All obligations under the Term Loan Facility are guaranteed by certain of the Company’s domestic subsidiaries, and are collateralized by substantially all of the Company’s assets and the assets of such subsidiaries, subject to certain exceptions and exclusions.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and provisions relating to events of default. If an event of default occurs, the Lenders under the Term Loan Facility will be entitled to take various actions, including the acceleration of amounts due under the Term Loan Facility and all actions generally permitted to be taken by a secured creditor. At September 30, 2019, the Company was in compliance with all covenants under the Credit Agreement.
S
enior Secured Asset-Based Revolving Credit Facility
On February 1, 2019, in connection with the completion of the ESI Merger, the Company entered into an asset-based credit agreement with Barclays Bank PLC, as administrative agent and collateral agent, the other borrowers from time to time party thereto, and the lenders and letters of credit issuers from time to time party thereto (the “ABL Credit Agreement”), that provides senior secured revolving credit financing of up to $100,000, subject to a borrowing base limitation (the “ABL Facility”). On April 26, 2019, the Company entered into a First Amendment to the ABL Credit Agreement which amended the borrowing base calculation for eligible inventory prior to an initial field examination and appraisal requirements. The borrowing base for the ABL Facility at any time equals the sum of: (a) 85% of certain eligible accounts; plus (b) prior to certain notice and field examination and appraisal requirements, the lesser of (i) 20% of net book value of eligible inventory in the United States and (ii) 30% of the borrowing base, and after the satisfaction of such requirements, the lesser of (i) the lesser of (A) 65% of the lower of cost or market value of certain eligible inventory and (B) 85% of the net orderly liquidation value of certain eligible inventory and (ii) 30% of the borrowing base; minus (c) reserves established by the administrative agent, in each case, subject to additional limitations and examination requirements for eligible accounts and eligible inventory acquired in an acquisition after February 1, 2019. The ABL Facility includes borrowing capacity in the form of letters of credit up to $25,000.
Borrowings under the ABL Facility bear interest at a rate per annum equal to, at the Company’s option, any of the following, plus, in each case, an applicable margin: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
, (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00% and (4) a floor of 0.00%; and (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, with a floor of 0.00%. The initial applicable margin for borrowings under the ABL Facility is 0.50% with respect to base rate borrowings and 1.50% with respect to LIBOR borrowings.
| 17) | Business Segment, Geographic Area and Product Information |
The Company is a global provider of instruments, subsystems and process control solutions that measure, monitor, deliver, analyze, power and control critical parameters of advanced manufacturing processes to improve process performance and productivity for its customers. The Company’s products are derived from its core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, power, reactive gas generation, vacuum technology, lasers, photonics,
sub-micron
positioning, vibration control, optics and laser-based manufacturing solutions. The Company also provides services relating to the maintenance and repair of its products, installation services and training. The Company’s primary served markets include semiconductor, industrial technologies, life and health sciences, and research and defense.
The Company’s Chief Operating Decision Maker (“CODM”) utilizes financial information to make decisions about allocating resources and assessing performance for the entire Company, which is used in the decision making process to assess performance. Effective February 1, 2019, in conjunction with its acquisition of ESI, the Company created a third reportable segment known as the Equipment & Solutions segment in addition to its 2 then-existing reportable segments: the Vacuum & Analysis segment and the Light & Motion segment.
The Vacuum & Analysis segment provides a broad range of instruments, components and subsystems which are derived from the Company’s core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, RF & DC power, reactive gas generation and vacuum technology.
The Light & Motion segment provides a broad range of instruments, components and subsystems which are derived from the Company’s core competencies in lasers, photonics,
sub-micron
positioning, vibration control, and optics.
The Equipment & Solutions segment provides laser-based manufacturing solutions for the micro-machining industry that enable customers to optimize production. The segment’s market is composed primarily of flexible and rigid PCB processing/fabrication, semiconductor wafer processing and passive component manufacturing & test. Equipment & Solutions incorporate specialized laser technology and proprietary control software to efficiently process the materials and components that are an integral part of electronic devices and systems.
The Company derives its segment results directly from the manner in which results are reported in its management reporting system. The accounting policies that the Company uses to derive reportable segment results are substantially the same as those used for external reporting purposes. The Company does not disclose external or intersegment revenues separately by reportable segment as this information is not presented to the CODM for decision making purposes
.
The following table sets forth net revenues by reportable segment:
| | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | | Nine Months Ended
September 30, | |
| | | | | | | | 2019 | | | 201 8 | |
| | $ | | | | $ | | | | | | | | $ | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | $ | | | | $ | | | | $ | 1,400,122 | | | $ | 1,614,567 | |
| | | | | | | | | | | | | | | | | |
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
This Quarterly Report on Form
10-Q
contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). When used herein, the words “believes,” “anticipates,” “plans,” “expects,” “estimates,” “would,” “will,” “intends” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect management’s current opinions and are subject to certain risks and uncertainties that could cause results to differ materially from those stated or implied. While we may elect to update forward looking statements in the future, we specifically disclaim any obligation to do so even if our estimates or expectations change. Risks and uncertainties include, but are not limited to those discussed in our Annual Report on Form
10-K
for the year ended December 31, 2018 and in the section entitled “Risk Factors” as referenced in Part II, Item 1A “Risk Factors” of this Quarterly Report on Form
10-Q.
We are a global provider of instruments, subsystems and process control solutions that measure, monitor, deliver, analyze, power and control critical parameters of advanced manufacturing processes to improve process performance and productivity for our customers. Our products are derived from our core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, power, reactive gas generation, vacuum technology, lasers, photonics,
sub-micron
positioning, vibration control, optics and laser-based manufacturing solutions. We also provide services relating to the maintenance and repair of our products, installation services and training. Our primary served markets include semiconductor, industrial technologies, life and health sciences, research and defense.
Acquisition of Electro Scientific Industries, Inc.
