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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 26, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 0-26946
INTEVAC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
CALIFORNIA 94-3125814
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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3550 BASSETT STREET
SANTA CLARA, CALIFORNIA 95054
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, INCLUDING ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 986-9888
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
On September 26, 1998 approximately 11,992,237 shares of the Registrant's
Common Stock, no par value, were outstanding.
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INTEVAC, INC.
INDEX
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NO. PAGE NO.
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets....................... 3
Condensed Consolidated Statements of Income................. 4
Condensed Consolidated Statements of Cash Flows............. 5
Notes to Condensed Consolidated Financial Statements........ 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings........................................... 23
ITEM 2. Changes in Securities....................................... 23
ITEM 3. Defaults Upon Senior Securities............................. 23
ITEM 4. Submission of Matters to a Vote of Security-Holders......... 23
ITEM 5. Other Information........................................... 23
ITEM 6. Exhibits and Reports on Form 8-K............................ 23
SIGNATURES........................................................... 24
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTEVAC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 26, DECEMBER 31,
1998 1997
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(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 745 $ 3,338
Short-term investments.................................... 61,175 67,804
Accounts receivable, net of allowances of $1,775 and
$1,505 at September 26, 1998 and December 31, 1997,
respectively........................................... 9,728 9,634
Inventories............................................... 23,570 35,915
Short-term note receivable, net of allowance of $395 at
December 31, 1997...................................... -- --
Prepaid expenses and other current assets................. 675 641
Deferred tax asset........................................ 6,572 6,572
-------- --------
Total current assets.............................. 102,465 123,904
Property, plant, and equipment, net......................... 14,615 13,760
Investment in 601 California Avenue LLC..................... 2,431 2,431
Goodwill and other intangibles.............................. 3,945 5,344
Debt issuance costs......................................... 1,782 2,029
Deferred tax assets and other assets........................ 192 326
-------- --------
Total assets...................................... $125,430 $147,794
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,523 $ 4,585
Accrued payroll and related liabilities................... 1,780 1,949
Other accrued liabilities................................. 7,119 10,304
Customer advances......................................... 9,913 28,247
Net liabilities of discontinued operations................ -- 794
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Total current liabilities......................... 21,335 45,879
Convertible notes........................................... 57,500 57,500
Long-term notes payable & other long-term liabilities....... 1,960 1,980
Shareholders' equity:
Common stock, no par value................................ 15,454 17,336
Retained earnings......................................... 29,181 25,099
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Total shareholders' equity........................ 44,635 42,435
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Total liabilities and shareholders' equity........ $125,430 $147,794
======== ========
</TABLE>
See accompanying notes.
3
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INTEVAC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27,
1998 1997 1998 1997
------------- ------------- ------------- -------------
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Net revenues........................... $14,657 $30,350 $84,693 $95,254
Cost of net revenues................... 10,693 21,186 61,025 65,805
------- ------- ------- -------
Gross profit........................... 3,964 9,164 23,668 29,449
Operating expenses:
Research and development............. 2,157 3,225 9,117 7,687
Selling, general and
administrative.................... 2,458 2,907 8,509 8,328
Restructuring........................ 71 -- 1,235 --
------- ------- ------- -------
Total operating expenses..... 4,686 6,132 18,861 16,015
------- ------- ------- -------
Operating income (loss)................ (722) 3,032 4,807 13,434
Interest expense....................... (1,027) (1,046) (3,100) (2,494)
Interest income and other, net......... 1,059 816 2,789 2,789
------- ------- ------- -------
Income (loss) from continuing
operations before income taxes....... (690) 2,802 4,496 13,729
Provision for income taxes............. (227) 871 1,485 4,805
------- ------- ------- -------
Income (loss) from continuing
operations........................... (463) 1,931 3,011 8,924
Gain from discontinued operations, net
of applicable income taxes........... -- -- 1,005 --
------- ------- ------- -------
Net income (loss)...................... $ (463) $ 1,931 $ 4,016 $ 8,924
======= ======= ======= =======
Basic earnings per share:
Income (loss) from continuing
operations........................ $ (0.04) $ 0.15 $ 0.25 $ 0.71
Net income (loss).................... $ (0.04) $ 0.15 $ 0.33 $ 0.71
Shares used in per share amounts..... 11,994 12,585 12,098 12,541
Diluted earnings per share:
Income (loss) from continuing
operations........................ $ (0.04) $ 0.15 $ 0.24 $ 0.67
Net income (loss).................... $ (0.04) $ 0.15 $ 0.32 $ 0.67
Shares used in per share amounts..... 11,994 13,104 12,414 15,294
</TABLE>
See accompanying notes.
4
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INTEVAC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
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SEPTEMBER 26, SEPTEMBER 27,
1998 1997
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OPERATING ACTIVITIES
Net income.................................................. $ 4,016 $ 8,924
Adjustments to reconcile net income to net cash and cash
equivalents provided by (used in) operating activities:
Depreciation and amortization.......................... 5,865 3,632
Gain on sale of Chorus Investment...................... (395) (785)
Gain on sale of discontinued operations................ (794) --
Foreign currency loss.................................. 71 --
Loss on IMAT investment................................ 132 39
Restructuring charge -- non-cash portion............... 194 --
Loss on disposal of equipment.......................... 95 38
Changes in assets and liabilities...................... (14,437) 1,290
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Total adjustments................................. (9,269) 4,214
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Net cash and cash equivalents provided by (used in)
operating activities...................................... (5,253) 13,138
INVESTING ACTIVITIES
Purchase of investments..................................... (107,993) (95,442)
Proceeds from sale of investments........................... 114,622 31,773
Proceeds from sale of Chorus Investment..................... 395 785
Investment in IMAT.......................................... -- (436)
Purchase of leasehold improvements and equipment............ (2,482) (5,014)
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Net cash and cash equivalents provided by (used in)
investing activities...................................... 4,542 (68,334)
FINANCING ACTIVITIES
Net borrowings under line of credit agreement............... -- (2)
Notes payable repayments.................................... -- (25)
Proceeds from issuance of common stock...................... 1,118 901
Repurchase of common stock.................................. (3,000) --
Proceeds from convertible bond offering..................... -- 55,197
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Net cash and cash equivalents provided by (used in)
financing activities...................................... (1,882) 56,071
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Net increase (decrease) in cash and cash equivalents........ (2,593) 875
Cash and cash equivalents at beginning of period............ 3,338 938
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Cash and cash equivalents at end of period.................. $ 745 $ 1,813
========= ========
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid for:
Interest.................................................. $ 3,838 $ 2,016
Income taxes.............................................. 4,065 5,440
Other non-cash changes:
Inventories capitalized for internal use.................. -- $ 567
</TABLE>
See accompanying notes.
5
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INTEVAC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS ACTIVITIES AND BASIS OF PRESENTATION
Intevac, Inc. ("Intevac" or the "Company") is a leading supplier of static
sputtering systems and related manufacturing equipment used to manufacture
thin-film disks for computer hard disk drives. Sputtering is a complex vacuum
deposition process used to deposit multiple thin-film layers on a disk. The
Company's primary objective is to be the industry leader in supplying disk
sputtering equipment by providing disk sputtering systems which have both the
highest overall performance and the lowest cost of ownership in the industry.
The Company's principal product, the MDP-250 disk sputtering system, enables
disk manufacturers to produce high performance, high capacity disks. The Company
sells its static sputtering systems and related manufacturing equipment to both
captive and merchant thin-film disk manufacturers. The Company sells and markets
its products directly in the United States, and through exclusive distributors
in Japan and Korea. The Company has established subsidiaries in Singapore and
Malaysia and a branch office in Taiwan to support its customers in Southeast
Asia.
