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AXCELIS TECHNOLOGIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) 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 "Liquidity and Capital Resources" and "Risk Factors" and others discussed elsewhere in this Form 10-K. 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 obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting forward-looking statements, except as may be required by law. Overview The semiconductor capital equipment industry is subject to significant cyclical swings in capital spending by semiconductor manufacturers. Capital spending is influenced by demand for semiconductors and the products using them, the utilization rate and capacity of existing semiconductor manufacturing facilities and changes in semiconductor technology, all of which are outside of our control. As a result, our revenue and gross margins fluctuate from year to year and period to period. Our established cost structure does not vary significantly with changes in volume. We may experience fluctuations in operating results and cash flows depending on our revenue as driven by the level of capital expenditures by semiconductor manufacturers. In December 2012, we sold to Lam Research Corporation the intellectual property rights and other assets relating to our dry strip systems product line. The sold intellectual property rights included, among other things, worldwide patent rights, patent applications, copyrights, industrial designs, know-how and related rights used by us in our dry strip products. As a result of this transaction, we ceased the sale of 300mm dry strip wafer processing equipment in September 2013. We can sell dry strip systems for smaller wafers until December 2015 and support our installed base of dry strip systems indefinitely. As a result of this continuing interest in the dry strip business, the sale of the intellectual property rights and other assets to Lam have been reported in continuing operations. Consolidation and partnering within the semiconductor manufacturing industry has resulted in a smaller number of customers representing a substantial portion of our business. Our net revenue from our ten largest customers accounted for 69.1% of total revenue for the year ended December 31, 2013 compared to 70.6% and 68.6% of revenue for the years ended December 31, 2012 and 2011, respectively. A successful semiconductor equipment manufacturer must not only provide some of the most technically complex products manufactured in the world but also must design its business to thrive during the inevitable low points in the cycle. The most recent cycle began with weak industry conditions in mid-2011 which continued through the first quarter of 2013. Beginning in the second quarter of 2013, we entered a period of gradual market improvement which continued during the third and fourth quarters. Our financial results in 2013 reflect our investment of a significant portion of our resources in research and development programs related to our new leading edge Purion ion implantation platform and the market introduction and initial sales of Purion systems. These results also reflect our efforts to lower our breakeven revenue levels by maintaining tight control of discretionary spending. We expect the market for our products to continue to improve through 2014. Throughout 2014 we expect to continue to grow Purion system sales and maintain tight control of our cost structure in order to sustain profitability throughout the full industry cycle. In the event that industry conditions cause the demand for our products to decline in future periods, we believe that we can align manufacturing and 18-------------------------------------------------------------------------------- operating expense levels to changing business conditions and provide sufficient liquidity to support operations. Operating results for the years presented are not necessarily indicative of the results that may be expected for future interim periods or years as a whole. Critical Accounting Estimates Management's discussion and analysis of our financial condition and results of operations are based upon Axcelis' consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and assumptions. Management's estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies are critical in the portrayal of our financial condition and results of operations and require management's most significant judgments and estimates in the preparation of our consolidated financial statements. For additional accounting policies see Notes to Consolidated Financial Statements Note 2. Summary of Significant Accounting Policies. Revenue Recognition Our revenue recognition policy involves significant judgment by management. As described below, we consider a broad array of facts and circumstances in determining when to recognize revenue, including contractual future service obligations to the customer, the complexity of the customer's post-delivery acceptance provisions, payment history, customer creditworthiness and the installation process. In the future, if the post-delivery acceptance provisions and installation process become more complex or result in a materially lower rate of acceptance, we may have to revise our revenue recognition policy, which could delay the timing of revenue recognition. Our system sales transactions are made up of multiple elements, including the system itself and elements that are not delivered simultaneously with the system. These undelivered elements might include a combination of installation services, extended warranty and support and spare parts, all of which are generally covered by a single sales price. Our system revenue arrangements with multiple elements are divided into separate units of accounting if specified criteria are