On February 1, 2019, we completed our acquisition of Electro Scientific Industries, Inc. (“ESI”) pursuant to an Agreement and Plan of Merger, dated as of October 29, 2018 (the “ESI Merger”). At the effective time of the ESI Merger and pursuant to the terms and conditions of the merger agreement, each share of ESI’s common stock that was issued and outstanding immediately prior to the effective time of the ESI Merger was converted into the right to receive $30.00 in cash, without interest and subject to deduction of any required withholding tax. We paid the former ESI stockholders aggregate consideration of approximately $1.033 billion, excluding related transaction fees and expenses, and
non-cash
consideration related to the exchange of share-based awards of approximately $31 million for a total purchase consideration of approximately $1.063 billion. We funded the payment of the aggregate consideration with a combination of our available cash on hand and the proceeds from our senior secured term loan facility as described below.
Effective February 1, 2019, in conjunction with our acquisition of ESI, we created a third reportable segment known as the Equipment & Solutions segment in addition to our two then-existing reportable segments: the Vacuum & Analysis segment and the Light & Motion segment. ESI provides laser-based manufacturing solutions for the micro-machining industry that enable customers to optimize production. ESI’s primary served markets include flexible and rigid PCB processing/fabrication, semiconductor wafer processing and passive component manufacturing and testing. ESI solutions incorporate specialized laser technology and proprietary control software to efficiently process the materials and components that are an integral part of electronic devices and systems.
The Vacuum & Analysis segment provides a broad range of instruments, components and subsystems which are derived from our core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, RF & DC power, reactive gas generation and vacuum technology.
The Light & Motion segment provides a broad range of instruments, components and subsystems which are derived from our core competencies in lasers, photonics,
sub-micron
positioning, vibration control, and optics.
We have a diverse base of customers. Approximately 52% and 44% of our net revenues for the nine months ended September 30, 2019 and 2018, respectively, were from sales to customers in our advanced markets. These include, but are not limited to, industrial technologies, life and health sciences, and research and defense.
Approximately 48% and 56% of our net revenues for the nine months ended September 30, 2019 and 2018, respectively, were from sales to semiconductor capital equipment manufacturers and semiconductor device manufacturers.
We expect the relative split in our net revenues between sales to customers in our advanced markets and sales to customers in our semiconductor capital equipment manufacturer and semiconductor device manufacturer markets will be relatively consistent for the foreseeable future, excluding the impact of any future acquisitions.
Net revenues from customers in our advanced markets increased by $12 million, or 5%, for the three months ended September 30, 2019, compared to the same period in the prior year, primarily due to an increase of $42 million from our Equipment & Solutions segment as a result of the ESI Merger. This increase was offset by a decrease of $21 million and $9 million in revenue from customers in our advanced markets, primarily in our industrial technologies market, in our Light & Motion and Vacuum & Analysis segments, respectively.
Net revenues from customers in our advanced markets increased by $38 million, or 5%, for the nine months ended September 30, 2019, compared to the same period in the prior year, primarily due to an increase of $123 million from our Equipment & Solutions segment as a result of the ESI Merger. This increase was offset by a decrease of $49 million and $36 million in revenue from customers in our advanced markets, primarily in our industrial technologies market, in our Light & Motion and Vacuum & Analysis segments, respectively.
Net revenues from semiconductor capital equipment manufacture and semiconductor device manufacture customers decreased by $37 million, or 14%, for the three months ended September 30, 2019, compared to the same period in the prior year. This decrease was comprised of a volume decrease in net semiconductor revenues of $37 million and $7 million in the Vacuum & Analysis and Light & Motion segments, respectively, offset by an increase of $7 million from our Equipment & Solutions segment as a result of the ESI Merger.
Net revenues from semiconductor capital equipment manufacture and semiconductor device manufacture customers decreased by $252 million, or 28%, for the nine months ended September 30, 2019, compared to the same period in the prior year. This decrease was comprised of a volume decrease in net semiconductor revenues of $255 million and $14 million in the Vacuum & Analysis and Light & Motion segments, respectively, offset by an increase of $17 million from our Equipment & Solutions segment as a result of the ESI Merger.
The semiconductor capital equipment industry has been experiencing a moderation in capital spending in the past twelve months and we have seen a similar effect on our semiconductor revenue over the same period. However, while the timing of a full market recovery remains uncertain, we are seeing improving market conditions. The semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we cannot be certain as to the timing or extent of future demand or any future weakness in the semiconductor capital equipment industry.
A significant portion of our net revenues is from sales to customers in international markets. For the nine months ended September 30, 2019 and 2018, international net revenues accounted for approximately 53% and 50% of our total net revenues, respectively. A significant portion of our international net revenues was from China, South Korea, Germany and Japan. We expect that international net revenues will continue to represent a significant percentage of our total net revenues. Long-lived assets located in the United States were $177 million and $147 million, as of September 30, 2019 and December 31, 2018, respectively, excluding goodwill and intangibles, and long-term
tax-related
accounts. Long-lived assets located outside of the United States were $91 million and $77 million, as of September 30, 2019 and December 31, 2018, respectively, excluding goodwill and intangibles, and long-term
tax-related
accounts.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported. There have been no material changes in our critical accounting policies since December 31, 2018, other than the adoption of ASC 842 as outlined below.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”), Leases, (“ASU
2016-02”),
to enhance the transparency and comparability of financial reporting related to leasing arrangements. We adopted ASU
2016-02
on January 1, 2019, or the effective date, and used the effective date as our date of initial application.
