News Column

VEECO INSTRUMENTS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

July 31, 2014

Executive Summary

Veeco Instruments Inc. (together with its consolidated subsidiaries, "Veeco", the "Company", "we", "us", and "our", unless the context indicates otherwise) creates process equipment that enables technologies for a cleaner and more productive world. We design, manufacture and market equipment primarily sold to make LEDs and hard-disk drives, as well as for solar cells, power semiconductors, wireless components, and micro-electro-mechanical systems ("MEMS"). Veeco develops highly differentiated, "best-in-class" process equipment for critical performance steps. Our products feature leading technology, low cost-of-ownership and high throughput. Core competencies in advanced thin film technologies, over 300 patents, and decades of specialized process know-how help us to stay at the forefront of these demanding industries. Veeco's LED & Solar segment designs and manufactures metal organic chemical vapor deposition ("MOCVD") and molecular beam epitaxy ("MBE") systems and components sold to manufacturers of LEDs, wireless components, power semiconductors, and solar cells, as well as for R&D applications. Our atomic layer deposition ("ALD") technology is used by manufacturers of flexible OLED displays and has further applications in the semiconductor and solar markets. Veeco's Data Storage segment designs and manufactures systems used to create thin film magnetic heads ("TFMH"s) that read and write data in hard disk drives. These include ion beam etch, ion beam deposition, diamond-like carbon, physical vapor deposition, chemical vapor deposition, and slicing, dicing and lapping systems. While our systems are primarily sold to hard drive customers, they also have applications in optical coatings, MEMS and magnetic sensors, and extreme ultraviolet ("EUV") lithography.



As of June 30, 2014, Veeco had approximately 780 employees to support our customers through product and process development, training, manufacturing, and sales and service sites in the U.S., South Korea, Taiwan, China, Singapore, Japan, Europe and other locations.

Veeco Instruments Inc. was organized as a Delaware corporation in 1989.

Highlights of the Second Quarter of 2014

Selected financial highlights include:

Revenue decreased 2.4% to $95.1 million in 2014 from $97.4 million in 2013. LED & Solar revenues increased 1.6% to $77.1 million from $75.9 million in 2013. Data Storage revenues decreased 16.4% to $18.0 million from $21.5 million in 2013;



Orders increased 22.6% to $104.0 million in 2014, compared to $84.8 million in 2013;

Our gross margin decreased to 32.2% in 2014 from 35.6% in 2013. Gross margins in LED & Solar decreased from 34.7% in 2013 to 31.0%. Data Storage gross margins decreased from 38.6% in 2013 to 37.7%. Our selling, general and administrative expenses increased to $21.9 million from $19.8 million in 2013. Selling, general and administrative expenses were 23.0% of net sales in 2014 compared to 20.3% in 2013; Our research and development expenses increased to $21.0 million from $20.9 million in 2013. Research and development expenses were 22.1% of net sales in 2014, compared to 21.4% in 2013;



Net income (loss) in 2014 was ($15.2) million compared to ($4.1) million in 2013;

Diluted net income (loss) per share in 2014 was ($0.39) compared to ($0.11) in 2013.

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Table of Contents Outlook After a long downturn in our MOCVD business, LED fab utilization rates have improved to high levels at most key accounts and LED lighting adoption is accelerating. Our customers are also reporting better market demand for LED backlighting products. It is encouraging to see that our leading customers are beginning to place orders for capacity expansions. MOCVD business conditions have improved from last year, but we have seen no sustained improvement in our other businesses. We have been working to streamline our business operations and reduce our expense structure, enabling investments in high growth opportunities such as LED and OLED display. These activities are planned through the rest of 2014 and will result in an approximate 10% reduction in our operating expenses as we exit 2014. Trends in the LED markets remain favorable, as indicated by our MOCVD first half order and revenue patterns compared to last year. While quarterly MOCVD order patterns fluctuate, we see solid growth ahead. We expect that Veeco's orders in the second half of fiscal 2014 will be better than the first half, driven primarily by growth in MOCVD. Yet, the timing and magnitude of key customer expansions could cause MOCVD orders to vary and be unpredictable on a quarterly basis. We continue to invest in MOCVD products and technology development to further improve our customers' cost of ownership and manufacturing capability. Competitive pricing pressure, which had a dramatic effect on our gross margins in 2013, is also difficult to predict. Our new ALD business was acquired as a "pre-revenue" business and thus decreased our earnings in 2013 and is currently expected to negatively impact our financial performance this year as well. The timing of production ALD orders from our key customer could have a significant impact on our expected revenue growth. We did not receive any ALD orders from our key customer in the first half of 2014. While Data Storage orders improved a bit on a sequential basis, low growth is expected to continue in the hard drive industry; our customers have excess manufacturing capacity and they have only been making select technology purchases. Future demand for our Data Storage products is unclear and orders are expected to fluctuate. We remain focused on managing the Company back to profitable growth by: 1) developing and launching game-changing new products that enable cost effective LED lighting, flexible OLED display encapsulation and other emerging technologies; 2) improving customer cost of ownership as well as our gross margins; 3) driving process improvement initiatives to make us more efficient; and 4) lowering expenses. The combination of improved business conditions, execution on our growth initiatives and lower operating expenses should help improve the Company's profitability in 2015. Our outlook discussion above constitutes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Our expectations regarding future results are subject to risks and uncertainties. Our actual results may differ materially from those anticipated.



You should not place undue reliance on any forward-looking statements, which speak only as of the dates they are made.

