| Our business is based on a myriad of technologies, encompassed in multiple different product lines, addressing various markets in different regions of the world |
| A business of our breadth and complexity requires significant management time, attention and resources |
| In addition, significant changes to our business, such as changes in manufacturing, operations, product lines, market focus or organizational structure or focus, can be distracting, time-consuming and expensive |
| These changes can have short-term adverse effects on our financial results, and may not provide their intended long-term benefits |
| We operate in highly competitive industries and we cannot be certain that we will be able to compete successfully in such industries |
| The industries in which we operate are intensely competitive |
| Established companies, both domestic and foreign, compete with each of our product lines |
| Many of our competitors have greater financial, engineering, manufacturing and marketing resources than we do, and may price their products very aggressively |
| Our significant competitors include: JEOL Ltd, Hitachi Ltd, Seiko Instruments Inc, Carl Zeiss SMT AG, Applied Materials, Orsay Physics SA and Credence Systems Corporation |
| In addition, some of our competitors may cooperate with each other, as in the case of the recently announced distribution arrangement between Seiko Instruments, Inc |
| and Carl Zeiss SMT AG in Japan |
| FEI COMPANY AND SUBSIDIARIES 5 ______________________________________________________________________ PART I Item 1A Risk Factors (continued) A substantial investment is required by customers to install and integrate capital equipment into their laboratories and process applications |
| As a result, once a manufacturer has selected a particular vendorapstas capital equipment, the manufacturer generally relies on that equipment for a specific production line or process control application and frequently will attempt to consolidate its other capital equipment requirements with the same vendor |
| Accordingly, if a particular customer selects a competitorapstas capital equipment, we expect to experience difficulty selling to that customer for a significant period of time |
| Our ability to compete successfully depends on a number of factors both within and outside of our control, including: • price; • product quality; • breadth of product line; • system performance; • ease of use; • cost of ownership; • global technical service and support; • success in developing or otherwise introducing new products; and • foreign currency movements |
| We cannot be certain that we will be able to compete successfully on these or other factors, which could negatively impact our revenues, gross margins and net income in the future |
| The loss of one or more of our key customers would result in the loss of significant net revenues |
| Although no single customer makes up more than 10prca of our net revenues, a relatively small number of customers account for a large percentage of our net revenues |
| Our business will be seriously harmed if we do not generate as much revenue as we expect from these key customers, if we experience a loss of any of our key customers or if we suffer a substantial reduction in orders from these customers |
| Our ability to continue to generate revenues from our key customers will depend on our ability to introduce new products that are desirable to these customers |
| Because we do not have long-term contracts with our customers, our customers may stop purchasing our products at any time, which makes it difficult to forecast our results of operations and to plan expenditures accordingly |
| We do not have long-term contracts with our customers |
| Accordingly: • customers can stop purchasing our products at any time without penalty; • customers are free to purchase products from our competitors; • we are exposed to competitive pricing pressure on each order; and • customers are not required to make minimum purchases |
| If we do not succeed in obtaining new sales orders from existing customers, our results of operations will be negatively impacted |
| Because many of our shipments occur in the last month of a quarter, we are at risk of one or more transactions not being delivered according to forecast |
| We have historically shipped approximately 75prca of our products in the last month of each quarter |
| As any one shipment may be significant to meet our quarterly sales projection, any slippage of shipments into a subsequent quarter may result in our not meeting our quarterly sales projection, which may adversely impact our results of operations for the quarter |
| We rely on a limited number of parts, components and equipment manufacturers |
| Failure of any of these suppliers to provide us with quality products in a timely manner could negatively affect our revenues and results of operations |
| Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business |
| We currently use numerous vendors to supply parts, components and subassemblies for the manufacture and support of our products |
| Some key parts, however, may only be obtained from a single supplier or a limited group of suppliers |
| In particular, we rely on Philips Enabling Technologies Group, BV, or Philips ETG, and Frencken Mechatronics BV for our supply of mechanical parts and subassemblies; Gatan, Inc |
| for critical accessory products; and Neways Electronics, NV and Benchmark Electronics for some of our electronic subassemblies |
| In addition, some of our suppliers rely on sole suppliers |
| As a result of this concentration of key suppliers, our results of operations may be materially and adversely affected if we do not timely and cos t-effectively receive a sufficient quantity of quality parts to meet our production requirements or if we are required to find alternative suppliers for these supplies |
| We may not be able to expand our supplier group or to reduce our dependence on single suppliers |