met, including whether the delivered element has stand-alone value to the customer. If the criteria are met, then the consideration received is allocated among the separate units based on their relative selling price, and the revenue is recognized separately for each of the separate units. We determine selling price for each unit of accounting (element) using vendor specific objective evidence ("VSOE") or third-party evidence ("TPE"), if they exist, otherwise, we use best estimated selling price ("BESP"). We generally expect that we will not be able to establish TPE due to the nature of our products, and, as such, we typically will determine selling price using VSOE or BESP. Where required, we determine BESP for an individual element based on consideration of both market and Company-specific factors, including the selling price and profit margin for similar products, the cost to produce the deliverable and the anticipated margin on that deliverable and the characteristics of the varying markets in which the deliverable is sold. 19 -------------------------------------------------------------------------------- Systems are not sold separately and VSOE or TPE is not available for the systems element. Therefore the selling price associated with systems is based on BESP. The allocated value for installation in the arrangement includes the greater of (i) the relative selling price of the installation or (ii) the portion of the sales price that will not be received until the installation is completed (the "retention"). The selling price of installation is based upon the fair value of the service performed, including labor, which is based upon the estimated time to complete the installation at hourly rates, and material components, both of which are sold separately. The selling price of all other elements (extended warranty for support, spare parts, and labor) is based upon the price charged when these elements are sold separately, or VSOE. Product revenue for products which have demonstrated market acceptance, is generally recognized upon shipment provided title and risk of loss has passed to the customer, evidence of an arrangement exists, prices are contractually fixed or determinable, collection is reasonably assured through historical collection results and regular credit evaluations, and there are no uncertainties regarding customer acceptance. Revenue from installation services is recognized at the time acceptance has occurred, as defined in the sales documentation, or, for certain customers, when both the acceptance has occurred and retention payment has been received. Revenue for other elements is recognized at the time products are shipped or the related services are performed. We generally recognize product revenue for systems which have demonstrated market acceptance at the time of shipment because the customer's post-delivery acceptance provisions and installation process have been established to be routine, commercially inconsequential and perfunctory. We believe the risk of failure to complete a system installation is remote. For initial shipments of systems with new technologies or in the small number of instances where we are unsure of meeting the customer's specifications or obtaining customer acceptance upon shipment of the system, we will defer the recognition of systems revenue and related costs until written customer acceptance of the system is obtained. This deferral period is generally within twelve months of shipment. Impairment of Long-Lived Assets We record impairment losses on long-lived assets when events and circumstances indicate that these assets might not be recoverable. Recoverability is measured by a comparison of the assets' carrying amount to their expected future undiscounted net cash flows. If such assets are considered to be impaired, the impairment is measured based on the amount by which the carrying value exceeds its fair value. Future actual performance could be materially different from our current forecasts, which could impact future estimates of undiscounted cash flows and may result in the impairment of the carrying amount of the long-lived assets in the future. This could be caused by strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our customer base, or a material adverse change in our relationships with significant customers. We did not record an impairment charge for the years ended December 31, 2013, 2012 or 2011. Accounts Receivable-Allowance for Doubtful Accounts We record an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is established based on a specific assessment of collectability of our customer accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be necessary. 20-------------------------------------------------------------------------------- Inventory-Allowance for Excess and Obsolescence We record an allowance for estimated excess and obsolete inventory. The allowance is determined using management's assumptions of materials usage, based on estimates of forecasted and historical demand and market conditions. If actual market conditions become less favorable than those projected by management, additional inventory write-downs may be required. Although we make every effort to ensure the accuracy of our forecasts or product demand and pricing assumptions, any significant unanticipated changes in demand, pricing, or technical developments would significantly impact the value of our inventory and our reported operating results. In the future, if we find that estimates are too optimistic and determine that inventory needs to be written down, the Company will recognize such costs in our cost of revenue at the time of such determination. Conversely, if we find our estimates are too pessimistic and we subsequently sell product that has previously been written down, our gross margin in that period