Cymer 10-Q 2012
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the Quarterly Period Ended March 31, 2012
For the transition period from to
Commission file number 0-21321
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report).
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The total number of shares of Common Stock, with $0.001 par value, outstanding on April 13, 2012 was 30,937,300.
Quarterly Period Ended March 31, 2012
(in thousands, except share data)
See Notes to Unaudited Consolidated Financial Statements.
(in thousands, except per share data)
See Notes to Unaudited Consolidated Financial Statements.
See Notes to Unaudited Consolidated Financial Statements.
See Notes to Unaudited Consolidated Financial Statements.
See Notes to Unaudited Consolidated Financial Statements.
Quarterly Period Ended March 31, 2012
1. BASIS OF PRESENTATION
Nature of Operations
Cymer, Inc., together with its wholly-owned subsidiaries, is engaged in the development, manufacturing and marketing of light sources for sale to customers who manufacture photolithography tools in the semiconductor equipment industry. We sell replacement parts and support directly to chipmaker customers as well as to our lithography tool manufacturer customers. Our TCZ reporting segment develops, integrates, markets, and supports silicon crystallization tools used in the manufacture of low temperature poly-silicon liquid crystal displays (LTPS LCD) and organic light emitting diode (OLED) displays.
We manufacture our products primarily at our San Diego headquarters, and we also conduct refurbishment manufacturing activities for replacement parts at our subsidiary located in South Korea. We sell our products to customers primarily in Europe, Japan, South Korea, Taiwan, the United States and other Asian countries. We provide customer support from our San Diego headquarters, and from our field offices located throughout China, Japan, the Netherlands, Singapore, South Korea, Taiwan and the United States.
Basis of Accounting
The accompanying unaudited consolidated financial information has been prepared by management, without audit, in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. The consolidated balance sheet at December 31, 2011 was derived from the audited consolidated financial statements at that date; however, it does not include all disclosures required by accounting principles generally accepted in the United States (U.S. GAAP).
In the opinion of management, the unaudited consolidated financial statements for the interim period presented reflect all material adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations as of and for such periods indicated. These unaudited consolidated financial statements and notes hereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011. Results for the interim periods presented herein are not necessarily indicative of results that may be reported for any other interim period or for the year ending December 31, 2012.
Principles of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of Cymer, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. References to Cymer, the Company, we, us, our and other similar words refer to Cymer, Inc. and its consolidated subsidiaries, unless the context suggests otherwise.
Use of Estimates
The unaudited consolidated financial statements have been prepared in conformity with U.S. GAAP. Applying these principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from those estimates.
Sales to ASML Holding N.V. (ASML) and Nikon, Corp. (Nikon), two of our three lithography tool manufacturing customers, and Samsung Electronics Co. (Samsung), one of our chipmaker customers, amounted to 34%, 10% and 10%, respectively, of total revenue for the three months ended March 31, 2012 and 42%, 9% and 10%, respectively, for the three months ended March 31, 2011. A loss of one or more of these customers would have a significant adverse effect on our operating results, financial condition, and cash flows.
Recently Adopted Accounting Standards
In June 2011, the FASB issued amended standards to increase the prominence of items reported in other comprehensive income. These amendments eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders equity and require that all changes in stockholders equityexcept investments by, and distributions to,
ownersbe presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. These new standards are effective for interim and annual periods beginning after December 15, 2011, and are to be applied retrospectively. The adoption of these amended standards affected the presentation of our other comprehensive income but not our financial position or results of operations.
Recently Issued Accounting Standards
In December 2011, the FASB issued amended standards to increase the prominence of offsetting assets and liabilities reported in financial statements. These amendments require an entity to disclose information about offsetting and the related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. These amendments will enhance disclosures by requiring improved information about financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. This information will enable users of an entitys financial statements to evaluate the effect or potential effect of netting arrangements on an entitys financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. These revised standards are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. These amended standards will require additional footnote disclosures for these enhancements but will not affect our financial position or results of operations.
2. FAIR VALUE MEASUREMENTS
We account for our financial assets and liabilities that are being measured and reported on at fair value on a recurring basis per the provisions of the authoritative guidance for fair value measurements. This includes certain items we report in cash equivalents and available-for-sale securities within our cash and cash equivalents, and short and long term investments on the accompanying unaudited consolidated balance sheets. In addition, our derivatives, which consist of foreign currency forward exchange contracts, are reported at fair value and are included in the scope of the authoritative guidance for fair value measurements and disclosures.
The authoritative guidance for fair value measurements stipulates that fair value is defined as the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, willing parties. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques include unobservable inputs and involve some level of estimation and judgment on the part of the reporting entity, the degree of which is dependent on the price transparency for the instruments or market and the instruments complexity.
Per the authoritative guidance for fair value instruments, assets and liabilities recorded at fair value in our unaudited consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The levels as defined by the fair value hierarchy in the authoritative guidance for fair value instruments are as follows:
Financial Assets and Liabilities Measured on a Recurring Basis
The majority of our available-for-sale securities and our foreign currency forward exchange contracts are priced via independent providers. In obtaining such valuation information from third parties, we have evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in our principal markets.
The fair values of our available-for-sale securities are determined by a matrix pricing, which is a mathematical technique widely used to value securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities relationship to other benchmark-quoted securities. Such assets are classified as Level 2 inputs in the fair value hierarchy and typically include commercial paper and government and corporate fixed income securities which are included in our investment portfolio.
Our foreign currency forward exchange contracts are valued using an income approach which includes observable Level 2 market inputs at the measurement date and uses a standard valuation technique to convert future foreign currency amounts to a single discounted present amount assuming participants are motivated, but not compelled, to transact. Level 2 inputs are limited to quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. Key inputs in this discounted calculation include spot currency exchange rates at the measurement date, interest rates, and credit default swap rates at standard quoted intervals. Credit default swaps on us are not available, so we estimated our credit risk premium based on a financing arrangement that was offered to us during the three months ended March 31, 2012 by a third party. The principal market in which we execute our foreign currency forward exchange contracts is the retail market. Mid-market pricing is used as a practical expedient for fair value measurements. Since significant inputs in the valuation of our foreign currency forward exchange contracts are observable in the active market, they are classified as Level 2 in the fair value hierarchy. For further discussion, see Note 6, Derivative Instruments and Hedging Activities.
Financial assets and liabilities (excluding cash balances) measured at fair value on a recurring basis are summarized below (in thousands):
Non-Financial Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
We apply fair value techniques on a non-recurring basis associated with: (1) valuing potential impairment losses related to goodwill, which are accounted for pursuant to the authoritative guidance for intangiblesgoodwill and other; and (2) valuing potential impairment losses related to long-lived assets, which are accounted for pursuant to the authoritative guidance for property, plant and equipment.
We develop, manufacture and market our products within two reportable business segments, Cymer and TCZ. Cymers primary business is to design, manufacture and sell light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools used in the manufacture of LTPS-LCD and OLED displays. We test for goodwill impairment at the reporting unit level. All of our goodwill is associated with our primary business unit, and we determine the fair value of this reporting unit based on a combination of inputs including our market capitalization, as well as Level 3 inputs such as discounted cash flows which are not observable from the market, directly or indirectly. We conduct our goodwill impairment analysis annually in the fourth quarter of each year, or upon the occurrence of certain triggering events. During the three months ended March 31, 2012, there have been no triggering events associated with our goodwill; therefore, no impairment analysis was conducted during the period. Historically, the fair value of our primary business reporting unit has significantly exceeded its carrying value.
We test for the impairment of our long-lived assets when triggering events occur and such impairment, if any, is measured at fair value. The inputs for fair value of our long-lived assets would be based on Level 3 inputs as data used for such fair value calculations would be based on discounted cash flows which are not observable from the market, directly or indirectly. During the three months ended March 31, 2012, there have been no triggering events associated with our long-lived assets; therefore, no impairment analysis was conducted during the period.
3. CASH, CASH EQUIVALENTS AND INVESTMENTS
Cash, cash equivalents and investments at March 31, 2012 consist of the following (in thousands):
Cash, cash equivalents and investments at December 31, 2011 consist of the following (in thousands):
The contractual maturities of our cash equivalents and investments at March 31, 2012 were as follows (in thousands):
We did not have any investments in individual securities that have been in a continuous unrealized loss position deemed to be temporary for more than 12 months at March 31, 2012.
Inventories consist of the following (in thousands):
The following table provides the changes in the carrying amount of goodwill during the three months ended March 31, 2012 (in thousands):
6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We conduct business in several currencies through our global operations with certain transactions denominated in local currencies, such as the Euro, Japanese Yen, South Korean Won and Taiwanese Dollars. We use derivative financial instruments, such as forward exchange contracts, to hedge certain forecasted foreign denominated transactions expected to occur over the next twelve to twenty-four months. The purpose of our derivative financial instruments is to mitigate the effect of the exchange rate fluctuations on certain foreign currency denominated revenue, costs and cash flows. We do not enter into derivative instruments for speculative purposes.
Our foreign currency risk falls into two primary categories. First, our gross profit margins are subject to change when we sell our products in one currency and the product costs are denominated in a different currency. To mitigate this risk, we enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges to mitigate fluctuations in the gross profit margins of these forecasted transactions. We also occasionally enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges when we anticipate purchasing a capital asset in a currency other than the functional currency of the entity purchasing the asset. Designated hedging instruments qualify for cash flow hedge accounting treatment if certain criteria are met. For example, at the inception of the hedge, we must have formal documentation of the hedging relationship and our management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged transaction, the nature of the risk being hedged, and how the hedging instruments effectiveness will be assessed. The hedging relationship must be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge. Interest charges or forward points on our forward contracts are excluded from the assessment of hedge effectiveness and are recorded in the consolidated statements of operations.
