SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended January 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-22366
CREDENCE SYSTEMS CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2878499
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(State or other jurisdiction) (IRS Employer
of incorporation or organization) Identification No.)
215 Fourier Ave., Fremont, California 94539
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (510) 657-7400
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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 Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
At February 28, 1999, there were 20,477,295 shares of the Registrant's
common stock, $0.001 par value per share, outstanding.
- --------------------------------------------------------------------------------
<PAGE>
CREDENCE SYSTEMS CORPORATION
INDEX PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.......................................... 3
Condensed Consolidated Balance Sheets......................... 3
Condensed Consolidated Statements of Operations............... 4
Condensed Consolidated Statements of Cash Flows............... 5
Notes to Condensed Consolidated Financial Statements.......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 24
Item 2. Changes in Securities......................................... 24
Item 3. Defaults Upon Senior Securities............................... 24
Item 4. Submission of Matters to a Vote of Securityholders............ 24
Item 5. Other Information............................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................. 24
2
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PART I - FINANCIAL INFORMATION
Item I - Financial Statements
CREDENCE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
January 31, October 31,
1999 1998/a/
---------- ----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents ......................... $ 58,343 $ 48,391
Restricted cash ................................... - 2,400
Short-term investments ............................ 46,770 62,777
Accounts receivable, net .......................... 37,442 33,901
Inventories ....................................... 35,141 37,406
Other current assets .............................. 30,458 40,676
------- -------
Total current assets ............................ 208,154 225,551
Long-term investments ............................... 23,666 20,357
Property and equipment, net ......................... 40,630 41,764
Other assets ........................................ 17,903 18,517
======= =======
Total assets .................................... $290,353 $306,189
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................. $ 6,433 $ 8,090
Accrued liabilities ............................... 21,936 26,978
Income taxes payable .............................. 2,017 5,877
Total current liabilities ....................... 30,386 40,945
Convertible subordinated notes ...................... 115,000 115,000
Minority interest ................................... 170 227
Stockholders' equity ................................ 144,797 150,017
======= =======
Total liabilities and stockholders' equity ...... $290,353 $306,189
======= =======
See accompanying notes.
/a/Derived from the audited consolidated balance sheet included in the Company's
Form 10-K for the year ended October 31, 1998.
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CREDENCE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
January 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Net sales ................................................. $ 26,490 $ 82,375
Cost of goods sold ........................................ 15,276 35,438
------- -------
Gross margin .............................................. 11,214 46,937
Operating expenses:
Research and development ............................... 9,003 13,491
Selling, general and administrative .................... 12,231 20,308
------- -------
Total operating expenses ........................... 21,234 33,799
------- -------
Operating income (loss) ................................... (10,020) 13,138
Interest and other income (expenses), net ................. (301) 958
------- -------
Income (loss) before income tax provision (benefit) ....... (10,321) 14,096
Income tax provision (benefit) ............................ (3,729) 4,934
Minority interest ......................................... (38) (29)
======= =======
Net income (loss) ......................................... $ (6,554) $ 9,191
======= =======
Net income (loss) per share
Basic ................................................. ($ 0.32) $ 0.42
======= =======
Diluted ............................................... ($ 0.32) $ 0.41
======= =======
Number of shares used in computing per share amount
Basic ................................................. 20,418 21,864
======= =======
Diluted ............................................... 20,418 22,415
======= =======
</TABLE>
See accompanying notes.
4
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CREDENCE SYSTEMS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
January 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ................................................................. $ (6,554) $ 9,191
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization .................................................. 5,301 4,326
Loss on disposal of property and equipment ..................................... 424 -
Minority interest .......................................................... (38) 29
Changes in operating assets and liabilities:
Restricted cash, accounts receivable, inventories and other current assets .. 10,113 (13,581)
Accounts payable, accrued liabilities and income taxes payable .............. (10,505) 7,072
------- -------
Net cash (used in) operating activities .................................. (1,259) 7,037
Cash flows from investing activities:
Purchases of available-for-sale securities ........................................ (7,731) (58,420)
Maturities of available-for-sale short-term securities ............................ 17,739 20,990
Sales of available-for-sale securities ............................................ 2,690 1,000
Acquisition of property and equipment ............................................. (2,086) (3,431)
Other assets ...................................................................... (682) (69)
Proceeds from sale of property and equipment ...................................... (20) -
------- -------
Net cash provided by (used in) investing activities ......................... 9,950 (39,930)
Cash flows from financing activities:
Issuance of common stock .......................................................... 228 1,594
Repurchase of common stock ........................................................ 1,052 (12,795)
Other ............................................................................. (19) -
------- -------
Net cash provided by (used in) financing activities ......................... 1,261 (11,201)
------- -------
Net increase (decrease) in cash and cash equivalents ................................. 9,952 (44,094)
Cash and cash equivalents at beginning of period ..................................... 48,391 132,761
======= =======
Cash and cash equivalents at end of period ........................................... $ 58,343 $ 88,667
======= =======
Supplemental disclosures of cash flow information:
Interest paid ..................................................................... - -
Income taxes refunded ............................................................. $(10,742) -
Income taxes paid ................................................................. - $ 2,063
Noncash investing activities:
Net transfers of inventory to property and equipment .............................. $ 1,229 $ 1,333
Noncash financing activities:
Income tax benefit from stock option exercises .................................... - $ 649
</TABLE>
See accompanying notes.
5
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Quarterly Financial Statements
------------------------------
The condensed consolidated financial statements and related notes for the
three months ended January 31, 1999 and 1998 are unaudited but include all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the financial
position and results of operations of the Company for the interim periods. The
results of operations for the three months ended January 31, 1999 and 1998 were
not necessarily indicative of the operating results to be expected for the full
fiscal year. The information included in this report should be read in
conjunction with the Company's audited consolidated financial statements and
notes thereto for the fiscal year ended October 31, 1998 included in the
Company's most recent Annual Report on Form 10-K and the additional risk factors
contained herein and therein, including, without limitation, risks relating to
fluctuations in our quarterly net sales and operating results, limited systems
sales; backlog, cyclicality of semiconductor industry, management of
fluctuations in our operating results, expansion of our product lines, limited
sources of supply; reliance on our subcontractors, highly competitive industry,
rapid technological change, importance of timely product introduction, customer
concentration; lengthy sales cycle, risks associated with acquisitions, changes
in financial accounting standards and accounting estimates, dependence on key
personnel, transition in our executive management, international sales,
proprietary rights, future capital needs; leverage, year 2000 readiness
disclosure, volatility of our stock price and effects of certain anti-takeover
provisions, as set forth in this Report. Any party interested in reviewing a
free copy of the Form 10-K or the Company's other publicly available documents
should write to the Chief Financial Officer of the Company.
USE OF ESTIMATES - The preparation of the accompanying unaudited
consolidated condensed financial statements requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements. Actual results could differ from those estimates.
2. Inventories
-----------
Inventories are stated at the lower of standard cost (which approximates
first-in, first-out cost) or market. Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
January 31, October 31,
1999 1998
----------- ----------
(unaudited)
<S> <C> <C>
Raw materials ................... $ 9,553 $ 9,860
Work-in-process ................. 18,782 21,609
Finished goods .................. 6,806 5,937
======= =======
$ 35,141 $ 37,406
======= =======
</TABLE>
3. Net Income (Loss) Per Share
---------------------------
Net income (loss) per basic share is based upon the weighted average
number of common shares outstanding during the period. Net income (loss) per
diluted share is based upon the weighted average number of common and dilutive
potential common shares outstanding during the period. The Company's convertible
subordinated notes are not dilutive potential common shares and, accordingly,
were excluded from the calculation of net income (loss) per diluted share.
