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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended December 31, 1997
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 registrant as specified in its charter)
CALIFORNIA 94-3007502
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
6325 SAN IGNACIO, SAN JOSE, CA 95119
(Address of principal executive offices) (Zip Code)
(408) 226 9900
(Registrant's telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last
report.)
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
----- -----
As of February 12, 1998 7,214,655 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 - December 31, 1997 and
September 30, 1997........................................... 2
Condensed Consolidated Statements of Income - three months
ended December 31, 1997 and 1996............................. 3
Condensed Consolidated Statements of Cash Flows - three months
ended December 31, 1997 and 1996............................. 4
Notes to Condensed Consolidated Financial Statements........... 5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 6
Risk Factors................................................... 9
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
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Photon Dynamics, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 SEPTEMBER 30, 1997
----------------- ------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,327 $ 4,831
Accounts receivable, net 6,754 9,785
Inventories 6,126 5,076
Prepaid expenses and other current assets 606 512
---------------- -----------------
Total current assets 19,813 20,204
Property, equipment, and leasehold improvements, net 2,056 2,226
Other assets 758 773
---------------- -----------------
Total assets $ 22,627 $ 23,203
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,410 $ 2,666
Accrued expenses and other liabilities 2,431 2,489
Customer deposits and deferred revenue 186 276
Current portion of long-term debt 3 4
---------------- -----------------
Total current liabilities 5,030 5,435
Noncurrent portion of long-term debt 5 6
Commitments and contingencies
Shareholders' equity:
Common stock 38,578 38,573
Accumulated deficit (20,636) (20,682)
Foreign currency translation adjustment and other (240) (14)
Notes receivable from shareholders (110) (115)
---------------- -----------------
Total shareholders' equity 17,592 17,762
---------------- -----------------
Total liabilities and shareholders' equity $ 22,627 $ 23,203
================ =================
</TABLE>
See accompanying notes to condensed consolidated financial statements
Note: The balance sheet at September 30, 1997 has been derived from the audited
consolidated 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 Income
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31,
1997 1996
-------------- ----------------
<S> <C> <C>
Revenue:
Product revenue $ 5,374 $ 5,096
Non product revenue - 1,150
--------------- ----------------
5,374 6,246
Cost of revenue
Product revenue 2,729 3,173
Non product revenue -
--------------- ----------------
2,729 3,173
--------------- ----------------
Gross margin 2,645 3,073
Operating expenses
Research and development 1,873 1,636
Selling, general and administrative 1,121 1,386
Asset recovery related to product line disposal (350) -
--------------- ----------------
Total operating expenses 2,644 3,022
--------------- ----------------
Operating income 1 51
Interest income 69 111
Interest expense and other (24) (107)
--------------- ----------------
Income before provision for income taxes 46 55
Provision for income taxes - 3
--------------- ----------------
Net income $ 46 $ 52
=============== ================
Basic and diluted net income per share $ 0.01 $ 0.01
=============== ================
Shares used in computing diluted net income per 7,152 6,955
share
=============== ================
Shares used in computing diluted net income per 7,492 7,513
share
=============== ================
</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>
THREE MONTHS ENDED DECEMBER 31,
1997 1996
---------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 46 $ 52
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 271 237
Changes in operating assets and liabilities:
Accounts receivable 3,031 579
Inventories (1,050) (137)
Prepaid expenses and other current assets (94) (177)
Other assets (211) 80
Accounts payable (256) (47)
Accrued expenses and other liabilities (58) 631
Customer deposits and deferred revenue (90) (98)
---------------- -----------------
Net cash provided by operating activities 1,589 1,120
INVESTING ACTIVITIES
Acquisition of property and equipment (101) (682)
Maturities of short term investments - 1,528
---------------- -----------------
Net cash (used in)/provided by investing activities (101) 846
FINANCING ACTIVITIES
Principal payments under capital leases (2) (7)
Proceeds from issuance of common stock 5 12
Issuance of note receivable from shareholders - (56)
Repayment of notes receivable from shareholders 5 -
---------------- -----------------
Net cash provided by/(used in) financing activities 8 (51)
---------------- -----------------
Net increase in cash and cash equivalents 1,496 1,915
Cash and cash equivalents at beginning of period 4,831 5,108
---------------- -----------------
Cash and cash equivalents at end of period $ 6,327 $ 7,023
================ =================
</TABLE>
See accompanying notes to condensed consolidated financial statements
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PHOTON DYNAMICS, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Statements
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q. 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 months ended December 31, 1997 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 30, 1998. For
