Net sales of $36.0 million for the second quarter of fiscal 2005 increased by $8.3 million, or 30%, as compared with the prior year period. For the six month period of fiscal 2005, net sales of $63.6 million increased by $11.7 million, or 23%, as compared with $51.9 million for the first six months of fiscal 2004. Our net sales for the second quarter and six months ended December 31, 2004 included $2.5 million and $4.2 million, respectively, from development services for Canon Inc.
For the second quarter and first six months of fiscal 2005, net sales in the semiconductor sector increased $2.4 million, or 15%, and $6.2 million, or 22%, respectively, as compared with the same periods in the prior year due primarily to an increase of $0.9 million and $1.3 million, respectively, in flat panel sales volume and an increase of $1.3 million and $4.6 million, respectively, in sales volume to our lithography customers, partially offset by decreases in the developmental services revenue of $1.4 million in the second quarter and $4.2 million in the first six months of fiscal 2005. The increase in flat panel sales and sales to lithography customers primarily was attributable to an increase in number of units sold. The year over year decline in developmental service agreement revenue is primarily attributable to the winding down of the initial development agreement with Canon and a slower than anticipated start on the further add-on work under the follow-up agreement signed on December 20, 2004. Sales for the second quarter in the industrial segment increased $5.9 million, or 51%, as compared with the same period in the prior year. Sales in the industrial segment for the six month period of fiscal 2005 increased by $5.5 million, or 23%, over the same period in the prior year. The increase in industrial segment sales for both periods is due primarily to a volume increase in large order optics deliveries of $2.4 million and an increase in contract manufacturing and engineering design services of $2.7 million in the second quarter and $3.7 million in the first six months of fiscal 2005.
Sales to Canon, a related party, represented $12.8 million, or 35%, of the total net sales for the second quarter of fiscal 2005 as compared with $12.5 million, or 45%, of the total net sales for the second quarter of fiscal 2004. For the first six months of fiscal 2005 and 2004, sales to Canon represented $25.4 million, or 40%, of net sales and $24.8 million, or 48%, of net sales, respectively. Canon sales decreased as a percent of total net sales due primarily to the increase in sales to our industrial base resulting from the strong orders in industrial in the first quarter and to a lesser extent to the increase in sales in the semiconductor market. Sales to Canon remained relatively stable as compared to the prior year quarter and six months reflecting an increase in product sales, offset by a decrease in revenue from the development services agreement.
Sales in U.S. dollars for the second quarter of fiscal 2005 were $28.3 million, or 79%, of total net sales for the period. For the first half of fiscal 2005, sales in U.S. dollars were $51.6 million, or 81%, of total net sales for the period. The majority of our foreign currency transactions and foreign operations are in the euro and Japanese yen. Management believes the percentage of sales in foreign currencies may increase in the coming year due to an increase in sales denominated in yen to Japanese customers. 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 currency 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 consolidated financial position and results of operations.
Gross profit for the second quarter of fiscal 2005 totaled $13.3 million, an increase of $2.9 million, or 28%, from $10.4 million in the second quarter of fiscal 2004. Gross profit as a percentage of sales for the second quarters of fiscal 2005 and 2004 were 37% and 38%, respectively. While the gross profit as a percentage of sales was relatively stable from the prior year period, the gross profit percentage in 2005 was negatively impacted by approximately two percentage points by new product ramp-up expenses for opto-mechanical assemblies and under absorbed factory overhead due to a production delay of certain assemblies. Gross profit for the first six months of fiscal 2005 was $24.4 million, an increase of $6.2 million, or 34%, as compared with the prior year period. Gross profit as a percentage of sales for the first six months of fiscal 2005 and 2004 were 38% and 35%, respectively. The gross profit as a percentage of sales in the first six months of 2004 was negatively impacted by quality and manufacturing problems in the factory that delayed shipments and increased our manufacturing costs in the first quarter of fiscal 2004. There were no similar costs in the current year period.
