| | | Six Months Ended December 31, |
| | | 2007 | | 2006 |
| Cash provided by operating activities: | | | | | | | | |
| Net earnings | | $ | 235 | | | $ | 7,366 | |
| |
| Adjustments to reconcile net earnings to cash | | | | | | | | |
| provided by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 3,570 | | | | 3,196 | |
| Deferred income taxes | | | (606 | ) | | | 2,971 | |
| Compensation cost related to share-based payments arrangements | | | 1,302 | | | | 1,109 | |
| Excess tax benefits from share-based payment arrangements | | | (12 | ) | | | (24 | ) |
| Minority interest | | | 879 | | | | 547 | |
| Provision for doubtful accounts and notes | | | 1,556 | | | | (11 | ) |
| Other, net | | | (333 | ) | | | 258 | |
| Changes in operating accounts: | | | | | | | | |
| Receivables | | | 8,034 | | | | 3,773 | |
| Inventories | | | 3,014 | | | | (6,239 | ) |
| Prepaid expenses | | | (82 | ) | | | (206 | ) |
| Accounts payable, accrued expenses, and taxes payable | | | (6,067 | ) | | | (7,528 | ) |
| Net cash provided by operating activities | | | 11,490 | | | | 5,212 | |
| Cash provided by (used for) investing activities: | | | | | | | | |
| Additions to property, plant, and equipment | | | (3,982 | ) | | | (4,808 | ) |
| Issuance of note receivable | | | (1,500 | ) | | | - | |
| Purchase of marketable securities | | | (4,963 | ) | | | (13,156 | ) |
| Additions to intangibles and other assets | | | (416 | ) | | | (301 | ) |
| Proceeds from the maturity of marketable securities | | | 21,593 | | | | 11,402 | |
| Net cash provided by (used for) investing activities | | | 10,732 | | | | (6,863 | ) |
| Cash provided by (used for) financing activities: | | | | | | | | |
| Repurchase of common stock | | | (16,235 | ) | | | - | |
| Dividend payments to minority interest | | | (751 | ) | | | - | |
| Employee stock purchase | | | 141 | | | | 163 | |
| Exercise of employee stock options | | | 280 | | | | 135 | |
| Vesting of restricted stock and related tax benefits | | | (87 | ) | | | - | |
| Excess tax benefits from share-based payment arangements | | | 12 | | | | 24 | |
| Net cash (used for) provided by financing activities | | | (16,640 | ) | | | 322 | |
| Effect of exchange rate changes on cash and cash equivalents | | | 357 | | | | (9 | ) |
| Net increase (decrease) in cash and cash equivalents | | | 5,939 | | | | (1,338 | ) |
| Cash and cash equivalents, beginning of period | | | 17,826 | | | | 20,318 | |
| Cash and cash equivalents, end of period | | $ | 23,765 | | | $ | 18,980 | |
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 “the Company”). The Company follows accounting principles generally accepted in the United States of America. 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 six months ended December 31, 2007 are not necessarily indicative of the results to be expected for the full fiscal year.
The Condensed Consolidated Balance Sheet at December 31, 2007, the Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2007 and 2006, and the Condensed Consolidated Statements of Cash Flows for the six months ended December 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, 2007, 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 three months ended December 31, 2007, 1,198,831 of the Company’s outstanding stock options and restricted stock awards (“Stock Grants”) (1,138,292 for the six months ended December 31, 2007) were excluded from the calculation of diluted earnings per share because they were antidilutive. For the three months ended December 31, 2006, 837,612 of the Company’s Stock Grants (899,412 for the six months ended December 31, 2006) were excluded from the calculation of diluted earnings per share.
