XNAS:ESIO Electro Scientific Industries Annual Report 10-K Filing - 3/31/2012
Effective Date 3/31/2012
| • FORM 10-K • AMENDMENT NO. 2 TO DEFERRED COMPENSATION PLAN 2008 RESTATEMENT • FORM OF RESTRICTED STOCK UNITS • FORM OF RESTRICTED STOCK UNITS AWARD • FORM OF STOCK APPRECIATION RIGHTS AGREEMENT • SUBSIDIARIES OF THE COMPANY • CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM • POWER OF ATTORNEY FOR FREDERICK BALL • POWER OF ATTORNEY FOR RICHARD J. FAUBERT • POWER OF ATTORNEY FOR EDWARD C. GRADY • POWER OF ATTORNEY FOR BARRY L. HARMON • POWER OF ATTORNEY FOR DAVID NIERENBERG • POWER OF ATTORNEY FOR JON D. TOMPKINS • POWER OF ATTORNEY FOR ROBERT R. WALKER • CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 • CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 • CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 • CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K
For the fiscal year ended March 31, 2012 OR
Commission File Number: 0-12853 ELECTRO SCIENTIFIC INDUSTRIES, INC. (Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: 503-641-4141 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value Series A No Par Preferred Stock Purchase Rights
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x Indicate by check mark if the Registrant is not required to file reports pursuant Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. ¨ Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨ Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the last sales price ($11.89) as reported by the NASDAQ Stock Market, as of the last business day of the Registrant’s most recently completed second fiscal quarter (September 30, 2011) was $292,569,038. The number of shares outstanding of the Registrant’s Common Stock as of June 4, 2012 was 29,141,902 shares. Documents Incorporated by Reference The Registrant has incorporated into Part III of this Form 10-K, by reference, portions of its Proxy Statement for its 2012 Annual Meeting of Shareholders.
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. 2012 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
Table of ContentsPART I
This annual report on Form 10-K contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in Item 1A Risk Factors. Where You Can Find More Information We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 as amended (Exchange Act). You can inspect and copy our reports, proxy statements and other information filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet site at www.sec.gov where you can obtain most of our SEC filings. We also make available, free of charge on our website at www.esi.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after they are filed electronically with the SEC. The information found on our website is not part of this Form 10-K. You can also obtain copies of these reports by contacting Investor Relations at (503) 641-4141. Fiscal Year Our fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, our fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012, our fiscal 2011 consisted of a 52-week period ending on April 2, 2011 and our fiscal 2010 reporting period consisted of a 53-week period ending on April 3, 2010. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted. Business Overview Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, communications and other industries. These features enable our customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States. Our advanced laser microfabrication systems allow microelectronics, semiconductor, and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance and improve production yields. Laser microfabrication comprises a set of precise micron-level processes, including via drilling, wafer scribing and dicing, material ablation, semiconductor memory-link cutting, electronic device trimming, and nano-level structuring to alter material characteristics such as color and texture. These processes require application-specific laser systems able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems improve production yields or enable improved performance for flexible interconnect material, semiconductor devices, light emitting diodes (LEDs), high-density interconnect (HDI) circuits, advanced semiconductor packaging, flat panel liquid crystal displays (LCDs) and other high value components. Additionally, we produce high-capacity test and inspection equipment that is critical to the quality control process during the production of multilayer ceramic capacitors (MLCCs). Our equipment ensures that each component meets the electrical and physical tolerances required to perform properly. We also produce products building on this technology that are used to test the electrical and optical characteristics, including wavelength, or color, and intensity, of packaged LEDs.
1
Table of ContentsIndustry Overview The microelectronics and semiconductor industries continue to be driven by demand for advanced features and improved functionality in increasingly smaller and smarter consumer devices. The technologies for consumer-oriented electronics such as smart phones, tablets, personal computers, mobile computing devices, video games and high-definition televisions have developed rapidly as increasingly affordable products have been introduced that offer more functionality in smaller packages. In addition, semiconductor and other advanced technologies are being used in a broadening set of markets and applications, including LEDs, solar, automotive, medical and security. These dynamics in turn are driving the need for faster, smaller, more complex, less expensive and higher-quality electronic devices and components. To achieve these improvements, component and other device manufacturers are increasing the circuit densities in these devices and investing in new technologies. For example, smaller and lighter semiconductor devices are driving the need to shrink the physical dimensions of the semiconductor packaging and the HDI circuit board on which they are mounted. Higher operating speeds of computers and communication products require more input and output channels within these packages and between the packages and the HDI circuit board. These trends require smaller, more accurate, and precisely tapered or shaped holes, known as vias, to create connections between layers and interconnecting devices. This trend is driving the use of an increasing amount of flexible interconnect between printed circuit boards (PCBs) and other components. These flexible circuits require the smallest and most accurate vias to create the connections between these devices. In addition, the ability to shrink the actual dimensions of a device is becoming increasingly more difficult, and producers are investing in new technologies, such as stacking thin silicon wafers into advanced three dimensional (3D) chip packages. We believe this trend will drive additional applications for laser processing, including scribing and dicing of ultra-thin wafers and drilling of through silicon vias (TSV). Smaller and more complex devices also require more capacitance to be designed into the circuit. This has resulted in a significant increase in the use of smaller, higher-capacitance passive components such as MLCCs. In calendar year 2011, estimated production of MLCCs was over 2 trillion units. These MLCCs must be tested electrically and optically to characterize performance and ensure reliability. Automated equipment to test these MLCCs in the manufacturing environment, like our high capacitance tester, can test and sort up to 750,000 parts per hour. Variations of advanced semiconductor technologies and manufacturing processes are increasingly being employed in the production of other types of devices and components, including LEDs. For example, automated laser-based systems, like our AccuScribe 2210 series, are used to scribe the sapphire wafer to separate individual devices in the production of LEDs. LEDs are increasingly utilized in electronics, display, automotive and general lighting applications. A significant portion of our business is derived from specialized microfabrication applications. Any material that can be cut, drilled, etched, or otherwise surface treated using a mechanical process can be microfabricated with greater precision and accuracy using a laser-based solution. As consumer electronics and other products or devices become more compact, mechanical processes will not be able to meet the stringent specifications demanded by producers. We believe the capabilities of laser-based solutions for microfabrication will enable our customers to move beyond the limitations of mechanical processes and generate significant growth for us in the future. Our Solutions We believe our products address the needs of microelectronics and semiconductor manufacturers by providing them with a high return on their investment due to measurable production benefits such as improved yield, increased throughput, higher performance, continued miniaturization and greater reliability.
2
Table of ContentsOur core competencies enable us to design, manufacture, and market a variety of integrated laser-based solutions for microfabrication applications in high-volume manufacturing environments. These core competencies include a deep understanding of laser/material interaction, laser beam positioning, optics and illumination including image processing and optical character recognition, high-speed motion control, small parts handling and systems engineering. We combine this technology expertise with a thorough understanding of our customers’ processes, and manufacturing agility to respond rapidly to customer demand to develop and deliver integrated solutions and products that address multiple markets and applications. Our customers manufacture components, semiconductors, interconnect/packaging devices, LEDs or other parts that serve a wide range of electronic applications. Our systems enable the manufacturing of these components and devices. The largest end-market applications for our customers are consumer electronics, computers and smart mobile devices. Our Strategy Our strategy is to leverage our core competencies to be a market leader in laser based microfabrication for microtechnology industries, including microelectronics, semiconductor, LED, and solar. These core competencies, combined with an understanding of our customers’ processes and the use of common platforms, enable us to address a broad range of laser-based applications and end markets within these industries. We intend to focus our efforts on businesses and applications where our differentiated capability enables us to be a market leader. The elements of our strategy are to gain share in our established markets and expand our addressable markets by (1) entering new applications within existing markets and (2) extending existing applications or technologies into adjacent markets. We will continue to invest in research and development to maintain our market leadership and increase the value of our products to global customers. Gain share in existing markets We intend to leverage our core competencies and existing technologies to grow our overall market position by serving manufacturers in semiconductor, advanced semiconductor packaging, flexible circuits, standard LEDs and passive components industries – markets in which we currently maintain a leadership position. We intend to maintain and grow our leadership position by developing new products and technologies that have higher performance, throughput and reliability, thereby providing greater technical capability and lowering the effective cost of ownership to our customers. Expand our addressable markets We plan to leverage our core competencies, customer collaboration, solutions expertise and common platforms to expand our addressable markets by entering into adjacent applications such as scribing, dicing, advanced microfabrication and inspection of different types of materials and devices within our existing markets. In addition, we believe there are opportunities to extend these same types of applications to enable better performance or yield improvement of devices or components used in adjacent end markets such as solar, medical, industrial and security. We intend to expand our addressable markets through both internal and external business development. Invest in research and development to maintain our technological leadership We intend to further develop our technological leadership by maintaining a significant level of investment in research and development. Our key technological capabilities include laser/material interaction, laser beam positioning, optics and illumination, including image processing and optical character recognition, high-speed motion control systems, small parts handling systems and systems integration. In addition, we continue to focus on developing and acquiring internal laser capability which can be used in our solutions. We consider our continuing ability to develop intellectual property to be an important component of our future success.
3
Table of ContentsIncrease the value of our products to global customers We are focused on improving our customers’ yield, throughput and productivity by utilizing our technology, global infrastructure, customer service and ability to integrate multiple technologies. We work with our market-leading, global customers through high-level, multi-disciplinary management and employee teams to define and produce the next generation of manufacturing systems. This requires confidential interaction between the customer and ESI, sharing technology and product roadmaps often looking out over a three- to five-year period. Our increased presence in Asia has allowed us to form even closer relationships with key customers in that region. Our Products We operate in one segment, high-technology manufacturing equipment, which is comprised of products that are organized in three groups: interconnect & microfabrication, semiconductor and components. Interconnect & Microfabrication Group (IMG) Our Interconnect & Microfabrication Group products address an expanding number of applications and materials on a broad set of substrates, including panels, continuous-feed reels, and discrete three dimensional components or devices. Interconnect Via Drilling For electrical interconnect applications, our laser microvia engineering systems target applications that require the highest accuracy and smallest via (hole) dimensions to create electrical connections between layers in flexible circuits, high-density circuit boards and IC packages. Our microvia drilling technology addresses the rapidly changing applications in IC packages, multichip modules and HDI circuit boards. Our ultraviolet (UV) laser processing systems employ state-of-the-art technology in lasers, optics and motion control. These products include single-beam and multi-beam systems that produce high-quality vias with the best-in-class placement accuracy for improved yield of packages and substrates. Advanced Microfabrication Our systems can be configured with a variety of lasers and material handling devices that make them ideal for other advanced laser-based microfabrication applications. As technologies enable shrinking sizes and consumer electronics and other devices become more compact, mechanical processes are not able to meet the stringent specifications demanded by manufacturers. We offer several platforms that enable customers to perform precision drilling, scribing, etching, routing or nano-structuring in many different types of materials and devices including glass, metal, plastic, paint and ceramics. The processed material or device is used in many different end markets including microelectronics, computer, medical, energy and display. Our model ML5900 is a particularly versatile platform optimized for industrial production and includes integrated inspection and a rotary stage for parallel processing of devices. We believe the capabilities of laser-based solutions for microfabrication will enable our customers to move beyond the limitations of mechanical processes. We also offer laser ablation systems that ablate material for identification and analysis applications, including forensics, mineral analysis and research. In September 2010, we acquired PyroPhotonics Lasers, Inc., a manufacturer of tailored-pulse fiber lasers. These lasers are used extensively in our memory repair systems. We believe this laser technology can also be utilized in solar and other microfabrication applications. Semiconductor Group (SG) Our Semiconductor Group products address multiple applications that utilize laser energy to process materials on wafer-based substrates. This includes traditional silicon wafers, LEDs wafers, and new ultrathin silicon wafers used in the three-dimensional (3D) packaging applications.
