Item 1. Business
Overview
We are the world’s leading supplier of light sources used in the photolithography process for semiconductor, or chip manufacturing. We provide state-of-the-art light sources designed to help enable the performance of leading edge wafer steppers and wafer scanners built by lithography tool manufacturers. We currently supply deep ultraviolet (“DUV”) light sources to our lithography tool manufacturer customers, ASML Holding N.V. (“ASML”), Canon, Inc. (“Canon”) and Nikon, Corp. (“Nikon”), who integrate our light source into their wafer steppers and scanners which they then provide to chipmakers. We provide installed base products in support of our chipmaker customers, who use our light sources in their advanced wafer patterning production processes. In addition, we provide comprehensive support products for our installed base of light sources to the lithography tool manufacturers as well as directly to chipmakers, which include all of the world’s largest semiconductor manufacturers. Our light sources constitute a substantial majority of all DUV light sources incorporated in lithography stepper and scanner tools at chipmakers worldwide. As a result, the majority of consumer electronics devices manufactured in the last several years contain a semiconductor manufactured using our light sources. We are continuing to invest in the development of extreme ultraviolet sources (“EUV”) for chip manufacturing. Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits; however, we have shipped six EUV 3100 pilot sources to date and, in 2011, we received customer acceptance and recorded revenue for three of these sources. We also received orders for our next generation EUV 3300 sources, which we expect to start shipping in 2012.
Our TCZ reporting segment develops, integrates, markets and supports silicon crystallization tools used in the manufacture of different types of displays, including high-resolution low temperature poly-silicon liquid crystal displays (“LTPS - LCD”) and organic light emitting diode (“OLED”) displays. To-date we have shipped
four TCZ tools, and received customer acceptance for two TCZ tools for display fabrication. We have received additional orders for TCZ tools, and we plan to record revenue associated with these tools when customer acceptance is received.
Cymer, Inc. was incorporated in California in 1986 and reincorporated in Nevada on July 12, 1996. Our headquarters is in San Diego, California, where we design, develop and manufacture our light sources and the majority of our replacement parts. To provide better support to our customers located outside of the United States, we maintain a replacement parts refurbishment facility and field service office in South Korea, and field service and support offices in China, Japan, the Netherlands, Singapore and Taiwan. We also maintain a field service office in the United States to support our installed base of light sources located at our United States-based chipmaker customers.
Financial Information about Segments and Geographic Areas
Financial information regarding our segments and the geographic areas where we operate is contained in Note 16 to our Consolidated Financial Statements included in Part II, Item 8 of this report.
Industry Background
The highly cyclical nature of the semiconductor industry is driven by demand for consumer electronic devices that contain semiconductor chips. The complexity of these chips has increased dramatically due to the demand for more sophisticated electronic devices that can provide more functionality, such as smart phones with internet and video capability, tablets and notebook computers that can download and play movies, automotive products, and advanced game consoles that are capable of driving the rapid action and vivid graphics that characterize today’s increasingly realistic and interactive video games. Additionally, there is growing consumer demand for this increased functionality to be available virtually everywhere, through wireless connectivity. These advances have been achieved without the devices increasing in size, and generally without significant increase in price, because chipmakers have been able, over the years, to make each generation of chips with smaller features and finer circuitry than the previous generation. “Moore’s Law”, first observed by Intel Corporation co-founder and former chairman Gordon E. Moore is well-known and widely used in the semiconductor industry to describe the advancement in semiconductor device technology. The semiconductor industry operates to this model, which requires chip makers to pack transistors more tightly with every new generation of chips, shrinking the size of transistors. Smaller transistors mean that semiconductor lithography machines must be able to print finer features with every new generation of chips. Semiconductor equipment suppliers have partnered with their chipmaker customers to enable the features on the chip to continue to shrink. Photolithography is one of the key technologies that enables this process to continue.
The basic building block of semiconductor technology is a thin, flat, round disc of pure silicon called a wafer, which is polished to a mirror-like finish. After polishing, the wafer must go through a complex manufacturing process that involves several hundred steps-all of which must be executed with extreme precision at the level of a few nanometers (“nm”) (one nm is a billionth of a meter). Standard processes, such as photolithography, etch and deposition, are repeated many times on the wafer, resulting in a buildup of microscopic structures, consisting of more than a billion transistors. When the wafer processing is complete, a single wafer will contain hundreds of individual chips, which are then cut, tested, bonded onto lead-wire “legs,” and then packaged in a ceramic or epoxy container.
The display industry continues to be driven by new applications, such as increasing use of smart phones, as well as ongoing expansion of traditional display markets such as laptops, tablets, and televisions. The display industry continues to introduce new capabilities, including better visual appeal such as three dimensional (“3D”) displays, lower power consumption, reduced thickness, and lower cost. In addition to the established display technologies such as liquid crystal displays that are used in numerous products, new display technologies such as OLED are starting to enter the market.
The Lithography Process
Photolithography is a process that uses light to print, or pattern, the complex circuit patterns onto the wafer. The ability to pattern smaller circuits depends, to a great degree, on the wavelength of the light used in the photolithography process. A shorter wavelength of light can pattern circuitry with smaller critical dimensions (“CD”), which in turn allows the transistors that serve as circuit switches to be smaller, which allows more devices to be put on a chip and thus enables higher levels of functionality. Our DUV light sources provide an extremely pure beam of ultraviolet light. The short wavelength of DUV light enables the required resolution, depth of focus and CD control required to pattern semiconductor circuits.
A lithography tool projects light from the light source through an image of the circuitry pattern on a photomask or reticle. A reticle is a glass plate with a layer of chrome on one side, on which the negative of the circuit pattern is etched. The image of the circuitry is transferred by the light being projected through a reduction lens onto a small portion of the surface of the silicon wafer.
To print the projected optical pattern, the wafer is coated with a thin film of light-sensitive material, called photoresist. The light exposes the photoresist, which is then developed (somewhat like photographic film) to create a stenciled image pattern. Next, through a process called “etch”, the unnecessary underlying material is selectively removed, creating an extremely fine circuit pattern. The wafer is inspected, particularly for pattern defects, any hardened residual photoresist is removed, and then the wafer is measured to make sure it meets predetermined specifications. Then the wafer surface is cleaned, generally by immersing it in acid, solvent, or deionized water. The process is repeated over multiple layers to build the electrical circuit structure. Depending on the type of chip being made, a total of 30 to 50 layers are patterned precisely over the first to complete the circuit fabrication, at which time the wafer is fully processed.
The light from these DUV sources is generated by mixing two gases-either krypton and fluorine (“KrF”), or argon and fluorine (“ArF”)-inside a discharge chamber within the light source system. When a short electrical charge is applied to the gases, the gas atoms combine briefly to form a molecule known as an excited dimer, or “excimer.” These gas molecules remain together for a few nano-seconds, and when they separate, produce an intense pulse of DUV light that is then purified and directed out one end of the light source to the lithography tool. Depending on the repetition rate of the laser, this procedure is repeated between 1,000 and 6,000 times per second (1,000 pulses per second equals one kilohertz (“kHz”)).
EUV is an advanced form of lithography that uses extremely short wavelength (13.5 nm) light, mirrors and reflective photomasks to image circuit patterns onto the surface of semiconductor wafers. The chips produced with EUV light sources are expected to contain features 22 nm wide or smaller, and are projected to be as much as 100 times faster than, with 1,000 times the memory capacity of, today’s most powerful computer chips. EUV lithography is viewed as the front runner for next generation critical dimension imaging after existing ArF 193 nm immersion lithography for layer patterning features 22 nm wide or smaller. NAND flash memory devices and dynamic random access memory (“DRAM”) devices are expected to be early adopters of EUV technology.
Products and Support
Our products include DUV and EUV photolithography light sources, silicon crystallization tools used in the manufacture of displays and installed base products designed to cost-effectively deliver high levels of performance, availability, and reliability to enable our customers to achieve their production goals.
Photolithography Light Sources
Our DUV light sources include the most advanced ArF immersion light sources for use on the most critical process layers. Chipmakers also use our ArF and Krf light sources to fill out or balance their production lines or add capacity to their manufacturing facilities (also referred to as “fabs”) for less critical layers. The extremely short wavelengths and highly narrowed bandwidths of our light sources work in concert with our lithography customers’ steppers and scanners and their sophisticated lens systems to help enable the very fine feature resolution required for patterning today’s most advanced semiconductor circuitry. In addition, the pulse energy
and repetition rate of our light sources enable our chipmaker customers to achieve high throughput in wafer processing. We have designed our light sources to be reliable, easy to install and compatible with existing semiconductor manufacturing processes. Additionally, we offer focus drilling technology for certain of our ArF immersion light sources. Focus drilling provides up to two times improvement in the depth of focus on the wafer, which can positively impact chipmakers’ yield.
Chipmaker demand for EUV light sources continues to be strong, as we believe EUV technology is the best path toward enabling Moore’s Law and scaling of semiconductors with features 22nm wide or smaller. We have accelerated our rate of EUV source development, and are continuing to increase our investment in development resources, manufacturing capacity, and field support to fulfill EUV source demand.
Our Laser-Produced Plasma (“LPP”) EUV light source is designed to provide scalable power that enables high volume manufacturing. Our LPP EUV source system consists of a high power, high repetition rate pulsed carbon dioxide laser, a beam delivery system, and a plasma vacuum vessel. The plasma vacuum vessel is complete with a droplet generator and collector, debris mitigation, and in-situ metrology to measure, monitor and control the system operation. The 13.5 nm wavelength is produced when a carbon dioxide laser pulse strikes small droplets of elemental tin in the plasma chamber. The laser heats the droplet of tin to the point of evaporation and super-heating to critical temperature, then the atoms shed their electrons and become highly ionized (i.e. a plasma). This causes the excited tin ions (the plasma) to emit light which is collected by a highly reflective mirror. The mirror reflects and directs the resulting 13.5nm wavelength energy and focuses it through an aperture and into the lithography system. The plasma chamber of the EUV source is directly coupled to the scanner system’s vacuum chamber inside the scanner enclosure, requiring close coordination between the designs of our EUV source and the scanner produced by the lithography tool manufacturer. We are working closely with ASML, a lithography tool manufacturer and current customer for our EUV sources, and our key suppliers to drive execution to our power and performance roadmap. Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits; however, we have shipped six EUV 3100 pilot sources to date and, in 2011, we received customer acceptance and recorded revenue for three of these sources. We also received orders for our next generation EUV 3300 sources, which we expect to start shipping in 2012.
Revenues generated from sales of DUV light sources were approximately $208.3 million, $191.6 million and $68.9 million for 2011, 2010 and 2009, respectively. Revenues from sales of EUV sources were approximately $22.3 million for 2011. No revenue was generated from sales of EUV sources in 2010 or 2009.
Our current DUV light source product portfolio consists primarily of the following:
XLR Series-193 nm ArF Immersion Light Sources. As chipmakers continue to reduce the feature sizes and shrink CDs on the wafer, they need to install the advanced tools required to enable patterning of the most critical layers. NAND flash memory and DRAM semiconductor manufacturers have been the most aggressive chipmakers in shrinking CDs, and have been driving demand for our most advanced light sources for ArF immersion lithography applications. DRAM manufacturers are in production with CDs at 45 nm. Currently, some chipmakers are in development of chip production with CDs of less than 32 nm. Leading edge semiconductor manufacturers in the memory, logic and foundry sectors have been developing ArF immersion extension down to CDs of 22 nm and implementing double-patterning technique, which means the increased demand for ArF immersion light sources could last for several years. The XLR Series is based on our dual discharge chamber master oscillator power amplifier (“MOPA”) light source architecture, with a regenerative ring amplifier in place of the traditional power amplifier. Built on our XL universal platform, this product series offers a step function
improvement in performance and cost of operation. Our XLR light sources are designed to enable our chipmaker customers to customize performance for specific applications through improved performance parameters and metrology options. Flexible power up to 90 watts (“W”), improved bandwidth stability and dose control enable higher CD control and yield, and this series offers longer pulse duration to extend the lifetime of the illuminator and lens, even at higher power levels. Cost of operation is reduced significantly through optical design and component robustness, leading to increased module lifetime. With active bandwidth stabilization and tuning capability, the XLR light sources offer improved bandwidth management for improved mask optical proximity correction matching and tool-to-tool matching, so customers can use multiple node mask sets in the same tool or the same mask in different tools. We sell primarily the XLR 600ix model of this series.
XLA Series-193 nm ArF Dry Light Sources. Though no longer considered leading edge technology, dry ArF lithography is still used to pattern a significant number of less-critical layers on wafers. Additionally, as CDs continue to shrink and drive demand for even finer resolution on the most critical layers, non-critical layers may be patterned with ArF dry scanners, which drives continued demand for these tools. Our XLA Series of ArF light sources was the first product series to be based on our dual-discharge chamber MOPA architecture. MOPA represented a paradigm shift in excimer laser architecture when it was introduced in 2003. The master oscillator creates a narrow bandwidth beam of light at low power. The beam then is directed into the power amplifier, where the power is increased significantly while maintaining the narrow bandwidth. This combination of bandwidth and power enabled our chipmaker customers to continue reducing CDs and increasing processing speeds, capacity and functionality of chips, while giving them the performance and cost advantages they need. Each product in the XLA Series is based on the XL universal platform, and we continue to sell the XLA 105 model of this series.
ELS 7010-248 nm KrF Dry Light Sources. We have been providing KrF light sources for volume chip production since 1996, when chipmakers required the adoption of DUV light sources in their fabs. Over the years, we have developed and sold a variety of increasingly powerful and productive KrF light sources. The 7000 Series is the first series that was designed and built on a common platform, enabling chipmakers to easily utilize the 193 nm wavelength produced by ArF and the 248 nm wavelength produced by KrF within the manufacturing environment. This “ease of use” feature was very important at the time because chipmakers were introducing ArF production into their fabs and the common platform simplified the introduction of this new technology. With a 4 kHz repetition rate and high output power, the 7000 Series provides our chipmaker customers with high wafer throughput and lower cost of operation by reason of advanced design and materials, and delivers a high level of tool availability to enable manufacturing efficiency and flexibility. Our bestselling light source of the series, the ELS-7010 is still in demand as chipmakers continue to prefer the higher power and narrower bandwidth offered by this system. In 2010, we introduced the ELS-7010x which allows customers to easily adjust power from 30 watts to 50 watts based on the changing wafer design requirements and production needs.
Legacy Light Sources. In addition to our current DUV product portfolio of light sources, we have numerous models of ArF and KrF light sources that have been superseded and are no longer in active production. However, these systems are still widely used by our customers and make up a substantial portion of our installed base of light sources. We continue to provide installed base products and maintain parts inventory for these systems.
Silicon Crystallization Tools
Our TCZ reporting segment develops, integrates, markets and supports silicon crystallization tools used in the manufacture of LTPS - LCD and OLED displays. The global display industry is driven by the high performance displays used in everyday consumer products, including televisions, smart phones, tablets, notebook computers and personal computer monitors. Consumer demand requires that displays of the future will need to be brighter, and have richer, more vivid colors, faster video capability, added functionality such as touch screen and scanning capability, wider viewing angles, and work well in sunlight and be more durable, all at a lower cost. To meet these growing market demands and advance the volume-production capabilities of displays, we developed an innovative production technology for fabricating displays.
Silicon crystallization is a key step in the manufacturing process for many types of high-resolution LTPS - LCD and OLED displays. A glass plate, coated with a thin film of amorphous silicon, is exposed to a high-power laser that converts the silicon into a poly-crystalline form, which is then used to create the pixel control circuit. Our silicon crystallization tool uses a 900W laser with advanced beam shaping optics to form a very narrow line focus that is 730 mm long, allowing a generation 4 size glass plate (730mm x 920mm) to be processed in a single pass. TCZ’s latest product processes generation 5 size glass plates (1300mm x 1500mm) using two passes. This approach is designed to produce very uniform crystalline silicon material across the entire glass plate, which is needed to support the high-performance circuitry on the high-resolution LTPS - LCD and OLED that controls the picture elements, or pixels. We believe our silicon crystallization tools will deliver high throughput and panel uniformity and reduce the cost of silicon crystallization for display manufacturers.
We currently record TCZ revenue when we receive customer acceptance of our silicon crystallization tools. We have shipped four TCZ tools, and received customer acceptance for two TCZ tools for display fabrication. We have received additional orders for TCZ tools.
Revenues generated from TCZ silicon crystallization tools were approximately $2.8 million and $4.0 million for 2011 and 2010, respectively. No revenue was generated by TCZ in 2009.
Installed Base Products
We derive a substantial portion of our revenue from the sale of installed base products, which include replacement parts, various service and support offerings and upgrades to lithography tool manufacturers as well as directly to chipmakers.
Contracts and Service Agreements
We provide ongoing support to our customers through contracts and service agreements. Under these agreements, we provide comprehensive support products to maintain the equipment within specifications. Certain contracts include the replacement of consumable and non-consumable parts.
Our OnPulse contracts offer a comprehensive approach to enhancing light source productivity, offering our customers predictable light source running costs that scale directly with pulse utilization. We provide our OnPulse contract customers on-site support from certified service engineers and continuous real-time light source monitoring. Replacement parts and support are covered under the OnPulse contract, which facilitates cost savings for our customers as well as simplified order and asset management. We believe that our OnPulse contracts offer our customers many compelling benefits, and this product has been well-received by our customers.
In 2011, we introduced light source data offerings, OnPulse Plus and SmartPulse, as an enhancement to our OnPulse contracts. These data offerings provide real time light source performance data in a new user interface, supporting chipmaker needs to improve process control and the quality of wafers. Additionally, for our OnPulse customers, we offer our third generation Gas Lifetime eXtension (iGLX) control system for ArF immersion light sources. The value-added feature of iGLX is an improvement over previous generations of gas management systems, and is designed to double gas lifetime and automate gas optimization.
Revenues generated from contracts and service agreements were approximately $280.8 million, $225.1 million and $122.5 million for 2011, 2010 and 2009, respectively.
Replacement Parts and Refurbishment Activities
Our light sources incorporate certain modules and subassemblies that require replacement or refurbishment following extended operation, including, but not limited to, discharge chambers and certain optical components. We provide these and all other spare and replacement parts for our light sources to our customers. Customers not participating in a contract or service agreement pay for the parts and labor as the parts are replaced.
We conduct parts refurbishment and materials reclamation activities for some of our core modules. These activities involve arrangements with our customers where we sell a new part to the customer at a reduced sales price if the customer returns the consumed core module being replaced. These returned modules contain a certain amount of material, primarily metal components, that may be reused by us in future core assemblies. A portion of the module’s sale price is related to the return of these consumed parts, and we record revenue based on the estimated fair value of the returned parts when we receive the returned modules from our customers. It has been our practice to continually improve the performance and extend the expected lifetimes of our replacement modules. The enhanced performance enables our customers to benefit from higher throughput and yield, while the extended lifetimes provide lower cost of operation. We continue to seek ways to add value for our customers and enable them to realize higher returns on their investment in light sources purchased from us.
Revenues generated from sales of replacement parts and refurbishment activities, including the receipt of reusable material contained within consumed assemblies returned from our customers, were approximately $80.0 million, $113.5 million and $116.2 million for 2011, 2010 and 2009, respectively.
Customers and End-Users
We currently supply light sources to ASML, Nikon, and Canon, lithography tool manufacturers who in turn supply their wafer steppers and scanners to chipmakers. We strive to maintain and strengthen our relationship with these lithography tool manufacturer customers by developing and providing compelling light source solutions in advance of their needs. We work closely with them to ensure that our product road map aligns with theirs, and that we can support each of them in a timely manner with the products required by our mutual chipmaker customers. We believe these efforts enhance our relationship with our lithography tool manufacturer customers and support our leadership position in the photolithography light source market.
We sell to customers in China, Europe, Japan, South Korea, Taiwan, the United States and other Asian countries. Our chipmaker customers include the world’s leading semiconductor manufacturers.
The target customers for our silicon crystallization tools are manufacturers of high-resolution LTPS - LCD and OLED displays, and we work closely with select manufacturers to assure we are developing products that will ultimately reduce the cost of manufacturing displays of varying shapes and sizes.
Sales to ASML, Nikon, and Samsung accounted for 35%, 11% and 10%, respectively, of total revenue in 2011. We expect that sales of our light source and other related products to these three customers will continue to account for a substantial portion of our revenue in the foreseeable future. Additionally, all of our current revenue and orders for EUV 3100 and 3300 sources are from ASML. The loss of any significant business from or production problems for any one of these customers would harm our business and financial condition. We believe there is limited credit risk exposure for us with these companies as they continue to demonstrate sound credit worthiness. However, our ability to generate future revenue from them is dependent on their ongoing financial condition and liquidity.
Backlog
We base our light source production schedule upon order backlog as well as informal customer forecasts. Our backlog includes only those orders for light sources and replacement parts for which we have accepted a purchase order from a customer, and that will be delivered to the customer within the following twelve months. Our backlog does not include installed base products, service or support which will be provided to our customers in the future or under contracts. Timing of delivery can be affected by many factors, including factors that cannot be easily predicted or controlled. Because it is the practice in our industry that customers may cancel or delay orders with little or no penalty, our backlog as of any particular date may not be a reliable indicator of actual sales for any succeeding period. At December 31, 2011, we had a DUV backlog, which includes light sources and replacement parts, of approximately $48.2 million compared with a DUV backlog of $63.6 million at December 31, 2010. In addition, at December 31, 2011, we had backlog of $23.5 million for EUV 3100 sources and $34.4 million for silicon crystallization tools.
Manufacturing
Our manufacturing activities, which consist of material management, assembly, integration and testing, are performed at our San Diego, California facility. This facility includes approximately 37,875 square feet of Class 10,000 cleanroom manufacturing and test space. Our San Diego facility also supports our EUV and silicon crystallization research, development and commercial production efforts. To better leverage our own resources, capitalize on the expertise of our key suppliers and respond more efficiently to our customers’ needs, we outsource the manufacture of many modules and subassemblies of our light sources. The modular design of our light source products enables this manufacturing outsourcing strategy with substantially all manufacturing of nonproprietary subassemblies currently contracted to third-party suppliers. As a result, we are increasingly dependent upon these contract suppliers to meet our manufacturing schedules. We believe the highly outsourced content and design of our products allows for reduced manufacturing cycle times and increased output per employee. To improve current production efficiencies, control costs, and manage overall manufacturing capacity, we intend to continue training manufacturing personnel, improving our assembly and test processes to further reduce cycle time, investing in additional manufacturing tooling and further developing our supplier management and engineering capabilities.
In addition to our manufacturing facility in San Diego, we have a facility in South Korea that refurbishes discharge chambers for light sources installed in South Korea and the Asia-Pacific region. This facility includes 6,550 square feet of Class 10,000 cleanroom manufacturing space.
We purchase a limited number of components and subassemblies included in our light sources, installed base products and silicon crystallization tools from a single supplier or a small group of suppliers. To reduce the risk associated with these suppliers, we have supply agreements in place and carry strategic inventories of these components. Strategic inventories are managed as a percentage of anticipated future demand. Whenever possible, we work with secondary suppliers to qualify additional sources of supply. We also have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract for the manufacture of various subassemblies of our products and depend on our contract manufacturers to deliver to our required specifications, schedule and quality standards. Some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and, therefore, are susceptible to industry fluctuations and are subject to the same risks and uncertainties as we are regarding their ability to respond to changing market and global conditions. To date we have been able to obtain adequate components and subassemblies for our light sources, installed base products and silicon crystallization tools in a timely manner from existing suppliers.
