial condition could be materially adversely affected.
The Company's gross margin is affected by a number of factors, including product mix, product pricing, cost of components, the proportion of third party products incorporated into the Company's systems, foreign currency exchange rates and manufacturing costs. For example, since high power semiconductor-based lasers and laser systems generally have higher gross margins than conventional lasers, absent other factors, a shift in sales toward semiconductor-based lasers and systems would lead to a gross margin improvement for the Company. On the other hand, if market conditions in the highly competitive conventional laser market forced the Company to lower unit prices, the Company would suffer a decline in gross margin unless the Company were able to timely offset the price reduction by a reduction in production costs or by sales of other products with higher gross margins. Either of these events could have a material effect on the Company's business, operating results and financial condition.
The Company's backlog on a given date consists of written purchase orders or other commitments for products which are scheduled to be shipped within the following twelve months. Orders in backlog are firm, but are generally subject to cancellation or rescheduling without penalty. Decisions by customers to reduce inventory levels could lead to reductions in purchases from the Company and could have a material adverse effect on the Company's business, operating results and financial condition.
Control by Principal Stockholder
TIS beneficially owns 79.1% of the outstanding shares of Common Stock of the Company. As a result, TIS will be able to control the outcome of matters requiring stockholder approval, including the election of directors, and will have the ability to control the business and affairs of the Company. So long as TIS continues to beneficially own a significant amount of the Company's outstanding Common Stock, only a limited percentage of the Common Stock will be traded in the public market.
The Company has entered into certain agreements with Spectra-Physics AB or its affiliates relating to certain aspects of the ongoing relationships between them, such as tax sharing, administrative support service, office space rental and trademark and patent license arrangements. Accordingly, the Company will depend in part on its continuing relationship with Spectra-Physics AB.
Risks Associated with Sole Suppliers and Limited Sources
A number of components necessary for the manufacture and operation of many of the Company's products such as crystals, ceramic components and Q switches are obtained from sole suppliers or a limited group of suppliers. The Company has experienced shortages of such supplies in the past. The Company does not maintain any long-term supply agreements with any of its suppliers. The Company's reliance on sole or a limited group of suppliers involves several risks, including a potential inability to obtain an adequate supply of required components and reduced control over pricing. The disruption or termination of any of these sources could have a material adverse effect on the Company's business, operating results and financial condition. Any inability to obtain adequate deliveries or any other circumstance that would require the Company to seek
alternative sources of supply or to manufacture such components internally could significantly delay the Company's ability to ship its products, which could damage relationships with current and prospective customers and could have a material adverse effect on the Company's business, operating results and financial condition.
Dependence on Key Personnel
The success of the Company depends to a significant degree on the efforts of the Company's senior management team. The Company's operations may be adversely affected if one or more members of senior management were to leave the Company. The Company is also dependent upon its ability to attract and retain qualified employees, particularly highly skilled design, process and test engineers involved in the manufacture of existing products and the development of new products and processes. The competition for such personnel is intense, and the loss of key employees or the failure to attract qualified new employees could have a material adverse effect on the Company's business, operating results and financial condition.
Manufacturing Risks
The manufacture of certain of the laser and optic components, products and systems sold by the Company is a highly complex and precise process. As a result of the technical complexity of the Company's products, changes in the Company's or its suppliers' manufacturing processes, or the inadvertent use of defective or contaminated materials by the Company or its suppliers, could result in a material adverse effect on the Company's ability to achieve acceptable manufacturing yields and product reliability. To the extent the Company does not achieve such yields or product reliability, its business, operating results, financial condition and customer relationships would be adversely affected.
The Company relies exclusively on its own production capability to manufacture certain optics and optical systems, semiconductor lasers, lasers and laser-based systems. Because the Company manufactures, packages and tests these components, products and systems at its own facilities, and such components, products and systems are not readily available from other sources, any interruption in manufacturing resulting from shortages of parts or equipment, fire, earthquake, natural disaster, equipment failures or otherwise would have a material adverse effect on the Company's business, operating results and financial condition.
Dependence on Key Markets and Successful Identification of New Markets
The Company's current products serve many applications in the materials processing, life sciences, research and development, printing and telecommunications markets. No assurances can be given that these markets will continue to generate significant or consistent demand for the Company's products. Existing markets could be significantly diminished by new technologies or products that replace or render obsolete the Company's technologies and products. The Company is dependent on successfully identifying new markets for its products. There can be no assurance that the Company will be able to successfully identify new high-growth markets in the future. Moreover, there can be no assurance that new markets will develop for the Company's or its customers' products, or that the Company's technology or pricing will enable such markets to develop.
Dependence on Key Customers
The Company's customers are generally not contractually obligated to purchase any specified quantity of products in any particular period, and product sales to major customers have varied widely from quarter to quarter and year to year. There can be no assurance that the Company's current customers will continue to place orders with the Company, that orders by existing customers will continue at the levels of previous periods or that the Company will be able to obtain orders from new customers. Loss of, or a material reduction in orders by, one or more of the Company's major customers would have a material adverse effect on the Company's business, operating results and financial condition. Even if relationships with existing major customers continue, such customers' requirements for the Company's products will depend on the success of their product development, marketing, sales and other business efforts. The Company's or its customer's
products could be replaced or made obsolete by other technologies or products, potentially leading to an adverse impact on the Company's business, operating results and financial condition.
Risks of Managing Future Growth
Any significant growth in the Company's sales or any significant expansion in the scope of its operations would likely strain the Company's management, financial, manufacturing and other resources and may require the Company to implement and improve a variety of operating, financial and other systems, procedures and controls. While the Company plans significant expansion of its manufacturing, sales, accounting and other information systems to meet these challenges, there can be no assurance that these efforts will succeed, or that any existing or new systems, procedures or controls will be adequate to support the Company's operations or that its systems, procedures and controls will be designed, implemented or improved in a cost effective and timely manner. Any failure to implement, improve and expand such systems, procedures and controls in a timely and efficient manner could have a material adverse effect on the Company's business, operating results and financial condition.
Rapid and Fundamental Technological Change
The laser and optics industry is characterized by extensive research and development expenditures and rapid technological change. The development by current or future competitors of new or improved products, processes or technologies may make the Company's current or proposed products obsolete or less competitive. Although the Company devotes significant resources to further develop and enhance its existing products, including its high power semiconductor-based lasers, there can be no assurance that new or alternative technologies will not make the Company's products obsolete or less competitive. The Company's future business, operating results and financial condition will depend on its ability to enhance its existing products, develop new products that address the particular needs of its customers and respond to technological advances and emerging industry standards and practices.
Competition
The Company's various markets are highly competitive. The Company's overall competitive position depends on a number of factors including the price, quality and performance of its products, the level of customer service, the development of new technology and the Company's ability to participate in emerging markets. The Company faces competition from three primary sources: current direct competitors, potential competitors and suppliers of new technologies. The Company offers a range of components, subsystems, products and systems and has a number of competitors worldwide in various segments of its markets. In its HPSL markets, direct competitors include SDL, Inc., Coherent, Inc., Siemens and Thompson-CSF. In its SLPSS laser markets, major competitors include Coherent, Inc. and Lightwave Electronics Inc. In the laser disk texturing market, the Company's major competitor is IBM Corporation. In its other product markets, the Company's major competitors include Coherent, Inc., Continuum (a division of Hoya) and Uniphase Corporation. None of the Company's competitors competes in all of the product areas and industries currently served by the Company. However, as existing or new markets continue to grow, the Company expects that new competitors will emerge and present competitors will seek to increase their market share.
New technologies may emerge to compete with the Company's products. In most of the Company's product lines, both the Company and its competitors are working to develop new technologies, or improvements and modifications to existing technologies, which will render present products obsolete. There can be no assurance that the Company's development efforts will be successful. In addition, there can be no assurance that markets will develop for any such future products, or that any such products will be competitive with other technologies or products that may be developed by others. Some of the Company's competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than the Company. In addition, some of these competitors may be able to respond more quickly to new or emerging technologies, evolving industry trends and changes in customer requirements and to devote greater resources to the development, promotion and sale of their products than the Company. There can be no assurance that the Company's current or potential competitors will not develop or acquire products comparable or superior to
those developed by the Company, combine or merge to form larger, more significant competitors, or adapt more quickly than the Company to new technologies, evolving industry trends and changing customer requirements. Increased competition has resulted and is expected, in the future, to result in price reductions, reduced margins or loss of market share, any of which could materially and adversely affect the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not have a material adverse effect on its business, operating results and financial condition. The Company expects that both direct and indirect competition will increase in the future. Additional competition could adversely affect the Company's business, operating results and financial condition through price reductions or loss of market share.
Dependence on Proprietary Technology; Risk of Patent Infringement Claims
The Company's future success and competitive position is dependent upon its proprietary technology, and the Company relies on patent, trade secret, trademark and copyright law to protect its intellectual property. There can be no assurance that the patents owned or licensed by the Company will not be invalidated, circumvented, challenged or licensed to others, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued within the scope of the claims sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology or design around the patents owned by the Company. In addition, effective copyright, patent and trade secret protection may be unavailable, limited or not applied for in certain foreign countries. Certain of the Company's technology is licensed on a non-exclusive basis from third parties which may license such technology to others, including competitors of the Company. There can be no assurance that the steps taken by the Company to protect its technology will prevent misappropriation of such technology.
The laser and optics industry is characterized by frequent litigation regarding patent and other intellectual property rights. Litigation has been necessary and may be necessary in the future to enforce the Company's patents and other intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Such litigation has in the past resulted in substantial costs and diversion of resources and any future actions could have a material adverse effect on the Company's business, operating results and financial condition. In particular, the Company has been involved in litigation with two of its principal competitors, SDL, Inc. and Uniphase Corporation. The SDL litigation, which was settled in 1997, was initiated by the Company in 1995 to enforce its rights under a technology agreement with SDL. The Uniphase litigation, which was settled in 1994, was initiated by the Company in 1991 to enforce the Company's rights under one of its patents.
From time to time the Company has received and expects in the future to receive notices of claims of infringement of other parties' proprietary rights. There can be no assurance that infringement claims (or claims for indemnification resulting from infringement claims) will not be asserted against the Company or will not result in an injunction against the sale of allegedly infringing products or otherwise materially adversely affect the Company's business, operating results and financial condition.
Risks Associated With International Sales
International sales accounted for approximately 46%, 45%, and 52%, of the Company's net sales in 1998, 1997 and 1996, respectively. International sales carry a number of inherent risks, including exposure to currency fluctuations, potentially adverse tax consequences, reduced protection for intellectual property rights in some countries, the impact of recessionary environments in economies outside the United States, generally longer receivable collection periods, changes in political and regulatory environments, tariffs and other potential trade barriers. In addition, certain of the Company's international sales are subject to export licensing and approvals by U.S. governmental agencies. Although to date the Company has experienced no significant difficulty in obtaining such licenses or approvals, the failure to obtain such licenses or approvals or comply with such regulations in the future could have a material adverse effect on the Company's business, operating results and financial condition.
Potential Adverse Impact of Environmental and Other Governmental Regulations
The Company's facilities and operations are subject to a wide variety of foreign, federal, state and local environmental laws, regulations and ordinances, including those related to air emissions, wastewater discharges and chemical and hazardous waste management and disposal ("Environmental Laws"). The Company's operations also are governed by laws relating to workplace safety and worker health, primarily the Occupational Safety and Health Act ("Employee Safety Laws"). Further, compliance with Environmental Laws also may require the acquisition of permits or other authorizations for certain activities and compliance with various standards or procedural requirements. Although the Company believes that its operations are in compliance in all material respects with current requirements under Environmental Laws and Employee Safety Laws, the nature of the Company's operations exposes it to the risk of liabilities or claims with respect to such matters.
Certain of these Environmental Laws, including the Comprehensive Environmental Response, Compensation and Liability Act, as amended by the Superfund Amendments and Reauthorization Act of 1986 ("CERCLA") and similar state laws (collectively, "Superfund Laws"), hold owners or operators of land or businesses liable for their own and for previous owners' or operators' releases of hazardous or toxic substances, materials or wastes, pollutants or contaminants, including petroleum and petroleum products ("Hazardous Substances"). Such Superfund Laws also provide for responses to and liability for releases of certain Hazardous Substances into the environment. The nature of the Company's operations and the long history of industrial uses at some of its current or former facilities expose the Company to risk of liabilities or claims under Superfund Laws. In 1988, the Company was named on the General Notification List of the Environmental Protection Agency (EPA)stating that the Company may be a Potentially Responsible Party (PRP) under the Superfund Laws for Hazardous Substances which may have been generated by its former operations at a former site. Since that time, the Company has not been named in the EPA's first or second tier lists, and has not been pursued as a PRP by the EPA or any of the other PRPs.
Since 1984, the Company's facilities in Mountain View, California ("Mountain View Site") have been undergoing investigation and remediation in response to past releases of industrial solvents to the soil and groundwater. In addition, the impacted groundwater has migrated to what is referred to as the North Bayshore Area. As a result of these past releases, the Mountain View Site and other neighboring sites are listed on the National Priorities List ("NPL" or the "Superfund List") under CERCLA. The Company is subject to orders issued by the California Regional Water Quality Control Board ("Orders") that require the Company to perform remediation on-site and off-site and investigate other potentially responsible parties. Pursuant to the Orders and other orders issued to other responsible parties, the Company and other responsible parties are jointly performing and funding remediation which includes soil vapor extraction and groundwater extraction, treatment and monitoring. All of the required soil and groundwater remediation and monitoring systems currently required by the Orders are in place, and consequently the initial capital expenses for such systems have been incurred. As of November 1998, the Company had received permission from the Regional Water Quality Control Board (RWQCB) to shut down one of its extraction wells and one of its soil vapor extraction units. The Company has also been given permission to run tests that may allow it to shut down a second well. The Company is further in process of applying for permission to shut down its second soil vapor extraction system. In October 1997, the Company was served with a complaint that had been filed in the Superior Court of the State of California seeking an unspecified amount of damages for personal injuries and property damage incurred by residents of a single location alleged to have resulted from the Company's and others' negligent and/or intentional handling of toxic chemicals (Rosario Balcita et al. v. Teledyne Semiconductor, Spectra-Physics Lasers, et al.). As of December 31, 1998, there has been a summary judgement ruling in the case in favor of the Company and its co-defendants in regards to the four adults involved in the case. There can be no assurance that the summary judgement will not be successfully appealed or that the complaint will be resolved without adverse impact to the Company's financial position or results of operations. There can be no assurances that other parties will not come forward and claim personal injury or property damage.
