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ZIGO > SEC Filings for ZIGO > Form 10-K on 13-Sep-2013All Recent SEC Filings

Show all filings for ZYGO CORP

Form 10-K for ZYGO CORP


13-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies, Significant Judgments and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures at the date of our consolidated financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, marketable securities, share-based compensation, warranty obligations, self-insured healthcare claims, income taxes, discontinued operations, contract revenue, economic hedges and long-lived assets. 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. We consider certain accounting policies related to revenue recognition and allowance for doubtful accounts, discontinued operations, inventory valuation, valuation of marketable securities, share-based compensation, warranty costs, self-insured health insurance costs, accounting for income taxes, contract revenue and valuation of long-lived assets to be critical policies due to the estimates and judgments involved in each.

Revenue Recognition and Allowance for Doubtful Accounts

We recognize revenue based on guidance provided in SEC Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition" and in accordance with authoritative guidance issued by the Financial Accounting Standard Board ("FASB") pertaining to revenue arrangements with multiple deliverables. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, our price is fixed or determinable and collectability is reasonably assured. We recognize revenue on our standard products when title passes to the customer upon shipment. While our standard products generally require installation, the installation is considered a perfunctory performance obligation. Standard products do not have customer acceptance criteria. Generally, software is a component of our standard product and, as such, is not separately recognized as revenue. We have standard rights of return for defective products that we account for as a warranty provision under authoritative guidance of accounting for contingencies. We do not have any price protection agreements or other post shipment obligations. For custom equipment where customer acceptance is part of the sales agreement, revenue is recognized when the customer has accepted the product. In cases where custom equipment does not have customer acceptance as part of the sales agreement, we recognize revenue upon shipment as long as the system meets the specifications as agreed upon with the customer. Certain transactions have multiple deliverables, with the deliverables clearly defined. To the extent that the secondary deliverables are other than perfunctory, we recognize the revenue on each deliverable, if separable, or on the completion of all deliverables, if not separable, all in a manner consistent with SAB No. 104 and related authoritative guidance. Standalone software products are recognized as revenue when they are shipped.

Certain customer transactions include payment terms whereby we receive a partial payment of the total order amount prior to the related revenue being recognized in our financial statements. These advance payments are included in progress payments, deferred revenue and billings in excess of costs and estimated earnings in the consolidated balance sheet. These progress payments relate to orders for custom equipment that require a lengthy build cycle and, in some cases, acceptance by the customer. We may negotiate payment terms with these customers on these particular orders and secure certain payments prior to or on shipment of the equipment. These payments remain in progress payments or deferred revenue until our applicable revenue recognition criteria have been met.

Certain contracts we enter into continue over an extended period of time. We review those contracts for possible revenue recognition as a long-term contract. If long-term contract accounting is appropriate, we then evaluate whether revenue should be recognized using the percentage-of-completion method. Under the percentage-of-completion method, we develop estimates as a basis for contract revenue and costs in progress as work on the contract continues. Estimates are reviewed and revised as additional information becomes available. During fiscal 2013, changes in estimates under the percentage of completeness method were not material. Revenue recognized in excess of billings is included in revenue recognized in excess of billings on uncompleted contracts in the consolidated balance sheet. Billings in excess of costs and earnings would be included in billings in excess of costs and estimated earnings on uncompleted contracts in the consolidated balance sheet. The percentage-of-completion method is used in circumstances in which all the following conditions exist:

The contract includes enforceable rights regarding goods or services to be provided to the customer, the consideration to be exchanged, and the manner and terms of settlement

Both the Company and the customer are expected to satisfy all contractual obligations and

Reasonably reliable estimates of total revenue, total cost and the progress toward completion can be made.

We maintain an allowance for doubtful accounts based on a continuous review of customer accounts, payment patterns and specific collection issues. We perform on-going credit evaluations of our customers and do not require collateral from our customers. For many of our international customers, we require an irrevocable letter of credit from the customer before a shipment is made. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, additional allowances may be required.

Discontinued Operations

The Company classifies operations as discontinued when the operations have either ceased, or are expected to be disposed of in a sale transaction in the near term and the operations and cash flows of all discontinued operations have been eliminated or will be eliminated upon consummation of the expected sale transaction and the Company will not have any significant continuing involvement in the discontinued operations. Authoritative guidance related to the impairment or disposal of long-lived assets requires the calculation of estimated fair value less cost to sell long-lived assets for assets held for sale. The calculation of estimated fair value less cost to sell includes significant estimates and assumptions, including, but not limited to: operating projections; discount rate; excess working capital levels; property values; and the anticipated costs involved in the selling process. As more fully described in Note 21, "Discontinued Operations", of our audited consolidated financial statements included in this Annual Report on Form 10-K, we discontinued the Singapore IC packaging operations of our vision systems product line, which was included in our Metrology Solutions segment, in September 2009.

