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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-27234
PHOTON DYNAMICS, INC.
(Exact name of small business issuer as specified in its charter)
CALIFORNIA 94-3007502
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1504 MCCARTHY BOULEVARD
MILPITAS, CA 95035
(Address of principal executive offices)
(408) 433 3922
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the last 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
--- ---
As of August 9, 1996 6,808,165 shares of the Issuer's Common Stock, no par
value, were outstanding.
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TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - June 30, 1996
and September 30, 1995....................................... 2
Condensed Consolidated Statements of Operations - three
and nine months ended June 30, 1996 and 1995................. 3
Condensed Consolidated Statements of Cash Flows - nine
months ended June 30, 1996 and 1995.......................... 4
Notes to Condensed Consolidated Financial Statements.......... 5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 6
OTHER Risk Factors.................................................. 8
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings............................................. 14
ITEM 2. Changes in Securities......................................... 14
ITEM 3. Defaults Upon Senior Securities............................... 14
ITEM 4. Submission of Matters to a Vote of Security Holders........... 14
ITEM 5. Other Information............................................. 14
ITEM 6. Exhibits and Reports on Form 8-K.............................. 14
Signatures.................................................... 15
1
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Photon Dynamics, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
June 30, September
1996 30, 1995
-------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................... $ 6,253 $ 298
Short term investments........................ 5,007 -
Accounts receivable, net of allowance
for doubtful accounts of $354 ($224 at
September 30, 1995).......................... 10,501 5,280
Inventories................................... 2,746 2,986
Prepaid expenses and other current
assets....................................... 331 219
-------- --------
Total current assets............................ 24,838 8,783
Property, equipment, and leasehold
improvements, net.............................. 2,021 1,418
Other assets.................................... 203 318
-------- --------
Total assets.................................... $ 27,062 $ 10,519
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................. $ 2,111 $ 1,684
Accrued expenses and other liabilities........ 3,083 2,368
Customer deposits and deferred revenue........ 216 1,251
Line of credit and other short-term debt...... 365 2,407
Current portion of long-term debt............. 23 364
-------- --------
Total current liabilities....................... 5,798 8,074
Noncurrent portion of long-term debt............ 320 588
Commitments and contingencies
Shareholders' equity:
Preferred stock............................... - 17,935
Common stock.................................. 37,935 3,008
Accumulated deficit........................... (16,916) (19,055)
Foreign currency translation adjustment....... 36 104
Notes receivable from shareholders............ (107) (135)
Unrealized loss on marketable securities...... (4) -
-------- --------
Total shareholders' equity...................... 20,944 1,857
-------- --------
Total liabilities and shareholders' equity...... $ 27,062 $ 10,519
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
Note: The balance sheet at September 30, 1995 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
2
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Photon Dynamics, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ----------------------
1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenue:
Product sales......................................... $7,609 $3,811 $18,881 $ 8,937
Development contracts................................. 100 1,046 1,341 3,331
------ ------ ------- -------
7,709 4,857 20,222 12,268
Cost of revenue:
Product sales......................................... 4,064 1,749 9,883 4,577
Development contracts................................. 46 1,330 962 3,268
------ ------ ------- -------
4,110 3,079 10,845 7,845
------ ------ ------- -------
Gross margin............................................ 3,599 1,778 9,377 4,423
Operating expenses:
Research and development.............................. 1,027 534 2,905 1,147
Selling, general, and administrative.................. 1,809 1,104 4,452 3,019
------ ------ ------- -------
Total operating expenses................................ 2,836 1,638 7,357 4,166
------ ------ ------- -------
Operating income........................................ 763 140 2,020 257
Interest income......................................... 179 9 484 14
Interest expense........................................ (47) (28) (215) (84)
Foreign exchange loss................................... (26) (11) (29) (20)
------ ------ ------- -------
Income before provision for income taxes................ 869 110 2,260 167
Provision for income taxes.............................. 44 - 121 -
------ ------ ------- -------
Net income.............................................. $ 825 $ 110 $ 2,139 $ 167
====== ====== ======= =======
Net income per share:................................... $ 0.11 $ 0.02 $ 0.29 $ 0.04
====== ====== ======= =======
