VEECO INSTRUMENTS INC - Quarter Report: 2015 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2015

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from           to          

 

Commission File Number:  0-16244

 

 

VEECO INSTRUMENTS INC.

(Exact name of registrant as specified in its charter)

 

 

(516) 677-0200

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes  x  No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes  x  No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	x	Accelerated filer	o
Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Title of Class		Shares Outstanding
Common Stock		as of October 20, 2015
par value $0.01 per share		40,943,204

 

 

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VEECO INSTRUMENTS INC.

 

INDEX

 

Safe Harbor Statement	1
PART I—FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3. Quantitative and Qualitative Disclosures about Market Risk	27
Item 4. Controls and Procedures	28
PART II—OTHER INFORMATION	29
Item 1. Legal Proceedings	29
Item 1A. Risk Factors	29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3. Defaults Upon Senior Securities	29
Item 4. Mine Safety Disclosures	29
Item 5. Other Information	29
Item 6. Exhibits	30
SIGNATURES	31

 

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Safe Harbor Statement

 

This quarterly report on Form 10-Q (the “Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Discussions containing such forward-looking statements may be found in Part I - Items 1, 2, and 3 hereof, as well as within this Report generally. In addition, when used in this Report, the words “believes,” “anticipates,” “expects,” “estimates,” “targets,” “plans,” “intends,” “will,” and similar expressions related to the future are intended to identify forward-looking statements. All forward-looking statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from projected results.

 

In addition, the preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Although these estimates and assumptions are based on knowledge of current events and planned actions to be undertaken in the future, they may ultimately differ from actual results. Operating results for the nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. All estimates and assumptions are subject to a number of risks and uncertainties that could cause actual results to differ materially from these estimates and assumptions.

 

The risks and uncertainties of Veeco Instruments Inc. (together with its consolidated subsidiaries, “Veeco,” the “Company,” “we,” “us,” and “our,” unless the context indicates otherwise) include, without limitation, the following:

 

·                  Unfavorable market conditions may adversely affect our operating results;

 

·                  A reduction or elimination of foreign government subsidies and economic incentives may adversely affect the future order rate for our MOCVD equipment;

 

·                  The cyclicality of the industries we serve directly affects our business;

 

·                  We operate in industries characterized by rapid technological change;

 

·                  We depend on a limited number of customers, located primarily in a limited number of regions, which operate in highly concentrated industries;

 

·                  We face significant competition;

 

·                  The timing of our orders, shipments, and revenue recognition may cause our quarterly operating results to fluctuate significantly;

 

·                  Our sales cycle is long and unpredictable;

 

·                  Our backlog is subject to customer cancellation or modification and such cancellation could result in decreased sales and increased provisions for excess and obsolete inventory and/or liabilities to our suppliers for products no longer needed;

 

·                  Our failure to estimate customer demand accurately could result in excess or obsolete inventory and/or liabilities to our suppliers for products no longer needed, while manufacturing interruptions or delays could affect our ability to meet customer demand;

 

·                  Our failure to successfully manage our outsourcing activities or failure of our outsourcing partners to perform as anticipated could adversely affect our results of operations and our ability to adapt to fluctuating order volumes;

 

·                  We rely on a limited number of suppliers, some of whom are our sole source for particular components;

 

·                  Our inability to attract, retain, and motivate key employees could have a material adverse effect on our business;

 

·                  Our acquisition strategy subjects us to risks associated with evaluating and pursuing these opportunities and integrating these businesses;

 

·                  Timing of market adoption of LED technology for general lighting is uncertain;

 

·                  Our sales to LED, data storage and other manufacturers are highly dependent on these manufacturers’ sales for consumer electronics applications, which can experience significant volatility due to seasonal and other factors, which could materially adversely impact our future results of operations;

 

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·                  Our operating results have been, and may continue to be, adversely affected by tightening credit markets;

 

·                  We are exposed to the risks of operating a global business, including the need to obtain export licenses for certain of our shipments and political risks in the countries we operate;

 

·                  We may be exposed to liabilities under the Foreign Corrupt Practices Act and any determination that we violated these or similar laws could have a material adverse effect on our business;

 

·                  We are subject to internal control evaluations and attestation requirements of Section 404 of the Sarbanes-Oxley Act and any delays or difficulty in satisfying these requirements or negative reports concerning our internal controls could adversely affect our future results of operations and our stock price;

 

·                  Changes in accounting pronouncements or taxation rules or practices may adversely affect our financial results;

 