will be favorably impacted. In 2013, we recorded an $8.5 million net decrease to our inventory reserves, primarily related to an $8.7 million disposal of previously, fully reserved inventory in the fourth quarter of 2013. Product Warranty We generally offer a one year warranty for all of our systems, the terms and conditions of which vary depending upon the product sold. For all systems sold, we accrue a liability for the estimated cost of standard warranty at the time of system shipment and defer the portion of systems revenue attributable to the fair value of non-standard warranty. Costs for non-standard warranty are expensed as incurred. Factors that affect our warranty liability include the number of installed units, historical and anticipated product failure rates, material usage and service labor costs. We periodically assess the adequacy of our recorded liability and adjust the amount as necessary. Share-Based Compensation Stock-based compensation expense with time based conditions is estimated as of the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which generally equals the vesting period, based on the number of awards that are expected to vest. Estimating the fair value for stock options requires judgment, including the expected term of our stock options, volatility of our stock, expected dividends, risk-free interest rates over the expected term of the options and the expected forfeiture rate. We are responsible for estimating volatility and have considered a number of factors when estimating volatility. Our method of estimating expected volatility for all stock options granted relies on a combination of historical and implied volatility. We believe that this blended volatility results in a more accurate estimate of the grant-date fair value of employee stock options because it more appropriately reflects the market's current expectations of future volatility. In limited circumstances, we also issue stock option grants with vesting based on performance conditions, such as the price of our common stock, or, a combination of time or performance conditions. The fair values and derived service periods for all grants that have vesting based on these performance conditions are estimated using the Monte Carlo valuation method. For each stock option grant with vesting based on a combination of time or performance conditions where vesting will occur if either condition is met, the related compensation costs are recognized over the shorter of the explicit service period or the derived service period. We use the straight-line attribution method to recognize expense for stock-based awards such that the expense associated with awards is evenly recognized throughout the period. 21 -------------------------------------------------------------------------------- The amount of stock-based compensation recognized is based on the value of the portion of the awards that are ultimately expected to vest. We estimate forfeitures at the time of grant and revise them, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the unvested portion of the surrendered stock-based award. The benefits of tax deductions in excess of recognized compensation cost is reported as a financing cash flow, rather than as an operating cash flow. Because the Company does not recognize the benefit of tax deductions in excess of recognized compensation cost due to its cumulative net operating loss position, this had no impact on the Company's consolidated statement of cash flows as of and for the years ended December 31, 2013, 2012 and 2011. Income Taxes We record income taxes using the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and net operating loss and tax credit carryforwards. Our consolidated financial statements contain certain deferred tax assets which have arisen primarily as a result of operating losses, as well as other temporary differences between financial and income tax accounting. We establish a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Significant management judgment is required in determining our provision for income taxes, the deferred tax assets and liabilities and any valuation allowance recorded against those net deferred tax assets. We evaluate the weight of all available evidence such as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences to determine whether it is more likely than not that some portion or all of the net deferred income tax assets will not be realized. Based on our level of deferred tax assets as of December 31, 2013 and our level of historical U.S. losses, we have determined that the current uncertainty regarding the realization of these assets is sufficient to warrant the need for a full valuation allowance against our U.S. net deferred tax assets. We have also determined that a valuation allowance is required on a portion of our foreign deferred tax assets. Our income tax expense includes the largest amount of tax benefit for an uncertain tax position that is more likely than not to be sustained upon audit based on the technical merits of the tax position. Settlements with tax authorities, the expiration of statutes of limitations for particular tax positions, or obtaining new information on particular tax positions may cause a change to the effective tax rate. The Company recognizes accrued interest related to unrecognized tax benefits as interest expense and penalties as operating expense. Change in Accounting Estimate Effective October 1, 2013, we changed our estimate of the useful life of our assets manufactured for internal use (which are amortized on a straight-line basis) from five years to ten years. This change in estimate resulted from the evaluation of the life cycle of our assets manufactured for internal use and the conclusion, that based on recent experience these products consistently have a longer life