| From time to time, we have experienced supply constraints with respect to the mechanical parts and subassemblies produced by Philips ETG If Philips ETG is not able to meet our supply requirements, these constraints may affect our ability to deliver products to customers in a timely manner, which could have an adverse effect on our results of operations |
| In addition, because we only have a few equipment suppliers, we may be more exposed to future cost increases for this equipment |
| The industries in which we sell our products are cyclical, which may cause our results of operations to fluctuate |
| Our business depends in large part on the capital expenditures of industry and institute, semiconductor and data storage customers, which accounted for the following percentages of our net sales (product and service) for the periods indicated: YEAR ENDED DECEMBER 31, 2005 2004 Industry and Institute 52dtta3 % 46dtta4 % Semiconductor 40dtta5 46dtta4 Data Storage 7dtta2 7dtta2 FEI COMPANY AND SUBSIDIARIES 6 ______________________________________________________________________ The data storage and semiconductor industries are cyclical |
| These industries have experienced significant economic downturns at various times in the last decade |
| Such downturns have been characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity |
| A downturn in one or more of these industries, or the businesses of one or more of our customers, could have a material adverse effect on our business, prospects, financial condition and results of operations |
| For example, in 2005, the semiconductor equipment market experienced weakness |
| Global economic conditions continue to be volatile and slower growth or reduced demand for our customers &apos products in the future would cause our business to decline |
| During downturns, our sales or margins may decline |
| The industry and institute market also is affected by overall economic conditions, but is not as cyclical as the semiconductor and data storage markets |
| However, industry and institute customer spending is highly dependent on governmental and private funding levels and timing, which can vary depending on budgetary and/or economic constraints |
| In 2005, North American industry and institute revenues were weak |
| We believe this weakness was due, at least in part, to delays in government funding to our customers and potential customers |
| As a capital equipment provider, our revenues depend in large part on the spending patterns of our customers, who often delay expenditures or cancel orders in reaction to variations in their businesses or general economic conditions |
| In an industry of prolonged economic downturn, we may not be able to reduce our significant fixed costs, such as manufacturing overhead, capital equipment or research and development costs, which may cause our gross margins to erode and our net loss to increase or earnings to decline |
| If our customers cancel or reschedule orders or if an anticipated order for even one of our systems is not received in time to permit shipping during a certain fiscal period, our operating results for that fiscal period may fluctuate and our business and financial results for such period could be materially and adversely affected |
| Our customers are able to cancel or reschedule orders, generally with limited or no penalties, depending on the productapstas stage of completion |
| The amount of purchase orders at any particular date, therefore, is not necessarily indicative of sales to be made in any given period |
| Our build cycle, or the time it takes us to build a product to customer specifications, typically ranges from one to six months |
| During this period, the customer may cancel the order, although generally we will receive a cancellation fee based on the agreed-upon shipment schedule |
| In addition, we derive a substantial portion of our net sales in any fiscal period from the sale of a relatively small number of high-priced systems, with a large portion in the last month of the quarter |
| As a result, the timing of revenue recognition for a single transaction could have a material effect on our revenue and results of operations for a particular fiscal period |
| Due to these and other factors, our net revenues and results of operations have fluctuated in the past and are likely to fluctuate significantly in the future on a quarterly and annual basis |
| It is possible that in some future quarter or quarters our results of operations will be below the expectations of public market analysts or investors |
| In such event, the market price of our common stock may decline significantly |
| Many of our projects are funded under federal, state and local government contracts and if we are found to have violated the terms of the government contracts or applicable statutes and regulations, we are subject to the risk of suspension or debarment from government contracting activities, which could have a material adverse affect on our business and results of operations |
| In addition, government contracts are subject to specific procurement regulations, contract provisions, and requirements relating to the formation, administration, performance, and accounting of these contracts |
| Many of these contracts include express or implied certifications of compliance with applicable laws and contract provisions |
| As a result of our government contracting, claims for civil or criminal fraud may be brought by the government for violations of these regulations, requirements or statutes |
| Further, if we fail to comply with any of these regulations, requirements or statutes, our existing government contracts could be terminated, we could be suspended from government contracting or subcontracting, including federally funded projects at the state level |
| If one or more of our government contracts are terminated for any reason, or if we are suspended from government work, we could suffer the loss of the contracts, w hich could have a material adverse effect on our business and results of operations |
