Zygo Corporation is a worldwide supplier of optical metrology instruments, precision optics and electro-optical design and manufacturing services, serving customers in the semiconductor capital equipment, research, defense, life sciences and industrial markets. We conduct the majority of our manufacturing in a 153,500 square foot facility in Middlefield, Connecticut, a 55,300 square foot facility in Richmond, California, and a 22,560 square foot facility in Tucson, Arizona. In May 2012, we purchased a 110,020 square-foot facility in Tucson, Arizona, which will function as the manufacturing site for our Tucson operation when we complete our transition to the new site.

Bookings for the second quarter of fiscal 2013 were $42.8 million, a decrease of 13% compared with bookings of $48.8 million in the second quarter of fiscal 2012 and an increase of 15% compared with bookings of $37.3 million in the first quarter of fiscal 2013. Bookings for the Metrology Solutions segment were 62% of the total; Optical Systems segment bookings were 38%. Backlog was $73.2 million at December 31, 2012, compared with $69.7 million at December 31, 2011, and $65.1 million at September 30, 2012. Currently, 63% of the backlog is Optical System bookings which generally carry a lower gross margin than Metrology Solutions. If the mix of revenues changes to a greater proportion of Optics revenues, it is likely to adversely affect reported gross margin. The impact on gross margin will also depend on future bookings, particularly Metrology bookings with shorter shipping cycles.

Our effective tax rate increased as a result of the reversal of the valuation allowance on deferred tax assets in the fourth quarter of fiscal 2012. Previous years' results benefitted from the offset effect of reversing valuation allowance against tax provision, essentially eliminating U.S. Federal income tax expense. Since the valuation allowance against deferred tax assets was eliminated at the end of fiscal 2012 due to improved operating performance and improved business outlook, current year results reflect tax expense at the full effective tax rate, modified by adjustment of prior period deferred tax asset balances as a component of the fiscal 2013 year tax provision.

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosures at the date of our condensed consolidated financial statements. On an ongoing basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, marketable securities, warranty obligations, income taxes, long-lived assets, share-based payments and accruals for health insurance. Management bases its estimates and judgments on historical experience and current market conditions and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. As discussed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2012, management considers the Company's policies on revenue recognition and allowance for doubtful accounts; inventory valuation; other-than-temporary impairment of marketable securities; share-based compensation; warranty costs; accounting for income taxes; valuation of long-lived assets; and accruals for health insurance to be critical accounting policies due to the estimates, assumptions and application of judgment involved in each.

                             RESULTS OF OPERATIONS

Net Revenues by Segment


                                     Fiscal 2013              Fiscal 2012

                                           Percentage               Percentage
(Amounts in millions)           Amount      of Total     Amount      of Total

Quarter ended December 31
Metrology Solutions             $  21.4             62 % $  25.5             64 %
Optical Systems                    13.2             38 %    14.5             36 %

Total                           $  34.6            100 % $  40.0            100 %


Six Months ended December 31
Metrology Solutions             $  47.3             63 % $  55.3             66 %
Optical Systems                    27.5             37 %    28.7             34 %

Total                           $  74.8            100 % $  84.0            100 %

Net revenues for the three months ended December 31, 2012 decreased $5.4 million, or 14%, compared with the prior year period, reflecting decreases in the Metrology Solutions segment revenues of 16% and in the Optical Systems segment of 9%. The decrease in the Metrology Solutions segment was primarily due to volume decreases of $3.0 million in instruments product lines related to microscopes and, to a lesser degree, large aperture systems and $0.8 million in certain product revenues attributable to soft demand in the semiconductor sector. The decrease in the Optical Systems segment was primarily due to volume decreases in optical components of $1.6 million and contract manufacturing of $0.3 million, partially offset by an increase in the extreme precision optics group of $0.5 million.

Net revenues for the six months ended December 31, 2012 decreased $9.2 million, or 11%, compared with the prior year period, reflecting decreases in the Metrology Solutions segment revenues of 15% and in the Optical Systems segment of 4%. The decrease in the Metrology Solutions segment of $8.0 million was primarily due to volume decreases in semiconductor related products of $5.6 million and instruments products of $3.1 million. The semiconductor market is still slow and has affected orders across several product lines. The Optical Systems segment declined $1.2 million year over year with increases in extreme precision optics of $3.7 million partially offsetting the declines in contract manufacturing and laser fusion optics.