Based on the Company's experience to date, the Company believes that the future cost of compliance with existing Environmental Laws (or liability for known environmental liabilities or claims) and Employee Safety Laws should not have a material adverse effect on the Company's business, operating results and
financial condition. However, future events, such as changes in existing laws and regulations or their interpretation, or the discovery of heretofore unknown contamination, may give rise to additional compliance costs or liabilities that could have a material adverse effect on the Company's business, operating results and financial condition. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of regulatory agencies or stricter or different interpretations of existing laws, may require additional expenditures by the Company that may be material.
Potential Sales of Stock by Holdings; Shares Eligible for Future Sale
Future sales by Spectra-Physics Holdings USA, Inc. of the Company's Common Stock could adversely affect the prevailing market price of the Common Stock. Holdings is permitted to sell in the public market specified amounts of Common Stock without registration pursuant to Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"). In addition, the Company is obligated under a registration rights agreement with Holdings to register under the Securities Act the shares of Common Stock owned by Holdings upon its demand.
No predictions can be made as to the effect, if any, that sales in the public market of shares or the availability of additional shares for future sale will have on the market price of the Common Stock. The market price of the Common Stock could be adversely affected by future sales of Common Stock or the perception that such sales may occur.
Certain Anti-Takeover Matters; Possible Issuance of Preferred Stock
Certain provisions of Delaware law, the Company's Certificate of Incorporation and the Company's Bylaws could delay or make more difficult a merger, tender offer or proxy contest involving the Company. The Company is subject to Section 203 of the Delaware General Corporation Law ("DGCL") which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any "interested stockholder" for a period of three years following the date that such stockholder became an interested stockholder. Under the Company's Certificate of Incorporation and Bylaws, the directors may enlarge the size of the Board and fill any vacancies on the Board. The Company's Bylaws provide that nominations for directors may not be made by stockholders at any annual meeting unless the stockholder intending to make a nomination notifies the Company of its intention a specified period in advance and furnishes certain information, and require advance notice of business to be brought by a stockholder before the annual meeting. The shares of the Company's Preferred Stock may be issued in the future without further stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as the Board of Directors may determine. The rights of holders of Common Stock will be subject to, and may be adversely affected by, the rights of any holders of Preferred Stock that may be issued in the future. The issuance of Preferred Stock and the application of Section 203 of the DGCL and certain other provisions of the Company's Certificate of Incorporation and Bylaws could have the effect of discouraging, delaying or preventing a change of control of the Company.
INDUSTRY BACKGROUND
A laser uses energy from a power source to stimulate a particular type of material, which creates and emits photons (i.e., light). The light emitted by lasers is more intense and has higher purity than the light emitted by conventional light sources. These characteristics enable applications in several broad markets such as materials processing, life sciences, research and development, printing and telecommunications. The principal factors that distinguish different types of lasers and determine the particular laser suitable for a specific application are wavelength (color), output power, repetition rate, cost and operating life.
During the early years of laser development in the 1960s and 1970s, lasers were relatively expensive and large, and had low reliability and performance characteristics. Consequently, lasers were used primarily for scientific research and limited industrial applications where there were few alternatives to lasers. Since then, improvements in laser technology have resulted in lower cost, smaller, more reliable and more efficient lasers. As a result, the use of lasers for industrial and other commercial applications has increased significantly.
Today, lasers are used in a wide range of applications and various markets including biotechnology, consumer electronics, industrial process control, materials processing, measurement, medical, printing, research and development, semiconductor manufacturing and telecommunications. According to Laser Focus World, the worldwide market for lasers grew from approximately $1.1 billion in 1993 to an estimated $3.9 billion in 1998, which represents a compound annual growth rate of approximately 29%.
Lasers can be generally classified into four basic types: gas, liquid, lamp pumped solid state and semiconductor-based. A significant portion of the installed base of lasers is comprised of gas, liquid and lamp pumped lasers. The principal markets for these conventional lasers have been materials processing, medical and scientific applications. According to Laser Focus World, the market for high power conventional lasers was approximately $1.6 billion in 1998, and is expected to increase to approximately $1.8 billion in 1999. Despite continuous advances in technology, significant shortcomings still exist with most conventional lasers. Most gas lasers are large, expensive, inefficient and fragile, many liquid lasers use carcinogenic dyes and have limited performance ranges, and lamp pumped lasers are limited by their dependence on inefficient and unreliable incandescent lamps. These lasers, while based upon older technology, have unique performance characteristics that make them the only current solution for certain demanding technical applications.
Semiconductor-based lasers are a relatively new and innovative technology. A semiconductor-based laser creates light from the flow of an electric current through a specially designed semiconductor device. Semiconductor-based lasers include both high and low power devices as well as semiconductor laser pumped solid state lasers.
The laser industry has been characterized by a high degree of technological innovation. Today, the laser industry is undergoing a fundamental technology transition to semiconductor-based lasers from conventional lasers. This transition is being driven by a number of advantages of semiconductor-based lasers including:
- Lower Operating Cost. The annual costs for power and water to operate a 10 W SLPSS laser is less than 5% of the cost to operate a gas laser. For example, the annual cost in California for power and water to operate a 10 W SLPSS laser for 2,000 hours is $300, compared to more than $17,000 for a 10 W gas laser.
- Smaller Size. Semiconductor-based lasers are much smaller than conventional lasers of comparable power. For example, a 10 W semiconductor-based laser is one-tenth the size of a 10 W gas laser, and semiconductor laser diodes can be as small as a grain of salt.
- Higher Reliability. Semiconductor pumped solid state lasers have lifetimes exceeding 10,000 hours, compared to 500 hours for a lamp pumped laser.
- Greater Efficiency. Semiconductor lasers convert electrical power to light much more efficiently, converting greater than 40% of input power compared to 0.02% for a gas laser.
As a result of the foregoing advantages, semiconductor-based lasers are replacing conventional laser technologies in existing applications as well as enabling many new applications. However, semiconductor-based lasers currently cannot address applications that require very high power output and laser light of certain wavelengths. Conventional lasers are the only solution for these technically demanding applications due to their unique performance characteristics.
The semiconductor-based laser market generally can be divided into two categories: low power (less than 0.5 W), such as lasers used in CD players and laser printers, and high power (0.5 W or greater). To date, the greatest penetration of semiconductor-based lasers has been in applications that require low power. As high power semiconductor-based laser technology continues to advance, the use of high power semiconductor-based lasers is expected to increase approximately 20% to 40% annually over the next several years according to Strategies Unlimited, a market research firm.
Customers for high power semiconductor-based lasers are seeking improved performance and reliability, reduced cost and a greater number of product offerings. Faced with these challenges and increasing time-to-market pressures, customers are increasingly relying upon third party technology providers for further innovations in lasers, optics and other related technologies. Meeting these requirements is extremely complex
and requires significant expertise, breadth of technology and engineering resources and a substantial financial commitment.
STRATEGY
The Company has been a leading supplier of lasers and laser systems for over 37 years and has been developing high power semiconductor-based lasers for the last 15 years. The Company has a significant proprietary and patented portfolio of lasers, optics and other related laser and manufacturing technologies. As a result, the Company believes that it is uniquely positioned to capitalize on the significant market opportunities for high power semiconductor-based lasers and end-user systems. Key elements of the Company's strategy include the following:
Capitalize on Leadership in Semiconductor-based Laser Technology. To enhance its leadership position, the Company is continuing to focus substantial resources on semiconductor-based laser technology, enabling the Company to continue developing new products for existing and emerging markets. For example, the Company continues to offer the highest power and brightest commercially available semiconductor-based lasers.
Develop New Applications and Markets. The Company leverages its technology and close working relationships with its key customers to develop innovative solutions to complex customer requirements. In response to specific customer needs, the Company has developed systems incorporating laser technology in applications such as hard disk texturing and floptical disk manufacturing, and is working with customers to develop systems incorporating laser technology in enhanced magnetic resonance imaging, fiber laser pumping, diamond machining and PC board drilling.
Introduce Systems Products. The Company's expertise in semiconductor-based laser and optics technology has enabled it to successfully introduce and market systems products in the disk drive industry. The Company's LZT-500, LZT-1000 and LZT-2000 systems use a Spectra-Physics SLPSS laser and optical beam train together with custom hardware and software to laser zone texture hard disks. Laser disk texturing systems increase the storage capacity of a hard disk. The Company is focused on developing other laser data storage systems based on its laser and optics technology.
Continue Supporting Conventional Laser Technology. The Company intends to maintain a leadership position in the supply of conventional laser systems through continued targeted research and development investments. The Company also intends to seek new applications for certain conventional technologies such as the application of ultra-fast technology to inspect and test semiconductor wafers.
Leverage Benefits of Strategic Vertical Integration. The Company has vertically integrated into strategic laser technologies, components and manufacturing processes such as optics and semiconductor wafers, and expects to continue such strategic vertical integration in the future. This vertical integration enables the Company to control the quality of strategic components, significantly improve time-to-market for new products and technologies and more easily identify new applications.
MARKETS
The Company produces a broad range of lasers, laser systems, optics, optical systems and end user systems for the industrial, OEM and research and development markets. The primary applications for the Company's products in these markets are as follows:
- Printing/Graphics. Historically, the commercial printing market has used silver halide-based film. In recent years, the commercial printing industry has increasingly shifted to thermal-based materials which require high power semiconductor-based lasers in the film exposure process. The Company believes that the incremental use of thermal-based materials for commercial printing will increase the demand for high power semiconductor-based lasers. The Company's high power semiconductor-based lasers are being used in conjunction with thermal-based plate development by a number of major film suppliers as well as in direct-to-press applications.
- Materials Processing. Materials processing encompasses a wide range of industrial processes that require the delivery of precisely controlled heat or light. Major segments of this market include:
Hard Disk Texturing. In hard disk drive manufacturing, disks must be roughened or "textured" to prevent the head from fusing to the smooth surface of the disk causing the hard drive to "crash." Traditional texturing involves the mechanical application of a diamond paste to the entire disk surface. Laser-based texturing -- in which a laser is used to create tiny bumps on the disk surface -- is rapidly replacing mechanical texturing. A laser produces faster, cleaner, less wasteful and more consistent texturing over a smaller area of the disk, enabling more of the disk to be used for storage and increases the disk's storage capacity.
Rapid Prototyping. Rapid Prototyping is the computer generation of three-dimensional objects from CAD/CAM system input which typically is used for producing models, manufacturing prototypes, masters and patterns. Rapid Prototyping involves exposing a proprietary photopolymer with ultraviolet light which "cures" the polymer creating a solid model in hours. Traditional hand crafting or machining methods can take weeks or even months to achieve the same result. Because of the advantages of SLPSS lasers, they have replaced conventional lasers in Rapid Prototyping applications requiring high power. The Company recently commenced shipments of a second generation high power laser for the Rapid Prototyping market.
Semiconductor Manufacturing, Inspection and Repair. Lasers are used to adjust the electrical characteristics of resistors, to inspect semiconductor wafers for defects and to repair semiconductor devices such as DRAMs and SRAMs. Because of their high reliability and ease of use, SLPSS lasers are widely used in these applications.
Via Hole Drilling. Historically, holes in printed circuit boards have been made using mechanical drilling techniques. Increased packing density has led to a new technique where very small holes are drilled from an outer layer to specific inner layers and then plated to make electrical contact. The size of these holes (80 microns or less) preclude efficient mechanical drilling and manufacturers are moving to laser-based methods. SLPSS lasers are increasingly being utilized for this application. The Company is actively involved in developing ultraviolet SLPSS laser sources for this application.
Marking. Marking applications include plastics marking (e.g., marking the keys on a computer keyboard) and the marking of finished electronic components (e.g., marking very small semiconductor packages in final stages of semiconductor manufacturing). SLPSS lasers are replacing conventional flash lamp pumped YAG lasers in these and other direct-write marking applications where the performance characteristics of SLPSS lasers are required.
- Research and Development. Research and development has historically been a major market for conventional laser technology, such as water cooled gas lasers, high energy flash lamp pumped YAG lasers and ultrafast systems with an installed base of tens of thousands of lasers. As new SLPSS lasers that can replicate the performance of conventional lasers are developed, they are rapidly replacing conventional lasers in this market. For example, in 1996 the Company commenced shipments of a 5 W CW green SLPSS laser called the Millennia to research and development customers. Recently, the Company introduced the Millennia s series of 2 W to 10 W systems packaged in the industry's smallest footprint. To date, approximately 900 Millennia lasers have been sold, many of which are being used by research and development customers to replace their existing water cooled ion lasers. Current applications for SLPSS lasers in the research and development market include pump lasers for ultrafast systems, confocal microscopy systems and seed lasers in amplifier systems.
- Life Sciences. Semiconductor-based lasers are increasingly used in therapeutic, surgical, dental and diagnostic medical applications. Therapeutic applications include a variety of skin treatments, such as hair removal, and thermal treatments using endoscopic delivery to internal organs such as the prostate. Surgical applications are expanding rapidly and now include general purpose endoscopic contact and non-contact surgical tools. Several diagnostic techniques, including magnetic resonance imaging, also
employ semiconductor lasers. In this market, the Company provides semiconductor-based lasers to medical device OEMs.
- Other. Part of the Company's strategy is to continue to identify applications for its technology in other markets. For example, the Company manufactures and sells conventional lasers for use in light shows and other entertainment market applications.
PRODUCTS
The Company produces a broad range of lasers, laser systems, optics, optical systems and end user systems. The Company's semiconductor-based laser products include HPSLs, SLPSS lasers and other SLPSS-based systems. Conventional products include gas lasers, flash lamp pumped yttrium aluminum garnet (YAG) lasers, optical parametric oscillators (OPOs), amplifiers, accessories, optics and optical systems, and related services.
The following chart illustrates the Company's principal products and their applications.
High Power Semiconductor Lasers. HPSLs are extremely efficient converters of electrical power to light and are also highly efficient in focusing generated light into small spots. While many applications require small spots of very intense heat, many others, such as pumping crystals and illumination, depend on the semiconductor laser's ability to create large amounts of nearly monochromatic photons. These lasers are compact, enabling more cost effective solutions to a large number of problems. Because the light from semiconductor-based lasers is emitted in a pattern very different from other lasers (more like a fan of light rather than a "beam"), the Company has developed technology to couple the light into an optical fiber to enhance the "beam" quality or more conveniently deliver the light to the desired location.