| Changes and fluctuations in governmentapstas spending priorities could adversely affect our revenue expectations |
| Because a substantial part of our overall business is generated either directly or indirectly as a result of federal and local government regulatory and infrastructure priorities, shifts in these priorities due to changes in policy imperatives or economic conditions are often unpredictable and may affect our revenues |
| Political instability in key regions around the world coupled with the United States governmentapstas commitment to the war on terror put at risk federal discretionary spending, including spending on nanotechnology research programs and projects that are of particular importance to our business |
| At the state and local levels, the need to compensate for reductions in the federal matching funds, as well as financing of federal unfunded mandates, creates strong pressures to cut back on research expenditures as well |
| There can be no assurances that potential reduction of federal funding would not adversely affect our business |
| FEI COMPANY AND SUBSIDIARIES 7 ______________________________________________________________________ PART I Item 1A Risk Factors (continued) We have long sales cycles for our systems, which may cause our results of operations to fluctuate and could negatively impact our stock price |
| Our sales cycle can be 12 months or longer and is unpredictable |
| Variations in the length of our sales cycle could cause our net sales and, therefore, our business, financial condition, results of operations, operating margins and cash flows, to fluctuate widely from period to period |
| These variations could be based on factors partially or completely outside of our control |
| The factors that could affect the length of time it takes us to complete a sale depend on many elements, including: • the efforts of our sales force and our independent sales representatives; • changes in the composition of our sales force, including the departure of senior sales personnel; • the history of previous sales to a customer; • the complexity of the customerapstas manufacturing processes; • the economic environment; • the internal technical capabilities and sophistication of the customer; and • the capital expenditure budget cycle of the customer |
| Our sales cycle also extends in situations where the sale involves developing new applications for a system or technology |
| As a result of these and a number of other factors that could influence sales cycles with particular customers, the period between initial contact with a potential customer and the time when we recognize revenue from that customer, if ever, may vary widely |
| The loss of key management or our inability to attract and retain sufficient numbers of managerial, engineering and other technical personnel could have a material adverse effect on our business and results of operations |
| Attracting qualified personnel is difficult and our recruiting efforts may not be successful |
| Specifically, our product generation efforts depend on hiring and retaining qualified engineers |
| The market for qualified engineers is very competitive |
| In addition, experienced management and technical, marketing and support personnel in the information technology industry are in high demand, and competition for such talent is intense |
| The loss of key personnel, or our inability to attract key personnel, could have a material adverse effect on our business, prospects, financial condition or results of operations |
| Philips Business Electronics International BV has significant influence on all company shareholder votes and may have different interests than our other shareholders |
| As of December 31, 2005, Philips Business Electronics International BV, or PBE, a subsidiary of Koninklijke Philips Electronics NV, owned approximately 25prca of our outstanding common stock |
| In addition, Jan C Lobbezoo, Executive Vice President, Philips International BV, an affiliate of Philips, serves on our Board of Directors |
| As a result, PBE has significant influence on matters submitted to our shareholders for approval, including proposals regarding: • any merger, consolidation or sale of all or substantially all of our assets; and • the election of members to our board of directors |
| In addition to its significant influence, PBEapstas interests may be significantly different from the interests of other owners of our common stock, holders of our options to purchase common stock and holders of our debt securities |
| Our customers experience rapid technological changes, with which we must keep pace, but we may be unable to introduce new products on a timely and cost-effective basis to meet such changes |
| The data storage, semiconductor and industry and institute industries experience rapid technological change and new product introductions and enhancements |
| Our ability to remain competitive depends in large part on our ability to develop, in a timely and cost-effective manner, new and enhanced systems at competitive prices and to accurately predict technology transitions |
| In addition, new product introductions or enhancements by competitors could cause a decline in our sales or a loss of market acceptance of our existing products |
| Increased competitive pressure also could lead to intensified price competition, resulting in lower margins, which could materially adversely affect our business, prospects, financial condition and results of operations |
| Our success in developing, introducing and selling new and enhanced systems depends on a variety of factors, including: • selection and development of product offerings; • timely and efficient completion of product design and development; • timely and efficient implementation of manufacturing processes; • effective sales, service and marketing functions; and • product performance |
