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| LTXC > SEC Filings for LTXC > Form 10-K on 15-Oct-2009 | All Recent SEC Filings |
15-Oct-2009
Annual Report
The following discussion should be read together with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this annual report on Form 10-K. Certain statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are forward-looking statements that involve risks and uncertainties. Words such as may, will, should, would, anticipates, expects, intends, plans, believes, seeks, estimates and similar expressions identify such forward-looking statements. The forward-looking statements contained herein are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Factors that might cause such a difference include, among other things, those set forth under "Risk Factors" and those appearing elsewhere in this Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. We assume no obligations to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements.
Overview
We design, manufacture, market and service semiconductor test solutions worldwide to leading companies in the semiconductor industry. Our semiconductor test equipment can test a broad range of analog, digital, mixed signal (a combination of analog and digital) and system in package, or SIP, semiconductor devices, all on a single test platform.
We focus our marketing and sales on integrated device manufacturers (IDMs), subcontractors, which perform manufacturing services for the semiconductor industry, foundries, which provide wafer manufacturing capability, and fabless companies, which design integrated circuits but have no manufacturing capability.
Merger with Credence Systems Corporation
On August 29, 2008, we completed a merger with Credence Systems Corporation ("Credence") and changed our name to LTX-Credence Corporation. However, because the merger with Credence was completed after the July 31 end of our 2008 fiscal year, our financial information for fiscal 2008 and previous fiscal years does not include the financial information or results of operations of Credence. Our financial information for fiscal 2009 includes the financial information and results of operations of Credence since the date of the merger on August 29, 2008.
As further discussed in Note 9 to the accompanying Consolidated Financial Statements, the merger of LTX and Credence did not result in new operating segments for reporting purposes under the provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information."
As a result of the merger, we undertook cost reduction measures to fully integrate the companies and realize a more streamlined business model. As a result of these actions, the combined headcount was reduced from 1,332 to 627 employees and temporary workers. As of July 31, 2009, we expect to pay $2.8 million of remaining severance costs within the next twelve months. These integration actions also resulted in merger related synergy savings of $25.0 million on an annual basis with actual savings of approximately $112.0 million.
Industry Conditions and Outlook
We sell capital equipment and services to companies that design, manufacture, assemble or test semiconductor devices. The semiconductor industry is highly cyclical, causing in turn a cyclical impact on our financial results. As a capital equipment provider, our revenue is driven by the capital expenditure budgets and spending patterns of our customers, who often delay or accelerate purchases in reaction to variations in their business. The level of capital expenditures by these semiconductor companies depends on the current and anticipated market demand for semiconductor devices and the products that incorporate them. Therefore, demand
for our semiconductor test equipment is dependent on growth in the semiconductor industry. In particular, three primary characteristics of the semiconductor industry drive the demand for semiconductor test equipment:
• increases in unit production of semiconductor devices;
• increases in the complexity of semiconductor devices used in electronic products; and
• the emergence of next generation device technologies, such as SIP.
The following graph shows the cyclicality in semiconductor test equipment orders and shipments from fiscal 1997 through fiscal 2009 (using the three month moving average), as calculated by SEMI, an industry trade organization:
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Consistent with our business strategy, we have continued to invest significant amounts in engineering and product development to develop and enhance our tester platforms during industry slowdowns. In fiscal 2009, engineering and product development expense was $71.2 million, or 51.8% of net sales, as compared to $46.0 million, or 33.9% of net sales, in fiscal 2008. Our engineering and development expenses increased sequentially on a quarterly basis in the first half of fiscal 2009. The increase in engineering and product development expense during these periods is due principally to the merger of LTX with Credence. The combined company continues to fund engineering and product development for the X-Series products, but it also funded additional next generation projects associated with ASL and Diamond, two new product lines acquired through the acquisition. Our engineering and development expense decreased sequentially on a quarterly basis in the second half of fiscal 2009. The decrease is related to reductions of force in the second half of fiscal 2009 as we finalized our combined company product roadmap.
We believe that our competitive advantage in the semiconductor test industry is primarily driven by the ability of our combined tester platforms to meet or exceed the cost and technical specifications required for the testing of advanced semiconductor devices. Our current investment in engineering and product development is focused on enhancements to and additions to our product offerings with new options and instruments designed for specific market segments. We believe this will continue to differentiate our tester platforms from the product offerings of our competitors.
