We are a global provider of instruments, subsystems and process control solutions that measure, control, power, monitor and analyze critical parameters of advanced manufacturing processes to improve process performance and productivity. We also provide services relating to the maintenance and repair of our products, software maintenance, installation services and training. Our products are derived from our core competencies in pressure measurement and control, materials delivery, gas composition analysis, control and information technology, power and reactive gas generation and vacuum technology. Our products are used in diverse markets, applications and processes. Our primary service markets are manufacturers of capital equipment for semiconductor devices, and for other thin film applications including flat panel displays, solar cells and light emitting diodes ("LEDs"), data storage media and other advanced coatings. We also leverage our technology into other markets with advanced manufacturing applications including medical equipment, pharmaceutical manufacturing, energy generation and environmental monitoring. We have a diverse base of customers that includes manufacturers of semiconductor capital equipment and semiconductor devices, thin film capital equipment used in the manufacture of flat panel displays, LEDs, solar cells, data storage media and other coating applications; and other industrial, medical, energy generation, environmental monitoring and manufacturing companies, and university, government and industrial research laboratories. During the years 2013, 2012 and 2011, approximately 68%, 62% and 61% of our net sales, respectively, were to semiconductor capital equipment manufacturers and semiconductor device manufacturers. We expect that sales to semiconductor capital equipment manufacturers and semiconductor device manufacturers will continue to account for a substantial portion of our sales. We have four reportable segments: Advanced Manufacturing Capital Equipment,
Analytical Solutions Group, Europe Region Sales & Service and Asia RegionSales & Service. The Advanced Manufacturing Capital Equipment segment includes the development, manufacture, sales and servicing of instruments and control products, power and reactive gas products and vacuum products, all of which are utilized in semiconductor processing and other similar advanced manufacturing processes. Sales in this segment include both external sales and intercompany sales (which are recorded at agreed upon transfer prices). External sales of these products made in Europeor Asiaare reported as sales in the Europe RegionSales & Service or Asia Region Sales & Service segments. The Analytical Solutions Groupincludes, gas composition analysis, information technology products and custom fabrication services. The Europeand Asia Region Sales and Service groups mainly resell and service the Advanced Manufacturing Capital Equipment and Analytical Solutions Groupproducts sold into their respective regions. We group our products into four groups of similar products based upon similarity of product function. These four groups of products are: Instruments and Control Products, Power and Reactive Gas Products, Vacuum Products and Analytical Solutions Group Products. Net revenues to semiconductor capital equipment manufacture and semiconductor device manufacture customers increased by 14% in 2013 compared to the prior year. Throughout all of 2012, we witnessed a drop in semiconductor capital spending, but conditions stabilized in the fourth quarter of 2012 and our semiconductor net revenues increased sequentially in each quarter of 2013. Net revenues to semiconductor capital equipment manufacture and semiconductor device manufacture customers declined by 20% in 2012 compared to 2011, and declined by 8% in 2011 compared to 2010. The semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we are uncertain as to the timing or extent of future demand or any future weakness in the semiconductor capital equipment industry. 24
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Our net revenues sold to other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications, decreased 13% in 2013 compared to the prior year. These advanced markets include general industrial, medical, solar, thin films, pharmaceutical and other markets. The decline in other advanced markets was primarily caused by a significant decrease in our solar product revenues, which declined by 73% in 2013 compared to the prior year, as the industry has contracted over the past few years due to oversupply. Excluding sales to customers in the solar market, revenues to other advanced markets declined by 5% in 2013 compared to the prior year. Approximately 32% of our net sales for 2013 were to other advanced markets and we anticipate that these markets will grow and could represent a larger portion of our revenue. A significant portion of our net sales, is in international markets. During the years 2013, 2012 and 2011, international net sales accounted for approximately 46%, 49% and 52% of our net sales, respectively. A significant portion of our international net sales were sales in
Japanand Korea. We expect that international net sales will continue to represent a significant percentage of our total net sales. On March 12, 2013, we completed our acquisition of Alter S.r.l. ("Alter") located in Reggio Emilia, Italy. Alter develops advanced microwave power generators, components and systems for industrial microwave heating, microwave plasma coating and semiconductor applications. The purchase price net of cash acquired and after final debt and working capital adjustments, was $2.4 million. Total cash paid as of June 30, 2013, net of cash acquired was $2.0 million. During June 2013, one of two holdback provisions was met and we released $0.1 million. We will pay the remaining $0.4 million, subject to a final holdback provision being met.