| Because new product development commitments must be made well in advance of sales, new product decisions must anticipate both the future demand for products under development and the equipment required to produce such products |
| We cannot be certain that we will be successful in selecting, developing, manufacturing and marketing new products or in enhancing existing products |
| The process of developing new high technology capital equipment products and services is complex and uncertain, and failure to accurately anticipate customers &apos changing needs and emerging technological trends, to complete engineering and development projects in a timely manner and to develop or obtain appropriate intellectual property could significantly harm our results of operations |
| We must make long-term investments and commit significant resources before knowing whether our predictions will result in products that the market will accept |
| For example, we have invested significant resources in the development of three-dimensional metrology products for semiconductor wafer manufacturing and sales have been modest |
| If three-dimensional metrology is not widely accepted, or if we fail to develop products that are accepted by the marketplace, our long-term growth FEI COMPANY AND SUBSIDIARIES 8 ______________________________________________________________________ could be harmed |
| In addition, we have invested substantial resources in our new Titan S/TEM electron microscope, and further engineering and development will be required to take full advantage of this new S/TEM platform |
| If the completion of further development is delayed, potential revenue growth could be deferred |
| To the extent that a market does not develop for a new product, we may decide to discontinue or modify the product |
| These actions could involve significant costs and/or require us to take charges in future periods |
| If these products are accepted by the marketplace, sales of our new products may cannibalize sales of our existing products |
| Further, after a product is developed, we must be able to manufacture sufficient volume quickly and at low cost |
| To accomplish this objective, we must accurately forecast production volumes, mix of products and configurations that meet customer requirements |
| If we are not successful in making accurate forecasts, our business and results of operations could be significantly harmed |
| Any failure by us to execute planned cost reductions successfully could result in total costs and expenses that are greater than expected |
| We have undertaken restructuring plans to bring operational expenses to appropriate levels for our business |
| In 2005, we took significant restructuring charges in connection with the closing of our Peabody, Massachusetts plant and otherwise |
| We may have further workforce reductions or rebalancing actions in the future |
| Significant risks associated with these actions and other workforce management issues that may impair our ability to achieve anticipated cost reductions or that may otherwise harm our business include delays in implementation of anticipated workforce reductions in highly regulated locations outside of the United States, particularly in Europe and Asia, redundancies among restructuring programs, decreases in employee morale and the failure to meet operational targets due to the loss of employees, particularly sales employees and engineers |
| Because we have significant operations outside of the United States, we are subject to political, economic and other international conditions that could result in increased operating expenses and regulation of our products and increased difficulty in maintaining operating and financial controls |
| Since a significant portion of our operations occur outside of the United States, our revenues and expenses are impacted by foreign economic and regulatory conditions |
| In the years ended December 31, 2005 and 2004, approximately 69prca and 62prca, respectively, of our revenues came from outside of the United States |
| We have manufacturing facilities in Brno, Czech Republic and Eindhoven, the Netherlands and sales offices in many other countries |
| In addition, approximately 31prca of our sales in the years ended December 31, 2005 and 2004 were derived from sales in Asia |
| In recent years, Asian economies have been highly volatile and recessionary, resulting in significant fluctuations in local currencies and other instabilities |
| Instabilities in Asian economies may continue and recur in the future or instability could occur in other foreign economies, any of which could have a material adverse effect on our business, prospects, financial condition, margins and results of operations |
| Moreover, we operate in approximately 50 countries; 29 with a direct presence and an additional 21 via sales agents |
| Some of our global operations are geographically isolated, are distant from corporate headquarters and /or have little infrastructure support |
| Therefore maintaining and enforcing operating and financial controls can be difficult |
| Failure to maintain or enforce controls could have a material adverse effect on our control over service inventories, quality of service, customer relationships and financial reporting |
| Our exposure to the business risks presented by Asian economies and other foreign economies will increase to the extent we continue to expand our global operations |
| International operations will continue to subject us to a number of risks, including: • longer sales cycles; • multiple, conflicting and changing governmental laws and regulations; • protectionist laws and business practices that favor local companies; • price and currency exchange rates and controls; • difficulties in collecting accounts receivable; • travel and transportation difficulties resulting from actual or perceived health risks (eg SARS and Avian Influenza); and • political and economic instability |