Options to purchase approximately 2,545,000 shares at an average price of $16.62
per share were outstanding at January 31, 1999, but were not included in the
computation of diluted net loss per share because the Company incurred a net
loss. Options to purchase 926,127 shares at an average price of $29.84 per share
were outstanding at January 31, 1998 but were not included in the computation of
diluted net income because the options' exercise price was greater than the
average market price of the common shares and, therefore, the effect would be
antidilutive. The following table sets forth the computation of basic and
dilutive earnings per share (in thousands), except per share amounts:
6
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
January 31,
--------------------
1999 1998
-------- --------
<S> <C> <C>
Numerator:
Numerator for basic and diluted net income (loss) per share-
net income (loss) ................................................. $ (6,554) $ 9,191
------- -------
Denominator:
Denominator for basic net income (loss) per share-
weighted-average shares ........................................... 20,418 21,864
Effect of dilutive securities-employee stock options ................. - 551
Denominator for diluted earnings per share-adjusted
weighted-average shares and assumed conversions ..................... 20,418 22,415
------- -------
Basic net income (loss) per share ................................. $( 0.32) $ 0.42
======= =======
Diluted net income (loss) per share ............................... $( 0.32) $ 0.41
======== =======
</TABLE>
4. Changes in Accounting Standards
-------------------------------
As of November 1, 1998 the Company adopted Statement of Financial
Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS
130 established new rules for the reporting and display of comprehensive income
(loss) and its components including unrealized gains or losses on the Company's
available-for-sale securities and foreign currency translation adjustments,
which prior to adoption were immaterial and were therefore excluded from net
income (loss).
5. Contingencies
-------------
The Company is involved in various claims arising in the ordinary course
of business, none of which, in the opinion of management, if determined
adversely against the Company, will have a material adverse effect on the
Company's business, financial condition or results of operations.
6. Special Charges
---------------
At January 31, 1999, approximately $1.5 million in accrued liabilities
related to special charges recorded in 1998 remained on the Company's balance
sheet, primarily representing rent on excess facilities. The cash expenditures
associated with these obligations will occur primarily in fiscal 1999. Cash
expenditures, associated with the special charges, during the first fiscal
quarter of 1999 were approximately $3.0 million, relating primarily to supplier
commitments and excess facilities.
7. Subsequent Events
-----------------
On March 12, 1999, the Company issued an aggregate of 129,167 shares of
its common stock in exchange for an aggregate of $3,500,000 of its 5 1/4%
Convertible Subordinated Notes due 2002. The Company may engage in similar
transactions in the future.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion may contain predictions, estimates and other
forward-looking statements that involve a number of risks and uncertainties.
While this discussion represents the Company's current judgment on the future
direction of the business, such risks and uncertainties could cause actual
results to differ materially from any future performance suggested herein.
Factors that could cause actual results to differ are identified throughout the
discussion below, as well as in the section entitled "Risk Factors" below, and
elsewhere in this report. The Company undertakes no obligation to publicly
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<PAGE>
revise any forward-looking statements to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events.
The following table sets forth items from the Condensed Consolidated
Statements of Operations as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended
January 31,
---------------------
1999 1998
-------- --------
Unaudited
<S> <C> <C>
Net sales .................................................... 100.0% 100.0%
Cost of goods sold ........................................... 57.7 43.0
----- -----
Gross margin ................................................. 42.3 57.0
Operating expenses
Research and development .................................. 34.0 16.4
Selling, general, and administrative ...................... 46.2 24.7
----- -----
Operating expenses ..................................... 80.2 41.1
----- -----
Operating income (loss) ...................................... (37.9) 15.9
Interest and other income (expenses), net .................... (1.1) 1.2
----- -----
Income (loss) before income tax provision (benefit) .......... (38.9) 17.1
Income tax provision (benefit) ............................... (14.1) 5.9
----- -----
Net income (loss) ............................................ (24.8%) 11.2%
===== =====
</TABLE>
RESULTS OF OPERATIONS
- ---------------------
NET SALES
Net sales consist of revenues from systems sales, spare parts sales,
maintenance contracts and software sales. Net sales were $26.5 million for the
first quarter of fiscal 1999, representing a decrease of 67.8% from the net
sales of $82.4 million in the comparable period of fiscal 1998. This decrease
was due primarily to a significant decline in worldwide demand for semiconductor
automatic test equipment, particularly in the Asia Pacific region and to delays
in revenue shipments of new products. International net sales accounted for
approximately 76.6% of the total net sales for the first quarter of fiscal 1999,
compared to approximately 67.1% for the comparable period a year ago. The
increase in international sales as a percentage of net sales resulted from the
fact that as the Company's sales declined overall between the periods presented,
the decline in domestic sales was greater than the decline in international
sales. The Company's international sales of its products and spare parts and its
service revenues are denominated primarily in United States dollars.
GROSS MARGIN
The Company's gross margin has been and will continue to be affected by a
variety of factors, including manufacturing efficiencies, pricing by competitors
or suppliers, new product introductions, product sales mix, production volume,
customization and reconfiguration of systems, international and domestic sales
mix and field service margins. Gross margin was 42.3% for the first quarter of
fiscal 1999, compared with 57.0% for the first quarter of fiscal 1998. The
decrease in gross margin as a percent of sales was due to significantly lower
average selling prices and due to higher costs caused by under-absorption of
manufacturing expenses and product development delays which will not be
alleviated completely until well into the current fiscal year.
8
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RESEARCH AND DEVELOPMENT
Research and development ("R&D") expenses were $9.0 million in the first
quarter of fiscal 1999, a decrease of $4.5 million or 33.3% over the same period
of fiscal 1998. Much of the reduction is due to cutbacks in project expenses as
well as savings generated by a two-week plant shutdown in the first quarter of
fiscal 1999. These projects expense cutbacks were initiated in fiscal 1998 while
the Company was reacting to a severe downturn in the industry. As a percentage
of net sales, R&D expenses were 34.0% for the first quarter of fiscal 1999, an
increase from 16.4% in the first quarter of fiscal 1998. The increase in these
expenses as a percentage of net sales is attributable primarily to the
significant decrease in net sales in the first quarter of fiscal 1999 as
compared with the comparable period of fiscal 1998. The Company currently
intends to continue to invest significant resources in the development of new
products and enhancements for the foreseeable future. Accordingly, the Company
expects these expenses to increase in absolute dollars for the remainder of
fiscal 1999.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses ("SG&A") were $12.2 million
in the first quarter of fiscal 1999, representing an $8.1 million or 39.8%
decrease from the comparable period of fiscal 1998. The spending decline from
the prior quarter is primarily due to reduced sales commissions on lower sales
volume and reduced payroll related expenses due to reduced headcount and due to
the savings generated by a two-week plant shutdown in the first quarter of
fiscal 1999. As a percentage of net sales, SG&A expenses were 46.2% for the
first quarter of fiscal 1999, compared with 24.7% for the corresponding period
in fiscal 1998. This increase as a percentage of net sales is primarily due to
the decrease in net sales. The Company expects SG&A expenses for the remainder
of fiscal 1999 to increase in absolute dollars. Increases expected in the
remainder of fiscal 1999 include, but are not necessarily limited to, the costs
of installing a new MIS system, increases in salaries of existing employees and
the costs of moving the Company's primary Oregon operations into a new facility,
including accelerated depreciated and amortization costs associated with
vacating the current primary facility, all of which are scheduled for
implementation in the third fiscal quarter of 1999.
INTEREST AND OTHER INCOME EXPENSES, NET
The Company generated net interest and other income (expense) of ($0.3)
million for the first quarter of fiscal 1999, as compared to $1.0 million for
the first quarter of fiscal 1998. The decrease is primarily due to lower
interest income caused by lower average cash balances.
INCOME TAXES
The Company's estimated effective tax rate for the first quarter of
fiscal 1999 was 36%, compared to 35% in the first three months of 1998. The tax
rate is computed based on projected fiscal year to date book income or loss.
Realization of a portion of the net deferred tax assets at January 31, 1999, is
dependent on the Company's ability to generate approximately $34,000,000 of
future taxable income. Management believes that it is more likely than not that
the assets will be realized based on forecasted income. However there can be no
assurance that the Company will meet its expectations of future income.
