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LTXC > SEC Filings for LTXC > Form 10-K on 11-Oct-2013All Recent SEC Filings

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Form 10-K for LTX-CREDENCE CORP


11-Oct-2013

Annual Report


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

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 any forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements.

Overview

We provide market-focused, cost-optimized automated test equipment (ATE) solutions for the semiconductor industry. We design, manufacture, market and service ATE solutions that address the broad, divergent test requirements of the wireless, computing, automotive and digital consumer markets of the semiconductor industry. Semiconductor designers and manufacturers worldwide use our equipment to test their devices during the manufacturing process. After testing, these devices are incorporated in a wide range of products, including personal and tablet computers, mobile internet equipment such as wireless access points and interfaces, broadband access products such as cable modems and set top boxes, personal communication and entertainment products such as mobile phones and personal digital music players, consumer products such as televisions, videogame systems and digital cameras, automobile electronics and power management devices used in portable and automotive electronics. We also sell hardware and software support and maintenance services for our test systems.

We focus our marketing and sales efforts on integrated device manufacturers (IDMs) and outsource assembly and test providers (OSATs) which perform assembly and testing services for the semiconductor industry, and fabless companies, which design integrated circuits but have no manufacturing capability. We offer our customers a comprehensive portfolio of test systems and provide a global network of strategically deployed applications and support resources.

On November 17, 2010, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Verigy Ltd., a corporation organized under the laws of Singapore ("Verigy"). In March 2011, prior to the closing of our merger with Verigy, the board of directors of Verigy determined that a proposal from Advantest Corporation to acquire all of the outstanding ordinary shares of Verigy for $15.00 per share in cash, on the terms and conditions set forth in a definitive implementation agreement proposed by Advantest, constituted a "Superior Offer" within the meaning of the Merger Agreement, the Verigy board of directors withdrew its recommendation in favor of the pending merger transaction between Verigy and us and, as a result we then terminated the Merger Agreement. As a result of the termination of the Merger Agreement, on March 25, 2011 Verigy paid us the $15.0 million Verigy Termination Fee required pursuant to the terms and conditions of the Merger Agreement, which is classified as other income in our statement of operations for the fiscal year ended July 31, 2011.

In the twelve months ended July 31, 2011, we incurred approximately $4.9 million of expenses related to the terminated Verigy transaction, of which $3.6 million has been recorded in selling, general and administrative expenses on our consolidated statement of operations. The remaining $1.3 million was related to a break-up fee and was recorded as a reduction of other income.

On September 6, 2013, we entered into a Purchase Agreement with Dover and, solely for the limited purposes set forth in the Purchase Agreement, Dover Parent, with respect to the Dover Acquisition. We currently expect the Dover Acquisition to be completed during the fourth calendar quarter of 2013 (the "Closing"). At the


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Closing, we will pay Dover or its designated affiliates an aggregate purchase price of $93.5 million, of which $73.5 million will be paid in cash through a combination of existing cash-on-hand and bank debt and $20.0 million will be paid by the issuance of a promissory note by us to Dover in the original principal amount of $20.0 million. The cash purchase price is subject to a post-Closing working capital adjustment, and will be increased by an amount equal to specified cash balances held by Dover and certain designated affiliates as of the Closing and decreased by an amount equal to any acquired indebtedness and the amount of certain transaction costs and employee related liabilities of Dover and certain designated affiliates as of the Closing. Subject to certain conditions, the original principal amount of the promissory note is also subject to reduction upon written certification from us to Dover prior to January 1, 2015 of certain specified events related to our relocation from or refurbishment of certain properties of the Acquired Businesses or the prepayment of the promissory note in full prior to such date. The promissory note will accrue interest on the unpaid balance for each day that it remains outstanding after the first anniversary of the date of issuance at a per annum rate equal to the London Interbank Offered Rate plus 10%, and may be prepaid by us at any time without penalty prior to the maturity date, which will be the date that is five years and three months following the issuance of the promissory note.

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 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 semiconductor device technologies.


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The following graph shows the cyclicality in semiconductor test equipment orders and shipments from fiscal 1998 through fiscal 2013 (using the three month moving average), as calculated by SEMI, an industry trade organization:

[[Image Removed: LOGO]]

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. During these slowdown periods, we implement cost reduction measures, such as the strict oversight of expenditures and reduction in discretionary travel and other variable overhead expenses. We believe that these reductions in operating expenses preserve 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 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 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, we have transitioned the manufacture of certain components and subassemblies to contract manufacturers, thereby reducing our fixed manufacturing costs associated with direct labor and overhead. We believe that transforming fixed product manufacturing costs into variable costs allows us to improve our performance in the highly cyclical semiconductor industry.