The effective portion of the gain or loss on the cash flow hedge is reported as a component of accumulated other income or loss and is reclassified into earnings when the hedged transaction affects earnings. Once the underlying hedged transaction is recorded, we de-designate the derivative, cease to apply hedge accounting treatment to the transaction and record any further gains or losses to other income (expense). The cash flows resulting from forward exchange contracts are classified in the consolidated statements of cash flows as part of cash flows from operating activities. If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective, and we would reclassify the ineffective portion of the hedge into other income (expense). We generally do not experience ineffectiveness of our cash flow hedges as a result of cancelled transactions and the accompanying consolidated statements of operations do not include such gains or losses. We adjust the level and use of derivatives as soon as practicable after learning that an exposure has changed. We review all exposures on derivative positions on a regular basis.
The second category of foreign currency risk occurs when transactions are recorded in our consolidated financial statements in a currency other than the applicable subsidiarys functional currency and the cash settlement of the transaction occurs at some point in the future. When transactions in non-functional currencies are recorded in our consolidated financial statements, changes in the recorded amounts resulting from fluctuations in the value of that currency are recorded to other income (expense). In order to mitigate these remeasurement gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge these transactions that have been recorded to our consolidated financial statements are not designated as hedges and, therefore, we record changes in their fair value to other income (expense). The U.S. dollar equivalent of all outstanding notional amounts of forward contracts was as follows (in thousands):
The fair value of all of our forward contracts totaled to an asset of $354,000 at March 31, 2012 and a liability of $1.5 million at December 31, 2011. As of March 31, 2012, the deferred loss, net of tax, for those that qualified for hedge accounting treatment was $14,000. We expect that this unrealized loss will be reclassified from accumulated other comprehensive income into earnings at the then-current values over the next twelve months as the underlying hedged transaction occur.
The derivative instruments that we enter into are subject to master netting arrangements and qualify for net presentation on the balance sheet. The gross fair value of derivative instruments in our unaudited consolidated balance sheets was as follows (in thousands):
The effect of derivative instruments on our unaudited consolidated statements of operations and comprehensive income (loss) (OCI) was as follows (in thousands):
We are exposed to credit losses in the event of nonperformance by the banks with which we transact foreign currency hedges. We manage this credit risk by transacting foreign currency hedging with more than one institution, only executing hedges with counterparties that meet our minimum requirements, monitoring the credit ratings of our counterparties on a periodic basis and negotiating contractual master netting provisions that allow us to record and offset liabilities to a counterparty against amounts due from that counterparty in an event of default. We do not receive collateral from our hedging counterparties. As of March 31, 2012, we have a total credit exposure of $457,000 from nonperformance of foreign exchange hedging counterparties.
7. OTHER BALANCE SHEET DETAILS
Details of other assets and other liabilities consist of the following (in thousands):
Equity Incentive Plan
We grant stock options and stock units from our 2011 Equity Incentive Plan (the Incentive Plan). The Incentive Plan provides for the issuance of incentive stock options, non-statutory stock options, stock purchase awards, stock bonus awards, stock appreciation rights, stock unit awards, performance stock awards, performance cash awards and other stock awards to our employees, non-employee directors and consultants.
Stock Options, Restricted Stock Unit Awards (RSUs) and Performance-Based Restricted Stock Unit Awards (PRSUs).
Stock options granted have an exercise price at least equal to the fair market value of our common stock on the dates of grant, expire no more than ten years from the date of grant, and generally vest ratably over a four-year period following the date of grant. Restricted stock unit awards granted generally vest one to three years from the date of grant. We also grant performance-based restricted stock unit awards to our executive officers and certain key management. The number of shares granted is subject to increase or decrease based upon actual performance against performance measures approved by the Compensation Committee of our Board of Directors.
The table below summarizes the total number of shares granted during the period:
We measure the fair value of stock-based awards using our closing stock price on the date of grant, and the fair value is recognized as expense over the requisite service period. We measure the fair value of stock options on the date of grant, as determined by the Black-Scholes option pricing model. We utilize a blended volatility, a combination of historical and implied volatility, in this valuation model. Historical volatility is based on a period commensurate with the expected term of the options. Implied volatility is derived based on a six-month period of traded options of our common stock. The expected term of our stock options represents the period of time options are expected to be outstanding and is based on observed historical exercise patterns for us, which we believe are indicative of future exercise behavior. For the risk free interest rate, we use the then currently available rate on zero coupon U.S. government issues with a remaining period commensurate with the expected term for valuing options. We have never declared or paid cash dividends on our common stock, and currently do not anticipate paying cash dividends in the future.
We did not grant stock options during the three months ended March 31, 2012. The following weighted average assumptions were used for valuing stock option granted during the three months ended March 31, 2011:
The components of share-based compensation expense were as follows (in thousands):
Stock Repurchase Program
In April 2008, our board authorized us to repurchase up to $100 million of our common stock. The program does not have a fixed expiration date and may be discontinued at any time. During the three months ended March 31, 2012, no shares were repurchased under this program. As of March 31, 2012, $57.8 million remains available for share repurchases under this program.
9. ACCUMULATED OTHER COMPREHENSIVE LOSS
Comprehensive income (loss) includes net income, foreign currency translation adjustments, net unrealized gains and losses on available-for-sale investments, net unrealized gains and losses on effective foreign currency forward exchange contracts, and net unrealized pension gains and losses. See the unaudited consolidated statements of comprehensive income for the effect of the components of comprehensive income (loss) to our net income.
The components of accumulated other comprehensive loss, net of tax, are as follows (in thousands):
10. EARNINGS PER SHARE (EPS)
Basic EPS is calculated by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated on the basis of the weighted-average number of shares of common stock including the effect of the potential dilution that could occur if securities to issue common stock were exercised or converted into common stock. Potential dilutive securities include outstanding stock options, RSUs, PRSUs, and stock issued pursuant to our Employee Stock Purchase Plan.
The following table sets forth a reconciliation of basic and diluted EPS (in thousands, except per share information):
11. INCOME TAXES
We calculate our interim tax provision in accordance with the guidance for accounting for income taxes in interim periods. At the end of each interim period, we estimate the annual effective tax rate and apply that tax rate to our ordinary year-to-date pre-tax income. The tax expense or benefit related to significant, unusual or extraordinary discrete events during the interim period is recognized in the interim period in which those events occurred. In addition, the effect of changes in enacted tax laws or rates or tax status is recognized in the interim period in which the change occurs.
The following table provides details of income taxes (dollars in thousands):
Our effective tax rate for the three months ended March 31, 2012 was less than the United States federal statutory rate of 35% due primarily to tax benefits related to investments in a foreign subsidiary totaling $9.1 million and lower tax rates on earnings in foreign jurisdictions. Additionally, during the three months ended March 31, 2012, we recorded as a discrete item a decrease in income tax expense of $1.0 million related to the successful appeal of a U.S. tax audit. The U.S. research and development tax credit expired on December 31, 2011. If the credit is reinstated, the tax benefit from the credit will be recognized in the quarter the reinstatement occurs.
Our effective tax rate for the three months ended March 31, 2011 was less than the United States federal statutory rate of 35% due primarily to a reduction in our net unrecognized tax benefits of $3.7 million due to the expiration of a foreign statute of limitations as well as benefits recognized for research and development credits and manufacturing deductions in the United States. These reductions were offset partially by an increase in our deferred tax liabilities of $1.0 million resulting from a foreign tax audit.
As of March 31, 2012, the balance of our net unrecognized tax benefits is $8.6 million, a decrease of $3.5 million from December 31, 2011. This decrease is due primarily to the effective settlement of the U.S. tax audit noted above. The remaining changes reflect accrued interest and changes in foreign exchange rates.
We are subject to taxation in the United States and in various states and foreign jurisdictions. Our tax years 2008 and forward are subject to examination by the IRS, our tax years 2000 and forward are subject to examination by material state jurisdictions, and our tax years 2004 and forward are subject to examination by material foreign jurisdictions.
Several of our subsidiaries are currently under audit or appeal. It is reasonably possible that the examination phase of these audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate and results of operations. However, based on the status of the various examinations or appeals in multiple jurisdictions, an estimate of the range of reasonably possible outcomes cannot be made at this time.
12. COMMITMENTS AND CONTINGENCIES
Guarantees and Warranties
In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of the authoritative guidance for guarantees with the exception of our standard warranty provisions associated with product sales and indemnification provisions related to intellectual property that are contained within many of our lithography tool manufacturer agreements.
We record a provision for warranty, which is included in cost of revenue and is recorded at the time that the related revenue is recognized. The warranty period and terms for light sources and replacement parts varies by light source system model. We review our warranty provision using a statistical financial model which calculates actual historical expenses, product failure rates, and potential risks associated with our different product models. We then use this financial model to calculate the future probable expenses related to warranty and the required level of the warranty provision. Throughout the year, we review the risk levels, historical cost information and failure rates used within this model and update them as information changes over the products life cycle. For new product offerings, such as extreme ultraviolet (EUV) sources and TCZ crystallization tools, for which we have limited or no historical failure rates, we estimate our future probable expenses related to the warranties based on an evaluation of parts covered under warranty and their expected failure rates determined through internal testing and analysis. If actual warranty expenditures differ substantially from our estimates, revisions to the warranty provision would be required. Actual warranty expenditures are recorded against the warranty provision as they are incurred. Consumed parts under warranty, when returned, are recorded as reductions to warranty expenditures during the period at their estimated fair value. We do not include the return of consumed parts in our statistical financial model used to estimate our provision for warranty because the specific parts and their estimated future fair value when returned, if any, cannot be reasonably estimated at the time revenue is recorded.