Inventory Valuation

Inventories are valued at the lower of cost or market, cost being determined on a first-in, first-out basis. Management evaluates the need to record adjustments for impairment of inventory on a quarterly basis. Our policy is to assess the valuation of all inventories, including raw materials, work-in-process and finished goods. Obsolete inventory or inventory in excess of management's estimated future usage, over a reasonable period of time, is written down to its estimated market value, if less than its cost. Contracts with fixed prices are evaluated to determine if estimated total costs will exceed revenue. A loss provision is recorded when the judgment is made that actual costs incurred plus estimated costs remaining to be incurred based on management's estimates will exceed total revenue from the contract. Inherent in the estimates of market value are management's estimates related to current economic trends, future demand for our products and technological obsolescence. Management estimates future product sales and service requirements and evaluates technological changes and other possible uses to determine if inventory is excess or obsolete. If actual market conditions are different than those projected by management, additional inventory adjustments affecting earnings may be required.

Other-Than-Temporary Impairment of Marketable Securities

Marketable securities have been primarily classified as held-to-maturity, which requires them to be carried at amortized cost. We also have certain securities that are classified as trading. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold. Management evaluates the need to record adjustments for impairment of marketable securities on a quarterly basis. Marketable securities with unrealized depreciation in fair value for twelve or more consecutive months and other securities with unrealized losses are reviewed to determine whether the decline in fair value is other than temporary. Investment ratings, company-specific events, general economic conditions and other reasons are evaluated in determining if the decline in fair value is other than temporary. If it is judged that a decline in fair value is other than temporary, the marketable security is valued at the current fair value and an impairment charge is reflected in earnings.

Share-Based Compensation

We calculate share-based compensation expense in accordance with authoritative guidance pertaining to share-based payments using the Black-Scholes option-pricing model to calculate the fair value of share-based awards. The key assumptions for this valuation method include the expected term of an option grant, stock price volatility, risk-free interest rate and dividend yield. The determination of these assumptions is based on history and future expectations and is subject to a high level of judgment. To the extent any of the assumptions were to change from year to year, the fair value of new option grants identical to those of prior years may vary significantly from the fair value of previously issued option grants.

Warranty Costs

We provide for the estimated cost of product warranties at the time revenue is recognized. We consider historical warranty costs actually incurred together with specifically identified circumstances to establish the warranty liability. The warranty liability is reviewed on a quarterly basis. Should actual costs differ from management's estimates, revisions to the estimated warranty liability may be required. A fifteen percent change in warranty liability would have an immaterial impact on our financial condition and results of operations.

Accounting for Income Taxes

Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax basis and operating loss and tax credit carryforwards. We must assess the likelihood that any deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we must establish a valuation allowance. Management considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In fiscal 2009, management determined that it was more likely than not that we would not be able to realize our deferred tax assets in the future, and an adjustment to record a full valuation allowance was charged to income tax expense. In fiscal 2012, the Company reversed a substantial amount of the valuation allowance based on the cumulative earnings for the last three years and future projected income. Our effective tax rate may vary from period to period based on changes in pre-tax income among jurisdictions that have higher or lower tax rates, changes to federal, state, or foreign tax laws and deductibility of certain costs and expenses by jurisdiction.

Economic Hedges

We hedge certain intercompany transactions by entering into forward contracts to reduce the impact of adverse fluctuations on earnings associated with foreign currency exchange rate changes. We do not enter into any derivative transactions for speculative purposes. In some cases, we design hedges such that they qualify for hedge accounting treatment. Contracts are entered into for periods consistent with the currency transaction exposures, generally three to fifteen months. Any gains and losses on the fair value of the contracts are expected to be largely offset by gains and losses in the same period on the underlying transactions unless they qualify for hedge accounting treatment, in which case the change in fair value would be charged to accumulated other comprehensive income.

Valuation of Long-Lived Assets

In accordance with authoritative guidance issued by the FASB pertaining to accounting for the impairment or disposal of long-lived assets, the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances, both internally and externally, that may suggest impairment. Some factors we consider important, which could trigger the impairment review, include a significant decrease in the market value of an asset, a significant change in the extent or manner in which an asset is used, a significant adverse change in the business climate that could affect the value of an asset, an accumulation of costs for an asset in excess of the amount originally expected, a current period operating loss or cash flow decline combined with a history of operating loss or cash flow uses or a projection that demonstrates continuing losses and a current expectation that it is more likely than not that a long-lived asset will be disposed of at a loss before the end of its estimated useful life.

