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NEWPORT CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2011 previously filed with the SEC. This discussion contains descriptions of our expectations regarding future trends affecting our business. Words such as "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "should," "will," "would," or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance or condition, trends in our business, or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements and other forward-looking statements made elsewhere in this report are made in reliance upon safe harbor provisions in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of several factors, including, but not limited to those factors set forth and discussed elsewhere in this Quarterly Report on Form 10-Q and in Item 1 (Business) and Item 1A (Risk Factors) of Part I, and Item 7 (Management's Discussion and Analysis of Financial Condition and Results of Operations) of Part II, of our Annual Report on Form 10-K/A for the year ended December 31, 2011. In light of the significant uncertainties inherent in the forward-looking information included in this report, the inclusion of this information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved and readers are cautioned not to place undue reliance on such forward-looking information. Except as required by law, we undertake no obligation to update or revise these forward-looking statements, whether as a result of new information, future events or otherwise. Overview We are a global supplier of advanced-technology products and systems, including lasers, photonics instrumentation, precision positioning and vibration isolation products and systems, optical components, subassemblies and subsystems, three-dimensional non-contact measurement equipment and advanced automated manufacturing systems. Our products are used worldwide in industries including scientific research, defense/security, microelectronics, life and health sciences and industrial markets. We operate within three distinct business segments, our Photonics and Precision Technologies (PPT) Division, our Lasers Division and our Ophir Division. All of our divisions offer a broad array of advanced technology products and services to original equipment manufacturer (OEM) and end-user customers across a wide range of applications in all of our targeted end markets. The following is a discussion and analysis of certain factors that have affected our results of operations and financial condition during the periods included in the accompanying consolidated financial statements. Critical Accounting Policies and Estimates The preparation of our financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate these estimates and assumptions on an ongoing basis. We base our estimates on our historical experience and on various other factors which we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the amounts of certain expenses that are not readily apparent from other sources. The accounting policies that involve the most significant judgments, assumptions and estimates used in the preparation of our financial statements are those related to revenue recognition, allowances for doubtful accounts, pension liabilities, inventory reserves, warranty obligations, asset impairment, income taxes and stock-based compensation. The judgments, assumptions and estimates used in these areas by their nature involve risks and uncertainties, and in the event that any of them prove to be inaccurate in any material respect, it could have a material effect on our reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. A summary of these critical accounting policies is included in Item 7 (Management's Discussion and Analysis of Financial Condition and Results of Operations) of Part II, of our Annual Report on Form 10-K/A for the fiscal year ended 19 -------------------------------------------------------------------------------- Table of Contents December 31, 2011. There have been no material changes to the critical accounting policies disclosed in our Annual Report on Form 10-K/A. Acquisition On January 13, 2012, we acquired all of the outstanding capital stock of ILX Lightwave Corporation (ILX) by means of a merger of our wholly owned subsidiary with and into ILX. The total purchase price for the acquisition was $9.0 million. An initial purchase price of $9.3 million was paid in cash at closing, of which $1.2 million was deposited at closing into escrow until July 12, 2013, to secure certain indemnification and other obligations of the ILX securityholders. The purchase price was subsequently reduced by $0.3 million, based on a calculation of ILX's net assets at closing. We incurred $0.1 million in transaction costs, which have been expensed as incurred and are included in selling, general and administrative expenses in the accompanying consolidated statements of income and comprehensive income. This acquisition expanded our optical power meter and fiber optic source product offerings, and added laser diode instrumentation and laser diode and light emitting diode (LED) burn-in, test and characterization systems to our product portfolio. ILX is now a part of our PPT Division. The consideration paid for the acquisition of ILX is allocated to the assets acquired, net of the liabilities assumed, based upon their estimated fair values as of the date