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Table of Contents Results of Operations:



Three Months Ended June 30, 2014 and 2013

Consistent with prior years, we report interim quarters, other than fourth quarters which always end on December 31, on a 13-week basis ending on the last Sunday within such period. The interim quarter ends are determined at the beginning of each year based on the 13-week quarters. The 2014 interim quarter ends are March 30, June 29 and September 28. The 2013 interim quarter ends were March 31, June 30 and September 29. For ease of reference, we report these interim quarter ends as March 31, June 30, and September 30 in our interim consolidated financial statements. The following table shows our Consolidated Statements of Operations, percentages of sales, and comparisons between the three months ended June 30, 2014 and 2013 (dollars in thousands): For the three months ended Dollar and June 30, Percentage Change 2014 2013 Period to Period Net sales $ 95,122 100.0 % $ 97,435 100.0 % $ (2,313 ) (2.4 )% Cost of sales 64,449 67.8 % 62,795 64.4 % 1,654 2.6 % Gross profit 30,673 32.2 % 34,640 35.6 % (3,967 ) (11.5 )% Operating expenses: Selling, general and administrative 21,891 23.0 % 19,779 20.3 % 2,112 10.7 % Research and development 21,011 22.1 % 20,870 21.4 % 141 0.7 % Amortization 2,899 3.0 % 855 0.9 % 2,044 239.1 % Restructuring 801 0.8 % - 0.0 % 801 * Total operating expenses 46,602 49.0 % 41,504 42.6 % 5,098 12.3 % Other operating, net (158 ) (0.2 )% (52 ) (0.1 )% (106 ) 203.8 % Operating income (loss) (15,771 ) (16.6 )% (6,812 ) (7.0 )% (8,959 ) 131.5 % Interest income (expense), net 72 0.1 % 236 0.2 % (164 ) (69.5 )% Income (loss) before income taxes (15,699 ) (16.5 )% (6,576 ) (6.7 )% (9,123 ) 138.7 % Income tax provision (benefit) (488 ) (0.5 )% (2,495 ) (2.6 )% 2,007 (80.4 )% Net income (loss) $ (15,211 ) (16.0 )% $ (4,081 ) (4.2 )% $ (11,130 ) 272.7 %



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* Not Meaningful Net Sales The following is an analysis of net sales by segment and by region (dollars in thousands): Net Sales Dollar and For the three months ended June 30, Percentage Change 2014 Percent of Total 2013 Percent of Total Period to Period Segment Analysis LED & Solar $ 77,154 81.1 % $ 75,933 77.9 % $ 1,221 1.6 % Data Storage 17,968 18.9 % 21,502 22.1 % (3,534 ) (16.4 )% Total $ 95,122 100.0 % $ 97,435 100.0 % $ (2,313 ) (2.4 )% Regional Analysis Americas (1) $ 14,410 15.1 % $ 12,644 13.0 % $ 1,766 14.0 % Europe, Middle East and Africa 6,099 6.4 % 6,930 7.1 % (831 ) (12.0 )% Asia Pacific 74,613 78.5 % 77,861 79.9 % (3,248 ) (4.2 )% Total $ 95,122 100.0 % $ 97,435 100.0 % $ (2,313 ) (2.4 )%



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(1) Less than 1% of net sales included within the Americas caption above have been derived from other regions outside the United States.

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Our LED & Solar segment net sales increased slightly in 2014 primarily due to higher sales of MBE systems. Data Storage net sales decreased in 2014 as our customers continue to have excess manufacturing capacity and have only been making select technology purchases. By region, net sales decreased in Asia Pacific, primarily due to a decrease in MOCVD sales in China and Japan. Net sales in Europe, Middle East and Africa ("EMEA") also decreased primarily due to lower sales of our Data Storage products, while net sales in the Americas increased primarily due to higher sales of our LED and Solar products. We believe that there will continue to be period-to-period variations in the geographic distribution of net sales. Orders increased 22.6% to $104.0 million from $84.8 million in the comparable prior period. LED & Solar bookings increased 38.9% to $80.7 million, principally due to MOCVD system orders, as certain of our LED customers are making modest capacity additions. Data Storage bookings decreased 12.4% to $23.3 million from the comparable prior period as our customers continue to have excess manufacturing capacity and have only been making select technology purchases. Our book-to-bill ratio for the three months ended June 30, 2014, which is calculated by dividing bookings recorded in a given time period by revenue recognized in the same time period, was 1.09 to 1. Our backlog as of June 30, 2014 was $162.8 million, compared to $143.3 million as of December 31, 2013. During the three months ended June 30, 2014, we recorded backlog adjustments of approximately $0.7 million related to orders that no longer met our booking criteria as well as an adjustments related to foreign currency translation of $0.2 million. Our backlog consists of orders for which we received a firm purchase order, a customer-confirmed shipment date within twelve months and a deposit, where required. As of June 30, 2014, we had customer deposits of $33.5 million. Gross Profit



Gross profit in dollars and gross margin for the periods indicated were as follows (dollars in thousands):

For the three months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Gross profit - LED & Solar $ 23,891$ 26,349 $ (2,458 ) (9.3 )% Gross margin 31.0 % 34.7 % Gross profit - Data Storage $ 6,782$ 8,291 $ (1,509 ) (18.2 )% Gross margin 37.7 % 38.6 % Gross profit - Total Veeco $ 30,673$ 34,640 $ (3,967 ) (11.5 )% Gross margin 32.2 % 35.6 % LED & Solar gross margins decreased primarily due to a sales mix of lower margin products. Lower average selling prices and fewer final acceptances also contributed to the decline in gross margin. Data Storage gross margins decreased principally due to a reduction in volume, partially offset by a sales mix of higher margin products.



Selling, General and Administrative Expenses

Selling, general and administrative expenses for the periods indicated were as follows (dollars in thousands):

For the three months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Selling, general and administrative $ 21,891$ 19,779 $ 2,112 10.7 % Percentage of net sales 23.0 % 20.3 % Selling, general and administrative expenses increased primarily due to equity compensation, personnel and personnel-related, and bonus expenses as well as the addition of costs from our ALD business, which was acquired in the fourth quarter of 2013. Partially offsetting this increase was the collection of a customer receivable during the second quarter, which was previously 25 --------------------------------------------------------------------------------



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reserved for in the fourth quarter of 2013, and a reduction in professional fees associated with our review of revenue accounting, which was completed in the fourth quarter of 2013.



Research and Development Expenses

Research and development expenses for the periods indicated were as follows (dollars in thousands): For the three months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Research and development $ 21,011$ 20,870 $ 141 0.7 % Percentage of net sales 22.1 % 21.4 % Research and development expenses remained flat. The addition of research and development costs in our ALD business, which was acquired in the fourth quarter of 2013, was principally offset by a reduction in overall research and development spending across the Company. We continue to focus our research and development expenses on projects in areas we anticipate to be high-growth. We selectively funded these product development activities which resulted in lower professional consulting expense, as well as reduced spending for project materials and personnel and personnel-related costs. Amortization Amortization for the periods indicated were as follows (dollars in thousands): For the three months ended June 30,



Dollar and Percentage Change

2014 2013 Period to Period Amortization $ 2,899 $ 855 $ 2,044 239.1 % Percentage of net sales 3.0 % 0.9 %



Amortization expense increased primarily due to the additional amortization associated with intangible assets acquired as part of our acquisition of our ALD business during the fourth quarter of 2013.