further information, refer to the audited consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 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>
December 31, September 30,
1997 1997
---------------- ----------------
<S> <C> <C>
Raw materials $ 1,479 $ 1,376
Work-in-process 2,075 1,677
Finished goods 2,572 2,023
---------------- ----------------
$ 6,126 $ 5,076
================ ================
</TABLE>
3. NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is effective for the Company's quarter ended
December 31, 1997. The Company is required to change the method currently used
to compute earnings per share and to restate all prior periods. Under the new
requirements for calculating basic earnings per share the dilutive effect of
stock options is excluded. Approximately 719,000 options have been excluded
from the calculation below as their effect would have been antidilutive. The
following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED DECEMBER 31,
--------------------
(In thousands, except per share amounts) 1997 1996
-------- -------
<S> <C> <C>
Numberator for basic and diluted net income per share $ 46 $ 52
Denominator for basic net income per share 7,152 6,955
Effect of dilutive securities
Employee stock options 227 401
Warrants 113 157
Denominator for diluted net income per share 7,492 7,513
Basic net income per share $ 0.01 $ 0.01
Diluted net income per share $ 0.01 $ 0.01
</TABLE>
5
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PHOTON DYNAMICS, INC
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The statements contained in this report on Form 10-Q 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-KSB, and annual reports to shareholders. Among the factors
that could cause actual results to differ materially are those discussed under
"Factors That May Affect Future Results" and elsewhere in this Form 10-Q.
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, 1997.
RESULTS OF OPERATIONS
Revenue. Revenue decreased to $5.4 million in the first quarter of fiscal
1998 from $6.2 million in the first quarter of fiscal 1997. Product revenue
increased to $5.4 million in the first quarter of fiscal 1998 from $5.1 million
in the first quarter of fiscal 1997. Although product revenue increased over
the prior year, it was below the Company's expectations due to the general
economic conditions in Korea. Some, but not all, of the shipments planned for
Korea in the first quarter of fiscal 1998 were delayed until the second quarter
of fiscal 1998 due to customer requests. In fiscal 1997, sales to Korea
represented 60% of total annual revenue. With the information currently
available, the Company believes that sales to Korea in the remainder of fiscal
1998 will be substantially less in both absolute dollars and as a percentage of
total revenue than in fiscal 1997. Backlog of products due to ship within one
year as of December 31, 1997 was $15.4 million, which consists of $9.4 million
to Japan and $5.4 million to Korea.
Non product revenue in the first quarter of fiscal 1997 includes a non
recurring $1 million initial fee paid by a Korean company for the rights to be
the exclusive value added reseller of the Company's FIS Flex-P product in Korea.
Gross Margin. Product revenue gross margin as a percent of revenue increased
to 49% in the first quarter of fiscal 1998 from 38% in the first quarter of
fiscal 1997. This increase in product gross margins was due to a favorable
product mix, manufacturing efficiencies resulting from higher production volumes
and reduced cost of service operations in Asia due to currency fluctuations.
The increase was offset by a decrease in non product gross margins which in the
first quarter of fiscal 1997 included a one time initial fee paid by a value
added reseller (see above). 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
spending to $1.9 million in the first quarter of fiscal 1998, or 35% of
revenue, from $1.6 million in the first quarter of fiscal 1997, or 26% of
revenue. The increase in research and development spending primarily reflects
the increased costs of hiring and retaining experienced engineers to increase
the level of new product development. The Company has identified and announced
a number of product enhancements that it believes will improve its ability to
sell to volume production environments. As a result, the Company increased its
level of research and development spending. However based on current revenue
projections the Company does not expect to increase the level of research and
development spending from current levels in the remainder of fiscal 1998.
Selling, General and Administrative. Selling, general and administrative
expenses in the first quarter of fiscal 1998 decreased to $1.1 million, or 21%
of revenue, from $1.4 million in the first quarter of fiscal 1997, or 22% of
revenue. The decrease is the result of the Company collecting previously
reserved receivables. Without this cash collection, total selling, general and
administrative costs for the first quarter of fiscal 1998 would have been $1.4
million. Selling, general and administrative expenses may increase in absolute
dollar amounts in fiscal 1998 and in future periods depending on
6
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factors such as the level of the Company's revenue and other operations. Selling
expenses may also fluctuate based on the Company's product and territory sales
mix, which have different sales channels and associated cost structures.
Asset recovery related to product line disposal. During the quarter ended
December 31, 1997 the Company received a payment of $350,000 in settlement of a
dispute related to the cancellation of its Defect Monitoring Tool (DMT) product
line. In September, 1996 the Company ceased operations of its DMT product line.
