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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the Quarterly Period Ended September 30, 2018

OR

For the transition period from          to

Commission File No. 001-36226

 

RUDOLPH TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

 

 

16 Jonspin Road, Wilmington, Massachusetts 01887

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (978) 253-6200

 

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).     Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐    No  ☒

The number of outstanding shares of the Registrant’s Common Stock on October 15, 2018 was 31,900,604.

 

 

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PART I FINANCIAL INFORMATION

Item 1. Financial Statements

RUDOLPH TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

The accompanying notes are an integral part of these financial statements.

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RUDOLPH TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

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RUDOLPH TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

 

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RUDOLPH TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

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RUDOLPH TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

 

NOTE 1. Basis of Presentation

The accompanying interim unaudited Condensed Consolidated Financial Statements have been prepared by Rudolph Technologies, Inc. (the “Company” or “Rudolph”) and in the opinion of management reflect all adjustments, consisting of normal recurring accruals, necessary for their fair presentation in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  Preparing financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes.  Actual amounts could differ materially from reported amounts.  The interim results for the three and nine month periods ended September 30, 2018 are not necessarily indicative of results to be expected for the entire year or any future periods.  This interim financial information should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (“2017 10-K”) filed with the Securities and Exchange Commission (“SEC”) on February 16, 2018.  The accompanying Condensed Consolidated Balance Sheet at December 31, 2017 has been derived from the audited consolidated financial statements included in the 2017 10-K.

 

Recent Accounting Pronouncements

Recently Adopted

Effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2016-16, “Income Tax (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.”  This ASU, which is part of the simplification initiative of the Financial Accounting Standards Board (“FASB”), is intended to reduce the complexity of U.S. GAAP and diversity in practice related to the tax consequences of certain types of intra-entity asset transfers, particularly those involving intellectual property.  The adoption of ASU No. 2016-16 did not have any impact on the Company’s consolidated financial position, results of operations, and cash flows.

Effective January 1, 2018, the Company adopted ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This ASU provides guidance on statement of cash flows presentation for eight specific cash flow issues where diversity in practice exists.  The adoption of ASU No. 2016-15 did not have a material impact on the Company’s consolidated financial position, results of operations, and cash flows.

Effective January 1, 2018, the Company adopted ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes nearly all existing revenue recognition guidance.  The core principle of this ASU is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. As a result of the adoption of ASU No. 2014-09, the Company changed its accounting policy for revenue recognition. Refer to Note 2, “Revenue” for further information.

Recently Issued

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.”  This ASU is part of the FASB’s larger disclosure framework project intended to improve the effectiveness of financial statement footnote disclosure.  ASU 2018-13 modifies required fair value disclosures related primarily to level 3 investments.  This ASU is effective for annual periods beginning after December 15, 2019 and interim periods within those annual periods.  The adoption of ASU 2018-13 is not expected to have a material effect on the Company’s consolidated financial position, results of operations, and cash flows.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.”  This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees.  An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost.  The ASU is effective for the fiscal years beginning after December 15, 2018, including interim periods within that fiscal year.  The adoption of ASU 2018-07 is not expected to have a material effect on the Company’s consolidated financial position, results of operations, and cash flows.  

In February 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.”  The new guidance allows

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companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act (the “2017 Tax Act”) from accumulated other comprehensive income to retained earnings.  The guidance also requires certain new disclosures regardless of a company’s election.  The standard is effective for annual periods beginning after December 15, 2018 and for interim periods within those annual periods, with earlier adoption permitted.  The adoption of ASU 2018-02 is not expected to have a material effect on the Company’s consolidated financial position, results of operations, and cash flows.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation (Topic718): Scope of Modification Accounting.”  This ASU amends the scope of modification accounting for share-based payment arrangements and provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under Accounting Standards Codification (“ASC”) 718.  The ASU is effective for the fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years.  The Company is currently evaluating the effect the adoption of ASU No. 2017-09 will have on its consolidated financial position, results of operations, and cash flows, if any.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”  This ASU eliminates Step 2 from the goodwill impairment test.   Accordingly, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to the excess, limited to the total amount of goodwill allocated to the reporting unit.  The ASU is effective for the fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years.  The Company is currently evaluating the effect the adoption of ASU No. 2017-04 will have on its consolidated financial position, results of operations, and cash flows, if any.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326),” which introduces new guidance for the accounting for credit losses on instruments within its scope.  Given the breadth of that scope, the new ASU will impact both financial services and non-financial services entities.  The standard is effective for fiscal years beginning after December 15, 2020.  The Company is currently evaluating the effect the adoption of ASU No. 2016-13 will have on its consolidated financial position, results of operations, and cash flows, if any.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The FASB issued this update to require the recognition of lease assets and lease liabilities on the balance sheet of lessees. In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements” and ASU No. 2018-10, “Codification Improvements to Topic 842, Leases.” ASU No. 2016-02 and the subsequent modifications are identified as “ASC 842.” ASC 842 will be effective for fiscal years beginning after December 15, 2018, including interim periods within such fiscal years. Early adoption is permitted. The Company intends to adopt ASC 842 using a modified retrospective transition method and will elect the package of practical expedients. The Company expects adoption to increase the assets and liabilities recorded on its consolidated balance sheet and increase the level of disclosures related to leases. In addition, the Company is in the process of identifying appropriate changes to its accounting policies, business processes, and related internal controls to support recognition and disclosure requirements under ASC 842.

Recently issued accounting guidance not discussed above is not applicable or did not have, or is not expected to have, a material impact to the Company.

NOTE 2. Revenue

Adoption of ASC Topic 606, “Revenue from Contracts with Customers”

On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.  The Company did not record a cumulative impact due to the adoption of Topic 606.

Revenue Recognition

Revenue is recognized when control of the promised goods or services are transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to receive in exchange for those goods or services.  The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

The Company has elected to account for shipping and handling activities as the fulfillment of a promise to transfer goods to the customer and therefore records these activities under the caption “Cost of revenue.”  Sales tax and any other taxes collected concurrent with revenue producing activities are excluded from revenue.  Incidental items that are immaterial in the context of the contract are recognized as expense.  These accounting policy elections are consistent with the manner in which the Company has historically recorded these items.  