August 29, 2012, we completed our acquisition of Plasmart, Inc.("Plasmart") located in Daejeon, Korea. Plasmart develops radio frequency (RF), plasma generation and monitoring systems for the semiconductor, flat panel display, active matrix organic light emitting diodes and solar photovoltaic industries. The purchase price was $22.6 million, net of $0.1 millionof cash acquired, after final working capital post-close adjustments.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts, inventory, warranty costs, stock-based compensation expense, intangible assets, goodwill and other long-lived assets, in-process research and development and income taxes. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the most significant judgments, assumptions and estimates we use in preparing our consolidated financial statements:
Revenue Recognition and Allowance for Doubtful Accounts. Revenue from product sales is recorded upon transfer of title and risk of loss to the customer provided that there is evidence of an arrangement, the sales price is fixed or determinable, and collection of the related receivable is reasonably assured. In most transactions, we have no obligations to our customers after the date products are shipped other than pursuant to warranty obligations. The Company does not frequently enter into arrangements with multiple deliverables however, for those revenue arrangements with multiple deliverables, we allocate revenue to each element based upon their 25
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relative selling price using vendor-specific objective evidence ("VSOE"), or third-party evidence ("TPE") or based upon the relative selling price using estimated prices if VSOE or TPE does not exist. We then recognize revenue on each deliverable in accordance with our policies for product and service revenue recognition. We defer the fair value of any undelivered elements until the undelivered element is delivered. Fair value is the price charged when the element is sold separately. Shipping and handling fees billed to customers, if any, are recognized as revenue. The related shipping and handling costs are recognized in cost of sales. We monitor and track the amount of product returns, provide for sales return allowances and reduce revenue at the time of shipment for the estimated amount of such future returns, based on historical experience. While product returns have historically been within our expectations and the provisions established, there is no assurance that we will continue to experience the same return rates that we have in the past. Any significant increase in product return rates could have a material adverse impact on our operating results for the period or periods in which such returns materialize. While we maintain a credit approval process, significant judgments are made by management in connection with assessing our customers' ability to pay at the time of shipment. Despite this assessment, from time to time, our customers are unable to meet their payment obligations. We continuously monitor our customers' credit worthiness, and use our judgment in establishing a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, there is no assurance that we will continue to experience the same credit loss rates that we have in the past. A significant change in the liquidity or financial position of our customers could have a material adverse impact on the collectability of accounts receivable and our future operating results. Inventory. We value our inventory at the lower of cost (first-in, first-out method) or market. We regularly review inventory quantities on hand and record a provision to write-down excess and obsolete inventory to its estimated net realizable value, if less than cost, based primarily on our estimated forecast of product demand. Once our inventory value is written-down and a new cost basis has been established, the inventory value is not increased due to demand increases. Demand for our products can fluctuate significantly. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases as a result of supply shortages or a decrease in the cost of inventory purchases as a result of volume discounts, while a significant decrease in demand could result in an increase in the charges for excess inventory quantities on hand. In addition, our industry is subject to technological change, new product development and product technological obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results. For 2013, 2012 and 2011, our total charges for excess and obsolete inventory totaled
$21.7 million, $15.0 millionand $14.9 million, respectively. Included in our total charges for excess and obsolete inventory in 2013 is $6.4 millionof special charges for obsolete inventory related to a unique product in a solar application as a result of slowing market conditions, which provided uncertainty as to the net realizable value of this inventory. Warranty Costs. We provide for the estimated costs to fulfill customer warranty obligations upon the recognition of the related revenue. We provide warranty coverage for our products ranging from 12 to 36 months, with the majority of our products ranging from 12 to 24 months. We estimate the anticipated costs of repairing our products under such warranties based on the historical costs of the repairs and any known specific product issues. The assumptions we use to estimate warranty accruals are re-evaluated periodically in light of actual experience and, when appropriate, the accruals are adjusted. Our determination of the appropriate level of warranty accrual is based upon estimates. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. Stock-Based Compensation Expense. We record compensation expense for all share-based payment awards to employees and directors based upon the estimated fair market value of the underlying instrument. Accordingly, share-based compensation cost is measured at the grant date, based upon the fair value of the award. 26
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We typically issue restricted stock units ("RSUs") as stock-based compensation. We also provide employees the opportunity to purchase shares through an Employee Stock Purchase Plan ("ESPP"). For RSUs, the fair value is the stock price on the date of grant. For shares issued under our ESPP, we have estimated the fair value on the date of grant using the Black Scholes pricing model, which is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, expected life, risk free interest rate and expected dividends. Management determined that blended volatility, a combination of historical and implied volatility, is more reflective of market conditions and a better indicator of expected volatility than historical or implied volatility alone. We are also required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. Certain RSUs involve stock to be issued upon the achievement of performance conditions (performance shares) under our stock incentive plans. Such performance shares become available subject to time-based vesting conditions if, and to the extent that, financial or operational performance criteria for the applicable period are achieved. Accordingly, the number of performance shares earned will vary based on the level of achievement of financial or operational performance objectives for the applicable period. Until such time that our performance can ultimately be determined, each quarter we estimate the number of performance shares more likely than not to be earned based on an evaluation of the probability of achieving the performance objectives. Such estimates are revised, if necessary, in subsequent periods when the underlying factors change our evaluation of the probability of achieving the performance objectives. Accordingly, share-based compensation expense associated with performance shares may differ significantly from the amount recorded in the current period. The assumptions used in calculating the fair value of share-based payment awards represents management's best estimates, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. Intangible Assets, Goodwill and Other Long-Lived Assets. As a result of our acquisitions, we have identified intangible assets and generated significant goodwill. Definite-lived intangible assets are valued based on estimates of future cash flows and amortized over their estimated useful life. Goodwill and indefinite-lived intangible assets are subject to annual impairment testing as well as testing upon the occurrence of any event that indicates a potential impairment. Intangible assets and other long-lived assets are also subject to an impairment test if there is an indicator of impairment. The carrying value and ultimate realization of these assets is dependent upon estimates of future earnings and benefits that we expect to generate from their use. If our expectations of future results and cash flows are significantly diminished, intangible assets and goodwill may be impaired and the resulting charge to operations may be material. When we determine that the carrying value of intangibles or other long-lived assets may not be recoverable based upon the existence of one or more indicators of impairment, we use the projected undiscounted cash flow method to determine whether an impairment exists, and then measure the impairment using discounted cash flows. To measure impairment for goodwill, we compare the fair value of our reporting units by measuring discounted cash flows to the book value of the reporting units. Goodwill would be impaired if the resulting implied fair value was less than the recorded book value of the goodwill. The estimation of useful lives and expected cash flows require us to make significant judgments regarding future periods that are subject to some factors outside of our control. Changes in these estimates can result in significant revisions to the carrying value of these assets and may result in material charges to the results of operations. We have elected to perform our annual goodwill impairment test as of