·                  We may be required to take additional impairment charges for goodwill and indefinite-lived intangible assets or definite-lived intangible and long-lived assets;

 

·                  The price of our common shares may be volatile and could decline significantly;

 

·                  The enforcement and protection of our intellectual property rights may be expensive and could divert our limited resources;

 

·                  We may be subject to claims of intellectual property infringement by others;

 

·                  We are subject to foreign currency exchange risks;

 

·                  If we are subject to cyber-attacks we could incur substantial costs and, if such attacks are successful, significant liabilities, reputational harm, and disruption to our operations;

 

·                  We have adopted certain measures that may have anti-takeover effects which may make an acquisition of our Company by another company more difficult;

 

·                  We are subject to risks of non-compliance with environmental, health, and safety regulations;

 

·                  Regulations related to conflict minerals will force us to incur additional expenses, may make our supply chain more complex, and may result in damage to our relationships with customers; and

 

·                  We have significant operations in locations which could be materially and adversely impacted in the event of a natural disaster or other significant disruption.

 

Consequently, such forward looking statements and estimates should be regarded solely as the current plans and beliefs of Veeco. We do not undertake any obligation to update any forward looking statements to reflect future events or circumstances after the date of such statements.

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Veeco Instruments Inc. and Subsidiaries

Consolidated Balance Sheets

(in thousands, except share amounts)

 

		September 30,			December 31,
		2015			2014
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	334,114		$	270,811
Short-term investments		68,877			120,572
Restricted cash		—			539
Accounts receivable, net		46,798			60,085
Inventory		69,973			61,471
Deferred cost of sales		9,665			5,076
Prepaid expenses and other current assets		22,589			23,132
Assets held for sale		5,000			6,000
Deferred income taxes		6,497			7,976
Total current assets		563,513			555,662
Property, plant and equipment, net		80,521			78,752
Intangible assets, net		137,476			159,308
Goodwill		114,908			114,959
Deferred income taxes		1,180			1,180
Other assets		21,091			19,594
Total assets		$	918,689		$	929,455
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	25,122		$	18,111
Accrued expenses and other current liabilities		41,728			48,418
Customer deposits and deferred revenue		89,025			96,004
Income taxes payable		7,764			5,441
Deferred income taxes		120			120
Current portion of long-term debt		333			314
Total current liabilities		164,092			168,408
Deferred income taxes		16,538			16,397
Long-term debt		1,281			1,533
Other liabilities		6,873			4,185
Total liabilities		188,784			190,523
Stockholders’ equity:
Preferred stock, 500,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $0.01 par value, 120,000,000 shares authorized; 40,924,013 and 40,360,069 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively		409			404
Additional paid-in capital		763,383			750,139
Accumulated deficit		(35,271		)	(13,080		)
Accumulated other comprehensive income		1,384			1,469
Total stockholders’ equity		729,905			738,932
Total liabilities and stockholders’ equity		$	918,689		$	929,455

 

See accompanying Notes to the Consolidated Financial Statements.

 

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Veeco Instruments Inc. and Subsidiaries

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

 

		Three months ended September 30,						Nine months ended September 30,
		2015			2014			2015			2014
Net sales		$	140,744		$	93,341		$	370,494		$	279,304
Cost of sales		86,494			60,783			232,038			182,296
Gross profit		54,250			32,558			138,456			97,008
Operating expenses, net:
Selling, general, and administrative		21,905			21,712			69,153			65,270
Research and development		19,200			19,968			57,904			60,747
Amortization of intangible assets		5,891			3,149			21,832			8,951
Restructuring		469			2,317			3,509			3,510
Asset impairment		—			2,864			126			2,864
Changes in contingent consideration		—			—			—			(29,368		)
Other, net		207			36			(795		)	(334		)
Total operating expenses, net		47,672			50,046			151,729			111,640
Operating income (loss)		6,578			(17,488		)	(13,273		)	(14,632		)
Interest income		256			344			787			730
Interest expense		(95		)	(39		)	(345		)	(189		)
Income (loss) before income taxes		6,739			(17,183		)	(12,831		)	(14,091		)
Income tax expense (benefit)		1,433			(3,206		)	9,360			(4,063		)
Net income (loss)		$	5,306		$	(13,977	)	$	(22,191	)	$	(10,028	)
Income (loss) per common share:
Basic		$	0.13		$	(0.35	)	$	(0.56	)	$	(0.26	)
Diluted		$	0.13		$	(0.35	)	$	(0.56	)	$	(0.26	)
Weighted average number of shares:
Basic		40,846			39,401			39,729			39,317
Diluted		40,979			39,401			39,729			39,317

 

See accompanying Notes to the Consolidated Financial Statements.

