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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 in Part I, Item 1 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, could, should, would, anticipates, expects, intends, plans, predicts, projects, 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 and adversely 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" in our Annual Report for the fiscal year ended July 31, 2013 filed on Form 10-K with the Securities and Exchange Commission on October 11, 2013 and those appearing elsewhere in this Quarterly Report on Form 10-Q. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and reflect management's estimates and 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 LTX-Credence Corporation ("LTX-Credence" or the "Company"), including the recently acquired atg-Luther & Maelzer, Everett Charles Technologies and Multitest businesses, is a global provider of test and handling capital equipment, interface products, test fixtures and services to the semiconductor, industrial, and electronics manufacturing industries. We design, manufacture, market and service systems and products that address the broad, divergent requirements of the mobility, industrial, medical, automotive and consumer end markets, offering a comprehensive portfolio of solutions and technologies, and a global network of strategically deployed applications and support resources. Semiconductor designers and manufacturers worldwide use our test and handling equipment and interface products to test their devices during the manufacturing process. Our interface products include the design, manufacturing and marketing of load 20 -------------------------------------------------------------------------------- Table of Contents boards, contactors, and pins used in various types of test equipment, and also in a wide variety of commercial and consumer applications. After testing, these devices are incorporated into a wide range of products, including personal and tablet computers, mobile internet equipment such as wireless access points and interfaces, broadband access products such as cable modems and set top boxes, personal communication and entertainment products such as mobile phones and personal digital music players, consumer products such as televisions, videogame systems and digital cameras, automobile electronics and power management devices used in portable and automotive electronics. We also design, manufacture and market printed circuit board (PCB) test systems used in the testing of preassembly PCBs. These testers are used to verify the quality of the PCB prior to the installation of components. The types of PCBs that are tested using these systems include a diverse set of electronic products including network servers, personal computers, tablet computers and mobile phones. Our text fixture products include the design, manufacturing and marketing of in-circuit and functional-circuit fixture design and fabrication services for testing assembled PCBs. We also sell hardware and software support and maintenance services for our products. The chart below displays our semiconductor and PCB manufacturing processes and identifies the product and service offerings at the various steps where our systems or products are used. [[Image Removed: LOGO]] For our semiconductor test related businesses we focus our marketing and sales efforts on integrated device manufacturers (IDMs), outsourced semiconductor assembly and test providers, (OSATs), which perform assembly and testing services for the semiconductor industry, and fabless semiconductor companies, which design integrated circuits but have no manufacturing capability. We offer our customers a comprehensive portfolio of semiconductor test systems, handlers and interface products and provide a global network of strategically deployed applications and support resources. For our PCB test systems and PCBA test fixtures and design services, our marketing and sales efforts are focused on the manufacturers' of PCBs, as well as the companies whose products the PCBs are incorporated. On September 6, 2013, we entered into a Master Sale and Purchase Agreement (Purchase Agreement) with Dover and, solely for the limited purposes set forth in the Purchase Agreement, Dover Corporation (Dover Parent). Pursuant to the Purchase Agreement, we agreed to purchase from Dover or its specified affiliates (collectively, the Sellers) all assets of the Sellers used exclusively or primarily in connection with the research and development, design, manufacture, assembly, production, marketing, distribution, sale and repair of probes, assembled board and bare board test equipment, and fixturing products and the provision of services related thereto (the ECT Business, and such assets and intellectual property, the ECT Assets) and all assets of the Sellers used exclusively or primarily in connection with the research and development, design, manufacture, assembly, production, marketing, distribution, sale and repair of semiconductor test handlers, semiconductor test contactors and sockets and semiconductor test load boards, and the provision of services related thereto (the MT Business, and such assets and intellectual property, the MT Assets). We also agreed to assume certain specified liabilities of the Sellers related primarily or exclusively to the Acquired Businesses or the Acquired Assets (as defined below). Under the Purchase Agreement, we would also acquire all of the issued and outstanding capital stock and other equity interests of specified indirect subsidiaries of Dover Parent and its affiliates that are engaged in the Acquired Businesses, including Everett Charles Technologies LLC (such capital stock and other equity interests, the Acquired Shares). The ECT Business and the MT Business are collectively referred to as the Acquired Businesses and the ECT Assets, the MT Assets and the Acquired Shares are collectively referred to as the Acquired Assets. The asset and share purchase transactions effected pursuant to the Purchase Agreement are collectively referred to as the "Acquisition." On December 1, 2013, the Company completed the Acquisition pursuant to the Purchase Agreement 21-------------------------------------------------------------------------------- Table of Contents On November 27, 2013, in anticipation of the completion of the Acquisition and to fund