Revenues from two customers accounted for 14% and 11% of net revenues for the three months ended December 31, 2011. No customer accounted for over 10% of revenues for the three months ended December 31, 2012. Revenues from one customer accounted for 10% of net revenues for the six months ended December 31, 2012. Revenues from two customers accounted for 12% and 11% of net revenues for the six months ended December 31, 2011. Revenues from these customers were included in both reporting segments.

Revenues denominated in U.S. dollars for the three months ended December 31, 2012 and 2011 were 76% and 79%, respectively, and 78% and 82% for the six months ended December 31, 2012 and 2011, respectively. The balance of revenue was denominated in Euro, Yen and Yuan. Revenues denominated in foreign currency are exposed to foreign exchange fluctuations from the time customers are invoiced in foreign currency until collection occurs. Significant changes in the values of foreign currencies relative to the value of the U.S. dollar, or in the general economic conditions in our export markets, could materially impact the revenues in these markets and our consolidated financial position and results of operations.

Gross Margin by Segment


                                                          Fiscal 2013                        Fiscal 2012


(Amounts in millions)                            Gross Profit     Gross Margin      Gross Profit     Gross Margin

Quarter ended December 31
Metrology Solutions                             $         11.6               54 %  $         15.0               59 %
Optical Systems                                            3.7               28 %             4.6               32 %

Total                                           $         15.3               44 %  $         19.6               49 %


Six months ended December 31
Metrology Solutions                             $         25.9               55 %  $         32.5               59 %
Optical Systems                                            6.9               25 %             8.8               31 %

Total                                           $         32.8               44 %  $         41.3               49 %

Gross margin for the three months ended December 31, 2012 was 44%, a decrease of five percentage points from the comparable prior year period. Within the Metrology Solutions segment, the decrease in gross margin for the three months ended December 31, 2012 compared with the prior year period was primarily due to a combination of overall lower volumes resulting in a decrease in labor and overhead absorption, lower margins on certain custom orders within the instruments product line and lower volumes in the semiconductor sector of products with traditionally more favorable gross margins. The gross margin of the Optical Systems segment for the three months ended December 31, 2012 decreased by four percentage points compared with the prior year period, primarily due to lower volumes, resulting in a decrease in labor and overhead absorption which increased other cost of sales and, to a lesser extent, lower than expected margins on certain custom orders.

Gross margin for the six months ended December 31, 2012 was 44%, a decrease of five percentage points from the comparable prior year period. Within the Metrology Solutions segment, the decrease in gross margin for the six months ended December 31, 2012 compared with the prior year period was primarily due to lower margins on certain custom orders within the instruments product line and the negative effect of lower volumes on labor and overhead absorption. The gross margin of the Optical Systems segment for the six months ended December 31, 2012 decreased by six percentage points compared with the prior year period, primarily due to a decrease in labor and overhead absorption.

Selling, General and Administrative Expenses ("SG&A")

                                       Fiscal 2013                  Fiscal 2012

                                            Percentage of                Percentage of
(Amounts in millions)            Amount     Net Revenues      Amount     Net Revenues

Quarter ended December 31 $ 8.6 25 % $ 8.1 20 % Six months ended December 31 $ 17.1 23 % $ 17.6 21 %

SG&A increased in the three months ended December 31, 2012 by $0.5 million from the comparable prior year period. The increase was primarily due to increased selling expense. For the six months ended December 31, 2012, SG&A decreased primarily due to lower employee incentive compensation partially offset by an increase in expenses related to increased headcount.

                                       Fiscal 2013                  Fiscal 2012

                                            Percentage of                Percentage of
(Amounts in millions)            Amount     Net Revenues      Amount     Net Revenues

Quarter ended December 31 $ 4.5 13 % $ 4.1 10 % Six months ended December 31 $ 9.1 12 % $ 8.1 10 %

RD&E for the three months ended December 31, 2012 increased by $0.4 million compared with the prior year period primarily due to the increases in spending in our lithography stage metrology product line. RD&E expense for the six months ended December 31, 2012 increased by $1.0 million compared with the prior year period, primarily due to the increases in spending in our lithography stage metrology and extreme precision optics product lines.