Sales and Marketing
We strive to best serve and understand our manufacturer and chipmaker customers’ performance and production needs. We work to ensure their understanding of the significant value-add our products offer. We have established product development and marketing and applications engineering teams who work closely with our customers to understand their needs. These teams support our direct sales and marketing efforts.
Support Services
We warrant our products against defects in design, materials, and workmanship. After a customer takes delivery of one of our new light sources or silicon crystallization tools, we provide product warranty support for the duration of the warranty. We also include a parts warranty on all replacements parts sold to our customers. The warranty coverage period varies by the type of part, since some part types include time-based warranty periods and others include usage-based warranty periods. We may offer a comprehensive contract to continue providing replacement products and support. We believe our success depends on enabling our customers to realize the highest possible return on their investment in our light sources and silicon crystallization tools. We provide our customers with on-site support at their facilities. Prior to shipment, our support personnel typically assist with customer site preparation and inspection. We also provide our customers with comprehensive information regarding product operation, maintenance, service, diagnostics and safety.
Our field engineers and technical support specialists provide field maintenance and front-line technical support for our customers from our San Diego headquarters, from our field offices located throughout the United States, and from our field offices located in China, Japan, South Korea, the Netherlands, Singapore, and Taiwan. To ensure that our customers receive replacement parts quickly and maintain the optimal level of productivity in their fabs, we maintain spares inventory at each of our field depot facilities per our customer support program. As our installed base of light sources and silicon crystallization tools grows, we believe it is critical that replacement parts, as well as our own logistics support organization, are available for quick response to the demands of our customers.
In order to provide the highly responsive and high quality support that our customers need to maximize their production efficiency, and provide it in a cost-effective manner, we maintain a highly-trained, service support staff that can provide rapid global support solutions. We continuously develop and enhance our direct support infrastructure in both our international and domestic markets. To achieve this level of capability and strive for continuous improvement, we recruit highly qualified field service personnel and provide additional training and certification.
Product Research and Development
Our product development strategy has been to develop in rapid succession technologically innovative new products that deliver superior performance with higher throughput and lower cost of operation to meet the continually evolving needs of our customers. We believe we must continue to anticipate our customers’ future needs, and develop and introduce new and enhanced light source products in order to support our customers, as well as to strengthen our leadership position in the industry. Execution of our strategy has enabled us to offer our customers increasingly higher value-added light sources in advance of their needs, while establishing our position as the technology and market leader in our field. We are also developing enhancements to our products that will improve tool productivity for high volume memory manufacturing and provide new optical capabilities for process improvement in the foundry and logic sectors. We intend to continue developing and enhancing our technology in order to provide our customers with innovative products to help ensure their success. Our EUV source efforts have been recognized as leading the industry in the development and commercialization of critical next generation light source technology. We also continue to invest in the development of our silicon crystallization tools used in the manufacture of high-resolution LTPS - LCD and OLED displays.
We have historically devoted a significant portion of our financial resources to research and development, and intend to continue to maintain a strategic investment in our product research and development activities in connection with our development of new products. Research and development expenses for 2011, 2010 and 2009 were $130.6 million, $89.2 million and $65.8 million, respectively.
Patent and Other Property Rights
We seek to protect our intellectual property rights in a number of ways, one of which is to obtain patent protection for our technology. As of December 31, 2011, we own a number of United States and foreign patents covering certain aspects of technology related to light sources, piezoelectric techniques and silicon crystallization tools. Patents related to our source technologies and piezoelectric techniques will expire at various times through 2030, and patents related to our silicon crystallization tools will expire at various times through 2029.
We also rely on trade secret protection, employee and third-party nondisclosure agreements and other intellectual property protection methods to protect our confidential information. These methods, however, may not be effective in protecting our confidential information, particularly our trade secrets, because third parties may independently develop substantially the same proprietary information and techniques, gain access to our trade secrets, or disclose our technology.
We have registered a number of trademarks in the United States and in some other countries. We are also trying to register additional trademarks in the United States and in other countries. We use these trademarks in our business and advertising materials, which are distributed throughout the world.
Competition
We currently have one DUV light source competitor, Gigaphoton. Gigaphoton is a wholly owned subsidiary of Komatsu and is headquartered in Japan. Our lithography tool manufacturer customers have purchased products from Gigaphoton and have qualified Gigaphoton’s DUV light sources for use with their products. Additionally, Gigaphoton’s DUV light sources have been qualified by a number of chipmakers in Europe, Japan, other regions in Asia and the United States, and Gigaphoton has an installed base of light sources at chipmakers in these regions. We also face competition from Gigaphoton and Ushio, also headquartered in Japan, in the development of EUV source technology.
The principal elements of competition in our markets are the technical performance characteristics of the light source products and the operating efficiency of the system, which is based on availability, reliability, performance efficiency, throughput, cost of ownership, and overall quality. We believe that we compete favorably with respect to these factors. Our management receives and evaluates internally-generated market research for the U.S. and foreign markets, as well as periodic public and customized market research data in order to gauge the effectiveness of our success rate in response to such factors.
We face strong competition in the high-resolution LTPS - LCD and OLED display market from a number of established competitors, including Japan Steel Works, AP Systems, Sumitomo Heavy Industries and others. Many of these companies have been qualified by a number of display makers in China, Japan, South Korea and Taiwan, and have a number of systems currently installed. In addition to the competitors mentioned above, there are other potential competitors that provide equipment that uses a thermal source, rather than a laser, to perform crystallization.
Employees
As of December 31, 2011, we employed approximately 1,000 regular and 120 temporary persons worldwide. The substantial majority of our employees are not party to a collective bargaining agreement, although we have ten employees in France and Italy who are subject to a collective bargaining agreement. We have not experienced work stoppages and believe that our employee relations are good.
Environmental Matters
We are subject to federal, state and local regulations, such as regulations related to the environment, land use, public utility utilization and the fire code, in connection with the storage, handling, discharge and disposal of substances that we use in our manufacturing process and in our facilities. We believe that our activities comply with current government regulations that are applicable to our operations and current facilities.
Available Information
Our filings with the Securities and Exchange Commission (“SEC”), including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) are available free of charge through the Investor Relations section of our company’s website at http://www.cymer.com and are accessible as soon as reasonably practicable after being electronically filed with or furnished to the SEC. Additionally, we regularly post copies of our press releases as well as additional information about us on our website. Interested persons can subscribe to email alerts that are sent automatically when we issue press releases, file our reports with the SEC or post certain other information to our website. Information accessible through our website does not constitute a part of this report.
Copies of this report are also available free of charge from Cymer Corporate Investor Communications, 17075 Thornmint Court, San Diego, CA 92127. In addition, our Corporate Governance Guidelines, Code of Conduct and written charters of the committees of the Board of Directors are accessible through the Corporate
Governance tab in the Investor Relations section of our website and are available in print to any shareholder who requests a copy. You may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy statements and other information we file with the SEC. The address of the SEC’s website is http://www.sec.gov.
Executive Officers
Set forth below is certain information regarding our executive officers and their ages as of February 8, 2012.
Robert P. Akins, co-founder, has served as our chairman and chief executive officer since our inception in 1986. He currently serves on the board of directors of KLA-Tencor Corporation and Semiconductor Equipment and Materials International (SEMI). He is also a member of the council of advisors to the Irwin and Joan Jacobs School of Engineering at the University of California, San Diego (“UCSD”), and serves on the board of the UCSD Foundation. Mr. Akins received the SEMI North America Award for contributions to the field of DUV lithography, the outstanding alumnus award from UCSD, and the 2007 William W. Otterson Award, which is awarded to the San Diego company whose products have demonstrated the most significant positive impact on society. Mr. Akins received a bachelor’s degree in physics and literature, and a doctorate in applied physics from UCSD.
Edward J. Brown, Jr. has served as our president and chief operating officer since his appointment in September 2005. From 1984 to 2005, Mr. Brown was employed at Applied Materials, Inc. where he held numerous high-level management positions including group vice president and senior advisor to the president, vice president and general manager of the Intel business unit, as well as managing director heading up their largest product division, global operations. Mr. Brown received a master’s degree in business administration from National University and a bachelor’s degree in industrial studies from San Diego State University.
Paul B. Bowman has served as our senior vice president, chief financial officer and secretary since his appointment in October 2009. From December 2008 until his appointment as chief financial officer in October 2009, he served as our interim chief financial officer, treasurer and secretary. From May 2008 until December 2008, Mr. Bowman served as our vice president of investor relations. Prior to joining us, Mr. Bowman served as chief financial officer of American Mold Guard, Inc. from April 2006 to April 2008. From 1996 to April 2006, Mr. Bowman was employed at Applied Materials, Inc., holding positions as the managing director of investor relations, managing director of finance for worldwide manufacturing and controller of the worldwide service division. Mr. Bowman received a bachelor’s degree in finance from Shippensburg State University.
Karen K. McGinnis has served as vice president, corporate controller, and chief accounting officer since her appointment in November 2009. Prior to joining us, Ms. McGinnis was employed by Insight Enterprises, Inc., a Fortune 500 global provider of information technology hardware, software and services, as chief accounting officer from September 2006 until March 2009 and as senior vice president of finance from 2001 through September 2006. Ms. McGinnis is a certified public accountant and received her bachelor’s degree in accounting from the University of Oklahoma.
Thomas J. Bondur has served as our vice president, global sales and marketing since his appointment in March 2011. From 2001 to 2011, Mr. Bondur was employed at Lam Research Corporation where he held
positions in business development, sales and marketing and Global Field Operations. He most recently managed the global business development organization and had direct operational responsibility for the North America and European regions. From 1995 to 2001, Mr. Bondur was employed at Applied Materials, Inc. where he held positions in the etch product group and managed sales to large global accounts. Mr. Bondur received a bachelor’s degree in business administration from the State University of New York at Oswego.
Executive officers serve at the discretion of the board of directors. There are no family relationships between any of the directors and our executive officers.
ITEM 1A.
ITEM 1A. Risk Factors
The risks described below may not be the only risks we face. Additional risks that we do not currently believe are material may also impair our business operations. If any of the events or circumstances described in the following risks occur, our business, financial condition, results of operations or cash flows could suffer, and the trading price of our common stock and our market capitalization could decline.
Our revenue and operating results from quarter to quarter and year to year have varied in the past and our future operating results may continue to fluctuate significantly.
Factors that contribute to fluctuations in our revenue and operating results include:
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global demand for semiconductors in general and, in particular, for leading edge devices with smaller circuit geometries;
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utilization rates of light sources by our chipmaker customers and pulse usage which affect our installed base products revenue and costs;
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cyclicality in the market for semiconductor manufacturing equipment;
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rates at which our chipmaker customers take delivery of photolithography tools from our lithography tool manufacturer customers;
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rates at which lithography tool manufacturer customers take delivery of light source systems from us;
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timing and size of orders from our customers;
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the ability of our customers to pay for products purchased from us;
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our ability to manage customer satisfaction and product reliability, and to provide effective field support to our customers;
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variability in the amount and timing of parts replacement costs under our contracts and service agreements, including our OnPulse contracts;
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changing or adverse global economic conditions, including energy prices, inflation, deflation, recession, unemployment, consumer confidence and demand, turmoil in the credit markets and financial services industry, political instability, and credit availability and their potential effects on our customers, suppliers, ability to sell products, and investments;
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improved or reduced market penetration by our competitors;
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demand for reduced product lead times from our customers;
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the mix of light source models, and the level of installed base products revenue in our total revenue;
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changes in the price and profitability of our products;
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our ability to develop and implement new technologies and introduce new products that meet our customers’ needs, in particular, EUV sources;
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research and development costs incurred to develop new technologies;
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demand for our EUV sources;
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global demand for panel displays, in particular, for high-resolution LTPS - LCD and OLED displays;
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demand for silicon crystallization tools used in the manufacture of high-resolution LTPS - LCD and OLED displays;
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our ability to manage our manufacturing and inventory requirements, including our inventory levels and controls at our widely dispersed operations;
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natural events such as severe weather and earthquakes in the locations in which we, our customers or our suppliers operate;
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the financial condition of our suppliers which, if negative, could affect their ability to supply us with the parts that we need to manufacture our products;
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foreign currency exchange rate fluctuations and possible protectionist measures in the countries in which we do business;
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our investments in marketable securities;
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changes in our effective tax rate;
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intellectual property protection; and
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potential impairments to our goodwill or long-lived assets.
Revenue from installed base products has grown as a percentage of our total revenue. The revenue from the operation of our installed base of light source systems depend on the rate at which our customers use these light source systems, the rate of growth of our installed base, and the mix of pulses from our various light source models. Our operating results for a particular period may be adversely affected if our customers reduce usage rates, or change their buying patterns, or if we incur higher parts replacement or service costs. Because we sell a limited number of light source systems, the precise timing for recognizing revenue from an order may have a significant effect on our total revenue for a particular period. As is the practice in our industry, our customers may cancel or reschedule orders with little or no penalty. Orders expected in one quarter could shift to another period due to changes in the anticipated timing of our customers’ purchase decisions or rescheduled delivery dates requested by our customers. Our operating results for a particular quarter or year may be adversely affected if our customers cancel or reschedule orders, or if we cannot fill orders timely due to unexpected delays in manufacturing, testing, shipping, or product acceptance or due to an unexpected material surge in demand. Our light source systems used in a production environment generate installed base product revenue based on system usage, which may also vary period to period. Additionally, we may be required to defer revenue associated with contracts that contain multiple deliverables.
We manage our expense levels based, in large part, on expected future revenue. As a result, if our actual revenue decreases below the level we expect, or we are not successful in aligning our manufacturing cost structure with decreasing production levels, our operating results will be adversely affected. As a result of these or other factors, we could fail to achieve our expectations as to future revenue, gross profit and gross margin, operating income, net income, earnings per share, and cash flows. Our failure to meet the performance expectations set and published by external sources could result in a sudden and significant drop in the price of our stock, particularly on a short-term basis, and could negatively affect the value of any investment in our stock.
Our business depends on the semiconductor and the semiconductor capital equipment industries, which are volatile and unpredictable.
We derive the majority of our revenue from our lithography tool manufacturer customers who, as original equipment manufacturers (“OEMs”), incorporate our light source systems in photolithography tools that they sell
to semiconductor manufacturers, or chipmakers, and from our chipmaker customers who purchase installed base products directly from us in support of their light source systems. Like us, our OEM customers depend on market demand for their products from the chipmakers. This market demand can be volatile and unpredictable and can affect our ability to accurately predict future revenue and, therefore, our ability to manage our future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction actions may be necessary in order for us to remain competitive and financially stable. During a down cycle or slowdown, we must adjust our cost and expense structure to prevailing market conditions while maintaining our longer term strategies and motivating and retaining our key employees. In contrast, during periods of rapid growth, we must quickly increase manufacturing capacity and personnel to meet our customers’ needs. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. We are not able to predict with any certainty the duration of any industry cycle or the timing or order of magnitude of any recovery from a down cycle or slowdown.
Downturns in the semiconductor industry often result in decreases in demand for semiconductor manufacturing equipment, including the photolithography tools that our OEM customers produce. Downturns in the semiconductor industry have generally had severe effects on the demand for semiconductor manufacturing equipment and to a lesser extent, the associated installed base products. Fluctuating levels of investment by chipmakers and resulting pricing volatility will continue to materially affect our aggregate bookings, revenue and operating results. Even during periods of reduced revenue, we believe we must continue to invest in research and development and maintain extensive ongoing worldwide customer support capabilities to meet our customers’ needs and to remain competitive. Continued spending to further these objectives may temporarily harm our financial results. Semiconductor industry downturns and slowdowns will likely continue to adversely affect our business, financial condition and operating results.
While revenue from installed base products has grown as a percentage of our total revenue, we continue to derive a significant percentage of our revenue from the sales of light source systems. Market conditions in the semiconductor industry and our OEM customers’ production efficiency can cause them to expand or reduce their orders for new light source systems as they try to manage their inventories and production requirements. We continue to work closely with our OEM customers to better understand these issues. However, we cannot guarantee that we will be successful in understanding our OEM customers’ inventory management or production requirements or that our OEM customers will not build up an excess inventory of light source systems. If our OEM customers retain an excess inventory of light source systems, our revenue could be reduced in future periods as the excess inventory is utilized, which could adversely affect our operating results, financial condition and cash flows. If our OEM customers demand shorter product lead times to improve their inventory and cash positions, our inventory management and cash position may be negatively affected, which may adversely affect our operating results, financial condition and cash flows.
Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits; Our EUV sources could fail to meet customer specifications or not be delivered on time.
We are investing significant financial and other resources to develop EUV source technology for chip manufacturing. These expenditures are reflected in our research and development expenses in our consolidated statements of operations, as well as inventory and property, plant and equipment in our consolidated balance sheets.
As of December 31, 2011, we have shipped six EUV 3100 pilot sources and received customer acceptance and recorded revenue for three of these sources in 2011. We also received orders for our next generation EUV 3300 sources, which we expect to start shipping in 2012. We currently record revenue associated with EUV sources when customer acceptance is received.
Our EUV sources are still under development and not yet capable of supporting the commercial production of integrated circuits. The technology underlying EUV is extremely complex, and we have experienced some
delays that have put us behind schedule in our EUV source development. We may not be able to introduce commercial EUV systems on time, or at all. If we are not able to meet customer specifications, or have reliability or performance problems, or if the pilot sources and eventually commercial systems do not meet customer specifications or are not introduced on time, or if our inventory balances exceed the net realizable value under the related contracts, or if a competitor’s source is selected over our source, we may experience the recording of impairment charges of our inventory and/or property, plant and equipment, reduced orders, order cancellations, higher manufacturing costs, delays in acceptance of and payment for new products, product rejections, and additional service and warranty expenses. These risks could also damage our reputation among the initial adopters of EUV source technology and limit our ability to penetrate the market. For example, we have entered into a supply agreement for EUV sources with ASML, one of our significant customers for DUV light sources. Significant setbacks in our EUV program, or disagreement with ASML regarding its specifications for commercial systems, could impact the amount and timing of purchases of DUV light sources by ASML. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.
A significant percentage of our revenue is derived from sales to a limited number of customers, and if we are not able to retain these customers, or they reschedule, reduce or cancel orders, or delay or default on payments, we may experience material adverse effects on our operating results, financial condition and cash flows.
Two large companies, ASML and Nikon, dominate the photolithography tool business. ASML, Nikon and Samsung, one of our chipmaker customers that purchase our installed base products, accounted for the following percentages of our revenue during the periods indicated:
We expect that sales to these customers will continue to account for a substantial portion of our revenue in the foreseeable future. None of our customers are obligated to purchase a minimum number of our products in the aggregate or during any particular period. We can provide no assurance that any of our customers will continue to purchase our products at past or current levels. Sales to any of these customers may be affected by many factors, some of which are beyond our control. These factors include:
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changes in global economic or market conditions affecting the semiconductor or the photolithography tool industries;
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our ability to develop and introduce new products, including EUV sources, that meet a customer’s needs and specifications;
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a change in a customer’s competitive position in its industry;
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a customer experiencing production problems or disruption for a variety of reasons, including but not limited to work stoppages, terrorism, political turmoil, fire, earthquake, energy shortages, flooding or other natural disasters;
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a decision to purchase light sources, silicon crystallization tools or other products from other suppliers;
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a change in a customer’s production or utilization rate; and
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a decline in a customer’s financial condition.
These companies accounted for the following percentages of our total accounts receivable at the dates indicated:
We believe there is limited credit risk exposure for us with these companies who continue to demonstrate sound creditworthiness. However, our ability to generate future revenue and collect accounts receivable from them is dependent on their ongoing financial condition and liquidity.
The loss of any significant business from, or production problems or disruption due to natural disasters for, any one of these customers may have a material adverse effect on our operating results, financial condition and cash flows.
The majority of our revenue is derived from selling our light source systems and supporting the installed base of light source systems being used in production.
We expect sales of our light source systems, including KrF and ArF systems, and the products in support of the installed base of light source systems to continue to account for a majority of our revenue in the near term. Continued market acceptance of our light source systems and installed base products is, therefore, critical to our future success. The rate at which chipmakers adopt light sources may vary, for reasons including:
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performance of ArF immersion-specific resists;
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potential shortages of specialized materials used in DUV optics;
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the productivity of double-patterning ArF lithography tools;
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our ability to develop and introduce an EUV source that meets customer specifications and our customers’ and chipmakers’ adoption of our EUV technology;
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consolidation of chipmakers; and
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the level of demand for chips with ever-smaller feature sizes.
We cannot guarantee that these factors can or will be overcome or that the demand for our light source systems and installed base products will not be materially reduced. The demand for our light source systems and installed base products, and therefore our operating results, financial condition and cash flows could be adversely affected by a number of factors, including:
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a decline in demand for our customers’ photolithography tools;
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a decline in chipmaker light source utilization rates or retirement of light sources in our installed base;
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a failure to achieve continued market acceptance of our products;
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a failure to manage customer satisfaction, product reliability, or maintain the effectiveness of direct field support;
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a failure to release enhanced versions of our products on a timely basis or to successfully develop and introduce EUV sources that meet customer specifications;
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a failure to meet certain performance specifications on EUV sources;
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a deterioration in global economic conditions;
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the introduction of one or more improved versions of light sources by our competitors; and
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technological changes that we are unable to address with our products.
We depend on a few key suppliers for purchasing components and subassemblies that are included in our products.
We purchase a limited number of components and subassemblies included in our light source systems, installed base products and silicon crystallization tools from a single supplier or a small group of suppliers. There may also be single source suppliers that we are not aware of for components of our purchased subassemblies. To reduce the risk associated with these suppliers, we have supply agreements in place and carry a strategic inventory of these components. Strategic inventories are managed as a percentage of future demand. We also have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract for the manufacture of various subassemblies of our products and depend on our contract manufacturers to deliver to our required specifications, schedule, and quality standards. Further, some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and, therefore, are susceptible to industry fluctuations and subject to the same risks and uncertainties as we are regarding the ability to respond to changing market and global economic conditions. Because many of these suppliers reduce their workforce in an industry downturn and rehire in an upturn, they may not be able to meet our requirements or respond quickly enough as an upturn begins and gains momentum. Due to the nature of our product development requirements, these key suppliers must rapidly advance their own technologies and production capabilities in order to support the introduction schedule of our new products. These suppliers may not be able to provide new modules and subassemblies when they are needed to satisfy our manufacturing and delivery schedules. These suppliers may also be adversely affected by economic conditions, which could result in a lack of available capital and limit their ability to access such capital, if needed, to fund their operations. In addition, if we cannot purchase enough of these materials, components or subassemblies, or if these items do not meet our quality standards, there could be delays or reductions in our product shipments, which may have a material adverse effect on our business, operating results, financial condition and cash flows.
We depend on the introduction of new products for our success, and we are subject to risks associated with rapid technological change.
The development, introduction and support of new products in a competitive business environment are complex processes and could be expensive. New or improved products may lead to higher costs and perhaps reduced profits. Rapid technological changes in semiconductor manufacturing processes subject us to increased pressure to develop technological advances which enable such processes. We believe that our future success depends in part upon our ability to develop, manufacture, and support new light source products with improved capabilities on a timely basis and to continue to enhance our existing product and process capabilities. Due to the risks inherent in transitioning to new products, we must forecast accurate demand for new products while managing the transition from established products. After our chipmaker customers have built their capacity to levels appropriate to meet existing demand, their demand for our light source products will depend, in part, on their sales forecasts, their estimates regarding the duration and magnitude of the current industry cycle and whether their projected manufacturing process yields will enable ongoing investments at a suitable level of capacity. To provide our customers with more productive and lower cost of operation systems, our existing light source systems and their process capabilities must be enhanced, and we must develop and manufacture new products, such as EUV sources, to continue to grow our business. We cannot guarantee that we will be able to grow our business. We may not be able to develop and introduce new sources, products or enhancements to our existing products and processes in a timely or cost effective manner that satisfies customer needs or achieves market acceptance. Development of new sources, products and enhancements to existing products represent significant investments of our resources, and there is no guarantee that we will realize a return on these investments. Further, we may not be able to effectively integrate new sources, products and applications into our current operations. Any of these risks could have a material adverse effect on our operating results, financial condition and cash flows.