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Contracts with customers may include multiple performance obligations. For such arrangements, the Company allocates revenue to each performance obligation based on its relative standalone selling price. The Company generally determines standalone selling prices based on the prices charged to customers or the expected cost plus margin.

Disaggregated Revenue

The following table presents the Company’s revenue disaggregated by revenue source:

 

The following table represents a disaggregation of revenue by timing of revenue:

 

See Note 15 for additional discussion of the Company’s disaggregated revenue in detail.

Systems Revenue

Revenue from systems is recognized when the Company transfers control of the product to the customer.  To indicate transfer of control, the Company must have a present right to payment, legal title must have passed to the customer and the customer must have the significant risks and rewards of ownership.  The Company generally transfers control for system sales when the customer or the customer’s agent picks up the system at the Company’s facility.  Payment for the majority of the Company’s systems have 80-90% of the invoice amount due within 30 days and the remaining amount due upon customer acceptance, which includes installation, recalibration and qualification by the customer.  Customer acceptance is generally based on the Company’s products meeting published performance specifications, which have been demonstrated prior to shipment.  The Company provides an assurance warranty on its systems for a period of twelve to fifteen months against defects in material and workmanship.  The Company provides for the estimated cost of product warranties at the time revenue is recognized.

Depending on the terms of the systems arrangement, the Company may also defer the recognition of a portion of the consideration expected to be received because the Company has to satisfy a future obligation (e.g., installation, training and extended warranties). The Company uses an observable price to determine the standalone selling price for separate performance obligations or a cost plus margin approach when one is not available.

Software Licensing, Support and Maintenance Revenue

Revenue from software licenses provides the customer with a right to use the software as it exists when made available to the customer.  Revenue from software licenses are recognized upfront at the point in time when the software is made available to the customer.  Revenue from licensing support and maintenance is recognized as the support and maintenance are provided, which is over the contract period.  Payment for software licensing, support and maintenance is generally due in 30 days.  

Parts Revenue

Revenue from parts is recognized when the Company transfers control of the product, which typically occurs when the Company ships the product from its facilities to the customer.  Payment for parts is generally due in 30 days.  

Services Revenue

Revenue from services primarily consists of service contracts, which provide additional maintenance coverage beyond the Company’s assurance warranty on its products, service labor, consulting and training.  Revenue from service contracts is recognized ratably over the term of the service contract.  Revenue from service labor, consulting and training is recognized as services are performed.  Payment for services is generally due in 30 days.  

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Contract Liabilities

The Company records contract liabilities when the customer has been billed in advance of the Company completing its performance obligations. These amounts are recorded as deferred revenue in the Consolidated Balance Sheets.  The beginning balance in deferred revenue was $7,206 as of January 1, 2018.

Changes in deferred revenue were as follows:

 

 

Practical Expedients

The Company generally expenses sales commissions when incurred because the amortization period is one year or less. These costs are recorded within selling, general and administrative expenses.

The Company does not adjust the amount of consideration for the effects of a significant financing component as the payment terms are generally one year or less.

The Company does not disclose the value of remaining performance obligations for contracts with an original expected length of one year or less and contracts for which the Company recognizes revenue in the amount to which it has the right to invoice.

NOTE 3. Fair Value Measurements

The Company applies a three-level valuation hierarchy for fair value measurements.  This hierarchy prioritizes the inputs into three broad levels.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the asset or liability.  Level 3 inputs are unobservable inputs based on management’s assumptions used to measure assets and liabilities at fair value.  A financial asset’s or liability’s fair value measurement classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

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The following tables provide the assets and liabilities carried at fair value measured on a recurring basis at September 30, 2018 and December 31, 2017:

 

 

The Company’s available-for-sale debt securities classified as Level 1 are based on quoted market prices that are available in active markets.

The Company’s available-for-sale debt securities classified as Level 2 are valued using observable inputs to quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency.  The foreign currency forward exchange contracts are primarily measured based on the foreign currency spot and forward rates quoted by the banks or foreign currency dealers.  Investment prices are obtained from third party pricing providers, which model prices utilizing the above observable inputs, for each asset class.

Level 3 liabilities consisted of contingent consideration related to an acquisition for which the Company uses a discounted cash flow model to value these liabilities.  The Level 3 assumptions used in the discounted cash flow model for the contingent consideration included projected revenue, timing of cash flows and estimates of discount rates of 9.4% and 8.6% for the nine months ended September 30, 2018 and 2017, respectively.  A significant decrease in the projected revenue or increase in discount rates could result in a significantly lower fair value measurement for the contingent consideration.  

This table presents a reconciliation of all liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2018:

 

 

See Note 4 for additional discussion regarding the fair value of the Company’s marketable securities.

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Fair Value of Other Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates fair value because of the short-term maturity of these instruments.  The estimated fair value of these obligations is based primarily on a market approach, comparing the Company’s interest rates to those rates the Company believes it would reasonably receive upon re-entry into the market.  Judgment is required to estimate the fair value, using available market information and appropriate valuation methods.

The carrying amount of the convertible note receivable approximates fair value based on current interest rates for instruments with similar characteristics.

NOTE 4. Marketable Securities

The Company has evaluated its investment policies and has determined that all of its marketable securities, which are comprised of debt securities, are to be classified as available-for-sale.  The Company’s available-for-sale debt securities are carried at fair value, with the unrealized gains and losses reported in Stockholders’ equity under the caption “Accumulated other comprehensive loss.”  Realized gains and losses on available-for-sale debt securities are included in “Other expense” in the Condensed Consolidated Statements of Operations.  The Company records other-than-temporary impairment charges for its available-for-sale debt securities when it intends to sell the securities, it is more-likely-than not that it will be required to sell the securities before a recovery, or when it does not expect to recover the entire amortized cost basis of the securities.  The cost of securities sold is based on the specific identification method.

The Company has determined that the gross unrealized losses on its marketable securities at September 30, 2018 and December 31, 2017 are temporary in nature.  The Company reviews its investment portfolio to identify and evaluate marketable securities that have indications of possible impairment.  Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been less than the cost basis, credit quality and the Company’s ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value.