 

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Veeco Instruments Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

(unaudited)

 

		Three months ended September 30,						Nine months ended September 30,
		2015			2014			2015			2014
Net income (loss)		$	5,306		$	(13,977	)	$	(22,191	)	$	(10,028	)
Other comprehensive income (loss), net of tax
Unrealized gain (loss) on available-for-sale securities		(17		)	6			9			127
Reclassifications from AOCI into net income		—			—			(1		)	(45		)
Currency translation gain (loss)		(63		)	(138		)	(93		)	(29		)
Total other comprehensive income (loss), net of tax		(80		)	(132		)	(85		)	53
Comprehensive income (loss)		$	5,226		$	(14,109	)	$	(22,276	)	$	(9,975	)

 

See accompanying Notes to the Consolidated Financial Statements.

 

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Veeco Instruments Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

		Nine months ended September 30,
		2015			2014
Cash flows from operating activities
Net loss		$	(22,191	)	$	(10,028	)
Reconciling adjustments:
Depreciation and amortization		30,766			17,649
Deferred income taxes		1,794			(4,973		)
Asset impairment		126			2,864
Share-based compensation expense		14,038			14,303
Provision for bad debts		—			(1,833		)
Gain on sale of lab tools		(841		)	(2,435		)
Change in contingent consideration		—			(29,368		)
Changes in operating assets and liabilities:
Accounts receivable		13,484			(36,149		)
Inventory and deferred cost of sales		(13,029		)	6,940
Prepaid expenses and other current assets		332			3,664
Accounts payable and accrued expenses		368			1,152
Customer deposits and deferred revenue		(7,929		)	30,799
Income taxes receivable and payable, net		2,323			691
Other, net		2,609			124
Net cash provided by (used in) operating activities		21,850			(6,600		)
Cash flows from investing activities
Capital expenditures		(11,069		)	(10,476		)
Proceeds from the liquidation of short-term investments		68,647			216,050
Payments for purchases of short-term investments		(17,000		)	(157,733		)
Proceeds from sale of lab tools		2,648			7,034
Other, net		(662		)	(2,262		)
Net cash provided by investing activities		42,564			52,613
Cash flows from financing activities
Proceeds from stock option exercises		1,344			9,485
Taxes paid related to net share settlement of equity awards		(2,129		)	(1,925		)
Repayments of long-term debt		(233		)	(215		)
Net cash provided by (used in) financing activities		(1,018		)	7,345
Effect of exchange rate changes on cash flows		(93		)	(149		)
Net increase in cash and cash equivalents		63,303			53,209
Cash and cash equivalents - beginning of period		270,811			210,799
Cash and cash equivalents - end of period		$	334,114		$	264,008
Supplemental information:
Interest paid		$	104		$	121
Income taxes paid		$	6,040		$	2,908

 

See accompanying Notes to the Consolidated Financial Statements.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements

(unaudited)

 

Note 1 - Basis of Presentation

 

The accompanying unaudited Consolidated Financial Statements of Veeco have been prepared in accordance with U.S. GAAP as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 270 for interim financial information and with the instructions to Rule 10-01 of Securities and Exchange Commission Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements as the interim information is an update of the information that was presented in Veeco’s most recent annual financial statements. For further information, refer to Veeco’s Consolidated Financial Statements and Notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”). In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal, recurring nature. Certain amounts previously reported have been reclassified in the financial statements to conform to the current presentation.

 

Veeco reports interim quarters on a 13-week basis ending on the last Sunday of each quarter. The fourth quarter always ends on the last day of the calendar year, December 31. The 2015 interim quarters end on March 29, June 28, and September 27, and the 2014 interim quarters ended on March 30, June 29, and September 28. These interim quarters are reported as March 31, June 30 and September 30 in Veeco’s interim consolidated financial statements.

 

Revenue recognition

 

Veeco sells systems, maintenance, service, components, and spare parts. Veeco recognizes revenue when all of the following criteria have been met: persuasive evidence of an arrangement exists with a customer; delivery of the specified products has occurred or services have been rendered; prices are contractually fixed or determinable; and collectability is reasonably assured. Revenue is recorded including shipping and handling costs and excluding applicable taxes related to sales.

