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ADEPT TECHNOLOGY INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 25, 2014

Adept is a global, leading provider of intelligent robots, autonomous mobile solutions and services that enable customers to achieve precision, speed, quality and productivity in their assembly, handling, packaging, testing, and logistical processes. With a comprehensive portfolio of high-performance motion controllers, application development software, vision-guidance technology and high-reliability robot mechanisms with autonomous capabilities, Adept provides specialized, cost-effective robotics systems and services to high-growth markets including medical, electronics, food and semiconductor; as well as to traditional industrial markets including machine tool automation and automotive components Through sales to system integrators, distributors, OEM partners and end-user companies, we sell our products and services into a few broad industries where we believe we can provide the best solutions for particular applications. We operate in two segments: Robotics and Services and Support.



Strategy

We develop innovative and proprietary products and solutions that meet the needs of our customers and that are based on our core expertise in industrial robots, vision guidance and autonomous vehicle technologies. In pursuit of our strategy, we intend to: Accelerate the launch of our mobile robot products into the global market-Our global markets for mobile products include flexible manufacturing, semiconductor, logistics and warehousing, and food.



Revitalize our core fixed robot business, including expanding our channels

and accelerating our regional selling and marketing approach-Our global

markets for our fixed products include small flexible manufacturing, food

and packaging within our capacity range of 7.5 pounds and below.



Grow our services business-Offer our customers a broader selection of

support solutions.

Our Actions in Support of our Strategy

We intend to integrate strategic relationships from core markets that will

drive volume and visibility.



We intend to have collaborative new product development for innovative

products.



We intend to continue to accelerate our service and support revenues with

existing and new product offerings. We have set specific sales objectives to leverage the cost of selling our products as we grow. 24



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We intend to scale our engineering resources, supply chain, and operations

worldwide. We continue to foster our culture by providing employees with clear direction, a focus on accountability and execution, and bottom line results. Results of Operations Revenues



Revenue by segment is shown below (in thousands, except %):

Year ended June 30, 2014 % Change 2013 % Change 2012 Robotics Revenues $ 45,084 24 % $ 36,353 (34 )% $ 54,815 Percentage of total revenues 78 % 78 % 83 % Services and Support Revenues 12,456 19 % 10,463 (8 )% 11,404 Percentage of total revenues 22 % 22 % 17 % Total Revenues $ 57,540 23 % $ 46,816 (29 )% $ 66,219 Total revenues were $57.5 million, $46.8 million and $66.2 million in fiscal 2014, 2013 and 2012, respectively, representing an increase of 23% in fiscal 2014 and a decrease of 29% in fiscal 2013. Robotics segment revenues were $45.1 million, $36.4 million and $54.8 million in fiscal 2014, 2013 and 2012, respectively, representing an increase of 24% in fiscal 2014 and a decrease of 34% in fiscal 2013. The increase in the Robotics revenues in fiscal 2014 were primarily due to increased sales to the medical and pharmacy, consumer goods, solar and semiconductor, and appliance markets. The decrease in Robotics revenues in fiscal 2013 were primarily due to a cyclical downturn broadly across Adept's markets, a continuing weak economy in Europe, decreased levels of capital investment in the solar and disk drive markets and delays of orders for Adept's packaging automation solutions. Services and support segment revenues were $12.5 million, $10.5 million and $11.4 million in fiscal 2014, 2013 and 2012, respectively, representing an increase of 19% in fiscal 2014 and a decrease of 8% in fiscal 2013. The increase in the services and support revenues in fiscal 2014 were primarily due to higher sales of service parts and other service related activities. The decrease in service and support revenues in fiscal 2013 were primarily due to a cyclical downturn broadly across Adept's markets.