The Company manufactures a range of HPSL products with wavelengths from 785 nm to 1800 nm and output powers from less than one Watt to stacked bars (two dimensional arrays) which produce hundreds or thousands of Watts. These products are available in various forms, from bare diodes on heat sinks, to fiber- coupled single emitters and bars, to two dimensional arrays, to fully integrated modules and microprocessor-controlled units containing power supplies and active coolers.
Semiconductor Laser Pumped Solid State Lasers. SLPSS lasers use semiconductor lasers to pump a crystal to produce laser beams with special characteristics in terms of mode quality, power stability, optical noise, monochromaticity or energy storage. Like HPSLs, SLPSS lasers are smaller, more efficient, more reliable and less costly to operate than the conventional laser technologies they are replacing.
The Company produces SLPSS lasers to satisfy a broad range of customer requirements. Depending on customer needs, an SLPSS laser can combine various features including a modular power supply and laser head designs, various crystals, fiber coupling, and different repetition rates, pulse widths and wavelengths. The Company's SLPSS lasers contain several design features that distinguish them from competing products. Examples of such features include: air cooled laser heads that do not require a separate water supply;
semiconductor lasers in the power supply rather than in the head which allow the lasers to be replaced in the field without disturbing system alignment; and lasers designed with significant overhead which increases reliability and product life. The Company has also developed a complete line of intelligent power supplies to satisfy demanding customer requirements. All of these power supplies support remote mounting of the fiber-coupled HPSL to enhance field serviceability.
Laser Disk Texturing Products. The Company's laser disk texturing products offer significant advantages over conventional mechanical processing. The Company's LZT-1000 and LZT-2000 have two main components: a laser texturing component, in which a semiconductor-based laser creates tiny bumps on the surface of the disks, and a material handling component, in which a robot inserts and removes the disks from the laser texturing fixture. The Company's LZT-500 includes only the laser texturing component which enables the customer to integrate the laser texturing system into its own proprietary material handling process. The LZT-2000, the Company's most recently released laser disk texturing system, uses a green laser to produce smaller bumps on the disk, further increasing the capacity of the disk. The Company's laser disk texturing systems can process up to 350 disks per hour.
Conventional Products. The Company is a leading supplier of high power conventional lasers to industrial and research and development customers. These lasers, while based upon older technology, have unique performance characteristics that make them the only current solution for certain demanding technical applications. According to Laser Focus World, the market for high power conventional lasers is expected to grow from $1.6 billion to $1.8 billion in 1999. The Company's strong market position and technology leadership in these conventional laser applications enhances its opportunity to expand its high growth semiconductor-based laser business by generating funds, capitalizing on strong customer relationships and leveraging its technological expertise. The Company manufactures and sells a broad range of conventional laser products including:
- Air-cooled gas lasers ranging from 5 to 300 mW (14 models)
- Water-cooled gas lasers ranging from 4 to 30 W (8 models)
- Flash lamp pumped YAG lasers ranging from 500 mJ to 3 J as well as 4 harmonic wavelengths (12 models)
- Ultrafast lasers with pulse widths as low as 50 femtoseconds (7 models)
- OPOs covering wavelengths from 220 nm to 2600 nm (4 basic models with numerous options)
- Amplifiers covering a wide range of powers, wavelengths, pulse widths and repetition rates (2 basic models with numerous options)
- Optics and optical systems with super-smooth surfaces (1 angstrom or less), damage thresholds of up to 1000 watts per square millimeter of continuous power and very low scatter optics
TECHNOLOGY
General. The word "laser" is an acronym for "light amplification by stimulated emission of radiation." A laser consists of (i) an active lasing medium that gives off its own light (radiation) when excited; (ii) an optical resonator with a partially reflective output mirror at one end and a fully reflective rear mirror at the other that permits the light to bounce back and forth between the mirrors through the lasing medium; and (iii) an external energy source used to excite the lasing medium. The energy source can be light from special lamps, light from another laser, an electric current or a chemical reaction. The lasing medium can be a gas (such as helium and neon, argon or carbon dioxide), a liquid (such as an organic dye), a semiconductor material (such as aluminum gallium arsenide) or a crystal (such as ruby, YAG or titanium sapphire). A laser works by causing the energy source to excite (pump) the lasing medium, converting the energy from the source into an emission consisting of particles of light (photons). These photons stimulate the release of more photons as they are reflected back and forth between the two mirrors that make up the laser's resonator. The resulting build-up in the number of photons is emitted in the form of a laser beam through the output port or "window" created by the partially reflective mirror. By changing the energy and the lasing medium, different
wavelengths and types of laser light can be produced. Heat generated by the excitation of the lasing medium is dissipated through a cooling mechanism, which varies according to the type of laser technology; lasers can be cooled by water, air or, in the case of semiconductor-based lasers, heat sinks attached to the semiconductor lasers.
Laser light has three fundamental properties that distinguish it from conventional "spontaneous emission" light sources: monochromaticity, directionality and coherence. Monochromaticity refers to the purity of color or spectral bandwidth of emitted light; directionality describes the degree of collimation or parallelism of the light rays; and coherence refers to the phase relationship of the light waves as they are propagated. Laser light features each of these properties to a high degree, and laser design revolves around modulating and combining the three properties to serve the requirements of specific applications. For example, monochromatic laser light can be used to probe the structure of atoms, control complex chemical reactions or produce realistic three dimensional holograms. Highly directional and coherent laser light can be focused to much smaller spot sizes than any ordinary light source which enables a wide range of applications including printing, marking and inspection and measurement. Lasers can be continuous wave, pulsed or modelocked with varying repetition rates; they can have different bandwidths (more or less monochromatic) and different line widths; and they come in different powers from microJoules to thousands of Watts. Different laser designs result in various output characteristics in terms of power, pulse width, repetition rate and wavelength depending on the needs of the application.
Spectra-Physics Technology. Formed in 1961 as the first commercial laser company, the Company has a long history of introducing innovative technologies and laser products. Some of the innovative laser products successfully introduced by the Company include: commercial argon gas lasers (1964), high power helium neon lasers (1976), sealed cavity air cooled gas lasers (1981), HPSLs (1983), fiber-coupled SLPSS lasers (1986), titanium-sapphire ultrafast lasers (1990), FC bar semiconductor technology (1992), high power CW SLPSS green lasers (1996) and the highest power (60 W) commercially available HPSLs (1998).
Recent examples of the Company's technological leadership in semiconductor-based lasers and systems include its discovery of QMAD, a patented technique for shortening the fundamental output wavelength from an SLPSS laser that enables the Company to produce green lasers with powers up to 12 W. The high efficiency QMAD technique has also enabled the Company to produce green SLPSS lasers with lower powers for price sensitive OEM markets. The Company also recently developed and commercialized high power semiconductor bars that produce over 60 W of power. In addition, the Company recently developed and commercialized a second generation high power SLPSS laser producing more than 300 mW of power. These new SLPSS lasers are displacing large frame gas lasers in the rapid prototyping market.
The Company is also a technology leader in laser disk texturing systems for the hard disk drive market. The Company's disk texturing systems incorporate diffraction limited optics capable of producing bumps on either aluminum or glass substrates less than 3 micons in diameter and below 20 nm in height with an autofocus servo to maintain long term consistency. Each tool incorporates conveyors and robotic automation capable of processing over 3 million disks annually, resulting in the lowest process costs per disk in the industry.
The Company also has state-of-the-art technology in its conventional products. For example, the Company's Tsunami offers the highest power, broadest tunability and widest pulse width coverage of any commercial ultrafast system. During 1998 the Company introduced green and ultraviolet versions of its INDI series pulsed, flash lamp-pumped Nd: YAG lasers for industrial applications such as marking of plastics and ceramic components, laser cleaning and flat-panel display repair. Additionally, the Company recently introduced its Advantage(TM) series of air-cooled argon ion lasers. These lasers utilize a power supply design which automatically senses and compensates for variations in line voltage. This power supply is also extremely compact, being only half the weight and 2/3 the size of previous designs. These air-cooled lasers can be used in such applications as semiconductor wafer inspection, confocal microscopy, DNA sequencing, flow cytometry, image setting and computer-to-plate printing.
SALES AND MARKETING
The Company's sales and service strategy is to have one primary channel to the customer on a worldwide basis. This is accomplished through a separate distribution organization responsible for selling and servicing products directly in several countries and through over 30 independent distributors in the rest of the world. The Company has direct sales units in North America, Japan, Germany, France, the Netherlands and the United Kingdom. The Company began establishing international direct sales offices in the mid-1970s. Distributors are managed by the Company's export unit which is based in Mountain View, California and has an office in Darmstadt, Germany.
As of January 31, 1999, the Company's direct sales units employ approximately 184 people performing sales, service engineering, customer support and administrative functions. They are responsible for the complete order fulfillment cycle, from quotation through order placement to delivery. The sales organization is also responsible for bringing the appropriate marketing and technical resources to bear on a customer's requirements and ensuring the customer receives high-quality support.
The Company's sales strategy also involves establishing long-term relationships with its customers. For industrial and OEM customers, this relationship starts at the early design-in of the Company's lasers and laser systems into customer applications. The Company supports its customers with on-site field service, technical service engineers and training programs and telephone support from its direct sales units. Each sales unit maintains an inventory of critical components and certain replacement systems and sub-systems to help minimize customer downtime. The Company in general warrants its products for twelve to twenty-four months depending on the product line. Certain manufacturing intensive industries such as the hard disk manufacturing industry require high levels of support to minimize costly downtime. The Company provides direct service to its hard disk drive customers which are principally located in California, Japan, Taiwan and Southeast Asia.
The Company's marketing activities include: analyzing and understanding future product requirements of the Company's target markets and translating those requirements into product specifications and cost targets by working closely with customers and key technologists in industry and academia; providing applications engineering support as part of the sales process to industrial and OEM customers; and product promotion, which includes participating in trade shows and conferences and advertising through trade journals, new product announcements and direct mailings.
Backlog consists of written purchase orders or other commitments for products which are scheduled to be shipped within the following twelve months. As of December 31, 1998, the Company's backlog was approximately $38.0 million, compared with approximately $49.1 million at December 31, 1997. Orders in backlog are firm, but are subject to cancellation or rescheduling by the customer without penalty. Because of the possible changes in product delivery schedules and cancellation of product orders and because the Company's sales will often not reflect orders shipped in the same quarter that they are booked, the Company's backlog at any particular date is not necessarily indicative of actual sales for any succeeding period.
CUSTOMERS
Through its global distribution and service network the Company provides a range of laser solutions to its major markets. The Company has approximately 2000 customers, over 800 of which are OEM customers and over 1200 are research and development customers. The Company's major customers include: 3D Systems, Becton Dickinson, DaiNippon Screen, Electro-Scientific Industries, ETEC, General Scanning, Haemonetics, IBM, Inspex, KLA/Tencor, Komag, Presstek, Rofin-Sinar, Seagate and Western Digital. During 1998 and 1997, 54.2% and 54.8% of the Company's sales were in North America, 19.4% and 19.7% were in Japan, 19.9% and 19.8% were in Europe, 3.9% and 2.9% were in Other Asia, and 2.6% and 2.8% were in Rest of the World respectively. No single customer accounted for more than 10% of the Company's sales for 1998 or 1997.
RESEARCH AND DEVELOPMENT
The Company's research and development activities are divided into two main areas: advanced research in selected fields such as optics fabrication and coating, HPSLs and SLPSS lasers; and product engineering which focuses on designing and developing products for known, quantified markets with clearly defined performance goals and cost targets. The primary focus of these research and development efforts is high power semiconductor-based lasers and laser systems. The Company often develops new products at the customer's design-in stage in order to maximize the functionality of the product for the customer. The Company's products are designed for manufacturability and serviceability. In addition, high parts commonality is a goal that has been achieved on a number of product lines through the use of common power supplies and laser head platforms.
In 1998, 1997 and 1996, the Company expended approximately $16.7 million, $14.4 million and $12.0 million, respectively, on internally funded research and development. In these three years, such expenditures included significant investments in the development of the Company's laser disk texturing system. The Company expects to continue to spend substantial amounts on research and development activities. The Company's ability to successfully compete will be substantially dependent on its ability to design, develop and introduce new products on a timely basis.
As of January 31, 1999, the Company had approximately 127 employees engaged in advanced research and product development and engineering, of whom approximately 74 are professional engineers or have master's or doctor's degrees (including 23 Ph.D.s). The Company's research and development activities are carried out in Mountain View, California for SLPSS lasers, optical coatings, laser disk texturing and conventional products, in Oroville, California for optical systems and optics fabrication and in Tucson, Arizona for HPSLs. The Company maintains close working relationships with several leading industrial, government and university research laboratories around the world. Such relationships include funding of third party research, joint development programs and licensing of patents developed by such organizations. The Company also participates in certain U.S. government funded programs such as Technology Reinvestment Program (TRP), when the programs' objectives are consistent with the Company's technology road map.
MANUFACTURING OPERATIONS
The Company's manufacturing activities include semiconductor laser manufacturing, plasma tube manufacturing, optics fabrication and coating, fine mechanics manufacturing and assembly, integration and test. One of the Company's core business philosophies is to concentrate its manufacturing efforts on strategic activities and to outsource production of other components. This philosophy forms the basis for the Company's vertical integration into semiconductor wafer fabrication, semiconductor lasers, optics fabrication and coating and very fine mechanical parts. The Company believes each of these operations is essential to the rapid development of new products and to maintaining a high level of product quality.
The Company focuses substantial efforts on maintaining and enhancing the efficiency and quality of its manufacturing operations. The Company uses kanban, just-in-time and product flow line techniques to reduce manufacturing cycle times and inventory levels and to enable it to offer on-time delivery and high quality products to its customers.
The Company has manufacturing operations in Mountain View and Oroville, California and Tucson, Arizona. The Company's four manufacturing operations in Mountain View include research optics manufacturing, plasma tube manufacturing, laser manufacturing and laser disk texturing manufacturing. The Company's manufacturing operations in Tucson include semiconductor laser manufacturing and integrated unit assembly. The Company has manufacturing operations in Oroville that include optics fabrication and coating, optical system manufacturing and metal component fabrication. The Company's principal manufacturing operations are:
- Semiconductor Laser Manufacturing. The Company's semiconductor laser manufacturing operation is vertically integrated and has capabilities in wafer fabrication, wafer processing, bar processing, device
packaging, test and burn-in and fiber-coupling. The Company has three large scale epitaxial deposition units, two of which are capable of handling three inch wafers.
- Plasma Tube Manufacturing. The Company makes three types of plasma tubes: glass, metal beryllium oxide and metal ceramic. These tubes are used as the photon source for its gas lasers.
