UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 26, 2008
Or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 000-25705
GSI Group Inc.
(Exact name of registrant as specified in its charter)
New Brunswick, Canada | 98-0110412 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
125 Middlesex Turnpike Bedford, Massachusetts, USA |
01730 | |
(Address of principal executive offices) | (Zip Code) |
(781) 266-5700
(Registrants 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 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 ¨ No x
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 (Section 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 ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of March 23, 2010, there were 47,901,978 of the Registrants common shares, no par value, issued and outstanding.
TABLE OF CONTENTS
Item No. |
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ITEM 1. |
3 | |||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
ITEM 2. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
52 | ||
ITEM 3. |
76 | |||
ITEM 4. |
77 | |||
81 | ||||
ITEM 1. |
81 | |||
ITEM 1A. |
82 | |||
ITEM 2. |
99 | |||
ITEM 3. |
101 | |||
ITEM 4. |
101 | |||
ITEM 5. |
101 | |||
ITEM 6. |
101 | |||
103 |
In August 2008, GSI Group Inc. (the Company) closed its acquisition of Excel Technology, Inc. (Excel). Delays in the integration of the financial accounting systems of the Company and Excel following the acquisition initially led to a delay of several weeks in the preparation of the Companys Quarterly Report on Form 10-Q for the quarterly period ended September 26, 2008 (the 2008 Q3 Report). Shortly thereafter and prior to filing the 2008 Q3 Report, the Company initiated an internal review of certain potential errors in the recognition of revenue related to sales to a customer in the first and second fiscal quarters of 2008 in the Companys Semiconductor Systems Segment, which were brought to the attention of the Audit Committee of the Companys Board of Directors (the Audit Committee) by Company management. Following this initial internal review, the Audit Committee, in consultation with the Companys outside legal counsel determined that it was appropriate to undertake an independent review of the potential revenue recognition issues brought to its attention.
On or about November 25, 2008, the Audit Committee initiated a broader independent review of sales transactions in the Semiconductor Systems Segment that contain arrangements with multiple deliverables for fiscal years 2007 and 2008. The review was subsequently expanded to include sales transactions in the Semiconductor Systems Segment, along with certain other sales transactions for fiscal years 2006, 2007 and 2008. To assist in its review, the Audit Committee retained independent legal counsel and forensic accounting experts.
On December 4, 2008, the Company announced that it identified errors in the recognition of revenue related to sales to a customer in the first and second fiscal quarters of 2008 in the Semiconductor Systems Segment and that the previously issued financial statements contained in the Companys Quarterly Reports on Form 10-Q for the periods ended March 28, 2008 and June 27, 2008 should no longer be relied upon.
Subsequently, the Company announced that it had identified additional revenue recognition errors related to the timing of revenue recognition from sales to certain Semiconductor Systems Segment customers during fiscal year 2007. The Audit Committee concluded, upon the recommendation of Company management, that the range of potential adjustments resulting from the identified errors is material to the financial statements of the Company for the periods indicated and as a result, the Audit Committee determined that the previously issued interim and annual historical financial statements for 2007 should no longer be relied upon. The Audit Committee thereafter expanded the scope of its investigation to include fiscal year 2006.
On March 30, 2009, the Company announced that it had identified additional revenue recognition errors related to the timing of revenue recognition from sales to certain Semiconductor Systems Segment customers during fiscal year 2006. The Audit Committee concluded, upon the recommendation of Company management, that the range of potential adjustments resulting from the identified errors is material to the financial statements of the Company for the periods indicated and as a result, the Audit Committee determined that the previously issued interim and annual historical financial statements for 2006 should no longer be relied upon.
The Audit Committees advisors reported the results of the investigation to the Audit Committee on April 24, 2009. The Company voluntarily reported the investigation results to the Securities and Exchange Commission (SEC) on April 30, 2009. The Company later announced in May 2009 that it was reviewing sales transactions of its Semiconductor Systems Segment during fiscal years 2004 and 2005 to determine if adjustments needed to be made to those periods. Thereafter, on June 30, 2009, the Company announced that it was undertaking a preliminary review of the timing of revenue recognized in connection with multiple element arrangements in its Precision Technology Segment from 2004 through 2008 to determine if adjustments need to be made to those periods (collectively with the Audit Committees review of transactions in the Semiconductor Systems Segment and any other related Company reviews of transactions in the Semiconductor Systems Segment and Precision Technology Segment, the Revenue Review). As is further explained in Note 2 of the Notes to Consolidated Financial Statements, in connection with the Revenue Review, the Company concluded that there were a number of adjustments required that primarily relate to revenue recognition and the corresponding adjustments to deferred revenue, cost of goods sold and other assets. Adjustments to revenue resulted in revenue and their related costs being deferred and recognized in subsequent periods once all revenue recognition criteria have been met. In addition, these adjustments did not affect the Companys cash balances. The transactions that are being restated as a result of the Revenue Review include transactions for which the complete facts required to make the appropriate assessment with respect to the timing of the revenue recognition were not communicated to the finance department at the time the initial revenue was booked. As of September 26, 2008, a substantial portion of the revenue deferred through the restatement remains deferred, pending the finalization of all deliverables under the terms of the arrangements with customers. The revenue adjustments, in aggregate for both the Semiconductor Systems and the Precision Technology Segments, primarily relate to:
| multiple-element arrangements for which objective and reliable evidence of fair value does not exist for one or more of the undelivered elements; |
1
| for those arrangements whereby it was determined that customer acceptance was required in order to record revenue in accordance with the Companys policy, the correction of the timing of revenue for instances where customer acceptance could not be demonstrated until a period subsequent to the period of original revenue recognition; |
| contractual terms that resulted in arrangements being deemed to not be fixed or determinable at the outset of the arrangement (including extended payment terms and contracts whereby product quantity mix was subject to adjustment during the term of the arrangement); and |
| certain other revenue adjustments which were not individually, or in the aggregate, significant. These adjustments have been reflected in the restated consolidated financial statements and primarily relate to the accounting for separately priced extended warranty contracts. |
In addition to adjustments from the Revenue Review, the Company has also identified and recorded the impact of certain adjustments which, due to their materiality, were not previously recorded. Certain of these adjustments affect revenue, cost of goods sold and operating expenses, as well as offsetting balance sheet accounts. These adjustments have been reflected in the accompanying consolidated financial statements.
In connection with its restatement, the Company and Ernst & Young LLP, its independent auditors, identified and reported to the Companys Audit Committee significant internal control matters that collectively constitute material weaknesses. Please see Item 4. Controls and Procedures below for a description of these matters, and of certain of the measures that have been implemented during 2009, to date, as well as additional steps the Company plans to take to strengthen its controls.
The Company does not anticipate amending its previously filed annual reports on Form 10-K or any quarterly reports on Form 10-Q. The consolidated financial statements and related consolidated financial information contained in previously filed reports, including for the years ended December 31, 2007 and 2006 and for the first two quarterly reports during 2008 and the first three quarters of 2007, should no longer be relied upon.
2
PART I FINANCIAL INFORMATION
Item 1. | Financial Statements |
CONSOLIDATED BALANCE SHEETS
(In thousands of U.S. dollars, except share data)
September 26, 2008 |
December
31, 2007 | |||||
(Unaudited) | (As Restated) | |||||
ASSETS | ||||||
Current Assets |
||||||
Cash and cash equivalents |
$ | 52,141 | $ | 172,387 | ||
Accounts receivable, net |
64,462 | 71,631 | ||||
Income taxes receivable |
37,180 | 21,790 | ||||
Inventories |
87,892 | 64,139 | ||||
Deferred tax assets |
11,041 | 8,541 | ||||
Deferred cost of goods sold |
35,285 | 37,194 | ||||
Deferred debt financing costs |
6,340 | | ||||
Other current assets |
6,267 | 7,120 | ||||
Current assets of discontinued business held for sale |
4,317 | 3,864 | ||||
Total current assets |
304,925 | 386,666 | ||||
Property, plant and equipment, net of accumulated depreciation and amortization |
70,794 | 28,382 | ||||
Deferred tax assets |
21,214 | 16,589 | ||||
Deferred cost of goods sold |
23,133 | 12,758 | ||||
Investments in auction rate securities |
25,860 | | ||||
Other assets |
2,253 | 1,566 | ||||
Intangible assets, net |
156,299 | 29,775 | ||||
Goodwill |
176,232 | 26,291 | ||||
Noncurrent assets of discontinued business held for sale |
4,649 | 5,618 | ||||
Total Assets |
$ | 785,359 | $ | 507,645 | ||
LIABILITIES AND STOCKHOLDERS EQUITY | ||||||
Current Liabilities |
||||||
Debt (Note 8) |
$ | 183,840 | $ | | ||
Accounts payable |
33,413 | 17,905 | ||||
Income taxes payable |
1,186 | 1,546 | ||||
Accrued compensation and benefits |
11,524 | 9,848 | ||||
Deferred revenue |
69,458 | 79,462 | ||||
Deferred tax liabilities |
798 | 286 | ||||
Other accrued expenses |
17,239 | 8,980 | ||||
Current liabilities of discontinued business held for sale |
1,568 | 1,577 | ||||
Total current liabilities |
319,026 | 119,604 | ||||
Deferred revenue |
39,133 | 22,101 | ||||
Deferred tax liabilities |
60,458 | 10,124 | ||||
Accrued restructuring, net of current portion |
1,106 | 1,015 | ||||
Income taxes payable |
4,050 | 3,966 | ||||
Accrued pension liability |
4,316 | 4,481 | ||||
Other liabilities |
5,044 | 676 | ||||
Minority interest |
164 | | ||||
Total liabilities |
433,297 | 161,967 | ||||
Commitments and contingencies (Note 14) |
||||||
Stockholders equity: |
||||||
Common shares, no par value; Authorized shares: unlimited; Issued and outstanding: 41,709,379 and 42,161,592, respectively |
304,595 | 310,970 | ||||
Additional paid-in capital |
36,858 | 8,191 | ||||
Retained earnings |
4,995 | 19,131 | ||||
Accumulated other comprehensive income |
5,614 | 7,386 | ||||
Total stockholders equity |
352,062 | 345,678 | ||||
Total Liabilities and Stockholders Equity |
$ | 785,359 | $ | 507,645 | ||
The accompanying notes are an integral part of these financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands of U.S. dollars, except per share amounts)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 26, 2008 |
September 28, 2007 |
September 26, 2008 |
September 28, 2007 |
|||||||||||||
(Unaudited) | (Unaudited, As Restated) |
(Unaudited) | (Unaudited, As Restated) |
|||||||||||||
Sales |
$ | 71,443 | $ | 84,077 | $ | 192,137 | $ | 223,699 | ||||||||
Cost of goods sold |
48,557 | 51,376 | 124,086 | 134,938 | ||||||||||||
Gross profit |
22,886 | 32,701 | 68,051 | 88,761 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development and engineering |
8,874 | 7,390 | 23,829 | 22,494 | ||||||||||||
Selling, general and administrative |
16,674 | 15,120 | 46,911 | 44,010 | ||||||||||||
Amortization of purchased intangible assets |
1,646 | 554 | 2,749 | 1,654 | ||||||||||||
Restructuring |
3,073 | 1,939 | 4,206 | 5,868 | ||||||||||||
Acquisition-related in-process research and development charge |
12,142 | | 12,142 | | ||||||||||||
Total operating expenses |
42,409 | 25,003 | 89,837 | 74,026 | ||||||||||||
Income (loss) from operations |
(19,523 | ) | 7,698 | (21,786 | ) | 14,735 | ||||||||||
Interest income |
595 | 1,708 | 2,763 | 4,921 | ||||||||||||
Interest expense |
(2,892 | ) | (26 | ) | (2,927 | ) | (107 | ) | ||||||||
Foreign exchange transaction gains (losses) |
(2 | ) | 682 | 269 | 463 | |||||||||||
Other income |
12 | 19 | 154 | 176 | ||||||||||||
Income (loss) from continuing operations before income taxes |
(21,810 | ) | 10,081 | (21,527 | ) | 20,188 | ||||||||||
Income tax provision (benefit) |
(7,600 | ) | 3,438 | (7,081 | ) | 6,858 | ||||||||||
Income (loss) from continuing operations |
(14,210 | ) | 6,643 | (14,446 | ) | 13,330 | ||||||||||
Income (loss) from discontinued operations, net of tax |
(19 | ) | 12 | 310 | 266 | |||||||||||
Net income (loss) |
$ | (14,229 | ) | $ | 6,655 | $ | (14,136 | ) | $ | 13,596 | ||||||
Net income (loss) from continuing operations per common share: |
||||||||||||||||
Basic |
$ | (0.34 | ) | $ | 0.16 | $ | (0.35 | ) | $ | 0.31 | ||||||
Diluted |
$ | (0.34 | ) | $ | 0.15 | $ | (0.35 | ) | $ | 0.31 | ||||||
Net income from discontinued operations per common share: |
||||||||||||||||
Basic |
$ | | $ | | $ | 0.01 | $ | 0.01 | ||||||||
Diluted |
$ | | $ | | $ | 0.01 | $ | 0.01 | ||||||||
Net income (loss) per common share: |
||||||||||||||||
Basic |
$ | (0.34 | ) | $ | 0.16 | $ | (0.34 | ) | $ | 0.32 | ||||||
Diluted |
$ | (0.34 | ) | $ | 0.15 | $ | (0.34 | ) | $ | 0.32 | ||||||
Weighted average common shares outstanding Basic |
41,677 | 42,654 | 41,792 | 42,344 | ||||||||||||
Weighted average common shares outstanding Diluted |
41,677 | 42,936 | 41,792 | 42,578 |
The accompanying notes are an integral part of these financial statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of U.S. dollars)
Nine Months Ended | ||||||||
September 26, 2008 |
September 28, 2007 |
|||||||
(Unaudited) | (Unaudited, As Restated) |
|||||||
Cash flows from operating activities: |
||||||||
Net income (loss) |
$ | (14,136 | ) | $ | 13,596 | |||
Adjustments to reconcile net income (loss) to net cash from operating activities: |
||||||||
Income from discontinued operations |
(310 | ) | (266 | ) | ||||
Depreciation and amortization |
11,656 | 11,038 | ||||||
Acquisition-related in-process research and development charge |
12,142 | | ||||||
Step-up value of acquired inventory sold |
366 | | ||||||
Share based compensation |
2,342 | 1,830 | ||||||
Deferred income taxes |
(378 | ) | 2,700 | |||||
Earnings from equity investments |
(87 | ) | (117 | ) | ||||
Unrealized loss on derivatives |
| 18 | ||||||
Gain on sale of property and assets |
(1,162 | ) | | |||||
Non-cash interest expense |
274 | | ||||||
Changes in current assets and liabilities, net of effects from business acquired: |
||||||||
Accounts receivable |
26,444 | (17,218 | ) | |||||
Inventories |
12,986 | 5,967 | ||||||
Deferred costs |
(8,110 | ) | (99 | ) | ||||
Other current assets |
(4,998 | ) | 5,730 | |||||
Deferred revenue |
6,511 | (1,530 | ) | |||||
Accounts payable, accruals and taxes receivable and payable |
(615 | ) | 1,699 | |||||
Cash used in operating activities of discontinued operations |
(153 | ) | (1,034 | ) | ||||
Cash provided by operating activities |
42,772 | 22,314 | ||||||
Cash flows from investing activities: |
||||||||
Acquisition of businesses |
(368,711 | ) | (3,006 | ) | ||||
Cash received in acquisition of businesses |
10,430 | | ||||||
Purchases of property, plant and equipment |
(16,404 | ) | (3,861 | ) | ||||
Proceeds from the sale of property, plant and equipment |
3,211 | | ||||||
Changes in other assets and liabilities |
10,229 | 381 | ||||||
Cash provided by (used in) investing activities of discontinued operations |
969 | (250 | ) | |||||
Cash used in investing activities |
(360,276 | ) | (6,736 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from issuance of debt |
210,000 | | ||||||
Payments for debt issuance costs |
(6,472 | ) | | |||||
Purchases of the Companys common shares |
(6,439 | ) | (2,414 | ) | ||||
Net proceeds from the issuance of share capital |
63 | 7,334 | ||||||
Excess tax benefit of stock options |
23 | 345 | ||||||
Cash provided by financing activities |
197,175 | 5,265 | ||||||
Effect of exchange rates on cash and cash equivalents |
83 | 2,587 | ||||||
Increase (decrease) in cash and cash equivalents |
(120,246 | ) | 23,430 | |||||
Cash and cash equivalents, beginning of period (1) |
172,387 | 138,315 | ||||||
Cash and cash equivalents, end of period (1) |
$ | 52,141 | $ | 161,745 | ||||
Supplemental disclosure of non cash financing activity: |
||||||||
Issuance of warrants |
$ | 26,302 | |
(1) | The Consolidated Statements of Cash Flows include cash and cash equivalent balances (in thousands) of $2, and $530 of the discontinued business held for sale for the nine months ended September 26, 2008, and September 28, 2007, respectively. |
The accompanying notes are an integral part of these financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization, Presentation and Significant Events
GSI Group Inc. (GSIG) and its subsidiaries (collectively the Company) designs, develops, manufactures and sells photonics-based solutions (consisting of lasers, laser systems and electro-optical components), precision motion devices, associated precision motion control technology and systems. Its customers incorporate its technology into their products or manufacturing processes, for a wide range of applications in a variety of markets, including: industrial, scientific, electronics, semiconductor, medical and aerospace. The Company operates in three segments: Precision Technology, Semiconductor Systems and Excel Technology, Inc. (Excel). The Companys principal markets are in North America, Europe, Japan and Asia-Pacific. The Company exists under the laws of New Brunswick, Canada.
Acquisition of Excel Technology, Inc.
In August 2008, the Company acquired Excel, a designer, manufacturer and marketer of photonics-based solutions consisting of lasers, laser-based systems, precision motion devices and electro-optical components, primarily for industrial and scientific applications. Excel, which was headquartered in East Setauket, New York, manufactures its products in plants located in the United States and Germany, and sells its products to customers worldwide, both directly and indirectly through resellers and distributors. The Company acquired Excel in exchange for a cash payment of $368.7 million, including transaction costs, a portion of which was financed by entering into a loan agreement for $210.0 million. This loan is further discussed in the section below titled Chapter 11 Bankruptcy Filing, and in Note 8 of Notes to Consolidated Financial Statements. Subsequent to the acquisition of Excel, the Company established a third segment which is comprised solely of the operations of the newly acquired entity. See Note 4 of Notes to Consolidated Financial Statements for further details regarding the Excel transaction.
Divestiture of U.S. General Optics Business
On October 8, 2008, the Company completed the sale of its General Optics business, located in Moorpark, California, (the U.S. Optics Business) for a sale price of $21.6 million, which represented a gain of $8.7 million, net of tax. The sale of the U.S. Optics Business is reported as Gain on Disposal of Discontinued Operations in our consolidated statements of operations for the year ended December 31, 2008. This business was part of the Companys Precision Technology Segment. The results of operations of the U.S. Optics Business have been reclassified and reported as income from discontinued operations in our consolidated statements of operations. See Note 5 of Notes to Consolidated Financial Statements for further details regarding the sale of the U.S. Optics Business.
NASDAQ Delisting Determination
On November 3, 2009, the NASDAQ Hearing Panel (the Panel) of the NASDAQ Stock Market (NASDAQ) notified the Company that it had determined to delist the Companys common shares from the NASDAQ Global Select Market and to suspend trading in the Companys common shares effective at the open of market on November 5, 2009. The Panels determination was made in connection with the Companys non-compliance with the filing requirements set forth in Listing Rule 5250(c)(1) due to the delayed filing of certain of our periodic reports. As permitted by NASDAQ rules, the Company timely appealed the Panels determination to the NASDAQ Listing and Hearing Review Council (the Listing Council). On January 15, 2010, the Listing Council notified the Company that it affirmed the Panels decision to delist the Companys securities. On March 15, 2010, the Company received notification from the NASDAQ Stock Market, LLC Board of Directors (the NASDAQ Board) that the NASDAQ Board has declined to call for review the January 15, 2010 decision of the Listing Council. Accordingly, pursuant to Listing Rule 5825, the Listing Councils decision represents the final decision of NASDAQ. In accordance with Listing Rule 5830 and Rule 12d2-2 under the Securities Exchange Act of 1934, NASDAQ filed an application on Form 25 with the SEC on April 5, 2010, to delist the Companys securities from NASDAQ. The application will become effective ten days after filing.
The Companys common shares are currently quoted on the Pink OTC Markets Inc., continuing under the trading symbol GSIGQ. The Company intends to seek relisting of its common shares on a national exchange as soon as possible once it becomes current in its reporting obligations.
6
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Chapter 11 Bankruptcy Filing
In connection with the Companys failure to file the 2008 Q3 Report, as described in the Explanatory Note, on December 12, 2008, the Company announced that it had received four letters from certain noteholders of the 11% Senior Notes due in 2013, in the principal amount of $210.0 million (the Senior Notes), issued by GSI Group Corporation (GSI US), alleging that the Company had failed to comply with a covenant in the Senior Note Indenture (the Indenture), relating to the Senior Notes, as a result of the Companys failure to file its 2008 Q3 Report within the time period specified by the rules and regulations of the SEC. These noteholders further alleged that, if such failure continued for 60 days from the date that the Company received notices of failure from holders comprising at least 25% of the aggregate principal amount of Senior Notes then outstanding, then such failure would constitute an event of default. Although the Company asserted that the letters did not constitute proper notice as required pursuant to the terms of the Indenture, and notified the trustee under the Indenture as such, the Company continued to work diligently to complete the review by its Audit Committee and to file its 2008 Q3 Report to avoid any claim of an Event of Default from occurring under the Indenture. Upon receipt of the letters from the noteholders, the Company commenced discussions with certain of the noteholders. On February 11, 2009, the Company announced that it entered into forbearance agreements with certain noteholders holding greater than 75% of the outstanding aggregate principal amount of the Senior Notes, pursuant to which such noteholders agreed to forbear from taking any action or exercising any remedies under the Indenture as a result of the Companys delayed periodic reports until February 27, 2009, pursuant to other terms and conditions more specifically set forth therein. On June 30, 2009, the Company announced that it reached an agreement on a non-binding term sheet with certain noteholders to consensually restructure the Companys outstanding obligations under the Senior Notes.