The Company also realizes revenues from the sales of system components,
contract research and development activities, flat panel display ("FPD")
manufacturing equipment and electron beam processing equipment. Intevac's system
component business consists primarily of sales of spare parts and after-sale
service to purchasers of the Company's disk sputtering systems, as well as sales
of components to other manufacturers of vacuum equipment. Contract research and
development revenues have been derived primarily from prime contracts awarded by
and subcontracts awarded under various Department of Defense ("DOD") and NASA
development projects for various photonics products and the FPD industry. FPD
manufacturing equipment consists of sputtering and rapid thermal processing
equipment for the manufacture of FPD's. Electron beam processing equipment is
used for curing inks, coatings and adhesives, in the manufacture of shrink wrap
films and for in-line sterilization.
The financial information at September 26, 1998 and for the three- and
nine-month periods ended September 26, 1998 and September 27, 1997 is unaudited,
but includes all adjustments (consisting only of normal recurring accruals) that
the Company considers necessary for a fair presentation of the financial
information set forth herein, in accordance with generally accepted accounting
principles for interim financial information, the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, it does not include all of the
information and footnotes required by generally accepted accounting principles
for annual financial statements. For further information, refer to the
Consolidated Financial Statements and footnotes thereto included or incorporated
by reference in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results inevitably will differ from those estimates, and such
differences may be material to the financial statements.
The results for the three- and nine-month periods ended September 26, 1998
are not considered indicative of the results to be expected for any future
period or for the entire year.
2. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this statement has no impact
on the Company's net income or shareholders' equity. The Company's total
comprehensive income was the same as its net income for all periods presented.
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INTEVAC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVENTORIES
The components of inventory consist of the following:
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<CAPTION>
SEPTEMBER 26, DECEMBER 31,
1998 1997
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(IN THOUSANDS)
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Raw materials.............................................. $ 7,556 $ 8,784
Work-in-progress........................................... 12,993 18,756
Finished goods............................................. 3,021 8,375
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$23,570 $35,915
======= =======
</TABLE>
A significant portion of the finished goods inventory is represented by
completed units at customer sites undergoing installation and acceptance
testing.
4. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
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<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
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SEPTEMBER 26, SEPTEMBER 27, SEPTEMBER 26, SEPTEMBER 27
1998 1997 1998 1997
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(IN THOUSANDS)
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Numerator:
Income (loss) from continuing
operations...................... $ (463) $ 1,931 $ 3,011 $ 8,924
======= ======= ======= =======
Net income (loss).................. $ (463) $ 1,931 $ 4,016 $ 8,924
======= ======= ======= =======
Numerator for basic earnings per
share -- income (loss) available
to common stockholders.......... (463) 1,931 4,016 8,924
Effect of dilutive securities:
6 1/2% convertible notes(1)..... -- -- -- 1,324
------- ------- ------- -------
Numerator for diluted earnings per
share -- income (loss) available
to common stockholders after
assumed conversions............. $ (463) $ 1,931 $ 4,016 $10,248
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share -- weighted-average
shares.......................... 11,994 12,585 12,098 12,541
Effect of dilutive securities:
Employee stock options(2)....... -- 519 316 556
6 1/2% convertible notes(1)..... -- -- -- 2,197
------- ------- ------- -------
Dilutive potential common shares... -- 519 316 2,753
------- ------- ------- -------
Denominator for diluted earnings
per share -- adjusted
weighted-average shares and
assumed conversions............. $11,994 $13,104 $12,414 $15,294
======= ======= ======= =======
</TABLE>
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(1) Diluted EPS for the three- and nine-month periods ended September 26, 1998
and for the three-month period ended September 27, 1997 excludes "as
converted" treatment of the Convertible Notes as their inclusion would be
anti-dilutive.
(2) Diluted EPS for the three-month period ended September 26, 1998 excludes
employee stock options as their inclusion would be anti-dilutive.
7
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INTEVAC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. RESEARCH AND DEVELOPMENT COST SHARING AGREEMENT
The Company entered into an agreement with a Japanese company to perform
best efforts joint research and development work. The nature of the project is
to develop a glass coating machine to be used in the production of flat panel
displays. The Company is reimbursed by the other party for one-half of the
actual costs of the project up to a ceiling of $9,450,000. As of September 26,
1998, the Company had received $7,900,000 under the agreement, all of which had
been applied to qualifying costs.
6. RELATED PARTY
In 1997, Intevac and Matsubo formed a joint venture, IMAT Inc. ("IMAT"), to
market the Company's flat panel manufacturing equipment in the Far East. The
Company's share of IMAT is 49% and the investment is being accounted for under
the equity method. At September 26, 1988, the cumulative adjustment related to
IMAT activity resulted in a decrease of approximately $276,000 in the Company's
investment in IMAT, which is included in other assets on the balance sheet. At
September 26, 1998, the Company had an outstanding receivable balance with IMAT
of $1,300,000 for a contract advance on an order for a flat panel machine. Total
contract advances with IMAT were $1,900,000 at September 26, 1998.
7. FOREIGN EXCHANGE CONTRACTS
In September 1998, the Company entered into a foreign exchange forward
contract to sell Japanese Yen in June 1999. The nominal amount of the forward
contract is $1.6M. The forward contract has been entered into to hedge a
specific order, which is expected to be received in the fourth quarter of 1998.
As the order has not yet been received, the forward contract has been accounted
for as a speculative hedge and has been accounted for under mark-to-market
accounting. Related gains and losses will be reported as a component of income
in the period incurred. As of September 26, 1998, related gains and losses were
immaterial.
8. STOCK OPTION REPRICING
In the third quarter of 1998, the Company approved an exchange program that
offered to each employee that held stock options granted between August 19, 1996
and July 31, 1998, the opportunity to exchange their options for newly granted
stock options. The new option would be for the same number of shares as
originally granted, but the vesting period would start on the day the new option
was granted. This offer was open for a two week period of time. The exercise
price of the new option was set at the fair market value of Intevac, Inc. common
stock on the date each employee notified the Company of their acceptance of the
exchange offer during the period.
New stock options were granted for a total of 500,700 shares of common
stock. The new option prices ranged from $6.250 to $8.375.
9. RESTRUCTURING
On March 2, 1998, as a result of weak demand for its disk sputtering
systems, the Company's management adopted a plan to reduce expenses. The expense
reduction plan included a reduction in force of approximately 90 employees out
of the Company's staff of contract and regular personnel. The reductions took
place at the Company's facilities in Santa Clara, CA; Los Gatos, CA; Rocklin,
CA; and Taiwan. Additionally, the Company relocated its Rapid Thermal Processing
("RTP") Operation from Rocklin to the Company's Santa Clara headquarters and
closed the Rocklin facility.
In the first quarter of 1998, the Company incurred a restructuring charge
of $1,164,000 related to the expense reduction plan. The significant components
of this charge include $290,000 for closure of the Rocklin facility, $462,000
for the balance of the rent due on the lease for such facility and $392,000 for
employee severance costs. Closure of the facility was complete at June 27, 1998.
8
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INTEVAC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On August 17, 1998, as a result of continued weak demand for its disk
sputtering systems, the Company's management implemented a reduction in force of
approximately 27 employees out of the Company's staff of contract and regular
personnel. The reductions took place at the Company's facilities in Santa Clara,
CA; Hayward, CA; Singapore; and Taiwan. In the third quarter of 1998, the
Company incurred a restructuring charge of $71,000 related to severance costs
for the affected employees.