Management will evaluate the realizability of the deferred tax assets quarterly
and assess the need for additional valuation allowances.
YEAR 2000 READINESS DISCLOSURE
The "Year 2000" issue results from the use in computer hardware and
software of two digits rather than four digits to define the applicable year.
When computer systems must process dates both before and after January 1, 2000,
two-digit year "fields" may create processing ambiguities that can cause errors
and system failures. The results of these errors may range from minor undetected
errors to complete shutdown of an affected system. These errors or failures may
have limited effects, or the effects may be widespread, depending on the
computer chip, system or software, and its location and function. The effects of
the Year 2000 problem are exacerbated because of the interdependence of computer
and telecommunications systems in the United States and throughout the world.
9
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Because of this interdependence, the failure of one system may lead to the
failure of many other systems even though the other systems are themselves "Year
2000 compliant."
Our Board of Directors has reviewed the Year 2000 issue generally and as
it may affect our business activity specifically. We are implementing a Year
2000 plan (the "Plan") which is designed to cover all of our activities and
which is monitored by the Board of Directors. We will modify the Plan as
circumstances change. Under the Plan, we are using a five-phase methodology for
addressing the issue. The phases are Awareness, Assessment, Renovation,
Validation and Implementation.
The Awareness phase consisted of defining the Year 2000 problem and
gaining executive level support and sponsorship for addressing it. We
established a Year 2000 program team and created an overall strategy. During the
Assessment phase, we inventoried all internal systems, products and supply chain
partners and prioritized each for renovation. We believe we have completed a
majority of the Awareness and Assessment phases; however, we will continue to
work in these areas as we complete our assessment of existing supply chain
partners and enter into new supply chain relationships in the ordinary course of
business. Renovation consists of converting, replacing, upgrading or eliminating
systems that have Year 2000 problems. We have begun Renovation on
mission-critical systems and have targeted completion for all but two systems by
March 31, 1999. The remaining two mission-critical systems are now scheduled for
completion of renovation by October 1999. Validation involves ensuring that
hardware and software fixes will work properly in 1999 and beyond and can occur
both before and after implementation. We began the Validation phase in late 1998
and will continue through October, 1999 to allow for thorough testing before the
Year 2000. Implementation is the installation of Year 2000 ready hardware and
software components in a live environment.
The impact of Year 2000 issues on our business will depend not only on
corrective actions that we take, but also on the way Year 2000 issues are
addressed by governmental agencies, businesses and other third parties that
provide us with services or data or receive services or data from us, or whose
financial condition or operational capability is important to us. To reduce this
exposure, we have an ongoing process of identifying and contacting
mission-critical third party vendors and other significant third parties to
determine their Year 2000 plans and target dates. Risks associated with any such
third parties located outside the United States may be higher insofar as it is
generally believed that non-U.S. businesses may not be addressing their Year
2000 issues on as timely a basis as U.S. businesses. Notwithstanding our
efforts, we cannot be certain that we, mission-critical third party vendors or
other significant third parties will adequately address their Year 2000 issues.
We are developing contingency plans in the event that we,
mission-critical third party vendors or other significant third parties fail to
adequately address Year 2000 issues. Such plans principally involve identifying
alternative vendors or internal remediation. We cannot ensure that any such
plans will fully mitigate any such failures or problems. Furthermore, there may
be certain mission-critical third parties, such as utilities, telecommunication
companies, or material vendors for which alternative arrangements or sources are
limited or unavailable.
Although it is difficult for us to estimate the total costs of
implementing the Plan, our current estimate is that such costs will be
approximately $2.5 million through October 1999 and beyond. However, although we
believe that our estimates are reasonable, we cannot be certain, for the reasons
stated in the next paragraph, that the actual costs of implementing the Plan
will not differ materially from the estimated costs. We have incurred costs of
approximately $1.3 million through January 31, 1999 in connection with the Plan.
A significant portion of total Year 2000 project expenses is represented by
existing staff that have been redeployed to this project. We do not believe that
the redeployment of existing staff will have a material adverse effect on our
business, results of operations or financial position. Nor do we expect
incremental expenses related to the Year 2000 project to materially impact
operating results in any one period.
For a number of reasons, we cannot predict or quantify the extent and
magnitude of the Year 2000 problem as it will affect our business, either before
or for some period after January 1, 2000. Among the most important reasons are:
o lack of control over systems used by third parties critical to our
operation;
10
<PAGE>
o dependence on third party software vendors to deliver Year 2000
upgrades in a timely manner;
o complexity of testing inter-connected networks and applications that
depend on third party networks; and
o the uncertainty surrounding how others will deal with liability issues
raised by Year 2000 related failures.
For example, we cannot be certain that systems used by third parties will
be Year 2000 ready by January 1, 2000, or by some earlier date, so as not to
create a material disruption to our business. Moreover, the estimated costs of
implementing the Plan do not take into account the costs, if any, that might be
incurred as a result of Year 2000-related failures that occur despite our
implementation of the Plan.
Although we are not aware of any material operational issues associated
with preparing our internal systems for the Year 2000 or of material issues with
respect to the adequacy of mission-critical third party systems, we cannot
ensure that we will not experience material unanticipated negative consequences
and/or material costs caused by undetected errors or defects in such systems or
by our failure to adequately prepare for the results of such errors or defects,
including the costs of related litigation, if any. The impact of such
consequences could have a material adverse effect on our business, financial
condition or results of operations.
INTRODUCTION OF THE EURO
We do not expect that the introduction and the use of the Euro will have
a material adverse effect on our business, financial condition or results of
operations.
LIQUIDITY AND CAPITAL RESOURCES
Net cash (used in) provided by operating activities was ($1.3) million
and $7.0 million for the three months ended January 31, 1999 and 1998,
respectively. Net cash flows used in operating activities for the first quarter
of 1999 was primarily due to a net loss of $6.6 million and a decrease in
liabilities of $10.5 million, offset by an increase in depreciation and
amortization of $5.3 million and a decrease in operating assets of $10.1
million. Net cash flows provided by operating activities for the first quarter
of 1998 resulted primarily from net income of $9.2 million, depreciation and
amortization of $4.3 million and increases in accounts payable, accrued
liabilities and income taxes payable of $7.1 million, partially offset by
increases in restricted cash, accounts receivable, inventories and other current
liabilities of $13.6 million.
Investing activities provided net cash flows of approximately $10.0
million and used $39.9 million for the three months ended January 31, 1999 and
1998, respectively. In the first three months of fiscal 1999, the Company had a
net decrease of $12.7 million in short term and long term investments and an
increase of $2.1 million in acquired property and equipment.
Net cash flows from financing activities provided $1.3 million and used
$11.2 million for three months ended January 1999 and 1998, respectively.
As of January 31, 1999, the Company had working capital of approximately
$177.8 million, including cash and short-term investments of $105.1 million,
$37.4 million of accounts receivable and $35.1 million of inventories. The
Company expects its accounts receivable to continue to represent a significant
portion of working capital. The Company believes that because of the relatively
long manufacturing cycles of many of its testers and the new products it has and
plans to continue to introduce, investments in inventories will also continue to
represent a significant portion of working capital. Significant investments in
accounts receivable and inventories may subject the Company to increased risks
which could materially adversely affect the Company's business, financial
condition and results of operations. Total current liabilities of $40.9 million
as of October 31, 1998 decreased to $30.4 million as of January 31, 1999. The
$10.6 million decrease was due to decreases in accounts payable, accrued
liabilities and income taxes payable. These decreases were primarily due to
reduced inventory purchases, payment of accrued liabilities related to payroll
and supplier commitments and the reduction of taxes payable due to the quarterly
net loss.