| If third parties assert that we violate their intellectual property rights, our business and results of operations may be materially adversely affected |
| Several of our competitors hold patents covering a variety of technologies that may be included in some of our products |
| In addition, some of our customers may use our products for applications that are similar to those covered by these patents |
| From time to time, we and our respective customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents |
| To date, none of these allegations has resulted in litigation |
| Our competitors or other entities may, however, assert infringement claims against us or our customers in the future with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others |
| If claims of infringement are asserted against our customers, those customers may seek indemnification from us for dama ges or expenses they incur |
| We also may face greater exposure to claims of infringement in the future because PBE no longer is our majority shareholder |
| As a result of PBEapstas reduction of ownership of our common stock in 2001, we no longer receive the benefit of many of the Philips patent cross-licenses that we previously received |
| FEI COMPANY AND SUBSIDIARIES 9 ______________________________________________________________________ PART I Item 1A Risk Factors (continued) If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position |
| These licenses, however, may not be available on satisfactory terms or at all |
| If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, these potential infringement claims could have a material adverse effect on our business, prospects, financial condition and results of operations |
| We may not be able to enforce our intellectual property rights, especially in foreign countries, which could materially adversely affect our business |
| Our success depends in large part on the protection of our proprietary rights |
| We incur significant costs to obtain and maintain patents and defend our intellectual property |
| We also rely on the laws of the United States and other countries where we develop, manufacture or sell products to protect our proprietary rights |
| We may not be successful in protecting these proprietary rights, these rights may not provide the competitive advantages that we expect, or other parties may challenge, invalidate or circumvent these rights |
| Further, our efforts to protect our intellectual property may be less effective in some countries where intellectual property rights are not as well protected as they are in the United States |
| Many United States companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries |
| We derived approximately 69prca and 62prca of our sales from foreign countries in the years ended December 31, 2005 and 2004, respectively |
| If we fail to adequately protect our intellectual property rights in these countries, our business may be materially adversely affected |
| Infringement of our proprietary rights could result in weakened capacity to compete for sales and increased litigation costs, both of which could have a material adverse effect on our business, prospects, financial condition and results of operations |
| We are substantially leveraged, which could adversely affect our ability to adjust our business to respond to competitive pressures and to obtain sufficient funds to satisfy our future manufacturing capacity and research and development needs |
| We have significant indebtedness |
| As of December 31, 2005, we had total convertible long-term debt of approximately dlra225dtta0 million, due in 2008 |
| The degree to which we are leveraged could have important consequences, including, but not limited to, the following: • our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate or other purposes may be limited; • the dilutive effects on our shareholders as a result of the up to 5cmam528cmam527 shares of common stock that would be issued in the event we elect to settle all or a portion of the Zero Coupon Convertible Notes in shares upon the bondholders &apos election to convert the notes once certain stock price metrics are met; • the dilutive effects on our shareholders as a result of up to 1cmam514cmam540 shares of our common stock that would be issued in the event all or a portion of the 5dtta5prca Subordinated Convertible Note holders elect to convert their notes; • a substantial portion of our cash flow from operations will be dedicated to the payment of the principal of, and interest on, our indebtedness; and • we may be more vulnerable to economic downturns, less able to withstand competitive pressures and less flexible in responding to changing business and economic conditions |
| Our ability to pay interest and principal on our debt securities, to satisfy our other debt obligations and to make planned expenditures will be dependent on our future operating performance, which could be affected by changes in economic conditions and other factors, some of which are beyond our control |
| A failure to comply with the covenants and other provisions of our debt instruments could result in events of default under such instruments, which could permit acceleration of the debt under such instruments and in some cases acceleration of debt under other instruments that contain cross-default or cross-acceleration provisions |
| We believe that cash flow from operations will be sufficient to cover our debt service and other requirements |
| If we are at any time unable to generate sufficient cash flow from operations to service our indebtedness, however, we may be required to attempt to renegotiate the terms of the instruments r elating to the indebtedness, seek to refinance all or a portion of the indebtedness or obtain additional financing |
| There can be no assurance that we will be able to successfully renegotiate such terms, that any such refinancing would be possible or that any additional financing could be obtained on terms that are favorable or acceptable to us |
