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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended October 31, 1998
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
215 Fourier Avenue, Fremont, California 94539
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (510) 657-7400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered
-------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
Preferred Stock Purchase Rights
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 [_]
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
The aggregate market value of voting stock held by non-affiliates of
the Registrant, as of January 20, 1999 was approximately $250,141,176 (based
upon the closing price for shares of the Registrant's common stock as reported
by the Nasdaq National Market for the last trading date prior to that date).
Shares of common stock held by each officer, director and holder of 5% or more
of the outstanding common stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
On January 20, 1999, approximately 20,446,311 shares of the Registrant's
common stock, $0.001 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 1999 Annual Meeting of
Stockholders to be held on March 24, 1999 are incorporated by reference into
Part III.
1
PART I
ITEM 1. BUSINESS
Credence Systems Corporation designs, manufactures, sells and services
automatic test equipment ("ATE") used for testing semiconductor integrated
circuits ("ICs"). The Company also develops, licenses and distributes related
software products. The Company serves a broad spectrum of the semiconductor
industry's testing needs through a wide range of products that test digital
logic, mixed-signal and non-volatile memory semiconductors. Credence utilizes
its proprietary technologies to design products intended to provide a lower
total cost of ownership than competing products while meeting the increasingly
demanding performance requirements of today's ATE market. The Company's products
are primarily designed to test semiconductors that are produced in high volume.
The Company's customers include major semiconductor manufacturers as well as
assembly and test services companies.
Credence was incorporated in California in March 1982 to succeed to the
business of a sole proprietorship and was reincorporated in Delaware in October
1993. The term "Credence" or the "Company" includes, when the context so
requires, Credence Systems Corporation, and its subsidiaries, including Fluence
Technology, Inc. ("Fluence"), formerly named Test Systems Strategies, Inc. (a
Delaware corporation), which the Company formed to acquire certain assets from
Test Systems Strategies, Inc. and its parent, Summit Design Inc., (the "Summit
Acquisition") in July 1997. It also includes certain fault simulation and test
program development products of Zycad Corporation ("Zycad"), which the Company
acquired in August 1997 (the "Zycad Acquisition"), and the memory test business
assets acquired from Heuristics Physics Laboratories, Inc. ("HPL") on June 1,
1998. 1
Background
- ----------
Dramatic advances in semiconductor process technology have improved the
performance and lowered the average selling prices ("ASPs") of semiconductor
devices (semiconductors) to levels that now support their use in a wide range of
office, consumer, automotive, communications, industrial and other products. In
order to maintain or improve gross margins as semiconductor ASPs decline,
semiconductor manufacturers are constantly seeking ways to reduce manufacturing
costs.
Testing is a principal element in the cost structure of high volume
production of semiconductors. As a result of improved efficiencies in wafer
fabrication, test costs have become a higher percentage of the total cost of
manufacturing. This shift in cost structure has changed the traditional criteria
for selection of ATE. Although performance was the dominant factor in the
selection of ATE in the past, the Company believes that economic considerations
have assumed much greater importance to semiconductor manufacturers. Purchasers
of ATE now examine more carefully the total cost of ownership of ATE. Total cost
of ownership includes the initial purchase price of the tester, as well as the
tester's reliability, flexibility, size, power and air conditioning
requirements, upgrade-ability and maintenance costs, including spare parts.
Traditionally, semiconductor die were minimally tested at wafer probe and
underwent rigorous performance testing to full specification only at the
completion of final packaging. Today, assembly and packaging have become
increasingly expensive compared with the cost of the die, such that their costs
may exceed the cost of the die itself. This trend has influenced semiconductor
manufacturers to shift performance testing increasingly toward wafer probe. By
subjecting devices to performance testing earlier in the manufacturing process,
defective die are detected and eliminated before assembly and packaging costs
are incurred.
Increased facility costs and the trend toward performance testing at
wafer probe have led to the increased importance of smaller testers in the
semiconductor manufacturing process. Performance testing at wafer probe requires
that the device under test be located in close physical proximity to the
measuring circuits of the tester in order to minimize potential signal
distortions that can negatively impact testing yields. Smaller testers can more
easily be placed in close physical proximity to such circuits. In addition,
- ----------
1 "Credence Systems Corporation," "Credence", "SC212," "ValStar," "Quartet,"
"Quartet One," "MemBIST," "Triton," "EPRO," "BOST," "Kalos," and "DUO" are
trademarks of the Company. This Annual Report on Form 10-K also includes
trademarks of other companies.
2
wafer probe test typically occurs in a clean room where potential contaminants
must be continually removed and temperatures kept constant. These special
maintenance requirements make clean rooms expensive to operate. Smaller testers
occupy less floor space and therefore assist in reducing clean room costs. In
addition, smaller testers that consume less power generally have reduced air
conditioning requirements.
For over 20 years, emitter-coupled logic ("ECL") has been the
conventional process technology used by the Company and others for the ICs used
in ATE due to its speed, repeatability and precision. ECL technology, however,
results in low functionality per chip and requires continuous power. As a
result, conventional ATE systems generally are large, expensive and require
significant electrical power to operate.
Another process technology commonly used in the manufacture of
semiconductors is complementary metal oxide semiconductor ("CMOS"). As compared
to ECL, CMOS technology allows higher functionality for a given chip size and
requires less power to operate. Some ATE manufacturers use a combination of ECL
and CMOS to lower the cost of ATE by reducing the use of ECL.
The production of ATE based exclusively on CMOS technology, however, had
been limited by the inability of CMOS to meet the timing and measurement demands
of semiconductor testing. Although the speed of CMOS was acceptable, its timing
stability was not. This problem results from the tendency of CMOS circuits to
experience timing drift as a function of temperature and voltage variation
during tests. To fully benefit from the economic and other advantages of CMOS
technology, the challenge has been to control this drift characteristic in order
to produce semiconductors for ATE that meet the performance requirements of
semiconductor testing.
The Credence Solution and Strategy
- ----------------------------------
Credence has developed proprietary CMOS stabilization methods that
minimize the drift characteristic of CMOS and enable the Company to produce
testers that are smaller and require less power than those based upon ECL
technology and that are intended to provide a lower total cost of ownership than
many competing products currently available while meeting the performance
demands of today's ATE market. CMOS technology allows the circuits used in
Credence's testers to be reduced, or "scaled" down in size as IC process
technology improves, resulting in higher performance and freeing space on the
die for additional functionality. This scalability feature enables the Company
to develop and manufacture smaller, higher performance ICs for use in its
testers at what Credence believes to be a lower cost, and with a potentially
shorter development cycle, than traditional process technologies.
Credence's objective is to be the leading supplier of cost-effective ATE
for production testing of ICs used in high volume applications. The Company's
business strategy incorporates the following key elements:
o Technology Leadership. The Company believes that its proprietary CMOS
stabilization technology enables the development of ATE that is
designed to meet the performance and cost of ownership requirements
of semiconductor manufacturers and assembly and test services
companies. In addition, the Company believes the scalability of this
technology will allow it to offer new products and enhancements in a
potentially shorter time and at a lower cost than many of its
competitors that base their products on traditional less-scalable
architecture.
o Lower Total Cost of Ownership. The Company seeks to provide ATE to
its customers at a lower total cost of ownership than many competing
products currently available while meeting the performance
requirements of its customers. The Company believes that the system
price, reliability, flexibility, size, power and air conditioning
requirements, upgradeability and maintenance costs, including spare
parts, of its testers enable its customers to more cost effectively
test ICs. Credence's proprietary CMOS stabilization technology is
integral to the successful implementation of this strategy.
o Diverse, High-Volume Markets. Credence's products target the testing
of digital logic, mixed-signal and non-volatile memory devices that
are used in a broad range of growing end-user market segments. The
Company's products are designed to test semiconductors that are
manufactured in high volume and are used in a variety of
applications such as automobiles, appliances, personal computers,
personal communications products, networking products, digital
televisions and multimedia hardware.
3
o Worldwide Technical Support and Customer Service. As semiconductor
manufacturers expand their operations worldwide, they require that
their ATE suppliers have the capability to provide global support and
service and training. To meet this requirement, Credence utilizes a
combination of direct sales, service and support personnel and a
broad network of independent distributors located in close proximity
to major customer sites. Credence and its distributors currently
maintain locations throughout the world to service and support
Credence's customers.
o Reduce Time-to-Market. The Company believes that its customers
require increasing levels of sophisticated software tools to assist
in the utilization of ATE that minimizes time-to-market. The Company
is focusing its software efforts on internal development of, and
acquisition of companies or businesses, that develop such tools.
Through its Fluence subsidiary, the Company has acquired the test
development series ("TDS") and TDX products lines, from Summit
Design, Inc. and Zycad, respectively, and has non-exclusive worldwide
distribution rights for the Analog Test and Analog BIST (built-in
self-test) products of Opmaxx, Inc. ("Opmaxx"). In addition, through
the acquisition of certain assets of HPL, th Company obtained an
array of memory BIST and related in-process software products. This
is expected to add significant market opportunities in the next two
years. The Company believes it is ideally positioned to capitalize
on the "Design-to-Test" and the "Design-for-Test" markets with its
new broad-based software product lines that integrate design and
test.
Products
- --------
Credence currently offers a wide variety of products that test digital
logic, mixed-signal and non-volatile memory ICs. Digital logic semiconductors
produce discrete "on" and "off" logical sequences that control functions, store
data, retrieve data and move and manipulate data at high rates of speed. An
example of digital logic semiconductors include logic devices such as
microcontrollers. Certain digital devices which store and retrieve data are
memory semiconductors. Non-volatile memory semiconductors retain their data when
the power is turned off. Mixed-signal semiconductors combine both digital and
analog functions. Analog semiconductors control external functions such as
sound, graphics, and motor controls by producing continuous varying voltage or
current. When these analog functions are combined onto a digital integrated
circuit, the resulting device is considered a mixed-signal device.
The Company's CMOS-based ATE products - the SC,Valstar, DUO and Quartet
series - are designed to test high speed devices used in applications such as
networking and personal computing as well as multimedia, digital television,
high-definition television and personal communications. The Company's memory
products Kalos, EPRO 142 and BTMA test non-volatile memory ("NVM") devices,
including ROM, EPROM, EEPROM and Flash memories used in high volume applications
in the consumer, automotive and telecommunications markets. During 1997, the
Company introduced the ValStar 2000, a system which enables the testing of very
complex devices, up to 1024 pins with high speed requirements. Also introduced
was the Kalos Flash memory test system, a highly integrated parallel system that
provides multi-site testing and is designed to lower the overall cost of test.
During fiscal 1998, the Company introduced the Quartet series. The
Quartet, a new system which is compatible with DUO, provides the enhanced
capabilities required to test consumer mixed signal products with 200 MHz I/O,
20 bit analog, video, and radio frequency ("RF") input and output. Quartet
directly addresses the cost sensitive needs of consumer related system-on-a-chip
("SOC") devices.
During fiscal 1997, the Company acquired two software products lines: the
Test Development Series ("TDS") product line in the Summit Acquisition and the
Test Design eXpert ("TDX") product line in the Zycad Acquisition. TDS converts
simulation waveform data and modifies it under user control to generate test
programs for use on ATE. TDX grades and generates test vector sets, and provides
other tools that enhance design testability.
During fiscal 1998, the Company acquired the MemBIST products from HPL.
The MemBIST products generate built-in self-test logic for embedded memories. In
addition, a sales representative agreement was signed between Opmaxx and
Fluence. The Opmaxx products are targeted at analog and mixed signal design and
test applications.