Current technologies that are still being developed and commercialized, such as EUV, and future technologies such as nano-imprint lithography and certain maskless lithography techniques may render our existing light source systems and products obsolete. We must manage product transitions, as the introduction of new products could have a negative adverse effect on our sales of existing products.
The display industry continues to be driven by new applications, such as the use of smart phones and ongoing expansion of traditional display markets such as laptops, tablets, and televisions. In addition, the display industry continues to introduce new capabilities, including better visual appearance such as three dimensional (“3D”) displays, lower power consumption, reduced thickness, and lower cost. In addition to the established display technologies such as LCDs that are used in numerous products, new display technologies such as OLED are starting to enter the market. Our current products might not adequately address these shifting demands, and we may not be able to develop and introduce new products or enhancements to our existing products and processes in a timely or cost effective manner that satisfies customer needs or achieves market acceptance.
We could fail to penetrate the display market and may not achieve profitability in our TCZ operating segment.
Our TCZ operating segment develops, integrates, markets and supports silicon crystallization tools used in the manufacture of different types of displays, including high-resolution LTPS-LCD and OLED displays. The manufacture of silicon crystallization tools is a new market for us and involves numerous risks. The global display industry historically has experienced considerable volatility in capital equipment investment levels, due in part to the limited number of high-resolution LTPS-LCD and OLED manufacturers and the concentrated nature of high-resolution LTPS-LCD and OLED end-use applications.
We may not experience sufficient demand for TCZ’s silicon crystallization tools for high-resolution LTPS-LCD and OLED processing in the manufacture of displays. We have shipped three TCZ tools and received customer acceptance for two TCZ tools for display fabrication. We have received additional orders for TCZ tools and will record revenue associated with these tools when customer acceptance is received. If future tools do not meet customer specifications or the customers decide not to place follow-on orders for additional tools, we may experience damage to our reputation among manufacturers of high-resolution LTPS-LCD and OLED fabrication systems and there is no guarantee that we will be able to materially penetrate this market or ever achieve profitability in our TCZ operating segment. To the extent TCZ is unable to achieve profitability, or we are obligated to provide increasing financial resources to support our silicon crystallization tool operations, our business, operating results, financial condition and cash flows could be materially adversely affected.
Global economic conditions could affect our revenue and operating results.
A general weakening of, or declining corporate or consumer confidence in, the global economy, or a reduction in corporate or consumer spending, could delay or significantly decrease purchases of our products by our customers, which are driven in part by indirect consumer demand for the electronic devices that contain semiconductor chips. It could also decrease revenue from our installed base products by causing our chipmaker customers to reduce their usage rates. Our revenue and operating results will be affected by uncertain or changing economic and market conditions including inflation, deflation, prolonged weak consumer demand or other changes which may affect the principal markets in which we conduct business. If economic or market conditions in the United States or other key global markets deteriorate, we may experience material adverse effects on our business, operating results, financial condition and cash flows.
Adverse economic and market conditions could also harm our business by negatively affecting the parties with whom we do business, including our business partners, our customers and our suppliers. These conditions could impair the ability of our customers to pay for products they have purchased from us. As a result, allowances for doubtful accounts and write-offs of accounts receivable from our customers may increase. In addition, our suppliers may experience financial difficulties that could negatively affect their operations and their ability to supply us with the parts we need to manufacture our products.
We face competition in the DUV and EUV lithography market and could face additional competition if other competitors enter the market.
Our future performance depends, in part, upon our ability to continue to compete successfully worldwide. The principal elements of competition in our markets are the technical performance characteristics of light source products and the operating efficiency of the system, which is based on availability, reliability, performance efficiency, cost of ownership, and overall quality.
We currently have one DUV light source competitor, Gigaphoton. Gigaphoton is a wholly owned subsidiary of Komatsu and is headquartered in Japan. Our customers have purchased products from Gigaphoton and have qualified Gigaphoton’s DUV light source systems for use with their products. Additionally, Gigaphoton’s DUV light sources have been qualified by a number of chipmakers in Europe, Japan, other regions in Asia and the United States, and Gigaphoton has an installed base of light source systems at chipmakers in these regions. We also face competition from Gigaphoton and Ushio, also headquartered in Japan, in the development of EUV source technology.
Future competitors may develop systems and products that are competitive to our products. This competition may affect our ability to sell our products. Larger companies with substantially greater resources, such as other manufacturers of industrial light sources for advanced lithography, may attempt to sell competitive products to our customers. Potential competitors may also be attracted to our growing installed base of DUV light sources which represents a significant revenue stream for us, and they may attempt to supply replacement parts to our customer base. If any existing or future competitors gain market acceptance, we could lose market share and our growth could slow or decline, which could have a material adverse effect on our business, operating results, financial condition and cash flows.
We face competition in the display market.
We face strong competition in the display market from a number of established competitors, including Japan Steel Works, AP Systems, Sumitomo Heavy Industries and others. Many of these companies have been qualified by a number of display makers in Japan, South Korea, Taiwan and China, and have a number of tools currently installed. In addition to the competitors mentioned above, there are other potential competitors that provide equipment for crystallization that uses a thermal source, rather than a laser, to perform crystallization.
We must effectively manage changes in our business.
In order to respond to the business cycles of the semiconductor industry and overall economic conditions, we must constantly adjust our business plan and cost structure. As the semiconductor equipment industry cycle moves between contraction and growth and the condition of the global economy changes, we need to:
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quickly adapt to changing sales and marketing channels;
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effectively manage our inventory levels;
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closely manage our global operations and cost structure;
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accurately forecast demand and meet production schedules for our products;
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differentiate our products from those of competitors, meet customer performance specifications, and drive efficiencies;
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allocate resources including key personnel between the development of new products and the enhancement of existing products, as most appropriate and effective for future growth;
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improve our product reliability through quality control, order fulfillment and customer support capabilities;
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attract, train, retain and motivate key personnel; and
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improve our processes and other internal management systems.
If we fail to effectively manage changes in our business, we may experience a material adverse effect on our operating results, financial condition and cash flows.
Any failure to manage our inventory levels and our inventory controls at our widely dispersed operations could adversely affect our business, operating results, financial condition and cash flows.
We need to continually evaluate and monitor the adequacy of our inventory levels. We also need to closely manage the levels of obsolete and excess parts. We have inventory located at warehouses at our corporate office in the United States and at bonded warehouses and customer locations throughout Asia, Europe and North America. The success of our business depends to a significant degree on our ability to maintain or increase the sales of our products in the markets in which we do business. If we overestimate demand for our products or the overall condition of the global economy, we could experience excess inventory levels and use unnecessary cash. As a result of such excess inventory, we may be required to significantly write down the value of our inventory, which would negatively affect our operating results and financial condition.
We could also sustain a loss in the event of a catastrophe in any of the locations where we maintain our inventory if our insurance is inadequate to cover such losses. We will be required to continually analyze the sufficiency of our inventory distribution systems in order to support our operations. We may not adequately anticipate all of the changing demands that will be imposed on these systems. An inability or failure to update our internal inventory distribution systems or procedures, as required, could have a material adverse effect on our business, operating results and financial condition.
International operations expose us to foreign currency exchange rate fluctuations for all foreign currencies in which we do business and we may be materially adversely affected by these fluctuations.
We have international subsidiaries that operate in foreign currencies. All of our international subsidiaries purchase inventory in U.S. Dollars from either our manufacturing facility in San Diego or from our South Korean subsidiary and, in many cases, resell these products to their customers in their local currency. In addition, we purchase certain inventory in Euros. We hedge the foreign currency risks associated with these intercompany transactions by entering into forward contracts. Although we enter into such forward contracts, they may not be adequate to eliminate the risk of foreign currency exchange rate exposures.
We have taken steps to mitigate our foreign currency exchange risks; however, these steps may fail to sufficiently hedge or otherwise manage our foreign currency risks properly and could have a material adverse effect on our operating results and financial condition.
International operations also expose us to currency fluctuations as we translate the financial statements of our international subsidiaries to U.S. Dollars, and a significant strengthening of the U.S. Dollar relative to international currencies would increase the effective prices our customers pay for our products, potentially reducing demand for them.
Failure to effectively maintain our direct service support operations could have a material adverse effect on our business.
We believe it is critical for us to provide direct, quick and responsive support to our chipmaker and direct customers who use our light source products in their photolithography systems as well as to display manufacturers that purchase our silicon crystallization tools. It is also essential to have well trained field service engineers to provide the high level of support that our customers have come to expect. Accordingly, we have an ongoing effort to develop our direct support system with service locations in China, Europe, Japan, Singapore, South Korea, Taiwan and the United States. This requires us to do the following:
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recruit and train qualified support service personnel; and
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maintain effective and highly trained resources who provide support to our customers in various countries.
We may not be able to attract and train qualified personnel to maintain our direct support operations successfully. Further, we may incur significant costs in providing this support. Failure to implement our direct support operation effectively could harm our operating results, financial condition and cash flows.
We are dependent on our suppliers and manufacturing facilities to assemble and test our products.
Operations at our primary manufacturing facility in San Diego and refurbishment facility in South Korea and operations at our suppliers are subject to disruption for a variety of reasons, including, but not limited to, work stoppages, terrorism, political turmoil, fire, natural disasters, or energy shortages. Such disruptions could cause delays in shipments of our products to our customers. Our San Diego facility, where we build our light source systems and replacement parts, poses the greatest risk. We provide no assurance that alternate production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms, or at all. Such disruption could result in cancellation of orders or loss of customers, which would have a material adverse effect on our operating results, financial condition and cash flows.
We depend on key personnel, particularly management and technical personnel, who may be difficult to attract and retain.
We are highly dependent on the services of many key employees in various areas, including:
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research and development;
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engineering;
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sales and marketing;
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direct service support;
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manufacturing; and
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management.
In particular, there are a limited number of experts in DUV and EUV source technology and the silicon crystallization process for display fabrication, and we require highly skilled hardware and software engineers. Competition for qualified personnel is intense and we cannot guarantee that we will be able to continue to attract and retain qualified personnel. We believe our future growth and operating results will depend on the following:
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the continued service of sufficient staff within the areas of research and development, engineering, sales and marketing, direct service support, manufacturing, and management;
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our ability to attract, train and retain highly-skilled key personnel; and
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the ability of key management to continue to expand, motivate and manage our employee base.
We grant equity awards to key employees. Stock options and restricted stock unit awards may not be viewed by key employees as a sufficient financial incentive during periods when stock price volatility could cause our stock price to fall, reducing the effectiveness of such awards as a means to retain and incentivize these employees. If we are unable to hire, train and retain key personnel as required, our operating results, financial condition and cash flows could be adversely affected.
Economic, political, regulatory and other events in geographic areas where we have significant revenue or operations could interfere with our business.
We serve a global market and a large portion of our revenue is derived from customers outside of the United States. We expect our international sales to continue to account for the majority of our total revenue. In order to support our foreign customers, we maintain a refurbishment facility in South Korea as well as field support facilities in China, Japan, the Netherlands, Singapore and Taiwan.
Various factors may inhibit our ability to manage our operations to address and support our global customers effectively. Further, our investments in these types of activities may not be viably competitive in the global market, or we may not be able to meet the support or manufacturing levels required by our global customers. Additionally, we are subject to risks inherent in doing business globally, including but not limited to:
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fluctuations in exchange rates and currency controls;
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political turmoil and global economic instability;
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imposition of trade barriers and restrictions, such as the Foreign Corrupt Practices Act, including changes in tariff and freight rates, foreign customs and duties;
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difficulty in coordinating our management and operations in various countries;
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difficulties in staffing and managing foreign subsidiary and branch operations;
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limited intellectual property protection in some countries;
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potentially adverse tax consequences in some countries;
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the possibility of challenging accounts receivable collections;
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the risk of business interruption as a result of natural disasters or supply chain disruptions;
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the effect of acts of terrorism and war;
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the burdens of complying with foreign laws, including regulatory structures and unexpected changes in regulatory environments; and
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distribution costs, disruptions in shipping or freight transportation.
A significant portion of our customer base is located in Asia. Political turmoil, economic problems and currency fluctuations affecting Asia could increase our risk in that region. It has not been difficult for us to comply with United States export controls; however, changes to these controls in the future could make it more difficult or impossible for us to export our products to many countries. There are certain risks for which we purchase limited or no insurance, including earthquake risk. Any of these vulnerabilities could have a material adverse effect on our business, operating results, financial condition and cash flows.
Currently, none of our United States employees and ten of our international employees are members of a labor union. However, if a greater number of our employees decide to join a union, our cost of doing business could increase, and we could experience contract delays, difficulty in adapting to a changing regulatory and economic environment, cultural conflicts between unionized and non-unionized employees, strikes and work stoppages, any of which could have a material adverse effect on our business, financial condition and operating results.
Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights. These types of claims could seriously harm our business or require us to incur significant costs.
We believe our success and ability to compete depend in part upon protecting our proprietary technology. We rely on a combination of patent, trade secret, copyright and trademark laws, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. We own and have numerous patents pending in the United States and various foreign countries covering certain aspects of technology related to our light source systems and silicon crystallization tool. Patents related to our source technologies and piezoelectric techniques will expire at various times through 2030, and patents related to our silicon crystallization tools will expire at various times through 2029.
Our pending patent applications and any future applications might not be approved. Our patents may not provide us with a competitive advantage and may be successfully challenged by third parties. In addition, third
parties’ patents might have an adverse effect on our ability to do business. Due to cost constraints, we do not seek international patent protection for all inventions that are covered by United States patents and patent applications. As a result, we do not have foreign patent protection for some of our inventions. Additionally, laws of some foreign countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products or intellectual property rights to the same extent as do the laws of the United States Therefore, the likelihood of piracy of our technology and products is greater in these countries. Further, third parties might independently develop similar products, duplicate our products, or design around patents that are granted to us.
Other companies or persons may file or have filed patent applications that are similar or identical to ours. As a result, we may have to participate in appropriate proceedings in the courts or the patent offices to determine the priority of inventions. These proceedings may determine that these third-party patent applications have priority over our patent applications. Loss of priority in these interference proceedings could result in substantial cost to us and loss of rights.
We also rely on the following to protect our confidential information and our other intellectual property:
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trade secret protection;
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employee nondisclosure agreements;
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third-party nondisclosure agreements; and
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other intellectual property protection methods.
However, we may not be successful in protecting our confidential information or intellectual property, particularly our trade secrets, because third parties may:
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develop substantially the same proprietary information or techniques independently;
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gain access to our trade secrets from unrelated third parties and/or without obligation of confidentiality; or
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disclose our technology following expiration of their confidentiality obligation.
We may be subject to patent litigation to enforce patents issued to us or defend ourselves against claimed infringement by our competitor or any other third party.
Third parties have notified us in the past, and may notify us in the future, that we are infringing their intellectual property rights. Also, we have notified third parties in the past, and may notify them in the future, that they may be infringing our intellectual property rights. In the future, patent litigation may result due to a claim of infringement by our competitor or any other third party or may be necessary to enforce patents issued to us. Any such litigation could result in substantial cost to us and diversion from our primary business efforts, which would have an adverse effect on our business, financial condition and operating results. Furthermore, our customers and the end-users of our products might assert other claims for indemnification that arise from infringement claims against them. If these assertions are successful, it may have a material adverse effect on our business, operating results, financial condition and cash flows. Instead of litigation, or as a result thereof, we may seek a license from third parties to use their intellectual property. However, we may not be able to obtain a license. Alternatively, we may design around the third party’s intellectual property rights or we may challenge these claims in legal proceedings. Any adverse determination in a legal proceeding could result in one or more of the following:
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loss of our proprietary rights;
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exposure to significant liabilities by other third parties;
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a requirement that we get a license from third parties on terms that are not favorable to us or not available at all; or
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an injunction that prohibits us from manufacturing or selling our products.
Any of these actions could be costly and would divert the efforts and attention of our management and technical personnel, which could have a material adverse effect on our business, operating results, financial condition and cash flows.
If our goodwill, amortizable intangible assets or property, plant and equipment become impaired, we may be required to record a significant charge to earnings.
We review our amortizable intangible assets, which are primarily patents, and our property, plant and equipment, for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. Goodwill is also tested for impairment at least annually and more often if certain triggering events or circumstances occur. Factors that may be considered to be a change in circumstances that would indicate the carrying value of our goodwill, amortizable intangible assets or property, plant and equipment may not be recoverable include reduced future cash flow estimates for our company, a decline in our stock price and market capitalization, slower growth rates in our industry and adverse global economic conditions. If, as a result of our impairment test, it is determined that our goodwill, amortizable intangible assets or property plant and equipment is impaired, we may be required to record a significant write down in our financial statements during the period in which such impairment is determined, which may have a material adverse effect on our operating results.
Our investments in marketable securities are subject to market, interest and credit risk that may reduce their value.
The value of our investments in marketable securities may be adversely affected by changes in interest rates, downgrades in the creditworthiness of bonds we hold, turmoil in the credit markets and financial services industry and by other factors which may result in other than temporary declines in the value of our investments. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio, which could have a material adverse effect on our operating results and financial position.
Changes in our effective tax rate may have a material adverse effect on our operating results, financial position and cash flows.
Our future effective tax rate may be adversely affected by a number of factors including:
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changes in available tax credits, particularly the federal research and development tax credit, which expired on December 31, 2011 and has not yet been reinstated;
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the resolution of issues arising from tax audits with various tax authorities;
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the jurisdictions in which profits are determined to be earned and taxed;
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changes in the valuation of our deferred tax assets and liabilities;
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adjustments to estimated taxes upon finalization of various tax returns;
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increases in expenses not deductible for tax purposes;
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changes in tax laws or the interpretation of such tax laws, such as the Internal Revenue Service (“IRS”) Code Section 199 manufacturing deduction which currently provides a tax benefit; and
•
the repatriation of non-U.S. earnings for which we have not previously provided for United States taxes.
An adverse change in our future effective tax rate could in turn, adversely affect our operating results, financial position and cash flows.
Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.
We are subject to taxation in the United States and in various states and foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, VAT and GST. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Although we believe that our approach to determining our worldwide income tax provisions and other tax accruals is consistent with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our determinations. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.
The field work for the 2003 through 2006 Internal Revenue Service (“IRS”) audit has closed. In connection with this audit, we have agreed to certain adjustments for our export income for the 2003 through 2006 tax years; however, this agreement did not result in a material change to our income tax expense. We have not agreed to proposed adjustments regarding the research and development tax credit and are in the process of appealing the proposed adjustment with the IRS. If resolved in favor of the IRS, these adjustments would require a material increase to our income tax expense. However, we expect to prevail with our position and have determined that a change in our tax reserves is not appropriate at this time.
From time to time, we are also audited by various state, federal and tax authorities of other countries in which we operate. Our tax years 2004 and forward are subject to examination by the IRS, our tax years 2000 and forward are subject to examination by material state jurisdictions, and our tax years 2004 and forward are subject to examination by material foreign jurisdictions. Several of our subsidiaries are currently under audit or appeal. No outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.
As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authority’s respective positions on any disputed matters. We provide for potential tax exposures by accruing for uncertain tax positions based on judgment and estimates including historical audit activity. If the reserves are insufficient or we are not able to establish a reserve under GAAP prior to completion or during the progression of any audits, there could be an adverse impact on our financial position and results of operations when an audit assessment is made.
It is reasonably possible that the examination phase of our current audits or appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate and our results of operations. In addition, our external costs of contesting and settling any dispute with the tax authorities could be substantial and adversely impact our financial position and results of operation.
We may not have sufficient cash to fund our current operations and future growth plans.
We believe that our cash resources remain sufficient for our planned operations; however, if global economic conditions deteriorate, our business conditions worsen, our plans change or other unanticipated events occur, we may need to raise additional cash through the establishment of financing facilities or the sale of equity or debt securities to fund our operations. Depending on market conditions, it could be difficult for us to raise the additional cash needed without incurring significant dilution of our existing stockholders or agreeing to significant restrictions on our ability to operate as currently planned. If we were unable to raise additional cash in such circumstances, we could be required to reduce costs through the delay, reduction or curtailment of our operating plan, including reductions in our global workforce or other cost reduction actions, any of which could have a material adverse effect on our operating results, financial condition or cash flows.
As of December 31, 2011, we have approximately $38.0 million of cash and cash equivalents in foreign subsidiaries. In the event these cash amounts are needed to fund operations in the U.S., we believe we would not be liable for U.S. taxes in connection with repatriating these funds given that these funds would be used to repay existing intercompany payables and/or loans due to the U.S. parent company.
The integration and operation of eDiag may disrupt our business and create additional expenses, and we may not achieve the anticipated benefits of the acquisition. We may also acquire other businesses or enter new markets that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational and financial challenges.
The risks involved with acquisitions, including the acquisition and integration of eDiag, mergers, and joint ventures or entering a new market include the following:
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diversion of management’s attention and resources to integrate the new business opportunity;
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failure to retain key personnel;
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customer dissatisfaction or performance problems with the acquired company or new product in a new market;
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costs associated with acquisitions and joint ventures and the integration of acquired operations;
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costs associated with developing, marketing, introducing and supporting a new product in a new market;
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failure to commercialize purchased technologies;
•
ability of the acquired companies, joint ventures or new markets to meet their financial projections;
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assumption of unknown liabilities or other unanticipated events or circumstances; and
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compliance with the Sarbanes-Oxley Act of 2002, new SEC regulations, NASDAQ Stock Market rules and new accounting standards as they relate to the new company or joint venture.
The success of our integration of eDiag assumes certain synergies and other benefits. We cannot assure you that these risks or other unforeseen factors will not offset the intended benefits of the acquisition, in whole or in part. The magnitude, timing and nature of any future acquisitions or investments will depend on a number of factors, including the availability of suitable candidates, the negotiation of acceptable terms, our financial capabilities and general economic and business conditions. Financing for future transactions would result in the utilization of cash, incurrence of debt, issuance of stock or some combination of the three. Further, any business that we acquire, any joint venture that we form, or new market we may enter may not achieve anticipated revenue or operating results and the costs of such activity may have a material adverse effect on our operating results, financial condition or cash flows.
We may experience difficulties with our enterprise resource planning (“ERP”) system or other critical information systems that we use for the daily operations of our business. System failure or malfunction or loss of data contained in these information systems may result in disruption of our operations and result in our inability to process transactions, and this could adversely affect our financial results.
System failure, malfunction or loss of data housed in our critical information systems could disrupt our ability to timely and accurately process transactions and produce key financial reports, including information on our operating results, financial position and cash flows. Any disruptions or difficulties that may occur in connection with our ERP system or other critical systems could also adversely affect our ability to complete important business processes such as the evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. We also regularly upgrade our information systems hardware and software to better meet the information requirements needed to effectively manage our business. If we encounter unforeseen problems with regard to our ERP system or other critical information systems, including those encountered during system upgrades, our business could be adversely affected.
Compliance with changing regulations and standards for accounting, corporate governance and public disclosure may result in additional expenses.