The following provides the changes in the product warranty accrual (in thousands):
Intellectual Property Indemnifications
We agree to indemnify certain of our customers in the general purchase agreements with our three lithography tool manufacturer customers, ASML, Canon and Nikon, and under certain of our development and supply agreements. These indemnifications generally include both general and intellectual property indemnification provisions that provide we defend these parties against certain infringement claims directed against our products. Under the indemnification provisions, we would pay costs and damages attributable to the infringement claims, including attorneys fees associated with settlements or defenses in respect of such claims, provided that certain conditions are satisfied. As of March 31, 2012, we were not subject to any pending general or intellectual property-related litigation or claims. We have not received any requests for nor have we been required to make any payments under these indemnification provisions.
Contingencies Related to Third-Party Review and Legal Actions
From time to time, we are subject to potential claims and assessments from third parties. We are also subject to various governmental audits and reviews. We continually assess whether or not such claims have merit and warrant accrual. Where appropriate, we accrue estimates of anticipated liabilities in the unaudited consolidated financial statements. Such estimates are subject to change and may affect our operating results, financial condition and cash flows.
We are from time to time party to legal actions in the normal course of business. Management does not expect the outcome of legal action to have a material effect on our operating results, financial condition and cash flows.
13. SEGMENT OPERATIONS
Operating segments are defined as components of a public entity which engage in business activity which may earn revenue and incur expenses and its operating results are reviewed regularly by the chief operating decision maker (CODM), or decision making group, in deciding how to allocate resources and in assessing performance. We develop, manufacture and market our products within two reportable business segments: Cymer and TCZ. Cymers primary business is to design, manufacture and sell light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools for use in the manufacture of high-resolution LTPS-LCS and OLED displays.
Our CODM is our chief operating officer who reviews the operations and full financial statements of Cymer and TCZ on a quarterly basis. Our CODM uses this information in order to make decisions on resources needed for our light sources and the silicon crystallization tools businesses and to assess the overall performance of these businesses. The accounting policies to derive our unaudited consolidated financial results are the same as those used for our segment reporting. Information related to our Cymer and TCZ operating segments is as follows (in thousands):
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in Item 1. Financial Statements of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and the section titled Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities Exchange Commission on February 16, 2012.
Statements in this Quarterly Report on Form 10-Q that are not strictly historical in nature are forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, but are not limited to, references to the outlook for the semiconductor industry and us; expected timelines for the adoption of new photolithography, extreme ultraviolet and display technologies by customers; expected domestic and international product sales and development; our research and development activities and expenditures; the development and intended commercialization of our extreme ultraviolet sources and commercialization of our silicon crystallization technologies; adequacy of our capital resources and investments; effects of business cycles in the semiconductor business; our competitive position; and our relationships with customers and third-party manufacturers of our products. These statements also may contain words such as believes, anticipates, expects, plans, intends and words of similar meaning. In addition, statements regarding backlog and book-to-bill ratios should not be read as predictions or projections of future performance. Forward-looking statements are predictions based on current information and our expectations, and involve a number of risks and uncertainties. The underlying information and our expectations are likely to change over time. Actual events or results may differ materially from those projected in the forward-looking statements due to various factors, including, but not limited to, those contained under the caption Risk Factors and elsewhere in this Quarterly Report on Form 10-Q. Forward-looking statements herein speak only as of the date of this Quarterly Report on Form 10-Q. Forward-looking statements herein speak only as of the date of this Quarterly Report on Form 10-Q. Unless required by law, we undertake no obligation to update or revise any forward-looking statements to reflect new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements.
Cymer, XLR, XLA, XL, OnPulse, SmartPulse, TCZ, and all other Cymer product or service names used herein are either registered trademarks or trademarks of Cymer, Inc. Other marks mentioned herein, if any, are the property of their respective holders.
Revenue of $150.5 million in the first quarter of 2012 represented a 3% decrease over the first quarter of 2011 and a 2% decrease over the fourth quarter of 2011. The decrease over prior year is primarily due to a decline in DUV light sources, which were partially offset by customer acceptance of three EUV 3100 sources, and an increase in installed base products revenue. The decline over last quarter is primarily due to a decrease in installed base product revenue. The majority of our source shipments continued to be argon and fluorine (ArF) sources in support of 45nm and below immersion lithography, and we also delivered several krypton and fluorine (KrF) sources.
Gross margin was 50.2% in the first quarter of 2012, a decrease from gross margin of 51.5% in the first quarter of 2011. The decrease in gross margin over prior year was due to the sale of three EUV sources at a low gross margin and an increase in freight expenses, offset partially by a decrease in costs associated with our installed base products, our continued focus on operational execution and a decrease in warranty expense due primarily to light source reliability improvements and decreases in costs. Gross margin remained relatively flat when compared to the fourth quarter of 2011. Operating expenses of $58.8 million in the first quarter of 2012 represent a 34% increase over the first quarter of 2011 and a 7% increase over the fourth quarter of 2011. The rise in operating expenses is primarily due to our increased investment in EUV source development. Operating expenses as a percentage of net sales increased to 39.1% in the first quarter of 2012, compared to 28.4% in the first quarter of 2011 and 35.9% in the fourth quarter of 2011.
As a result of the above, we reported first quarter 2012 net income of $21.5 million, compared to $28.8 million net income in the first quarter of 2011 and $12.5 million of net income in the fourth quarter of 2011. Additionally, our cash and investments increased to $347.9 million at March 31, 2012. Net cash provided by operations for the three months ended March 31, 2012 was $31.6 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. For a summary of significant accounting policies, see Note 1 to the Consolidated Financial Statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2011. The preparation of these financial statements requires us to
make estimates and use judgment that may impact the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent liabilities. As a part of our ongoing internal processes, we regularly evaluate our estimates and judgments associated with revenue recognition, inventory valuation, warranty obligations, stock-based compensation, income taxes, allowances for doubtful accounts, long-lived assets valuation, goodwill valuation, assets and liabilities valuation, and contingencies and litigation. We base these estimates and judgments upon historical information, projected information, and other facts and assumptions that we believe to be valid and reasonable under the circumstances. These assumptions and facts form the basis for making judgments and estimates and for determining the carrying values of our assets and liabilities that are not apparent from other sources. Adverse global economic conditions, illiquid credit markets, volatile equity, foreign currency fluctuations and declines in consumer spending have increased the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, particularly those related to the condition of the economy, actual results could differ significantly from these estimates.
We believe that revenue recognition, inventory valuation, warranty obligations, stock-based compensation, allowance for doubtful accounts, long-lived assets valuation, and income taxes require more significant judgments and estimates in the preparation of our unaudited consolidated financial statements than do other of our accounting estimates and judgments.
There have been no changes to the items disclosed as critical accounting policies and estimates in Management Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011.
RESULTS OF OPERATIONS
The following table sets forth certain items in our unaudited consolidated statements of operations as a percentage of total revenue:
We develop, manufacture and market our products within two reportable business segments, Cymer and TCZ. Cymers primary business is to design, manufacture and sell light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools used in the manufacture of LTPS-LCD and OLED displays. The discussion which follows for revenue, cost of revenue and operating expenses includes our unaudited consolidated results and identifies those amounts associated with the TCZ segment, which are included in the unaudited consolidated amounts, for the three months ended March 31, 2012 and 2011. Additional information regarding our reporting segments is contained in Note 13 to our Unaudited Consolidated Financial Statements in Part I, Item 1 of this report.
Three Months Ended March 31, 2012 and 2011
Revenue. The following table summarizes the components of our revenue (in thousands, except units sold):
Total revenue, compared to the same period in the prior year, decreased primarily due to reduced demand for DUV light sources as chipmakers assess their capital investment needs, offset by increased demand for our installed base products. Additionally, we received acceptance and recorded revenue for three EUV 3100 sources during the current quarter. The average selling price of our DUV light sources increased slightly due to a change in the DUV product mix of light sources sold when compared to the same period in the prior year, as ArF light sources have a higher average selling price than KrF light sources. Our installed base product revenue increased primarily due to the continued customer adoption of our OnPulse product, an increase in pulse utilization of our light sources by chipmaker customers, and a higher percentage of those pulses generated by ArF light sources.
Sales to ASML, Nikon and Samsung amounted to 34%, 10% and 10%, respectively, of total revenue for the quarter ended March 31, 2012, and 42%, 9% and 10%, respectively, of total revenue for the quarter ended March 31, 2011.
Our sales to external customers consist of sales generated from each of the following geographic locations in which we do business (in thousands):
We anticipate that international sales will continue to account for a significant portion of our sales.
Backlog. Our DUV backlog includes only those orders for light sources and replacement parts for which we have accepted a purchase order from a customer, and that will be delivered to the customer within the following 12 months. In addition, our DUV backlog does not include service or support which will be provided to our customers in the future or under service contracts. Timing of delivery can be affected by many factors, including factors that cannot be easily predicted or controlled. Because it is the practice in our industry that customers may cancel or delay orders with little or no penalty, our backlog as of any particular date may not be a reliable indicator of actual sales for any succeeding period.
Our backlog for DUV light sources and replacement parts at March 31, 2012 was $56.2 million compared to $71.0 million at March 31, 2011. DUV bookings for the quarter ended March 31, 2012 and 2011 were $135.8 million and $161.5 million, respectively. The DUV book-to-bill ratio for the quarter ended March 31, 2012 was 1.06 compared to 1.05 for the quarter ended March 31, 2011. The decrease in backlog and bookings year over year primarily reflects softened demand for our DUV systems in the first quarter of 2012 as chipmakers assess their capital equipment needs.
We also had a backlog of $34.4 million for silicon crystallization tools at March 31, 2012. Revenue will be recorded for these tools when customer acceptance has occurred.
Cost of revenue. Cost of revenue includes direct material and labor, warranty expenses, license fees, manufacturing and service overhead. Cost of revenue also includes foreign exchange gains and losses on foreign currency forward exchange contracts (forward contracts) associated with purchases of our products for resale under firm third-party sales commitments. Costs incurred for shipping and handling are included in cost of revenue at the time the related revenue is recognized. Amounts billed to a customer, if any, for shipping and handling are reported as revenue.