At the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the facts and circumstances present. Most leases with a term greater than one year are recognized on the balance sheet as
right-of-use
assets, short-term lease liabilities and long-term lease liabilities. We have elected not to recognize on the balance sheet leases with terms of one year or less. Operating lease liabilities and their corresponding
right-of-use
assets are recorded based on the present value of lease payments over the expected remaining fixed lease term. Certain adjustments to the
right-of-use
asset may be required for items such as incentives received. In calculating the present value of future lease payments, we utilize our incremental borrowing rates, which are the rates incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. We have elected to utilize a single blended interest rate based on currencies, geographies and lease terms that comprise the lease portfolio.
Although separation of lease and
non-lease
components is required, certain practical expedients are available. Entities may elect the practical expedient to not separate lease and
non-lease
components. We have elected to account for the lease and
non-lease
components of each of our operating leases as a single lease component and allocate all of the contract consideration to the lease component only. The lease component results in an operating
right-of-use
asset being recorded on the balance sheet and amortized on a straight-line basis as lease expense.
Many of our leases contain options to renew and extend lease terms, and options to terminate leases early. We do not recognize the
right-of-use
asset or lease liability for renewal or termination periods unless we are reasonably certain to exercise the option at lease inception.
For further information about our critical accounting policies, including our revenue recognition policy, please see the discussion of critical accounting policies in our Annual Report on Form
10-K
for the year ended December 31, 2018 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates.”
Service revenues consisted mainly of fees for services related to the maintenance and repair of our products, sales of spare parts, and installation and training. Service revenues increased $15.4 million and $33.5 million during the three and nine month periods ended September 30, 2019, respectively, compared to the same periods in the prior year. These increases were primarily attributed to increases in service revenues from customers in our advanced markets of $16.8 million and $39.6 million for the three and nine months ended September 30, 2019, respectively, from the Equipment & Solutions segment as a result of the ESI Merger.
Total international net revenues, including product and service, were $251.3 million and $747.1 million for the three and nine months ended September 30, 2019, respectively, compared to $243.9 million and $812.8 million for the three and nine months ended September 30, 2018, respectively. The increase of $7.4 million for the three months ended September 30, 2019, compared to the same period in the prior year, was primarily due to an increase in net revenues from China, primarily as a result of the ESI Merger. The decrease of $65.7 million for the nine months ended September 30, 2019, was primarily due to decreases in net revenues in South Korea and Japan, primarily due to decreases in semiconductor revenues for our Vacuum & Analysis segment, partially offset by an increase in net revenues from China, as a result of the ESI Merger.
The following table sets forth our net revenues by reportable segment:
| | | | | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | | Nine Months Ended
September 30, | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | $ | | | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | $ | | | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | | | | | |
Net revenues from our Vacuum & Analysis segment decreased $45.4 million and $292.0 million for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year, due to decreases in net revenues from semiconductor customers of $36.0 million and $255.5 million for the three and nine months ended September 30, 2019, respectively, and decreases in net revenues from customers in our advanced markets of $9.4 million and $36.5 million for the three and nine months ended September 30, 2019, respectively, primarily from customers in our industrial technologies market.
Net revenues from our Light & Motion segment decreased $28.6 million and $62.9 million for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year. The decreases were primarily attributed to decreases in net revenues from customers in our advanced markets of $21.2 million and $49.1 million for the three and nine months ended September 30, 2019, respectively, primarily from customers in our industrial technologies market. The remainder of the decreases were attributed to decreases in net revenues from semiconductor customers of $7.4 million and $13.8 million for the three and nine months ended September 30, 2019, respectively.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | | | | | | | |
Gross profit as a percentage of net revenues: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | % | | | | % | | | | )% | | | | % | | | | % | | | | )% |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | % | | | | % | | | | )% | | | | % | | | | % | | | | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Gross profit as a percentage of net product revenues decreased by 4.5 percentage points for both the three and nine months ended September 30, 2019, compared to the same periods in the prior year, primarily due to lower factory utilization and lower revenue volumes, partially offset by favorable product mix.
Gross profit as a percentage of net service revenues increased by 5.1 percentage points and 0.8 percentage points for the three and nine month periods ended September 30, 2019, respectively, compared to the same periods in the prior year, primarily due to favorable absorption and favorable product mix, partially offset by higher material costs.
The following table sets forth gross profit as a percentage of net revenues by reportable segment:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | | | | | | | |
Gross profit as a percentage of net revenues: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | % | | | | % | | | | )% | | | | % | | | | % | | | | )% |
| | | | | | | | | | | | ) | | | | | | | | | | | | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | % | | | | % | | | | )% | | | | % | | | | % | | | | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Gross profit for our Vacuum & Analysis segment decreased by 3.7 and 3.5 percentage points for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year, primarily due to lower factory utilization, higher material costs and lower revenue volumes.
Gross profit for our Light & Motion segment decreased by 2.9 and 3.3 percentage points for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year, primarily due to lower factory utilization, lower revenue volumes and unfavorable product mix.
Gross profit for our Equipment & Solutions segment was 45.2% and 38.1% for the three and nine months ended September 30, 2019, respectively. The nine months ended September 30, 2019 includes the inventory
step-up
adjustment to fair value from purchase accounting of $7.6 million. Excluding this adjustment, the gross margin for the nine months ended September 30, 2019 would have been 43.6% for this period.
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Research and development expenses | | $ | | | | $ | | | | $ | | | | $ | | |
Research and development expenses increased $9.7 million for the three months ended September 30, 2019, compared to the same period in the prior year, primarily due to $7.2 million from the ESI Merger, which primarily included $4.5 million of compensation-related expenses, $1.1 million of project materials and $0.8 million of depreciation expense, and an increase of $2.3 million of project materials related to the legacy MKS business.
Research and development expenses increased $19.1 million for the nine months ended September 30, 2019, compared to the same period in the prior year, primarily due to $18.7 million from the ESI Merger, which primarily included $12.2 million of compensation-related expenses, $2.4 million of project materials, $2.2 million of depreciation expense and $1.0 million of occupancy costs, and an increase of $1.8 million of project materials related to the legacy MKS business.