The following table sets forth the Company's current product offerings,
their features and examples of typical devices tested by each product. Included
in certain of the basic features are the anticipated cycle speed in megahertz
("MHz"), timing accuracy in either picoseconds ("ps") or nanoseconds ("ns"), the
number and characteristics of the pins and the density in megabits ("Mb") of the
device that can be tested:
4
- -------------- --------------- -------------- -------------------------------- ------------------------------------
Product Series Models Basic Features Typical Devices
- -------------- --------------- -------------- -------------------------------- ------------------------------------
SC SC 312 50 - 100 MHz Microcontrollers, ASSPs, DSPs and
SC Micro 64 - 304 Pins FPGAs
+ 350-500 ps accuracy
--------------- -------------- -------------------------------- ------------------------------------
ValStar VS2000 200 MHz Microprocessors, RISC circuits,
Digital + 200 ps accuracy PLDs, FPGAs, ASICs and ASSPs
512-1024 Pins
-------------- -------------------------------- ------------------------------------
VS2000e 200 MHz Microprocessors, RISC circuits,
+ 200 ps accuracy PLDs, FPGAs, ASICs and ASSPs
512-1024 Pins
- -------------- --------------- -------------- -------------------------------- ------------------------------------
DUO DUO DUO-SE - 50 MHz Multimedia devices, mass storage,
DUO-SE DUO - 100 MHz DSPs, ASICs, Datacom and specialty
DUO-SX DUO-SX- 200 MHz devices, mobile communication
DUO-RF DUO-RF-50-100 MHz devices, complex audio devices
Mixed- --------------- -------------- -------------------------------- ------------------------------------
Signal Quartet ONE 512 digital Multimedia devices, mass storage,
200 MHz DSPs, ASICs, Datacom and specialty
+ 175 ps accuracy devices, mobile communication
Analog, Video, Audio, RF devices, complex audio devices
- -------------- --------------- -------------- -------------------------------- -------------------------------------
EPRO 142/AX 10-50 MHz ROM, EEPROM, EPROM, and Flash
KALOS 256Mb memories
Personal Kalos + 1ns
--------------- -------------- -------------------------------- ------------------------------------
Memory BTMA 2001 Benchtop Memory Analysis and ROM, EEPROM, EPROM, Flash and SRAM
Products 2555 Verification Testers
2555A
--------------- -------------- -------------------------------- ------------------------------------
BOST "Built-Off Self-Test" Processors, graphics engines,
Embedded memory test ASIC's and other multimedia devices
External solution for digital
and mixed signal devices
- -------------- --------------- -------------- -------------------------------- ------------------------------------
Logic SC Series tester integrated Microcontrollers, ASSPs and FPGAs
into 8" wafer prober, without
Workcell Triton extending outside the prober
perimeter
-------------- -------------------------------- ------------------------------------
Memory Kalos tester integrated into 8" ROM, EEPROM, EPROM, and Flash
wafer prober, without extending memories
outside the prober perimeter
- -------------- --------------- -------------- -------------------------------- ------------------------------------
TDS Tools Design Test Generates tester specific Tools apply to digital logic devices
programs
Verifies timing specifications
--------------- -------------- -------------------------------- ------------------------------------
TDX Tools Design Test Verifies test vector quality Tools apply to digital logic devices
Supports design for test
strategies
--------------- -------------- -------------------------------- ------------------------------------
Software HPL Memory BIST Generates built-in self-test Tools apply to all memory devices
(BIST) logic. Partitioned
solutions using BIST, ATE, and
built-off self-test (BOST)
--------------- -------------- -------------------------------- ------------------------------------
Opmaxx* DesignMaxx Design verification and Tools apply to analog and
Design, Test FaultMaxx sensitivity analysis, design mixed-signal devices
TestMaxx fault coverage, test evaluation
and optimization
--------------- -------------- -------------------------------- ------------------------------------
Opmaxx* BISTMaxx Built-in self-test (BIST) Tools apply to analog and
Analog BIST generation for analog and mixed-signal devices
mixed-signal devices
- -------------- --------------- -------------- -------------------------------- ------------------------------------
* The Opmaxx products are not owned by the Company, but are licensed pursuant to
a sales representative agreement.
5
Digital Products
----------------
SC. The model SC 212 was first shipped in 1992 and incorporates one of
the Company's proprietary CMOS stabilization methods. This product requires
approximately 30 square feet of floor space and 4 kilowatts of power for 304
pins. The SC Micro is a cost-reduced version of the SC 212. This system offers
the Company's customers a full capability test system at a price as low as
$2,000 per digital pin channel. This per channel price has previously been
available only in test systems with reduced functionality - requiring users to
compromise the quality of their device testing. The SC Micro retains the
customer's test quality while continuing to lower its test costs. In 1997 the
Company expanded the SC series by introducing and shipping the SC 312, which
runs at a higher speed (100 MHz) and has improved accuracy over the SC 212. The
purchase price of these testers typically ranges from $350,000 to $850,000
depending upon configuration.
ValStar. The VS2000 was introduced in 1997 and the Company believes it is
the first system designed specifically with the desired performance cost
structure for volume production of high pin count VLSI devices. This product
offers up to 1,024 input/output ("I/O") pins at 200 MHz data rates, and requires
less than four square meters of floor space. A fully loaded system consumes only
16 kilowatts of power, which is generally less than many competitive systems,
thus lowering operating costs. The purchase price of the VS 2000 typically
ranges from $1,000,000 to $3,600,000 depending on configuration The latest
system in the ValStar line up was introduced in 1998. Unlike the VS2000, the
VS2000e uses a customer specific external testhead positioner. The purchase
price of the VS2000e typically ranges from $1,000,000 to $3,600,000 depending on
configuration.
Mixed-Signal Products
---------------------
Quartet. Quartet is the Company's new high performance mixed-signal
product series. First introduced in 1998, Quartet builds on the Duo series by
addressing the needs of device manufacturers serving the Consumer-Mixed-Signal
("CMS") marketplace. CMS devices combine the power of digital processors with CD
quality audio, broadcast video and wireless communications onto a single, cost
sensitive system-on-a-chip ("SOC"). The Quartet One, the first of the Quartet
Series, addresses all four of these requirements in an integrated, ready for
volume production package. With 200 MHz digital, 20 bit audio, 300 MHz video and
6GHz RF, Quartet One is designed to meet the needs of the most complex SOC
devices. With typical system prices between $750,000 and $2,000,000, the Quartet
provides the low cost of test required by the CMS market.
Duo. The Duo Series is the Company's proven solution for high volume
mixed-signal testing. With over 200 systems in the field, Duo has become a
mainstream solution for both Integrated Device Manufacturers and the
Semiconductor Manufacturing Service companies. The typical purchase price of the
Duo ranges from $600,000 to $1,500,000.
Memory Products
---------------
EPRO. The Company's EPRO memory product line includes the model 142/AX.
The model 142/AX was first shipped by EPRO in 1982. The purchase price of these
non-volatile memory testers typically ranges from $30,000 to $80,000, depending
upon configuration.
KALOS. Introduced in November 1997, the Kalos is a highly integrated,
parallel system designed to test flash memory. Running at 50 MHz, it provides
multi-site testing and is designed to lower the customer's cost of test. The
Kalos features a unique tester-on-a-card architecture, which places all test
functions for each site on a single card and thus reduces floor space and power
consumption while increasing performance. The typical purchase price of the
Kalos ranges from $400,000 to $800,000.
Personal Kalos. Personal Kalos is a desktop engineering version of the
high-throughput Kalos tester. The typical price for a Personal Kalos ranges from
$100,000 to $120,000.
BTMA. The 2001, 2555 and 2555A are NVM engineering testers focused on the
lab environment. Acquired from HPL in 1998, the BTMA line is designed to be
usable by design engineers and other non-test specialists to debug and
characterize NVM designs and yield problems. The BTMA software user interface
makes it the premier platform for this function. The purchase price for these
testers typically ranges from $50,000 to $250,000.
6
BOST. Built-Off Self-Test ("BOST") technology is a new element in
transforming the role of test from an expensive and passive device validation
procedure into a series of solutions that can shrink development cycles, reduce
costs, meet time-to-market demands and improve die yields. BOST integrates a
device specific Built-In Self-Test ("BIST") engine directly into a custom
circuit on the load board. Consulting services for BOST memory testing are
available today and pricing is dependent on configuration.
Workcell Products
-----------------
In 1996, the Company established the Workcell product group. A Workcell
enhances manufacturing productivity by integrating previously distinct equipment
into a single, highly efficient tool. In 1997, the Company debuted its
sophisticated Triton series of wafer test systems. Triton Logic and Triton
Memory - the industry's first suite of Workcell wafer test solutions - feature a
production worthy wafer prober integrated with a robust ATE test system.
Triton Logic. This is a complete wafer probing Workcell in one of the
industry's smallest packages for use in volume production environments for
microcontrollers and other embedded controller devices with heavy logic demands.
The Triton Logic centralizes all operator functions and eliminates the
unnecessary duplication of manipulators, monitors and keypads previously
associated with separate testers and probers. A 100 MHz Final Test at Probe test
system, the Triton is capable of matching the performance of package test at the
wafer level.
Triton Memory. Leveraging Credence's tester-on-a-card architecture,
Triton Memory tests as many as 16 sites in parallel at speeds of 50 MHz. All
functions required to test a Flash memory device appear on one card. An
inherently parallel, high-performance system that improves throughput rates, the
Triton Memory tests each device asynchronously from one another - while embedded
within an 8" wafer prober. The tester is an integral part of the prober's
structure, eliminating independent vibrations associated with current interface
concepts. The typical price of a Triton memory ranges from $450,000 to
$1,300,000.
Software Products
-----------------
Software products provide tools to IC manufacturers to help create
detailed tests that ensure product quality and shorten time-to-market.
TDS. The TDS product line consists primarily of Converter, Conditioner,
and WaveBridge products. Converters take waveform data from simulator-specific
representations into an industry-standard representation. Conditioners modify
waveform data to enable it to fit specific tester environments. WaveBridge
modules generate the actual test programs. Converters are available to support
most commonly used simulators, and WaveBridge modules are available for a
variety of ATE models. Other programs that analyze waveform data and provide
other design-to-test functions are also included in the TDS product line.
TDX. The TDX product line allows the design engineer to verify complex
designs with full timing accuracy, Iddq, pattern generation, scan generation and
testability analysis.
MemBIST. MemBIST software generates built-in self-test logic for designs
that use embedded memories. The software minimizes the test time and chip area
required for self-test logic of embedded memories. Users can also designate
varying levels of detail for the diagnostic information to be produced by the
BIST logic, from simple "pass/fail" to topologically correct bitmaps that can be
used in failure analysis.
Opmaxx. The Opmaxx product line provides a full set of software tools for
testing analog and mixed signal devices, as well as designing them for
testability. DesignMaxx provides analog design optimization, verification, and
sensitivity analysis. FaultMaxx evaluates analog/mixed-signal fault coverage and
fault-grades test stimulus. TestMaxx evaluates and optimizes analog/mixed-signal
tests. BISTMaxx generates built-in self-test for analog/mixed signal device
functionality, both on-chip and off-chip.
7
Customers, Markets and Applications
- -----------------------------------
Credence targets digital logic, mixed-signal, non-volatile memory device
and system-on-a-chip manufacturers that serve a broad range of growing end-user
market segments. These customers manufacture semiconductors in high volume for
use in applications such as automobiles, appliances, personal computers,
personal communications products, networking products, digital televisions and
multimedia hardware.
In addition to marketing its products to major semiconductor
manufacturers, the Company has developed relationships with numerous assembly
and test services companies. Semiconductor manufacturers and fabless
semiconductor companies increasingly utilize these subcontractors as a means of
lowering their fixed production costs, thus minimizing the effects of
cyclicality inherent in the semiconductor industry. As a result, these assembly
and test services companies have become an increasingly important segment of the
ATE market.
The Company believes that its success depends in large part upon the
success of its major customers. The loss of or any reduction in orders by a
significant customer (including the potential for reductions in orders by
assembly and test services companies which that customer may utilize), including
reductions due to market, economic or competitive conditions in the
semiconductor industry or in other industries that manufacture products
utilizing semiconductors has adversely affected, and may continue to adversely
affect, the Company's business, financial condition or results of operations.
The Company's ability to increase its sales in the future will depend in part
upon its ability to obtain orders from new customers as well as upon the
financial condition and success of its customers and the general global economy.
There can be no assurance that the Company's sales will not decrease in the
future or that the Company will be able to retain existing customers or to
attract new ones.
For information on the Company's geographic data and major customers, see
Note 4 to the consolidated financial statements included elsewhere herein. The
Company's international sales are primarily denominated in United States
dollars. The Company anticipates that its international business will continue
to account for a significant portion of net sales in the foreseeable future.