October 31of each year, or more often if events or circumstances indicate that there may be impairment. Goodwill is the amount by which the cost of acquired net assets exceeded the fair value of those net assets on the date of acquisition. We allocate goodwill to reporting units at the time of acquisition or when there is a change in the reporting structure and base that 27
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allocation on which reporting units will benefit from the acquired assets and liabilities. Reporting units are defined as operating segments or one level below an operating segment, referred to as a component. The estimated fair value of our reporting units was based on discounted cash flow models derived from internal earnings and internal and external market forecasts. Determining fair value requires the exercise of significant judgment, including judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. Discount rates are based on a weighted average cost of capital ("WACC"), which represents the average rate a business must pay its providers of debt and equity. The WACC used to test goodwill is derived from a group of comparable companies. Assumptions in estimating future cash flows are subject to a high degree of judgment and complexity. We make every effort to forecast these future cash flows as accurately as possible with the information available at the time the forecast is developed. We have the option of first assessing qualitative factors to determine whether it is necessary to perform the current two-step impairment test or we can perform the two-step impairment test without performing the qualitative assessment. For the reporting units that did not experience any significant adverse changes in their business or reporting structures or any other adverse changes, and the reporting unit's fair value substantially exceeded its amount from the prior year assessment, we performed the qualitative "Step 0" assessment. In performing the qualitative Step 0 assessment, we considered certain events and circumstances specific to the reporting unit and to the entity as a whole, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. For the remaining reporting units that did not meet these criteria we performed the two-step goodwill impairment test. Under the two-step goodwill impairment test, we compared the fair value of each reporting unit to its respective carrying amount, including goodwill. If the fair value of the reporting unit exceeds the fair value, the second step of the goodwill impairment test must be completed to measure the amount of impairment loss, if any. The second step compares the implied fair value of goodwill with the carrying value of goodwill. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit, the excess of the fair value over amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference. As of
October 31, 2013, we performed our annual impairment assessment of goodwill and determined that it is more likely than not that the fair values of the reporting units exceed their carrying amount. We will continue to monitor and evaluate the carrying value of goodwill. If market and economic conditions or business performance deteriorate, this could increase the likelihood of us recording an impairment charge. However, management believes it is not reasonably likely that an impairment will occur at any of its reporting units over the next twelve months. In-Process Researchand Development. We value tangible and intangible assets acquired through our business acquisitions, including in-process research and development ("IPR&D"), at fair value. We determine IPR&D through established valuation techniques for various projects for the development of new products and technologies and capitalize IPR&D as an intangible asset. If the projects are completed, the intangible asset will be amortized to earnings over the expected life of the completed product. If the R&D projects are abandoned, we will write-off the related intangible asset. The value of IPR&D is determined using the income approach, which discounts expected future cash flows from projects under development to their net present value. Each project is analyzed and estimates and judgments are made to determine the technological innovations included in the utilization of core technology, the complexity, cost, time to complete development, any alternative future use or current technological feasibility and the stage of completion. Income Taxes. We evaluate the realizability of our net deferred tax assets and assess the need for a valuation allowance on a quarterly basis. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income to realize the assets. We record a 28
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valuation allowance to reduce our net deferred tax assets to the amount that may be more likely than not to be realized. To the extent we established a valuation allowance an expense is recorded within the provision for income taxes line in the consolidated statements of operations and comprehensive income. In future periods, if we were to determine that it was more likely than not that we would not be able to realize the recorded amount of our remaining net deferred tax assets, an adjustment to the valuation allowance would be recorded as an increase to income tax expense in the period such determination was made. Accounting for income taxes requires a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolutions of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. We re-evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any change in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of total net sales of certain line items included in our consolidated statements of operations and comprehensive income data: Years Ended December 31, 2013 2012 2011 Net revenues: Product 84.9 % 83.4 % 87.4 % Service 15.1 16.6 12.6 Total net revenues 100.0 % 100.0 % 100.0 % Cost of revenues: Product 50.4 48.2 47.1 Service 9.8 9.9 7.3 Total cost of revenues 60.2 % 58.1 % 54.4 % Gross profit 39.8 % 41.9 % 45.6 % Research and development 9.5 9.3 7.4
Selling, general and administrative 21.2 19.8
15.6 Litigation - 0.8 - Insurance reimbursement (0.1 ) - -
Completed acquisition costs - 0.2
Restructuring 0.2 0.1
Amortization of acquired intangible assets 0.3 0.1
0.1 Income from operations 8.7 % 11.6 % 22.5 % Interest income, net 0.1 0.1 0.1
Income before income taxes 8.8 % 11.7 %
Provision for income taxes 3.5 4.2
6.8 Net income 5.3 % 7.5 % 15.8 % 29
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Net Revenues Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Product
$ 568.3 $ 536.8 $ 719.05.9 % (25.3 )% Service 101.1 106.7 103.5 (5.3 ) 3.1 Total net revenues $ 669.4 $ 643.5 $ 822.54.0 % (21.8 )% Product revenues increased $31.5 millionduring 2013 compared to the prior year. Product revenues related to our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers increased by $59.4 million, or 17.8%. The increase in the semiconductor markets we serve was mainly the result of volume increases in four consecutive quarters in 2013 in product revenues to the semiconductor markets. Our product revenues for other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications, decreased by $27.8 million, or 13.7%. The decrease in our non-semiconductor markets was primarily caused by volume decreases of $21.0 millionin our solar market and $9.9 millionin our general industrial market. The solar market has decreased over the past few years due to overcapacity. The industrial market decrease relates to specific projects. Product revenues decreased $182.2 millionduring 2012 compared to 2011. Product revenues related to our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers decreased by $101.3 million, or 23.3%, mainly the result of volume decreases throughout 2012. Our product revenues for other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications, decreased by $80.9 million, or 28.4%. We saw a significant decrease in the solar and LED markets, which decreased by an aggregate of 63.4%, as end market customers continued to utilize existing product shipments from 2010 and 2011. Service revenues consisted mainly of fees for services related to the maintenance and repair of our products, software maintenance, installation services and training. Service revenues decreased $5.6 millionduring 2013 compared to the prior year. The decrease is primarily attributed to the timing and fulfillment of service orders as we transitioned and merged one of our service locations into an existing service site. Service revenues increased $3.2 millionduring 2012 compared to 2011. The increase related primarily to our foreign locations where we had made investments in our service organizations. Total international net revenues, including product and service, were $305.5 millionfor 2013 or 45.6% of net sales, compared to $316.6 millionfor 2012, or 49.2% of net sales, and $431.4 million, or 52.5% of net sales, for 2011.