Our research and development efforts are primarily focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity.
We have thousands of products, and our research and development efforts primarily consist of a large number of projects related to these products, none of which is individually material to us. Current projects typically have durations of 3 to 30 months depending upon whether the product is an enhancement of existing technology or a new product. Our current initiatives include projects to enhance the performance characteristics of older products, to develop new products and to integrate various technologies into subsystems. These projects support in large part the transition in the semiconductor industry to smaller integrated circuit geometries and in the flat panel display and solar markets to larger substrate sizes, which require more advanced process control technology. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants, material costs for prototypes and other expenses related to the design, development, testing and enhancement of our products.
We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets. We expect to continue to make significant investment in research and development activities. We are subject to risks from products not being developed in a timely manner, as well as from rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor industry and advanced technology markets. We develop products that are technologically advanced so that they are positioned to be chosen for use in each successive generation of semiconductor capital equipment. If our products are not chosen to be designed into our customers’ products, our net revenues may be reduced during the lifespan of those products.
Selling, General and Administrative
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Selling, general and administrative expenses | | $ | | | | $ | | | | $ | | | | $ | | |
Selling, general and administrative expenses increased by $11.3 million for the three months ended September 30, 2019, compared to the same period in the prior year. This increase was primarily attributed to $9.6 million from the ESI Merger, which primarily included $6.1 million of compensation-related expense, $1.0 million of depreciation expense, $0.7 million of travel and entertainment expense and $0.4 million of commissions expense. The increase was also attributed to an increase of $1.3 million of compensation-related expense, $0.8 million of information technology related expenses and $0.6 million of bad debt expense related to the legacy MKS business.
Selling, general and administrative expenses increased by $17.8 million for the nine months ended September 30, 2019, compared to the same period in the prior year. This increase was primarily attributed to $27.9 million from the ESI Merger, which primarily included $17.6 million of compensation-related expense, $3.1 million of depreciation expense, $1.7 million of travel and entertainment expense and $1.7 million of consulting and professional fees. The increase was also attributed to an increase of $1.5 million of information technology related expenses, partially offset by a decrease of $9.8 million of compensation-related expense and $1.7 million of depreciation expense, related to the legacy MKS business.
Fees and Expenses Related to Incremental Term Loan Facility
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Fees and expenses related to term loan | | $ | | | | $ | | | | $ | | | | $ | | |
We recorded fees and expenses during the three and nine months ended September 30, 2019, related to Amendment No. 6 which included the fifth repricing of our Term Loan Facility and the combination of the two existing tranches of our Term Loan Facility with a maturity date in February 2026. We also recorded fees and expenses during the nine months ended September 30, 2019 related to Amendment No. 5, which established a second tranche for our term loan commitment in the original principal amount of $650 million. We recorded fees and expenses during the nine months ended September 30, 2018 related to the fourth repricing of our 2016 Term Loan Facility.
Acquisition and Integration Costs
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Acquisition and integration costs | | $ | | | | $ | | | | $ | | | | $ | | ) |
We recorded acquisition and integration costs related to the ESI Merger, which closed on February 1, 2019, during the three and nine months ended September 30, 2019. These costs consisted primarily of compensation costs for certain executives from ESI who had change in control provisions in their respective ESI employment agreements that were accounted for as dual-trigger arrangements and other stock vesting accelerations, as well as consulting and professional fees associated with the ESI Merger.
During the three and nine months ended September 30, 2018, we reversed a portion of acquisition and integration costs recognized during previous periods related to the acquisition of Newport Corporation in April 2016 (the “Newport Merger”), related to severance agreement provisions that were not met.
We recorded restructuring costs during the three and nine months ended September 30, 2019, which consisted primarily of severance costs related to an organization-wide reduction in workforce, the consolidation of service functions in Asia and the movement of certain products to low cost regions. We also recorded expense during the nine months ended September 30, 2019 related to a legal settlement from a contractual obligation we assumed as part of the Newport Merger.
Restructuring costs during the three and nine months ended September 30, 2018 were primarily comprised of severance costs related to transferring a portion of our shared services functions to a third party as well as the consolidation of certain shared service functions in Asia. We also recorded environmental costs during the nine months ended September 30, 2018, related to an Environmental Protection Agency-designated Superfund site, which was acquired as part of the Newport Merger.
Amortization of Intangible Assets
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Amortization of intangible assets | | $ | | | | $ | | | | $ | | | | $ | | |
Amortization of intangible assets increased by $6.3 million and $17.5 million during the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year, primarily due to the amortization of intangible assets acquired as part of the ESI Merger.
Interest expense, net, increased by $10.1 million and $22.0 million for the three and nine months ended September 30, 2019, respectively, primarily due to interest expense related to Amendment No. 5 as described below.
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Other (income) expense, net | | $ | | ) | | $ | | | | $ | | | | $ | | |
The changes in other (income) expense, net, for the three and nine months ended September 30, 2019, respectively, compared to the same periods in the prior year, primarily related to changes in foreign exchange rates.
Provision for Income Taxes
| | | | | | | | | | | | | | | | | |
| | | | | | |
| | | | | | | | | | | | |
Provision for income taxes | | $ | | | | $ | | | | $ | | | | $ | | |
Our effective tax rates for the three and nine months ended September 30, 2019 were 14.4% and 20.4%, respectively. Our effective tax rates for the three and nine months ended September 30, 2019, and related income tax expense, were lower than the U.S. statutory tax rate due to the deduction for foreign derived intangible income, the geographic mix of income earned by our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate and the impact of various tax credits, offset by the global intangible
low-taxed
income inclusion and a correction of an
out-of-period
error with respect to deferred tax assets related to limitations on the deduction of executive compensation in the amount of $5.0 million. This correction, which was recorded during the
quarter ended June 30, 2018, but should have been recorded during the three months ended September 30, 2018, increased our effective tax rate for the three and six months ended June 30, 2019 and the nine months ended September 30, 2019 by 9.8%, 7.5% and 3.8%, respectively. The error and subsequent adjustment were not material to prior or current interim and annual financial statements.