The Company schedules production of its systems based upon order backlog
and order forecast. The Company includes in its backlog only those customer
orders for systems (including upgrades) for which it has accepted purchase
orders and assigned shipment dates within the following twelve months. The
majority of the Company's orders are subject to cancellation or rescheduling by
the customer with limited or no penalties. The Company's backlog at any
particular date may not necessarily be representative of actual sales for any
succeeding period due to orders received for systems to be shipped in the same
quarter, possible changes in system delivery schedules, cancellation of orders
and potential delays in system shipments. As of October 31, 1998, the Company's
order backlog for systems (exclusive of orders for spare parts and service and
support) was approximately $ 32.3 million, as compared with $97.5 million as of
October 31, 1997.
Sales, Service and Support
- --------------------------
The Company currently markets and sells its products in the United States
principally through its direct sales organization, with direct sales employees
and representatives in over 16 locations. Outside the United States, the Company
utilizes both direct sales employees and a broad network of distributors, with
direct sales employees and distributors in over 15 countries. Sales through
distributors represented approximately 45%, 36% and 36% of net sales during
fiscal years 1998, 1997 and 1996, respectively.
The Company and its distributors have sales and support centers located
in the United States, Europe, Israel, and throughout Asia from which both direct
Credence personnel and independent sales and service representatives sell and
support the equipment. The Company believes that field support is critical to
its customers. Support encompasses many of the components of the total cost of
ownership for ATE. Credence seeks to develop long-term relationships with major
ATE customers through extensive support consisting of teams of professional
sales, applications, training and service personnel. These personnel are located
in close physical proximity to key customer sites in order to provide the
required support in a timely fashion. The sales process includes consultations
with customers to help them purchase the most cost-effective equipment for their
needs, to help develop custom test programs to optimize production throughput,
to assist in long-term self-sufficiency through training of customer test
engineering personnel and to provide the service capacity and preventive
8
maintenance to reduce downtime for customers' systems. Customer support includes
field personnel and in-house applications personnel who work closely with design
engineering groups to modify existing equipment to meet the latest performance
requirements.
In Japan, a wholly-owned subsidiary of the Company provides sales and
service to its customers. In addition, the Company has a relationship with
Innotech, Corporation ("Innotech"), a distributor of the Company's products in
Japan. In 1997 the Company formed a joint venture with Innotech to engage in the
customization and manufacture of ATE products for sale by both companies. In
March 1996, the Company established a service and support subsidiary in Korea.
The Company also has a relationship with Itek, Inc., a distributor of the
Company's products in Korea.
The Company's standard policy is to warrant its new systems against
defects in design, materials and workmanship for one year for parts and labor.
The Company offers its customers additional support after the warranty period in
the form of maintenance contracts for specified time periods. Such contracts
include various options such as board replacement, priority response, planned
preventive maintenance, scheduled one-on-one training, daily on-site support and
monthly system and performance analysis.
Research and Development
- ------------------------
The ATE market is subject to rapid technological change and new product
introductions. The Company's ability to be competitive in this market will
depend in significant part upon its ability to successfully develop and
introduce new products, enhancements and related software tools on a timely and
cost-effective basis. This will enable customers to integrate such products into
their operations as they begin volume manufacturing of the next generation of
semiconductors.
Credence has pursued a technology acquisition strategy to complement its
internal research and development efforts. In 1988, the Company completed its
acquisition of Axiom Technology Corporation, which added mixed-signal testing
capability. In 1989, the Company completed its acquisition of ASIX Systems
Corporation ("Asix"), which added one of its proprietary CMOS stabilization
methods. In 1990, the Company acquired the STS Division of Tektronix
Inc.("Tektronix"), which added a second proprietary CMOS stabilization method.
In 1993, the Company acquired various patents from Tektronix. In March 1995, the
Company acquired EPRO, which added non-volatile memory testing capability. In
July 1997, the Company acquired the test development software assets through the
Summit Acquisition. In August 1997, the Company acquired the fault simulation
and test program development products of Zycad, and in June 1998, the Company
purchased certain assets and assumed certain liabilities relating to the memory
test business of HPL.
Each of the stabilization methods acquired by Credence provides a
different solution to the tendency of CMOS to experience timing drift as a
function of temperature and voltage variation. The first proprietary solution
uses a timing phase detection circuit combined with a voltage control mechanism
to compensate for thermal, voltage and process drift. The second uses a unique
combination of counters and heating circuits to provide stability through
thermal means. These methods allow the Company's CMOS-based ICs to achieve the
timing repeatability necessary to meet the performance requirements of ATE and
to realize the economic and other advantages of CMOS technology over ECL
technology. CMOS circuits use less space than those based on ECL as the circuits
require less power and can be more closely packed together.
During 1998, the Company enhanced its Duo product line with new
capabilities including high performance audio testing, testing of analog
circuitry for wireless communication applications and embedded memory test
capability. These features enable single insertion system-on-a-chip testing
capability. The Company will continue to focus research and development efforts
on ensuring that its products have the ability to efficiently test
state-of-the-art customer devices which combine analog, high speed digital
logic, and memory on a single circuit.
Credence's ongoing research and development efforts also include focusing
on increased cycle speed, accuracy and pin counts of its testers. In addition,
the Company is working on a software development program that is intended to
provide for upward compatibility through the Company's products. Credence will
also continue to focus efforts on providing software solutions which allow more
rapid, cost-effective development of ATE test programs which reduce
time-to-market of customer integrated circuit designs. The Company currently
intends to continue to invest significant resources in the development of new
products and enhancements for the foreseeable future.
9
Research and development ("R&D") expenses were $47.5 million (excluding a
$2 million charge for acquired in-process R&D), $37.4 million (excluding a $6
million charge for acquired in-process R&D), and $35.4 million in fiscal 1998,
1997 and 1996, respectively.
Proprietary Rights
- ------------------
The Company currently holds 34 United States patents, which expire over
time through April 2017. In addition, the Company currently has 12 foreign
patents, which expire over time through September 2011. The two United States
patents acquired from Asix and Tektronix underlying the Company's proprietary
CMOS stabilization methods expire in February 2007 and December 2007,
respectively.
The Company has granted a license to Tektronix with respect to patents
obtained in the acquisition of the STS Division of Textronix, and certain other
intellectual property rights (collectively, the "Tektronix Rights"), including a
patent covering one of the Company's proprietary CMOS stabilization
technologies, that were assigned to the Company by Tektronix in 1993. Tektronix
has a worldwide, perpetual, irrevocable, non-exclusive, royalty free,
fully-paid, sublicensable and transferable license to the Tektronix Rights.
Tektronix may not grant rights under the Tektronix Rights to make, use, sell or
otherwise distribute ATE for testing ICs to any entity other than
Sony-Tektronix, a Tektronix joint venture affiliate that does not currently
offer production ATE, and to a successor-in-interest to Tektronix. Tektronix may
not grant or assign such rights to any other party that is a Credence
competitor. In addition, Tektronix may not knowingly sell components
incorporating the Tektronix Rights to any other party. The Company and Tektronix
have granted to each other a worldwide, perpetual, irrevocable, non-exclusive,
royalty free, fully-paid, sublicensable and transferable license to all
improvements, enhancements, modifications or derivative works created before
August 1996 ("Improvements") of intellectual property that was licensed or
assigned pursuant to a Technology Agreement dated December 31, 1990, as amended
on August 12, 1993, including the Tektronix Rights, to make, use and sell ATE
for testing ICs. Tektronix's license to the Improvements is subject to the same
restrictions as its license to the Tektronix Rights.
The Company attempts to protect its intellectual property rights through
patents, copyrights, trademarks and maintenance of trade secrets and other
measures. There can be no assurance that others will not independently develop
equivalent intellectual property or that the Company can meaningfully protect
its intellectual property. There can be no assurance that any patent owned by
the Company will not be invalidated, circumvented or challenged, that the rights
granted thereunder will provide competitive advantages to the Company or that
any of the Company's pending patent applications will be issued. Furthermore,
there can be no assurance that others will not develop similar products,
duplicate the Company's products or design around the patents owned by the
Company. In addition, litigation has been and may continue to be necessary 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. For additional information with respect to the Company's
intellectual property, review the information set forth under "Risk
Factors-Proprietary Rights."
Manufacturing and Suppliers
- ---------------------------
The Company's manufacturing objective is to produce ATE that conforms to
its customers' requirements at the lowest commercially practical manufacturing
cost. Credence relies on outside vendors to manufacture certain components and
subassemblies including several custom integrated circuits. The Company seeks to
manage its inventory levels through agreements with both suppliers and
subcontractors that provide just-in-time delivery of these components and
subassemblies. The Company assembles these components and subassemblies to
create finished testers in the configuration specified by its customers. In
general, Credence uses standard components and prefabricated parts available
from numerous suppliers. However, certain components and subassemblies necessary
for the manufacture of the Company's testers are obtained from a sole supplier
or a limited group of suppliers and the Company is in the process of qualifying
a second source for some of those components. There can be no assurance that
such alternative source will be qualified or available to the Company. The
Company's reliance on a sole or a limited group of suppliers and on outside
subcontractors involves certain risks, including a potential inability to obtain
an adequate supply of required components, and reduced control over pricing and
timely delivery of components. See "Risk Factors - Limited Sources of Supply;
Reliance on Sub-contractor."
10
Competition
- -----------
The ATE industry is intensely competitive. Credence faces substantial
competition throughout the world, primarily from ATE manufacturers located in
the United States, Europe and Japan, as well as from certain of its customers.
The Company's competitors in the digital semiconductor testing market include
Advantest Corporation ("Advantest"), Ando Electric Co., Ltd., LTX Corporation
("LTX"), Schlumberger Ltd. ("Schlumberger"), Hewlett-Packard Company ("HP") and
Teradyne, Inc. ("Teradyne"). In the mixed-signal semiconductor testing market,
the Company's competitors include Teradyne, LTX, HP, Schlumberger, and
Advantest. In the non-volatile memory testing market the Company's competitors
include Teradyne, HP and Advantest. See "Risk Factors - Highly Competitive
Industry."
The principal elements of competition in the Company's markets and the
basis upon which ATE customers select testers include throughput, tools for
reducing customer product time-to-market, product performance and total cost of
ownership. The Company believes that it competes favorably with respect to these
factors.
Employees
- ---------
As of October 31, 1998, the Company had a total of 646 employees,
including 160 engaged in manufacturing, 167 in research and development, 60 in
applications, 175 in sales, marketing and service, and 84 in general
administration. Many of the Company's employees are highly skilled, and the
Company believes its future results of operations will depend in large part on
its ability to attract and retain such employees. None of the Company's
employees are represented by a labor union, and the Company has not experienced
any work stoppages. The Company considers its employee relations to be good.
RISK FACTORS
Fluctuations in Our Quarterly Net Sales and Operating Results
- -------------------------------------------------------------
[ GRAPH SHOWING THE COMPANY'S NET SALES AND QUARTERLY NET INCOME (LOSS) ]
[ FOR THE THREE FISCAL YEARS ENDED OCTOBER 31, 1998, IN $ MILLIONS. ]
A variety of factors affect our 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
capital equipment industry specifically;
o timing of new product announcements and new product releases by us
or our competitors;
11
o market acceptance of our new products and enhanced version 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 customs ICs, 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 OEMs, 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:
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 incur
a net loss in the next several quarters of fiscal 1999. Due to all of these
things, our operating results are likely to continue to be below the initial
expectations of public market analysts and investors, as they were frequently
during the last several quarters. If so, 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
12
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. Our backlog as of October 31, 1998,
has decreased by approximately 67% since October 31, 1997.
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.
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 ATE
which the Company sells. This industry slowdown has had and may continue to have
a material adverse effect on the Company's product backlog, balance sheet and
results of operations. Therefore, there can be no assurance that the Company's
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%. 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 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
13
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 or 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
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.
14
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
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 Summit, Zycad and HPL product line acquisitions. 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
15
experiencing significant delays in the introduction of our Valstar, 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
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
34%, 30% and 25% of our net sales in fiscal 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
16
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
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.
17
International Sales
- -------------------
International sales accounted for approximately 69%, 70% and 67% of our
total net sales for the 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
60%, 66% and 58% of our total net sales in 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 are currently in the process of assessing the issues raised by the
introduction of a single European currency ("Euro") introduced on January 1,
1999. While still in the assessment phase, 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
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.
18
The prior owner of a European patent application relating to one of our
proprietary CMOS stabilization methods abandoned the application after the
European patent examiner cited prior art embodying allegedly similar claims.