The following table sets forth the reconciliation of basic weighted average shares outstanding and diluted weighted average shares outstanding for the periods presented:
| | | Three Months Ended December 31, | | Six Months Ended December 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Basic weighted average shares | | | | | | | | |
| outstanding | | 17,492,889 | | 18,125,839 | | 17,843,145 | | 18,121,783 |
| Dilutive effect of stock options | | | | | | | | |
| and restricted shares | | 314,233 | | 440,341 | | 343,082 | | 382,583 |
| Diluted weighted average shares | | | | | | | | |
| outstanding | | 17,807,122 | | 18,566,180 | | 18,186,227 | | 18,504,366 |
Note 3: Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated balance sheets within equity, but separate from the parent’s equity. Furthermore, the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of operations. The provisions of SFAS 160 are effective for the fiscal year beginning July 1, 2009.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS 141R offers specific guidance on how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquirer, and goodwill acquired or any bargain purchase gains. The provisions of SFAS 141R are effective for the fiscal year beginning July 1, 2009.
In February 2007, the FASB issued 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. The provisions of SFAS 159 are effective for our fiscal year beginning July 1, 2008. We are in the process of evaluating the impact of SFAS 159 on our financial statements.
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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 in the process of evaluating the impact of the provisions of SFAS 157 on our financial statements.
Note 4: Share-Based Payments
We recorded share-based compensation expense for the three months ended December 31, 2007 and 2006 of $567 and $508, respectively, with a related tax benefit of $204 and $183, respectively. Share-based compensation expense for the six months ended December 31, 2007 and 2006 was $1,302 and $1,109, respectively, with a related tax benefit of $469 and $399, respectively.
Stock Options
An independent third party assisted the Company in determining the Black-Scholes weighted average assumptions utilized in both fiscal 2008 and 2007 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 six months ended December 31, 2007 was $5.05. There were no stock option grants for the three months ended December 31, 2007. The weighted-average fair value of stock option grants for the three and six months ended December 31, 2006 and was $6.62 and $6.15, respectively. The table below indicates the key assumptions used in the option valuation calculations for options granted in the periods presented and a discussion of our methodology for developing each of the assumptions used in the valuation model:
| | | Three Months Ended December 31, | | Six Months Ended December 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Term | | - | | 4.1 Years | | 4.0 Years | | 4.1 Years |
| Volatility | | - | | 52.1% | | % | | 52.1% |
| Dividend yield | | - | | 0.0% | | 0.0% | | 0.0% |
| Risk-free interest rate | | - | | 4.7%-4.8% | | 4.2% | | 4.7%-4.8% |
| Forfeiture rate | | - | | 10.7% | | 11.0% | | 10.7% |
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.
Restricted Stock
Our share-based compensation expense also includes the effects of restricted stock grants and units. The compensation expense related to restricted stock awards 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.
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Note 5: Comprehensive Income
Total comprehensive income was as follows:
| | | Three Months Ended December 31, | | Six Months Ended December 31, |
| | | 2007 | | 2006 | | 2007 | 2006 |
| Net earnings | | $ | 1,179 | | $ | 3,714 | | | $ | 235 | | $ | 7,366 | |
| Unrealized loss on marketable | | | | | | | | | | | | | | |
| securities, net of tax | | | - | | | (3 | ) | | | - | | | (6 | ) |
| Foreign currency translation effect | | | 112 | | | 171 | | | | 521 | | | 80 | |
| Comprehensive income | | $ | 1,291 | | $ | 3,882 | | | $ | 756 | | $ | 7,440 | |
Note 6: Notes Receivable
In October 2007, we loaned $1,500 to an unrelated third party (“Seller”), evidenced by a Subordinated Convertible Promissory Note (“Note”). The Note had a maturity date of December 31, 2007 and called for interest to be paid at a rate of 12%. In December 2007, we entered into a Letter of Intent (“LOI”) to purchase a segment of the Seller. The LOI extended the due date of the loan until the later of the expiration date of the LOI or the date that either party terminated the LOI. In January 2008, after conducting additional due diligence, we terminated the LOI and informed the Seller that we would not purchase the segment of the business. The Seller has had financial difficulty, has had an interim receiver appointed, and has indicated its inability to repay the Note. Based on these facts, we recorded a charge against the full value of the loan of $1,500 in the second quarter of fiscal 2008.