Our effective tax rates for the three and nine months ended September 30, 2018 were 18.5% and 17.6%, respectively. Our effective tax rates for the three and nine months September 30, 2018, and related income tax expense, were lower than the U.S. statutory rate due to foreign earnings taxed at lower rates, windfall benefits of stock compensation and the deduction for foreign derived intangible income, offset by the tax effect of the provision for global intangible low taxed income inclusion and state income taxes.
As of September 30, 2019, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $41.2 million. At December 31, 2018, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $32.7 million. The net increase is primarily attributable to the addition of historical gross unrecognized tax benefits for ESI as a result of the ESI Merger during the quarter ended March 31, 2019. As of September 30, 2019, excluding interest and penalties, there were approximately $33.4 million of net unrecognized tax benefits that, if recognized, would impact our annual effective tax rate. We accrue interest and, if applicable, penalties for any uncertain tax positions. Interest and penalties are classified as a component of income tax expense. As of September 30, 2019 and December 31, 2018, we had accrued interest on unrecognized tax benefits of approximately $0.6 million and $0.6 million, respectively.
Over the next 12 months it is reasonably possible that we may recognize approximately $1.2 million of previously net unrecognized tax benefits, excluding interest and penalties, related to federal, state and foreign tax positions as a result of the expiration of statutes of limitation. The U.S. statute of limitations remains open for tax years 2016 through present. The statute of limitations for our tax filings in other jurisdictions varies between fiscal years 2013 through the present. We also have certain federal credit carry-forwards and state tax loss and credit carry-forwards that are open to examination for tax years 2000 through the present.
We are subject to examination by U.S. federal, state and foreign tax authorities. The U.S. Internal Revenue Service commenced an examination of our U.S. federal income tax filings for tax years 2015 and 2016 during the quarter ended September 30, 2017. This audit was effectively settled during the quarter ended March 31, 2018, and the impact was not material. Also during the quarter ended March 31, 2018 we received notification from the U.S. Internal Revenue Service of their intent to audit our U.S. subsidiary, Newport Corporation, for tax year 2015. This audit commenced during the quarter ended June 30, 2018 and was effectively settled during the quarter ended June 30, 2019 with a no change result.
On a quarterly basis, we evaluate both positive and negative evidence that affects the realizability of net deferred tax assets and assess the need for a valuation allowance. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income in each jurisdiction of the right type to realize the assets.
Our future effective tax rate depends on various factors, including further interpretations and guidance from U.S. federal and state governments on the impact of the enactment of the Tax Cuts and Jobs Act, the adoption of the proposed regulations on the foreign derived intangible income and additional regulations on the global intangible
low-taxed
income provision, as well as the geographic composition of our
pre-tax
income, and changes in income tax reserves for unrecognized tax benefits. We monitor these factors and timely adjust our estimates of the effective tax rate accordingly. We expect that the geographic mix of
pre-tax
income will continue to have a favorable impact on our effective tax rate, however the geographic mix of
pre-tax
income can change based on multiple factors resulting in changes to the effective tax rate in future periods. While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax law and regulations. Additionally, the recognition and measurement of certain tax benefits include estimates and judgment by management. Accordingly, we could record additional provisions or benefits for U.S. federal, state, and foreign tax matters in future periods as new information becomes available.
Liquidity and Capital Resources
Cash and cash equivalents and short-term marketable investments totaled $475.1 million at September 30, 2019, compared to $718.2 million at December 31, 2018. This decrease primarily related to the use of $406.0 million of cash to fund the payment of a portion of the purchase price for ESI on February 1, 2019.
Net cash provided by operating activities was $167.2 million for the nine months ended September 30, 2019 and resulted from net income of $97.6 million, which included
non-cash
charges of $139.5 million, offset by a net increase in working capital of $69.9 million. The net increase in working capital was due to an increase in inventories of $25.8 million, a decrease in accounts payable of $24.0 million, an increase in other current and
non-current
assets of $18.2 million, a decrease in accrued compensation of $13.4 million, a decrease in income taxes of $0.8 million, offset by a decrease in trade accounts receivable of $9.3 million and an increase in other current and
non-current
liabilities of $3.0 million.
Net cash provided by operating activities was $278.3 million for the nine months ended September 30, 2018 and resulted from net income of $321.3 million, which included
non-cash
charges of $99.1 million, offset by a net increase in working capital of $142.1 million. The net increase in working capital was due to an increase in inventories of $80.4 million, an increase in accounts receivable of $23.1 million and an increase in other current and
non-current
assets of $17.7 million, related to an increase in business activities, a decrease in accrued compensation of $15.5 million, a decrease in income taxes of $13.9 million and a decrease in accounts payable $0.4 million. These increases in working capital were offset by an increase in other current and
non-current
liabilities of $8.9 million.
Net cash used in investing activities was $907.7 million for the nine months ended September 30, 2019 and was primarily due to the payment of a portion of the purchase price for the ESI Merger of $988.6 million and purchases of production-related equipment of $44.7 million, offset by net sales and maturities of short-term investments of $84.4 million and proceeds from the sale of long-lived assets of $41.2 million. Net cash used in investing activities was $47.4 million for the nine months ended September 30, 2018, due to the purchases of production-related equipment of $36.9 million and net purchases of short-term investments of $10.5 million.
Net cash provided by financing activities was $490.0 million for the nine months ended September 30, 2019 and was primarily from net proceeds of $534.3 million, mainly from our 2019 Incremental Term Loan Facility, as described below, used to finance the ESI Merger, offset by dividend payments made to common stockholders of $32.6 million and net payments related to tax payments for employee stock awards of $11.7 million. Net cash used in financing activities was $167.5 million for the nine months ended September 30, 2018, and resulted from the repurchase of common stock of $75.0 million, partial repayment of our Term Loan Facility of $50.0 million, dividend payments made to common stockholders of $31.6 million and net payments related to tax payments for employee stock awards of $13.6 million, partially offset by net borrowings relating to our lines of credit of $2.7 million.