Other Income (Expense)


                                        Fiscal 2013                   Fiscal 2012

                                             Percentage of                 Percentage of
(Amounts in millions)            Amount      Net Revenues      Amount      Net Revenues

Quarter ended December 31 $ (0.2 ) 1 % $ 0.1 0 % Six months ended December 31 $ (0.2 ) 0 % $ (0.2 ) 0 %

Other expense for the three and six months ended December 31, 2012 consisted primarily of imputed interest on a future contingent liability and foreign currency translation adjustments. Other income for the three months ended December 31, 2011 included a gain recorded due to a reduction in the anticipated future consideration expected to be paid by us related to a past acquisition.

Income Tax Expense


                                      Fiscal 2013               Fiscal 2012

(Amounts in millions)            Amount     Tax Rate %     Amount     Tax Rate %


Quarter ended December 31       $    0.3             16 % $    0.8             11 %
Six months ended December 31    $    1.8             27 % $    1.6             10 %

Income tax expense for the three months ended December 31, 2012 included income taxes in United States federal, state and foreign jurisdictions partially offset by a tax benefit of $0.5 million to correct an error in recording deferred tax asset balances as of June 30, 2012 relating to fixed assets recorded in an acquisition and foreign tax credits. Income tax expense for the three months ended December 31, 2011 included income taxes for state and foreign jurisdictions only. Income tax expense for the six months ended December 31, 2012 included a tax benefit of $0.9 million to correct an error in recording deferred tax asset balances as of June 30, 2012 related to fixed assets recorded in an acquisition and foreign tax credits. In the prior year for both the three and six month periods ended December 31, 2011, the valuation allowance recorded on substantially all net deferred tax assets, including those in the United States, effectively eliminated U.S. federal tax expense. The valuation allowance against deferred tax assets was eliminated at the end of fiscal 2012

Revenues from Canon Inc., a shareholder, and Canon Sales Co., Inc., a distributor of certain of our products in Japan and a subsidiary of Canon Inc. (collectively referred to as "Canon"), amounted to $2.9 million and $4.3 million (8% and 11% of net revenues, respectively) for the three months ended December 31, 2012 and 2011, respectively. For the six months ended December 31, 2012 and 2011, revenues from Canon amounted to $5.7 million and $9.1 million (8% and 11% of net revenues, respectively). Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. At December 31, 2012 and June 30, 2012, there were, in the aggregate, $1.2 million and $1.6 million, respectively, of trade accounts receivable from Canon.

We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal source of liquidity is our cash reserves and operating cash flows. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include: capital expenditures, customer credit requirements, investments in businesses and the availability of bank lines of credit.

At December 31, 2012, cash and cash equivalents were $77.3 million, a decrease of $6.8 million from $84.1 million at June 30, 2012. Cash in a money market account is invested primarily in U.S. government securities. We do not believe there is any risk to liquidity in the money market account, nor are there currently any limits on redemptions.

Cash provided by operating activities from continuing operations decreased period over period by $22.9 million to $1.5 million, due primarily to a decrease in net income of $9.1 million and a decrease in cash flows from fiscal 2012 to fiscal 2013 attributable to increases in inventories, unbilled costs on long-term contracts and prepaid taxes. The decrease in cash flows related to inventories is due to an increase in certain inventory lines for production in process on longer-term projects.

Cash used for investing activities increased $5.0 million to $6.7 million, due primarily to the buyout of the noncontrolling interest of ZygoLOT for $3.2 million (€2.5 million), and an increase in additions to property, plant and equipment of $1.8 million.

Cash used for financing activities increased $2.4 million to $1.9 million, due primarily to dividend payments to noncontrolling interests of $1.0 million and increases in the repurchase of restricted stock of $0.8 million.

We currently have no lines of credit. In the future, if the need for debt or credit lines arises, there is no assurance that we would be able to secure such financing. We believe we have sufficient cash flows from operations and cash reserves to maintain adequate amounts of liquidity and to meet our future liquidity requirements for at least the next twelve months.

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt, or operating parts of our business that are not consolidated into our financial statements. We have not guaranteed any obligations of a third party.