Changing regulatory requirements for corporate governance and public disclosure including SEC regulations, NASDAQ Stock Market rules, and the Financial Accounting Standards Board’s accounting standards requirements and the expected future requirement to transition to or converge with international financial reporting standards are creating uncertainty and additional complexities for publicly held companies such as ours. For example, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access. Stockholder activism, the current political environment, financial reform legislation and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact (in ways we cannot currently anticipate) the manner in which we operate our business. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonably necessary resources to comply with such compliance programs and rules and all other evolving standards. These investments may result in increased general and administrative costs and a diversion of our management’s time and attention from strategic revenue generating and cost management activities.
We are dependent on air transport to conduct our business and disruption of domestic and international air transport systems could adversely affect our business.
We depend on regular and reliable air transportation on a worldwide basis for many of our routine business functions. If civil aviation in the United States or abroad is disrupted by terrorist activities or security responses to the threat of terrorism, regulatory compliance issues, weather or atmospheric conditions or for any other reason, our business could be adversely affected in the following ways:
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supplies of raw materials and components for the manufacture of our products or our customers’ products may be disrupted;
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we may not be able to deliver our products to our customers in a timely manner;
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we may not be able to provide timely service of or support for installed light sources for chipmakers; and
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our sales and marketing efforts may be disrupted.
We are subject to many standards and regulations of foreign governments and, even though we intend to comply, we may not always be in compliance with these rules, or we may be unable to design or redesign our products to comply with these rules.
Many foreign government standards and regulations apply to our products and these standards and regulations are frequently being amended. Although we intend to meet all foreign standards and regulations, our products may not comply with all of them. Further, it might not be cost effective for us to redesign our products to comply with these foreign government standards and regulations. Our inability to design products to fully comply with foreign standards, therefore, could have a material adverse effect on our business.
Our chipmaker customers’ prolonged use of our products in high volume production may not produce the results they desire and, as a result, our reputation and that of our customers who supply photolithography tools to the chipmakers could be damaged in the semiconductor industry.
Over time, our light source products may not meet our chipmaker customers’ production specifications or operating cost requirements after the light source has been used for a long period in high volume production. If any chipmaker cannot successfully achieve or sustain their volume production using our light sources, our reputation could be damaged with them and with lithography tool manufacturers. This would have a negative effect on our business.
Our operations are subject to environmental and other government regulations that may expose us to liabilities for noncompliance.
We are subject to federal, state and local regulations, such as regulations related to the environment, land use, public utility utilization and the fire code, in connection with the storage, handling, discharge and disposal of substances that we use in our manufacturing process and in our facilities. We believe that our activities comply with current government regulations that are applicable to our operations and current facilities. We may be required to purchase additional capital equipment or meet other requirements to comply with these government regulations in the future, if they change. Further, these government regulations may restrict us from expanding our operations. Adopting measures to comply with changes in the government regulations, our failure to comply with environmental and land use regulations, or restrictions on our ability to discharge hazardous substances, could subject us to future liability or cause our manufacturing operations to be reduced or stopped. This could have a material adverse effect on our business, operating results, financial condition and cash flows.
Our products are subject to potential product liability claims if personal injury or death results from their use.
We are exposed to significant risks for product liability claims if personal injury or death results from the use of our products. We may experience material product liability losses in the future. We maintain insurance against product liability claims; however, our insurance coverage may not continue to be available on terms that are acceptable to us. This insurance coverage also may not adequately cover liabilities that we incur. Further, if our products are defective, we may be required to recall or redesign these products. A successful claim against us that exceeds our insurance coverage level, or any claim or product recall that results in adverse publicity against us, could have a material adverse effect on our business, operating results, financial condition and cash flows.
Disputes may arise over the ownership of intellectual property resulting from our research and development activities that have been partially funded by other parties.
In the past, we have occasionally received funds through research and development arrangements with third parties to pay for a portion of our research and development costs associated with the design and development of specific products. Additionally, funds from lithography tool manufacturers and chipmaker customers have been used to fund a portion of our source systems research and development efforts. In connection with providing these research and development services, we try to make contractually clear who owns the intellectual property that results from such activities. Disputes over the ownership or rights to use or market the resulting intellectual property could arise between the funding organizations and us. Any dispute over ownership of the intellectual property we develop or have developed could restrict our ability to market our products and have a material adverse effect on our business.
Trademark infringement claims against our registered and unregistered trademarks would be expensive and we may have to stop using such trademarks and pay damages.
We have registered a number of trademarks including “CYMER” in the United States and in some other countries. We are also trying to register additional trademarks in the United States and in other countries. These registrations in other countries, or any new registrations we may undertake in the United States, could be unsuccessful.
We use these trademarks in the course of our business and in advertising materials, which are distributed throughout the world. While we take precautions against trademark infringement before using our trademarks in new markets, we may be subject to claims of trademark infringement. The process of negotiating a settlement or coexistence agreement to allow us to continue using our trademarks in a particular market could be expensive or distract us from our primary business efforts, potentially adversely affecting our financial condition or operations. Furthermore, if we must undertake negotiations, and the negotiations are ultimately unsuccessful, we
would either need to discontinue using the trademarks in the new market, risk facing litigation or potentially pay damages. Even if we ultimately prevail, litigation could be expensive or distract us from our primary business efforts.
The price of our common stock has fluctuated and may continue to fluctuate widely.
The price of our common stock has historically been subject to fluctuations and could continue to fluctuate in response to a variety of factors, including the risk factors contained in this report.
Various factors may significantly affect the market price and volatility of our common stock, including:
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the cyclical nature of the semiconductor industry;
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actual or anticipated fluctuations in our operating results, including our net income, revenue and product gross margins;
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conditions and trends in lithography, display manufacturing and other technology industries;
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announcements of innovations in technology;
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new products offered by us or our competitors;
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developments of patents or proprietary rights;
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changes in financial estimates by securities analysts;
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global political, economic, and market conditions, including a recession or economic deterioration; and
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failure to properly manage any single or combination of risk factors listed in this section.
Stock markets in the United States can experience extraordinary volatility. Severe price fluctuations in a company’s stock have frequently been followed by securities litigation. If such litigation were initiated against us, it may result in substantial costs and a diversion of management’s attention and resources and, therefore, could have a material adverse effect on our business, operating results, financial condition and cash flows.
Some anti-takeover provisions contained in our articles of incorporation and bylaws, as well as provisions of Nevada law and our executive employment contracts, could impair a takeover attempt.
Our articles of incorporation and bylaws contain provisions which could have the effect (separately, or in combination) of rendering more difficult or discouraging a merger, acquisition or other change of control deemed undesirable by our Board of Directors. These include provisions:
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authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;
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limiting the liability of, and providing indemnification to, our directors and officers;
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requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our Board of Directors;
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controlling the procedures for conduct of stockholder meetings and election and removal of directors; and
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specifying that stockholders may not take action by written consent.
These provisions, alone or together, could deter or delay hostile takeovers, proxy contests and changes in control or management.
As a Nevada corporation, we are subject to Nevada law. Nevada law does not grant stockholders the authority to call a special meeting unless the corporation’s articles of incorporation or bylaws otherwise provide;
neither our articles of incorporation nor our bylaws contain such a provision. Nevada law may also limit the ability of certain stockholders to engage in certain business combinations with us and may limit the voting rights of stockholders who acquire 20% or more of our outstanding shares. Either limitation could discourage or increase the difficulty of an attempted merger, acquisition or other change of control.
Additionally, we have employment agreements with certain officers under which severance payments would become payable in the event of specified terminations without cause or terminations under certain circumstances after a change in control. If such persons were terminated without cause or under certain circumstances after a change of control, and the severance payments under the current employment agreements were to become payable, the officers would receive certain payments and other benefits which depend on the individual officer’s employment agreement but generally include continued base salary and health insurance payments for a period of time, lump sum bonus payments and accelerated vesting of equity awards.
Any provision of our articles of incorporation, bylaws, employment agreements or Nevada law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock in connection with such a transaction and also could affect the price that some investors are willing to pay for our common stock.
Sales of additional common stock and securities convertible into our common stock may dilute the voting power of current holders.
We may issue equity securities in the future the terms and rights of which are superior to those of our common stock. Our articles of incorporation authorize the issuance of up to 5,000,000 shares of preferred stock. These are “blank check” preferred shares, meaning that our Board of Directors is authorized, from time to time, to issue the shares and designate their voting, conversion and other rights, including rights superior, or preferential, to rights of already outstanding shares, all without stockholder consent. No preferred shares are outstanding, and we currently do not intend to issue any shares of preferred stock. Any shares of preferred stock that may be issued in the future could be given voting and conversion rights that could dilute the voting power and equity of existing holders of shares of common stock and have preferences over shares of common stock with respect to dividends and liquidation rights.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We conduct our operations in both owned and leased properties. Our corporate headquarters and primary manufacturing facilities, as well as a leased warehouse facility, are located in San Diego, California. We also own a manufacturing facility in South Korea, where we currently refurbish our discharge chamber assemblies for certain models of our light sources. Additionally, we lease several domestic and international field service offices. We believe that our facilities are adequate to meet the needs of our current business operations. At December 31, 2011, our principal leased and owned properties were as follows:
(1) Building and land owned by us.
(2) Building owned by us. Land leased through December 2020.
(3) This lease is expected to be renewed for a term of at least one year.
Item 3.
Item 3. Legal Proceedings
None.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information. Our common stock is publicly traded on the NASDAQ Global Select Market under the symbol “CYMI.” The following table sets forth, for the periods indicated, the high and low sale prices of our common stock as reported by the NASDAQ Global Select Market.
Registered Shareholders. On February 8, 2012, the closing sales price of our common stock on the NASDAQ Global Select Market was $50.94 and there were 168 registered holders of record as of that date.
Dividends. We have never declared or paid cash dividends on our common stock, and currently do not anticipate paying cash dividends in the future.
Securities Authorized for Issuance Under Equity Compensation Plans. The information required to be disclosed by Item 201(d) of Regulation S-K regarding our equity securities authorized for issuance under our equity incentive plans is incorporated herein by reference to the section entitled “Equity Compensation Plan Information” in our definitive Proxy Statement for our Annual Meeting of Stockholders to be held on May 17, 2012.
Issuer Purchases of Equity Securities. On April 21, 2008, we announced that our board of directors authorized us to repurchase up to $100 million of our common stock. The purchases have been made from time to time in the open market. We did not repurchase any shares during the fourth quarter of 2011, and the approximate dollar value of remaining shares that we are authorized to purchase under the program was $57.8 million at December 31, 2011. The program does not have a fixed expiration date and may be discontinued at any time.
Performance Measurement Comparison.
The following performance graph shows the five-year cumulative total stockholder return on our common stock assuming a $100 investment of our common stock at the closing price of $43.95 on December 31, 2006. This is compared with the cumulative total return of our common stock, the securities comprising the Nasdaq Composite Index, and the securities comprising the Philadelphia Semiconductor Index (the “PHLX Semiconductor Index”).
Each of the indices assumes reinvestment of dividends, if any. No dividends have been declared nor paid on our common stock. The performance shown in the graph is required by the SEC and represents past performance and should not be considered an indication of future performance of our common stock.
COMPARISON OF 5 YEARS CUMULATIVE TOTAL RETURN *
Among Cymer, Inc., The NASDAQ Composite Index
And The PHLX Semiconductor Index
* The material in this section is not “soliciting material” and is not deemed “filed” with the SEC. It is not to be incorporated by reference into any filing of Cymer, Inc. made under the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing, except to the extent we specifically incorporate this section by reference.
Item 6.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and notes thereto included in Part II, Item 8 of this report.
Overview
We are engaged in the development, manufacturing and marketing of light sources for sale to customers who manufacture photolithography tools in the semiconductor equipment industry. We sell replacement parts and support services directly to our chipmaker customer as well as to our lithography tool manufacturer customers. Our TCZ reporting segment develops, integrates, markets, and supports silicon crystallization tools used in the manufacture of displays. Because we derive a substantial portion of our revenues from lithography tool manufacturers and chipmakers, we are subject to the volatile and unpredictable cyclical nature of the semiconductor equipment industry. During the downturn in the global economy and semiconductor industry in early 2009, we focused on cost structure improvements and operational efficiencies, while continuing to focus on providing comprehensive support products for the installed base and investments in the development and commercialization of our EUV source technology and silicon crystallization tools. As a result, we were well positioned for the upturn beginning in late 2009 and continuing into 2010. Although DUV light source demand softened in the second half of the year, 2011 was a year of record revenue coupled with strong profits and operating cash flows. We also improved our DUV competitive position, extended our OnPulse value, and continued our investments in the development and commercialization of EUV source technology and TCZ silicon crystallization tools in 2011.
Revenue of $594.2 million in 2011 represented an 11% increase over 2010. This increase is primarily due to installed base products growth, increased demand for DUV light sources and the sale of three EUV 3100 sources. We continue to expand our installed base product offering by introducing new advanced performance enhancements and data offerings to our OnPulse customers. OnPulse now accounts for over 80% of our installed base products revenue, covers over 65% of our active production light sources and has been adopted by all top ten chipmakers globally. The majority of our DUV light source shipments continued to be ArF immersion sources in support of 45nm and below chipmaking, and we also delivered several KrF sources. During the first half of the year, customers increased their investment in existing and new fab expansions; however, demand softened in the second half of the year as chipmakers assessed their capital investment needs. Additionally, although we have experiences some delays that have put us behind schedule in our EUV source development, we began production on our EUV 3300 source in fulfillment of the initial order we received from ASML this year, valued at over $200 million.
Gross margin was 51.4% in 2011, a slight increase over gross margin of 51.1% in 2010. The increase in gross margin over the prior year was driven primarily by a decrease in costs associated with our installed base products, our continued focus on operational execution and a decrease in inventory write-downs. These improvements in gross margin were partially offset by the sale of three EUV sources at a low gross margin and an increase in freight expenses.
Operating expenses of $197.6 million in 2011 represent a 30% increase over 2010, due primarily to our increased investment in the development and commercialization of our EUV source technology and TCZ silicon crystallization tools, offset partially by decreases in costs associated with variable compensation programs. As a percentage of revenue, operating expenses increased to 33.3% in 2011 from 28.4% in 2010.
Our effective tax rate remained relatively stable at 26% in 2011 compared to 25% in 2010.
Net income was $80.2 million in 2011, compared to net income attributable to Cymer, Inc. of $91.0 million in 2010. In 2011, we generated cash flows from operations of $116.5 million, and our cash and investments balance grew to $323.6 million at December 31, 2011.
As we enter 2012, we believe our installed base products will continue to grow driven by increased ArF pulses utilized on our light sources by chipmaker customers, an increased installed base of light sources, and the proliferation of DUV light source enhancements. We expect chipmaker investment in 2X nm and below manufacturing capacity will be the primary driver of DUV light source demand. We will continue to invest in EUV development resources, manufacturing capacity, and field support. We view 2012 as a pivotal year towards advancing power and performance for EUV sources and meeting the initial EUV 3300 source demand. Our priorities in 2012 include the following: successful EUV 3300 source development and commercialization; continued DUV market competitiveness; extended delivery of OnPulse value and reliability; and development and manufacturing of TCZ silicon crystallization tools to fulfill demand and secure additional orders in support of advanced display manufacturing.
Critical Accounting Policies and Estimates
General
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and use judgment that may impact the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent liabilities. As a part of our ongoing internal processes, we regularly evaluate our estimates and judgments associated with revenue recognition, inventory valuation, warranty obligations, stock- based compensation, income taxes, allowances for doubtful accounts, long-lived assets valuation, goodwill valuation, assets and liabilities valuation, and contingencies and litigation. We base these estimates and judgments upon historical information, projected information, and other facts and assumptions that we believe to be valid and reasonable under the circumstances. These assumptions and facts form the basis for making judgments and estimates and for determining the carrying values of our assets and liabilities that are not apparent from other sources. Adverse global economic conditions, illiquid credit markets, volatile equity, foreign currency fluctuations and declines in consumer spending have increased the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, particularly those related to the condition of the economy, actual results could differ significantly from these estimates.
We believe that revenue recognition, inventory valuation, warranty obligations, stock-based compensation, allowance for doubtful accounts, long-lived assets valuation, and income taxes require more significant judgments and estimates in the preparation of our consolidated financial statements than do other of our accounting estimates and judgments.
Revenue Recognition
Our revenues include light sources, silicon crystallization tools and installed base products, which consist of OnPulse contracts, service support and replacement parts, and to a lesser extent, service, upgrades, and refurbishments of our light sources.
We recognize revenue when title and risk of loss have passed, evidence of an arrangement has been obtained, pricing is fixed or determinable at the date of sale, and collectability is reasonably assured. Our sales arrangements do not include general rights of return or cancellation privileges.
Light Sources and Silicon Crystallization Tools
We recognize revenue for light sources and silicon crystallization tools at one of the following three points, depending on the terms of our arrangement with our customer: 1) shipment of the system, 2) delivery of the system, or 3) receipt of an acceptance certificate from the customer. For the majority of our DUV light source sales, the shipping terms are F.O.B. shipping point, and revenue is recognized upon shipment. Our current sales arrangements for EUV sources and TCZ silicon crystallization tools contain acceptance criteria, and revenue is recognized upon system acceptance by the customer.
Certain of our revenue arrangements include additional elements, such as future product upgrades or services. In accordance with the authoritative guidance for revenue recognition arrangements with multiple deliverables, we allocate the total consideration in the arrangement to the multiple elements using the relative selling price of the delivered and undelivered items, based on vendor specific objective evidence or estimated selling price.
If vendor specific objective evidence is not available, as third party evidence is generally not available to us due to the proprietary nature of our products, the estimated selling price is determined considering market conditions and estimated gross margins, as well as factors that are specific to us.
Installed Base Products-OnPulse Contracts, Support Services, and Replacement Parts
Revenue associated with our OnPulse contracts, which include primarily replacement parts and to a much lesser extent services, is recognized monthly based on the number of pulses utilized by our customers on their light sources that are covered under their OnPulse arrangement. Revenue from services, including our data services, is recognized as the services are rendered. To date, the revenue associated with the service element of our OnPulse contracts combined with revenue from our support services has been less than 10% of our total revenue.
For our replacement part sales, the shipping terms are F.O.B. shipping point, and revenue is recognized upon shipment. For a significant portion of our replacement parts revenue, our customers return the consumed assembly to us as part of the sale of the new part. We reuse some of the material within these core assemblies, mainly metal components, for the future build of core assemblies. As a result, our revenue consists of both cash and the fair value of the reusable parts received from our customers as consideration for these replacement part sales. Revenue associated with our customers’ return of core assemblies is recognized upon receipt of the returned core assembly. The amount of the revenue is determined based upon the fair value of the reusable parts that we expect to yield from the returned core assembly based on historical experience. If the return of the core assembly is related to a part being replaced under our warranty provisions or under a service or support contract with our customer, we will recognize the estimated fair value of the reusable component as a reduction to cost of revenue.
On a limited basis, we sell upgrades for our light sources or refurbish light sources owned by our customers to their original or new condition. Revenue from upgrades is recognized when the upgrade has been successfully installed by us and accepted by the customer. Revenue from refurbished light sources is recognized when the refurbishment process has been completed and, depending upon the customer, the proper delivery or acceptance terms have been met.
We report revenue net of any sales-based taxes assessed by governmental authorities that are imposed on or concurrent with sales transactions.
Deferred Revenue
Deferred revenue represents payments received from our customers in advance of the delivery of products and/or services or before the satisfaction of all revenue recognition requirements, as described above.
Inventory Valuation
Our inventories are recorded at the lower of cost, determined on a first-in, first-out basis, or estimated market value. Our inventories include raw materials, work-in-process, finished goods, and replacement and reusable parts, which we use in our contract arrangements, refurbishment activities and warranty obligations.
As part of our regular business activities, we conduct parts refurbishment and material reclamation activities related to some of our core assemblies, particularly our chamber assemblies. We receive consumed core
assemblies back from our customers as partial consideration for the purchase of new parts or when core assemblies are replaced under OnPulse contracts or warranty claims. The fair value of the reusable parts contained within the consumed assembly is recorded in inventory based upon historical data on the value of the reusable parts that we typically yield from a consumed core assembly.
Obsolete inventory, or inventory for which we do not have expected usage based on our forecasted demand, is written down to its estimated market value, if less than its cost. The methodologies used to analyze excess and obsolete inventory and determine the value of our inventory are significantly affected by future demand and usage of our products. There are many factors that could potentially affect the future demand or usage of our products, including the following:
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condition of the semiconductor and display industries, which are cyclical in nature;
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rate at which our customers take delivery of our systems and our replacement parts;
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loss of any of our major customers or a significant change in demand from any of these customers;
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overall mix of system models or replacement parts and any changes to that mix required by our customers;
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utilization rates of our light sources at chipmakers;
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overall condition of the global economy which can positively or negatively impact the demand for our products;
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customer acceptance of new products or discontinued use of our products; and
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engineering change orders, including those changes inherent in the development of emerging technologies such as EUV.
Additionally, service level requirements of our customers require us to keep certain levels of replacement parts at or near customer locations. Based upon our experience, we believe that the estimates we use to calculate the value of our inventories are reasonable and properly reflect the risk of excess and obsolete inventory. During changing or adverse economic conditions or when introducing new products and product lines, it is difficult to estimate the future demand for our products. As a result, the likelihood that the usage period for our inventory will substantially differ from our estimates is increased. If actual demand or the usage periods of our inventory are substantially different from our estimates, such differences may have a material adverse effect on our operating results and financial condition.
We will also write-down inventory when the cost basis of the inventory is greater than its net realizable value. Net realizable value represents the estimated selling price of the inventory reduced by the costs of completion and disposal. We include all direct costs in our estimated costs of completion, including estimated warranty and installation costs. If actual selling prices or costs of completion are substantially different from our estimates, such differences may have a material adverse effect on our operating results and financial condition.
Warranty Obligations
We maintain an accrual for the estimated cost of product warranties associated with sales of our products. Warranty costs include replacement parts and labor costs to repair our products during the warranty period. We record a provision for warranty, which is included in cost of revenues, at the time that the related revenue is recognized. The warranty period and terms for systems and replacement parts varies by system model. We review our warranty provision using a statistical financial model which calculates actual historical expenses, product failure rates, and potential risks associated with our different product models. We then use this financial model to calculate the future probable expenses related to warranties and the required level of the warranty provision. Throughout the year, we review the risk levels, historical cost information and failure rates used within this model and update them as information changes over the product’s life cycle. For new product
offerings, such as EUV sources and TCZ crystallization tools, for which we have limited or no historical failure rates, we estimate our future probable expenses related to the warranties based on an evaluation of parts covered under warranty and their expected failure rates determined through internal testing and analysis. If actual warranty expenditures differ substantially from our estimates, revisions to the warranty provision would be required. Actual warranty expenditures are recorded against the warranty provision as they are incurred. Consumed parts under warranty, when returned, are recorded as reductions to warranty expenditures during the return period at their estimated fair value. We do not include the return of consumed parts in our statistical financial model used to estimate our provision for warranty because the specific parts and their estimated future fair value when returned, if any, cannot be reasonably estimated at the time revenue is recorded.
We actively engage in product improvement programs and processes to limit our warranty costs; however, our warranty obligation is affected by the complexity of our product, product failure rates and costs incurred to correct those product failures at customers’ sites. The industry in which we operate is subject to rapid technological change, and as a result, we periodically introduce newer, more complex products. Although we classify these newly released products as having a higher risk in our warranty model resulting in higher warranty provisions, we are more likely to have differences between the estimated and actual warranty costs for these new products. Warranty provisions for our older and more established products are more predictable as more historical data is available. If actual product failure rates or estimated costs to repair those product failures were to differ from our estimates, revisions to our estimated warranty provision would be required, which could have a material effect on our operating results and financial condition.