Restructuring Restructuring for the periods indicated were as follows (dollars in thousands): For the three months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Restructuring $ 801 $ - $ 801 * Percentage of net sales 0.8 % *



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* Not Meaningful

During the first quarter of 2014, we announced the consolidation of our Ft. Collins, Colorado facility into our Plainview, New York facility and took additional measures to improve profitability in a challenging business environment. We expect to substantially complete the consolidation by the end of 2014. During the three months ended June 30, 2014, we recorded restructuring charges of $0.8 million. These charges consisted of personnel severance and related costs. We expect to incur approximately $1.1 million and $0.1 million of additional restructuring charges in our Data Storage segment throughout the remainder of 2014 and 2015, respectively, related to these actions. The reductions in head count principally relate to our Data Storage and MBE businesses. Subsequent to quarter end, the company announced additional restructuring activities. Included in these activities is further consolidation of our Data Storage Segment facilities and additional headcount reductions to help contain costs and further improve profitability. As a result of these actions, we anticipate total costs of approximately $3.9 million, all of which will be incurred through the remainder of 2014. 26 --------------------------------------------------------------------------------



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We did not record any restructuring charges during the three months ended June 30, 2013.

Income Taxes Income tax provision (benefit) for the periods indicated were as follows (dollars in thousands): For the three months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Income tax provision (benefit) $ (488 )$ (2,495 ) $ 2,007 (80.4 )% Effective tax rate 3.1 % 37.9 % Our provision for income taxes consists of U.S. federal, state and local, and foreign taxes in amounts necessary to align our year-to-date tax provision with the effective tax rate we expect to achieve for the full year.



For the three months ended June 30, 2014, the effective tax rate was lower than the statutory tax rate principally because we did not provide a current tax benefit on a portion of our domestic pre-tax losses as such amounts are not realizable on a more-likely-than-not basis and we have provided for a full valuation allowance on these amounts.

For the three months ended June 30, 2013, the effective tax rate was higher than the statutory tax rate primarily due to tax rate differences in the foreign jurisdictions in which the Company operates and an income tax benefit related to the generation of current year research and development tax credits. 27 --------------------------------------------------------------------------------



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Six Months Ended June 30, 2014 and 2013

The following table shows our Consolidated Statements of Operations, percentages of sales, and comparisons between the six months ended June 30, 2014 and 2013 (dollars in thousands): For the six months ended Dollar and June 30, Percentage Change 2014 2013 Period to Period Net sales $ 185,963 100.0 % $ 159,216 100.0 % $ 26,747 16.8 % Cost of sales 121,513 65.3 % 102,024 64.1 % 19,489 19.1 % Gross profit 64,450 34.7 % 57,192 35.9 % 7,258 12.7 % Operating expenses: Selling, general and administrative 43,558 23.4 % 39,427 24.8 % 4,131 10.5 % Research and development 40,779 21.9 % 41,607 26.1 % (828 ) (2.0 )% Amortization 5,802 3.1 % 1,711 1.1 % 4,091 239.1 % Restructuring 1,193 0.6 % 531 0.3 % 662 124.7 % Total operating expenses 91,332 49.1 % 83,276 52.3 % 8,056 9.7 % Other operating, net (370 ) (0.2 )% 352 0.2 % (722 ) * Changes in contingent consideration (29,368 ) (15.8 )% - 0.0 % (29,368 ) * Operating income (loss) 2,856 1.5 % (26,436 ) (16.6 )% 29,292 * Interest income (expense), net 236 0.1 % 428 0.3 % (192 ) (44.9 )% Income (loss) before income taxes 3,092 1.7 % (26,008 ) (16.3 )% 29,100 * Income tax provision (benefit) (857 ) (0.5 )% (11,856 ) (7.4 )% 10,999 (92.8 )% Net income (loss) $ 3,949 2.1 % $ (14,152 ) (8.9 )% $ 18,101 *



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* Not Meaningful Net Sales The following is an analysis of net sales by segment and by region (dollars in thousands): Net Sales Dollar and For the six months ended June 30, Percentage Change 2014 Percent of Total 2013 Percent of Total Period to Period Segment Analysis LED & Solar $ 147,909 79.5 % $ 118,240 74.3 % $ 29,669 25.1 % Data Storage 38,054 20.5 % 40,976 25.7 % (2,922 ) (7.1 )% Total $ 185,963 100.0 % $ 159,216 100.0 % $ 26,747 16.8 % Regional Analysis Americas (1) $ 22,290 12.0 % $ 25,077 15.8 % $ (2,787 ) (11.1 )% Europe, Middle East and Africa 16,319 8.8 % 11,480 7.2 % 4,839 42.2 % Asia Pacific 147,354 79.2 % 122,659 77.0 % 24,695 20.1 % Total $ 185,963 100.0 % $ 159,216 100.0 % $ 26,747 16.8 %



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(1) Less than 1% of net sales included within the Americas caption above have been derived from other regions outside the United States.

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Our LED & Solar segment net sales increased in 2014 primarily due to increased sales of MOCVD systems to certain of our LED customers due to higher capacity requirements. Data Storage net sales decreased as our customers continue to have excess manufacturing capacity and have only been making select technology purchases. By region, net sales increased in Asia Pacific, primarily due to an increase in MOCVD sales in China and Japan. Net sales in Europe, Middle East and Africa ("EMEA") also increased primarily due to higher sales of MOCVD and Data Storage products while net sales in the Americas decreased. We believe that there will continue to be period-to-period variations in the geographic distribution of net sales. Orders increased 33.1% to $206.6 million from $155.2 million in the comparable prior period. LED & Solar bookings increased 66.5% to $167.8 million, principally due to MOCVD system orders, as certain of our LED customers are making modest capacity additions. Data Storage bookings decreased 28.6% to $38.8 million from the comparable prior period as our customers have excess manufacturing capacity and they have only been making select technology purchases. Our book-to-bill ratio for the six months ended June 30, 2014, which is calculated by dividing bookings recorded in a given time period by revenue recognized in the same time period, was 1.11 to 1. Our backlog as of June 30, 2014 was $162.8 million, compared to $143.3 million as of December 31, 2013. During the six months ended June 30, 2014, we recorded backlog adjustments of approximately $0.9 million related to orders that no longer met our booking criteria as well as adjustments related to foreign currency translation of $0.2 million. Our backlog consists of orders for which we received a firm purchase order, a customer-confirmed shipment date within twelve months and a deposit, where required. As of June 30, 2014, we had customer deposits of $33.5 million. Gross Profit