- Optics Fabrication and Coating. The Company fabricates and coats many of the optics used in its lasers. These operations are conducted in a state-of-the-art facility constructed to Class 10,000 clean room standards with portions of the building maintained at either Class 1000 or Class 100 levels as required.
- Fine Mechanics Manufacturing. The fine mechanics operation primarily produces aluminum and stainless steel components with relatively high feature content and surface finish requirements for use in the Company's laser and optical systems.
- Research Optics Manufacturing. The Company's film coating facility is designed for the development of new coating technology and the production of very large optics up to three feet in diameter.
- Assembly, Integration and Test. As part of the manufacturing process, the Company assembles, integrates and tests its systems, including laser, laser disk texturing, optical and power supply systems.
INTELLECTUAL PROPERTY
The Company has approximately 152 active patents and approximately 79 additional patent applications pending. The Company also has a royalty-free license to all of SDL's patents applied for or issued prior to June 25, 1993.
The Company's future success and competitive position is dependent upon its proprietary technology, and the Company relies on patent, trade secret, trademark and copyright law to protect its intellectual property. There can be no assurance that any of the patents owned or licensed by the Company will not be invalidated, circumvented, challenged or licensed to others, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued within the scope of the claims sought by the Company, if at all. Furthermore, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology or design around the patents owned by the Company. In addition, effective copyright, patent and trade secret protection may be unavailable, limited or not applied for in certain foreign countries. Certain of the Company's technology is licensed on a non-exclusive basis from third parties which may license such technology to others, including competitors of the Company. There can be no assurance that the steps taken by the Company to protect its technology will prevent misappropriation of such technology.
COMPETITION
The Company's various markets are highly competitive. The Company's overall competitive position depends on a number of factors including the price, quality and performance of its products, the level of customer service, the development of new technology and the Company's ability to participate in emerging markets. The Company faces competition from three primary sources: current direct competitors, potential competitors and suppliers of new technologies. The Company offers a range of components, subsystems, products and systems and has a number of competitors worldwide in various segments of its markets. In its HPSL markets, direct competitors include SDL, Inc., Coherent, Inc., Siemens and Thompson-CSF. In its SLPSS laser markets, major competitors include Coherent, Inc. and Lightwave Electronics Inc. In the laser disk texturing market, the Company's major competitor is IBM Corporation. In its other product markets, the Company's major competitors include Coherent, Inc., Continuum (a division of Hoya) and Uniphase Corporation. None of the Company's competitors competes in all of the product areas and industries currently served by the Company. However, as existing or new markets continue to grow, the Company expects that new competitors will emerge and present competitors will seek to increase their market share.
EMPLOYEES
At January 31, 1999, the Company had 864 full time employees, including 127 in research, development and engineering, 184 in sales, service and marketing, 450 in operations and 103 in general management, administration and finance. The Company intends to hire additional personnel in each of these areas. The Company also had approximately 31 temporary workers and consultants at January 31, 1999. The Company's employees are not represented by any collective bargaining organization, and the Company has never experienced a general work stoppage, slowdown or strike. The Company considers its employee relations to be good.
ITEM 2.
ITEM 2. PROPERTIES
The Company conducts its business from office and manufacturing facilities at six locations in Mountain View, California, two facilities in Oroville, California and one facility in Tucson, Arizona. In the aggregate, the Company occupies approximately 46,100 square feet of owned space and 129,500 square feet of leased space in Mountain View, 63,000 square feet of leased space in Oroville and 78,956 square feet of owned space in Tucson. The Company's lease agreements have expiration dates ranging from 1999 to 2008. In addition, the Company leases sales and service offices in Tokyo and Osaka, Japan, Darmstadt, Germany, Z.A. de Courtaboeuf, France, Eindhoven, the Netherlands and Hemel Hempstead, Great Britain. These leases have expiration dates ranging from 2000 to 2002.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company's facilities and operations are subject to a wide variety of Environmental Laws and Employee Safety Laws. Further, compliance with Environmental Laws also may require the acquisition of permits or other authorizations for certain activities and compliance with various standards or procedural requirements. Although the Company believes that its operations are in compliance in all material respects with current requirements under Environmental Laws and Employee Safety Laws, the nature of the Company's operations exposes it to the risk of liabilities or claims with respect to such matters.
Certain of these Environmental Laws, including Superfund Laws, hold owners or operators of land or businesses liable for their own and for previous owners' or operators' releases of Hazardous Substances. Such Superfund Laws also provide for responses to and liability for releases of certain Hazardous Substances into the environment. The nature of the Company's operations and the long history of industrial uses at some of its current or former facilities expose the Company to risk of liabilities or claims under Superfund Laws. In 1988, the Company was named on the General Notification List of the Environmental Protection Agency (EPA)stating that the Company may be a Potentially Responsible Party (PRP) under the Superfund Laws for Hazardous Substances which may have been generated by its former operations at a former site. Since that time, the Company has not been named in the EPA's first or second tier lists, and has not been pursued as a PRP by the EPA or any of the other PRPs.
Since 1984, the Company's facilities in Mountain View, California ("Mountain View Site") have been undergoing investigation and remediation in response to past releases of industrial solvents to the soil and groundwater. In addition, the impacted groundwater has migrated to what is referred to as the North Bayshore Area. As a result of these past releases, the Mountain View Site and other neighboring sites are listed on the NPL or the Superfund List under CERCLA. The Company is subject to Orders that require the Company to perform remediation on-site and off-site and investigate other potentially responsible parties. Pursuant to the Orders and other orders issued to other responsible parties, the Company and other responsible parties are jointly performing and funding remediation which includes soil vapor extraction and groundwater extraction, treatment and monitoring. All of the required soil and groundwater remediation and monitoring systems currently required by the Order are in place, and consequently the initial capital expenses for such systems have been incurred. As of November 1998, the Company had received permission from the Regional Water Quality Control Board (RWQCB) to shut down one of its extraction wells and one of its vapor extraction units. The Company has also been given permission to run tests that may allow it to shut down a second well. The Company is further in process of applying for permission to shut down its second soil vapor extraction
system. In October 1997, the Company was served with a complaint that had been filed in the Superior Court of the State of California seeking an unspecified amount of damages for personal injuries and property damage incurred by residents of a single location alleged to have resulted from the Company's and others' negligent and/or intentional handling of toxic chemicals (Rosario Balcita et al. v. Teledyne Semiconductor, Spectra-Physics Lasers, et al.). As of December 31, 1998, there has been a summary judgement ruling in the case in favor of the Company and its co-defendants in regards to the four adults in the case. There can be no assurance that the summary judgement will not be successfully appealed or that the complaint will be resolved without adverse impact to the Company's financial position or results of operations. There can be no assurances that other parties will not come forward and claim personal injury or property damage.
Based on the Company's experience to date, the Company believes that the future cost of compliance with existing Environmental Laws (or liability for known environmental liabilities or claims) and Employee Safety Laws should not have a material adverse effect on the Company's business, operating results and financial condition. However, future events, such as changes in existing laws and regulations or their interpretation, or the discovery of heretofore unknown contamination, may give rise to additional compliance costs or liabilities that could have a material adverse effect on the Company's business, operating results and financial condition. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of regulatory agencies or stricter or different interpretations of existing laws, may require additional expenditures by the Company that may be material.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE BY SECURITY HOLDERS
None.
ITEM 5.
ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Spectra-Physics Lasers, Inc.'s Common Stock began trading on the NASDAQ National Market System under the symbol SPLI on December 12, 1997. Prior to such time, there was no public market for the Common Stock of the Company. The following table sets forth for the periods indicated the high and low sale prices per share for the Company's Common Stock as reported on the Nasdaq National Market.
The number of stockholders of record as of February 26, 1999 was 24. No cash dividends have been declared or paid and the Company has no present intention to declare or pay cash dividends.
On December 18, 1997, the Company issued a total of 408,043 shares of Common Stock to three employees of Opto Power Corporation, the Company's wholly owned subsidiary, pursuant to the Spectra-Physics Restricted Stock Plan and in partial exchange for such employees' agreement to cancel options to purchase, in the aggregate, up to 20% of the outstanding common stock of Opto Power Corporation on a fully diluted basis.
The subparagraph numbers listed below correspond to the applicable sections on Item 701 (f) of Regulation S-K.
- --------------- * On January 5, 1998, the Company received net proceeds of $3,248,000 pursuant to the offering of 360,000 shares of Common stock upon the exercise of the underwriters' overallotment option.
None of the expenses incurred in the offering, nor the use of proceeds of the offering, were paid to (i) directors, officers, general partners of the issuer or their associates, (ii) persons owning 10% or more of any class of securities of the issuer or (iii) affiliates of the issuer.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
- --------------- (1) Includes $1,657,000 in 1997, $1,915,000 in 1996, and $863,000 in 1995 of legal expenses associated with a lawsuit which was settled in the second quarter of fiscal 1997; and $14,100,000 in 1997, $5,000,000 in 1996 and $1,000,000 in 1995 of compensation expense associated with certain stock options.
(2) In May 1997, the Company received net proceeds of $17,010,000 in settlement of a lawsuit.
(3) See Note 2 of the Notes to the Consolidated Financial Statements for an explanation of shares used in computing net income (loss) per share.
(4) Other data is presented as supplemental information and should not be construed as a substitute, or better, indicator of, results of operations than operating income (loss) or net income (loss) determined in accordance with generally accepted accounting principles. This data represents actual operating income (loss) adjusted for the following: (a)legal expenses associated with a lawsuit of $1,657,000 in 1997, $1,915,000 in 1996 and $863,000 in 1995; and (b) compensation expense associated with stock options of $14,100,000 in 1997, $5,000,000 in 1996 and $1,000,000 in 1995. While such items are not expected to be incurred in the future, there can be no assurances that similar items might not occur.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a leader in the design, development, manufacture and distribution of lasers and laser systems for a broad range of markets. Spectra-Physics AB, a multinational corporation based in Sweden which is listed for trading on the Stockholm Stock Exchange, indirectly owns 80.4% of the Company's outstanding Common Stock. On February 22, 1999, shareholders of Spectra-Physics AB holding approximately 98.4% of the outstanding shares of Spectra-Physics AB tendered their shares to Thermo Instrument Systems Inc. (TIS), which shares were thereafter accepted by TIS for approximately $355 million. Accordingly, TIS now indirectly owns approximately 79.1% of the Company's outstanding common stock. Prior to the Reorganization described below, the Company, Opto Power Corporation and Spectra-Physics Laser Data Systems, Inc., together with various foreign subsidiaries of Spectra-Physics AB that conducted sales and technical support operations on their behalf, were operated as a functional group called the Lasers and Optics Group. In preparation for the Company's initial public offering, the Lasers and Optics Group was reorganized (the "Reorganization") in October 1997 so that the assets and liabilities (including contractual rights and obligations) of the Lasers and Optics Group are now held by the Company.
In December 1997, the Company completed an initial public offering of 2,400,000 shares of Common Stock, at an offering price of $10.00 per share. An additional 360,000 shares of common stock were sold in January 1998 in accordance with an overallotment option granted to the underwriters. The net proceeds from the sale of these shares was approximately $23.9 million.
The 1997 and 1996 consolidated financial statements reflect the financial position, results of operations and cash flows of the Company as if it were a separate entity. The Company's historical results have varied significantly from period to period due to the inclusion of charges related to legal expenses associated with a lawsuit and compensation expenses associated with certain stock options. The Company also incurred interest expense on loans and advances from Spectra-Physics AB and foreign currency gains and losses resulting from the Company's participation in Spectra-Physics AB's foreign currency hedging program. None of these charges and credits are expected to be incurred in the future. However, there can be no assurance that similar items might not occur.
Net sales for products are recognized upon shipment. The Company derives its revenue primarily from the sale of high power semiconductor-based and conventional lasers and laser systems. High power semiconductor-based lasers and laser systems are sold into the OEM/industrial market and the research and development market. The OEM/industrial market is characterized by unit sales, with varying prices, in volumes of as much as several thousand units. Conventional lasers are primarily sold into the research and development market. This market is typically characterized by the sale of single units and systems with prices that range from approximately $3,000 to $500,000. Sales in this market have historically varied from quarter to quarter due to seasonal fluctuations and governmental spending patterns. Over the last three years, a growing proportion of the Company's total net sales and most of its sales growth have been from high power semiconductor-based lasers.
The Company's sales have shown a pattern in the last several years whereby the fiscal fourth quarter net sales represent a large share of the Company's annual net sales and whereby the Company's first quarter net sales decline significantly compared to the fourth quarter of the prior fiscal year. The Company believes these sales patterns occur in part because of seasonal sales patterns related to customers' fiscal years and in part from the Company's incentive compensation plan which compensates employees based on annual results. The Company recognizes that the non-linear pattern of its shipments leads to inefficiencies in asset and employee utilization. The Company is taking steps to mitigate this sales trend, but this pattern is likely to continue in the near term.
The Company's gross margin is affected by a number of factors, including product mix, product pricing, cost of components, the proportion of third party products incorporated into the Company's systems, foreign currency exchange rates and manufacturing costs. For example, since high power semiconductor-based lasers and laser systems generally have higher gross margins than conventional lasers, absent other factors, a shift in
sales toward high power semiconductor-based lasers and laser systems would lead to a gross margin improvement for the Company. On the other hand, if market conditions in the highly competitive conventional laser market forced the Company to lower unit prices, the Company would suffer a decline in gross margin unless the Company were able to timely offset the price reduction by a reduction in production costs or by sales of other products with higher gross margins. Either of these events could have a material effect on the Company's business, operating results and financial condition.
The Company spends a significant amount of resources on research and development. In recent years, the Company has focused much of these resources on high power semiconductor-based lasers and laser systems. The Company expects to continue to spend substantial resources in developing high power semiconductor- based lasers and laser systems while making focused research and development expenditures to maintain its leadership position in conventional lasers.
A significant proportion of the Company's sales are to international customers and are denominated in currencies other than the U.S. dollar. The Company also has sales and support operations located in certain European countries and in Japan which operate in local currencies. As a result, while the Company attempts to hedge its economic risk of foreign currency fluctuations, the Company is exposed to fluctuations in foreign currency exchange rates. These fluctuations have had in the past, and may have in the future, a significant impact on the Company's results of operations.