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The Company's principal sources of liquidity as of January 31, 1999
consisted of approximately $58.3 million of cash and cash equivalents,
short-term investments of $46.8 million and $40.0 million available under the
Company's unsecured working capital line of credit expiring on July 23, 1999. In
addition, the Company has $23.7 million of available for sale securities,
classified as long-term. As of January 31, 1999, no amounts were outstanding
under the unsecured line of credit. Additionally, as of January 31, 1999, the
Company had operating leases for facilities and test and other equipment
totaling approximately $46.6 million.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk for changes in interest rates
relates primarily to the Company's investment portfolio and long-term debt
obligations. The Company maintains a strict investment policy which ensures the
safety and preservation of its invested funds by limiting default risk, market
risk, and reinvestment risk. The Company's investments consists primarily of
commercial paper, medium term notes, asset backed securities, US. Treasury notes
and obligations of U.S. Government agencies, bank certificates of deposit,
auction rate preferred securities, corporate bonds and municipal bonds. The
table below presents notional amounts and related weighted-average interest
rates by year of maturity for the Company's investment portfolio and long-term
debt obligations (in thousands, expect percent amounts):
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003 Thereafter
-------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Cash Equivalents
Fixed rate $ 58,343 - - - - -
Average rate 4.97% - - - - -
Short term investments
Fixed rate $ 46,770 - - - - -
Average rate 5.72% - - - - -
Long term investments
Fixed rate $ - $ 23,666 - - - -
Average rate - 5.39% - - - -
-------- -------- -------- -------- -------- --------
Total investment securities $105,113 $ 23,666 - - - -
Average rate 5.32% 5.39% - - - -
Long term debt
Fixed rate - - - $115,000 - -
Average rate - - - 5.25% - -
</TABLE>
The Company mitigates default risk by attempting to invest in high credit
quality securities and by constantly positioning its portfolio to respond
appropriately to a significant reduction in a credit rating of any investment
issuer or guarantor. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity and maintains a
prudent amount of diversification.
The Company has no cash flow exposure due to rate changes for its $115
million Convertible Subordinated Notes. The Company has a $40 million line of
credit under which it can borrow either at the bank's prime rate or the LIBOR
rate. As of January 31, 1999, the Company had no borrowings under its line of
credit.
12
<PAGE>
RISK FACTORS
Fluctuations in Our Quarterly Net Sales and Operating Results
PERFORMANCE GRAPH APPEARS HERE
------------------------------
($ Millions)
<TABLE>
<CAPTION>
1996 1997 1998 1999
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
---------------------- ---------------------- ---------------------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Sales 61.0 66.4 67.2 44.2 40.3 43.4 51.1 69.4 82.4 74.6 37.3 22.4 26.5
Net Income (loss) 10.5 11.5 11.6 4.3 1.5 3.3 (0.9) 7.3 9.2 8.8 (33.6)(10.7) (6.6)
</TABLE>
A variety of factors affect our net sales and results of operations. The
above graph illustrates that our quarterly net sales and operating results have
fluctuated significantly. We believe they will continue to fluctuate for a
number of reasons, including:
o economic conditions in the semiconductor industry in general and
capital equipment industry specifically;
o timing of new product announcements and new product releases by us or
our competitors;
o market acceptance of our new products and enhanced versions of
existing products;
o manufacturing inefficiencies associated with the start-up of our new
products, changes in our pricing or payment terms and cycles, and
those of our competitors, customers and suppliers;
o manufacturing capacity and ability to volume produce systems and meet
customer requirements;
o write-offs of excess and obsolete inventories, and uncollectible
receivables;
o patterns of capital spending by our customers, delays, cancellations
or rescheduling of customer orders due to customer financial
difficulties or otherwise;
o changes in overhead absorption levels due to changes in the number of
systems manufactured, the timing and shipment of orders, availability
of components including custom integrated circuits ("IC's"),
subassemblies and services, customization and reconfiguration of
systems and product reliability;
o expenses associated with acquisitions and alliances;
o operating expense reductions, including costs relating to facilities
consolidations and related expenses;
o the proportion of our direct sales and sales through third parties,
including distributors and original equipment manufacturers ("OEM"),
the mix of products sold, the length of manufacturing and sales
cycles, product discounts; and
o natural disasters, political and economic instability, regulatory
changes and outbreaks of hostilities.
We presently intend to introduce many new products and product
enhancements in the future, the timing and success of which will affect our
business, financial condition and results of operations. Our gross margins on
system sales have varied significantly, and will continue to vary significantly
based on a variety of factors, including:
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o manufacturing inefficiencies;
o pricing concessions by us and our competitors and pricing by our
suppliers;
o hardware and software product sales mix;
o inventory write-downs;
o production volume;
o new product introductions;
o product reliability;
o absorption levels and the rate of capacity utilization;
o customization and reconfiguration of systems; and
o international and domestic sales mix and field service margins.
New and enhanced products typically have lower gross margins in the early
stages of commercial introduction and production. Although we have recorded and
continue to record provisions for estimated sales returns, uncollectible
accounts, and product warranty costs, we cannot be certain that our estimates
will be adequate. We may be required to record charges in future quarters to
reflect, in part, the cost of additional facilities consolidation, as it occurs.
We cannot forecast with any certainty the impact of these and other
factors on our sales and operating results in any future period. In addition,
our need for continued significant expenditures for research and development,
marketing and other expenses for new products, capital equipment purchases and
worldwide training and customer service and support, among other factors, will
make it difficult for us to reduce our significant fixed expenses in a
particular period if we don't meet our net sales goals for that period. As a
result, we cannot be certain that we will become profitable again or that we
will not continue to sustain losses in the future. We believe that we will
continue to incur quarterly net losses until the fourth quarter of fiscal 1999.
As a result, the price of our common stock may continue to be materially
adversely affected.
Limited Systems Sales; Backlog
We derive a substantial portion of our net sales from the sale of a
relatively small number of systems that typically range in price from $350,000
to $3.6 million, other than certain memory products and software products, for
which the price range is typically below $50,000. As a result, our net sales and
operating results for a particular period could be significantly impacted by the
timing of recognition of revenue from a single transaction. Our net sales and
operating results for a particular period could also be materially adversely
affected if an anticipated order from even one customer is not received in time
to permit shipment during that period. Backlog at the beginning of a quarter
typically does not include all orders necessary to achieve our sales objectives
for that quarter. In addition, orders in backlog are subject to cancellation,
delay, deferral or rescheduling by customers with limited or no penalties.
Consequently, our quarterly net sales and operating results have in the past and
will in the future depend upon our obtaining orders for systems to be shipped in
the same quarter that the order is received.
Furthermore, we ship certain products generating most of our net sales
near the end of each quarter. Accordingly, our failure to receive an anticipated
order or a delay or rescheduling in a shipment near the end of a particular
period may cause net sales in a particular period to fall significantly below
expectations, which could have a material adverse effect on our business,
financial condition or results of operations. The relatively long manufacturing
cycle of many testers has caused and could continue to cause future shipments of
testers to be delayed from one quarter to the next, which could materially
adversely affect our business, financial condition or results of operations.
Furthermore, as we and our competitors announce new products and technologies,
customers may defer or cancel purchases of our existing systems, which could
have a material adverse effect on our business, financial condition or results
of operations. We cannot forecast the impact of these and other factors on sales
and operating results.
14
<PAGE>
Cyclicality of Semiconductor Industry
Our business and results of operations depend largely upon the capital
expenditures of manufacturers of semiconductors and companies that specialize in
contract packaging and/or testing of semiconductors, including manufacturers and
contractors that are opening new or expanding existing fabrication facilities or
upgrading existing equipment, which in turn depend upon the current and
anticipated market demand for semiconductors and products incorporating
semiconductors. The semiconductor industry has been highly cyclical with
recurring periods of oversupply, which often have had a severe effect on the
semiconductor industry's demand for test equipment, including the systems we
manufacture and market. We believe that the markets for newer generations of
semiconductors will also be subject to similar fluctuations.