The following table sets forth our net revenues by reportable segment:
Net Revenues Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012
Advanced Manufacturing CapitalEquipment $ 528.0 $ 479.8 $ 647.910.1 % (26.0 )% Analytical Solutions Group 56.3 62.8 61.3 (10.3 ) 2.4 Europe Region Sales & Service 48.5 51.4 75.3 (5.7 ) (31.6 ) Asia Region Sales & Service 218.0 229.7 305.4 (5.1 ) (24.8 ) Corporate, Eliminations and Other (181.4 ) (180.2 ) (267.4 ) (0.7 ) 32.6 Total net revenues $ 669.4 $ 643.5 $ 822.54.0 % (21.8 )% 30
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Net revenues for the Advanced Manufacturing Capital Equipment segment increased by 10.1% in 2013 compared to the prior year. This increase is mainly due to an increase of 23.8% in revenues from our top two customers who represented approximately 29% of our total revenues in 2013. These customers operate mainly in the semiconductor market, which increased by 14% in 2013 compared to 2012. Net revenues for the
Analytical Solutions Groupsegment decreased by 10.3% in 2013 compared to the prior year and increased by 2.4% in 2012 compared to the prior year. This segment sells more to our other advanced markets rather than to our semiconductor market. We saw an overall decrease in other advanced markets of 12.7% in 2013 compared to 2012, largely driven by decreases in our solar and general industrial markets. While we saw an overall decrease in in other advanced markets in 2012 of 24.3%, the overall increase in 2012 in the Analytical Solutions Groupwas primarily driven by an increase in sales in our general and industrial markets, which increased by 7.2% compared to the prior year. The Europe Region Sales & Service segment decreased by 5.7% in 2013 compared to the prior year. The decrease in sales is primarily attributed to the timing of certain projects from a few customers in France. The Asia Region Sales & Service segment revenues decreased by 5.1% in 2013 compared to the prior year. These decreases are primarily the result of decreases in sales to other advanced markets, mainly in the solar market which decreased by 80.1%. In addition, foreign exchange rates, primarily related to the Japanese Yen which decreased by approximately 22% in 2013, had an unfavorable impact on revenues for the Asia Region Sales & Service segment. Excluding the impact of solar and unfavorable foreign exchange revenues for the Asia Region Sales & Service segment increased by 2.9%. Net revenues for the Advanced Manufacturing Capital Equipment segment, Europe Region Sales & Service segment and the Asia Region Sales & Service segment decreased by 26.0%, 31.6% and 24.8%, respectively, for 2012 compared to 2011. This was primarily caused by the decrease in our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers which decreased 23.3% in the same period as noted above. The majority of our sales in these three reportable segments are sold to the semiconductor capital equipment and semiconductor device manufacturers. In addition, the decrease in the Europe Region Sales & Service segment was also impacted by a decrease related to the solar market. The following is gross profit as a percentage of net revenues by product and service: Gross Profit Years Ended December 31, % Points % Points Change Change (As a percentage of net revenues) 2013 2012 2011 in 2013 in 2012 Product 40.6 % 42.2 % 46.1 % (1.6 ) (3.9 ) Service 35.3 40.5 42.0 (5.2 ) (1.5 ) Total gross profit percentage 39.8 % 41.9 % 45.6 % (2.1 ) (3.7 ) Gross profit on product revenues decreased by 1.6 percentage points during 2013 compared to the prior year. The decrease was primarily due to a decrease of 2.7 percentage points due to unfavorable product mix, a decrease of 0.9 percentage points due to higher excess and obsolete inventory charges and 0.5 percentage points from unfavorable foreign exchange. These decreases were partially offset by an increase of 1.2 percentage points due to favorable revenue volumes and 1.1 percentage points due to lower overhead expenses. Gross profit on product revenues decreased by 3.9 percentage points during 2012 compared to the prior year. The decrease was primarily due to a decrease of 3.7 percentage points due to unfavorable product revenue volume and overhead absorption from lower production and 0.3 percentage points due to higher excess and obsolete inventory charges. These decreases were partially offset by an increase of 0.2 percentage points due to lower compensation related expenses. 31
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Cost of service revenues consists primarily of costs for providing services for repair and training which includes salaries, related expenses and other overhead costs. Service gross profit for 2013 decreased by 5.2 percentage points compared to the prior year. The decrease was primarily attributed to a decrease of 2.3 percentage points due to unfavorable product mix, a decrease of 1.1 percentage points due to unfavorable foreign exchange, a decrease of 0.6 percentage points due to higher overhead charges, a decrease of 0.5 percentage points due to unfavorable revenue volumes and a decrease of 0.4 percentage points due to higher warranty charges. Service gross profit for 2012 decreased by 1.5 percentage points compared to the prior year. This decrease was mainly attributed to a decrease of 3.6 percentage points due to higher overhead spending. This decrease was partially offset by an increase of 1.9 percentage points due to favorable product mix and an increase of 0.5 percentage points due to favorable revenue volume. The following is gross profit as a percentage of net revenues by reportable segment: Gross Profit Years Ended December 31, % Points % Points Change Change (As a percentage of net revenues) 2013 2012 2011 in 2013 in 2012 Advanced Manufacturing Capital Equipment 35.5 % 35.7 % 40.7 % (0.2 ) (5.0 ) Analytical Solutions Group 52.3 52.2 51.9 0.1 0.3 Europe Region Sales & Service 28.0 29.5 28.3 (1.5 ) 1.2 Asia Region Sales & Service 19.7 16.1 14.8 3.6 1.3 Corporate, Eliminations and Other 3.9 (7.4 ) (4.8 ) 11.3 (2.6 ) Total net revenues 39.8 % 41.9 % 45.6 % (2.1 ) (3.7 ) Gross profit for the Advanced Manufacturing Capital Equipment segment decreased 0.2 percentage points and 5.0 percentage points in 2013 and 2012, respectively, compared to the prior year. The decrease of 0.2 percentage points in 2013 is primarily due to higher excess and obsolete inventory charges and unfavorable product mix, partially offset by an increase in revenue volume. The decrease of 5.0 percentage points in 2012 is primarily due to a decline in revenue volume. Gross profit for the
Analytical Solutions Groupincreased 0.1 percentage points and 0.3 percentage points in 2013 and 2012, respectively, compared to the prior year. The slight increase of 0.1 percentage points in 2013 is primarily attributed to favorable product mix, partially offset by unfavorable revenue volume. The increase of 0.3 percentage points in 2012 is primarily attributed to product mix, favorable revenue volume and lower warranty charges, partially offset by lower overhead spending.