Revenue by geography is shown below (in thousands, except %):

Year ended June 30, 2014 % change 2013 % change 2012 United States $ 13,289 5 % $ 12,708



(30 )% $ 18,259

23 % 27 % 28 % Europe 25,973 15 % 22,572



(30 )% 32,212

45 % 48 % 49 % Asia 15,700 54 % 10,218



(20 )% 12,815

27 % 22 % 19 % Other countries 2,578 96 % 1,318



(55 )% 2,933

5 % 3 % 4 % Total International 44,251 30 % 34,108 (29 )% 47,960 77 % 73 % 72 % Total Revenues $ 57,540 23 % $ 46,816 (29 )% $ 66,219 25



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US revenues were $13.3 million, $12.7 million and $18.3 million in fiscal 2014, 2013 and 2012, respectively, representing an increase of 5% in fiscal 2014 and a decrease of 30% in fiscal 2013. The increase in fiscal 2014 was primarily in the medical and pharmacy, and research markets which offset a decline in the automotive market. The decrease in fiscal 2013 was primarily in the medical and pharmacy and packaging solutions markets. International revenues were $44.3 million, $34.1 million and $48.0 million in fiscal 2014, 2013 and 2012, respectively, representing an increase of 30% in fiscal 2014 and a decrease of 29% in fiscal 2013. The increase in fiscal 2014 was primarily in the solar and semiconductor markets in Asia and Europe as well as other manufacturing markets in Asia and consumer goods in Europe. The decrease in fiscal 2013 was primarily in packaging solutions, solar and semiconductor and disk drive markets.



Gross Margin

Gross margin was 46.3%, 40.8%, and 42.3% for the years ended June 30, 2014, 2013 and 2012, respectively. The increases in gross margin for fiscal 2014 was primarily the result of a lower gross margin in fiscal 2013 due to an increase of the excess and obsolete inventory reserve of $900,000, as well as to improved product mix and cost reduction efforts. We may experience significant fluctuations in our gross margin percentage from period to period due to changes in volume, changes in availability of components, changes in product configuration, increased price-based competition, changes in our sales mix and/or changes in operating costs. In particular, we expect that sales into the Asia market will have a negative impact as compared to sales into the United States or European markets. In addition, we expect that changes in currency valuations will continue to impact gross margin, as a significant portion of our revenues are in Euro and a portion of our components are paid for in Japanese yen. Operating Expenses For the years ended June 30, 2014, 2013, and 2012, total operating expenses were $27.0 million, $29.5 million and $31.1 million, respectively, representing a decrease of 9% in fiscal 2014 and 5% in fiscal 2013. The decrease in 2014 was primarily the result of restructuring and impairment of intangible assets and goodwill charges totaling $2.5 million in 2013 with no such charges in 2014, and to lower average headcount in 2014 as compared to 2013. The decrease in 2013 was primarily the result of lower average headcount and consulting expenses. Research, Development and Engineering Expenses. For the years ended June 30, 2014, 2013 and 2012, research, development and engineering ("R&D") expenses were $6.8 million, $7.6 million and $8.7 million, respectively, representing a decrease of 11% in fiscal 2014 and 12% in fiscal 2013. The decrease in both years was primarily due to lower average headcount for the year compared to the prior year, and with respect to fiscal 2013, to the consolidation of the Company's Denmark R&D operations with its US R&D operations. Selling, General and Administrative Expenses. For the years ended June 30, 2014, 2013 and 2012, selling, general and administrative ("SG&A") expenses were $19.8 million, $19.0 million and $20.7 million, respectively, representing an increase of 4% in fiscal 2014 and a decrease of 8% in fiscal 2013. The increase in fiscal 2014 was due primarily to increased headcount related costs and commissions due to higher sales. The decrease in fiscal 2013 was primarily due to lower average headcount for the year compared to the prior year, and to lower consulting expense.



Amortization. For the years ended June 30, 2014, 2013 and 2012, amortization expense was $0.2 million, $0.4 million and $0.5 million, respectively.

