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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission File Number: 0-12853
ELECTRO SCIENTIFIC INDUSTRIES, INC.
Registrants telephone number: (503) 641-4141
Registrants web address: www.esi.com
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 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the Registrants Common Stock at August 1, 2012 was 29,311,118 shares.
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
These unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements are to be read in conjunction with the financial statements and notes included in the Companys Annual Report on Form 10-K for its fiscal year ended March 31, 2012. These interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. The results for interim periods are not necessarily indicative of the results of operations for the entire year.
The preparation of 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.
There have been no significant changes to the Companys significant accounting policies from those presented in Note 2 Summary of Significant Accounting Policies to the consolidated financial statements included in the Companys Annual Report on Form 10-K for its fiscal year ended March 31, 2012. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.
2. Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) Accounting Standards Update (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 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). 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, in the first quarter of 2013 did not have a material effect on the Companys financial position, results of operations and cash flows.
In July 2012, the FASB issued ASU 2012-02, IntangiblesGoodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (ASC ASU 2012-02). ASC ASU 2012-02 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting units fair value is less than its carrying amount before performing the quantitative 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, the entity is not required to perform further impairment test and assessment. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The Company plans to early adopt ASC ASU 2012-02 in 2013, and does not expect that this adoption will have a material effect on its financial position, results of operations and cash flows.
3. Restricted Cash
As of June 30, 2012, the Company had restricted cash of $22.3 million, which collateralizes commercial letters of credit substituted for the cash bond previously held by the Kaohsiung District Court of Taiwan. The total restricted cash balance of $22.3 million was included in Restricted cash on the Condensed Consolidated Balance Sheets at June 30, 2012 as a current asset. See Note 15 Legal Proceedings below for further discussion.
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 value of the Companys 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-settled stock appreciation rights (SARs) grant the right to receive shares of the Companys 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 SARs or stock options during the first quarter of 2013. The Company granted SARs during the first quarter of 2012, but did not grant any stock options in that period.
Share-based compensation expense was included in the Companys Condensed Consolidated Statements of Operations as follows:
As of June 30, 2012, no share-based compensation expenses were capitalized. The Company had $10.3 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted-average period of 1.8 years.
Share-based compensation expense decreased by $1.8 million resulting primarily from a decrease in estimated attainment of performance based grants, the prior year accelerated expense associated with the Chief Executive Officers retirement eligibility date and a lower grant date fair value associated with new awards granted in the first quarter of 2013.
5. 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 Companys fair value hierarchy for its financial assets measured at fair value on a recurring basis as of June 30, 2012 and March 31, 2012 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 June 29, 2012 and March 30, 2012 were utilized to calculate unrealized gain/loss.
During the first quarter of 2013, there were no transfers between level 1 and level 2 assets. As of June 30, 2012, the Company did not hold any auction rate securities (ARS) investments. In the first quarter of 2012, the Company sold all of its remaining ARS for approximately $6.0 million and all of its related 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 June 30, 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 June 30, 2012 and March 31, 2012, management had not identified any events or circumstances that indicated the investments were impaired; therefore, as presented in Note 8 Other Assets, the full carrying value of $9.0 million was included in Other assets on the Consolidated Balance Sheets at June 30, 2012 and March 31, 2012.
Certain information regarding the Companys investments at June 30, 2012, and March 31, 2012 was as follows (in thousands):
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 June 30, 2012 and March 31, 2012.
Underlying maturities of investments at June 30, 2012 were $147.8 million within one year and $13.0 million between one to five years.
Inventories are principally valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Components of inventories were as follows:
7. Other Current Assets
Other current assets consisted of the following:
8. Other Assets
Other assets consisted of the following:
9. Business Acquisitions
On June 14, 2012, the Company acquired Eolite Systems, a designer and manufacturer of unique fiber lasers, for approximately $9.7 million in cash for all of their outstanding shares. The Company also incurred approximately $0.8 million in acquisition and integration related costs, which is included in Selling, service and administration expenses in the Condensed Consolidated Statements of Operations. Allocation of the purchase price to goodwill and identifiable assets is subject to the final determination of purchase price and valuation of the assets acquired and liabilities assumed. The Company preliminarily recorded approximately $5.5 million of identifiable intangible assets, $4.1 million of goodwill, $3.0 million of tangible assets, which included $0.5 million in cash and short-term investments, and assumed debt and other liabilities totaling approximately $2.9 million. The operating results of this acquisition are included in the Companys results of operations since the date of acquisition. Pro forma financial information has not been provided for the acquisition of Eolite Systems as it was not material to the Companys overall financial position.