If one or more of such facts or circumstances exist, we evaluate the carrying value of long-lived assets to determine if an impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and compare that value to the carrying value of the assets. If the carrying value of the assets is greater than the estimated future cash flows, the assets are written down to the estimated fair value. We determine the estimated fair value of the assets based on a current market value of the assets. If a current market value is not readily available, a projected discounted cash flow method is applied using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Our cash flow estimates contain management's best estimates, using appropriate and customary assumptions and projections at the time.

Health Insurance

We are self-insured for the majority of our group health insurance. We rely on claims experience in determining an adequate liability for claims incurred, but not reported. To the extent actual claims exceed estimates, we may be required to record additional expense. We also carry catastrophic insurance to manage our health insurance liability which provides for specific dollar caps on our liability for both single claims and total annual claims. A six percent change in actual claims would have an immaterial impact on our financial condition and results of operations.

Adoption of New Accounting Guidance

In February 2013, the FASB issued Accounting Standards Update ("ASU") No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of ASU No. 2013-02 is to improve the reporting of reclassifications out of accumulated other comprehensive income ("AOCI"). Entities are required to disclose changes in AOCI balances by component and significant items reclassified out of AOCI. The effective date for ASU No. 2013-02 for Zygo is the first quarter of fiscal year 2014 with early adoption allowed. We have decided to adopt this accounting guidance as of June 30, 2013. The adoption of this guidance did not have a material impact on our consolidated financial statements.

OVERVIEW

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 and industrial markets. Optical instruments products encompass non-contact optical measurement instruments. Optics products consist of high performance macro-optics components, optical coatings and optical system assemblies. We conduct the majority of our manufacturing in our 153,500 square-foot facility in Middlefield, Connecticut, our 55,300 square-foot facility in Richmond, California and a 22,560 square-foot leased 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.

Our net earnings in fiscal 2013 were $0.41 per diluted share compared with $2.30 per diluted share in fiscal 2012. The results in fiscal 2012, benefited from the reversal of a valuation allowance on our deferred tax assets of $1.01 per diluted share. Net earnings in fiscal 2011 of $1.05 per diluted share included a gain on acquisition of $0.11 per diluted share.

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. The valuation allowance against U.S.-based 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 amounts recorded to adjust prior period deferred tax asset balances as components of the fiscal 2013 year tax provision, as well as the inclusion of research and development credits in the third quarter of fiscal 2013 after passage of legislation in January 2013 extending the credit.

At the beginning of fiscal 2013, we purchased the remaining 40% in the ZygoLOT GmbH joint venture ("ZygoLOT") for 2.5 million. For fiscal 2013 100% of the income from ZygoLOT was included in our consolidated statements of operations. Net Income per diluted share increased by $0.05 related to the increase in ownership percentage in ZygoLOT in fiscal 2013.

Our backlog at June 30, 2013 was $89.8 million, compared with $68.0 million at June 30, 2012. Net bookings for fiscal 2013 were $172.3 million compared with $172.8 million in fiscal 2012 with the Metrology Solutions segment accounting for 68% of the bookings received and the Optical Systems segment accounting for the remaining 32%.

Results of Operations

Fiscal 2013 Compared with Fiscal 2012



Net Revenue by Segment



                                                     Year Ended
    (Dollars in millions)          June 30, 2013                    June 30, 2012
                                          Percentage of                    Percentage of
                             Amount           Total           Amount           Total
    Metrology Solutions     $   93.6                  63 %   $  106.2                  64 %
    Optical Systems             55.8                  37 %       60.6                  36 %
    Total                   $  149.4                 100 %   $  166.8                 100 %

Revenue for fiscal 2013 decreased 10% compared with the prior year period, reflecting decreases in the Metrology Solutions segment revenue of 12% and decreases in Optical Systems segment revenue of 8%. The decrease in the Metrology Solutions segment revenue was primarily due to volume decreases in instruments products of $8.2 million and volume decreases in semiconductor-related lithography revenue of $2.9 million, attributable to reduced capital spending across a number of industries, including automotive and semiconductor. The decrease in the Optical Systems segment revenue was primarily due to decreases in Optical components of $3.0 million and in contract manufacturing of $2.0 million.

We experienced revenue decreases across all of our geographical regions with the exception of the Japan region. The Americas region declined $10.8 million and the China region decreased $4.6 million, primarily due to volume decreases across most product lines.

No customer accounted for over 10% of revenue for the fiscal year ended June 30, 2013. Revenue from two customers individually accounted for 11% and 10% of the net revenue for the fiscal year ended June 30, 2012. Revenue from these customers was included in both of our segments.