Restructuring charges. Operationally from time to time, Adept has undertaken restructuring and other cost reduction actions to support its financial model which emphasizes cost efficiency balanced with investments in the Company's product initiatives and revenue generating activities. For the years ended June 30, 2014, 2013, 26



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and 2012, restructuring charges were $0, $0.8 million and $1.3 million, respectively. The fiscal 2013 charge related primarily to a reduction in work force and the 2012 charge related to the consolidation of the Company's Denmark R&D operations with its US R&D operations. Foreign Currency Exchange Gain.Adept's foreign subsidiaries' balance sheet accounts are translated at current period ending exchange rates and statements of operations are translated at the average rate for the period. Translation gains and losses are recorded as a separate component of accumulated other comprehensive income in stockholders' equity. For the years ended June 30, 2014, 2013, and 2012, foreign currency exchange gain (loss) was $0.3 million, $0 and $(0.7) million, respectively, due to movements in foreign currency exchange rates. As Adept conducts business on a global basis it is exposed to adverse or beneficial movements in foreign currency exchange rates. The dollar/euro and the dollar/yen markets currently present the largest foreign currency exchange rate risk for Adept. Provision for (Benefit from) Income Taxes. Adept typically provides for income taxes during interim reporting periods based upon an estimate of our annual effective tax rate. We also maintain a liability to cover the cost of additional tax exposure items on the filing of federal and state income tax returns as well as filings in foreign jurisdictions. Each of these filing jurisdictions may audit the tax returns filed and propose adjustments. Adjustments arise from a variety of factors, including different interpretations of statutes and regulations. The liability method is used to account for income taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance to reduce deferred tax assets to the amount that is expected to be realized on a more-likely-than-not basis. Deferred tax expense results from the change in the net deferred tax asset or liability between periods. For the years ended June 30, 2014, 2013, and 2012, the provision for (benefit from) income taxes was $0.3 million, $(0.3) million and $(0.4) million, respectively. The income tax provision in fiscal 2014 related primarily to foreign taxes. The benefit from income taxes in fiscal 2013 and 2012 related primarily to the release of income tax reserves in Singapore, France and Germany due to expired statutes of limitations and settled audits, offset by minimum state and foreign taxes.



Liquidity and Capital Resources

Cash and cash equivalents were $7.6 million at June 30, 2014. During the year ended June 30, 2014, cash and cash equivalents increased by $1.3 million. Net cash provided by operating activities was $1.0 million, representing net loss of $0.3 million and cash used for working capital of $1.9 million, offset by depreciation and amortization and stock-based compensation expense totaling $3.1 million. Net cash used in investing activities was $0.4 million, which represented purchases of property and equipment and increases in restricted cash. Net cash provided by financing activities of $1.3 million primarily consisted of proceeds from employee stock plans, offset by payment for taxes for restricted stock awards surrendered to satisfy tax obligations.



Redeemable Convertible Preferred Stock

In 2013, the Company issued 8,000 shares of its Series A redeemable convertible preferred stock (the "redeemable convertible preferred stock"), par value $0.001 per share, at a price of $1,000 per share, subject to the terms of its Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock (the "Certificate of Designations") for net proceeds of $7.6 million. The Certificate of Designations set forth the terms, rights, provisions for conversion to common stock, obligations and preferences of the redeemable convertible preferred stock and provided that holders of the redeemable convertible preferred stock were entitled to receive dividends payable quarterly in arrears, at the election of Adept either in cash, or, subject to certain equity conditions, in common stock calculated based upon the volume weighted average price of the common stock for a period preceding the dividend date. Dividends on the redeemable convertible preferred stock accrued at the prime rate plus 3% up to a maximum amount of 4%. Each share of redeemable convertible preferred stock was convertible, at the option of the holder and upon certain mandatory conversion events, into common stock, at 27



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a conversion rate of $4.60 per common share (as adjusted for stock splits, stock dividends, reverse stock splits, stock combinations, reclassifications and similar events). In February 2014, all of the outstanding redeemable convertible preferred stock plus accrued dividends through the date of conversion was converted into 1.7 million shares of common stock of the Company.