On July 25, 2011, our Board of Directors approved a share repurchase program for the repurchase of up to an aggregate of $200 million of our outstanding common stock from time to time in open market purchases, privately negotiated transactions or through other appropriate means. The timing and quantity of any shares repurchased depends upon a variety of factors, including business conditions, stock market conditions and business development activities, including but not limited to merger and acquisition opportunities. These repurchases may be commenced, suspended or discontinued at any time without prior notice. We have repurchased approximately 2,588,000 shares of common stock for approximately $127.0 million pursuant to the program since its adoption. During the nine months ended September 30, 2019, there were no repurchases of common stock. During the three and nine months ended September 30, 2018, we repurchased approximately 818,000 shares of our common stock for $75.0 million, for an average of $91.67 per share.
Holders of our common stock are entitled to receive dividends when and if they are declared by our Board of Directors. In addition, we accrue dividend equivalents on the restricted stock units we assumed in the ESI Merger when dividends are declared by our Board of Directors. Our Board of Directors declared a cash dividend of $0.20 per share during each of the first, second and third quarters of 2019, respectively, which totaled $32.6 million, or $0.60 per share. Our Board of Directors declared a cash dividend of $0.18 per share during the first quarter of 2018 and $0.20 per share during the second and third quarters of 2018, which totaled $31.6 million, or $0.58 per share.
On October 28, 2019, our Board of Directors declared a quarterly cash dividend of $0.20 per share to be paid on December 6, 2019 to shareholders of record as of November 25, 2019. Future dividend declarations, if any, as well as the record and payment dates for such dividends, are subject to the final determination of our Board of Directors. In addition, under the terms of the Term Loan Facility and ABL Facility, each as defined below, we may be restricted from paying dividends under certain circumstances.
Term Loan Credit Agreement
In connection with the completion of the Newport Merger in April 2016, we entered into a term loan credit agreement (the “Credit Agreement”) with Barclays Bank PLC, as administrative agent and collateral agent, and the lenders from time to time party thereto (the “Lenders”), that provided senior secured financing in the original principal amount of $780.0 million (the “2016 Term Loan Facility”), subject to increase at the Company’s option and subject to receipt of lender commitments in accordance with the Credit Agreement (the 2016 Term Loan Facility, together with the 2019 Incremental Term Loan Facility and 2019 Term Loan Refinancing Facility (each as defined below), the “Term Loan Facility”). Prior to the effectiveness of Amendment No. 6 (as defined below), the 2016 Term Loan Facility had a maturity date of April 29, 2023. As of September 30, 2019, borrowings under the Term Loan Facility bear interest per annum at one of the following rates selected by the Company: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
(3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00%, and (4) a floor of 1.75%, plus, in each case, an applicable margin; or (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, subject to a LIBOR rate floor of 0.0%, plus an applicable margin. The Company has elected the interest rate as described in clause (b). The Credit Agreement provides that, unless an alternate rate of interest is agreed, all loans will be determined by reference to the base rate if the LIBOR rate cannot be ascertained, if regulators impose material restrictions on the authority of a lender to make LIBOR rate loans, or for other reasons. The 2016 Term Loan Facility was issued with original issue discount of 1.00% of the principal amount thereof.
We subsequently entered into four separate repricing amendments to the 2016 Term Loan Facility, which decreased the applicable margin for LIBOR borrowings from 4.0% to 1.75%, with a LIBOR rate floor of 0.75%. As a consequence of the pricing of the 2019 Incremental Term Loan Facility (defined below), the applicable margin for the 2016 Term Loan Facility was increased to 2.00% (from 1.75%) with respect to LIBOR borrowings and 1.00% (from 0.75%) with respect to base rate borrowings.
On September 30, 2016, we entered into an interest rate swap agreement, which has a maturity date of September 30, 2020, to fix the rate on $335.0 million of the then-outstanding balance of the 2016 Term Loan Facility. The rate was fixed at 1.198% per annum plus the applicable credit spread, which was 1.75% at September 30, 2019. At September 30, 2019, the notional amount of this transaction was $250.0 million and it had a fair value asset of $1.2 million.
We incurred $28.7 million of deferred finance fees, original issue discount and repricing fees related to the term loans under the 2016 Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method.
On February 1, 2019, in connection with the completion of the ESI Merger, we entered into an amendment (“Amendment No. 5”) to the Credit Agreement. Amendment No. 5 provided an additional tranche
B-5
term loan commitment in the original principal amount of $650.0 million (the “2019 Incremental Term Loan Facility”), all of which was drawn down in connection with the closing of the ESI Merger. Pursuant to Amendment No. 5, we also effectuated certain amendments to the Credit Agreement which make certain of the negative covenants and other provisions less restrictive. Prior to the effectiveness of Amendment No. 6 (as defined below), the 2019 Incremental Term Loan Facility had a maturity date of February 1, 2026 and bore interest at a rate per annum equal to, at our option, a base rate or LIBOR rate (as described above) plus, in each case, an applicable margin equal to 1.25% with respect to base rate borrowings and 2.25% with respect to LIBOR borrowings. The 2019 Incremental Term Loan Facility was issued with original issue discount of 1.00% of the principal amount thereof.
On April 3, 2019, we entered into an interest rate swap agreement, which has a maturity date of March 31, 2023, to fix the rate on $300.0 million of the then-outstanding balance of the 2019 Incremental Term Loan Facility. The rate was fixed at 2.309% per annum plus the applicable credit spread, which was 1.75% at September 30, 2019. At September 30, 2019, the notional amount of this transaction was $300.0 million and it had a fair value liability of $8.1 million.