of the acquisition. The excess of the purchase price over the estimated fair value of the assets acquired, net of the estimated fair value of the liabilities assumed, is recorded as goodwill. Below is a summary of the purchase price, assets acquired and liabilities assumed: (In thousands) Assets acquired and liabilities assumed: Cash $ 44 Accounts receivable 1,224 Inventories 861 Other assets 587 Goodwill 3,762 Developed technology 2,800 Customer relationships 1,100 Other intangible assets 1,090 Deferred income taxes (1,841 ) Other liabilities (644 ) $ 8,983 The goodwill related to this acquisition has been allocated to our PPT Division and will not be deductible for tax purposes, as this was a merger. Goodwill During 2011, we acquired multiple businesses, which resulted in us recording goodwill in our Lasers Division and Ophir Division of $6.1 million and $67.8 million, respectively. Political deadlock in Congress due to ideological differences and the current presidential election year in the U.S., as well as the prospect of automatic spending cuts scheduled to take effect in January 2013 absent Congressional action, have created enormous uncertainty in the levels of Federal spending on research and defense programs for 2013. As a result, many research customers have reduced their spending for any new research projects in 2012 that would extend into 2013 until they have better visibility as to their 2013 funding levels. Similarly, many U.S. defense contractors have reduced their spending levels in 2012 until they have better visibility as to defense procurement levels in 2013. Further, the uncertainty caused by the massive overhaul of the U.S. healthcare system under recent legislation, as well as the possibility for repeal of that legislation in the future, have caused many customers in the life and health sciences market to halt, delay or reduce their spending until they have better visibility as to the future regulatory environment. As a result, our actual 2012 sales, and in particular the sales of our Ophir Division, are below the levels that we had originally forecasted. These sales levels and other factors could negatively impact our evaluation of the goodwill associated with our business. We believe that the assumptions we use in evaluating the goodwill associated with our business 20 -------------------------------------------------------------------------------- Table of Contents are reasonable, however we may be required to recognize a goodwill impairment charge in the future as a result of subsequent changes to the factors underlying such assumptions. Stock-Based Compensation During the nine months ended September 29, 2012, we granted 0.5 million restricted stock units and 0.4 million stock-settled stock appreciation rights with weighted average grant date fair values of $17.11 and $7.92, respectively. The total stock-based compensation expense included in our consolidated statements of income and comprehensive income was as follows: Three Months Ended Nine Months Ended September 29, October 1, September 29, October 1, (In thousands) 2012 2011 2012 2011 Cost of sales $ 189 $ 133 $ 490 $ 354 Selling, general and administrative expenses 1,767 1,210 5,075 3,807 Research and development expense 217 166 700 518 $ 2,173 $ 1,509 $ 6,265 $ 4,679 Results of Operations for the Three and Nine Months Ended September 29, 2012 and October 1, 2011 The following table presents our results of operations for the periods indicated as a percentage of net sales: Percentage of Net Sales Three Months Ended Nine Months Ended September 29, October 1, September 29, October 1, 2012 2011 2012 2011 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 56.0 55.6 56.4 54.9 Gross profit 44.0 44.4 43.6 45.1 Selling, general and administrative expenses 26.1 24.2 27.2 24.4 Research and development expense 9.0 8.9 8.9 8.3 Operating income 8.9 11.3 7.5 12.4 Foreign currency translation gain from dissolution of subsidiary - - - 1.9 Gain on sale of investments 0.6 - 1.4 - Interest and other expense, net (1.5) (1.9) (1.6) (1.6) Income before income taxes 8.0 9.4 7.3 12.7 Income tax provision 2.8 1.1 2.2 0.9 Net income 5.2 8.3 5.1 11.8 Net loss attributable to non-controlling interests (0.1) - (0.0) - Net income attributable to Newport Corporation 5.3 % 8.3 % 5.1 % 11.8 % In the following discussion regarding our net sales, certain prior period amounts have been reclassified between end markets to conform to the current period presentation. Net Sales Net sales for the three months ended September 29, 2012 increased by $17.3 million, or 13.8%, compared with the corresponding period in 2011. Net sales for the nine months ended September 29, 2012 increased by $69.6 million, or 18.1%, compared with the corresponding period in 2011. For the three months ended September 29, 2012, net sales by our PPT Division decreased $2.8 million, or 3.5%, compared with the corresponding prior year period, and net sales by our Lasers Division decreased $4.1 million, or 8.8%, compared with the corresponding prior year period. For the nine months ended September 29, 2012, net sales by our PPT Division decreased $8.4 million, or 21 -------------------------------------------------------------------------------- Table of Contents 3.4%, and net sales by our Lasers Division decreased $1.1 million, or 0.8%, compared with the corresponding prior year period. Our Ophir Division, which