Bank credit facility

In 2014, the Company entered into a Loan and Security Agreement (the "Agreement") with a bank. Under the Agreement, the Company may borrow an amount not to exceed the lesser of (i) $10.0 million and (ii) $2.5 million plus 80% of eligible domestic and foreign subsidiary accounts receivable. The Agreement specifies the criteria for determining eligible accounts receivable and sets forth ongoing conditions precedent to the Company's ability to borrow under the Agreement. Amounts borrowed under the Agreement may be repaid and reborrowed until its maturity on June 9, 2016, at which time all advances shall be immediately due and payable in full. Amounts borrowed under the Agreement shall bear interest at the prime rate plus 0.75%. Adept and certain of its subsidiaries have granted the bank a security interest in substantially all of their respective assets (excluding intellectual property) to secure the outstanding obligations under the Agreement. The Agreement contains customary representations and warranties by the Company and customary affirmative and negative covenants, including, among other requirements, requirements as to permissible use of proceeds, restrictions on Adept's ability to dispose of assets, make acquisitions, be acquired, undergo a change of control, incur indebtedness, grant liens, transfer funds to subsidiaries, make distributions to its stockholders, make investments, or enter into certain transactions with affiliates, subject to specified exceptions. Further, the Agreement contains a financial covenant that requires the Company to achieve certain minimum EBITDA levels specified in the Agreement. The Agreement contains customary events of default that entitle the bank to accelerate Adept's obligations and require repayment of the outstanding indebtedness, increase the applicable interest rate by an additional 4.00% per annum, and enforce the bank's security interest against the collateral. These events of default include, among others, Adept's breach of payment obligations or covenants, material misrepresentations, events constituting a material adverse change, and bankruptcy and insolvency defaults.



At June 30, 2014, the Company had no borrowings under the Agreement.

Through June of 2014, the Company had a credit facility with a bank which was originally entered into in 2009, and was amended and restated in 2013 and amended in 2014. The credit facility provided for borrowings of up to $8 million at specified advance rates.



Off-Balance Sheet Arrangements

As of June 30, 2014, the Company did not have any material off-balance sheet arrangements.

Contractual Obligations and Commitments

The following is a summary of Adept's contractual obligations as of June 30, 2014 (in thousands): Operating Purchase leases commitments Total Less than 1 year $ 2,100$ 9,100$ 11,200 1 to 3 years 1,700 1,700 3 to 5 years 200 200 More than 5 years - - - Total $ 4,000$ 9,100$ 13,100 28



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Critical Accounting Policies

Adept's accounting policies are more fully described in Note 2 of the Notes to the Consolidated Financial Statements. The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires the Company to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements. We consider the accounting polices described below to be our critical accounting policies. These critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies. Revenue Recognition. The Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, shipment has occurred, the fee is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product is specified by the customer or is uncertain, revenue is deferred until all acceptance criteria have been met. Contracts and/or customer purchase orders are used to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. The Company assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. The Company assesses collectibility based primarily on the creditworthiness of the customer as determined by credit checks and payment history. Revenue for orders is generally not recognized until the product is shipped and title has transferred to the buyer. The Company bears all costs and risks of loss or damage to the goods up to that point. The Company's shipment terms typically provide that title passes to the buyer upon delivery of the goods to the carrier named by the buyer at the named place or point. If no precise point is indicated by the buyer, delivery is deemed to occur when the carrier takes the goods into its charge from the place determined by the Company. Other shipment terms may provide that title passes to the buyer upon delivery of the goods to the buyer. Shipping and handling costs are included in cost of sales. Revenue from sales to distributors is recognized upon shipment, assuming all other criteria for revenue recognition have been met. Distributors do not have a right of return. Revenue from purchased extended warranty and post contract support agreements is deferred and recognized ratably over the term of the warranty or support period. The Company presents revenue net of sales taxes and any similar assessments. Adept's products have features that are enabled or enhanced through the use of software enabling tools and other software elements, which are embedded within its products. Adept's software enabling tools or other software elements do not operate independently, and they are not sold separately and cannot be used without Adept's hardware products. The Company also sells optional software used to enhance capability of its products. Adept believes that the software component of its products is incidental to its products and services taken as a whole. Service and Support revenue consists of sales of spare parts, training, consulting and customer support. Revenues from training and consulting are recognized at the time the service is performed and the customer has accepted the work. These services are not essential to the product functionality and, therefore, do not bear on the revenue recognition policy for Adept's component products.