than previously estimated. We believe that this change in estimate more accurately reflects the productive life of these assets. The change in useful life has been accounted for as a change in accounting 22-------------------------------------------------------------------------------- estimate, and will be effective on new assets manufactured for internal use, on a prospective basis beginning October 1, 2013. As a result of the change in the estimated life of assets manufactured for internal use, profit before tax and net profit were approximately $0.1 million higher, for both the fourth quarter and the full year ended December 31, 2013. The change in estimated useful life of assets did not have an impact on the earnings per share disclosed in the consolidated statements of operations. Results of Operations The following table sets forth our results of operations as a percentage of total revenue: Years Ended December 31, 2013 2012 2011 Revenue: Product 86.7 % 85.7 % 90.0 % Services 13.3 14.3 10.0 Total revenue 100.0 100.0 100.0 Cost of revenue: Product 54.5 60.8 56.8 Services 10.8 10.6 7.3 Total cost of revenue 65.3 71.4 64.1 Gross profit 34.7 28.6 35.9 Operating expenses: Research and development 17.8 19.9 14.8 Sales and marketing 10.8 12.7 9.1 General and administrative 13.0 13.1 9.8 Gain on sale of dry strip systems assets and intellectual property (0.6 ) (3.9 ) - Restructuring charges 1.2 2.0 - Total operating expenses 42.2 43.8 33.7 Income (loss) from operations: (7.5 ) (15.2 ) 2.2 Other income (expense): Interest income - - - Interest expense (0.3 ) - - Other, net (0.5 ) (0.7 ) 0.1 Total other income (expense) (0.8 ) (0.7 ) 0.1 Income (loss) before income taxes (8.3 ) (15.9 ) 2.3 Income taxes 0.5 0.8 0.7 Net income (loss) (8.8 )% (16.7 )% 1.6 % 23 -------------------------------------------------------------------------------- Revenue The following table sets forth our revenues. Years ended Period-to-Period Years ended Period-to-Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands)Revenues: Product $ 169,587 $ 174,309 $ (4,722 ) (2.7 )% $ 174,309 $ 287,324 $ (113,015 ) (39.3 )% Percentage of revenues 86.7 % 85.7 % 85.7 % 90.0 % Services 26,045 29,076 (3,031 ) (10.4 )% 29,076 32,092 (3,016 ) (9.4 )% Percentage of revenues 13.3 % 14.3 % 14.3 % 10.0 % Total revenues $ 195,632 $ 203,385 $ (7,753 ) (3.8 )% $ 203,385 $ 319,416 $ (116,031 ) (36.3 )% 2013 Compared with 2012 Product Product revenue which includes new system sales, sales of spare parts, product upgrades and used system sales was $169.6 million or 86.7% of revenue in 2013, compared with $174.3 million, or 85.7% or revenue in 2012. The decrease in product revenue in 2013 is attributable to the weak semiconductor market and a related decrease in capital spending by semiconductor manufacturers early in 2013. Weak sales of our ion implant systems combined with our customers' suspended spending for consumables, spare parts and upgrades resulted in this decline in product revenue in 2013 compared with 2012. Approximately 23.1% of systems revenue in 2013 was from sales of 200mm products and 76.9% was from sales of 300mm products, compared with 23.4% and 76.6% for sales of 200mm products and 300mm products in 2012, respectively. A portion of our revenue from system sales is deferred until installation and other services related to future deliverables are performed. The total amount of deferred revenue at December 31, 2013 and 2012 was $4.7 million and $6.9 million, respectively. The decrease was mainly due to the decrease in systems sales in 2013 and the timing of acceptance of deferred system sales. Services Service revenue, which includes the labor component of maintenance and service contracts and fees for service hours provided by on-site service personnel, was $26.0 million, or 13.3% of revenue for 2013, compared with $29.1 million, or 14.3% of revenue for 2012. Although service revenue should increase with the expansion of the installed base of systems, it can fluctuate from period to period based on capacity utilization at customers' manufacturing facilities, which affects the need for equipment service. The decrease during 2013 was primarily due to a decrease in fabrication utilization in the semiconductor industry during 2013. 2012 Compared with 2011 Product Product revenue was $174.3 million or 85.7% of revenue in 2012, compared with $287.3 million, or 90.0% or revenue in 2011. The decrease in product revenue in 2012 is attributable to the continued weak semiconductor market and a related decrease in capital spending by semiconductor manufacturers during 2012. Ongoing weak sales of our ion implant and dry strip systems combined with our 24-------------------------------------------------------------------------------- customers' suspended spending for consumables, spare parts and upgrades resulted in this decline in product revenue in 2012 compared with 2011. Approximately 23.4% of systems revenue in 2012 was from sales of 200mm products and 76.6% was from sales of 300mm products, compared with 24.9% and 75.1% for sales of 200mm products and 300mm products in 2011, respectively. The total amount of deferred revenue at December 31, 2012 and 2011 was $6.9 million and $12.3 million, respectively. The decrease was mainly due to the decrease in systems sales in 2012 and the timing of acceptance of deferred system sales. Services Service revenue was $29.1 million, or 14.3% of revenue for 2012, compared with $32.1 million, or 10.0% of revenue for 2011. The decrease during 2012 was primarily due to a decrease in fabrication utilization in the semiconductor industry during 2012. Revenue Categories used by Management In addition to the line item revenue categories discussed above, management also uses revenue categorizations which look at revenue by product line (the most significant of which is ion implant) and by aftermarket, as described below. 