The cost of revenue increased slightly to $75.0 million for the quarter ended March 31, 2012 from $74.9 million for the same period in the prior year. Gross profit decreased to $75.5 million with a 50.2% gross margin for the quarter ended March 31, 2012 from $79.5 million with a 51.5% gross margin for the same period in the prior year. The decrease in gross margin over prior year was due to the sale of three EUV sources at a low gross margin and an increase in freight expenses, offset partially by a decrease in costs associated with our installed base products, our continued focus on operational execution and a decrease in warranty expense due primarily to light source reliability improvements and decreases in costs. Included in cost of revenue was $224,000 and $318,000 for the quarters ended March 31, 2012 and 2011, respectively, for our TCZ segment.
Research and development. Research and development expenses include costs of continuing product development projects, which consist primarily of employee and material costs, depreciation of equipment and other engineering related costs. Research and development expenses increased 52% to $42.3 million for the quarter ended March 31, 2012 from $27.8 million for the same period in the prior year primarily due to increased investment in EUV source development when compared to the same period in the prior year. In addition, research and development expenses included $3.5 million and $3.1 million for the quarters ended March 31, 2012 and 2011, respectively, for our TCZ segment. As a percentage of total revenue, research and development expenses increased to 28.1% for the quarter ended March 31, 2012 from 18.0% for the same period in the prior year.
Sales and marketing. Sales and marketing expenses include sales, marketing, customer support staff and other marketing expenses. Sales and marketing expenses increased 7.6% to $6.5 million for the quarter ended March 31, 2012 from $6.0 million for the same period in the prior year. The increase in sales and marketing expenses primarily reflects increased employee related costs and increased travel costs when compared to the same period in the prior year. Included in sales and marketing expenses were $453,000 and $523,000 for the quarters ended March 31, 2012 and 2011, respectively, for our TCZ segment. As a percentage of total revenue, sales and marketing decreased to 4.3% for the quarter ended March 31, 2012 compared to 3.9% for same period in the prior year.
General and administrative. General and administrative expenses consist primarily of management and administrative personnel costs, professional services including external audit and consultant fees, and administrative operating costs. General and administrative expenses remained flat at $10.0 million for the quarter ended March 31, 2012 and 2011, respectively. Included in general and administrative expenses were $211,000 and $321,000 for the quarters ended March 31, 2012 and 2011, respectively, for our TCZ segment. As a percentage of total revenue, general and administrative expenses increased to 6.7% for the quarter ended March 31, 2012 compared to 6.5% for the same period in the prior year.
Other income (expense). Other income (expense) consists primarily of interest income earned on our investment portfolio, foreign currency exchange gains or losses associated with fluctuations in the value of the functional currencies of our foreign subsidiaries against the U.S. Dollar and other items that may be specific to a reporting period. Other income was $17,000 for the quarter ended March 31, 2012 compared to $798,000 for the same period in the prior year. The decrease is primarily due to foreign currency exchange losses of $263,000 for the quarter ended March 31, 2012 compared to foreign currency exchange gains of $784,000 for the same period in the prior year.
Income tax (benefit) expense. The tax benefit of $4.8 million for the three months ended March 31, 2012 and tax expense of $7.7 million for the three months ended March 31, 2011 reflect an effective tax rate of (29%) and 21%, respectively. The decrease in the effective tax rate for the three months ended March 31, 2012 was due primarily to tax benefits related to investments in a foreign subsidiary totaling $9.1 million, offset partially by a reduction in the benefits recognized for the U.S. research and development tax credit and U.S. manufacturing deductions. The U.S. research and development tax credit expired on December 31, 2011. If the credit is reinstated, the tax benefit from the credit will be recognized in the quarter the reinstatement occurs. Additionally, during the three months ended March 31, 2012, we recorded as a discrete item a decrease in income tax expense of $1.0 million related to the successful appeal of a U.S. tax audit.
Our future effective tax rate depends on various factors, such as tax legislation and credits and the geographic compositions of our pre-tax income. Additionally, several of our subsidiaries are under audit or appeal. It is reasonably possible that the examination phase of these audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2012, we had $347.9 million in cash and cash equivalents, short-term investments and long-term investments (total cash and investments) compared to $323.6 million at December 31, 2011. This increase is due primarily from cash flows generated by our operations.
A summary of cash provided by (used in) operating, investing and financing activities were as follows during the three months ended March 31, 2012 (in thousands):
Net cash provided by operating activities for the three months ended March 31, 2012 primarily reflects net earnings for the period before depreciation, amortization, stock-based compensation and provision for deferred income taxes and an increase in deferred revenue of $26.0 million. These increases in cash were offset partially by $24.0 million decrease in other liabilities. The decrease in other liabilities primarily reflects payment of our 2011 variable cash compensation programs during the quarter.
The primary use of cash in investing activities during the three months ended March 31, 2012 reflects purchases of investments, net of proceeds from sales of securities, of $3.0 million and capital expenditures of $9.3 million primarily related to our investment in EUV.
The primary sources of cash provided by financing activities during the three months ended March 31, 2012 are $3.4 million of proceeds and $1.5 million of excess tax benefits from the exercise of employee stock options. The sources of cash were offset partially by $3.0 million of install payments related to our acquisition of eDiag in 2011.
Prospective Capital Needs
We require substantial resources to fund the operations of our business, and in particular to fund our investment in new technologies, including inventory and capital in support of these technologies. We expect purchases of property, plant and equipment in 2012 to be approximately $30.0 million to $50.0 million, a significant portion of which will relate to purchases of equipment and facility improvements associated with development and manufacturing of our EUV sources and equipment to support our installed base product offerings. In addition, we require resources to fund our normal operations.
We believe that our operating cash flows, together with our current cash, cash equivalents and marketable securities will be sufficient to cover our working capital needs for our normal operations, and our investments in our new technologies, including EUV and silicon crystallization tools, for at least the next 12 months. It is possible that we may need to raise additional funds to finance our activities or to acquire assets, products or new technologies beyond the next 12 months. We may also decide that it is prudent in the current business and economic environment to secure commitments to access additional capital, including equity or debt securities, to protect our long term liquidity position. As of March 31, 2012, we have approximately $35.7 million of cash and cash equivalents in foreign subsidiaries. In the event these cash amounts are needed to fund operations in the U.S., we believe we would not be liable for U.S. taxes in connection with repatriating these funds given that these funds would be used to repay existing intercompany payables and/or loans due to the U.S. parent company.
In April 2008, our board of directors authorized us to repurchase up to $100.0 million of our common stock. During the three months ended March 31, 2012, we had no purchases under this program and $57.8 million remains available for share repurchases under this program.
Our future capital requirements may vary materially from those currently planned. We anticipate that the amount of capital we will need in the future will depend on many factors, including:
OFF BALANCE SHEET ARRANGEMENTS
At March 31, 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest, or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships with or enter into transactions with persons or entities that derive benefits from their non-independent relationship with us.
There have been no material changes to our contractual obligations from the information provided in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the year ended December 31, 2011.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 1 to our unaudited consolidated financial statements in Part I, Item 1 of this report for a description of recently issued accounting standards, including our expected dates of adoption and estimated effects on our results of operations and financial condition.
FOREIGN CURRENCY RISK
We conduct business in several international currencies through our global operations. Our foreign currency hedging program manages fluctuations in the value of the Euro, Japanese Yen, South Korean Won and the Taiwanese Dollar. Our foreign currency risk falls into two primary categories.
First, we are subject to uncertain gross profit margins when we forecast selling products in one currency and the product costs are denominated in a different currency, primarily for the purchases of our products for resale under firm third-party sales commitments. In this instance, we enter into derivative financial instruments; principally forward contracts, which we designate as cash flow hedges in order to mitigate fluctuations in the gross profit margins of these forecasted transactions. We also occasionally enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges in order to mitigate fluctuations in depreciation expense when we anticipate purchases of capital assets in a currency other than the functional currency of the entity purchasing the asset.
Forward contracts on forecasted transactions that hedge uncertain gross profit margins generally qualify for cash flow hedge accounting treatment. The effective portion of the gain or loss on the cash flow hedge is reported as a component of accumulated other comprehensive income or loss and is reclassified into earnings when the hedged transaction affects earnings. Once the underlying hedged transaction is recorded, we de-designate the derivative, cease to apply hedge accounting treatment to the transaction and record any further gains or losses to other income (expense). If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective and we would reclassify the ineffective portion of the hedge into other income (expense). We generally have not experienced ineffectiveness of cash flow hedges from cancelled transactions.
The second category of foreign currency risk occurs when transactions are recorded to our unaudited consolidated financial statements in a currency other than the applicable entitys functional currency and the cash settlement of the transaction occurs at some point in the future. When transactions in non-functional currency are recorded to our unaudited consolidated financial statements, any changes in the recorded amounts resulting from fluctuations in the value of that currency will be recorded to other income (expense). In order to mitigate these revaluation gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge transactions that have been recorded to our unaudited consolidated financial statements are not designated as hedges, and we record changes in their fair value to other income (expense) in order to attempt to offset gains and losses on the underlying transactions. We considered the historical trends in currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 20% for all currencies could be experienced in the near term. These changes would have resulted in an adverse effect on income before income taxes of approximately $335,000 and $2.0 million at March 31, 2012 and 2011, respectively. These changes at March 31, 2012 and 2011 are after consideration of the offsetting effect of approximately $12.9 million and $4.7 million, respectively, from forward exchange contracts in place at that time. These reasonably possible adverse changes in foreign currency exchange rates of 20% were applied to net assets and liabilities denominated in currencies other than the functional currencies at the balance sheet dates to compute the adverse effect these changes would have had on our income before income taxes in the near term.