4
Table of ContentsSemiconductor Memory Yield Improvement Systems Our semiconductor memory yield improvement products are designed to cost-effectively meet the production challenges faced by semiconductor manufacturers, including shrinking circuit sizes, material changes and increasing numbers of memory devices per wafer. As circuit densities in semiconductor memory devices such as dynamic random access memory (DRAM) have increased, manufacturers have built redundant cells into their memory designs and connected them with small electrical links on the device surface. During the manufacturing process, wafers with billions of individual memory cells are tested to identify defective cells. Our laser systems are then used to cut links that reprogram the device by disconnecting the paths to defective portions of the memory device and replacing them with functional redundant cells. This process enables significant post-repair yield improvements that are essential to our customers’ profitability. Our 98XX series systems are designed specifically for the 300mm wafer processing market but can also handle 200mm wafers. Our systems can be configured for multiple colors including infrared, green and UV. With the introduction of our 9850TPIR+ Dual-Beam, Tailored-Pulse Laser Link-Processing system, we offer unmatched flexibility in processing complex, next-generation fuse designs and materials. In addition, our dual-beam architecture provides significant throughput advantages compared to a single-beam repair tool. These high performance systems deliver increased manufacturing productivity and lower cost of ownership. Ultra-Thin Silicon Wafer Processing The advent of 3D chip packaging technologies is driving the need for silicon wafers to become thinner in order to allow for stacking of wafers within the same packaging geometry. As wafers become thinner, they become more challenging to cut into discrete chips using traditional mechanical saws. Our model 9900 uses a laser to dice ultra-thin silicon wafers, those with a thickness of 50 microns or below. The model 9900 also enables 3D packaging through its ability to process through-silicon vias that are key to electrically connecting the stacked wafers. As 3D technologies are developed, we believe the use of lasers will become increasingly important to productivity and performance. LED Wafer Scribing Our AccuScribe line of sapphire wafer scribing systems is a key component in the manufacture of LEDs. During production, LEDs are created on a thin wafer of synthetic sapphire crystal that must be broken into individual units at the end of the process. The brittle nature of the sapphire wafer requires that it be carefully cut in order to prevent unwanted fractures and yield losses when the wafer is broken apart into discrete LEDs. The AccuScribe systems use a laser to scribe the wafer with a precise groove between individual LEDs. When mechanical force is applied to the wafer, it fractures along these grooves and allows the wafer to be split apart into discrete LEDs. As requirements for the light output of LEDs increase, driven by general illumination, the challenges to scribe the wafer without damaging the device and impacting the light output become more difficult. We believe our new AccuScribe 2600 will enable the scribing of these devices without impacting light output and will be capable of scribing the most advanced LED designs for general illumination applications. LCD Repair Our laser LCD repair systems are critical to improving yields in the manufacture of flat panel displays. During production, individual pixels of a display may develop electrical defects that result in no light emission or the emission of only a steady white light. To correct these defects, flat panel display producers employ a laser repair process to isolate the electrical defects during production by cutting the inputs to the pixel. Our laser systems are primarily sold to the manufacturers of LCD repair tools as a key component of their products.
5
Table of ContentsComponents Group (CG) We design and manufacture products that combine high-speed small parts handling technology with real-time control systems to provide highly automated, cost-effective solutions for manufacturers of MLCCs and other passive components such as capacitor arrays, inductors, resistors, varistors and hybrid circuits. These components, produced in quantities of trillions of units per year, process analog, digital and high-frequency signals and are used extensively in nearly all electronic products. We provide several types of products and solutions in this market. Our MLCC test systems employ high-speed handling and positioning techniques to precisely load, test and sort MLCCs based on their electrical energy storage capacity, or capacitance, and their electrical energy leakage, or dissipation factor. Our 35XX series is the most productive tester in the market today and continues to gain acceptance with major MLCC manufacturers that have traditionally developed and used their own in-house systems. Our latest 3510 model enables high speed testing of the industry’s smallest metric 0402 capacitors used primarily in advanced cell phone and tablet designs. Circuit fine-tuning systems are application-specific laser systems that adjust the electrical performance of a hybrid circuit, or that adjust an electronic assembly containing many circuits, by removing a precise amount of material from one or more circuit components. Finally, we produce consumable products such as carrier plates and termination belts, both of which are used to hold MLCCs during the manufacturing and testing process. We have applied our proprietary handling technologies used for MLCC test to develop the 3800 LED Package Test System to perform high speed optical and visual test of packaged LEDs. Packaged LEDs are sorted by light output and color to enable the manufacturer to optimize price and color matching of the devices. We believe our technologies provide superior yield and throughput over existing tools. Customers Our top ten customers for 2012, 2011 and 2010 accounted for approximately 56%, 62% and 56% of total net sales, respectively. One customer, Apple Inc. and its affiliates, accounted for approximately 29%, 24% and 30% of total net sales in 2012, 2011 and 2010, respectively. In 2011, Hynix Semiconductor Inc. and Taiyo Yuden Co., Ltd., each individually accounted for approximately 11% of total net sales. No other customer individually accounted for more than 10% of total net sales in 2012, 2011 or 2010. See Note 23 “Product and Geographic Information” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data for our net sales by geographic area. Sales, Marketing and Service We sell our products worldwide through direct sales and service offices, value-added resellers and independent representatives located around the world. ESI has direct sales and service personnel in Oregon, California and several other states; China, Japan, Korea, Singapore and Taiwan in Asia; and France, Germany and the United Kingdom in Europe. We serve selected customers in the Americas, Europe, Israel and additional countries through manufacturers’ representatives. We have a substantial base of installed products in use by leading microelectronics and semiconductor manufacturers. We emphasize strong working relationships with these customers to meet their needs for additional systems and to facilitate the successful development and sale of new products to these customers. We generally employ service personnel wherever we have a significant installed base. We offer a variety of warranty, maintenance and parts replacement programs to service the requirements of our customers’ high-volume manufacturing environments. Backlog Backlog consists of purchase orders for products and spare parts that we expect to ship within 12 months and service contracts for performance generally within 24 months. Backlog does not include deferred system
6
Table of Contentsrevenue. Backlog was $69.1 million at March 31, 2012 compared to $65.5 million at April 2, 2011, representing an increase of 5% driven by timing of shipments. The stated backlog is not necessarily indicative of sales for any future period, because of possible order cancellations or deferrals, shipping or acceptance delays, nor does backlog represent any assurance that we will realize a profit from filling the orders. Research, Development and Technology We believe that our ability to compete effectively and deliver customer solutions depends, in part, on our ability to maintain and expand our expertise in core technologies and product applications. Our primary core competencies and capabilities include:
Our research and development expenditures for 2012, 2011 and 2010 were $42.6 million (17% of net sales), $41.1 million (16% of net sales) and $33.6 million (23% of net sales), respectively. Competition Our markets are dynamic, cyclical and highly competitive. The principal competitive factors in our markets are product performance, cost of ownership, ease of use, reliability, service, technical support, a product improvement path, price, proprietary technology, manufacturing responsiveness and established relationships with customers, which includes familiarity with their products. We believe that our products compete favorably with respect to these factors. Some of our competitors have greater financial, engineering and manufacturing resources and larger distribution networks than we do. Some of our customers develop, or have the ability to develop, manufacturing equipment similar to our products. Competition in our markets may intensify and our technological advantages may be reduced or lost as a result of technological advances by competitors or customers or changes in electronic device processing technology. Our Interconnect & Microfabrication Group competes with laser systems provided by Hitachi Via Mechanics, Ltd., LPKF Laser & Electronics AG, Mitsubishi Electric Corporation and several Chinese and Korean companies who compete within their local markets. The principal competitor for our Semiconductor Group is GSI Group Inc. Competitors for LED scribing include DISCO Corporation, JP Sercel Associates, Inc. and Laser Solutions, Inc. LCD repair competitors include Quantel USA, Inc. and HOYA Corporation. For the Components Group, our competitors include Humo Laboratory, Ltd., GSI Group Inc., Ismeca Semiconductor SA, Shibuya Kogya Co., Ltd. and Tokyo Weld Co., Ltd. as well as component manufacturers that develop systems for internal use. Manufacturing and Supply Our primary production facilities are located in Singapore; Portland, Oregon; Klamath Falls, Oregon; and Beijing, China. Our Singapore facility is our primary systems manufacturing facility and manufactures certain IMG, LED, CG and laser ablation products. The Portland facility manufactures our SG products and provides
7
Table of Contentsadvanced manufacturing and prototype capability. The Klamath Falls facility manufactures CG consumable products. The Beijing facility manufactures certain laser products. Our Singapore and Beijing, China, operations are located in leased facilities. As we continue our efforts to streamline the organization and improve efficiencies, we expect a growing percentage of final systems will be shipped from Singapore. We use qualified manufacturers to supply many components and sub-system modules for our products. Our systems use high-performance computers, peripherals, lasers and other components from various suppliers. Some of the components we use are obtained from a single source or a limited group of suppliers. An interruption in the supply of a particular component would have a temporary adverse impact on us. We believe our relationships with our suppliers are good. Patents and Other Intellectual Property We have a policy of seeking patents, when appropriate, on inventions relating to new products and improvements that are discovered or developed as part of our ongoing research, development and manufacturing activities. We own 222 United States patents and 460 patents issued outside of the United States as of March 31, 2012. Additionally, as of March 31, 2012, we had 400 patent applications pending in the United States and 1,629 patent applications pending outside of the United States. Although our patents are important, we believe that the competitiveness of our products also depends on the technical competence and innovation of our employees. We rely on copyright protection for our proprietary software. We also rely upon trade secret protection for our confidential and proprietary information. Others may independently develop substantially equivalent proprietary information and techniques, and we may be unable to meaningfully protect our trade secrets. Employees As of March 31, 2012, we employed 627 people. Many of our employees are highly skilled, and our success will depend in part upon our ability to attract and retain such employees, who are in great demand. We have never had a work stoppage or strike, and no employees are represented by a labor union or covered by a collective bargaining agreement. We consider our employee relations to be good. Environmental Compliance During fiscal 2012, we retained ISO 14001 certification via surveillance audit for our environmental management system for our Portland, Oregon operations. We do not expect compliance with international, federal, state and local provisions that have been enacted or adopted related to the discharge of materials into the environment or otherwise relating to protection of the environment to have a material effect on our capital expenditures, earnings or competitive position. Section 1502 of the Dodd-Frank act enacted in July 2011 requires disclosure about the use of certain specified conflict minerals emanating from Democratic Republic of the Congo and neighboring counties. We await issuance of the final rules surrounding the disclosure requirements from the SEC which will enable estimation of compliance costs.
8
Table of Contents
The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may differ materially. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to, the following: Risks Related to Our Competition and Customers Volatility of Our Customers’ Industries Our business is dependent upon the capital expenditures of manufacturers of microelectronics, semiconductors and light emitting diodes (LEDs) used in consumer electronics, computers, wireless communications and other electronic products. The capital equipment market for microelectronics, semiconductor and consumer electronics manufacturers has historically been characterized by sudden and severe cyclical variations in product supply and demand due to a number of factors including capacity utilization, timing of customers’ new product introductions and demand for their products, inventory levels relative to demand and access to affordable capital. The timing, severity and duration of these market cycles are difficult or impossible to predict. As a result, business levels can vary significantly from quarter to quarter or year to year. Significant downturns in the market for microelectronics, semiconductors, and LEDs used in electronic devices or in the market for consumer electronics reduce demand for our products and may materially and adversely affect our business, financial condition and results of operations. For example, starting in the second half of fiscal 2012, we experienced the negative impact of an uncertain economic environment, slower market growth and overcapacity in several of our markets, which resulted in overall lower order and revenue levels. As a result of this uncertain economic environment, our total order volume declined in 2012 compared to 2011. The degree of the impact of any downturn on our business depends on a number of factors, including: the strength of the global and United States economies; the overall level of demand for consumer electronics products; the stability of global financial systems; and the overall health of the microelectronics, semiconductor, LEDs and consumer electronics industries. Highly Competitive Markets We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to, and new generations of, products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We believe that to be competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements. We may not be able to compete successfully in the future and increased competition may result in price reductions, reduced profit margins and loss of market share. Increased Price Pressure We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products. In addition, we may agree to pricing concessions with our customers in connection with volume orders. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.
