| | | Nine Months Ended March 31, |
| | | 2007 | | | 2006 | |
| |
| Cash provided by operating activities: | | | | | | | | |
| Net earnings | | $ | 11,332 | | | $ | 9,970 | |
| |
| Adjustments to reconcile net earnings to cash | | | | | | | | |
| provided by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 4,800 | | | | 4,608 | a |
| Deferred income taxes | | | 4,736 | | | | 2,811 | |
| Compensation cost related to share-based payments arrangements | | | 1,668 | | | | 1,389 | |
| Excess tax benefits from share-based payment arrangements | | | (81 | ) | | | (120 | ) |
| Minority interest | | | 772 | | | | 614 | |
| Other, net | | | 218 | | | | 119 | |
| Changes in operating accounts: | | | | | | | | |
| Receivables | | | 1,234 | | | | 2,094 | |
| Inventories | | | (8,013 | ) | | | (3,491 | ) |
| Prepaid expenses | | | 201 | | | | 801 | |
| Accounts payable, accrued expenses, and taxes payable | | | (7,741 | ) | | | (8,346 | ) |
| Net cash provided by operating activities | | | 9,126 | | | | 10,449 | |
| Cash used for investing activities: | | | | | | | | |
| Additions to property, plant, and equipment | | | (7,115 | ) | | | (4,501 | ) |
| Purchase of marketable securities | | | (26,744 | ) | | | (25,408 | ) |
| Additions to intangibles and other assets | | | (564 | ) | | | (460 | ) |
| Proceeds from the maturity of marketable securities | | | 21,902 | | | | 15,100 | |
| Net cash used for investing activities | | | (12,521 | ) | | | (15,269 | ) |
| Cash provided by financing activities: | | | | | | | | |
| Employee stock purchase | | | 330 | | | | 492 | |
| Exercise of employee stock awards | | | 574 | | | | 820 | |
| Excess tax benefits from share-based payment arangements | | | 81 | | | | 120 | |
| Dividend payment to minority interest | | | - | | | | (622 | ) |
| Net cash provided by financing activities | | | 985 | | | | 810 | |
| Effect of exchange rate changes on cash and cash equivalents | | | (8 | ) | | | - | |
| Net decrease in cash and cash equivalents | | | (2,418 | ) | | | (4,010 | ) |
| Cash and cash equivalents, beginning of period | | | 20,318 | | | | 20,949 | |
| Cash and cash equivalents, end of period | | $ | 17,900 | | | $ | 16,939 | |
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except for per share amounts)
Note 1: Principles of Consolidation and Presentation
Zygo Corporation is a worldwide supplier of optical metrology instruments, precision optics, and electro-optical design and manufacturing services, serving customers in the semiconductor capital equipment and industrial markets. The accompanying condensed consolidated financial statements include the accounts of Zygo Corporation and its subsidiaries (“ZYGO,” “we,” “us,” “our” or “Company”). All material transactions and accounts with the subsidiaries have been eliminated from the condensed consolidated financial statements. The results of operations for the three and nine months ended March 31, 2007 are not necessarily indicative of the results to be expected for the full fiscal year.
The Condensed Consolidated Balance Sheet at March 31, 2007, the Condensed Consolidated Statements of Operations for the three and nine months ended March 31, 2007 and 2006, and the Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2007 and 2006 are unaudited but, in management’s opinion, include all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the results of the interim periods. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended June 30, 2006, including items incorporated by reference therein.
Note 2: Earnings Per Share
Basic and diluted earnings per share are calculated in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.” For the third quarter of fiscal 2007, 823,698 of the Company’s outstanding stock options and restricted stock awards (“Stock Grants”) (849,298 for the first nine months of fiscal 2007) were excluded from the calculation of diluted earnings per share. For the third quarter of fiscal 2006, 719,149 of the Company’s outstanding Stock Grants (917,449 for the first nine months of fiscal 2006) were excluded from the calculation of diluted earnings per share. These Stock Grants could be included in the calculation in the future if the average market value of the common shares increases.