At September 30, 2018 and December 31, 2017, marketable securities are categorized as follows:

 

 

The amortized cost and estimated fair value of marketable securities classified by the maturity date listed on the security, regardless of the Condensed Consolidated Balance Sheet classification, are as follows at September 30, 2018 and December 31, 2017:

 

 

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The following table summarizes the estimated fair value and gross unrealized holding losses of marketable securities, aggregated by investment instrument and period of time in an unrealized loss position, at September 30, 2018 and December 31, 2017:

 

 

See Note 2 for additional discussion regarding the fair value of the Company’s marketable securities.

NOTE 5. Convertible Note Receivable

 

The Company entered into a convertible loan agreement with Simax Precision Technologies Limited (“Simax”) on May 31, 2018.  Simax may borrow from the Company up to $15,000 in multiple promissory notes.  The Company expects to be a supplier of lithography modules to Simax which is focused on the manufacture, sale and service of lithography systems.  

 

The convertible notes will bear a rate of interest of 4.25% per annum payable on a semi-annual basis.  The convertible notes provide the Company with the option to convert the outstanding indebtedness into equity.   If the Company does not elect to exercise its option to convert the notes, Simax will repay the principal amount outstanding and any outstanding interest in equal installments beginning on the fifth anniversary of the loan date and continuing on a quarterly basis over the next three years.

 

As of September 30, 2018, the Convertible notes receivable balance was $1,000 with accrued interest of $4.

 

NOTE 6. Derivative Instruments and Hedging Activities

The Company, when it considers it to be appropriate, enters into forward exchange contracts to hedge the economic exposures arising from foreign currency denominated transactions. At September 30, 2018 and December 31, 2017, these contracts included the future sale of Japanese Yen to purchase U.S. dollars.  Derivative instruments are recognized as either, “Prepaid expenses and other current assets” or “Other current liabilities” in the Condensed Consolidated Balance Sheets and are measured at fair value.  The foreign currency forward exchange contracts were entered into by the Company’s Japanese subsidiary to economically hedge a portion of certain intercompany obligations.  The forward exchange contracts are not designated as hedges for accounting purposes and increases in the fair value of $111 for the nine months ended September 30, 2018 and a decrease in the fair value of $251 for the nine months ended September 30, 2017, are recorded under the caption “Other expense (income), net” in the Condensed Consolidated Statements of Operations.

The dollar equivalent of the U.S. dollar forward exchange contracts and related fair values as of September 30, 2018 and December 31, 2017 were as follows:

 

 

 

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NOTE 7. Purchased Intangible Assets

Purchased intangible assets as of September 30, 2018 and December 31, 2017 are as follows:

 

 

Intangible asset amortization expenses for the three and nine months ended September 30, 2018 were $384 and $1,147, respectively.  For the three and nine month periods ended September 30, 2017, intangible assets amortization expenses were $506 and $1,516, respectively.  Assuming no change in the gross carrying value of identifiable intangible assets and estimated lives, estimated amortization expenses for the remainder of 2018 are $386, and for each of the next five years estimated amortization expenses are $1,544 for 2019, $1,341 for 2020, $594 for 2021, $527 for 2022, and $511 for 2023.

NOTE 8. Balance Sheet Details

Inventories

Inventories are comprised of the following:

 

 

The Company has established reserves of $12,164 and $13,035 as of September 30, 2018 and December 31, 2017, respectively, for slow moving and obsolete inventory, which are included in the amounts above.

 

Property, Plant and Equipment

Property, plant and equipment, net is comprised of the following:

 

 

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Other assets

Other assets is comprised of the following:

 

 

Other current liabilities

Other current liabilities is comprised of the following:

 

 

Other non-current liabilities

Other non-current liabilities is comprised of the following:

 

 

NOTE 9. Commitments and Contingencies

Intellectual Property Indemnification Obligations

The Company has entered into agreements with customers that include limited intellectual property indemnification obligations that are customary in the industry.  These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions.  The nature of the intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its customers.  Historically, the Company has not made any indemnification payments under such agreements and no amount has been accrued in the accompanying Condensed Consolidated Financial Statements with respect to these indemnification guarantees.

Warranty Reserves

The Company generally provides a warranty on its products for a period of 12 to 15 months against defects in material and workmanship.  The Company estimates the costs that may be incurred during the warranty period and records a liability in the amount of such costs at the time revenue is recognized.  The Company’s estimate is based primarily on historical experience.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.  Settlements of warranty reserves are generally associated with sales that occurred during the 12 to 15 months prior to the quarter-end and warranty accruals are related to sales during the same year.

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Changes in the Company’s warranty reserves are as follows:

 

 

Warranty reserves are reported in the Condensed Consolidated Balance Sheets under the caption “Accounts payable and accrued liabilities.”

Legal Matters

From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business.  There are no legal proceedings pending or threatened against the Company that management believes are likely to have a material adverse effect on the Company’s consolidated financial position or otherwise.

Line of Credit

The Company has a credit agreement with a bank that provides for a line of credit which is secured by the marketable securities the Company has with the bank.  The Company is permitted to borrow up to 70% of the value of eligible securities held at the time the line of credit is accessed.  The available line of credit as of September 30, 2018 was approximately $102 million with an available interest rate of 3.8%.  The credit agreement is available to the Company until such time that either party terminates the arrangement at their discretion.  The Company has not utilized the line of credit to date.

NOTE 10. Share-Based Compensation

Restricted Stock Unit Activity

A summary of the activity with respect to the Company’s unvested restricted stock units during the nine months ended September 30, 2018 is as follows:

 

 

Included in the number of shares granted in the table directly above are 53 market performance-based restricted stock units (“MPRSUs”) granted to executives in 2018.  Vesting of these MPRSUs is contingent upon the Company meeting certain total shareholder return (“TSR”) levels as compared to a select peer group over three years from the year granted.  The 2018 MPRSUs cliff vest at the end of the three-year period and have a maximum potential to vest at 200% (105 shares) based on TSR performance.  The related share-based compensation expense is determined based on the estimated fair value of the underlying shares on the date of grant and is recognized straight-line over the vesting term.  The estimated fair value per share of the MPRSUs was $30.76.