Following negotiations between the Company and certain noteholders about the restructuring, on November 20, 2009 (the Petition Date), GSIG and two of its United States subsidiaries, GSI US and MES International, Inc. (MES and, collectively with GSIG and GSI US, the Debtors), filed voluntary petitions for relief (the Chapter 11 Petitions) under Chapter 11 of the United States Bankruptcy Code (the Bankruptcy Code) in the United States Bankruptcy Court for the District of Delaware (the Court) (the Chapter 11 Cases). Following the Petition Date, the Debtors continue to operate their business as debtors-in-possession under the jurisdiction of the Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Court.
On November 19, 2009, in anticipation of filing the Chapter 11 Petitions, the Debtors entered into a Noteholder Restructuring Support Agreement with eight of ten of the beneficial holders (the Consenting Noteholders) of the Senior Notes, representing Consenting Noteholders holding approximately 88.1% of the outstanding principal amount of the Senior Notes. Pursuant to the Noteholder Restructuring Support Agreement, the Consenting Noteholders agreed, subject to certain conditions, to support the Joint Chapter 11 Plan of Reorganization proposed by the Debtors, which was filed with the Chapter 11 Petitions.
On March 16, 2010, the Debtors entered into an Amended and Restated Plan Noteholder Restructuring Support Agreement (as amended, the Plan Support Agreement) with Consenting Noteholders holding approximately 88.1% of the outstanding principal amount of the Senior Notes. Pursuant to the Plan Support Agreement, the Consenting Noteholders have agreed to support a modified plan, in substantially the form of the Second Modified Joint Chapter 11 Plan of Reorganization for the Debtors as filed with the Court on March 16, 2010, and attached as Exhibit A to the Amended Plan Support Agreement (the Second Modified Plan).
On April 9, 2010, the Debtors filed their Third Modified Joint Chapter 11 Plan of Reorganization (as modified, the Plan) with the Court, which reflected further modifications to the Second Modified Plan. The terms of the Plan are hereafter described under the heading The Third Modified Joint Chapter 11 Plan of Reorganization.
The Third Modified Joint Chapter 11 Plan of Reorganization
Pursuant to the Plan, which is subject to Court approval, the holders of claims under the Senior Notes (the Senior Note Claims) would, in exchange for the Senior Note Claims, receive their pro rata share of (i) shares of new convertible preferred stock of GSIG (the Preferred Shares), which, on an as-converted basis, would represent approximately 53.8% of GSIGs post-consummation outstanding shares, (ii) new secured notes in the aggregate amount of $110 million, (iii) excess cash available under the Plan to the extent certain allowed claims exceed $22.5 million and (iv) a cash payment (the Cash Payment) in an amount of $69,315 for each day from and including the Petition Date until the plan distribution date. Under the terms of the Plan and because the Debtors commenced the Chapter 11 Cases by November 20, 2009, this Cash Payment would be reduced by $2.1 million. On the effective date of the Plan, GSIG would also pay any and all interest accrued on the Senior Note Claims until the Petition Date. As of the Petition Date, there is approximately $6.03 million in accrued and unpaid interest with respect to the Senior Notes. The Preferred Shares would have a 1x liquidation preference and be
7
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
mandatorily redeemable after 8 years for cash or, if certain circumstances are met, common shares of GSIG. The Preferred Shares would be voted on an as-converted basis together with GSIGs common shares and share pari passu in any dividend declared on common shares, but not have any guaranteed fixed dividend rights. The interest rate on the new secured notes would be 12.25% and, at GSI USs option, subject to GSIGs compliance with a fixed charge coverage ratio defined in the indenture for the new secured notes to be entered into upon the effective date of the Plan, would be payable in kind at a compounded rate of 13%. The new secured notes would be issued by GSI US, guaranteed by GSIG, ten of GSI USs United States subsidiaries, and two of GSIGs Canadian subsidiaries and secured by substantially all the assets of GSI US and the guarantors.
As part of the Plan, GSIGs wholly owned subsidiary, GSI Group Limited, would, in exchange for claims under an unsecured note in the principal amount (as fixed pursuant to the Plan) of $20 million, payable by GSI US to GSI Group Limited (the GSI UK Note Claim), receive (i) Preferred Shares, which, on an as-converted basis, would represent approximately 5.1% of GSIGs post-consummation outstanding shares, (ii) approximately $10.5 million of the new secured notes, (iii) its pro rata share of the excess cash available under the Plan to the extent certain allowed claims exceed $22.5 million and (iv) its pro rata share of the Cash Payment, as adjusted. On the effective date of the Plan, GSIG would also pay interest accrued on the GSI UK Note Claim until the Petition Date.
As contemplated by the Plan, existing shareholders would (i) retain 41.1% of GSIGs post-consummation outstanding shares, which would be issued in common shares and (ii) receive one series of three-year warrants to purchase a number of common shares equal to 10% of 111% of the post consummation outstanding shares of GSIG (that is, the number of shares of GSIG that would equal 10% of the shares of GSIG, including the Preferred Shares on an as-converted basis, before taking into account the number of shares represented by such warrants) at a strike price of $2.50 per share.
Under the proposed Plan, all classes of claims, including all claims by vendors and suppliers, would be unimpaired and paid in full, except for the Senior Note Claims, the GSI UK Note Claim and the equity interest in GSIG.
The Plan provides that its effectiveness is subject to customary conditions, including, without limitation, that the effective date occurs on or before May 20, 2010, unless such date is extended pursuant to the Plan Support Agreement.
The Plan contemplates that the Debtors will continue to operate their businesses in substantially their current form. On November 23, 2009, the Debtors obtained the Courts approval of so-called first day motions providing for the continued payment of vendors and suppliers under normal terms in the ordinary course of business for goods and services provided to the Debtors prior to and after the Petition Date. On December 18, 2009, the Court approved the Plan Support Agreement. The Court further approved the Debtors Disclosure Statement with respect to the Plan on January 8, 2010, and set a date for consideration of confirmation of the Plan for April 16, 2010.
The Plan provides that, following the effective date of the Plan, GSIGs Board of Directors would be comprised of seven directors, to include its Chief Executive Officer, three members to be appointed by the beneficial holders of the Senior Notes, two members to be appointed by the current shareholders of GSIG and one member to be appointed by the current board of directors of GSIG, which member will be selected from the members of GSIGs current board of directors as of the date of the Plan. The Plan anticipates that the current officers of GSIG would continue as officers of GSIG following the effective date of the Plan.
The recoveries summarized above and the other terms of GSIGs restructuring are more fully described in the Plan, which forms a part of the Plan Support Agreement.
The Plan Support Agreement
The Debtors proposed financial restructuring, as set forth in the Plan, has the support of Consenting Noteholders holding approximately 88.1% of the principal amount of the outstanding Senior Notes, representing 80% of all holders of the Senior Notes. The Plan Support Agreement was approved by the Court on December 18, 2009, and, as noted above, was amended and restated on March 16, 2010.
The Plan Support Agreement requires the Consenting Noteholders, and their successors and assigns, (i) to timely file a notice with the Court indicating that the votes previously submitted by the Consenting Noteholders with respect to the Plan shall constitute and be deemed votes accepting and in favor of the Plan, (ii) not to object to confirmation of the Plan and not
8
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
to object to, or otherwise commence, any proceeding to oppose or alter the Plan or support an alternative restructuring, (iii) not to withdraw, change or revoke their votes with respect to the Plan, except as otherwise permitted in the Plan Support Agreement, and (iv) except as otherwise permitted in the Plan Support Agreement, not to take any other action, including commencing any legal proceeding, that is inconsistent with, or that would materially prevent, hinder or delay the consummation of, the restructuring.
The support of the Consenting Noteholders under the Plan Support Agreement will terminate under certain circumstances, including, without limitation, if (i) the Debtors are in material breach of any obligations under the Plan Support Agreement, (ii) the Debtors file any motion or pleading with the Court that is inconsistent in a material respect with the Plan Support Agreement or the Plan, (iii) the Court grants relief that is materially inconsistent with the Plan Support Agreement or the Plan, (iv) the Debtors fail to achieve certain deadlines with respect to the approval of the Plan Support Agreement or the disclosure statement or confirmation or effectiveness of the Plan, (v) a trustee is appointed in the Chapter 11 Cases or any of the Chapter 11 Cases is dismissed or converted to a case under Chapter 7 of the Bankruptcy Code or if the Debtors make a motion for such appointment, dismissal or conversion, (vi) the Court enters an order invalidating, disallowing, subordinating, recharacterizing or limiting the principal and interest components of the Senior Note Claims or disgorging any amounts paid prior to the Petition Date from any holder of the Senior Note Claims or (vii) there is a Material Adverse Change to GSIG (as defined in the Plan Support Agreement).
The Plan Support Agreement provides that GSIG shall use its best efforts to (i) support and complete the restructuring and all transactions contemplated by the Plan, (ii) take any and all necessary and appropriate actions in furtherance of the restructuring, (iii) complete the restructuring and all transactions contemplated under the Plan within set time-frames, (iv) obtain any and all required regulatory and/or third-party approvals for the restructuring, and (v) not directly or indirectly seek, solicit, support, consent to, or participate in the negotiation or formulation of alternate plans of reorganization, certain other corporate transactions, such as mergers, dissolutions, or a sale of substantially all of GSIGs assets or any other action that is inconsistent with the reorganization as contemplated by the Plan Support Agreement.
Subsequent to the Petition Date, the provisions in Financial Accounting Standards Board (FASB) Staff Position (FSP) 90-7-1, Financial Reporting by Entities in Reorganization under the Bankruptcy Code, apply to the Debtors financial statements while the Debtors operate under the provisions of Chapter 11. FSP 90-7-1 does not change the application of generally accepted accounting principles in the preparation of financial statements. However, FSP 90-7-1 does require that the financial statements, for periods including and subsequent to the filing of the Chapter 11 petition, distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business.
Companies Creditors Arrangement Act
On April 8, 2010, the Debtors commenced certain parallel proceedings to the Chapter 11 Cases before the Court of Queens Bench of New Brunswick (the NB Court), pursuant to section 46 of the Companies Creditors Arrangement Act, for an order of the NB Court recognizing the foreign main proceeding constituting the Chapter 11 Cases and seeking relief from certain actions by the NB Court.
Going Concern
Operating in bankruptcy imposes significant risks and uncertainties on our business. See Item 1A Risk Factors Risks Relating to Bankruptcy for a discussion of the risks and uncertainties relating to our business and investing in the Companys securities as a result of the Chapter 11 Cases.
The Company believes that when it emerges from bankruptcy, it will be sufficiently capitalized. The Company expects that it will have assets that exceed its liabilities, and that those assets, as well as the net assets derived from its continuing operations, will be sufficient to meet the Companys obligations, including the obligations with respect to the payment of interest, and repayment of principal under the New Term Loan. Notwithstanding the Companys expectation upon its emergence from bankruptcy, uncertainties inherent in the bankruptcy process raise substantial doubt about the Companys ability to continue as a going concern. In particular, until the terms of the Plan are confirmed by the Court, the Company may be required to pay the Senior Note Claims under the original terms of the Senior Notes. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
9
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
2. Restatement of Previously Issued Financial Statements
In August 2008, the Company completed its acquisition of Excel. Delays in the integration of the financial accounting systems of the Company and Excel following the acquisition initially led to a delay of several weeks in the preparation of the Companys Quarterly Report on Form 10-Q for the quarterly period ended September 26, 2008 (the 2008 Q3 Report). Shortly thereafter and prior to filing the 2008 Q3 Report, the Company initiated an internal review of certain potential errors in the recognition of revenue related to sales to a customer in the first and second fiscal quarters of 2008 in the Companys Semiconductor Systems Segment, which were brought to the attention of the Audit Committee of the Companys Board of Directors (the Audit Committee) by Company management. Following this initial internal review, the Audit Committee, in consultation with the Companys outside legal counsel, determined that it was appropriate to undertake an independent review of the potential revenue recognition issues brought to its attention.
On or about November 25, 2008, the Audit Committee initiated a broader independent review of sales transactions in the Semiconductor Systems Segment, along with certain other sales transactions that contain arrangements with multiple deliverables for fiscal years 2007 and 2008. The review was subsequently expanded to include fiscal year 2006. To assist in its review, the Audit Committee retained independent legal counsel and forensic accounting experts.
On December 4, 2008, the Company announced that it identified errors in the recognition of revenue related to sales to a customer in the first and second fiscal quarters of 2008 in the Semiconductor Systems Segment and that the previously issued financial statements contained in the Companys Quarterly Reports on Form 10-Q for the periods ended March 28, 2008 and June 27, 2008 should no longer be relied upon.
Subsequently, the Company announced that it had identified additional revenue recognition errors related to the timing of revenue recognition from sales to certain Semiconductor Systems Segment customers during fiscal year 2007. The Audit Committee concluded, upon the recommendation of Company management, that the range of potential adjustments resulting from the identified errors is material to the financial statements of the Company for the periods indicated and as a result, the Audit Committee determined that the previously issued interim and annual historical financial statements for 2007 should no longer be relied upon. The Audit Committee thereafter expanded the scope of its investigation to include fiscal year 2006.
On March 30, 2009, the Company announced that it had identified additional revenue recognition errors related to the timing of revenue recognition from sales to certain Semiconductor Systems Segment customers during fiscal year 2006. The Audit Committee concluded, upon the recommendation of Company management, that the range of potential adjustments resulting from the identified errors is material to the financial statements of the Company for the periods indicated and as a result, the Audit Committee determined that the previously issued interim and annual historical financial statements for 2006 should no longer be relied upon.
The Audit Committees advisors reported the results of the investigation to the Audit Committee on April 24, 2009. The Company voluntarily reported the investigation results to the SEC on April 30, 2009. Thereafter, on June 30, 2009, the Company announced that it was undertaking a preliminary review of the timing of revenue recognized in connection with multiple element arrangements in its Precision Technology Segment from 2004 through 2008 to determine if adjustments need to be made to those periods (collectively with the Audit Committees review of transactions in the Semiconductor Systems Segment and any other related Company reviews of transactions in the Semiconductor Systems Segment and Precision Technology Segment, the Revenue Review).
As part of its Revenue Review procedures, the Company assessed historic revenue transactions back to 2002. Transactions prior to 2004 were reviewed to the extent that the Company had reason to believe such transactions could materially affect the consolidated financial statements for 2004, or any period after 2004. The restated consolidated financial statements include a number of adjustments primarily related to the timing of revenue recognition which impacts revenue, cost of goods sold, deferred revenue, and deferred cost of goods sold.
Adjustments arising from the Revenue Review resulted in sales and their related costs being deferred and recognized in subsequent periods, once all revenue recognition criteria have been met. In addition, these adjustments did not affect the Companys cash balances. As of September 26, 2008, a substantial portion of the revenue identified in the Revenue Review remains deferred, pending the finalization of all deliverables under the terms of the customer arrangements. The corresponding costs have also been deferred and are included as deferred cost of goods sold as a component of other deferred
10
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
assets in the accompanying financial statements. All the deferred revenue and the deferred cost of goods sold have been classified as current or long-term, based on the Companys assessment of when each particular transaction is anticipated to be recognized into revenue.
As discussed further below, the majority of adjustments from the Revenue Review were derived from the Companys incorrect accounting for multiple element arrangements, the determination of fixed and determinable consideration, and the determination of customer acceptance. The Company found inconsistent and incorrect application of its policies. The transactions that are being restated as a result of the Revenue Review include transactions for which the complete facts required to make the appropriate assessment with respect to the timing of the revenue recognition were not communicated to the finance department at the time the initial revenue was booked. Refer to Note 3 of Notes to Consolidated Financial Statements for discussion of the Companys revenue recognition policy.
In addition to adjustments from the Revenue Review, the Company has also recorded the impact of certain adjustments which, due to their materiality, were not previously recorded. Certain of these adjustments affect revenue, cost of goods sold, the provision for income taxes, and, to a lesser extent, operating expenses.