10. Accrued Liabilities
Accrued liabilities consisted of the following:
As a result of the Eolite Systems acquisition, the Company assumed $1.8 million of loans payable recorded at fair value, which will be repaid during the second quarter of 2013.
11. Product Warranty Accrual
The following is a reconciliation of the change in the aggregate accrual for product warranty:
Net warranty charges incurred include labor charges and costs of replacement parts for system repairs under warranty. These costs are recorded net of any estimated cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Companys suppliers for defective components. The provision for warranty charges reflects the estimate of future anticipated net warranty costs to be incurred for all products under warranty at quarter end and is recorded to cost of sales.
12. Deferred Revenue
Generally, revenue is recognized upon fulfillment of acceptance criteria at the Companys factory and title transfer which frequently occurs at the time of delivery to a common carrier. Revenue is deferred whenever title transfer is pending and/or acceptance criteria have not yet been fulfilled. Deferred revenue occurrences include sales to Japanese customers, shipments of substantially new products and shipments with custom specifications and acceptance criteria. In sales involving multiple element arrangements, the relative selling price of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.
The following is a reconciliation of the changes in deferred revenue:
13. Earnings Per Share
The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share:
Awards of options, stock-settled stock appreciation rights (SARs) and unvested restricted stock units (RSUs) representing an additional 3.9 million and 2.5 million shares for the first quarters of 2013 and 2012, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.
14. Product and Geographic Information
Net sales by product type were as follows:
Net sales by geographic area, based on the location of the end user, were as follows:
15. Legal Proceedings
All Ring Patent Infringement Prosecution
The Companys proceedings against All Ring Tech Co., Ltd (All Ring) in Taiwan for alleged patent infringement are ongoing. 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 total restricted cash balance was included in Restricted cash on the Condensed Consolidated Balance Sheets as of June 30, 2012.
In June 2011, the Kaohsiung District Court of Taiwan orally announced its judgment, finding that the Capacitor Tester Model RK-T6600, as well as All Rings RK-T2000 and RK-L50 systems, had infringed the 207469 patent, ordering All Ring to pay the Company approximately $24.0 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 any system infringing the 207469 patent. 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, the Company filed its response to All Rings appeal. All Ring and the Company have each filed additional briefs with the Intellectual Property Court. See the Companys Form 10-K for the year ended March 31, 2012 for further background and additional information related to these proceedings.
In the ordinary course of business, the Company is 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 the Companys consolidated financial position, results of operations or cash flows.
16. Restructuring and Cost Management Plans
In 2012, the Company continued its efforts to reduce its worldwide cost structure through transition of certain procurement and manufacturing activities to Asia and additionally identified and initiated other cost reduction actions. The estimated completion date for these actions is September 30, 2012. See the Companys Form 10-K for the year ended March 31, 2012 for additional information related to restructuring and cost management plans.
In the first quarter of 2013, no additional restructuring costs were incurred. At June 30, 2012 and March 31, 2012, the amount of unpaid restructuring costs included in accrued liabilities was $0.3 million and $1.0 million, respectively.
The following table presents the amounts related to restructuring costs payable (in thousands):
17. Shareholders Equity
Share Repurchase Program
On May 15, 2008, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of the Companys outstanding common stock primarily to offset dilution from equity compensation programs. On December 9, 2011, the Board of Directors terminated the 2008 repurchase program and authorized a new share repurchase program totaling $20.0 million to acquire shares of the Companys outstanding common stock. The repurchases are to be made at managements 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. The Company did not repurchase any shares under this program in either the first quarter of 2013 or in 2012. There is no fixed completion date for the repurchase program. See the Companys Form 10-K for the year ended March 31, 2012 for additional information related to these share repurchase programs.
On December 9, 2011, the Board of Directors adopted a dividend policy under which the Company intends to pay quarterly cash dividends. The following table summarizes the dividends declared and paid by the Company during the first quarter of 2013 and the fourth quarter of 2012:
During the first quarter of 2013, the Company paid the dividend at the rate of $0.08 per outstanding common share for a total amount of $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 ESIs 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 ESIs shareholders.
The statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words believes, expects, anticipates 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 materially differ as a result of many factors, including the risks described in Part II, Item 1A Risk Factors.
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.
Summary of Sequential Quarterly Results
The first quarter of 2013, ended June 30, 2012, reflected sequential improvement in our financial results despite continued challenges in some of our markets. Strong demand for our advanced microfabrication products contributed to sequential orders growth. Total order volume for the first quarter of 2013 was $74.1 million, compared to $70.3 million for the fourth quarter of 2012, which ended March 31, 2012. The sequential increase in orders was driven by orders for microfabrication and MLCC products. Demand remained weak in our DRAM and LED business.
Orders for our Interconnect & Microfabrication Group (IMG) products decreased modestly compared to the prior quarter, primarily driven by lower flex interconnect orders. Flex interconnect orders declined after a record quarter in March 2012 as customers absorbed significant capacity ordered in the last two quarters. The flex interconnect business continues to have robust customer activity, primarily a result of increasing use of flexible circuitry and market growth of mobile electronics, particularly in smart phones and tablet devices.
Orders for our Semiconductor Group (SG) products remained low in the first quarter with virtually no demand from the dynamic random access memory (DRAM) market. Our LED wafer scribing products saw a slight increase in demand, although the market remains in an over-supply condition.
Orders for our Components Group (CG) products more than doubled compared to the prior quarter. The increase was primarily driven by demand for our new 3510 MLCC MicroChip tester which addresses the new smallest size capacitors, used in smart phones and tablets.
Net sales of $59.0 million for the first quarter of 2013 increased $13.5 million from $45.5 million for the prior quarter. The increase in net sales was driven primarily by our IMG products, which increased $16.0 million as a result of higher sequential shipments of our flex interconnect systems ordered last quarter. SG product sales decreased $4.6 million due to slowing demand from our memory repair customers. CG sales increased $2.1 million driven by demand from our MLCC customers.
Gross margin improved to 40.1% on net sales of $59.0 million for the first quarter of 2013 compared to 37.0% on net sales of $45.5 million for the prior quarter. Gross margin rates improved due to the benefit of higher production volumes and lower inventory write-offs, partially offset by the mix impact of quantity pricing on high volume orders.
Net operating expenses of $25.2 million in the first quarter of 2013 decreased $2.1 million compared to $27.3 million in the prior quarter. This decrease was primarily due to $2.9 million in restructuring costs and $1.0 million in loss on disposal of assets incurred in the fourth quarter of 2012 that did not repeat in the first quarter of 2013. Additionally, research, development and engineering (RD&E) expenses decreased by $0.7 million compared to the prior quarter. These decreases were partially offset by an increase of $2.4 million in selling, service and administration (SS&A) expenses. The restructuring costs and the loss on disposal of assets in the fourth quarter of 2012 were primarily a result of implementing our globalization strategy and other cost control measures. The decrease in RD&E expenses during the first quarter of 2013 was primarily due to lower project materials and new product development costs. SS&A expenses increased primarily due to share-based compensation expense as well as acquisition and integration costs for Eolite Systems. Share-based compensation expense increased primarily due to accelerated expense associated with Chief Executive Officers retirement eligibility date and immediate vesting of the annual board of director share grants.
Operating loss was $1.5 million in the first quarter of 2013, a decrease of $8.9 million compared to an operating loss of $10.5 million in the prior quarter. The decrease was primarily due to higher net sales and lower operating expenses discussed above.
The effective tax rate was 44.3% for the first quarter of 2013, resulting from an income tax benefit of $0.8 million, compared to an effective rate of 26.4% for the prior quarter that resulted from an income tax benefit of $2.8 million. The primary factor impacting the effective tax rate for first quarter of 2013 was the level of net loss for the quarter and the proportion of foreign earnings relative to pretax income or loss.
Net loss for the first quarter of 2013 was $0.9 million compared to net loss of $7.7 million in the prior quarter due to the impact of the items discussed above.
Quarter Ended June 30, 2012 Compared to Quarter Ended July 2, 2011
Results of Operations
The following table presents results of operations data as a percentage of net sales:
Net sales were $59.0 million for the first quarter of 2013, a decrease of $18.1 million or 23% compared to net sales of $77.0 million for the first quarter of 2012. Revenue decreased primarily due to lower demand for SG products, specifically in the memory repair and LED scribing markets. We also experienced lower demand for our CG products.