Gross profit for the Europe Region Sales & Service segment decreased 1.5 percentage points in 2013 as compared to 2012 and increased 1.2 percentage points in 2012 as compared to 2011. The decrease of 1.5 percentage points in 2013 is primarily related to unfavorable product mix. The increase of 1.2 percentage points in 2012 is primarily related to favorable product mix, partially offset by a decline in revenue volume.
Gross profit for the Asia Region Sales & Service segment increased 3.6 percentage points and 1.3 percentage points in 2013 and 2012, respectively, compared to the prior year. The increase of 3.6 percentage points in 2013 is primarily related to favorable product mix, lower excess and obsolete inventory charges and lower overhead spending, partially offset by unfavorable foreign exchange. The increase of 1.3 percentage points in 2012 is primarily related to favorable product mix, partially offset by lower revenue volume. 32
Table of Contents Research and Development Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Research and development expenses
$ 63.6 $ 60.1 $ 61.05.7 % (1.5 )% Research and development expenses increased $3.5 millionduring 2013 compared to the prior year. The increase is primarily attributed to an increase of $3.4 millionin compensation-related costs, including variable compensation and an increase of $0.4 millionin project materials. These increases are partially offset by a decrease of $0.6 millionin consulting costs. Research and development expenses decreased $0.9 millionduring 2012 compared to the prior year. The decrease resulted from additional cost control measures including a decrease of $0.9 millionin consulting costs and a $0.5 milliondecrease in project materials. These decreases are partially offset by a $0.4 millionincrease in patent related costs. Our research and development is primarily focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity. We have thousands of products and our research and development efforts primarily consist of a large number of projects related to these products, none of which is individually material to us. Current projects typically have durations of 3 to 30 months depending upon whether the product is an enhancement of existing technology or a new product. Our current initiatives include projects to enhance the performance characteristics of older products, to develop new products and to integrate various technologies into subsystems. These projects support in large part, the transition in the semiconductor industry to smaller integrated circuit geometries and in the flat panel display and solar markets to larger substrate sizes, which require more advanced process control technology. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants, material costs for prototypes and other expenses related to the design, development, testing and enhancement of our products. We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets, and we expect to continue to make significant investment in research and development activities. We are subject to risks if products are not developed in a timely manner, due to rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor industry and other advanced technology markets. We develop products that are technologically advanced so that they are positioned to be chosen for use in each successive generation of semiconductor capital equipment. If our products are not chosen to be designed into our customers' products, our net revenues may be reduced during the lifespan of those products.
Selling, General and Administrative
Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Selling, general and administrative expenses
$ 142.0 $ 127.2 $ 128.011.7 % (0.6 )% Selling, general and administrative expenses increased $14.8 millionduring 2013 compared to the prior year. The increase is primarily attributed to a $10.0 millionincrease in compensation related costs primarily related to variable compensation and higher fringe benefit costs, a $2.6 millionincrease related to executive retirement costs recorded in the fourth quarter of 2013 as a result of the retirement of our Chief Executive Officer in December 2013and a $1.6 millionincrease in consulting costs. 33
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Selling, general and administrative expenses decreased
$0.8 millionduring 2012 compared to the prior year. The decrease consists mainly of a $2.5 millionfavorable impact from foreign exchange fluctuations, a $0.5 milliondecrease in facilities related expenses, a $0.4 milliondecrease in recruiting and relocation expenses and a $0.3 milliondecrease in advertising and investor relations expenses. These decreases are partially offset by a $1.8 millionincrease in professional fees, primarily related to legal expenses, a $0.5 millionincrease in depreciation expense and a $0.5 millionincrease in bad debt expense. Litigation Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Litigation $ - $ 5.3$ - (100.0 )% 100.0 % Litigation with shareholders of one of our former subsidiaries was settled for $5.3 millionduring the third quarter of 2012. The complaint alleged certain claims against us including breach of contract, implied covenants, and statutory violations. The claims sought unspecified damages and equitable relief. This litigation was long standing and we made the decision to reach a settlement primarily to eliminate future legal expenses related to the suit. Insurance Reimbursement Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Insurance reimbursement $ (1.1 )$ - $ - (100.0 )% - %
In the second quarter of 2013, we recovered
Completed Acquisition Costs Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012
Completed acquisition costs
(86.4 )% 100.0 % We incurred
$0.2 millionof acquisition costs in 2013 related to our March 2013acquisition of Alter. These costs are comprised of legal fees. We incurred $1.3 millionof acquisition costs in 2012 related to our August 2012acquisition of Plasmart. These costs consisted of investment banking fees, legal fees and due diligence costs. Restructuring Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Restructuring $ 1.4 $ 0.3$ - 297.1 % 100.0 % During 2013, we incurred restructuring charges primarily related to the consolidation of certain facilities. The majority of these costs were related to severance expenses and these programs were substantially completed by December 31, 2013. The plans included a small reduction in headcount. During the fourth quarter of 2012, we implemented a workforce reduction plan as a result of a slowdown in our business. We reduced our worldwide workforce by 84 people and recorded a restructuring charge of $0.3 million. This restructuring was substantially complete at December 31, 2012. 34
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Amortization of Acquired Intangible Assets
Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012
Amortization of acquired intangible assets
$ 2.1 $ 1.0 $ 1.0106.7 % 2.1 % Amortization increased by $1.1 millionduring 2013 compared to the prior year. This increase is primarily attributed to an increase in intangible assets from our August 2012acquisition of Plasmart and our March 2013acquisition of Alter, offset by intangible assets that became fully amortized. Amortization expense remained relatively flat during 2012 compared to the prior year. Increased amortization expense from our August 2012Plasmart acquisition was offset by intangible assets that became fully amortized during the year. Interest Income, Net Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012 Interest income, net $ 0.9 $ 0.9 $ 1.1- % (18.9 )% Net interest income for 2013 remained flat compared to the prior year. Net interest income decreased $0.2 millionduring 2012 compared to the prior year, partially due to higher interest expense related to the acquisition of Plasmart, which had debt when we acquired them in August 2012. Provision for Income Taxes Years Ended December 31, % Change % Change (Dollars in millions) 2013 2012 2011 in 2013 in 2012