At March 31, 2012, we had outstanding forward contracts to buy $43.0 million in exchange for South Korean Won, $17.0 million in exchange for Taiwanese Dollars and to sell $3.1 million in exchange for Japanese Yen and $62.8 million in exchange for Euros. These contracts expire on various dates through February 2014. The fair value of all our forward contracts totaled an asset of $457,000 and a liability of $103,000 at March 31, 2012. The deferred loss, net of tax, for those that qualified for hedge accounting treatment was $14,000 as of March 31, 2012.
We maintain an investment portfolio consisting primarily of government and corporate fixed income securities, commercial paper and money market funds. While it is our general intent to hold such securities until maturity, we will occasionally sell certain securities for cash flow purposes. Therefore, our investments are classified as available-for-sale and are carried on the balance sheet at fair value. If interest rates were to increase instantaneously and uniformly by 100 basis points, the fair market value of our investment portfolio as of March 31, 2012 would decrease by $1.7 million.
Evaluation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange
Act of 1934, as amended (the Exchange Act), as of March 31, 2012, have concluded that as of such date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting. There has been no change in our internal control over financial reporting during the quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on the Effectiveness of Internal Control. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal controls may vary over time.
PART II. OTHER INFORMATION
The risks described below may not be the only risks we face. Additional risks that we do not currently believe are material may also impair our business operations. The risk factors set forth below with an asterisk (*) next to the title contain changes to the description of the risk factors associated with our business as previously disclosed in Item 1A to our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. If any of the events or circumstances described in the following risks occur, our business, financial condition, results of operations or cash flows could suffer, and the trading price of our common stock and our market capitalization could decline.
Our revenue and operating results from quarter to quarter and year to year have varied in the past and our future operating results may continue to fluctuate significantly.
Factors that contribute to fluctuations in our revenue and operating results include:
Revenue from installed base products has grown as a percentage of our total revenue. The revenue from the operation of our installed base of light source systems depend on the rate at which our customers use these light source systems, the rate of growth of our installed base, and the mix of pulses from our various light source models. Our operating results for a particular period may be adversely affected if our customers reduce usage rates, or change their buying patterns, or if we incur higher parts replacement or service costs. Because we sell a limited number of light source systems, the precise timing for recognizing revenue from an order may have a significant effect on our total revenue for a particular period. As is the practice in our industry, our customers may cancel or reschedule orders with little or no penalty. Orders expected in one quarter could shift to another period due to changes in the anticipated timing of our customers purchase decisions or rescheduled delivery dates requested by our customers. Our operating results for a particular quarter or year may be adversely affected if our customers cancel or reschedule orders, or if we cannot fill orders timely due to unexpected delays in manufacturing, testing, shipping, or product acceptance or due to an unexpected material surge in demand. Our light source systems used in a production environment generate installed base product revenue based on system usage, which may also vary period to period. Additionally, we may be required to defer revenue associated with contracts that contain multiple deliverables.
We manage our expense levels based, in large part, on expected future revenue. As a result, if our actual revenue decreases below the level we expect, or we are not successful in aligning our manufacturing cost structure with decreasing production levels, our operating results will be adversely affected. As a result of these or other factors, we could fail to achieve our expectations as to future revenue, gross profit and gross margin, operating income, net income, earnings per share, and cash flows. Our failure to meet the performance expectations set and published by external sources could result in a sudden and significant drop in the price of our stock, particularly on a short-term basis, and could negatively affect the value of any investment in our stock.
Our business depends on the semiconductor and the semiconductor capital equipment industries, which are volatile and unpredictable.
We derive the majority of our revenue from our lithography tool manufacturer customers who, as original equipment manufacturers (OEMs), incorporate our light source systems in photolithography tools that they sell to semiconductor manufacturers, or chipmakers, and from our chipmaker customers who purchase installed base products directly from us in support of their light source systems. Like us, our OEM customers depend on market demand for their products from the chipmakers. This market demand can be volatile and unpredictable and can affect our ability to accurately predict future revenue and, therefore, our ability to manage our future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction actions may be necessary in order for us to remain competitive and financially stable. During a down cycle or slowdown, we must adjust our cost and expense structure to prevailing market conditions while maintaining our longer term strategies and motivating and retaining our key employees. In contrast, during periods of rapid growth, we must quickly increase manufacturing capacity and personnel to meet our customers needs. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. We are not able to predict with any certainty the duration of any industry cycle or the timing or order of magnitude of any recovery from a down cycle or slowdown.
Downturns in the semiconductor industry often result in decreases in demand for semiconductor manufacturing equipment, including the photolithography tools that our OEM customers produce. Downturns in the semiconductor industry have generally had severe effects on the demand for semiconductor manufacturing equipment and to a lesser extent, the associated installed base
products. Fluctuating levels of investment by chipmakers and resulting pricing volatility will continue to materially affect our aggregate bookings, revenue and operating results. Even during periods of reduced revenue, we believe we must continue to invest in research and development and maintain extensive ongoing worldwide customer support capabilities to meet our customers needs and to remain competitive. Continued spending to further these objectives may temporarily harm our financial results. Semiconductor industry downturns and slowdowns will likely continue to adversely affect our business, financial condition and operating results.
While revenue from installed base products has grown as a percentage of our total revenue, we continue to derive a significant percentage of our revenue from the sales of light source systems. Market conditions in the semiconductor industry and our OEM customers production efficiency can cause them to expand or reduce their orders for new light source systems as they try to manage their inventories and production requirements. We continue to work closely with our OEM customers to better understand these issues. However, we cannot guarantee that we will be successful in understanding our OEM customers inventory management or production requirements or that our OEM customers will not build up an excess inventory of light source systems. If our OEM customers retain an excess inventory of light source systems, our revenue could be reduced in future periods as the excess inventory is utilized, which could adversely affect our operating results, financial condition and cash flows. If our OEM customers demand shorter product lead times to improve their inventory and cash positions, our inventory management and cash position may be negatively affected, which may adversely affect our operating results, financial condition and cash flows.
Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits; Our EUV sources could fail to meet customer specifications or not be delivered on time. *
We are investing significant financial and other resources to develop EUV source technology for chip manufacturing. These expenditures are reflected in our research and development expenses in our consolidated statements of operations, as well as inventory and property, plant and equipment in our consolidated balance sheets.
As of March 31, 2012, we have shipped, received customer acceptance and recorded revenue for six EUV 3100 pilot sources. We also received orders for our next generation EUV 3300 sources, which we expect to start shipping this year. We currently record revenue associated with EUV sources when customer acceptance is received equal to amounts that are fixed and determinable at the date of acceptance.
Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits. The technology underlying EUV is extremely complex, and we have experienced some delays that have put us behind schedule in our EUV source development. We may not be able to introduce commercial EUV systems on time, or at all. If we are not able to meet customer specifications, or have reliability or performance problems, or if the pilot sources and eventually commercial systems do not meet customer specifications or are not introduced on time, or if our inventory balances exceed the net realizable value under the related contracts, or if a competitors source is selected over our source, we may experience any or all of the following: the need to record impairment charges to our inventory and/or property, plant and equipment, reduced orders, order cancellations, higher manufacturing costs, delays in acceptance of and payment for new products, product rejections, and additional service and warranty expenses. These risks could also damage our reputation among the initial adopters of EUV source technology and limit our ability to penetrate the market. For example, we have entered into a supply agreement for EUV sources with ASML, one of our significant customers for DUV light sources. Significant setbacks in our EUV program, or disagreement with ASML regarding its specifications for commercial systems, could impact the amount and timing of purchases of DUV light sources by ASML. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.
A significant percentage of our revenue is derived from sales to a limited number of customers, and if we are not able to retain these customers, or they reschedule, reduce or cancel orders, or delay or default on payments, we may experience material adverse effects on our operating results, financial condition and cash flows.
Two large companies, ASML and Nikon, dominate the photolithography tool business. ASML, Nikon and Samsung, one of our chipmaker customers that purchase our installed base products, accounted for the following percentages of our revenue during the periods indicated:
We expect that sales to these customers will continue to account for a substantial portion of our revenue in the foreseeable future. None of our customers are obligated to purchase a minimum number of our products in the aggregate or during any particular period. We can provide no assurance that any of our customers will continue to purchase our products at past or current levels. Sales to any of these customers may be affected by many factors, some of which are beyond our control. These factors include:
These companies accounted for the following percentages of our total accounts receivable at the dates indicated:
We believe there is limited credit risk exposure for us with these companies who continue to demonstrate sound creditworthiness. However, our ability to generate future revenue and collect accounts receivable from them is dependent on their ongoing financial condition and liquidity.
The loss of any significant business from, or production problems or disruption due to natural disasters for, any one of these customers may have a material adverse effect on our operating results, financial condition and cash flows.
The majority of our revenue is derived from selling our light source systems and supporting the installed base of light source systems being used in production.
We expect sales of our light source systems, including KrF and ArF systems, and the products in support of the installed base of light source systems to continue to account for a majority of our revenue in the near term. Continued market acceptance of our light source systems and installed base products is, therefore, critical to our future success. The rate at which chipmakers adopt light sources may vary, for reasons including:
We cannot guarantee that these factors can or will be overcome or that the demand for our light source systems and installed base products will not be materially reduced. The demand for our light source systems and installed base products, and therefore our operating results, financial condition and cash flows could be adversely affected by a number of factors, including:
We depend on a few key suppliers for purchasing components and subassemblies that are included in our products.