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 U.S. economy may materially and adversely affect our


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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, or other competitive pressures. 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 United States 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 base these estimates and assumptions on historical experience and evaluate them on an ongoing 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 and which involve the most complex and subjective judgments or assessments are as follows: revenue recognition, inventory reserves, income taxes, valuation of goodwill and identifiable intangible assets, impairment of long-lived assets other than goodwill, product warranty costs, and allowances for doubtful accounts.

A summary of those accounting policies and estimates that we believe to be most critical to fully understanding and evaluating 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

We recognize revenue when persuasive evidence of an arrangement exists, delivery and customer acceptance (if required) has occurred or services have been rendered, the seller's price is fixed or determinable, and collectability is reasonably assured. 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 and is incorporated herein by reference.

Inventory Reserves

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 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. Such reserves are not reversed until the related inventory is sold or otherwise disposed. Our inventory reserves policy is described in Note 2, Summary of Significant Accounting Policies, contained in the Notes to Consolidated Financial Statements included in this report and is incorporated herein by reference.

Income Taxes

In accordance with FASB ASC Topic 740, Income Taxes ("ASC 740"), we recognize deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax


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basis 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. ASC 740 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 it operates, the length of carryback and carryforward periods, existing sales backlog and future sales projections. Where there have been cumulative losses in recent years, ASC 740 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 net 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 $200.1 million at July 31, 2012, to $204.5 million at July 31, 2013. The increase in our valuation allowance compared to the prior year was primarily due to an increase in deferred tax assets associated with the current year taxable loss generated in various jurisdictions.

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 our merger with Credence in August 2008, and Internal Revenue Code Section 382 guidance, the future utilization of our net operating loss deductions will be significantly limited. See Note 5 to our Consolidated Financial Statements.

Valuation of Goodwill

In accordance with Topic 350, Intangibles-Goodwill and Other, to the FASB ASC ("ASC 350"), we are required to review goodwill by reporting unit for impairment at least annually or more often if there are indicators of impairment present. We have determined our entire business represents one reporting unit. Historically, we have performed our annual impairment analysis during the fourth quarter of each year. We evaluated the implied fair value based on our market capitalization of our one reporting unit as compared to the carrying value of the net assets assigned to our reporting unit as of July 31, 2013 and July 31, 2012. As of those dates, the implied fair value of the goodwill of our reporting unit exceeded our carrying value of our net assets and therefore no impairment existed. As discussed in Note 2 to the Consolidated Financial Statements, there were no impairment conditions present during the year and therefore we did not conduct an interim impairment test.

Valuation of Identifiable Intangible Assets

Our identifiable intangible assets include developed technology, distributor and key customer relationships and trade names. Our developed technology relates to patents, patent applications and know-how with respect to the technologies embedded in our currently marketed products.

We primarily used the income approach to value the existing technology and other intangible assets as of the date of acquisition. 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 intangible assets, we considered paragraph 11 of ASC 350, which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors include 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


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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 have been amortizing these intangible assets over their estimated useful lives using a method that is based on estimated future cash flows as we believe this approximates the pattern in which the economic benefits of the intangible assets will be derived.

Impairment of Long-Lived Assets Other Than Goodwill

On an on-going basis, our management reviews the carrying value and period of amortization or depreciation of long-lived assets. In accordance with FASB ASC Topic 360, Property, Plant and Equipment, ("ASC 360"), we review whether impairment losses exist on long-lived assets when indicators of impairment are present. During this review, we re-evaluate the significant assumptions used in determining the original cost and estimated useful life of long-lived assets. Although the assumptions may vary, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been a permanent impairment of the value of long-lived assets based upon events or circumstances that have occurred since acquisition. The extent of the impairment amount recognized is based upon the difference of the impaired asset's estimated fair value and its carrying value. As of July 31, 2013 there were no indicators that required us to conduct a recoverability test at that date.

Product Warranty Costs

We provide standard warranty coverage on our systems, providing labor and parts necessary to repair the systems during the warranty period. We account for the estimated warranty cost as a charge to cost of sales when the revenue is recognized. Our product warranty cost policy is described in Note 2, Summary of Significant Accounting Policies, contained in the Notes to Consolidated Financial Statements included in this report and is incorporated herein by reference.