The net effects of all of the restatement adjustments on the statement of operations for the nine months ended September 28, 2007 are as follows (in thousands, except per share data):
Nine Month Period
Ended September 28, 2007 | ||||||||||
As Reported | Adjustments | As Restated | ||||||||
Sales |
$ | 222,614 | $ | 1,085 | $ | 223,699 | ||||
Cost of goods sold |
131,073 | 3,865 | 134,938 | |||||||
Gross profit |
91,541 | (2,780 | ) | 88,761 | ||||||
Operating expenses |
76,229 | (2,203 | ) | 74,026 | ||||||
Income (loss) from operations |
15,312 | (577 | ) | 14,735 | ||||||
Interest income (expense), other income (expense), and foreign exchange transaction gains (losses), net |
5,174 | 279 | 5,453 | |||||||
Income from continuing operations, before income taxes |
20,486 | (298 | ) | 20,188 | ||||||
Income tax provision (benefit) |
6,468 | 390 | 6,858 | |||||||
Income from continuing operations |
14,018 | (688 | ) | 13,330 | ||||||
Income from discontinued operations, net of tax |
277 | (11 | ) | 266 | ||||||
Net income (loss) |
$ | 14,295 | $ | (699 | ) | $ | 13,596 | |||
Net income per share - basic |
$ | 0.34 | $ | (0.02 | ) | $ | 0.32 | |||
Net income per share - diluted |
$ | 0.34 | $ | (0.02 | ) | $ | 0.32 |
11
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The net effects of all of the restatement adjustments on the statement of operations for the three months ended September 28, 2007 are as follows (in thousands, except per share data):
Three Month Period
Ended September 28, 2007 | ||||||||||
As Reported | Adjustments | As Restated | ||||||||
Sales |
$ | 81,076 | $ | 3,001 | $ | 84,077 | ||||
Cost of goods sold |
47,194 | 4,182 | 51,376 | |||||||
Gross profit |
33,882 | (1,181 | ) | 32,701 | ||||||
Operating expenses |
25,889 | (886 | ) | 25,003 | ||||||
Income (loss) from operations |
7,993 | (295 | ) | 7,698 | ||||||
Interest income (expense), other income (expense), and foreign exchange transaction gains (losses), net |
2,383 | | 2,383 | |||||||
Income from continuing operations, before income taxes |
10,376 | (295 | ) | 10,081 | ||||||
Income tax provision (benefit) |
2,713 | 725 | 3,438 | |||||||
Income from continuing operations |
7,663 | (1,020 | ) | 6,643 | ||||||
Income from discontinued operations, net of tax |
109 | (97 | ) | 12 | ||||||
Net income (loss) |
$ | 7,772 | $ | (1,117 | ) | $ | 6,655 | |||
Net income per share - basic |
$ | 0.18 | $ | (0.03 | ) | $ | 0.16 | |||
Net income per share - diluted |
$ | 0.18 | $ | (0.03 | ) | $ | 0.15 |
The net effects of all of the restatement adjustments on the statements of operations for the six months ended June 27, 2008 and June 29, 2007 are as follows (in thousands, except per share data):
Six Month Period Ended June 27, 2008 |
Six Month Period Ended June 29, 2007 | ||||||||||||||||||||
As Reported |
Adjustments | As Restated |
As Reported |
Adjustments | As Restated | ||||||||||||||||
Sales |
$ | 131,800 | $ | (11,106 | ) | $ | 120,694 | $ | 141,538 | $ | (1,916 | ) | $ | 139,622 | |||||||
Cost of goods sold |
80,796 | (5,267 | ) | 75,529 | 83,879 | (317 | ) | 83,562 | |||||||||||||
Gross profit |
51,004 | (5,839 | ) | 45,165 | 57,659 | (1,599 | ) | 56,060 | |||||||||||||
Operating expenses |
49,315 | (1,887 | ) | 47,428 | 50,340 | (1,317 | ) | 49,023 | |||||||||||||
Income (loss) from operations |
1,689 | (3,952 | ) | (2,263 | ) | 7,319 | (282 | ) | 7,037 | ||||||||||||
Interest income (expense), other income (expense), and foreign exchange transaction gains (losses), net |
2,467 | 79 | 2,546 | 2,791 | 279 | 3,070 | |||||||||||||||
Income from continuing operations, before income taxes |
4,156 | (3,873 | ) | 283 | 10,110 | (3 | ) | 10,107 | |||||||||||||
Income tax provision (benefit) |
1,091 | (572 | ) | 519 | 3,755 | (335 | ) | 3,420 | |||||||||||||
Income (loss) from continuing operations |
3,065 | (3,301 | ) | (236 | ) | 6,355 | 332 | 6,687 | |||||||||||||
Income from discontinued operations, net of tax |
136 | 193 | 329 | 168 | 86 | 254 | |||||||||||||||
Net income (loss) |
$ | 3,201 | $ | (3,108 | ) | $ | 93 | $ | 6,523 | $ | 418 | $ | 6,941 | ||||||||
Net income per share - basic |
$ | 0.08 | $ | (0.07 | ) | $ | 0.00 | $ | 0.15 | $ | 0.01 | $ | 0.16 | ||||||||
Net income per share - diluted |
$ | 0.08 | $ | (0.07 | ) | $ | 0.00 | $ | 0.15 | $ | 0.01 | $ | 0.16 |
12
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The net effects of all of the restatement adjustments on the statements of operations for the three months ended June 27, 2008 and June 29, 2007 are as follows (in thousands, except per share data):
Three Month Period Ended June 27, 2008 |
Three Month Period Ended June 29, 2007 | |||||||||||||||||||||
As Reported |
Adjustments | As Restated |
As Reported |
Adjustments | As Restated | |||||||||||||||||
Sales |
$ | 62,772 | $ | (3,303 | ) | $ | 59,469 | $ | 70,266 | $ | 3,634 | $ | 73,900 | |||||||||
Cost of goods sold |
38,340 | (1,479 | ) | 36,861 | 41,271 | 1,992 | 43,263 | |||||||||||||||
Gross profit |
24,432 | (1,824 | ) | 22,608 | 28,995 | 1,642 | 30,637 | |||||||||||||||
Operating expenses |
24,520 | (983 | ) | 23,537 | 25,294 | (919 | ) | 24,375 | ||||||||||||||
Income (loss) from operations |
(88 | ) | (841 | ) | (929 | ) | 3,701 | 2,561 | 6,262 | |||||||||||||
Interest income (expense), other income (expense), and foreign exchange transaction gains (losses), net |
1,138 | | 1,138 | 1,627 | | 1,627 | ||||||||||||||||
Income from continuing operations, before income taxes |
1,050 | (841 | ) | 209 | 5,328 | 2,561 | 7,889 | |||||||||||||||
Income tax provision (benefit) |
94 | 165 | 259 | 2,088 | 389 | 2,477 | ||||||||||||||||
Income (loss) from continuing operations |
956 | (1,006 | ) | (50 | ) | 3,240 | 2,172 | 5,412 | ||||||||||||||
Income from discontinued operations, net of tax |
138 | (28 | ) | 110 | 83 | 24 | 107 | |||||||||||||||
Net income (loss) |
$ | 1,094 | $ | (1,034 | ) | $ | 60 | $ | 3,323 | $ | 2,196 | $ | 5,519 | |||||||||
Net income per share - basic |
$ | 0.03 | $ | (0.02 | ) | $ | 0.01 | $ | 0.08 | $ | 0.05 | $ | 0.13 | |||||||||
Net income per share - diluted |
$ | 0.03 | $ | (0.02 | ) | $ | 0.01 | $ | 0.08 | $ | 0.05 | $ | 0.13 |
The net effects of all of the restatement adjustments on the statements of operations for the three months ended March 28, 2008 and March 30, 2007 are as follows (in thousands, except per share data):
Three Month Period Ended March 28, 2008 |
Three Month Period Ended March 30, 2007 | |||||||||||||||||||||
As Reported |
Adjustments | As Restated |
As Reported |
Adjustments | As Restated | |||||||||||||||||
Sales |
$ | 69,028 | $ | (7,803 | ) | $ | 61,225 | $ | 71,272 | $ | (5,550 | ) | $ | 65,722 | ||||||||
Cost of goods sold |
42,456 | (3,788 | ) | 38,668 | 42,608 | (2,309 | ) | 40,299 | ||||||||||||||
Gross profit |
26,572 | (4,015 | ) | 22,557 | 28,664 | (3,241 | ) | 25,423 | ||||||||||||||
Operating expenses |
24,795 | (904 | ) | 23,891 | 25,046 | (398 | ) | 24,648 | ||||||||||||||
Income (loss) from operations |
1,777 | (3,111 | ) | (1,334 | ) | 3,618 | (2,843 | ) | 775 | |||||||||||||
Interest income (expense), other income (expense), and foreign exchange transaction gains (losses), net |
1,329 | 79 | 1,408 | 1,164 | 279 | 1,443 | ||||||||||||||||
Income from continuing operations, before income taxes |
3,106 | (3,032 | ) | 74 | 4,782 | (2,564 | ) | 2,218 | ||||||||||||||
Income tax provision (benefit) |
997 | (737 | ) | 260 | 1,667 | (724 | ) | 943 | ||||||||||||||
Income (loss) from continuing operations |
2,109 | (2,295 | ) | (186 | ) | 3,115 | (1,840 | ) | 1,275 | |||||||||||||
Income from discontinued operations, net of tax |
(2 | ) | 221 | 219 | 85 | 62 | 147 | |||||||||||||||
Net income (loss) |
$ | 2,107 | $ | (2,074 | ) | $ | 33 | $ | 3,200 | $ | (1,778 | ) | $ | 1,422 | ||||||||
Net income per share - basic |
$ | 0.05 | $ | (0.05 | ) | | $ | 0.08 | $ | (0.05 | ) | $ | 0.03 | |||||||||
Net income per share - diluted |
$ | 0.05 | $ | (0.05 | ) | | $ | 0.08 | $ | (0.05 | ) | $ | 0.03 |
13
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The net effects of all of the restatement adjustments on selected balance sheet accounts as of December 31, 2007, and on the statement of stockholders equity as of December 31, 2006 are as follows (in thousands):
Year Ended December 31, 2007 | ||||||||||
As Reported | Adjustments | As Restated | ||||||||
Assets: |
||||||||||
Cash and cash equivalents |
$ | 171,713 | $ | 674 | $ | 172,387 | ||||
Accounts receivable, net |
71,403 | 228 | 71,631 | |||||||
Inventories |
64,002 | 137 | 64,139 | |||||||
Deferred cost of goods sold: |
||||||||||
Current |
429 | 36,765 | 37,194 | |||||||
Long-term |
| 12,758 | 12,758 | |||||||
Total deferred cost of goods sold |
429 | 49,523 | 49,952 | |||||||
Income tax receivable and deferred tax assets |
30,378 | 16,542 | 46,920 | |||||||
All other assets not listed above |
102,286 | 330 | 102,616 | |||||||
Total assets |
$ | 440,211 | $ | 67,434 | $ | 507,645 | ||||
Liabilities and Stockholders Equity: |
||||||||||
Deferred revenue: |
||||||||||
Current |
$ | 9,949 | $ | 69,513 | $ | 79,462 | ||||
Long-term |
| 22,101 | 22,101 | |||||||
Total deferred revenue |
9,949 | 91,614 | 101,563 | |||||||
Income taxes payable and deferred tax liabilities |
12,846 | 3,076 | 15,922 | |||||||
All other liabilities not listed above |
43,298 | 1,184 | 44,482 | |||||||
Total liabilities |
66,093 | 95,874 | 161,967 | |||||||
Stockholders equity |
374,118 | (28,440 | ) | 345,678 | ||||||
Liabilities and stockholders equity |
$ | 440,211 | $ | 67,434 | $ | 507,645 | ||||
Year Ended December 31, 2006 | ||||||||||
As Reported | Adjustments | As Restated | ||||||||
Decrease in stockholders equity |
$ | 343,073 | $ | (25,397 | ) | $ | 317,676 |
14
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The following table presents the impact of the restatement adjustments to the Companys beginning retained earnings (accumulated deficit) balance, cumulatively to reflect adjustments booked to all periods prior to January 1, 2007 (in thousands):
Amount | ||||
Retained earnings, December 31, 2006 (as previously reported) |
$ | 29,431 | ||
Adjustments from: |
||||
Semiconductor Systems Segment Revenue Review, before income tax effect |
(28,402 | ) | ||
Precision Technology Segment Revenue Review, before income tax effect |
(7,566 | ) | ||
All other non-income tax adjustments |
241 | |||
Income tax adjustments |
10,418 | |||
Total adjustments |
(25,309 | ) | ||
Retained earnings, December 31, 2006 (as restated) |
$ | 4,122 | ||
The net effects of all of the restatement adjustments on the condensed cash flow statements for the nine months ended September 28, 2007 are as follows (in thousands):
Nine Months Ended September 28, 2007 |
||||||||||||
As Reported(1) | Adjustments | As Restated | ||||||||||
Net income (loss) |
$ | 14,295 | $ | (699 | ) | $ | 13,596 | |||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |
12,940 | 2,263 | 15,203 | |||||||||
Changes in assets and liabilities |
(5,049 | ) | (1,436 | ) | (6,485 | ) | ||||||
Cash flows from operating activities |
22,186 | 128 | 22,314 | |||||||||
Cash flows from investing activities |
(6,524 | ) | (212 | ) | (6,736 | ) | ||||||
Cash flows from financing activities |
5,265 | | 5,265 | |||||||||
Effect of exchange rates on cash and cash equivalents |
2,503 | 84 | 2,587 | |||||||||
Net increase (decrease) to cash and cash equivalents |
23,430 | | 23,430 | |||||||||
Cash and cash equivalents, beginning of year (2) |
138,315 | | 138,315 | |||||||||
Cash and cash equivalents, end of year (2) |
$ | 161,745 | | $ | 161,745 | |||||||
(1) | Amounts as reported reflect operating activities associated with discontinued operations as changes in assets and liabilities. |
(2) | The Consolidated Statements of Cash Flows include cash and cash equivalent balances (in thousands) of $1,814 and $530 of the discontinued operations as of December 31, 2006 and the nine months ended September 28, 2007, respectively. |
15
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The net effects of all of the restatement adjustments on the condensed cash flow statements for the six months ended June 27, 2008 are as follows (in thousands):
Six Months Ended June 27, 2008 |
||||||||||||
As Reported(1) | Adjustments | As Restated | ||||||||||
Net income (loss) |
$ | 3,201 | $ | (3,108 | ) | $ | 93 | |||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |
6,304 | (185 | ) | 6,119 | ||||||||
Changes in assets and liabilities |
16,753 | 6,106 | 22,859 | |||||||||
Cash flows from operating activities |
26,258 | 2,813 | 29,071 | |||||||||
Cash flows from investing activities |
(9,924 | ) | (2,517 | ) | (12,441 | ) | ||||||
Cash flows from financing activities |
(6,378 | ) | 130 | (6,248 | ) | |||||||
Effect of exchange rates on cash and cash equivalents |
1,602 | (1,100 | ) | 502 | ||||||||
Net increase (decrease) to cash and cash equivalents |
11,558 | (674 | ) | 10,884 | ||||||||
Cash and cash equivalents, beginning of year (2) |
171,713 | 674 | 172,387 | |||||||||
Cash and cash equivalents, end of year (2) |
$ | 183,271 | | $ | 183,271 | |||||||
(1) | Amounts as reported reflect operating activities associated with discontinued operations as changes in assets and liabilities. |
(2) | The Consolidated Statements of Cash Flows include cash and cash equivalent balances (in thousands) of $1 and $1 of the discontinued operations for the year ended December 31, 2007 and the six months ended June 27, 2008, respectively. |
The following discussion provides additional information regarding the adjustments that were identified during the Revenue Review. Certain transactions may have been restated for multiple reasons but have been included in the most applicable category.
Semiconductor Systems Segment
The Companys product sales to customers of its Semiconductor Systems segment are typically multiple element arrangements. These arrangements generally include: hardware components, software components, installation services, an initial warranty period and training on the use of the product. Certain of these arrangements may also include other elements including specified product or software upgrades, product performance commitments and may also include separately priced extended warranty services.
Multiple Element Arrangements without Objective and Reliable Evidence of Fair Value for Undelivered Elements
The Revenue Review identified certain arrangements whereby there were undelivered elements for which objective and reliable evidence of fair value did not exist at the time that the revenue was initially recorded. The Company has deferred the revenue under these arrangements, and recognizes the revenue at the point in time when such undelivered elements are resolved. These undelivered elements include undelivered hardware, delivered hardware not functioning to specifications, and undelivered future software features or functionality committed as part of the arrangement. Additionally, the Company evaluated the unit of accounting for certain transactions based on the guidance in AICPAs Technical Practice Aid (TPA) 5100.39, Software Revenue Recognition for Multiple Element Arrangements. As a result, certain multiple customer orders that were originally accounted for as separate transactions are accounted for as one transaction in the restatement.
The Determination of Customer Acceptance
Under the Companys policy, sales to customers in Japan, sales to new customers, and sales of new products to existing customers, as defined in its policy, are required to be recorded upon the customer having installed, tested and accepted the product at the customers site. Without acceptance for these types of sales, the Company is unable to conclude
16
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
that the delivery has been achieved in accordance with the criteria in the SECs Staff Accounting Bulletin (SAB) 104, Revenue Recognition. The Revenue Review noted instances whereby the criteria required under its policy to record revenue at the time of shipment had not be achieved; therefore revenue was improperly recognized in an earlier period. In such cases, the Company has deferred revenue recognition until the appropriate customer acceptance was received. Additionally, the Company noted instances where there were two documents representing customer acceptance; one form on a format provided by the Company, and another on a customer-specific form. Often these forms were provided from the customer on separate dates. In these cases of dual acceptance, the Company has performed procedures to assess when all deliverables were made, and then reviewed that against the multiple customer acceptance forms. As a result of these procedures, revenue has been generally recorded on the later of the two acceptance forms dates.
Determination that the Fees are not Fixed or Determinable
Under the Companys policy, arrangements with extended payment terms are not considered to be fixed or determinable. Accordingly, revenue is recognized as the payments become due. The Revenue Review noted instances whereby the arrangements with extended payment terms were not properly identified and revenue was improperly recognized in an earlier period. The revenue, as restated, reflects revenue being recorded as the payments have become due.
Other
The Revenue Review also identified certain other revenue adjustments which were not individually, nor in the aggregate, significant. These adjustments have been reflected in the restated consolidated financial statements and primarily relate to the accounting for separately priced extended warranty contracts. In certain arrangements, the amount deferred for extended warranty contracts differed from the stated price of the extended warranty contracts. In such cases, the Company has adjusted the amount of deferred revenue to equal the stated price of the extended warranty contracts, with the recognition of the adjusted amount recorded over the appropriate period of the extended warranty.
Precision Technology Segment
The Companys product sales to customers of its Precision Technology segment generally represent customer orders for a large volume of one or more types of components and occasionally include services such as installation, training and preventative maintenance plans. In order to meet customer production and inventory requirements, these arrangements frequently provide for the delivery of the components over several quarters.
Multiple Element Arrangements without Objective and Reliable Evidence of Fair Value for Undelivered Elements
The Revenue Review identified certain arrangements whereby there were undelivered elements for which objective and reliable evidence of fair value did not exist at the time that the revenue was initially recorded. Additionally, the Company evaluated the unit of accounting for certain transactions based on the guidance in TPA 5100.39. As a result, certain multiple customer orders that were originally accounted for as separate transactions are accounted for as one transaction in the restatement.
A typical order includes a variety of products shipped over several reporting periods. These transactions were historically recognized based on the invoice price of each product shipped. The restated revenue is recognized under the multiple units shipped methodology, whereby revenue is recognized in each period based upon the lowest common percentage of the products shipped in the period. This approximates a proportional performance model of revenue recognition. This generally results in a partial deferral of revenue to a later reporting period. No revenue is recognized unless one unit of each product has been delivered.
Determination that the Fees are not Fixed or Determinable
The Revenue Review identified certain customer arrangements that included customer rights to adjust the product quantity mix or otherwise involved uncertainty regarding the terms of the arrangement. In such cases, the Company has determined that the arrangement fees are not fixed or determinable and revenue is recognized when the order is completely fulfilled.
17
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Summary of Sales Adjustments
The following tables reflect the adjustments identified during the Companys Revenue Review, as well as from the recording of previously unrecorded immaterial adjustments. The tables present a reconciliation of sales as previously reported to amounts as restated for the periods indicated (in thousands):
Three Months Ended September 28, 2007 |
Nine Months Ended September 28, 2007 |
|||||||
Sales, as previously reported |
$ | 81,076 | $ | 222,614 | ||||
Revenue Restatement Adjustments: |
||||||||
Semiconductor Systems Segment: |
||||||||
Multiple element arrangements |
(4,517 | ) | (8,719 | ) | ||||
Customer acceptance not assured |
289 | 3,584 | ||||||
Price not fixed or determinable |
| (654 | ) | |||||
Other |
(296 | ) | (615 | ) | ||||
Subtotal Semiconductor Systems Segment |
(4,524 | ) | (6,404 | ) | ||||
Precision Technology Segment: |
||||||||
Multiple element arrangements |
(753 | ) | (713 | ) | ||||
Price not fixed or determinable |
8,488 | 8,332 | ||||||
Other |
(210 | ) | (130 | ) | ||||
Subtotal Precision Technology Segment |
7,525 | 7,489 | ||||||
Total revenue restatement adjustments |
3,001 | 1,085 | ||||||
Sales, as restated |
$ | 84,077 | $ | 223,699 | ||||
Three Months Ended | Three Months Ended | Six Months Ended | ||||||||||||||||||||||
March 28, 2008 |
March 30, 2007 |
June 27, 2008 |
June 29, 2007 |
June 27, 2008 |
June 29, 2007 |
|||||||||||||||||||
Sales, as previously reported |
$ | 69,028 | $ | 71,272 | $ | 62,772 | $ | 70,266 | $ | 131,800 | $ | 141,538 | ||||||||||||
Revenue Restatement Adjustments: |
||||||||||||||||||||||||
Semiconductor Systems Segment: |
||||||||||||||||||||||||
Multiple element arrangements |
(5,981 | ) | (7,182 | ) | (6,078 | ) | 2,980 | (12,059 | ) | (4,202 | ) | |||||||||||||
Customer acceptance not assured |
1,108 | 1,685 | 325 | 1,611 | 1,433 | 3,296 | ||||||||||||||||||
Price not fixed or determinable |
(691 | ) | | | (654 | ) | (691 | ) | (654 | ) | ||||||||||||||
Other |
(351 | ) | (221 | ) | (215 | ) | (99 | ) | (566 | ) | (320 | ) | ||||||||||||
Subtotal Semiconductor Systems Segment |
(5,915 | ) | (5,718 | ) | (5,968 | ) | 3,838 | (11,883 | ) | (1,880 | ) | |||||||||||||
Precision Technology Segment: |
||||||||||||||||||||||||
Multiple element arrangements |
(2,121 | ) | 126 | 197 | (86 | ) | (1,924 | ) | 40 | |||||||||||||||
Price not fixed or determinable |
224 | 42 | 2,388 | (198 | ) | 2,612 | (156 | ) | ||||||||||||||||
Other |
9 | | 80 | 80 | 89 | 80 | ||||||||||||||||||
Subtotal Precision Technology Segment |
(1,888 | ) | 168 | 2,665 | (204 | ) | 777 | (36 | ) | |||||||||||||||
Total revenue restatement adjustments |
(7,803 | ) | (5,550 | ) | (3,303 | ) | 3,634 | (11,106 | ) | (1,916 | ) | |||||||||||||
Sales, as restated |
$ | 61,225 | $ | 65,722 | $ | 59,469 | $ | 73,900 | $ | 120,694 | $ | 139,622 | ||||||||||||
18
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Expense Adjustments
In connection with its Revenue Review, the Company has deferred the corresponding direct costs associated with the deferred revenue. These deferred costs have been recorded as deferred cost of goods sold, in the current and long-term sections of the accompanying balance sheets, as appropriate, and are reflected in the statements of operations as cost of goods sold when the related revenue is recognized. These costs represent the direct and incremental costs that are attributable to the product whose revenue is being deferred.
The following tables reflect the adjustments to cost of goods sold and operating expenses that were identified as a result of the Companys Revenue Review, as well as from the recording of previously unrecorded immaterial adjustments. The tables present a reconciliation of previously reported amounts to amounts as restated for the periods indicated (in thousands):
Three Months Ended September 28, 2007 |
Nine Months Ended September 28, 2007 |
|||||||
Cost of goods sold, as previously reported |
$ | 47,194 | $ | 131,073 | ||||
Semiconductor Systems segment adjustments |
(969 | ) | (2,981 | ) | ||||
Precision Technology segment adjustments |
4,265 | 4,146 | ||||||
Reclassification of amortization of intangible assets (core technology) |
886 | 2,700 | ||||||
Cost of goods sold, as restated |
$ | 51,376 | $ | 134,938 | ||||
Operating expenses, as previously reported |
$ | 25,889 | $ | 76,229 | ||||
Reclassification of amortization of intangible assets (core technology) |
(886 | ) | (2,700 | ) | ||||
All other operating expense adjustments |
| 497 | ||||||
Operating expenses, as restated |
$ | 25,003 | $ | 74,026 | ||||
19
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Three Months Ended | Three Months Ended | Six Months Ended | ||||||||||||||||||||||
March 28, 2008 |
March 30, 2007 |
June 27, 2008 |
June 29, 2007 |
June 27, 2008 |
June 29, 2007 |
|||||||||||||||||||
Cost of goods sold, as previously reported |
$ | 42,456 | $ | 42,608 | $ | 38,340 | $ | 41,271 | $ | 80,796 | $ | 83,879 | ||||||||||||
Semiconductor Systems segment adjustments |
(3,507 | ) | (3,298 | ) | (3,815 | ) | 1,286 | (7,322 | ) | (2,012 | ) | |||||||||||||
Precision Technology segment adjustments |
(1,155 | ) | 38 | 1,538 | (157 | ) | 383 | (119 | ) | |||||||||||||||
Reclassification of amortization of intangible assets (core technology) |
874 | 951 | 798 | 863 | 1,672 | 1,814 | ||||||||||||||||||
Cost of goods sold, as restated |
$ | 38,668 | $ | 40,299 | $ | 36,861 | $ | 43,263 | $ | 75,529 | $ | 83,562 | ||||||||||||
Operating expenses, as previously reported |
$ | 24,795 | $ | 25,046 | $ | 24,520 | $ | 25,294 | $ | 49,315 | $ | 50,340 | ||||||||||||
Reclassification of amortization of intangible assets (core technology) |
(874 | ) | (951 | ) | (798 | ) | (863 | ) | (1,672 | ) | (1,814 | ) | ||||||||||||
All other operating expense adjustments |
(30 | ) | 553 | (185 | ) | (56 | ) | (215 | ) | 497 | ||||||||||||||
Operating expenses, as restated |
$ | 23,891 | $ | 24,648 | $ | 23,537 | $ | 24,375 | $ | 47,428 | $ | 49,023 | ||||||||||||
Income Taxes
In connection with its Revenue Review, the Company has reassessed it provision for income taxes. As part of its assessment of its provision for income taxes, the Company has recorded two primary adjustments.