Gross profit in dollars and gross margin for the periods indicated were as follows (dollars in thousands):

For the six months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Gross profit - LED & Solar $ 50,343$ 40,334 $ 10,009 24.8 % Gross margin 34.0 % 34.1 % Gross profit - Data Storage $ 14,107$ 16,858 $ (2,751 ) (16.3 )% Gross margin 37.1 % 41.1 % Gross profit - Total Veeco $ 64,450$ 57,192 $ 7,258 12.7 % Gross margin 34.7 % 35.9 %



LED & Solar gross margins remained flat from the comparable prior period despite the increase in sales volume primarily due to a sales mix of lower margin products and fewer final acceptances. Data Storage gross margins decreased principally due to reduced sales volume and a sales mix of lower margin products.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the periods indicated were as follows (dollars in thousands):

For the six months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Selling, general and administrative $ 43,558$ 39,427 $ 4,131 10.5 % Percentage of net sales 23.4 % 24.8 % Selling, general and administrative expenses increased primarily due to bonus, equity compensation and personnel and personnel-related expenses as well as the addition of costs from our ALD business, which was acquired in the fourth quarter of 2013. Partially offsetting this increase was a reduction in professional fees associated with our review of revenue accounting, which was completed in the fourth quarter of 2013 and the collection of a customer receivable during the second quarter, which was previously reserved for in the fourth quarter of 2013. 29

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Research and Development Expenses

Research and development expenses for the periods indicated were as follows (dollars in thousands): For the six months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Research and development $ 40,779$ 41,607 $ (828 ) (2.0 )% Percentage of net sales 21.9 % 26.1 % We reduced our overall research and development spending by focusing our research and development expenses on projects in areas we anticipate to be high-growth. We selectively funded these product development activities which resulted in lower professional consulting expense and personnel and personnel-related costs as well as reduced spending for project materials. This decrease was partially offset by the addition of research and development costs in our ALD business, which was acquired in the fourth quarter of 2013. Amortization Amortization for the periods indicated were as follows (dollars in thousands): For the six months ended June 30,



Dollar and Percentage Change

2014 2013 Period to Period Amortization $ 5,802$ 1,711 $ 4,091 239.1 % Percentage of net sales 3.1 % 1.1 %



Amortization expense increased primarily due to the additional amortization associated with intangible assets acquired as part of our acquisition of our ALD business during the fourth quarter of 2013.

Restructuring Restructuring for the periods indicated were as follows (dollars in thousands): For the six months ended June 30,



Dollar and Percentage Change

2014 2013 Period to Period Restructuring $ 1,193 $ 531 $ 662 124.7 % Percentage of net sales 0.6 % 0.3 % During the first quarter of 2014, we announced the consolidation of our Ft. Collins, Colorado facility into our Plainview, New York facility and took additional measures to improve profitability in a challenging business environment. We expect to substantially complete the consolidation by the end of 2014. During the six months ended June 30, 2014, we recorded restructuring charges of $1.2 million and notified approximately 49 employees of their termination from the Company. These charges consisted of personnel severance and related costs. We expect to incur approximately $1.1 million and $0.1 million of additional restructuring charges in our Data Storage segment throughout the remainder of 2014 and 2015, respectively, related to these actions. The reductions in head count principally relate to our Data Storage and MBE businesses.



During the six months ended June 30, 2013, we took measures to improve profitability, including a reduction of discretionary expenses, realignment of our senior management team and consolidation of certain sales, business and administrative functions. As a result of these actions, we recorded a restructuring charge of $0.5 million.

Subsequent to quarter end, the company announced additional restructuring activities. Included in these activities is further consolidation of our Data Storage Segment facilities and additional headcount reductions to help contain costs and further improve profitability. As a result of these actions, we anticipate total costs of approximately $3.9 million, all of which will be incurred through the remainder of 2014. 30 --------------------------------------------------------------------------------



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Changes in Contingent Consideration

Changes in contingent consideration for the periods indicated were as follows (dollars in thousands): For the six months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period



Changes in contingent consideration $ (29,368 ) $ -

$ (29,368 ) * Percentage of net sales (15.8 )% 0.0 %



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* Not Meaningful

As part of Veeco's acquisition agreement with Synos, there were certain contingent payments due to the selling shareholders of Synos dependent on the achievement of certain milestones. The aggregate fair value of the contingent consideration arrangement as of December 31, 2013 was $29.4 million. We estimate the fair value of acquisition-related contingent consideration based on management's probability-weighted present value of the consideration expected to be transferred during the remainder of the earn-out period, based on the forecast related to the milestones. The fair value of the contingent consideration is reassessed by us on a quarterly basis using additional information as it becomes available. Any change in the fair value of an acquisition's contingent consideration liability results in a gain or loss that is recorded in the earnings of that period. As of March 31, 2014, we determined that the agreed upon post-closing milestones were not met or are not expected to be achieved and therefore reversed the remaining $29.4 million liability of the contingent consideration and recorded it as a change in contingent consideration in the Consolidated Statement of Operations. The post-closing milestones are divided into two contingencies. The first, tied to receipt of certain purchase orders, had an evaluation date of March 31, 2014, which, was not met and accounted for $20.2 million of the reversed liability. The second is based on achieving certain full year 2014 revenue and gross margin thresholds, which are unlikely to be met and accounted for $9.2 million of the reversed liability. As of June 30, 2014 the second contingency, with a maximum potential value of $75.0 million, remains contractually outstanding. Income Taxes Income tax provision (benefit) for the periods indicated were as follows (dollars in thousands): For the six months ended June 30, Dollar and Percentage Change 2014 2013 Period to Period Income tax provision (benefit) $ (857 )$ (11,856 ) $ 10,999 (92.8 )% Effective tax rate 27.7 % 45.6 % Our provision for income taxes consists of U.S. federal, state and local, and foreign taxes in amounts necessary to align our year-to-date tax provision with the effective tax rate we expect to achieve for the full year. For the six months ended June 30, 2014, the effective tax rate was lower than the statutory tax rate principally because we did not provide a current tax benefit on a portion of our domestic pre-tax losses as such amounts are not realizable on a more-likely-than-not basis and we have provided for a full valuation allowance on these amounts. The effective tax rate was also impacted because we did not provide a tax provision on the gain from the settlement of the contingent consideration related to the Synos acquisition. For the six months ended June 30, 2013, the effective tax rate was higher than the statutory tax rate primarily due to tax rate differences in the foreign jurisdictions in which the Company operates, an income tax benefit related to the generation of current year research and development tax credits, and a discrete benefit related to legislation enacted in the first quarter of 2013 which extended the Federal Research and Development Credit for both the 2012 and 2013 tax years. 31