| We may have exposure to income tax rate fluctuations as well as to additional tax liabilities, which would impact our financial position |
| As a corporation with operations both in the United States and abroad, we are subject to income taxes in both the United States and various foreign jurisdictions |
| Our effective tax rate is subject to fluctuation as the income tax rates for each year are a function of the following factors, among others: • the effects of a mix of profits or losses earned by us and our subsidiaries in numerous foreign tax jurisdictions with a broad range of income tax rates; • our ability to utilize recorded deferred tax assets; • changes in contingencies related to taxes, interest or penalties resulting from tax audits; and • changes in tax laws or the interpretation of such laws |
| Changes in the mix of these items and other items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial position |
| FEI COMPANY AND SUBSIDIARIES 10 ______________________________________________________________________ We are also subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the United States and various foreign jurisdictions |
| We are regularly under audit by tax authorities with respect to both income and non-income taxes and may have exposure to additional tax liabilities as a result of these audits |
| Significant judgment is required in determining our provision for income taxes and other tax liabilities |
| Although we believe that our tax estimates are reasonable, we cannot assure you that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals |
| We may have underestimated past restructuring charges or we may incur future restructuring and asset impairment charges, either of which may adversely impact our results of operations |
| In 2005 and over the last few years, we initiated a series of restructurings of our operations involving, among other things, the reduction of our workforce and the consolidation of excess facilities |
| Restructuring charges for 2005 totaled dlra8dtta5 million |
| We anticipate having further reductions to our workforce and will continue to consolidate additional facilities in the first half of fiscal 2006 |
| We may incur additional restructuring and related expenses, which may have a material adverse effect on our business, financial condition or results of operations |
| The charges in connection with these restructurings are only estimates and may not be accurate |
| As part of these restructurings, we ceased to use certain of our leased facilities and, accordingly, we have negotiated, and are continuing to negotiate, certain lease terminations and/or subleases of our facilities |
| We cannot predict when or if we will be successful in negotiating lease termination agreements or subleases of our facilities on terms acceptable to us |
| If we are not successful in negotiating terms acceptable to us, or at all, we may be required to materially increase our restructuring and related expenses in future periods |
| Further, if we have further reductions to our workforce or consolidate additional facilities in the future we may incur additional restructuring and related expenses, which could have a material adverse effect on our business, financial condition or results of operations |
| In addition, we test our goodwill and other intangible assets for impairment annually or when an event occurs indicating the potential for impairment |
| If we record an impairment charge as a result of this analysis, it could have a material impact on our results of operations |
| We could also incur material charges as a result of write-downs of inventories or other tangible assets |
| FASBapstas adoption of Statement 123(R) will affect our reported results of operations and may affect how we compensate our employees and conduct our business |
| On October 13, 2004, the FASB adopted Statement 123(R), "e Share-Based Payment, "e which will require us, starting in fiscal 2006, to measure compensation costs for all stock based compensation (including stock options and our employee stock purchase plan, as currently constructed) at fair value and take a compensation charge equal to that value |
| If the FASBapstas Statement 123(R) was in effect for the periods reported in this Annual Report on Form 10-K, we would have had to reduce net income by approximately dlra34dtta4 million, dlra12dtta4 million and dlra9dtta5 million, net of tax, respectively, for the years ended December 31, 2005, 2004 and 2003 |
| In October 2005, we announced the acceleration of vesting of certain unvested, underwater stock options |
| The effect of this acceleration will be to reduce the aggregate compensation expense in 2006 and future years as a result of implementing SFAS Nodtta 123(R) |
| However, this acceleration did not eliminate all of the additional compensation charges that we will incur due to the adoption of the new rule |
| Changes in accounting pronouncements or taxation rules or practices can have a significant effect on our reported results |
| Other new accounting pronouncements or taxation rules and varying interpretations of accounting pronouncements or taxation practices have occurred and may occur in the future |
| This change to existing rules, future changes, if any, or the questioning of current practices may adversely affect our reported financial results, change the mix of compensation we pay to our employees or change the way we conduct our business |
| Due to our extensive international operations and sales, we are exposed to foreign currency exchange rate risks that could adversely affect our revenues, gross margins and results of operations |
| A significant portion of our sales and expenses are denominated in currencies other than the United States dollar, principally the euro |
| Approximately 15prca to 25prca of our revenue in a given year is denominated in euros, while more than half of our expenses are denominated in euro or other foreign currencies |
