TMCnet News
LTX-CREDENCE CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read together with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-Q. Certain statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are forward-looking statements that involve risks and uncertainties. Words such as may, will, should, would, anticipates, expects, intends, plans, believes, seeks, estimates and similar expressions identify such forward-looking statements. The forward-looking statements contained herein are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Factors that might cause such a difference include, among other things, those set forth under "Risk Factors" and those appearing elsewhere in this Form 10-Q. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. We assume no obligations to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements. Overview We provide focused, cost-optimized automated test equipment (ATE) solutions. We design, manufacture, market and service semiconductor test solutions that address the broad, divergent test requirements of the wireless, computing, automotive and entertainment market segments. Our semiconductor test equipment can test a broad range of analog, digital, mixed signal (a combination of analog and digital) and system in package, or SIP, semiconductor devices, all on a single test platform. Semiconductor designers and manufacturers worldwide use our equipment to test their devices during the manufacturing process. After testing, these devices are then incorporated in a wide range of products, including computers, mobile internet equipment such as wireless access points and interfaces, broadband access products such as cable modems and set top boxes, personal communication products such as mobile phones and personal digital music players, consumer products such as televisions, videogame systems, digital cameras and automobile electronics, and for power management in portable and automotive electronics. We focus our marketing and sales efforts on integrated device manufacturers (IDMs), outsource assembly and test providers (OSATs), which perform manufacturing services for the semiconductor industry, and fabless companies, which design integrated circuits but have no manufacturing capability. We provide our customers with a comprehensive portfolio of test systems and a global network of strategically deployed applications and support resources. As previously disclosed, on November 17, 2010, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with Verigy Ltd., a corporation organized under the laws of Singapore ("Verigy"), Alisier Limited, a corporation organized under the laws of Singapore ("Holdco"), Lobster-1 Merger Corporation, a Massachusetts corporation and a wholly-owned subsidiary of Verigy ("Merger Sub-1"), and Lobster-2 Merger Corporation, a Massachusetts corporation and a wholly-owned subsidiary of Holdco ("Merger Sub-2"). On December 6, 2010, Verigy announced that it had received an unsolicited non-binding proposal from Advantest Corporation ("Advantest") to acquire all of the outstanding Verigy ordinary shares for $12.15 per share in cash. Subsequently, on December 23, 2010, Verigy announced that it had received a revised non-binding proposal from Advantest to acquire all of the outstanding Verigy ordinary shares for $15.00 per share in cash. On March 25, 2011, we notified Verigy of the termination of the Merger Agreement, effective immediately, due to the occurrence of a Triggering Event (as defined in the Merger Agreement) with respect to Verigy. In connection with the termination, Verigy paid us the $15,000,000 Verigy Termination Fee contemplated by the Merger Agreement on March 25, 2011. In the three and nine months ended April 30, 2011, we have incurred approximately $1.9 million and $4.7 million of expenses related to this transaction, of which $0.6 million and $3.4 million, respectively have been recorded in selling, general and administrative expenses on our consolidated statement of operations. The remaining $1.3 million was related to a break-up fee and was recorded as other income (expense). See Note 5 to our consolidated financial statements for information regarding the status of pending shareholder lawsuits associated with this transaction. 19 -------------------------------------------------------------------------------- Table of Contents On April 19, 2011, we received a demand letter pursuant to Mass. Gen. Laws ch. 156D, § 7.42 sent on behalf of Joel Krieger, a purported LTX-Credence shareholder, whose putative class action complaint, Krieger v. LTX-Credence Corp., et. al., No. 10-04713, filed on December 3, 2010 in the Superior Court for the Commonwealth of Massachusetts, was recently dismissed. The letter demands that we commence legal proceedings against the Company's directors and senior officers for breaches of their fiduciary duties, gross negligence and mismanagement, waste of corporate assets, and abuse of control, all arising out of our pursuit of a merger transaction with Verigy. Independent members of the Board of Directors are in the process of conducting an inquiry into the letter and matters raised therein. Industry Conditions and Outlook We sell capital equipment and services to companies that design, manufacture, assemble or test semiconductor devices. The semiconductor industry is highly cyclical, causing in turn a cyclical impact on our financial results. As a capital equipment provider, our revenue is driven by the capital expenditure budgets and spending patterns of our customers, who often delay or accelerate purchases in reaction to variations in their business. The level of capital expenditures by these semiconductor companies depends on the current and anticipated market demand for semiconductor devices and the products that incorporate them. Therefore, demand for our semiconductor test equipment is dependent on growth in the semiconductor industry. In particular, three primary characteristics of the semiconductor industry drive the demand for semiconductor test equipment: • increases in unit production of semiconductor devices; • increases in the complexity of semiconductor devices used in electronic products; and • the emergence of next generation device technologies, such as SIP. The following graph shows the cyclicality in semiconductor test equipment orders and shipments from fiscal 1997 through fiscal 2010 (using the three month moving average), as calculated by SEMI, an industry trade organization: [[Image Removed: LOGO]] Consistent with our business strategy, we have continued to invest significant amounts in engineering and product development to develop and enhance our tester platforms during industry slowdowns. For the nine months ended April 30, 2011 engineering and product development expense was $39.2 million or 21.0% of net sales as compared to $36.2 million or 24.8% of net sales for the nine months ended April 30, 2010. We believe that our competitive advantage in the semiconductor test industry is primarily driven by the ability of our tester platforms to meet or exceed the cost and technical specifications required for the testing of advanced semiconductor devices. Our current investment in engineering and product development is focused on enhancements to and additions to our product offerings with new options and instruments designed for specific market segments. We believe this will continue to differentiate our tester platforms from the product offerings of our competitors. In addition, over the past several years, we have transitioned the manufacture of certain components and subassemblies to contract manufacturers, thereby reducing our fixed manufacturing costs associated with direct labor and overhead. We believe that transforming product manufacturing costs into variable costs will in the future allow us to improve our financial performance during cyclical downturns while preserving our historic gross margins during cyclical upturns. 