As of September 30, 2018 and December 31, 2017, there was $11,088 and $9,420 of total unrecognized compensation cost related to restricted stock units granted under the Company’s stock plans, respectively.  That cost is expected to be recognized over a weighted average period of 2.1 years and 2.2 years for each of the respective periods.

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NOTE 11. Other Expense (Income), net

Other expense (income), net is comprised of the following:

 

 

NOTE 12. Income Taxes

The following table provides details of income taxes:

 

 

The income tax provision for the three and nine months ended September 30, 2018 was computed based on the Company’s annual forecast of profit by jurisdiction and forecasted effective tax rate for the year.  The changes in the Company’s effective tax rate for the three and nine months ended September 30, 2018 as compared to the same period in 2017 are primarily due to enactment of U.S. tax reform, which provides for a change in the corporate tax rate from 35% to 21%, changes in the mix of forecasted earnings by jurisdictions and the Foreign Derived Intangible Income Deduction.

The 2017 Tax Act was enacted on December 22, 2017.  The 2017 Tax Act reduces the U.S. federal corporate income tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, provides tax benefits for export sales and creates new taxes on certain foreign sourced earnings.  The Company is applying the guidance in SAB 118 when accounting for the enactment-date effects of the 2017 Tax Act.  At September 30, 2018, the Company has not completed its accounting for all of the tax effects of the 2017 Tax Act.  In all cases, the Company will continue to make and refine its calculations as additional analysis is completed.  The Company’s estimates may also be affected as it gains a more thorough understanding of the 2017 Tax Act.  These changes could be material to income tax expense.

Foreign-Derived Intangible Income:  The 2017 Tax Act provides tax incentives to U.S. companies to earn income from the sale, lease or license of goods and services abroad in the form of a deduction for foreign-derived intangible income (“FDII”).  FDII is taxed at an effective rate of 13.1% for taxable years beginning after December 31, 2017 and at an effective rate of 16.4% for taxable years beginning after December 31, 2025. The accounting for the deduction for FDII is similar to a special deduction and should be accounted for based on the guidance in ASC 740-10-25-37.  The tax benefits for special deductions ordinarily are recognized no earlier than the year in which they are deductible on a tax return.  As of September 30, 2018, the Company has made sufficient progress in its calculations to reasonably estimate the effect on its estimated annual effective tax rate.  Since a large portion of the Company’s sales are made to non-U.S. customers, this adjustment decreased its effective tax rate by 4.3%.  The Company will continue to refine its calculations, which may result in changes to this amount.

The Company does not expect other provisions of the 2017 Tax Act, including global intangible low-taxed income (“GILTI”), the new interest expense limitations and base erosion anti-abuse tax (“BEAT”) to have a material impact on the Company’s effective tax rate.

Deferred Tax Assets and Liabilities: The Company remeasured certain deferred tax assets and liabilities based on the rates to which they are expected to reverse in the future, which is anticipated to be 21%.  The Company recorded a provisional amount of $8.0 million as of December 31, 2017 related to the remeasurement of certain deferred tax balances. Due to the continued refinement of the Company’s transition tax calculation, discussed further below, and the effect it may have on the measurement of NOLs and other carryforwards, the Company will continue to analyze and refine its calculations related to the measurement of these balances.

One-Time Transition Tax: The one-time transition tax is based on its total post-1986 earnings and profits (“E&P”), which it has deferred from U.S. income taxes under previous U.S. law.  The Company originally recorded a provisional amount for its one-time transition tax liability for all of its foreign subsidiaries, resulting in a transition tax benefit (net of foreign tax credits)

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of $0.1 million being recorded at December 31, 2017.  As the Company continues to refine its E&P analysis, it will refine its calculations of the one-time transition tax, which could affect the measurement of this liability.  No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax, or any additional outside basis difference inherent in these entities, as these amounts continue to be indefinitely reinvested in foreign operations.

The Company currently has a partial valuation allowance recorded against certain foreign and state net operating loss and credit carryforwards where the realizability of such deferred tax assets is substantially in doubt.  Each quarter, the Company assesses the likelihood that it will be able to recover its deferred tax assets. The Company considers available evidence, both positive and negative, including forecasted earnings in assessing the need for a valuation allowance.  As a result of the Company’s analysis, it concluded that it is more likely than not that a portion of its deferred tax assets will not be realized. Therefore, the Company continues to provide a valuation allowance against certain deferred tax assets.  The Company continues to monitor available evidence and may reverse some or all of the remaining valuation allowance in future periods, if appropriate.  The Company has a recorded valuation allowance against certain of its deferred tax assets of $2,447 as of September 30, 2018 and December 31, 2017.

NOTE 13. Earnings Per Share

Basic earnings per share is calculated using the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share is computed in the same manner and also gives effect to all dilutive common equivalent shares outstanding during the period.  Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive.  In accordance with U.S. GAAP, these shares were not included in calculating diluted earnings per share.

The following table sets forth the weighted average number of restricted stock units that have been excluded from the calculation of diluted earnings per share as their effect would have been anti-dilutive:

 

 

The Company’s basic and diluted earnings per share amounts are as follows:

 

 

NOTE 14. Accumulated Other Comprehensive Loss

Comprehensive income includes net income, foreign currency translation adjustments and net unrealized gains and losses on available-for-sale debt securities.  See the Condensed Consolidated Statements of Comprehensive Income for the effect of the components of comprehensive income on the Company’s net income.

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The components of accumulated other comprehensive loss, net of tax, are as follows:

 

 

NOTE 15. Segment Reporting and Geographic Information

The Company is engaged in the design, development, manufacture and support of high-performance control metrology, defect inspection, advanced packaging lithography and data analysis systems used by microelectronics device manufacturers. The Company and its subsidiaries currently operate in a single operating segment: the design, development, manufacture and support of high-performance process control defect inspection and metrology, advanced packaging lithography and process control software systems used by microelectronics device manufacturers.  Therefore the Company has one reportable segment.  The Company’s chief operating decision maker is the Chief Executive Officer (the “CEO”).  The CEO allocates resources and assesses performance of the business and other activities at the reportable segment level.