In connection with the Revenue Review, the Company reassessed the probability of realization of deferred tax assets in certain jurisdictions taking into account the effect of the restatement. This assessment, while conducted currently in connection with the restatement activities, was performed using only those facts that were known or expected to be knowable at the time in which each accounting period would have been initially closed. Pursuant to SFAS 109 the Company only recognizes a deferred tax asset when it is more likely than not of recovery, considering future reversal of deferred tax liabilities, available taxable income in carryback periods, the probability of future taxable income after a pattern of generating income in the jurisdiction or tax planning strategies that the Company can implement. Accordingly, adjustments have been reflected to the beginning balance sheet to reduce the deferred tax assets, and the corresponding beginning retained earnings balance.
The provision for income taxes has been further adjusted to reflect the statutory rate, adjusted by timing items and other appropriate current period tax credits, as applied against the as adjusted income and loss of the Company in various periods. See Note 12 of the Notes to Consolidated Financial Statements for further disclosure.
3. Summary of Significant Accounting Policies
Basis of presentation
These consolidated financial statements have been prepared by the Company in U.S. dollars and in accordance with U.S. generally accepted accounting principles, applied on a consistent basis.
The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (SEC), and the instructions to Form 10-Q and the provisions of Regulation S-X pertaining to interim financial statements. Accordingly, certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations.
20
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The interim consolidated financial statements include the accounts of the Company. Intercompany transactions and balances have been eliminated. In the opinion of management, all adjustments and accruals necessary for a fair presentation have been made and include only normal recurring adjustments and accruals. The results for interim periods are not necessarily indicative of results to be expected for the year or for any future periods.
Basis of consolidation
The consolidated financial statements include the accounts of GSI Group Inc. and its wholly owned subsidiaries, including the accounts of Excel since August 20, 2008. The accounts of Excel include its 50% owned joint venture, Excel Laser Technology Private Limited (Excel SouthAsia JV), since it is a variable interest entity and the Company is the primary beneficiary of the joint venture. Financial information related to the joint venture is not considered material to the consolidated financial statements. Intercompany accounts and transactions have been eliminated.
Comparative amounts
In addition to the adjustments from the restatement, certain prior quarter amounts have been reclassified to conform to the current quarter presentation in the financial statements and notes as of and for the quarter ended September 26, 2008. These reclassifications primarily relate to the Companys discontinued operations, which have been presented separately in the accompanying consolidated financial statements, as further described in Note 5. These reclassifications also include an adjustment to reflect the amortization of core technology in cost of goods sold. Since these costs had previously been included in selling, general and administrative expenses, the adjustment for this reclassification is included as a separate line in the restatement schedules in Note 2 that present the nature of the changes to the cost of goods sold and operating expenses. These reclassifications had no effect on the Companys previously reported results of operations, or financial position.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of sales and expenses during the reporting periods. On an ongoing basis, the Company evaluates its estimates, assumptions and judgments, including those related to revenue recognition; allowance for doubtful accounts; inventory costing and reserves; the assessment of warranty reserves; the valuation of goodwill, intangible assets and other long-lived assets; accounting for business combinations; share-based payments; employee benefit plans; accounting for restructuring activities; accounting for income taxes and related valuation allowances; and, accounting for loss contingencies. Actual results could differ significantly from those estimates.
Cash and cash equivalents
Cash equivalents consist principally of money market funds invested in U.S. Treasury Securities and repurchase agreements of U.S. Treasury Securities that have original maturities of 90 days or less. The Company does not believe it is exposed to any significant credit risk related to its cash equivalents.
Financial instruments and fair value measurements
Financial instruments with remaining maturities that are payable within one year from the balance sheet date are classified as current. Financial instruments with remaining maturities that are payable more than one year from the balance sheet date are classified as long-term.
Long-term Investments
As of September 26, 2008, the Company held auction rate securities, recorded at a fair value of $25.9 million, and with a par value of $32.3 million. These securities were acquired as part of the Companys purchase of Excel in 2008. These auction rate notes are student loans backed by the federal government and are privately insured. Current capital market conditions have impacted the Companys ability to liquidate certain auction rate securities. Liquidity for these auction rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals, usually every 7, 28, 35 or 90 days. In the past, the auction process has allowed investors to roll over their holdings or obtain immediate liquidity by selling the securities at par. Due to the current capital market conditions, auctions have not had
21
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
sufficient bidders to allow investors to complete a sale of some auction rate securities. Due to the uncertainty in the market as to when these auction rate notes will be refinanced or the auctions will resume, the Company has classified these instruments as long-term assets available for sale. If the credit ratings of the issuer, the bond insurers or the collateral deteriorates further, or if the issuers of these auction rate securities are unable to successfully close further auctions, the Company may further reduce the carrying value of these investments and may in the future be required to record impairment charges against these investments, some of which may be considered other-than-temporary impairment charges. From the date of the Companys acquisition of Excel, through September 26, 2008, the Company has recorded an unrealized gain on these investments of $0.9 million and has recorded that gain, net of tax, within other comprehensive income. See Note 17 for discussion of sales of auction rate securities after September 26, 2008.
At September 26, 2008 and December 31, 2007, the Company had a 25.1% equity investment in a privately held company located in the United Kingdom, valued at $0.9 million at September 26, 2008 and December 31, 2007, and included in Other Assets in the accompanying consolidated balance sheets. The Company uses the equity method to record the results of this entity. In relation to this investment, the Company recognized gains as other income of approximately $87,000 and approximately $117,000 for the nine months ended September 26, 2008 and September 28, 2007, respectively. In relation to this investment, the Company recognized a loss as other expense of approximately $56,000 for the three months ended September 26, 2008 and a gain as other income of approximately $23,000 for the three months ended September 28, 2007.
Fair Value Measurements
On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) 157, Fair Value Measurements, with no impact on its consolidated results and financial position. SFAS 157 defines fair value, establishes a framework for measuring fair value, and enhances disclosures about fair value measurements. Fair value is defined as the price that would be received for an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Valuation techniques must maximize the use of observable inputs and minimize the use of unobservable inputs.
SFAS 157 establishes a value hierarchy based on three levels of inputs, of which the first two are considered observable and the third is considered unobservable:
| Level 1. Quoted prices for identical assets or liabilities in active markets which we can access. |
| Level 2. Observable inputs other than those described in Level 1. |
| Level 3. Unobservable inputs. |
The following table summarizes the financial assets, as of September 26, 2008, that are measured at fair value on a recurring basis (in thousands):
September 26, 2008 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant
Other Unobservable Inputs (Level 3) | |||||||||
Cash equivalents (a) |
$ | 38,459 | $ | 38,459 | $ | | $ | | ||||
Auction rate securities (b) |
25,860 | | | 25,860 | ||||||||
Total |
$ | 64,319 | $ | 38,459 | $ | | $ | 25,860 | ||||
(a) | Cash equivalents are valued at quoted market prices in active markets. |
(b) | Auction rate securities are valued based on assumptions that market participants might use in their estimates of fair value (including, among other factors, underlying collateral and lack of liquidity). |
The following table summarizes the activity with respect to the auction rate securities (in thousands):
Balance at December 31, 2007 |
$ | | |
Added in connection with Excel acquisition |
24,985 | ||
Unrealized gains |
875 | ||
Balance at September 26, 2008 |
$ | 25,860 | |
22
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
See Note 8 of the Notes to Consolidated Financial Statements for discussion of the estimated fair value of our Senior Notes.
Accounts receivable and allowance
Trade accounts receivable are recorded at the invoiced amount. The Company generally does not require collateral for trade accounts receivable. The Company maintains an allowance for doubtful accounts. The allowance for doubtful accounts is based on the Companys best estimate of the amount of probable credit losses resulting from the inability of the Companys customers to make required payments. The Company determines the allowance based on a variety of factors including the age of amounts outstanding relative to their contractual due date, specific customer factors, and other known risks and economic trends in industries. Charges booked to the allowance for doubtful accounts are recorded as selling, general and administrative expenses, and are recorded in the period that they are determined to be uncollectible.
Inventories
Inventories, which include materials and conversion costs, are stated at the lower of cost or market, using the first-in, first-out method. Market is defined as replacement cost for raw materials and net realizable value for other inventories. Demo inventory is recorded at the lower of cost or its net realizable value.
Property, plant and equipment
Property, plant and equipment are stated at cost and the Company uses the straight-line method to determine depreciation and amortization over estimated useful lives. Estimated useful lives for buildings and improvements range from 3 to 60 years and for machinery and equipment from 1 to 13 years. Leasehold improvements are amortized over the lesser of their useful lives or the lease term, including option periods expected to be utilized. Repairs and maintenance are expensed as incurred.
The carrying values of property, plant and equipment are reviewed for impairment whenever changes in events or circumstances indicate their carrying values may not be recoverable. The impairment analyses are conducted in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-lived Assets. No impairment charges were recorded in the third quarter or first nine months of 2008 or 2007. In the fourth quarter of 2008, the Company recorded a charge to reduce the carrying value of its goodwill, intangible assets and other long-lived assets by $215.1 million, including $5.4 million to write-down property, plant and equipment to fair value. See the section on Impairment below and Note 17 for additional information on this subsequent event.
Business combinations
The Company determines and allocates the purchase price of an acquired company to the tangible and intangible assets acquired and liabilities assumed as well as to in-process research and development as of the business combination date in accordance with SFAS 141, Business Combinations. The purchase price allocation process requires the Company to use significant estimates and assumptions, including fair value estimates, as of the business combination date including:
| estimated fair values of intangible assets; |
| expected costs to complete any in-process research and development projects; |
| estimated income tax assets and liabilities assumed from the acquiree; and, |
| estimated fair value of pre-acquisition contingencies assumed from the acquiree. |
While the Company uses its best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business combination date, its estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the purchase price allocation period, the Company records adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill. Generally, with the exception of unresolved income tax matters, subsequent to the purchase price allocation period any adjustment to assets acquired or liabilities assumed is included in operating results in the period in which the adjustment is determined.
23
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
In-process research and development costs are expensed when acquired and represent the estimated fair value as of the dates of acquisition of in-process projects acquired that have not yet reached technological feasibility and have no alternative future uses.
In fiscal 2009, the Company will adopt SFAS 141 (revised 2007), Business Combinations. Refer to Recent Accounting Pronouncements (below) for additional information.
Goodwill and intangible assets
Goodwill represents the excess of the purchase price in a business combination over the fair value of the acquired tangible and intangible net assets. In connection with its acquisition of Excel, the Company acquired certain trade names classified as intangible assets with indefinite lives. Goodwill and indefinite-lived intangibles are not amortized but they are required to be assessed for impairment at least annually. The Company also has certain intangible assets with definite lives that are amortized over their estimated useful lives. These definite-lived intangible assets were acquired in connection with the Companys historic business combinations. Their estimated useful lives are the periods over which their economic benefits are expected to be realized. The Company reviews its useful life assumptions, including the classification of certain intangible assets as indefinite-lived, on a periodic basis to determine if changes in circumstances warrant revisions to them. The Companys most significant intangible assets are acquired technology; customer relationships; and trademarks and trade names.
All of the Companys goodwill and intangible assets reside in our Precision Technology and Excel Segments.
Impairment
Our product lines generally correspond with our reporting units which is the level at which we evaluate our goodwill, intangible assets and other long-lived assets for impairment. The values of each reporting unit include assets and liabilities which relate to the reporting units operations. Additionally, reporting units that benefit from corporate assets or liabilities are allocated a portion of those corporate assets and liabilities on a systematic, proportional basis. Impairment analyses of goodwill and indefinite-lived intangible assets are conducted in accordance with SFAS 142, Goodwill and Other Intangible Assets. We test our goodwill balances annually in the beginning of the second quarter and more frequently if indicators are present or changes in circumstances suggest that impairment may exist. The Companys indefinite-lived intangible assets represent trade names that were acquired in the August 2008 acquisition of Excel. We will assess these indefinite-lived intangible assets for impairment on an annual basis in the beginning of the second quarter, beginning in 2009, and more frequently if indicators are present or changes in circumstances suggest that impairment may exist.
Intangible assets with definite lives are amortized over their estimated useful lives. The carrying values of definite-lived intangible assets and other long-lived assets (property, plant and equipment) are reviewed for impairment whenever changes in events or circumstances indicate their carrying values may not be recoverable. The impairment analyses are conducted in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-lived Assets.
No impairment charges were recorded in the third quarter or first nine months of 2008 or 2007. In the fourth quarter of 2008, the Company recorded a charge to reduce the carrying value of its goodwill, intangible assets and other long-lived assets by $215.1 million. The impairments of intangible assets and other long-lived assets (property, plant and equipment) were reflected as reductions in their gross carrying amounts. See Note 17 for additional information on this and other subsequent events.
Revenue recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, risk of loss has passed to the customer and collection of the resulting receivable is reasonably assured. Revenue recognition requires judgment and estimates, which may affect the amount and timing of revenue recognized in any given period.
The Company follows the provisions of Emerging Issues Task Force (EITF) 00-21, Revenue Arrangements with Multiple Deliverables for all multiple element arrangements. Under EITF 00-21, the Company assesses whether the
24
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes and whether objective and reliable evidence of fair value exists for these separate units of accounting. The Company applies the residual method when objective and reliable evidence of fair value exists for all of the undelivered elements in a multiple element arrangement. When objective and reliable evidence of fair value does not exist for all of the undelivered elements in a multiple element arrangement, the Company recognizes revenue under the multiple units shipped methodology, whereby revenue is recognized in each period based upon the lowest common percentage of the products shipped in the period. This approximates a proportional performance model of revenue recognition. This generally results in a partial deferral of revenue to a later reporting period. No revenue is recognized unless one unit of each product has been delivered.
Although certain of the Companys products contain operating and application software, the Company has determined the software element is incidental in accordance with the AICPAs Statement of Position (SOP 97-2) and EITF 03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.
The Company determines the unit of accounting for certain transactions based on the guidance in TPA 5100.39. In particular, multiple purchase orders may be deemed to be interrelated and considered to constitute a multiple element arrangement for accounting purposes.
Semiconductor Systems transactions are generally multiple element arrangements which may include hardware, software, installation, training, an initial standard warranty, and optional extended warranty arrangements. The Company generally designs, markets and sells these products as standard configurations. For those standard configurations where acceptance criteria, if any, exist and are demonstrated prior to shipment, revenue is recorded at the time of shipment. For those cases where acceptance criteria cannot be demonstrated prior to shipment of a product or if a significant amount of fees are due upon acceptance, the Company recognizes revenue upon customer acceptance. Acceptance is generally required for sales of Semiconductor Systems segment products to Japanese customers, sales of New Products, which are considered by the Company, for purposes of revenue recognition determination, to be either (a) a product that is newly released to all customers, including a product which may have been existing previously, but which has been substantially upgraded with respect to its features or functionality; or, (b) the sale of an existing product to a customer who has not previously purchased that product. The Company follows a set of predetermined criteria when changing the classification of a New Product to a standard configuration whereby acceptance criteria are considered to be demonstrated at the time of shipment.
Precision Technology and Excel transactions include both single element and multiple element transactions. Multiple element transactions may include two or more products and occasionally also contain installation, training or preventative maintenance plans. Revenue is generally recognized under the multiple units shipped methodology described above.
The Companys Semiconductor Systems segment also sells spare parts and consumable items, which are not subject to acceptance criteria. Revenue for these spare parts and consumable items is generally recognized under the multiple units shipped methodology described above.
Installation is generally a routine process that occurs within a short period of time from delivery and the Company has concluded that this obligation is inconsequential and perfunctory. As such, for transactions that include installation, and for which customer acceptance has not been deemed necessary in order to record the revenue, the cost of installation is accrued at the time product revenue is recorded and no related revenue is deferred. Historically, the costs of installation have not been significant.
The initial standard warranty for product sales is accounted for under the provisions of SFAS 5, Accounting for Contingencies, as the Company has the ability to ascertain the probable likelihood of the liability, and can estimate the amount of the liability. A provision for the estimated cost related to warranty is recorded to cost of goods sold at the time revenue is recognized. The Companys estimate of costs to service the warranty obligations are based on historical experience and expectations of future conditions. To the extent the Company experiences increased warranty claims or increased costs associated with servicing those claims, revisions to the estimated warranty liability are recorded as increases or decreases to the accrual at that time, with an offsetting entry recorded to cost of goods sold.
The Company also sells optional extended warranty services, and preventative maintenance contracts, at the time of their product purchase. The Company accounts for these agreements in accordance with provisions of FASB Technical Bulletin (FTB) 90-1 Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts under which it recognizes the separately priced extended warranty and preventative maintenance fees over the associated period.
25
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The Company, at the request of its customers, may at times perform professional services for its customers, generally for the maintenance and repairs of products previously sold to those customers. These services are usually in the form of time and materials based contracts which are short in their duration. Revenue for time and material services is recorded at the completion of services requested under a customers purchase order. Customers may, at times subsequent to the initial product sale, purchase a service contract whereby services, including preventative maintenance plans, are provided over a defined period, generally one year. Revenue for such service contracts are recorded ratably over the period of the contract.
The Company typically negotiates trade discounts and agreed terms in advance of order acceptance and records any such items as a reduction of revenue. The Companys revenue recognition policy allows for revenue to be recognized under arrangements where the payment terms are 180 days or less, presuming all other revenue recognition criteria have been met. From time to time, based on the Companys review of customer creditworthiness and other factors, the Company may provide its customers with payment terms that exceed 180 days. To the extent all other revenue recognition criteria have been met, the Company recognizes revenue for these extended payment arrangements as the payments become due.
The Company has significant deferred revenue included in its accompanying consolidated balance sheets, with balances (including both current and long-term amounts) of $108.6 million and $101.6 million as of September 26, 2008 and December 31, 2007, respectively. A significant majority of these amounts relate to arrangements whereby the entire arrangement has been accounted for as deferred revenue, as there is no fair value for the undelivered elements. Upon the final delivery of the undelivered element(s) of the arrangement, the revenue will be recorded for that arrangement. To a much lesser extent, the deferred revenue balances relate to either: (a) the unrecognized portion of a multiple element arrangements that is being recognized into revenue over a ratable basis as associated services are performed; (b) arrangements not currently recognizable due to the arrangement not being fixed and determinable at its inception; (c) the future amortization to revenue of extended warranty contracts and preventative maintenance plans; (d) revenue deferrals for product shipments with FOB destination shipping terms; and (e) deposits from customers against future orders. The classification of deferred revenue, and deferred cost of goods sold, is based on the Companys expectations relative to when the revenue will be recognizable, based on facts known to the Company as of the date its financial statements are released.
Deferred cost of goods sold
The Company defers the corresponding direct costs associated with the deferred revenue. These deferred costs have been recorded as deferred cost of goods sold, in the current and long-term sections of the accompanying balance sheets, as appropriate, and are reflected in the statements of operations as cost of goods sold when the related revenue is recognized. These costs represent the direct and incremental costs that are attributable to the product whose revenue is being deferred.
Research and development and engineering costs
Internal costs relating to research and development and engineering costs incurred for new products and enhancements to existing products are expensed as incurred.
Product warranty
The Company generally warrants its products for material and labor to repair and service the system. The standard warranty is generally a period of up to 12 months, with the exception of two product lines, DRC Encoders and JK lasers, both being product lines that are included in the Precision Technology segment, and which have a warranty period of 24 months. The accounting for warranty provisions is discussed in the Revenue Recognition section of this Note 3.
Share-based compensation
The Company has stock-based compensation plans which are more fully described in Note 10. The Company adopted SFAS 123(R) Accounting for Share-Based Payment on a modified prospective basis effective January 1, 2006.
26
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Shipping & handling costs
Shipping and handling costs are recorded in cost of goods sold.
Advertising costs
Advertising costs are expensed as incurred.
Foreign currency translation
The financial statements of the Company and its subsidiaries outside the United States have been translated into United States dollars in accordance with the SFAS 52, Foreign Currency Translation. Assets and liabilities of foreign operations are translated from foreign currencies into United States dollars at the exchange rates in effect on the balance sheet date. Sales and expenses are translated at the average exchange rate in effect for the period. Accordingly, gains and losses resulting from translating foreign currency financial statements are reported as a separate component of other comprehensive income in stockholders equity. Foreign currency transaction gains and losses are included in net income on the accompanying consolidated statements of operations. Foreign exchange transaction losses were $2,000 for the quarter ended September 26, 2008 and foreign exchange transaction gains were $682,000 for the quarter ended September 28, 2007. Foreign exchange transaction gains were $269,000 and $463,000 for the nine months ended September 26, 2008 and September 28, 2007, respectively.
These amounts arose primarily from transactions denominated in currencies other than the functional currency, as well as from gains or (losses) on derivative contracts.
Restructuring charges
In accounting for its restructuring activities, the Company follows the provisions of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. In accounting for these obligations, the Company makes assumptions related to the amounts of employee severance, benefits, and related costs and to the time period over which facilities will remain vacant, sublease terms, sublease rates and discount rates. Estimates and assumptions are based on the best information available at the time the obligation has arisen. These estimates are reviewed and revised as facts and circumstances dictate; changes in these estimates could have a material effect on the amount previously expensed against the Companys earnings, and currently accrued on the Companys consolidated balance sheet.