Selling, general, and administrative expenses (“SG&A”) in the second quarter of fiscal 2005 amounted to $5.7 million, an increase of $0.1 million, or 2%, from $5.6 million in the second quarter of fiscal 2004. For the first six months of fiscal 2005 and 2004, SG&A remained relatively stable at $11.4 million. As a percentage of net sales, SG&A for the second quarter of fiscal 2005 and fiscal 2004 was 16% and 20%, respectively. For the first six months of fiscal 2005 and 2004, SG&A as a percentage of sales was 18% and 22%, respectively. The decrease in SG&A as a percentage of sales for both periods of fiscal 2005 was due to the costs remaining stable on a higher sales volume.
Research, development, and engineering expenses (“R&D”) for the second quarter of fiscal 2005 totaled $3.7 million, an increase of $0.4 million, or 12%, from $3.3 million in the second quarter of fiscal 2004. For the first six months of fiscal 2005 and 2004, R&D expenses were $6.9 million and $6.6 million, respectively. This increase was primarily due to costs associated with various semiconductor initiatives.
The income tax expense from continuing operations in the second quarter of fiscal 2005 totaled $1.5 million, or 36% of pre-tax earnings, as compared with an income tax expense of $0.7 million, or 39% of pre-tax income, in the second quarter of fiscal 2004. The income tax expense from continuing operations for the first six months of fiscal 2005 totaled $2.4 million, or 36% of pre-tax earnings, as compared with an income tax expense of $0.2 million, or 38% of pre-tax income, for the first six months of fiscal 2004. Our overall effective tax rate, including discontinued operations, was 36% for the second quarter of fiscal 2005 as compared with 48% in the comparable prior year period. Our overall effective tax rate, including discontinued operations, was 36% for the first six months of fiscal 2005 as compared with 50% in the comparable prior year period. The decrease in the overall effective tax rate is primarily due to an increase in the percentage of pre-tax income from domestic operations, which has a lower effective tax rate than income from foreign operations. Research and development credits, which have historically been included in our effective tax rate calculation, were excluded in the second quarter of fiscal 2005 due to certain statutory limitations.
RELATED PARTY TRANSACTIONS
In September 2002, we entered into a contract with Canon Inc. related to the development of certain interferometers (refer to Note 5 of our unaudited consolidated financial statements for additional information). In March 2004, we signed a preliminary agreement to begin further add-on work, with a definitive agreement signed on December 20, 2004. Our net sales for the second quarter and six months ended December 31, 2004 included $2.5 million and $4.2 million, respectively, from these development services for Canon Inc.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2004, working capital was $61.9 million, an increase of $3.4 million from $58.5 million at June 30, 2004. We maintained cash, cash equivalents, and marketable securities at December 31, 2004 totaling $35.4 million, as compared with $34.4 million at June 30, 2004. Major fluctuations in working capital included a reduction in accounts receivable of $2.7 million due to collections, an increase in inventories of $9.7 million due to anticipated shipments in the third and fourth quarters of fiscal 2005 and an increase in progress payments of $3.9 million. There were no borrowings outstanding under our $3.0 million bank line of credit at December 31, 2004. The line of credit was renewed in December 2004.
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During fiscal 2004 we entered into an agreement to sell our vacant Westborough, Massachusetts, facility. The sale transaction, anticipated to be completed in the second half of fiscal 2005, is expected to generate approximately $1.8 million in cash, net of selling expenses.
Acquisitions of property, plant, and equipment were $3.4 million in the second quarter of fiscal 2005, which includes $1.3 million for the construction of an addition to our existing Middlefield, Connecticut, facility. The building addition is expected to be completed during fiscal 2005 for an additional $0.8 to $1.0 million, and will be funded from existing cash balances. The additional space is expected to be used primarily for manufacturing. Management believes that cash generated from operations, together with the liquidity provided by existing cash balances, will be sufficient to satisfy our liquidity requirements for the next 12 months.