Shares used in computing net income per share........... 7,717 5,356 7,315 5,400
====== ====== ======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
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Photon Dynamics, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED JUNE 30,
1996 1995
------- -------
OPERATING ACTIVITIES
<S> <C> <C>
Net income...................................... $ 2,139 $ 167
Adjustments to reconcile net income to
net cash used in operating activities:
Depreciation and amortization................. 506 384
Changes in operating assets and liabilities:
Accounts receivable......................... (5,221) (831)
Inventories................................. 240 (1,705)
Prepaid expenses and other current assets... (112) (201)
Other assets................................ 58 (78)
Accounts payable............................ 412 (177)
Accrued expenses and other liabilities...... 715 (102)
Customer deposits and deferred revenue...... (1,035) 491
------- -------
Net cash used in operating activities........... (2,298) (2,052)
INVESTING ACTIVITIES
Acquisition of property and equipment........... (1,109) (624)
Acquisition of short term investments........... (9,547) -
Disposal of short term investments.............. 4,540 -
------- -------
Net cash used in investing activities.......... (6,116) (624)
FINANCING ACTIVITIES
Borrowings under lines of credit................ - 300
Proceeds from issuance of note payable.......... - 1,000
Proceeds from issuance of short term debt....... - 237
Repayment of lines of credit.................... (2,325) -
Principal payments under capital leases......... (22) (43)
Proceeds from issuance of common stock, net
of issuance costs.............................. 17,020 66
Payment of notes payable........................ (304) (59)
------- -------
Net cash provided by financing activities....... 14,369 1,501
------- -------
Net increase (decrease) in cash and cash
equivalents.................................... 5,955 (1,175)
Cash and cash equivalents at beginning of
period......................................... 298 1,236
------- -------
Cash and cash equivalents at end of period...... $ 6,253 $ 61
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
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PHOTON DYNAMICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-QSB and
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine months ended June 30,
1996 are not necessarily indicative of the results that may be expected for the
fiscal year ended September 30, 1996. For further information, refer to the
audited consolidated financial statements and footnotes thereto included in the
Company's Registration Statement on Form SB-2 for the fiscal year ended
September 30, 1995.
Short Term Investments
Effective October 1, 1994, the Company adopted Statement of Financial
Accounting Standards No.115 "Accounting for Investments in Certain Debt and
Equity Securities" (FAS 115), which requires investment securities to be
classified as either held to maturity, trading or available for sale. The
Company has classified its investment portfolio as available for sale. Under
FAS 115, investments classified as available for sale are required to be
recorded at fair value and any temporary difference between an investment's cost
and its fair value is recorded as a separate component of stockholders' equity.
At June 30, 1996, short term investments consisted of commercial paper and
fixed rate notes classified as available for sale. The cost of these securities
approximated the fair value and the amount of unrealized gains or loss was not
significant. These securities mature through May 1997.
2. INVENTORIES
Inventories are stated at the lower of cost or market, with cost being
determined on a first-in, first-out basis.
<TABLE>
<CAPTION>
June 30, September 30,
(In thousands) 1996 1995
-------- -------------
<S> <C> <C>
Raw Materials............ $2,440 $1,322
Work-in-process.......... 287 461
Finished goods........... 19 1,203
------ ------
$2,746 $2,986
====== ======
</TABLE>
3. INITIAL PUBLIC OFFERING
In November 1995, the Company completed an initial public offering
("IPO") of 2,932,500 shares of Common Stock, of which 2,127,661 shares were
issued and sold by the Company and 804,839 shares were sold by stockholders.
The IPO raised approximately $17.8 million before deducting offering expenses.
5
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PHOTON DYNAMICS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the year ended
September 30, 1995.
Results of Operations
Total revenues for the third quarter of fiscal 1996 increased 59% to
$7,709,000 from the third quarter of fiscal 1995 level of $4,857,000. Revenues
for the first nine months of fiscal 1996 were $20,222,000, an increase of 65%
from $12,268,000 in the comparable period of 1995. The increase in product sales
of 100% to $7,609,00 in the third quarter of fiscal 1996 ($3,811,000 in the
third quarter of fiscal 1995) was primarily attributable to the introduction of
new products during the later part of fiscal 1995, as well as enhancements to
existing products which shipped for the first time in the third quarter of
fiscal 1996.
Revenues from development contracts accounted for 1% and 7% of total
revenue for the three and nine month periods ended June 30, 1996, respectively,
compared to 22% and 27% for the same periods of the prior fiscal year. This
decrease in percentage terms is the result of the completion of two major
development contracts. The Company expects revenue under development contracts
to decline on an absolute dollar basis in fiscal 1996.