We purchase a limited number of components and subassemblies included in our light source systems, installed base products and silicon crystallization tools from a single supplier or a small group of suppliers. There may also be single source suppliers that we are not aware of for components of our purchased subassemblies. To reduce the risk associated with these suppliers, we have supply agreements in place and carry a strategic inventory of these components. Strategic inventories are managed as a percentage of future demand. We also have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract for the manufacture of various subassemblies of our products and depend on our contract manufacturers to deliver to our required specifications, schedule, and quality standards. Further, some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and, therefore, are susceptible to industry fluctuations and subject to the same risks and uncertainties as we are regarding the ability to respond to changing market and global economic conditions. Because many of these suppliers reduce their workforce in an industry downturn and rehire in an upturn, they may not be able to meet our requirements or respond quickly enough as an upturn begins and gains momentum. Due to the nature of our product development requirements, these key suppliers must rapidly advance their own technologies and production capabilities in order to support the introduction schedule of our new products. These suppliers may not be able to provide new modules and subassemblies when they are needed to satisfy our manufacturing and delivery schedules. These suppliers may also be adversely affected by economic conditions, which could result in a lack of available capital and limit their ability to access such capital, if needed, to fund their operations. In addition, if we cannot purchase enough of these materials, components or subassemblies, or if these items do not meet our quality standards, there could be delays or reductions in our product shipments, which may have a material adverse effect on our business, operating results, financial condition and cash flows.
We depend on the introduction of new products for our success, and we are subject to risks associated with rapid technological change.
The development, introduction and support of new products in a competitive business environment are complex processes and could be expensive. New or improved products may lead to higher costs and perhaps reduced profits. Rapid technological changes in
semiconductor manufacturing processes subject us to increased pressure to develop technological advances which enable such processes. We believe that our future success depends in part upon our ability to develop, manufacture, and support new light source products with improved capabilities on a timely basis and to continue to enhance our existing product and process capabilities. Due to the risks inherent in transitioning to new products, we must forecast accurate demand for new products while managing the transition from established products. After our chipmaker customers have built their capacity to levels appropriate to meet existing demand, their demand for our light source products will depend, in part, on their sales forecasts, their estimates regarding the duration and magnitude of the current industry cycle and whether their projected manufacturing process yields will enable ongoing investments at a suitable level of capacity. To provide our customers with more productive and lower cost of operation systems, our existing light source systems and their process capabilities must be enhanced, and we must develop and manufacture new products, such as EUV sources, to continue to grow our business. We cannot guarantee that we will be able to grow our business. We may not be able to develop and introduce new sources, products or enhancements to our existing products and processes in a timely or cost effective manner that satisfies customer needs or achieves market acceptance. Development of new sources, products and enhancements to existing products represent significant investments of our resources, and there is no guarantee that we will realize a return on these investments. Further, we may not be able to effectively integrate new sources, products and applications into our current operations. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.
Current technologies that are still being developed and commercialized, such as EUV, and future technologies such as nano-imprint lithography and certain maskless lithography techniques may render our existing light source systems and products obsolete. We must manage product transitions, as the introduction of new products could have a negative adverse effect on our sales of existing products.
The display industry continues to be driven by new applications, such as the use of smart phones and ongoing expansion of traditional display markets such as laptops, tablets, and televisions. In addition, the display industry continues to introduce new capabilities, including better visual appearance such as three dimensional (3D) displays, lower power consumption, reduced thickness, and lower cost. In addition to the established display technologies such as LCDs that are used in numerous products, new display technologies such as OLED are starting to enter the market. Our current products might not adequately address these shifting demands, and we may not be able to develop and introduce new products or enhancements to our existing products and processes in a timely or cost effective manner that satisfies customer needs or achieves market acceptance.
We could fail to penetrate the display market and may not achieve profitability in our TCZ operating segment.
Our TCZ operating segment develops, integrates, markets and supports silicon crystallization tools used in the manufacture of different types of displays, including high-resolution LTPS-LCD and OLED displays. The manufacture of silicon crystallization tools is a new market for us and involves numerous risks. The global display industry historically has experienced considerable volatility in capital equipment investment levels, due in part to the limited number of high-resolution LTPS-LCD and OLED manufacturers and the concentrated nature of high-resolution LTPS-LCD and OLED end-use applications.
We may not experience sufficient demand for TCZs silicon crystallization tools for high-resolution LTPS-LCD and OLED processing in the manufacture of displays. We have shipped three TCZ tools and received customer acceptance for two TCZ tools for display fabrication. We have received additional orders for TCZ tools and will record revenue associated with these tools when customer acceptance is received. If future tools do not meet customer specifications or the customers decide not to place follow-on orders for additional tools, we may experience damage to our reputation among manufacturers of high-resolution LTPS-LCD and OLED fabrication systems and there is no guarantee that we will be able to materially penetrate this market or ever achieve profitability in our TCZ operating segment. To the extent TCZ is unable to achieve profitability, or we are obligated to provide increasing financial resources to support our silicon crystallization tool operations, our business, operating results, financial condition and cash flows could be materially adversely affected.
Global economic conditions could affect our revenue and operating results.
A general weakening of, or declining corporate or consumer confidence in, the global economy, or a reduction in corporate or consumer spending, could delay or significantly decrease purchases of our products by our customers, which are driven in part by indirect consumer demand for the electronic devices that contain semiconductor chips. It could also decrease revenue from our installed base products by causing our chipmaker customers to reduce their usage rates. Our revenue and operating results will be affected by uncertain or changing economic and market conditions including inflation, deflation, prolonged weak consumer demand or other changes which may affect the principal markets in which we conduct business. If economic or market conditions in the United States or other key global markets deteriorate, we may experience material adverse effects on our business, operating results, financial condition and cash flows.
Adverse economic and market conditions could also harm our business by negatively affecting the parties with whom we do business, including our business partners, our customers and our suppliers. These conditions could impair the ability of our customers to pay for products they have purchased from us. As a result, allowances for doubtful accounts and write-offs of accounts receivable from our customers may increase. In addition, our suppliers may experience financial difficulties that could negatively affect their operations and their ability to supply us with the parts we need to manufacture our products.
We face competition in the DUV and EUV lithography market and could face additional competition if other competitors enter the market.
Our future performance depends, in part, upon our ability to continue to compete successfully worldwide. The principal elements of competition in our markets are the technical performance characteristics of light source products and the operating efficiency of the system, which is based on availability, reliability, performance efficiency, cost of ownership, and overall quality.
We currently have one DUV light source competitor, Gigaphoton. Gigaphoton is a wholly owned subsidiary of Komatsu and is headquartered in Japan. Our customers have purchased products from Gigaphoton and have qualified Gigaphotons DUV light source systems for use with their products. Additionally, Gigaphotons DUV light sources have been qualified by a number of chipmakers in Europe, Japan, other regions in Asia and the United States, and Gigaphoton has an installed base of light source systems at chipmakers in these regions. We also face competition from Gigaphoton and Ushio, also headquartered in Japan, in the development of EUV source technology.
Future competitors may develop systems and products that are competitive to our products. This competition may affect our ability to sell our products. Larger companies with substantially greater resources, such as other manufacturers of industrial light sources for advanced lithography, may attempt to sell competitive products to our customers. Potential competitors may also be attracted to our growing installed base of DUV light sources which represents a significant revenue stream for us, and they may attempt to supply replacement parts to our customer base. If any existing or future competitors gain market acceptance, we could lose market share and our growth could slow or decline, which could have a material adverse effect on our business, operating results, financial condition and cash flows.
We face competition in the display market.
We face strong competition in the display market from a number of established competitors, including Japan Steel Works, AP Systems, Sumitomo Heavy Industries and others. Many of these companies have been qualified by a number of display makers in Japan, South Korea, Taiwan and China, and have a number of tools currently installed. In addition to the competitors mentioned above, there are other potential competitors that provide equipment for crystallization that uses a thermal source, rather than a laser, to perform crystallization.
We must effectively manage changes in our business.
In order to respond to the business cycles of the semiconductor industry and overall economic conditions, we must constantly adjust our business plan and cost structure. As the semiconductor equipment industry cycle moves between contraction and growth and the condition of the global economy changes, we need to:
If we fail to effectively manage changes in our business, we may experience a material adverse effect on our operating results, financial condition and cash flows.
Any failure to manage our inventory levels and our inventory controls at our widely dispersed operations could adversely affect our business, operating results, financial condition and cash flows.
We need to continually evaluate and monitor the adequacy of our inventory levels. We also need to closely manage the levels of obsolete and excess parts. We have inventory located at warehouses at our corporate office in the United States and at bonded warehouses and customer locations throughout Asia, Europe and North America. The success of our business depends to a significant
degree on our ability to maintain or increase the sales of our products in the markets in which we do business. If we overestimate demand for our products or the overall condition of the global economy, we could experience excess inventory levels and use unnecessary cash. As a result of such excess inventory, we may be required to significantly write down the value of our inventory, which would negatively affect our operating results and financial condition.
We could also sustain a loss in the event of a catastrophe in any of the locations where we maintain our inventory if our insurance is inadequate to cover such losses. We will be required to continually analyze the sufficiency of our inventory distribution systems in order to support our operations. We may not adequately anticipate all of the changing demands that will be imposed on these systems. An inability or failure to update our internal inventory distribution systems or procedures, as required, could have a material adverse effect on our business, operating results and financial condition.
International operations expose us to foreign currency exchange rate fluctuations for all foreign currencies in which we do business and we may be materially adversely affected by these fluctuations.
We have international subsidiaries that operate in foreign currencies. All of our international subsidiaries purchase inventory in U.S. Dollars from either our manufacturing facility in San Diego or from our South Korean subsidiary and, in many cases, resell these products to their customers in their local currency. In addition, we purchase certain inventory in Euros. We hedge the foreign currency risks associated with these intercompany transactions by entering into forward contracts. Although we enter into such forward contracts, they may not be adequate to eliminate the risk of foreign currency exchange rate exposures.
We have taken steps to mitigate our foreign currency exchange risks; however, these steps may fail to sufficiently hedge or otherwise manage our foreign currency risks properly and could have a material adverse effect on our operating results and financial condition.
International operations also expose us to currency fluctuations as we translate the financial statements of our international subsidiaries to U.S. Dollars, and a significant strengthening of the U.S. Dollar relative to international currencies would increase the effective prices our customers pay for our products, potentially reducing demand for them.
Failure to effectively maintain our direct service support operations could have a material adverse effect on our business.