Deferred revenues represent payments received from customers in advance of the delivery of products or services, or before the satisfaction of all revenue recognition requirements.

Allowance for Doubtful Accounts. The allowance for doubtful accounts reflects the Company's estimate of probable losses inherent in its accounts receivable balances. Adept regularly reviews the adequacy of its allowance for doubtful accounts by considering factors such as payment history and creditworthiness of the customer. Amounts (credited) charged to bad debt expense were $(54,000), $173,000 and $150,000 in fiscal 2014, 2013 and fiscal 2012, respectively. 29



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Inventories. Inventories are stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market. We adjust inventory for estimated obsolescence or unmarketable inventory based on a periodic review of inventory balances, product demand and product lifecycle.

Warranties. We provide for the estimated cost of product warranties at the time revenue is recognized.

Capitalization of Software Development Costs. We capitalize certain software development costs. We begin capitalizing software development costs upon the establishment of technological feasibility, which is established upon the completion of a working model or a detailed program design. Costs incurred prior to technological feasibility are charged to expense as incurred. Capitalization ceases when the product is considered available for general release to customers. Capitalized software development costs are amortized to costs of revenues over the estimated economic lives of the software products based on product life expectancy. Generally, estimated economic lives of the software products do not exceed three years. Accounting for Income Taxes. Income taxes are accounted for under the liability method whereby deferred tax assets or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not such assets will not be realized. The Company's valuation allowance is primarily attributable to net deferred tax assets in the United States. Management believes that it is more likely than not that the Company will not realize certain of these deferred tax assets, and, accordingly, a valuation allowance has been provided for such amounts. The Company only recognizes the tax benefit of uncertain tax positions 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 positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company's practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Foreign Currency Accounting. The functional currencies of our foreign subsidiaries are generally their respective local currencies. Accordingly, gains and losses from the translation of the financial statements of the foreign subsidiaries are reported as a separate component of accumulated other comprehensive income. Realized and unrealized gains and losses from transactions, including intercompany balances not considered to be a permanent investment, denominated in currencies other than an entity's functional currency are included in foreign currency exchange loss in the accompanying consolidated statements of operations and comprehensive loss. We do not currently apply a hedging strategy against our currency positions. Stock-based compensation. Stock-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period of the individual equity instrument. Determining the fair value of stock-based awards at the grant date requires judgment, including estimating the expected term of stock options, the expected volatility of our stock, risk-free interest rate and expected dividends. The computation of the expected volatility assumption used in the Black-Scholes calculation for option grants is based on historical volatility as options on our stock are not traded. When establishing the expected life assumption, we review annual historical employee exercise behavior of option grants with similar vesting periods. In addition, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. If actual forfeitures differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected. Commitments and Contingencies. We evaluate potential commitments and contingencies based on their anticipated outcome. If we determine, after consideration of all known facts and consultation with legal counsel, that a loss related to the potential matter is neither probable or cannot be reasonably estimated as of the date of issuance of our fiscal period-end reports, we do not accrue for the potential liability. If a loss is reasonably possible related to the matter, we will disclose the relevant facts of the matter along with an estimated loss amount or range if such amount or range can be reasonably estimated. 30



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New Accounting Pronouncements

See Note 2 to the Consolidated Financial Statements for a description of certain recent accounting pronouncements including the expected dates of adoption and effects on our results of operations and financial condition.


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