Accumulated other comprehensive income (loss)
The following table provides the details of accumulated other comprehensive income at:
September 26, 2008 | December 31, 2007 (As Restated) |
|||||||
Accumulated foreign currency translations |
$ | 9,046 | $ | 11,660 | ||||
Unrealized gain on available for sale investments, net of tax of $335 |
540 | | ||||||
Accrued pension liability, net of tax of $271 (December 31, 2007 $227) |
(3,972 | ) | (4,274 | ) | ||||
Total accumulated other comprehensive income |
$ | 5,614 | $ | 7,386 |
27
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Comprehensive net income (loss)
The components of comprehensive income (loss) are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 26, 2008 |
September 28, 2007 (As Restated) |
September 26, 2008 |
September 28, 2007 (As Restated) |
|||||||||||||
Net income (loss) |
$ | (14,229 | ) | $ | 6,655 | $ | (14,136 | ) | $ | 13,596 | ||||||
Change in foreign currency translation adjustments (1) |
(3,920 | ) | 2,569 | (2,615 | ) | 4,993 | ||||||||||
Unrealized gain on available for sale investments, net of tax |
540 | | 540 | | ||||||||||||
Change in accrued pension liability, net of tax |
297 | (24 | ) | 302 | (224 | ) | ||||||||||
Cumulative effect of adopting FIN 48 |
| | | (136 | ) | |||||||||||
Accumulated comprehensive net income (loss) |
$ | (17,312 | ) | $ | 9,200 | $ | (15,909 | ) | $ | 18,229 | ||||||
(1) | The foreign currency translation adjustments are primarily related to the movement in the British Pound, Japanese Yen and European Union Euro. |
Derivative financial instruments
The Companys primary objective for holding derivative financial instruments is to manage currency risk. In accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities, the Companys accounting policies for these instruments are based on whether they meet the criteria for designation as hedging transactions, including cash flow, or net investment hedges. The Company did not have any derivative instruments that qualify for hedge accounting under SFAS 133 at September 26, 2008 or December 31, 2007. In cases when the Company does have derivative contracts, it records all derivatives at fair value as assets or liabilities in the consolidated balance sheet and any changes are recognized in other income and expense.
When the Company enters into foreign currency derivative contracts, the contracts are generally for less than six months duration with the purpose of hedging foreign currency risk on sales transactions. At September 26, 2008, the Company held forward contracts to: sell Japanese yen for the equivalent of $3.7 million; buy British Pounds and European Union Euros for $7.4 million and $1.2 million, respectively. As of September 26, 2008, the Company has recorded an unrealized gain of $4,000 relating to these contracts. At December 31, 2007, the Company held forward contracts to: sell Japanese yen for the equivalent of $7.9 million; settle U.S. dollar / Japanese yen average strike option with an underlying currency amount of 400 million yen (U.S. equivalent of $3.5 million); and buy British pounds for the equivalent of $4.2 million.
Net income (loss) per common share
Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. For diluted net income (loss) per common share, the denominator also includes any dilutive outstanding stock options, restricted stock and warrants determined using the treasury stock method. Common and common share equivalent disclosures are (in thousands):
Three Months Ended | Nine Months Ended | |||||||
September 26, 2008 |
September 28, 2007 (As Restated) |
September 26, 2008 |
September 28, 2007 (As Restated) | |||||
Weighted average common shares outstanding |
41,677 | 42,654 | 41,792 | 42,344 | ||||
Dilutive potential common shares (1) |
| 282 | | 234 | ||||
Diluted common shares |
41,677 | 42,936 | 41,792 | 42,578 | ||||
Excluded from diluted common shares calculationstock options, restricted stock and warrants that are anti-dilutive (2) |
7,738 | 388 | 7,534 | 1,065 | ||||
(1) | Due to the Companys net loss position for the three months ended and nine months ended September 26, 2008, all dilutive shares are excluded as their effect would also have been anti-dilutive. |
(2) | Subsequent to September 26, 2008, the warrants that were issued in connection with the debt were exercised and converted into shares of common stock. |
28
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Accounting for income taxes
The liability method is used to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. A valuation allowance is established to reduce the deferred tax assets if it is more likely than not that the related tax benefits will not be realized in the future.
Recent Accounting Pronouncements
Disclosures about Derivative Instruments and Hedging Activities
In March 2008, the FASB issued SFAS 161 Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB statement No. 133. SFAS 161 requires enhanced disclosures about an entitys derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. At initial adoption, SFAS 161 encourages, but does not require, comparative disclosures for earlier periods. The Company does not expect that this new pronouncement will have a material impact on the Companys financial statements in future periods.
Business Combinations
In December 2007, the FASB issued SFAS 141 (revised 2007) Business Combinations. SFAS 141R establishes principles and requirements for the method in which the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company believes that this new pronouncement, once adopted, will have an impact on its accounting for future business combinations, however, the effect will be dependent upon the particular acquisition(s) that may be made in the future.
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS 115. SFAS 159 provides businesses with the option to measure financial instruments and certain other items at fair market value. Unrealized gains and losses on items for which the fair market value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007, provided that the entity also elects to apply the provisions of SFAS 157, Fair Value Measurements, as discussed below. The Company adopted SFAS 159 on January 1, 2008 with no impact on its consolidated results and financial position.
Fair Value Measurements
In September 2006, the FASB issued SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy to classify the source of the information. This statement is effective for the Company beginning January 1, 2008. The Company adopted SFAS 157 with no impact on its consolidated results and financial position.
In February 2008, the FASB issued FSP 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The nonfinancial assets and nonfinancial liabilities to which SFAS 157 was not applied are included in the Companys accompanying consolidated balance sheets under the captions: property, plant and equipment, net; other assets; goodwill; and, intangible assets, net. The Company has not determined the effect on its consolidated financial statements from the application of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and liabilities. The partial adoption of SFAS 157 for financial assets and financial liabilities did not impact the Companys consolidated results of operations or financial condition.
29
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset in a Market That Is Not Active, which clarifies the application of Statement 157 when the market for a financial asset is inactive. Specifically, FSP 157-3 clarifies how (1) managements internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value. The guidance of FSP 157-3 was effective immediately for financial statements that have not been issued, accordingly we have adopted its provisions with respect to our financial assets and liabilities since June 28, 2008.
In April 2009, the FASB issued FSP 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. This FSP re-emphasizes that regardless of market conditions the fair value measurement is an exit price concept as defined in SFAS 157. This FSP clarifies and includes additional factors to consider in determining whether there has been a significant decrease in market activity for an asset or liability and provides additional clarification on estimating fair value when the market activity for an asset or liability has declined significantly. The scope of this FSP does not include assets and liabilities measured under level 1 inputs. FSP 157-4 is applied prospectively to all fair value measurements where appropriate and is effective for interim and annual periods ending after June 15, 2009. The Company will adopt FSP 157-4 during its quarter ended October 2, 2009, and does not anticipate that the adoption will have a material impact on its consolidated results of operations or financial condition.
In April 2009, the FASB issued FSP 107-1 and Accounting Principles Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments. FSP 107-1 and APB 28-1 amend SFAS 107, Disclosures about Fair Value of Financial Instruments, to require publicly-traded companies, as defined in APB 28, Interim Financial Reporting, to provide disclosures on the fair value of financial instruments in interim financial statements. FSP 107-1 and APB 28-1 are effective for interim periods ending after June 15, 2009. The Company will adopt FSP 107-1 and APB28-1 during its quarter ended October 2, 2009, and expects that the adoption will require expanded disclosure, but will not have a material impact on its consolidated results of operations or financial condition.
In April 2009, the FASB issued FSP 115-2 and 124-2 Recognition and Presentation of Other-Than-Temporary Impairments. This FSP amends the requirements for the recognition and measurement of other-than-temporary impairments for debt securities by modifying the pre-existing intent and ability indicator. Under FSP 115-2, for impaired debt securities, an other-than-temporary impairment is triggered when there is intent to sell the security, it is more likely than not that the security will be required to be sold before recovery, or the security is not expected to recover the entire amortized cost basis of the security. Additionally, FSP 115-2 changes the presentation of other-than-temporary impairments in the income statement for those impairments attributed to credit losses. FSP 115-2 is effective for interim and annual reporting periods ending after June 15, 2009. The Company will adopt FSP 115-2 during its quarter ended October 2, 2009, and expects that the adoption will not have a material impact on its consolidated results of operations or financial condition.
Non-Controlling Interests in Consolidated Financial Statements
In December 2007, the FASB issued SFAS 160 Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51. SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply the pronouncement before that date. Upon the adoption of this SFAS 160, the Company will reclassify the existing amount attributable to its 50% noncontrolling interest in Excel South Asia JV from liabilities into stockholders equity.
Determination of the Useful Life of Intangible Assets
In April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under SFAS 142. FSP 142-3 amends paragraph 11(d) of SFAS 142 to require an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset.
30
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
FSP 142-3 also requires the following incremental disclosures for renewable intangible assets: the weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class; the entitys accounting policy for the treatment of costs incurred to renew or extend the term of a recognized intangible asset; and, for intangible asset renewed or extended during the period: (1) for entities that capitalize renewal or extension costs, the costs incurred to review or extend the asset, for each major intangible asset class; and, (2) the weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class.
FSP 142-3 is effective for financial statements for fiscal years beginning after December 15, 2008. The guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Accordingly, FSP 142-3 would not serve as a basis to change the useful life of an intangible asset that was acquired prior to the effective date. However, the incremental disclosure requirements described above would apply to all intangible assets, including those recognized in periods prior to the effective date of FSP 142-3. The Company is currently evaluating the impact that the adoption of FSP 142-3 will have on its consolidated financial statements.
Revenue Recognition
In September 2009, the FASBs Emerging Issues Task Force issued EITF 08-1 Revenue Arrangements with Multiple Deliverables. EITF 08-1 requires revenue to be allocated to multiple elements using relative fair value based on vendor-specific-objective-evidence, third party evidence or estimated selling price. The residual method becomes obsolete under this guidance. This guidance is effective for arrangements entered into, or materially modified, in periods beginning on or after June 15, 2010, with earlier adoption permitted. The Company is evaluating the impact that its adoption of EITF 08-1 may have on its financial position, results of operations and cash flows.
In September 2009, FASBs Emerging Issues Task Force issued EITF 09-3 Certain Revenue Arrangements That Include Software Elements. EITF 09-3 addresses certain revenue arrangements that include software elements. This guidance states that tangible products with hardware and software components that work together to deliver the product functionality are considered non-software products, and the accounting guidance under the revenue arrangements with multiple deliverables is to be followed. This guidance is effective for arrangements entered into, or materially modified, in periods beginning on or after June 15, 2010, with earlier adoption permitted. The Company does not expect EITF 09-3 to have any impact on its financial position, results of operations and cash flows.
Subsequent Events
In May 2009, the FASB issued SFAS 165, Subsequent Events which establishes general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The provisions of SFAS 165 are effective for interim and annual reporting periods ending after June 15, 2009, and are not expected to have any impact on the Companys financial position, results of operations, or cash flows.
Recodification of Accounting Standards
In June 2009, the FASB issued authoritative guidance to establish the FASB Accounting Standards Codification as the source of authoritative accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. This guidance is effective for the Companys interim reporting period ended on October 2, 2009 and only impacts references for accounting guidance.
Accounting for Entities in Bankruptcy and Coming out of Bankruptcy
In April 2008, the FASB issued FSP 90-7-1, An Amendment of AICPA Statement of Position 90-7. FSP 90-7-1 nullifies certain requirements regarding changes in accounting principles that will be applicable to the financial statements of an entity emerging from bankruptcy. Any changes in accounting principles required within the twelve months following the implementation of fresh start accounting by such an entity are no longer required to be adopted at the time fresh start accounting is implemented. Entities emerging from bankruptcy that implement fresh start accounting should only follow accounting standards in effect at the date fresh start accounting is implemented, including any standards eligible for early adoption. The Company will assess the impact of the application of this standard when and if fresh start accounting is required upon resolution of its bankruptcy proceedings.
31
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
4. Business Combinations
Acquisition of Excel Technology, Inc.
On August 20, 2008, the Company acquired 78.6% of the outstanding common shares of Excel. Thereafter, the Company commenced a tender offering for all remaining Excel common shares. On August 27, 2008, the Company had obtained 92.8% of Excels outstanding shares and performed a short form merger to acquire Excels remaining outstanding shares. On August 29, 2008, the Company completed its acquisition of Excel for a cash purchase price of $368.7 million, including: a payment of $32.00 per outstanding common share of Excel; a payment of $32.00 less the strike price of each outstanding option for the purchase of common stock and restricted share of common stock; and transaction costs. In addition to these payments, employee termination costs totaling $18.4 million were paid to the chief executive officer and chief financial officer of Excel; these costs have not been included in the purchase price, but are included in the allocation of the purchase consideration. Excel provides complementary products, technologies, and distribution channels. The Company believes that the combined Company will provide its customers a significantly broader product offering. The Company has initiated the integration of key operating units, and those activities are either complete or well underway. These synergistic efforts have enabled substantial cost savings initiatives. Certain integration activities have been delayed due to the Companys Revenue Review and the Chapter 11 Cases. The Company plans to finalize its integration activities in 2010.
The Company accounted for the acquisition as a purchase. The Company has included Excels results of operations with the Companys results beginning August 20, 2008. Subsequent to the acquisition of Excel, the Company established a third segment which is comprised solely of the operations of the newly acquired entity. The Company has recorded the assets purchased and liabilities assumed (collectively, the net assets) based on their estimated fair values at the date of acquisition. Under the provisions of SFAS 141, the excess of the total purchase consideration over the fair value of net assets is recorded to goodwill. The goodwill recognized on the Excel acquisition reflects synergies and other benefits expected to be realized from the combination of the two businesses following the acquisition. The goodwill recorded in connection with this acquisition is not deductible for tax purposes.
A summary of the purchase price allocation is as follows (in thousands):
Total Purchase Consideration: |
|||
Cash paid to shareholders |
$ | 347,730 | |
Cash paid to option holders and restricted stockholders |
12,674 | ||
Transaction fees |
8,307 | ||
Total Purchase Consideration |
$ | 368,711 | |
Allocation of the Purchase Consideration: |
|||
Cash and cash equivalents |
10,430 | ||
Long-term investments (auction rate securities) |
24,985 | ||
Accounts receivable |
20,435 | ||
Inventories |
37,690 | ||
Income tax receivable |
7,002 | ||
Deferred tax assets |
3,442 | ||
Property, plant and equipment |
33,050 | ||
Identifiable intangible assets |
132,685 | ||
In-process research and development charge |
12,142 | ||
Goodwill |
149,941 | ||
Other assets |
2,292 | ||
Total assets acquired |
434,094 | ||
Accounts payable and accrued expenses |
15,554 | ||
Income taxes payable |
348 | ||
Deferred tax liabilities, non-current |
47,541 | ||
Other liabilities |
1,940 | ||
Total liabilities assumed |
65,383 | ||
Net assets acquired |
$ | 368,711 | |
32
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The deferred tax liability primarily relates to the tax impact of future tax amortization associated with the identified intangible assets acquired, the adjustment in fair value of certain tangible assets acquired, and the difference between book and tax basis for original issue discount on the debt. The estimated taxes are based on an expected effective tax rate of 36.35%.
The Company used the income approach to determine fair value of the intangible assets. This approach calculates fair value by discounting the after-tax cash flows back to a present value. The baseline data for this analysis were based on the cash flow estimates used to price the transaction. Cash flows were forecasted for each intangible asset, and then discounted based on an appropriate discount rate. In estimating the useful life of the amortizable intangible assets, the Company considered paragraph 11 of SFAS 142, which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors included a review of the expected use by the combined company of the assets acquired; the expected useful life of any other asset (or group of assets) related to the acquired assets; legal, regulatory or other contractual provisions that may limit the useful life of an acquired asset or may enable the extension of the useful life of an acquired asset without substantial cost; the effects of obsolescence, demand, competition and other economic factors; and the level of maintenance expenditures required to obtain the expected future cash flows from the asset. Definite-lived intangible assets are being amortized on a straight-line basis.
The value assigned to in-process research and development was determined using an income approach by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. At the date of acquisition, the development of these projects had not yet reached technological feasibility, and had no alternative future uses. Accordingly, the Company has expensed the value of this research and development at the acquisition date. Due to the nature of the forecasts and the risks associated with the developmental projects, a discount rate of 15.0% was used to discount the net cash flows to their present value. The Company anticipates costs to complete the development of these projects will be $4.4 million, and will be completed between December 2008 and December 2010. The successful development of new products and product enhancements is subject to numerous risks and uncertainties, both known and unknown, including unanticipated delays, access to capital, budget overruns, technical problems and other difficulties that could result in the abandonment or substantial change in the design, development and commercialization of these new products and enhancements. Given the uncertainties inherent with product development and introduction, there can be no assurance that any of the combined Companys product development efforts will be successful on a timely basis or within budget, if at all. The failure of the combined Company to develop new products and product enhancements on a timely basis or within budget could harm the combined Companys results of operations and financial condition.
The following assets are the identifiable intangible assets acquired and their respective weighted average lives (dollars in thousands):
Amount | Weighted Average Life (Years) | ||||
Amortizable intangible assets: |
|||||
Core technology |
$ | 42,355 | 9.9 | ||
Customer relationships |
44,764 | 11.9 | |||
Customer backlog |
3,186 | 1.0 | |||
Non-compete agreements |
8,040 | 2.9 | |||
Amortizable intangible assets |
98,345 | 10.0 | |||
Non-amortizable intangible assets: |
|||||
Trade names |
34,340 | ||||
Total identifiable intangible assets |
$ | 132,685 | |||
The Company undertook an impairment review of its goodwill, intangible assets and other long-lived assets (property, plant and equipment) at December 31, 2008 due to the significant downturn in the global economy in 2008, particularly in the fourth quarter. The impairment charge totaled $215.1 million of which $182.7 million pertained to Excels goodwill, intangible assets and property, plant and equipment. See Note 17 for additional information on this and other subsequent events.
33
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Acquisition of the U.K. Beryllium Business
On June 1, 2007, the Company acquired the beryllium mirror and structures business of U.K.-based Thales Optronics (Taunton) Ltd, (the U.K. Beryllium Business) for $3.0 million, consisting of $2.5 million in payments to former shareholders, plus $0.5 million in acquisition related expenses. The acquisition helped strengthen the Companys market position in optical scanning. The acquisition was accounted for under SFAS 141. The Company allocated the costs of acquisition to the assets acquired and liabilities assumed based on the fair values at the acquisition date. In performing this analysis, the fair value of the net assets acquired was greater than the purchase price. In accordance with SFAS 141, the excess of the fair value of the acquired net assets over the purchase cost was allocated on a pro rata basis to the acquired long term assets, which consisted of property, plant and equipment and intangible assets. The results of operations of this business are included in the Precision Technology segment of the Companys consolidated financial statements from the acquisition date. Total assets acquired were $3.8 million and liabilities assumed were $0.8 million.
Supplementary Pro Forma Information (Unaudited)
The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and Excel as if the acquisition had occurred at the beginning of each of the periods presented with pro forma adjustments to give effect to amortization of intangible assets, an increase in interest expense on acquisition financing and certain other adjustments together with related tax effects. The unaudited pro forma financial information excludes the material, non-recurring charge for the purchased in-process research and development charge of $12.1 million. No pro-forma information has been presented for the acquisition of the U.K. Beryllium Business, because such information is not material to the Companys financial results. The unaudited pro forma condensed consolidated financial information is presented for informational purposes only. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the merger been completed at the dates indicated. In addition, the unaudited pro forma condensed consolidated financial information does not purport to project the future financial position or operating results of the combined Company after completion of the acquisition (in thousands, except per share amounts):
Three Months Ended | Nine Months Ended | |||||||||||||
September 26, 2008 |
September 28, 2007 |
September 26, 2008 |
September 28, 2007 | |||||||||||
Sales |
$ | 90,556 | $ | 121,523 | $ | 290,294 | $ | 342,618 | ||||||
Income (loss) from continuing operations |
(28,106 | ) | 2,674 | (22,403 | ) | 3,829 | ||||||||
Income (loss) from discontinued operations, net of tax |
(19 | ) | 12 | 310 | 266 | |||||||||
Net income (loss) |
$ | (28,125 | ) | $ | 2,686 | $ | (22,093 | ) | $ | 4,095 | ||||
Income (loss) from continuing operations per share basic |
$ | (0.67 | ) | $ | 0.06 | $ | (0.54 | ) | $ | 0.09 | ||||
Income (loss) from discontinued operations per share basic |
| | 0.01 | 0.01 | ||||||||||
Net income (loss) per share basic |
$ | (0.67 | ) | $ | 0.06 | $ | (0.53 | ) | $ | 0.10 | ||||
Income (loss) from continuing operations per share assuming dilution |
$ | (0.67 | ) | $ | 0.05 | $ | (0.54 | ) | $ | 0.08 | ||||
Income (loss) from discontinued operations per share assuming dilution |
| | 0.01 | 0.01 | ||||||||||
Net income (loss) per share assuming dilution |
$ | (0.67 | ) | $ | 0.06 | $ | (0.53 | ) | $ | 0.08 | ||||
5. Discontinued Operations
The Company evaluates its businesses and product lines periodically for strategic fit within its operations. On July 3, 2008, the Company entered into a definitive agreement to sell its General Optics business located in Moorpark, California and part of the Companys Precision Technology Segment for $21.6 million. The sale was closed on October 8, 2008. The Company included all current and historical earnings from the General Optics business in the income from discontinued operations on the consolidated statement of operations. The Company will recognize a pre-tax gain on the sale of this business in the fourth quarter of 2008.