Provision for income taxes
(13.2 )% (51.9 )%
The provision for income taxes in 2013, 2012 and 2011 are comprised of U.S. federal, state and foreign income taxes.
Our effective tax rate for the years 2013, 2012 and 2011 was 39.7%, 36.1%, and 30.3%, respectively. The effective tax rate in 2013, and related income tax expense was higher than the U.S. statutory tax rate primarily due to a decision made during the quarter ended
September 30, 2013to pay currently, at a substantially reduced rate, taxes on certain accumulated earnings of its Israeli subsidiary relating to calendar year periods 2002-2011 covered under its tax holiday that expired on December 31, 2011. This additional charge was partially offset by additional U.S. tax incentives realized and recognized as discrete events during the quarter ended September 30, 2013, and the geographic mix of income and profits earned by our international subsidiaries being taxed at rates lower than the U.S. statutory rate. Additionally, certain tax incentives realized by the Company were recognized as discrete events during the quarter ended March 31, 2013. These incentives were reinstated under The American Taxpayer Relief Act of 2012 that was signed into law on January 2, 2013. The effective tax rate in 2012 and related income tax expense is higher than the U.S. statutory tax rate primarily due to the expiration of certain tax incentives under U.S. tax law noted above, and non-deductible acquisition costs that were offset in part by geographic mix of income and profits earned by our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate. Had the extension been enacted prior to January 1, 2013, our effective tax rate for 2012 would have been reduced by approximately 3%. The effective tax rate in 2011 and related income tax expense was lower than the U.S. statutory tax rate primarily due to geographic mix of income and profits earned by our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate. 35
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December 31, 2013, our total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $47.7 million. At December 31, 2012, our total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $40.7 million. The net increase at December 31, 2013from December 31, 2012was primarily attributable to an increase in new and existing reserves for uncertain tax positions in 2013. At December 31, 2013, there were $24.8 million, excluding interest and penalties, of net unrecognized tax benefits that, if recognized, would affect our annual effective tax rate. We accrued interest and, if applicable, penalties for any uncertain tax positions. Interest and penalties were classified as a component of income tax expense. At December 31, 2013, 2012 and 2011, we had accrued interest on unrecognized tax benefits of approximately $2.2 million, $1.6 millionand $1.0 million, respectively. Over the next 12 months it is reasonably possible that we may recognize approximately $12.6 millionof previously net unrecognized tax benefits related to various U.S. federal, state and foreign tax positions as a result of the conclusion of various audits and the expiration of statutes of limitations. We are subject to examination by U.S. federal, state and foreign tax authorities. The Internal Revenue Service commenced an examination of our U.S. federal tax filings for tax years 2007 through 2009 during the quarter ended June 30, 2012. As a result, the U.S. statute of limitations remains open between tax years 2007 through present. The statute of limitations for our tax filings in other jurisdictions varies between fiscal years 2006 through present. On a quarterly basis, we evaluate both positive and negative evidence that affect the realizability of net deferred tax assets and assess the need for a valuation allowance. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income to realize the assets. During 2013, we decreased our valuation allowance by $0.4 millionprimarily related to the expiration of US capital loss carry forwards. In 2012, we increased our valuation allowance by $1.0 millionprimarily related to an increase in state tax credit carry forwards because we determined it is more likely than not that the deferred tax assets related to these attributes will not be realized. In 2011, we increased our valuation allowance by $1.2 millionprimarily related to capital losses incurred from our foreign affiliates because we determined it is more likely than not that the deferred tax assets related to these attributes will not be realized. In 2013, we recorded a net benefit to income tax expense of $0.1 million, excluding interest and penalties, due to discrete reserve releases primarily related to the statutes of limitations expiring. In 2011, we recorded a net benefit to income tax expense of $2.1 million, excluding interest and penalties, due to discrete reserve releases primarily related to the effective settlement of a German tax audit for years 2001 through 2005. During 2006, we received a notification letter from the Israeli Ministry of Industry Trade and Labor("MITL") indicating that our Israeli operations were in compliance with requirements relating to the tax holiday granted to our manufacturing operations in Israelin 2001. This tax holiday expired at December 31, 2011and was subject to meeting continued investment, employment and other requirements under the guidelines of the MITL. This tax holiday resulted in income tax savings of approximately $1.0 millionand $2.7 millionfor the years 2011 and 2010, respectively. Upon expiration of its tax holiday, we elected to be treated under a new preferential Israeli tax regime under which a tax rate of 10% applies for 2012, is reduced to 7% for 2013, and increased to 9% for 2014. Our Israeli subsidiary is currently under examination for tax years 2009 through 2011 and expects the audit to be effectively settled during the quarter ended March 31, 2014. On September 13, 2013, the U.S. Department of the Treasuryand Internal Revenue Service released final tangible property regulations that provide guidance on the tax treatment regarding the deduction and capitalization of expenditures related to tangible property. While early adoption is available, the effective date to implement these regulations is for tax years beginning on or after January 1, 2014. The Company is currently assessing these rules and the impact to its financial statements, if any, but believes adoption of these regulations will not have a material impact on its consolidated results of operations, cash flows or financial position. Our future effective income tax rate depends on various factors, such as tax legislation and the geographic composition of our pre-tax income. We monitor these factors and timely adjust our effective tax rate accordingly. 36
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Additionally, the effective tax rate could be adversely affected by changes in the valuation of deferred tax assets and liabilities. In particular, the carrying value of deferred tax assets, which are predominantly in
the United States, is dependent on our ability to generate sufficient future taxable income in the United States. While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax regulations. Additionally, the recognition and measurement of certain tax benefits include estimates and judgment by management and inherently includes subjectivity. Accordingly, we may record additional provisions due to U.S. federal, state, and foreign tax-related matters in the future as we revise estimates or settle or otherwise resolve the underlying matters.