Gross margins as a percent of revenue were 47% and 46%, for the three and
nine month periods ended June 30, 1996, respectively, compared to 37% and 36%
for the same periods of the prior fiscal year. This increase in gross margins
was due to the relative decrease in development contract revenue, with
associated lower gross margins, as a percentage of total revenue. The gross
margin for product sales decreased from 54% in the third quarter of fiscal 1995
to 47% in the third quarter of fiscal 1996. This decrease on an annual basis is
due to the high product gross margins achieved in the third quarter of fiscal
1995, as a result of favorable foreign exchange rates on Yen denominated sales
as well as a favorable product mix. Overall product gross margins will fluctuate
on a quarterly basis as the Company's product mix fluctuates.
Research and Development. The Company increased its research and
development expenses on an absolute dollar basis to $1,027,000 in the third
quarter of fiscal 1996, or 13% of revenue, from $534,000 in the third quarter of
fiscal 1995, or 11% of revenue. In addition to these research and development
expenses incurred for product development, the Company spent $46,000 in the
third quarter of fiscal 1996, and $1,330,000 in the third quarter of fiscal 1995
in performance of its obligations under third party development contracts. The
combination of research and development expenses and costs incurred on
development contracts was $1,073,000 or 14% of revenue in the third quarter of
fiscal 1996 and $1,864,000 or 38% of revenue, in the third quarter of fiscal
1995 and $3,867,000 or 19% of revenue and $4,415,000 or 36% of revenue for the
nine months periods ended June 30, 1996 and 1995. The decrease on a percentage
of revenue and absolute dollar basis reflects the unusually high level of
material, engineering personnel and payroll costs related to development
contracts in the third quarter of 1995. The Company does not expect that these
combined product development expenses will decline in absolute dollar amounts in
the remainder of fiscal 1996.
Selling, General and Administrative. Selling, general and administrative
expenses in the third quarter of fiscal 1996 increased to $1,809,000, from the
third quarter of fiscal 1995 level of $1,104,000, 23% of revenue in both
periods. Total selling, general and administrative expenses for the first nine
months of fiscal 1996 were $4,452,000, an increase from $3,019,000 in the
comparable period of 1995, 22% and 25% of revenue respectively. The decrease on
a percentage basis was attributable to cost control measures, primarily
reductions in staffing levels. Selling, general and administrative expenses may
increase in absolute dollar amounts in fiscal 1996 and in future periods
depending on factors including, the level of the Company's revenue and other
operations. Selling expenses
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may also fluctuate based on the Company's product and territory sales mix, which
have different sales channels and associated cost structures.
Interest income/expense. Interest income in the third quarter of fiscal
1996 increased to $179,000 from the third quarter of fiscal 1995 level of
$9,000. Total interest income for the first nine months of fiscal 1996 increased
to $484,000 from $14,000 in the comparable period of 1995 as a result of
interest received on the proceeds from the Company's Initial Public Offering
("IPO") in November 1995. Interest expense was $215,000 and $84,000 for the nine
months ended June 30, 1996 and 1995 because of increases in borrowings under the
Company's revolving bank lines of credit which were repaid in the first quarter
of fiscal 1996.
Provision for Income Tax. The Company's effective tax rate for the three
and nine months ended June 30, 1996 was 5%. This is lower than the statutory
rate of 34% due to the utilization of loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its growth primarily from a combination of amounts
raised in equity financing, loans, lines of credit from a bank and cash flows
from operations. As of June 30, 1996, the Company had working capital of
$19,040,000 of which $6,253,000 was cash or cash equivalents. The Company also
has $3 million in line of credit financing from Silicon Valley Bank, which
expired in July 1996, and under which there were no amounts outstanding at June
30, 1996. Borrowings under these lines of credit bear interest at one or one
and one-half percentage points above the prime rate. These lines of credit are
secured by substantially all of the Company's assets and contain certain
financial and other covenants. In addition, the Company has a $1 million, 3 year
term loan of which $675,000 was outstanding as of June 30, 1996. In November
1995, the Company completed its IPO of 2,932,500 shares of Common Stock, of
which 2,127,661 shares were issued and sold by the Company and 804,839 shares
were sold by stockholders. The IPO raised approximately $17.8 million before
deducting offering expenses.
For operating activities, net cash used by operations was $2,298,000 in the
first nine months of fiscal compared to $2,052,000 in the comparable period in
fiscal 1995. This decrease in cash flow reflects an increased level of
profits, and tighter inventory control offset by an increase in accounts
receivable balances. The factors affecting the accounts receivable balance
include, the Company's credit terms to customers which typically have a small
portion of the payment extended for a period of months after shipment resulting
in a larger accounts receivable balance, especially when combined with the
growth in product sales in the third quarter of fiscal 1996 compared to the
third quarter of fiscal 1995, as well as the near quarter end timing of such
product shipments.