we established in connection with our acquisition of Ophir Optronics Ltd. (Ophir) in October 2011, contributed net sales of $24.2 million and $79.1 million for the three and nine months ended September 29, 2012, respectively. Our net sales for the three and nine months ended September 29, 2012 also included $5.3 million and $20.9 million, respectively, of net sales from High Q Laser GmbH (High Q), which we acquired in July 2011 and which is included in our Lasers Division, and $1.9 million and $5.5 million, respectively, of net sales from ILX, which we acquired in January 2012 and which is included in our PPT Division. Net sales from High Q for the three and nine months ended October 1, 2011 were $4.9 million. We did not have any comparable sales for Ophir or ILX in the prior year periods. For the three months ended September 29, 2012 compared with the corresponding period in 2011, we experienced increases in net sales to our industrial manufacturing and other end markets and to our scientific research and defense/security end markets, and decreases in sales to our life and health sciences and microelectronics end markets. For the nine months ended September 29, 2012 compared with the corresponding period in 2011, we experienced increases in net sales to all of our end markets, except for the microelectronics market. Sales by Ophir were primarily to customers in our scientific research and defense/security end markets and industrial manufacturing and other end markets, sales by High Q were primarily to customers in our life and health sciences end market, and sales by ILX were primarily to customers in our industrial and other end markets. Net sales to the scientific research and defense/security markets for the three months ended September 29, 2012 increased $8.0 million, or 19.1%, compared with the same period in 2011. Net sales to these markets for the nine months ended September 29, 2012 increased $28.3 million, or 23.0%, compared with the same period in 2011. The increases in both periods were due to the addition of sales from our acquisition of Ophir, which contributed sales to these markets of $11.6 million and $38.6 million during the three and nine months ended September 29, 2012, respectively, offset in part by lower sales to these markets by our Lasers Division and PPT Division due to adverse macroeconomic conditions in these markets as a result of budget constraints and uncertainty in future global research and defense spending levels. Generally, our net sales to these markets by each of our divisions may fluctuate from period to period due to changes in overall research and defense spending levels and the timing of large sales relating to major research and aerospace/defense programs and, in some cases, these fluctuations may be offsetting between our divisions or between such periods. Net sales to the microelectronics market for the three months ended September 29, 2012 decreased $1.3 million, or 3.8%, compared with the same period in 2011. Net sales to this market for the nine months ended September 29, 2012 decreased $11.8 million, or 9.7%, compared with the same period in 2011. The decreases in sales to this market in both periods were due primarily to cyclical downturns in the semiconductor equipment industry. Sales to the microelectronics market were not impacted significantly by any of our acquisitions. Net sales to the life and health sciences market for the three months ended September 29, 2012 decreased $1.5 million, or 5.0%, compared with the same period in 2011. Net sales to this market for the nine months ended September 29, 2012 increased $17.7 million, or 21.7%, compared with the same period in 2011. The decrease in sales to this market for the three month period was due primarily to lower sales of products for bioinstrumentation applications, offset in part by the addition of $1.8 million of sales from our acquisition of Ophir. The increase in sales to this market for the nine month period was due primarily to our acquisitions of High Q and Ophir, which contributed total sales of $26.9 million to this market during this period, offset in part by decreased sales of products for bioinstrumentation applications. High Q contributed $4.2 million of sales to this market in both prior year periods. Net sales to our industrial manufacturing and other end markets for the three months ended September 29, 2012 increased $12.1 million, or 64.4%, compared with the same period in 2011. Net sales to these markets for the nine months ended September 29, 2012 increased $35.4 million, or 61.6%, compared with the same period in 2011. The increases in sales to these markets in both periods were due primarily to our acquisitions of Ophir and ILX, which contributed total sales to these markets of $10.6 million and $32.5 million during the three and nine months ended September 29, 2012, respectively. 