As of September 26, 1998, of the foregoing amounts, approximately $398,000
in termination benefits had been paid out to affected employees and $299,000 had
been spent related to the relocation of the RTP Operation, the closure of the
Rocklin facility and rent on the lease on such facility.
10. SUBSEQUENT EVENTS
In October 1998, the Company entered into a foreign exchange forward
contract to sell Japanese Yen in July 1999. The nominal amount of the forward
contract is $10.0M. The forward contract will be utilized to mitigate yen
fluctuation exposure related to future yen denominated orders.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements
which involve risks and uncertainties. The Company's actual results may differ
materially from those discussed in the forward-looking statements. Factors that
might cause such a difference, include but are not limited to, the risk factors
set forth elsewhere in this Quarterly Report on Form 10-Q under "Certain Factors
Which May Affect Future Operating Results" and in other documents the Company
files from time to time with the Securities and Exchange Commission, including
the Company's Annual Report on Form 10-K filed in March 1998, Form 10-Q's and
Form 8-K's.
OVERVIEW
The Company's revenues are generated by the sale of disk sputtering systems
and related disk manufacturing equipment; system components; contract research
and development activities; flat panel display manufacturing equipment; and
electron beam processing equipment. Disk sputtering systems and related disk
manufacturing equipment generally represent the majority of the Company's
revenue, and Intevac is a leading supplier of this equipment. Sputtering is a
complex vacuum deposition process used to deposit multiple thin-film layers on a
disk. Intevac's system component business consists primarily of sales of spare
parts and after-sale service to purchasers of the Company's disk sputtering
systems, as well as sales of components to other manufacturers of vacuum
equipment. Contract research and development revenues have been derived
primarily from prime contracts awarded by and subcontracts awarded under various
DOD and NASA development projects for various photonics products and the FPD
industry. Flat panel display manufacturing equipment consists of sputtering and
rapid thermal processing equipment for the manufacture of FPD's. Electron beam
processing equipment is used for curing inks, coatings and adhesives, in the
manufacture of shrink-wrap films and for sterilization.
In the first quarter of 1997, the Company completed the sale of $57.5
million of its 6 1/2% Convertible Subordinated Notes Due 2004 (the "Convertible
Notes"). In the second quarter of 1997, the Company paid $0.4 million for a 49%
interest in IMAT Inc. ("IMAT"), a joint venture formed with its Japanese
distributor, Matsubo, to market the Company's flat panel manufacturing equipment
in the Far East. In the fourth quarter of 1997, the Company purchased all of the
assets of RPC Industries ("RPC"). RPC is a manufacturer of electron beam
processing systems. This acquisition was accounted for under the purchase
method. The total purchase price was approximately $1.0 million plus contingent
payments equal to 25% of the future earnings of RPC. The total of these
contingent payments is limited to approximately $7.7 million.
In March 1998, as a result of weak orders for its disk sputtering systems
and an expectation that revenues would decline significantly in the third
quarter of 1998, the Company implemented an expense reduction plan that involved
the termination of approximately 20% of the Company's work force. As part of the
expense reduction plan, the Company also decided to close its Rocklin,
California facility and transfer its Rapid Thermal Processing Operation from
Rocklin to the Company's headquarters in Santa Clara. During the first quarter
of 1998, the Company incurred a restructuring charge of approximately $1.2
million related to the expense reduction plan.
In August 1998, as a result of continued weak demand for its disk
sputtering systems, the Company's management implemented a reduction in force of
approximately 27 employees out of the Company's staff of contract and regular
personnel. The reductions took place at the Company's facilities in Santa Clara,
CA; Hayward, CA; Singapore; and Taiwan. In the third quarter of 1998, the
Company incurred a restructuring charge of $71,000 related to severance costs
for the affected employees.
As of September 26, 1998, of the foregoing amounts, approximately $398,000
in termination benefits had been paid out to affected employees and $299,000 had
been spent related to the relocation of the RTP Operation, the closure of the
Rocklin facility and rent due on the lease for such facility.
The Company's backlog was $26.1 million and $71.1 million at September 26,
1998 and September 27, 1997, respectively. The Company includes in backlog the
value of purchase orders for its products with scheduled delivery dates.
Delivery dates may be rescheduled from time to time. The Company's backlog at
the
10
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beginning of a quarter may not include all system orders needed to achieve the
Company's revenue objectives for that quarter.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 26, 1998 AND SEPTEMBER 27, 1997
Net revenues. Net revenues consist primarily of sales of the Company's disk
sputtering systems and related equipment used to manufacture thin-film disks for
computer hard disk drives, and, to a lesser extent, flat panel display
manufacturing equipment, system components, contract research and development
and electron beam processing equipment. Net revenues from the sales of
sputtering systems and electron beam processing equipment are recognized upon
customer acceptance. Sales of related equipment and system components are
recognized upon product shipment, and contract research and development is
recognized in accordance with contract terms, typically as costs are incurred.
Net revenues decreased by 52% to $14.7 million for the three months ended
September 26, 1998 from $30.4 million for the three months ended September 27,
1997. The decrease in net revenues was due to a decrease in the net revenues
from disk manufacturing equipment and to a lesser extent a decrease in the net
revenues from flat panel display manufacturing equipment, which was partially
offset by an increase in net revenues from electron beam processing equipment
and contract research and development. Based upon its current backlog of orders
and the scheduled shipment dates, the Company expects that net revenues during
each of the three-month periods ended December 31, 1998 and March 27, 1999 will
be less than or equal to the net revenues recorded during the three months ended
September 26, 1998.
International sales decreased by 90% to $2.1 million for the three months
ended September 26, 1998 from $22.0 million for the three months ended September
27, 1997. The decrease in international sales was primarily due to a decrease in
the sales of disk manufacturing equipment to international customers.
International sales constituted 14% of net revenues for the three months ended
September 26, 1998 and 72% of net revenues for the three months ended September
27, 1997.
Gross margin. Cost of net revenues consists primarily of purchased
materials, fabrication, assembly, test, installation, warranty costs, scrap and
costs attributable to contract research and development. Gross margin was 27.0%
for the three months ended September 26, 1998 as compared to 30.2% for the three
months ended September 27, 1997. Gross margins declined primarily as the result
of lower shipment levels which resulted in higher overhead costs as a percent of
revenue. The Company believes that gross margins will decline further in the
three-month period ended December 31, 1998 as the result of continuing industry
over-capacity, which has caused an intense competitive environment and
significantly reduced overall demand for the disk manufacturing equipment sold
by the Company and its competitors.
Research and development. Research and development expense consists
primarily of prototype materials, salaries and related costs of employees
engaged in ongoing research, design and development activities for disk
manufacturing equipment, flat panel manufacturing equipment and electron beam
processing equipment and research by the Photonics Division. Company-funded
research and development expense decreased by 33% to $2.2 million for the three
months ended September 26, 1998 from $3.2 million for the three months ended
September 27, 1997, representing 14.7% and 10.6%, respectively, of net revenue.
This decrease was primarily the result of approximately $1.2 million of cost
sharing funds received from the Company's D-STAR development partner and
credited to research and development expense during the three months ended
September 26, 1998. There were approximately $0.3 million of comparable credits
recorded during the three months ended September 27, 1997. The Company also
received approximately $0.1 million of cost sharing credits from the National
Institute of Science and Technology ("NIST") during the three-month period ended
September 26, 1998 related to the development of advanced lubrication
techniques. There were no comparable credits from NIST recorded during the three
months ended September 27, 1997. In addition, research and development expenses
for the three-month periods ended September 26, 1998 and September 27, 1997 do
not include $1.3 million and $0.9 million, respectively, of other expenditures
that are charged to cost of sales in connection with contract research and
development activities.