Stock-Based Compensation
The fair value of stock-based compensation awards is measured on the grant date and is recognized as expense over the employee’s requisite service period. The fair value of the stock award is determined using the Black-Scholes option pricing model for stock options and the quoted price of our common stock on the grant date for restricted stock units. The Black-Scholes option pricing model requires the use of subjective assumptions including the expected term of the stock options and our expected stock price volatility over the expected term of the stock options. An estimated forfeiture rate is applied and included in the calculation of stock-based compensation expense at the time that the stock option or other stock awards, such as our restricted stock unit awards, are granted and revised if necessary in subsequent periods if actual forfeiture rates differ from those estimates. If we change any of the key assumptions that we use in the Black-Scholes option pricing model as described above, or if we decide to use a different valuation model in the future or change our forfeiture rate, the compensation expense that we record may differ significantly in the future from what we have recorded in prior periods and could materially affect our operating results.
We also grant performance restricted stock units (“PRSUs”) to our executive officers and certain key employees. PRSUs are a form of share-based award in which the number of shares ultimately received will be determined based on achievement against defined performance metrics. Grants of PRSUs during the past three years have contained at least one of the following performance metrics over a defined performance period: revenue and net income performance compared to our annual operating plan (“AOP”), revenue and net income relative performance compared to a specified group of peer companies, DUV and EUV install value market share and eligible individual’s management by objectives (“MBO”) achievement. We record compensation expense each period based on our estimate of the most probable number of PRSUs that will be issued. This estimate requires significant estimates and projections about our financial performance relative to our AOP or to the financial performance of the specified group of peer companies, our DUV and EUV install value market share and the performance of individuals against their specific MBOs. If our estimates change or actual results are different than the estimates used in prior periods, we would be required to increase or decrease compensation expense, which could materially affect our operating results.
Allowance for Doubtful Accounts
The majority of our trade receivables are derived from sales to lithography tool manufacturers or semiconductor manufacturer customers located throughout the world. In order to monitor potential credit losses, we perform periodic credit evaluations of our customers’ financial condition. We maintain an allowance for doubtful accounts for probable credit losses based upon our assessment of the expected collectability of our accounts receivable. We take into consideration the following when making this assessment;
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our customer’s payment history and how current they are on paying their outstanding receivables balance;
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our history of successfully collecting on past due or aged receivables from our customers;
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our customer’s current financial condition and any circumstances of which we are aware that would affect our customer’s ability to meet its financial obligations to us; and
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our judgments as to prevailing economic conditions in the industry and global economy and their effect on our customers.
If circumstances change, and the financial conditions of our customers are adversely affected and they are unable to meet their financial obligations to us, or the judgments used by us to determine a customer’s allowance prove to be incorrect, we may need to record additional allowances. In addition, due to our concentrated customer base, the trade receivable balance owed by any one customer can be significant. As a result, if our assessment of the financial condition of our customers, even a single customer, proves to be incorrect, we would have to record additional and potentially significant allowances and bad debt expense, which would have a material adverse effect on our business, operating results, financial condition and cash flows.
Long-Lived Assets Valuation
Included in our long-lived assets are property, plant and equipment and definite-lived intangible assets. Long-lived assets are reviewed for impairment when events or circumstances indicate that the carrying amount of an asset may not be recoverable. Factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset, a significant change in the long-lived asset’s physical condition, and operating or cash flow losses associated with the use of the long-lived asset. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future net cash flows, undiscounted and without interest, expected to be generated by the asset. An impairment loss would be recognized when the carrying amount of a long-lived asset or asset group is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset or asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. Based on our assessment of potential impairments during 2011, 2010, and 2009, there were no factors identified that would indicate an impairment of our long-lived assets.
Significant judgments and estimates by management are required to project cash flows and, if required, estimate the fair value of the long-lived assets. The estimated future cash flows are based upon, among other things, our strategic plans with regard to our business and operations, assumptions about expected future operating performance, and the interpretation of current and future economic indicators. To the extent that the judgments used by us to calculate our future cash flows prove to be inaccurate or there are significant changes in market conditions, the overall condition of the global economy or our strategic plans change, it is possible that our conclusions regarding long-lived asset impairment could change. This could result in significant impairment charges, which would have a material adverse effect on our business, operating results and financial position.
Income Taxes
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We consider past operating results, future market growth, forecasted earnings, historical and
projected taxable income, the mix of earnings in the jurisdictions in which we operate, prudent and feasible tax planning strategies and statutory tax law changes in determining the need for a valuation allowance. If we were to determine that it is more likely than not that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income tax expense in the period such determination is made. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, the previously provided valuation allowance would be reversed. These changes to the valuation allowance, and resulting increases or decreases in income tax expense, could have a material effect on our operating results.
Our income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While we believe we have appropriate support for the positions taken on our tax returns, we regularly assess the potential outcomes of examinations by tax authorities in determining the adequacy of our provision for income taxes, and adjust the income tax provision, income taxes payable and deferred taxes in the period in which the facts that give rise to a revision become known.
Results of Operations
The following table sets forth certain items in our consolidated statements of operations as a percentage of total revenues:
We develop, manufacture and market our products within two reportable business segments, Cymer and TCZ. Cymer’s primary business is to design, manufacture and sell DUV and EUV light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools used in the manufacture of high-resolution LTPS-LCD and OLED displays. The discussion which follows for revenues, cost of revenues and operating expenses includes our consolidated results and identifies those amounts associated with the TCZ segment, which are included in the consolidated amounts, for the years ended December 31, 2011, 2010 and 2009. Additional information regarding our reporting segments is contained in Note 16 to our Consolidated Financial Statements in Part II, Item 8 of this report.
Years Ended December 31, 2011 and 2010
Revenues. The following table summarizes the components of our revenue (in thousands, except units sold):
(1) For purposes of calculating the average selling price of our light sources and silicon crystallization tools, we have excluded the effect of deferred revenue between periods in order to present the actual average selling price per unit sold.
Total revenue, compared to the prior year, increased primarily due to continued demand for DUV light sources and installed base products as well as the sale of three EUV 3100 pilot sources during 2011. During the first half of the year, customers increased their investment in existing and new fab expansions; however, this demand softened in the second half of the year as chipmakers assessed their upcoming capital investment needs. The increase in DUV light sources revenues was primarily due to continued investments in ArF immersion light sources in support of 45nm and below chipmaking and an increase in purchases of KrF light sources when compared to the prior year. The average selling price of our DUV light sources decreased due to an increase in the percentage of light sources sold that were KrF, as KrF light source systems have a lower average selling price than ArF light source systems. Our installed base product revenue increased when compared to the prior year primarily due to our customers’ continued adoption of our OnPulse product, an increase in DUV pulses utilized on our light sources by chipmaker customers and a higher percentage of those pulses generated by ArF systems. Additionally, we recorded TCZ segment revenue during 2011 and 2010 as a result of customer acceptance of our silicon crystallization tools.
Our DUV backlog includes only those orders for light sources and replacement parts for which we have accepted a purchase order from a customer, and that will be delivered to the customer within the following 12 months. In addition, our DUV backlog does not include service or support which will be provided to our customers in the future or under service contracts. Timing of delivery can be affected by many factors, including factors that cannot be easily predicted or controlled. Because it is the practice in our industry that customers may cancel or delay orders with little or no penalty, our backlog as of any particular date may not be a reliable indicator of actual sales for any succeeding period.
Our backlog for DUV light sources and replacement parts at December 31, 2011 was $48.2 million compared to $63.6 million at December 31, 2010. DUV bookings for 2011 and 2010 were relatively flat at $548.6 million and $547.6 million, respectively. The DUV book-to-bill ratio, which includes light sources and replacement parts, for 2011 was 0.96 compared to 1.04 for 2010. The decrease in the backlog and book-to-bill ratio reflects decreased orders for DUV light sources as chipmakers assess their upcoming capital investment needs.
We also had a backlog of $23.5 million for EUV 3100 sources and $34.4 million for silicon crystallization tools at December 31, 2011. Revenue will be recorded for these sources and tools when customer acceptance has occurred.
Sales to ASML, Nikon and Samsung amounted to 35%, 11% and 10%, respectively, of total revenue for 2011, and 30%, 15% and 10%, respectively, of total revenue for 2010.
Our sales to external customers consist of sales generated from each of the following geographic locations in which we do business (in thousands):
We anticipate that international sales will continue to account for a significant portion of our sales.
Cost of revenues. Cost of revenues includes direct material and labor, warranty expenses, license fees, manufacturing and service overhead. Cost of revenues also includes foreign exchange gains and losses on foreign currency forward exchange contracts (“forward contracts”) associated with purchases of our products for resale under firm third-party sales commitments. Costs incurred for shipping and handling are included in cost of revenues at the time the related revenue is recognized. Amounts billed to a customer, if any, for shipping and handling are reported as revenue.
The cost of revenues increased 10.6% to $289.1 million for 2011 from $261.4 million for 2010. Gross profit increased to $305.1 million with a 51.4% gross margin for 2011 from $272.8 million with a 51.1% gross margin for 2010. The increase in gross profit over prior year was primarily due to the higher level of sales of light sources and installed based products. The increase in gross margin over the prior year was driven primarily by a decrease in costs associated with our installed base products, our continued focus on operational execution and a decrease in inventory write-downs. These improvements in gross margin were partially offset by the sale of three EUV sources at a low gross margin and an increase in freight expenses. Included in cost of revenue were $4.0 million and $5.1 million for 2011 and 2010, respectively, for our TCZ segment.
Research and development. Research and development expenses include costs of continuing product development projects, which consist primarily of employee and material costs, depreciation of equipment and other engineering related costs. Research and development expenses increased 46.5% to $130.6 million for 2011 from $89.2 million for 2010. This increase was primarily due to our increased investment in EUV source commercialization and development, including an increase in headcount related employee costs when compared to the prior year. In addition, we continue to increase our investment in our development of silicon crystal tools, and research and development expenses included $12.5 million and $7.7 million for 2011 and 2010, respectively, for our TCZ segment. As a percentage of total revenues, research and development expenses increased to 22.0% for the year ended December 31, 2011 from 16.7% for 2010.
Sales and marketing. Sales and marketing expenses include sales, marketing, customer support staff and other marketing expenses. Sales and marketing expenses increased 10.9% to $25.1 million for 2011 from $22.7 million for 2010. The increase in sales and marketing expenses primarily reflects an increase in employee related costs due to increased headcount and increased travel costs, which were partially offset by a decline in costs associated with our variable compensation programs when compared to the prior year. Included in sales and marketing expenses were $2.0 million and $2.2 million for 2011 and 2010, respectively, for our TCZ segment. As a percentage of total revenues, sales and marketing remained flat for 2011 at 4.2% when compared to 2010.
General and administrative. General and administrative expenses consist primarily of management and administrative personnel costs, professional services including external audit and consultant fees, and administrative operating costs. General and administrative expenses increased 5.0% to $41.8 million for 2011 from $39.8 million for 2010 primarily due to an increase in employee related costs due to increased headcount, increased outside service costs and lower bad debt recoveries in 2011 compared to 2010. These increases in expenses were partially offset by a decrease in costs associated with our variable compensation programs when compared to prior year. Included in general and administrative expenses were $1.0 million and $1.5 million for 2011 and 2010, respectively, for our TCZ segment. As a percentage of total revenues, general and administrative expenses decreased to 7.1% for the 2011 compared to 7.5% for 2010.
Other income (expense). Other income (expense) consists primarily of interest income earned on our investment portfolio, foreign currency exchange gains or losses associated with fluctuations in the value of the functional currencies of our foreign subsidiaries against the U.S. Dollar and other items that may be specific to a reporting period. Other income was $855,000 for 2011 compared to other expense of $32,000 for 2010. The increase in other income primarily reflects foreign currency exchange gains in 2011 compared to foreign currency exchange losses in 2010.
Income tax expense. Income tax expense of $28.2 million and $30.3 million reflect effective tax rates of 26.0% and 25.0% for 2011 and 2010, respectively. The slight increase in the effective tax rate for 2011 was primarily due to a decrease in federal research and development credits taken in 2011 compared to 2010. Additionally, during 2011 we recorded the following discrete items: a decrease in income tax expense of $4.8 million for a reduction in our net unrecognized tax benefits due primarily to the expirations of statute of limitations and an increase in income tax expense of $754,000 due to the change in certain foreign corporate tax rates, which reduced the balance of our deferred tax assets in those foreign subsidiaries. This compares to the following discrete items recorded during 2010: a net tax benefit of $324,000, which represents our estimate of TCZ net operating loss carryforwards we expect to utilize in the future given the retroactive revocation of TCZ’s tax holiday in Singapore, and a net tax benefit in the United States of $1.2 million based on our estimate of the outcome of a foreign tax audit. We are currently negotiating settlement of this audit with the foreign tax authority and the United States Treasury Department, and our estimated benefit could change as negotiations evolve. Final resolution of this audit may not be known for several years.
Our future effective tax rate could be unfavorably affected by various factors, such as tax legislation and credits, particularly the federal research and development tax credit, which expired on December 31, 2011 and has not been reinstated, and the geographic compositions of our pre-tax income. Additionally, several of our subsidiaries are under audit or appeal. It is reasonably possible that the examination phase of these audits or
appeals may conclude in the next 12 months, and that the related tax reserves or unrecognized tax benefits for uncertain tax positions may change, potentially having a material effect on our effective tax rate and our results of operations.
Years Ended December 31, 2010 and 2009
Revenues. The following table summarizes the components of our revenue (in thousands, except units sold):
(1) For purposes of calculating the average selling price, we have excluded the effect of deferred light source system revenue between periods in order to present the actual price per light source system sold.
Total revenue increased primarily due to improved market conditions and chipmaker customers’ increased investment in new and existing fab expansions. The increase in light source revenues was primarily due to a higher level of investment in ArF light sources in support of 45nm and below immersion chipmaking as well as an increase in KrF light source purchases. The average selling price of our light sources decreased due to an increase in the percentage of light sources sold that were KrF, which have a lower average selling price than ArF light sources. Our installed base product revenue increased due to a continued rise in DUV pulses utilized on our light sources by chipmaker customers, increasing pulse value as the mix of ArF pulses continues to rise, and an increase in the number of installed base ArF light sources.
We also recorded our first TCZ segment revenue during 2010 for the relocation, installation and final acceptance of a silicon crystallization tool by a large Korean display manufacturer. There were no revenues associated with our TCZ segment in 2009.
Sales to ASML, Nikon and Samsung amounted to 30%, 15% and 10%, respectively, of total revenue for 2010, and 15%, 18% and 13%, respectively, of total revenue for 2009.
Our sales to external customers consist of sales generated from each of the following geographic locations in which we do business (in thousands):
Cost of revenues. The cost of revenues increased 52.7% to $261.4 million for 2010 from $171.3 million for 2009. Gross profit increased to $272.8 million with a 51.1% gross margin for 2010 from $136.4 million with a 44.3% gross margin for 2009. The increase in gross margin over prior year was driven primarily by our continued focus on operational execution, previously implemented cost structure improvements, improved manufacturing absorption, lower write downs of inventory, decreases in warranty expenses due to light source reliability improvements, and lower freight costs as a percentage of revenue. Included in cost of revenues for 2010 was $5.1 million related to the relocation, installation and final acceptance of our first silicon crystallization tool and installation costs on a second tool and $898,000 in 2009 for installation costs related to our TCZ segment.
Research and development. Research and development expenses increased 35.5% to $89.2 million for 2010 from $65.8 million for 2009. Research and development spending increased in 2010 as we raised our level of investment in EUV source development, increased headcount, and increased costs associated with variable compensation programs that are closely linked to improvements in business levels and company performance. In 2009, research and development expenses were negatively impacted by the reductions in workforce and adjusted spending on our DUV product portfolio. Research and development expenses included $7.7 million and $4.2 million for 2010 and 2009, respectively, for our TCZ segment. The increase in research and development expenses for TCZ is due primarily to assuming full ownership of the joint venture in January 2010. As a percentage of total revenues, research and development expenses decreased to 16.7% for 2010 from 21.4% for 2009.
Sales and marketing. Sales and marketing expenses increased 36.5% to $22.7 million for 2010 from $16.6 million for 2009. Included in sales and marketing expenses were $2.2 million and $2.3 million for 2010 and 2009, respectively, for our TCZ segment. The increase in sales and marketing expenses primarily reflects an increase in headcount and costs associated with variable compensation programs that are closely linked to improvements in business levels and company performance. As a percentage of total revenues, sales and marketing decreased to 4.2% for 2010 compared to 5.4% for 2009.
General and administrative. General and administrative expenses increased 44.4% to $39.8 million for 2010 from $27.6 million for 2009, primarily due to an increase in headcount and costs associated with variable compensation programs that are closely linked to improvements in business levels and company performance. These increases were partially offset by a decline in bad debt expense as a result of improved risk profiles and payment histories of certain of our customers compared to 2009. Included in general and administrative expenses were $1.5 million and $995,000 for 2010 and 2009, respectively, for our TCZ segment. As a percentage of total revenues, general and administrative expenses decreased to 7.5% for 2010 compared to 8.9% for 2009.
Restructuring. There were no restructuring expenses in 2010. During 2009, we reduced our worldwide workforce by approximately 26 percent or a total of 230 employees, as part of our cost reduction efforts in response to the deterioration in the lithography sector of the semiconductor capital equipment market at the time. These reductions in workforce affected only employees at our Cymer segment. As a result of these reductions in our workforce, we recorded restructuring expense of approximately $8.4 million during 2009.
Other income (expense). Other expense improved to $32,000 of net other income for 2010 primarily due to a negligible foreign currency loss compared to other expense of $918,000 for 2009 which was primarily due to foreign currency losses of $1.1 million as a result of the depreciation of the Korean Won against the U.S. Dollar at the beginning of 2009.
Income tax expense. Income tax expense of $30.3 million and $8.4 million reflect effective tax rates of 25% and 49% for 2010 and 2009, respectively. The decrease in the effective tax rate was due primarily to an increase in our research and development tax credits in 2010, the incurrence of foreign losses in 2009 that could not be benefited, and an increase in our ability to utilize the U.S. manufacturing benefit due to increased profitability in 2010. We recorded a net tax benefit in the United States of $1.2 million based on our estimate of the outcome of a foreign tax audit. We are currently negotiating settlement of this audit with the foreign tax authority and the
United States Treasury Department, and our estimated benefit could change as negotiations evolve. Final resolution of this audit may not be known for several years. We also recorded a net tax benefit in the United States of $324,000, which represents our estimate of TCZ net operating loss carryforwards we expect to utilize in the future given the retroactive revocation of TCZ’s tax holiday in Singapore. The $324,000 net tax benefit represents the establishment of a $3.2 million deferred tax asset, offset by a valuation allowance of $2.9 million.
Liquidity and Capital Resources
In recent years, we have funded our operations primarily from cash generated from operations and proceeds from employee stock option exercises. We have also from time to time utilized cash to repurchase shares of our common stock. In summary, our cash flows were as follows (in thousands):
Operating Activities
Net cash provided by operating activities in 2011 primarily reflects net income for the year as adjusted to exclude the effects of non-cash charges, primarily depreciation, amortization, stock-based compensation and provision for deferred income taxes. Additionally, increases in deferred revenue of $28.8 million, related primarily to advance payments received from ASML for purchase orders under a multi-year supply agreement for EUV 3300 sources, and increases in other assets of $14.9 million, primarily related to income taxes receivable, contributed to positive operating cash flow. These increases in cash were offset partially by a $24.9 million decrease in other liabilities and a $14.7 million increase in inventories. The decrease in other liabilities primarily reflects the decrease in accrued payroll related to our variable cash compensation programs and a decrease in income taxes payable. The increase in inventories is primarily in support of EUV demand.
Net cash provided by operating activities in 2010 primarily reflects net income for the year as adjusted to exclude the effects of non-cash charges, primarily depreciation, amortization, stock-based compensation and provision for deferred income taxes. Additionally, increases in other liabilities of $21.4 million, primarily related to increases in accrued payroll related to variable cash compensation programs, and increases in deferred revenue of $8.7 million, related to advance payments received from ASML for purchase orders under a multi-year supply agreement for EUV 3100 pilot sources and advance payments for a silicon crystallization tool, contributed to positive operating cash flow. These increases in operating cash flow were offset partially by a $48.7 million increase in accounts receivable, a $30.7 million increase in inventory and a $27.9 million increase in other assets, primarily related to income taxes receivable. The increase in accounts receivable results primarily from the increase in revenue and, to a lesser extent, an increase in days sales outstanding to 79 days at December 31, 2010 from 75 days at December 31, 2009. The increase in inventory is due primarily to the production of EUV sources. The increase in income taxes receivable is due primarily to the reinstatement of the research and development credit at the end of 2010.
Net cash provided by operating activities in 2009 primarily reflects net income for the year as adjusted to exclude the effects of non-cash charges, primarily depreciation, amortization and stock-based compensation, a reduction in inventory levels, and increases in accounts payable and deferred revenue. The $4.4 million decrease in inventory was primarily due to decreases in our spare parts inventory levels during 2009. These decreases in our spare parts inventory levels were partially offset by increases in inventory related to EUV sources and silicon crystallization tools. These increases in inventory also resulted in an increase in accounts payable of $9.3 million.
The increase in deferred revenue of $7.4 million primarily reflects advance payments received from ASML during 2009 for purchase orders under a multi-year supply agreement for EUV 3100 pilot sources. These increases in operating cash flow were offset by increases in accounts receivable and decreases in other liabilities. The increase in accounts receivable was primarily the result of a higher level of shipments occurring later in the fourth quarter, which resulted in higher accounts receivable balances at the end of the year. The decrease in other liabilities was primarily due to the decrease in our warranty provision as a result of reduced sales and the lower number of light sources under warranty at December 31, 2009.
Investment Activities
Net cash used in investing activities in 2011 of $166.2 million reflects purchases of investments, net of proceeds from sales of investments, of $137.2 million, capital expenditures of $25.3 million primarily related to our EUV research, development and commercial production efforts, and the acquisition of eDiag for $3.8 million, net of cash acquired, as noted below.
On April 1, 2011, we acquired all of the outstanding equity of eDiag for consideration totaling $15.0 million payable in cash, with $6.0 million paid on April 1, 2011 and $3.0 million payable on each of April 1, 2012, 2013 and 2014. We acquired $2.2 million in cash as part of the acquisition. There was no debt assumed with the acquisition. Additionally, we entered into a services agreement with the president and previous majority stockholder of eDiag that pays him $2.5 million on April 1, 2015 and $2.5 million on April 1, 2016, if he continues his employment with us through those dates.
Net cash used in investing activities in 2010 of $10.7 million was due primarily to the timing of short-term investments that matured and were reinvested during the period as well as capital expenditures primarily related to our EUV research, development and commercial production efforts.
Net cash used in investing activities in 2009 consisted primarily of $28.3 million of purchases of short-term and long-term securities, net of reinvestment of such securities during the year. In addition, cash used in investing activities included the acquisition of $7.2 million of property, plant and equipment, a significant portion of which relates to equipment associated with our EUV research, development and commercial production efforts, software and equipment purchases, and equipment purchases related to TCZ.
Financing Activities
The primary sources of cash provided by financing activities during 2011 are $16.3 million of proceeds from the exercise of employee stock options and $4.0 million of excess tax benefits related to the stock option exercises.
Net cash used in financing activities in 2010 primarily reflects the repurchase of $19.3 million of our common stock and $2.2 million for the purchase of the non-controlling interest in TCZ. These uses of cash were partially offset by $9.4 million received from the exercise of employee stock options and purchases under the employee stock purchase plan and $2.1 million of excess tax benefits related to stock option exercises.