The following table lists the different sources of revenue:

 

 

For geographical revenue reporting, revenue is attributed to the geographic location to which the product is shipped.  Revenue by geographic region is as follows:

 

 

The following customer accounted for more than 10% of total revenue for the indicated periods:

 

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NOTE 16. Share Repurchase Authorization

In January 2015, the Board of Directors authorized the Company to repurchase up to 3,000 shares of the Company’s common stock with no established end date.  The authorization allows for repurchases to be made in the open market or through negotiated transactions from time to time.  During the three and nine months ended September 30, 2018, the Company repurchased 2 shares of common stock pursuant to the share repurchase authorization.  At September 30, 2018, there were 709 shares available for future stock repurchases under this share repurchase authorization.  Shares of common stock purchased under the share repurchase authorization are retired.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

Certain statements in this Quarterly Report on Form 10-Q (this “Form 10-Q”) are forward-looking statements, including those concerning our business momentum and future growth, acceptance of our products and services, our ability to deliver both products and services consistent with our customers’ demands and expectations and to strengthen our market position, our expectations of the semiconductor market outlook, future revenue, gross profits, research and development and engineering expenses, selling, general and administrative expenses, product introductions, technology development, manufacturing practices, cash requirements, our dependence on certain significant customers and anticipated trends and developments in and management plans for our business and the markets in which we operate, our anticipated revenue as a result of acquisitions, and our ability to be successful in managing our cost structure and cash expenditures and results of litigation.  The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements may be identified by words such as, but not limited to, “anticipate,” “believe,” “expect,” “intend,” “plan,” “should,” “may,” “could,” “will” and words or phrases of similar meaning, as they relate to our management or us.

The forward-looking statements contained herein reflect our expectations with respect to future events and are subject to certain risks, uncertainties and assumptions.  Actual results may differ materially from those included in such forward-looking statements for a number of reasons including, but not limited to, the following: variations in the level of orders which can be affected by general economic conditions; seasonality and growth rates in the semiconductor manufacturing industry and in the markets served by our customers; the global economic and political climates; difficulties or delays in product functionality or performance; the delivery performance of sole source vendors; the timing of future product releases; failure to respond adequately to either changes in technology or customer preferences; changes in pricing by us or our competitors; our ability to manage growth; changes in management; risk of nonpayment of accounts receivable; changes in budgeted costs; our ability to leverage our resources to improve our position in our core markets, to weather difficult economic environments, to open new market opportunities and to target high-margin markets; the strength/weakness of the back-end and/or front-end semiconductor market segments; our ability to successfully integrate acquired businesses into our business and fully realize, or realize within the expected time frame, the expected combination benefits from the acquisitions; the imposition of tariffs or trade restrictions and costs, burdens and restrictions associated with other governmental actions and the “Risk Factors” set forth in Item 1A in our 2017 10-K and any subsequently filed Quarterly Reports on Form 10-Q.  The forward-looking statements reflect our position as of the date of this report and we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Critical Accounting Policies

The preparation of condensed consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make judgments, assumptions and estimates that affect the amounts reported.  Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.

A critical accounting policy is defined as one that is both material to the presentation of our condensed consolidated financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition or results of operations.  Specifically, these policies have the following attributes: (1) we are required to make judgments and assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, could have a material effect on our financial position and results of operations.

Estimates and assumptions about future events and their effects cannot be determined with certainty.  We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances.  These estimates may change as new events occur, as additional information is obtained and as our operating

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environment changes.  In addition, management is periodically faced with uncertainties, the outcomes of which are not within our control and will not be known for prolonged periods of time. Certain of these uncertainties are discussed in our 2017 10-K in the Items entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our condensed consolidated financial statements are fairly stated in accordance with U.S. GAAP, and provide a fair presentation of our financial position and results of operations.

For more information, please see our critical accounting policies as previously disclosed in our 2017 10-K.

During the quarter ended March 31, 2018, the Company adopted the provisions of ASC 606, “Revenue from Contracts with Customers.”  See Note 1 to the Condensed Consolidated Financial Statements included in this Form 10-Q regarding the impact of recent accounting pronouncements on our financial position and results of operations and Note 2, “Revenue,” in the notes to the financial statements, related to the impact of the adoption of ASC 606 on our financial statements and accounting policies.

Overview

We are a worldwide leader in the design, development, manufacture and support of process control tools that perform macro-defect inspections and metrology, lithography systems and process control analytical software used by semiconductor and advanced packaging device manufacturers.  We deliver comprehensive solutions throughout the semiconductor fabrication process with our families of proprietary products that provide critical yield-enhancing information, enabling microelectronic device manufacturers to drive down costs and the time to market of their devices.  We provide process and yield management solutions used in both wafer processing facilities, often referred to as “front-end” manufacturing, and device packaging and test facilities, or “back-end” manufacturing, through a portfolio of standalone systems for macro-defect inspection, lithography, probe card test and analysis, and transparent and opaque thin film measurements.  All of our systems feature sophisticated software and production-worthy automation.  In addition, our advanced process control software portfolio includes powerful solutions for standalone tools, group of tools, or factory-wide suites to enhance productivity and achieve significant cost savings.  Our systems are backed by worldwide customer support.

Our business is affected by the annual spending patterns of our customers on semiconductor capital equipment.  The amount that our customers devote to capital equipment spending depends on a number of factors, including general worldwide economic conditions, as well as other economic drivers such as sales of personal computers, tablets, cell phones, wearable devices, other personal electronic devices and automotive sales.  Current forecasts by industry analysts for the semiconductor device manufacturing industry project an increase in capital equipment spending of approximately 7% for 2018.  Our revenue and profitability tend to follow the trends of certain segments within the semiconductor market.

Historically, a significant portion of our revenue in each quarter and year has been derived from sales to relatively few customers, and we expect this trend to continue.  For the nine months ended September 30, 2018 and for the years ended December 31, 2017, 2016 and 2015, aggregate sales to customers that individually represented at least five percent of our revenue accounted for 21.7%, 27.2%, 34.5%, and 23.3% of our revenue, respectively.