11
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Selling, general and administrative. Selling, general and administrative
expense consists primarily of selling, marketing, customer support, financial,
travel, management, legal and professional services. Domestic sales are made by
the Company's direct sales force, whereas international sales are made by
distributors that typically provide sales, installation, warranty and ongoing
customer support. The Company also has subsidiaries in Singapore and Malaysia
and a branch office in Taiwan to support customers in Southeast Asia and markets
its flat panel manufacturing equipment to the Far East through its Japanese
joint venture, IMAT. Selling, general and administrative expense decreased by
15% to $2.5 million for the three months ended September 26, 1998 from $2.9
million for the three months ended September 27, 1997, representing 16.8% and
9.6%, respectively, of net revenue. The decrease in expense was primarily the
result of reduced headcount and the reversal of employee profit sharing accruals
which was partially offset by additional selling, general and administrative
expenses associated with the electron beam equipment business which was acquired
during the fourth quarter of 1997. Company-wide headcount declined to 289
employees at September 26, 1998 from 378 employees at September 27, 1997.
Restructuring expense. In August 1998, the Company reduced its staff by
approximately 9%. This reduction was in addition to the approximate 20%
reduction in staff completed during March 1998. During the three months ended
September 26, 1998, the Company recorded approximately $71,000 of restructuring
expense related to severance pay for the employees terminated as part of the
August reduction in force.
Interest expense. Interest expense consists primarily of interest on the
Convertible Notes, and, to a lesser extent, interest on approximately $2.0
million of long-term debt related to the purchase of Cathode Technology in 1996.
Interest expense for the three months ended September 26, 1998 was essentially
unchanged when compared to the three months ended September 27, 1997.
Interest and other income, net. Interest and other income, net consists
primarily of interest income on the Company's investments, income related to the
sale of the Company's 20% interest in the capital stock of Chorus Corporation
and early payment discounts on the purchase of inventories, goods and services,
partially offset by the Company's 49% share of the loss incurred by IMAT.
Interest and other income, net increased by 30% to $1.1 million for the three
months ended September 26, 1998 from $0.8 million for the three months ended
September 27, 1997 as the result of increased income related to the sale of the
Company's 20% interest in the capital stock of Chorus.
Provision for income taxes. Income tax expense as a percentage of pretax
income for the three months ended September 26, 1998 and September 27, 1997 was
33% and 31%, respectively. The Company's tax rate differs from the applicable
statutory rates primarily due to benefits from the Company's foreign sales
corporation and tax-exempt interest income partially offset by nondeductible
goodwill amortization. The tax rate for the three months ended September 27,
1997 was lower due to a year-to-date adjustment in the Company's tax provision
rate from 36% to 35%.
NINE MONTHS ENDED SEPTEMBER 26, 1998 AND SEPTEMBER 27, 1997
Net revenues. Net revenues decreased by 11% to $84.7 million for the nine
months ended September 26, 1998 from $95.3 million for the nine months ended
September 27, 1997. The decrease in net revenues was due to a reduction in net
revenues from disk manufacturing equipment, which was partially offset by an
increase in net revenues from flat panel display manufacturing equipment,
electron beam processing equipment (which was acquired during the fourth quarter
of 1997) and contract research and development.
International sales decreased by 13% to $46.3 million for the nine months
ended September 26, 1998 from $53.2 million for the nine months ended September
27, 1997. The decrease in revenues from international sales was primarily due to
a decrease in sales of disk manufacturing equipment, which was partially offset
by an increase in sales from electron beam processing equipment. International
sales constituted 55% of net revenues for the nine months ended September 26,
1998 and 56% of net revenues for the nine months ended September 27, 1997.
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Gross margin. Gross margin was 27.9% for the nine months ended September
26, 1998 as compared to 30.9% for the nine months ended September 27, 1997. The
reduction in gross margins was primarily due to the negative gross margin
incurred on the RIGEL flat panel sputtering system acceptance.
Research and development. Research and development expense increased to
$9.1 million for the nine months ended September 26, 1998 from $7.7 million for
the nine months ended September 27, 1997, representing 10.8% and 8.1%,
respectively, of net revenues. The increase was primarily the result of
increased development expenses in disk manufacturing products and to a lesser
extent electron beam processing equipment, which were partially offset by lower
development expense on flat panel manufacturing products.
Research and development expense in the nine months ended September 26,
1998 does not include costs of $1.2 million reimbursed to the Company under the
terms of a research and development cost sharing agreement with the Company's
D-STAR development partner, nor do they include costs of $0.2 million reimbursed
to the Company under the terms of a research and development contract with NIST.
Research and development expenses in the nine months ended September 27, 1997 do
not include costs of $1.3 million reimbursed to the Company under the terms of a
research and development cost sharing agreement with the Company's D-STAR
development partner, nor do they include costs of $1.5 million reimbursed to the
Company under a DARPA development contract funding development of the D-STAR and
delivery of a beta-site unit. There were no comparable credits from NIST
recorded during the nine months ended September 27, 1997. In addition, research
and development expenses for the nine month periods ended September 26, 1998 and
September 27, 1997 do not include $3.2 million and $2.4 million, respectively,
of other expenditures that are charged to cost of sales in connection with
contract research and development activities.
Selling, general and administrative. Selling, general and administrative
expense increased to $8.5 million for the nine months ended September 26, 1998
from $8.3 million for the nine months ended September 27, 1997, representing
10.0% and 8.7%, respectively, of net revenues. The increase in selling, general
and administrative expense was the result of additional selling, general and
administration expenses associated with the electron beam equipment business
which was acquired during the fourth quarter of 1997, partially offset by
decreased expenses in other business units.
Restructuring expense. In March 1998, the Company's management adopted a
restructuring plan to relocate its Rapid Thermal Processing Operation from
Rocklin, California to the Company's Santa Clara, California headquarters and to
close the Rocklin facility. The restructuring plan also included an approximate
20% reduction in the worldwide staff of the Company's contract and regular
employees. In August 1998, the Company terminated an additional 9% of its
workforce. As a result of the restructuring plan and the August reduction in
force, the Company expensed approximately $1.2 million of restructuring expense
in the nine months ended September 26, 1998. The restructuring expense included
approximately $0.8 million related to closure of the Rocklin facility and
approximately $0.4 million of severance pay for terminated employees.
Interest expense. Interest expense increased by $0.6M for the nine months
ended September 26, 1998 due to interest incurred on the Company's 6 1/2%
Convertible Notes issued in the first quarter of 1997.
Interest and other income, net. Interest and other income, net was $2.8
million for the nine months ended September 26, 1998 and $2.8 million for the
nine months ended September 27, 1997 as the result of increased interest income
on funds raised from the sale of the Company's 6 1/2% Convertible Subordinated
Notes due 2004, which was offset by decreased income related to the sale of the
Company's 20% interest in the capital stock of Chorus and an increase in the
Company's 49% share of the loss incurred by IMAT.
Discontinued operations. During the nine months ended September 26, 1998,
the Company recorded a gain from discontinued operations of $1.0M resulting from
the reimbursement and reversal of excess warranty reserves related to the sale
of the Company's night vision business in 1995.