9
Table of ContentsRevenues are Largely Dependent on Few Customers We depend on a few significant customers for a large portion of our revenues. In 2012, our top ten customers accounted for approximately 56% of total net sales, with one customer accounting for approximately 29% of total net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in technologies or solutions used by customers, changes in products manufactured by customers or in end-user demand for those products, selection of suppliers other than us, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. If we were to lose any of our significant customers or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected. Revenues are Largely Based on the Sale of a Small Number of Product Units We derive a substantial portion of our revenue from the sale of a relatively small number of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:
As a result of these risks, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance. Risks Related to Our Supply Chain and Production Variability of Production Capacity To meet rapidly changing demand in the industries we serve, we must effectively manage our resources and production capacity. During periods of decreasing demand for our products, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our supply chain. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in next-generation product technology and to support and service our products. Conversely, when upturns occur in the markets we serve, we may have difficulty rapidly and effectively increasing our manufacturing capacity or procuring sufficient materials to meet sudden increases in customer demand that could result in the loss of business to our competitors and harm to our relationships with our customers. If we are not able to timely and appropriately adapt to changes in our business environment, our business, financial condition or results of operations may be materially and adversely affected. Problems with Critical Suppliers We use a wide range of components from numerous suppliers in the manufacture of our products, including custom electronic, laser, optical and mechanical components. We generally do not have guaranteed supply
10
Table of Contentsarrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, some key parts are available only from a single supplier or a limited group of suppliers in the short term. In addition, some of the lasers we use in our products are difficult to manufacture, and as a result we may not receive an adequate supply of lasers in a timely fashion to fill orders. Operations at our suppliers’ facilities are subject to disruption or discontinuation for a variety of reasons, including changes in business relationships, competitive factors, financial difficulties, work stoppages, fire, natural disasters or other causes. Any such disruption or discontinuation to our suppliers’ operations could interrupt or reduce our manufacturing activities and delay delivery of our products, any or all of which could materially and adversely affect our results of operations. In addition, when markets recover from economic downturns, there is a heightened risk that one or more of our suppliers may not be able to meet increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers. Problems with Contract Manufacturers We have arrangements with contract manufacturers to complete the manufacturing of certain of our products or product subcomponents. Any significant interruption in our contract manufacturers’ ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, financial difficulties, natural disasters, delay or interruption in the receipt of inventory, customer prioritization or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations. Charges for Excess or Obsolete Inventory One factor on which we compete is the ability to ship products on schedules required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine inventory to be purchased. We also order materials based on our technology roadmap, which represents management’s assessment of technology that will be utilized in new products that we develop. Certain types of inventory, including lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which would negatively affect our financial results. Also, if we alter our technology or product development strategy, we may have inventory that may not be usable under the new strategy, which may also result in material accounting charges. For example, during 2012, we recorded $2.0 million of charges in cost of sales for an inventory write-off associated with discontinued products. Risks Related to Our Organization Operating a Global Business International shipments accounted for 92% of net sales in 2012, with 87% of our net shipments to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. We also have significant foreign operations, including manufacturing facilities in Singapore and China, research and development facilities in Canada and Taiwan, and sales and service offices in various countries. Under our globalization strategy, we intend to increase our foreign operations in the future. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:
11
Table of Contents
Our business and operating results could also be impacted, directly or indirectly, by natural disasters, outbreaks of infectious disease, military action, international conflicts, terrorist activities, civil unrest and associated political instability. Many of our facilities, including our Portland, Oregon headquarters, are in areas with known earthquake risk. Some of these events or circumstances may also result in heightened security concerns with respect to domestic and international travel and commerce, which may further affect our business and operating results. In particular, due to these uncertainties, we are subject to the following additional risks:
Implementation and Modification of Globalization Strategy We are implementing our globalization strategy in which we are moving certain operational resources and capabilities to different countries in Asia to be closer to many of our significant customers and to reduce costs. We believe this strategy will enhance customer relationships, improve our responsiveness, and reduce our manufacturing costs for certain products. We opened a manufacturing facility in Singapore in the fourth quarter of 2010, which manufactures certain IMG, LED, CG and laser ablation products and is now our primary system manufacturing facility. Additionally, we have a manufacturing facility in Beijing China, which manufactures certain laser products. Our globalization strategy is subject to a variety of complexities and risks, many of which we have little experience managing, and which may divert a substantial amount of management’s time. These risks include:
12
Table of Contents
These and other factors could delay the development and implementation of our strategy, as well as impair our gross margins, delay shipments and deliveries, cause us to lose sales, require us to write off investments already made, damage our reputation and harm our business, financial condition and results of operations. If we decide to change our current globalization strategy, we may incur charges for certain costs incurred. Acquisitions and Divestitures We may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies, such as our September 2010 acquisition of certain assets of PyroPhotonics Lasers, Inc. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:
Furthermore, the accounting for an acquisition could result in significant charges resulting from amortization or write-off of intangible assets we acquire. Our inability to effectively manage these risks could result in our inability to realize the anticipated benefits of an acquisition on a timely basis, or at all, and materially and adversely affect our business, financial condition and results of operations. In addition, all acquisition transaction costs must be expensed as incurred rather than capitalized, which may have a material adverse effect on our results of operations. The means by which we finance an acquisition may also significantly affect our business or the value of the shares of our common stock. If we issue common stock to pay for an acquisition, the ownership percentage of our existing shareholders will be diluted and the value of the shares held by our existing shareholders could be reduced. If we use cash on hand to pay for an acquisition, the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. If we borrow funds in connection with an acquisition, we would be required to use cash to service the debt and to comply with financial and other covenants. We may from time to time also make strategic investments in development stage companies. Investments in development stage companies are subject to a high degree of risk. We could lose all or a portion of our investment in any such company.
13
Table of ContentsHiring and Retention of Personnel Our continued success depends in part upon the services of our key managerial, financial and technical personnel. The loss of key personnel, or our inability to attract, assimilate and retain qualified personnel, could result in the loss of customers, inhibit our ability to operate and grow our business and otherwise have a material adverse effect on our business and results of operations. We have previously had to, and may in the future have to, impose salary reductions on employees during economic downturns in an effort to maintain our financial position. These actions may have an adverse effect on employee loyalty and may make it more difficult for us to attract and retain key personnel. Competition for qualified personnel in the industries in which we compete is intense, and we may not be successful in attracting and retaining qualified personnel. We may incur significant costs in our efforts to recruit and retain key personnel, which could affect our financial position and results of operations. Risks Related to Technology Markets Characterized by Rapid Technological Change The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes and the requirements of current and potential customers. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. The introduction by us or by our competitors of new or enhanced products, or alternative technologies, may cause our customers to defer, change or cancel orders for our existing products or cease purchasing our products altogether. For example, our semiconductor memory customers are exploring alternative redundancy technologies such as electrical redundancy technology. If our customers were to achieve sufficient yield improvement with one of these technologies and convert it into their manufacturing process, there could be a material adverse effect on the size of the addressable market of our memory yield improvement systems. In addition, we believe the semiconductor memory repair market is maturing, which could result in lower demand for our memory repair products during up cycles than we have experienced historically. Further, we cannot assure that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technology changes or emerging industry standards. If we are unable to develop new or enhanced products to address product or technology changes or new industry standards on a timely basis or at all, or if our new or enhanced products are not accepted by the market, or if our customers adopt alternative technologies, our business, financial condition and results of operations may be adversely affected. Need to Invest in Research and Development Our industry is characterized by the need for continued investment in research and development. Because of intense competition in the industries in which we compete, if we were to fail to invest sufficiently in research and development, our products could become less attractive to our current and potential customers or obsolete, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area, our operating results could be materially harmed if our net sales decline. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales. Products are Highly Complex Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer
14
Table of Contentssatisfaction or result in claims against us. As a result, we may have to replace certain components or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products, loss of sales and increased expenses and warranty costs, which would harm our business and adversely affect our revenues and profitability. Risks Related to Legal Matters Protection of Proprietary Rights – Generally Our success depends significantly upon the protection of our proprietary rights. We attempt to protect our proprietary rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. We incur substantial costs to obtain and maintain patents and to defend our intellectual property rights. For example, we initiated litigation against All Ring Tech Co., Ltd. in Taiwan in August 2005 alleging that certain of our patent rights had been violated. We rely upon the laws of the United States and foreign countries where we develop, manufacture or sell our products to protect our proprietary rights. 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. Protection of Proprietary Rights – Foreign Jurisdictions Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. Many United States companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins. Intellectual Property Infringement Claims Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. While we attempt in our designs to avoid patent infringement, from time to time we and our 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. Competitors or others have in the past and may in the future assert infringement claims against our customers or us 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 damages or expenses they incur. If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question 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, our financial condition and results of operations could be materially and adversely affected. Tax Audits and Changes in Tax Law We are periodically under audit by United States and foreign tax authorities and may have exposure to additional tax liabilities as a result. Significant judgment is required in determining our provision for income and other tax liabilities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made.
15
Table of ContentsLegal Proceedings From time to time we are subject to various legal proceedings, including breach of contract claims and claims that involve possible infringement of patent or other intellectual property rights of third parties. It is inherently difficult to assess the outcome of litigation matters, and there can be no assurance that we will prevail in any litigation. Any litigation could result in substantial cost and diversion of management’s attention, which by itself could have a material adverse effect on our financial condition and results of operations. Further, adverse determinations in such litigation could result in loss of our property rights, subject us to significant liabilities, require us to seek licenses from others or prevent us from manufacturing or selling our products, any of which could materially adversely affect our business, financial condition, results of operations or cash flows. Provisions Restricting Our Acquisition 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. Our Board of Directors has also adopted a shareholder rights plan, or “poison pill,” which would significantly dilute the ownership of a hostile acquirer. In addition, the Oregon Control Share Act and the Oregon Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the effect of lengthening the time required for a person to acquire control of us through a proxy contest or the election of a majority of our Board of Directors, may deter efforts to obtain control of us and may 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. Risks Related to Financial Matters Unfavorable Currency Exchange Rate Fluctuations Currency exchange rate fluctuations could have an adverse effect on our sales and results of operations and we could experience losses with respect to forward exchange contracts into which we may enter. Unfavorable currency fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to those customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our results of operations could be materially and adversely affected. In addition, some of our foreign sales are denominated in the currency of the country in which these products are sold and the currency we receive in payment for such sales could be less valuable at the time of receipt as a result of exchange rate fluctuations. From time to time, we enter into forward exchange contracts to hedge the value of accounts receivable primarily denominated in Japanese yen and other currencies. However, we cannot be certain that our efforts will be adequate to protect us against significant currency fluctuations or that such efforts will not expose us to additional exchange rate risks, which could adversely affect our results of operations. Fluctuations in Effective Tax Rate As a global company, we are subject to taxation in the United States and numerous foreign jurisdictions. Our effective tax rate is subject to fluctuation from one period to the next because the income tax rates for each year are a function of many factors, including: (a) taxable income levels and the effects of a mix of profits (losses) earned by ESI and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates; (b) our ability to utilize deferred tax assets; (c) taxes, refunds, interest or penalties resulting from tax audits; (d) the magnitude of various credits and deductions as a percentage of total taxable income; and (e) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial position and results of operations.
16
Table of ContentsImpairment of Intangible Assets We held a total of $8.3 million in acquired intangible assets and $4.0 million in goodwill at March 31, 2012. We review our acquired intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment using a qualitative and quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value. We performed our annual goodwill impairment analysis during the fourth quarter of 2012 and determined that it was not “more likely than not” that the fair value of our single reporting unit was less than its carrying value. Based on current economic conditions combined with our stock price, which has remained below carrying value per share since mid-May 2012, we anticipate performing a goodwill impairment test during the first quarter of 2013. If at any time management determines that an impairment exists, we will be required to reflect the impaired value as part of operating income, which will result in a reduction in earnings and a corresponding reduction in our net asset value in the period such impairment is identified. Stock Price Volatility The market price of our common stock has fluctuated widely. During fiscal 2012, our stock price fluctuated between a high of $19.88 per share and a low of $11.10 per share. Consequently, the current market price of our common stock may not be indicative of future market prices, and we may be unable to sustain or increase the value of an investment in our common stock. Factors affecting our stock price, many of which are outside of our control, may include:
In addition, the stock market has recently experienced significant price and volume fluctuations. These fluctuations have particularly affected the market prices of the securities of high-technology companies like ours. These market fluctuations could adversely affect the market price of our common stock. Reduction or Cessation of Dividends Our Board of Directors first adopted a dividend policy in December 2011. We intend to pay quarterly dividends subject to capital availability and periodic determinations by our Board of Directors that cash dividends are in the best interest of our shareholders and are in compliance with all laws and agreements applicable to the declaration and payment of cash dividends. Future dividends may be affected by, among other factors: our views on potential future capital requirements for investments in acquisitions; funding of research and development; legal risks; stock repurchase programs; changes in federal and state income tax laws or corporate laws; and changes to our business model. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. A reduction or cessation in our dividend payments could have a negative effect on our stock price.
17
Table of ContentsImpairment of Investments Our investment portfolio is primarily comprised of commercial paper, debt securities issued by U.S. governmental agencies and municipal debt securities. These investments are intended to be highly liquid and low risk. If the markets for these securities were to deteriorate for any reason, including as a result of a downgrade in the credit rating of U.S. government securities, the liquidity and value of these investments could be negatively affected, which could result in impairment charges. Any such impairment charges may have a material impact on our financial condition and results of operations.
None.
Our executive and administrative headquarters, which houses our primary engineering and marketing functions as well as some of our Semiconductor Group (SG) manufacturing facilities, are located in a four-building complex with 250,800 square feet of space on 15 acres in Portland, Oregon. Additionally, our Components Group (CG) consumable products are manufactured at a 53,000 square foot plant on 31 acres in Klamath Falls, Oregon. We own all of these buildings. We believe the productive capacity of these facilities to be adequate and suitable for the requirements of our business for the foreseeable future. Our primary system manufacturing facilities are located in leased facilities in Singapore. We lease approximately 26,000 square feet of facilities in Singapore where we manufacture certain Interconnect & Microfabrication Group (IMG), LED, CG and laser ablation products. We also lease approximately 65,000 square feet of facilities in Fremont, California that are used primarily for engineering and marketing of our LED products and as a demonstration center for our microfabrication systems. We additionally lease approximately 20,150 square feet of facilities in Beijing, China, where we manufacture certain laser products. Additionally, we lease other office and facility space in various locations throughout the United States and various foreign countries.
All Ring Patent Infringement Prosecution In August 2005, we commenced a proceeding in the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. We alleged that All Ring’s Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes ESI’s Taiwan Patent No. 207469, entitled “Circuit Component Handler” (the 207469 patent). As part of this proceeding, the Court issued a Provisional Attachment Order (PAO) in August 2005, restricting the use of some of All Ring’s assets. All Ring then filed a bond with the Court to obtain relief from the attachment of its assets. In July 2007, the Court issued a second PAO and approximately $6.0 million was restricted in All Ring’s accounts. The second PAO remains in effect and cannot be revoked. In October 2005, we filed a formal patent infringement action against All Ring in the Court. Also in October 2005, the Court executed a Preliminary Injunction Order (PIO) that prohibits All Ring from manufacturing, selling, offering for sale or using the Capacitor Tester until final judgment is entered in the formal patent infringement action. The Court dismissed All Ring’s application to revoke the PIO on January 18, 2008, and the PIO remains in place. On June 3, 2011 the Court orally announced its judgment, finding that the Capacitor Tester, as well as All Ring’s RK-T2000 and RK-L50 systems, had infringed the 207469 patent, ordering All Ring to pay ESI approximately $24 million in damages, plus interest accrued from November 4, 2005 through the payment date at a rate of 5%, and enjoining All Ring from selling the infringing systems. The written judgment was issued on
18
Table of ContentsJune 13, 2011. On June 16, 2011, All Ring posted a cash bond for approximately $24.0 million to prevent the provisional execution of the judgment. All Ring appealed this judgment to the Intellectual Property Court on June 28, 2011 and on October 31, 2011, we filed our response to All Ring’s appeal. We and All Ring have each filed additional briefs with the Intellectual Property Court. The Intellectual Property Court is expected to hold its final hearing in this matter in October 2012. As a part of these proceedings, we established three letters of credit for approximately $19.5 million in July 2009, September 2009 and June 2011, which are collateralized by $22.3 million of restricted cash. The total restricted cash balance of $22.3 million was included in Restricted cash on the Consolidated Balance Sheets at March 31, 2012 as a current asset. In the ordinary course of business, we are involved in various other legal matters, either asserted or unasserted, and investigations. In the opinion of management, ultimate resolution of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Not Applicable.