 

Contracts with customers frequently contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple-element arrangements and to determine how the revenue should be allocated among the accounting units. Veeco also evaluates whether multiple transactions with the same customer or related parties should be considered part of a single, multiple-element arrangement based on an assessment of whether the contracts or agreements are negotiated or executed within a short time frame of each other or if there are indicators that the contracts are negotiated in contemplation of one another. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria have been met in order to recognize revenue in the appropriate accounting period.

 

When there are separate units of accounting, Veeco allocates revenue to each element based on the following selling price hierarchy: vendor-specific objective evidence (“VSOE”) if available; third party evidence (“TPE”) if VSOE is not available; or the best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. BESP is used for the majority of the elements in Veeco’s arrangements. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items.

 

Veeco considers many facts when evaluating each of its sales arrangements to determine the timing of revenue recognition including its contractual obligations, the customer’s creditworthiness, and the nature of the customer’s post-delivery acceptance provisions. Veeco’s system sales arrangements, including certain upgrades, generally include field acceptance provisions that may include functional or mechanical test procedures. For the majority of the arrangements, a customer source inspection of the system is performed in Veeco’s facility or test data is sent to the customer documenting that the system is functioning to the agreed upon specifications prior to delivery. Historically, such source inspection or test data replicates the field acceptance provisions that are performed at the customer’s site prior to final acceptance of the system. When Veeco objectively demonstrates that the criteria specified in the contractual acceptance provisions are achieved prior to delivery, revenue is recognized upon system delivery since there is no substantive contingency remaining related to the acceptance provisions at that date, subject to the retention amount constraint described below. For new products, new applications of existing products, or for products with substantive customer acceptance provisions

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

where Veeco can not objectively demonstrate that the criteria specified in the contractual acceptance provisions have been achieved prior to delivery, revenue and the associated costs are fully deferred and recognized upon the receipt of final customer acceptance, assuming all other revenue recognition criteria have been met.

 

System sales arrangements, including certain upgrades, generally do not contain provisions for the right of return, forfeiture, refund, or other purchase price concessions. In the rare instances where such provisions are included, all revenue is deferred until such rights expire. The sales arrangements generally include installation. The installation process is not deemed essential to the functionality of the equipment since it is not complex; it does not require significant changes to the features or capabilities of the equipment or involve constructing elaborate interfaces or connections subsequent to factory acceptance. Veeco has a demonstrated history of consistently completing installations in a timely manner and can reliably estimate the costs of such activities. Most customers engage Veeco to perform the installation services, although there are other third-party providers with sufficient knowledge who could complete these services. Based on these factors, installation is deemed inconsequential or perfunctory relative to the system sale as a whole, and as a result, installation service is not considered a separate element of the arrangement. As such, Veeco accrues the cost of the installation at the time of revenue recognition for the system.

 

In many cases Veeco’s products are sold with a billing retention, typically 10% of the sales price which is payable by the customer when field acceptance provisions are completed. The amount of revenue recognized upon delivery of a system or upgrade, if any, is limited to the lower of i) the amount billed that is not contingent upon acceptance provisions or ii) the value of the arrangement consideration allocated to the delivered elements, if such sale is part of a multiple-element arrangement.

 

Veeco’s contractual terms with customers in Japan generally specify that title and risk and rewards of ownership transfer upon customer acceptance. As a result, for customers in Japan, revenue is recognized upon the receipt of written customer acceptance. A distributor is used for almost all sales to customers in Japan. Title passes to the distributor upon shipment, however, due to customary local business practices, the risks and rewards of ownership of the system transfers to the end customers upon their acceptance. As such, Veeco recognizes revenue upon receipt of written acceptance from the end customer.

 

Veeco recognizes revenue related to maintenance and service contracts ratably over the applicable contract term. Revenue from the sales of components, spare parts, and specified service engagements is recognized at the time of delivery in accordance with the terms of the applicable sales arrangement.

 

Incremental direct costs incurred related to the acquisition of a customer contract, such as sales commissions, are expensed as incurred, even if the related revenue is deferred in accordance with the above policy.

 

Recent accounting pronouncements

 

The FASB issued Accounting Standards Update (“ASU”) No. 2014-09, as amended by ASU 2015-14: Revenue from Contracts with Customers (the “Update”). The Update requires Veeco’s revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which Veeco expects to be entitled in exchange for those goods or services. The Update outlines a five-step model to make the revenue recognition determination and requires new financial statement disclosures. Publicly-traded companies are required to adopt the Update for reporting periods beginning after December 15, 2017. The ASU provides for different transition alternatives. Veeco is evaluating the impact of adopting the Update on its consolidated financial statements and related financial statement disclosures and has not yet determined which method of adoption will be selected.