The following table sets forth the reconciliation of basic weighted average shares outstanding and diluted weighted average shares outstanding:
| | | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Basic weighted average shares | | | | | | | | |
| outstanding | | 18,162,840 | | 18,068,637 | | 18,135,268 | | 18,037,323 |
| Dilutive effect of stock options | | | | | | | | |
| and restricted shares | | 490,676 | | 406,137 | | 429,061 | | 280,753 |
| Diluted weighted average shares | | | | | | | | |
| outstanding | | 18,653,516 | | 18,474,774 | | 18,564,329 | | 18,318,076 |
Note 3: Recent Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value, with unrealized gains and losses related to these financial instruments reported in earnings at each subsequent reporting date. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is in the process of evaluating the impact of SFAS 159 on our financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin 108 (“SAB 108”) to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. SAB 108 is effective as of the end of our 2007 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of June 30, 2007 for errors that were not previously deemed material, but are material under the guidance in SAB 108. We do not expect the adoption of SAB 108 to have a material effect on our financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS 158"). SFAS 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare, and other post-retirement plans in their financial statements. The provisions of SFAS 158 are effective as of the end of our fiscal year ending June 30, 2007. We are currently evaluating the impact of the provisions of SFAS 158 on our company.
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In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for our fiscal year beginning July 1, 2008. We are currently evaluating the impact of the provisions of SFAS 157 on our company.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the Company's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." The provisions of FIN 48 are effective for our fiscal year beginning July 1, 2007. We are currently evaluating the impact of the provisions of FIN 48 on our company.
Note 4: Share-Based Payments
We recorded share-based compensation expense for the three months ended March 31, 2007 and 2006 of $559 and $199, respectively, with a related tax benefit of $201 and $71, respectively. Shared-based compensation for the nine months ended March 31, 2007 and 2006 was $1,668 and $1,389, respectively, with a related tax benefit of $601 and $497, respectively. Beginning after July 1, 2005, we made changes to our employee stock purchase plan which rendered the plan non-compensatory in accordance with SFAS No. 123(R), “Share-Based Payment.”
Stock Options
An independent third party assisted the Company in determining the Black-Scholes weighted average assumptions utilized in both fiscal 2007 and 2006 stock option valuations. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate, dividend yield, exercise price, and forfeiture rate. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense. Under the assumptions indicated below, the weighted-average fair value of stock option grants for the three and nine months ended March 31, 2007 were $7.09 and $6.23, respectively. The weighted-average fair value of stock option grants for the nine months ended March 31, 2006 was $5.41. The table below indicates the key assumptions used in the option valuation calculations for options granted in the three and nine months ended March 31, 2007 and March 31, 2006, and a discussion of our methodology for developing each of the assumptions used in the valuation model:
| | | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | | 2007 | | | 2006 | | 2007 | | 2006 |
| Term | | 4.1 Years | | * | | 4.1 Years | | 4.1 Years |
| Volatility | | 52.1 | % | | * | | 52.1 | % | | 52.9 | % |
| Dividend yield | | 0.0 | % | | * | | 0.0 | % | | 0.0 | % |
| Risk-free interest rate | | 4.8 | % | | * | | 4.7%-4.8 | % | | 3.9%-4.4 | % |
| Forfeiture rate | | 10.7 | % | | * | | 10.7 | % | | 10.6 | % |
* No stock options were granted during the three months ended March 31, 2006.
Term – This is generally the period of time over which the options granted are expected to remain outstanding. Options granted have a maximum term of ten years. An increase in the expected term will increase compensation expense.
Volatility – This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. Volatilities are based on implied volatilities from traded options of ZYGO’s shares, historical volatility of ZYGO’s shares, and other factors, such as expected changes in volatility arising from planned changes in ZYGO’s business operations. An increase in the expected volatility will increase compensation expense.
Dividend Yield – We did not make any dividend payments during the last five fiscal years and we have no plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease compensation expense.
Risk-Free Interest Rate – This is the U.S. Treasury rate for the week of the grant having a term equal to the expected term of the option. An increase in the risk-free interest rate will increase compensation expense.
Forfeiture Rate – This is the estimated percentage of options granted that are expected to be forfeited or canceled before becoming fully vested. An increase in the forfeiture rate will decrease compensation expense.
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Restricted Stock
Our share-based compensation expense also includes the effects of restricted stock grants. The compensation expense related to restricted stock grants is determined based on the market price of our stock at the date of grant applied to the total number of shares that are anticipated to fully vest, which is then amortized over the expected term.