This prior art was not referenced in the corresponding United States patent
application. Based upon our review to date of the cited prior art and the
European examiner's objections, and in part upon the advice of our outside
patent counsel, we believe that such prior art is unlikely to affect the
validity or scope of the claims of the United States issued patent. Such prior
art, however, is relevant to the scope of certain claims set forth in the United
States patent covering another of our proprietary CMOS stabilization methods.
The European examiner referred to this prior art in the corresponding European
patent application. The European application was approved, but with narrower
claims than the United States patent. This prior art was not referenced in the
corresponding United States patent. Based in part upon the advice of outside
patent counsel, and on our review of current products, we believe that this
patent will continue to be valuable in preventing imitation of our products
covered by this patent. Additionally, in mid-1992, a third party suggested that
certain claims set forth in this patent might be invalid as a result of other
alleged prior art. On November 13, 1997, we requested that the United States
Patent and Trademark Office ("USPTO") re-examine the subject United States
patent in light of the two prior art references. On January 7, 1998, the USPTO
responded by granting our request for re-examination. On May 21, 1998, the USPTO
notified us of its intent to issue a re-examination certificate with claims
comparable in scope to the European patent. The USPTO issued the re-examination
certificate on September 1, 1998.
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 October 31, 1998 of approximately 43%. 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.
19
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.
Year 2000 Readiness
- -------------------
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 by March 31, 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. We are
in the early stages of the Implementation phase.
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 preliminary estimate is that such costs will be
approximately $2.5 million through June 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 $500,000 through October 31, 1998 in connection with the Plan. A
significant portion of total Year 2000 project expenses is represented by
20
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;
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. 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.
ITEM 2. PROPERTIES
The Company maintains its corporate headquarters in Fremont,
California. This leased facility, totaling 104,400 square feet, contains
corporate administration, sales, marketing, applications, engineering, local
customer support and memory products manufacturing. The lease on this facility
expires in June 2004. The Company's digital and mixed signal manufacturing
facilities, as well as additional marketing, applications, engineering and
customer support functions, are located in a 90,000 square foot facility in
Beaverton, Oregon. The lease covering this 90,000 square foot facility expires
in November 2002. An additional 42,000 square foot building houses Beaverton,
Oregon sales, administration and customer service groups under a lease expiring
21
in February 2001. The Company's software business is primarily located in a
22,000 square foot building in Beaverton, Oregon. The lease on this building
expires in August 2002. The Company maintains various remote sales and service
offices in the United States.
During the first half of fiscal 1998 the Company entered into an
agreement to lease an additional 35,000 square feet of space in Fremont,
California which was intended to be used primarily for sales and service.
Additionally, the Company entered into an agreement covering 175,000 square feet
of space in Hillsboro, Oregon which is intended to become the new location for
all of the Company's Oregon operations except for its software business and is
scheduled for occupancy by the Company during the third fiscal quarter of 1999.
The Company has, however, during the last three quarters of fiscal 1998,
experienced a significant decrease in its net sales as compared to the preceding
quarters and as compared to its expectations at the beginning of fiscal 1998 and
a corresponding reduction in its anticipated headcount. Consequently, the
Company's current facilities exceed its current and anticipated short term
needs. At October 31, 1998, the Company was in the process of finding qualified
new or sub- tenants for its vacant 35,000 square foot facility in Fremont, for
its currently occupied 42,000 square foot and 90,000 square foot Beaverton
facilities and for a portion of its to be occupied 175,000 square foot facility
in Hillsboro. The Company also maintains a 14,000 square foot facility in
Fremont that was subleased in September, 1998. The lease and sublease on this
14,000 square foot facility both expire in November, 1999. There is no assurance
that the Company will be able to sublease any or all of its excess facilities
for an amount that would equal or exceed its total committed costs for such
facilities and the related leasehold improvements.
In January 1999, the Company negotiated the termination of the lease for
its 42,000 square foot Beaverton facility whereby the landlord agreed to
terminate the lease effective March, 1999. As a result of this lease
termination, the Company will be required to expense approximately $750,000,
related primarily to lease termination fees and write-off of unamortized
leaseholds. The Company believes there is a reasonable likelihood that similar
expenses will be required as the Company finds new or sub- tenants for its other
excess facilities, or if it is unable to find any such new or sub- tenants. Due
to the significant uncertainties surrounding the timing and amount of such
potential write-offs, no accrual for such future expenses had been made as of
October 31, 1998.
ITEM 3. LEGAL PROCEEDINGS
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None
22
EXECUTIVE OFFICERS AND KEY EMPLOYEES
The executive officers and key employees of the Company, and their ages
and positions as of December 15, 1998, are as follows:
Name Age Position
Dr. William Howard, Jr. 56 Chairman
David A. Ranhoff 43 Executive Vice President, Sales and Marketing *
Dennis P. Wolf 45 Executive Vice President, Chief Financial Officer and Secretary *
Clyde Armstrong 54 Vice President, Worldwide Sales
Jerry Bruce 42 Vice President, Treasurer and Corporate Controller *
Rick Carmichael 50 Senior Vice President, Corporate Marketing
David K. Cheung 45 Senior Vice President, Engineering
George W. DeGeer 52 Senior Vice President, Operations
John DiGirolamo 57 CEO and President of Fluence Technology, Inc.
Robert E. Huston 57 Vice President, Test Technology
Dave O'Brien 42 Senior Vice President, Information Technology
*Executive officer
Dr. William Howard, Jr., has served as a Director of the Company since
February 1995 and as Chairman since December 1998. His current term as Director
ends in 2001. Dr. Howard has been a self-employed consultant for various
semiconductor and microelectronics companies since December 1990. From October
1987 to December 1990, Dr. Howard was a senior fellow at the National Academy of
Engineering conducting studies of technology management. Dr. Howard held various
management positions at Motorola, Inc. between 1969 and 1987, most recently as
Senior Vice President and Director of Research and Development. Dr. Howard
serves on the boards of directors of VLSI Technology, Inc., BEI Electronics,
Inc., Ramtron International, Inc., and Xilinx, Inc., as well as several private
companies.
David A. Ranhoff, along with Mr. Wolf, was named to the Office of the
President in December 1998. Mr. Ranhoff became Executive Vice President in
January 1997 and had served as Senior Vice President, Sales and Marketing from
July 1996 to January 1997 and as Senior Vice President, Sales, Marketing and
Service from July 1995 to June 1996. Mr. Ranhoff served as Senior Vice
President, Sales and Service from August 1993 to July 1995 and as Vice
President, Sales from January 1993 to August 1993. He served as Vice President,
European Operations from July 1990 to December 1992. From March 1988 to June
1990, Mr. Ranhoff served as Managing Director of European Operations of the
Company and as National Sales Manager from July 1985 to March 1988. Prior to
joining the Company, Mr. Ranhoff served for eight years in various sales and
management positions for GenRad, Inc.
Dennis P. Wolf, Executive Vice President, Chief Financial Officer and
Secretary, joined Credence Systems Corporation in March of 1998 and, along with
Mr. Ranhoff, was named to the Office of the President in December 1998. Mr. Wolf
joined Credence from Centigram Communications Corporation where he began his
tenure as Senior Vice President and Chief Financial Officer and then became
acting Chief Executive Officer. Prior to joining Centigram, Mr. Wolf was Vice
President and Chief Financial Officer of Pyramid Technology after serving as
Vice President and Chief Financial Officer of Dynacraft, a National
Semiconductor Company. Additionally, he had held various executive and
managerial positions at Apple Computer and Sun Microsystems.
Clyde Armstrong joined Credence as Vice President, Worldwide Sales in
October 1996. Prior to joining Credence, Mr. Armstrong was at LTX/Trillium from
1994 to 1996 as Vice President and General Manager of Digital Business Unit,
responsible for engineering, marketing and support operations. From 1981 to
1984, Mr. Armstrong was at Eaton Corporation as Vice President of Board Test
Product Group. From 1967 to 1981, Mr. Armstrong worked in International Sales at
Fairchild Test Systems. Mr. Armstrong has extensive experience working in Asia,
Brazil and Europe during the past twenty years and managed direct sales and
support organizations as well as distributors and sales representatives world
wide. Mr. Armstrong possesses over 30 years of experience in the semiconductor
industry.
23
Jerry Bruce joined Credence in May 1993 and has served as Vice President,
Treasurer and Corporate Controller since August 1998, as Vice President and
Corporate Controller from March 1998 to August 1998, as Vice President,
Controller, Acting Chief Financial Officer and Secretary from December 1997 to
March 1998, as Vice President, Controller from July 1997 to December 1997, as
Vice President, Treasurer from January 1995 to July 1997 and as Vice President,
Controller from May 1993 to January 1995. From June 1988 to May 1993, Mr. Bruce
held various financial management positions at Silicon Valley Group, Inc. a
semiconductor equipment manufacturer. From July 1986 to June 1988, Mr. Bruce
served as Chief Financial Officer of CXR Telcom, Inc. a telecommunications test
equipment manufacturer. From June 1980 to July 1986, Mr. Bruce held positions of
increasing responsibility in the audit practice of Ernst & Young LLP.
Richard C. Carmichael rejoined the Company in September 1996 and has served
as Senior Vice President, Corporate Marketing since that time. From September
1995 to December 1995 Mr. Carmichael served as Vice President of Marketing at
Megatest Corporation and then, after the acquisition of Megatest Corporation by
Teradyne, Inc., Mr. Carmichael held the position of Marketing Manager, Megatest
Division for Teradyne, Inc. until September 1996. Mr. Carmichael served as
Senior Vice President, Marketing for the Company from August 1993 until August
1995 and Vice President, Marketing from July 1992 to August 1993. Mr. Carmichael
first joined the Company in January 1991 and served as Western Area Sales
Manager from January 1991 to July 1992. From January 1989 to December 1990, Mr.
Carmichael was the Regional Sales Manager for the STS Division of Tektronix.
Prior to joining the Company, Mr. Carmichael served for nine years in various
sales and marketing positions, most recently as Vice President of Sales for
Megatest Corporation, a semiconductor test manufacturer
David K. Cheung has served as Senior Vice President, Engineering since
January 1995, as Vice President, Engineering from May 1994 to January 1995 and
as Director of Engineering from October 1993 to May 1994. From September 1992 to
October 1993, Mr. Cheung served as Director of Engineering at Schlumberger
Technologies, Inc., where he led the development of advanced digital IC testers.
Mr. Cheung held various management positions at Schlumberger from 1982 to
September 1992.
George W. DeGeer has served as Senior Vice President, Operations since
August, 1996, as Senior Vice President, Manufacturing from January 1995 to
August, 1996, as Vice President, Manufacturing from October 1993 to January
1995, as Director of Manufacturing from July 1992 to October 1993, and as Vista
Manufacturing Manager from January 1991 to July 1992. Prior to joining the
Company, Mr. DeGeer held various manufacturing management positions at Tektronix
for more than twenty years.
John DiGirolamo has served as Chief Executive Officer and President of
Fluence Technology, Inc. ("Fluence" formerly TSSI) since October 1997. From July
1997 to October 1997, Mr. DiGirolamo served as Vice President of Worldwide Sales
and Marketing for Fluence. Mr. DiGirolamo served as Director of Sales at Summit
Design, Inc., from May 1996 to July 1997. Mr. DiGirolamo served at the Company
as Vice President, Worldwide Sales from June 1995 to April 1996. Prior to
joining the Company in 1995, Mr. DiGirolamo held a variety of senior level
positions within the industry, including a tenure at GenRad, Inc. as General
Manager and Director of Sales & Marketing for Western operations. Mr. DiGirolamo
possesses over 33 years of experience in the semiconductor equipment and test
industry.
Robert E. Huston has served as Vice President, Test Technology since August
1992. From February 1983 to August 1992, Mr. Huston was a co-founder and fellow
of Trilium Corporation and was the architect of the Micromaster series of test
systems. Mr. Huston was a fellow at LTX from August 1988 to August 1992,
developing high frequency test strategies. He served in various senior
engineering positions beginning in 1967 at Fairchild working with a team to
develop the LSI test system.
David O'Brien has served as Senior Vice President, Information Technology
since July 1995. Mr. O'Brien served as Senior Vice President, Marketing from May
1994 to July 1995, as Senior Vice President, Engineering from August 1993 to May
1994 and as Vice President, Engineering from July 1992 to August 1993. Mr.