19
Table of ContentsPART II
Common Stock Prices Our common stock trades on the NASDAQ Stock Market under the symbol ESIO. There were approximately 562 shareholders of record as of June 4, 2012, and on that date there were 29,141,902 common shares outstanding. The closing price on June 4, 2012 was $10.89. The following table shows the high and low closing prices for our common stock as reported on the NASDAQ Stock Market for the fiscal quarters indicated:
Share Repurchase Program On May 15, 2008, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock primarily to offset dilution from equity compensation programs. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. There was no fixed completion date for the repurchase program. We did not repurchase any shares under this program during 2012. As of March 31, 2012, a total of 372,825 shares had been repurchased for $5.3 million under this authorization at an average price of $14.16 per share, calculated inclusive of commissions and fees. Any cash used to settle repurchase transactions is reflected as a component of cash used in financing activities on the Consolidated Statements of Cash Flows. On December 9, 2011, the Board of Directors terminated the prior repurchase program and authorized a new share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. We did not repurchase any shares under this program in 2012. There is no fixed completion date for the repurchase program. Disclosures related to securities authorized for issuance under our Equity Compensation Plans are incorporated by reference into Item 12 of this annual report on Form 10-K, Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters, from our Proxy Statement for our fiscal 2012 annual meeting.
20
Table of ContentsDividends On December 9, 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. Accordingly, we declared a dividend of $0.08 per outstanding common share to shareholders of record on January 27, 2012. During the fourth quarter of 2012, we paid the dividend for a total amount of $2.3 million. There were no dividends declared or paid during 2011. Subsequent to the year ended March 31, 2012, the Board of Directors declared an $0.08 per outstanding common share cash dividend on May 10, 2012, payable June 18, 2012 to shareholders of record on June 4, 2012. The estimated amount to be paid as a result of the May 10, 2012 declaration is $2.3 million. ESI currently anticipates that it will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on ESI’s financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of ESI’s shareholders.
21
Table of ContentsStock Performance Graph The graph below compares the cumulative 58-month total return to holders of Electro Scientific Industries, Inc. common stock with the cumulative total returns of the S&P 500 Index and the S&P Information Technology Index for the same period. The graph assumes that the value of the investment in Electro Scientific Industries, Inc. common stock and in each of the indices (including reinvestment of dividends) was $100.00 on June 2, 2007 and tracks it through March 31, 2012. Historical stock price performance should not be relied upon as indicative of future stock price performance.
22
Table of Contents
23
Table of Contents
Overview of Business Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, communications and other industries. These features enable our customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States. Our advanced laser microfabrication systems allow microelectronics, semiconductor, and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance and improve production yields. Laser microfabrication comprises a set of precise micron-level processes, including via drilling, wafer scribing and dicing, material ablation, semiconductor memory-link cutting, electronic device trimming, and nano-level structuring to alter material characteristics such as color and texture. These processes require application-specific laser systems able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems improve production yields or enable improved performance for flexible interconnect material, semiconductor devices, light emitting diodes (LEDs), high-density interconnect (HDI) circuits, advanced semiconductor packaging, flat panel liquid crystal displays (LCDs) and other high value components. Additionally, we produce high-capacity test and inspection equipment that is critical to the quality control process during the production of multilayer ceramic capacitors (MLCCs). Our equipment ensures that each component meets the electrical and physical tolerances required to perform properly. We also produce products building on this technology that are used to test the electrical and optical characteristics, including color and intensity, of packaged LEDs. Overview of Financial Results Our fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, our fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012, our fiscal 2011 reporting period consisted of a 52-week period ending on April 2, 2011 and our fiscal 2010 reporting period consisted of a 53-week period ending on April 3, 2010. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted. In the first half of 2012, the combination of relatively healthy markets, strong sales of new products and delivery on 2011 backlog drove excellent revenue growth. In the second half of 2012, we experienced the negative impact of an uncertain economic environment, slower market growth and overcapacity in several of our markets, which resulted in overall lower order and revenue levels. Despite the impact of this trend, our flex interconnect business experienced healthy growth over the prior year. Our total order volume in 2012 was $255.5 million, down approximately 10%, compared to orders of $284.6 million in 2011. Orders for our Interconnect & Microfabrication (IMG) products increased by approximately 20% in 2012 compared to 2011. The increase was due to continued growth in our flex interconnect businesses driven by strong demand from our flex circuit customers for our industry leading 5330xi model via drilling system. The demand was primarily a result of increasing use of flexible circuitry and market growth of mobile electronics particularly smart phones and tablet devices. Orders for our microfabrication products were driven by follow on demand from existing applications and the introduction of our new model 5950 low cost platform. However, the lumpy nature of microfabrication design wins negatively impacted revenue levels for IMG in the second half of 2012. Orders for our Semiconductor Group (SG) products decreased approximately 45% in 2012 compared to 2011. The decrease was driven by lower demand for our memory repair systems and LED scribing systems as a primarily as a result of slower growth and overcapacity in the DRAM and LED markets in the second half of the year.
24
Table of ContentsOrders for our Components Group (CG) products decreased approximately 45% in 2012 compared to 2011. Our MLCC customers continued utilizing their existing capacity as growth in MLCC consumption reflected only modest demand for consumer electronics. Total shipments were $251.5 million in 2012 compared to $259.6 million in 2011. By product group, IMG shipments increased by approximately 35%, SG shipments decreased by approximately 30% in 2012 and CG shipments decreased by approximately 50%, all consistent with the trends in their respective order levels. Backlog was $69.1 million as of March 31, 2012 compared to $65.5 million as of April 2, 2011. Net sales were $254.2 million in 2012 compared to $256.8 million in 2011. This decrease was primarily due to lower sales in SG and CG driven by lower demand for DRAM and by MLCC customers’ continued utilization of existing capacity, partially offset by the increase in IMG sales as a result of higher demand for our flex-circuit via drilling and shipments of our advanced microfabrication systems. Gross profit was $107.7 million in 2012 compared to $108.9 million in 2011. This decrease was primarily due to $2.0 million of charges in cost of sales for an inventory write-off associated with discontinued products in the fourth quarter. Gross margins were 42.4% on net sales of $254.2 million in 2012 compared to 42.4% on net sales of $256.8 million in 2011. While overall gross margins remained flat year over year on similar volumes, excluding the inventory write-off, they improved slightly on favorable product mix. Net operating expenses of $106.5 million in 2012 increased $5.0 million from $101.5 million in 2011. This increase was primarily due to a $3.0 million increase in restructuring costs, a $2.1 million increase in share-based compensation expense and a $1.2 million increase in loss on disposal of assets and the write-off of engineering materials. These increases were partially offset by savings achieved from cost control measures and the reduction in net legal settlements from the prior year. The increases in restructuring costs and the loss on disposal of assets were a result of implementing our ongoing globalization strategy and other cost control measures. The increase in share-based compensation expense was primarily due to accelerated expense associated with the Chief Executive Officer’s retirement eligibility date and increased attainment of performance-based grants. Operating income was $1.2 million in 2012 compared to $7.4 million in 2011, a decrease of $6.2 million. This decrease was primarily due to higher operating expenses and the charge for an inventory write-off discussed above. Non-operating income was $2.3 million in 2012 compared to $0.9 million in 2011. The increase was primarily due to a $2.0 million increase in gain on sale of previously impaired auction rate securities (ARS), compared to 2011. Net income was $4.9 million in 2012 compared to net income of $7.9 million in 2011.
25
Table of ContentsResults of Operations The following table presents results of operations data as a percentage of net sales for the years ended March 31, 2012, April 2, 2011 and April 3, 2010:
Fiscal Year Ended March 31, 2012 Compared to Fiscal Year Ended April 2, 2011 Net Sales The following table presents net sales information by product group:
Net sales for 2012 decreased $2.6 million or 1% from net sales for 2011. Sales in IMG increased by 34% while SG and CG decreased by 25% and 47%, respectively. IMG sales for 2012 increased $42.6 million compared to 2011. The increase in IMG sales was driven by higher sales of our flex-circuit via drilling and advanced microfabrication systems. Demand from the flex-circuit and integrated circuit packaging segments of the market has continued to strengthen as a result of growth in portable consumer electronics such as smart phones and tablet computers. Additionally, increased shipments for our advanced microfabrication products were driven by follow-on orders to expand capacity for existing applications. SG sales for 2012 decreased $20.0 million compared to 2011. The decrease in SG revenues was primarily driven by lower sales of our memory repair systems as a result of slower demand for DRAM and related overcapacity in the DRAM market.
26
Table of ContentsCG sales for 2012 decreased $25.2 million compared to 2011. The decrease was primarily driven by MLCC customers’ continued utilization of existing capacity reflecting only modest growth in the demand for consumer electronics. The following table presents net sales information by geographic region:
Gross Profit
Gross profit was $107.7 million for 2012, a decrease of $1.3 million or 1% compared to 2011. Gross profit decreased primarily due to $2.0 million of charges in cost of sales for an inventory write-off associated with discontinued products in the fourth quarter. Gross profit as a percentage of net sales was 42.4% for 2012 and 2011. While overall gross margins remained flat year over year on similar volumes, excluding the inventory write-off, they improved slightly on favorable product mix. Operating Expenses
Selling, Service and Administration Selling, service and administration (SS&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs. SS&A expenses for 2012 increased $0.3 million compared to 2011. This increase was primarily attributable to a $1.6 million increase in share-based compensation expense, which was driven by accelerated expense associated with the Chief Executive Officer’s retirement eligibility date and increased attainment of performance-based grants. This increase was largely offset by lower compensation expense. Research, Development and Engineering Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for 2012 increased $1.5 million compared to 2011. This increase was primarily due to higher project materials costs and increased professional fees associated with patent activity.
27
Table of ContentsShare-Based Compensation The table of operating expenses shown above includes $10.4 million and $8.2 million of share-based compensation expense for 2012 and 2011, respectively. The increase in share-based compensation expense was primarily driven by accelerated expense associated with the Chief Executive Officer’s retirement eligibility date and increased attainment of performance-based grants. Restructuring Costs As part of our globalization strategy, during 2011, we initiated a restructuring plan to reduce our worldwide cost structure through transition of certain procurement and manufacturing activities to Asia. In 2012, we continued our globalization efforts and we additionally identified and initiated other cost reduction actions. As a result of these actions, we recognized $3.8 million of restructuring costs in 2012. The estimated completion date for these actions is September 30, 2012. The restructuring costs of $3.8 million incurred in 2012 were comprised primarily of $1.9 million of employee severance and related benefits and $1.7 million of accelerated depreciation for certain assets. We shortened the depreciable lives of these assets in the fourth quarter of 2012 largely as a result of consolidating facilities in the United States and Asia. Restructuring costs were $0.8 million in 2011 primarily due to employee severance and related benefits. Loss on Disposal of Assets As a part of our on-going globalization strategy and cost reduction actions discussed above, in 2012, we recognized a loss of $1.0 million resulting from disposal of certain fixed assets primarily used in testing and development. Legal Settlement Costs In 2009, James Dooley, our former Chief Executive Officer, initiated arbitration against us seeking severance in connection with his 2003 termination for cause. On December 10, 2010, the assigned arbitrator ruled in favor of Mr. Dooley and, as a result, we recognized approximately $1.4 million in legal settlement costs in 2011. On December 27, 2010, we filed a complaint seeking declaratory relief to vacate the arbitration award with the United States District Court, District of Oregon. On May 17, 2011, the court ruled in favor of Mr. Dooley. On May 19, 2011, we filed a motion for the court to admit into evidence certain testimony of Mr. Dooley, arguing that the court was in error in not admitting it in the proceeding, and asking the court to reconsider its ruling based on that evidence. On June 14, 2011, the court ruled in favor of admitting the testimony into evidence, but also reaffirmed its original ruling upholding the arbitrator’s award. We did not further appeal and paid the award in the first quarter of 2012. As a result, we recognized an additional $0.6 million in legal settlement costs in 2012. Non-operating Income and Expense Gain on sale of Previously Impaired Auction Rate Securities (ARS) During the first quarter of 2012, we sold all of our remaining ARS with a total par value of $14.7 million for approximately $6.5 million. We recorded a total gain of $2.7 million, which included $1.4 million in reclassification of previously recorded unrealized gains out of accumulated other comprehensive income. See Note 5 “Fair Value Measurements” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data for further discussion.