Note 5: Comprehensive Income
Our total comprehensive income was as follows:
| | | Three Months Ended March 31, | | | | Nine Months Ended March 31, |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| |
| Net earnings | | $ | 3,966 | | | $ | 4,097 | | | $ | 11,332 | | | $ | 9,970 | |
| Unrealized loss on marketable | | | | | | | | | | | | | | | | |
| securities, net of tax | | | (1 | ) | | | (3 | ) | | | (7 | ) | | | (10 | ) |
| Foreign currency translation effect | | | 86 | | | | 114 | | | | 166 | | | | (4 | ) |
| Comprehensive income | | $ | 4,051 | | | $ | 4,208 | | | $ | 11,491 | | | $ | 9,956 | |
Note 6: Inventories
Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. At March 31, 2007 and June 30, 2006, inventories were as follows:
| | | March 31, | | June 30, |
| | | 2007 | | 2006 |
| |
| Raw materials and manufactured parts | | $ | 21,236 | | $ | 17,536 |
| Work in process | | | 18,062 | | | 17,321 |
| Finished goods | | | 6,939 | | | 3,225 |
| | | $ | 46,237 | | $ | 38,082 |
Note 7: Property, Plant, and Equipment
Property, plant, and equipment are stated at cost. Maintenance and repairs are charged to expense as incurred. Management evaluates, on an ongoing basis, the carrying value of our property, plant, and equipment and makes adjustments when impairments are identified. Depreciation is based on the estimated useful lives of the various classes of assets and is computed using the straight-line method. At March 31, 2007 and June 30, 2006, property, plant, and equipment were as follows:
| | | | | | | | | | | Estimated |
| | | March 31, | | | June 30, | | | Useful Life |
| | | | 2007 | | | | 2006 | | | (Years) |
| Land | | $ | 615 | | | $ | 615 | | | – | |
| Building and improvements | | | 16,999 | | | | 16,848 | | | 15 | –40 |
| Machinery, equipment, and office furniture | | | 54,005 | | | | 49,889 | | | 3 | –8 |
| Leasehold improvements | | | 783 | | | | 772 | | | 1 | –5 |
| Construction in progress | | | 5,051 | | | | 2,916 | | | – | |
| | | | 77,453 | | | | 71,040 | | | | |
| Accumulated depreciation | | | (42,403 | ) | | | (38,409 | ) | | | |
| | | $ | 35,050 | | | $ | 32,631 | | | | |
Depreciation expense for the three months ended March 31, 2007 and 2006 was $1,535 and $1,442, respectively. Depreciation expense for the nine months ended March 31, 2007 and 2006 was $4,588 and $4,243, respectively.
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Note 8: Intangible Assets
Intangible assets include patents, trademarks, and license agreements. The cost of intangible assets is amortized on a straight-line basis over estimated useful lives ranging from 5-17 years. Intangible assets, at cost, at March 31, 2007 and June 30, 2006 were as follows:
| | | March 31, 2007 | | | June 30, 2006 | |
| | | |
| Patents and trademarks | | $ | | | 7,432 | | | | $ | 7,042 | |
| License agreements | | | | | - | | | | | 1,350 | |
| | | | | | 7,432 | | | | | 8,392 | |
| Accumulated amortization | | | | | (1,317 | ) | | | | (2,467 | ) |
| Total | | $ | | | 6,115 | | | | $ | 5,925 |
Intangible amortization expense was $76 and $92 for the three months ended March 31, 2007 and 2006, respectively, and $231 and $260 for the nine months ended March 31, 2007 and 2006, respectively. Amortization expense related to certain intangible assets is included in cost of goods sold in the Condensed Consolidated Statements of Operations.
Note 9: Warranty
A limited warranty is provided on our products for periods ranging from 3 to 18 months and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires management to make estimates of product return rates and expected costs to repair or replace products under warranty. If actual return rates or repair and replacement costs, or both, differ significantly from management’s estimates, adjustments to the expense will be required.
The following is a reconciliation of the accrued warranty liability, which is included in the other accrued liabilities in the Condensed Consolidated Balance Sheets:
| | | Nine Months Ended March 31, | |
| | | 2007 | | | 2006 | |
| Beginning balance | | $ | 1,660 | | | $ | 1,395 | |
| Reductions for payments made | | | (1,079 | ) | | | (937 | ) |
| Changes in accruals related to pre-existing | | | | | | | | |
| warranties | | | (312 | ) | | | 326 | |
| Changes in accruals related to warranties | | | | | | | | |
| issued in the current period | | | 1,321 | | | | 955 | |
| Ending balance | | $ | 1,590 | | | $ | 1,739 | |
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Note 10: Segment Information
During the second quarter of fiscal 2007, we reorganized the business into two operating divisions – Metrology and Optics. Beginning with the second fiscal quarter, we have begun reporting our segments as Metrology and Optics. Prior to the second quarter, our segments were reported as Semiconductor and Industrial. Prior year segment information has been restated in a manner consistent with our new reporting segments.