34
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the following amounts, related to the General Optics business, have been segregated from continuing operations and included in discontinued operations net of tax, in the consolidated statement of operations.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) |
|||||||||||||
Sales of discontinued business held for sale |
$ | 2,625 | $ | 2,538 | $ | 9,150 | $ | 8,651 | ||||||||
Pre-tax income of discontinued business held for sale |
148 | 81 | 535 | 441 | ||||||||||||
Provision for taxes on income of discontinued business held for sale |
(167 | ) | (69 | ) | (225 | ) | (175 | ) | ||||||||
Income (loss) from discontinued business held for sale net of tax |
$ | (19 | ) | $ | 12 | $ | 310 | $ | 266 | |||||||
The assets and liabilities relating to the U.S. Optics Business have been segregated from other of the Companys assets and liabilities in the accompanying consolidated balance sheets. Net cash flows of the Companys discontinued operations from each of the categories of operating, investing and financing were not significant for the periods ended September 26, 2008 and December 31, 2007.
6. Goodwill and Intangible Assets
Goodwill
Goodwill is recorded when the consideration for an acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. The change in the carrying amount of goodwill during the nine months ended September 26, 2008 is as follows (in thousands):
Balance at December 31, 2006 and 2007, as restated |
$ | 26,291 | |
Acquisition of Excel |
149,941 | ||
Balance at September 26, 2008 |
$ | 176,232 | |
Intangible Assets
Intangible assets consist of the following (in thousands):
September 26, 2008 | ||||||||||||
Gross Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
Weighted Average Remaining Life (Years) | |||||||||
Amortizable intangible assets: |
||||||||||||
Patents and acquired technology |
$ | 91,453 | $ | (35,243 | ) | $ | 56,210 | 8.6 | ||||
Customer relationships |
59,650 | (7,986 | ) | 51,664 | 10.8 | |||||||
Customer backlog |
3,186 | (358 | ) | 2,828 | 0.9 | |||||||
Non-compete agreements |
8,040 | (314 | ) | 7,726 | 2.8 | |||||||
Trademarks, trade names and other |
6,025 | (2,495 | ) | 3,530 | 10.3 | |||||||
Amortizable intangible assets |
168,354 | (46,396 | ) | 121,958 | 9.0 | |||||||
Non-amortizable intangible assets: |
||||||||||||
Trade names |
34,341 | n/a | 34,341 | |||||||||
Totals |
$ | 202,695 | $ | (46,396 | ) | $ | 156,299 | |||||
35
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
December 31, 2007 (As Restated) | ||||||||||||
Gross
Carrying Amount |
Accumulated Amortization |
Net Carrying Amount |
Weighted Average Remaining Life (Years) | |||||||||
Amortizable intangible assets: |
||||||||||||
Patents and acquired technology |
$ | 49,755 | $ | (32,797 | ) | $ | 16,958 | 5.7 | ||||
Customer relationships |
15,258 | (6,410 | ) | 8,848 | 5.1 | |||||||
Trademarks, trade names and other |
6,161 | (2,192 | ) | 3,969 | 10.9 | |||||||
Totals |
$ | 71,174 | $ | (41,399 | ) | $ | 29,775 | 6.2 | ||||
All definite-lived intangible assets are amortized on a straight-line basis over their remaining life. Amortization expense for customer relationships, trademarks and definite-lived trademarks, trade names and other are included in operating expenses and were $1.6 million and $0.6 million in the three month periods ended September 26, 2008 and September 28, 2007, respectively, and $2.7 million and $1.7 million in the nine month periods ended September 26, 2008 and September 28, 2007, respectively. Amortization expense for the patents and acquired technology are included in the cost of goods sold in the accompanying statements of operations and were $1.2 million and $0.9 million in the three month periods ended September 26, 2008 and September 28, 2007, respectively, and $2.9 million and $2.7 million in the nine month periods ended September 26, 2008 and September 28, 2007, respectively.
Estimated amortization expense for each of the five succeeding years as of September 26, 2008, is as follows (in thousands):
Year Ending December 31, |
Cost of
Goods Sold |
Operating Expenses |
Total | ||||||
2008 (3 months from September 26, 2008) |
$ | 1,809 | $ | 2,957 | $ | 4,766 | |||
2009 |
7,234 | 10,733 | 17,967 | ||||||
2010 |
7,234 | 8,548 | 15,782 | ||||||
2011 |
7,197 | 7,540 | 14,737 | ||||||
2012 |
6,384 | 5,230 | 11,614 | ||||||
2013 |
6,384 | 4,787 | 11,171 | ||||||
Thereafter |
19,966 | 25,955 | 45,921 | ||||||
Total |
$ | 56,208 | $ | 65,750 | $ | 121,958 | |||
The Company undertook an impairment review of its goodwill, intangible assets and other long-lived assets (property, plant and equipment) at December 31, 2008 due to the significant downturn in the global economy in 2008, particularly in the fourth quarter. An impairment charge of $215.1 million was recorded on these assets in the fourth quarter of 2008. See Note 3 and Note 17 for additional information on this impairment.
36
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
7. Supplementary Balance Sheet Information
The following tables provide the details of selected balance sheet items as of September 26, 2008 and December 31, 2007:
Inventories
September 26, 2008 |
December
31, 2007 (As Restated) | |||||
(In thousands) | ||||||
Raw materials |
$ | 47,517 | $ | 28,431 | ||
Work-in-process |
20,710 | 13,776 | ||||
Finished goods |
13,054 | 17,626 | ||||
Demo and consigned inventory |
6,611 | 4,306 | ||||
Total inventories |
$ | 87,892 | $ | 64,139 | ||
Other Current Assets
September 26, 2008 |
December 31, 2007 (As Restated) | |||||
(In thousands) | ||||||
Prepaid expenses |
$ | 4,669 | $ | 4,573 | ||
U.K. buildings held for sale |
307 | 1,814 | ||||
Other current assets |
1,291 | 733 | ||||
Total |
$ | 6,267 | $ | 7,120 | ||
At December 31, 2007, the Company had a property in the U.K. available for sale, with a net book value of $1.5 million, which building was sold in 2008 for $3.2 million. The Company recorded a net gain of $1.7 million.
Other Accrued Expenses
September 26, 2008 |
December 31, 2007 (As Restated) | |||||
(In thousands) | ||||||
Accrued interest |
$ | 2,567 | $ | | ||
Accrued warranty |
4,848 | 4,216 | ||||
Accrued professional fees |
1,393 | 1,236 | ||||
Accrued third party sales commissions |
610 | 612 | ||||
Customer deposits |
568 | 35 | ||||
Accrued restructuring, current portion |
3,366 | 327 | ||||
Other |
3,887 | 2,554 | ||||
Total |
$ | 17,239 | $ | 8,980 | ||
37
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Accrued Warranty
September 26, 2008 |
December 31, 2007 (As Restated) |
|||||||
(In thousands) | ||||||||
Balance at beginning of the year |
$ | 4,216 | $ | 4,814 | ||||
Assumed in Excel acquisition |
1,214 | | ||||||
Charged to costs and expenses |
4,929 | 4,283 | ||||||
Use of provision |
(5,667 | ) | (4,888 | ) | ||||
Foreign currency exchange rate changes |
156 | 7 | ||||||
Balance at September 26, 2008 |
$ | 4,848 | $ | 4,216 | ||||
8. Debt
On August 20, 2008 (the Closing Date), the Company issued to various investors $210.0 million of unsecured senior notes (the Senior Notes), along with detachable warrants (the Warrants) for the purchase of 5,882,520 of the Companys common shares, for collective net proceeds to the Company of $203.5 million. The proceeds were used to fund a portion of the Companys acquisition of Excel, and the Senior Notes carry a fixed interest rate of 11.0%. The Warrants were net exercised by the holders in October 2008, in exchange for 5,858,495 common shares of the Company. The Company ascribed a fair value to the Warrants in the amount of $26.3 million as of the Closing Date. The fair value was based upon the Black-Scholes option pricing model, assuming a risk-free interest rate of 3.0%, an expected term of 5.0 years, a volatility rate of 85.0% and a 0.0% dividend yield.
The Senior Notes pay interest semi-annually and mature in August 2013. After the first year anniversary of the Closing Date, the Company may redeem up to 50% of the Senior Notes with no penalty or premium. After the third anniversary of the Closing Date, the Company may redeem all remaining Senior Notes, again with no penalty or premium. The Senior Notes require the Company to comply with certain covenants that restrict the Company from taking on additional debt, repurchasing equity, making investments or selling certain assets. Under the Bankruptcy Code, our status as a bankruptcy debtor automatically accelerates the payment of all of the Companys debt, including that arising under the Senior Notes. Accordingly, the Company has classified this debt as current in its September 26, 2008 consolidated financial statements. As further discussed in Note 1, under The Third Modified Joint Chapter 11 Plan of Reorganization the holders of the Senior Notes have agreed to exchange their Senior Note Claims in exchange for: (i) approximately 53.8% of GSIGs post-consummation outstanding shares, (ii) new secured notes in the aggregate amount of $110 million, (iii) excess cash available under the Plan to the extent certain allowed claims exceed $22.5 million, and (iv) their pro rata portion of the Cash Payment.
The $26.3 million value of the warrants was recorded as a discount against the debt. This discount is being amortized to interest expense using the effective interest method over the life of the Senior Notes. In connection with the issuance of the Senior Notes, the Company incurred $6.5 million in issuance fees which are included in other current assets. These issuance fees are being amortized to interest expense over the contractual term of the Senior Notes. As of September 26, 2008, the unamortized portion of the valuation of the warrants was $26.2 million, and the unamortized debt issuance costs were $6.3 million. The Senior Notes, net of the value of the warrants and net of the debt issuance costs, constitute a net carrying value of $183.8 million at September 26, 2008. There was no debt outstanding as of December 31, 2007. For the nine months ended September 26, 2008, the total amount recorded to interest expense, including the accretion of the warrant value, and of the debt issuance costs, was $2.8 million.
As discussed further at Note 2 of Notes to Consolidated Financial Statements, in connection with the Revenue Review, the Company failed to timely file its annual and quarterly reports. In connection with the issuance of the Warrants, the Company and the Warrant holders entered into a Registration Rights Agreement (the RRA), dated as of August 20, 2008, pursuant to which the Company agreed to register the common shares issuable upon exercise of the Warrants. The Company filed that registration statement on Form S-3 in October 2008, simultaneously with the exercise of the Warrants. As a result of its failure to file its Quarterly Report on Form 10-Q for the period ended September 26, 2008, on November 12, 2008 the Company notified the former Warrant holders that it was indefinitely suspending its registration statement on Form S-3. Pursuant to the RRA , the Company is obligated to maintain the effectiveness of the registration statement until the earlier of (i) the date which is twelve (12) months after the Effective Time (October 23, 2008) and (ii) the date on which there are no registrable securities (the Maintenance Period). Under the RRA, monetary penalties accrue and are payable to the former Warrant holders for failure to maintain an effective registration statement during the Maintenance Period, subject to certain terms and conditions more specifically set forth therein. The maximum penalty payments payable under these provisions is approximately $4.0 million. As of September 26, 2008, the Company incurred no penalties under the RRA.
38
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Chapter 11 Bankruptcy Filing
On November 20, 2009 the Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. The filing by the Debtors constitutes a pre-arranged proposed joint plan of reorganization (the Plan), which was supported by 88.1% of the holders of the Senior Notes. As proposed, the Plan, among other things, would allow the Company to (a) restructure the currently outstanding Senior Notes, and (b) restructure currently outstanding intercompany debt of $20.0 million that is owed from GSI US to GSI Group Limited.
Refer to Note 1 for further discussion of the Chapter 11 Bankruptcy Filing, The Third Modified Joint Chapter 11 Plan of Reorganization, and The Plan Support Agreement.
Fair Value of Debt
The estimated fair value of the Companys Senior Notes approximated $204.0 million at September 26, 2008. This fair value estimate represents the value at which the Company estimates the lenders could trade our debt within the financial markets, and do not represent the settlement value of these long-term debt liabilities to the Company. The fair value of these long-term debt issues will continue to fluctuate each period based on fluctuations in market interest rates, and these fluctuations may have little to no correlation to the Companys outstanding debt balances. Our Senior Notes are not publicly traded, but private party sales may occur. The fair value of our Senior Notes is based on quoted prices for similar liabilities, or similar liabilities traded as assets.
9. Stockholders Equity
Capital stock
The authorized capital of the Company consists of an unlimited number of common shares without nominal or par value. Holders of common shares are entitled to one vote per share. Holders of common shares are entitled to receive dividends, if and when declared by the Board of Directors, and to share ratably in its assets legally available for distribution to the stockholders in the event of liquidation. Holders of common shares have no redemption or conversion rights.
Warrants
As discussed in Note 8, in August 2008 the Company issued Warrants which were later net exercised in October 2008 for an aggregate of 5,858,495 common shares.
39
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Shareholders Rights Plan
At the annual meeting of shareholders held on May 15, 2008, shareholders approved a resolution approving the continuation, amendment and restatement of the Companys shareholders rights plan.
Prior to the 2008 annual meeting of shareholders, the board of directors of the Company approved an amended and restated shareholder rights plan agreement to be dated May 15, 2008, if approved by shareholders at such meeting. The rights plan was originally approved by the Companys shareholders on May 26, 2005 and its continued existence had to be approved and confirmed by independent shareholders on or before the date of the Companys 2008 annual meeting of shareholders or the rights plan would expire.
The amended and restated shareholder rights plan continues to create a right (which is only triggered if a person or a control group acquires 20% or more of the Companys issued and outstanding publicly traded common shares) for each shareholder, other than the acquiring person or its associates or affiliates, to acquire additional common shares of the Company at one-half of the then market price at the time of exercise. The net effect of an exercise is to dilute the prospective acquirers share position, and inhibits a change of control event unless the rights plan has been withdrawn or the buyer makes a bid that is permitted by the terms of the plan.
The rights plan is intended to give the Companys Board of Directors more time and control over any sale process and increase the likelihood of maximizing shareholder value.
Stock Repurchase Plan
In December 2005, the Companys Board of Directors authorized a stock repurchase program providing for the repurchase of up to $15.0 million in shares of the Companys common shares. In February 2008, the Companys Board of Directors authorized an increase in the Stock Repurchase Program up to a total of $40.0 million. The Company repurchased and retired 772,467 shares, 816,830 shares, and 381,300 shares in 2008, 2007, and 2006, respectively, at an aggregate cost of $6.4 million, $7.8 million, and $3.8 million, respectively. The program was suspended in May 2008 as a result of the Companys decision to acquire Excel. At September 26, 2008, $21.9 million remains available for future Company purchases under this program.
10. Share-Based Compensation
The Company has several share-based compensation plans, including the 2006 Equity Incentive Plan, under which stock-based grants may be issued and several other plans under which no new grants will be made. The 2006 Equity Incentive Plan provides for grants of various stock-based awards including, but not limited to, stock options, stock appreciation rights and restricted stock. Since 2006, the Company has issued only restricted stock in the form of time and performance-based grants to senior executives, key employees and directors.
2006 Equity Incentive Plan
On May 15, 2006, shareholders of the Company approved the 2006 Equity Incentive Plan which provides for the sale or grant of various awards of, or the value of, the Companys common shares including stock options, stock appreciation rights, restricted stock and performance shares and units, performance-based awards, and stock grants, to officers, directors, employees and certain consultants to the Company. The maximum number of shares of the Companys common shares which may be issued pursuant to the 2006 Equity Incentive Plan is 9,406,000 shares, including a 2.5 million share increase as approved by the Companys shareholders at the May 2008 annual meeting, and subject to adjustment in the event of certain corporate events and reduced by the number of shares already issued pursuant to awards under the Companys 1992 and 1995 Equity Incentive Plans. The plan has a ten year term. As of September 26, 2008, there were 3,162,909 common shares available for future issuance under this plan.
The Company recorded compensation expense related to restricted stock awards issued under the 2006 Equity Incentive Plan totaling $0.8 million in the three month periods ended September 26, 2008 and September 28, 2007, and $2.3 million and $1.8 million in the nine month periods ended September 26, 2008 and September 28, 2007, respectively. Stock compensation expense is primarily included in selling, general, and administrative expenses, and as an increase to additional paid-in capital on the Companys consolidated balance sheets. Earnings before income taxes were reduced by these amounts. As the restricted stock is issuable to the holder, subject to vesting provisions, with no consideration payable by the holder, the grant date fair value per share is based on the quoted stock price on the date of the grant.
40
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
It is the Companys policy to issue new shares for equity awards. The Company recognizes compensation expense on fixed awards on a straight-line basis over the requisite service period, which is generally from the grant of the awards through the end of the vesting period. Restricted stock awards have generally been issued with a three-year vesting period. The Company reduces the compensation expense by an estimated forfeiture rate which is based on actual experience. The Company assesses the likelihood that performance-based shares will be earned based on the probability of meeting the performance criteria. For those performance-based awards that are deemed probable of achievement, an expense is recorded, and for those awards that are deemed not probable of achievement no expense is recorded. The Company assesses the probability of achievement each quarter.
The table below summarizes activity relating to restricted stock awards issued under the 2006 Equity Incentive Plan, which includes both time-based and performance-based awards:
Number
of Shares (in thousands) |
Weighted- Average Grant Date Fair Value | |||||
Nonvested restricted stock at December 31, 2007 |
1,167 | $ | 9.78 | |||
Granted |
805 | $ | 7.91 | |||
Vested |
(305 | ) | $ | 9.67 | ||
Forfeited |
(399 | ) | $ | 9.62 | ||
Nonvested restricted stock at September 26, 2008 |
1,268 | $ | 8.67 | |||
Other Incentive Compensation Plans
The Company has several stock option plans and a warrant plan with outstanding grants that pre-date the 2006 Equity Incentive Plan. In 2005, the unvested options were accelerated. No new options will be granted under pre-2006 equity plans as all future equity grants will be issued exclusively under the 2006 Equity Incentive Plan.
Stock option and warrant activity under these plans is presented below:
Number of Shares (in thousands) |
Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term in Years |
Aggregate Intrinsic Value (millions) | ||||||||
Outstanding at December 31, 2007 |
1,228 | $ | 10.46 | ||||||||
Granted |
| | |||||||||
Exercised |
(16 | ) | 3.89 | ||||||||
Forfeited and expired |
(440 | ) | 12.37 | ||||||||
Outstanding at September 26, 2008 |
772 | $ | 9.51 | 1.8 | $ | 387.9 | |||||
Exercisable at September 26, 2008 |
772 | $ | 9.51 | 1.8 | $ | 387.9 | |||||
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and warrants and the quoted price of common shares for the options and warrants that were in the money at September 26, 2008.
11. Employee Benefit Plans
U.K. Defined Benefit Pension Plan
The Company maintains a pension plan in the United Kingdom that consists of two components: the Final Salary Plan (the U.K. Plan), which is a defined benefit plan, and the Retirement Savings Plan, which is a defined contribution
41
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
plan. In 1997, membership to the U.K. Plan was closed and in 2003 the Company was allowed to stop accruing additional benefits to the participants. Benefits under the U.K. Plan were based on the employees years of service and compensation. Most of the beneficiaries of this plan are no longer employed by the Company. The Company follows a pension funding policy based on widely used actuarial methods as permitted by regulatory authorities. The funded amounts reflect actuarial assumptions regarding compensation, interest and other projections. The assets of the U.K. Plan consist primarily of equity, real estate and fixed income securities of U.K. and foreign issuers.
Pension and other benefit costs reflected in the accompanying consolidated statements of operations are based on the projected benefit method of valuation. Within the accompanying consolidated balance sheets, pension plan benefit liabilities are included in accrued compensation and benefits.
The table below sets forth the estimated net periodic pension cost (benefit) of the U.K. Plan (in thousands):
Three Months Ended |
Nine Months Ended |
|||||||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) |
|||||||||||||
Components of the net periodic pension cost (benefit): |
||||||||||||||||
Service cost |
$ | | $ | | $ | | $ | | ||||||||
Interest cost |
412 | 409 | 1,200 | 1,227 | ||||||||||||
Expected return on plan assets |
(465 | ) | (449 | ) | (1,329 | ) | (1,348 | ) | ||||||||
Amortization of unrecognized gains |
23 | 97 | 45 | 292 | ||||||||||||
Net periodic pension cost (benefit) |
$ | (30 | ) | $ | 57 | $ | (84 | ) | $ | 171 | ||||||
Japan Defined Benefit Pension Plan
The Company maintains a tax qualified pension plan in Japan that covers substantially all Japanese employees. The Company deposits funds in various fiduciary-type arrangements and/or purchases annuities. Benefits are based on years of service and the employees compensation at retirement. Employees with less than twenty years of service to the Company receive a lump sum benefit payout. Employees with twenty or more years of service to the Company, receive a benefit that is guaranteed for a certain number of years. Participants may under certain circumstances, receive a benefit upon termination of employment.
The assumptions that are used to value the costs and obligations of the plan reflect the Japanese economic environment. The Company continues to fund the plan sufficient to meet current benefits as well as fund a portion of future benefits as permitted by regulatory authorities.