28
Table of ContentsInterest and Other Income (Expense), net Interest and other expense, net, consists of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees, and other miscellaneous non-operating items. Net interest and other income (expense) were as follows:
Net interest and other expense was $0.4 million in 2012 compared to net interest and other income of $0.2 million in 2011. The decrease was primarily attributable to lower interest yields on our investments and market losses on assets held for our deferred compensation plan. We sold our remaining ARS in the fourth quarter of 2011 and early in the first quarter of 2012, which were earning above market interest rates. Income Taxes
The income tax benefit for 2012 was $1.4 million on pretax income of $3.5 million, an effective rate of 40.6%. For 2011, the income tax provision was $0.4 million on pretax income of $8.3 million, an effective rate of 4.7%. In 2012, our effective tax rate was favorably impacted by the increased tax advantages from growth in our Singapore manufacturing operations as well as higher tax credits. Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations. Net Income
As a result of the factors discussed above, net income for 2012 was $4.9 million, or $0.17 per basic and diluted share, compared to net income of $7.9 million, or $0.28 per basic and diluted share for 2011.
29
Table of ContentsFiscal Year Ended April 2, 2011 Compared to Fiscal Year Ended April 3, 2010 Net Sales The following table presents net sales information by product group:
Net sales for 2011 increased $107.9 million or 72% over net sales for 2010. Sales increased in all three business groups, with significant dollar increases in SG and IMG. IMG sales for 2011 increased $35.2 million or 40% compared to 2010. The increase in IMG sales was driven by higher sales of our flex-circuit via drilling and advanced microfabrication systems. Demand from the flex-circuit and integrated circuit packaging segments of the market continued to strengthen as a result of consumer demand for portable electronics. Additionally, demand continued to increase for advanced microfabrication products with the development of new applications as well as follow-on orders to expand capacity for existing applications. SG sales for 2011 increased $50.2 million or 176% compared to 2010. The increase in SG revenues was primarily driven by recovery in the DRAM market and expansion of LED manufacturing in Asia. Strong prices for DRAM combined with increasing demand for Mobile DRAM for portable electronics drove additional demand for our memory repair systems. Additionally, with the release of our proprietary tailored pulse laser technology, we were able to increase our market share in laser-based memory repair. CG sales for 2011 were up $22.5 million or 71% compared to 2010. This increase was due to deliveries of MLCC test systems and consumable parts on higher orders that began in the second half of 2010. Utilization levels of existing capacity remained high as our customers satisfy the increasing demand for MLCCs in consumer electronics. The following table presents net sales information by geographic region:
Net sales for 2011 increased across all geographic regions compared to 2010, but primarily in Asia where net sales increased 85%. Sales increased in all three product groups in Asia as a result of a continued trend by our customers to source their high-volume manufacturing in that region. Gross Profit
30
Table of ContentsGross profit was $108.9 million for 2011, an increase of $53.1 million or 95% compared to 2010. Gross profit increased largely due to the higher sales discussed above, combined with the favorable impact of higher production utilizing the same fixed costs. Gross profit as a percentage of net sales was 42.4% for 2011 compared to 37.5% for 2010. This improvement was largely due to leveraging of higher production volume relative to fixed costs, and also improvements in product mix during the year. Operating Expenses
Selling, Service and Administration Selling, service and administration (SS&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs. SS&A expenses for 2011 increased $9.7 million compared to 2010. This increase was primarily attributable to overall increases in business activity and improved operating results driven by sustained macroeconomic and electronics industry recoveries, which resulted in increased headcount and higher compensation costs. Other factors included an increase in share-based compensation expense of $1.4 million driven by incremental charges from our annual stock grant and an acquisition cost of $0.3 million resulting from a business acquisition in 2011. In addition, we initiated several temporary cost reduction measures in 2009 and 2010, including salary reductions, which were restored in late 2010. These increases in expenses were partially offset by acquisition settlement proceeds of $0.9 million received and lower purchase accounting expense in 2011. Research, Development and Engineering Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for 2011 increased $7.5 million compared to 2010. This increase was primarily due to increased project expenses, headcount and compensation expenses, including the restoration of higher levels of pay. Share-Based Compensation The table of operating expenses shown above includes $8.2 million and $6.7 million of share-based compensation expense for 2011 and 2010, respectively. Share-based compensation expense increased in 2011 compared to 2010 primarily due to the incremental charges from the annual stock grant in 2011. Legal Settlement Costs In 2009, James Dooley, former Chief Executive Officer of the Company, initiated arbitration against us seeking severance in connection with his 2003 termination for cause. On December 10, 2010, the assigned arbitrator ruled in favor of Mr. Dooley and, as a result, we recognized approximately $1.4 million in legal settlement costs in 2011. On December 27, 2010, we filed a complaint seeking declaratory relief to vacate the
31
Table of Contentsarbitration award with the United States District Court, District of Oregon. On May 17, 2011, the court ruled in favor of Mr. Dooley. On May 19, 2011, we filed a motion for the court to admit into evidence certain testimony of Mr. Dooley, arguing that the court was in error in not admitting it in the proceeding, and asking the court to reconsider its ruling based on that evidence. On June 14, 2011, the court ruled in favor of admitting the testimony into evidence, but also reaffirmed its original ruling upholding the arbitrator’s award. Restructuring Costs As part of our globalization strategy, during 2011, we initiated a restructuring plan to reduce our worldwide cost structure through transition of certain procurement and manufacturing activities to Asia. As a result of these actions, we recognized $0.8 million of restructuring costs in 2011. Merger Termination Proceeds, net No merger termination proceeds or merger transaction costs were received or incurred in 2011. Net merger termination proceeds for 2010 were $4.5 million, which represented the receipt of a $5.4 million merger termination fee partially offset by $0.9 million of merger transaction costs. Non-operating Income and Expense Gain on Sale of Previously Impaired Auction Rate Securities (ARS) In 2011, we sold a certain ARS with a par value of $3.0 million for approximately $0.7 million, and recorded a gain of $0.7 million as the security was previously written down to zero value. See Note 5 “Fair Value Measurements” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data for further discussion on the ARS. Other-than-temporary Impairment of Auction Rate Securities (ARS) There was no other-than-temporary impairment charge of ARS in 2011. In 2010, other-than-temporary impairment charges related to our ARS were $1.3 million. This charge was recorded during the fourth quarter due to the suspension of interest payments by the issuer of certain of our ARS and decreases in the credit quality of bond insurers of certain of our other ARS. See Note 5 “Fair Value Measurements” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data. Interest and Other Income, net Interest and other income, net, consists of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees, ARS valuation fees and other miscellaneous non-operating items. Net interest and other income was as follows:
In 2011, net interest and other income was $0.2 million compared to $1.4 million in 2010. The decrease was primarily attributable to the lower interest income due to market-driven decreases in yields, foreign currency losses due to appreciation of the Chinese Yuan, higher hedging costs of the Korean Won and increased bank fees due to higher banking activity in 2011.
32
Table of ContentsIncome Taxes
The income tax provision for 2011 was $0.4 million on pretax income of $8.3 million, an effective rate of 4.7%. For 2010, the income tax benefit was $9.8 million on pretax loss of $21.8 million, an effective rate of 44.9%. In 2011, our effective tax rate was favorably impacted by the increased tax advantages from growth in our Singapore manufacturing operations, benefits from the extension of the research and development tax credit benefit and the recognition of domestic production activities benefit. Net Income (Loss)
As a result of the factors discussed above, net income for 2011 was $7.9 million, or $0.28 per basic and diluted share, compared to net loss of $12.0 million, or $0.44 per basic share for 2010. Financial Condition and Liquidity At March 31, 2012, our principal sources of liquidity were cash and cash equivalents of $69.8 million, short-term investments of $106.7 million and accounts receivable of $32.7 million. We also held $22.3 million in restricted cash which represented collateral for commercial letters of credit related to our ongoing legal proceedings against All Ring Tech Co., Ltd. At March 31, 2012, we had a current ratio of 6.93 and held no long-term debt. Working capital of $269.5 million increased $9.8 million compared to April 2, 2011 balance of $259.7 million. We also held approximately $23.0 million of non-current investments at March 31, 2012. In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. Accordingly, a dividend of $0.08 per outstanding common share was paid on February 17, 2012 to shareholders of record on January 27, 2012. The dividend amount paid as a result of the December 9, 2011 declaration was $2.3 million. Subsequent to the year ended March 31, 2012, the Board of Directors declared an $0.08 per outstanding common share cash dividend on May 10, 2012, payable June 18, 2012 to shareholders of record on June 4, 2012. The estimated amount to be paid as a result of the May 10, 2012 declaration is $2.3 million. We currently anticipate that we will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on our financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders. In May 2008, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock primarily to offset dilution from equity compensation programs. Repurchases under the program were made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. We did not repurchase any shares under this program during 2012 or 2011. As of March 31, 2012, a total of 372,825 shares had been repurchased under this authorization for $5.3 million at an average price of $14.16 per share, calculated inclusive of commissions and fees. There was no fixed completion date for the repurchase program.
33
Table of ContentsIn December 2011, the Board of Directors terminated the above 2008 repurchase program and authorized a new share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock. The repurchases are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. We did not repurchase any shares under this program in 2012. There is no fixed completion date for the repurchase program. As of March 31, 2012, we did not hold any ARS investments. During the first quarter of 2012, we sold all of the remaining ARS for approximately $6.0 million and all of the preferred stock for approximately $0.5 million. These ARS had a total estimated fair value of $5.2 million as of April 2, 2011, which consisted of $10.7 million par value ARS and $4.0 million par value ARS which were converted by the bond issuer to its preferred stock in 2009. We recorded a gain of $2.7 million in the first quarter of 2012, which included $1.4 million in reclassification of previously recorded unrealized gain out of accumulated other comprehensive income. Sources and Uses of Cash Net cash provided by operating activities totaled $14.3 million for 2012 due to $23.2 million from net income and non-cash items partially offset by $8.9 million from net changes within working capital. Cash provided by operating activities is net income adjusted for certain non-cash items and changes in assets and liabilities within working capital. In 2012, the primary sources of cash outflow from working capital consisted of $16.9 million decreases in accounts payable and accrued liabilities, $5.3 million decreases in deferred revenue and $4.4 million increases in inventories, partially offset by $11.2 million decreases in trade receivables, $3.9 million decreases in shipped systems pending acceptance and $2.6 million from decreases in other current assets. In 2012, net cash used in investing activities of $62.5 million primarily resulted from $929.2 million of purchases of investments, and $4.9 million of purchases of property, plant and equipment, partially offset by $883.3 million of proceeds from sales and maturities of investments including the sale of ARS. Additionally, restricted cash increased by $11.5 million in 2012 because of our ongoing legal proceedings against All Ring Tech Co., Ltd. In 2012, net cash provided by financing activities of $1.2 million primarily resulted from $3.0 million of proceeds from stock plan activity partially offset by $2.3 million of cash dividends paid to shareholders. We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations, any dividends which may be declared, our share repurchase program and contractual obligations for at least the next twelve months. Contractual Obligations The contractual commitments and obligations below represent our estimates of future payments under fixed contractual obligations and commitments. The actual payments may differ from these estimates due to changes in our business needs, cancellation provisions, and other factors. We cannot provide certainty regarding the timing of the payment schedule and the amounts of payments. The following table summarizes our contractual commitments and obligations as of March 31, 2012, by the fiscal year in which they are due:
34
Table of ContentsThis table does not include $8.6 million of unrecognized tax benefits due to the uncertainty with respect to the timing of future cash flows as of March 31, 2012. We are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities and the total amounts of income tax payable and the timing of such tax payments may depend on the resolution of current and future tax examinations which cannot be estimated. Critical Accounting Policies and Estimates The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our estimates are based on historical experience and on various assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. See Note 2 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data for additional information. Our critical accounting policies and estimates include the following:
Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to the customer at the time of delivery of the product to a common carrier. Revenue is recognized upon such delivery, provided that fulfillment of acceptance criteria can be demonstrated prior to shipment. Where the acceptance criteria cannot be demonstrated prior to shipment, or in the case of substantially new products, revenue is deferred until acceptance has been received. For multiple element arrangements, the fair values of any undelivered elements are deferred until the elements are delivered and acceptance criteria are met. Revenues are recorded net of taxes collected which are required to be submitted to government authorities. Installation services are not essential to the functionality of the delivered equipment and installation revenue is deferred until installation is complete. Historically, neither the costs of installation accrued nor the fair value of installation service revenue deferred has been material. Revenues associated with sales to customers under local contracts in Japan are recognized upon title transfer, which generally occurs upon customer acceptance. Revenues related to spare parts and consumable sales are generally recognized upon shipment. Revenues related to maintenance and service contracts are recognized ratably over the duration of the contracts.