Net cash used in financing activities in 2009 primarily reflects the payment of $140.7 million for the redemption of our outstanding convertible subordinated notes that matured on February 15, 2009. This payment was partially offset by proceeds received from the exercise of employee stock options and purchases under the employee stock purchase plan totaling $6.7 million, an additional cash investment in TCZ from Zeiss, the former TCZ minority shareholder, and excess tax benefits from stock option exercises.
Effect of Exchange Rate Changes
Most of our foreign subsidiaries operate in currencies other than the U.S. Dollar, and a substantial portion of their cash balances can be denominated in these foreign currencies. As a result, our cash and cash equivalent
balances are subject to the effects of the fluctuations in these currencies against the U.S. Dollar at the end of each reporting period. Several of the foreign currencies in which our subsidiaries operate have experienced volatility over the past several years. The net effect of exchange rate changes on cash and cash equivalents, when expressed in U.S. Dollar terms, was an increase in cash of $295,000, $2.1 million and $102,000 for the years ended December 31, 2011, 2010 and 2009, respectively.
For the year ended December 31, 2011, cash and cash equivalents were positively affected by $478,000 due to the Japanese Yen strengthening against the U.S. Dollar and the effect it had on the cash balances held at our Japanese subsidiary. This increase was partially offset by $91,000 due to the weakening of the Taiwan Dollar against the U.S. Dollar.
For the year ended December 31, 2010, cash and cash equivalents were positively affected by $1.8 million due to the Japanese Yen strengthening against the U.S. Dollar and the effect it had on the cash balances held at our Japanese subsidiary. In addition, volatility of the Korean Won against the U.S. Dollar throughout the year positively affected cash and cash equivalents by $479,000. These increases were offset by $341,000 due to the weakening of the Euro against the U.S. Dollar.
For the year ended December 31, 2009, cash and cash equivalents were positively affected by $726,000 due to the Korean Won and the Euro strengthening against the U.S. Dollar and the effect it had on the cash balances denominated in these currencies held at our subsidiary offices. This increase was offset by $652,000 due to the weakening of the Japanese Yen against the U.S. Dollar.
Prospective Capital Needs
We require substantial resources to fund the operations of our business, particularly to fund our investment in new technologies, including inventory and capital in support of these technologies. We expect purchases of property, plant and equipment in 2012 to be approximately $30.0 million to $50.0 million, a significant portion of which will relate to purchases of equipment and facility improvements associated with development and manufacturing of our EUV sources and equipment to support our installed base product offerings. In addition, we require resources to fund our normal operations.
We believe that our operating cash flows, together with our current cash, cash equivalents and marketable securities will be sufficient to cover our working capital needs for our normal operations, and our investments in our new technologies, including EUV and silicon crystallization tools, for at least the next 12 months. It is possible that we may need to raise additional funds to finance our activities or to acquire assets, products or new technologies beyond the next 12 months. We may also decide that it is prudent in the current business and economic environment to secure commitments to access additional capital, including equity or debt securities, to protect our long term liquidity position. As of December 31, 2011, we have approximately $38.0 million of cash and cash equivalents in foreign subsidiaries. In the event these cash amounts are needed to fund operations in the U.S., we believe we would not be liable for U.S. taxes in connection with repatriating these funds given that these funds would be used to repay existing intercompany payables and/or loans due to the U.S. parent company.
In April 2008, our board of directors authorized us to repurchase up to $100.0 million of our common stock. During 2011, we had no purchases under this program. At December 31, 2011, $57.8 million remains available for share repurchases under this program.
Our future capital requirements may vary materially from those currently planned. We anticipate that the amount of capital we will need in the future will depend on many factors, including:
•
the required investments in our new technologies such as EUV light sources and TCZ silicon crystallization tools and in the products derived from them;
•
the market acceptance of our products;
•
the overall levels of sales of our products and gross profit margins;
•
general economic and political conditions and specific conditions in the markets in which we operate, including the volatility in the semiconductor industry, and trends in the semiconductor markets in various geographic regions, including seasonality in sales of consumer products into which semiconductors are incorporated;
•
the timing and requirements of spending to support product development efforts for our current technologies and other operating costs;
•
our competitors’ responses to our products and our anticipation of and responses to their products;
•
our manufacturing activity;
•
the levels of inventory and accounts receivable that we maintain;
•
the inability of certain of our customers who depend on credit to have access to their traditional sources of credit to finance the purchase of products from us, particularly during changing or adverse global economic conditions, which may lead them to reduce their level of purchases or to seek credit or other accommodations from us;
•
competitive labor market compensation requirements;
•
acquisitions of assets, products or new technologies;
•
repurchases of our common stock;
•
capital improvements for new and existing facilities; and
•
our relationships with suppliers and customers.
Transactions with Related Parties
Under our audit committee charter, our audit committee is responsible for reviewing and approving all related party transactions on a quarterly basis. In addition, our board of directors determines annually whether any related party relationships exist among the directors which would interfere with the judgment of individual directors in carrying out his responsibilities as director. We did not have any related party transactions in 2011.
Contractual Obligations
The following summarizes our contractual obligations as of December 31, 2011 (in thousands):
(1) Purchase obligations represent outstanding purchase commitments by us at December 31, 2011, including purchase orders that have cancellation provisions requiring little or no payment. The amounts are included in the table above because management believes that cancellation of these purchase orders is unlikely and expects to make future cash payments according to the contractual terms or in similar amounts for similar materials.
(2) Other long-term liabilities primarily represent liabilities for uncertain tax positions, deferred compensation, future payments associated with the eDiag acquisition, and post-retirement benefits related to our foreign
pension plan. The timing of payments resulting from uncertain tax positions will depend on a number of factors and we are unable to project if and when this might occur, if at all, within the next five years. Accordingly, we cannot make reasonable estimates of the amount and period of potential cash settlements, if any, with taxing authorities. Therefore, we have included $12.4 million of long-term income taxes payable in the column marked “Other”. The timing of payments of deferred compensation in the table above represents the current elections by participants, which are subject to change.
Off Balance Sheet Arrangements
At December 31, 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest, or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships with or enter into transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed herein.
Recently Issued Accounting Standards
See Note 1 to our Consolidated Financial Statements in Part II, Item 8 of this report for a description of recent accounting standards, including our expected dates of adoption and the estimated effects on our results of operations and financial condition.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Risk
We conduct business in several international currencies through our global operations. Our foreign currency hedging program manages fluctuations in the value of the Euro, Japanese Yen, South Korean Won and the Taiwanese Dollar. Our foreign currency risk falls into two primary categories.
First, we are subject to uncertain gross profit margins when we forecast selling products in one currency and the product costs are denominated in a different currency, primarily for the purchases of our products for resale under firm third-party sales commitments. In this instance, we enter into derivative financial instruments; principally forward contracts, which we designate as cash flow hedges in order to mitigate fluctuations in the gross profit margins of these forecasted transactions. We also occasionally enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges when we anticipate purchases of capital assets in a currency other than the functional currency of the entity purchasing the asset.
Forward contracts on forecasted transactions that hedge uncertain gross profit margins generally qualify for cash flow hedge accounting treatment. The effective portion of the gain or loss on the cash flow hedge is reported as a component of accumulated other comprehensive income or loss and is reclassified into earnings when the hedged transaction affects earnings. Once the underlying hedged transaction is recorded, we de-designate the derivative, cease to apply hedge accounting treatment to the transaction and record any further gains or losses to other income (expense). If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective and we would reclassify the ineffective portion of the hedge into other income (expense). We generally have not experienced ineffectiveness of cash flow hedges from cancelled transactions.
The second category of foreign currency risk occurs when transactions are recorded to our consolidated financial statements in a currency other than the applicable entity’s functional currency and the cash settlement of
the transaction occurs at some point in the future. When transactions in non-functional currency are recorded to our consolidated financial statements, any changes in the recorded amounts resulting from fluctuations in the value of that currency will be recorded to other income (expense). In order to mitigate these revaluation gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge transactions that have been recorded to our consolidated financial statements are not designated as hedges, and we record changes in their fair value to other income (expense) in order to attempt to offset gains and losses on the underlying transactions. We considered the historical trends in currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 20% for all currencies could be experienced in the near term. These changes would have resulted in an increase to income before income taxes of approximately $169,000 at December 31, 2011 and a decrease to income before income taxes of approximately $100,000 at December 31, 2010. These amounts are after consideration of the offsetting effect of approximately $12.4 million and $7.3 million at December 31, 2011 and 2010, respectively from forward exchange contracts in place at that time. These reasonably possible adverse changes in foreign currency exchange rates of 20% were applied to net assets and liabilities denominated in currencies other than the functional currencies at the balance sheet dates to compute the adverse effect these changes would have had on our income before income taxes in the near term.
At December 31, 2011, we had outstanding forward contracts to buy $38.0 million in exchange for South Korean Won, $15.0 million in exchange for Taiwanese Dollars, and to sell $69.6 million in exchange for Japanese Yen and $1.4 million in exchange for Euros. These contracts expire on various dates through August 2012. The fair value of all our forward contracts totaled an asset of $371,000 and a liability of $1.91 million at December 31, 2011.
Investment Risk
We maintain an investment portfolio consisting primarily of government and corporate fixed income securities, commercial paper and money market funds. While it is our general intent to hold such securities until maturity, we will occasionally sell certain securities for cash flow purposes. Therefore, our investments are classified as available-for-sale and are carried on the balance sheet at fair value. If interest rates were to increase instantaneously and uniformly by 100 basis points, the fair market value of our investment portfolio as of December 31, 2011 and 2010 would decrease by approximately $1.4 million and $289,000, respectively.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is included in Part IV Items 15(a)(1) and (2) of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
1. Evaluation of Disclosure Controls and Procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2011, have concluded that as of such date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
2. Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over our financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act).
We assessed the effectiveness of our internal control over financial reporting as of December 31, 2011, using the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon this assessment, we have concluded that, as of December 31, 2011, our internal control over financial reporting was effective.
KPMG LLP, an independent registered public accounting firm, audited the effectiveness of our internal control over financial reporting as of December 31, 2011 and their report appears on page of this Annual Report on Form 10-K.
3. Changes in Internal Control Over Financial Reporting. There has been no change in our internal control over financial reporting during the fourth quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
4. Inherent Limitations on the Effectiveness of Internal Control. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal controls may vary over time.
Item 9B.
Item 9B. Other Information
None.
PART III
Certain information required by Part III of this Annual Report on Form 10-K is omitted from this report because we expect to file a definitive proxy statement for our 2012 Annual Meeting of Stockholders (the “Proxy Statement”) within 120 days after the end of our fiscal year pursuant to Regulation 14A promulgated under the Exchange Act, and the information included in the Proxy Statement is incorporated herein by reference to the extent provided below. With the exception of the information specifically incorporated herein by reference from our definitive Proxy Statement into this Annual Report on Form 10-K, our definitive Proxy Statement shall not be deemed to be filed as part of this Annual Report. Without limiting the foregoing, the information contained in the sections entitled “Report of the Audit Committee” and the “Report of the Compensation Committee” in our definitive Proxy Statement is not incorporated by reference into this Annual Report on Form 10-K or deemed “filed” with the SEC.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Directors
The information required by Item 10 of Form 10-K regarding our directors is incorporated herein by reference to the information contained in the section entitled “Proposal 1-Election of Directors” in our definitive Proxy Statement.
Executive Officers
The information required by Item 10 of Form 10-K regarding our executive officers is disclosed in Part I, Item I of this Annual Report under the section entitled “Executive Officers.”
Corporate Governance
The information required by Item 10 of Form 10-K regarding compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the information contained in the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement.
The information required by Item 10 of Form 10-K regarding the members of our Audit Committee and our Audit Committee financial expert is incorporated herein by reference to the information contained in the section entitled “Information Regarding the Board of Directors and its Committees-Audit Committee” in our definitive Proxy Statement.
The information required by Item 10 of Form 10-K regarding the procedures by which stockholders may recommend candidates for director to the Nominating and Corporate Governance Committee is incorporated herein by reference to the information contained in the “Questions and Answers About These Proxy Materials and Voting” section and the section entitled “Information Regarding the Board of Directors and its Committees-Nominating and Corporate Governance Committee” in our definitive Proxy Statement.
Code of Ethics
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or corporate controller, or persons performing similar functions. We have posted the code of ethics on our website which can be accessed at http://www.cymer.com under “Investors.” In addition, we will promptly disclose on our website (1) the nature of any amendment to the code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or corporate controller, or persons performing similar functions and (2) the nature of any waiver, including an implicit waiver, from a provision of the code of ethics that is granted to one of these specified officers, and the name of such person who is granted the waiver on our website in the future.
Item 11.
Item 11. Executive Compensation.
The information required by Item 11 of Form 10-K regarding executive compensation is incorporated herein by reference to the information contained in the sections entitled “Executive Compensation” and “Director Compensation” in our definitive Proxy Statement.
The information required by Item 11 of Form 10-K regarding compensation committee interlocks and insider participation and the report of the Compensation Committee of our Board of Directors is incorporated herein by reference to the information contained in the sections entitled “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in our definitive Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by Item 12 of Form 10-K regarding equity compensation plans under which our common stock may be issued as of December 31, 2011 is incorporated herein by reference to the information contained in the section entitled “Equity Compensation Plan Information” in our definitive Proxy Statement. The information required by Item 12 of Form 10-K regarding security ownership of certain beneficial owners and management is incorporated herein by reference to the information contained in the section entitled “Security Ownership of Certain Beneficial Owners and Management” in our definitive Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by Item 13 of Form 10-K regarding transactions with related persons, promoters and certain control persons, if any, is incorporated herein by reference to the information contained in the section entitled “Certain Relationships and Related Transactions” in our definitive Proxy Statement. The information required by Item 13 of Form 10-K regarding director independence is incorporated herein by reference to the information contained in the section entitled “Information Regarding the Board of Directors and its Committees-Independence of the Board of Directors” in our definitive Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by Item 14 of Form 10-K is incorporated herein by reference to the information contained in the sections entitled “Independent Registered Public Accounting Firm Fees” and “Pre-Approval Policies and Procedures” in our definitive Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) The following documents are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K:
(1)(2) Financial Statements and Financial Statement Schedule. The following Consolidated Financial Statements of Cymer, Inc., Financial Statement Schedule and Reports of Independent Registered Public Accounting Firm are included in a separate section of this Annual Report on Form 10-K beginning on page:
All other financial statement schedules have been omitted because the required information is not applicable or not present in amounts sufficient to require submission of the schedule, or because the information required is included in our consolidated financial statements or the notes thereto.
(3) Exhibits. The exhibits listed under Item 15(b) hereof are filed with, or incorporated by reference into, this Annual Report on Form 10-K. Each management contract or compensatory plan or arrangement is identified separately in item 15(b) hereof.
(b) Exhibits.
The following exhibits are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K:
# Indicates management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert P. Akins, Paul B. Bowman and Karen K. McGinnis, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his or her substitute or substituted, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Cymer, Inc.:
We have audited the accompanying consolidated balance sheets of Cymer, Inc. and subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2011. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule of valuation and qualifying accounts. These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cymer, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related consolidated financial statement schedule of valuation and qualifying accounts, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cymer Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 16, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
San Diego, California
February 16, 2012
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Cymer, Inc.:
We have audited Cymer, Inc.’s (the Company) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Cymer, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting in Item 9A2. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Cymer, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cymer, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the years in the three year period ended December 31, 2011, and the related consolidated financial statement schedule, and our report dated February 16, 2012 expressed an unqualified opinion on those consolidated financial statements and consolidated financial statement schedule.
/s/ KPMG LLP
San Diego, California
February 16, 2012
CYMER, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
See Notes to Consolidated Financial Statements.
CYMER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
See Notes to Consolidated Financial Statements.
CYMER, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
See Notes to Consolidated Financial Statements.
CYMER, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(in thousands)
See Notes to Consolidated Financial Statements.
CYMER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Summary of Significant Accounting Policies
Nature of Operations
Cymer, Inc., together with its wholly-owned subsidiaries, is engaged in the development, manufacturing and marketing of light sources for sale to customers who manufacture photolithography tools in the semiconductor equipment industry. We sell replacement parts and support services directly to our chipmaker customer as well as to our lithography tool manufacturer customers. Our TCZ reporting segment develops, integrates, markets, and supports silicon crystallization tools used in the manufacture of high-resolution low temperature poly-silicon liquid crystal displays (“LTPS - LCD”) and organic light emitting diode (“OLED”) displays.
We manufacture our products primarily at our San Diego headquarters, and we also conduct refurbishment manufacturing activities for replacement parts at our subsidiary located in South Korea. We sell our products to customers primarily in Europe, South Korea, Japan, Taiwan, the United States and other Asian countries. We provide customer support from our San Diego headquarters, and from our field offices located throughout China, South Korea, Japan, the Netherlands, Singapore, Taiwan and the United States.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Cymer, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. References to “Cymer”, “the Company,” “we,” “us,” “our” and other similar words refer to Cymer, Inc. and its consolidated subsidiaries, unless the context suggests otherwise.
All significant intercompany balances and transactions have been eliminated in consolidation. References to “Cymer”, “the Company,” “we,” “us,” “our” and other similar words refer to Cymer, Inc. and its consolidated subsidiaries, unless the context suggests otherwise.
Use of Estimates
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Applying these principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.
Fair Value of Financial Instruments
The fair value of our cash and cash equivalents, restricted cash, accounts receivable, accounts payable, and other current liabilities approximate their carrying amounts due to their short-term nature.
Cash Equivalents
All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.
Restricted Cash
At December 31, 2011, we have $5.9 million in restricted cash associated with a secured bond that we entered into as a result of a foreign tax audit. The secured bond expires in July 2012 and, therefore, the restricted cash is included in current assets.
Investments
We determine the appropriate classification of our investments at the time of acquisition and reevaluate such determination at each balance sheet date. Available-for-sale securities are carried at quoted fair value, with unrealized gains and losses reported in stockholders’ equity as a component of accumulated other comprehensive income (loss). Realized gains and losses are determined using the specific identification method and are included in interest income.
Inventories
Inventories are recorded at the lower of cost, determined on a first-in, first-out basis, or estimated market value. Inventory costs include material, labor and manufacturing overhead costs. Our inventories include reusable parts that we receive from our customers as part of consumed assemblies. We refurbish these returned core assemblies, which consist primarily of metal components, and reuse them in future core assemblies. Refurbishment costs are capitalized as incurred. We review the components of our inventory on a quarterly basis for excess or obsolete inventory and make appropriate adjustments to the value of our inventory in the period that such excess or obsolete inventory is identified.
As part of our regular business activities, we conduct significant parts refurbishment and material reclaim activities related to some of our core assemblies, particularly our chamber assemblies. These activities involve arrangements with our customers where we sell a new part to the customer at a reduced sales price if the customer returns the consumed core assembly that the new part replaces. These returned core assemblies contain a certain amount of material, primarily metal components, that may be reused by us in the manufacture of future core assemblies. Upon receipt of these consumed core assemblies from our customers, we record an entry to recognize the estimated fair value of the reusable components either 1) as revenue if the return of the core assembly relates to a spare part replacement sale or 2) as a reduction in cost of revenues if the return of the core assembly is related to a part being replaced under our warranty provisions or under a service and support contract. The fair value of the reusable parts contained within the consumed assembly is recorded in inventory based upon historical data on the value of the reusable parts that we typically yield from a consumed core assembly and evaluated for recoverability along with our other inventory.
Property, Plant and Equipment
Our property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method over 20 years for buildings; one to five years for equipment; and three to five years for light sources built for internal use. Amortization of leasehold improvements and leased equipment is calculated using the straight-line method over the lease term or the estimated useful life of the assets, whichever period is shorter. Additions and improvements are capitalized, while maintenance and repairs are expensed as incurred. When depreciable assets are retired, or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any related gains or losses are included within operating income in the consolidated statement of operations.
Valuation of Long-Lived Assets
We review the carrying amount and remaining useful life of our long-lived assets, which includes property, plant and equipment and definite-lived intangible assets, for impairment when events or circumstances indicate that the carrying amount may not be recoverable. Other factors that would indicate potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset, a significant change in the long-lived asset’s physical condition, and operating or cash flow losses associated with the use of the long-lived asset. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to the future net cash flows, undiscounted and without interest, expected to be generated by the asset. An impairment loss would be recognized when the carrying amount of a long-lived asset or asset group
is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset or asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. Based on our assessment of potential impairments during 2011, 2010 and 2009, there were no indicators identified that would warrant an impairment of our long-lived assets.
Goodwill and Intangible Assets
Goodwill is not amortized but instead is tested annually for impairment at the reporting unit level, or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. We perform our impairment test annually during the fourth quarter. In September 2011, the FASB issued revised guidance to simplify how entities test goodwill for impairment. Under the revised guidance, entities have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Accounting Standards Codification Topic 350. If, after assessing qualitative factors, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If deemed necessary, a two-step test is used to identify the potential impairment and to measure the amount of goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, there is an indication that goodwill maybe impaired and the amount of the loss, if any, is measured by performing step two. Under step two, the impairment loss, if any, is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill.
Intangible assets that are determined to have definite lives are amortized utilizing a straight-line basis over their estimated useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. Our intangible assets consist of patents and developed technology, which are amortized using the straight-line basis over their expected useful lives.
Foreign Currency Translation
The financial statements of our foreign subsidiaries where the functional currency is the local currency are translated into U.S. Dollars using current rates of exchange for assets and liabilities and rates of exchange that approximate the rates in effect at the transaction date for revenues, cost of revenues, expenses, gains and losses. Gains and losses resulting from foreign currency translation are accumulated as a separate component of our consolidated statement of equity in accumulated other comprehensive income (loss). Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations.
Derivative Instruments
We conduct business in several international currencies through our global operations. We maintain a foreign exchange risk management policy with the goal of protecting product margins and minimizing the short term volatility of reported earnings due to foreign currency risk exposure. In accordance with our policy, we use financial instruments, principally forward contracts, to manage certain of our foreign currency risk exposures. Forward contracts acquired to protect the product margins of forecasted transactions, primarily the purchases of our products for resale under firm third-party sales commitments are accounted for in accordance with the provisions of the authoritative guidance for derivatives and hedging. We also enter into forward contracts to offset gains and losses on assets and liabilities held in non-functional currencies, primarily the intercompany U.S. Dollar denominated liabilities of our foreign subsidiaries and do not designate these forward contracts as hedges pursuant to the authoritative guidance for derivatives and hedging. We record all forward contracts at fair value based on the quoted exchange rates for such instruments. We do not enter into forward contracts for speculative purposes. For further discussion, see Note 8, “Derivative Instruments and Hedging Activities”.
Guarantees and Warranties
In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of the authoritative guidance for guarantees, with the exception of standard warranty provisions associated with product sales and indemnification provisions related to intellectual property that are contained within many of our lithography tool manufacturer agreements. See Note 14, “Commitments and Contingencies” for further information regarding our guarantees and warranties.
Revenue Recognition
Our revenues include light sources, silicon crystallization tools, and installed base products, which consist of OnPulse contracts, service support and replacement parts, and to a lesser extent, service, upgrades, and refurbishments of our light sources.
We recognize revenue when title and risk of loss have passed, evidence of an arrangement has been obtained, pricing is fixed or determinable at the date of sale, and collectability is reasonably assured. Our sales arrangements do not include general rights of return or cancellation privileges.