 

Veeco is also evaluating other pronouncements recently issued but not yet adopted. The adoption of these pronouncements is not expected to have a material impact on Veeco’s consolidated financial statements.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Note 2 - Income (Loss) Per Common Share

 

Basic income (loss) per common share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. The calculation of basic loss per common share excludes participating shares since the securities’ holders are not obligated to fund these losses.

 

Diluted income per common share is calculated by dividing net income available to common stockholders by the weighted average number of common shares and common share equivalents outstanding during the period. The dilutive effect of outstanding options to purchase common stock, non-participating restricted share awards, and non-participating restricted share units is considered in diluted income per common share by application of the treasury stock method.  The dilutive effect of outstanding performance share awards and units are included in income per common share when performance targets have been achieved.

 

The computations of basic and diluted income (loss) per common share are:

 

		Three months ended September 30,						Nine months ended September 30,
		2015			2014			2015			2014
		(in thousands, except per share data)
Net income (loss)		$	5,306		$	(13,977	)	$	(22,191	)	$	(10,028	)
Net income (loss) per common share:
Basic		$	0.13		$	(0.35	)	$	(0.56	)	$	(0.26	)
Diluted		$	0.13		$	(0.35	)	$	(0.56	)	$	(0.26	)
Basic weighted average shares outstanding		40,846			39,401			39,729			39,317
Effect of potentially dilutive share-based awards		133			—			—			—
Diluted weighted average shares outstanding		40,979			39,401			39,729			39,317
Nonvested participating shares excluded from basic net loss per share since the securities’ holders are not obligated to fund losses		—			1,185			1,076			1,142
Shares excluded from the diluted calculation since Veeco incurred a net loss as their effect would be antidilutive		—			323			165			348
Potentially dilutive non-participating shares excluded from the diluted calculation as their effect would be antidilutive		2,264			1,344			2,066			1,057

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Note 3 - Assets

 

Investments and Assets held for sale

 

Marketable securities are generally classified as available-for-sale and reported at fair value, with unrealized gains and losses, net of tax, presented as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income” in the Consolidated Balance Sheets. These securities may include U.S. treasuries, government agency securities, corporate debt, and commercial paper, all with maturities of greater than three months when purchased. All realized gains and losses and unrealized losses resulting from declines in fair value that are other than temporary are included in “Other, net” in the Consolidated Statements of Operations.

 

Fair value is the price that would be received for an asset or the amount paid to transfer a liability in an orderly transaction between market participants. Veeco classifies certain assets based on the following fair value hierarchy:

 

Level 1:          Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;

 

Level 2:        Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; and

 

Level 3:          Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

The level used within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Veeco has evaluated the estimated fair value of financial instruments using available market information and valuations as provided by third-party sources. In determining fair value, information from pricing services is utilized to value securities based on quoted market prices in active markets and matrix pricing. Matrix pricing is a mathematical valuation technique that does not rely exclusively on quoted prices of specific investments, but on the investment’s relationship to other benchmarked quoted securities. The use of different market assumptions and/or estimation methodologies could have a significant effect on the fair value estimates. The following table presents assets that are measured at fair value on a recurring basis (excluding cash and cash equivalents):

 

		Level 1			Level 2			Total
		(in thousands)
September 30, 2015
U.S. treasuries		$	54,731		$	—		$	54,731
Government agency securities		—			2,999			2,999
Corporate debt		—			11,147			11,147
December 31, 2014
U.S. treasuries		$	81,527		$	—		$	81,527
Corporate debt		—			39,045			39,045

 

There were no transfers between fair value measurement levels during the nine months ended September 30, 2015. There were no financial assets or liabilities measured at fair value using Level 3 fair value measurements at September 30, 2015 or December 31, 2014.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

The amortized cost and fair value of available-for-sale securities consist of:

 

					Gross			Gross
		Amortized			Unrealized			Unrealized			Estimated
		Cost			Gains			Losses			Fair Value
		(in thousands)
September 30, 2015
U.S. treasuries		$	54,693		$	38		$	(0	)	$	54,731
Government agency securities		2,999			—			—			2,999
Corporate debt		11,142			6			(1		)	11,147
Total available-for-sale securities		$	68,834		$	44		$	(1	)	$	68,877
December 31, 2014
U.S. treasuries		$	81,506		$	27		$	(6	)	$	81,527
Corporate debt		39,031			20			(6		)	39,045
Total available-for-sale securities		$	120,537		$	47		$	(12	)	$	120,572