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Liquidity and Capital Resources

Our cash and cash equivalents, restricted cash and short-term investments consist of the following: June 30, December 31, 2014 2013 Cash and cash equivalents $ 232,332$ 210,799 Restricted cash 518 2,738 Short-term investments 252,165 281,538 Cash, cash equivalents, restricted cash and short-term investments $ 485,015$ 495,075 As of June 30, 2014 and December 31, 2013, cash and cash equivalents of $154.9 million and $150.6 million, respectively, were held outside the United States. Liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Cash balances are generated and held in many locations throughout the world. It is our current intent to permanently reinvest our funds from Singapore, China, Taiwan, South Korea, and Malaysia outside of the United States and our current plans do not demonstrate a need to repatriate them to fund our United States operations. As of June 30, 2014, we had $127.3 million in cash held offshore on which we would have to pay significant United States income taxes to repatriate in the event that we need the funds for our operations in the United States. Additionally, local government regulations may restrict our ability to move cash balances to meet cash needs under certain circumstances. We currently do not expect such regulations and restrictions to impact our ability to make acquisitions, pay vendors, or conduct operations throughout the global organization. As of June 30, 2014 and December 31, 2013, our restricted cash was in Germany and our short-term investments were in the United States. We believe that our projected cash flow from operations combined with our cash and short term investments will be sufficient to meet our projected working capital and other cash flow requirements for the next twelve months, as well as our contractual obligations.



A summary of the cash flow activity for the six months ended June 30, 2014 is as follows (in thousands):

Cash Flows from Operating Activities

Net income (loss) $ 3,949 Non-cash charges: Change in contingent consideration (29,368 ) Depreciation and amortization



11,600

Non-cash equity-based compensation



9,813

Other (7,046 ) Changes in operating assets and liabilities: Accounts receivable (32,721 ) Inventories 12,052 Accounts payable



(8,026 ) Accrued expenses, customer deposits, deferred revenue and other current liabilities

29,638

Other (6,667 ) Net cash provided by (used in) operating activities $ (16,776 )



The primary cash drivers of the $16.8 million use of cash from operations were:

A $32.7 million use of cash due to the increase in accounts receivable, primarily due to the timing of invoicing to customers resulting in receivables remaining outstanding at the end of the quarter;

A $8.0 million use of cash due to the decrease in accounts payable primarily driven by reduced purchasing activity;

An $12.1 million generation of cash due to the decrease in inventory due to our reduced purchasing activity, and;

An $29.6 million generation of cash due to the increase in accrued expenses primarily driven by increases in payroll related accruals, customer deposits and deferred revenue. 32 --------------------------------------------------------------------------------



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Cash Flows from Investing Activities

Proceeds from the liquidation of short-term investments $ 121,233 Payments for purchases of short-term investments

(92,029 ) Other 1,840



Net cash provided by (used in) investing activities $ 31,044

The primary cash driver of the $31.0 million generation of cash from investing was due to the net liquidation of short-term investments during the period.

Cash Flows from Financing Activities

Proceeds from stock option exercises $ 9,125 Other (2,008 )



Net cash provided by (used in) financing activities $ 7,117

The primary cash driver of the $7.1 million generation of cash from financing was an $9.1 million generation of cash due to stock option exercises.

As of June 30, 2014, restricted cash consists of $0.5 million which serves as collateral for bank guarantees that provide financial assurance that the Company will fulfill certain customer or lease obligations. This cash is held in custody by the issuing bank, and is restricted as to withdrawal or use while the related bank guarantees are outstanding. 33 --------------------------------------------------------------------------------



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Off-Balance Sheet Arrangements and Contractual Obligations

We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources other than the lease commitments, letters of credit and bank guarantees, purchase commitments and other obligations discussed below. Long-Term Debt Long-term debt obligations consist of principle and interest payments for our St. Paul, MN facility. As of June 30, 2014, the Company's total future principle and interest payments have not changed significantly from our "Contractual Obligations" table in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2013 annual report on Form 10-K. Lease Commitments The Company's major facility leases are typically for terms not exceeding 5 years and generally provide renewal options for terms not exceeding five additional years. As of June 30, 2014, the Company's total future minimum lease payments under noncancelable operating leases have not changed significantly from our "Contractual Obligations" table in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2013 annual report on Form 10-K. In accordance with relevant accounting guidance, we account for our office leases as operating leases with expiration dates ranging from 2014 through 2018, excluding renewal options. There are future minimum annual rental payments required under the leases. Leasehold improvements made at the beginning of or during a lease are amortized over the shorter of the remaining lease term or the estimated useful lives of the assets. There are no material sublease payments receivable associated with the leases.



Letters of Credit and Bank Guarantees

Letters of credit and bank guarantees are issued by a bank on our behalf as needed. As of June 30, 2014, we had letters of credit outstanding of $0.6 million and bank guarantees outstanding of $2.5 million, of which, $0.5 million is collateralized against cash that is restricted from use. As of June 30, 2014, we had $43.7 million of unused lines of credit available. The line of credit is available to draw upon to cover performance bonds as required by our customers. Purchase Commitments



Purchase commitments are primarily for inventory used in manufacturing our products. It has been our practice not to enter into purchase commitments extending beyond one year. As of June 30, 2014, we have $67.7 million in open purchase commitments and $10.6 million of offsetting supplier deposits.