Provision for income taxes. Income tax expense as a percentage of pretax
income for the nine months ended September 26, 1998 and September 27, 1997 was
33% and 35%, respectively. The tax rate declined in 1998 because a larger
percentage of 1998 income is expected to be derived from tax-exempt interest
income.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities used cash of $5.3 million for the nine
months ended September 26, 1998. The cash used was due primarily to reductions
in customer advances, other accrued liabilities, accounts payable and net
liabilities of discontinued operations, which were partially offset by lower
inventories, depreciation and amortization expense, and net income.
The Company's investing activities provided cash of $4.5 million for the
nine months ended September 26, 1998 due to the net redemption of investments
and proceeds related to the sale of the Company's interest in the Chorus
Corporation, which were partially offset by the purchase of fixed assets.
The Company's financing activities used cash of $1.9 million for the nine
months ended September 26, 1998, primarily due to the repurchase of 341,000
shares of the Company's stock for $3.0 million, which was partially offset by
the sale of the Company's stock to its employees through the Company's employee
benefit plans.
YEAR 2000
The Company is currently evaluating the software and computer systems it
uses in order to ensure compliance with Year 2000 issues. This evaluation, and
any corrective actions required, is estimated to be largely completed no later
than March 31, 1999. The Company does not expect to encounter significant
problems or that material expenditures will be required to comply with Year 2000
issues. These expectations are based primarily on the fact that the Company
purchases all business software from third party vendors.
Specific actions to be taken include: reviewing all software used
internally by the Company and assessing the vendor's plans to comply with Year
2000; testing of all hardware to ensure its ability to recognize dates after
1999; contacting significant suppliers to determine their ability to comply with
Year 2000; and reviewing all products the Company ships for Year 2000 problems.
The expectations of the findings of this project and the date on which the
Company believes it will be completed are based on management's best estimates.
However, there can be no guarantee that these expectations will be achieved, and
actual results could differ materially.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS
Fluctuations of Results of Operations
The Company's operating results have historically been subject to
significant quarterly and annual fluctuations. The Company believes that its
operating results will continue to fluctuate on a quarterly and annual basis due
to a variety of factors. These factors include the cyclicality of the thin-film
disk manufacturing and disk drive industries, patterns of capital spending by
customers, the timing of significant orders, order cancellations or
reschedulings, exchange rate fluctuations, market acceptance of the Company's
products, unanticipated delays in design, engineering or production or in
customer acceptance of product shipments, changes in pricing by the Company or
its competitors, the timing of product announcements or introductions by the
Company or its competitors, the mix of systems sold, the relative proportions of
sputtering systems, system components and subassemblies, electron beam
processing systems, and contract research and development net revenues, the
availability and cost of components and subassemblies, changes in product
development costs, and expenses associated with acquisitions.
The Company derives the majority of its net revenues from the sale of a
relatively small number of sputtering systems. Over the last eleven quarters,
the number of systems accepted by customers in any particular quarter has varied
from three to thirteen and, as a result, the Company's net revenues and
operating results for a particular period could be materially adversely affected
if an anticipated order for even one system is not received in time to permit
shipment and customer acceptance during that accounting period. Over the last
eleven quarters the Company's gross margin and operating income (loss) as a
percentage of net revenues has fluctuated from approximately 25% to 40% of net
revenues and from (9)% to 18% of net revenues, respectively. The Company
anticipates that its unit shipments, revenues, gross and operating margins will
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continue to fluctuate. As a result, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance.
The Company's backlog at the beginning of a quarter may not include all
system orders needed to achieve the Company's revenue objectives for that
quarter. In addition, orders in backlog are subject to cancellation, and
although the Company generally requires a deposit on orders for its systems,
such deposits may not be sufficient to cover the expenses incurred by the
Company for the manufacture of the canceled systems or fixed operating expenses
associated with such systems. The Company may from time to time manufacture a
system in anticipation of an order that may not be placed during the period or
at all. In any given quarter in which such a system is manufactured, the Company
may not receive funds to cover its manufacturing costs. Orders may be subject to
delay, deferral or rescheduling by a customer. From the date the Company
receives an order, it often takes more than six months before the net revenues
from such order are recognized and even longer before final payment is received.
The relatively long manufacturing cycles of many of the Company's products has
caused and could cause shipments of such products to be delayed from one quarter
to the next, which could materially adversely affect the Company's business,
financial condition and results of operations for a particular quarter.
Announcements by the Company or its competitors of new products and technologies
could cause customers to defer purchases of the Company's existing systems,
which would have a material adverse effect on the Company's business, financial
condition and results of operations.
Installing and integrating new sputtering systems into the thin-film disk
manufacturing process requires a substantial investment by a customer. Sales of
the Company's systems depend, in significant part, upon the decision of a
prospective customer to replace obsolete equipment or to increase manufacturing
capacity by upgrading or expanding existing manufacturing facilities or
constructing new manufacturing facilities, all of which typically involve a
significant capital commitment. Therefore, customers often require a significant
number of product presentations and demonstrations, as well as substantial
interaction with the Company's senior management, before making a purchasing
decision. Accordingly, the Company's systems typically have a lengthy sales
cycle, during which the Company may expend substantial funds and management time
and effort with no assurance that a sale will result. Furthermore, the Company's
expense levels are based, in part, on its expectations as to future net
revenues. If revenue levels are below expectations, operating results are likely
to be adversely affected. Net income, if any, may be disproportionately affected
by a reduction in net revenues because a proportionately smaller amount of the
Company's expenses varies with its net revenues. The impact of these and other
factors on the Company's sales and operating results in any future period cannot
be forecasted with certainty.
Due to all of the foregoing factors, the Company expects its quarterly
operating results to fluctuate significantly and may in certain quarters be
below the expectations of securities analysts and investors. In such event it is
likely that the price of the Company's Common Stock would be materially
adversely affected.
Cyclicality of the Media Industry
The cyclicality of the disk drive industry, among other factors, may cause
prospective customers to postpone decisions regarding major capital
expenditures, including purchases of the Company's systems. Customers with
existing orders for the Company's systems may also request delays in their
previously requested delivery schedules. The Company's business depends upon
capital expenditures by manufacturers of thin-film disks, including
manufacturers that are opening new fabrication facilities or entering the
market, expanding or upgrading existing facilities, or replacing obsolete
equipment, which in turn depend upon the current and anticipated market demand
for hard disk drives. In recent years, the disk drive industry has experienced
significant growth, which, in turn, has caused significant growth in the capital
equipment industry supplying manufacturers of thin-film disks. However, the disk
drive industry is cyclical and historically has experienced periods of
oversupply, resulting in significantly reduced demand for thin-film disks and
for the capital equipment used to manufacture such disks, including the systems
manufactured and marketed by the Company.
A number of hard disk drives manufacturers and component suppliers have
reported both substantial reductions in revenues and substantial financial
losses. Many of these manufacturers attributed their problems
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to an excess supply of hard drives, or, in the case of component suppliers, an
excess supply of components for hard drives (including thin-film disks) and
rapid changes in technology which caused a number of products to become
obsolete. This industry-wide over-capacity has led to a period of reduced demand
for thin-film disk production and for the capital equipment used in such
production. In March of 1998, as a result of weak orders for its disk sputtering
systems, the Company implemented an expense reduction plan that involved the
termination of approximately 20% of the Company's work force. In August of 1998
the Company terminated another 9% of its work force as the result of continuing
weak demand for its products.
Cyclical downturns in the hard disk drive industry are likely to materially
adversely affect the Company's business, financial condition and results of
operations.