Trade Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount, do not bear interest, and typically have a contractual maturity of ninety days or less. A majority of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. The volatility of the industries that we serve can cause certain of our customers to experience shortages of cash, which can impact their ability to make required payments. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers' financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon our assessment of the expected collectability of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowances. In any circumstances in which we are aware of a customer's inability to meet its financial obligations, we provide an allowance, which is based on the age of the receivables, the circumstances surrounding the customer's financial situation and our historical experience. If circumstances change, and the financial condition of our customers were adversely affected resulting in their inability to meet their financial obligations to us, we may need to record additional allowances. Account balances are charged off against the allowance when it is determined the receivable will not be recovered.


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Results of Operations

The following table sets forth for the periods indicated the principal items included in the Consolidated Statements of Operations data:

                                 Year End July 31,                            Year End July 31,
                                                               %                                            %
                                2013           2012          Change          2012           2011          Change
Net product sales             $ 117,997      $  95,357          23.7 %     $  95,357      $ 207,831         (54.1 )%
Net service sales                33,985         36,777          (7.6 )        36,777         41,699         (11.8 )

Net sales                       151,982        132,134          15.0         132,134        249,530         (47.0 )
Cost of sales                    71,223         63,637          11.9          63,637         95,290         (33.2 )

Gross profit                     80,759         68,497          17.9          68,497        154,240         (55.6 )
Engineering and product
development expenses             52,314         49,864           4.9          49,864         52,697          (5.4 )
Selling, general and
administrative expenses          39,253         36,348           8.0          36,348         48,968         (25.8 )
Amortization of purchased
intangible assets                 1,582          3,163         (50.0 )         3,163          5,961         (46.9 )
Restructuring                       476          1,104         (56.9 )         1,104            363         204.1

(Loss) income from
operations                      (12,866 )      (21,982 )       (41.5 )       (21,982 )       46,251        (147.5 )
Other (expense) income:
Interest expense                   (233 )         (179 )        30.2            (179 )         (309 )       (42.1 )
Interest income                     883            910          (3.0 )           910            349         160.7
Other (expense) income, net        (186 )          444        (141.9 )           444         13,472         (96.7 )

(Loss) income before income
taxes                           (12,402 )      (20,807 )       (40.4 )       (20,807 )       59,763        (134.8 )
Benefit from income taxes          (275 )         (938 )       (70.7 )          (938 )         (315 )       197.8

Net (loss) income             $ (12,127 )    $ (19,869 )       (39.0 )%    $ (19,869 )    $  60,078        (133.1 )%

Net (loss) income per
share:
Basic                         $   (0.25 )    $   (0.40 )                   $   (0.40 )    $    1.22
Diluted                       $   (0.25 )    $   (0.40 )                   $   (0.40 )    $    1.19
Weighted average common
shares used in computing
net (loss) income per
share:
Basic                            47,719         49,080                        49,080         49,398
Diluted                          47,719         49,080                        49,080         50,415


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The following table sets forth for the periods indicated the principal items included in the Consolidated Statements of Operations as percentages of net sales:

                                                        Percentage of Net Sales
                                                          Year Ended July 31,
                                                   2013          2012          2011
   Net sales                                        100.0 %       100.0 %       100.0 %
   Cost of sales                                     46.9          48.2          38.2

   Gross profit                                      53.1          51.8          61.8
   Engineering and product development expenses      34.5          37.7          21.1
   Selling, general and administrative expenses      25.8          27.5          19.6
   Amortization of purchased intangible assets        1.0           2.4           2.4
   Restructuring                                      0.3           0.8           0.1

   (Loss) income from operations                     (8.5 )       (16.6 )        18.6
   Other (expense) income:
   Interest expense                                  (0.2 )        (0.1 )        (0.1 )
   Interest income                                    0.6           0.7           0.1
   Other (expense) income, net                       (0.1 )         0.3           5.4

   (Loss) income before income taxes                 (8.2 )       (15.7 )        24.0
   Benefit from income taxes                         (0.2 )        (0.7 )        (0.1 )

   Net (loss) income                                 (8.0 )%      (15.0 )%       24.1 %

Fiscal 2013 Compared to Fiscal 2012

Net sales. Revenue from product sales increased in the year ended July 31, 2013 as compared to July 31, 2012 driven primarily by our continued dominant position in the RF Power Amplifier market space with the PAx tester, sales into the Automotive market with our X-Series testers, and by the ASSP and Microcontroller market segments which drove increased sales of the Diamondx tester, which was launched in fiscal 2012.

Service revenue decreased in the year ended July 31, 2013 as compared to July 31, 2012 primarily due to increased reliability of our test equipment which reduces the demand for post-warranty service contracts and lower value service contracts based on the lower average selling price of the underlying testers.

Sales to our ten largest customers during each of the fiscal years ended . . .

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