Light Sources and Silicon Crystallization Tools
We recognize revenue for light sources and silicon crystallization tools at one of following three points, depending on the terms of our arrangement with our customer: 1) shipment of the system, 2) delivery of the system, or 3) receipt of an acceptance certificate from the customer. For the majority of our DUV light source sales, the shipping terms are F.O.B. shipping point, and revenue is recognized upon shipment. Our current sales arrangements for EUV sources and TCZ silicon crystallization tools contain acceptance criteria, and revenue is recognized upon system acceptance by the customer.
Certain of our revenue arrangements include additional elements, such as future product upgrades or services. In accordance with the authoritative guidance for revenue recognition arrangements with multiple deliverables, we allocate the total consideration in the arrangement to the multiple elements using the relative selling price of the delivered and undelivered items, based on vendor specific objective evidence or estimated selling price.
If vendor specific objective evidence is not available, as third party evidence is generally not available to us due to the proprietary nature of our products, the estimated selling price is determined considering market conditions and estimated gross margins, as well as factors that are specific to us. Delivery of the additional elements generally occurs within one to three years.
Installed Base Products-OnPulse Contracts, Support Services, and Replacement Parts
Revenue associated with our OnPulse contracts, which include primarily replacement parts and to a much lesser extent services, is recognized monthly based on the number of pulses utilized by our customers on their light sources that are covered under their OnPulse arrangement. Revenue from support services, including our data services, is recognized as the services are rendered. To date, the revenue associated with the service element of our OnPulse contracts when combined with revenue generated from our support services has been less than 10% of our total revenue.
For our replacement part sales, the shipping terms are F.O.B. shipping point, and revenue is recognized upon shipment. For a significant portion of our replacement parts revenue, our customers return the consumed assembly to us as part of the sale of the new part. We reuse some of the material within these core assemblies, mainly metal components, for the future build of core assemblies. As a result, our revenue consists of both cash and the fair value of the reusable parts received from our customers as consideration for these replacement part
sales. Revenue associated with our customers’ return of core assemblies is recognized upon receipt of the returned core assembly. The amount of the revenue is determined based upon the fair value of the reusable parts that we expect to yield from the returned core assembly based on historical experience. If the return of the core assembly is related to a part being replaced under our warranty provisions or under a service or support contract with our customer, we will recognize the estimated fair value of the reusable component as a reduction to cost of revenue.
On a limited basis, we sell upgrades for our light sources or refurbish light sources owned by our customers to their original or new condition. Revenue from upgrades is recognized when the upgrade has been successfully installed by us and accepted by the customer. Revenue from refurbished light sources is recognized when the refurbishment process has been completed and, depending upon the customer, the proper delivery or acceptance terms have been met.
We report revenue net of any sales-based taxes assessed by governmental authorities that are imposed on or concurrent with sales transactions.
Deferred Revenue
Deferred revenue represents payments received from our customers in advance of the delivery of products and/or services or before the satisfaction of all revenue recognition requirements, as described above. Costs directly attributable to the deferred revenue are also deferred until the related revenue is recognized if the arrangement is profitable.
Shipping and Handling Costs
Costs incurred for shipping and handling are included in cost of revenues at the time the related revenue is recognized. Amounts billed to a customer, if any, for shipping and handling are reported as revenue.
Research and Development Costs
We expense research and development costs in the period they are incurred.
Advertising Expenses
Advertising costs are expensed as incurred. Advertising expenses amounted to approximately $559,000, $572,000 and $649,000, for 2011, 2010, and 2009, respectively.
Stock-Based Compensation
We grant stock options and stock units from our 2011 Equity Incentive Plan, which provides for the issuance of incentive stock options, non-statutory stock options, stock appreciation rights, stock bonus awards, stock purchase awards, stock unit awards, performance-based stock unit awards, and other stock awards to our employees, non-employee directors and consultants.
Under the fair value recognition provisions of the authoritative guidance for stock-based compensation awards, we measure the fair value of stock-based awards at the grant date and the fair value is recognized as expense over the requisite service period. The fair value of stock options is determined by a Black-Scholes option pricing model. We value stock unit awards based on the fair value of our common stock on the date that the stock unit award is granted. Stock-based compensation expense related to stock options and stock unit awards with only service conditions is recognized straight line over the requisite service period for the entire award. Stock-based compensation expense related to stock unit awards with performance-based conditions is recognized on a straight-line basis over the service period for each separately vesting portion of the award as if the award was, in substance, multiple awards (i.e., a graded vesting basis). Additionally, we adjust the compensation expense over
the service period based upon the expected achievement of the performance conditions. An estimated forfeiture rate is applied and included in the calculation of stock-based compensation expense at the time that the stock option or stock unit awards are granted and revised, if necessary, in subsequent periods, if actual forfeiture rates differ from those estimates.
Income Taxes
We utilize the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. We assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent management believes that recovery is more likely than not, we do not establish a valuation allowance. The calculation of our tax provision is dependent upon the geographic composition of our world-wide earnings, tax regulations governing each region and the availability of tax credits.
Our income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While we believe we have appropriate support for the positions taken on our tax returns, we regularly assess the potential outcomes of examinations by tax authorities in determining the adequacy of our provision for income taxes, and adjust the income tax provision, income taxes payable and deferred taxes in the period in which the facts that give rise to a revision become known.
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. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. We recognize interest and penalties related to uncertain tax positions in our income tax expense.
We recognize excess tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. An excess tax benefit occurs when the actual tax benefit realized by us upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, originally recorded for such award. When assessing whether a tax benefit relating to share-based compensation has been realized, we follow the tax law ordering method, under which current year share-based compensation deductions are assumed to be utilized before net operating loss carryforwards and other tax attributes.
We use the “short-cut” method for calculating the tax effects of share-based compensation. The “short-cut” method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of share-based compensation, and to determine the subsequent impact on the APIC pool.
In accordance with the authoritative guidance for stock compensation, we have presented excess tax benefits for the exercise of stock options as a financing activity in the consolidated statement of cash flows.
Earnings Per Share (“EPS”)
Basic EPS is calculated by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is calculated on the basis of the weighted-average number of shares of common stock including the effect of the potential dilution that could occur if securities to issue common stock were exercised or converted into common stock. Potential dilutive securities include outstanding stock options, restricted stock units (“RSUs”), performance restricted stock units (“PRSUs”), and stock issued pursuant to our Employee Stock Purchase Plan (“ESPP”).
The following table sets forth the basic and diluted EPS for the years ended December 31, 2011, 2010 and 2009 (in thousands, except per share information):
Accumulated Other Comprehensive Loss
Comprehensive income (loss) includes net income, foreign currency translation adjustments, net unrealized gains and losses on available-for-sale securities, net unrealized gains and losses on effective foreign currency forward exchange contracts, and net unrealized pension gains and losses. See the consolidated statements of comprehensive income for the effect of the components of comprehensive income (loss) to our net income.
The components of accumulated other comprehensive loss are as follows (in thousands):
Concentrations of Risk and Related Uncertainties
Credit Risk. Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of cash and cash equivalents, accounts receivable, investments, and foreign exchange contracts receivable.
Cash and cash equivalents. We invest our excess cash in an effort to preserve capital, provide liquidity, maintain diversification and generate returns relative to our corporate investment policy and prevailing market conditions. We have not experienced any material losses in our cash and cash equivalents. The cash balances in financial institutions and cash equivalent securities that we hold are in excess of federally insured limits. We perform periodic evaluations of the relative credit standing of the financial institutions and securities and limit the risk by selecting financial institutions and securities with a strong relative credit rating. Cash equivalents as of December 31, 2011 and 2010 were $39.7 million and $85.1 million, respectively. We have established investment credit policies that focus on the credit quality of obligors, limit credit concentrations, encourage diversification and require periodic creditworthiness reviews.
Accounts receivable. We maintain an allowance for doubtful accounts for estimated losses on accounts receivable based on evaluation of the aging of receivables, payment histories of our customers, financial condition of our customers, and the overall economic environment. We write off individual accounts against the allowance when we become aware of our customer’s inability to meet its financial obligation to us.
Our customer base is disbursed among many geographic regions and is comprised largely of multinational companies. For geographic customer concentrations, see Note 16, “Segment and Geographic Information”. In 2011, 2010 and 2009, revenue from three customers accounted for 56%, 55% and 46% of our total revenue, respectively. In 2011 and 2010, these customers comprised 42% and 51% of total receivables at December 31, 2011 and 2010, respectively. We expect that sales to these customers will continue to account for a substantial portion of our revenue. None of our customers are obligated to purchase a minimum number of our products in the aggregate or during any particular period. We can provide no assurance that any of our customers will continue to purchase our products at past or current levels. The loss of business from any of these customers would have a material adverse effect on our operating results, financial condition, and cash flows.
Investments. Investment activity, including review of our investment policy and defining acceptable risk levels, is subject to periodic review and approval by senior management. We invest primarily in debt securities which are rated investment grade and have established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by consideration of external determinants, typically ratings assigned by nationally recognized ratings agencies, and are supplemented by an internal credit evaluation. Obligor, asset sector and industry concentrations are subject to established limits and are monitored on a periodic basis.
Foreign exchange contracts receivable. We enter into foreign exchange forward contracts with major financial institutions in order to manage our risk of transacting business in several foreign currencies. Obligations under these forward contracts are unsecured, so we have established counterparty limits and we review the creditworthiness of these financial institutions on a periodic basis. In addition, we have entered into ISDA master agreements that contain netting provisions in the event that one party defaults on its obligations to the other.
Supplier Risk. We purchase a limited number of components and subassemblies included in our light sources, installed base products and silicon crystallization tools from a single supplier or a small group of suppliers. Whenever possible, we work with secondary suppliers to qualify additional sources of supply. To reduce the risk associated with limited-source suppliers, we have supply agreements in place and carry strategic inventory of these components. Strategic inventories are managed as a percentage of future demand. We also have vendor-managed inventory of critical components to further reduce the risk of a single supplier. In addition, we contract for the manufacture of various subassemblies of our products and depend on our contract manufacturers to deliver to our required specifications, schedule and quality standards. Further, some of our suppliers have specialized in supplying equipment or manufacturing services to semiconductor equipment manufacturers and, therefore, are susceptible to industry fluctuations and are subject to the same risks and uncertainties regarding their ability to respond to changing market and global conditions. To date we have been able to obtain adequate components and subassemblies for our light sources, installed base products and silicon crystallization tools in a timely manner from existing suppliers.
Recently Adopted Accounting Standards
In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance to require additional disclosures for fair value measurements including the following: (1) amounts transferred in and out of Level 1 and 2 fair value measurements, which is effective for interim and annual reporting periods beginning after December 15, 2009 (“Part I”), and (2) activities in Level 3 fair value measurements including purchases, sales, issuances, and settlements, which is effective for interim and annual reporting periods beginning after December 15, 2010 (“Part II”). We adopted Part I of the revised guidance for fair value measurements disclosures on January 1, 2010, which did not have a material effect on our consolidated financial statements. We adopted Part II of the revised guidance for fair value measurement disclosures on January 1, 2011, which did not have a material effect on our consolidated financial statements.
Recently Issued Accounting Standards
In December 2011, the FASB issued amended standards to increase the prominence of offsetting assets and liabilities reported in financial statements. These amendments require an entity to disclose information about offsetting and the related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. These amendments will enhance disclosures by requiring improved information about financial instruments and derivative instruments that are either offset or subject to an enforceable master netting arrangement or similar agreement. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. These revised standards are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. These amended standards will require additional footnote disclosures for these enhancements but will not affect our financial position or results of operations.
In June 2011, the FASB issued amended standards to increase the prominence of items reported in other comprehensive income. These amendments eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and require that all changes in stockholders’ equity-except investments by, and distributions to, owners-be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In addition, these amendments require that we present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. In December 2011, the FASB issued additional guidance that defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income. The deferral is temporary until the FASB reconsiders the operational concerns and needs of financial statement users. These new standards are effective for interim and annual periods beginning after December 15, 2011, and are to be applied retrospectively. These amended standards will affect the presentation of other comprehensive income but will not affect our financial position or results of operations.
2. Acquisition
On April 1, 2011, we acquired all of the outstanding equity of eDiag, a privately held company based in Seoul, Korea. eDiag complemented our OnPulse product by providing a portfolio of software solutions for lithography source performance data mining and analytics. Combining our current fault monitoring, predictive techniques and worldwide service infrastructure with eDiag’s data analysis capabilities, we have developed data services, OnPulse Plus and Smart Pulse, which provide customers with information to assist them in driving increased operational efficiency and improved availability of their light sources.
We acquired eDiag for consideration totaling $15.0 million payable in cash, with $6.0 million paid on April 1, 2011 and $3.0 million payable on each of April 1, 2012, 2013 and 2014. There was no debt assumed
with the acquisition. Additionally, we entered into a services agreement with the president and previous majority stockholder of eDiag that pays him $2.5 million on April 1, 2015 and $2.5 million on April 1, 2016, if he continues his employment with us through those dates. The payments under the services agreement will be recorded as bonus expense over the respective service periods.
The following table summarizes the purchase price and the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):
Under the acquisition method of accounting, the purchase price as shown in the table above is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The excess purchase price over fair value of net assets acquired was recorded as goodwill. The estimated values of current assets and liabilities were based upon their historical costs on the date of acquisition due to their short-term nature. The estimated values of property and equipment were based on their depreciated historical costs on the date of acquisition, which approximated fair value.
We recorded the fair value of identifiable intangible assets, consisting of developed technology, in the amounts of $3.7 million using an income valuation approach. The income valuation approach is based on Level 3 inputs in the fair value hierarchy. This valuation technique provides an estimate of the fair value of an asset based on the cash flows that the asset can be expected to generate over its remaining useful life. The developed technology is being amortized using the straight-line method over its estimated economic life of 5.0 years. Amortization expense, recognized in cost of sales, for the period from the acquisition date through December 31, 2011 was $554,000 and is estimated to be approximately $738,000 per year through March 31, 2016.
Goodwill of $8.5 million, none of which is deductible for tax purposes, represents the excess of the purchase price over the estimated fair value assigned to tangible and identifiable intangible assets acquired and liabilities assumed from eDiag. The carrying amount of goodwill is allocated to our Cymer operating segment.
We have consolidated the results of operations for eDiag since its acquisition on April 1, 2011. Our historical results would not have been materially affected by the acquisition of eDiag and, accordingly, we have not presented pro forma information.
3. Fair Value Measurements
We account for our financial assets and liabilities that are being measured and reported on at fair value on a recurring basis per the provisions of the authoritative guidance for fair value measurements. This includes certain items we report in cash equivalents and available-for-sale securities within our cash and cash equivalents, and short and long term investments on the accompanying consolidated balance sheets. In addition, our derivatives, which consist of foreign currency forward exchange contracts, are reported at fair value and are included in the scope of the authoritative guidance for fair value measurements and disclosures.
The authoritative guidance for fair value measurements stipulates that fair value is defined as the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, willing parties. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques include unobservable inputs and involve some level of estimation and judgment on the part of the reporting entity, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.
Per the authoritative guidance for fair value instruments, assets and liabilities recorded at fair value in our consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The levels as defined by the fair value hierarchy in the authoritative guidance for fair value instruments are as follows:
Level 1-
Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2-
Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly at the measurement date.
Level 3-
Inputs are unobservable for the asset or liability and usually reflect the reporting entity’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
Financial Assets and Liabilities Measured on a Recurring Basis
The majority of our available-for-sale securities and our foreign currency forward exchange contracts are priced via independent providers. In obtaining such valuation information from third parties, we have evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in our principal markets.
Available-for-Sale Securities
The fair values of our available-for-sale securities are determined by a matrix pricing, which is a mathematical technique widely used to value securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark-quoted securities. Such assets are classified as Level 2 inputs in the fair value hierarchy and typically include commercial paper and government and corporate fixed income securities which are included in our investment portfolio.
Preferred Stock
We hold preferred stock that was distributed to us when an auction rate security was dissolved in April 2009. We recorded impairment charges in 2009 totaling $291,000 associated with this security. On August 4, 2010, the issuer filed Chapter 11 bankruptcy protection, and we believe it is unlikely we will receive any future cash flow from this preferred stock. The preferred stock was valued at zero at December 31, 2011 and 2010, respectively.
Derivative Instruments
Our foreign currency forward exchange contracts are valued using an income approach which includes observable Level 2 market inputs at the measurement date and uses a standard valuation technique to convert future foreign currency amounts to a single discounted present amount assuming participants are motivated, but not compelled, to transact. Level 2 inputs are limited to quoted prices for similar assets or liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. Key inputs in this discounted calculation include spot currency exchange rates at the measurement date, interest rates, and credit default swap rates at standard quoted intervals. Credit default swaps on us are not available, so we estimated our credit risk premium based on a financing arrangement that was offered to us during the three months ended
December 31, 2011 by a third party. The principal market in which we execute our foreign currency forward exchange contracts is the retail market. Mid-market pricing is used as a practical expedient for fair value measurements. Since significant inputs in the valuation of our foreign currency forward exchange contracts are observable in the active market, they are classified as Level 2 in the fair value hierarchy. For further discussion, see Note 8, “Derivative Instruments and Hedging Activities.”
Financial assets and liabilities (excluding cash balances) measured at fair value on a recurring basis are summarized below (in thousands):
(1) We did not have any transfers in or out of Level 1 or Level 2.
(2) Included in other current assets on the accompanying consolidated balance sheets.
(3) Included in other current liabilities on the accompanying consolidated balance sheets.
Non-Financial Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
We apply fair value techniques on a non-recurring basis associated with: (1) valuing potential impairment losses related to goodwill, which are accounted for pursuant to the authoritative guidance for intangibles-goodwill and other; and (2) valuing potential impairment losses related to long-lived assets, which are accounted for pursuant to the authoritative guidance for property, plant and equipment.
We develop, manufacture and market our products within two reportable business segments, Cymer and TCZ. Cymer’s primary business is to design, manufacture and sell light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools used in the manufacture of high-resolution LTPS-LCD and OLED displays. We test for goodwill impairment at the reporting unit level. All of our goodwill is associated with our primary business unit, and we determine the fair value of this reporting unit, when required, based on a combination of inputs including our market capitalization, as well as Level 3 inputs such as discounted cash flows which are not observable from the market, directly or indirectly. We conduct our goodwill impairment analysis annually in the fourth quarter of each year, or upon the occurrence of certain triggering events. No such triggering events occurred during the year ended December 31, 2011. Historically, the fair value of our primary business reporting unit has significantly exceeded its carrying value.
We test for the impairment of our long-lived assets when triggering events occur and such impairment, if any, is measured at fair value. The inputs for fair value of our long-lived assets would be based on Level 3 inputs as data used for such fair value calculations would be based on discounted cash flows which are not observable from the market, directly or indirectly. During the year ended December 31, 2011, there have been no triggering events associated with our long-lived assets; therefore, no impairment analysis was conducted during the period.
4. Cash, Cash Equivalents and Investments
Cash, cash equivalents and investments at December 31, 2011 consist of the following (in thousands):
Cash, cash equivalents and investments at December 31, 2010 consist of the following (in thousands):
The contractual maturities of our cash equivalents and investments at December 31, 2011 were as follows (in thousands):
We did not have any investments in individual securities that have been in a continuous unrealized loss position deemed to be temporary for more than 12 months at December 31, 2011.
5. Accounts Receivable
Accounts receivable consist of the following (in thousands):
6. Inventories
Inventories consist of the following (in thousands):
7. Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
Depreciation expense totaled $17.6 million, $18.1 million, and $19.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.
8. Derivative Instruments and Hedging Activities
We conduct business in several currencies through our global operations with certain transactions denominated in local currencies, such as the Euro, Japanese Yen, South Korean Won and Taiwanese Dollars. We use derivative financial instruments, such as forward exchange contracts, to hedge certain forecasted foreign denominated transactions expected to occur over the next twelve months. The purpose of our derivative financial instruments is to mitigate the effect of the exchange rate fluctuations on certain foreign currency denominated revenue, costs and cash flows. We do not enter into derivative instruments for speculative purposes.
Our foreign currency risk falls into two primary categories. First, our gross profit margins are subject to change when we sell our products in one currency and the product costs are denominated in a different currency. To mitigate this risk, we enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges to mitigate fluctuations in the gross profit margins of these forecasted transactions. We also occasionally enter into derivative financial instruments, principally forward contracts, which we designate as cash flow hedges when we anticipate purchasing a capital asset in a currency other than the functional currency of the entity purchasing the asset. Designated hedging instruments qualify for cash flow hedge accounting treatment if certain criteria are met. For example, at the inception of the hedge, we must have formal documentation of the hedging relationship and our management objective and strategy for undertaking the
hedge, including identification of the hedging instrument, the hedged transaction, the nature of the risk being hedged, and how the hedging instrument’s effectiveness will be assessed. The hedging relationship must be highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge. Interest charges or “forward points” on our forward contracts are excluded from the assessment of hedge effectiveness and are recorded in the consolidated statements of operations.
The effective portion of the gain or loss on the cash flow hedge is reported as a component of accumulated other income or loss and is reclassified into earnings when the hedged transaction affects earnings. Once the underlying hedged transaction is recorded, we de-designate the derivative, cease to apply hedge accounting treatment to the transaction and record any further gains or losses to other income (expense). The cash flows resulting from forward exchange contracts are classified in the consolidated statements of cash flows as part of cash flows from operating activities. If all or a portion of the forecasted transaction were cancelled, this would render all or a portion of the cash flow hedge ineffective, and we would reclassify the ineffective portion of the hedge into other income (expense). We generally do not experience ineffectiveness of our cash flow hedges as a result of cancelled transactions and the accompanying consolidated statements of operations do not include such gains or losses. We adjust the level and use of derivatives as soon as practicable after learning that an exposure has changed. We review all exposures on derivative positions on a regular basis.
The second category of foreign currency risk occurs when transactions are recorded in our consolidated financial statements in a currency other than the applicable subsidiary’s functional currency and the cash settlement of the transaction occurs at some point in the future. When transactions in non-functional currencies are recorded in our consolidated financial statements, changes in the recorded amounts resulting from fluctuations in the value of that currency are recorded to other income (expense). In order to mitigate these remeasurement gains and losses, we enter into derivative financial instruments, principally forward contracts. The forward contracts that hedge these transactions that have been recorded to our consolidated financial statements are not designated as hedges and, therefore, we record changes in their fair value to other income (expense).
The U.S. dollar equivalent of all outstanding notional amounts of forward contracts was as follows (in thousands):
The fair value of all of our forward contracts totaled to a liability of $1.5 million and $1.1 million at December 31, 2011 and 2010, respectively.
The derivative instruments that we enter into are subject to master netting arrangements and qualify for net presentation on the balance sheet. The gross fair value of derivative instruments in our consolidated balance sheets was as follows (in thousands):
The effect of derivative instruments on our consolidated statements of operations and other comprehensive income (loss) (“OCI”) was as follows (in thousands):
(1) The amount represents the gain (loss) recognized in income on the amount of the hedging relationship excluded from effectiveness testing. There was no gain (loss) recognized in income related to an ineffective portion of the hedging relationship.
We are exposed to credit losses in the event of nonperformance by the banks with which we transact foreign currency hedges. We manage this credit risk by transacting foreign currency hedging with more than one institution, only executing hedges with counterparties that meet our minimum requirements, monitoring the credit ratings of our counterparties on a periodic basis and negotiating contractual master netting provisions that allow us to record and offset liabilities to a counterparty against amounts due from that counterparty in an event of default. We do not receive collateral from our hedging counterparties. As of December 31, 2011, we have a total credit exposure of $371,000 from nonperformance of foreign exchange hedging counterparties.