| Particularly as a result of this imbalance, changes in the exchange rate between the United States dollar and foreign currencies, especially the euro, can impact our revenues, gross margins, results of operations and cash flows |
| We enter into foreign forward exchange contracts to partially mitigate the impact of specific cash, receivables or payables positions denominated in foreign currencies |
| We also enter into various forward extra contracts (a combination of a foreign forward exchange contract and an option), as well as standard option contracts, to partially mitigate the impact of changes in the euro against the dollar on our European operating results |
| These contracts are considered derivatives |
| We are required to carry all open derivative contracts on our balance sheet at fair value |
| When specific accounting criteria have been met, derivative contracts can be designated as hedging instruments and changes in fair value related to these derivative contracts are recorded in other comprehensive income, rather than net income, until the underlying hedged transaction affects net income |
| We are FEI COMPANY AND SUBSIDIARIES 11 ______________________________________________________________________ PART I Item 1A Risk Factors (continued) required to record changes in fair value for derivatives not designated as hedges in net income in the current period |
| Prior to the second quarter of fiscal 2004, none of our derivative contracts were designated as hedges and all realized and unrealized gains and losses were recognized in net income in the current period |
| Our ability to designate derivative contracts as hedges significantly reduces the volatility in our operating results due to changes in the fair value of the derivative contracts |
| Achieving hedge designation is based on evaluating the effectiveness of the derivative contracts &apos ability to mitigate the foreign currency exposure of the linked transaction |
| We are required to monitor the effectiveness of all new and open derivative contracts designated as hedges on a quarterly basis |
| Based on our evaluation in 2005, we recorded charges totaling dlra0dtta5 million in other income/expense related to hedge dedesignations and ineffectiveness |
| Failure to meet the hedge accounting requirements could result in the requirement to record deferred and current realized and unrealized gains and losses into net income in the current period |
| This failure could result in significant fluctuations in operating results |
| In addition, we will continue to recognize unrealized gains and losses related to the changes in fair value of derivative contracts not designated as hedges in the current period net income |
| Accordingly, the related i mpact to operating results may be recognized in a different period than the foreign currency impact of the linked asset, liability or transaction |
| The hedging transactions we undertake limit our exposure to changes in the dollar/euro exchange rate |
| The hedges are designed to protect us as the dollar weakens, but also provide us with some flexibility if the dollar strengthens |
| Foreign currency losses recorded in other income/expense, inclusive of the impact of derivatives, totaled dlra1dtta5 million, dlra3dtta1 million and dlra1dtta2 million, respectively, in 2005, 2004 and 2003 |
| Our acquisition and investment strategy subjects us to risks associated with evaluating and pursuing these opportunities and integrating these businesses |
| In addition to our efforts to develop new technologies from internal sources, we also may seek to acquire new technologies from external sources |
| As part of this effort, we may make acquisitions of, or make significant debt and equity investments in, businesses with complementary products, services and/or technologies |
| Acquisitions can involve numerous risks, including management issues and costs in connection with the integration of the operations and personnel, technologies and products of the acquired companies, the possible write-downs of impaired assets, and the potential loss of key employees of the acquired companies |
| The inability to effectively manage any of these risks could seriously harm our business |
| Additionally, difficulties in integrating any potential acquisitions into our internal control structure could result in a failure of our internal control over financial reporting, which, in turn, could create a materia l weakness |
| Our debt and equity investments in unconsolidated subsidiaries, which totaled dlra3dtta3 million at December 31, 2005, may not prove to be successful and we could lose all or a portion of our investments and/or could be required to take write-offs related to these investments |
| In 2005, we recorded impairment charges and realized losses totaling dlra6dtta4 million related to these investments and may be required to record additional impairment charges related to these investments in the future |
| To the extent we make investments in entities that we control, or have significant influence in, our financial results will reflect our proportionate share of the financial results of the entity |
| Issues arising from our enterprise resource planning system could affect our operating results and ability to manage our business effectively |
| Our ability to design, manufacture, market and service products and systems is dependent on information technology systems that encompass all of our major business functions |
| During 2005, we embarked upon a new enterprise resource planning ( "e ERP "e ) software system to enable us to fully integrate our diverse locations and processes |
| In total, dlra7dtta6 million was spent in 2005 with another dlra0dtta4 million spent in the first quarter of 2006 |
| After a review of the projected costs and time to complete the project, we abandoned this project and expensed these costs in the respective periods discussed above |
| Updating our existing system presents the potential for additional difficulties |