CRITICAL ACCOUNTING POLICIES, SIGNIFICANT JUDGMENTS, AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosures at the date of our consolidated financial statements. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, warranty obligations, income taxes, and long-lived assets. Management bases its estimates and judgments on historical experience and current market conditions and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We consider certain accounting policies related to revenue recognition and allowance for doubtful accounts, inventory valuation, warranty costs, accounting for income taxes, and valuation of long-lived assets to be critical policies due to the estimates and judgments involved in each.
Revenue Recognition and Allowance for Doubtful Accounts
We recognize revenue based on guidance provided in SEC SAB No. 104, “Revenue Recognition” and in accordance with EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, our price is fixed or determinable, and collectibility is reasonably assured. We recognize revenue on our standard products when title passes to the customer upon shipment. While our standard products generally require installation, the installation is considered a perfunctory performance obligation. The standard products do not have customer acceptance criteria. We have standard rights of return that we account for as a warranty provision under SFAS No. 5. We do not have any price protection agreements or other post shipment obligations. We also sell custom equipment and do have situations where customer acceptance is part of the sales agreement. In these situations, revenue is not recognized until the customer has accepted the product. In cases where custom equipment does not have customer acceptance as part of the sales agreement, we recognize revenue upon shipment as long as the system meets the specifications as agreed upon with the customer. Certain transactions have multiple deliverables, with the deliverables clearly defined. To the extent that the secondary deliverables are other than perfunctory, we recognize the revenue on each deliverable, if separable, or on the completion of all deliverables, if not separable, all in a manner consistent with EITF 00-21. Generally, software is a component of our standard product and, as such, is not separately recognized as revenue. Standalone software products are recognized as revenue when they are shipped.
We maintain an allowance for doubtful accounts based on a continuous review of customer accounts, payment patterns, and specific collection issues. We perform on-going credit evaluations of our customers and do not require collateral from our customers. For many of our international customers, we require an irrevocable letter of credit to be issued by the customer before a shipment is made. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.
Inventory Valuation
Inventories are valued at the lower of cost or market, cost being determined on a first-in, first-out basis. Management evaluates the need to record adjustments for impairment of inventory on a monthly basis. Our policy is to assess the valuation of all inventories, including raw materials, work-in-process, and finished goods. Obsolete inventory or inventory in excess of management’s estimated future usage is written down to estimated market value, if less than its cost. Contracts with fixed prices are evaluated to determine if estimated total costs will exceed revenues. A loss provision is recorded when the judgment is made that actual costs incurred plus estimated costs remaining to be incurred will exceed total revenues
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from the contract. Inherent in the estimates of market value are management’s estimates related to current economic trends, future demand for our products, and technological obsolescence. Significant management judgments must be made when providing for obsolete and excess inventory and losses on contracts. If actual market conditions are different than those projected by management, additional inventory write-downs and loss accruals may be required.
Warranty Costs
We provide for the estimated cost of product warranties at the time revenue is recognized. We consider historical warranty costs actually incurred and specifically identified circumstances to establish the warranty liability. The warranty liability is reviewed on a quarterly basis. Should actual costs or revised estimated costs differ from management’s prior estimates, revisions to the estimated warranty liability would be required.
Accounting for Income Taxes
Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carryforwards. SFAS No. 109, “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect the likelihood of the realization of deferred tax assets. We record a valuation allowance to reduce our deferred tax assets to an estimated realizable amount based on historical and forecasted results. While management has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event management were to determine that ZYGO would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made. Likewise, should management determine that ZYGO would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the valuation allowance would be charged to income in the period such determination was made. Our effective tax rate may vary from period to period, generally based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, and deductibility of certain costs and expenses by jurisdiction.
Valuation of Long-Lived Assets
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances, both internally and externally, that may suggest impairment. Some factors we consider important, which could trigger the impairment review, include a significant decrease in the market value of an asset, a significant change in the extent or manner in which an asset is used, a significant adverse change in the business climate that could affect the value of an asset, an accumulation of costs for an asset in excess of the amount originally expected, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection that demonstrates continuing losses, and a current expectation that, more likely than not, a long-lived asset will be disposed of significantly before the end of its estimated useful life.