22 -------------------------------------------------------------------------------- Table of Contents The table below reflects our net sales by geographic region. Sales are attributed to each location based on the customer address to which the product is shipped. Three Months Ended September 29, October 1, Percentage (In thousands) 2012 2011 Increase Increase United States $ 61,741 $ 57,729 $ 4,012 6.9 % Germany 16,225 16,058 167 1.0 Other European countries 18,913 15,941 2,972 18.6 Japan 15,913 10,323 5,590 54.2 Other Pacific Rim countries 20,157 19,223 934 4.9 Rest of world 9,932 6,324 3,608 57.1 $ 142,881 $ 125,598 $ 17,283 13.8 % Nine Months Ended September 29, October 1, Percentage (In thousands) 2012 2011 Increase Increase United States $ 188,997 $ 173,624 $ 15,373 8.9 % Germany 56,228 38,029 18,199 47.9 Other European countries 56,388 51,483 4,905 9.5 Japan 47,028 37,081 9,947 26.8 Other Pacific Rim countries 73,346 59,233 14,113 23.8 Rest of world 31,716 24,691 7,025 28.5 $ 453,703 $ 384,141 $ 69,562 18.1 % The increases in sales to customers in the United States and Germany for the three months ended September 29, 2012 compared with the corresponding period in 2011 were attributable to higher sales to our industrial manufacturing and other end markets and our scientific research and defense/security end markets, offset in part by lower sales to our microelectronics and life and health sciences end markets. The increases in sales into these countries for the nine months ended September 29, 2012 compared with the corresponding period in 2011 were attributable to higher sales to all of our end markets other than the microelectronics market. In particular, in the United States, sales to our industrial manufacturing and other end markets, and our scientific research and defense/security end markets, were positively impacted by our acquisition of Ophir. In Germany, sales to our life and health sciences market were positively impacted by our acquisition of High Q. The increases in sales to customers in other parts of Europe for the three and nine months ended September 29, 2012 compared with the corresponding prior year periods were attributable to higher sales to all of our end markets other than the microelectronics market. The increases in sales to customers in Japan for the three and nine months ended September 29, 2012 compared with the corresponding prior year periods were due to higher sales to all of our end markets other than the life and health sciences market. The increases in sales to customers in other parts of the Pacific Rim for the three and nine months ended September 29, 2012 compared with the corresponding prior year periods were due to higher sales to all of our end markets, with the exception of lower sales to our scientific research and defense/security markets for the three month period and lower sales to our life and health sciences market for the nine month period. The increase in sales to customers in the rest of the world for the three and nine months ended September 29, 2012 compared with the corresponding prior year periods were due to higher sales to all of our end markets other than the microelectronics market. 23 -------------------------------------------------------------------------------- Table of Contents Gross Margin Gross margin was 44.0% and 44.4% for the three months ended September 29, 2012 and October 1, 2011, respectively, and 43.6% and 45.1% for the nine months ended September 29, 2012 and October 1, 2011, respectively. The addition of Ophir in October 2011 has resulted in decreases in overall gross margins for the 2012 periods compared with the 2011 periods, as the gross margins of our Ophir Division are generally lower than our overall gross margins. In addition, gross margins of our PPT Division decreased in the current year periods compared with the prior year periods due to a higher proportion of sales of lower margin products. Gross margins of our Lasers Division increased during the three months ended September 29, 2012 compared with the corresponding prior year period, due to lower charges for excess and obsolete inventory and lower manufacturing costs related to certain products. Gross margins of our Lasers Division increased during the nine months ended September 29, 2012 due to lower charges for excess and obsolete inventory and warranty reserves, offset in part by higher manufacturing costs for certain products. In general, we expect that our gross margin will vary in any given period depending upon factors such as our mix of sales, product pricing variations, manufacturing absorption levels, and changes in levels of inventory and warranty reserves. Selling, General and Administrative (SG&A) Expenses SG&A expenses totaled $37.3 million, or 26.1% of net sales, and $30.4 million, or 24.2% of net sales, for the three months ended September 29, 2012 and October 1, 2011, respectively. SG&A expenses totaled $123.3 million, or 27.2% of net sales, and $93.6 million, or 24.4% of net sales, for the nine months ended September 29, 2012 and October 1, 2011, respectively. The increases in SG&A expenses in the 2012 periods compared with the prior year periods were due to increased personnel costs and amortization expenses related to acquired intangible assets as a result of our acquisitions of Ophir, High Q and ILX. SG&A expenses related to Ophir, High Q and ILX totaled $9.4 million and $31.2 million for the three and nine months ended September 29, 2012, respectively. In the prior year periods, SG&A expenses related to High Q, which we acquired in July 2011, totaled $0.8 million, and there were no comparable SG&A expenses for Ophir or ILX. In general, we expect that SG&A expense will vary as a percentage of net sales in the future based on our sales level in any given period. Because the majority of our SG&A expense is fixed in the short term, changes in SG&A expense will likely not be in proportion