9. Goodwill and Intangible Assets
Goodwill
The following table provides the changes in the carrying amount of goodwill during the year ended December 31, 2011 (in thousands):
There were no changes in our goodwill balance during the years ended December 31, 2010 or 2009.
Intangible Assets
Intangible assets consist of the following (dollars in thousands):
(1) The decrease in the gross balance of patents at December 31, 2011 is due to our write off of fully-amortized patents of $10.3 million, which reduced both the gross patent and accumulated amortization balances by the same amount.
(2) The developed technology was recorded in connection with the acquisition of eDiag (see Note 2).
Intangible assets that are determined to have definite lives are amortized on a straight-line basis over their estimated useful lives, and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. The expected useful life of our patents can vary depending on the nature of the technology and their remaining useful life. Amortization expense associated with our intangible assets was $1.3 million, $682,000 and $1.6 million for the years ended December 31, 2011, 2010, and 2009, respectively.
Amortization expense related to intangible assets at December 31, 2011 for the next five years and thereafter is expected to be as follows (in thousands):
10. Other Balance Sheet Details
Details of other assets and liabilities consist of the following (in thousands):
11. Equity
Stock Award Plans
We have the following equity incentive plans or incentive programs that include equity based awards:
2011 Equity Incentive Plan (the “Incentive Plan”)
In May 2011, at our annual meeting of stockholders, our stockholders approved the Incentive Plan, which replaced our 2005 Equity Incentive Plan (the “2005 Plan”). The Incentive Plan provides for the issuance of incentive stock options, non-statutory stock options, stock purchase awards, stock bonus awards, stock appreciation rights, stock unit awards, performance stock awards, performance cash awards and other stock awards to our employees, non-employee directors and consultants. Stock options granted under the Incentive Plan have an exercise price at least equal to the fair market value of our common stock on the dates of grant, expire no more than ten years from the date of grant, and generally vest ratably over a four-year period following the date of grant. Restricted stock unit awards granted generally vest one to three years from the date of grant. We also grant performance-based restricted stock unit awards to our executive officers and certain key management. The number of shares granted is subject to increase or decrease based on actual performance against performance measures approved by the Compensation Committee of our Board of Directors.
Following the date approved by our stockholders, any shares available for issuance under our 2005 Plan became available for issuance under the Incentive Plan, and any outstanding stock awards that terminate or expire under the 2005 Plan that would have reverted to the share reserve of the 2005 Plan will become available for issuance under the Incentive Plan. The number of shares available for grant under the Incentive Plan was 2,007,850 at December 31, 2011. Awards and options to purchase 229,244 shares were outstanding under this plan as of December 31, 2011.
2005 Plan
The 2005 Plan provided for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, stock bonus awards, stock purchase awards, stock unit awards, performance-based stock unit awards, and other stock awards to our employees, non-employee directors and consultants. Stock options granted under the 2005 Plan had an exercise price at least equal to the fair market value of our common stock on the dates of grant, expire no more than ten years from the date of grant, and generally vest ratably over a four-year period following the date of grant. Restricted stock unit awards granted generally vest one to three years from the date of grant. We also granted performance-based restricted stock unit awards to our executive officers and certain key management. The 2005 Plan was terminated in May 2011 with the stockholders’ approval of the Incentive Plan. Awards and options to purchase 1,774,245 shares were outstanding under this plan as of December 31, 2011.
2000 Equity Incentive Plan (the “2000 Plan”)
The 2000 Plan provided for the grant of options to our employees or consultants who were neither directors nor officers. The exercise prices of the options granted under the 2000 Plan were equal to the fair market value of our common stock on the dates of grant. Options issued under the 2000 Plan expire ten years after the options were granted and generally vest ratably over a four-year period following the date of grant. The 2000 Plan was terminated in May 2005 with the stockholders’ approval of the 2005 Plan. Options to purchase 182,683 shares were outstanding under this plan as of December 31, 2011.
1996 Stock Option Plan (the “1996 Plan”)
The 1996 Plan provided for the grant of incentive stock options to our employees and nonqualified stock options to our employees, directors and consultants. The exercise prices of options granted under the 1996 Plan were at least equal to the fair market value of our common stock on the dates of grant. Options issued under the 1996 Plan expire five to ten years after the options were granted and generally vest ratably over a four-year period following the date of grant. The 1996 Plan was terminated in May 2005 with the stockholders’ approval of the 2005 Plan. Options to purchase 213,738 shares were outstanding under this plan as of December 31, 2011.
Stock Options, Restricted Stock Unit Awards and Performance-Based Restricted Stock Unit Awards
A summary of the stock award activity under our equity incentive plans is as follows:
(1) The number of shares subject to PRSUs granted represents the aggregate target awards for such PRSUs. The number of shares ultimately issued will be determined based on our performance related to market share, revenue, and net income targets. The shares, if any, will be issued following the end of the applicable performance period.
The weighted-average grant-date fair value of options granted during the years ended December 31, 2011, 2010 and 2009 was $14.84, $9.84, and $8.11 per share, respectively. The total intrinsic value of options exercised during the years ended December 31, 2011, 2010, and 2009 was $7.5 million, $3.1 million, and $1.6 million, respectively.
The total cash received from employees as a result of employee stock option exercises for the years ended December 31, 2011, 2010, and 2009 was $15.5 million, $8.8 million, and $6.2 million, respectively. In connection with these exercises, the excess tax benefit recognized by us for the years ended December 31, 2011, 2010, and 2009 was $4.0 million, $2.1 million, and $267,000, respectively. We settle employee stock option exercises and RSU and PRSU releases with newly issued shares of our common stock.
Stock-Based Compensation Expense
Stock-based compensation expense consists of the following (in thousands):
As of December 31, 2011, the unamortized compensation expense related to outstanding unvested options, RSUs and PRSUs was $1.1 million, $18.3 million, and $4.6 million, respectively, and is expected to be recognized over a weighted-average period of 2.89, and 1.95 and 1.13 years, respectively.
We measure the fair value of stock options on the date of grant, as determined by the Black-Scholes option pricing model. We utilize a blended volatility, a combination of historical and implied volatility, in this valuation model. Historical volatility is based on a period commensurate with the expected term of the options. Implied volatility is derived based on a six-month period of traded options of our common stock. The expected term of our stock options represents the period of time options are expected to be outstanding and is based on observed historical exercise patterns for us, which we believe are indicative of future exercise behavior. For the risk free interest rate, we use the then currently available rate on zero coupon U.S. government issues with a remaining period commensurate with the expected term for valuing options. We have never declared or paid cash dividends on our common stock, and currently do not anticipate paying cash dividends in the future.
The following weighted average assumptions were used for valuing our stock options granted:
We value stock unit awards based on the fair value of our common stock on the date that the stock unit award is granted. Stock-based compensation expense related to stock options and stock unit awards with only service conditions is recognized straight line over the requisite service period for the entire award. Stock-based compensation expense related to stock unit awards with performance-based conditions is recognized on a straight-line basis over the service period for each separately vesting portion of the award as if the award was, in substance, multiple awards (i.e., a graded vesting basis). Additionally, we adjust the compensation expense over the service period based upon the expected achievement of the performance conditions. An estimated forfeiture rate is applied and included in the calculation of stock-based compensation expense at the time that the stock option or stock unit awards are granted and revised if necessary in subsequent periods, if actual forfeiture rates differ from those estimates.
Employee Stock Purchase Plan
Under the ESPP, eligible employees may purchase shares of our common stock through payroll deductions of up to 15% of his or her compensation, at a price per share equal to 95% of the fair market value of our common stock at the end of the purchase period.
The number of shares issuable under the ESPP as of December 31, 2011 was 243,060. Because our ESPP is a non-compensatory plan as defined by the authoritative guidance for stock compensation, no stock-based compensation expense is recorded for our ESPP. The total cash received from employees as a result of ESPP shares issued during the year ended December 31, 2011, 2010, and 2009 was $792,000, $632,000, and $622,000, respectively.
Stock Repurchase Programs
In April 2008, our board authorized us to repurchase up to $100 million of our common stock. The program does not have a fixed expiration date and may be discontinued at any time. During the years ended December 31, 2011 and 2009, no shares were repurchased and during the year ended December 31, 2010, we repurchased 560,000 shares for $19.3 million under this program. As of December 31, 2011, $57.8 million remain available under this program for repurchases.
12. Income Taxes
The components of income before income tax expense and income tax expense are summarized as follows (in thousands):
The following schedule reconciles the difference between the U.S. federal income tax expense at the statutory rate (35%) to our income tax expense (dollars in thousands):
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our net deferred tax assets and liabilities are as follows (in thousands):
The valuation allowance is based on our assessment that it is more likely than not that certain deferred tax assets will not be realized in the foreseeable future. The valuation allowance as of December 31, 2011 includes allowances related to TCZ’s net operating loss carryforwards of $2.7 million and allowances related to capital loss carryforwards of $2.1 million. We have a deferred tax asset of $3.0 million related to TCZ’s net operating losses of $21.0 million that are available to us as a result of a retroactive revocation in 2010 of TCZ’s tax holiday in Singapore. These net operating loss carryforwards do not expire; however, we have a valuation allowance of $2.7 million against the deferred tax asset as we believe it is more likely than not that only the net deferred tax asset of $324,000 will be realized. We also have a deferred tax asset of $2.1 million related to a $5.6 million capital loss generated in 2009. We have a full valuation allowance against this deferred tax asset as we believe it is more than likely that we will not generate sufficient capital gains to utilize the capital loss carryforward after consideration of our tax planning strategies. The $214,000 decrease in the valuation allowance from December 31, 2010 was due to partial utilization of the TCZ net operating loss carryforward, noted above. As of December 31, 2011, we had California state research and development credit carryforwards of $26.8 million, which will carry forward indefinitely. With regard to our net deferred tax assets, we believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the benefit; therefore, no valuation allowance has been provided for these assets.
The following is a reconciliation of the amount of gross unrecognized tax benefits (in thousands):
Included in the balance of unrecognized tax benefits at December 31, 2011 is $11.3 million of net tax benefits that, if recognized, would affect our effective tax rate. We recognize interest and penalties related to uncertain tax positions in our income tax expense. As of December 31, 2011 and 2010, respectively, we had approximately $2.2 million and $2.5 million of accrued interest and penalties related to uncertain tax positions. During the years ended December 31, 2011, 2010, and 2009, we recorded interest and penalties, of $231,000 $250,000 and $185,700, respectively.
We are subject to taxation in the United States and in various states and foreign jurisdictions. The field work for the 2003 through 2006 Internal Revenue Service (“IRS”) audit has closed. In connection with this audit, we have agreed to certain adjustments for our export income for the 2003 through 2006 tax years; however, this agreement did not result in a material change to our income tax expense. We have not agreed to proposed adjustments regarding the research and development tax credit and are in the process of appealing the proposed adjustment with the IRS. If resolved in favor of the IRS, these adjustments would require a material increase to our income tax expense. However, we expect to prevail with our position and have determined that a change in our tax reserves is not appropriate at this time.
Our tax years 2004 and forward are subject to examination by the IRS, our tax years 2000 and forward are subject to examination by material state jurisdictions, and our tax years 2004 and forward are subject to examination by material foreign jurisdictions.
We benefit from a tax holiday in Korea where we manufacture certain of our replacement parts. The tax holiday is awarded by Korea’s Ministry of Finance and Economy to promote capital investment in certain qualified high-technology businesses. The holiday is effective for a 10-year period, from 2003 through 2012, and provided exemption from corporate income tax of 100% of eligible income through 2009 and provides exemptions for 50% of eligible income from 2010 through 2012. Since inception, the tax holiday has produced tax benefits to us totaling $4.7 million.
It is our intention to reinvest undistributed earnings of our foreign subsidiaries and thereby indefinitely postpone their remittance. Accordingly, we have not provided U.S. federal income and foreign withholding taxes on $78.7 million of undistributed earnings from non-U.S. operations as of December 31, 2011. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings.
13. Employee Benefit Plans
Defined Contribution Plans
We have a defined contribution plan in the United States that qualifies under Section 401(k) of the Internal Revenue Code, and we offer defined contribution plans at certain of our international subsidiaries. Participating United States employees contribute a percentage of their eligible compensation, subject to certain annual IRS
limits. The plan is available to all eligible United States employees who meet the service requirement. In accordance with the provisions of the terms of the plan, we may make discretionary matching contributions of up to 4% of each participating employee’s eligible compensation, not to exceed $5,000 per participant in the plan year.
We matched defined contribution participant amounts of $2.5 million and $2.9 million for the years ended December 31, 2011 and 2010, respectively. In connection with our cost reduction actions conducted in 2009, we suspended our 401(k) matching program; therefore, no matching contributions were made for the year ended December 31, 2009.
Executive Deferred Compensation Plan
We have an executive deferred compensation plan for key management level employees in which the employee may elect to defer receipt of current compensation from us in order to provide retirement and other benefits on behalf of such employee backed by company owned life insurance policies. This plan is intended to be an unfunded, nonqualified deferred compensation plan that complies with the provisions of Section 409A of the Internal Revenue Code. The cash surrender value of the company owned life insurance policies totaled $4.9 million and $4.4 million as of December 31, 2011 and 2010, respectively, and is included in other assets in the consolidated balance sheets. Our liability for the deferred compensation plan totaled $5.2 million and $4.0 million as of December 31, 2011 and 2010, respectively, and is included in other liabilities in the consolidated balance sheets.
Executive Option and Group Health Coverage Extension Program
We have an executive option and health coverage extension program for eligible executives who meet certain minimum service and age requirements. This program is designed to provide extended benefits to eligible executives who retire and cease to serve us on a full-time basis. Under the terms of the program, the executive acts as our consultant for a term of four years and in return for these services, the executive continues to vest in his or her eligible stock options after the retirement separation date. The program also provides the former executive with specified health insurance continuation benefits until they reach the age of 65. One former executive continued to participate in the health insurance benefits in 2011, 2010, and 2009.
Retirement Plans
Our Cymer Japan (“CJI”) subsidiary has a retirement allowance and pension plan which covers a substantial portion of their employees. Benefits under the plan are based upon years of service and compensation levels. The CJI pension plan consists of a Retirement Allowance and Pension Plan for CJI employees. The expense for the CJI pension plan is recorded pursuant to the authoritative guidance for retirement benefits. The CJI pension plan is an unfunded plan and includes no plan assets.
Our Cymer Korea (“CKI”) subsidiary terminated their pension plan in July 2011. Plan assets were distributed to participants on or before August 30, 2011. Prior to its termination, CKI maintained a trust fund with a life insurance company, which is a guaranteed investment product and heavily regulated by the Korean government. For CKI’s pension plan, this type of fund was the only investment option allowed by relevant laws and regulations. All of CKI pension plan assets were held in a Variable Rate Guaranteed Investment Fund. These pension plan assets were recorded based on the total amount contributed plus any compounded and accrued interest. There were no other categories of pension plan assets. The vast majority of pension plan assets, as well as a minimum rate of return, were guaranteed by the Korean government.
The reconciliation of beginning and ending balances of the projected benefit obligation and plan assets, and the funded status of the pension plans are as follows (in thousands):
(1) The authoritative guidance for retirement benefits requires employers to recognize the unfunded status of a benefit plan, measured as the difference between the plan assets at fair value and the projected benefit obligation, in their balance sheet. Therefore, we have recorded the unfunded status of the pension plans above in noncurrent liabilities.
(2) Represents amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income. There were no unrecognized transition costs or unrecognized prior service costs.
The recognition of the unfunded status on the balance sheet requires employers to recognize actuarial gains and losses as a component of other comprehensive income. We recorded the unrecognized actuarial gains and losses included in our pension plans in other comprehensive income (loss). The total amount recorded in accumulated other comprehensive income (loss) after taxes was an unrecognized actuarial gain of $54,000 for the year ended December 31, 2011 and a loss of $279,000 and $162,000 for the years ended December 31, 2010 and 2009, respectively.
Net period costs consisted of the following (in thousands):
The following weighted average assumptions were used in computing the projected benefit obligation and net periodic pension costs:
The mortality rates for the CJI pension plan were as announced by the Japanese Ministry of Health and Welfare in September 2009 for use in funding valuation of the Employees’ Pension Fund.
Estimated future benefit payments expected under the CJI pension plan are as follows (in thousands):
14. Commitments and Contingencies
Leases
We lease certain facilities under non-cancelable operating leases. The lease terms on these facilities are through December 2015 and provide for certain rent abatements and minimum annual increases and options to extend the terms. In addition, we have a land lease in Korea with a lease term that expires in December 2020. This land lease is exempt from lease payments because the building meets certain investment and operational criteria of the Korean government.
Building rent expense under operating leases, net of sublease building rental income, is recognized on a straight-line basis over the life of the related lease. Rent expense includes payments for building rent, utilities and services. Sublease rental income, which concluded at the end of 2009, included payments by our tenants for building rent and reimbursement of utilities and services. For the years ended December 31, 2011, 2010, and 2009, net rent expense totaled approximately $2.4 million, $2.3 million and $330,000, respectively. Sublease rental income totaled approximately $5.2 million for the year ended December 31, 2009. There was no sublease rental income for the year ended December 31, 2011 or 2010.
Total future minimum lease commitments under operating leases are as follows (in thousands):
We had capital lease obligations of $720,000 as of December 31, 2011. Capital lease obligations expire at various dates, with the latest maturity in 2014. The current portion of the total obligation of $258,000 is included in other current liabilities and the remaining long-term portion of $462,000 is included in other long-term liabilities on the consolidated balance sheets. Assets held under capital leases are included in net property, plant and equipment on the consolidated balance sheets. Total future minimum lease commitments under capital leases are as follows (in thousands):
Guarantees and Warranties
We record a provision for warranty, which is included in cost of revenues and is recorded at the time that the related revenue is recognized. The warranty period and terms for light sources and replacement parts varies by light source system model. We review our warranty provision using a statistical financial model which calculates actual historical expenses, product failure rates, and potential risks associated with our different product models. We then use this financial model to calculate the future probable expenses related to warranty and the required level of the warranty provision. Throughout the year, we review the risk levels, historical cost information and failure rates used within this model and update them as information changes over the product’s life cycle. For new product offerings, such as EUV sources and TCZ crystallization tools, for which we have limited or no historical failure rates, we estimate our future probable expenses related to the warranties based on an evaluation of parts covered under warranty and their expected failure rates determined through internal testing and analysis. If actual warranty expenditures differ substantially from our estimates, revisions to the warranty provision would be required. Actual warranty expenditures are recorded against the warranty provision as they are incurred. Consumed parts under warranty, when returned, are recorded as reductions to warranty expenditures during the period at their estimated fair value. We do not include the return of consumed parts in our statistical financial model used to estimate our provision for warranty because the specific parts and their estimated future fair value when returned, if any, cannot be reasonably estimated at the time revenue is recorded.
The following table provides the changes in the product warranty accrual (in thousands):
(1) Warranty expenditures are net of consumed parts returned of $1.5 million and $2.2 million, respectively, for the years ended December 31, 2011 and 2010.
Intellectual Property Indemnifications
We agree to indemnify certain of our customers in the general purchase agreements with our three lithography tool manufacturer customers, ASML, Canon and Nikon, and under certain of our development and
supply agreements. These indemnifications generally include both general and intellectual property indemnification provisions that provide we defend these parties against certain infringement claims directed against our products. Under the indemnification provisions, we would pay costs and damages attributable to the infringement claims, including attorneys’ fees associated with settlements or defenses in respect of such claims, provided that certain conditions are satisfied. As of December 31, 2011, we were not subject to any pending general or intellectual property-related litigation or claims. We have not received any requests for nor have we been required to make any payments under these indemnification provisions.
Contingencies Related to Third-Party Review and Legal Actions
From time to time, we are subject to potential claims and assessments from third parties. We are also subject to various governmental audits and reviews. We continually assess whether or not such claims have merit and warrant accrual. Where appropriate, we accrue estimates of anticipated liabilities in the consolidated financial statements. Such estimates are subject to change and may affect our operating results, financial condition and cash flows.
We are from time to time party to legal actions in the normal course of business. Management does not expect the outcome of current legal action in the normal course of business to have a material effect on our operating results, financial condition and cash flows.
15. Related Party Transactions
We did not have any related party transactions in 2011. During 2010, we engaged Exponent, Inc., to perform a one-time component reliability analysis for a fee of $164,000. Mr. Michael R. Gaulke, a member of our board of directors and member of Exponent’s board of directors, served as an executive officer of Exponent until he retired from his executive chairman role on June 3, 2010.
On January 15, 2010, we purchased the remaining 40% ownership interest in TCZ, which increased our ownership in TCZ from 60% to 100%. Prior to January 15, 2010, we shared ownership of TCZ with Carl Zeiss SMT AG and Carl Zeiss Laser Optics Beteiligungsgesellschaft mbH (collectively, “Zeiss”) under a joint venture agreement. Under the terms of the joint venture agreement, Zeiss was a related party. In addition to transactions that occurred among us, Zeiss and TCZ related to the joint venture, we also purchased certain optical parts directly from Zeiss and periodically sold our light source system products to them. Associated with these related party transactions, we recorded revenue of $869,000 in 2009. Effective January 15, 2010, Zeiss was no longer a related party.
16. Segment and Geographic Information
Operating segments are defined as components of a public entity which engage in business activity which may earn revenues and incur expenses and its operating results are reviewed regularly by the chief operating decision maker (“CODM”), or decision making group, in deciding how to allocate resources and in assessing performance. We develop, manufacture and market our products within two reportable business segments: Cymer and TCZ. Cymer’s primary business is to design, manufacture and sell light sources and installed base products for use in photolithography systems used in the manufacture of semiconductors. TCZ develops, integrates, markets and supports silicon crystallization tools for use in the manufacture of high-resolution LTPS - LCD and OLED displays.
Our CODM is our chief operating officer who reviews the operations and full financial statements of Cymer and TCZ on a quarterly basis. Our CODM uses this information in order to make decisions on resources needed for our light sources and silicon crystallization tools businesses and to assess the overall performance of these businesses. The accounting policies to derive our consolidated financial results are the same as those used for our segment reporting. Information related to our Cymer and TCZ operating segments is as follows (in thousands):
(1) Reconciling items represent intercompany revenue between segments.
(2) TCZ operating loss is presented net of noncontrolling interest in 2010 and 2009.
(3) Reconciling items in 2010 and 2009 represent unallocated items not segregated between the two segments.
Geographic Information
Sales to external customers and long-lived assets, classified by geographic location, are as follows (in thousands):
(1) Sales to external customers consist of sales generated from each of the geographic locations. All significant intercompany balances are eliminated in consolidation.
(2) Long-lived assets include property, plant and equipment attributed to the geographic location in which they are located.
We expect that sales in these geographic areas will continue to account for a substantial portion of our revenue. The loss of business from any of these regions would have a material adverse effect on our operating results, financial condition, and cash flows.
The following customers accounted for 10 percent or more of our revenues in 2011, 2010 and 2009, with revenues attributable to our Cymer reporting segment.
17. Restructuring Costs
From November 2008 through March 2009, we reduced our worldwide workforce by approximately 38 percent in response to reduced business levels in the lithography sector of the semiconductor capital equipment market and the effect of the global economic market conditions. As a result of these reductions in workforce, we recorded charges to restructuring expense, primarily severance charges of $8.4 million for the year ended December 31, 2009. All such amounts were paid by December 31, 2009.
18. Quarterly Financial Data (Unaudited)
The table below includes quarterly data (in thousands, except per share data):
(1) Earnings per share are computed separately for each quarter and the full year using the respective weighted average shares. Therefore, the sum of the quarterly earnings per share amounts may not equal the annual amounts reported.
CYMER, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2011, 2010 and 2009 (in thousands)
S-1