The DMT product group worked exclusively on a single customer project not in the
flat panel market. As a result of the cancellation of this project, the
associated inventory and assets of this product line which were not transferred
to other products were disposed of. The Company recorded a $844,000 charge to
write down the inventory and assets associated with the product line in the
fourth quarter of fiscal 1996.
Interest income. Interest income in the first quarter of fiscal 1998 decreased
to $69,000 from $111,000 in the first quarter of fiscal 1997 as a result of
reduced average cash and investment balances.
Interest expense and other. Interest expense and other consists of interest
expense and foreign exchange gains and losses.
Provision for Income Taxes. The Company's effective tax rate for the three
months ended December 31, 1997 is lower than the statutory rate of 34% due to
the utilization of loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had working capital of $14.8 million of
which $6.3 million was cash or cash equivalents.
Cash provided by operating activities was $1.6 million for the three months
ended December 31, 1997. Working capital items that significantly impacted cash
balances in the quarter were accounts receivable and inventory. The Company's
accounts receivable balance decreased $3.0 million to $6.8 million. During the
quarter ended December 31, 1997, the Company collected some older extended
receivables resulting in a lower account receivable balance. The Company's
credit terms to customers typically extend a small portion of the payment
extended for a period of months after shipment. Inventory balances increased as
a result of increased finished goods and work in process related to products due
to ship to Korea in the second quarter of fiscal 1998. There can be no
assurance that such products will ship during that period or at all.
In the first quarter of fiscal 1997 the Company relocated to a new facility
and as a result spent $682,000 on capital additions which related primarily to
leasehold improvements for the new facility.
The Company believes that cash and cash equivalents and cash flow from
operations will be sufficient to satisfy working capital requirements and
capital equipment needs for the next 12 months. As of December 31, 1997, the
Company had no material outstanding commitments to purchase or lease capital
equipment.
The Company believes that success in its industry requires substantial capital
in order to maintain the flexibility to take advantage of opportunities as they
may arise. The Company may, from time to time, invest in or acquire
complementary businesses, products or technologies. The Company may effect
additional equity or debt financing to fund such activities. The sale of
additional equity or convertible debt could result in additional dilution to the
Company's shareholders.
The Company is in the process of addressing internal and external year 2000
issues. It does not believe that these issues will materially affect either the
operations or results of the Company.
OTHER FACTORS AFFECTING COMPANY RESULTS
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 $1.5 million. 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 or
cancellations by customers or unexpected manufacturing difficulties, may cause
revenue for that quarter to fall significantly below the
7
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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 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 believes that the current economic conditions in
East Asia and specifically Korea will have a negative impact on the Company's
results of operations if the Korean Won continues to fall or remain at current
levels against the U.S. dollar. This could result in lower average sales prices
for the Company's products in Korea, cancellation of orders or failure to place
new orders for the Company's equipment. For a further discussion of the
Company's business and certain risk factors pertaining to its business, please
refer to the Company's 1997 Annual Report on Form 10-KSB.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
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 $1.5 million. 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 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.
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 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 continuing
market introduction, marketing and cost-effective manufacture of the Company's
array test product line, of which a new version, the ArrayChecker, first
shipped in September 1997. The Company continues to perform research and
development work with respect to the array test systems to attain additional
performance specifications, including increased throughput levels and detection
sensitivity. The Company has experienced delays in the development of
performance specifications required by new and existing customers. No assurance
can be given that development efforts related to other performance parameters
will be successful. The Company believes that future orders of array test
systems will be dependent on its ability to attain requested throughput levels
and other performance parameters. The Company has experienced delays in
obtaining final acceptance and final payment on some products. If products have
performance, reliability or quality problems or shortcomings, then the Company
may experience reduced orders, higher manufacturing costs, 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 array test or inspection technologies by a broader group of customers.
Such Customers include additional international customers and FPD manufacturers
which currently do not perform the type of FPD array test or inspection offered
by the Company's products or which utilize alternative technologies for, or
methods of, inspection, such as "open/short" array 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 array test or inspection systems
involves a significant technological and financial commitment as compared to
current alternatives such as human inspection and "open/short" array testers
There can be no assurance that the Company will be successful in obtaining
broader acceptance of its array test or inspection technologies. Failure to
achieve broader acceptance would have an adverse effect on the Company's results
of operations.