35
Table of ContentsInventory Valuation We regularly evaluate the value of our inventory based on a combination of factors including, but not limited to, the following: forecasted sales or usage, historical usage rates, estimated service period, product end-of-life dates, estimated current and future market values, service inventory requirements and new product introductions. Purchasing requirements and alternative uses for the inventory are explored within these processes to mitigate inventory exposure. Raw materials with quantities in excess of forecasted usage are reviewed quarterly for obsolescence by our engineering and operating personnel. Raw material obsolescence write-downs are typically caused by engineering change orders or product end-of-life adjustments in the market. Research and development product costs are generally expensed as incurred. Engineering materials that are expected to provide future value are generally classified as raw materials inventory. Finished goods are reviewed quarterly by product marketing and operating personnel to determine if inventory carrying costs exceed market selling prices. When necessary, we record inventory write-downs as an increase to cost of sales based on the above factors and take into account worldwide quantities on hand and forecasted demand into our analysis. Additionally, from time to time, we may make strategic decisions to exit or alter product lines which may result in an inventory write-down. If circumstances related to our inventories change, our estimates of the value of inventory could materially change. Product Warranty Reserves We evaluate obligations related to product warranties quarterly. A standard one-year warranty is provided on most products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by our suppliers for defective components. Using historical data, we estimate average warranty cost per system or part type and record the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a significant change in warranty-related incidents occurs, the impact of the change in the warranty accrual could be material. Accrued product warranty is included on the Consolidated Balance Sheets as a component of accrued liabilities. Allowance for Doubtful Accounts Credit limits are established by reviewing the financial history and stability of each customer. Where appropriate, we obtain credit rating reports and financial statements of the customer to establish and modify their credit limits. On certain foreign sales, we require letters of credit. We regularly evaluate the collectability of our trade receivable balances based on a combination of factors. When a customer’s account becomes past due, we talk with the customer to determine the cause. If we determine that a customer will be unable to fully meet its financial obligation to us, such as in the case of a bankruptcy filing or other material events impacting its business, we record a specific reserve for bad debt to reduce the related receivable to the amount we expect to recover given all information then available. If circumstances related to specific customers change, our estimates of the recoverability of receivables could materially change. We record estimated bad debt expense as an increase to selling, service and administration expenses. Accrued Restructuring Costs We have engaged, and may continue to engage, in restructuring actions, which require us to make estimates in certain areas including expenses for severance and other employee separation costs. Because we have a history of paying severance benefits, expenses and liabilities associated with exit or disposal activities are recognized when probable and estimable. For further discussion on the restructuring activities and related charges in 2012,
36
Table of Contentsrefer to our discussion of “Restructuring Costs” in the “Results of Operations” section above and Note 24 “Restructuring and Cost Management Plans” to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data. Share-Based Compensation We measure and recognize compensation expense for all share-based payment awards granted to our employees and directors, including employee stock options, stock-settled stock appreciation rights (SARs), non-vested restricted stock units and purchases under the employee stock purchase plan, based on the estimated fair value of the award on the grant date. We use the Black-Scholes valuation model as our method of valuation for stock option and SAR awards. The use of the Black-Scholes valuation model to estimate the fair value of stock option and SAR awards requires us to make assumptions regarding the risk-free interest rate, expected dividend yield, expected term and expected volatility over the expected term of the award. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates based on our historical data, but these estimates involve inherent uncertainties and the recognition of expense could be materially different in the future. Compensation expense is only recognized on awards that are estimated to ultimately vest. Therefore, based on historical forfeiture rates and patterns, the estimated future forfeitures are factored into the compensation expense to be recognized over the vesting period. We update our forfeiture estimates at least annually and recognize any changes to accumulated compensation expense in the period of change. If actual forfeitures differ significantly from our estimates, our results of operations could be materially impacted. Income Taxes We are subject to income taxes in the United States and in numerous foreign jurisdictions and in the ordinary course of business, there are transactions and calculations where the ultimate tax determination is uncertain. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We recognize interest and penalties, if any, related to the unrecognized tax benefits in income tax expense. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those assets and liabilities are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. When management determines that it is more likely than not that a deferred tax asset will not be fully realized, a valuation allowance is established to reduce deferred tax assets to the amount expected to be realized. Should management’s assumptions and expectations be inaccurate, our financial condition and results of operations could be adversely affected in future periods. Fair Value Measurements Fair value is defined under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820 “Fair Value Measurements and Disclosures” (ASC Topic 820). When determining fair value on the financial assets and liabilities, we consider the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Valuation of Cost Method Equity Investments As of March 31, 2012, minority equity investments included $6.0 million invested in Series D Preferred Stock and $3.0 million invested in Series E Preferred Stock of OmniGuide, Inc., representing an 11% interest. At each reporting period, we determine whether events or circumstances have occurred that are likely to have a
37
Table of Contentssignificant adverse effect on the fair value of these investments. If there are no events or circumstances identified that would adversely affect the fair value of the investments, the fair values of the investments are not calculated as it is not practicable to do so. As of March 31, 2012, we had not identified any events or circumstances that indicated the investments were impaired; therefore, the full carrying value of $9.0 million was included in Other assets on the Consolidated Balance Sheets. Valuation of Long-Lived Assets Long-lived assets, principally property and equipment and identifiable intangibles held and used by us, are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. We evaluate recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. There were no events or circumstances during 2012 that would indicate the carrying value of our long-lived assets may not be recoverable. Valuation of Goodwill We account for goodwill pursuant to Accounting Standards Codification (ASC) Topic 350 as amended in September 2011 by Accounting Standard Update (ASU) 2011-08, “Intangibles- Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASC ASU 2011-08). ASC Topic 350 requires that goodwill be tested for impairment at least annually. ASC ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. We test goodwill for impairment using a qualitative and quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value. Goodwill was tested for impairment in the fourth quarter of 2012 and it was determined that there was no impairment as of March 31, 2012.
The primary objectives of our investment activities are to preserve principal and maintain liquidity to meet operating needs. To achieve these objectives, we maintain an investment portfolio of cash, cash equivalents, and investments in a variety of securities, including commercial paper, corporate bonds and U.S. government agency notes. Interest Rate Risk Our investment securities are subject to interest rate risk and will decline in value if interest rates increase. The majority of these securities are classified as available-for-sale securities; therefore, the impact on fair value of interest rate changes is reflected as a separate component of shareholders’ equity. Due to the short duration of our investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair value of our invested assets. Investment Risk Our marketable securities are classified as available-for-sale securities measured at fair value. The market value of our investments is influenced by market risks, liquidity risk and the credit worthiness of underlying issuers of our investment. We strive to minimize the investment risk by investing in high quality securities and by utilizing experienced and high credit quality financial institutions to manage the investment portfolio. As of March 31, 2012, we did not hold any auction rate securities (ARS) investments. During the first quarter of 2012, we sold all of our remaining ARS with a total par value of $14.7 million for approximately $6.5
38
Table of Contentsmillion and recorded a total gain of $2.7 million in the first quarter of 2012 including $1.4 million in reclassification of previously recorded unrealized net gains out of accumulated other comprehensive income. Foreign Currency Exchange Rate Risk We purchase derivative financial instruments on a limited basis and do not use them for trading purposes. We do, however, use derivatives to manage well-defined foreign currency risks. We enter into forward exchange contracts to hedge the value of material non-functional currency monetary asset and liability balances. The net effect of an immediate 10% change in exchange rates on the forward exchange contracts and the underlying hedged positions would not be material to our financial position or the results of our operations. The table below summarizes, by currency, the notional amounts of our forward exchange contracts in U.S. dollars as of March 31, 2012 and April 2, 2011. The “bought” amounts represent the net U.S. dollar equivalents of commitments to purchase foreign currencies, and the “sold” amounts represent the net U.S. dollar equivalents of commitments to sell foreign currencies. The foreign currency amounts have been translated into a U.S. dollar equivalent value using the exchange rates at the reporting date.
39
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Electro Scientific Industries, Inc.: We have audited the accompanying consolidated balance sheets of Electro Scientific Industries, Inc. and subsidiaries as of March 31, 2012 and April 2, 2011, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended March 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electro Scientific Industries, Inc. and subsidiaries as of March 31, 2012 and April 2, 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2012, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Electro Scientific Industries, Inc.’s internal control over financial reporting as of March 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 12, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP Portland, Oregon June 12, 2012
40
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of March 31, 2012 and April 2, 2011
See Accompanying Notes to Consolidated Financial Statements
41
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended March 31, 2012, April 2, 2011 and April 3, 2010
See Accompanying Notes to Consolidated Financial Statements
42
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS) For the years ended March 31, 2012, April 2, 2011 and April 3, 2010
See Accompanying Notes to Consolidated Financial Statements
43
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended March 31, 2012, April 2, 2011 and April 3, 2010
See Accompanying Notes to Consolidated Financial Statements
44
Table of ContentsELECTRO SCIENTIFIC INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. The Company Electro Scientific Industries, Inc. together with its wholly-owned subsidiaries (collectively, the Company) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. The Company’s advanced laser systems enable precise structuring of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, communications and other industries. These features enable the Company’s customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, the Company is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States. 2. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include the accounts of Electro Scientific Industries, Inc. and its subsidiaries. Certain prior period amounts have been reclassified to conform to the current period’s presentation, with no effect on previously reported earnings or cash flows. All intercompany accounts and transactions have been eliminated. The Company’s fiscal year consists of 52 or 53 weeks ending on the Saturday nearest March 31. Accordingly, the fiscal 2012 reporting period consisted of a 52-week period ending on March 31, 2012, the fiscal 2011 reporting period consisted of a 52-week period ending on April 2, 2011 and the fiscal 2010 reporting period consisted of a 53-week period ending on April 3, 2010. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted. Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. Management believes that the estimates used are reasonable. Significant estimates made by management include: revenue recognition; inventory valuation; product warranty reserves; allowance for doubtful accounts; accrued restructuring costs; share-based compensation; income taxes including the valuation of deferred tax assets; fair value measurements; valuation of cost method equity investments; valuation of long-lived assets; and valuation of goodwill. Risks and Uncertainties The Company uses financial instruments that potentially subject it to concentrations of credit risk. Such instruments include cash equivalents, available-for-sale marketable securities, trade receivables and financial instruments used in hedging activities. The Company invests cash in cash deposits, money market funds, commercial paper, certificates of deposit and readily marketable securities. Investments are placed with high credit quality financial institutions and the credit exposure from any one institution or instrument is minimized. See Note 5 “Fair Value Measurements” for further discussion on these investments. The Company sells a significant portion of its products to a small number of large semiconductor and microelectronics manufacturers. The top ten customers accounted for approximately 56%, 62% and 56% of total
45
Table of Contentsnet sales in 2012, 2011 and 2010, respectively. One consumer electronics manufacturer accounted for approximately 29%, 24% and 30% of total net sales in 2012, 2011 and 2010, respectively. In 2011, two other customers individually accounted for approximately 11% of total net sales. No other customer individually accounted for more than 10% of total net sales in 2012, 2011 and 2010. The Company’s operating results may be adversely affected if orders and revenues from these key customers decline. The Company uses qualified manufacturers to supply many components and sub-system modules of its products. The systems that the Company manufactures use high-performance computers, peripherals, lasers and other components from various suppliers. The Company obtains some of the components from a single source or a limited group of suppliers. An interruption in the supply of a particular component would have a temporary adverse impact on the Company’s operating results. The Company’s net investment exposure in foreign subsidiaries translated into U.S. dollars using the period-end exchange rates at March 31, 2012 and April 2, 2011 was approximately $45.5 million and $39.7 million, respectively. The potential loss in fair value resulting from a hypothetical 10% adverse change in foreign exchange rates would be approximately $4.6 million and $4.0 million at March 31, 2012 and April 2, 2011, respectively. Foreign exchange rate gains or losses on foreign investments as of March 31, 2012 were reflected as a cumulative translation adjustment, net of tax, and do not affect the Company’s results of operations. The Company’s operations involve a number of other risks and uncertainties including but not limited to those relating to the cyclicality of the semiconductor and microelectronics markets, the effect of general economic conditions, rapid changes in technology and international operations. Cash Equivalents and Investments All highly liquid investments with a maturity of 90 days or less at the date of purchase are considered to be cash equivalents. Short-term investments reflect marketable securities that have maturities of less than one year or are subject to immediate pre-payment or call provisions. These securities consist primarily of marketable debt securities and are classified as “available-for-sale securities” and recorded at fair market value. Unrealized gains and losses on short-term investments are recorded as a component of accumulated other comprehensive income (loss) within shareholders’ equity. To determine whether any existing impairment is other-than-temporary and requires recognition of an impairment loss in the results of operations, the Company evaluates its marketable securities based on the nature of the investments and the Company’s intent and ability to hold the securities until the securities are no longer in an unrealized loss position. Restricted Cash Restricted cash represents cash which collateralizes commercial letters of credit substituted for a cash bond previously held by the Kaohsiung District Court of Taiwan related to the Company’s proceedings against All Ring Tech Co., Ltd (All Ring). As a part of these proceedings, the Company established three letters of credit for approximately $19.5 million in July 2009, September 2009 and June 2011, which are collateralized by $22.3 million of restricted cash. The Intellectual Property Court in Taiwan is expected to hold its final hearing in this matter in October 2012. The total restricted cash balance of $22.3 million was included in Restricted cash on the Consolidated Balance Sheets at March 31, 2012 as a current asset. See Note 21 “Legal Proceedings” below for further discussion. Accounts Receivable and Allowance for Doubtful Accounts Trade accounts receivable are stated at the amount the Company expects to collect and do not bear interest. Credit limits are established by reviewing the financial history and stability of each customer. Where appropriate, the Company obtains credit rating reports and financial statements of the customer to establish or modify credit limits. On certain foreign sales, letters of credit are required. The collectability of trade receivable balances is regularly evaluated based on a combination of factors such as customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. If it is
46
Table of Contentsdetermined that a customer will be unable to fully meet its financial obligation, such as in the case of a bankruptcy filing or other material events impacting its business, a specific reserve for bad debt is recorded to reduce the related receivable to the amount expected to be recovered. Accrued Restructuring Costs The Company has engaged, and may continue to engage, in restructuring actions, which require it to make estimates in certain areas including expenses for severance and other employee separation costs. Because the Company has a history of paying severance benefits, expenses associated with exit or disposal activities are recognized when probable and estimable. Should the actual amounts differ from our estimates, the amount of the restructuring charges could be materially impacted. See Note 24 “Restructuring and Cost Management Plans” for further discussion. Inventories Inventories are principally valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Costs utilized for inventory valuation purposes include material, labor and manufacturing overhead. Shipped Systems Pending Acceptance Shipped systems pending acceptance relate to systems that have been ordered and shipped to the customer, but have been deferred in accordance with the Company’s revenue recognition policy. Shipped systems pending acceptance are recognized as cost of sales once all criteria for revenue recognition have been met and revenue is recorded. Shipped systems pending acceptance are valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Costs utilized in the valuation of shipped systems pending acceptance include material, labor and manufacturing overhead and exclude costs of installation. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance, repairs and minor improvements are expensed as incurred. Major improvements and additions are capitalized. When assets are sold or retired, the cost and related accumulated depreciation and amortization are removed from the accounts and the resulting gain or loss is included as a component of operating expenses. Long-Lived Asset Impairment Long-lived assets, principally property, plant and equipment and identifiable definite-lived intangibles, are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. The Company’s purchased patents are amortized over their estimated useful lives, generally ten to seventeen years. Other purchased intangible assets with definite useful lives are carried at cost less accumulated amortization. Amortization expense is recognized on either a straight-line or sum-of-the-years digits method over the estimated useful lives of the intangible assets, which range from one to seven years.