O'Brien served as Vice President, Beaverton Business Unit from October 1991 to
July 1992; Vice President, Marketing - Vista from August 1991 to September 1991;
Vice President Software Products from October 1990 to July 1991; Vice President,
Engineering from July 1987 to September 1990; Director of Engineering from
October 1986 to June 1987; and Software Engineering Manager of the Company from
January 1983 to September 1986.
Officers serve at the discretion of the Board of Directors, until their
successors are appointed. There are no family relationships among executive
officers or directors of the Company.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's common stock is traded on the Nasdaq National Market under
the symbol CMOS. High and low stock prices for the last two fiscal years were:
1998 1997
-------------- --------------
Quarter Ended High Low High Low
-------------- ------ ------ ------ ------
January 31 $35.25 $18.13 $25.75 $13.75
April 30 34.00 24.87 24.25 13.88
July 31 28.50 16.87 36.63 15.75
October 31 20.56 9.31 55.00 26.88
There were approximately 307 stockholders of record at December 5, 1998.
To date, the Company has not declared or paid any cash dividends on its common
stock. The Company does not anticipate paying any dividends on its common stock
in the foreseeable future and, under its current credit agreements, such payment
would require prior bank approval.
ITEM 6. SELECTED FINANCIAL DATA
The comparability of the following selected financial data is affected by
a variety of factors, and this data is qualified by reference to and should be
read in conjunction with the consolidated financial statements and notes thereto
elsewhere in this Annual Report on Form 10-K and the Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Year ended October 31,
---------- ---------- ---------- ---------- ----------
(in thousands, except per share amounts) 1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
Consolidated Statement of Operations Data:
Net sales ................................ $ 216,803 $ 204,092 $ 238,788 $ 176,805 $ 118,211
Operating income (loss) .................. (42,572) 15,063 54,334 43,817 24,208
Income (loss) before taxes ............... (41,270) 18,230 58,267 46,649 24,939
Net income (loss) ........................ (26,282) 10,693 37,703 30,354 19,193
Net income (loss) per basic share ........ $ (1.22) $ 0.49 $ 1.75 $ 1.50 $ 1.04
Net income (loss) per diluted share ...... $ (1.22) $ 0.47 $ 1.72 $ 1.45 $ 0.97
Consolidated Balance Sheet Data:
Working capital .......................... $ 184,606 $ 250,336 $ 144,623 $ 126,395 $ 64,101
Total assets ............................. 306,189 358,141 223,042 186,593 103,668
Long-term debt, less current maturities .. 115,000 115,000 -- -- 655
Retained earnings ........................ 68,440 94,722 84,029 46,326 16,604
Stockholders' equity ..................... 150,017 204,911 189,782 150,286 78,213
- -------------------------------------------------------------------------------------------------------------------
Quarterly 1998
(in thousands, except per share amounts) 1st 2nd 3rd 4th
(unaudited)
Net sales ......................... $ 82,375 $ 74,660 $ 37,322 $ 22,446
Gross profit (loss) ............... 46,937 42,996 (531) 2,045
Operating income (loss) ........... 13,138 12,832 (49,311) (19,231)
Income (loss) before taxes ........ 14,096 13,032 (49,318) (19,080)
Net income (loss) ................. 9,191 8,787 (33,586) (10,674)
Net income (loss) per basic share . $ 0.42 $ 0.41 $ (1.55) $ (0.51)
Net income (loss) per diluted share $ 0.41 $ 0.40 $ (1.52) $ (0.51)
25
Quarterly 1997
(in thousands, except per share amounts) 1st 2nd 3rd* 4th
(unaudited)
Net sales ......................... $ 40,261 $ 43,355 $ 51,082 $ 69,394
Gross profit ...................... 20,822 24,981 29,444 38,889
Operating income (loss) ........... 585 4,039 (364) 10,803
Income before taxes ............... 1,612 4,913 647 11,058
Net income (loss) ................. 1,054 3,286 (897) 7,250
Net income (loss) per basic share . $ 0.05 $ 0.15 $ (0.04) $ 0.33
Net income (loss) per diluted share $ 0.05 $ 0.15 $ (0.04) $ 0.32
In addition to the historical information contained herein, the
discussion in this Annual Report on Form 10-K contains forward-looking
statements, within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
that involve risks and uncertainties, such as statements of the Company's plans,
objectives, expectations, and intentions. The cautionary statements made in this
Annual Report on Form 10-K should be read as being applicable to all related
forward-looking statements whenever they appear in this Annual Report on Form
10-K. The Company's actual results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences include those
discussed below as well as those cautionary statements and other factors set
forth in "Risk Factors" and elsewhere herein.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
- --------
The following discussions should be read in conjunction with the
consolidated financial statements, and notes thereto, included elsewhere herein.
Certain of the statements contained in this Annual Report on Form 10-K to
Stockholders are forward-looking statements and involve a number of risks and
uncertainties.
The Company's sales, gross margins and operating results have in the past
fluctuated significantly, and will in the future fluctuate significantly
depending upon a variety of factors. The factors that have caused and will
continue to cause the Company's results to fluctuate include cyclicality or
downturns in the semiconductor market and the markets served by the Company's
customers, the timing of new product announcements and releases by the Company
or its competitors, market acceptance of new products and enhanced versions of
the Company's products, manufacturing inefficiencies associated with the start
up of new products, changes in pricing by the Company, its competitors,
customers or suppliers, the ability to volume produce systems and meet customer
requirements, inventory obsolescence, patterns of capital spending by customers,
delays, cancellations or reschedulings of orders due to customer financial
difficulties or otherwise, expenses associated with acquisitions and alliances,
product discounts, product reliability, the proportion of direct sales and sales
through third parties, including distributors and original equipment
manufacturers, the mix of products sold, the length of manufacturing and sales
cycles, natural disasters, political and economic instability, regulatory
changes and outbreaks of hostilities. Due to these and additional factors,
historical results and percentage relationships discussed in this Annual Report
on Form 10-K will not necessarily be indicative of the results of operations for
any future period. For a further discussion of the Company's business, and risk
factors affecting its results of operations, please refer to the section
entitled "Risk Factors" included elsewhere herein.
Results of Operations
- ---------------------
1998 vs 1997
NET SALES. Net sales consist of revenues from the sale of systems,
upgrades, spare parts, maintenance contracts and software. Net sales increased
6% to $216.8 million in fiscal 1998 from $204.1 million in fiscal 1997; however,
the Company's net sales decreased from $82.4 million in the first quarter of
26
fiscal 1998 to $22.4 million for the fourth quarter of fiscal 1998. The
year-over-year increase over 1997 was driven primarily by increased worldwide
demand for semiconductor automatic test equipment ("ATE"), including the
Company's products, during the end of calendar 1997 and including the first
quarter of the Company's fiscal 1998. This was followed by a very significant
decline in worldwide demand for semiconductor ATE, which led to a material
decline in net sales of the Company's products in the last three quarters of
fiscal 1998. During fiscal 1998, the Company's net sales were also materially
adversely affected by its inability to complete three major product
introductions, consisting of the VS2000 high-performance digital tester, the
Quartet high-performance mixed signal tester and the Kalos memory tester. The
Company believes that its existing completed products were being primarily
purchased when its customers required increased capacity and that these three
newer products, once completed, will be primarily purchased by customers seeking
increased functionality instead of or in addition to increased capacity. The
Company believes it will be unable to achieve a significant increase in net
sales until either increased demand for semiconductors causes an increase in
"capacity buys" or until the Company completes its major product introductions
and can generate increased "functionality buys" with its newer products.
International net sales accounted for approximately 69% and 70% of total
net sales in fiscal 1998 and 1997, respectively. The Company's net sales to the
Asia Pacific region accounted for approximately 60% and 66% of total net sales
in fiscal 1998 and 1997, respectively, and thus are subject to the risk of
economic instability in that region that materially adversely affected the
demand for the Company's products in 1998. Capital markets in Korea and other
areas of Asia have been highly volatile, resulting in economic instabilities.
These instabilities may continue or worsen, which could continue to materially
adversely affect demand for the Company's products.
GROSS MARGIN. The Company's gross margin as a percentage of net sales
decreased to 42.2% in fiscal 1998 from 55.9% in fiscal 1997. The decrease was
due primarily to special charges taken in fiscal 1998 as a result of a
significant decrease in net sales in the last three quarters of fiscal 1998. The
Company recorded special charges to cost of goods sold in 1998 totaling $28.4
million, consisting primarily of write-offs for excess or obsolete inventory, as
more fully described below. Additionally, gross margins were negatively impacted
due to lower average selling prices caused by increased competition in the
markets the Company serves and due to inefficiencies caused by the lower
manufacturing volumes.
RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses as a
percentage of net sales were 21.9% and 18.3%, in fiscal 1998 and 1997,
respectively. R&D expenses increased to $47.5 million in fiscal 1998 from $37.4
million in fiscal 1997, reflecting continued investments in the development of
new products, as well as enhancements of existing product lines. The Company
currently intends to continue to invest significant resources in the development
of new products and enhancements for the foreseeable future; however, the
Company has taken steps to reduce operating expenses in light of current
industry conditions.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses increased to $64.2 million in fiscal 1998 from $55.7 million
in fiscal 1997, an increase of 15.3%. The increase in fiscal 1998 resulted
primarily from marketing costs associated with new product introductions and
higher operating expenses associated with acquisitions made during 1998 and the
last half of fiscal 1997, partially offset by decreases in expenditures in the
latter three quarters of fiscal 1998 as the Company responded to the general
downturn in the semiconductor industry. During this period of depressed
revenues, the Company has undertaken a project to replace a majority of its
financial, manufacturing, distribution, planning and control systems with the
R/3 system from SAP America, Inc., and anticipates that this system will be
operational before the end of fiscal 1999. This project is intended to improve
operational efficiencies to support anticipated future growth in the business.
IN-PROCESS RESEARCH AND DEVELOPMENT. In June 1998, the Company purchased
from Heuristics Physics Laboratories, Inc. ("HPL") certain assets and assumed
certain liabilities relating to their memory self test business for $8.0 million
in cash and the assumption of $0.2 million in liabilities. Additionally, the
Company agreed to make payments to the shareholder representatives of HPL in an
amount equal to 10% of the Company's net sales of products derived from the
assets acquired from HPL's design for test division for a period of two years
following the acquisition. In connection with the HPL acquisition, the Company
recognized $2.0 million of acquired in-process research and development
("IPR&D"). The remaining $6.2 million has been capitalized, of which $5.3
million is for purchased technology and other intangible assets which will be
amortized ratably over their estimated useful lives of five years.
The Company's management made certain assessments with respect to the
determination of all identifiable assets resulting from, or to be used in,
27
research and development activities as of the acquisition date. Each of these
activities was evaluated, by both interviews and data analysis, to determine its
state of development and related fair value. The Company's review indicated that
the IPR&D had not reached a state of technological feasibility and the
underlying technology had no alternative future use to the Company in other
research and development projects or otherwise. In the case of IPR&D, fair
values of the corresponding technologies were determined using an income
approach, which included a discounted future earnings methodology. Under this
methodology, the value of the in-process technology is comprised of the total
present value of the anticipated after-tax cash flows attributable to the
in-process project, discounted to net present value, taking into account the
uncertainty surrounding the successful development of the purchased IPR&D.
The HPL acquired IPR&D consists of projects related to memory self test.
These projects are aimed at the development of products that can perform self
testing of on-chip memories, self testing of off-chip memories, automated memory
test vector generation, built-in memory repair analysis and built-in automated
memory circuit repair. The Company estimated that approximately 50% of the
research and development effort, based on complexity, had been completed at the
date of the acquisition. The significant work remaining on these projects was
estimated to take approximately 16 engineering person years, at a cost of
approximately $1.3 million and be completed in late fiscal 1999 or early fiscal
2000. As of October 31, 1998, the Company believed that the projections of time
and cost had not materially changed. As of the acquisition date, HPL was in the
alpha stage of development and required the resolution of certain memory self
test technological hurdles in order to complete the technology. The items
remaining to be addressed at the acquisition date included the following:
expansion of built-in self test (BIST) capability to address large (beyond
mega-bit) embedded memories used in the emerging system-on-a-chip market,
completion of third generation BIST, automation tools allowing the generation of
user-configurable test algorithms on the active load board of a test system,
completion of manufacturing oriented memory BIST architecture enabling parallel
test execution and full diagnostics for engineering debug and yield analysis,
and completion of the first built-in redundancy analyzer, software to direct
laser repair stations and embedded memory self repair.