Note 7: Inventories
Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. At December 31, 2007 and June 30, 2007, inventories were as follows:
| | | December 31, | | June 30, | |
| | | 2007 | | 2007 |
| | | | | | | | |
| Raw materials and manufactured parts | | $ | 18,055 | | $ | 20,268 | |
| Work in process | | | 16,910 | | | 17,115 | |
| Finished goods | | | 5,659 | | | 5,665 | |
| | | $ | 40,624 | | $ | 43,048 | |
Note 8: 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 December 31, 2007 and June 30, 2007, property, plant, and equipment were as follows:
| | | December 31, | | June 30, | | Estimated Useful Life | |
| | | 2007 | | 2007 | | (Years) |
| Land | | $ | 615 | | | $ | 615 | | | - |
| Building and improvements | | | 17,169 | | | | 17,085 | | | 15-40 |
| Machinery, equipment, and office furniture | | | 59,519 | | | | 56,395 | | | 3-8 |
| Leasehold improvements | | | 818 | | | | 795 | | | 1-5 |
| Construction in progress | | | 3,658 | | | | 5,231 | | | - |
| | | | 81,779 | | | | 80,121 | | | |
| Accumulated depreciation | | | (45,028 | ) | | | (43,772 | ) | | |
| | | $ | 36,751 | | | $ | 36,349 | | | |
Depreciation expense for the three months ended December 31, 2007 and 2006 was $1,813 and $1,533, respectively.
Depreciation expense for the six months ended December 31, 2007 and 2006 was $3,487 and $3,053, respectively.
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Note 9: Intangible Assets
Intangible assets include patents and trademarks. The cost of intangible assets is amortized on a straight-line basis over estimated useful lives ranging from 11-17 years. Intangible assets, at cost, at December 31, 2007 and June 30, 2007 were as follows:
| | | December 31, | | June 30, | |
| | | | 2007 | | | 2007 |
| Patents and trademarks | | $ | 7,864 | | | $ | 7,504 | |
| Accumulated amortization | | | (1,533 | ) | | | (1,394 | ) |
| | | $ | 6,331 | | | $ | 6,110 | |
Intangible amortization expense was $85 and $81 for the three months ended December 31, 2007 and 2006, respectively, and $170 and $155 for the six months ended December 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 10: 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:
| | | Six Months Ended December 31, | |
| | | 2007 | | 2006 |
| Beginning Balance | | $ | 1,552 | | | $ | 1,660 | |
| Reductions for payments made | | | (784 | ) | | | (880 | ) |
| Changes in accruals related to pre-existing | | | | | | | | |
| warranties | | | (100 | ) | | | 190 | |
| Changes in accruals related to warranties | | | | | | | | |
| made in the current period | | | 653 | | | | 766 | |
| Ending Balance | | $ | 1,321 | | | $ | 1,736 | |
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Note 11: Segment Information
During the second quarter of fiscal 2007, we reorganized the business into two operating divisions – Metrology and Optics. Beginning with that second fiscal quarter, we began reporting our segments as Metrology and Optics. Prior to the second quarter, our segments were reported as Semiconductor and Industrial. Segment information for all prior periods has been restated in a manner consistent with our new reporting segments.
ZYGO’s Metrology division (segment) consists of OEM and in-line products primarily for the semiconductor and industrial markets. The Optics division (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 six months ended December 31, 2007 and 2006, segment sales and gross profit are as follows:
| | | Three Months Ended December 31, | | Six Months Ended December 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| Metrology | | | | | | | | |
| Sales | | $29,229 | | $31,900 | | $49,154 | | $63,698 |
| Gross profit | | $14,041 | | $16,007 | | $22,223 | | $30,728 |
| Gross profit as a % of sales | | 48% | | 50% | | 45% | | 48% |
| Optics | | | | | | | | |
| Sales | | $11,140 | | $12,782 | | $22,929 | | $22,091 |
| Gross profit | | $2,605 | | $3,760 | | $5,475 | | $6,830 |
| Gross profit as a % of sales | | 23% | | 29% | | 24% | | 31% |
| | | | | | | | | |
| Total | | | | | | | | |
| Sales | | $40,369 | | $44,682 | | $72,083 | | $85,789 |
| Gross profit | | $16,646 | | $19,767 | | $27,698 | | $37,558 |
| Gross profit as a % of sales | | 41% | | 44% | | 38% | | 44% |
Separate financial information by segment for total assets, capital expenditures, and depreciation and amortization is not evaluated by our 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:
| | | Three Months Ended December 31, | | Six Months Ended December 31, |
| | | 2007 | | 2006 | | 2007 | | 2006 |
| |
| Americas | | $17,724 | | $17,126 | | $33,262 | | $32,290 |
| Europe | | 7,085 | | 5,407 | | 11,202 | | 9,202 |
| Japan | | 10,669 | | 16,652 | | 20,561 | | 32,003 |
| Pacific Rim | | 4,891 | | 5,497 | | 7,058 | | 12,294 |
| Total | | $40,369 | | $44,682 | | $72,083 | | $85,789 |
Note 12: 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 $6,739 and $12,303 (17% of net sales for each period) for the three and six months ended December 31, 2007, respectively, as compared with $13,026 (29% of net sales) and $25,643 (30% of net sales), respectively, for the comparable prior year periods. Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. At December 31, 2007 and June 30, 2007, there were, in the aggregate, $3,312 and $4,515, respectively, of trade accounts receivable from Canon.