ZYGO’s Metrology segment consists of OEM and in-line products primarily for the semiconductor and industrial markets. The Optics segment consists of components and opto-mechanical assemblies primarily for the medical, defense, and aerospace industries, which are included in the industrial market. For the three and nine months ended March 31, 2007 and 2006, segment sales and gross profit are as follows:
| | | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Metrology | | | | | (as restated) | | | | | (as restated) |
| Sales | | $ | 35,763 | | $ | 31,566 | | $ | 99,461 | | $ | 90,938 |
| Gross profit | | $ | 16,836 | | $ | 13,760 | | $ | 47,564 | | $ | 40,561 |
| Gross profit as a % of sales | | | 47% | | | 44% | | | 48% | | | 45% |
| Optics | | | | | | | | | | | | |
| Sales | | $ | 12,892 | | $ | 11,482 | | $ | 34,983 | | $ | 30,047 |
| Gross profit | | $ | 3,575 | | $ | 2,687 | | $ | 10,405 | | $ | 6,231 |
| Gross profit as a % of sales | | | 28% | | | 23% | | | 30% | | | 21% |
| |
| Total | | | | | | | | | | | | |
| Sales | | $ | 48,655 | | $ | 43,048 | | $ | 134,444 | | $ | 120,985 |
| Gross profit | | $ | 20,411 | | $ | 16,447 | | $ | 57,969 | | $ | 46,792 |
| Gross profit as a % of sales | | | 42% | | | 38% | | | 43% | | | 39% |
We operate through our two core business segments of Metrology and Optics. Both of these business segments sell in two principal global markets - Semiconductor and Industrial. Supplementary sales and gross profit data by global markets is as follows:
| | | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Semiconductor | | | | | | | | | | | | |
| Sales | | $ | 29,792 | | $ | 25,534 | | $ | 80,801 | | $ | 68,182 |
| Gross profit | | $ | 12,858 | | $ | 10,731 | | $ | 35,347 | | $ | 27,242 |
| Gross profit as a % of sales | | | 43% | | | 42% | | | 44% | | | 40% |
| Industrial | | | | | | | | | | | | |
| Sales | | $ | 18,863 | | $ | 17,514 | | $ | 53,643 | | $ | 52,803 |
| Gross profit | | $ | 7,553 | | $ | 5,716 | | $ | 22,622 | | $ | 19,550 |
| Gross profit as a % of sales | | | 40% | | | 33% | | | 42% | | | 37% |
| Total | | | | | | | | | | | | |
| Sales | | $ | 48,655 | | $ | 43,048 | | $ | 134,444 | | $ | 120,985 |
| Gross profit | | $ | 20,411 | | $ | 16,447 | | $ | 57,969 | | $ | 46,792 |
| Gross profit as a % of sales | | | 42% | | | 38% | | | 43% | | | 39% |
Separate financial information by segment for total assets, capital expenditures, and depreciation and amortization is not evaluated by the chief operating decision-maker. Substantially all of our operating expenses, assets, and depreciation and amortization are U.S. based.
Sales by geographic area were as follows:
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| | | Three Months Ended March 31, | | Nine Months Ended March 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| |
| Americas | | $ | 17,696 | | $ | 14,400 | | $ | 49,986 | | $ | 41,385 |
| Europe | | | 4,409 | | | 2,966 | | | 13,612 | | | 10,606 |
| Japan | | | 18,048 | | | 22,156 | | | 50,051 | | | 55,698 |
| Pacific Rim | | | 8,502 | | | 3,526 | | | 20,795 | | | 13,296 |
| Total | | $ | 48,655 | | $ | 43,048 | | $ | 134,444 | | $ | 120,985 |
Note 11: Transactions with Stockholder
Sales to Canon Inc., a stockholder, and Canon Sales Co., Inc., a distributor of certain of our products in Japan and a subsidiary of Canon Inc. (collectively referred to as “Canon”), amounted to $11,837 (24% of net sales) and $37,480 (28% of net sales) for the three and nine months ended March 31, 2007 as compared with $16,403 (38% of net sales) and $44,385 (37% of net sales) for the comparable prior year periods, respectively. Included in these aggregate sales to Canon are sales related to development services of certain interferometers of $171 and $4,051 for the three and nine months ended March 31, 2007, respectively, as compared with $5,187 and $14,759 for the three and nine months ended March 31, 2006, respectively. Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. Revenues generated from the development agreements are recorded on a cost-plus basis. At March 31, 2007 and June 30, 2006, there were, in the aggregate, $4,108 and $5,966, respectively, of trade accounts receivable from Canon.