We have experienced shipment delays, delays in commitments and purchase
order restructurings by several customers and we expect delays and
restructurings may continue. Accordingly, we cannot be certain that we will be
able to achieve or maintain our current or prior level of sales or rate of
growth. We anticipate that a significant portion of new orders may depend upon
demand from semiconductor device manufacturers building or expanding fabrication
facilities and new device testing requirements that are not addressable by
currently installed test equipment, and there can be no assurance that such
demand will develop to a significant degree, or at all. In addition, our
business, financial condition or results of operations may be adversely affected
by any factor adversely affecting the semiconductor industry in general or
particular segments within the semiconductor industry. The recent Asian
financial crisis has contributed to a widespread uncertainty and a slowdown in
the semiconductor industry. This slowdown in the semiconductor industry has
resulted in reduced spending for semiconductor capital equipment, including
automatic test equipment ("ATE") which the Company sells. This industry slowdown
has had and may continue to have a material adverse effect on product backlog,
balance sheet and results of operations. Therefore, there can be no assurance
that the operating results will not continue to be materially adversely affected
if downturns or slowdowns in the semiconductor industry continue or occur again
in the future.
Management of Fluctuations in Our Operating Results
We have over the last several years experienced significant fluctuations
in our operating results. In fiscal 1998, we generated revenue of $82.4 million
for the first quarter and $22.4 million for the fourth quarter, a decrease of
73% and our net sales for the first quarter of fiscal 1999 were $26.5 million.
Since 1993, except for cost-cutting efforts during the past two years, we have
overall significantly increased the scale of our operations in general to
support periods of increased sales levels and expanded product offerings and
have expanded operations to address critical infrastructure and other
requirements, including the hiring of additional personnel, significant
investments in R&D to support product development, our establishment of a joint
venture with Innotech Corporation and numerous acquisitions. However, in the
past and including the three quarters ended October 31, 1998, as discussed
above, we have experienced significant revenue declines and reductions in our
operations. These fluctuations in our sales and operations have placed a
considerable strain on our management, financial, manufacturing and other
resources. In order to effectively deal with the changes brought on by the
cyclical nature of the industry, we have been required to implement and improve
a variety of highly flexible operating, financial and other systems, procedures
and controls capable of expanding or contracting consistent with our business.
However, we cannot be certain that any existing or new systems, procedures or
controls will be adequate to support fluctuations in our operations or that our
systems, procedures and controls will be cost-effective or timely. Any failure
to implement, improve and expand or contract such systems, procedures and
controls efficiently and at a pace consistent with our business could have a
material adverse effect on our business, financial condition and our results of
operations.
Expansion of Our Product Lines
We are currently devoting and intend to continue to devote significant
resources to the development of new products and technologies. During fiscal
1999, we intend to evaluate these new products and to invest significant
resources in plant and equipment, leased facilities, inventory, personnel and
other costs, to begin or prepare to increase production of these products and to
provide the marketing, administration and after-sales service and support, if
any, required to service and support these new hardware and software products.
Accordingly, we cannot be certain that gross profit margin and inventory levels
will not continue to be adversely impacted by continued delays in new product
15
<PAGE>
introductions or start-up costs associated with the initial production and
installation of these new product lines. These start-up costs include additional
manufacturing overhead, additional inventory and warranty reserve requirements
and the enhancement of after-sales service and support organizations. In
addition, the increases in inventory on hand for new hardware and software
product development and customer support requirements have increased and will
continue to increase the risk of inventory write-offs. We cannot be certain that
operating expenses will not increase, relative to sales, as a result of adding
additional marketing and administrative personnel, among other costs, to support
our additional products. If we are unable to achieve significantly increased net
sales or if sales fall below expectations, our operating results will continue
to be materially adversely affected. We cannot be certain that our net sales
will increase or remain at recent levels or that any new products will be
successfully commercialized or contribute to revenue growth.
Limited Sources of Supply; Reliance on Our Subcontractors
We obtain certain components, subassemblies and services necessary for
the manufacture of our testers from a limited group of suppliers. We do not
maintain long-term supply agreements with most of our vendors and we purchase
most of our components and subassemblies through individual purchase orders. The
manufacture of certain of our components and subassemblies is an extremely
complex process. We also rely on outside vendors to manufacture certain
components and subassemblies and to provide certain services. We have recently
experienced and continue to experience significant reliability, quality and
timeliness problems with several critical components including certain custom
integrated circuits. In addition, we and certain of our subcontractors
periodically experience significant shortages and delays in delivery of various
components and subassemblies. We cannot be certain that these or other problems
will not continue to occur in the future with our suppliers or outside
subcontractors. Our reliance on a limited group of suppliers and on outside
subcontractors involves several risks, including an inability to obtain an
adequate supply of required components, subassemblies and services and reduced
control over the price, timely delivery, reliability and quality of components,
subassemblies and services. Shortages, delays, disruptions or terminations of
the sources for these components and subassemblies have delayed and could
continue to delay shipments of our systems and new products and could continue
to have a material adverse effect on our business, financial condition or
results of operations. Our continuing inability to obtain adequate yields or
timely deliveries or any other circumstance that would require us to seek
alternative sources of supply or to manufacture such components internally could
also have a material adverse effect on our business, financial condition or
results of operations. Such delays, shortages and disruptions would also damage
relationships with current and prospective customers and have and could continue
to allow competitors to penetrate such customer accounts. We cannot be certain
that our internal manufacturing capacity or that of our suppliers and
subcontractors will be sufficient to meet customer requirements.
Highly Competitive Industry
The ATE industry is intensely competitive. Because of the substantial
investment required to develop test application software and interfaces, we
believe that once a semiconductor manufacturer has selected a particular ATE
vendor's tester, the manufacturer is likely to use that tester for a majority of
its testing requirements for the market life of that semiconductor and, to the
extent possible, subsequent generations of similar products. As a result, once
an ATE customer chooses a system for the testing of a particular device, it is
difficult for competing vendors to achieve significant ATE sales to such
customer for similar use. Our inability to penetrate any large ATE customer or
achieve significant sales to any ATE customer could have a material adverse
effect on our business, financial condition or results of operations.
We face substantial competition throughout the world, primarily from ATE
manufacturers located in the United States, Europe and Japan, as well as several
of our customers. Many competitors have substantially greater financial and
other resources with which to pursue engineering, manufacturing, marketing and
distribution of their products. Certain competitors have recently introduced or
announced new products with certain performance or price characteristics equal
or superior to certain products we currently offer. These competitors have
recently introduced products that compete directly against our products. We
believe that if the ATE industry continues to consolidate through strategic
alliances or acquisitions, we will continue to face significant additional
competition from larger competitors that may offer product lines and services
more complete than ours. Our competitors are continuing to improve the
16
<PAGE>
performance of their current products and to introduce new products,
enhancements and new technologies that provide improved cost of ownership and
performance characteristics. New product introductions by our competitors could
continue to cause a decline in our sales or loss of market acceptance of our
existing products.
Moreover, our business, financial condition or results of operations
could continue to be materially adversely affected by increased competitive
pressure and continued intense price-based competition. We have experienced and
continue to experience significant price competition in the sale of our testers.
In addition, pricing pressures typically become more intense at the end of a
product's life cycle and as competitors introduce more technologically advanced
products. We believe that to be competitive, we must continue to expend
significant financial resources in order to, among other things, invest in new
product development and enhancements and to maintain customer service and
support centers worldwide. We cannot be certain that we will be able to compete
successfully in the future.