to changes in net sales. Research and Development (R&D) Expense R&D expense totaled $12.9 million, or 9.0% of net sales, and $11.2 million, or 8.9% of net sales, for the three months ended September 29, 2012 and October 1, 2011, respectively. R&D expense totaled $40.3 million, or 8.9% of net sales, and $31.8 million, or 8.3% of net sales, for the nine months ended September 29, 2012 and October 1, 2011, respectively. The increases in R&D expense in the current year periods compared with the prior year periods were due to the addition of R&D expense of Ophir, High Q and ILX. R&D expense for Ophir, High Q and ILX totaled $3.5 million and $11.1 million for the three and nine months ended September 29, 2012, respectively. In the prior year periods, R&D expense related to High Q totaled $0.5 million, and there was no comparable R&D expense for Ophir or ILX. The increases in R&D expense in the current year periods were offset in part by decreased spending in our PPT Division and in other parts of our Lasers Division due to reductions in headcount, suspension of work on certain projects and the completion of other projects. We believe that the continued development and advancement of our products and technologies is critical to our success, and we intend to continue to invest in R&D initiatives, while working to ensure that our efforts are focused and the resources are deployed efficiently. In general, we expect that R&D expense as a percentage of net sales will vary in the future based on our sales level in any given period. Because of our commitment to continued product development, and because the majority of our R&D expense is fixed in the short term, changes in R&D expense will likely not be in proportion to changes in net sales. 24 -------------------------------------------------------------------------------- Table of Contents Gain on Sale of Investments We hold equity interests in privately-held corporations, which were accounted for using the cost method. During previous years, we had reduced the carrying values of these interests to zero due to the corporations' poor financial condition at that time. In the second quarter of 2012, one of these corporations was acquired in a merger transaction, and we received $5.3 million for our interest as a result of the acquisition. In the third quarter of 2012, another of these corporations redeemed its shares from us for $1.0 million, which amount was received in the fourth quarter of 2012. Interest and Other Expense, Net Interest and other expense, net totaled $2.1 million and $2.3 million for the three months ended September 29, 2012 and October 1, 2011, respectively, and $7.1 million and $6.4 million for the nine months ended September 29, 2012 and October 1, 2011, respectively. The decrease in interest and other expense, net for the three months ended September 29, 2012 compared with the same period in 2011 was due primarily to lower interest expense as a result of the repayment of our convertible notes in February 2012 and to foreign currency transaction gains, offset in part by derivative instrument losses and by interest expense related to the term loan under our secured credit facility. The increase in interest and other expense, net for the nine months ended September 29, 2012 compared with the same period in 2011 was due primarily to a $0.6 million gain that occurred in the second quarter of 2011 associated with the recovery of amounts relating to previously discontinued operations, which did not recur in the 2012 period, and derivative instrument losses that occurred in the 2012 period, offset in part by lower interest expense as a result of the repayment of our convertible notes. Income Taxes Our effective tax rate was 34.4% and 11.5% for the three months ended September 29, 2012 and October 1, 2011, respectively, and 30.4% and 7.3% for the nine months ended September 29, 2012 and October 1, 2011, respectively. We had previously established a valuation allowance against substantially all domestic and certain foreign deferred tax assets due to the uncertainty as to the timing and ultimate realization of those assets. During the fourth quarter of 2011, we achieved a cumulative three-year income position in the United States. Management considered this position along with other available evidence, both positive and negative, and determined, as of December 31, 2011, that it was more likely than not that the net deferred tax assets (exclusive of deferred tax liabilities related to indefinite-lived intangibles) would be realized, with the exception of domestic capital losses, domestic unrealized losses, certain foreign net operating loss carryforwards and other miscellaneous foreign deferred tax assets, and we therefore released substantially all of the valuation allowance against our U.S. deferred tax assets. During the first quarter of 2012, we released $1.4 million of our remaining valuation allowance related to certain deferred tax assets due to the expected recovery of certain investments and capital loss carryovers. During the second quarter of 2012, we substantially completed a corporate reorganization related to the U.S. subsidiaries of Ophir, which necessitated updates to the estimated state tax rates used to value our domestic deferred tax assets and liabilities, and as a result, we recognized a $1.0 million tax benefit. During the third quarter of 2012, we released $0.4 million of our valuation allowance related to certain deferred tax assets due to the recovery of certain other investments. Our effective tax rates for the three and nine months ended September 29, 2012 reflected a return to statutory tax rates in the United States, offset in part by the items outlined above. Our effective tax rates for the three and nine months ended October 1, 2011 were favorably impacted by a greater percentage of our earnings being reported in the U.S., which was offset by a reduction in the valuation allowance maintained against our U.S. deferred tax assets at that time. In addition, in the first quarter of 2011, we recognized as a discrete item a non-taxable currency translation gain of $7.2 million associated with the dissolution of our French financing subsidiary, which was a disregarded entity for U.S. tax purposes. Under Accounting Standards Codification (ASC) 740-270, Income Taxes - Interim Reporting, we are required to evaluate and make any necessary adjustments to our effective tax rate each quarter as new information is obtained that may affect the assumptions used to estimate our annual effective tax rate. Our assumptions relate to factors such as the projected level and projected mix of pre-tax earnings in the various tax jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, expected utilization of tax credits and changes in or the interpretation of tax laws in jurisdictions in which we conduct business. In addition, jurisdictions for which we have projected losses for the year, or a year-to- 25 -------------------------------------------------------------------------------- Table of Contents date loss, where no tax benefit can be recognized, are excluded from the calculation of the estimated annual effective tax rate. Changes in our assumptions and the inclusion or exclusion of certain jurisdictions could result in a higher or lower effective tax rate during a particular quarter. We utilize ASC 740-10-25, Income Taxes - Recognition, which requires income tax positions to meet a more-likely-than-not recognition threshold to be recognized in the financial statements. Under ASC 740-10-25, tax positions that previously failed to meet the more-likely-than-not threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. As a multi-national corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If we ultimately determine that the payment of these liabilities will be unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect the ultimate assessment to be. As a result of these adjustments, our effective tax rate in a given financial statement period could be materially affected. The income tax returns of one of our wholly owned Japanese subsidiaries for the taxable years of 2009 through 2011 are currently under audit by the Japanese tax authorities. We do not expect the results of this examination to have a material effect on our financial condition or results of operations. Liquidity and Capital Resources Our cash and cash equivalents, restricted cash and marketable securities balances increased to a total of $76.9 million as of September 29, 2012 from $72.9 million as of December 31, 2011. This increase was attributable primarily to cash provided by operating activities, offset in part by cash used for net repayments of debt, payment of the purchase price for our acquisition of ILX, annual incentive compensation payouts and the purchases of property and equipment. Net cash provided by our operating activities of $54.3 million for the nine months ended September 29, 2012 was attributable primarily to cash provided by our results of operations, a decrease in accounts receivable of $4.0 million due to the timing of collections and an increase in accrued expenses and other liabilities of $2.7 million due to the timing of payments, offset in part by a decrease in accrued payroll and related expenses of $9.4 million due primarily to annual incentive compensation payouts, an increase in gross inventory of $3.8 million and a decrease in accounts payable of $1.1 million due to timing of payments. Net cash used in investing activities of $3.9 million for the nine months ended September 29, 2012 was attributable to net cash paid for our acquisition of ILX of $8.9 million, purchases of property and equipment of $8.3 million and net purchases of marketable securities of $1.4 million, offset in part by the net change in restricted cash of $9.4 million, which was primarily a result of the lapse of restrictions on cash, which had been held, and was subsequently used, for repayment of our convertible notes, and $5.4 million in cash received on the sale of assets. Net cash used in financing activities of $37.9 million for the nine months ended September 29, 2012 was attributable to net repayments of borrowings of $37.3 million (which consisted primarily of principal payments on the term loan under our secured credit facility of $13.9 million, the repayment of the remaining $12.4 million of our convertible notes, the repayment of $6.5 million of loans in Israel, and the repayment of all of our loans and lines of credit in Austria totaling $4.2 million) and payments of $3.1 million in connection with the cancellation of restricted stock units for taxes owed by employees upon the vesting of restricted stock units issued under our stock incentive plans, offset in part by proceeds of $2.4 million from the sale of