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Note 13: 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 December 31, 2007, we had seven currency contracts outstanding involving our Japanese operations with notional amounts aggregating $7,600. For the three months ended December 31, 2007 and 2006, we recognized net unrealized gains of $109 and net unrealized losses of $88, respectively, from foreign currency forward contracts. For the six months ended December 31, 2007 and 2006, we recognized net unrealized losses of $474 and net unrealized gains of $71, respectively, from foreign currency forward contracts. These gains and losses are substantially offset by foreign exchange losses and gains on intercompany balances recorded by our subsidiaries. Any net gains and losses, after such offsets, are included in other income in the Condensed Consolidated Statements of Operations.
Note 14: Income Taxes
The income tax rate for the three and six months ended December 31, 2007 was 36%, as compared with 35% for the comparable prior year periods.
The increase of one percentage point in the tax rate was primarily due to the loss of the deduction attributable to the Extraterritorial Income Exclusion (“EIE”), which was repealed effective January 1, 2007, partially offset by an increase in earnings in foreign jurisdictions that have a lower tax rate.
We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on July 1, 2007. As a result of this adoption, we recognized a liability for unrecognized income tax benefits of $1,535, an increase in income tax receivables of $616, and a charge of approximately $919 to the July 1, 2007 retained earnings balance. As of the adoption date, we had gross tax-affected unrecognized tax benefits of $1,784, of which $1,168, if recognized, would affect the effective tax rate. Due to our net operating loss carryforwards, we have accrued no interest and penalties for the unrecognized tax benefits; however, our accounting policy is to recognize interest related to unrecognized tax benefits in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense. In the normal course of business, we provide for uncertain tax positions and adjust our unrecognized tax benefits accordingly. For the quarter ended December 31, 2007, we made no adjustments to our uncertain tax positions. We are not aware of any tax positions that would create a significant adjustment to the unrecognized tax benefits during the next 12 months.
We are subject to U.S. federal income tax as well as income tax in multiple state and foreign jurisdictions. We are no longer subject to U.S. federal income tax audit or tax adjustments for years prior to June 30, 1997. We are no longer subject to state and foreign income tax audit or tax adjustments for years prior to June 30, 2000 and June 30, 2003, respectively. We are currently not under income tax audit in any jurisdictions.
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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. We conduct the majority of our manufacturing in our 153,500 square foot facility in Middlefield, Connecticut and our 39,780 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, starting with the second quarter of fiscal 2007, we began reporting our operating segments as Metrology and Optics. Segment information for all periods prior to this reorganization has been restated in a manner consistent with our new reporting segments. The Metrology division (segment) consists of OEM and in-line products. The Optics division (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.
Orders for the three months ended December 31, 2007 were $42.9 million, as compared with $49.7 million for the comparable prior year period and $36.5 million for the three months ended September 30, 2007. Orders for lithography products and display systems accounted for the majority of the increase over the first quarter of fiscal 2008. Lithography orders include orders from Canon, our largest customer. We expect lithography orders to increase during the remainder of our fiscal year. Orders from our Metrology segment accounted for 80% of the orders received, with the Optics segment accounting for the remaining 20%.