Rapid Technological Change; Importance of Timely Product Introduction
The ATE market is subject to rapid technological change. Our ability to
compete in this market depends upon our ability to successfully develop and
introduce new hardware and software products and enhancements and related
software tools with greater features on a timely and cost-effective basis,
including the products under development that we acquired in the EPRO merger and
the acquisition of certain product lines from Summit Design, Inc., Zycad
Corporation and Heuristic Physics Laboratories, Inc. Our customers require
testers and software products with additional features and higher performance
and other capabilities. We are therefore required to enhance the performance and
other capabilities of our existing systems and software products and related
software tools. Any success we may have in developing new and enhanced systems
and software products and new features to our existing systems and software
products will depend upon a variety of factors, including:
o product selection; o timely and efficient completion of product
design;
o implementation of manufacturing and assembly processes;
o successful coding and debugging of software;
o product performance;
o reliability in the field; and
o effective sales and marketing.
Because we must make new product development commitments well in advance
of sales, new product decisions must anticipate both future demand and the
availability of technology to satisfy that demand. We cannot be certain that we
will be successful in selecting, developing, manufacturing and marketing new
hardware and software products or enhancements and related software tools. Our
inability to introduce new products and related software tools that contribute
significantly to net sales, gross margins and net income would have a material
adverse effect on our business, financial condition and results of operations.
New product or technology introductions by our competitors could cause a decline
in sales or loss of market acceptance of our existing products. In addition, if
we introduce new products, existing customers may curtail purchases of the older
products and delay new product purchases. Any unanticipated decline in demand
for our hardware or software products could have a materially adverse affect on
our business, financial condition or results of operations.
Significant delays can occur between the time we introduce a system and
the time we are able to produce that system in volume. We have in the past
experienced significant delays in the introduction, volume production and sales
of our new systems and related feature enhancements and are currently
experiencing significant delays in the introduction of our VS2000, Quartet and
Kalos series testers as well as certain enhancements to our existing SC and DUO
series testers. These delays have been primarily related to our inability to
successfully complete product hardware and software engineering within the time
frame originally anticipated, including design errors and redesigns of ICs. As a
17
<PAGE>
result, certain customers have experienced significant delays in receiving and
using certain of our testers in production. We cannot be certain that these or
additional difficulties will not continue to arise or that such delays will not
continue to materially adversely affect customer relationships and future sales.
Moreover, we cannot be certain that we will not encounter these or other
difficulties that could delay future introductions or volume production or sales
of our systems or enhancements and related software tools. We have incurred and
may continue to incur substantial unanticipated costs to ensure the
functionality and reliability of our testers and to increase feature sets. If
our systems continue to have reliability, quality or other problems, or the
market perceives certain of our products to be feature deficient, we may suffer
reduced orders, higher manufacturing costs, delays in collecting accounts
receivable and higher service, support and warranty expenses, or inventory
write-offs, among other effects. Our failure to have a competitive tester and
related software tools available when required by a semiconductor manufacturer
could make it substantially more difficult for us to sell testers to that
manufacturer for a number of years. We believe that the continued acceptance,
volume production, timely delivery and customer satisfaction of our newer
digital, mixed signal and non-volatile memory testers are of critical importance
to our future financial results. As a result, our inability to correct any
technical, reliability, parts shortages or other difficulties associated with
our systems or to manufacture and ship the systems on a timely basis to meet
customer requirements could damage our relationships with current and
prospective customers and would continue to materially adversely affect our
business, financial condition and results of operations.
Customer Concentration; Lengthy Sales Cycle
One customer, Spirox Corporation, (a distributor in Taiwan) accounted for
57%, 34%, 30% and 25% of our net sales in the first quarter of fiscal 1999 and
fiscal years 1998, 1997, and 1996, respectively. Consequently, our business,
financial condition and results of operations could be materially adversely
affected by the loss of or any reduction in orders by this or any other
significant customer, including losses or reductions due to continuing or other
technical, manufacturing or reliability problems with our products or continued
slow-downs in the semiconductor industry or in other industries that manufacture
products utilizing semiconductors. Our ability to maintain or increase sales
levels will depend upon: o our ability to obtain orders from existing and new
customers;
o our ability to manufacture systems on a timely and cost-effective
basis;
o our ability to complete the development of our new hardware and
software products;
o our customers' financial condition and success;
o general economic conditions; and
o our ability to meet increasingly stringent customer performance and
other requirements and shipment delivery dates.
Sales of our systems depend in part upon the decision of semiconductor
manufacturers to develop and manufacture new semiconductor devices or to
increase manufacturing capacity. As a result, sales of our testers are subject
to a variety of factors we cannot control. In addition, the decision to purchase
a tester generally involves a significant commitment of capital, with the
attendant delays frequently associated with significant capital expenditures.
For these and other reasons, our systems have lengthy sales cycles during which
we may expend substantial funds and management effort to secure a sale,
subjecting us to a number of significant risks. We cannot be certain that we
will be able to maintain or increase net sales in the future or that we will be
able to retain existing customers or attract new ones.
Risks Associated with Acquisitions
We have developed in significant part through mergers and acquisitions of
other companies and businesses. We intend in the future to pursue additional
acquisitions of complementary product lines, technologies and businesses. We may
have to issue debt or equity securities to pay for future acquisitions, which
could be dilutive. We have also incurred and may continue to incur certain
liabilities or other expenses in connection with acquisitions, which have and
could continue to materially adversely affect our business, financial condition
and results of operations. Although we believe we have accounted for our
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acquisitions properly, the U.S. Securities and Exchange Commission (the "SEC")
has recently been reviewing more closely the accounting for acquisitions by
companies, particularly in the area of "in-process" research and development
costs. If we are required by the SEC to restate any charge that we recognized in
an acquisition so far, that could result in a lesser charge to income and
increased amortization expense, which could also have a material adverse effect
on our business, financial condition and results of operations.
In addition, acquisitions involve numerous other risks, including:
o difficulties assimilating the operations, personnel, technologies and
products of the acquired companies;
o diversion of our management's attention from other business concerns;
o risks of entering markets in which we have no or limited experience;
and
o the potential loss of key employees of the acquired companies.
For these reasons, we cannot be certain what effect future acquisitions
may have on our business, financial condition and results of operations.
Changes in Financial Accounting Standards and Accounting Estimates
We prepare our financial statements to conform with generally accepted
accounting principles ("GAAP"). GAAP are subject to interpretation by the
American Institute of Certified Public Accountants, the SEC and various bodies
formed to interpret and create appropriate accounting policies. A change in
those policies can have a significant effect on our reported results, and may
even affect our reporting of transactions completed before a change is
announced. Accounting policies affecting many other aspects of our business,
including rules relating to purchase and pooling-of-interests accounting for
business combinations, employee stock purchase plans and stock options grants,
have recently been revised or are under review. Changes to those rules or the
questioning of current practices may have a material adverse effect on our
reported financial results or on the way we conduct our business.
In addition, our preparation of financial statements in accordance with
GAAP requires that we make estimates and assumptions that affect the recorded
amounts of assets and liabilities, disclosure of those assets and liabilities at
the date of the financial statements and the recorded amounts of expenses during
the reporting period. A change in the facts and circumstances surrounding those
estimates could result in a change to our estimates and could impact our future
operating results.
Dependence on Key Personnel
Our future operating results depend substantially upon the continued
service of our executive officers and key personnel, none of whom are bound by
an employment or non-competition agreement. Our future operating results also
depend in significant part upon our ability to attract and retain qualified
management, manufacturing, technical, engineering, marketing, sales and support
personnel. Competition for such personnel is intense, and we cannot ensure
success in attracting or retaining such personnel. There may be only a limited
number of persons with the requisite skills to serve in these positions and it
may be increasingly difficult for us to hire such personnel over time. Our
business, financial condition and results of operations could be materially
adversely affected by the loss of any of our key employees, by the failure of
any key employee to perform in his or her current position, or by our inability
to attract and retain skilled employees.