Liquidity and Capital Resources
Cash, cash equivalents and short-term marketable investments totaled
$589.6 millionat December 31, 2013, a decrease of $25.6 millioncompared to $615.2 millionat December 31, 2012. This decrease was mainly due to dividend payments to common stockholders and net purchases of long-term investments, partially offset by net income and non-cash net charges. The primary driver in our current and anticipated future cash flows is and will continue to be cash generated from operations, consisting mainly of our net income, excluding non-cash changes and changes in operating assets and liabilities. In periods when our sales are growing, higher sales to customers will result in increased trade receivables, and inventories will generally increase as we build products for future sales. This may result in lower cash generated from operations. Conversely, in periods when our sales are declining, our trade accounts receivable and inventory balances will generally decrease, resulting in increased cash from operations. Net cash provided by operating activities was $76.1 millionfor 2013 and resulted mainly from net income of $35.8 million, which included non-cash net charges of $53.4 million, partially offset by an increase in working capital of $9.3 million. The increase in working capital consisted primarily of an increase in trade accounts receivable of $36.2 millionand an increase in inventories of $29.8 million. These increases are partially offset by an increase in income taxes of $27.2 million, an increase in accounts payable of $23.2 millionand an increase in accrued compensation and other liabilities of $7.7 million. The increase in trade accounts receivable and accounts payable was caused by an increase in our business in the fourth quarter of 2013 compared to the fourth quarter of 2012. Net cash provided by operating activities was $137.2 millionfor 2012 and resulted mainly from net income of $48.0 million, which included non-cash net charges of $43.4 millionand a decrease in working capital of $44.0 million. The decrease in working capital consisted primarily of a decrease in trade accounts receivable of $38.3 million, a decrease in other current assets of $7.7 millionand a decrease in inventory of $5.3 million. These decreases are partially offset by a decrease in accounts payable of $8.3 million. The decrease in accounts payable and accounts receivable was caused by a slowdown in our business in the fourth quarter of 2012 compared to the fourth quarter of 2011. Net cash used in investing activities was $36.5 millionfor 2013 and resulted primarily from the net purchases of investments of $21.6 million, $12.4 millionused for the purchases of production related equipment and facility expansion and $2.3 million, primarily used for the acquisition of Alter. Net cash used in investing activities was $117.9 millionfor 2012 and resulted primarily from the net purchases of investments of $76.1 million, the acquisition of Plasmart of $22.6 millionnet of cash acquired and $17.7 millionin purchases of production related equipment. Net cash used in financing activities was $37.1 millionfor 2013 and consisted primarily of $34.0 millionin dividend payments made to common stockholders and $2.9 millionfor the repurchase of Common Stock. Net cash used in financing activities was $47.0 millionfor 2012 and consisted primarily of $32.7 millionin dividend payments made to common stockholders, $11.5 millionfor the repurchase of Common Stock, and $6.5 millionof net payments made on short-term borrowings. These decreases were partially offset by $2.1 millionof tax benefit from stock-based compensation. 37
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Our Japanese subsidiary has lines of credit and short-term borrowing arrangements with two financial institutions, which generally expire and are renewed at three month intervals. These lines of credit provide for aggregate borrowings as of
December 31, 2013of up to an equivalent of $21.9 millionU.S. dollars. There were no borrowings outstanding under these arrangements at December 31, 2013and December 31, 2012We also had various lines of credit and short and long-term borrowing arrangements as a result of our acquisition of Plasmart in 2012 and Alter in March 2013. All of these lines of credit and borrowing arrangements were paid off and terminated in 2013. There were no outstanding balances at December 31, 2013and 2012. We have provided financial guarantees for certain unsecured borrowings and have standby letters of credit, some of which do not have fixed expiration dates. At December 31, 2013, our maximum exposure as a result of these performance bonds and standby letters of credit was approximately $1.3 million. On July 25, 2011, our board of directors approved a share repurchase program for the repurchase of up to an aggregate of $200 millionof our Common Stock from time to time in open market purchases, privately negotiated transactions or through other appropriate means. The timing and quantity of any shares repurchased will depend upon a variety of factors, including business conditions, stock market conditions and business development activities, including, but not limited to, merger and acquisition opportunities. These repurchases may be commenced, suspended or discontinued at any time without prior notice. During 2013, we repurchased approximately 107,000 shares of our Common Stock for $2.9 millionat an average price of $26.87per share. During 2012, we repurchased approximately 434,000 shares of our Common Stock for $11.5 millionat an average price of $26.46per share. Holders of our Common Stock are entitled to receive dividends when they are declared by our board of directors. For the year ended December 31, 2013, we paid cash dividends of $34.0 millionin aggregate, or $0.64per share. Future dividend declarations, if any, as well as the record and payment dates for such dividends, are subject to the final determination of our board of directors. On February 10, 2014, our board of directors declared a quarterly cash dividend of $0.16per share to be paid on March 14, 2014to shareholders of record as of March 3, 2014. Our total cash and cash equivalents and short-term marketable investments at December 31, 2013consisted of $321.4 millionheld in the U.S. and $268.2 millionheld by our foreign subsidiaries, substantially all of which would be subject to tax in the U.S. if returned to the U.S. We believe our existing U.S. cash and short-term investment balances are adequate to meet domestic operating needs, including estimated working capital, planned capital expenditure requirements and any future cash dividends, if declared, or share repurchases in the next twelve months and foreseeable future.