In October 2007, we loaned $1.5 million to an unrelated third party (“Seller”), evidenced by a Subordinated Convertible Promissory Note (“Note”). The Note had a maturity date of December 31, 2007 and called for interest to be paid at a rate of 12%. In December 2007, we entered into a Letter of Intent (“LOI”) to purchase a segment of the Seller. The LOI extended the due date of the loan until the later of the expiration date of the LOI or the date that either party terminated the LOI. In January 2008, after conducting additional due diligence, we terminated the LOI and informed the Seller that we would not purchase the segment of the business. The Seller has had financial difficulty, has had an interim receiver appointed, and has indicated its inability to repay the Note. Based on these facts, we recorded a charge against the full value of the loan of $1.5 million in the second quarter of fiscal 2008. We are working on a plan to receive alternate value for the Note in lieu of a cash payment. For instance, we may be interested in obtaining certain technologies of the Seller that would be beneficial to us in our current markets. To the extent we are able to obtain any value for the Note, whether in cash or technology rights, we would reverse the charge for an amount equal to the value of the property actually received.
We have $35.8 in our marketable securities portfolio as of December 31, 2007, of which $23.8 million is classified as short-term. The credit losses taken by major financial institutions and the reduction in the Federal Reserve rate may have an effect on the valuation of the portfolio and our future interest income. We monitor the valuation of the individual securities in our portfolio and, if any security is deemed to have an other than temporary impairment, we will have to take a charge for the impairment amount. We have not taken an impairment charge on any of our marketable securities during the six months ended December 31, 2007.
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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 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, 2007, 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.
As discussed below and in Note 14 to the Condensed Consolidated Financial Statements, we adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on July 1, 2007. Other than these changes, there have been no significant changes in our critical accounting estimates during the first six months of fiscal 2008. In the ordinary course of business there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is a 50% or less likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Where applicable, associated interest has also been recognized.
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RESULTS OF OPERATIONS
Net Sales
| | | Fiscal 2008 | | Fiscal 2007 |
| | | | | | Net Sales | | | | | Net Sales |
| (Dollars in millions) | | Amount | | % | | Amount | | % |
| Quarter ended December 31 | | | | | | | | | | | | |
| Metrology | | $ | 29.2 | | 72 | % | | $ | 31.9 | | 71 | % |
| Optics | | | 11.2 | | 28 | % | | | 12.8 | | 29 | % |
| Total | | $ | 40.4 | | 100 | % | | $ | 44.7 | | 100 | % |
| | | | | | | | | | | | | |
| Six months ended December 31 | | | | | | | | | | | | |
| Metrology | | $ | 49.2 | | 68 | % | | $ | 63.7 | | 74 | % |
| Optics | | $ | 22.9 | | 32 | % | | $ | 22.1 | | 26 | % |
| Total | | $ | 72.1 | | 100 | % | | $ | 85.8 | | 100 | % |
Overall, net sales for the three months ended December 31, 2007 decreased 10% from the comparable prior year period, reflecting decreases in Metrology segment sales of 8% and Optics segment sales of 13%. The decrease in Metrology segment sales was primarily due to volume decreases in lithography of $5.6 million partially offset by an increase in our core instrument sales of $2.7 million. The decrease in lithography sales was primarilydue to a decrease in sales to Canon, our largest customer. Lithography sales to Canon represented 17% of total sales in the three months ended December 31, 2007, as compared with 29% in the comparable prior year period. The decrease in Optics segment sales was attributable to a decrease in optical assemblies of $1.5 million, primarily due to the completion of an existing contract manufacturing order while new contract manufacturing orders are being brought online.
Net sales for the six months ended December 31, 2007 decreased 16% from the comparable prior year period, reflecting a decrease in Metrology segment sales of 23% and an increase in the Optics segment sales of 4%. The decrease in Metrology segment sales was primarily due to volume decreases in lithography of $12.3 million, display solutions of $2.6 million, and semiconductor of $1.6, partially offset by an increase in our core instrument sales of $1.9 million. The lithography sales decrease was primarilydue to a decrease of $13.3 million in sales to Canon sales. Lithography sales to Canon represented 17% of total sales in the six months ended December 31, 2007, as compared with 30% in the comparable prior year period. The increase in Optics segment sales was attributable to delivery of a major order during the first quarter of fiscal 2008.