Intense Competition
The Company's disk sputtering business experiences intense competition
worldwide from two principal competitors, Balzers A.G. ("Balzers") and Anelva
Corporation ("Anelva"), each of which is a large manufacturer of complex vacuum
equipment and thin-film disk manufacturing systems and has sold a substantial
number of thin-film disk sputtering machines worldwide. Both Balzers and Anelva
are manufacturers of static sputtering systems, and each has substantially
greater financial, technical, marketing, manufacturing and other resources than
the Company. The Company also experiences competition from two other
manufacturers of static sputtering systems as well as from the manufacturers of
thin-film disks that have developed the capability to manufacture their own
sputtering systems. There can be no assurance that the Company's competitors
will not develop enhancements to, or future generations of, competitive products
that offer superior price or performance features or that new competitors will
not enter the Company's markets and develop such enhanced products. Furthermore,
the failure of manufacturers of thin-film disks currently using in-line machines
and manufacturers using internally developed sputtering systems to switch to
static sputtering systems in the future could adversely affect the Company's
ability to increase its sputtering system market share.
In addition, the Company's two principal competitors are based in foreign
countries and have cost structures and system prices based on foreign
currencies. Accordingly, currency fluctuations could cause the Company's
dollar-priced products to be less competitive than its competitors' products
priced in other currencies. Currency fluctuations could also increase the
Company's cost structure relative to those of its competitors, which could make
it more difficult for the Company to maintain its gross margins. For example, at
December 31, 1997 the exchange rate for Japanese Yen was approximately 130
Yen/$. In the period between December 31, 1997 and November 3, 1998 the Yen/$
exchange rate has fluctuated between approximately 115 Yen/$ and 147 Yen/$. The
Company may from time to time enter into both economic and speculative foreign
currency contracts in an effort to reduce the overall risk of currency
fluctuations to the Company's business. However, there can be no assurance that
these foreign currency hedging activities will not materially adversely affect
the Company's financial condition and results of operations.
Given the lengthy sales cycle and the significant investment required to
integrate a disk sputtering system into the manufacturing process, the Company
believes that once a thin-film disk manufacturer has selected a particular
supplier's disk sputtering equipment, the manufacturer generally relies upon
that equipment for the specific production line application and frequently will
continue to purchase its other disk sputtering equipment from the same supplier.
The Company expects to experience difficulty in selling to a particular customer
for a significant period of time if that customer selects a competitor's disk
sputtering equipment. Accordingly, competition for customers in the disk
sputtering equipment industry is particularly intense, and suppliers of disk
sputtering equipment may offer pricing concessions and incentives to attract
customers, which could adversely affect the Company's business, financial
condition, gross margins and results of operations. Because of these competitive
factors, there can be no assurance that the Company will be able to compete
successfully in the future.
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Customer Concentration
Historically, a significant portion of the Company's revenues in any
particular period have been attributable to sales to a limited number of
customers. For example, Matsubo, HMT Technology and Trace Storage Technology
accounted for 37%, 17% and 15%, respectively of the Company's total net revenues
in 1997, and Matsubo, Seagate and HMT Technology accounted for 32%, 32% and 13%,
respectively, of the Company's total net revenues in 1996. Seagate, HMT
Technology, and Matsubo accounted for 40%, 20% and 17%, respectively, of the
Company's total net revenues in 1995. The Company's largest customers change
from period to period as large thin-film disk fabrication facilities are
completed and new projects are initiated. The Company expects that sales of its
products to relatively few customers will continue to account for a high
percentage of its net revenues in the foreseeable future. For example, 68% of
the Company's backlog at December 31, 1997 was represented by two customers for
disk sputtering systems, with each representing 10% or more of the Company's
backlog at December 31, 1997. None of the Company's customers has entered into a
long-term agreement requiring it to purchase the Company's products. As
purchases related to a particular new or expanded fabrication facility are
completed, sales to that customer may decrease sharply or cease altogether. If
completed contracts are not replaced on a timely basis by new orders from the
same or other customers, the Company's net revenues could be adversely affected.
The loss of a significant customer, any reduction in orders from any significant
customer or the cancellation of a significant order from a customer, including
reductions or cancellations due to customer departures from recent buying
patterns, financial difficulties of a customer or market, economic or
competitive conditions in the disk drive industry, could materially adversely
affect the Company's business, financial condition and results of operations.
Limited Number of Opportunities
The Company's business depends upon capital expenditures by manufacturers
of thin-film disks, of which there are a limited number worldwide. According to
a April 1997 report by TrendFocus, an independent market research firm, as of
the end of 1996 there were 231 installed disk sputtering lines (sputtering
systems and related equipment such as plating, polishing, texturing, lubrication
and test equipment as well as related handling equipment) worldwide and only 15
companies in the world with five or more installed disk sputtering lines.
Therefore, winning or losing an order from any particular customer could
significantly affect the Company's operating results. In addition, the Company's
opportunities to sell its systems are further limited by the fact that some of
the manufacturers of thin-film disks have adopted an in-line approach as opposed
to the Company's static approach to thin-film disk manufacturing. These
manufacturers have invested significant amounts of capital in their in-line
systems, and there may be significant resistance to change to a static approach
in the future. The construction of new thin-film disk fabrication facilities
involves extremely large capital expenditures, resulting in few thin-film disk
fabrication facilities being constructed worldwide at any particular time. A
substantial investment is also required by disk manufacturers to install and
integrate additional thin-film disk manufacturing equipment in connection with
upgrading or expanding their existing fabrication facilities. These costs are
far in excess of the cost of purchasing the Company's system. The magnitude of
such capital expenditures has caused certain thin-film disk manufacturers to
forego purchasing significant additional thin-film disk manufacturing equipment.
Consequently, only a limited number of opportunities for the Company to sell its
systems may exist at any given time.
On October 11, 1998 one of the Company's customers, StorMedia, filed for
Chapter 11 bankruptcy protection. The Company expects to charge approximately
$97,000 of accounts receivable balances with StorMedia to its bad debt reserves
during the three-month period ended December 31, 1998. Representatives of
Stormedia have informed the Company that StorMedia intends to cease operations
and liquidate its assets. This will result in two MDP-250A disk sputtering
systems, four MDP-250B disk sputtering systems, twenty-three disk lubrication
systems and one contact start stop tester, all manufactured by the Company,
becoming available for resale by StorMedia. The availability of this equipment
for resale, in competition with sales by the Company, could materially adversely
affect the Company's business, financial condition and results of operations.
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Rapid Technological Change; New Products
The disk drive industry in general, and the thin-film disk manufacturing
industry in particular, is characterized by rapid technological change and
evolving industry standards. The Company maintains an active development program
to make sputter system improvements, to add additional capabilities that will
improve disk performance, increase machine throughput, permit optimum
utilization of alternative substrates, lower cost of ownership and respond to
future market requirements. The Company's ability to remain competitive has
required and will continue to require substantial investments in research and
development to advance its technologies. The failure to develop, manufacture and
market new systems, or to enhance existing systems, would have a material
adverse effect on the Company's business, financial condition and results of
operations. In the past, the Company has experienced delays from time to time in
the introduction of, and certain technical difficulties with, certain of its
systems and enhancements. In addition, the Company's competitors can be expected
to continue to develop and introduce new and enhanced products, any of which
could cause a decline in market demand for the Company's systems or a reduction
in the Company's margins as a result of intensified price competition.
Changes in the manufacturing processes for thin-film disks could also have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company anticipates continued changes in the
requirements of the disk drive industry and thin-film disk manufacturing
technologies. There can be no assurance that the Company will be able to
develop, manufacture and sell systems that respond adequately to such changes.