The Company has five reportable segments: the Commercial Systems Group (CSG) business unit; the Industrial and Scientific Lasers (ISL) business unit; the Original Equipment Manufacturer (OEM) business unit; Opto Power Corporation (OPC); and Spectra-Physics Distribution (SPD) business unit. CSG designs and manufactures optics, thin films, fabricated parts, plasma tubes, and subsystems for all operating units within the Company and external customers. CSG also designs, manufactures and markets low power laser sources and beam delivery systems for OEM products in the industrial and medical instrumentation markets. ISL designs, markets and manufactures high power semiconductor-based and conventional lasers for the industrial and scientific markets. OEM designs, markets and manufactures high power semiconductor-based lasers for various OEM markets. OPC designs, markets and manufactures high power semiconductor-based laser diodes, components and systems. SPD is the Company's worldwide sales, service and support organization. Reference is made to Footnote 10 of the Consolidated Financial Statements for disclosures of certain financial information related to the reportable segments.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results of operations as a percentage of net sales:
- --------------- * See footnote (4) of Item 6. Selected Financial Data.
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Net sales
Net sales were $169.0 million in 1998, $159.2 million in 1997, and $135.4 million in 1996, representing an increase of 6.2% from 1997 to 1998 and 17.5% from 1996 to 1997. Net sales for 1998, calculated using foreign currency exchange rates for 1997, and for 1997, calculated using foreign currency exchange rates for 1996, increased 8.2% from 1997 to 1998, and 23.2% from 1996 to 1997. The growth in sales in actual terms was principally due to increased volumes of high-power semiconductor-based lasers and laser systems, as the market for these products expanded due to customers' acceptance of these products. Sales of high power semiconductor based lasers increased to 50.2% of total sales in 1998 from 48.1% in 1997 and 34.9% in 1996. Net sales were in the following geographic markets:
Net sales are attributed in the above table based on the location of the Company's customer. Substantially all sales in North America, Other Asia and Rest of the World are denominated in U.S. dollars. Europe and Japan in the above table include sales from the Company's European and Japan sales subsidiaries, respectively. Export sales to countries not located in Asia are included in Rest of the World.
Net sales at actual currency exchange rates increased: 4.9% from 1997 to 1998 and 33.6% from 1996 to 1997 for North America; 4.8% from 1997 to 1998 and 2.7% from 1996 to 1997 for Japan; 6.9% from 1997 to 1998 and 3.6% from 1996 to 1997 for Europe; 39.3% from 1997 to 1998 and 0.6% from 1996 to 1997 for Other Asia; and 1.2% from 1997 to 1998 for Rest of the World. Net sales at actual currency exchange rate decreased 2.8% from 1996 to 1997 for Rest of the World. Net sales for 1998, calculated using foreign currency exchange rates for 1997, and for 1997, calculated using foreign currency exchange rates for 1996, increased: 4.9% from 1997 to 1998 and 33.6% from 1996 to 1997 for North America; 12.9% from 1997 to 1998 and 14.6% from 1996 to 1997 for Japan; 8.7% from 1997 to 1998 and 15.1% from 1996 to 1997 for Europe; 39.3% from 1997 to 1998 and 0.6% from 1996 to 1997 for Other Asia; and 1.2% from 1997 to 1998 for Rest of the World. Net sales at constant currency exchange rate decreased 2.8% from 1996 to 1997 for Rest of the World.
Reduced orders and sales in the commercial printing and graphics market due to an announced production slowdown by a major customer and the unavailability of direct-to-press thermal printing plates negatively impacted sales growth for 1998. The materials processing market was similarly affected by the worldwide slowdown in the semiconductor and disk drive industries. Widely published reports foresee no upturn in the semiconductor or disk drive industries until late 1999 thereby limiting the growth of the Company's sales into these markets. The Company's strategy continues to be to seek sales and profit growth in OEM/industrial opportunities and the Company is pursuing OEM/industrial opportunities in other markets.
Cost of products sold and gross margin
Cost of products sold includes all manufacturing materials and labor and a proportionate share of manufacturing overhead costs, as well as costs of shipping, tooling, royalties, third party products incorporated in the Company's products and provisions for excess and obsolete inventories and warranty. Cost of products sold varies by product mix, product pricing, cost of components, the proportion of third party products incorporated in systems manufactured by the Company, and manufacturing costs.
Gross margin was $65.3 million in 1998, $60.4 million in 1997, and $47.1 million in 1996, representing an increase of 8.1% from 1997 to 1998, and 28.2% from 1996 to 1997. As a percentage of net sales, gross margin was 38.6%, 37.9%, and 34.8% in 1998, 1997 and 1996, respectively. The principal reasons for the improvement in gross margin as a percentage of net sales in 1998 compared to 1997 and in 1997 compared to 1996 was the higher proportion of sales of high power semiconductor-based lasers and laser systems which generally have higher gross margins than conventional products and the increase in sales that allowed the absorption of fixed manufacturing overhead expenses over a larger unit base. Additionally, the Company experienced improved manufacturing yields in 1998 compared to 1997 in the production of semiconductor-based lasers. Mitigating these favorable factors in 1998 was the negative effect on gross margins from the strengthening of the U.S. dollar compared to non-U.S. dollar currencies, particularly the Yen.
Operating expenses
Operating expenses totaled $51.6 million in 1998, $62.7 million in 1997, and $47.9 million in 1996, representing a decrease of 17.6% from 1997 to 1998 and an increase of 30.9% from 1996 to 1997. As a percentage of net sales, operating expenses were 30.5%, 39.3%, and 35.4% in 1998, 1997, and 1996, respectively. Included in other operating expenses were legal expenses associated with a lawsuit which was settled in the second quarter of 1997 of $1.7 million in 1997 and $1.9 million in 1996, and compensation expense associated with certain stock options of two subsidiaries of $14.1 million in 1997 and $5.0 million in 1996. The stock options for one subsidiary were modified so as to establish the measurement date and the amount of compensation expense the Company is required to record and, for the other subsidiary, were cancelled for a combination of cash and common stock of the Company. Accordingly, the Company does not expect to incur additional compensation expense relating to these stock options in the future. Excluding such
legal and compensation expenses, operating expenses increased 10.1% from 1997 to 1998 and 14.5% from 1996 to 1997 and were 30.5%, 29.4% and 30.3% of net sales in 1998, 1997 and 1996, respectively.
Research and development expenses represent expenses associated with Company funded research and new product development, and efforts designed to improve the performance of existing products and manufacturing processes. Customer funded product development engineering for certain OEM customers and the U.S. government, which to date has been minimal, is recorded as a reduction of research and development expenses. Research and development expenses are charged to operations as incurred.
Research and development expenses totaled $16.7 million in 1998, $14.4 million in 1997 and $12.0 million in 1996, representing an increase of 16.5% from 1997 to 1998 and 19.7% from 1996 to 1997. As a percentage of net sales, research and development expenses were 9.9%, 9.0% and 8.9% in 1998, 1997 and 1996, respectively. The increase in research and development expenses was principally focused on semiconductor-based lasers and laser systems.
Selling, general and administrative expenses include the expenses of the Company's sales and support subsidiaries in the United Kingdom, France, Germany, the Netherlands and Japan as well as the Company's North American sales and support organization, and other administrative expenses such as legal, accounting and corporate offices.
Selling, general and administrative expenses totaled $34.9 million in 1998, $32.5 million in 1997 and $29.0 million in 1996, representing an increase of 7.3% from 1997 to 1998 and 12.3% from 1996 to 1997. As a percentage of net sales, selling, general and administrative expenses were 20.7%, 20.4% and 21.4% in 1998, 1997 and 1996, respectively. The principal reasons for the increase in selling, general and administrative expenses in dollar terms in 1998 compared to 1997 were increased expenses associated with penetrating the industrial/OEM markets and costs of being a public company. The principal reasons for the increase in selling, general and administrative expenses in dollar terms in 1997 compared to 1996 were increased salaries and benefits, including performance and incentive bonuses, and increased sales and marketing efforts aimed at the high powered semi-conductor based lasers and laser systems markets offset in part by the impact of the strengthening U.S. dollar compared to non-U.S. dollar currencies.
Interest income (expense)
Interest income totaled $1.3 million in 1998. Interest expense totaled $4.0 million in 1997 and $5.4 million in 1996. Interest income for 1998 was earned on the Company's invested cash and cash equivalents. Interest expense in 1997 and 1996 was incurred on loans and advances from Spectra-Physics AB and affiliates. Interest expense was also imputed on the certain non-interest bearing advances from Spectra-Physics AB and affiliates. The amount of such imputed interest was $0.6 million in 1997 and $1.0 million in 1996. In connection with the Reorganization, Spectra-Physics AB and affiliates converted all loans and advances to the Company to equity. Accordingly, beginning October 1, 1997, the Company no longer incurred interest expense on such loans and advances.
Foreign currency gain (loss)
Effective October 1, 1998, the Company adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires that all derivatives, including foreign currency exchange contracts, be recognized on the balance sheet at fair value. Derivatives that are not hedges must be recorded at fair value through earnings. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is to be immediately recognized in earnings. The adoption of SFAS No. 133 resulted in no cumulative effect on income or other comprehensive income for the Company.
Forward foreign exchange contracts are used primarily by the Company to hedge certain operational ("cash flow" hedges) and balance sheet ("fair value" hedges) exposures resulting from changes in foreign
currency exchange rates. Such exposures primarily result from portions of the Company's operations and assets that are denominated in currencies other than the U.S. dollar, primarily the Japanese Yen and certain European currencies. These foreign exchange contracts are entered into to hedge anticipated intercompany product sales and recorded accounts receivable made in the normal course of business, and accordingly, are not speculative in nature. As part of its overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, the Company hedges a portion of its foreign currency exposures anticipated over the ensuing twelve-month period. At December 31, 1998, the Company had effectively hedged approximately 60% of its estimated foreign currency exposures that principally relate to anticipated cash flows to be remitted to the U.S. over the ensuing twelve month period, using foreign exchange contracts that generally have maturities of twelve months or less. The Company does not hold or transact in financial instruments for purposes other than risk management.
The Company records its foreign currency exchange contracts at fair value in its consolidated balance sheet as accrued and other current liabilities and the related gains or losses on these hedge contracts are deferred as a component of other comprehensive income. These deferred gains and losses are recognized in income in the period in which the underlying anticipated transaction occurs. Unrealized gains and losses resulting from the impact of currency exchange rate movements on forward foreign exchange contracts designated to offset certain non-U.S. dollar denominated assets are recognized as other income or expense in the period in which the exchange rates change and offset the foreign currency losses and gains on the underlying exposures being hedged.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in fair value or cash flows of a hedged item (including forecasted transactions); (2) the derivative is sold or terminated; (3) the derivative is dedesignated as a hedge instrument, because it is unlikely that a forecasted transaction will occur or a balance sheet exposure ceases to exist; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the balance sheet at its fair value until it settles, and the hedged asset will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value until it settles, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in income. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet until it settles, with changes in its fair value recognized in current period earnings.
The Company has also entered into foreign currency exchange contracts to hedge certain intercompany loan transactions. These forward contracts effectively change certain foreign currency denominated debt into U.S. dollar denominated debt. No such contracts existed at December 31, 1998.
At December 31, 1998, the Company had contracts for the sale of foreign currencies and the purchase of U.S. dollars totaling $ 44.0 million. At December 31, 1998, the Company had deferred losses relating to its foreign currency contracts of approximately $0.1 million, which is all expected to be recognized in income over the next twelve months.
The following table provides information about the Company's foreign currency derivative financial instruments outstanding as of December 31, 1998. The information is provided in U.S. dollar amounts, as presented in the Company's consolidated financial statements. The table presents the notional amount (at contract exchange rates) and the weighted average contractual foreign currency exchange rates. All contracts mature within twelve months.
Foreign currency spot/forward contracts (in thousands, except average contract rates):
- --------------- * The estimated fair value is based on the estimated amount at which the contracts could be settled based on forward exchange rates.
The cash requirements of the above described financial instruments approximate their fair value. Cash flows associated with these financial instruments are classified consistent with the cash flows from the transactions being hedged. The Company's forward foreign exchange contracts contain market and credit risk not recognized in the consolidated financial statements. The market risk associated with these instruments resulting from currency exchange rate movements is expected to offset the market risk of the underlying transactions and assets being hedged. The credit risk is that the Company's banking counterparties may be unable to meet the terms of the agreements. The Company minimizes such risk by limiting its counterparties to major financial institutions with credit ratings of A/A-2 or better. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored. Management does not expect any loss as a result of default by other parties. However, there can be no assurances that the Company will be able to mitigate market and credit risks described above.
For the period from the fourth quarter of 1997 to the adoption of SFAS No. 133, the Company followed SFAS No. 52, "Foreign Currency Translation," and used forward exchange contracts to hedge only assets and firm commitments that exposed the Company to enterprise risk as a result of fluctuations in foreign currency exchange rates. Gains and losses on forward exchange contracts that were designated as hedges of firm orders were deferred in other current liabilities and were included in the measurement of the underlying transaction. Hedge accounting was only applied if the derivative reduced the risk of the underlying hedged item and was designated at inception as a hedge. Derivatives were measured for effectiveness both at inception and on an ongoing basis. During this period, no derivative ceased to meet the criteria for deferral and all expected firm commitments occurred. No contract was sold or terminated prior to maturity.
Prior to the fourth quarter of 1997, the Company entered into forward foreign exchange contracts with Spectra-Physics AB. These contracts were entered into in anticipation of product sales made in the normal course of business, and accordingly, did not qualify for hedge accounting under SFAS No. 52. Since the forward foreign exchange contracts were not designated as hedges of firm, identifiable foreign currency commitments, the unrealized gains and losses resulting from the impact of foreign currency exchange rate movements on these contracts were recognized in the periods in which the exchange rates changed. Such gains and losses were recorded as other income or expense.
Income tax expense (benefit)
The Company is part of a tax sharing arrangement with affiliates of Spectra-Physics AB. For periods prior to September 30, 1997, income tax expense reflected foreign taxes only due to the expectation by the Company at that time of continuing losses in the U.S. Deferred tax assets were established relating to differences between the financial statements and tax basis of assets and liabilities based on enacted tax laws and rates applicable to the period in which the differences are expected to affect taxable income. These
deferred tax assets were offset in total by a valuation allowance due to the expectation of continued losses in the U.S.
During the quarter ended September 30, 1997, the Company decreased the tax valuation allowance and recognized a tax benefit relating to the above items (net of foreign taxes) totaling $23.3 million. The decrease of the valuation allowance and the recognition of the tax benefit in the quarter was based on management's expectations regarding future taxable income for the Company. Management's expectations included the consideration of the conversion of loans and advances from Spectra-Physics AB and affiliates to equity in October 1997 which eliminated related interest charges in the future.