Capital expenditures during the first nine months of fiscal 1996 were
$1,109,000 compared to $624,000 in the first nine months of fiscal 1995. The
increase is the result of the capitalization of engineering and demonstration
equipment related to the Company's latest products.
7
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RISK FACTORS
The Company's future results may be affected by inherent uncertainties
that exist in the test, inspection and repair equipment business for the flat
panel industry. Such uncertainties include, but are not limited to, the
following
FACTORS AFFECTING EARNINGS AND STOCK PRICE
The statements contained in this report on Form 10-QSB that are not purely
historical are forward looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. All forward looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward looking statements. It is important to note that the Company's actual
results could differ materially from those in such forward looking statements.
You should consult the risk factors listed from time to time in the Company's
reports on Form 10-QSB, 10-KSB, and annual reports to shareholders. Among the
factors that could cause actual results to differ materially are the following
risk factors:
VARIABILITY OF QUARTERLY RESULTS OF OPERATIONS; LIMITED HISTORY OF PROFITABILITY
The Company has experienced and expects to continue to experience
significant fluctuations in its quarterly results of operations. The Company
derives substantially all of its revenue from the sale of a relatively small
number of systems, which typically range in price from $400,000 to $1,500,000.
As a result, the timing of the sale of a single system could have a significant
impact on the Company's quarterly revenue and results of operations. The failure
to receive anticipated orders or delays in shipments in a particular quarter,
due, for example, to unanticipated shipment reschedulings, cancellations by
customers or unexpected manufacturing difficulties, may cause revenue for that
quarter to fall significantly below the Company's expectations, which would have
a material adverse effect on the Company's results of operations for such
quarter. The Company's backlog at the beginning of each quarter is not
necessarily indicative of actual sales for any succeeding period. All orders are
subject to delay or cancellation with limited or no penalty. The Company's sales
will often reflect orders shipped in the same quarter that they are received.
Other factors which may have an influence on the Company's results of operations
in a particular quarter include the volume, mix and timing of the receipt of
orders from major customers, competitive pricing pressures, costs of components
and subsystems, the Company's ability to design, manufacture and introduce new
products on a cost effective and timely basis, the delay between incurrence of
expenses to further develop marketing and service capabilities and realization
of benefits from such improved capabilities, fluctuations in foreign exchange
rates, the timing of recognition of revenue under development contracts, the
introduction and announcement of new products by the Company's competitors and
changing conditions in the FPD ( "Flat Panel Display")market worldwide. In
particular, due to substantial differences in gross margin for the Company's
products, changes in the mix of products sold could result in substantial
fluctuations in the Company's gross margin. Accordingly, the Company's results
of operations are subject to significant variability from quarter to quarter.
The Company first achieved profitability in the quarter ended December 31, 1994.
Although it has been profitable each quarter since then, there can be no
assurance that the Company will be able to sustain profitability in the future.
DEPENDENCE ON RECENTLY INTRODUCED AND NEW PRODUCTS
The markets for the Company's products are characterized by rapidly
changing technologies, extensive research and new product introductions. The
Company believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop and manufacture new
products. As a result, the Company expects to continue to make a significant
investment in engineering, research and development. There can be no assurance
that the Company will be successful in the introduction, marketing and cost
effective manufacture of any of its new or recently introduced products or that
the Company will be able to develop and introduce new products
8
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or enhancements to its existing products and processes in a timely manner which
satisfy customer needs, achieve market acceptance or address technological
changes in the FPD industry. In order to develop new products successfully, the
Company is dependent upon close relationships with its customers and the
willingness of those customers to share information with the Company. The
failure to develop products and introduce them successfully and in a timely
manner could adversely affect the Company's competitive position and results of
operations. The Company's future results of operations are highly dependent on
the successful introduction, marketing and cost-effective manufacture of its