We do not have purchase contracts with any of our customers that obligate them to continue to purchase our products, and they could cease purchasing products from us at any time.  A delay in purchase or a cancellation by any of our large customers could cause quarterly revenue to vary significantly.  In addition, during any given quarter, a significant portion of our revenue may be derived from the sale of a relatively small number of systems, with one customer accounting for 10% or more of our revenue.  One customer accounted for 10.5% of our revenue for the nine months ended September 30, 2018.  The following table lists the average selling price for our systems:

 

 

A significant portion of our revenue is derived from customers outside of the United States.  A substantial portion of our international sales is denominated in U.S. dollars.  We expect that revenue generated from customers outside of the United States will continue to account for a significant percentage of our revenue.

The sales cycle for our systems typically ranges from six to twenty-four months and can be longer when our customers are evaluating new technology.  Due to the length of these cycles, we invest significantly in research and development and sales and marketing in advance of generating revenue related to these investments.

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Results of Operations for the Three and Nine Month Periods Ended September 30, 2018 and 2017

Revenue.  Our revenue is primarily derived from the sale of our systems, services, spare parts and software licensing.  Our revenue of $60.4 million decreased 9.7% for the three months ended September 30, 2018 as compared to the same period in 2017, in which revenue totaled $66.9 million.  For the nine month period ended September 30, 2018 and 2017, our revenue totaled $211.0 million and $195.0 million, respectively, representing a year-over-year increase of 8.2%.

The following table lists, for the periods indicated, the different sources of our revenue in dollars (thousands) and as percentages of our total revenue:

 

 

Total systems and software revenue increased $15.6 million for the nine months ended September 30, 2018, as compared to the nine months ended September 30, 2017.  Process control system revenue increased $10.1 million for the nine months ended September 30, 2018, as compared to the same period in 2017, primarily due to higher metrology system sales in the 2018 period.  Lithography system revenue increased $4.2 million for the nine months ended September 30, 2018, as compared to the same period in 2017, primarily due to the shipment of a JetStep G system during the first half of 2018.  Software revenue increased $1.4 million for the nine months ended September 30, 2018, as compared to the same period in 2017.  Systems revenue generated by our latest product releases and major enhancements in each of our product families amounted to 74% of total revenue for the nine months ended September 30, 2018, as compared to 70% of total revenue for the nine months ended September 30, 2017.  The year-over-year increase in total parts and services revenue for the nine months ended September 30, 2018 is primarily due to increased spending by our customers on system upgrades and repairs of existing systems.  Parts and services revenue are generated from parts sales, maintenance service contracts, system upgrades, as well as from time and material billable service calls. 

For the three months ended September 30, 2018, total systems and software revenue decreased $6.1 million, as compared to the same period in the prior year.  Lithography systems revenue decreased $4.2 million for the three months ended September 30, 2018, as compared to the same period in 2017, primarily due to less JetStep units sold.  There was also a decrease of $2.7 million in process control system revenue for the three months ended September 30, 2018, as compared to the same period in 2017, primarily due to fewer inspection and metrology units sold.  The decrease in total systems and software revenue was partially offset by an increase of $0.9 million in software revenue for the three months ended September 30, 2018, as compared to the same period in 2017. Systems revenue generated by our latest product releases and major enhancements in each of our product families amounted to 72% of total revenue for the three months ended September 30, 2018, as compared to 75% of total revenue for the three months ended September 30, 2017. 

Deferred revenue of $7.6 million was recorded in the Condensed Consolidated Balance Sheet under the caption “Deferred revenue” and $1.1 million was recorded under the caption “Other non-current liabilities” at September 30, 2018.  Deferred revenue primarily consisted of $6.3 million for deferred maintenance agreements and $2.4 million for outstanding deliverables.

Gross Profit.  Our gross profit has been and will continue to be affected by a variety of factors, including manufacturing efficiencies, provision for excess and obsolete inventory, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, international and domestic sales mix, system and software product mix and parts and service margins.  Our gross profit was $31.5 million and $115.6 million for the three and nine months ended September 30, 2018, respectively, as compared to $35.1 million and $102.5 million for the same periods in 2017.  Our gross profit represented 52.0% and 54.8% of our revenue for the three and nine months ended September 30, 2018, respectively.  For both the three and nine months ended September 30, 2017, gross profit represented 52.5% of our revenue.  The increase in gross profit as a percentage of revenue for the nine months ended September 30, 2018, as compared to the same period in 2017, is primarily due to system and software product mix and the sale of a lithography system that had been previously written down in purchase accounting.  We expect our gross profit to be in the range of 52.0% to 53.0% for the quarter ending December 31, 2018.

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Operating Expenses.  Major components of operating expenses include research and development, as well as selling, general and administrative expenses.

Research and Development.  Our research and development expenses were $12.3 million and $36.8 million for the three and nine months ended September 30, 2018, respectively, as compared to $12.0 million and $36.2 million for the same periods in 2017.  Research and development expenses represented 20.4% and 17.5% of our revenue for the three and nine months ended September 30, 2018, respectively, as compared to 18.0% and 18.6% of revenue for the prior year periods.  Research and development expenses increased for the year-over-year periods due to increases in compensation and project costs, which were partially offset by a decrease in litigation expenses.

Selling, General and Administrative.  Our selling, general and administrative expenses were $11.1 million and $35.9 million for the three and nine months ended September 30, 2018, respectively, as compared to $10.1 million and $29.9 million for the same periods in 2017.  Selling, general and administrative expenses represented 18.4% and 17.0% of our revenue for the three and nine months ended September 30, 2018, respectively, as compared to 15.1% and 15.3% of our revenue for the same periods in 2017.  The year-over-year dollar increase for the nine months ended September 30, 2018 in selling, general and administrative expenses was primarily due to an increase in compensation costs, an increase in sales commissions and a loss recorded for the possible misappropriation of payroll taxes by a third party accountant.

Income Taxes. We recorded an income tax provision of $1.2 million and $6.3 million for the three and nine months ended September 30, 2018, respectively.  Our effective tax rate of 14.6% differs from the statutory rate of 21% for the nine months ended September 30, 2018 primarily due to the enactment of the 2017 Tax Act, which provides for a projected foreign derived intangible income deduction and a federal research and development credit.  For the three and nine months ended September 30, 2017, we recorded an income tax provision of $8.3 million and $14.3 million, respectively.