Sales in U.S. dollars for the three months ended December 31, 2007 were approximately 73% of total net sales, with the remaining 27% being in Euro or Yen. 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 2008 | | Fiscal 2007 |
| | | | | | Gross | | | | | Gross |
| (Dollars in millions) | | Amount | | Margin % | | Amount | | Margin % |
| Quarter ended December 31 | | | | | | | | | | | | |
| Metrology | | $ | 14.0 | | 48 | % | | $ | 16.0 | | 50 | % |
| Optics | | | 2.6 | | 23 | % | | | 3.8 | | 29 | % |
| Total | | $ | 16.6 | | 41 | % | | $ | 19.8 | | 44 | % |
| Six months ended December 31 | | | | | | | | | | | | |
| Metrology | | $ | 22.2 | | 45 | % | | $ | 30.7 | | 48 | % |
| Optics | | | 5.5 | | 24 | % | | | 6.9 | | 31 | % |
| Total | | $ | 27.7 | | 38 | % | | $ | 37.6 | | 44 | % |
Gross profit as a percentage of net sales for the three and six months ended December 31, 2007 was 41% and 38% respectively, which represents a decrease of three and six percentage points, respectively, from the comparable prior year periods. Within the Metrology segment, the decrease in gross profit as a percentage of net sales for both the three and six month periods of fiscal 2008 as compared with fiscal 2007 is primarily due to unabsorbed costs due to lower lithography sales volume. Within the Optics segment, the decrease in gross profit as a percentage of net sales for the three and six months periods of fiscal 2008 as compared with fiscal 2007 is primarily due to shipments for the initial production run of the helmet mounted display units that resulted in zero margin due to cost over-runs on the initial units. Final units of the initial production run are expected to be completed during the third quarter of fiscal 2008.
Selling, General, and Administrative Expenses ("SG&A")
| | | Fiscal 2008 | | Fiscal 2007 | |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| Quarter ended December 31 | | $ | 7.8 | | 19 | % | | $ | 8.7 | | 19 | % |
| Six months ended December 31 | | $ | 15.2 | | 21 | % | | $ | 16.3 | | 19 | % |
SG&A expenses decreased in the three and six months ended December 31, 2007 by $0.9 million and $1.1 million, respectively, from the comparable prior year period. The decrease in SG&A for both periods was primarily attributable to lower administration expense related to decreased bonus and profit sharing expenses based on year to date company earnings, partially offset by increases in semiconductor and flat panel sales and marketing expense.
Research, Development, and Engineering Expenses ("RD&E")
| | | Fiscal 2008 | | Fiscal 2007 | |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| Quarter ended December 31 | | $ | 5.4 | | 13 | % | | $ | 5.5 | | 12 | % |
| Six months ended December 31 | | $ | 11.1 | | 15 | % | | $ | 10.6 | | 12 | % |
RD&E for the three months ended December 31, 2007 was lower by $0.1 million as compared with the comparable prior year period. For the six months ended December 31, 2007, RD&E increased by $0.5 million, which was primarily attributable to continued development efforts within our Metrology segment, including our semiconductor initiatives, and to a lesser extent, in display and optical assemblies. We continue to focus and build on our semiconductor initiatives as one of our core areas of expected future growth.
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Provision for Doubtful Accounts and Notes
| | | Fiscal 2008 | | Fiscal 2007 |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| Quarter ended December 31 | | $ | 1.6 | | 4 | % | | $ | 0.1 | | 0 | % |
| Six months ended December 31 | | $ | 1.6 | | 2 | % | | $ | - | | - | |
Provision for doubtful accounts and notes for the three and six months ended December 31, 2007 increased by $1.5 million and $1.6 million, respectively, as compared with the comparable prior year period. $1.5 million of this increase was attributable to a charge against a note receivable which was recorded in the second quarter of fiscal 2008.