 

Available-for-sale securities in a loss position consist of:

 

		September 30, 2015						December 31, 2014
					Gross						Gross
		Estimated			Unrealized			Estimated			Unrealized
		Fair Value			Losses			Fair Value			Losses
		(in thousands)
U.S. treasuries		$	2,000		$	(0	)	$	35,001		$	(6	)
Corporate debt		1,139			(1		)	13,069			(6		)
Total available-for-sale securities in a loss position		$	3,139		$	(1	)	$	48,070		$	(12	)

 

At September 30, 2015 and December 31, 2014, there were no short-term investments that had been in a continuous loss position for more than 12 months.

 

The available-for-sale securities at September 30, 2015 all contractually mature in one year or less. Actual maturities may differ from contractual maturities. Veeco may sell these securities prior to maturity based on the needs of the business. In addition, borrowers may have the right to call or prepay obligations prior to scheduled maturities.

 

There were minimal realized gains for the three and nine months ended September 30, 2015 and September 30, 2014. The cost of securities liquidated is based on specific identification.

 

Accounts receivable

 

Accounts receivable is presented net of an allowance for doubtful accounts of $0.2 million and $0.7 million at September 30, 2015 and December 31, 2014, respectively.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Inventory

 

Inventory is stated at the lower of cost or market approximating actual costs using a first-in, first-out basis.

 

Inventory consists of:

 

		September 30, 2015			December 31, 2014
		(in thousands)
Materials		$	38,043		$	28,637
Work-in-process		26,612			26,778
Finished goods		5,318			6,056
Total inventory		$	69,973		$	61,471

 

Deferred cost of sales

 

For new products, new applications of existing products, or for products with substantive customer acceptance provisions where Veeco can not objectively demonstrate that the criteria specified in the contractual acceptance provisions have been achieved prior to delivery, the recognition of revenue and the recognition of associated costs are deferred until receipt of final customer acceptance, assuming all other revenue recognition criteria have been met.

 

Prepaid expenses and other current assets

 

Prepaid expenses and other current assets primarily consist of supplier deposits, as well as prepaid value-added tax, lease deposits, prepaid insurance, and prepaid licenses.

 

Veeco outsources a portion of its manufacturing to third parties. For outsourced products, Veeco maintains a certain level of internal manufacturing capability. Supplier deposits were $11.1 million and $12.7 million at September 30, 2015 and December 31, 2014, respectively.

 

Assets held for sale

 

Assets held for sale consist of a vacant building and land which were designated as held for sale during 2014. The carrying value reflects Veeco’s estimate of fair value less costs to sell using the sales comparison market approach.

 

Property, plant, and equipment

 

Property, plant, and equipment consist of:

 

		September 30, 2015			December 31, 2014
		(in thousands)
Land		$	9,592		$	9,392
Building and improvements		54,562			51,979
Machinery and equipment		108,613			104,815
Leasehold improvements		5,417			4,356
Gross property, plant and equipment		178,184			170,542
Less: accumulated depreciation and amortization		97,663			91,790
Net property, plant, and equipment		$	80,521		$	78,752

 

For the three and nine months ended September 30, 2015, depreciation expense was $3.2 million and $8.9 million, respectively, and $2.9 million and $8.7 million for the comparable 2014 periods.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Goodwill

 

There were no new acquisitions or impairments during the nine months ended September 30, 2015. The purchase accounting related to the $145.5 million December 4, 2014 acquisition of Solid State Equipment LLC (“SSEC”), which has been renamed Veeco Precision Surface Processing LLC (“PSP”), has been finalized. Changes in goodwill consist of:

 

		Gross carrying			Accumulated
		amount			impairment			Net amount
		(in thousands)
Goodwill - December 31, 2014		$	238,158		$	123,199		$	114,959
Purchase price allocation adjustment		(51		)	—			(51		)
Goodwill - September 30, 2015		$	238,107		$	123,199		$	114,908

 

Intangible assets

 

There were no new acquisitions or impairments during the nine months ended September 30, 2015. The components of purchased intangible assets consist of:

 

		September 30, 2015									December 31, 2014
					Accumulated									Accumulated
		Gross			Amortization						Gross			Amortization
		Carrying			and			Net			Carrying			and			Net
		Amount			Impairment			Amount			Amount			Impairment			Amount
		(in thousands)
Technology		$	222,358		$	116,958		$	105,400		$	222,358		$	106,342		$	116,016
Customer relationships		47,885			20,578			27,307			47,885			14,918			32,967
Trademarks and tradenames		2,730			1,719			1,011			3,050			1,096			1,954
Indefinite-lived trademark		2,900			—			2,900			2,900			—			2,900
Other		6,241			5,383			858			6,320			849			5,471
Total		$	282,114		$	144,638		$	137,476		$	282,513		$	123,205		$	159,308

 

Other intangible assets consist of patents, licenses, customer backlog, and non-compete agreements.