Note 12: Hedging Activities
We enter into foreign currency forward contracts to reduce the impact of adverse fluctuations on earnings associated with foreign currency exchange rate changes. We do not enter into any derivative transactions for speculative purposes. These contracts are not designated as cash flow, fair value, or net investment hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, and therefore, are marked-to-market with changes in fair value recorded in the Condensed Consolidated Statement of Operations. These contracts are entered into for periods consistent with the expected currency transaction exposures, generally three to six months. Any gains and losses on the fair value of these contracts should largely offset corresponding losses and gains on the underlying transactions.
As of March 31, 2007, we had eight currency contracts outstanding involving our Japanese operations aggregating $6,800. For the three months ended March 31, 2007 and 2006, we recognized unrealized losses from foreign currency forward contracts of $140 and unrealized gains of $14, respectively. For the nine months ended March 31, 2007 and 2006, we recognized unrealized losses from foreign currency forward contracts of $69 and $2, respectively. These gains and losses are substantially offset by foreign exchange losses and gains on intercompany balances recorded by our subsidiaries. These net gains and losses are included in other income in the Condensed Consolidated Statements of Operations.
Note 13: Income Taxes
| | | Fiscal 2007 | | | Fiscal 2006 |
| | | | | | Tax Rate | | | | | Tax Rate |
| | | Amount | | % | | Amount | | % |
| |
| Quarter ended March 31 | | $ | 2,643 | | 39% | | $ | 961 | | 19% |
| Nine months ended March 31 | | $ | 6,903 | | 36% | | $ | 4,463 | | 30% |
Income tax expense for both the three and nine months ended March 31, 2006 was favorably impacted by the Company’s redetermination of deductions to foreign trading income, also referred to as an Extraterritorial Income Exclusion (“EIE”), related to fiscal 2006 and fiscal 2004. The income tax rate for the three and nine months ended March 31, 2007 includes only a half year of tax benefit for the EIE, which was repealed effective December 31, 2006. The EIE is the primary difference in both the three and nine month periods, partially offset by tax on monies repatriated from foreign jurisdictions in fiscal 2006.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
Zygo Corporation is a worldwide supplier of optical metrology instruments, precision optics, and electro-optical design and manufacturing services, serving customers in the semiconductor capital equipment and industrial markets. Optical metrology instruments encompass non-contact optical measurement instruments. Precision optics products consist of high performance macro-optics components, optical coatings, and optical system assemblies. We conduct the majority of our manufacturing in our 153,500 square foot facility in Middlefield, Connecticut and our 22,560 square foot facility in Tucson, Arizona.
During the second quarter of fiscal 2007, we reorganized our business into two operating divisions – Metrology and Optics. Consistent with this reorganization, beginning with last fiscal quarter, we have begun reporting our operating segments as Metrology and Optics. The Metrology segment consists of OEM and in-line products. The Optics segment consists of components and opto-mechanical assemblies primarily for the medical, defense, and aerospace markets. These two business segments continue to serve two global markets: semiconductor and industrial.
Development services have accounted for a significant amount of our revenue over the past several years. These development services contracts with Canon Inc. have been completed as of March 31, 2007. For the entire year of fiscal 2006, we recognized $20.0 million on these development services contracts as compared with $4.1 million in the first nine months of fiscal 2007. Increases in overall sales, including new product sales in the current quarter, coupled with our existing backlog are expected to more than offset the decrease in the development services revenue in the current year.
We achieved an order level for the third quarter of fiscal 2007 of $38.9 million as compared with $49.7 million for the second quarter of fiscal 2007 and $45.3 million for the third quarter of fiscal 2006. This order flow decreased backlog at March 31, 2007 to $82.7 million. As expected, we experienced a decline in stage metrology lithography orders this quarter as a result of inventory correction actions by one of our customers. Although we expect these corrections to continue in the fourth quarter, total stage metrology lithography orders are still expected to be in the $45-$50 million range for the fiscal year, similar to stage metrology lithography orders in fiscal 2006. Orders in the third quarter of fiscal 2007 for the Metrology and Optics segments were $21.6 million and $17.3 million, respectively. Orders are included in our backlog to the extent they are expected to be delivered within a twelve month period. Backlog does not include commitments from customers with expected delivery dates beyond twelve months.