recently introduced In-Process Test Mass Production System (IPT-MPS), the first
two units of which the Company shipped in September 1995. The Company continues
to perform research and development work with respect to the IPT-MPS system to
attain additional throughput levels requested by the Company's customers and
other performance parameters sought by manufacturers of active matrix liquid
crystal displays ("AMLCDs") for their volume production environments. The
Company has experienced delays in implementing the software necessary to achieve
throughput rates. No assurance can be given that development efforts related to
other performance parameters will be successful. The Company believes that
future orders of IPT-MPS systems will be dependent on its ability to attain
requested throughput levels and other performance parameters. In addition to the
IPT-MPS system, the Company's IPT-E system, two of its Flat Panel Inspection
Systems (FIS), the FIS-250 system and FIS-300 system, and two repair systems the
ILW-305 and ILW-405 were introduced in the preceding twelve months. Sales of
these recently introduced products comprise a substantial portion of the
Company's revenue. The Company has experienced delays in obtaining final
acceptance and final payment on some of these new products. If such new or
recently introduced products have performance, reliability or quality problems
or shortcomings, then the Company may experience reduced orders, higher
manufacturing costs, continued delays in collecting accounts receivable and
additional warranty and service expenses which may have an adverse effect on the
Company's results of operations. In addition, future growth in sales of the
Company's products will depend upon the acceptance of the Company's IPT or FIS
technologies by a broader group of customers, including additional international
customers and FPD manufacturers who currently do not perform the type of FPD
test or inspection offered by the Company's products or utilize alternative
technologies for, or methods of, inspection, such as "open/short" testing and
human visual inspection. Because of the large capital commitment involved in the
construction and operation of an FPD manufacturing facility, the decision by an
FPD manufacturer to purchase the Company's IPT or FIS systems involves a
significant technological and financial commitment as compared to current
alternatives such as human inspection and open/short testers. While the Company
is actively promoting the acceptance of these technologies, there can be no
assurance that the Company will be successful in obtaining broader acceptance of
its IPT or FIS technologies. Failure to achieve broader acceptance would have an
adverse effect on the Company's results of operations.
DEPENDENCE ON PRINCIPAL CUSTOMERS
The FPD industry is extremely concentrated, with virtually all major FPD
manufacturers and many of the Company's principal customers located in Asia.
Although the composition of the Company's largest customers has changed from
year to year, direct sales to the Company's top four end user customers in each
of fiscal 1994 and 1995 accounted for approximately 79% and 71%, respectively,
of the Company's total revenue. Direct sales to the Company's top customer in
each of fiscal 1994 and 1995 accounted for approximately 25% of the Company's
total revenue. During these years, a substantial portion of the Company's total
revenue was contract revenue for development of the Company's IPT product
family, which revenue is expected to decline in future years. The Company
currently has no long-term purchase commitments with any of its customers and
sales are generally made pursuant to purchase orders. All orders are subject to
delay or cancellation with limited or no penalty. A reduction, delay, or
cancellation of orders from one or more of its significant customers, or the
loss of one or more of such customers, could have a material adverse effect on
the Company's results of operations.
DEPENDENCE ON SINGLE OR LIMITED SUPPLIERS
Certain of the components and subassemblies included in the Company's
systems are obtained from a single source or a limited group of suppliers. For
example, the Company has obtained all of the high speed image processing
systems, materials handling platforms and ultra-high resolution cameras used in
its products from single
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source suppliers, including Kodak Corporation and Anorad Corporation. The
Company has not entered into any formal agreements with such suppliers, other
than long term purchase orders and, in some cases, volume pricing agreements.
The partial or complete loss of such suppliers could increase the Company's
manufacturing costs or delay product shipments while the Company qualifies a new
supplier, could require redesigning the Company's products and could therefore
have an adverse effect on the Company's results of operations and damage
customer relationships. Further, a significant increase in the price of one or
more of the components supplied by such suppliers could adversely affect the
Company's results of operations.