 

Other assets

 

Veeco has an ownership interest of less than 20% in a non-marketable investment. Veeco does not exert significant influence over the investee, and therefore the investment is carried at cost. Additional investments of $1.6 million were made during the nine months ended September 30, 2015, increasing the carrying value of this investment from $19.4 million at December 31, 2014 to $21.0 million at September 30, 2015. Veeco’s ownership interest and participating rights have not substantively changed. Therefore, Veeco continues to carry the investment at cost. The investment is subject to a periodic impairment review; as there are no open-market valuations, the impairment analysis requires significant judgment. The analysis includes assessments of the investee’s financial condition, the business outlook for its products and technology, its projected results and cash flow, business valuation indications from recent rounds of financing, the likelihood of obtaining subsequent rounds of financing, and the impact of equity preferences held by Veeco relative to other investors. Fair value of the investment is not estimated unless there are identified events or changes in circumstances that could have a significant adverse effect on the fair value of the investment. No such events or circumstances are present.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Note 4 - Liabilities

 

Accrued expenses and other current liabilities

 

The components of accrued expenses and other current liabilities consist of:

 

		September 30, 2015			December 31, 2014
		(in thousands)
Payroll and related benefits		$	24,886		$	28,938
Warranty		6,546			5,411
Installation		2,112			2,861
Sales, use, and other taxes		1,633			1,776
Professional fees		2,480			2,752
Restructuring liability		718			1,428
Other		3,353			5,252
Total accrued liabilities		$	41,728		$	48,418

 

Other liabilities include accruals for costs related to customer training, royalties, and travel.

 

Warranty reserves

 

Warranties are typically valid for one year from the date of system final acceptance. Estimated warranty costs are determined by analyzing specific product and historical configuration statistics and regional warranty support costs. The estimate is affected by product failure rates, material usage, and labor costs incurred in correcting product failures during the warranty period. Unforeseen component failures or exceptional component performance can impact warranty costs. Changes in product warranty reserves include:

 

		(in thousands)
Warranty reserves - December 31, 2014		$	5,411
Warranties issued		5,316
Settlements made		(2,550		)
Changes in estimate		(1,631		)
Warranty reserves - September 30, 2015		$	6,546

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Restructuring accruals

 

During the nine months ended September 30, 2015, additional accruals were recognized and payments made related to the 2014 closing of Veeco’s Ft. Collins, Colorado and Camarillo, California facilities. Business activities formerly conducted at these sites have been transferred to the Plainview, New York facility. In addition, Veeco is closing the Hyeongok-ri, South Korea facility. Veeco has accrued and paid for restructuring activities during the nine months ended September 30, 2015. Additional restructuring costs to be accrued for these activities are not expected to be significant.

 

		Personnel
		Severance and			Facility
		Related Costs			Closing Costs			Total
		(in thousands)
Restructuring accrual - December 31, 2014		$	1,428		$	—		$	1,428
Provision		2,421			1,088			3,509
Payments		(3,377		)	(842		)	(4,219		)
Restructuring accrual - September 30, 2015		$	472		$	246		$	718

 

Customer deposits and deferred revenue

 

Customer deposits totaled $32.4 million and $73.0 million at September 30, 2015 and December 31, 2014, respectively. The remainder of the balance relates to deferred revenue consisting of billings associated with customer contracts for which all revenue recognition criteria have not yet been met.

 

Long-term debt

 

Debt consists of a mortgage note payable with a carrying value of $1.6 million at September 30, 2015 and $1.8 million at December 31, 2014. The annual interest rate on the mortgage is 7.91%, and the final payment is due on January 1, 2020. The mortgage note payable is secured by the property currently held for sale. A discounted cash flow model was used to calculate a level 3 fair value estimate of $1.7 million at September 30, 2015 and $2.0 million at December 31, 2014.