In addition, over the past several years, we have increasingly transitioned the manufacture of certain components and subassemblies to contract manufacturers, thereby reducing our fixed manufacturing costs associated with direct labor and overhead. This strategy has further reduced our fixed manufacturing costs. We believe that transforming product manufacturing costs into variable costs will in the future allow us to improve our performance during cyclical downturns while preserving our historic gross margins during cyclical upturns.
During fiscal years 2005 and 2006, we took several additional cost reduction measures to further mitigate the adverse effect of cyclical downturns on our results of operations. Our total worldwide headcount was reduced from 635 employees and 55 temporary workers at the end of fiscal 2004 to 466 employees and 16 temporary workers at the end of fiscal 2008. During fiscal year 2009, and after the merger of LTX and Credence, we undertook cost reduction measures to fully integrate the companies and to realize a more streamlined business model. As a result of these actions, the combined headcount was reduced from 1,332 to 627 employees and temporary workers. In addition, we continued to maintain other cost reduction measures, such as the strict oversight and reduction in discretionary travel and other variable overhead expenses. We believe that these reductions in operating costs have reduced our costs while preserving our ability to fund critical product research and development efforts and continue to provide our customers with the levels of responsiveness and service they require.
We are also exposed to the risks associated with the volatility of the U.S. and global economies. The lack of visibility regarding whether or when there will be sustained growth periods for the sale of electronic goods and information technology equipment, and uncertainty regarding the amount of sales, underscores the need for caution in predicting growth in the semiconductor test equipment industry in general and in our revenues and profits specifically. Slow or negative growth in the domestic economy may continue to materially and adversely affect our business, financial condition and results of operations for the foreseeable future. Our results of operations would be further adversely affected if we were to experience lower than anticipated order levels, cancellations of orders in backlog, extended customer delivery requirements or pricing pressure as a result of a slowdown. At lower levels of revenue, there is a higher likelihood that these types of changes in our customers' requirements would adversely affect our results of operations because in any particular quarter a limited number of transactions accounts for an even greater portion of sales for the quarter.
Critical Accounting Policies and the Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. We based these
estimates and assumptions on historical experience, and evaluate them on an
on-going basis to ensure they remain reasonable under current conditions. Actual
results could differ from those estimates. We believe that our most critical
accounting policies upon which our financial reporting depends on and which
involve the most complex and subjective decisions or assessments are as follows:
revenue recognition, inventory reserves, income taxes, warranty, goodwill and
other intangibles, impairment of long-lived assets and allowances for doubtful
accounts.
A summary of those accounting policies and estimates that we believe to be most critical to fully understand, and evaluate, our financial results is set forth below. The summary should be read in conjunction with our Consolidated Financial Statements and related disclosures elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
Our revenue recognition policy is described in Note 2, Summary of Significant Accounting Policies, contained in the Notes to Consolidated Financial Statements included in this report. We recognize revenue when persuasive evidence of an arrangement exists, delivery or customer acceptance, if required, has occurred or services have been rendered, the seller's price is fixed or determinable and collectibility is reasonably assured.
Inventory
We sell capital equipment to companies that design, manufacture, assemble, and test semiconductor devices. We are exposed to a number of economic and industry factors that could result in portions of our inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, changes in our customers' capital expenditures, technological changes in our markets, our ability to meet changing customer requirements, competitive pressures in products and prices, and the availability of key components from our suppliers. Our policy is to establish inventory reserves when conditions exist that suggest our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand for our products or market conditions. We regularly evaluate the ability to realize the value of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, estimated product end of life dates, estimated current and future market values and new product introductions. Purchasing and alternative usage options are also explored to mitigate inventory exposure. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value. Pursuant to SAB Topic 5-BB, inventory reserves establish a new cost basis for inventory. Such reserves are not reversed until the related inventory is sold or otherwise disposed. For the year ended July 31, 2009, we recorded $0.2 million in sales of previously written-off inventory. There were $1.2 million of sales related to previously reserved items recorded for the year ended July 31, 2008 and $4.4 million of sales related to previously reserved items recorded for the year ended July 31, 2007. The net incremental gross margin and net income for these transactions did not have a significant impact on operating margins and overall operating results. As of July 31, 2009, our inventory of $35.3 million is stated net of inventory reserves of $56.6 and consists of Fusion products, X-Series products, ASL products, and Diamond products.