Other Obligations Pursuant to our agreement to acquire Synos, we may be obligated to pay up to an additional $75 million if certain conditions are met. We currently do not expect this contingency to be met. 34

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Application of Critical Accounting Policies

General Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Management continually monitors and evaluates its estimates and judgments, including those related to bad debts, inventories, intangible and other long-lived assets, income taxes, warranty obligations, restructuring costs, and contingent liabilities, including potential litigation. Management bases its 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 consider certain accounting policies related to revenue recognition, short-term investments, the valuation of inventories, the impairment of goodwill and indefinite-lived intangible assets, the impairment of long-lived assets, fair value measurements, warranty costs, income taxes and equity-based compensation to be critical policies due to the estimation processes involved in each. We have reclassified certain amounts previously reported in our financial statements to conform to the current presentation. Revenue Recognition We recognize revenue when all of the following criteria have been met: persuasive evidence of an arrangement exists with a customer; delivery of the specified products has occurred or services have been rendered; prices are contractually fixed or determinable; and collectability is reasonably assured. Revenue is recorded including shipping and handling costs and excluding applicable taxes related to sales. A significant portion of our revenue is derived from contractual arrangements with customers that have multiple elements, such as systems, upgrades, components, spare parts, maintenance and service plans. For sales arrangements that contain multiple elements, we split the arrangement into separate units of accounting if the individually delivered elements have value to the customer on a standalone basis. We also evaluate whether multiple transactions with the same customer or related party should be considered part of a multiple element arrangement, whereby we assess, among other factors, whether the contracts or agreements are negotiated or executed within a short time frame of each other or if there are indicators that the contracts are negotiated in contemplation of each other. When we have separate units of accounting, we allocate revenue to each element based on the following selling price hierarchy: vendor-specific objective evidence ("VSOE") if available; third party evidence ("TPE") if VSOE is not available; or our best estimate of selling price ("BESP") if neither VSOE nor TPE is available. We utilize BESP for the majority of the elements in our arrangements. The accounting guidance for selling price hierarchy did not include BESP for arrangements entered into prior to January 1, 2011; and as such we recognized revenue for those arrangements as described below. We consider many facts when evaluating each of our sales arrangements to determine the timing of revenue recognition, including the contractual obligations, the customer's creditworthiness and the nature of the customer's post-delivery acceptance provisions. Our system sales arrangements, including certain upgrades, generally include field acceptance provisions that may include functional or mechanical test procedures. For the majority of our arrangements, a customer source inspection of the system is performed in our facility or test data is sent to the customer documenting that the system is functioning to the agreed upon specifications prior to delivery. Historically, such source inspection or test data replicates the field acceptance provisions that will be performed at the customer's site prior to final acceptance of the system. As such, we objectively demonstrate that the criteria specified in the contractual acceptance provisions are achieved prior to delivery and, therefore, we recognize revenue upon delivery since there is no substantive contingency remaining related to the acceptance provisions at that date, subject to the retention amount constraint described below. For new products, new applications of existing products or for products with substantive customer acceptance provisions where we cannot objectively demonstrate that the criteria specified in the contractual acceptance provisions have been achieved prior to delivery, revenue and the associated costs are deferred and fully recognized upon the receipt of final customer acceptance, assuming all other revenue recognition criteria have been met. Our system sales arrangements, including certain upgrades, generally do not contain provisions for right of return or forfeiture, refund, or other purchase price concessions. In the rare instances where such provisions are included, we defer all revenue until such rights expire. In many cases our products are sold with a billing retention, typically 10% of the sales price (the "retention amount"), which is typically payable by the customer when field acceptance provisions are completed. The amount of revenue recognized upon delivery of a system or upgrade, if any, is limited to the lower of i) the amount billed that is not contingent 35

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upon acceptance provisions or ii) the value of the arrangement consideration allocated to the delivered elements, if such sale is part of a multiple-element arrangement. For transactions entered into prior to January 1, 2011, under the accounting rules for multiple-element arrangements in place at that time, we deferred the greater of the retention amount or the relative fair value of the undelivered elements based on VSOE. When we could not establish VSOE or TPE for all undelivered elements of an arrangement, revenue on the entire arrangement was deferred until the earlier of the point when we did have VSOE for all undelivered elements or the delivery of all elements of the arrangement. Our sales arrangements, including certain upgrades, generally include installation. The installation process is not deemed essential to the functionality of the equipment since it is not complex; that is, it does not require significant changes to the features or capabilities of the equipment or involve building elaborate interfaces or connections subsequent to factory acceptance. We have a demonstrated history of consistently completing installations in a timely manner and can reliably estimate the costs of such activities. Most customers engage us to perform the installation services, although there are other third-party providers with sufficient knowledge who could complete these services. Based on these factors, we deem the installation of our systems to be inconsequential or perfunctory relative to the system as a whole, and as a result, do not consider such services to be a separate element of the arrangement. As such, we accrue the cost of the installation at the time of revenue recognition for the system. In Japan, where our contractual terms with customers generally specify title and risk and rewards of ownership transfer upon customer acceptance, revenue is recognized and the customer is billed upon the receipt of written customer acceptance. During the fourth quarter of fiscal 2013, we began using a distributor for almost all of our product and service sales to customers in Japan. Title and risk and rewards of ownership of our system sales still transfer to our end-customers upon their acceptance. As such, there is no impact to our policy of recognizing revenue upon receipt of written acceptance from the end customer. Revenue related to maintenance and service contracts is recognized ratably over the applicable contract term. Component and spare part revenue are recognized at the time of delivery in accordance with the terms of the applicable sales arrangement. Short-Term Investments We determine the appropriate balance sheet classification of our investments at the time of purchase and evaluate the classification at each balance sheet date. As part of our cash management program, we maintain a portfolio of marketable securities which are classified as available-for-sale. These securities include United States treasuries and government agency securities with maturities of greater than three months. Securities classified as available-for-sale are carried at fair market value, with the unrealized gains and losses, net of tax, included in the determination of comprehensive income (loss) and reported in equity. Net realized gains and losses are included in net income (loss). Inventory Valuation Inventories are stated at the lower of cost (principally first-in, first-out method) or market. On a quarterly basis, management assesses the valuation and recoverability of all inventories, classified as materials (which include raw materials, spare parts and service inventory), work-in-process and finished goods. Materials inventory is used primarily to support the installed tool base and spare parts sales and is reviewed for excess quantities or obsolescence by comparing on-hand balances to historical usage, and adjusted for current economic conditions and other qualitative factors. Historically, the variability of such estimates has been impacted by customer demand and tool utilization rates. The work-in-process and finished goods inventory is principally used to support system sales and is reviewed for recoverability by considering whether on hand inventory would be utilized to fulfill the related backlog. As we typically receive deposits for our orders, the variability of this estimate is reduced as customers have a vested interest in the orders they place with us. Recoverability of such inventory is evaluated by monitoring customer demand, current sales trends and product gross margins. Management also considers qualitative factors such as future product demand based on market outlook, which is based principally upon production requirements resulting from customer purchase orders received with a customer-confirmed shipment date within the next twelve months. Historically, the variability of these estimates of future product demand has been impacted by backlog cancellations or modifications resulting from unanticipated changes in technology or customer demand. 36 --------------------------------------------------------------------------------