Other Income
| | | Fiscal 2008 | | Fiscal 2007 |
| (Dollars in millions) | | Amount | | % of Sales | | Amount | | % of Sales |
| Quarter ended December 31 | | $ | 0.9 | | 2 | % | | $ | 0.7 | | 2 | % |
| Six months ended December 31 | | $ | 2.0 | | 3 | % | | $ | 1.5 | | 2 | % |
Other income for the three and six months ended December 31, 2007 increased by $0.2 million and $0.5 million, respectively, from the comparable prior year periods. This increase was attributable to foreign currency net unrealized and realized gains.
Income Tax Expense
| | | Fiscal 2008 | | Fiscal 2007 |
| | | | | | Tax Rate | | | | | Tax Rate |
| (Dollars in millions) | | Amount | | % | | Amount | | % |
| Quarter ended December 31 | | $ | 1.0 | | 36 | % | | $ | 2.2 | | 35 | % |
| Six months ended December 31 | | $ | 0.6 | | 36 | % | | $ | 4.3 | | 35 | % |
The income tax rate for the three and six months ended December 31, 2007 was 36% as compared with 35% in the comparable prior year periods. This increase in the tax rate is primarily due to the loss of the deduction attributable to the Extraterritorial Income Exclusion, which was repealed effective January 1, 2007, partially offset by an increase in earnings in foreign jurisdictions that have a comparatively lower tax rate.
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 $6.7 million and $12.3 million (each 17% of net sales) for the three and six months ended December 31, 2007, as compared with $13.0 million (29% of net sales) and $25.6 million (30% of net sales) for the comparable prior year periods. Selling prices of products sold to Canon are based, generally, on the terms customarily given to distributors. At December 31, 2007 and June 30, 2007, there were, in the aggregate, $3.3 million and $4.5 million, respectively, of trade accounts receivable from Canon.
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LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2007, cash and marketable securities were $59.6 million, a decrease of $10.6 million from $70.2 million at June 30, 2007. The decrease was primarily due to the repurchase of $16.2 million of our common stock under our publicly announced stock buyback program, partially offset by decreases in inventory and accounts receivable.
Cash Flow from Operating Activities
| | | Six Months Ended December 31, |
| | | 2007 | | 2006 |
| Net cash flows provided by | | | | | | | |
| operating activities | | $ | 11.5 | | $ | 5.2 | |
Cash flow from operating activities for the six months of fiscal 2008 increased by $6.3 million as compared with the prior year period. This was primarily due to a positive change in inventory related cash flows of $9.3 million, as a result of decreasing inventory levels in the six months ended December 31, 2007 as compared with increasing inventory levels in the comparable prior year period. A reduction in accounts receivable as a result of improved collections on lower revenues also contributed to the increase in cash flow by $4.3 million. These increases in cash flow from operating activities were offset in part primarily by a decrease in net income of $7.1 million.
Cash Flow from Investing Activities
| | | Six Months Ended December 31, |
| | | 2007 | | 2006 |
| Net cash flows provided by (used for) | | | | | | | |
| investing activities | | $ | 10.7 | | $ | (6.9 | ) |
Cash flows provided by investing activities were favorably impacted by the difference in investing cash flows for the six months of fiscal 2008 as compared with the prior year period. This change was primarily related to an $18.4 million increase resulting from increased proceeds from the maturity of marketable securities, combined with the decreased purchases of marketable securities which were being used to fund the stock buyback program, partially offset by a $1.5 million loan extended to an unrelated third party.
Cash Flow from Financing Activities
| | | Six Months Ended December 31, |
| | | 2007 | | | 2006 |
| Net cash flows provided by (used for) | | | | | | | | |
| financing activities | | $ | (16.6 | ) | | $ | 0.3 | |
Cash flows used for financing activities in the six months ended December 31, 2007 were impacted by $16.2 million for the repurchase of our common stock under our stock buyback program and a dividend payment to a minority interest holder in one of our consolidated subsidiaries of $0.8 million.