We believe it is critical for us to provide direct, quick and responsive support to our chipmaker and direct customers who use our light source products in their photolithography systems as well as to display manufacturers that purchase our silicon crystallization tools. It is also essential to have well trained field service engineers to provide the high level of support that our customers have come to expect. Accordingly, we have an ongoing effort to develop our direct support system with service locations in China, Europe, Japan, Singapore, South Korea, Taiwan and the United States. This requires us to do the following:
We may not be able to attract and train qualified personnel to maintain our direct support operations successfully. Further, we may incur significant costs in providing this support. Failure to implement our direct support operation effectively could harm our operating results, financial condition and cash flows.
We are dependent on our suppliers and manufacturing facilities to assemble and test our products.
Operations at our primary manufacturing facility in San Diego and refurbishment facility in South Korea and operations at our suppliers are subject to disruption for a variety of reasons, including, but not limited to, work stoppages, terrorism, political turmoil, fire, natural disasters, or energy shortages. Such disruptions could cause delays in shipments of our products to our customers. Our San Diego facility, where we build our light source systems and replacement parts, poses the greatest risk. We provide no assurance that alternate production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms, or at all. Such disruption could result in cancellation of orders or loss of customers, which would have a material adverse effect on our operating results, financial condition and cash flows.
We depend on key personnel, particularly management and technical personnel, who may be difficult to attract and retain.
We are highly dependent on the services of many key employees in various areas, including:
In particular, there are a limited number of experts in DUV and EUV source technology and the silicon crystallization process for display fabrication, and we require highly skilled hardware and software engineers. Competition for qualified personnel is intense and we cannot guarantee that we will be able to continue to attract and retain qualified personnel. We believe our future growth and operating results will depend on the following:
We grant equity awards to key employees. Stock options, performance-based restricted stock unit awards and restricted stock unit awards may not be viewed by key employees as a sufficient financial incentive during periods when stock price volatility could cause our stock price to fall, reducing the effectiveness of such awards as a means to retain and incentivize these employees. If we are unable to hire, train and retain key personnel as required, our operating results, financial condition and cash flows could be adversely affected.
Economic, political, regulatory and other events in geographic areas where we have significant revenue or operations could interfere with our business.
We serve a global market and a large portion of our revenue is derived from customers outside of the United States. We expect our international sales to continue to account for the majority of our total revenue. In order to support our foreign customers, we maintain a refurbishment facility in South Korea as well as field support facilities in China, Japan, the Netherlands, Singapore and Taiwan.
Various factors may inhibit our ability to manage our operations to address and support our global customers effectively. Further, our investments in these types of activities may not be viably competitive in the global market, or we may not be able to meet the support or manufacturing levels required by our global customers. Additionally, we are subject to risks inherent in doing business globally, including but not limited to:
A significant portion of our customer base is located in Asia. Political turmoil, economic problems and currency fluctuations affecting Asia could increase our risk in that region. It has not been difficult for us to comply with United States export controls; however, changes to these controls in the future could make it more difficult or impossible for us to export our products to many countries. There are certain risks for which we purchase limited or no insurance, including earthquake risk. Any of these vulnerabilities could have a material adverse effect on our business, operating results, financial condition and cash flows.
Currently, ten of our international employees are members of a labor union; however, none of our United States employees are members of a labor union. If a greater number of our employees decide to join a union, our cost of doing business could increase, and we could experience contract delays, difficulty in adapting to a changing regulatory and economic environment, cultural conflicts between unionized and non-unionized employees, strikes and work stoppages, any of which could have a material adverse effect on our business, financial condition and operating results.
Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights. These types of claims could seriously harm our business or require us to incur significant costs.
We believe our success and ability to compete depend in part upon protecting our proprietary technology. We rely on a combination of patent, trade secret, copyright and trademark laws, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. We own and have numerous patents pending in the United States and various foreign countries covering certain aspects of technology related to our light source systems and silicon crystallization tool. Patents related to our source technologies and piezoelectric techniques will expire at various times through 2030, and patents related to our silicon crystallization tools will expire at various times through 2029.
Our pending patent applications and any future applications might not be approved. Our patents may not provide us with a competitive advantage and may be successfully challenged by third parties. In addition, third parties patents might have an adverse effect on our ability to do business. Due to cost constraints, we do not seek international patent protection for all inventions that are covered by United States patents and patent applications. As a result, we do not have foreign patent protection for some of our inventions. Additionally, laws of some foreign countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products or intellectual property rights to the same extent as do the laws of the United States Therefore, the likelihood of piracy of our technology and products is greater in these countries. Further, third parties might independently develop similar products, duplicate our products, or design around patents that are granted to us.
Other companies or persons may file or have filed patent applications that are similar or identical to ours. As a result, we may have to participate in appropriate proceedings in the courts or the patent offices to determine the priority of inventions. These proceedings may determine that these third-party patent applications have priority over our patent applications. Loss of priority in these interference proceedings could result in substantial cost to us and loss of rights.
We also rely on the following to protect our confidential information and our other intellectual property:
However, we may not be successful in protecting our confidential information or intellectual property, particularly our trade secrets, because third parties may:
We may be subject to patent litigation to enforce patents issued to us or defend ourselves against claimed infringement by our competitor or any other third party.
Third parties have notified us in the past, and may notify us in the future, that we are infringing their intellectual property rights. Also, we have notified third parties in the past, and may notify them in the future, that they may be infringing our intellectual property rights. In the future, patent litigation may result due to a claim of infringement by our competitor or any other third party or may be necessary to enforce patents issued to us. Any such litigation could result in substantial cost to us and diversion from our primary business efforts, which would have an adverse effect on our business, financial condition and operating results. Furthermore, our customers and the end-users of our products might assert other claims for indemnification that arise from infringement claims against them. If these assertions are successful, it may have a material adverse effect on our business, operating results, financial condition and cash flows. Instead of litigation, or as a result thereof, we may seek a license from third parties to use their intellectual property. However, we may not be able to obtain a license. Alternatively, we may design around the third partys intellectual property rights or we may challenge these claims in legal proceedings. Any adverse determination in a legal proceeding could result in one or more of the following:
Any of these actions could be costly and would divert the efforts and attention of our management and technical personnel, which could have a material adverse effect on our business, operating results, financial condition and cash flows.
If our goodwill, amortizable intangible assets or property, plant and equipment become impaired, we may be required to record a significant charge to earnings.
We review our amortizable intangible assets, which are primarily patents, and our property, plant and equipment, for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. Goodwill is also tested for impairment at least annually and more often if certain triggering events or circumstances occur. Factors that may be considered to be a change in circumstances that would indicate the carrying value of our goodwill, amortizable intangible assets or property, plant and equipment may not be recoverable include reduced future cash flow estimates for our company, a decline in our stock price and market capitalization, slower growth rates in our industry and adverse global economic conditions. If, as a result of our impairment test, it is determined that our goodwill, amortizable intangible assets or property plant and equipment is impaired, we may be required to record a significant write down in our financial statements during the period in which such impairment is determined, which may have a material adverse effect on our operating results.
Our investments in marketable securities are subject to market, interest and credit risk that may reduce their value.
The value of our investments in marketable securities may be adversely affected by changes in interest rates, downgrades in the creditworthiness of bonds we hold, turmoil in the credit markets and financial services industry and by other factors which may result in other than temporary declines in the value of our investments. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio, which could have a material adverse effect on our operating results and financial position.
Changes in our effective tax rate may have a material adverse effect on our operating results, financial position and cash flows.
Our future effective tax rate may be adversely affected by a number of factors including:
An adverse change in our future effective tax rate could in turn, adversely affect our operating results, financial position and cash flows.
Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.*
We are subject to taxation in the United States and in various states and foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, VAT and GST. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Although we believe that our approach to determining our worldwide income tax provisions and other tax accruals is consistent with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our determinations. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.
From time to time, we are audited by various state, federal and tax authorities of the countries in which we operate. Our tax years 2008 and forward are subject to examination by the IRS, our tax years 2000 and forward are subject to examination by material state jurisdictions, and our tax years 2004 and forward are subject to examination by material foreign jurisdictions. Several of our subsidiaries are currently under audit or appeal. No outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.
As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authoritys respective positions on any disputed matters. We provide for potential tax exposures by accruing for uncertain tax positions based on judgment and estimates including historical audit activity. If the reserves are insufficient or we are not able to establish a reserve under GAAP prior to completion or during the progression of any audits, there could be an adverse impact on our financial position and results of operations when an audit assessment is made.
It is reasonably possible that the examination phase of our current audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate and our results of operations. In addition, our external costs of contesting and settling any dispute with the tax authorities could be substantial and adversely impact our financial position and results of operation.
We may not have sufficient cash to fund our current operations and future growth plans.
We believe that our cash resources remain sufficient for our planned operations; however, if global economic conditions deteriorate, our business conditions worsen, our plans change or other unanticipated events occur, we may need to raise additional cash through the establishment of financing facilities or the sale of equity or debt securities to fund our operations. Depending on market conditions, it could be difficult for us to raise the additional cash needed without incurring significant dilution of our existing stockholders or agreeing to significant restrictions on our ability to operate as currently planned. If we were unable to raise additional cash in such circumstances, we could be required to reduce costs through the delay, reduction or curtailment of our operating plan, including reductions in our global workforce or other cost reduction actions, any of which could have a material adverse effect on our operating results, financial condition or cash flows.
As of March 31, 2012, we have $35.7 million of cash and cash equivalents in foreign subsidiaries. In the event these cash amounts are needed to fund operations in the U.S., we believe we would not be liable for U.S. taxes in connection with repatriating these funds given that these funds would be used to repay existing intercompany payables and/or loans due to the U.S. parent company.
The integration and operation of a business acquisition may disrupt our business and create additional expenses, and we may not achieve the anticipated benefits of the acquisition. We may also acquire other businesses or enter new markets that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational and financial challenges.