stock under employee stock plans. In October 2011, we entered into a credit agreement with certain lenders (Credit Agreement). The Credit Agreement and the related security agreement provide for a senior secured credit facility consisting of a $185 million term loan and a $65 million revolving line of credit, each with a term of five years, which is secured by substantially all of our domestic assets as well as a pledge of certain shares of our subsidiaries. The initial interest rates per annum applicable to amounts outstanding under the term loan and the revolving line of credit are, at our option, either (a) the base rate as defined in the Credit Agreement (Base Rate) plus 1.75%, or (b) the Eurodollar Rate 26 -------------------------------------------------------------------------------- Table of Contents as defined in the Credit Agreement (Eurodollar Rate) plus 2.75%. The margins over the Base Rate and Eurodollar Rate applicable to the term loan and loans outstanding under the revolving line of credit are subject to adjustment in future periods based on our consolidated leverage ratio, as defined in and calculated under the Credit Agreement, provided that the maximum applicable margins are 2.00% for Base Rate loans and 3.00% for Eurodollar Rate loans, and the minimum applicable margins are 1.25% for Base Rate loans and 2.25% for Eurodollar Rate loans. Principal amortization and interest payments on the term loan are due quarterly. At September 29, 2012, we had a remaining balance of $171.1 million outstanding on the term loan with an effective interest rate of 2.97%. At September 29, 2012, there was no balance outstanding under the revolving line of credit, with $63.6 million available after considering outstanding letters of credit totaling $1.4 million. Our ability to borrow funds under the revolving line of credit is subject to certain conditions, including compliance with certain covenants and making certain representations and warranties. During 2011, we issued 200 million yen ($2.6 million at September 29, 2012) in private placement bonds through a Japanese bank. These bonds bear interest at a rate of 0.62% per year, payable in cash semiannually in arrears on June 30 and December 31 of each year, and mature on June 30, 2014. The bonds are included in long-term debt in the accompanying consolidated balance sheets as of September 29, 2012. At September 29, 2012, we had (i) four revolving lines of credit with Japanese banks; (ii) two agreements with Japanese banks under which we sell trade notes receivable with recourse; (iii) seven loans with Japanese banks; and (iv) six loans with Israeli banks, as follows: Principal Amount Amount Available for Outstanding Borrowing Description (in millions) (in millions) Interest Rate(s) Expiration Date(s) Japanese lines of credit $ 5.8 $ 7.4 1.18% to 2.475% Various dates through July 2013 Japanese agreements for $ 1.1 $ 6.0 1.48% No expiration sale of receivables dates Japanese loans $ 1.3 $ - 1.25% to 1.45% Various dates through November 2016 Israeli loans $ 4.1 $ - 2.97% to 4.50% Various dates through October 2015 In May 2008, our Board of Directors approved a share repurchase program, authorizing the purchase of up to 4.0 million shares of our common stock. No purchases were made under this program during the nine months ended September 29, 2012. As of September 29, 2012, 3.9 million shares remained available for purchase under the program. However, the terms of the senior secured credit facility that we entered into in October 2011 restrict our ability to purchase additional shares under this program during the term of such facility. During the remainder of 2012, we expect to use $2 million to $4 million of cash for capital expenditures. We believe that our current working capital position, together with our expected future cash flows from operations and the borrowing availability under our lines of credit, will be adequate to fund our operations in the ordinary course of business, our anticipated capital expenditures, our debt payment requirements and other contractual obligations for at least the next twelve months. However, this belief is based upon many assumptions and is subject to numerous risks including those discussed in Item 1A (Risk Factors) of Part I of our Annual Report on Form 10-K/A for the year ended December 31, 2011. Except for the aforementioned capital expenditures, we have no present agreements or commitments with respect to any material acquisitions of businesses, products, product rights or technologies or any other material capital expenditures. However, we will continue to evaluate acquisitions of and/or investments in products, technologies, capital equipment or improvements or companies that complement our business and may make such acquisitions and/or investments in the future. 27 -------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In July 2012, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment, which amends the guidance in ASC 350, Intangibles-Goodwill and Other. ASU No. 2012-02 allows, but does not require, companies first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. ASU No. 2012-02 will be effective for fiscal years beginning after September 15, 2012 and early adoption is permitted but has not been elected. The adoption of ASU No. 2012-02 will not have a material impact on our financial position or results of operations. |