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Following identification of potential excess or obsolete inventory, management evaluates the need to write down inventory balances to estimated market value, if less than cost. Inherent in the estimates of market value are management's estimates related to our future manufacturing schedules, customer demand, technological and/or market obsolescence, possible alternative uses, and ultimate realization of potential excess inventory. Unanticipated changes in demand for our products may require a write down of inventory that could materially affect our operating results.



Goodwill and Indefinite-Lived Intangible Asset Impairment

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. We account for goodwill and intangible assets with indefinite useful lives in accordance with relevant accounting guidance related to goodwill and other intangible assets, which states that goodwill and intangible assets with indefinite useful lives should not be amortized, but instead tested for impairment at least annually at the reporting unit level. Our policy is to perform this annual impairment test in the fourth quarter, using a measurement date of October 1st, of each fiscal year or more frequently if impairment indicators arise. Impairment indicators include, among other conditions, cash flow deficits, a historical or anticipated decline in revenue or operating profit, adverse legal or regulatory developments and a material decrease in the fair value of some or all of the assets. The guidance provides an option for an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If we determine the two-step impairment test is necessary, we are required to determine if it is appropriate to use the operating segment, as defined under guidance for segment reporting, as the reporting unit, or one level below the operating segment, depending on whether certain criteria are met. We have identified five reporting units that are required to be reviewed for impairment. The five reporting units are aggregated into two segments: the VIBE and Mechanical reporting units which are reported in our Data Storage segment; and the MOCVD, MBE and ALD reporting units which are reported in our LED & Solar segment. In identifying the reporting units management considered the economic characteristics of operating segments including the products and services provided, production processes, types or classes of customer and product distribution. We perform this impairment test by first comparing the fair value of our reporting units to their respective carrying amount. When determining the estimated fair value of a reporting unit, we utilize a discounted future cash flow approach since reported quoted market prices are not available for our reporting units. Developing the estimate of the discounted future cash flow requires significant judgment and projections of future financial performance. The key assumptions used in developing the discounted future cash flows are the projection of future revenues and expenses, working capital requirements, residual growth rates and the weighted average cost of capital. In developing our financial projections, we consider historical data, current internal estimates and market growth trends. Changes to any of these assumptions could materially change the fair value of the reporting unit. We reconcile the aggregate fair value of our reporting units to our adjusted market capitalization as a supporting calculation. The adjusted market capitalization is calculated by multiplying the average share price of our common stock for the last ten trading days prior to the measurement date by the number of outstanding common shares and adding a control premium. If the carrying value of the reporting units exceed the fair value we would then compare the implied fair value of our goodwill to the carrying amount in order to determine the amount of the impairment, if any.



Definite-Lived Intangible and Long-Lived Assets

Definite-lived intangible assets consist of purchased technology, customer-related intangible assets, patents, trademarks, covenants not-to-compete, software licenses and deferred financing costs. Purchased technology consists of the core proprietary manufacturing technologies associated with the products and offerings obtained through acquisition and are initially recorded at fair value. Customer-related intangible assets, patents, trademarks, covenants not-to-compete and software licenses that are obtained in an acquisition are initially recorded at fair value. Other software licenses and deferred financing costs are initially recorded at cost. Intangible assets with definitive useful lives are amortized using the straight-line method over their estimated useful lives for periods ranging from 2 years to 17 years. 37 --------------------------------------------------------------------------------



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Property, plant and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. Long-lived assets, such as property, plant, and equipment and intangible assets with definite useful lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment indicators include, among other conditions, cash flow deficits, a historical or anticipated decline in revenue or operating profit, adverse legal or regulatory developments and a material decrease in the fair value of some or all of the assets. Assets are grouped at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows generated by other asset groups. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flow expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Accounting for Acquisitions Our growth strategy has included the acquisition of businesses. The purchase price of these acquisitions has been determined after due diligence of the acquired business, market research, strategic planning, and the forecasting of expected future results and synergies. Estimated future results and expected synergies are subject to judgment as we integrate each acquisition and attempt to leverage resources. The accounting for the acquisitions we have made requires that the assets and liabilities acquired, as well as any contingent consideration that may be part of the agreement, be recorded at their respective fair values at the date of acquisition. This requires management to make significant estimates in determining the fair values, especially with respect to intangible assets, including estimates of expected cash flows, expected cost savings and the appropriate weighted average cost of capital. As a result of these significant judgments to be made we often obtain the assistance of independent valuation firms. We complete these assessments as soon as practical after the closing dates. Any excess of the purchase price over the estimated fair values of the identifiable net assets acquired is recorded as goodwill. Fair Value Measurements Accounting guidance requires that we disclose the type of inputs we use to value our assets and liabilities that are required to be measured at fair value, based on three categories of inputs as defined in such. Level 1 inputs are quoted, unadjusted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Level 2 inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. These requirements apply to our long-lived assets, goodwill, cost method investment and intangible assets. We use Level 3 inputs to value all of such assets. We primarily apply the market approach for recurring fair value measurements. Warranty Cost Our warranties are typically valid for one year from the date of final acceptance. We estimate the costs that may be incurred under the warranty we provide and record a liability in the amount of such costs at the time the related revenue is recognized. Estimated warranty costs are determined by analyzing specific product and historical configuration statistics and regional warranty support costs. Our warranty obligation is affected by product failure rates, material usage, and labor costs incurred in correcting product failures during the warranty period. Unforeseen component failures or exceptional component performance can also result in changes to warranty costs. If actual warranty costs differ substantially from our estimates, revisions to the estimated warranty liability would be required. 38 --------------------------------------------------------------------------------