The net periodic benefit cost for the defined benefit pension plan was determined as follows (in thousands):
Three Months Ended |
Nine Months Ended |
|||||||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) |
|||||||||||||
Components of the net periodic pension cost: |
||||||||||||||||
Service cost |
$ | 51 | $ | 40 | $ | 154 | $ | 120 | ||||||||
Interest cost |
6 | 5 | 19 | 16 | ||||||||||||
Expected return on plan assets |
(1 | ) | (1 | ) | (4 | ) | (2 | ) | ||||||||
Amortization of unrecognized gains |
17 | 15 | 52 | 43 | ||||||||||||
Net periodic pension cost |
$ | 73 | $ | 59 | $ | 221 | $ | 177 | ||||||||
12. Income Taxes
At the end of each interim reporting period, the Company determines its estimated annual effective tax rate, which is revised, as required, at the end of each successive interim period based on facts known at that time. The estimated annual
42
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
effective tax rate is applied to the year-to-date pre-tax income at the end of each interim period. The tax effect of significant unusual items is reflected in the period in which they occur. Since the Company is incorporated in Canada, it is required to use Canadas statutory tax rate of 29.5% in the determination of the estimated annual effective tax rate. The Companys reported effective tax rate for continuing operations, after restatement, of 33.2% for the nine months ended September 26, 2008, differed from the expected Canadian federal statutory rate of 29.5%, primarily due to the mix of jurisdictions in which the Company earns it income, the tax impact or non-deductibility of the acquired in-process research and development related to the Excel acquisition, and the adjustment of utilization of net operating losses during the Internal Revenue Service (the IRS) appeal review for the tax years from 1999 to 2002, offset in part by the increase in interest receivable resulting from the IRS audit for the tax years from 1999 to 2002, the increase in the potential refunds and accrued interest income from the potential refunds claimed on the federal amended returns for the tax years from 2000 to 2006, and the provision to return adjustments in the United States.
As part of the process of preparing the consolidated financial statements, the Company is required to estimate its income tax provision (benefit) in each of the jurisdictions in which it operates. This process involves estimating the current income tax provision (benefit) together with assessing the future effects of temporary differences resulting from differing treatment of items for tax and accounting purposes. The Company recognizes deferred tax assets and liabilities based on the differences between the financial statement carrying amount and the tax bases of assets and liabilities.
The Company records a valuation allowance if it is more likely than not that a portion of its deferred tax assets will not be realized. The Company has considered historical losses, future taxable income, and expected reversals of existing temporary differences in assessing the need for a valuation allowance. The Company has not recorded a provision for withholding tax on undistributed earnings of foreign subsidiaries as the Company currently has no plans to repatriate those earnings. Determination of the amount of unrecognized deferred tax liabilities is not practicable because of the complexities associated with its hypothetical calculation.
As of September 26, 2008, the Company had total unrecognized tax benefits of $4.3 million, all of which, if recognized would favorably affect its effective tax rate. The Company expects that the changes in the unrecognized benefits within the next twelve months will not be material. The total unrecognized tax benefits changed materially from last quarter due to adding Excels unrecognized tax benefits of $1.3 million at the time of the acquisition. Given the uncertainty regarding when the authorities will complete their examinations and the possible outcomes of their examinations, a current estimate of the range of reasonably possible significant increases or decreases in income tax that may occur within the next twelve months cannot be made. However, the Company expects that the changes in the unrecognized benefits within the next twelve months would not be material. In addition the Company has settled its Canadian audit after the balance sheet date and this settlement will have no significant effect on the Companys uncertain tax positions.
The reconciliation of the total amounts of unrecognized tax benefits at the beginning of the first quarter and the end of the third quarter of 2008 is as follows:
Balance at January 1, 2008 |
$ | 3,537 | ||
Additions based on tax positions related to the current year |
43 | |||
Additions for tax positions of prior years |
700 | |||
Additions for Excels tax positions at the acquisition |
1,300 | |||
Reductions for tax positions of prior years |
| |||
Lapse of the applicable statute of limitations |
(952 | ) | ||
Reclassified due to payment made |
(378 | ) | ||
Balance at September 26, 2008 |
$ | 4,250 | ||
The Company recognizes interest and penalties related to unrecognized tax benefits as income tax expense. As of September 26, 2008, the Company had approximately $0.7 million of accrued interest and penalties related to uncertain tax positions. During the nine months ended September 26, 2008, the Company recognized approximately $0.3 million in interest and penalties.
The Company files state and federal income tax returns in the United States and in foreign jurisdictions. Generally, the Company is no longer subject to United States federal, state or local, or foreign income tax examinations by tax authorities for the years before 2002 as these years have been effectively settled as described in FSP FIN 48-1 Definition of Settlement in FASB Interpretation No. 48. During 2007, the Company settled an audit with the Internal Revenue Service for tax years 1999 2002. Furthermore, the Company closed an audit with the Japanese tax authorities for tax years 2004 -2006 resulting in no adjustments. Currently, the Company is under audit in the United States for tax years 2004 and 2005 and in Canada for tax years 2002 2004. The Companys income tax returns may be reviewed in the following countries and for the following periods under the appropriate statutes of limitations: United States (2004-present), Canada (2002-present), United Kingdom (2004-present), Germany (2004-present), Japan (2007-present), Taiwan (2003-present), and Korea (2003-present).
In connection with the Chapter 11 Cases described in Note 1 of Notes to Consolidated Financial Statements, the IRS has filed amended proofs of claim aggregating approximately $7.7 million for amounts it claims the Company owes for 2002 through 2008. The IRS has provided no information to substantiate its claims. The Company believes the IRS claims are without merit and intends to vigorously object to them in Bankruptcy Court. Consequently, the Company believes no adjustment of its estimated tax liability pursuant to FIN 48 is required.
43
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
13. Restructuring
The following table summarizes restructuring expense (net of benefit) in the consolidated statement of operations:
Three Months Ended | Nine Months Ended | ||||||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) |
||||||||||||
United Kingdom restructuring |
$ | | $ | 2,002 | $ | (322 | ) | $ | 5,973 | ||||||
Munich restructuring |
16 | (63 | ) | 147 | (107 | ) | |||||||||
Novi restructuring |
45 | | 1,369 | 2 | |||||||||||
Bedford restructuring |
3,012 | | 3,012 | | |||||||||||
Total restructuring expense (net of benefit) |
$ | 3,073 | $ | 1,939 | $ | 4,206 | $ | 5,868 | |||||||
United Kingdom Restructuring
In 2007, the Company implemented a plan to expand its manufacturing operations in China and restructure its manufacturing operations in the United Kingdom. These actions are part of the Precision Technology segments overall plan to expand its presence in Asia and increase profitability. For the nine months ended September 28, 2007, the Company incurred $6.0 million in restructuring costs of which: $2.6 million related to termination benefits, $3.0 million was for inventory write offs and $0.4 million was for manufacturing transition costs.
On February 29, 2008 and June 27, 2008, the Company executed agreements to sell assets related to its otherwise discontinued Impact product line, and certain assets related to its LaserMark and Excimer laser product lines. The majority of the assets sold in the transaction represent inventory that had already been written off and were included as part of the restructuring charges recorded in 2007. The results of the sales resulted in a restructuring benefit of $0.3 million for the nine months ended September 26, 2008. Payments received on asset sales that are due beyond one year will be recorded as restructuring benefits when they are received.
Munich Restructuring
As a result of restructuring programs undertaken in 2000 through 2004, and the subsequent sublease of the Companys Munich, Germany facility, in May 2007 through the end of its lease term, the Company historically carried a $1.1 million accrual for the cost of this lease. The Company regularly reviews its assumptions with respect to this excess space, including contractual lease payments, and proceeds from the sublease. Following this review, the Company has booked adjustments to the lease restructuring in each of 2008 and 2007, and as of September 26, 2008, cumulative expense related to this restructuring program is $2.6 million. The remaining accrual will be paid ratably over the remaining term of the lease, which expires in January 2013.
Novi Restructuring
In the second quarter of 2008, the Company implemented a plan to close its Novi, Michigan facility, which provided U.S. sales, applications and service support to a product line included in the Companys Precision Technology segment. The Novi facility was consolidated within the Companys Bedford, Massachusetts facility. In connection with this action, the Company recorded a restructuring charge of $1.4 million, consisting of $0.7 million for employee severance and $0.7 million in lease abandonment and related costs. The majority of these employee severance payments were made in 2008, and the remaining amounts have been paid in 2009. The lease costs are being paid ratably over the duration of the lease, which ends in 2012.
Bedford Restructuring
In September 2008, the Company consolidated its operations and facilities in Massachusetts to a new facility in Bedford, Massachusetts. At that time, the Company implemented a plan to reduce its United States workforce by approximately 50 people and took a restructuring charge in the third quarter of 2008 of $3.0 million for severance costs. $1.2 million of this amount was charged to the Semiconductor Systems Segment; $0.7 million was charged to the Precision Technology Segment; and $1.1 million was charged against corporate operations. The workforce reduction is expected to save the Company $6.8 million in annual salary and related costs.
44
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Rollforward of Accrued Expenses related to Restructuring
The following table summarizes the balance of the restructuring accruals on the Companys consolidated balance sheets (in thousands):
Total | ||||
Balance at December 31, 2007 |
$ | 1,342 | ||
Restructuring charges (benefits), net |
4,206 | |||
Cash payments and other adjustments |
(1,076 | ) | ||
Balance at September 26, 2008 |
$ | 4,472 | ||
14. Commitments and Contingencies
Operating leases
The Company leases certain equipment and facilities under operating lease agreements. Most of these lease agreements expire between 2009 and 2020. In the United Kingdom, where longer lease terms are more common, the Company has land leases that extend through 2078. Under the terms of the facility leases, the Company is responsible to pay real estate taxes and other operating costs. In connection with its acquisition of Excel in 2008, the Company assumed fourteen new facility leases used in manufacturing, research and development, sales and administration. The rent on certain leases is subject to escalation clauses in future years.
In 2007, the Company signed a 12-year lease for a 147,000 square foot facility in Bedford, Massachusetts. The terms of the lease provide the Company with two renewal options for periods of five years each. The Company consolidated its Natick, Massachusetts, Billerica, Massachusetts and Wilmington, Massachusetts operations into this facility. The consolidation was completed in the second quarter of 2008. Under the terms of the lease agreement, the landlord waived the first 5.5 months rent (representing a savings of $0.7 million). This savings is being amortized as a reduction to rent expense over the life of the lease, and is included in other liabilities. The Company incurred $14.2 million in expenditures through September 26, 2008 to fit-up and occupy the Bedford facility, of which the landlord provided $4.0 million in allowances. The landlord allowance has been included in the Companys accompanying consolidated balance sheets in property, plant and equipment, and in other liabilities. The property, plant and equipment balance being amortized to depreciation expense ratably over this life of the lease, and the landlord allowance is being offset as a reduction to rent expense, ratably over the life of the lease.
Legal proceedings and disputes
The Companys French subsidiary, GSI Lumonics SARL (Lumonics), is subject to a claim by a customer, SCGI, that a Laserdyne 890 system delivered in 1999 had unresolved technical problems. During the third quarter of 2005, GSI France, parent of Lumonics, filed for bankruptcy protection, which was granted by the French court on July 7, 2005. On April 18, 2006, the court fixed SCGIs claim against Lumonics at 598,079 Euros, plus court costs and expert fees of 85,945 Euros. SCGI accepted the courts determination. SCGI is now demanding that the Liquidator bring an action in the United Kingdom against GSI Group Ltd., the parent corporation of GSI France. The Company is not aware of any facts to support a claim. The Companys French counsel is addressing these points directly with the Liquidator. At this time, the Company does not believe it will be required to make any payments regarding this action. Accordingly, nothing has been accrued in the Companys accompanying consolidated financial statements.
On August 6, 2008, a purported stockholder of Excel Technology, Inc., a subsidiary of the Company, filed a complaint seeking certification of a class action lawsuit in the Supreme Court of the State of New York, County of New York, docketed as Joseph Choquette, v. Antoine Dominic, Steven Georgiev, Donald E. Weeden, Ira J. Lamel, J. Donald Hill and Excel Technology, Inc., Index No. 08/602294 (the Choquette Action) against Excel and each of its directors. The Choquette Action purports to be brought individually and on behalf of all public stockholders of Excel. The Choquette Action alleges that Excels director defendants breached their fiduciary duties to Excels stockholders in connection with the proposed tender offer by the Company and that each of the defendants aided and abetted such alleged breach of Excels director defendants fiduciary duties. Based on these allegations, the Choquette Action seeks, among other relief, an order
45
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
declaring the action to be a class action, enjoining preliminarily and permanently the tender offer and the merger with the Company, rescinding, to the extent already implemented, the tender offer and the merger with the Company or any of the terms thereof or awarding rescissory damages, directing that the defendants account to plaintiff and other members of the class for all damages caused by them and account for all profits and any special benefits obtained as a result of a breach of their fiduciary duties to the purported stockholder and other members of the class, awarding plaintiff the costs of the Choquette Action including a reasonable allowance for the expenses of plaintiffs attorneys and experts and granting plaintiff and other members of the class such further relief as the court deems just and proper. On August 14, 2008, Excel and the individual defendants in the Choquette Action filed a motion to dismiss the lawsuit. On August 18, 2008, the plaintiff in the Choquette Action filed a motion seeking a preliminary injunction to enjoin consummation of the tender offer and to require Excel to issue additional and supplementary disclosures in Excels Schedule 14D-9 filing. On August 19, 2008, the court denied plaintiffs motion for a preliminary injunction. On April 15, 2009, the court granted defendants motion to dismiss and entered judgment dismissing the complaint with prejudice.
On December 12, 2008, in connection with the delayed filing of its results for the quarter ended September 26, 2008, and the announcement of a review of revenue transactions, a putative shareholder class action alleging federal securities violations was filed in the United States District Court for the District of Massachusetts against us, a former officer and a current officer and director. Specifically, the complaint alleges that the Company and the individual defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeks recovery of damages in an unspecified amount. The action was brought on behalf of a putative class of shareholders who purchased the Companys stock between April 30, 2008 and December 3, 2008. A lead plaintiff, Mason Tenders District Council Trust Funds, was appointed on May 8, 2009. On July 1, 2009, the Court ordered lead plaintiff to file a consolidated or amended complaint within 30 days of the Companys filing of restatements for certain of its historical financial results with the SEC. During the last several months, the parties have been in settlement discussions and the parties have reached an agreement in principle to settle this lawsuit. The settlement would, in general, cover purchasers of the common stock of the Company between February 27, 2007 and June 30, 2009. The agreement in principle is subject to a number of contingencies including confirmatory discovery by the Lead Plaintiff, after which Lead Plaintiff may affirm or void the agreement in principle, preliminary and final approval by the District Court, and to the extent required by law, approval by the Bankruptcy Court. Although the agreement in principle is not final, the total settlement amount is well within the Companys insurance policy limits; the Companys contribution to the settlement amount would be limited to the balance of the companys self-insured retention.
The Company is also subject to various legal proceedings and claims that arise in the ordinary course of business. The Company does not believe that the outcome of these claims will have a material adverse effect upon the Companys financial conditions or results of operations but there can be no assurance that any such claims, or any similar claims, would not have a material adverse effect upon the Companys financial condition or results of operations.
Chapter 11 Bankruptcy Filing
On November 20, 2009, the Debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for Delaware, as discussed in Note 1.
SEC Investigation
As discussed in the Explanatory Note to the Quarterly Report on Form 10-Q, we have conducted a Revenue Review of certain of our historic revenue transactions. On May 14, 2009, we received a notice from the SEC indicating that the SEC is conducting a formal investigation relating to our historical accounting practices and the restatement of our historical consolidated financial statements. The Company is cooperating fully with the SECs investigation. The Company cannot predict the outcome of the investigation at this time.
Issuance of Unregistered Securities
The Company inadvertently issued unregistered shares of common stock under its 2006 Plan as a result of its inadvertent failure to file with the SEC a registration statement on Form S-8. The 2006 Plan was approved by the Companys shareholders in May 2006. From March 2007 through March 2010, the Company issued approximately 773,037 duly authorized common shares with a total fair market value at the date of issuance of approximately $3,889,796 to fifty-two employees and directors under its 2006 Plan. As a result, the Company may be subject to civil litigation, enforcement proceedings, fines, sanctions and/or penalties.
46
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
The Company may also be subject to claims by participants in the 2006 Plan for rescission of their acquisitions of common shares under the 2006 Plan under federal securities laws until the expiration of the applicable statute of limitations period, which is one year under federal law from the date of transaction. If applicable, such participants may have the right to rescind their purchases for an amount equal to the purchase price for the shares (or if the shares have been disposed of, claims for any damages with respect to any loss on such disposition) plus interest from the date of purchase. However, under applicable provisions of federal law (including section 510(b) of the Bankruptcy Code (11 U.S.C. §-510(b)), and in connection with our Chapter 11 Cases, if the Companys proposed Plan is confirmed, the holders of any such damage claims and related rescission or other rights would, the Company believes, be entitled to receive a distribution under the Plan of common shares of the reorganized Company only. The Company believes that the most likely result is that any such claims, if allowed, would result in the holder receiving that quantity of common shares in the reorganized Company that are determined by a court to result in equal treatment of such claim holders and existing equity holders. Furthermore, rescission or damages claims of a shareholder who holds the above described unregistered shares, but receives new shares, as contemplated by the Plan, would be discharged upon the Companys emergence from the bankruptcy proceedings. Such new shares would be issued pursuant to an exemption from registration under §1145 of the Bankruptcy Code and be freely tradable by holders who are not deemed to be underwriters. The Company cannot predict the outcome of this matter at this time and the effect it may have on the Companys financial condition or results of operations.
Guarantees and Indemnifications
In the normal course of its operations, the Company executes agreements that provide for indemnification and guarantees to counterparties in transactions such as business dispositions, the sale of assets, sale of products and operating leases. Additionally, the by-laws of the Company require it to indemnify certain current or former directors, officers, and employees of the Company against expenses incurred by them in connection with each proceeding in which he or she is involved as a result of serving or having served in certain capacities. Indemnification is not available with respect to a proceeding as to which it has been adjudicated that the person did not act in good faith in the reasonable belief that the action was in the best interests of the Company. On June 5, 2009, the board of directors of the Company approved a form of indemnification agreement to be implemented by the Company with respect to its directors and officers. The form of indemnification agreement provides, among other things, that each director and officer of the Company who signs the indemnification agreement shall be indemnified to the fullest extent permitted by applicable law against all expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred by such officer or director in connection with any proceeding by reason of his or her relationship with the Company. In addition, the form of indemnification agreement provides for the advancement of expenses incurred by such director or officer in connection with any proceeding covered by the indemnification agreement, subject to the conditions set forth therein and to the extent such advancement is not prohibited by law. The indemnification agreement also sets out the procedures for determining entitlement to indemnification, the requirements relating to notice and defense of claims for which indemnification is sought, the procedures for enforcement of indemnification rights, the limitations on and exclusions from indemnification, and the minimum levels of directors and officers liability insurance to be maintained by the Company.
Credit Risks and Other Uncertainties
The Company maintains financial instruments such as cash and cash equivalents, trade receivables and financial instruments used in hedging activities. From time to time, certain of these instruments may subject the Company to concentrations of credit risk whereby one institution may hold a significant portion of the cash and cash equivalents, or one customer may compose a large portion of the accounts receivable balances.
At December 31, 2007, there was a concentration of credit risk related to the Companys position in trade accounts receivable. At that time, one customer, Rexchip Electronics Corporation, represented 21% of the outstanding accounts receivable. There was no such concentration of credit risk as of September 26, 2008. Credit risk with respect to trade accounts receivables is generally minimized because of the diversification of the Companys operations, as well as its large customer base and its geographical dispersion.
The Company acquired certain auction rate securities in connection with its purchase of Excel. In current markets, the fair value of these auction rate securities is not able to be ascertained by observable inputs. See Note 3 of the Notes to Consolidated Financial Statements for further discussion.
47
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Certain of the components and materials included in the Companys laser systems and optical products are currently obtained from single source suppliers. There can be no assurance that a disruption of this outside supply would not create substantial manufacturing delays and additional cost to the Company.
The Companys operations involve a number of other risks and uncertainties including, but not limited to, the cyclicality of the semiconductor and electronics markets, the effects of general economics conditions, rapidly changing technology, and international operations.
15. Segment Information
As a result of the Companys acquisition of Excel, it reassessed its segment reporting based on the operating and reporting structure of the combined company. The Company has concluded that the acquisition of Excel has resulted in the establishment of a third segment which is comprised solely of the operations of the newly acquired entity. The Companys segments and their principal activities consist of the following:
Precision Technology
This segments products include technologies for precision motion, linear and rotary motion control, medical printers, lasers, electro-optical components and precision optics used in a broad range of commercial and semiconductor applications. These products are used in the electronics, aerospace, materials processing, data storage, imaging and other light industrial markets. The products are designed and manufactured at the Companys facilities in the United States, Europe and Asia.
Semiconductor Systems
The Companys Semiconductor Systems Segments products are designed and manufactured at its facility in the United States. Specific applications include laser repair to improve yields in the production of memory chips; laser marking systems for work-in-process management and traceability of silicon wafers; laser trimming of linear and mixed signal integrated circuits and chip resistors; and inspection of solder paste and component placement on printed circuit boards. The Semiconductor Systems Segment also derives significant revenues from parts and service to its installed base.
Excel
This segments products include lasers, electro-optical components, precision optics and photonics-based solutions primarily consisting of laser systems used in a broad range of commercial and scientific research applications. These products are used in the electronics, aerospace, materials processing, data storage, imaging and other light industrial markets. The products are designed and manufactured at the Companys facilities in the United States and Europe.