Future payments due under debt, lease and purchase commitment obligations as of
Payment Due By Period Less than After Contractual Obligations (In thousands) Total 1 Year 1-3 years 3-5 years 5 years Other (1) Operating lease obligations
$ 28,045 $ 7,484 $ 9,916 $ 6,790 $ 3,855$ - Purchase obligations(2) 132,018 125,453 6,565 - - - Other long-term liabilities reflected on the Balance Sheet under U.S. GAAP(3) 63,073 - - - 16,328 46,745 Total $ 223,136 $ 132,937 $ 16,481 $ 6,790 $ 20,183 $ 46,745
(1) This balance relates to our reserve for uncertain tax positions.
-------------------------------------------------------------------------------- Table of Contents (2) As of
December 31, 2013, we have entered into purchase commitments for
certain inventory components and other equipment and services used in our
normal operations. The majority of these purchase commitments covered by
these arrangements are for periods of less than one year and aggregate to
(3) The majority of this balance relates to reserve for uncertain tax positions
and accrued compensation for certain executives related to supplemental
We believe that our current cash and investments position and available borrowing capacity, together with the cash anticipated to be generated from operations, will be sufficient to satisfy our estimated working capital, planned capital expenditure requirements, and any future cash dividends declared by our board of directors or share repurchases through at least the next 12 months and the foreseeable future. Derivatives We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments and those utilized as economic hedges. We operate internationally, and in the normal course of business, are exposed to fluctuations in interest rates and foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. We have used derivative instruments, such as forward contracts, to manage certain foreign currency exposure. By nature, all financial instruments involve market and credit risks. We enter into derivative instruments with major investment grade financial institutions and no collateral is required. We have policies to monitor the credit risk of these counterparties. While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties. We hedge a portion of our forecasted foreign currency denominated intercompany sales of inventory, over a maximum period of eighteen months, using forward foreign exchange contracts accounted for as cash-flow hedges related to Japanese, South Korean, British and Euro currencies. To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, and otherwise meet the hedge accounting criteria, changes in the derivatives' fair value are not included in current earnings but are included in accumulated other comprehensive income in stockholders' equity. These changes in fair value will subsequently be reclassified into earnings, as applicable, when the forecasted transaction occurs. To the extent that a previously designated hedging transaction is no longer an effective hedge, any ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period it occurs. The cash flows resulting from forward exchange contracts are classified in the consolidated statements of cash flows as part of cash flows from operating activities. We do not enter into derivative instruments for trading or speculative purposes. To the extent that hedge accounting criteria is not met, the foreign currency forward contracts are considered economic hedges and changes in the fair value of these contracts are recorded immediately in earnings in the period in which they occur. These include hedges that are used to reduce exchange rate risks arising from the change in fair value of certain foreign currency denominated assets and liabilities (i.e., payables, receivables) and other economic hedges where the hedge accounting criteria were not met.
We had forward exchange contracts with notional amounts totaling
December 31, 2013, the unrealized gain that will be reclassified from accumulated other comprehensive income to earnings over the next twelve months is immaterial. The ineffective portions of the derivatives are recorded in selling, general and administrative costs and were immaterial in 2013, 2012 and 2011. 39
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We sometimes hedge certain intercompany and other payables with forward exchange contracts. Typically, as these derivatives hedge existing amounts that are denominated in foreign currencies, the derivatives do not qualify for hedge accounting. The foreign exchange loss on these derivatives was a
$0.2 millionin 2013, $1.6 millionin 2012 and zero in 2011. Realized and unrealized gains and losses on forward exchange contracts that do not qualify for hedge accounting are recognized currently in earnings. The cash flows resulting from forward exchange contracts are classified in our consolidated statements of cash flows as part of cash flows from operating activities. We do not hold or issue derivative financial instruments for trading purposes. Gains and losses on forward exchange contracts that qualify for hedge accounting are classified in cost of products in 2013 and totaled a gain of $1.1 million. In 2012 and 2011, these gains and losses were classified in selling, general and administrative and totaled a loss of $0.9 millionand gain of $4.0 million, respectively.
Off-Balance Sheet Arrangements
We do not have any financial partnerships with unconsolidated entities, such as entities often referred to as structured finance, special purpose entities or variable interest entities which are often established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had such relationships.
Recently Issued Accounting Pronouncements
July 18, 2013, the Financial Accounting Standards Boardissued Accounting Standards Update ("ASU") 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists." Under the new standard, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carry-forwards that would be utilized, rather than only against carry-forwards that are created by unrecognized tax benefits. The provisions of this ASU are effective for interim and annual periods beginning on or after December 15, 2013. We do not expect the adoption of ASU No. 2013-11 to have a material effect on our consolidated financial statements.