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INTERNATIONAL OPERATIONS
Approximately 98% of the Company's total revenue for fiscal 1997 was
attributable to sales outside the U.S. The Company expects that international
sales and in particular sales to Asia 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 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 PRINCIPAL CUSTOMERS
The FPD industry is extremely concentrated, with almost 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
fiscal 1997 and top six in fiscal 1996 accounted for approximately 83% and 78%,
respectively, of the Company's total revenue. 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 THE JAPANESE AND KOREAN MARKETS
The future performance of the Company will depend, in part, upon its ability
to continue to compete successfully in the Japanese and Korean markets, the two
largest markets for FPD array test, inspection and repair equipment. The
Company's ability to compete in such markets in the future is dependent upon
continuing free trade between Korea, 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 and Korean customers and the continuing ability of
the Company to maintain satisfactory relationships with leading companies in the
Japanese and Korean FPD industry. The Company believes that the Japanese and
Korean companies with which it competes may have a competitive advantage in
Japan and Korea because of the preference of some customers for local equipment
suppliers because such customers may have longer standing or closer business
relationships with such competitors. The Company's sales to Japan and Korea and
results of operations will also be affected by the overall health of the
Japanese and Korean economies, including the effects of currency exchange rate
fluctuations on the global competitiveness of Japanese and Korean FPD
manufacturers. The Company believes that the current economic conditions in
East Asia and specifically Korea will have a negative impact on the Company's
results of operations if the Korean Won continues to fall against the US dollar.
This could result in lower average sales prices for the Company's products in
Korea, cancellation of orders or failure to place new orders for the Company's
equipment.
RELATIONSHIP WITH IHI
The Company has granted certain exclusive manufacturing and sales rights to
IHI with respect to its array test systems developed prior to June 1997, for
Japan, Korea, a number of other Asian countries, Saudi Arabia, Australia, New
Zealand, India and Sri Lanka (the "IHI Territory"). 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 array test systems
to be sold by IHI in its territory. The agreements between IHI and the Company
provided for the Company to assist IHI in its sales efforts in these countries
in exchange for a commission. This relationship continued on an exclusive basis
for the IHI territory until June 1997, since which IHI has had non-exclusive
manufacturing and sales rights in its territory. In exchange for these rights,
IHI has provided significant funding for development of the array test 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 Dynamics to manufacture all array test systems sold by IHI in the IHI
territory. IHI had agreed to allow Photon Dynamics to sell directly all array
test systems
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outside Japan through June 1997. Since June 1997, IHI and the Company have been
operating under a memorandum of understanding whereby IHI continues to sell
array test systems in Japan and the Company sells directly outside Japan in the
IHI territory. IHI and the Company are currently in negotiations for IHI to be
the exclusive reseller of all of the Company's products in Japan. IHI would
continue to perform all support and service for system units in Japan, while
Photon would provide support and service in the remainder of the IHI territory.
There can be no guarantee that the Company and IHI will successfully complete
these negotiations on favorable terms to the Company.
To the extent IHI determines to exercise its contractual rights to manufacture
and sell the Company's systems in the IHI territory, such action could reduce
revenue of the Company attributable to these IHI manufactured array test 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 array test systems 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 array test systems in Japan, such
action by IHI could have a material adverse effect on the Company's ability to
compete in this market 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 sales and support of array test systems
in Japan.
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 source suppliers, including Kodak Corporation and Dover
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.
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 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, 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 service organizations and long-
standing customer relationships with major FPD manufacturers. In the event that
the Company's current negotiations with IHI are not successful, IHI may compete
with the Company selling the Company's array test systems in Japan, Korea and
the rest of the IHI territory. See "Relationship with IHI". 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
11
<PAGE>
multiple technologies and solutions, including competitors' products, to
replicate 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 customer service and
support. There can be no assurance that the Company will have sufficient
resources to continue to make such investments or that even if sufficient funds
are available, 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 temporarily limited the quantities of laptop computers that
were manufactured, which in turn may have reduced demand from laptop computer
manufacturers for certain FPDs. If these conditions had continued for an
extended period, the resulting reduced long-term demand for FPDs suitable for
laptop computers could have affected adversely the level of capital expenditure
by FPD manufacturers. 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. 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.
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.
12
<PAGE>
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
27 Financial Data Schedule
(b) REPORTS ON FORMS 8-K
None.
14
<PAGE>
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.
PHOTON DYNAMICS, INC.
(Registrant)
Date: February 13, 1998 /s/ Vincent Sollitto
-------------------------------------------
Vincent Sollitto
Chief Executive Officer and Director
(Principal Executive Officer)
Date: February 13, 1998 /s/ Howard Bailey
-------------------------------------------
Howard Bailey
Chief Financial Officer and Secretary
(Principal Financial and Accounting
Officer)
15
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
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