Reportable Segment Financial Information
Three Months Ended |
Nine Months Ended |
|||||||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) |
|||||||||||||
(In thousands) | ||||||||||||||||
Sales |
||||||||||||||||
Precision Technology |
$ | 34,568 | $ | 53,270 | $ | 118,941 | $ | 137,996 | ||||||||
Semiconductor Systems |
17,116 | 32,121 | 55,025 | 89,209 | ||||||||||||
Excel |
20,410 | | 20,410 | | ||||||||||||
Intersegment sales elimination |
(651 | ) | (1,314 | ) | (2,239 | ) | (3,506 | ) | ||||||||
Total |
$ | 71,443 | $ | 84,077 | $ | 192,137 | $ | 223,699 | ||||||||
48
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||
September 26, 2008 |
September
28, 2007 (As Restated) |
September 26, 2008 |
September
28, 2007 (As Restated) | |||||||||
(In thousands) | ||||||||||||
Gross Profit |
||||||||||||
Precision Technology |
$ | 11,000 | $ | 20,626 | $ | 42,913 | $ | 51,015 | ||||
Semiconductor Systems |
3,923 | 11,652 | 17,213 | 37,213 | ||||||||
Excel |
7,673 | | 7,673 | | ||||||||
Intersegment sales elimination |
290 | 423 | 252 | 533 | ||||||||
Total |
$ | 22,886 | $ | 32,701 | $ | 68,051 | $ | 88,761 | ||||
The Company reports operating expenses and its assets on a consolidated basis to the chief operating decision maker.
Significant Customers
At September 26, 2008, no customer accounted for 10% or more of the Companys accounts receivable balance. At December 31, 2007, there was one customer, Rexchip Electronics Corporation, which accounted for 21% of the Companys accounts receivable balance.
16. Related Party Transactions
Richard B. Black, the Chairman of the Company, is also the President and Chief Executive Officer of ECRM, Inc., a company which manufactures laser systems equipment for the printing and publishing industry and which is a customer of the Company. All sales to ECRM, Inc. were made pursuant to the Companys standard contract terms and conditions. The Nominating and Governance Committee of the Companys Board of Directors has reviewed and confirmed that ECRM, Inc. received no favored commercial treatment.
The Company recorded sales and raw material purchases from Sumitomo Heavy Industries Ltd., a significant shareholder. The amounts and terms are essentially equivalent to similar third-party transactions.
The following table summarizes related party transactions in the consolidated statements of operations (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||
September 26, 2008 |
September 28, 2007 (As Restated) |
September 26, 2008 |
September 28, 2007 (As Restated) | |||||||||
Sales to ECRM, Inc. |
$ | | $ | 117 | $ | 245 | $ | 709 | ||||
Sales to Sumitomo Heavy Industries Ltd. |
769 | 953 | 2,791 | 2,619 | ||||||||
Purchases from Sumitomo Heavy Industries Ltd. |
60 | | 107 | 52 |
The following table summarizes the related party transactions on the balance sheet (in thousands):
September 26, 2008 |
December 31, 2007 (As Restated) | |||||
Accounts receivable from ECRM, Inc. |
$ | 146 | $ | 211 | ||
Accounts receivable from Sumitomo Heavy Industries Ltd. |
468 | 461 | ||||
Accounts payable to Sumitomo Heavy Industries Ltd. |
4 | |
49
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
17. Subsequent Events
Impairment of Goodwill, Intangible Assets and Other Long-lived Assets
As discussed in Note 3 of Notes to Consolidated Financial Statements, the Company tests its goodwill balances and assesses its indefinite-lived assets annually in the beginning of the second quarter or more frequently if indicators are present or changes in circumstances suggest that impairment may exist. Definite-lived intangible and other long-lived assets are reviewed for impairment whenever changes in events or circumstances indicate their carrying value may not be recoverable.
The significant downturn in the global economy during the fourth quarter of 2008 negatively impacted the Companys projected revenues, expenses and cash flows, suggesting that an impairment of the Companys goodwill, intangible and other long-lived assets might exist. As a result, the Company undertook a review of these assets. Based upon the results of that review, the Company recorded an impairment charge of $215.1 million on its goodwill, intangible assets and other long-lived assets as of December 31, 2008
Bankruptcy Proceedings
Refer to Note 1 for further discussion of the Chapter 11 Bankruptcy Filing, The Third Modified Joint Chapter 11 Plan of Reorganization, and The Plan Support Agreement.
NASDAQ Delisting Determination
On November 3, 2009, the NASDAQ Hearing Panel of NASDAQ notified the Company that it had determined to delist the Companys common shares from the NASDAQ Global Select Market and to suspend trading in the Companys common shares. In accordance with Listing Rule 5830 and Rule 12d2-2 under the Securities Exchange Act of 1934, NASDAQ filed an application on Form 25 with the SEC on April 5, 2010, to delist the Companys securities from NASDAQ. The application will become effective ten days after filing. See Note 1 NASDAQ Delisting Determination of the Notes to Consolidated Financial Statements for further discussion.
SEC Investigation
As discussed in the Explanatory Note to this Quarterly Report on Form 10-Q, we have conducted a Revenue Review of certain of our historic revenue transactions. On May 14, 2009, we received a notice from the SEC indicating that the SEC is conducting a formal investigation relating to our historical accounting practices and the restatement of our historical consolidated financial statements. The Company is cooperating fully with the SECs investigation.
Costs Associated with Exit or Disposal Activities
In December 2008, the Company announced the transfer of all volume related manufacturing from its Rugby, U.K. facility, to the Companys facilities in China and newly acquired Excel manufacturing sites. These activities were completed in 2009, at a total cost of $5.0 million, which is composed of non-cash land and building impairment charges of $3.6 million, employee severance costs of $1.1 million, and facility related charges of $0.3 million. In December 2008, the Company recorded $3.9 million of this total to restructuring expense. It was composed of $3.6 million of non-cash land and building charges, and $0.3 million of employee severance costs. In addition to the amount recorded to restructuring and other expense, the Company recorded a charge of $0.6 million for inventory write-offs against cost of goods sold in 2008. The remaining portion of this restructuring activity has been recorded to restructuring and other expense in 2009. Additionally, in October 2009, the Company sold the Rugby, U.K. facility for proceeds of $3.6 million. The Company recorded a gain of $0.1 million on sale of the Rugby, U.K. facility in 2009.
Additionally, the Company has undertaken a number of cost reduction initiatives, including a workforce reduction of approximately 214 employees in fiscal 2009. The total approximate severance paid in 2009 by the Company in connection with these initiatives was approximately $3.9 million.
Auction Rate Securities
As discussed in Note 3 of Notes to Consolidated Financial Statements, the Company has holdings in Auction Rate Securities for which market stability does not currently exist. The Company had some success in liquidating these holdings during 2009. Of the $32.3 million in par value securities that the Company held as of September 26, 2008, it sold $19.3 million in 2009, and recorded net realized gains of $2.4 million on its sales of these securities. As of December 31, 2009, the Company continues to hold auction rate securities with a par value of $13.0 million. If the credit ratings of the issuer, the
50
GSI GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(Unaudited)
bond insurers or the collateral deteriorate further or if the issuers of these auction rate securities are unable to successfully close further auctions, the Company may further reduce the carrying value of these investments and may in the future be required to record impairment charges against these investments, some of which may be considered other-than-temporary impairment charges. The Company may be required to wait until market stability is restored for these instruments or until the final maturity of the underlying notes (up to 30 years) to recover its investment.
Amended Lease Agreement
In February 2010, the Company entered into an Amended Lease Agreement with 125 Middlesex Turnpike, LLC to reduce the term of its current lease at 125 Middlesex Turnpike, Bedford, Massachusetts from 12 years (of which approximate 10 years were remaining) to 3 years from the new effective date of March 12, 2010. The rental payment will continue at $0.1 million per month. The landlord has the right to terminate upon a written notice of termination (the Termination Notice) setting forth the new date on which the term of the lease shall expire (the Early Termination Date), which date shall be (a) no less than nine (9) months after the date of the Termination Notice, and (b) in any event, no earlier than June 1, 2011.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with the Consolidated Financial Statements and Notes included in Item 1 of this Quarterly Report on Form 10-Q. The MD&A contains certain forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, Section 27A of the United States Securities Act of 1933, as amended, and Section 21E of the United States Securities Exchange Act of 1934, as amended. These forward-looking statements include, but are not limited to anticipated financial performance; drivers of revenue growth; managements plans and objectives for future operations and expenditures; business prospects; industry trends; market conditions; changes in accounting principles and changes in actual or assumed tax liabilities; expectations regarding tax exposure; anticipated capital requirements and working capital needs; amounts of debt, including expectations relative to the restructuring of the debt through Chapter 11 bankruptcy proceedings; anticipated reinvestment of future earnings; anticipated expenditures in regard to the Companys benefit plans; and its anticipated use of currency hedges. These forward-looking statements are neither promises nor guarantees, but involve risks and uncertainties that may cause actual results to differ materially from those in the forward-looking statements. Factors that may cause such differences include, but are not limited to, managements ability to maintain or accurately forecast revenue growth or to anticipate and accurately forecast a decline in revenue from any of the Companys products or services; the Companys ability to compete in an intensely competitive market; its ability to develop and introduce new products or enhancements on schedule and that respond to customer requirements and rapid technological change; new product introductions and enhancements by competitors; the Companys ability to select and implement appropriate business models; plans and strategies and efforts to execute on them; the Companys ability to identify, hire, train, motivate, and retain highly qualified management/other key personnel and its ability to manage changes and transitions in management/other key personnel; the impact of global economic conditions on the Companys business; unauthorized use or misappropriation of its intellectual property; as well as the risk factors discussed herein and in other periodic reports filed with the SEC. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date they are made. Management and the Company disclaim any obligation to publicly update or revise any such statement to reflect any change in its expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those contained in the forward-looking statements.
Business Overview
We design, develop, manufacture and sell photonics-based solutions (consisting of lasers, laser systems and electro-optical components), precision motion devices, associated precision motion control technology and systems. Our customers incorporate our technology into their products or manufacturing processes, for a wide range of applications in the industrial, scientific, electronics, semiconductor, medical and aerospace markets. Our products allow customers to make advances in materials and processing technology and to meet extremely precise manufacturing specifications, including device complexity and miniaturization.
The photonics and electro-optical industry is subject to intense competition and rapid technological developments. Our strength and success is dependent upon developing and delivering successful, timely and cost effective solutions to our customers. For us to maintain our performance, we believe we must continue to increase our operational efficiencies, improve and refine our existing products, expand our product offerings and develop new applications for our technology.
The Company strives to create shareholder value through:
| Organic sales growth by delivering a consistent stream of successful new product launches, |
| Generating high levels of cash flow from operations, and |
| Acquiring and successfully integrating businesses that have complementary and established core competencies. |
We and our subsidiaries serve three primary industries or market segments: Precision Technology, Semiconductor Systems, and Excel. The Companys Precision Technology Segment primarily sells components to original equipment manufacturers (OEMs), who then integrate its products into application specific products or systems. The Companys OEM products include those based on its core competencies in laser, precision motion and motion control technology. The Companys Semiconductor Systems Segment designs, develops and sells production systems that process semiconductor wafers using laser beams and high precision motion technology. The Company sells manufacturing systems to integrated
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device manufacturers and wafer processors. The Companys Excel Segment, acquired in August 2008, designs, manufactures and markets photonics-based solutions consisting of lasers, laser-based systems, precision motion devices and electro-optical components, primarily for industrial and scientific applications. The Companys Excel Segment primarily sells components to OEMs, who then integrate its products into application specific products or systems.
Strategy
GSI strives to expand its presence in its most attractive markets both through organic growth and strategic acquisitions. This strategy led to our acquisition of Excel in the third quarter of 2008. This transaction was a major step for us, as it introduced our presence in some of the attractive markets in which the Excel Segment operates, and it expanded our presence in some of the most attractive markets in which the Precision Technology Segment operates. During 2008 and 2009, we initiated the integration of Excels operations with ours. In 2010, we intend to focus on the completion of the integration of Excel into our operations and on the continued development and introduction of new products. In addition, we intend to continue to explore potential divestments of non-strategic businesses.
We had a number of significant events in 2008, 2009 and 2010 through the filing of this Quarterly Report on Form 10-Q. A discussion of those events follows.
Significant Events in 2008
Financial data, when presented throughout Managements Discussion and Analysis of Financial Condition and Results of Operations, includes the effect of each of the following in the applicable reporting period:
1. | Restatement of our Financial Results. This restatement is more fully described in the Explanatory Note immediately preceding Part I of this Quarterly Report on Form 10-Q, and in Note 2, Restatement of Previously Issued Financial Statements, of Notes to Consolidated Financial Statements. The following table presents revenues and deferred revenues as reported and as restated (in thousands): |
Nine
Months Ended September 26, 2008 |
Year-Ended December 31, | ||||||||||||||
2007 | 2006 | 2005 | 2004 | ||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
Revenues: |
|||||||||||||||
As reported (a) |
$ | 192,137 | $ | 306,067 | $ | 302,083 | $ | 251,761 | $ | 321,367 | |||||
As restated |
| $ | 291,081 | $ | 259,030 | $ | 248,283 | $ | 319,508 | ||||||
Deferred revenue (b): |
|||||||||||||||
As reported (a) |
$ | 108,591 | $ | 9,949 | $ | 2,965 | $ | 2,963 | $ | 1,811 | |||||
As restated |
| $ | 101,563 | $ | 80,283 | $ | 36,511 | $ | 30,411 |
(a) | Excludes U.S. Optics Business which is classified as discontinued operations. |
(b) | Includes current and non-current deferred revenue. |
2. | Divestiture of our U.S. Optics Business. On October 8, 2008, we completed the sale of our U.S. Optics Business for $21.6 million. The U.S. Optics Business was included in our Precision Technology Segment and is shown in the accompanying consolidated statement of operations as discontinued operations since the business was held for sale as of September 26, 2008. The divestiture of the U.S. Optics Business is more fully described in Note 5, Discontinued Operations of Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. |
3. | Excel Acquisition. In August 2008, we completed the acquisition of Excel Technology, Inc., a designer, manufacturer and marketer of photonics-based solutions consisting of lasers, laser based systems, precision motion devices and electro-optical components, primarily for industrial and scientific applications. We believe that Excels |
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complementary products, technologies, and distribution channels will enable us to provide customers with a significantly broader set of technical solutions thereby allowing us to expand our market share. The Excel acquisition had a material impact on our results of operations in 2008. Excel is included in our consolidated financial statements since August 20, 2008. See Note 4, Business Combinations, of Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q for additional details. |
4. | Debt Financing. The acquisition of Excel was financed in part with net cash proceeds received from the sale of $210.0 million of 11% unsecured senior notes and warrants to purchase our common shares. The remainder of the purchase price we paid for Excel was provided by cash on hand at the time of closing. |
5. | Impairment of Goodwill, Intangible Assets and Other Long-lived Assets. During the fourth quarter of 2008, we recorded an impairment charge of $215.1 million resulting from our assessment of the fair value of our goodwill, intangible and other long-lived assets as of December 31, 2008. The impairment charge included an impairment of the goodwill, intangible and other long-lived assets we acquired as part of the Excel acquisition in August 2008, that is more fully discussed below under Critical Accounting Policies and Estimates, and also in Note 3 of Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. |
6. | Restructuring Charges. During the three-month and nine-month periods ended September 26, 2008, we recorded restructuring charges of $3.1 million and $4.2 million, respectively, resulting from various actions including workforce reductions and the cessation or relocation of certain activities. These actions are discussed below, in our discussion of our results of operations for the three-month and nine-month periods ended September 26, 2008 and September 28, 2007. |
Significant Events in 2009 and 2010
In 2009 and 2010, the Company had a number of significant developments. These developments are discussed in the Explanatory Note that precedes Part I of this Quarterly Report on Form 10-Q, Note 1 of Notes to Consolidated Financial Statements under the headings NASDAQ Delisting Determination, Chapter 11 Bankruptcy Filing, The Third Modified Joint Chapter 11 Plan of Reorganization and The Plan Support Agreement and in Note 17 of Notes to Consolidated Financial Statements under the headings, SEC Investigation, Costs Associated with Exit or Disposal Activities, Auction Rate Securities and Amended Lease Agreement.
In addition to these events, we undertook a number of restructuring activities in 2009. We also undertook a number of cost reduction initiatives, including a workforce reduction of approximately 214 employees in fiscal 2009. The total approximate severance paid in 2009 by the Company in connection with these initiatives was approximately $3.9 million. The approximate annualized savings realized by us from these workforce reductions was approximately $11.2 million in 2009.
Our Revenue Review and related restatement of historic financial statements continued into 2009. The costs for these activities are significant, and have been charged to restructuring and other costs as incurred.
Going Concern
As a result of certain of the significant events discussed above and uncertainties inherent in the bankruptcy process, there is substantial doubt about our ability to continue as a going concern. Operating in bankruptcy imposes significant risks and uncertainties on our business. See Item 1A Risk Factors Risks Relating to Bankruptcy of Part II of this Quarterly Report on Form 10-Q for a discussion of the risks and uncertainties relating to our business and investing in our securities as a result of the Chapter 11 Cases.
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We believe that when we emerge from bankruptcy, we will be sufficiently capitalized. We expect that we will have assets that exceed our liabilities, and that those assets, as well as the net assets derived from our continuing operations, will be sufficient to meet our obligations, including the obligations with respect to the payment of interest, and repayment of principal under the New Term Loan (see The Third Modified Joint Chapter 11 Plan of Reorganization in Note 1 of Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q). Notwithstanding our expectation upon our emergence from bankruptcy, uncertainties inherent in the bankruptcy process raise substantial doubt about our ability to continue as a going concern. In particular, until the Plan is confirmed by the Court, we may be required to pay the Senior Note Claims under the original terms of the Senior Notes. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Overview of Financial Results
As a result of the significant events described above, our financial results in 2008 differ significantly from those in recent years. During the nine months ended September 26, 2008, we reported a net loss of $14.1 million, compared to net income of $13.6 million in the corresponding period in 2007. Our operating results for the nine-month period included a significant charge of $12.1 million relating to the write-off of acquisition related in-process research and development in connection with our acquisition of Excel. In addition, we expensed $4.2 million in connection with restructuring activities during the first nine months of 2008 compared with $5.9 million during the first nine months of 2007.
Results of Operations for the Three Months Ended September 26, 2008 Compared with the Three Months Ended September 28, 2007
The following table sets forth our unaudited results of operations as a percentage of sales for the periods indicated:
Three Months Ended | ||||||
September 26, 2008 |
September 28, 2007 (As Restated) |
|||||
Sales |
100.0 | % | 100.0 | % | ||
Cost of goods sold |
68.0 | 61.1 | ||||
Gross profit |
32.0 | 38.9 | ||||
Research and development and engineering |
12.4 | 8.8 | ||||
Selling, general and administrative |
23.3 | 18.0 | ||||
Amortization of purchased intangibles |
2.3 | 0.6 | ||||
Restructuring |
4.3 | 2.3 | ||||
Acquisition related in-process research and development charge |
17.0 | | ||||
Total operating expenses |
59.3 | 29.7 |
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Three Months Ended | ||||||
September 26, 2008 |
September 28, 2007 (As Restated) |
|||||
Income (loss) from operations |
(27.3 | ) | 9.2 | |||
Interest income |
0.8 | 2.0 | ||||
Interest expense |
(4.0 | ) | | |||
Foreign exchange transaction gain (losses) |
| 0.8 | ||||
Other income (expense), net |
| | ||||
Income (loss) from continuing operations before income taxes |
(30.5 | ) | 12.0 | |||
Income tax provision (benefit) |
(10.6 | ) | 4.1 | |||
Income (loss) from continuing operations |
(19.9 | ) | 7.9 | |||
Income from discontinued operations, net of tax |
| | ||||
Net income (loss) |
(19.9 | )% | 7.9 | % | ||
Sales
The following table sets forth sales by business segment for the periods noted (dollars in thousands):
Three Months Ended | |||||||||||||||
September 26, 2008 | September 28, 2007 (As Restated) |
Increase (Decrease) |
Percentage Change |
||||||||||||
Precision Technology |
$ | 34,568 | $ | 53,270 | $ | (18,702 | ) | (35.1 | )% | ||||||
Semiconductor Systems |
17,116 | 32,121 | (15,005 | ) | (46.7 | )% | |||||||||
Excel |
20,410 | | 20,410 | | |||||||||||
Intersegment sales elimination (1) |
(651 | ) | (1,314 | ) | 663 | (50.5 | )% | ||||||||
Total |
$ | 71,443 | $ | 84,077 | $ | (12,634 | ) | (15.0 | )% | ||||||
(1) | Sales of the Precision Technology segments products to the Semiconductor Systems segment. |
Sales of the various product lines that comprise our Precision Technology Segment decreased by $18.7 million, or 35.1%, from $53.3 million during the three months ended September 28, 2007 to $34.6 million during the three months ended September 26, 2008. The decrease in sales of these product lines was primarily attributable to declines in our
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Spindles, Scanners and Encoders product lines in the third quarter of 2008 compared with the third quarter of 2007. Worldwide demand for those products weakened markedly beginning in the third quarter of 2008 as turmoil in world financial markets intensified, credit conditions tightened and business and consumer confidence plummeted. The weakness in demand continued during the fourth quarter of 2008 and early 2009. Also, during the third quarter of 2007, we recognized approximately $8.5 million of revenue that had previously been deferred because the customer arrangements were not fixed and determinable. When the customer arrangements became fixed and determinable in the third quarter of 2007, the revenue was recognized.
Semiconductor Systems Segment revenues decreased by $15.0 million, or 46.7%, from $32.1 million during the three months ended September 28, 2007 to $17.1 million during the three months ended September 26, 2008. The decrease in Semiconductor Systems sales was primarily attributable