47
Table of ContentsGoodwill Impairment The Company accounts for goodwill pursuant to Accounting Standards Codification (ASC) Topic 350 as amended in September 2011 by Accounting Standard Update (ASU) 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASC ASU 2011-08). ASC Topic 350 requires that goodwill be tested for impairment at least annually. ASC ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. The Company tests goodwill for impairment using a qualitative and quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value. Goodwill was tested for impairment in the fourth quarter of 2012 and it was determined that there was no impairment as of March 31, 2012. Other Assets Other assets include consignment, demonstration (demo) and training equipment, minority equity investments and long-term deposits. Consignment, demo and training equipment are recorded at the lower of standard costs or estimated market values, until the assets are sold. As of March 31, 2012 and April 2, 2011, the Company had a $9.0 million minority equity investment in preferred stock of OmniGuide, Inc. (OmniGuide), a private company, which included $6.0 million of Series D Preferred Stock and $3.0 million of Series E Preferred Stock. These investments are accounted for as cost method investments as the Company does not have the ability to significantly influence OmniGuide. At each reporting period end, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of the investments. If there are no identified events or circumstances that may have a significant adverse effect on the fair value of the investments, the fair value of the investments are not calculated as it is not practicable to do so. As of March 31, 2012, management had not identified any events or circumstances that indicated the investments were impaired, therefore the full carrying value of $9.0 million was included in other assets on the Consolidated Balance Sheets. Fair Value of Financial Instruments The carrying amounts of financial instruments, including cash equivalents and accrued liabilities approximate fair value because of the nature of the underlying transactions and short-term maturities involved. Current and non-current marketable securities are recorded at fair value which is defined under Financial Accounting Standards Board (FASB) ASC Topic 820 “Fair Value Measurements and Disclosures” (ASC Topic 820). ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:
See Note 5 “Fair Value Measurements” for further discussion and disclosure of fair value on our financial assets and investments.
48
Table of ContentsDerivative Financial Instruments The Company’s primary objective for holding derivative financial instruments is to manage currency risk. The Company’s accounting policies for these instruments are based on whether they meet the Company’s criteria for designation as hedging transactions, either as cash flow or fair value hedges. A hedge of the exposure to variability in the cash flows of an asset or a liability, or of a forecasted transaction, is referred to as a cash flow hedge. A hedge of the exposure to changes in fair value of an asset or a liability, or of an unrecognized firm commitment, is referred to as a fair value hedge. The criteria for designating a derivative as a hedge include the instrument’s effectiveness in risk reduction and, in most cases, a one-to-one matching of the derivative instrument to its underlying transaction. Revenue Recognition The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title and risk of loss generally pass to the customer at the time of delivery of the product to a common carrier. Revenue is recognized upon such delivery, provided that fulfillment of acceptance criteria can be demonstrated prior to shipment. Where the acceptance criteria cannot be demonstrated prior to shipment, or in the case of substantially new products, revenue is deferred until acceptance has been received. For multiple element arrangements, the fair value of any undelivered elements is deferred until the elements are delivered and acceptance criteria are met. Revenues are recorded net of taxes collected which are required to be submitted to government authorities. Installation services are not essential to the functionality of the delivered equipment and installation revenue is deferred until installation is complete. Neither the costs of installation accrued nor the fair value of installation service revenue deferred has been material. Revenues associated with sales to customers under local contracts in Japan are recognized upon title transfer, which generally occurs upon customer acceptance. Revenues related to spare parts and consumable sales are generally recognized upon shipment. Revenues related to maintenance and service contracts are recognized ratably over the duration of the contracts. Product Warranty The Company evaluates obligations related to product warranties quarterly. A standard one-year warranty from the date of acceptance is provided on most products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. Using historical data, the Company estimates average warranty cost per system or part type and records the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a significant change in warranty-related incidents occurs, the impact of the change in the warranty accrual could be material. Accrued product warranty is included on the Consolidated Balance Sheets as a component of accrued liabilities. Research and Development Research and development costs, which include labor and related employee expenses, patent maintenance fees, project materials costs, project subcontractors, depreciation of engineering equipment, building costs and other administration expenses, are generally expensed as incurred. Engineering materials that are expected to provide future value are included in inventories.
49
Table of ContentsTaxes on Unremitted Foreign Income The Company provides for income taxes on its foreign subsidiaries’ taxable income based on the effective income tax rate in each respective jurisdiction. The Company provides for deferred taxes on the undistributed earnings of a subsidiary, except to the extent that the income is intended to be indefinitely reinvested or remitted in a tax-free liquidation. The only foreign jurisdiction where the Company is permanently reinvested is Singapore. The cumulative amount of earnings upon which U.S. income taxes have not been provided was $20.9 million and $13.6 million as of March 31, 2012 and April 2, 2011, respectively. The unrecognized deferred tax liability related to these earnings was $7.3 million and $4.2 million as of March 31, 2012 and April 2, 2011, respectively. Comprehensive Income (Loss) Comprehensive income (loss) includes net income (loss) and “other comprehensive income,” which includes charges or credits to equity that are not the result of transactions with shareholders. Comprehensive income (loss) within these consolidated financial statements includes primarily cumulative foreign currency translation adjustments and unrealized gains and losses on securities available for sale. The cumulative translation adjustment included in accumulated other comprehensive income (loss) at March 31, 2012 and April 2, 2011 was $0.6 million and $0.3 million, respectively. Earnings Per Share Basic earnings per share (EPS) is computed utilizing the weighted average number of shares outstanding during the period. Diluted EPS also considers common stock equivalents, such as stock options, stock-settled stock appreciation rights (SARs), employee stock purchase plan (ESPP) shares and restricted stock units, to the extent that they are not antidilutive. Share-Based Compensation The Company recognizes expense related to the fair value of its share-based compensation awards. The Company uses the Black-Scholes model to estimate the fair value of all share-based compensation awards on the date of grant, except for unvested restricted stock units, which are valued at the fair market value of the Company’s stock on the date of award. The Company recognizes the compensation expense for options, SARs and unvested restricted stock units on a straight-line basis over the requisite service period of the award. Segment Reporting The Company complies with ASC Topic 280 “Segment Reporting” (ASC Topic 280). ASC Topic 280, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products, major customers and the geographies in which the entity holds material assets and reports revenue. An operating segment is defined as a component that engages in business activities whose operating results are reviewed by the chief operating decision maker and for which discrete financial information is available. Based on the provisions of ASC Topic 280, the Company has determined that it operates in one segment. The Company manages its resources and assesses its performance on an enterprise-wide basis. Employee Benefit Plans The Company has an employee savings plan under the provisions of Section 401(k) of the Internal Revenue Code. During 2012 and 2011, contributions to the plan by the Company were $0.3 million and $0.2 million, respectively. The Company has defined benefit retirement plans at certain of its foreign subsidiaries. The Company accounts for these plans based on the provisions of ASC Topic 715 “Compensation-Retirement Benefits”.
50
Table of Contents3. Recent Accounting Pronouncements In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) Accounting Standards Update (ASU) 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASC ASU 2011-04). ASC ASU 2011-04 will result in common fair value measurement and disclosure requirements in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRSs). These disclosures include: (a) information about transfers between level 1 and level 2 of the fair value hierarchy; (b) information about the sensitivity of a fair value measurement categorized within level 3 of the fair value hierarchy to changes in unobservable inputs and any interrelationships between those unobservable inputs; and (c) the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value of such items is required to be disclosed. The adoption of ASC ASU 2011-04 in the fourth quarter of 2012 did not have a material effect on the Company’s financial position, results of operations or cash flows. In June 2011, the FASB issued ASU 2011-05 “Comprehensive Income: Presentation of Comprehensive Income” (ASC ASU 2011-05). ASC ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity; however, it does not change the items that must be reported in other comprehensive income. ASC ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, and the total of comprehensive income. In December 2011, the FASB issued ASC ASU 2011-12 “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. ASC ASU 2011-12 defers the effective date pertaining to the requirement in ASC ASU 2011-05 regarding the reclassification adjustments for each component of accumulated other comprehensive income in both net income and other comprehensive income on the face of the financial statements. The adoption of ASC ASU 2011-05, as amended by ASC ASU 2011-12, will become effective for the Company’s first quarter of 2013. The adoption of ASC ASU 2011-05 is not expected to have a material effect on the Company’s financial position, results of operations and cash flows. In September 2011, the FASB issued ASC ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASC ASU 2011-08). ASC ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-step impairment test. The Company adopted ASC ASU 2011-08 in the second quarter of 2012. 4. Share-Based Compensation The Company recognizes expense related to the fair value of its share-based compensation awards using the Black-Scholes model to estimate the fair value of awards on the date of grant, except for unvested restricted stock unit awards, which are valued at the fair market value of the Company’s stock on the date of award. The Company recognizes compensation expense for all share-based compensation awards on a straight-line basis over the requisite service period of the award. Stock Plans In October 2004, the shareholders approved the adoption of the 2004 Stock Incentive Plan (the 2004 Plan) that replaced various stock compensation plans that were previously approved by the shareholders or the Board of Directors (the Replaced Plans), except with respect to options and other awards previously outstanding. Outstanding options and awards remained subject to the terms of the Replaced Plans under which they were
51
Table of Contentsoriginally granted. At that time, the shareholders also approved the reservation of 3,000,000 shares of common stock for issuance under the 2004 Plan. These shares are in addition to any shares of common stock that, at the time the 2004 Plan was approved by shareholders, were available for grant under the Replaced Plans or that may subsequently become available for grant under any of the Replaced Plans through the expiration, termination, forfeiture or cancellation of grants. In January 2005, the Board of Directors approved certain amendments to the 2004 Plan. These amendments prohibit grants of stock options or stock-settled stock appreciation rights (SARs) with an exercise price less than fair market value, require that time-based restricted stock awards have a minimum vesting period of at least three years, with the subject shares vesting no more quickly than one-third annually over the three-year period, and expressly prohibit the reservation of additional shares under the 2004 Plan without shareholder approval. In October 2007, the shareholders approved an additional amendment to the 2004 Plan to permit awards to non-employee service providers and implement certain claw-back provisions. The 2004 Plan allows for grants of stock options, stock appreciation rights, stock bonuses (including restricted stock units), restricted stock, performance-based awards and dividend equivalents. Stock options and SARs outstanding under the 2004 Plan and the Replaced Plans vest over variable periods determined at the grant date, generally with terms of immediate vesting or up to four years, and expire ten years from the date of grant. Options and SARs issued under the 2004 Plan and the Replaced Plans are exercisable at prices not less than fair market value on the date of the grant. The 2004 Plan prohibits repricing of options and SARs granted without prior shareholder approval. Certain restricted stock units awarded under the 2004 Plan vest based on performance criteria that are tied to the Company’s results of operations, personal performance criteria, and, in certain cases, length of service. Unvested restricted stock awards are credited with dividend equivalents in the form of additional unvested restricted stock units at the same time and in the same amount as dividends paid to shareholders of the Company. The dividend equivalents have the same vesting and terms as the underlying restricted stock award. In September 1990, the shareholders approved the adoption of the 1990 Employee Stock Purchase Plan, as amended in September 1998, October 2003, October 2004, January 2008 and August 2009 (the ESPP), pursuant to which 3,400,000 shares of common stock have been reserved for issuance to participating employees. Eligible employees may elect to contribute up to 15 percent of their base wage and commissions during each pay period. The ESPP provides for separate overlapping twenty-four month offerings starting every three months. Each offering has eight purchase dates occurring every three months on designated dates. The offerings under the ESPP commence on February 15, May 15, August 15 and November 15 of each calendar year. Any eligible employee may participate in only one offering at a time and may purchase shares only through payroll deductions permitted under the ESPP. At the end of each three-month purchase period, the purchase price is determined and the accumulated funds are used to automatically purchase shares of common stock. The purchase price per share is equal to 85 percent of the lower of the fair market value of the common stock on (a) the first day of the offering period or (b) the date of purchase. The ESPP also provides that if the fair market value of the common stock on the first day of the new offering period is less than or equal to the fair market value of the common stock on the first date of any ongoing offering, employees participating in any such ongoing offering will be automatically withdrawn from it and enrolled in the new offering. The Company granted SARs starting in the first quarter of 2010. SARs grant the right to receive shares of the Company’s stock equivalent to the increase in stock value of a specified number of shares over a specified period of time, divided by the stock price at the time of exercise. The Company uses the Black-Scholes model to estimate the fair value of SARs. Similar to options, SARs are recorded at the fair value of the award at grant date and the expense is recognized on a straight-line basis over the requisite service period of the award. The Company did not grant any stock options during 2012 and 2011 and did not grant any SARs prior to the first quarter of 2010.