Our gross profit as a percentage of sales of 42% for the third quarter of fiscal 2007 represents a significant improvement over the prior year’s third quarter gross profit as a percentage of sales of 38%. This quarter’s gross profit was reduced by a charge for expected cost over-runs on the initial production run related to the Company’s helmet mounted display contract. Shipments on the initial production run will begin in the fourth quarter and carry into the first quarter of fiscal 2008.
Research, development, and engineering (“RD&E”) expenses increased by $5.7 million to $16.6 million, which represents 12% of net sales for the first nine months of fiscal 2007 as compared with 9% of net sales for the first nine months of fiscal 2006. We anticipate continued higher RD&E expenses for the remainder of the fiscal year as compared with the prior fiscal year. We continue to devote resources to our semiconductor initiatives and the development of other new products and technologies, as well as enhancing our existing core technology products.
CRITICAL ACCOUNTING POLICIES, SIGNIFICANT JUDGMENTS, AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosures at the date of our condensed consolidated financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, marketable securities, warranty obligations, income taxes, long-lived assets, and share-based payments. Management bases its estimates and judgments on historical experience and current market conditions and on various
12
other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. As discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006, management considers the Company’s policies on Revenue Recognition and Allowance for Doubtful Accounts; Inventory Valuation; Other than Temporary Impairment of Marketable Securities; Share-Based Compensation; Warranty Costs; Accounting for Income Taxes; Valuation of Long-Lived Assets; and accruals for Health Insurance to be critical accounting policies due to the estimates, assumptions, and application of judgment involved in each.
RESULTS OF OPERATIONS
| Net Sales | | | | | | | | | | | | |
| | | Fiscal 2007 | | Fiscal 2006 |
| | | | Net Sales | | | | | Net Sales |
| (Dollars in millions) | | Amount | | % | | Amount | | % |
| Quarter ended March 31 | | | | | | | | | | | | |
| Metrology | | $ | 35.8 | | 74 | % | | $ | 31.6 | | 73 | % |
| Optics | | $ | 12.9 | | 26 | % | | $ | 11.4 | | 27 | % |
| Total | | $ | 48.7 | | 100 | % | | $ | 43.0 | | 100 | % |
| | | | | | | | | | | | | |
| Nine months ended March 31 | | | | | | | | | | | | |
| Metrology | | $ | 99.5 | | 74 | % | | $ | 90.9 | | 75 | % |
| Optics | | $ | 34.9 | | 26 | % | | $ | 30.1 | | 25 | % |
| Total | | $ | 134.4 | | 100 | % | | $ | 121.0 | | 100 | % |
Overall, net sales increased 13% in the third quarter of fiscal 2007 as compared with the prior year. Metrology sales, which includes development services, increased 13% in the third quarter of fiscal 2007 as compared with the prior year. This increase in sales was primarily due to volume increases in Display Solutions sales of $7.0 million and lithography sales of $3.4 million which more than offset anticipated declines in development service revenues of $5.0 million. The increase in lithography sales in the third quarter of fiscal 2007 was due to the higher order volume in the first six months of fiscal 2007 as compared with the first six months of fiscal 2006. Optics sales increased by 13% for the third quarter of fiscal 2007 as compared with the prior year period. This increase in sales deliveries was attributable to an increase in Laser Optics sales of $1.3 million and in Optical Systems assembly sales of $1.1 million, which includes deliveries of optical assemblies for the National Ignition Facility and medical device equipment.
Net sales increased 11% for the nine months ended March 31, 2007 as compared with the prior year. Metrology sales increased 9% in the first nine months of fiscal 2007 as compared with the prior year. This increase was due primarily to volume increases in Precision Positioning Solutions sales of $9.8 million and in Display Solutions of $9.8 million, partially offset by the anticipated decline in development service revenue of $10.7 million. Optics sales increased by 16% for the nine months ended March 31, 2007 as compared with the prior year period. This increase occurred primarily in the Optical Systems Solutions of $2.9 million, and Laser Optics of $1.8 million.
Sales in U.S. dollars for the three and nine months of fiscal 2007 were approximately 80% of total net sales for the periods. For our sales which are based in foreign currency, we are exposed to foreign exchange fluctuations from the time customers are invoiced in foreign currency until collection occurs. Significant changes in the values of foreign currencies relative to the value of the U.S. dollar can impact the sales of our products in export markets, as would changes in the general economic conditions in those markets. In the absence of a substantial increase in sales orders in currencies other than U.S. dollars, we believe a 10% appreciation or depreciation of the U.S. dollar against the Euro and Yen would have an immaterial impact on our condensed consolidated financial position and results of operations.