 

Note 5 - Commitments and Contingencies

 

Minimum lease commitments

 

At September 30, 2015, Veeco’s total future minimum lease payments under non-cancelable operating leases have not changed significantly from the footnote disclosure in the 2014 Form 10-K.

 

Purchase commitments

 

Veeco has purchase commitments under certain contractual arrangements to make future payments for goods and services. These contractual arrangements secure the rights to various assets and services to be used in the future in the normal course of business. Veeco has purchase commitments of $103.1 million at September 30, 2015, substantially all of which become due within one year.

 

Bank guarantees and letters of credit

 

Veeco has bank guarantees and letters of credit issued by a financial institution on its behalf as needed to cover performance bonds required by customers. At September 30, 2015, outstanding bank guarantees and letters of credit totaled $17.1 million, and unused bank guarantees and letters of credit of $48.7 million were available to be drawn upon.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Legal proceedings

 

Veeco and certain other parties were named as defendants in a lawsuit filed on April 25, 2013 in the Superior Court of California, County of Sonoma. The plaintiff in the lawsuit, Patrick Colbus, seeks unspecified damages and asserts claims that he suffered burns and other injuries while he was cleaning a molecular beam epitaxy system alleged to have been manufactured by Veeco. The lawsuit alleges, among other things, that the molecular beam epitaxy system was defective and that Veeco failed to adequately warn of the potential risks of the system. Veeco believes this lawsuit is without merit and intends to defend vigorously against the claims. Veeco is unable to predict the outcome of this action or to reasonably estimate the possible loss or range of loss, if any, arising from the claims asserted therein. Veeco believes that, in the event of any recovery by the plaintiff from Veeco, such recovery would be fully covered by insurance.

 

Veeco is involved in other legal proceedings arising in the normal course of business. The resolution of these matters is not expected to have a material adverse effect on Veeco’s consolidated financial position, results of operations, or cash flows.

 

Note 6 - Equity

 

Accumulated Other Comprehensive Income (“AOCI”)

 

The following table presents the changes in the balances of each component of AOCI, net of tax:

 

		Currency translation gain (loss)			Minimum Pension Liability			Unrealized Gains on Available-for- sale Securities			Total
		(in thousands)
Balance at December 31, 2014		$	2,333		$	(881	)	$	17		$	1,469
Other comprehensive income (loss) before reclassifications		(93		)	—			9			(84		)
Amounts reclassified from AOCI		—			—			(1		)	(1		)
Other comprehensive income (loss)		(93		)	—			8			(85		)
Balance at September 30, 2015		$	2,240		$	(881	)	$	25		$	1,384

 

Veeco did not allocate tax expense to other comprehensive income for the nine months ended September 30, 2015 as Veeco is in a full valuation allowance position such that a deferred tax asset related to amounts recognized in other comprehensive income is not regarded as realizable on a more-likely-than-not basis.

 

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Veeco Instruments Inc. and Subsidiaries

Notes to the Consolidated Financial Statements - continued

(unaudited)

 

Note 7 - Share-based compensation

 

Restricted share awards are issued to employees that are subject to specified restrictions and a risk of forfeiture. The restrictions typically lapse over one to five years and may entitle holders to dividends and voting rights. Other types of share-based compensation include performance share awards, performance share units, and restricted share units (collectively with restricted share awards, “restricted shares”), as well as options to purchase common stock. Share-based compensation expense was recognized in the following line items in the Consolidated Statements of Operations:

 

		Three months ended September 30,						Nine months ended September 30,
		2015			2014			2015			2014
		(in thousands)
Cost of sales		$	787		$	619		$	2,102		$	1,799
Selling, general, and administrative		3,288			2,766			9,197			9,191
Research and development		1,044			1,105			2,739			3,313
Total share-based compensation expense		$	5,119		$	4,490		$	14,038		$	14,303

 

Equity activity related to restricted shares:

 

				Weighted Average Grant Date
		Number of Shares		Fair Value
		(in thousands)
Restricted shares outstanding - December 31, 2014		1,237		$	34.27
Granted		640		30.85
Vested		(248	)	37.95
Forfeited		(65	)	35.80
Restricted shares outstanding - September 30, 2015		1,564		$	32.22

 

Equity activity related to stock options:

 

				Weighted Average
		Number of Options		Exercise Price
		(in thousands)
Stock options outstanding - December 31, 2014		2,391		$	31.65
Granted		16		30.22
Exercised		(92	)	17.44
Expired or forfeited		(119	)	38.63
Stock options outstanding - September 30, 2015		2,196		$	31.86

 

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