52
Table of ContentsShare-based compensation expense was included in the Company’s Consolidated Statements of Operations as follows:
The share-based compensation expense increase in 2012 compared to 2011 was primarily driven by accelerated expense associated with the Chief Executive Officer’s retirement eligibility date and increased attainment of performance-based grants. The share-based compensation expense increased in 2011 compared to 2010 primarily due to the incremental charges from the annual stock grant in 2011. The total amount of cash received from the stock plan awards was $3.0 million, $1.3 million and $1.4 million for 2012, 2011 and 2010, respectively. All stock plan awards are settled with newly issued shares. No share-based compensation costs were capitalized during 2012. As of March 31, 2012, the Company had $11.2 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 1.51 years. Valuation Assumptions The Black-Scholes option pricing model is utilized to determine the fair value of options and SARs granted. The following weighted average assumptions were used in calculating the fair value during the periods presented:
The following weighted average assumptions were used to estimate the fair value of ESPP shares issued during the periods presented:
The risk-free interest rates used are based on the U.S. Treasury yields over the expected terms. In December 2012, the Board of Directors adopted a dividend policy under which the Company intends to pay quarterly cash dividends. Accordingly, the Company paid a dividend of $0.08 per outstanding common share in the fourth quarter of 2012. There were no dividends declared or paid during 2011 and 2010. The expected dividend yield used is derived using a mathematical formula which uses the expected Company annual dividend rate over the expected term divided by the fair value of the Company’s common stock at the grant date. The expected term and forfeiture estimates for stock options and SARs are based on an analysis of actual exercise behavior. The expected term for the ESPP is the weighted average length of the purchase periods. The Company uses its historical volatility over the estimated expected term as the expected volatility.
53
Table of ContentsAt March 31, 2012, the Company had 8,601,332 shares of its common stock reserved for issuance under all of the above plans combined. Of those shares, 4,343,188 are subject to issuance under currently outstanding stock options, SARs and stock awards and 4,258,144 shares, including 807,656 shares available for issuance under the ESPP, are available for future grants. The weighted-average fair-value of share-based compensation awards, including stock option and SAR awards granted and vested during the period, unvested restricted stock unit awards granted during the period and the intrinsic value of stock options and SARs exercised during the period were:
Share-Based Payment Award Activity Information with respect to stock option and SAR activity was as follows:
Information with respect to unvested restricted stock unit awards activity was as follows:
54
Table of Contents5. Fair Value Measurements Financial Assets Measured at Fair Value ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:
The Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of March 31, 2012 and April 2, 2011 was as follows (in thousands):
For Level 1 assets, the Company utilized quoted prices in active markets for identical assets. For Level 2 assets, exclusive of forward contracts, the Company utilized quoted prices in active markets for similar assets. For forward contracts, spot prices at March 30, 2012 and April 1, 2011 were utilized to calculate fair values. The Level 3 assets consisted of ARS and preferred stock acquired through the conversion of ARS. As none of the Company’s ARS traded through the auction process, estimated fair values were based primarily upon the income approach using a discounted cash flow model which took into account the following: (i) the underlying
55
Table of Contentsstructure of each security; (ii) the present value of future principal and interest payments discounted at rates that reflect current market conditions; (iii) consideration of the probabilities of default, restructuring or redemption by the issuer (trigger events); (iv) estimates of the recovery rates in the event of default for each security; (v) the financial condition, results, ratings of and financial claims on the bond insurers and issuers; and (vi) the underlying trust assets of the securities. During 2012, there were no transfers between Level 1 and Level 2 assets. As of March 31, 2012, the Company did not hold any ARS investments. During the first quarter of 2012, the Company sold all of its remaining ARS for approximately $6.0 million and all of its preferred stock for approximately $0.5 million. These ARS had a total estimated fair value of $5.2 million as of April 2, 2011, which consisted of $10.7 million par value ARS and $4.0 million par value ARS which were converted by the bond issuer to its preferred stock in 2009. The Company recorded a gain of $2.7 million in the first quarter of 2012, which included $1.4 million in reclassification of previously recorded unrealized gain out of accumulated other comprehensive income. As of April 2, 2011, the Company held ARS with a total estimated fair value of $5.2 million. The contractual maturities of these securities range up to calendar year 2050, and several securities and the preferred stock do not have stated maturities. These securities previously provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 to 35 days. As a result of the liquidity issues experienced in the global credit and capital markets, the Company’s ARS began to experience failed auctions during fiscal 2008. Since that time, none of the Company’s ARS traded through the auction process and the credit quality of the counterparties deteriorated. Consequently, it was determined that the declines in fair value of these securities in 2010 and 2009 represented other-than-temporary impairments in accordance with U.S. generally accepted accounting principles. Accordingly, the Company recognized other-than-temporary impairment charges of $1.3 million in 2010. There were no other-than-temporary impairments of ARS in 2012 and 2011. As of the beginning of 2010, in accordance with the adoption of ASC Topic 320 “Investments – Debt and Equity Securities” (ASC Topic 320), the Company recorded a cumulative-effect adjustment to increase the opening balance of retained earnings by $0.4 million, which represented the non-credit portion of the ARS loss previously recorded as an other-than-temporary impairment on the Consolidated Statements of Operations. The credit portion of the ARS loss was determined by direct estimation of the change in fair value attributable to market movements. The Company utilized market indices representing investments of constant credit quality over time and measured the index yield, which is considered attributable to non-credit related factors, at the beginning and end of the period. The effect of this change in yield on the value of the security was measured and subtracted from the total change in fair value to arrive at the estimated change in value attributable to changes in credit quality. As of April 2, 2011, the estimated fair value of the Company’s ARS of $5.2 million included $1.4 million of total net unrealized gains. These unrealized gains were recorded in accumulated other comprehensive income. The Company’s ARS were classified as non-current assets on the Consolidated Balance Sheets at April 2, 2011. During the fourth quarter of 2011, the Company sold a certain ARS with a par value of $3.0 million for approximately $0.7 million. The Company recorded a gain of $0.7 million in 2011 as the security was previously written down to zero value. During 2010, the Company sold certain ARS with a par value of $1.9 million pursuant to a tender agreement with the parent company of the securities’ original issuer. The Company received approximately $1.4 million on the sale of the ARS, which had an estimated fair value of $1.6 million prior to the quarter in which it was sold. As a result of the sale in 2010, the Company reclassified $0.3 million of the previously recorded unrealized net gain out of accumulated other comprehensive income.
56
Table of ContentsThe following table illustrates the activity related to credit loss on ARS from March 28, 2009 to March 31, 2012:
The following table illustrates Level 3 activity from April 3, 2010 to March 31, 2012:
As of March 31, 2012, the Company had $6.0 million invested in Series D Preferred Stock and $3.0 million invested in Series E Preferred Stock of OmniGuide, Inc., representing an 11% interest. At each reporting period end, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of these investments. If there are no events or circumstances identified that would adversely affect the fair value of the investments, the fair values of the investments are not calculated as it is not practicable to do so. As of March 31, 2012 and April 2, 2011, management had not identified any events or circumstances that indicated the investments were impaired; therefore, as presented in Note 12 “Other Assets”, the full carrying value of $9.0 million was included in Other assets on the Consolidated Balance Sheets at March 31, 2012 and April 2, 2011.
57
Table of ContentsInvestments Certain information regarding the Company’s investments at March 31, 2012 and April 2, 2011 was as follows (in thousands):
In addition to the sales of ARS, the Company sold certain available-for-sale securities for approximately $3.5 million at cost during 2012. Other than the sale of ARS discussed above, the Company had no sales of available-for-sale securities during 2011. For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income (loss), the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive income (loss) were insignificant as of March 31, 2012 and April 2, 2011. Underlying maturities of investments at March 31, 2012 were $148.0 million within one year and $23.0 million between one to five years. 6. Business Acquisition In September 2010, the Company acquired certain assets of PyroPhotonics Lasers, Inc. (PyroPhotonics), a manufacturer of tailored-pulse fiber lasers, for approximately $8.1 million in cash plus acquisition related costs of approximately $0.3 million. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their fair values. Analyses supporting the purchase price allocation included a valuation of assets and liabilities as of the closing date, an analysis of intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value.
58
Table of ContentsThe following table presents the allocation of the purchase price of $8.1 million to the assets acquired and liabilities assumed based on their fair values (in thousands):
The acquisition was an investment to integrate PyroPhotonics’ technology into certain of the Company’s product groups, which supported the premium paid over the fair market value of the individual assets. As a result, the Company recorded $4.0 million of goodwill. A portion of the goodwill amount is deductible for tax purposes. As a result of the acquisition, the Company recorded $3.6 million of identifiable intangible assets including $3.2 million of in-process research and development (IPR&D) at the date of the acquisition. The IPR&D program consisted of three laser platforms with primary focus on PyroFlex-25. The PyroFlex-25 is a unique pulse-programmable fiber laser platform designed to serve a broad range of industrial applications. The PyroFlex-25 is currently in the final stages of development, aimed towards a full production release in fiscal 2013. In determining the value of in-process research and development, the Company applied the excess earnings method. The key value drivers under the excess earnings method are as follows: (a) projected revenue and earnings generated by the assets; (b) expected economic life of the asset; (c) contributory asset charges that would be paid to the requisite operating assets; and (d) a discount rate which reflects risk associated with receiving future cash flows. Forecasted sales and expenses were projected individually for these three laser platforms including PyroFlex-25. The selected discount rate for the IPR&D was 25.6%. In applying a discount rate for the IPR&D, the Company considered the overall weighted average cost of capital of PyroPhotonics. The operating results of this acquisition are included in the Company’s results of operations since the date of acquisition. 7. Inventories The components of inventories at March 31, 2012 and April 2, 2011 were as follows:
8. Other Current Assets Other current assets at March 31, 2012 and April 2, 2011 consisted of the following:
59
Table of Contents9. Property, Plant and Equipment Property, plant and equipment as of March 31, 2012 and April 2, 2011 consisted of the following:
Depreciation expense totaled $12.5 million, $10.3 million and $10.0 million in 2012, 2011 and 2010, respectively. In 2012, the Company recorded $1.7 million of accelerated depreciation expense for certain assets. The Company shortened the depreciable lives of these assets in the fourth quarter of 2012 largely as a result of consolidating facilities in the United States and Asia. 10. Goodwill As of March 31, 2012 and April 2, 2011, the Company had $4.0 million in goodwill because of the PyroPhotonics acquisition in 2011. As a result of the acquisition, the Company recorded $3.6 million of identifiable intangible assets and $4.0 million of goodwill. See Note 6 “Business Acquisition” for additional discussion. 11. Acquired Intangible Assets Acquired intangible assets as of March 31, 2012 and April 2, 2011 consisted of the following:
60
Table of ContentsAmortization expense for acquired intangible assets has been recorded on the Consolidated Statements of Operations as follows:
The estimated amortization expense for acquired intangible assets in future years is as follows (in thousands):
The above table excludes estimated amortization expense on certain in-process research and development assets as the project completion dates are not known as of March 31, 2012. 12. Other Assets Other assets consisted of the following as of March 31, 2012 and April 2, 2011:
13. Income Taxes The Company accounts for income taxes under the asset and liability method. Under this method, deferred income taxes are recognized for the future tax consequences attributable to temporary differences between the financial statement and tax balances of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those assets and liabilities are expected to be recovered or settled. The effect on deferred taxes resulting from a change in tax rates is recognized in income in the period that includes the enactment date. When management determines that it is not more likely than not that a deferred tax asset will be fully realized, a valuation allowance is established to reduce deferred tax assets to the amount expected to be realized.
61
Table of ContentsNet deferred tax assets at March 31, 2012 and April 2, 2011 consisted of the following:
As of March 31, 2012 the Company had approximately $32.4 million in tax assets resulting from federal, state and foreign net operating losses and tax credits. A detailed breakdown of the net operating loss carryforwards (tax-effected) and tax credits at March 31, 2012 and April 2, 2011 was as follows:
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