Among other things, the 2017 Tax Act lowered the U.S. federal corporate income tax rate from 35% to 21% and implemented a territorial tax system.  The lower U.S. corporate income tax rate is effective January 1, 2018; however the U.S. deferred tax assets and liabilities were re-measured in 2017 when the 2017 Tax Act was enacted.  Also in 2017, as part of the transition to the new territorial tax system, the 2017 Tax Act imposed a one-time tax on deemed repatriation of foreign subsidiaries’ earnings.  At September 30, 2018, we have not completed our accounting for the tax effects of enactment of the 2017 Tax Act; however, we have made reasonable estimates of the effects.  The total provisional impact of the 2017 Tax Act as summarized below, which is included as a component of the provision from income taxes, is further described in Note 12 in the accompanying Notes to the Condensed Consolidated Financial Statements (dollars in thousands).

 

 

We are continuing to assess the impact of the 2017 Tax Act and may record adjustments in 2018 as additional analysis is completed and as we gain a more thorough understanding of the legislation.

Our future effective income tax rate depends on various factors, such as future impacts of the 2017 Tax Act, new tax legislation, the geographic composition of our pre-tax income, the amount of our pre-tax income as business activities fluctuate, and non-deductible expenses incurred in connection with acquisitions and research and development credits as a percentage of aggregate pre-tax income.

We currently have a partial valuation allowance recorded for certain foreign and state loss and credit carryforwards where the realizability of such deferred tax assets is substantially in doubt.  Each quarter we assess the likelihood that we will be able to recover our deferred tax assets primarily relating to state research and development credits.  We consider available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance.  

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As a result of our analysis, we concluded that it is more likely than not that a portion of our net deferred tax assets will not be realized.  Therefore, we continue to provide a valuation allowance against certain net deferred tax assets.  We continue to monitor available evidence and may reverse some or all of the valuation allowance in future periods, if appropriate.

Liquidity and Capital Resources

At September 30, 2018, we had $194.3 million of cash, cash equivalents and marketable securities and $320.9 million in working capital.  At December 31, 2017, we had $177.4 million of cash, cash equivalents and marketable securities and $279.8 million in working capital.

Operating activities provided $24.4 million in net cash and cash equivalents for the nine months ended September 30, 2018.  The net cash and cash equivalents provided by operating activities during the nine months ended September 30, 2018 resulted primarily from net income, adjusted to exclude the effect of non-cash operating charges of $50.6 million and offset by a decrease in cash used in operating assets and liabilities of $26.2 million.  This decrease was primarily attributed to an increase in inventories.  Operating activities provided $42.8 million in net cash and cash equivalents for the nine months ended September 30, 2017.  The net cash and cash equivalents provided by operating activities during the nine months ended September 30, 2017 resulted primarily from net income, adjusted to exclude the effect of non-cash operating charges of $33.3 million and an increase in cash provided from operating assets and liabilities of $9.5 million.  

Net cash and cash equivalents of $34.1 million provided by investing activities during the nine months ended September 30, 2018 resulted from proceeds from sales of marketable securities of $152.6 million, offset by the purchase of marketable securities of $113.4 million, capital expenditures of $4.1 million, and cash advanced on a convertible note receivable of $1.0 million.  Net cash and cash equivalents used in investing activities of $10.7 million during the nine months ended September 30, 2017 resulted from the purchase of marketable securities of $103.2 million and capital expenditures of $7.4 million, partially offset by proceeds from sales of marketable securities of $99.9 million.

Net cash and cash equivalents used in financing activities during the nine months ended September 30, 2018 of $1.6 million was due primarily to the payment of contingent consideration for acquired business of $1.1 million, and tax payments related to shares withheld for share-based compensation plans of $1.0 million, offset by proceeds from sales of shares through share-based compensation plans of $0.5 million.  For the nine months ended September 30, 2017, financing activities used $2.4 million, which resulted primarily from tax payments related to share withheld for share-based compensation plans of $1.3 million, the redemption of stock warrants of $1.0 million and payment of contingent consideration for acquired business of $0.4 million, partially offset by proceeds from sales of shares through share-based compensation plans of $0.3 million.

From time to time, we evaluate whether to invest in or acquire new or complementary businesses, products and/or technologies.  We may fund all of a portion of the price of these investments or acquisitions in cash, stock, or a combination of cash and stock.

We entered into a convertible loan agreement with Simax Precision Technologies Limited (“Simax”) on May 31, 2018.  Simax may borrow up to $15 million in multiple promissory notes from us.  We expect to be a supplier of lithography modules to Simax which is focused on the manufacture, sale and service of lithography systems.  As of the date of this report, Simax has borrowed $1 million and we anticipate that they will borrow an additional $4 million during the three months ended December 31, 2018 under the convertible loan agreement. See Note 5 in the accompanying Notes to the Condensed Consolidated Financial Statements included in this Form 10-Q for further information.

In January 2015, our Board of Directors authorized the Company to repurchase up to 3.0 million shares of our common stock with no established end date.  The authorization allows for repurchases to be made in the open market or through negotiated transactions from time to time.  During the nine months ended September 30, 2018, the Company repurchased 1.6 thousand shares of common stock pursuant to the shares repurchase authorization.  At September 30, 2018, there were 0.7 million shares available for future stock repurchases under this share repurchase authorization.  Shares of common stock purchased under the share repurchase authorization are retired.  For further information, see Note 16 in the accompanying Notes to the Condensed Consolidated Financial Statements included in this Form 10-Q.

We have a credit agreement with a bank that provides for a line of credit that is secured by the marketable securities we have with the bank.  We are permitted to borrow up to 70% of the value of eligible securities held at the time the line of credit is accessed.  As of September 30, 2018, the available line of credit was approximately $102 million with an available interest rate of 3.8%.  The credit agreement is available to us until such time that either party terminates the arrangement at its discretion.  To date, we have not utilized this line of credit.