Transition in Our Executive Management
We have experienced several transitions in executive management in recent
years. In conjunction with the departure in December 1998 of our former chairman
and chief executive officer, our Board of Directors appointed David A. Ranhoff,
executive vice president, and Dennis P. Wolf, executive vice president, chief
financial officer and secretary, jointly to the office of the president. The
Board also named a new chairman, Dr. William Howard, Jr., and began a search for
a new chief executive officer. Mr. Wolf joined us as senior vice president and
chief financial officer in March 1998 after the December 1997 departure of the
Company's previous chief financial officer. These transitions have placed
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<PAGE>
significant demands on our operational, administrative and financial staff and
we anticipate that these demands will increase in the near term. We cannot be
certain that such transitions will not have a material adverse effect on our
business, financial condition and results of operations, on the way we are
perceived by the market or on the price of our common stock.
International Sales
International sales accounted for approximately 77%, 69%, 70% and 67% of
our total net sales for the first quarter of fiscal 1999 and fiscal years 1998,
1997 and 1996, respectively. As a result, we anticipate that international sales
will continue to account for a significant portion of our total net sales in the
foreseeable future. These international sales will continue to be subject to
certain risks, including: o changes in regulatory requirements;
o tariffs and other barriers;
o political and economic instability;
o an outbreak of hostilities;
o integration of foreign operations of acquired businesses;
o foreign currency exchange rate fluctuations;
o difficulties with distributors, joint venture partners, original
equipment manufacturers, foreign subsidiaries and branch operations;
o potentially adverse tax consequences; and
o the possibility of difficulty in accounts receivable collection.
We are also subject to the risks associated with the imposition of
domestic and foreign legislation and regulations relating to the import or
export of semiconductor equipment. We cannot predict whether the import and
export of our products will be subject to quotas, duties, taxes or other charges
or restrictions imposed by the United States or any other country in the future.
Any of these factors or the adoption of restrictive policies could have a
material adverse effect on our business, financial condition or results of
operations. Net sales to the Asia Pacific region accounted for approximately
71%, 60%, 66% and 58% of our total net sales for the first quarter of fiscal
1999 and for the fiscal years 1998, 1997 and 1996, and thus demand for our
products is subject to the risk of economic instability in that region and could
continue to be materially adversely affected. Countries in the Asia Pacific
region, including Korea and Japan, have recently experienced weaknesses in their
currency, banking and equity markets. These weaknesses could continue to
adversely affect demand for our products, the availability and supply of our
product components, and our consolidated results of operations. The current
Asian financial crisis has contributed to a widespread uncertainty and a
slowdown in the semiconductor industry. This slowdown has resulted in reduced
spending on semiconductor capital equipment, including ATE, and has had, and may
continue to have, a material adverse effect on our product backlog, balance
sheet and results of operations.
We do not expect that the introduction and the use of the Euro will have
a material adverse effect on our business, financial condition or results of
operations.
Proprietary Rights
We attempt to protect our intellectual property rights through patents,
copyrights, trademarks, maintenance of trade secrets and other measures,
including entering into confidentiality agreements. However, we cannot be
certain that others will not independently develop substantially equivalent
intellectual property or that we can meaningfully protect our intellectual
property. Nor can we be certain that our patents will not be invalidated, deemed
unenforceable, circumvented or challenged, or that the rights granted thereunder
will provide us with competitive advantages, or that any of our pending or
future patent applications will be issued with claims of the scope we seek, if
at all. Furthermore, we cannot be certain that others will not develop similar
products, duplicate our products or design around our patents, or that foreign
20
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intellectual property laws or agreements into which we've entered will protect
our intellectual property rights. Inability or failure to protect our
intellectual property rights could have a material adverse effect upon our
business, financial condition and results of operations. We have been involved
in extensive, expensive and time-consuming reviews of, and litigation
concerning, patent infringement claims. In addition, we have at times been
notified that we may be infringing intellectual property rights of third parties
and we expect to continue to receive notice of such claims in the future.
In July, 1998, inTEST IP Corporation ("inTEST") alleged in writing that
one of our products is purportedly infringing a patent held by inTEST. We may
also be obligated to other third parties relating to this allegation. We are
currently investigating the allegation. Based in part on the opinion of outside
counsel, we believe we have meritorious defenses to the claims. However, we
cannot be certain of success in defending this patent infringement claim or
claims for indemnification resulting from infringement claims.
Certain of our customers have received notices from Mr. Jerome Lemelson
alleging that the manufacture of semiconductor products and/or the equipment
used to manufacture semiconductor products infringes certain patents issued to
Mr. Lemelson. We were notified by a customer in 1990 and by a different customer
in late 1994 that we may be obligated to defend or settle claims that our
products infringe Mr. Lemelson's patents, and that if it is determined that the
customer infringes Mr. Lemelson's patents, such customer intends to seek
indemnification from us for damages and other related expenses. We have not
received further communications from such customers regarding these matters.
We cannot be certain of success in defending current or future patent
infringement claims or claims for indemnification resulting from infringement
claims. Our business, financial condition and results of operations could be
materially adversely affected if we must pay damages to a third party or suffer
injunction or if we expend significant amounts in defending any such action,
regardless of the outcome. With respect to any claims, we may seek to obtain a
license under the third party's intellectual property rights. We cannot be
certain, however, that the third party will grant us a license on reasonable
terms or at all. We could decide, in the alternative, to continue litigating
such claims. Litigation has been and could continue to be extremely expensive
and time consuming, and could materially adversely affect our business,
financial condition or results of operations, regardless of the outcome.
Future Capital Needs; Leverage
Developing and manufacturing new ATE systems and enhancements is highly
capital intensive. In order to be competitive, we must make significant
investments in capital equipment, expansion of operations, systems, procedures
and controls, research and development and worldwide training, customer service
and support, among many other items. We may be unable to obtain additional
financing in the future on acceptable terms, or at all. In connection with our
issuance in September 1997 of convertible promissory notes ("the Notes"), we
incurred $115 million of indebtedness which resulted in a ratio of long-term
debt to total capitalization at January 31, 1999 of approximately 44%. As a
result, our principal and interest obligations have increased substantially. The
degree to which we are leveraged could materially adversely affect our ability
to obtain financing for working capital, acquisitions or other purposes and
could make our business more vulnerable to industry downturns and competitive
pressures. Our ability to meet debt service obligations will be dependent upon
our future performance, which will be subject to financial, business and other
factors affecting our operations, many of which are beyond our control. If we
raise additional funds by issuing equity securities, our stockholders could be
significantly diluted. We may exchange Notes for shares of our common stock or
may refinance or exchange the Notes, which may also dilute our stockholders and
may make it difficult for us to obtain additional future financing, if needed.
If we are unable to obtain adequate funds, we may be required to
restructure or refinance our debt or to delay, scale back or eliminate certain
of our research and development, acquisition or manufacturing programs. We may
also need to obtain funds through arrangements with partners or others and we
may be required to relinquish rights to certain of our technologies or potential
products or other assets.
21
<PAGE>
Year 2000 Readiness Disclosure
The "Year 2000" issue results from the use in computer hardware and
software of two digits rather than four digits to define the applicable year.
When computer systems must process dates both before and after January 1, 2000,
two-digit year "fields" may create processing ambiguities that can cause errors
and system failures. The results of these errors may range from minor undetected
errors to complete shutdown of an affected system. These errors or failures may
have limited effects, or the effects may be widespread, depending on the
computer chip, system or software, and its location and function. The effects of
the Year 2000 problem are exacerbated because of the interdependence of computer
and telecommunications systems in the United States and throughout the world.
Because of this interdependence, the failure of one system may lead to the
failure of many other systems even though the other systems are themselves "Year
2000 compliant."
Our Board of Directors has reviewed the Year 2000 issue generally and as
it may affect our business activity specifically. We are implementing a Year
2000 plan (the "Plan") which is designed to cover all of our activities and
which is monitored by the Board of Directors. We will modify the Plan as
circumstances change. Under the Plan, we are using a five-phase methodology for
addressing the issue. The phases are Awareness, Assessment, Renovation,
Validation and Implementation.