We incurred $11.4 million of deferred finance fees and original issue discount fees related to the term loans under the 2019 Incremental Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method.
On September 27, 2019, we entered into an amendment (“Amendment No. 6”) to the Credit Agreement. Amendment No. 6 refinanced all existing loans outstanding under the 2016 Term Loan Facility and 2019 Incremental Term Loan Facility (“Existing Term Loans”) for a tranche
B-6
term loan commitment in the original principal amount of $896.8 million (“2019 Term Loan Refinancing Facility”). Each lender of the Existing Term Loans who elected to participate in the 2019 Term Loan Refinancing Facility was deemed to have exchanged the aggregate outstanding principal amount of its Existing Term Loans outstanding under the Credit Agreement for an equal aggregate principal amount of tranche
B-6
term loans under the 2019 Term Loan Refinancing Facility. On the effective date of Amendment No. 6 and immediately prior to the exchanges described above, we made a voluntary prepayment of $50.0 million, which was applied to the Existing Term Loans on a pro rata basis.
We incurred $2.2 million of original issue discount fees related to the term loans under the 2019 Term Loan Refinancing Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method.
As of September 30, 2019, the remaining balance of deferred finance fees and original issue discount of the Term Loan Facility was $12.3 million. A portion of the deferred finance fees and original issue discount have been accelerated in connection with the various debt prepayments and extinguishments during 2016, 2017, 2018 and 2019.
The 2019 Term Loan Refinancing Facility matures on February 2, 2026, and bears interest at a rate per annum equal to, at our option, a base rate or LIBOR rate (as described above) plus, in each case, an applicable margin equal to 0.75% with respect to base rate borrowings and 1.75% with respect to LIBOR borrowings. The 2019 Term Loan Refinancing Facility was issued with original issue discount of 0.25% of the principal amount thereof.
We are required to make scheduled quarterly payments each equal to 0.25% of the original principal amount of the 2019 Term Loan Refinancing Facility with the balance due on February 2, 2026. If, on or prior to the date that is six months after the closing date of Amendment No. 6, we prepay any loans under the 2019 Term Loan Refinancing Facility in connection with a repricing transaction, we must pay a prepayment premium of 1.00% of the aggregate principal amount of the loans so prepaid.
As of September 30, 2019, after total principal prepayments of $525.0 million (which includes a $50.0 million prepayment made during the three months ended September 30, 2019) and regularly scheduled principal payments of $10.4 million, the total outstanding principal balance of the Term Loan Facility was $894.6 million and the interest rate was 3.59%.
Under the Credit Agreement, we are required to prepay outstanding term loans, subject to certain exceptions, with portions of our annual excess cash flow as well as with the net cash proceeds of certain of our asset sales, certain casualty and condemnation events and the incurrence or issuance of certain debt. As a result of our current total leverage ratio, we are not required to make a prepayment of excess cash flow for the period ended September 30, 2019.
All obligations under the Term Loan Facility are guaranteed by certain of our domestic subsidiaries, and are collateralized by substantially all of our assets and the assets of such subsidiaries, subject to certain exceptions and exclusions.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and provisions relating to events of default. If an event of default occurs, the Lenders under the Term Loan Facility will be entitled to take various actions, including the acceleration of amounts due under the Term Loan Facility and all actions generally permitted to be taken by a secured creditor. At September 30, 2019, we were in compliance with all covenants under the Credit Agreement.
Senior Secured Asset-Based Revolving Credit Facility
On February 1, 2019, in connection with the completion of the ESI Merger, we entered into an asset-based credit agreement with Barclays Bank PLC, as administrative agent and collateral agent, the other borrowers from time to time party thereto, and the lenders and letters of credit issuers from time to time party thereto (the “ABL Credit Agreement”), that provides senior secured revolving credit financing of up to $100.0 million, subject to a borrowing base limitation (the “ABL Facility”). On April 26, 2019, we entered into a First Amendment to the ABL Credit Agreement which amended the borrowing base calculation for eligible inventory prior to an initial field examination and appraisal requirements. The borrowing base for the ABL Facility at any time equals the sum of: (a) 85% of certain eligible accounts; plus (b) prior to certain notice and field examination and appraisal requirements, the lesser of (i) 20% of net book value of eligible inventory in the United States and (ii) 30% of the borrowing base, and after the satisfaction of such requirements, the lesser of (i) the lesser of (A) 65% of the lower of cost or market value of certain eligible inventory and (B) 85% of the net orderly liquidation value of certain eligible inventory and (ii) 30% of the borrowing base; minus (c) reserves established by the administrative agent, in each case, subject to additional limitations and examination requirements for eligible accounts and eligible inventory acquired in an acquisition after February 1, 2019. The ABL Facility includes borrowing capacity in the form of letters of credit up to $25.0 million.
Borrowings under the ABL Facility bear interest at a rate per annum equal to, at our option, any of the following, plus, in each case, an applicable margin: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
, (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00% and (4) a floor of 0.00%; and (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, with a floor of 0.00%. The initial applicable margin for borrowings under the ABL Facility is 0.50% with respect to base rate borrowings and 1.50% with respect to LIBOR borrowings. Commencing with the completion of the first fiscal quarter ending after the closing of the ABL Facility, the applicable margin for borrowings thereunder is subject to upward or downward adjustment each fiscal quarter, based on the average historical excess availability during the preceding quarter.
In addition to paying interest on any outstanding principal under the ABL Facility, we are required to pay a commitment fee in respect of the unutilized commitments thereunder equal to 0.25% per annum. We must also pay customary letter of credit fees and agency fees.
We incurred $0.8 million of costs in connection with the ABL Facility, which were capitalized and included in other assets in the accompanying consolidated balance sheet and are being amortized to interest expense over the contractual term of five years of the ABL Facility. As a result of a prior asset-based facility being terminated concurrently with our entry into the ABL Facility, we wrote off $0.2 million of previously capitalized debt issuance costs.