Our future capital requirements will depend on many factors, including the timing and amount of our revenue and our investment decisions, which will affect our ability to generate additional cash.  We expect that our existing cash, cash

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equivalents, marketable securities and availability under our line of credit will be sufficient to meet our anticipated cash requirements for working capital, capital expenditures and other cash needs for the next 12 months following the filing of this Form 10-Q.  Thereafter, if cash generated from operations and financing activities is insufficient to satisfy our working capital requirements, we may seek additional funding through bank borrowings, sales of securities or other means.  There can be no assurance that we will be able to raise any such capital on terms acceptable to us or at all.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate and Credit Market Risk

We are exposed to changes in interest rates and market liquidity including our investments in certain available-for-sale debt securities.  Our available-for-sale securities consist of fixed and variable rate income investments, such as municipal notes, municipal bonds and corporate bonds.  We continually monitor our exposure to changes in interest rates, market liquidity and credit ratings of issuers for our available-for-sale debt securities.  It is possible that we are at risk if interest rates, market liquidity or credit ratings of issuers change in an unfavorable direction.  The magnitude of any gain or loss will be a function of the difference between the fixed or variable rate of the financial instrument and the market rate, and our financial condition and results of operations could be materially affected.  Based on a sensitivity analysis performed on our marketable securities held as of September 30, 2018, an immediate adverse change of 10% in interest rates (e.g., a change from 3.00% to 3.30%) would result in an immaterial decrease in the fair value of our available-for-sale debt securities and would not have a material impact on our consolidated financial position, results of operations or cash flows.

Foreign Currency Risk

A substantial portion of our systems and software sales are denominated in U.S. dollars with the exception of Japan.  As a result, we have relatively little exposure to foreign currency exchange risk with respect to these sales. Substantially all of our sales in Japan are denominated in Japanese yen.  From time to time, we may enter into forward exchange contracts to economically hedge a portion, but not all, of the existing and anticipated foreign currency denominated transactions expected to occur within 12 months.  The change in fair value of the forward exchange contracts is recognized under the caption “Other (income) expense” in the Condensed Consolidated Statements of Operations for each reporting period. As of September 30, 2018, we had nineteen forward exchange contracts outstanding with a total notional contract value of $5.7 million.  We do not use derivative financial instruments for trading or speculative purposes.

We have branch operations in Taiwan, Singapore and South Korea and wholly-owned subsidiaries in Europe, Japan and China.  Our international subsidiaries and branches operate primarily using local functional currencies.  Our exposure to foreign currency exchange rate fluctuations arise from intercompany balances between our U.S. headquarters and that of our foreign owned entities. Our intercompany balances are denominated in U.S. dollars. Since each foreign entity’s functional currency is generally denominated in its local currency, there is exposure to foreign exchange risk when the foreign entity’s intercompany balance is remeasured at a reporting date, resulting in transaction gains or losses. The intercompany balance, exposed to foreign currency risk, as of September 30, 2018 was approximately $26.0 million. A hypothetical change of 10% in the relative value of the U.S. dollar versus local functional currencies could result in approximately $1.8 million in foreign currency exchange losses / (gains) which would be recorded as non-operating expense in other expense (income) in our Condensed Consolidated Statements of Operations.  We cannot accurately predict future exchange rates or the overall impact of future exchange rate fluctuations on our business, results of operations and financial condition.

Item 4. Controls and Procedures

We maintain a set of disclosure controls and procedures, as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act, designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to our management, including our CEO and Chief Financial Officer (“CFO”), as appropriate, to allow for timely decisions regarding required disclosure.  The disclosure controls and procedures are designed to provide reasonable assurance of achieving the desired control objectives.

Scope of the Controls Evaluation

The evaluation of our disclosure controls and procedures included a review of the controls’ objectives and design, our implementation of the controls and the effect of the controls on the information generated for use in this Form 10-Q.  In the course of the evaluation, we sought to identify data errors, control problems or acts of fraud and confirm that appropriate corrective actions, if any, including process improvements, were being undertaken.  This type of evaluation is performed on a quarterly basis so that the conclusions of management, including the CEO and CFO, concerning the effectiveness of the controls can be reported in our Quarterly Reports on Form 10-Q and in our Annual Reports on Form 10-K.  Many of the

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components of our disclosure controls and procedures are also evaluated on an ongoing basis by other personnel in our accounting, finance, internal audit and legal functions.  The overall goals of these various evaluation activities are to monitor our disclosure controls and procedures and to modify them on an ongoing basis as necessary.  A control system can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.  Because of inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.

Conclusions

As of September 30, 2018, an evaluation of our disclosure controls and procedures was carried out under the supervision and with the participation of our management, including the CEO and CFO.  Based on this evaluation, the CEO and CFO have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this Form 10-Q.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

For a description of our previously reported legal proceedings refer to Part I, Item 3, “Legal Proceedings” in our 2017 10-K.

From time to time we may be a party to routine legal proceedings and claims in the ordinary course of business.  There are no legal proceedings pending or threatened against the Company that management believes are likely to have a material adverse effect on the Company’s consolidated financial position or otherwise.

Item 1A. Risk Factors

There have been no material changes to our risk factors as discussed in Part I, Item 1A, “Risk Factors” in our 2017 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In January 2015, our Board of Directors authorized the Company to repurchase up to 3.0 million shares of our common stock with no established end date.  The authorization allows for repurchases to be made in the open market or through negotiated transactions from time to time.  During the nine months ended September 30, 2018, the Company repurchased 1.6 thousand shares of common stock pursuant to the share repurchase authorization.  At September 30, 2018, there were 0.7 million shares available for future stock repurchases under this share repurchase authorization.  Shares of common stock purchased under the share repurchase authorization are retired.  For further information, see Note 16 in the accompanying Notes to the Condensed Consolidated Financial Statements.

In addition to our share repurchase program, we withhold shares of common stock associated with net share settlements to cover tax withholding obligations upon the vesting of restricted stock units awarded under our equity incentive program.  During the three and nine months ended September 30, 2018, we withheld 0.1 thousand and 36 thousand shares, respectively, through net share settlements.  For the three and nine months ended September 30, 2018 net share settlements costs were $3 thousand and $980 thousand, respectively.  Please refer to Note 10 in the accompanying Notes to the Condensed Consolidated Financial Statements for additional information regarding our share-based compensation plans.

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The following table provides details of the shares of common stock purchased and withheld during the three months ended September 30, 2018 (in thousands, except per share data):

 

 

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

 

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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