RELATIONSHIP WITH IHI
The Company has granted certain exclusive manufacturing and sales rights
to Ishikawajima-Harima Heavy Industries Co., Ltd. ("IHI") with respect to its
IPT systems, including the IPT-MPS, for Japan, Korea, a number of other Asian
countries, Saudi Arabia, Australia, New Zealand, India and Sri Lanka. Under the
terms of this relationship the Company reserves the rights to manufacture
certain critical components and to sell the components to IHI for inclusion in
IPT systems to be sold by IHI in its territory. The agreements between IHI and
the Company further provide for the Company to assist IHI in its sales efforts
in these countries in exchange for a commission. This relationship continues on
an exclusive basis for the IHI territory until June 1997, and, if such
exclusivity is not renewed, IHI will have non-exclusive manufacturing and sales
rights in its territory in periods thereafter. In exchange for these rights, IHI
has provided and continues to provide significant funding for development of the
IPT systems, which funding substantially enhanced the Company's ability to
complete development of these systems in a timely fashion. To date, IHI has
allowed Photon to manufacture all IPT systems sold by IHI in the IHI territory,
and the Company expects that many, if not all, of the IPT systems that will be
sold in IHI's territory will be manufactured by the Company. At present, IHI and
Photon share sales responsibility for Photon manufactured IPT systems in Japan,
and IHI has agreed to allow Photon to sell directly all IPT systems outside
Japan through December 31, 1996. IHI performs all support and service for system
units in Japan, while Photon provides support and service in the balance of the
IHI territory. To the extent IHI determines in the future to exercise fully its
contractual rights to manufacture and sell these systems in the IHI territory,
such action would reduce revenue of the Company attributable to these IHI
manufactured IPT systems and may have a material adverse effect on the Company's
results of operations. Given the concentration of FPD manufacturers in the IHI
territory, the Company is highly dependent on IHI and the success of the
Company's relationship with IHI to market and sell the IPT systems, including
the IPT-MPS, in these critical markets. In the event IHI should determine to
reduce its internal budgets, staffing levels, research and development funding
or other allocations of its resources for the development, manufacture, sale and
support of IPT systems in its territory, such action by IHI could have a
material adverse effect on the Company's ability to compete in these markets and
on the Company's results of operations. While the Company believes that both it
and IHI have obtained significant mutual benefit from their continuing
relationship, no assurance can be given that the IHI relationship will continue
to provide such benefits to the Company or that the Company's results of
operations will not be adversely impacted in the future based on its dependency
on IHI for the manufacture, sales and support of IPT systems in Japan and other
important Asian markets in the IHI territory.
INTERNATIONAL OPERATIONS
Approximately 63% of the Company's total revenue for fiscal 1995 was
attributable to sales outside the U.S. The Company expects that international
sales will continue to represent a significant portion of its total sales. Sales
to customers outside the U.S. are subject to risks, including the imposition of
governmental controls, the need to comply with a wide variety of foreign and
U.S. export laws, political and economic instability, trade restrictions,
changes in tariffs and taxes, longer payment cycles typically associated with
international sales, and the greater difficulty of administering business
overseas as well as general economic conditions. Although substantially all of
the Company's direct international sales are denominated in U.S. dollars, both
direct sales by the Company and sales through IHI may be affected by changes in
demand resulting from fluctuations in interest and currency exchange rates. To
the extent the Company's sales are denominated in foreign currency, the
Company's revenue and results of operations may also be directly affected by
fluctuations in foreign currency exchange rates. Furthermore, although the
Company endeavors to meet technical standards established by foreign regulatory
bodies, there can be no
10
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assurance that the Company will be able to comply with changes in foreign
standards in the future. The inability of the Company to design products to
comply with foreign standards could have a material adverse effect on the
Company. In addition, the laws of certain foreign countries may not protect the
Company's intellectual property to the same extent as do the laws of the U.S.
DEPENDENCE ON JAPANESE MARKET
The future performance of the Company will be dependent, in part, upon its
ability to continue to compete successfully in the Japanese market, one of the
largest markets for FPD test, inspection and repair equipment. The Company's
ability to compete in this market in the future is dependent upon continuing
free trade between Japan and the U.S., the continuing ability of the Company to
develop products in a timely manner that meet the technical requirements of its
Japanese customers and the continuing ability of the Company to maintain
satisfactory relationships with leading companies in the Japanese FPD industry.
The Company believes that the Japanese companies with which it competes may have
a competitive advantage in Japan because of the preference of some Japanese
customers for Japanese equipment suppliers because such customers may have
longer standing or closer business relationships with such competitors. The
Company's sales to Japan and results of operations will also be affected by the
overall health of the Japanese economy, including the effects of currency
exchange rate fluctuations on the global competitiveness of Japanese FPD
manufacturers.
RAPID AND FUNDAMENTAL TECHNOLOGICAL CHANGE
The FPD industry is an evolving industry characterized by extensive
research and development which has and is expected to continue to lead to rapid
technological change. The development by others of new or improved products or
technologies may make the Company's current or proposed products obsolete or
less competitive. Although the Company devotes significant efforts and financial
resources to further develop and enhance its existing products, there can be no
assurance that advances in other or alternative technologies will not make the
Company's products obsolete or less competitive. Currently, the predominant
technology used in the FPD industry is liquid crystal display ("LCD")
technology. Although the Company has installed its products or has entered into
discussions with manufacturers utilizing virtually all of the alternative FPD
technologies which the Company believes are commercially viable FPD
technologies, its revenue is derived primarily from sales of products related to
a variant of LCD technology used in a substantial portion of all FPDs, AMLCD
technology. An industry shift away from AMLCD technology or the emergence of new
competing technologies could have a material adverse effect on the Company's
business and results of operations.