the purchase price therefore, we entered into a credit agreement (Credit Agreement) with Everett Charles Technologies LLC (ECT and together with us, the Borrowers), Silicon Valley Bank, as lender, administrative agent and issuing lender (SVB), and the several lenders from time to time party thereto (the Lenders). The Credit Agreement provides for a senior secured credit facility in favor of the Borrowers in the aggregate principal amount of up to $55.0 million (the Facility). See the Liquidity and Capital Resources for more information regarding our obligations and expected impact to our liquidity from the Credit Agreement. See Note 3 to the Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a more complete description of the Business Combination. Pursuant to the Purchase Agreement, in connection with the closing of the Acquisition, we paid the Sellers an aggregate purchase price of $93.5 million, of which $73.5 million was paid in cash through a combination of existing cash-on-hand and bank debt and $20.0 million was paid by the issuance of promissory notes by us to the certain Sellers in the original principal amount of $20.0 million. Pursuant to the Purchase Agreement, the cash purchase price was increased by $11.5 million, an amount equal to specified cash balances held by the Acquired Businesses as of the Closing and decreased by an amount equal to any acquired indebtedness and the amount of certain transaction costs and employee related liabilities of the Acquired Businesses as of the Closing. The cash purchase price was also increased by $2.6 million for a working capital adjustment as specified in the Purchase Agreement. After giving effect to the Post-Closing purchase price adjustments described above, and including the reduction in the promissory note, the aggregate purchase price paid to the Sellers as of the date of this report is $105.6 million. Subject to certain conditions, the original principal amount of the promissory notes are also subject to reduction upon written certification from us to Dover prior to January 1, 2015 of certain specified events related our relocation from or refurbishment of certain properties of the Acquired Businesses, or the prepayment of the promissory note in full prior to such date. In January 2014, we executed leases for two new facilities, and in February 2014, we provided Dover with written certification of a planned relocation from certain properties of the Acquired Businesses. Consequently, the original principal amount of the promissory note issued to Dover was reduced by $2.0 million. The promissory notes may be reduced further by $1.75 million subject to certification from us to Dover of other specified events that have not yet occurred. The promissory notes accrue interest on the unpaid balance for each day that they remain outstanding after December 1, 2014 at a per annum rate equal to the London Interbank Offered Rate plus 10%, and may be prepaid by us at any time without penalty prior to May 1, 2019. On or prior to December 1, 2013, we and Dover, or their affiliates, respectively, also entered into a transition services agreement, an intellectual property termination agreement and a license agreement which govern certain ongoing relationships between us and Dover and their respective affiliates following the closing. Pursuant to the Purchase Agreement, we have also agreed to assume certain liabilities related to the Acquired Businesses. See the Liquidity and Capital Resources section for more information regarding our obligations and expected impact to our liquidity pursuant to the Purchase Agreement. Since the Acquisition closed prior to January 31, 2014, the Acquired Assets and liabilities assumed are included in our unaudited consolidated balance sheet as of January 31, 2014. Through January 31, 2014, we incurred an aggregate of approximately $3.4 million in expenses in connection with the Acquisition, and we expect to incur additional expenses relating to the integration of the Acquired Businesses into our operations. Industry Conditions and Outlook We sell capital equipment, consumables and services to companies that design, manufacture, assemble or test semiconductor devices and PCBs. The electronics manufacturing industry, of which semiconductors and PCBs are key components, is highly cyclical, causing a cyclical impact on our financial results. Approximately 50% of our revenues are derived from selling capital equipment. As a result, 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 companies depends on the current and anticipated market demand for semiconductor devices and PCBs and the products that incorporate them. Therefore, demand for our capital equipment and other products and services are dependent on growth in the electronics industry. In particular, three primary characteristics of the industry in which we operate drive the demand for our products and services: • increases in unit production of semiconductor devices and PCBs; • increases in the complexity of semiconductor devices and PCBs used in electronic products; and • the emergence of next generation electronic products requiring new semiconductor or PCB technologies. 22 -------------------------------------------------------------------------------- Table of Contents The following graph shows the cyclicality in semiconductor test and handling equipment orders and shipments from fiscal 2007 through January 2014 (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 products during industry slowdowns. During these slowdown periods, we implement cost reduction measures, such as the strict oversight of expenditures and reduction in discretionary travel and other variable overhead expenses. We believe that these reductions in operating expenses preserve 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 believe that our competitive advantages in the semiconductor test and PCB test industries are primarily driven by the ability of our products to meet or exceed the cost and technical specifications required for the testing of advanced semiconductor devices and PCBs. Our current investment in engineering and product development is focused on enhancements and additions to our product offerings with new options, instruments and performance enhancements designed for specific market segments. We believe this will continue to differentiate our products from the product offerings of our competitors. 