20 -------------------------------------------------------------------------------- Table of Contents We continue to maintain other cost reduction measures, such as the strict oversight and reduction in discretionary travel and other variable overhead expenses. We believe that these reductions in operating costs have reduced our costs while preserving our ability to fund critical product research and development efforts and continue to provide our customers with the levels of responsiveness and service they require. We are also exposed to the risks associated with the volatility of the U.S. and global economies. The lack of visibility regarding whether or when there will be sustained growth periods for the sale of electronic goods and information technology equipment, and uncertainty regarding the amount of sales, underscores the need for caution in predicting growth in the semiconductor test equipment industry in general and in our revenues and profits specifically. Slow or negative growth in the domestic economy may continue to materially and adversely affect our business, financial condition and results of operations for the foreseeable future. Our results of operations would be further adversely affected if we were to experience lower than anticipated order levels, cancellations of orders in backlog, extended customer delivery requirements or pricing pressure as a result of a slowdown. At lower levels of revenue, there is a higher likelihood that these types of changes in our customers' requirements would adversely affect our results of operations because in any particular quarter a limited number of transactions accounts for an even greater portion of sales for the quarter. Critical Accounting Policies and the Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical experience and evaluate them on an on-going basis to ensure they remain reasonable under current conditions. Actual results could differ from those estimates. We believe that our most critical accounting policies upon which our financial reporting depends and which involve the most complex and subjective decisions or assessments are as follows: revenue recognition, inventory reserves, income taxes, warranty, goodwill and other intangibles, impairment of long-lived assets and allowances for doubtful accounts. A summary of those accounting policies and estimates that we believe to be most critical to fully understand and evaluate our financial results is set forth below. The summary should be read in conjunction with our Consolidated Financial Statements and related disclosures elsewhere in this Form 10-Q. Revenue Recognition Our revenue recognition policy is described in Note 2, Summary of Significant Accounting Policies, contained in the Notes to Consolidated Financial Statements included in this report. We recognize revenue when persuasive evidence of an arrangement exists, delivery or customer acceptance (if required) has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Inventory We sell capital equipment to companies that design, manufacture, assemble, and test semiconductor devices. We are exposed to a number of economic and industry factors that could result in portions of our inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, changes in our customers' capital expenditures, technological changes in our markets, our ability to meet changing customer requirements, competitive pressures in products and prices, and the availability of key components from our suppliers. Our policy is to establish inventory reserves when conditions exist that suggest our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand for our products or market conditions. We regularly evaluate the ability to realize the value of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, estimated product end of life dates, estimated current and future market values and new product introductions. Purchasing and alternative usage options are also explored to mitigate inventory exposure. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value. Such reserves are not reversed until the related inventory is sold or otherwise disposed. For the three and nine months ended April 30, 2011 we recorded sales of $8.3 million and $13.2 million of previously reserved inventory, which represents gross cash received from the customer. We released reserves of $2.0 million and $3.4 million in the three and nine months ended April 30, 2011, related to these sales. For the three and nine months ended April 30, 2010 we recorded sales of $1.0 million and $1.0 million of previously reserved inventory. We released reserves of $0.4 million and $0.4 million in the three and nine months ended April 30, 2010, related to these sales. For the three and nine months ended April 30, 2011 and April 30, 2010, we recorded no material provisions for obsolete inventory. As of April 30, 2011 and July 31, 2010, our inventory of $21.3 million and $21.0 million, respectively, is stated net of inventory reserves of $42.3 million and $45.6 million, respectively, and primarily consists of Fusion, X-Series, ASL, and Diamond products. 