Under the tax sharing agreement in place through September 1997, the Company's net operating loss carryovers referred to above were used to offset the taxable income of other members of the tax filing group with no benefit to the Company. Accordingly, the deferred tax asset arising from the net operating loss carryforwards (amounting to $10.2 million) was recorded as a dividend to Spectra-Physics AB. Effective October 1997, the Company and affiliates of Spectra-Physics AB entered into a new tax sharing arrangement which generally requires the Company to determine its U.S. tax liability as a separate consolidated group.
The Company's effective tax rate is 38% of pre-tax income. During the third quarter of 1998, the Company recorded an income tax adjustment of $0.4 million to reverse excess income tax reserves. Income tax expense was $5.3 million in 1998, and $0.6 million in 1996. Income tax benefit was $21.0 million in 1997. The income tax expense in 1996 represented foreign taxes currently payable at each of the applicable country's statutory rate.
The Company expects its future effective tax rate to approximate statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
Through the third quarter of 1997, the Company had satisfied its liquidity requirements through cash provided by Spectra-Physics AB and affiliates in the form of loans and advances. As of October 1, 1997, all outstanding loans and advances from Spectra-Physics AB and affiliates were converted to equity. At December 31, 1998, the Company had working capital of $72.3 million, including cash and cash equivalents of $34.6 million, compared to working capital at December 31, 1997 of $68.9 million, including cash and cash equivalents of $33.5 million.
Cash provided by operating activities was $8.8 million, $26.6 million and $4.3 million in the years ended December 31, 1998, 1997 and 1996, respectively. Substantially all the net cash provided by operating activities in 1998 represented the net income for the year ($9.6 million) adjusted for the non-cash impact of depreciation and amortization ($5.8 million) and for the increase in accounts receivable ($6.3 million). The increase in accounts receivable was the result of a proportionately higher amount of sales in the last month of 1998 compared to 1997 causing days sales outstanding (DSO) to increase from 82 days at December 31, 1997, to 92 days at December 31, 1998. Substantially all the net cash provided by operating activities in 1997 represented the net income for the year ($33.9 million, which included a $21.0 million income tax benefit) adjusted for the non-cash impact of depreciation, amortization and deferred taxes ($3.4 million) and for the increase in inventories ($4.0 million). Substantially all the net cash provided by operating activities in 1996 represented the net loss for the year ($4.2 million) adjusted for the non-cash impact of depreciation and amortization ($4.4 million) and for the increase in accounts receivable ($4.3 million) and accrued and other liabilities ($8.4 million). The increase in accounts receivable in 1996 was principally the result of a 23% increase in sales in the fourth quarter of 1996 compared to the fourth quarter of 1995. The increase in accrued and other liabilities was principally the result of increased accrued compensation expense related to certain stock options ($5.0 million).
Cash used in investing activities, mostly purchases of property, plant and equipment, was $15.7 million, $9.4 million and $5.0 million in the years ended December 31, 1998, 1997 and 1996, respectively.
Cash provided by financing activities was $7.7 million, $13.7 million, and $2.1 million in the years ended December 31, 1998, 1997 and 1996, respectively. During the year ended December 31, 1998, financing activities include the sale of 360,000 shares of common stock in accordance with an overallotment option
granted to the underwriters of the Company's initial public offering of $3.2 million and increases in net borrowings under the Company's credit facilities of $4.4 million. During the year ended December 31, 1997, net transfers to Spectra-Physics AB and affiliates and changes in loans and advances from Spectra-Physics AB amounted to a net decrease in cash of $25.7 million, principally relating to the utilization by affiliates of Spectra-Physics AB of the Company's net operating loss carryfoward for tax purposes and the remittance to Spectra-Physics AB of cash received by the Company on the settlement of litigation. This amount was offset by the net proceeds from the Company's initial public offering of its common stock of $20.7 million, by $17.2 million of cash provided by Spectra-Physics AB to settle certain stock options and other liabilities, and by $1.5 million of net borrowings under the Company's credit facilities. All of the cash provided by financing activities during the year ended December 31, 1996, represented changes in loans and advances from Spectra- Physics AB and affiliates.
The effect of foreign currency exchange rate changes on cash was $0.4 million in the year ended December 31, 1998. These activities resulted in an increase in cash and cash equivalents of $1.1 million, $31.0 million and $1.5 million in the years ended December 31, 1998, 1997 and 1996, respectively.
In October 1997, the Company entered into certain agreements with employees of its Opto Power subsidiary who held stock options to purchase common stock of the subsidiary. Under the agreements, the option holders agreed to terminate the options in exchange for a combination of cash payment and the Company's common stock. Such cash payments totalled approximately $14.7 million and were funded by a capital contribution by Spectra-Physics AB and affiliates.
As part of the Reorganization, the Company assumed a short-term credit facility in Japan. The credit facility is with several banks, is unsecured, allows aggregate borrowings of 2.1 billion Yen ($18.2 million) and bears interest at 1.625% per annum. At December 31, 1998, there were approximately $11.8 million of borrowings outstanding under this facility. The Company's foreign subsidiaries other than Japan have credit facilities aggregating $4.5 million, none of which was outstanding as of December 31, 1998. The Company also has available in the U.S. two committed, unsecured credit facilities aggregating $20.0 million and a $10.0 million uncommitted, unsecured credit facility with a bank. The committed facilities are through June 2000. At December 31, 1998, there were no borrowings under either facility.
The Company has reviewed its short- and long-term liquidity needs. The Company's liquidity needs for at least the next twelve months will be met by cash flows from operations, existing cash balances and borrowings available under its credit facilities.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The fair value of the Company's cash and cash equivalents would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due to the short-term nature of the Company's portfolio.
The Company regularly hedges its non-U.S. dollar-based exposures in the U.S. by entering into forward foreign exchange contracts. The terms of these contracts are for periods matching the duration of the underlying exposure and generally range from three months up to one year. The short-term nature of these contracts has resulted in these instruments having insignificant fair values at December 31, 1998. The Company's largest foreign currency exposure is against the Japanese yen, primarily because Japan has a higher proportion of local currency denominated sales. Relative to foreign currency exposures existing at December 31, 1998, a 10% unfavorable movement in foreign exchange rates would not expose the Company to significant losses in earnings or cash flows or significantly diminish the fair value of its foreign currency financial instruments, primarily due to the short lives of the affected financial instruments that effectively hedge substantially all of the Company's year-end exposures to fluctuations in foreign currency exchange rates. The calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, such changes typically affect the volume of sales or the foreign currency sales price as competitors' products become more or less attractive. The Company's sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency selling prices. See additional discussion of foreign currency exchange contracts under the heading "Foreign currency gain (loss)".
YEAR 2000 COMPLIANCE
An issue exists for all companies that rely on computers as the year 2000 approaches. Known as the "Millennium Bug" or the "Year 2000 (Y2K) Problem" the problem stems from the way that some computer systems and other chip containing equipment were programmed to process date information. To conserve memory, dates were stored as two digit, rather than as four digit, numbers with all the dates assumed to be between 1900 and 1999. Thus the year 2000 would be stored as "00" and be assumed to be 1900, and year 2001 as "01", and be assumed to be 1901, etc. This practice will result in incorrect results when computers so programmed perform arithmetic operations, comparisons or data field sorting with dates later than 1999.
The Board of Directors of Spectra-Physics, and all levels of management, are well aware of the Y2K problem, and plans have been made to address the issue. Spectra-Physics' Y2K compliance plans are supervised by the Vice President of Finance, and progress is under ongoing review by the Board. The Company's Year 2000 Project Team has completed its review of Spectra-Physics' (a) Information Technology (IT) and non-IT systems, (b) products, (c) vendors and (d) customers and is acting to correct identified problems.
Information Technology (IT) and non-IT systems
Spectra-Physics has completed a review of its Information Technology (IT) and non-IT systems at all of its sites. The Company has identified a few items that are not Y2K compliant and has created a plan to bring them into compliance in advance of the year 2000. The Company feels that it will be able to accomplish this goal by (a) using its internal programming staff, (b) using outside computer consultants in a few limited cases, and (c) buying replacements for some specific systems. Costs in connection with these solutions are expected to be in the range of $0.5 million to $0.8 million over the period of January 1, 1998 to June 30, 1999, and these costs will be funded by operating cash flow. Through December 31, 1998, the Company has not incurred any of these costs.
If such modifications or replacements are not completed in a timely manner, the Y2K problem may have a material adverse effect on the operations of the Company.
Products
The Company has completed a thorough review of its products. This review has uncovered no material Y2K issues with Spectra-Physics products.
Vendors and Suppliers
The Company has performed a review of its suppliers and vendors and has identified a subset of them as being "critical" vendors. Spectra-Physics has sent letters to each of these critical vendors asking them about their Y2K readiness. The Company has received responses from a majority of these vendors and is satisfied with their Y2K readiness. Those vendors who did not respond, or whose response the Company found inadequate, will be sent a second letter. The responses to the second letter are expected by the end of the first quarter of 1999. The Company will then assess their responses and, for those who are not Y2K compliant, or have not yet responded, the Company's purchasing department will contact them. If a critical vendor is not Y2K compliant, and such vendor cannot remedy its noncompliance and Spectra-Physics cannot identify an alternative vendor, there may be a material adverse effect on the operations of the Company.
Customers
The Company will prepare a listing of its top customers during the first quarter of 1999 and send a Y2K compliance letter to them. Since no one customer of the Company makes up more than 5% of the Company's total sales, the Company is not subject to as much risk as companies with more concentrated sales. The Company expects to complete the survey of its customers during the second quarter of 1999. The Company will assess their Y2K readiness and will work with those who are not compliant to identify alternative methods for them to order from Spectra-Physics.
The business communities' understanding of the Y2K Problem is continually evolving, and all plans may need to be reviewed as the year 2000 approaches. Further third party Y2K problems (suppliers to Spectra-Physics' vendors, for example) which are outside the control of Spectra-Physics may have an effect on Spectra-Physics' ability to serve its customers. This, in turn, may have a material adverse effect on the Company's operations. The Company is working to be ready for the year 2000 and will continue to modify plans and efforts as necessary.
Costs
The reviews of Company products, vendors and suppliers, and customers are performed by the Company's manufacturing, research and development, and IT staff as part of their on-going duties. No incremental costs have been, or are expected to be, incurred.
EUROPEAN MONETARY UNION (EMU)
The euro is a new currency introduced by certain European countries collectively known as the European Monetary Union (EMU). The euro was introduced on January 1, 1999 and the eleven participating EMU members established fixed conversion rates between their existing currencies (legacy currencies) and the euro. The legacy currencies have no value of their own but will be subsets of the euro. The legacy currencies and the euro will both be used through June 30, 2002 when the legacy currencies will be withdrawn (euro only environment).
The introduction of the euro could have an adverse impact on a company's information systems, its markets and the economies in which it operates.
With regards to information systems, the Company has completed a thorough review of its information systems and believes the introduction of the euro in 1999 will have no material impact on its systems. Furthermore, the Company's review indicates that the Company's information systems can operate in the "euro only" environment in 2002. As that date gets closer the Company expects to conduct another survey concerning the euro's impact on information systems.
With regards to the Company's markets, the Company has reviewed its customer list and current selling practices and expects no material adverse impact from the introduction of the euro.
The Company is currently unable to determine the ultimate long term financial impact of the exclusive use of the euro on the Company's markets and on the economies of the countries in which the Company operates. This impact will be dependent upon the evolving competitive situations and macro-economic impact of the introduction of the euro.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14(a) for an index to the consolidated financial statements and supplementary information which are attached hereto.
ITEM 9.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding Registrant's officers and directors will be set forth under the captions "Management" and "Election of Directors" in the Registrant's proxy statement for use in connection with the Annual Meeting of Stockholders to be held in May 1999 (the "1999 Proxy Statement"), and is incorporated herein by reference. The 1999 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant's fiscal year end.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning compensation of the Registrant's directors and executive officers will be set forth under the captions "Election of Directors -- Compensation of Directors" and "Management -- Summary Compensation of Named Executive Officers" in the Registrant's 1999 Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management will be set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Registrant's 1999 Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will be set forth under the caption "Certain Relationships and Related Transactions" in the Registrant's 1999 Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND FORM 8-K REPORTS
(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of Spectra-Physics Lasers, Inc. are filed as part of this report on Form 10-K:
Independent Accountants' Report
Consolidated Balance Sheet -- December 31, 1998 and 1997
Consolidated Statement of Operations -- Years ended December 31, 1998, 1997 and 1996
Consolidated Statement of Cash Flows -- Years Ended December 31, 1998, 1997 and 1996
Consolidated Statement of Stockholders' Equity -- Years Ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
Schedule II -- Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the matter or conditions are not present or the information required to be set forth therein is included in the Consolidated Financial Statements hereto.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the three-months ended December 31, 1998.
(c) EXHIBITS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on March 10, 1999.
SPECTRA-PHYSICS LASERS, INC.
By: /s/ PATRICK L. EDSELL
------------------------------------ Patrick L. Edsell Chairman, President and Chief Executive Officer
POWER OF ATTORNEY
Know all men by these presents, that each person whose signature appears below constitutes and appoints Patrick L. Edsell and Thomas J. Scannell, jointly and severally, his attorneys-in-fact, each with the power of substitution for him in any and all capacities, to sign any amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereor.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders Spectra-Physics Lasers, Inc.
We have audited the accompanying consolidated balance sheet of Spectra-Physics Lasers, Inc. as of December 31, 1998 and 1997, and the related consolidated statements of operations, cash flows, and stockholders' equity for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Spectra-Physics Lasers, Inc. as of December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
PRICEWATERHOUSECOOPERS LLP.
San Jose, California January 22, 1999
SPECTRA-PHYSICS LASERS, INC.
CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
See Notes to Consolidated Financial Statements.
SPECTRA-PHYSICS LASERS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See Notes to Consolidated Financial Statements.
SPECTRA-PHYSICS LASERS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
See Notes to Consolidated Financial Statements.
SPECTRA-PHYSICS LASERS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
See Notes to Consolidated Financial Statements.
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND BASIS OF PRESENTATION
Spectra-Physics Lasers, Inc. designs, develops, manufactures and distributes lasers and laser systems for the industrial, original equipment manufacturer (OEM), and research and development markets.