COMPETITION
The FPD equipment industry is highly competitive. The Company faces the
prospect of substantial future competition from established companies, some of
which are expected to be larger companies, or parts thereof, some of which are
expected to have greater financial, engineering and manufacturing resources than
the Company and some of which are expected to have larger sales and service
organizations and long-standing customer relationships with major FPD
manufacturers. In the event that the Company's agreements with IHI are not
extended in 1997, IHI may compete with the Company in selling the Company's IPT
systems in Japan, Korea and the rest of the IHI territory. The Company also
expects it may face additional competition from new entrants into the FPD
equipment industry and from competitors utilizing new technologies. The
Company's competitors can be expected to continue to improve the design and
performance of their products and to introduce new products with competitive
price/performance characteristics. In addition, the Company's customers may
choose to develop proprietary technology and FPD equipment which may obviate or
lessen their need to purchase the Company's products. The Company's customers
may also use multiple technologies and solutions, including competitors'
products, to provide the functionality of the Company's systems. Competitive
pressures may necessitate price reductions which could adversely affect the
Company's results of operations. Although the Company believes that it has
certain technological and other advantages over its competitors, realizing and
maintaining such advantages will require a continued high level of investment by
the Company in engineering, research and development, marketing and
11
<PAGE>
customer service and support. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to make the technological advances necessary to maintain
such competitive advantages.
FLAT PANEL DISPLAY INDUSTRY DOWNTURNS OR SLOWDOWNS
The Company's business depends in large part upon the capital equipment
expenditures of FPD manufacturers, which in turn depend on the current and
anticipated market demand for FPDs and products utilizing FPDs. For example, the
Company believes that historical shortages of supplies of semiconductor
components may have in the past temporarily limited the quantities of laptop
computers that were manufactured, which in turn may have reduced demand from
laptop computer manufacturers for certain FPDs. Should these conditions have
continued for an extended period, the resulting reduced long-term demand for
FPDs suitable for laptop computers could adversely affect the level of capital
expenditure by FPD manufacturers. Although to date the FPD industry has had a
relatively steady growth rate, the FPD industry may, like the semiconductor
industry, become highly cyclical and experience periodic downturns or slowdowns
in growth, which may have a material adverse effect on capital equipment
expenditures by FPD manufacturers and in turn adversely affect the Company's
results of operations. No assurance can be given that the Company's results of
operations would not be adversely affected if such downturns or slowdowns in the
FPD industry were to occur in the future. In addition, the need for continued
investment in engineering, research and development and marketing required to
penetrate targeted foreign markets and maintenance of extensive worldwide
customer service and support capabilities will limit the Company's ability to
reduce expenses during downturns or slowdowns in growth in the FPD industry.
PATENTS AND PROPRIETARY RIGHTS
The Company's future success and competitive position are dependent in
part upon its proprietary technology, and the Company relies on patent, trade
secret, trademark and copyright law to protect its intellectual property. There
can be no assurance that any patent owned or licensed by the Company will not be
invalidated, circumvented, challenged or licensed to others, 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
the scope of the claims sought by the Company, if at all. Furthermore, there can
be no assurance that others will not develop technologies that are similar or
superior to the Company's technology, duplicate the Company's technology or
design around the patents owned by the Company. In addition, effective copyright
and trade secret protection may be unavailable or limited in certain foreign
countries. There can be no assurance that the steps taken by the Company will
prevent misappropriation of its technology. In addition, litigation may be
necessary in the future to enforce the Company's patents and other intellectual
property rights, to protect the Company's trade secrets, to determine the
validity and scope of the proprietary rights of others or to defend against
claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's results of operations.
Competitors in both the U.S. and foreign countries, many of which have
substantially greater resources and have made substantial investments in
competing technologies, may have applied for or obtained, or may in the future
apply for and obtain, patents that will prevent, limit or interfere with the
Company's ability to manufacture and sell its products. The Company has not
conducted an independent review of patents issued to third parties. Although the
Company believes that its products do not infringe the patents or other
proprietary rights of third parties, there can be no assurance that other third
parties will not assert infringement claims against the Company or that such
claims will not be successful. Even successful defense of patent suits are both
costly and time-consuming. An adverse outcome in the defense of a patent suit
could subject the Company to significant liabilities to third parties, require
disputed rights to be licensed from third parties or require the Company to
cease selling its products.