There can be no assurance that these projects will achieve technological
feasibility or that the Company will be able to successfully market products
based on such technology. Should these in-process projects fail, the value of
the Company's investment in these incomplete technologies would be diminimous or
zero. A failure to successfully develop and market memory self test products
could have a material adverse affect on the Company's business, financial
condition or results of operations.
During fiscal 1997, the Company expensed $6.0 million of IPR&D resulting
from the acquisition of certain assets of Summit Design, Inc., and Summit's
wholly owned subsidiary, Test Systems Strategies, Inc. (the "TSSI acquisition").
The IPR&D associated with the TSSI acquisition related to the development of a
standard tester interface language ("STIL"). The STIL development project is
approximately 35% complete as of October 31, 1998. The significant technological
hurdles remaining to be addressed include: the ability to parse mega-vector
files and make them immediately available to the application program interface;
the ability to effectively process both batch and online input from engineering
design automation ("EDA") simulation tools, the development of efficient
algorithms for taking event data from EDA simulation tools and mapping it into
the limited resources of a given ATE system according to a standard set of
rules; and the development of additional STIL constructs which enable the use of
STIL as a design stimulus language, enable the use of STIL for representing test
patterns for embedded cores, representing the test program flow in STIL,
representing test methods in STIL and defining voltage and current levels
associated with STIL waveforms. The Company estimates that as of October 31,
1998, the remaining research and development work on the STIL project will take
approximately 13 engineering person years, at a cost of approximately $2.0
million and will be completed in fiscal 2000. The project has progressed more
slowly than originally projected due to lower than anticipated staffing. The
lower staffing levels were a result of the Company's actions to reduce expenses
during a period of reduced revenues and earnings. There can be no assurance that
the Company will be able to complete the development and successful marketing of
any STIL based products. A failure to successfully develop and market STIL based
products could have a material adverse effect on the Company's business,
financial condition or results of operations.
SPECIAL CHARGES. In the third and fourth quarters of fiscal 1998, the
Company recorded special charges totaling $48.7 million, of which $28.4 million
was classified as cost of goods sold and the balance was classified as operating
expenses. These charges were recorded as a result of the Company's response to a
major downturn in the current and forecasted business outlook for the ATE and
related semiconductor and semiconductor equipment industries which took place
during the period. As a result of this industry downturn, the Company has
28
downsized its operations including reducing headcount, reducing the volume of
products being produced and cancelling and delaying various projects, including
facilities expansions and certain research and development projects. The impact
of this downturn and these decisions is that significant amounts of the
Company's inventories, receivables, fixed assets, prepaid expenses, investments
and purchased technologies have been impaired and certain liabilities have been
incurred. As a result, the Company has written down the related assets to their
net realizable values and made provision for the estimated liabilities.
Of the $48.7 million in charges, approximately $28.4 million was charged
as cost of goods sold, of which approximately $26.7 million was related to
write-down of excess or obsolete inventories. The elements of the charges during
fiscal 1998 are as follows (in thousands):
Write down of inventories to net realizable value
(including expected losses on supplier commitments) ........... $26,678
Write down of excess fixed assets to fair value ................ 7,272
Write down of purchased technology and investments to fair value 5,118
Write-off of prepaid and other current assets .................. 2,444
Excess facility costs .......................................... 2,641
Provision for uncollectible receivables ........................ 3,389
Employee termination benefits and accrued liabilities .......... 1,196
-------
$48,738
At October 31, 1998, approximately $4.8 million in accrued liabilities
related to special charges remained on the Company's balance sheet, primarily
the accrued loss on supplier commitments of $2.4 million and approximately $1.9
million for 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 fiscal 1998 were approximately
$700,000, relating primarily to excess facilities and to severance costs.
INTEREST INCOME. The Company generated interest income of $8.5 million
and $4.8 million in fiscal 1998 and 1997, respectively. The increase was due to
interest earned on significantly higher average cash and investments balances
provided by the receipt of proceeds from the convertible subordinated notes
issued in late fiscal 1997.
INTEREST AND OTHER EXPENSES. Interest and other expenses increased to
$7.2 million in fiscal 1998 from $1.6 million in fiscal 1997, primarily due to
the interest expense on the Company's convertible subordinated notes.
INCOME TAX. Excluding the impact of in-process research and development,
the Company's effective tax rate for fiscal 1998 and 1997 was 37% and 34%,
respectively. Excluding the impact of the in-process research and development,
the tax benefit rate in fiscal 1998 approximated the combined federal and state
statutory rate, while the effective tax rate in 1997 was lower, primarily due to
the benefit of the Company's foreign sales corporation.
Realization of a portion of the net deferred tax assets is dependent on
the Company's ability to generate approximately $30,000,000 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. A valuation allowance
has been established in both fiscal 1998 and 1997 to offset a portion of the
deferred tax assets attributable to the in-process research and development. Due
to the period over which these tax benefits will be recognized, sufficient
uncertainty exists regarding the realizability of a portion of these assets to
warrant a valuation allowance. Management will evaluate the realizability of the
deferred tax assets quarterly and assess the need for additional valuation
allowances.
1997 vs. 1996
NET SALES. Net sales decreased 14.5% to $204.1 million in fiscal 1997
from $238.8 million in fiscal 1996. The decrease was primarily due to the
effects of a worldwide downturn in the demand for semiconductor ATE.
International sales accounted for approximately 70% in fiscal 1997 compared to
67% in fiscal 1996. The Company's net sales to the Asia Pacific region accounted
for approximately 66% and 58% of total net sales in fiscal 1997 and 1996,
respectively.
GROSS MARGIN. The Company's gross margin as a percentage of net sales
decreased to 55.9% in fiscal 1997 from 59.4% in fiscal 1996. The decreases were
due primarily to a significant decrease in revenue shipments beginning in the
fourth fiscal quarter of 1996, which resulted in an underutilization of
29
manufacturing capacity, offset partially by decreased expenses resulting from
the resizing of certain areas in operations. The fiscal 1997 decrease was also
due in part to inventory write-downs taken for obsolete items as a result of the
Company's introduction of new products and modification and phasing out of older
products.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses as a
percentage of net sales were 18.3% in fiscal 1997 as compared to 14.8% in fiscal
1996, reflecting increased expenses and lower net sales in fiscal 1997 as
compared to fiscal 1996. Research and development expenses increased to $37.4
million in fiscal 1997 from $35.4 million in fiscal 1996, reflecting continued
investments in the development of new products, as well as enhancements of
existing product lines.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 7.1% to $55.7 million in fiscal 1997 from $52.0 million in
fiscal 1996. The increase in fiscal 1997 resulted primarily from marketing
costs, associated with new product introductions, operating expenses associated
with acquisitions made during the year, costs of increasing the Company's global
infrastructure such as offices in Southeast Asia, and legal and other expenses
for patent litigation that was settled in fiscal 1997 and acquisitions. In
fiscal 1997, selling, general and administrative expenses as a percentage of net
sales increased over fiscal 1996, due primarily to the reduced net sales.
IN-PROCESS RESEARCH AND DEVELOPMENT. During fiscal 1997, the Company
expensed $6.0 million of IPR&D resulting from the acquisition of certain assets
of Summit Design, Inc., and Summit's wholly owned subsidiary, Test Systems
Strategies, Inc. (the "TSSI acquisition"). The IPR&D associated with the TSSI
acquisition related to the development of a standard tester interface language
("STIL"). The STIL development project is approximately 35% complete as of
October 31, 1998. The significant technological hurdles remaining to be
addressed include: the ability to parse mega-vector files and make them
immediately available to the application program interface; the ability to
effectively process both batch and online input from engineering design
automation ("EDA") simulation tools, the development of efficient algorithms for
taking event data from EDA simulation tools and mapping it into the limited
resources of a given ATE system according to a standard set of rules; and the
development of additional STIL constructs which enable the use of STIL as a
design stimulus language, enable the use of STIL for representing test patterns
for embedded cores, representing the test program flow in STIL, representing
test methods in STIL and defining voltage and current levels associated with
STIL waveforms. The Company estimates that as of October 31, 1998, the remaining
research and development work on the STIL project will take approximately 13
engineering person years, at a cost of approximately $2.0 million and will be
completed in fiscal 2000. The project has progressed more slowly than originally
projected due to lower than anticipated staffing. The lower staffing levels were
a result of the Company's actions to reduce expenses during a period of reduced
revenues and earnings. There can be no assurance that the Company will be able
to complete the development and successful marketing of any STIL based products.
A failure to successfully develop and market STIL based products could have a
material adverse effect on the Company's business, financial condition or
results of operations.
INTEREST INCOME. The Company generated interest income of $4.8 million
and $4.2 million in fiscal 1997 and fiscal 1996, respectively. The increase was
due to interest earned on significantly higher cash and short-term investments
balances provided by operations and the receipt of proceeds from convertible
subordinated notes, offset in part by cash used to increase accounts receivable
and inventory as well as for capital expenditures and acquisitions.
INTEREST AND OTHER EXPENSES. Interest and other expenses increased to
$1.6 million in fiscal 1997 from $0.2 million in fiscal 1996, primarily due to
the interest expense on the Company's convertible subordinated notes.
INCOME TAX. The effective tax rate of 35% for fiscal 1996 was lower than
the combined federal and state statutory rate in effect for that year, due
primarily to the foreign sales corporation benefits. In fiscal 1997, the
Company's effective tax rate increased to 41%, primarily due to the recognition
of only a portion of the tax benefit associated with the in-process research and
development charge. In-process research and development amounts are deductible
over an extended period of time, and therefore, a valuation allowance was
established to offset a portion of the resulting deferred tax asset.
Year 2000 Readiness
- -------------------
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
30
and system failures. The results of these errors may range from minor undetected
errors to the 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."
The Company's Board of Directors has reviewed the Year 2000 issue
generally and as it may affect the Company's business activity. The Company is
implementing a Year 2000 plan (the "Plan") which is designed to cover all of the
Company's activities. The Plan will be modified as circumstances change and is
monitored by the Company's Board of Directors. Under the Plan, the Company is
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. A Year 2000
program team was established and an overall strategy created. During the
Assessment phase, all internal systems, products and supply-chain partners were
inventoried and prioritized for renovation. The Company believes it has
completed a majority of the Awareness and Assessment phases; however, ongoing
work will be required in these areas as the Company completes its assessment of
existing supply-chain partners and enters 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. Renovation has
begun on mission-critical systems and is targeted for completion by March 31,
1999. Validation involves ensuring that hardware and software fixes will work
properly in 1999 and beyond and can occur both before and after implementation.
Validation started 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
Company is in the early stages of the Implementation phase.
The impact of Year 2000 issues on the Company will depend not only on the
corrective actions that the Company takes, but also on the way in which Year
2000 issues are addressed by governmental agencies, businesses and other third
parties that provide services or data to, or receive services or data from, the
Company, or whose financial condition or operational capability is important to
the Company. To reduce this exposure, the Company has 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 are U.S.
businesses. Notwithstanding the Company's efforts, there can be no assurance
that the Company, mission-critical third-party vendors or other significant
third parties will adequately address their Year 2000 issues.
The Company is developing contingency plans in the event that the
Company, 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. There can be no
assurance 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 where alternative
arrangements or sources are limited or unavailable.
Although it is difficult to estimate the total costs of implementing the
Plan, through June 1999 and beyond, the Company's preliminary estimate is that
such costs will be approximately $2.5 million. However, although management
believes its estimates are reasonable, there can be no assurance, for the
reasons stated in the next paragraph, that the actual costs of implementing the
Plan will not differ materially from the estimated costs. The Company has
incurred costs of approximately $500,000 through October 31, 1998, 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. The
Company does not believe that the redeployment of existing staff will have a
material adverse effect on its business, results of operations or financial
position. Incremental expenses related to the Year 2000 project are not expected
to materially impact operating results in any one period.