Table of Contents Income Taxes We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense, together with assessing temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. The carrying value of our deferred tax assets is adjusted by a partial valuation allowance to recognize the extent to which the future tax benefits will be recognized on a more likely than not basis. Our deferred tax assets consist primarily of net operating loss and tax credit carry forwards and timing differences between the book and tax treatment of inventory, acquired intangible assets, and other asset valuations. Realization of these net deferred tax assets is dependent upon our ability to generate future taxable income. We record valuation allowances in order to reduce our deferred tax assets to the amount expected to be realized. In assessing the adequacy of recorded valuation allowances, we consider a variety of factors, including the scheduled reversal of deferred tax liabilities, future taxable income and prudent and feasible tax planning strategies. Under the relevant accounting guidance, factors such as current and previous operating losses are given significantly greater weight than the outlook for future profitability in determining the deferred tax asset carrying value. Relevant accounting guidance addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under such guidance, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such uncertain tax positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Equity-Based Compensation We grant equity-based awards, such as stock options and restricted stock or restricted stock units, to certain key employees to create a clear and meaningful alignment between compensation and shareholder return and to enable the employees to develop and maintain a stock ownership position. While the majority of our equity awards feature time-based vesting, performance-based equity awards, which are awarded from time to time to certain key Company executives, vest as a function of performance, and may also be subject to the recipient's continued employment which also acts as a significant retention incentive. Equity-based compensation cost is measured at the grant date, based on the fair value of the award and is recognized as expense over the employee requisite service period. In order to determine the fair value of stock options on the date of grant, we apply the Black-Scholes option-pricing model. Inherent in the model are assumptions related to risk-free interest rate, dividend yield, expected stock-price volatility and option life. The risk-free rate assumed in valuing the options is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The dividend yield assumption is based on our historical and future expectation of dividend payouts. While the risk-free interest rate and dividend yield are less subjective assumptions, typically based on objective data derived from public sources, the expected stock-price volatility and option life assumptions require a level of judgment which make them critical accounting estimates. We use an expected stock-price volatility assumption that is a combination of both historical volatility calculated based on the daily closing prices of our common stock over a period equal to the expected term of the option and implied volatility, and utilization of market data of actively traded options on our common stock, which are obtained from public data sources. We believe that the historical volatility of the price of our common stock over the expected term of the option is a strong indicator of the expected future volatility and that implied volatility takes into consideration market expectations of how future volatility will differ from historical volatility. Accordingly, we believe a combination of both historical and implied volatility provides the best estimate of the future volatility of the market price of our common stock.



The expected option term, representing the period of time that options granted are expected to be outstanding, is estimated using a lattice-based model incorporating historical post vest exercise and employee termination behavior.

We estimate forfeitures using our historical experience, which is adjusted over the requisite service period based on the extent to which actual forfeitures differ or are expected to differ, from such estimates. Because of the significant amount of judgment 39 --------------------------------------------------------------------------------



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used in these calculations, it is reasonably likely that circumstances may cause the estimate to change.

With regard to the weighted-average option life assumption, we consider the exercise behavior of past grants and model the pattern of aggregate exercises.

We settle the exercise of stock options with newly issued shares.

With respect to grants of performance based awards, we assess the probability that such performance criteria will be met in order to determine the compensation expense. Consequently, the compensation expense is recognized straight-line over the vesting period. If that assessment of the probability of the performance condition being met changes, we would recognize the impact of the change in estimate in the period of the change. As with the use of any estimate, and owing to the significant judgment used to derive those estimates, actual results may vary. We have elected to treat awards with only service conditions and with graded vesting as one award. Consequently, the total compensation expense is recognized straight-line over the entire vesting period, so long as the compensation cost recognized at any date at least equals the portion of the grant date fair value of the award that is vested at that date.



Recent Accounting Pronouncements

Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period: In June 2014, the FASB issued Accounting Standards Update No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period" (Topic 718). The amendments in this ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. Revenue from Contracts with Customers: In May 2014, the FASB issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers" (Topic 606). ASU No. 2014-09 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard outlines a five-step model to be used to make the revenue recognition determination and requires new financial statement disclosures. The standard is effective for interim and annual periods beginning after December 15, 2016 and allows entities to choose among different transition alternatives. We are evaluating the impact of adopting the standard on our consolidated financial statements and related financial statement disclosures, and we have not yet determined which method of adoption will be selected. Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. In April 2014, the FASB issued ASU No. 2014-08 that changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal of a component or group of components that is disposed of or is classified as held for sale and "represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results." For disposals of individually significant components that do not qualify as discontinued operations, an entity must disclose pre-tax earnings of the disposed component. For public business entities, this guidance is effective prospectively for all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. 40

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Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists: In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists." ASU 2013-11 requires entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the tax law. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. We adopted this as of January 1, 2014 and it did not have a material impact on our consolidated financial statements. Presentation of Financial Statements: In April 2013, the FASB issued ASU No. 2013-07, "Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting." The objective of ASU 2013-07 is to clarify when an entity should apply the liquidation basis of accounting. The update provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. This ASU is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. We adopted this as of January 1, 2014 and will evaluate the materiality of its impact on our consolidated financial statements when there are any indications that liquidation is imminent. Parent's Accounting for the Cumulative Translation Adjustment: In March 2013, the FASB issued ASU No. 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." This new standard is intended to resolve diversity in practice regarding the release into net income of a cumulative translation adjustment ("CTA") upon derecognition of a subsidiary or group of assets within a foreign entity. ASU No. 2013-05 is effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. We have adopted this as of January 1, 2014 and currently anticipate that it could have an impact on our consolidated financial statements, in the event of derecognition of a foreign subsidiary in 2014 or thereafter. During the three months ended June 30, 2014, the Company began executing a plan to liquidate our foreign subsidiary in Japan. Please see note Commitments, Contingencies and Other Matters for additional information.


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