Of the $35.3 million inventory balance at July 31, 2009, $4.7 million consists of "last time buy" custom components primarily for Fusion HFi and ASL products, $24.7 million consists of materials and components to support current requirements for Fusion HFi, X-Series, ASL and Diamond products, and $4.9 million consists of evaluation inventory at customers. In addition, there is $1.0 million of deferred inventory costs related to shipment of inventory where revenue recognition is subject to product acceptance at July 31, 2009. If actual demand for our products deteriorates or market conditions are less favorable than those that we project, additional inventory reserves may be required. See Note 2 to our Consolidated Financial Statements.
Income Taxes
In accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", ("SFAS No. 109"), we recognize deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax bases of assets and liabilities calculated using enacted tax rates for the year in which the differences are expected to be reflected in the tax return. Valuation allowances are established when necessary to reduce deferred taxes to the amount expected to be realized.
We have deferred tax assets resulting from tax credit carryforwards, net operating losses and other deductible temporary differences, which will reduce taxable income in future periods. SFAS No. 109 requires that a valuation allowance be established when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's performance, the market environment in which we operate, length of carryback and carryforward periods, existing sales backlog and future sales projections. Where there are cumulative losses in recent years, SFAS No. 109 creates a strong presumption that a valuation allowance is needed. This presumption can be overcome in very limited circumstances. As a result of our cumulative loss position in recent years and the increased uncertainty relative to the timing of profitability in future periods, we continue to maintain a valuation allowance for our entire net deferred tax assets. The valuation allowance for deferred tax assets increased from $231.1 million at July 31, 2008, to $550.7 million at July 31, 2009. We expect to record a full valuation allowance on future tax benefits until we can sustain an appropriate level of profitability. Until such time, we would not expect to recognize any significant tax benefits in our future results of operations. We will continue to monitor the recoverability of our deferred tax assets on a periodic basis. As a result of the merger and Internal
Revenue Service Code Section 382 guidance, the future utilization of the combined company's net operating loss deductions will be significantly limited. See Note 6 to our Consolidated Financial Statements.
We adopted Financial Accounting Standards Board Interpretation Number 48, "Accounting for Uncertain Tax Positions" ("FIN 48") on August 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109," Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in a tax return. There were no adjustments to our accumulated deficit as a result of the implementation of FIN 48.
Valuation of Goodwill
The estimated purchase price for the merger with Credence has been allocated to assets acquired and liabilities assumed based on their estimated fair values. We then allocated the purchase price in excess of net tangible assets acquired to identifiable intangible assets, including in process research and development, based upon a detailed valuation that uses information and assumptions provided by management, as further described below. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill.
We follow the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which requires that goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with a definitive useful life are amortized over their estimated useful life. Assets recorded in these categories are tested for impairment at least annually or when a change in circumstances may result in future impairment. Management uses a discounted cash flow analysis to test goodwill, at least annually or when indicators of impairment exist, which requires that certain assumptions and estimates be made regarding industry economic factors and future profitability of the acquired business to assess the need for an impairment charge. The provisions of SFAS 142 require that a two-step impairment test be performed for goodwill. In the first step, we will compare the fair value of the reporting unit to which goodwill has been allocated to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test and determine the implied fair value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference.
Determining the number of reporting units and the fair value of a reporting unit requires us to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and determining appropriate market comparables. We believe these assumptions to be reasonable but actual conditions are unpredictable and inherently uncertain. Actual future results may differ from our estimates.
As discussed in Note 2 to the Consolidated Financial Statements, during the year we conducted analyses of the potential impairment of goodwill and concluded that this asset was not impaired at July 31, 2009. We will continue to perform these analyses until indicators of impairment are no longer present.
Valuation of Identifiable Intangible Assets
As part of the preliminary purchase price allocation Credence's identifiable intangible assets include existing technology, customer relationships and trade names. Credence's existing technology relates to patents, patent applications and know-how with respect to the technologies embedded in its currently marketed products.
We primarily used the income approach to value the existing technology and other intangibles. This approach calculates fair value by estimating future cash flows attributable to each intangible asset and discounting them to present value at a risk-adjusted discount rate.