Revenue denominated in U.S. dollars for fiscal 2013 and 2012 was 76% and 81% of total net revenue, respectively. The balance of revenue was denominated primarily in Euro, Yen and Yuan. Revenue based in foreign currency is 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 revenue of our products in these markets and our consolidated financial position and results of operations.

Gross Margin by Segment



                                                     Year Ended
 (Dollars in millions)            June 30, 2013                       June 30, 2012

                         Gross Profit      Gross Margin      Gross Profit      Gross Margin
 Metrology Solutions     $        50.6                54 %   $        61.5                58 %
 Optical Systems                  15.1                27 %            20.2                33 %
 Total                   $        65.7                44 %   $        81.7                49 %

Gross margin for fiscal 2013 was 44%, which represents a decrease of five percentage points from the comparable prior year period. Within the Metrology Solutions segment, gross margin decreased to 54% for the fiscal year ended June 30, 2013 compared with the prior year comparable period of 58%, primarily due to a decrease in volume of high margin custom systems within the instruments business and the negative effect of lower volumes on labor and overhead absorption.

Within the Optical Systems segment, the gross margin decreased to 27% for the fiscal year ended June 30, 2013 compared with 33% in the comparable prior year period. The Optical Systems segment gross margin decrease was primarily due to product mix related to a large order with lower gross margins, a decrease in labor and overhead absorption on lower overall volumes and a one-time loss provision on a specific project.

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

                                                     Year Ended
   (Dollars in millions)           June 30, 2013                     June 30, 2012
                                          Percentage of                     Percentage of
                            Amount         Net Revenue        Amount         Net Revenue

$ 34.9 23 % $ 35.5 21 %

SG&A decreased in fiscal 2013 by $0.6 million from the comparable prior year period. The decrease was primarily due to a reduction in performance-based compensation expense, which decreased SG&A by $2.4 million, and lower external commissions, partially offset by increased employee costs and benefits. The increase in SG&A as a percentage of revenue was due to lower revenue in fiscal 2013.

Research, Development and Engineering Expenses ("RD&E")

                                                     Year Ended
   (Dollars in millions)           June 30, 2013                     June 30, 2012
                                          Percentage of                     Percentage of
                            Amount         Net Revenue        Amount         Net Revenue

$ 18.7 13 % $ 16.5 10 %

RD&E expense increased in fiscal 2013 by $2.2 million compared with the prior year period. The increase was primarily due to spending on several development projects in our instruments and lithography product lines and in our Extreme Precision Optics Group ("EPO"). RD&E spending as a percentage of net revenue increased to 13% for fiscal 2013 from 10% in fiscal 2012 due to increased spending and lower revenue in fiscal 2013.

Other Income (Expense)



                                                     Year Ended
  (Dollars in millions)           June 30, 2013                      June 30, 2012
                                          Percentage of                      Percentage of
                           Amount          Net Revenue        Amount          Net Revenue

$ (0.2 ) - $ (0.5 ) -

Other income (expense) for fiscal 2013 was ($0.2) million for fiscal 2013 compared with other expense of ($0.5) million in fiscal 2012. The $0.3 million dollar decrease primarily related to net foreign exchange realized and unrealized losses.

Income Tax Expense (Benefit)



                                                     Year Ended
      (Dollars in millions)         June 30, 2013                  June 30, 2012
                                              Tax Rate                       Tax Rate
                               Amount        Percentage       Amount        Percentage

                              $    2.9                24 %   $   (15.8 )             54 %

Income tax expense in fiscal 2013 was based on United States federal and state income tax and income taxes in foreign locations. Income tax expense in fiscal 2013 benefited from the inclusion of research and development tax credits as part of the American Taxpayer Relief Act of 2012 signed into law during the third quarter of fiscal 2013. Fiscal 2013 was also benefitted by $0.9 million to correct deferred tax asset balances as of June 30, 2012.

In fiscal 2012, we recognized a tax benefit of $18.9 million from the reversal of substantially all of the valuation allowance on our net United States-based deferred tax assets. Realization of the future tax benefits is dependent on the Company's ability to generate sufficient taxable income in future periods. Through fiscal 2011, a predominant portion of the Company's net deferred tax assets were reserved due to the uncertainty of realization through future earnings. In fiscal 2012, the Company determined that based upon all available evidence, positive and negative, including the Company's taxable income over the past three fiscal years and expected future profitability, substantially all of its United States-based deferred tax assets were more likely than not to be realized through future earnings.

Net Earnings from Continuing Operations Attributable To Zygo Corporation



                                                      Year Ended
. . .
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