If such circumstances exist, we evaluate the carrying value of long-lived assets to determine if impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and comparing that value with the carrying value of the assets. If the carrying value of the assets is greater than the estimated future cash flows, the assets are written down to the estimated fair value. We determine the estimated fair value of the assets based on a current market value of the assets. If a current market value is not readily available, a projected discounted cash flow method is applied using a discount rate determined by management to be commensurate with the risk inherent in the current business model. Our cash flow estimates are based upon management’s best estimates, using appropriate and customary assumptions and projections at the time.
Health Insurance
Beginning in January 2004, we became self-insured for the majority of our group health insurance. We rely on claims experience in determining an adequate liability for claims incurred, but not reported. To the extent actual claims exceed estimates, we may be required to record additional expense. A one percent change in actual claims would have an annual impact of approximately $25,000 on our financial condition and results of operations.
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.
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RISK FACTORS THAT MAY IMPACT FUTURE RESULTS
Risk factors that may impact future results include those disclosed in our Form 10-K for the year ended June 30, 2004.
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 first six months of fiscal 2005.
For discussion of our exposure to market risk, refer to Item 7a. Quantitative and Qualitative Disclosures about Market Risk, presented in our Annual Report filed with the Securities and Exchange Commission on Form 10-K for the year ended June 30, 2004.
Item 4. Controls and Procedures
ZYGO maintains “disclosure controls and procedures,” as such term is defined under Securities Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing 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. We have carried out an evaluation, as of the end of the period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon their evaluation and subject to the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in ensuring that material information relating to ZYGO is made known to the Chief Executive Officer and Chief Financial Officer by others within our company during the period in which this report was being prepared.
There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on November 11, 2004. The following matter was submitted to a vote of the Company’s stockholders:
Proposal No. 1 - Election of Board of Directors
The following individuals, all whom were Zygo Corporation directors immediately prior to the vote, were elected as a result of the following vote:
| | For | | Against | |
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Eugene G. Banucci | | 15,209,054 | | 313,480 | |
Yousef A. El-Mansy | | 15,207,639 | | 314,895 | |
Paul F. Forman | | 13,987,399 | | 1,535,135 | |
Samuel H. Fuller | | 15,206,379 | | 316,155 | |
Seymour E. Liebman | | 14,030,727 | | 1,491,807 | |
Robert G. McKelvey | | 12,913,687 | | 2,608,847 | |
J. Bruce Robinson | | 14,026,653 | | 1,495,881 | |
Robert B. Taylor | | 15,089,416 | | 433,118 | |
Bruce W. Worster | | 15,206,379 | | 316,155 | |
Carl A. Zanoni | | 14,004,677 | | 1,517,857 | |
There were no other matters submitted to a vote of our stockholders.
Item 6. Exhibits
10.1 | Development Agreement Amendment dated December 20, 2004, between Zygo Corporation and Canon Inc. (1) |
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31.1 | Certification of Chief Executive Officer under Rule 13a-14(a) |
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31.2 | Certification of Chief Financial Officer under Rule 13a-14(a) |
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32.1 | Certification of Chief Executive Officer and Chief Financial Officer |
(1) Certain portions of this exhibit have been omitted pursuant to a request for an order granting confidential treatment by the Securities and Exchange Commission. The omitted non-public information has been filed with the Securities and Exchange Commission.
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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.
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Zygo Corporation
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| | | (Registrant) |
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/s/ J. Bruce Robinson
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| | | J. Bruce Robinson
President, Chairman, and Chief Executive Officer |
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/s/ Walter A. Shephard
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| | | Walter A. Shephard
Vice President, Finance, Chief Financial Officer, and Treasurer |
Date: February 9, 2005 | | | |
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