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Gross Profit by Segment
| | | Fiscal 2007 | | Fiscal 2006 |
| | | | | | Gross | | | | | Gross |
| (Dollars in millions) | | Amount | | Margin % | | Amount | | Margin % |
| Quarter ended March 31 | | | | | | | | | | |
| Metrology | | $ | 16.8 | | 47% | | $ | 13.7 | | 44% |
| Optics | | | 3.6 | | 28% | | | 2.7 | | 23% |
| Total | | $ | 20.4 | | 42% | | $ | 16.4 | | 38% |
| Nine months ended March 31 | | | | | | | | | | |
| Metrology | | $ | 47.6 | | 48% | | $ | 40.6 | | 45% |
| Optics | | | 10.4 | | 30% | | | 6.2 | | 21% |
| Total | | $ | 58.0 | | 43% | | $ | 46.8 | | 39% |
Gross profit as a percentage of sales for the third quarter and nine months of fiscal 2007 was 42% and 43%, respectively, an increase of four percentage points as compared with each of the comparable prior year periods. Improved factory performance and material cost reductions across both segments, as well as product mix, contributed to the overall increase. We are continuing to implement lean manufacturing initiatives which have contributed to improved utilization of our manufacturing resources. In addition, certain products in the Optics division had improved margins as we increased production levels, partially offset by a onetime charge in the third quarter of fiscal 2007 for anticipated cost over-runs associated with the initial production run of the helmet mounted display contract. Development services, which have historically carried a lower gross profit as a percentage of sales, were less than 1% of net sales in the third quarter of fiscal 2007 period and 3% for the first nine months of fiscal 2007 as compared with over 12% in the comparable prior periods. This change in volume of development services contributed approximately two percentage points to the increase in gross profit as a percentage of sales in both the three and nine month periods.
Selling, General, and Administrative Expenses (“SG&A”)
| | | Fiscal 2007 | | Fiscal 2006 |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| |
| Quarter ended March 31 | | $ | 8.4 | | 17% | | $ | 8.0 | | 19% |
| Nine months ended March 31 | | $ | 24.7 | | 18% | | $ | 22.5 | | 19% |
The third quarter increase in SG&A was primarily due to increased selling expenses related to personnel costs, including commissions, and increased marketing activity, attributable to greater sales volume. For the nine months ended March 31, 2007, the increase in SG&A was due primarily to new marketing initiatives of $0.7 million, foreign office expense of $0.6 million as we continue to expand our presence internationally, and selling expenses related to personnel costs of $0.6 million. We continue to increase our presence in the Asia territories with increased technical sales and support staff.
Research, Development, and Engineering Expenses
| | | Fiscal 2007 | | Fiscal 2006 |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| |
| Quarter ended March 31 | | $ | 6.1 | | 13% | | $ | 3.9 | | 9% |
| Nine months ended March 31 | | $ | 16.6 | | 12% | | $ | 10.9 | | 9% |
The increase in RD&E for the quarter ended March 31, 2007 as compared with the prior year period was primarily due to continued development efforts on our Semiconductor Solutions initiatives of $0.7 million and development efforts on new technologies for our Display Solutions of $0.7 million. We also continued ongoing development of our core technologies accounting for most of the remaining increase, including exploratory research costs of $0.3 million. The increase in RD&E for the nine months ended March 31, 2007 was primarily driven by development efforts on semiconductor initiatives of $2.7 million,
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continued efforts on Display Solutions of $1.9 million, and continued development of the helmet mounted display for defense applications of $1.0 million. Fiscal 2006 included a customer reimbursement of $0.7 million.
Other Income
| | | Fiscal 2007 | | Fiscal 2006 |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| Quarter ended March 31 | | $ | 0.9 | | 2% | | $ | 0.7 | | 2% |
| Nine months ended March 31 | | $ | 2.3 | | 2% | | $ | 1.7 | | 1% |
Other income for the three and nine months ended March 31, 2007 increased by $0.2 million and $0.6 million, respectively, over the prior year periods. This increase was primarily attributable to the cumulative year over year effect of increases in yields on our investments and an increase in our investment portfolio.