Prior to the Reorganization referred to below, Spectra-Physics Lasers, Opto Power Corporation, and Spectra-Physics Laser Data Systems, Inc., together with various foreign subsidiaries of Spectra-Physics AB that conducted sales and technical support operations on their behalf (collectively the "Company"), were operated as a functional group called the Lasers and Optics Group. In preparation for its initial public offering the Company was reorganized in October 1997 so that the assets and liabilities (including contractual rights and obligations) of the Lasers and Optics Group were held directly or indirectly by the Company. Accordingly, pursuant to various agreements (i) the assets and liabilities of the Lasers and Optics Group not held by the Company were transferred to the Company and (ii) the assets and liabilities of the Company not part of the Lasers and Optics Group were transferred to SPAB's subsidiaries (other than the Company and its subsidiaries.) In connection with the Reorganization, intercompany receivables and payables were eliminated. Unless specified otherwise, SPAB refers to Spectra-Physics AB and/or affiliates of Spectra-Physics AB (other than the Company and its subsidiaries). All entities involved in the reorganization were direct or indirect wholly-owned subsidiaries of SPAB.
The accompanying consolidated financial statements includes the accounts of the Company and reflects the financial position, results of operations, and cash flows of the Company as if it were a separate entity for each period presented. The accompanying financial statements do not include assets and liabilities not part of the Laser and Optics Group. These net assets were transferred to SPAB. The Reorganization described above has been accounted for as a transfer between entities under common control in a manner similar to a pooling of interests.
The accompanying consolidated financial statements also include allocations of certain SPAB corporate and group expenses (including cash management and treasury, legal, employee benefits, insurance, income taxes and corporate overhead services) relating to the Company's businesses. Management believes these allocations are reasonable. However, the financial information included herein may not necessarily reflect the consolidated financial position, results of operations, and cash flows of the Company in the future or what they would have been had the Company been a separate entity during the periods presented.
In connection with the Reorganization, the Company entered into several agreements with SPAB that provide for (1) certain tax sharing matters, (2) registration rights in favor of SPAB, (3) the use of the Spectra-Physics name and trademark, (4) cross licensing of certain patents, (5) certain distribution arrangements, and (6) various indemnification arrangements. In addition, certain subsidiaries of the Company and certain subsidiaries of SPAB entered into agreements providing for the continuation of certain ongoing service and facilities leasing arrangements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
Use of Estimates:
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Such estimates relate to the useful lives of property, plant and equipment, allowances for doubtful accounts and customer returns, inventory realizability, potential accruals
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
relating to litigation matters, warranty and other accruals, and contingent assets and liabilities. Actual results could differ from those estimates, and such differences may be material to the financial statements.
Cash Equivalents:
The Company considers all highly liquid investments with a maturity of 90 days or less when purchased to be cash equivalents. Cash equivalents (which are classified as available for sale) are stated at cost, which approximates fair value, and consist of bankers' acceptances, repurchase agreements, commercial paper, time deposits, and money market funds of major banks and other institutions.
Inventories:
Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market.
Property, Plant and Equipment:
Property, plant and equipment are stated at cost and are depreciated on a straight-line basis over the estimated useful lives of the related assets of 3 to 25 years.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of " effective as of the beginning of fiscal 1997. The adoption of this statement had no material effect on the Company's financial statements.
Intangible Assets:
Intangible assets, principally patent rights, are stated at cost and amortized on a straight-line basis over their estimated useful lives of generally 7 to 17 years.
Foreign Currency Translation:
The local currency of the Company's subsidiaries in the United Kingdom, Germany, the Netherlands, France and Japan are the functional currencies for each entity. The assets and liabilities and sales and expense accounts of these foreign subsidiaries have been translated using the exchange rate at the balance sheet date and the weighted average exchange rate for the period, respectively.
The net effect of the translation of the accounts of the Company's subsidiaries has been included in stockholders' equity as foreign currency translation adjustments. The net effect of adjustments that arise from exchange rate changes on transactions denominated in a currency other than the local currency are included in other income (expense) as incurred.
Environmental Matters:
Accruals for remediation costs are recognized when management determines that it is probable that a liability has been incurred and such costs can be reasonably estimated. Such accruals are recorded at undiscounted amounts and are recorded even if significant uncertainties exist over the ultimate cost of the remediation. Ongoing environmental compliance costs, including maintenance and monitoring costs, are charged against the accrual.
Sales Recognition:
Net sales and related cost of sales for products are recognized upon shipment.
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Concentrations:
Cash is invested in deposits with banks in the United States and in countries where subsidiaries operate. Deposits in these banks may exceed the amount of insurance provided on such deposits; however, the Company is exposed to loss only to the extent of the amount of cash reflected on its balance sheet. The Company has not experienced any losses on its deposits of cash.
The Company markets its products on both a direct and an OEM basis principally in North America, Europe and Japan to companies for use in printing, micro-machining, marking, materials processing, medical, semiconductor manufacturing, inspection and repair applications, as well as universities and other entities involved in research. No individual customer accounts for more than 10% of net sales. The Company has adopted credit policies and standards to accommodate growth into these markets. The Company performs continuing credit evaluations of its customers' financial condition and although the Company generally does not require collateral, letters of credit may be required from its customers in certain circumstances. Bad debt losses to date have been insignificant.
A number of components necessary for the manufacture and operation of many of the Company's products are obtained from a sole supplier or a limited group of suppliers. The disruption or termination of any of these sources could have a material adverse effect on the Company's business, operating results and financial condition.
Warranty Costs:
Upon shipment of product, the Company accrues the estimated cost of warranty. The Company in general warrants its products for twelve to twenty-four months depending on the product line.
Advertising and Promotion Costs:
The Company's policy is to expense advertising and promotion costs as they are incurred. The Company's advertising and promotion expenses were approximately $1.8 million, $1.9 million, and $1.3 million in the years ended December 31, 1998, 1997, and 1996, respectively.
Income Taxes:
The accompanying financial statements reflect the provisions of SFAS No. 109, "Accounting for Income Taxes." Accordingly, the Company uses the liability method to calculate deferred taxes. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities based on enacted tax laws and rates applicable to the period in which differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to amounts that are more likely than not to be realized.
Income taxes have been provided as if the Company were a separate taxable entity. Under the Company's tax sharing agreement with SPAB prior to the Reorganization, however, the consolidated tax liability of the tax group for a given year was allocated only to companies in the group which had separate taxable income for that year. The tax liability was allocated pro-rata based on each company's relative separate taxable income. Companies with losses were not allocated any of the tax liability and were not given any benefit for their losses. Any differences between the Company's method for providing income tax expense (benefit) in the historical financial statements and the tax sharing arrangement it had with SPAB were reflected in Parent equity (deficit) as contributions or dividends. Effective October 1997, the Company and SPAB entered into a new tax sharing arrangement that generally requires the Company to determine its U.S. tax liability as a separate consolidated group.
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Derivative Instruments and Hedging:
Effective October 1, 1998, the Company adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires that all derivatives, including foreign currency exchange contracts, be recognized on the balance sheet at fair value. Derivatives that are not hedges must be recorded at fair value through earnings. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in fair value of assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is to be immediately recognized in earnings. The adoption of SFAS No. 133 resulted in no cumulative effect on income or other comprehensive income for the Company.
Forward foreign exchange contracts are used primarily by the Company to hedge certain operational ("cash-flow" hedges) and balance sheet("fair value" hedges) exposures resulting from changes in foreign currency exchange rates. Such exposures primarily result from portions of the Company's operations and assets that are denominated in currencies other than the U.S. dollar, primarily the Japanese Yen and certain European currencies. These foreign exchange contracts are entered into to hedge anticipated intercompany product sales and recorded accounts receivable made in the normal course of business, and accordingly, are not speculative in nature. As part of its overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, the Company hedges a portion of its foreign currency exposures anticipated over the ensuing twelve-month period. At December 31, 1998, the Company had effectively hedged approximately 60% of its estimated foreign currency exposures that principally relate to anticipated cash flows to be remitted to the U.S. over the ensuing twelve month period, using foreign exchange contracts that generally have maturities of twelve months or less. The Company does not hold or transact in financial instruments for purposes other than risk management.
The Company records its foreign currency exchange contracts at fair value in its consolidated balance sheet as accrued and other current liabilities and the related gains or losses on these hedge contracts are deferred as a component of other comprehensive income. These deferred gains and losses are recognized in income in the period in which the underlying anticipated transaction occurs. Unrealized gains and losses resulting from the impact of currency exchange rate movements on forward foreign exchange contracts designated to offset certain non-U.S. dollar denominated assets are recognized as other income or expense in the period in which the exchange rates change and offset the foreign currency losses and gains on the underlying exposures being hedged.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in fair value or cash flows of a hedged item (including forecasted transactions); (2) the derivative is sold or terminated; (3) the derivative is dedesignated as a hedge instrument, because it is unlikely that a forecasted transaction will occur or a balance sheet exposure ceases to exist; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried on the balance sheet at its fair value until it settles, and the hedged asset will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value until it settles, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in income. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet until it settles, with changes in its fair value recognized in current period earnings.
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has also entered into foreign currency exchange contracts to hedge certain intercompany loan transactions. These forward contracts effectively change certain foreign currency denominated debt into U.S. dollar denominated debt. No such contracts existed at December 31, 1998.
At December 31, 1998, the Company had contracts for the sale of foreign currencies and the purchase of U.S. dollars totaling $44.0 million. At December 31, 1998 the Company had deferred losses relating to its foreign currency contracts of approximately $0.1 million, which is all expected to be recognized in income over the next twelve months.
The following table provides information about the Company's foreign currency derivative financial instruments outstanding as of December 31, 1998. The information is provided in U.S. dollar amounts, as presented in the Company's consolidated financial statements. The table presents the notional amount (at contract exchange rates) and the weighted average contractual foreign currency exchange rates. All contracts mature within twelve months.
Foreign currency spot/forward contracts (in thousands, except average contract rates):
- --------------- * The estimated fair value is based on the estimated amount at which the contracts could be settled based on forward exchange rates.
The cash requirements of the above described financial instruments approximate their fair value. Cash flows associated with these financial instruments are classified consistent with the cash flows from the transactions being hedged. The Company's forward foreign exchange contracts contain market and credit risk not recognized in the consolidated financial statements. The market risk associated with these instruments resulting from currency exchange rate movements is expected to offset the market risk of the underlying transactions and assets being hedged. The credit risk is that the Company's banking counterparties may be unable to meet the terms of the agreements. The Company minimizes such risk by limiting its counterparties to major financial institutions with credit ratings of A/A-2 or better. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored. Management does not expect any loss as a result of default by other parties. However, there can be no assurances that the Company will be able to mitigate market and credit risks described above.
For the period from the fourth quarter of 1997 to the adoption of SFAS No. 133, the Company followed SFAS No. 52, "Foreign Currency Translation," and used forward exchange contracts to hedge only assets and firm commitments that exposed the Company to enterprise risk as a result of fluctuations in foreign currency exchange rates. Gains and losses on forward exchange contracts that were designated as hedges of firm orders were deferred in other current liabilities and were included in the measurement of the underlying transaction. Hedge accounting was only applied if the derivative reduced the risk of the underlying hedged item and was designated at inception as a hedge. Derivatives were measured for effectiveness both at inception and on an
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ongoing basis. During this period, no derivative ceased to meet the criteria for deferral and all expected firm commitments occurred. No contract was sold or terminated prior to maturity.
Prior to the fourth quarter of 1997, the Company entered into forward foreign exchange contracts with SPAB. These contracts were entered into in anticipation of product sales made in the normal course of business, and accordingly, did not qualify for hedge accounting under SFAS No. 52. Since the forward foreign exchange contracts were not designated as hedges of firm, identifiable foreign currency commitments, the unrealized gains and losses resulting from the impact of foreign currency exchange rate movements on these contracts were recognized in the periods in which the exchange rates changed. Such gains and losses were recorded as other income or expense.
Net Income (Loss) Per Share:
The Company has adopted SFAS No. 128, "Earnings Per Share" effective December 31, 1997. SFAS No. 128 requires the presentation of basic and diluted net income (loss) per share. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed giving effect to all diluted potential common shares that were outstanding during the period. Dilutive potential common shares consist of the incremental common shares issuable upon the exercise of stock options. In 1998 and 1997, weighted average shares were 16,168,000 and 13,162,000, respectively, and in 1998 and 1997 the shares used in the diluted calculation included 305,000 shares and 29,000 shares, respectively, due to grants of options to purchase shares of common stock. The shares used in the diluted net income per share calculation in the fourth quarter of 1998 excluded the effects of 2,113,645 options as these options had exercise prices greater than the average market price of the Company's common stock for that quarter, and accordingly, were anti-dilutive. Stock options granted by subsidiaries of the Company were not included in the calculation of net income (loss) per share as they were anti-dilutive. Basic and diluted net loss per share for 1996 gives effect to the Reorganization.
Stock Based Compensation:
In 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123, "Accounting for Stock-Based Compensation," which establishes a fair value based method of accounting for stock-based compensation plans and is effective for fiscal years beginning after December 15, 1995. SFAS No. 123 allows a company to continue to follow the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and disclose the pro forma impact of SFAS No. 123 on results of operations and earnings per share. The Company has elected to continue to account for its stock-based compensation plans in accordance with the provisions of APB 25. As the terms of certain stock-based compensation plans obligated the Company to settle the options in cash in certain instances, the Company has reflected compensation expense relating to these stock-based compensation plans in the statement of operations.
Reclassifications:
Certain 1997 and 1996 amounts have been reclassified to conform to the 1998 presentation.
3. TRANSACTIONS WITH SPAB
SPAB allocated certain expenses relating to cash management and treasury, legal, employee benefits, insurance, income taxes and corporate overhead services. Charges were allocated to the Company based on actual amounts incurred on behalf of the Company or agreed upon amounts or percentages based on the Company's headcount and sales that management of the Company believes were reasonable. Amounts charged to operations were $0.3 million in each of the years ended December 31, 1997 and 1996, respectively.
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SPAB used a centralized cash management program to finance its operations. Cash deposits from the Company's operations were transferred to SPAB on a periodic basis and SPAB funded the Company's disbursement bank account as required. Prior to the Reorganization, the Company and SPAB had an agreement whereby SPAB charged the Company interest based on certain of the Company's net balance payable to SPAB calculated using SPAB cost of related borrowed funds. Certain borrowings from SPAB were not subject to interest charges; however, interest expense has been imputed in the accompanying statement of operations at rates consistent with actual rates charged to the Company. Beginning in October 1997, the Company no longer participates in SPAB's centralized cash management program.