The ABL Credit Agreement also contains customary representations and warranties, affirmative covenants and provisions relating to events of default. If an event of default occurs, the lenders under the ABL Facility will be entitled to take various actions, including the acceleration of amounts due under the ABL Facility and all actions permitted to be taken by a secured creditor. We have not borrowed against this ABL Facility to date.
Sale of Long-Lived Assets
In August of 2019, we sold two of our buildings in Boulder, Colorado and three of our buildings in Portland, Oregon. Total net cash proceeds received for these two transactions was $41.2 million and we recognized a net gain on the sale of these long-lived assets of $6.8 million.
Off-Balance
Sheet Arrangements
We do not have any financial partnerships with unconsolidated entities, such as entities often referred to as structured finance, special purpose entities or variable interest entities, which are often established for the purpose of facilitating
off-balance
sheet arrangements or for other contractually narrow or limited purposes. Accordingly, we have no
off-balance
sheet arrangements that have or are reasonably expected to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Other than the 2019 Incremental Term Loan Facility for $650.0 million and the 2019 Term Loan Refinancing Facility described above, there have been no other changes outside the ordinary course of business to our contractual obligations as disclosed in our Annual Report on Form
10-K
for the year ended December 31, 2018.
Recently Issued Accounting Pronouncements
In August 2018, the FASB issued ASU
2018-15,
“Intangibles-Goodwill and
Other-Internal-Use
Software (Subtopic
350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.” This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain
internal-use
software (and hosting arrangements that include an
internal-use
software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments to this update. This standard is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the requirements of this ASU and the impact of pending adoption on our consolidated financial statements.
In June 2016, the FASB issued ASU
2016-13,
“Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This standard introduced the expected credit losses methodology for the measurement of credit losses on financial assets that are not measured at fair value through net income and replaces today’s “incurred loss” model with an “expected credit loss” model that requires consideration of a broader range of information to estimate expected credit losses over the lifetime of the asset. There have been several consequential subsequent amendments to this standard. This standard is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the requirements of this ASU and the impact of pending adoption on our consolidated financial statements.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Information concerning market risk is contained in the section entitled “Quantitative and Qualitative Disclosures About Market Risk” contained in our Annual Report on Form
10-K
for the year ended December 31, 2018 filed with the Securities and Exchange Commission on February 26, 2019. As of September 30, 2019, there were no material changes in our exposure to market risk from December 31, 2018.
| ITEM 4. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2019. The term “disclosure controls and procedures,” as defined in Rules
13a-15(e)
and
15d-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules
13a-15(f)
and
15d-15(f)
under the Exchange Act) during the quarter ended September 30, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
| ITEM 1. | LEGAL PROCEEDINGS. |
In 2016, two putative class actions lawsuit captioned Dixon Chung v. Newport Corp., et al., Case No.
A-16-733154-C,
and Hubert C. Pincon v. Newport Corp., et al., Case No.
A-16-734039-B,
were filed in the District Court, Clark County, Nevada on behalf of a putative class of stockholders of Newport Corporation (“Newport”) for claims related to the merger agreement (“Newport Merger Agreement”) between the Company, Newport, and a wholly-owned subsidiary of the Company (“Merger Sub”). The lawsuits named as defendants the Company, Newport, Merger Sub, and certain then current and former members of Newport’s board of directors. Both complaints alleged that Newport directors breached their fiduciary duties to Newport’s stockholders by agreeing to sell Newport through an inadequate and unfair process, which led to inadequate and unfair consideration, by agreeing to unfair deal protection devices and by omitting material information from the proxy statement. The complaints also alleged that the Company, Newport and Merger Sub aided and abetted the directors’ alleged breaches of their fiduciary duties. The Court consolidated the actions, and plaintiffs later filed an amended complaint captioned In re Newport Corporation Shareholder Litigation, Case No.
A-16-733154-B,
in the District Court, Clark County, Nevada, on behalf of a putative class of Newport’s stockholders for claims related to the Newport Merger Agreement. The amended complaint alleged Newport’s former board of directors breached their fiduciary duties to Newport’s stockholders and that the Company, Newport and Merger Sub had aided and abetted these breaches. It sought monetary damages, including
pre-
and post-judgment interest. In June 2017, the Court granted defendants’ motion to dismiss and dismissed the amended complaint against all defendants but granted plaintiffs leave to amend.
On July 27, 2017, plaintiffs filed a second amended complaint containing substantially similar allegations but naming only Newport’s former directors as defendants. On August 8, 2017, the Court dismissed the Company and Newport from the action. The second amended complaint seeks monetary damages, including
pre-
and post-judgment interest. The Court granted a motion for class certification on September 27, 2018, appointing Mr. Pincon and Locals 302 and 612 of the International Union of Operating Engineers - Employers Construction Industry Retirement Trust as class representatives. On June 11, 2018, plaintiff Dixon Chung was voluntarily dismissed from the litigation. On May 1, 2019, the Court granted the defendants’ motion to strike plaintiffs’ jury demand and determined that the case will be tried by the Court, and not a jury. Discovery in the action is complete. On August 9, 2019, plaintiffs filed a motion for leave to file a third amended complaint, which was denied on October 10, 2019. On August 23, 2019, defendants filed a motion for summary judgment. A bench trial is scheduled for January 2020.
The Company is subject to various legal proceedings and claims, which have arisen in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our results of operations, financial condition or cash flows.
Information regarding risk factors affecting the Company’s business are discussed in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2018 in the section entitled “Risk Factors.” There have been no material changes to the risk factors as described in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form
10-K
for the year ended December 31, 2018 and a supplemental risk factor described in our Quarterly Report on Form
10-Q
for the quarter ended June 30, 2019.