The extent and magnitude of the Year 2000 problem as it will affect the
Company, both before and for some period after January 1, 2000, are difficult to
predict or quantify for a number of reasons. Among the most important are lack
of control over systems that are used by third parties who are critical to the
Company's operation, dependence on third-party software vendors to deliver Year
2000 upgrades in a timely manner, complexity of testing inter-connected networks
and applications that depend on third-party networks and the uncertainty
surrounding how others will deal with liability issues raised by Year 2000
31
related failures. There can be no assurance, for example, 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 the Company's 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 the Company's implementation of the Plan.
Although the Company is not aware of any material operational issues
associated with preparing its internal systems for the Year 2000, or material
issues with respect to the adequacy of mission-critical third-party systems,
there can be no assurance that the Company will not experience material
unanticipated negative consequences and/or material costs caused by undetected
errors or defects in such systems or by the Company's 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 the Company's business, financial condition or
results of operations.
Introduction of the Euro
- ------------------------
The Company is currently in the process of assessing the issue raised by
the introduction of a single European currency ("Euro") introduced on January 1,
1999. While still in the assessment phase, the Company does not expect that the
introduction and the use of the Euro will have a material effect on the
Company's financial condition or results of operations.
Liquidity and Capital Resources
- -------------------------------
In fiscal 1998, the Company's operations provided $10.2 million in net
cash, primarily as a result of cash generated from the $26.3 million net loss
after reconciling the non-cash impact of special charges of $48.7 million and
depreciation and amortization of $21.1 million. Additionally, the increase in
the Company's deferred income taxes provided cash of $10.5 million. These
amounts were partially offset by the use of cash caused by changes in working
capital accounts. The decrease in accounts receivable provided cash of $18.0
million, primarily as a result of lower fourth quarter sales volumes year over
year. During fiscal 1998, the Company purchased product licenses of $7.6
million, thereby utilizing restricted cash. The increase in inventories, which
utilized cash of $31.1 million, was due in part to the Company's inability to
anticipate the drop in demand which occurred during the year, and in part due to
purchases of inventories for new products which subsequently did not meet
revenue expectations, due primarily to engineering delays. The increase in
prepaid expenses and other current assets, which utilized cash of $19.4 million,
was due primarily to the increase of $18.7 million in prepaid and refundable
income taxes, which was caused primarily by the Company's net loss. A decrease
in accounts payable, primarily due to reduced purchases of inventories, provided
cash of $5.3 million.
Net cash used in investing activities during fiscal 1998 was $65.0
million. Net purchases of available-for-sale securities were $40.0 million. Net
acquisitions of property and equipment were $11.3 million and an additional
$15.0 million of cash was used to purchase other assets.
Net cash used in financing activities of $30.0 million was primarily due
the use of $32.8 million to repurchase the Company's common stock, offset
partially by issuances of common stock under the Company's equity benefit plans
totaling $3.2 million. As of October 31, 1998, the Company's principal sources
of liquidity consisted of $133.9 million in cash, cash equivalents, restricted
cash and available-for-sale securities, compared with $186.3 million at October
31, 1997. The Company has $40.0 million available under its unsecured bank line
of credit expiring in July 1999. At October 31, 1998, there were no amounts
outstanding under these agreements. Borrowings are subject to the Company's
compliance with financial and other covenants. The Company received waivers,
effective October 31, 1998, of compliance with certain financial covenants and
has subsequently renegotiated the applicable financial covenants under the
credit facility. The Company has outstanding debt of $115.0 million consisting
of convertible subordinated notes, due in 2002. Additionally, as of October 31,
1998, the Company has operating leases for facilities and test and other
equipment totaling approximately $47.5 million due through 2014. The Company
expects that its existing cash and investments balances, together with its
current or successor line of credit and anticipated cash flow from operations
will satisfy its financing requirements for at least the next 12 months.
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 continue to represent a
significant portion of working capital. Significant investments in accounts
receivable and inventories subject the Company to increased risks, and could
continue to materially adversely affect the Company's business, financial
32
condition and results of operations. The semiconductor industry has historically
been highly cyclical and has experienced downturns, which have had a material
adverse effect on the semiconductor industry's demand for automatic test
equipment, including equipment manufactured and marketed by the Company. In
addition, the automatic test equipment industry is highly competitive, and
subject to rapid technological change. It is reasonably possible that events
related to the above factors may occur in the near term which would cause a
change to the Company's estimate of the net realizable value of receivables,
inventories or other assets, and the adequacy of costs accrued for warranty and
other liabilities. Such changes could materially adversely affect the Company's
business, financial condition and results of operations.
ITEM 7A. 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 consist primarily of
commercial paper, medium term notes, asset backed securities, U.S. 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, except percentages).
1999 2000 2001 2002 2003 Thereafter
Cash equivalents
Fixed rate $ 42,379 - - - - -
Average rate 5.04% - - - - -
Restricted cash
Fixed rate 2,400 - - - - -
Average rate 4.11% - - - - -
Short term investments
Fixed rate $ 62,777 - - - - -
Average rate 5.74% - - - - -
Long term investments
Fixed rate - $ 20,357 - - - -
Average rate - 5.81% - - - -
--------- --------- -------- --------- -------- ---------
Total investment securities $ 107,556 $ 20,357 $ - $ - $ - $ -
Average rate 5.43% 5.81%
Long term debt - - - $ 115,000 - -
Fixed rate
Average rate - - - 5.25% - -
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 $40.0 million line of
credit under which it can borrow either at the bank's prime rate or as a
function of the LIBOR rate. As of October 31, 1998, the Company had no
borrowings under its line of credit.
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For the years ended October 31, 1998, 1997 and 1996
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Ernst & Young LLP, Independent Auditors 35
Consolidated Balance Sheets
-- October 31, 1998 and 1997 36
Consolidated Statements of Operations
-- Years Ended October 31, 1998, 1997 and 1996 37
Consolidated Statements of Stockholders' Equity
-- Years Ended October 31, 1998, 1997 and 1996 38
Consolidated Statements of Cash Flows
-- Years Ended October 31, 1998, 1997 and 1996 39
Notes to Consolidated Financial Statements 40
34
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Credence Systems Corporation
We have audited the accompanying consolidated balance sheets of Credence
Systems Corporation as of October 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended October 31, 1998. Our audits also
included the financial statement schedule listed in the Index 14(a).These
financial statements and this schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and this schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Credence Systems Corporation at October 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended October 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ ERNST & YOUNG LLP
San Jose, California
November 25, 1998
35
CREDENCE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
October 31,
ASSETS 1998 1997
---- ----
Current assets:
Cash and cash equivalents .............................................................. $ 48,391 $ 132,761
Restricted cash ........................................................................ 2,400 10,002
Short-term investments ................................................................. 62,777 35,013
Accounts receivable, net of allowance for doubtful accounts of $5,409 and $1,763 in 1998
and 1997, respectively ............................................................. 33,901 55,246
Inventories ............................................................................ 37,406 42,125
Deferred income taxes .................................................................. 16,609 5,853
Prepaid expenses and other current assets .............................................. 24,067 7,148
--------- ---------
Total current assets ............................................................... 225,551 288,148
Long-term investments ....................................................................... 20,357 8,561
Property and equipment, net ................................................................. 41,764 43,050
Other assets, net of accumulated amortization of $10,102 and $5,043 in 1998 and 1997,
respectively ........................................................................... 18,517 18,382
--------- ---------
Total assets ....................................................................... $ 306,189 $ 358,141
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable ....................................................................... $ 8,090 $ 13,182
Accrued expenses and other liabilities ................................................. 26,978 20,346
Income taxes payable ................................................................... 5,877 4,284
--------- ---------
Total current liabilities .......................................................... 40,945 37,812
Convertible subordinated notes .............................................................. 115,000 115,000
Minority interest ........................................................................... 227 418
Stockholders' equity:
Preferred stock:
Authorized shares-- 1,000 ($0.001 par value); no shares issued ..................... - -
Common stock:
Authorized shares -- 40,000 ($0.001 par value)
Issued and outstanding shares-- 21,723 in 1998 and 21,981 in 1997 ................. 21 22
Additional paid-in capital ......................................................... 111,818 110,167
Treasury stock, at cost, 1,332 shares in 1998 ...................................... (19,979) -
Retained earnings ...................................................................... 58,157 94,722
--------- ---------
Total stockholders' equity ......................................................... 150,017 204,911
--------- ---------
Total liabilities and stockholders' equity ......................................... $ 306,189 $ 358,141
========= =========
See accompanying notes.
36
CREDENCE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Year Ended October 31,
--------- --------- ---------
1998 1997 1996
--------- --------- ---------
Net sales:
Systems and upgrades ........................ $ 187,887 $ 186,264 $ 221,096
Service, spare parts and software ........... 28,916 17,828 17,692
--------- --------- ---------
Total net sales ......................... 216,803 204,092 238,788
Cost of goods sold - on net sales .................. 97,004 89,956 97,010
Cost of goods sold - special charges ............... 28,352 -- --
--------- --------- ---------
Gross margin ....................................... 91,447 114,136 141,778
Operating expenses:
Research and development .................... 47,484 37,350 35,442
Selling, general and administrative ......... 64,151 55,701 52,002
In-process research and development ......... 1,998 6,022 -
Special charges ............................. 20,386 - -
--------- --------- ---------
Total operating expenses .................... 134,019 99,073 87,444
--------- --------- ---------
Operating income (loss) ............................ (42,572) 15,063 54,334
--------- --------- ---------
Interest income .................................... 8,497 4,769 4,155
Interest & other (income) expenses, net ............ 7,195 1,602 222
--------- --------- ---------
Income (loss) before income tax provision (benefit) (41,270) 18,230 58,267
Income tax provision (benefit) ..................... (14,785) 7,531 20,564
--------- --------- ---------
Income (loss) before minority interest ............. (26,485) 10,699 37,703
Minority interest .................................. (203) 6 -
========= ========= =========
Net income (loss) .................................. $ (26,282) $ 10,693 $ 37,703
========= ========= =========
Net income (loss) per share
Basic ....................................... $ (1.22) $ 0.49 $ 1.75
========= ========= =========
Diluted ..................................... $ (1.22) $ 0.47 $ 1.72
========= ========= =========
Number of shares used in computing per share amounts
Basic ....................................... 21,533 21,865 21,532
========= ========= =========
Diluted ..................................... 21,533 22,512 21,977
========= ========= =========
See accompanying notes.
37
CREDENCE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Additional Treasury Stock Total
----------------- Paid-in ------------------ Retained Stockholders'
Shares Amount Capital Shares Amount Earnings Equity
-------- -------- ---------- -------- -------- -------- ------------
Balance at October 31, 1995 21,421 $ 21 $103,939 - $ - $ 46,326 $150,286
Issuance of common stock on exercise of options
under incentive stock option plans 133 1 243 - - - 244
Issuance of common stock under employee stock
purchase plan 89 - 1,232 - - - 1,232
Income tax benefit from stock option exercises - - 317 - - - 317
Net income - - - - - 37,703 37,703
-------- -------- ---------- -------- -------- -------- --------
Balance at October 31, 1996 21,643 22 105,731 - - 84,029 89,782
Issuance of common stock on exercise of options
under incentive stock option plans 226 - 1,971 - - - 1,971
Issuance of common stock under employee stock
purchase plan 112 - 1,564 - - - 1,564
Income tax benefit from stock option exercises - - 901 - - - 901
Net income - - - - - 10,693 10,693
-------- -------- ---------- -------- -------- -------- --------
Balance at October 31, 1997 21,981 22 110,167 - - 94,722 204,911
Issuance of common stock on exercise of options
under incentive stock option plans 141 - 1,260 - - - 1,260
Issuance of common stock under employee stock
purchase plan 101 - 1,931 - - - 1,931
Repurchase and retirement of common stock (500) (1) (2,512) - - (10,283) (12,796)
Purchase of treasury shares - - - (1,332) (19,979) - (19,979)
Income tax benefit from stock option exercises - - 972 - - - 972
Net loss - - - - - (26,282) (26,282)
======== ======== ========== ======== ======== ======== ========
Balance at October 31, 1998 21,723 $ 21 $111,818 (1,332) $(19,979) $ 58,157 $150,017
======== ======== ========== ======== ======== ======== ========
See accompanying notes.