21 -------------------------------------------------------------------------------- Table of Contents Income Taxes In accordance with Topic 740, Income Taxes ("ASC 740") to the FASB ASC, we recognize deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax basis of assets and liabilities calculated using enacted tax rates for the year in which the differences are expected to be reflected in the tax return. Valuation allowances are established when necessary to reduce deferred taxes to the amount expected to be realized. We have deferred tax assets resulting from tax credit carryforwards, net operating losses and other deductible temporary differences, which will reduce taxable income in future periods. ASC 740 requires that a valuation allowance be established when it is "more likely than not" that all or a portion of deferred tax assets will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's performance, the market environment in which it operates length of carryback and carryforward periods, existing sales backlog and future sales projections. Where there are cumulative losses in recent years, ASC 740 creates a strong presumption that a valuation allowance is needed. This presumption can be overcome in very limited circumstances. As a result of our cumulative loss position in recent years and the increased uncertainty relative to the timing of profitability in future periods, we continue to maintain a valuation allowance for our entire net deferred tax assets. The valuation allowance for deferred tax assets decreased from $550.7 million at July 31, 2009, to $223.4 million at July 31, 2010. The decrease in our valuation allowance compared to the prior year was primarily due to decreases in deferred tax assets with respect to net operating loss and credit carryforwards that are subject to annual limitations as defined in sections 382 and 383 of the Internal Revenue Code. We expect to record a full valuation allowance on future tax benefits until we can sustain an appropriate level of profitability. Until such time, we would not expect to recognize any significant tax benefits in our future results of operations. We will continue to monitor the recoverability of our deferred tax assets on a periodic basis. As a result of the merger and Internal Revenue Service Code Section 382 guidance, the future utilization of the combined company's net operating loss deductions will be significantly limited. We adopted Subtopic 740-10, Accounting for Income Taxes, to the FASB ASC ("ASC 740-10") on August 1, 2007. ASC 740-10 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements. ASC 740-10 prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in a tax return. There were no adjustments to our accumulated deficit as a result of the implementation of ASC 740-10. Valuation of Goodwill We follow the provisions of Topic 350, Intangibles-Goodwill and Other to the FASB ASC ("ASC 350"), which requires that goodwill and intangible assets with indefinite useful lives are not amortized. Intangible assets with a definitive useful life are amortized over their estimated useful lives. Assets recorded in these categories are tested for impairment at least annually or when a change in circumstances may result in impairment. We use a discounted cash flow analysis to test goodwill, at least annually or when indicators of impairment exist, which requires that certain assumptions and estimates be made regarding industry economic factors and future profitability of the acquired business to assess the need for an impairment charge. The provisions of ASC 350 require that a two-step impairment test be performed for goodwill. In the first step, we compare the fair value of the reporting unit to which goodwill has been allocated to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test and determine the implied fair value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference. As further discussed in Note 3 to the consolidated financial statements, we operate in one reporting unit. Determining the number of reporting units and the fair value of a reporting unit requires us to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and appropriate market comparables. We believe these assumptions to be reasonable, but actual conditions are unpredictable and inherently uncertain. Actual future results may differ from our estimates. As discussed in Note 2 to the consolidated financial statements, there were no impairment conditions present during the quarter ending April 30, 2011, and therefore we did not conduct an interim impairment test. During the quarter ending July 31, 2010, we conducted analyses of the potential impairment of goodwill and concluded that this asset was not impaired at that date. We will perform these analyses if indicators of impairment return prior to our annual impairment date. 22 -------------------------------------------------------------------------------- Table of Contents Valuation of Identifiable Intangible Assets Our identifiable intangible assets include existing technology, customer relationships and trade names. Our existing technology relates to patents, patent applications and know-how with respect to the technologies embedded in our currently marketed products. We primarily used the income approach to value our existing technology and other intangibles. This approach calculates fair value by estimating future cash flows attributable to each intangible asset and discounting it to present value at a risk-adjusted discount rate. In estimating the useful life of acquired assets, we considered paragraph 11 of ASC 350, which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors included a review of the expected use by the combined company of the assets acquired, the expected useful life of another asset (or group of assets) related to the acquired assets, legal, regulatory or other contractual provisions that may limit the useful life of an acquired asset or may enable the extension of the useful life of an acquired asset without substantial cost, the effects of obsolescence, demand, competition and other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the asset. We expect to amortize these intangible assets over estimated useful lives using a method that is based on estimated future cash flows as we believe this will approximate the pattern in which the economic benefits of the assets will be derived. Warranty We provide standard warranty coverage on our systems, providing labor and parts necessary to repair the systems during the warranty period. We account for the estimated warranty cost as a charge to cost of sales when the revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. We use actual service hours and parts expense per system and apply the actual labor and overhead rates to estimate the warranty charge. The actual product performance and/or field expense profiles may differ, and in those cases we adjust the warranty accrual accordingly. Allowance for Doubtful Accounts A majority of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers' financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon our assessment of the expected collectability of all accounts receivable. The allowance for doubtful accounts is reviewed periodically to assess the adequacy of the allowances. In any circumstances in which we are aware of a customer's inability to meet its financial obligations, we provide an allowance, which is based on the age of the receivables, the circumstances surrounding the customer's financial situation and our historical experience. If circumstances change, and the financial condition of our customers were adversely affected resulting in their inability to meet their financial obligations to us, we may need to record additional allowances. Recent Accounting Pronouncements See Note 10 to the consolidated financial statements included in this Quarterly Report on Form 10-Q, regarding the impact of certain recent accounting pronouncements on our consolidated financial statements. |