2013 Compared with 2012 Ion Implant Included in total revenue of $195.6 million in 2013 is revenue from sales of ion implantation products and related service of $164.0 million, or 83.8% of total revenue, compared with $156.1 million, or 76.7%, of total revenue in 2012. The increase in ion implant's share of total revenue for 2013 reflects a reduction in dry strip revenue following the sale of assets relating to the dry strip product line in December 2012 as discussed in the Overview. Total revenue in ion implant increased slightly as the market improved in 2013. Aftermarket We refer to the business of selling spare parts, product upgrades, and used systems combined with the sale of maintenance labor and service contracts and service hours, as the "aftermarket" business. Included in total revenue of $195.6 million in 2013 is revenue from our aftermarket business of $120.6 million, compared to $124.1 million for 2012. Aftermarket revenue generally increases with the expansion of the installed base of systems but can fluctuate from period to period based on capacity utilization at customers' manufacturing facilities which affects the sale of spare parts and demand for equipment service. The decrease in aftermarket revenue in 2013 compared to 2012 was due to a decrease in fabrication utilization in the semiconductor industry during 2013. 2012 Compared with 2011 Ion Implant Included in total revenue of $203.4 million in 2012 is revenue from sales of ion implantation products and related service of $156.1 million, or 76.7% of total revenue, compared with $237.9 million, or 74.5%, of total revenue in 2011. The dollar decrease was due to the factors discussed above for product revenue. Annual revenue from the sale of ion implantation products and service typically averages from 70.0% to 80.0% of total revenue. 25-------------------------------------------------------------------------------- Aftermarket Included in total revenue of $203.4 million in 2012 is revenue from our aftermarket business of $124.1 million, compared to $147.6 million for 2011. The decrease in aftermarket revenue in 2012 compared to 2011 was due to a decrease in fabrication utilization in the semiconductor industry during 2012. Gross Profit / Gross Margin The following table sets forth our gross profit. Years ended Period-to-Period Years ended Period-to-Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands) Gross Profit: Product $ 62,909 $ 50,716 $ 12,193 24.0 % $ 50,716 $ 106,083 $ (55,367 ) (52.2 )% Product gross margin 37.1 % 29.1 % 29.1 % 36.9 % Services 5,026 7,455 (2,429 ) (32.6 )% 7,455 $ 8,654 (1,199 ) (13.9 )% Services gross margin 19.3 % 25.6 % 25.6 % 27.0 % Total gross profit $ 67,935 $ 58,171 $ 9,764 16.8 % $ 58,171 $ 114,737 $ (56,566 ) (49.3 )% Gross margin 34.7 % 28.6 % 28.6 % 35.9 % 2013 Compared with 2012 Product Gross margin from product revenue was 37.1% for the twelve months ended December 31, 2013, compared to 29.1% for the twelve months ended December 31, 2012, an increase of 8.0 percentage points. Gross profit increased by 7.0 percentage points due to a lower excess inventory charge. A favorable mix of systems sales and lower warranty costs increased gross profit by 1.9 percentage points. These increases were partially offset by a 0.9 percentage point decrease in gross profit resulting from lower margins on parts and upgrade revenue. Services Gross margin from service revenue was 19.3% for the twelve months ended December 31, 2013, compared to 25.6% for the twelve months ended December 31, 2012. The decrease in gross profit is attributable to changes in the mix of service contracts and the unfavorable absorption of fixed service costs. 2012 Compared with 2011 Product Gross margin from product revenue was 29.1% for the twelve months ended December 31, 2012, compared to 36.9% for the twelve months ended December 31, 2011, a decrease of 7.8 percentage points. Gross profit decreased by 7.7 percentage points due to a higher excess inventory charge of $13.4 million recorded during the fourth quarter of 2012, as a result of our comprehensive review of our worldwide inventory levels. Lower systems sales volumes and the related unfavorable absorption of fixed overhead costs also contributed to the reduction in gross profit by 9.0 percentage points. These decreases were partially offset by an 8.9 percentage point increase in gross profit resulting from a higher margin mix of parts and upgrade revenue. 26-------------------------------------------------------------------------------- Services Gross margin from service revenue was 25.6% for the twelve months ended December 31, 2012, compared to 27.0% for the twelve months ended December 31, 2011. The decrease in gross profit is attributable to changes in the mix of service contracts and the unfavorable absorption of fixed service costs. Operating Expenses The following table sets forth our operating expenses: Years ended Period-to-Period Years ended Period-to-Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands) Research and development $ 34,756 $ 40,401 $ (5,645 ) (14.0 )% $ 40,401 $ 47,176 $ (6,775 ) (14.4 )% Percentage of revenues 17.8 % 19.9 % 19.9 % 14.8 % Sales and marketing 21,159 25,889 (4,730 ) (18.3 )% 25,889 29,255 (3,366 ) (11.5 )% Percentage of revenues 10.8 % 12.7 % 12.7 % 9.1 % General and administrative 25,471 26,554 (1,083 ) (4.1 )% 26,554 31,174 (4,620 ) (14.8 )% Percentage of revenues 13.0 % 13.1 % 13.1 % 9.8 % Gain on sale of dry strip assets and intellectual property (1,167 ) (7,904 ) 6,737 85.2 % (7,904 ) - (7,904 ) - % Percentage of revenues (0.6 )% (3.9 )% (3.9 )% 0.0 % Restructuring charges 2,334 4,169 (1,835 ) (44.0 )% 4,169 - 4,169 - % Percentage of revenues 1.2 % 2.0 % 2.0 % 0.0 % Total operatingexpenses $ 82,553 $ 89,109 $ (6,556 ) (7.4 )% $ 89,109 $ 107,605 $ (18,496 ) (17.2 )% Percentage of revenues 42.2 % 43.8 % 43.8 % 33.7 % Our operating expenses consist primarily of personnel costs, including salaries, commissions, bonuses, share-based compensation and related benefits and taxes; project material costs related to the design and development of new products and enhancement of existing products; and professional fees, travel and depreciation expenses. Personnel costs are our largest expense, representing $47.3 million, or 58.1% of our total operating expenses, excluding the gain on sale of the dry strip assets and intellectual property of $1.2 million and restructuring charges of $2.3 million, for the year ended December 31, 2013; $52.5 million, or 56.5%, of our total operating expenses, excluding the gain on sale of the dry strip assets and intellectual property of $7.9 million and restructuring charges of $4.2 million for the year ended December 31, 2012; and $62.5 million, or 58.1%, of our total operating expenses for the year ended December 31, 2011. In general, operating expenses declined from 2011 to 2013 as a result of our efforts to maintain tight control of discretionary spending. Research and Development Period-to- Period-to- Years ended Period Years ended Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands) Research and development $ 34,756 $ 40,401 $ (5,645 ) (14.0 )% $ 40,401 $ 47,176 $ (6,775 ) (14.4 )% Percentage of revenues 17.8 % 19.9 % 19.9 % 14.8 % Our ability to remain competitive depends largely on continuously developing innovative technology, with new and enhanced features and systems and introducing them at competitive prices on 27-------------------------------------------------------------------------------- a timely basis. Accordingly, based on our strategic plan, we establish annual R&D budgets to fund programs that we expect will drive competitive advantages. 2013 Compared with 2012 Research and development expense was $34.8 million in 2013, a decrease of approximately $5.6 million, or 14.0%, compared with $40.4 million in 2012. The decrease was primarily due to the reduction in payroll costs of $3.2 million as a result of lowering our headcount through reductions in force. As we focused our R&D spend on critical programs, consulting, project material and related costs decreased by $0.5 million and depreciation expense for internal use assets used as demonstration and/or test systems decreased by $1.5 million. 2012 Compared with 2011 Research and development expense was $40.4 million in 2012, a decrease of approximately $6.8 million, or 14.4%, compared with $47.2 million in 2011. The decrease was primarily due to the reduction in payroll costs of $2.4 million as a result of lowering our headcount through reductions in force and the cost savings realized by three weeks of unpaid furloughs taken by our employees. As we focused our R&D spend on critical programs, consulting and project material costs decreased by $2.6 million and depreciation expense for internal use assets used as demonstration and/or test systems decreased by $1.4 million. Sales and Marketing Period-to- Period-to- Years ended Period Years ended Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands) Sales and marketing $ 21,159 $ 25,889 $ (4,730 ) (18.3 )% $ 25,889 $ 29,255 $ (3,366 ) (11.5 )% Percentage of revenues 10.8 % 12.7 % 12.7 % 9.1 % Our sales and marketing expenses result primarily from the sale of our equipment and services through our direct sales force. 2013 Compared with 2012 Sales and marketing expense was $21.2 million in 2013, a decrease of $4.7 million, or 18.3%, compared with $25.9 million in 2012. The decrease was primarily due to the reduction in payroll costs of $1.6 million as a result of lowering our headcount through reductions in force. In addition, consulting and project material costs decreased by $0.3 million and travel costs decreased by $0.3 million due to reduced travel. In addition, there was a one-time marketing expense of $2.1 million associated with our evaluation programs in 2012. 2012 Compared with 2011 Sales and marketing expense was $25.9 million in 2012, a decrease of $3.4 million, or 11.5%, compared with $29.3 million in 2011. The decrease was primarily due to the reduction in payroll costs of $5.0 million as a result of lowering our headcount through reductions in force and the cost savings realized by three weeks of unpaid furloughs taken by our employees. In addition, freight expenses decreased by $0.5 million due to lower shipments and travel costs decreased by $0.8 million due to reduced travel. The decreases in expenses were partially offset by a one-time marketing expense of $2.1 million associated with our evaluation programs and an increase in consulting expenses of $0.4 million. 28-------------------------------------------------------------------------------- General and Administrative Period-to- Period-to- Years ended Period Years ended Period December 31, Change December 31, Change 2013 2012 $ % 2012 2011 $ % (dollars in thousands) General and administrative $ 25,471 $ 26,554 $ (1,083 ) (4.1 )% $ 26,554 $ 31,174 $ (4,620 ) (14.8 )% Percentage of revenues 13.0 % 13.1 % 13.1 % 9.8 % 2013 Compared with 2012 General and administrative expense was $25.5 million in 2013, a decrease of $1.1 million, or 4.1% compared with $26.6 million in 2012. The decrease was due to the reduction in payroll costs of $0.4 million as a result of lower headcount, lower legal fees of $0.5 million associated with patents related to our dry strip product line which was sold in 2012, and lower facility related costs. 