| Moreover, if the existing system, as updated, is not sufficient to meet our needs, it could adversely affect our ability to do the following in a timely manner: manage and replenish inventory, fulfill and process orders, manufacture and ship products in a timely manner, invoice and collect receivables, place purchase orders and pay invoices, coordinate sales and marketing activities, prepare our financial statements, manage our accounting systems and controls and otherwise carry on our business in the ordinary course |
| Any such disruption could adversely affect our business, prospects, financial condition and results of operations |
| Moreover, difficulties arising from the ERP system could result in a failure of our internal control over financial reporting, which, in turn, could result in a material weakness and a qualified report from our independent registered public accounting firm |
| Terrorist acts or acts of war and natural disasters may seriously harm our business and revenues, costs and expenses and financial condition |
| Terrorist acts, acts of war and natural disasters (wherever located around the world) may cause damage or disruption to us, our employees, facilities, partners, suppliers, distributors and customers, any and all of which could significantly impact our revenues, expenses and financial condition |
| This impact could be disproportionately greater on us than on other companies as a result of our significant international presence |
| The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties that could adversely affect our business and results of operations in FEI COMPANY AND SUBSIDIARIES 12 ______________________________________________________________________ ways that cannot presently be predicted |
| We are largely uninsured for losses and interruptions caused by terrorist acts, acts of war and natural disasters and our headquarters are located in Oregon, which is subject to earthquakes |
| Unforeseen health, safety or environmental costs could impact our future net earnings |
| Some of our operations use substances that are regulated by various federal, state and international laws governing health, safety and the environment |
| We could be subject to liability if we do not handle these substances in compliance with safety standards for storage and transportation and applicable laws |
| It is our policy to apply strict standards for environmental protection to sites inside and outside the United States, even when not subject to local government regulations |
| We will record a liability for any costs related to health, safety or environmental remediation when we consider the costs to be probable and the amount of the costs can be reasonably estimated |
| Provisions of our charter documents could make it more difficult for a third party to acquire us even if the offer may be considered beneficial by our shareholders |
| Our articles of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our Board of Directors |
| Among other things, our Board of Directors has adopted a shareholder rights plan, or "e poison pill, "e which would significantly dilute the ownership of a hostile acquirer |
| These provisions make it more difficult for a third party to acquire us without negotiation |
| These provisions may apply even if the offer may be considered beneficial by our shareholders |
| See "e Description of Capital Stock "e for additional information on these provisions |
| Many of our current and planned products are highly complex and may contain defects or errors that can only be detected after installation, which may harm our reputation |
| Our products are highly complex, and there is no assurance that our extensive product development, manufacturing and testing processes will be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us |
| As a result, we could have to replace certain components and/or provide remediation in response to the discovery of defects in products that are shipped |
| The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers |
| These occurrences could also result in the loss of, or delay in, market acceptance of our products and loss of sales, which would harm our business and adversely affect our revenues and profitability |
| Some of our systems use hazardous gases and emit x-rays, which, if not properly contained, could result in property damage, bodily injury and death |
| A hazardous gas or x-ray leak could result in substantial liability and could also significantly damage customer relationships and disrupt future sales |
| Moreover, remediation could require redesign of the tools involved, creating additional expense, increasing tool costs and damaging sales |
| In addition, the matter could involve significant litigation that would divert management time and resource and cause unanticipated legal expense |
| Further, if such a leak involved violation of health and safety laws, we may suffer substantial fines and penalties in addition to the other damage suffered |
| We may not be successful in obtaining the necessary export licenses to conduct operations abroad, and the United States Congress may prevent proposed sales to foreign customers |
| We are subject to export control laws that limit who we sell to, what we sell and where |
| Moreover, licenses for the export are required from government agencies for some of our products in accordance with various statutory authorities, including the Export Administration Act of 1979, the International Emergency Economic Powers Act of 1977, the Trading with the Enemy Act of 1917 and the Arms Export Control Act of 1976 |
| We can give no assurance that we will be successful in obtaining these necessary licenses in order to conduct business abroad |
| Failure to comply with applicable export controls or the termination or significant limitation on our ability to export certain of our products would have an adverse effect on our business, results of operations and financial condition |