In addition, the data storage industry is subject to constantly evolving
technological standards. There can be no assurance that future technological
innovations will not reduce demand for thin-film disks. The Company's business,
financial condition and results of operations could be materially adversely
affected by any trend toward technology that would replace thin-film disks as a
storage medium.
The Company's success in developing and selling enhanced disk sputtering
systems and other new products depends upon a variety of factors, including
accurate prediction of future customer requirements, technology advances, cost
of ownership, introduction of new products on schedule, cost-effective
manufacturing and product performance in the field. The Company's new product
decisions and development commitments must anticipate the requirements for the
continuously evolving disk drive industry approximately two or more years in
advance of sales. Any failure to accurately predict customer requirements and to
develop new generations of products to meet those requirements would have a
sustained material adverse effect on the Company's business, financial condition
and results of operations. New product transitions could adversely affect sales
of existing systems, and product introductions could contribute to quarterly
fluctuations in operating results as orders for new products commence and orders
for existing products decline. There can be no assurance that the Company will
be successful in selecting, developing, manufacturing and marketing new products
or enhancements of existing products.
In September 1998 the Company announced that it was developing a new disk
sputtering system, the MDP-250K. The MDP-250K disk sputtering system is derived
from its predecessor, the MDP-250B. Maximum throughput is targeted to be over
1100 disks per hour compared to 550 disks per hour for the MDP-250B. Vacuum
levels and transport time have been improved, which should lead to reduced
contamination and improved magnetic performance. Leading edge deposition
techniques, such as ion beam and RF magnetron deposition will be fully
integrated. Windows NT based software, a graphical user interface and modern
factory host communications are incorporated. The MDP-250K is expected to be
available during the first half of 1999. Although the Company believes its
current inventory reserves are adequate to cover the transition to the MDP-250K,
any reductions in existing and/or forecasted orders for the MDP-250B could cause
additional MDP-250B parts to become obsolete, which could materially adversely
affect the Company's financial results.
Flat Panel Display Manufacturing Equipment Risks
In 1997, the Company spent approximately $4.9 million on various programs
to fund the development of equipment for use in the FPD industry, of which
approximately 54% was paid for by the Company's
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development partners. In exchange for certain development funding, the Company
has granted to one of its development partners the exclusive rights to
manufacture and market the Company's FPD sputtering systems in Japan. As of
September 26, 1998 all of the approximately $7.9 million advanced by the
Company's development partner had been applied to qualifying costs. The Company
has limited experience in the development, manufacture, sale and marketing of
FPD manufacturing equipment, having sold only three rapid thermal processing
("RTP") systems to date and two of its FPD sputtering systems. Although the
Company delivered and the customer accepted a larger version of its FPD
sputtering machine during 1998, there can be no assurance that the market for
FPD manufacturing equipment targeted by the Company will develop as quickly or
to the degree which the Company currently anticipates, or that the Company's
proposed FPD manufacturing equipment will achieve market acceptance. There can
be no assurance the Company will receive additional customer sponsored research
and development funding in the future. The failure to receive additional
customer-sponsored research and development funds could result in the Company
internally funding the development of such FPD manufacturing equipment, and the
costs of such research and development may have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the Company will continue to fund research and development in
the FPD area.
Risks Associated with International Sales and Operations
Foreign sales accounted for 64%, 41% and 20% of revenues in 1997, 1996 and
1995, respectively. Substantially all of the Company's Disk Equipment foreign
sales are to companies in the Far East. The Company anticipates that sales to
customers in the Far East will continue to be a significant portion of its
revenues in the foreseeable future. In order to effectively service customers
located in Southeast Asia, the Company has established sales and service
operations in Singapore, Taiwan and Malaysia and a joint venture in Japan. Sales
and operating activities outside of the United States are subject to certain
inherent risks, including fluctuations in the value of the United States dollar
relative to foreign currencies, tariffs, quotas, taxes and other market
barriers, political and economic instability, restrictions on the export or
import of technology, potentially limited intellectual property protection,
difficulties in staffing and managing international operations and potentially
adverse tax consequences. The Company's products have been sold to companies
headquartered in the United States, Japan, Taiwan and Korea and have been
installed in factories in the United States, Japan, Singapore, Malaysia, Korea
and Taiwan. All of the Far Eastern countries with which the Company does
business have banking systems and foreign currency exposures that have
experienced serious troubles recently and therefore subject the Company's
customers to substantial business risks. There can be no assurance that any of
these factors will not have a material adverse effect on the Company's business,
financial condition or results of operations. In particular, although the
Company's international sales have been denominated in United States dollars,
such sales and expenses may not be denominated in dollars in the future, and
currency exchange fluctuations in countries where the Company does business
could materially adversely affect the Company's business, financial condition
and results of operations.
Dependence on Key Employees
The Company's operating results will depend significantly upon the
continued contributions of its officers and key management, engineering,
marketing, customer support and sales personnel, many of whom would be difficult
to replace. The Company does not have an employment agreement with any of its
employees or maintain key person life insurance with respect to any employee.
The loss of any key employee could have a material adverse effect on the
Company's business, financial condition and results of operations. Employees of
the Company are currently required to enter into a confidentiality agreement as
a condition of their employment. However, these agreements do not expressly
prohibit the employees from competing with the Company after leaving its employ.
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Ability to Attract Qualified Personnel
The Company's operating results depend in significant part upon its ability
to retain and attract qualified management, engineering, marketing, customer
support and sales personnel. Competition for such personnel is intense and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel. The failure to attract and retain such personnel could
make it difficult to undertake or could significantly delay the Company's
research and development efforts and the expansion of its manufacturing
capabilities or other activities, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Leverage
In connection with the sale of the Convertible Notes, the Company incurred
a substantial increase in the Company's ratio of long-term debt to total
capitalization (shareholders' equity plus long-term debt). The ratios at
September 26, 1998 and December 31, 1997 were approximately 57.1% and 58.4%,
respectively. As a result of this indebtedness, the Company incurred substantial
principal and interest obligations. The degree to which the Company is leveraged
could have a material adverse effect on the Company's ability to obtain
additional financing for working capital, acquisitions or other purposes and
could make it more vulnerable to industry downturns and competitive pressures.
The Company's ability to meet its debt service obligations will be dependent on
the Company's future performance, which will be subject to financial, business
and other factors affecting the operations of the Company, many of which are
beyond its control.
Manufacturing Risks
The Company's systems have a large number of components and are highly
complex. The Company may experience delays and technical and manufacturing
difficulties in future introductions or volume production of new systems or
enhancements. In addition, some of the systems built by the Company must be
customized to meet individual customer site or operating requirements. The
Company may be unable to complete the development or meet the technical
specifications of its new systems or enhancements or to manufacture and ship
these systems or enhancements in a timely manner. Such an occurrence would
materially adversely affect the Company's business, financial condition and
results of operations as well as its relationships with customers. In addition,
the Company may incur substantial unanticipated costs early in a product's life
cycle, such as increased cost of materials due to expediting charges, other
purchasing inefficiencies and greater than expected installation and support
costs which cannot be passed on to the customer. Any of such events could
materially adversely affect the Company's business, financial condition and
results of operations.