12
<PAGE>
MANAGEMENT OF GROWTH
The Company has recently experienced and may continue to experience growth
in the number of its employees and the scope of its operations, resulting in
increased responsibilities for management personnel. To manage recent and
potential future growth effectively, the Company will need to continue to
implement and improve its operational, financial and management information
systems and to hire, train, motivate and manage a growing number of employees.
The future success of the Company also will depend on its ability to attract and
retain qualified technical, marketing and management personnel, particularly
highly skilled software engineers, for whom competition is intense. In
particular, the current availability of qualified engineers is limited, and
competition among companies for skilled and experienced engineering personnel is
very strong. The Company is currently attempting to hire a number of engineering
personnel and has experienced delays in filling such positions. The Company
expects to experience continued difficulty in filling its needs for qualified
engineers and other personnel. There can be no assurance that the Company will
be able to achieve or manage effectively any such growth, and failure to do so
could delay product development cycles or otherwise have a material adverse
effect on the Company's results of operations.
DEPENDENCE ON KEY EMPLOYEES
The future success of the Company is dependent, in part, on its ability to
retain certain key personnel. The Company also needs to attract additional
skilled personnel in all areas of its business to continue to grow. While many
of the Company's current employees have many years of service with the Company,
there can be no assurance that the Company will be able to retain its existing
personnel or attract additional qualified employees in the future.
POSSIBLE VOLATILITY OF COMMON STOCK PRICE
Many factors such as, but not limited to, announcements of technological
innovations or new products by the Company, its competitors or third parties, as
well as quarterly variations in the Company's actual or anticipated results of
operations, may cause the market price of the Company's Common Stock to
fluctuate significantly. Furthermore, the stock market has experienced extreme
price and volume fluctuations, which have particularly affected the market
prices of many high technology companies and which have often been unrelated to
the operating performance of such companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.
13
<PAGE>
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) EXHIBITS
11.1 Statement Re Computation of Per Share Earnings
27.1 Financial Data Schedule
(b) REPORTS ON FORMS 8-K
None.
14
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PHOTON DYNAMICS, INC.
(Registrant)
Date: August 12, 1996 /s/ Vincent Sollitto
------------------------------------
Vincent Sollitto
Chief Executive Officer and Director
(Principal Executive Officer)
Date: August 12, 1996 /s/ Howard Bailey
------------------------------------
Howard Bailey
Chief Financial Officer and Secretary
(Principal Financial and Accounting
Officer)
15
<PAGE>
EXHIBIT 11.1
PHOTON DYNAMICS, INC.
STATEMENT RE COMPUTATION OF EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Primary and Fully Diluted Earnings Per Share
- --------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
--------------------------- --------------------------
1996 1995 1996 1995
-------- ------ ------ ------
<S> <C> <C> <C> <C>
Net income......................................................... $ 825 $ 110 $2,139 $ 167
Reduction of interest expense related to modified treasury stock
method............................................................ - 4 - 26
------ ------ ------ ------
Adjusted net income................................................ $ 825 $ 114 $2,139 $ 193
====== ====== ====== ======
Computation of weighted average common and common equivalent shares
outstanding:
Common stock.................................................... 6,848 954 6,435 903
Convertible preferred shares.................................... - 3,486 - 3,486
Options and warrants............................................ 869 454 880 549
Shares related to SAB No. 55, 64. SMF 83........................ - 462 - 462
------ ------ ------ ------
Total weighted average common and common equivalent shares
outstanding....................................................... 7,717 5,356 7,315 5,400
------ ------ ------ ------
Net income per share............................................... $ 0.11 $ 0.02 $ 0.29 $ 0.04
====== ====== ====== ======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-QSB
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> APR-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 6,253,000
<SECURITIES> 5,007,000
<RECEIVABLES> 10,501,000
<ALLOWANCES> 354,000
<INVENTORY> 2,746,000
<CURRENT-ASSETS> 24,838,000
<PP&E> 2,021,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 27,062,000
<CURRENT-LIABILITIES> 5,798,000
<BONDS> 0
0
0
<COMMON> 37,935,000
<OTHER-SE> (16,991,000)
<TOTAL-LIABILITY-AND-EQUITY> 27,062,000
<SALES> 7,609,000
<TOTAL-REVENUES> 7,609,000
<CGS> 4,110,000
<TOTAL-COSTS> 2,836,000
<OTHER-EXPENSES> 26,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 47,000
<INCOME-PRETAX> 869,000
<INCOME-TAX> 44,000
<INCOME-CONTINUING> 825,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 825,000
<EPS-PRIMARY> 0.11
<EPS-DILUTED> 0.11
</TABLE>