In estimating the useful life of the acquired assets, we considered paragraph 11 of SFAS No. 142, which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors included a review of the expected use by the combined company of the assets acquired, the expected useful life of another asset (or group of assets) related to the acquired assets, legal, regulatory or other contractual provisions that may limit the useful life of an acquired asset or may enable the extension of the useful life of an acquired asset without substantial cost, the effects of obsolescence, demand, competition and other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the asset. We expect to amortize these intangible assets over their estimated useful lives using a method that is based on estimated future cash flows as we believe this will approximate the pattern in which the economic benefits of the assets will be derived.
Impairment of Long-Lived Assets
In connection with the recent merger with Credence, during the quarter ended October 31, 2008, we developed a product roadmap for the combined company which led to the phase out of approximately $3.7 million of certain consignment testers and property and equipment related to the ASL 3KRF, Diamond D40, and Sapphire product lines. In light of market conditions, we also wrote down $0.4 million of certain equipment for which we do not believe we will recover the cost. Accordingly, we recorded an impairment loss for the three months ended October 31, 2008 of $5.0 million. In the quarter ended January 31, 2009, we recorded additional impairment charges of $0.8 million related to the reduction in the fair value of the land that we own adjacent to our Hillsboro, Oregon facility.
Due to the decline in our stock price and lower than expected revenues for the year ended July 31, 2009, we conducted recoverability tests in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") based on undiscounted cash flows of our long-lived assets which contemplates significant cost savings. As a result of these tests, we determined there were no additional impairment losses on long-lived assets for the year ended July 31, 2009. However, actual performance in the near and longer-term could be materially different from these forecasts, which could impact future estimates of undiscounted cash flows and may result in the impairment of the carrying amount of long-lived assets. This could be caused by events such as strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our customer base, or a material negative change in our relationships with significant customers. Accordingly, we will continue to perform this analysis on a quarterly basis for the foreseeable future, to the extent impairment indicators are still present.
Valuation of Acquired In-Process Research and Development
As part of the preliminary purchase price allocation for Credence, approximately $6.3 million of the purchase price has been allocated to acquired in-process research and development projects, primarily related to Credence's ASL and Diamond tester product lines. The amount allocated to acquired in-process research and development represents the estimated value based on risk-adjusted cash flows related to in-process projects that have not yet reached technological feasibility and have no alternative future uses as of the date of the acquisition. The primary basis for determining the technological feasibility of these projects was a detailed review of the development status of each project including factors such as costs incurred/remaining, technological risks achieved/remaining, and incompleteness.
The fair value assigned to acquired in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the
projects, and discounting the net cash flows to their present value. The revenue projection used to value the acquired in-process research and development was based on estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by us and our competitors. The resulting net cash flows from such projects were based on our estimates of cost of sales, operating expenses, and income taxes from such projects.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations and the implied rate of return from the transaction model plus a risk premium. Due to the nature of the forecasts and the risks associated with the developmental projects, appropriate risk-adjusted discount rates were used for the in-process research and development projects. The discount rates are based on the stage of completion and uncertainties surrounding the successful development of the purchased in-process technology projects.
In accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"), we recorded a charge in year ended July 31, 2009 for the full amount of the acquired in-process research and development.
Restructuring Costs
As a result of the Credence merger, we assumed previous Credence management approved restructuring plans designed to reduce headcount, consolidate facilities and to align that company's capacity and infrastructure to anticipated customer demand and transition of its operations for higher utilization of facility space. In connection with these plans, we assumed a total liability of approximately $6.0 million. Subsequent to the completion of the Merger, we incurred an additional $0.9 million related to these actions.
Additionally, we recorded as part of our purchase accounting a liability of approximately $13.0 million in accordance with EITF Issue No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3") primarily related to termination of certain Credence employees in connection with the Company's merger with Credence. In addition, we recorded a liability of approximately $2.9 million for legacy LTX employees related to the merger with Credence and other post-employment obligations. Our plan was finalized within one year of the date of the merger. All adjustments to severance and/or retention costs directly related to the Credence restructuring were recorded as an adjustment to goodwill. For the year ended July 31, 2009, we recorded $21.2 million of expense to operations associated with restructuring activities.
We are accounting for Restructuring Costs under both Statement of Financial Accounting Standards No. 146-Accounting for Costs Associated with Exit or Disposal Activities and Statement of Financial Accounting Standards No. 112-Employers' Accounting for Postemployment Benefits-an amendment of FASB Statements No. 5 and 4.
Warranty
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