In certain instances, the Company is dependent upon a sole supplier or a
limited number of suppliers, or has qualified only a single or limited number of
suppliers, for certain complex components or sub-assemblies utilized in its
products. The Company has a key supplier program in which it appoints certain
key vendors as sole suppliers for certain parts with the goal of improving
response time and reducing costs. In addition, the Company makes extensive use
of suppliers serving the semiconductor equipment business and such suppliers may
choose to give priority to their semiconductor equipment customers that are much
larger than the Company. Any prolonged inability to obtain adequate deliveries
could require the Company to pay more for inventory, parts and other supplies,
seek alternative sources of supply, delay its ability to ship its products and
damage relationships with current and prospective customers. Any such delay or
damage could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company conducts substantially all of its manufacturing activities at
its leased facilities in Santa Clara, Hayward and Los Gatos, California. The
Company's Santa Clara, Hayward and Los Gatos facilities are located in a
seismically active area. A major catastrophe (such as an earthquake or other
natural disaster) could result in a prolonged interruption of the Company's
business.
Acquisitions
The Company's business strategy includes acquiring related businesses,
products or technologies. The Company completed one acquisition during 1997 and
three acquisitions during 1996 and expects that it may
20
<PAGE> 21
pursue additional acquisitions in the future. Any future acquisition may result
in potentially dilutive issuance of equity securities, the write-off of
in-process research and development and the assumption of debt and contingent
liabilities, any of which could materially adversely affect the Company's
business, financial condition and results of operations. Additionally, as a
result of the Company's ongoing repurchase of its stock in the open market, the
Company may not be able to use the "pooling of interests" method of accounting
in some acquisitions, and the Company may therefore be required to amortize any
intangible assets acquired in connection with any acquisition.
The Company incurred a charge to operations of $0.3 million in the fourth
quarter of 1997 and $5.8 million in the second quarter of 1996 to reflect the
purchase of in-process research and development related to the acquisitions
completed in those quarters. In addition, the Company is amortizing intangible
assets of approximately $9.0 million gross, and $3.9 million net at September
26, 1998, relating to the four acquisitions. The amortization period for such
costs is over the useful lives of the assets, which range from two years to
seven years. Additionally, unanticipated expenses may be incurred relating to
the integration of technologies, research and development and administrative
functions. Any acquisition will involve numerous risks, including difficulties
in the assimilation of the acquired company's employees, operations and
products, uncertainties associated with operating in new markets and working
with new customers, and the potential loss of the acquired company's key
employees.
Patents and Other Intellectual Property
The Company currently has 25 patents issued in the United States and 3
patents issued in foreign countries, and has pending patent applications in the
United States and foreign countries. Of the 25 U.S. patents, 8 relate to
sputtering, 10 relate to RTP, 1 relates to lubrication systems and 6 relate to
photonics. Two foreign patent relates to sputtering and one relates to
photonics. In addition, the Company has the right to utilize certain patents
under licensing arrangements with Litton Industries, Varian Associates, Stanford
University, Lawrence Livermore Laboratories and Alum Rock Technology.
There can be no assurance that any of the Company's patent applications
will be allowed or that any of the allowed applications will be issued as
patents. There can be no assurance that any patent owned by the Company will not
be invalidated, deemed unenforceable, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages to the Company or
that any of the Company's pending or future patent applications will be issued
with claims of the scope sought by the Company, if at all. Furthermore, there
can be no assurance that others will not develop similar products, duplicate the
Company's products or design around the patents owned by the Company. In
addition, there can be no assurance that foreign patent rights, intellectual
property laws or the Company's agreements will protect the Company's
intellectual property rights. Failure to protect the Company's intellectual
property rights could have a material adverse effect upon the Company's
business, financial condition and results of operations.
There has been substantial litigation in the technology industry regarding
intellectual property rights. The Company has from time to time received claims
that it is infringing third parties' intellectual property rights. In August
1993, Rockwell International Corporation ("Rockwell") sued the Federal
government alleging infringement of certain patent rights with respect to the
contracts the Federal government has had with a number of companies, including
Intevac. The Federal government has notified Intevac that it may be liable in
connection with contracts for certain products from the Company's discontinued
night vision business. Although the Company believes it will have no material
liability under these contracts, there can be no assurance that the resolution
of the claims by Rockwell with the Federal government will not have a material
adverse effect on the Company's business, operating results and financial
condition. In the first quarter of 1997, Rockwell's patent in suit was held
invalid. Rockwell appealed that decision, and in the second quarter of 1998, the
appellate court reversed the decision of the lower court and referred the case
again to the lower court to determine the validity of the patent.
There can be no assurance that other third parties will not in the future
claim infringement by the Company with respect to current or future patents,
trademarks, or other proprietary rights relating to the Company's disk
sputtering systems, flat panel display manufacturing equipment or other
products. Any
21
<PAGE> 22
present or future claims, with or without merit, could be time-consuming, result
in costly litigation, cause product shipment delays or require the Company to
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. Any of the foregoing could have a material adverse effect
upon the Company's business, operating results and financial condition.
In addition, the Company believes that one of its competitors may be
infringing the Company's patent rights in connection with products currently
being offered by this competitor. Although the Company has not undertaken formal
legal proceedings, the Company has informed this competitor that the Company
believes its patent rights are being infringed and that the Company may
undertake litigation to protect its patent rights if necessary. If undertaken,
such litigation could be costly, time-consuming and result in legal claims being
made against the Company, which could have a material adverse effect on the
Company's business, operating results and financial condition. In addition,
there can be no assurance that the Company would ultimately prevail in any such
litigation.
Environmental Regulations
The Company is subject to a variety of governmental regulations relating to
the use, storage, discharge, handling, emission, generation, manufacture,
treatment and disposal of toxic or other hazardous substances, chemicals,
materials or waste. Any failure to comply with current or future regulations
could result in substantial civil penalties or criminal fines being imposed on
the Company, or its officers, directors or employees, suspension of production,
alteration of its manufacturing process or cessation of operations. Such
regulations could require the Company to acquire expensive remediation or
abatement equipment or to incur substantial expenses to comply with
environmental regulations. Any failure by the Company to properly manage the
use, disposal or storage of, or adequately restrict the release of, hazardous or
toxic substances could subject the Company to significant liabilities.
22
<PAGE> 23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
None.
23
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEVAC, INC.
<TABLE>
<S> <C>
Date: November 10, 1998 By: /s/ NORMAN H. POND
--------------------------------------------------------
Norman H. Pond
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 10, 1998 By: /s/ CHARLES B. EDDY III
--------------------------------------------------------
Charles B. Eddy III
Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)
</TABLE>
24
<PAGE> 25
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AT SEPTEMBER 26, 1998 (UNAUDITED) AND THE
CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) FOR THE NINE MONTHS ENDED
SEPTEMBER 26, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-26-1998
<CASH> 745
<SECURITIES> 61,175
<RECEIVABLES> 11,503
<ALLOWANCES> 1,775
<INVENTORY> 23,570
<CURRENT-ASSETS> 102,465
<PP&E> 25,085
<DEPRECIATION> 10,470
<TOTAL-ASSETS> 125,430
<CURRENT-LIABILITIES> 21,335
<BONDS> 59,460
0
0
<COMMON> 15,454
<OTHER-SE> 29,181
<TOTAL-LIABILITY-AND-EQUITY> 125,430
<SALES> 84,693
<TOTAL-REVENUES> 84,693
<CGS> 61,025
<TOTAL-COSTS> 61,025
<OTHER-EXPENSES> 18,570
<LOSS-PROVISION> 291
<INTEREST-EXPENSE> 3,100
<INCOME-PRETAX> 4,496
<INCOME-TAX> 1,485
<INCOME-CONTINUING> 3,011
<DISCONTINUED> 1,005
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,016
<EPS-PRIMARY> 0.33
<EPS-DILUTED> 0.32
</TABLE>