Income Taxes
| | | Fiscal 2007 | | Fiscal 2006 |
| | | | | | Tax Rate | | | | | Tax Rate |
| (Dollars in millions) | | Amount | | % | | Amount | | % |
| |
| Quarter ended March 31 | | $ | 2.6 | | 39% | | $ | 1.0 | | 19% |
| Nine months ended March 31 | | $ | 6.9 | | 36% | | $ | 4.5 | | 30% |
Income tax expense for both the three and nine months ended March 31, 2006 was favorably impacted by the Company’s redetermination of deductions to foreign trading income, also referred to as an Extraterritorial Income Exclusion (“EIE”), related to fiscal 2006 and fiscal 2004. The income tax rate for the three and nine months ended March 31, 2007 includes only a half year of tax benefit for the EIE, which was repealed effective December 31, 2006. The EIE is the primary difference in both the three and nine month periods, partially offset by tax on monies repatriated from foreign jurisdictions in fiscal 2006.
TRANSACTIONS WITH STOCKHOLDER
Sales to Canon Inc., a stockholder, and Canon Sales Co., Inc., a distributor of certain of our products in Japan and a subsidiary of Canon Inc. (collectively referred to as “Canon”), amounted to $11.8 million (24% of net sales) and $37.5 million (28% of net sales) for the three and nine months ended March 31, 2007, as compared with $16.4 million (38% of net sales) and $44.4 million (37% of net sales) for the comparable prior year periods, respectively. Included in these aggregate sales to Canon are sales related to development services of certain interferometers of $0.2 million and $4.1 million for the three and nine months ended March 31, 2007, respectively, as compared with $5.2 million and $14.8 million for the three and nine months ended March 31, 2006, respectively. Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. Revenues generated from the development agreements are recorded on a cost-plus basis. At March 31, 2007 and June 30, 2006, there were, in the aggregate, $4.1 million and $6.0 million, respectively, of trade accounts receivable from Canon.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2007, cash and marketable securities were $67.9 million, an increase of $2.4 million from $65.5 million at June 30, 2006. Cash flows from operating activities were $9.1 million for the nine months of fiscal 2007 as compared with cash flows of $10.4 million for the comparable period in the prior year. The decrease in operating cash flows for the nine months of fiscal 2007 as compared with the prior year was primarily due to an increase in inventories of $4.5 million to support the backlog partially offset by increased net income of $1.4 million and utilization of deferred tax assets of $1.9 million.
Acquisitions of property, plant, and equipment totaled $7.1 million during the nine months ended March 31, 2007.
There were no borrowings outstanding under our $3.0 million bank line of credit agreement at March 31, 2007 or June 30, 2006. The agreement contains certain financial covenants which, among others, relate to debt service and consolidated debt ratios. The agreement expires in November 2007. Although cash requirements will fluctuate based on the timing and extent of various factors, management believes that cash generated from operations, together with the liquidity provided by existing cash and marketable securities balances and borrowing capability, will be sufficient to satisfy our liquidity requirements for the next 12 months.
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OFF-BALANCE SHEET ARRANGEMENTS
We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt, or operating parts of our business that are not consolidated into our financial statements. We have not guaranteed any obligations of a third party.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes that have occurred in our quantitative and qualitative market risk disclosures during the nine months of fiscal 2007. For discussion of our exposure to market risk, refer to Item 7a., “Quantitative and Qualitative Disclosures about Market Risk”, presented in our Annual Report on Form 10-K for the year ended June 30, 2006 filed with the Securities and Exchange Commission.
Item 4. Controls and Procedures
The effectiveness of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing, and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate misconduct completely. In designing, implementing, and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation, as of the end of the period covered by this report, of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting on a timely basis information required to be disclosed by ZYGO in the reports that it files or submits under the Exchange Act and were effective in ensuring that information required to be disclosed by ZYGO in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in our internal control over financial reporting that occurred in our most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - Other Information
Item 1A. Risk Factors
In addition to the other information set forth in this report, the reader should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended June 30, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 6. Exhibits
| (a) | Exhibits: |
| | | |
| | 10.1 | Agreement between ZYGO Corporation and Carl A. Zanoni |
| |
| | 31.1 | Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
| | 31.2 | Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
| | 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
| | 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | Zygo Corporation |
| | (Registrant) |
| | |
| | |
| | |
| | /s/ J. Bruce Robinson |
| | J. Bruce Robinson |
| | Chairman and Chief Executive Officer |
| | |
| | |
| | |
| | |
| | /s/ Walter A. Shephard |
| | Walter A. Shephard |
| | Vice President, Finance, Chief Financial Officer, and Treasurer |
Date: May 9, 2007
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EXHIBIT INDEX
| 10.1 | Agreement between ZYGO Corporation and Carl A. Zanoni |
| |
| 31.1 | Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
| 31.2 | Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
| 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