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 U.S. economy may 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, or other competitive pressures. 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. 23 -------------------------------------------------------------------------------- Table of Contents 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 Notes and related disclosures in Part I, Item 1 in this Quarterly Report on 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 Part 1, Item 1 in this Quarterly Report on Form 10-Q. 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 Reserves 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 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. These reserves are not reversed until the related inventory is sold or otherwise disposed. Our inventory reserves policy is described in Note 2. Income Taxes In accordance with FASB ASC Topic 740, Income Taxes (Topic 740), 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. Topic 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, the length of carryback and carryforward periods, existing sales backlog and future sales projections. Where there are cumulative losses in recent years, Topic 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 increased from $200.1 million at July 31, 2012, to $204.5 million at July 31, 2013. The increase in our valuation allowance compared to the prior year was primarily due to an increase in deferred tax assets associated with the current year taxable loss generated in various jurisdictions. 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 with Credence in 2008 and Internal Revenue Service Code Section 382 guidance, the future utilization of the combined company's net operating loss deductions will be significantly limited. Valuation of Goodwill We perform our annual goodwill impairment test as required under the provisions of ASC 350-10, Intangibles-Goodwill and Other on July 31 of each fiscal year unless interim indicators of impairment exist. Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Our goodwill represents the excess of acquisition costs over estimated fair value of net assets acquired from StepTech, Inc on June 10, 2003, and from our merger with Credence Systems Corporation ("Credence") on August 29, 2008. There was no goodwill associated with the acquisition of the ECT and Multitest businesses on December 1, 2013. As a result of the recent acquisition, we are still evaluating the impact on the structure of the reporting units of the combined company. During the quarter ending January 31, 2014, we did not identify any triggering events that would result in an interim test of goodwill. 24-------------------------------------------------------------------------------- Table of Contents As discussed in Note 2, Summary of Significant Accounting Policies, contained in the Notes to the Consolidated Financial Statements included Part 1, Item 1 in this Quarterly Report on Form 10-Q, there were no impairment conditions present during the year and therefore we did not conduct an interim impairment test. Valuation of Identifiable Intangible Assets Our identifiable intangible assets include developed technology, distributor and key customer relationships, and trademarks. We primarily used the income approach to value the existing technology and other intangible assets as of the date of acquisition. This approach calculates fair value by estimating future cash flows attributable to each intangible asset and discounting them to present value at a risk-adjusted discount rate. In estimating the useful life of the acquired intangible assets, we considered paragraph 11 of FASB ASC 350, which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors include 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 have amortized these intangible assets over their estimated useful lives using a method that is based on estimated future cash flows as we believe this amortization methodology approximates the pattern in which the economic benefits of the intangible assets will be derived. Impairment of Long-Lived Assets Other Than Goodwill On an on-going basis, our management reviews the carrying value and period of amortization or depreciation of long-lived assets. In accordance with Topic 360, Property, Plant and Equipment, to the FASB ASC, we review whether impairment losses exist on long-lived assets when indicators of impairment are present. During this review, we re-evaluate the significant assumptions used in determining the original cost and estimated useful life of long-lived assets. Although the assumptions may vary, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been a permanent impairment of the value of long-lived assets based upon events or circumstances that have occurred since acquisition. The extent of the impairment amount recognized is based upon the difference of the impaired asset's estimated fair value and its carrying value. As of January 31, 2014 and July 31, 2013, there were no indicators that required us to conduct a recoverability test as of these dates. Product Warranty Costs 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. Our product warranty cost policy is described in Note 2, Summary of Significant Accounting Policies, contained in the Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and is incorporated herein by reference. Trade Accounts Receivable and Allowance for Doubtful Accounts Trade accounts receivable are recorded at the invoiced amount, do not bear interest, and typically have a contractual maturity of ninety days or less. A majority of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. The volatility of the industries that we serve can cause certain of our customers to experience shortages of cash, which can impact their ability to make required payments. 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. Account balances are charged off against the allowance when it is determined the receivable will not be recovered. Recent Accounting Pronouncements Our recent accounting pronouncements are described in Note 11, Recent Accounting Pronouncements, contained in the Notes to Consolidated Financial Statements included in this Quarterly Report on Form 10-Q and is incorporated herein by reference. 25 -------------------------------------------------------------------------------- Table of Contents |