The risks involved with acquisitions, mergers, and joint ventures or entering a new market include the following:
The success of an acquisition assumes certain synergies and other benefits. We cannot assure you that these risks or other unforeseen factors will not offset the intended benefits of the acquisition, in whole or in part. The magnitude, timing and nature of any future acquisitions or investments will depend on a number of factors, including the availability of suitable candidates, the negotiation of acceptable terms, our financial capabilities and general economic and business conditions. Financing for future transactions would result in the utilization of cash, incurrence of debt, issuance of stock or some combination of the three. Further, any business that we acquire, any joint venture that we form, or new market we may enter may not achieve anticipated revenue or operating results and the costs of such activity may have a material adverse effect on our operating results, financial condition or cash flows.
We may experience difficulties with our enterprise resource planning (ERP) system or other critical information systems that we use for the daily operations of our business. System failure or malfunction or loss of data contained in these information systems may result in disruption of our operations and result in our inability to process transactions, and this could adversely affect our financial results.
System failure, malfunction or loss of data housed in our critical information systems could disrupt our ability to timely and accurately process transactions and produce key financial reports, including information on our operating results, financial position and cash flows. Any disruptions or difficulties that may occur in connection with our ERP system or other critical systems could also adversely affect our ability to complete important business processes such as the evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. We also regularly upgrade our information systems hardware and software to better meet the information requirements needed to effectively manage our business. If we encounter unforeseen problems with regard to our ERP system or other critical information systems, including those encountered during system upgrades, our business could be adversely affected.
Compliance with changing regulations and standards for accounting, corporate governance and public disclosure may result in additional expenses.
Changing regulatory requirements for corporate governance and public disclosure including SEC regulations, NASDAQ Stock Market rules, and the Financial Accounting Standards Boards accounting standards requirements and the expected future requirement to transition to or converge with international financial reporting standards are creating uncertainty and additional complexities for publicly held companies such as ours. For example, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as say on pay and proxy access. Stockholder activism, the current political environment, financial reform legislation and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact (in ways we cannot currently anticipate) the manner in which we operate our business. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonably necessary resources to comply with such compliance programs and rules and all other evolving standards. These investments may result in increased general and administrative costs and a diversion of our managements time and attention from strategic revenue generating and cost management activities.
We are dependent on air transport to conduct our business and disruption of domestic and international air transport systems could adversely affect our business.
We depend on regular and reliable air transportation on a worldwide basis for many of our routine business functions. If civil aviation in the United States or abroad is disrupted by terrorist activities or security responses to the threat of terrorism, regulatory compliance issues, weather or atmospheric conditions or for any other reason, our business could be adversely affected in the following ways:
We are subject to many standards and regulations of foreign governments and, even though we intend to comply, we may not always be in compliance with these rules, or we may be unable to design or redesign our products to comply with these rules.
Many foreign government standards and regulations apply to our products and these standards and regulations are frequently being amended. Although we intend to meet all foreign standards and regulations, our products may not comply with all of them. Further, it might not be cost effective for us to redesign our products to comply with these foreign government standards and regulations. Our inability to design products to fully comply with foreign standards, therefore, could have a material adverse effect on our business.
Our chipmaker customers prolonged use of our products in high volume production may not produce the results they desire and, as a result, our reputation and that of our customers who supply photolithography tools to the chipmakers could be damaged in the semiconductor industry.
Over time, our light source products may not meet our chipmaker customers production specifications or operating cost requirements after the light source has been used for a long period in high volume production. If any chipmaker cannot successfully achieve or sustain their volume production using our light sources, our reputation could be damaged with them and with lithography tool manufacturers. This would have a negative effect on our business.
Our operations are subject to environmental and other government regulations that may expose us to liabilities for noncompliance.
We are subject to federal, state and local regulations, such as regulations related to the environment, land use, public utility utilization and the fire code, in connection with the storage, handling, discharge and disposal of substances that we use in our manufacturing process and in our facilities. We believe that our activities comply with current government regulations that are applicable to our operations and current facilities. We may be required to purchase additional capital equipment or meet other requirements to comply with these government regulations in the future, if they change. Further, these government regulations may restrict us from expanding our operations. Adopting measures to comply with changes in the government regulations, our failure to comply with environmental and land use regulations, or restrictions on our ability to discharge hazardous substances, could subject us to future liability or cause our manufacturing operations to be reduced or stopped. This could have a material adverse effect on our business, operating results, financial condition and cash flows.
Our products are subject to potential product liability claims if personal injury or death results from their use.
We are exposed to significant risks for product liability claims if personal injury or death results from the use of our products. We may experience material product liability losses in the future. We maintain insurance against product liability claims; however, our insurance coverage may not continue to be available on terms that are acceptable to us. This insurance coverage also may not adequately cover liabilities that we incur. Further, if our products are defective, we may be required to recall or redesign these products. A successful claim against us that exceeds our insurance coverage level, or any claim or product recall that results in adverse publicity against us, could have a material adverse effect on our business, operating results, financial condition and cash flows.
Disputes may arise over the ownership of intellectual property resulting from our research and development activities that have been partially funded by other parties.
In the past, we have occasionally received funds through research and development arrangements with third parties to pay for a portion of our research and development costs associated with the design and development of specific products. Additionally, funds from lithography tool manufacturers and chipmaker customers have been used to fund a portion of our source systems research and development efforts. In connection with providing these research and development services, we try to make contractually clear who owns the intellectual property that results from such activities. Disputes over the ownership or rights to use or market the resulting intellectual property could arise between the funding organizations and us. Any dispute over ownership of the intellectual property we develop or have developed could restrict our ability to market our products and have a material adverse effect on our business.
Trademark infringement claims against our registered and unregistered trademarks would be expensive and we may have to stop using such trademarks and pay damages.
We have registered a number of trademarks including CYMER in the United States and in some other countries. We are also trying to register additional trademarks in the United States and in other countries. These registrations in other countries, or any new registrations we may undertake in the United States, could be unsuccessful.
We use these trademarks in the course of our business and in advertising materials, which are distributed throughout the world. While we take precautions against trademark infringement before using our trademarks in new markets, we may be subject to claims of trademark infringement. The process of negotiating a settlement or coexistence agreement to allow us to continue using our trademarks in a particular market could be expensive or distract us from our primary business efforts, potentially adversely affecting our financial condition or operations. Furthermore, if we must undertake negotiations, and the negotiations are ultimately unsuccessful, we would either need to discontinue using the trademarks in the new market, risk facing litigation or potentially pay damages. Even if we ultimately prevail, litigation could be expensive or distract us from our primary business efforts.
The price of our common stock has fluctuated and may continue to fluctuate widely.
The price of our common stock has historically been subject to fluctuations and could continue to fluctuate in response to a variety of factors, including the risk factors contained in this report.
Various factors may significantly affect the market price and volatility of our common stock, including:
Stock markets in the United States can experience extraordinary volatility. Severe price fluctuations in a companys stock have frequently been followed by securities litigation. If such litigation were initiated against us, it may result in substantial costs and a diversion of managements attention and resources and, therefore, could have a material adverse effect on our business, operating results, financial condition and cash flows.
Some anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law and our executive employment contracts, could impair a takeover attempt.
Our articles of incorporation and bylaws contain provisions which could have the effect (separately, or in combination) of rendering more difficult or discouraging a merger, acquisition or other change of control deemed undesirable by our Board of Directors. These include provisions:
These provisions, alone or together, could deter or delay hostile takeovers, proxy contests and changes in control or management.
As a Nevada corporation, we are subject to Nevada law. Nevada law does not grant stockholders the authority to call a special meeting unless the corporations articles of incorporation or bylaws otherwise provide; neither our articles of incorporation nor our bylaws contain such a provision. Nevada law may also limit the ability of certain stockholders to engage in certain business combinations with us and may limit the voting rights of stockholders who acquire 20% or more of our outstanding shares. Either limitation could discourage or increase the difficulty of an attempted merger, acquisition or other change of control.
Additionally, we have employment agreements with certain officers under which severance payments would become payable in the event of specified terminations without cause or terminations under certain circumstances after a change in control. If such persons were terminated without cause or under certain circumstances after a change of control, and the severance payments under the current employment agreements were to become payable, the officers would receive certain payments and other benefits which depend on the individual officers employment agreement but generally include continued base salary and health insurance payments for a period of time, lump sum bonus payments and accelerated vesting of equity awards.
Any provision of our articles of incorporation, bylaws, employment agreements or Nevada law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock in connection with such a transaction and also could affect the price that some investors are willing to pay for our common stock.
Sales of additional common stock and securities convertible into our common stock may dilute the voting power of current holders.
We may issue equity securities in the future the terms and rights of which are superior to those of our common stock. Our articles of incorporation authorize the issuance of up to 5,000,000 shares of preferred stock. These are blank check preferred shares, meaning that our Board of Directors is authorized, from time to time, to issue the shares and designate their voting, conversion and other rights, including rights superior, or preferential, to rights of already outstanding shares, all without stockholder consent. No preferred shares are outstanding, and we currently do not intend to issue any shares of preferred stock. Any shares of preferred stock that may be issued in the future could be given voting and conversion rights that could dilute the voting power and equity of existing holders of shares of common stock and have preferences over shares of common stock with respect to dividends and liquidation rights.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable
(b) Not applicable
(c) On April 21, 2008, we announced that our board of directors authorized us to repurchase up to $100 million of our common stock. The purchases have been made from time to time in the open market. We did not repurchase any shares during the first quarter of 2012, and the approximate dollar value of remaining shares that we are authorized to purchase under the program was $57.8 million at March 31, 2012. The program does not have a fixed expiration date and may be discontinued at any time.
ITEM 5. Other Information
(b) There were no material changes to the procedures by which security holders may recommend nominees to our board of directors.
ITEM 6. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this quarterly report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.