The following table presents net sales information by product group:
IMG sales in the first quarter of 2013 decreased slightly by $0.5 million or 1% compared to the first quarter of 2012. The decrease was driven by lower revenue from our advanced microfabrication customers, which was particularly strong in the first quarter of 2012 due to a large follow-on order received that quarter. The decrease in microfabrication was mostly offset by increased sales in the flex-circuit market driven by strong demand for smart phones and tablets which utilize an increased amount of flex circuitry in their designs.
SG sales in the first quarter of 2013 decreased $14.5 million or 80% compared to the first quarter of 2012. The decrease in sales was driven by a lack of demand for memory repair and lower orders for LED systems. The DRAM and LED markets are currently in an over-capacity condition and are negatively impacted by slow macroeconomic growth.
CG sales in the first quarter of 2013 decreased $3.1 million or 29% compared to the first quarter of 2012. The decrease is a result of most MLCC customers continuing to absorb capacity created by systems delivered in prior quarters and by lower overall demand for MLCCs.
The following table presents net sales information by geographic region:
Compared to the first quarter of 2012, net sales for the first quarter of 2013 decreased $16.5 million or 24% in Asia, decreased $1.6 million or 27% in the Americas and remained flat in Europe. The decreases in Asia were primarily due to lower sales for our SG products, which were the result of the over-supply condition discussed above. Net sales in the Americas and Europe remain a lower percentage of total sales as purchases in these regions are primarily for specialized uses or research and development purposes, as compared to the trend by our Asian customers to source their high-volume manufacturing in that region.
The following table presents gross profit information:
Gross profit for the first quarter of 2013 was $23.7 million, a decrease of $10.1 million compared to gross profit of $33.8 million for the first quarter of 2012. Gross profit as a percentage of net sales decreased to 40.1% for the first quarter of 2013 from 43.8% for the first quarter of 2012. These decreases were primarily related to lower revenue levels and the resulting decrease in production capacity utilization, combined with the mix impact of quantity pricing on high volume orders.
The following table presents operating expense information:
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 were $15.7 million for the first quarter of 2013, a decrease of $0.8 million compared to the first quarter of 2012. This decrease was primarily related to a $1.7 million reduction in share-based compensation, partially offset by an increase of $0.8 million in acquisition and integration costs for Eolite Systems. The decrease in share-based compensation primarily resulted from a decrease in estimated attainment of performance based grants, the prior year accelerated expense associated with the Chief Executive Officers retirement eligibility date and the lower grant date fair value for new awards granted in the first quarter of 2013.
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 were $9.5 million for the first quarter of 2013, a decrease of $1.7 million compared to the first quarter of 2012. The decrease was primarily due to a reduction in project material and consulting costs, and to a lesser extent, lower labor costs associated with selective decreases in headcount.
Legal Settlement Costs
There were no legal settlement costs in the first quarter of 2013. Legal settlement costs for the first quarter of 2012 were $0.6 million, and consisted of court and legal fees associated with the All Ring litigation and other legal matters.
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. As of June 30, 2012, we did not hold any ARS investment. See Note 5 Fair Value Measurements to the Condensed Consolidated Financial Statements in Item 1 Financial Statements and Supplementary Data for further discussion.
Interest and Other (Expense) Income, net
Interest and other income, net, consists of interest income and expense, market gains and losses on assets held for our deferred compensation plan, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees and other miscellaneous non-operating items. Net interest and other expense of $0.2 million for the first quarter of 2013 remained fairly flat compared to the first quarter of 2012.
The following table presents income tax information:
The income tax benefit for the first quarter of 2013 was $0.8 million on pretax loss of $1.7 million, an effective tax benefit rate of 44.3%. For the first quarter of 2012, the income tax provision was $2.2 million on pretax income of $8.1 million, an effective tax rate of 26.7%. The primary factor impacting the effective tax rate for first quarter of 2013 was the level of loss for the quarter and the proportion of foreign earnings relative to pretax income or loss.
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, or the ability to fully utilize our deferred tax assets. 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 (Loss)
The following table presents net income (loss) information:
Net loss for the first quarter of 2013 was $0.9 million, or $0.03 per share, compared to net income of $5.9 million, or $0.21 per basic share and $0.20 per diluted share for the first quarter of 2012. The decline was primarily due to lower revenue in the first quarter of 2013 partially offset by lower overall operating expenses.