2012 Compared with 2011 General and administrative expense was $26.6 million in 2012, a decrease of $4.6 million, or 14.8% compared with $31.2 million in 2011. The decrease was due to the reduction in payroll costs of $2.6 million as a result of lowering our headcount through reductions in force and the cost savings realized by three weeks of unpaid furloughs taken by our employees, lower facility related costs of $1.1 million, which were partially due to the three weeks of plant shutdowns, lower professional fees of $0.3 million and lower consulting costs of $0.6 million. Gain on Sale of Dry Strip Assets and Intellectual Property On December 3, 2012, we sold our dry strip system assets and intellectual property to Lam Research. 2013 Compared with 2012 The $1.2 million gain on sale of dry strip assets and intellectual property in 2013 was related to the achievement of reaching certain milestones with Lam in 2013. 2012 Compared with 2011 The $7.9 million gain on sale of dry strip assets and intellectual property in 2012 was comprised of $8.7 million in proceeds received for the sale, offset by approximately $0.8 million of product and material costs related to the lab system and other components purchased by Lam. Restructuring During 2012 and 2013, we implemented multiple reductions in force to improve the focus of our operations, control costs to achieve future profitability and conserve cash. 2013 Compared with 2012 In 2013, we recorded $2.3 million in restructuring expense for severance and related costs as a result of this reduction in force as compared to $4.2 million in restructuring expense for severance and related costs during the twelve months ended December 31, 2012. 29-------------------------------------------------------------------------------- 2012 Compared with 2011 In 2012, we recorded a restructuring expense for severance and related costs of $4.2 million, which included a $0.1 million non-cash charge related to the modification of a share-based award during twelve months ended December 31, 2012. Approximately $0.5 million of the restructuring costs were associated with the sale of the dry strip assets and intellectual property. Other Income (Expense) 2013 Compared with 2012 Other expense was $1.5 million for the twelve months ended December 31, 2013 compared to other expense of $1.5 million for the twelve months ended December 31, 2012. Other income (expense) consists primarily of foreign exchange gains and losses attributable to fluctuations of the U.S. dollar against the local currencies of certain of the countries in which we operate, interest earned on our invested cash balances, bank fees associated with our financing arrangements and interest expense related to our term loan. 2012 Compared with 2011 Other expense was $1.5 million for the twelve months ended December 31, 2012 compared to other income of $0.3 million for the twelve months ended December 31, 2011. Other income (expense) consists primarily of foreign exchange gains and losses attributable to fluctuations of the U.S. dollar against the local currencies of certain of the countries in which we operate, interest earned on our invested cash balances and bank fees associated with maintaining our credit facility. During the years ended December 31, 2013, 2012 and 2011, we had no significant off-balance-sheet risk such as foreign exchange contracts, option contracts or other foreign hedging arrangements Income Taxes Income tax expense was $1.0 million, $1.6 million and $2.4 million for the twelve months ended December 31, 2013, 2012 and 2011, respectively. Our income tax expense is due primarily to operating results of foreign entities in jurisdictions in Europe and Asia, where we earn taxable income. We have significant net operating loss carryforwards in the United States and certain European jurisdictions, and, as a result, we do not currently pay significant income taxes in those jurisdictions. Additionally, we do not recognize the tax benefit for such losses in the United States and certain European taxing jurisdictions. During 2013, the statute of limitations expired for an uncertain tax position for $0.4 million in a foreign jurisdiction that was reserved for in 2008. This resulted in a benefit to tax expense of $0.3 million and a reduction to interest expense of $0.1 million. The expiration of the statute of limitations did not have a significant impact on our results of operations or cash flows for the twelve months ended December 31, 2013. During the year ended December 31, 2013, we incurred charges related to the write-off of deferred tax assets in certain foreign jurisdictions that were no longer realizable, which resulted in a non-cash tax expense of $0.4 million. The charge did not have a significant impact on our results of operations or cash flows for the twelve months ended December 31, 2013. Liquidity and Capital Resources Our liquidity is affected by many factors. Some of these relate specifically to the operations of our business, for example, the rate of sale of our product lines, and others relate to the uncertainties of global economies, including the availability of credit and the condition of the overall semiconductor 30 -------------------------------------------------------------------------------- equipment industry. Our established cost structure does not vary significantly with changes in volume. We have reduced operating expense to achieve profitability towards the lower end of our quarterly revenue swings. We experience fluctuations in operating results and cash flows depending on our revenue as driven by the level of capital expenditures by semiconductor manufacturers. For the full year 2013, $15.0 million of cash was used to support operating activities. This compares to cash used to support operations of $10.6 million in 2012. The $4.4 million increase in cash used by operations in 2013 was predominately driven by the decrease in the Company's loss from operations excluding non-cash charges for depreciation and amortization and stock based compensation expense. We received $1.2 million in cash in 2013 for the achievement of milestones associated with the Lam transaction, which was partially offset by $0.8 million in capital expenditures. Cash also had a net increase from financing activities of $15.7 million, driven by the $15.0 million proceeds from the issuance of our term loan and $1.7 million of proceeds from the exercise of stock options partially off-set by $0.8 million of long-term restricted cash related to our term loan. Cash and cash equivalents at December 31, 2013 are $46.3 million, compared to $45.0 million at December 31, 2012. Working capital at December 31, 2013 was $149.4 million. Approximately $23.0 million of cash was located in foreign jurisdictions as of December 31, 2013. Capital expenditures were $0.8 million and $0.6 million for the years ended December 31, 2013 and 2012, respectively. Total capital expenditures for 2014 are projected to be slightly higher than in 2013. Future capital expenditures beyond 2014 will depend on a number of factors, including the timing and rate of expansion of our business and our ability to generate cash to fund them. We have an interest reserve account, outstanding standby letters of credit and surety bonds in the amount of $4.7 million to support our term loan as well as specified operating and insurance programs and certain value added tax claims in Europe. The following represents our commercial commitments as of December 31, 2013 (in thousands): Amount of Commitment Expiration by Period Other Commercial Commitments Total 2014 2015-2018 Surety bonds $ 1,432 $ 172 $ 1,260 Standby letters of credit 2,473 2,473 - Interest reserve escrow 825 - 825 $ 4,730 $ 2,645 $ 2,085 The following represents our contractual obligations as of December 31, 2013 (in thousands): Payments Due by Period Contractual Obligations Total 2014 2015-2018 2018-2021 Debt Obligations $ 15,000 471 14,529 - Interest Payments 2,045 808 1,237 - Purchase order commitments 24,468 24,238 230 - Operating leases 4,574 2,762 1,812 - $ 46,087 $ 28,279 17,808 - We have no off-balance sheet arrangements at December 31, 2013, exclusive of operating leases. We have net operating loss and tax credit carryforwards, the tax effect of which aggregate $131.4 million at December 31, 2013. These carryforwards, which expire principally between 2014 and 31-------------------------------------------------------------------------------- 2032, are available to reduce future income tax liabilities in the United States and certain foreign jurisdictions. It is Company policy to provide taxes for the total anticipated tax impact of the undistributed earnings of our wholly-owned foreign subsidiaries,' as such earnings are not expected to be reinvested indefinitely. The Company anticipates that U.S. tax resulting from remitting such earnings will be off-set by net operating loss or credit carryforwards to the extent available. In addition, the Company does not anticipate incurring a foreign withholding tax on remitting such earnings since it does not intend to remit the earnings as dividends. On July 5, 2013, we entered into a Business Loan Agreement with Northern Bank & Trust Company (the "Bank"), which provides for a three year term loan of $15.0 million, secured by our real estate in Beverly, Massachusetts (the "Term Loan"). The Term Loan bears interest at the rate of 5.5% per annum, with payments of principal beginning August 5, 2014 on a 10 year amortization schedule of the principal on a straight-line basis. Interest is payable monthly beginning on August 5, 2013. All outstanding principal and unpaid interest is due and payable on July 5, 2016. In addition, under the Term Loan, the Company must comply with financial covenants relating to debt service ratio, net worth and liquidity. As of December 31, 2013, we were in compliance with all covenant requirements of the Term Loan. In connection with closing the term loan with Northern Bank & Trust Company, we terminated our revolving credit facility with Silicon Valley Bank, which had provided for borrowings of up to $30.0 million. We paid a $0.3 million early termination fee to Silicon Valley Bank. In the fourth quarter, we reinstated a revolving credit facility with Silicon Valley Bank pursuant to a Loan and Security Agreement dated October 31, 2013. The facility provides for borrowings up to $10.0 million, based primarily on accounts receivable, and is subject to certain financial covenants requiring us to maintain minimum levels of operating results and liquidity. The agreement will terminate on October 31, 2015. The Company uses the facility to support letters of credit and for short term borrowing as needed. At December 31, 2013, our available borrowing capacity under this revolving credit facility was $7.5 million and we were compliant with all covenants of the credit facility. There were no borrowings against this facility during the year-ended December 31, 2013. We believe that based on our current market, revenue, expense and cash flow forecasts, our existing cash, cash equivalents and borrowing capacity will be sufficient to satisfy our anticipated cash requirements for the short and long-term. In the event that demand for our products declines in future periods, we believe we can align manufacturing and operating spending levels to the changing business conditions and provide sufficient liquidity to support operations. Related-Party Transactions There are no significant related-party transactions that require disclosure in the consolidated financial statements for the year ended December 31, 2013, or in this Annual Report on Form 10-K. Recent Accounting Pronouncements A discussion of recent accounting pronouncements is included in Note 2 to the consolidated financial statements for the year ended December 31, 2013 included in this Annual Report on Form 10-K. |