The activity in the net transfers (to) from SPAB account, is summarized below (in thousands):
4. BALANCE SHEET ACCOUNTS
Inventories, property, plant and equipment, and accrued and other current liabilities consisted of the following (in thousands):
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Credit facilities:
As part of the Reorganization, the Company assumed a short-term credit facility in Japan. The credit facility is with several banks, is unsecured, allows aggregate borrowings of 2.1 billion Yen ($18.2 million) and bears interest at 1.625% per annum. At December 31, 1998, there were approximately $11.8 million of borrowings outstanding under this facility. The Company's foreign subsidiaries other than Japan have credit facilities aggregating $4.5 million, none of which was outstanding as of December 31, 1998. The Company also has available in the U.S. two committed, unsecured credit facilities aggregating $20.0 million and a $10.0 million uncommitted, unsecured credit facility with a bank. The committed facilities are through June 2000. At December 31, 1998, there were no borrowings under either facility.
5. STOCKHOLDERS' EQUITY
Preferred Stock:
After the Reorganization, the Company's authorized preferred stock was 10,000,000 shares with a par value of $0.01 per share. The Board of Directors may, at its discretion, designate one or more series of preferred stock and establish the voting, dividend, liquidation, and other rights and preferences of the shares of each series, and provide for the issuance of shares of any series.
Stock Options:
Spectra-Physics Lasers, Inc. The Company has adopted the 1997 Spectra-Physics Lasers, Inc. Stock Option Plan which provides for the granting of non-qualified stock options ("options") to certain officers, key employees and non-employee directors of the Company. The aggregate maximum number of shares of common stock available for award under the 1997 Plan is 2,309,721 shares, subject to adjustment to reflect changes in the Company's capitalization. No awards can be made under the 1997 Plan more than 10 years after the date the plan was adopted. The exercise price of the options will be determined by the Board of Directors, provided that the exercise price must be at least 100% of the fair market value of a share of common stock on the date the option is granted. An option's term shall not exceed ten years from the date of grant. No option may be exercised sooner than six months from the date of grant.
Options vest 25% upon the first anniversary of the grant date and 6.25% at the end of each three-month period thereafter. Subject to the terms of the 1997 Plan, options will be exercisable to the extent vested beginning two years after the grant date. Accordingly, no option was exercisable at December 31, 1998 and 1997. These options may not be exercised following termination of the grantee's employment with the Company, except that in the event that a grantee's employment terminates due to death, disability or retirement, options held by such grantee or his estate shall be exercisable, to the extent vested at the time of termination of employment, for a period of three (3) months after termination of employment or, if later, the
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
end of the foregoing two-year period. The weighted average fair value of options granted in 1998 and 1997 were $5.74 per share and $4.33 per share, respectively. A summary of option activity follows:
Exercise prices of outstanding options at December 31, 1998 were:
As permitted under SFAS 123, the Company has elected to follow APB No. 25, in accounting for stock awards to employees. Under APB No. 25, the Company generally recognizes no compensation expense with respect to such awards under fixed plans. Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS 123 which also requires that the information be determined as if the Company has accounted for its employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in these subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options.
The effect of applying SFAS No. 123 resulted in pro forma net income of $8.9 million and $33.8 million in 1998 and 1997, respectively, and earnings per share basic and diluted of $0.55 and $0.54, respectively in 1998 and $2.56 in 1997.
Spectra-Physics Laser Data Systems, Inc. Spectra-Physics Laser Data Systems, Inc. ("Laser Data"), a subsidiary of the Company, granted certain of its employees options to purchase up to 20% of total common stock outstanding. One-half of the options vested annually beginning in 1996 and ending in 1999 and one-half
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
were performance-based options. At December 31, 1996, all the options remained outstanding and 40 shares under option were vested. The options were exercisable from the effective date of an initial public offering of Laser Data's common stock until the earlier of the first anniversary of such initial public offering or May 1, 2000. If a sale of control of the subsidiary occurred before May 1, 2000, the subsidiary was to redeem the options, to the extent vested, by paying the holders the difference between the exercise price and the per share value received in the sale of control (unless the acquirer in the sale of control did not wish such options to be cancelled, in which case they were not to be redeemed). Subject to certain qualifications, if neither an initial public offering nor a sale of control occurred before May 1, 2000, the subsidiary was to redeem the options by paying its option holders the difference, on a per-share basis, between the exercise price and the fair value of the subsidiary's common stock as determined by the board of directors, provided that the holders of a majority of the options were allowed to request an independent appraisal of the board's valuation. In 1997, prior to the modifications described below, the Company recorded a charge to operations of $0.2 million in connection with the Laser Data options.
In December 1997, these options were modified so that all of the options became exercisable (a) during the period (i) beginning on the effective date of a Laser Data initial public offering, if any, and (ii) ending on the earlier to occur of the first anniversary following any such initial public offering and February 28, 2000 (after which time the right to exercise vested options is terminated) or (b) during the period commencing on February 28, 2000 and ending on December 31, 2002. The options were also modified such that 31% of the options were vested with the remaining options vesting at varying rates through December 31, 1999, and Laser Data's requirement to redeem the options was eliminated. These modifications resulted in (1) a new measurement date for the options, for which the Company recorded a charge of $1.0 million, based on the difference between the exercise price of the options and the estimated fair value of Laser Data on the date the options were modified, and (2) the establishment of the amount of compensation expense related to these options. At December 31, 1998 and 1997 options to purchase 180 shares and 174 shares were outstanding at a weighted average price of $0.05 per share, none were exercisable, and 118 shares and 54 shares under option were vested.
6. BENEFIT AND INCENTIVE PLANS
The Company sponsors a defined contribution plan covering substantially all U.S. employees. The plan provides for limited Company matching of participants' contributions. Contributions to the plan by the Company and charged to operations were $0.8 million, $0.6 million and $0.5 million in the years ended December 31, 1998, 1997 and 1996, respectively.
The Company's Executive Incentive Plan and Employee Bonus Plan provides certain officers and employees of the Company with annual incentive cash bonus awards based on the achievement of certain pre-established quantitative and qualitative goals, including overall Company profitability. The Company charged to operations $0.0 million, $2.4 million and $1.9 million in the years ended December 31, 1998, 1997 and 1996, respectively, under these plans.
7. INCOME TAXES
Income (loss) before income taxes consisted of the following (in thousands):
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The provision for income taxes for the year ended December 31, 1996 represented foreign taxes currently payable at each of the applicable country's statutory rate. Income tax expense (benefit) for the years ended December 31, 1998 and 1997 consisted of the following (in thousands):
The following table summarizes the significant differences between the U.S. Federal statutory rate and the Company's income tax expense (benefit) for financial statement purposes (in thousands):
The Company's deferred tax assets are comprised of the following (in thousands):
Income taxes have been provided as if the Company were a separate taxable entity. For periods prior to September 30, 1997, income tax expense reflected foreign taxes only due to the expectation by the Company at that time of continuing losses in the U.S. Deferred tax assets were established relating to: (i) net operating loss carryforwards, which included interest expense from SPAB; (ii) accrued compensation associated with
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
employee stock options; (iii) inventory valuation reserves; and (iv) other accruals. These deferred tax assets were offset in total by a valuation allowance due to the expectation of continued losses in the U.S.
During the quarter ended September 30, 1997, the Company decreased the tax valuation allowance and recognized a tax benefit relating to the above items (net of foreign taxes) totaling $23.3 million. The decrease of the valuation allowance and the recognition of the tax benefit in the quarter was based on management's expectations regarding future taxable income for the Company. Management's expectations included the consideration of the conversion of loans and advances from SPAB to equity in October 1997 which will eliminate related interest charges in the future.
For U.S. income tax return purposes, the Company was part of a U.S. consolidated group pursuant to a tax sharing agreement among SPAB affiliated companies through September 1997. Under this tax sharing agreement, the Company's net operating loss carryovers referred to above were used to offset the taxable income of other members of the tax filing group with no benefit to the Company. Accordingly, the deferred tax asset arising from the net operating loss carryforwards (amounting to $10.2 million) was recorded as a dividend to SPAB.
8. COMMITMENTS
The Company leases manufacturing, research and development and office facilities under non-cancellable operating leases which expire in 1999 through 2008. The Company is responsible for taxes, insurance and maintenance expenses related to the leased facilities. Under the terms of certain lease agreements, the leases may be extended, at the Company's option, and certain of the leases provide for adjustments of the minimum monthly rent.
Future minimum annual lease payments under the leases are as follows (in thousands):
Rent expense was $3.2 million, $2.5 million and $2.4 million in the years ended December 31, 1998, 1997, and 1996, respectively.
9. ENVIRONMENTAL MATTERS
Since 1984, the Company has been identified by federal and state authorities as one of several potentially responsible parties ("PRPs") in conjunction with past releases of industrial solvents to soil and groundwater at one of the Company's facilities. The site has been listed on the National Priorities List, or "Superfund List," and the Company is subject to orders requiring it to perform remediation on-and off-site. Applicable federal law imposes joint and several liability on each PRP for the cleanup of this site. Pursuant to these orders, the Company and other PRPs are jointly performing and funding remediation that includes soil treatment, on-site and off-site groundwater extraction, treatment and monitoring. All of the required soil and groundwater remediation and monitoring systems currently required by the order are in place, and consequently the initial capital expenditures for such systems have been incurred. Generally, the Company has determined its share of total estimated clean up and remediation costs and has accrued the amount that it believes to be its share of the total cost.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Measurement of environmental accruals is subject to uncertainties, including the evolving nature of environmental regulations and their enforcement, the amount of time required to complete remediation, and the extent to which other PRPs will bear their share of the remediation costs. The Company estimates that at December 31, 1998 the remediation process will be completed at a cost ranging from approximately $2.1 million to $4.3 million. It is possible that the Company's recorded estimate of its obligation may change. At December 31, 1998 and 1997, the Company had accrued its best estimate of the liability of approximately $2.0 million (of which $1.2 million was included in long term liabilities) and $2.1 million (of which $1.5 million was included in long term liabilities), respectively, for anticipated future remediation costs associated with the Superfund site referred to above. During the years ended December 31, 1998, 1997 and 1996, the Company paid approximately $0.1 million, $0.1 million, and $0.5 million, respectively, for remediation of this site.
In October 1997, the Company was served with a complaint that had been filed in the Superior Court of the State of California seeking an unspecified amount of damages for personal injuries and property damage incurred by residents of a single location alleged to have resulted from the Company's and others' negligent and/or intentional handling of toxic chemicals. As of December 1998, there has been a summary judgement ruling in the case in favor of the Company and its co-defendants in regards to the four adults involved in the case. There can be no assurance that the summary judgement will not be successfully appealed or that the complaint will be resolved without adverse impact to the Company's financial position or results of operations. There can be no assurances that other parties will not come forward and claim personal injury or property damage.
10. SEGMENT REPORTING
Effective December 31, 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Statement 131 requires enterprises to report information about operating segments in annual financial statements and selected information about reportable segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers.
Description of the types of products and services from which each of the reportable segment derives its revenues
Spectra-Physics Lasers, Inc. has five reportable segments: the Commercial Systems Group (CSG) business unit; the Industrial and Scientific Lasers (ISL) business unit; the Original Equipment Manufacturer (OEM) business unit; Opto Power Corporation (OPC); and Spectra-Physics Distribution (SPD) business unit. CSG designs and manufactures optics, thin films, fabricated parts, plasma tubes, and subsystems for all operating units within the Company and external customers. CSG also designs, manufactures, and markets low power laser sources and beam delivery systems for OEM products in the industrial and medical instrumentation markets. ISL designs, markets and manufactures high power semiconductor-based and conventional lasers for the industrial and scientific markets. OEM designs, markets and manufactures high power semiconductor-based lasers for various OEM markets. OPC designs, markets and manufactures high power semiconductor-based laser diodes, components and systems. SPD is the Company's worldwide sales, service and support organization.
Measurement of segment profit or loss and segment assets
The Company evaluates performance and allocates resources based on Earnings Before Interest and Taxes (EBIT). The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Intersegment sales and transfers are recorded at intercompany transfer prices which approximate sales as if conducted on an arm's length basis.
Factors management used to identify the Company's reportable segments
The Company's reportable segments are business units that are, except for SPD, organized primarily by technology (for example, high power semiconductor-based, semiconductor laser pumped solid state, optics, air cooled lasers.) The reportable segments are each managed separately because they manufacture and distribute distinct products with different production methods and different customer bases.
Information about segments (in thousands):
SPECTRA-PHYSICS LASERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Reconciliations of segments information to financial statements (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net sales are attributed in the above table based on the location of the Company's customer. Substantially all sales in North America, Other Asia, and Rest of the World are denominated in U.S. dollars. Europe and Japan in the above table include sales from the Company's European and Japan sales subsidiaries, respectively. Export sales to countries not located in Asia are included in Rest of the World.
For all years presented, no one customer accounted for 10% or more of total net sales.
11. OTHER STATEMENT OF OPERATIONS ITEMS
Included in other operating expenses in the years ended December 31, 1997 and 1996, was $1.7 million and $1.9 million, respectively, of legal expenses associated with a lawsuit which was settled in the second quarter of 1997. As a result of the settlement, the Company received $17.0 million of net proceeds which was included as other income in the year ended December 31, 1997.
Also included in other operating expenses in the years ended December 31, 1997 and 1996, was $14.1 million and $5.0 million, respectively, of compensation expense associated with certain stock options of two subsidiaries. The stock options for one subsidiary were modified so as to establish the measurement date and the amount of compensation expense the Company is required to record and, for the other subsidiary, were cancelled for a combination of cash and common stock of the Company. Accordingly, the Company does not expect to incur additional compensation expense relating to these stock options in the future. In the fourth quarter of 1997, the Company paid approximately $14.9 million and issued 408,043 shares of common stock to cancel the stock options of the second subsidiary. The cash payments were funded through an equity contribution by SPAB.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. SUBSEQUENT EVENT (UNAUDITED)
On February 22, 1999, shareholders of SPAB holding approximately 98.4% of the outstanding shares of SPAB tendered their shares to Thermo Instrument Systems Inc. (TIS), which shares were thereafter accepted by TIS for approximately $355 million. Accordingly, TIS now indirectly owns approximately 79.1% of the Company's outstanding common stock.
13. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of quarterly financial results (in thousands except per share amounts):
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders Spectra-Physics Lasers, Inc.
In connection with our audits of the consolidated financial statements of Spectra-Physics Lasers, Inc. as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, which financial statements are included in this Form 10-K, we have also audited the financial statement schedule listed in Item 14(a) herein.
In our opinion, this financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.
PRICEWATERHOUSECOOPERS LLP
San Jose, California January 22, 1999
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS)
EXHIBIT INDEX