The Awareness phase consisted of defining the Year 2000 problem and
gaining executive level support and sponsorship for addressing it. We
established a Year 2000 program team and created an overall strategy. During the
Assessment phase, we inventoried all internal systems, products and supply chain
partners and prioritized each for renovation. We believe we have completed a
majority of the Awareness and Assessment phases; however, we will continue to
work in these areas as we complete our assessment of existing supply chain
partners and enter into new supply chain relationships in the ordinary course of
business. Renovation consists of converting, replacing, upgrading or eliminating
systems that have Year 2000 problems. We have begun Renovation on
mission-critical systems and have targeted completion for all but two systems by
March 31, 1999. The remaining two mission-critical systems are now scheduled for
completion of renovation by October 1999. Validation involves ensuring that
hardware and software fixes will work properly in 1999 and beyond and can occur
both before and after implementation. We began the Validation phase in late 1998
and will continue through June 1999 to allow for thorough testing before the
Year 2000. Implementation is the installation of Year 2000 ready hardware and
software components in a live environment.
The impact of Year 2000 issues on our business will depend not only on
corrective actions that we take, but also on the way Year 2000 issues are
addressed by governmental agencies, businesses and other third parties that
provide us with services or data or receive services or data from us, or whose
financial condition or operational capability is important to us. To reduce this
exposure, we have an ongoing process of identifying and contacting
mission-critical third party vendors and other significant third parties to
determine their Year 2000 plans and target dates. Risks associated with any such
third parties located outside the United States may be higher insofar as it is
generally believed that non-U.S. businesses may not be addressing their Year
2000 issues on as timely a basis as U.S. businesses. Notwithstanding our
efforts, we cannot be certain that we, mission-critical third party vendors or
other significant third parties will adequately address their Year 2000 issues.
We are developing contingency plans in the event that we,
mission-critical third party vendors or other significant third parties fail to
adequately address Year 2000 issues. Such plans principally involve identifying
alternative vendors or internal remediation. We cannot ensure that any such
plans will fully mitigate any such failures or problems. Furthermore, there may
be certain mission-critical third parties, such as utilities, telecommunication
companies, or material vendors for which alternative arrangements or sources are
limited or unavailable.
Although it is difficult for us to estimate the total costs of
implementing the Plan, our current estimate is that such costs will be
approximately $2.5 million through October 1999 and beyond. However, although we
believe that our estimates are reasonable, we cannot be certain, for the reasons
stated in the next paragraph, that the actual costs of implementing the Plan
will not differ materially from the estimated costs. We have incurred costs of
approximately $1.3 million through January 31, 1999 in connection with the Plan.
A significant portion of total Year 2000 project expenses is represented by
existing staff that have been redeployed to this project. We do not believe that
22
<PAGE>
the redeployment of existing staff will have a material adverse effect on our
business, results of operations or financial position. Nor do we expect
incremental expenses related to the Year 2000 project to materially impact
operating results in any one period.
For a number of reasons, we cannot predict or quantify the extent and
magnitude of the Year 2000 problem as it will affect our business, either before
or for some period after January 1, 2000. Among the most important reasons are:
o lack of control over systems used by third parties critical to our
operation;
o dependence on third party software vendors to deliver Year 2000
upgrades in a timely manner;
o complexity of testing inter-connected networks and applications that
depend on third party networks; and
o the uncertainty surrounding how others will deal with liability issues
raised by Year 2000 related failures.
For example, we cannot be certain that systems used by third parties will
be Year 2000 ready by January 1, 2000, or by some earlier date, so as not to
create a material disruption to our business. Moreover, the estimated costs of
implementing the Plan do not take into account the costs, if any, that might be
incurred as a result of Year 2000-related failures that occur despite our
implementation of the Plan.
Although we are not aware of any material operational issues associated
with preparing our internal systems for the Year 2000 or of material issues with
respect to the adequacy of mission-critical third party systems, we cannot
ensure that we will not experience material unanticipated negative consequences
and/or material costs caused by undetected errors or defects in such systems or
by our failure to adequately prepare for the results of such errors or defects,
including the costs of related litigation, if any. The impact of such
consequences could have a material adverse effect on our business, financial
condition or results of operations.
Volatility of Our Stock Price
We believe that factors such as announcements of developments related to
our business, fluctuations in our financial results, general conditions or
developments in the semiconductor and capital equipment industry and the general
economy, sales or purchases of our common stock in the marketplace,
announcements of our technological innovations or new products or enhancements
or those of our competitors, developments in patents or other intellectual
property rights, developments in our relationships with customers and suppliers,
or a shortfall or changes in revenue, gross margins or earnings or other
financial results from analysts' expectations or an outbreak of hostilities or
natural disasters, could continue to cause the price of our common stock to
fluctuate, perhaps substantially. In recent years the stock market in general,
and the market for shares of small capitalization companies in particular,
including ours, have experienced extreme price fluctuations, which have often
been unrelated to the operating performance of affected companies. For example,
in fiscal 1997, the price of our common stock ranged from a high of $55.00 to a
low of $13.75. In fiscal 1998, the price of our common stock ranged from a high
of $35.25 to a low of $9.31 and during the first three months of fiscal 1999,
the price of our common stock ranged from a high of $29.88 to a low of $13.69.
The market price of our common stock is likely to continue to fluctuate
significantly in the future, including fluctuations unrelated to our
performance.
Effects of Certain Anti-Takeover Provisions
Certain provisions of our Amended and Restated Certificate of
Incorporation, shareholders rights plan, equity incentive plans, Bylaws and of
Delaware law may discourage certain transactions involving a change in corporate
control. In addition to the foregoing, our classified board of directors, the
shareholdings of our officers, directors and persons or entities that may be
deemed affiliates, the adoption of a shareholder rights plan and the ability of
our Board of Directors to issue "blank check" preferred stock without further
stockholder approval could have the effect of delaying, deferring or preventing
a third party to acquire us and may adversely affect the voting and other rights
of holders of our common stock.
23
<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 Securityholders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index on page 26.
(b) The Company filed a report on Form 8-K on December 9, 1998
reporting its financial results for the fourth fiscal quarter
and fiscal year ended October 31, 1998 and reporting the
resignation of its Chairman and Chief Executive Officer.
(c) The Company filed a report on Form 8-K/A on December 11, 1998
to amend the December 9, 1998 Form 8-K, from which one page of
an exhibit was inadvertently omitted.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant duly caused this Report to be signed on its behalf by
the undersigned thereunto duly authorized.
CREDENCE SYSTEMS CORPORATION
-------------------------------------
(Registrant)
March 17, 1999 /s/ DENNIS P. WOLF
-------------- -------------------------------------
Date Dennis P. Wolf
Executive Vice President,
Chief Financial Officer and Secretary
25
<PAGE>
EXHIBIT INDEX
Exhibit
Number
27.1 EDGAR Financial Data Schedule
26
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF OPERATIONS, THE CONSOLIDATED BALANCE SHEETS, AND THE
ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000893162
<NAME> q#ygjp9a
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLAR
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> OCT-31-1999
<PERIOD-START> NOV-01-1998
<PERIOD-END> JAN-31-1999
<EXCHANGE-RATE> 1
<CASH> 58,343
<SECURITIES> 70,436
<RECEIVABLES> 42,505
<ALLOWANCES> 5,063
<INVENTORY> 35,141
<CURRENT-ASSETS> 208,154
<PP&E> 90,697
<DEPRECIATION> 50,067
<TOTAL-ASSETS> 290,353
<CURRENT-LIABILITIES> 30,386
<BONDS> 115,000
0
0
<COMMON> 21
<OTHER-SE> 144,776
<TOTAL-LIABILITY-AND-EQUITY> 290,353
<SALES> 26,490
<TOTAL-REVENUES> 26,490
<CGS> 15,276
<TOTAL-COSTS> 15,276
<OTHER-EXPENSES> 21,234
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,690
<INCOME-PRETAX> (10,321)
<INCOME-TAX> (3,729)
<INCOME-CONTINUING> (6,554)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,554)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
</TABLE>