There were no borrowings outstanding under our $3.0 million bank line of credit agreement during the second quarter of fiscal 2008. The line of credit agreement, which expired in November 2007, was subsequently renewed in February 2008 and now expires in November 2008. The agreement contains certain financial covenants which, among others, relate to debt service and consolidated debt ratios. 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.
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.
17
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 three months ended December 31, 2007. Our exposure to market risk is presented in Item 7a., “Quantitative and Qualitative Disclosures about Market Risk,” of our Annual Report on Form 10-K for the year ended June 30, 2007, 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 us in the reports that we file or submit under the Exchange Act and were effective in ensuring that information required to be disclosed by us in the reports that we file or submit 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, 2007, 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 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about our purchases during the quarter ended December 31, 2007 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act.
| | | | | | | Total number of | | Approximate dollar |
| | | | | | | shares purchased as | | value of shares that |
| | | | | | | part of publicly | | may yet be purchased |
| | | Total number of | | Average price | | announced | | under the plans or |
| Period | | shares purchased | | paid per share | | plans or programs (1) | | programs (in millions) |
| October 1, 2007 - October 31, 2007 | | 364,262 | | $12.66 | | 364,262 | | $15.5 |
| November 1, 2007 - November 30, 2007 | | (2) 158,967 | | $11.47 | | 158,576 | | $13.7 |
| December 1, 2007 - December 31, 2007 | | 405,927 | | $12.05 | | 405,927 | | $8.8 |
| (1) | In August 2007, our Board of Directors authorized the repurchase of up to $25.0 million of our outstanding common stock. During the six months ended December 31, 2007, the repurchases occurred from time to time as market conditions warranted through transactions in the open market. The share repurchases have been effected pursuant to plans in conformity with Rule 10b5-1 under the Securities Exchange Act of 1934. This rule allows public companies to adopt written, pre-arranged stock trading plans when they do not have material, non-public information in their possession. The adoption of this stock trading plan allows us to repurchase our shares during periods when we otherwise might be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. |
| |
| (2) | During the three months ended December 31, 2007, we purchased 391 shares of common stock from certain of our employees related to withholding tax obligations arising from the vesting of their restricted stock. |
| |
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Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on November 14, 2007. The following matters were submitted to a vote of the Company’s stockholders:
Proposal No. 1 – Election of Board of Directors
The following individuals, all of whom were directors of our company immediately prior to the vote, were elected as a result of the following vote:
| | For | | Against | |
| Eugene G. Banucci | 15,227,227 | | 411,227 |
| Yousef A. El-Mansy | 15,231,927 | | 406,527 |
| Samuel H. Fuller | 15,233,150 | | 405,304 |
| Seymour E. Liebman | 15,260,292 | | 378,162 |
| Robert G. McKelvey | 15,170,943 | | 467,511 |
| J. Bruce Robinson | 14,961,383 | | 677,071 |
| Robert B. Taylor | 15,228,395 | | 410,059 |
| Carol P. Wallace | 15,226,978 | | 411,476 |
| Bruce W. Worster | 15,057,667 | | 580,787 |
| Carl A. Zanoni | 15,272,230 | | 366,224 | |
| | | | | |
| Proposal No. 2 – Ratification of appointment of Deloitte & Touche LLP as our independent registered public accounting firm for fiscal 2008 were as follows: |
| | | | | |
| | For | Against | Abstain | |
| | 15,487,346 | 121,832 | 29,276 | |
There were no other matters submitted to a vote of our stockholders.
Item 6. Exhibits
| (a) | Exhibits: |
| |
| | 10.1 | Employment Agreement dated November 19, 2007 between Zygo Corporation and Mr. Douglas J. Eccleston (Exhibit 99.1 to the Company’s Current Reports on Form 8-K dated November 20, 2007)* |
| |
| | 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 |
| |
* Incorporated herein by reference.
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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: February 8, 2008 |
21
EXHIBIT INDEX
| 10.1 | Employment Agreement dated November 19, 2007 between Zygo Corporation and Mr. Douglas J. Eccleston (Exhibit 99.1 to the Company’s Current Reports on Form 8-K dated November 20, 2007)* |
| |
| 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 |
| |
* Incorporated herein by reference.