Financial Condition and Liquidity
At June 30, 2012, our principal sources of liquidity were cash and cash equivalents of $84.3 million, short-term investments of $100.6 million and accounts receivable of $28.1 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 June 30, 2012, we had a current ratio of 6.17 and held no long-term debt. Working capital of $268.6 million declined slightly compared to the March 31, 2012 balance of $269.5 million. We also held approximately $13.0 million of non-current investments at June 30, 2012.
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.
In December 2011, the Board of Directors terminated the 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 managements 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 either in the first quarter of 2013 or in 2012. There is no fixed completion date for the repurchase program. See the Form 10-K for the year ended March 31, 2012 for additional discussion related to these share repurchase programs.
In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. The following table summarizes the dividend declared and paid by us during the first quarter of 2013 and the fourth quarter of 2012:
During the first quarter of 2013, the dividend amount paid as a result of the May 10, 2012 declaration was $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.
Sources and Uses of Cash
Net cash provided by operating activities totaled $11.4 million for the first quarter of 2013 due to our $0.9 million net loss offset significantly by inflows from working capital and non-cash changes. During the first quarter of 2013, the primary sources of cash inflow from working capital consisted of a $4.9 million decrease in trade receivables, $3.9 million increase in accounts payable and accrued liabilities, $1.0 million decrease in shipped systems pending acceptance, and a $0.5 million decrease in other current assets, partially offset by a $1.9 million increase in inventories and a $0.2 million decrease in deferred revenue.
For the first quarter of 2013, net cash provided by investing activities of $6.1 million was primarily due to $330.3 million of proceeds from sales and maturities of investments, partially offset by $313.9 million of purchases of investments, and $9.5 million of net cash paid for acquisition of Eolite Systems, a designer and manufacturer of unique fiber lasers. Net cash used in financing activities of $2.9 million primarily resulted from $2.3 million of cash dividends paid to shareholders and $0.6 million of cash used in net stock plan activity including employee tax deposits related to stock awards, partially offset by employee stock purchase activity.
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.
Critical Accounting Policies and Estimates
We reaffirm the Critical Accounting Policies and Estimates in Part II Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations reported in our Form 10-K for the year ended March 31, 2012.
There have been no material changes in the market risk disclosure contained in our Form 10-K for the year ended March 31, 2012.
Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our President and Chief Executive Officer (CEO) and our Chief Financial Officer (CFO) required by Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on managements evaluation of those disclosure controls and procedures. This disclosure should be read in conjunction with the Section 302 Certifications for a complete understanding of the topics presented.
Disclosure Controls and Procedures
Our management has evaluated, under the supervision and with the participation of our CEO and CFO, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on that evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the first quarter of 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
All Ring Patent Infringement Prosecution
Our proceedings against All Ring Tech Co., Ltd (All Ring) in Taiwan for alleged patent infringement are ongoing. 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 was included in Restricted cash on the Condensed Consolidated Balance Sheets as of June 30, 2012.
In June 2011, the Kaohsiung District Court of Taiwan orally announced its judgment, finding that the Capacitor Tester Model RK-T6600, as well as All Rings RK-T2000 and RK-L50 systems, had infringed the 207469 patent, ordering All Ring to pay us approximately $24.0 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 any system infringing the 207469 patent. 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 Rings appeal. We and All Ring have each filed additional briefs with the Intellectual Property Court. See our Form 10-K for the year ended March 31, 2012 for further background and additional information related to these proceedings.
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.
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.
Revenues 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 arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. 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 managements 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 or our customers 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 China and Singapore, research and development facilities in Canada, France 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:
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 managements time. These risks include:
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 June 2012 acquisition of Eolite Systems. 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.
Hiring 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 satisfaction 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.
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 managements 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. The ability to utilize our deferred tax assets is highly dependent on future taxable income. If we were to experience an on-going decline in taxable income, there is a risk that our deferred tax assets could be subject to additional valuation allowance. 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.
Impairment of Intangible Assets
We held a total of $13.5 million in acquired intangible assets and $8.2 million in goodwill at June 30, 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 around carrying value per share since mid-May 2012, we will continue to monitor the situation. 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.
Impairment 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.
This list is intended to constitute the exhibit index.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.