38
CREDENCE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended October 31,
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1998 1997 1996
--------- --------- ---------
Cash flows from operating activities
Net income (loss) ...................................................... $ (26,282) $ 10,693 $ 37,703
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization ........................................ 21,146 13,984 11,485
Acquired in-process research and development ......................... 1,998 - -
Loss related to special charges ...................................... 48,738 - -
Loss (gain) on disposal of property and equipment .................... (38) 430 (123)
Deferred income taxes ................................................ (10,504) (3,432) 1,039
Minority interest .................................................... (203) 6 -
Changes in operating assets and liabilities
Restricted cash ................................................... 7,602 (10,002) -
Accounts receivable ............................................... 17,955 (6,221) (4,976)
Inventories ....................................................... (31,094) (16,440) (13,339)
Prepaid expenses and other current assets ......................... (19,363) (4,242) 1,303
Accounts payable .................................................. (5,292) (660) 2,571
Accrued expenses and other liabilities ............................ 2,995 2,517 (1,852)
Income taxes payable .............................................. 2,565 3,654 (2,794)
--------- --------- ---------
Net cash provided by (used in) operating activities .......... 10,223 (9,713) 31,017
Cash flows from investing activities
Purchases of available-for-sale securities ............................. (152,808) (68,983) (80,028)
Maturities of available-for-sale securities ............................ 90,548 56,663 55,625
Sales of available-for-sale securities ................................. 22,700 10,673 -
Proceeds from the maturity of held-to-maturity securities .............. - - 11,521
Acquisition of property and equipment .................................. (11,268) (16,223) (24,689)
Other assets ........................................................... (15,022) (9,201) (4,209)
Proceeds from sale of property and equipment ........................... 829 2,007 4,057
--------- --------- ---------
Net cash used in investing activities ........................ (65,021) (25,064) (37,723)
Cash flows from financing activities
Principal payments under capital lease obligations ..................... - - (655)
Issuance of common stock ............................................... 3,191 3,477 1,476
Repurchase of common stock ............................................. (32,775) - -
Issuance of 5 1/4% convertible subordinated notes ...................... - 115,000 -
Other .................................................................. 12 412 -
--------- --------- ---------
Net cash provided by (used in) financing activities .......... (29,572) 118,889 821
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ....................... (84,370) 84,112 (5,885)
Cash and cash equivalents at beginning of the period ....................... 132,761 48,649 54,534
========= ========= =========
Cash and cash equivalents at end of the period ............................. $ 48,391 $ 132,761 $ 48,649
========= ========= =========
Supplemental disclosures of cash flow information:
Interest paid .......................................................... $ 6,121 $ 1 $ 48
Income taxes paid ...................................................... $ 11,746 $ 7,443 $ 22,319
Noncash investing activities:
Net transfers of inventory to property and equipment ................... $ 9,135 $ 10,036 $ 3,505
See accompanying notes.
39
CREDENCE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Organization and Summary of Significant Accounting Policies
Organization
- ------------
Credence Systems Corporation ("Credence" or the "Company") was
incorporated under the laws of the State of California in March 1982 and was
reincorporated in Delaware in October 1993. The principal business activity of
the Company is the design, development, manufacture, sale and service of
automatic test equipment used in the production of semiconductors. As a result
of acquisitions made during fiscal 1997 and 1998, Credence is also involved in
the design, development, sale and service of software enabling the development
of customer test programs used by automatic test equipment. The Company has a
subsidiary in Japan engaged in sales, marketing and service of the Company's
products and a subsidiary in Korea engaged in service of the Company's products.
Also, the Company has a joint venture with Innotech Corporation in Japan engaged
in the customization, development and manufacture of product for sale by both
companies. The joint venture is 50.1% owned by the Company and is consolidated
in the financial statements. The operations of and net investment in foreign
subsidiaries are not material.
Basis of Presentation
- ---------------------
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned and majority owned subsidiaries. All
significant intercompany transactions and balances have been eliminated. Certain
prior year amounts in the Consolidated Financial Statements and related notes
have been reclassified to conform to the current year's presentation.
Revenue Recognition
- -------------------
Revenue and related warranty expenses are recognized upon product
shipment. Net sales consist of product and service sales, less discounts and
estimated allowances. A provision for the estimated costs to enhance the
functionality and reliability of the installed base is recorded when such
requirements become known. Revenues from service contracts are recognized
ratably over the contract period. The Company recognizes software revenue in
accordance with the American Institute of Certified Public Accountants Statement
of Position 97-2, which calls for recognizing revenue when a non-cancellable
license agreement has been signed, the software product has been shipped, there
are no uncertainties surrounding product acceptance, the fees are fixed and
determinable, and collection is considered probable. For customer license
agreements that meet the Company's revenue recognition policy, the portion
allocated to software license fees will generally be recognized in the current
period, while the portion allocated to services is recognized as the services
are performed.
Cash, Cash Equivalents, and Short-term Investments
- --------------------------------------------------
For purposes of cash flow reporting, the Company considers all highly
liquid investments with minimum yield risks and original maturity dates of three
months or less to be cash equivalents. Short-term investments consist primarily
of commercial paper, medium term notes, asset-backed securities, U.S. Treasury
notes and obligations of U.S. Government agencies, bank certificates of deposit,
auction rate preferred securities, corporate bonds and municipal bonds carried
at amortized costs adjusted to fair market value.
Management classifies investments as trading, available-for-sale or
held-to-maturity at the time of purchase and periodically re-evaluates such
classification. There were no securities classified as trading as of October 31,
1998 or 1997. Securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at cost with corresponding premiums or
discounts amortized over the life of the investment to interest income. There
were no securities classified as held-to-maturity as of October 31, 1998 or
1997. Securities not classified as held-to-maturity are classified as
available-for-sale and reported at fair market value. Unrealized gains or losses
on available-for-sale securities, if material, are included, net of tax, in
equity until disposition. Realized gains and losses and declines in value judged
to be other-than-temporary on available-for-sale securities are included in
interest income. The cost of securities sold is based on the specific
identification method.
40
The fair market value of cash equivalents, restricted cash and short-term
and long-term investments is substantially equal to the carrying value and
represents the quoted market prices at the balance sheet dates.
Cash and cash equivalents are categorized as follows (in thousands):
October 31, 1998 1997
--------- ---------
Money market ...................................... $ 11,799 $ 20,866
Commercial paper .................................. 8,304 73,277
Auction rate preferred securities ................. - 25,000
Corporate bonds ................................... 2,061 5,000
Obligations of U.S. Government agencies............ 215 1,978
Other debt securities ............................. - 7,614
--------- ---------
Cash equivalents ................................ 2,379 33,735
Cash .............................................. 6,012 (974)
--------- ---------
Cash and cash equivalents ....................... $ 48,391 $ 132,761
========= =========
The short-term investments mature in less than one year. All long-term
investments have maturities of one to two years. At October 31, 1998 and 1997,
these investments are classified as available-for-sale and are categorized as
follows (in thousands):
October 31, 1998 1997
-------- --------
Commercial paper and medium term notes ................... $ 28,048 $ 22,186
Treasury notes and obligations of U.S. Government agencies 8,542 9,173
Asset backed securities .................................. 13,332 -
Auction rate preferred securities ........................ 2,060 -
Certificates of deposit .................................. 1,999 7,997
Corporate bonds .......................................... 18,345 412
Municipal bonds .......................................... 10,808 -
Other debt securities .................................... - 3,806
------- -------
$83,134 $ 43,574
======= =======
Restricted Cash
- ---------------
Restricted cash represents cash in escrow related to commitments by the
Company under an agreement with Summit Design, Inc. to purchase product
licenses. These funds are invested in a money market account.
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):
October 31, 1998 1997
------- -------
Raw materials . ........................................ $ 9,860 $24,862
Work-in-process ........................................ 21,609 14,173
Finished goods ......................................... 5,937 3,090
------- -------
$37,406 $42,125
======= =======
41
Prepaid Expenses and Other Current Assets
- -----------------------------------------
Prepaid expenses and other current assets consist of the following (in
thousands):
October 31, 1998 1997
------- -------
Prepaid and refundable income taxes .................. $18,682 $ -
Prepaid expenses and other ........................... 5,385 7,148
------- -------
$24,067 $ 7,148
======= =======
Property and Equipment and Other Assets
- ---------------------------------------
Property and equipment are stated at cost and are depreciated using the
straight-line method over the assets' estimated useful lives of three to five
years. Assets under capitalized leases are amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the lease
term. Property and equipment consist of the following (in thousands):
October 31, 1998 1997
-------- --------
Machinery and equipment ........................... $ 43,013 $ 36,816
Software .......................................... 10,223 10,830
Leasehold improvements ............................ 11,798 8,248
Furniture and fixtures ............................ 4,840 5,039
Spare parts ....................................... 18,390 17,026
------- -------
88,264 77,959
Less accumulated depreciation and amortization .... 46,500 34,909
------ -------
Net property and equipment ........................ $ 41,764 $ 43,050
======= =======
Other assets consist primarily of purchased technologies, other
intangibles and related rights which are amortized using the straight-line
method over the assets' estimated useful lives of three to five years.
Accumulated amortization associated with intangible assets is approximately
$10,102,000 and $5,043,000 at October 31, 1998 and 1997, respectively.
In 1995, the Financial Accounting Standards Board ("FASB") released the
Statement of Financial Accounting Standards ("SFAS") No. 121 (SFAS 121),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be disposed of." SFAS 121 requires recognition of impairment of long-lived
assets in the event the net book value of such assets exceeds the future
undiscounted cash flows attributable to such assets. The Company adopted SFAS
121 on November 1, 1996. Adoption of SFAS 121 had a material impact on the
Company's financial position and results of operations as described more fully
in Note 3 herein.
Accrued Expenses and Other Liabilities
- --------------------------------------
Accrued expenses and other liabilities consist of the following (in
thousands):
October 31, 1998 1997
-------- --------
Accrued payroll and related liabilities $ 6,767 $ 6,061
Accrued warranty 3,874 3,277
Accrued distributor commissions 1,706 3,174
Deferred revenue 3,065 2,748
Accrued loss on supplier commitments 2,400 -
Other accrued liabilities 9,166 5,086
-------- --------
$ 26,978 $ 20,346
======== ========
42
Net Income (Loss) Per Share
- ---------------------------
The Company adopted SFAS No. 128, "Earnings Per Share", (SFAS 128)
beginning in the first quarter of fiscal 1998. Accordingly, basic net income
(loss) per share is based upon the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is based upon
the weighted-average number of common shares 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 diluted net income (loss) per share. Weighted-average
options to purchase 932,998 shares at an average price of $28.58 per share were
outstanding at October 31, 1998, but were not included in the computation of
diluted net loss per share because the options' exercise price was greater than
the average market price of the common shares and the Company incurred a net
loss. Therefore, the effect of including the options would be antidilutive. All
net income (loss) per share amounts for all periods have been presented to
conform to SFAS 128 requirements. The following table sets forth the computation
of basic and diluted net income (loss) per share (in thousands, except per share
amounts):
1998 1997 1996
-------- -------- --------
Numerator:
Numerator for basic and diluted net income (loss) per share -
net income (loss) ........................................... $(26,282) $ 10,693 $ 37,703
-------- -------- --------
Denominator:
Denominator for basic net income (loss) per share -
weighted-average shares ..................................... 21,533 21,865 21,532
Effect of dilutive securities - employee stock options ........ 647 445
-------- -------- --------
Denominator for diluted net income(loss) per share - adjusted
weighted-average shares and assumed exercises ................. 21,533 22,512 21,977
-------- -------- --------
Basic net income (loss) per share ........................... $ (1.22) $ 0.49 $ 1.75
Diluted net income (loss) per share ......................... $ (1.22) $ 0.47 $ 1.72
Recent Accounting Pronouncements
- --------------------------------
In June 1997, the FASB released SFAS No. 130, "Reporting Comprehensive
Income", (SFAS 130). SFAS 130 establishes standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements and is effective for fiscal years beginning after
December 15, 1997. Adoption of SFAS 130 is not expected to have a material
impact on the Company's consolidated financial statements. In June 1997, the
FASB released SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", (SFAS 131). SFAS 131 will change the way companies report
selected segment information in annual financial statements and also requires
those companies to report selected segment information in interim financial
reports to stockholders. SFAS 131 is effective for fiscal years beginning after
December 15, 1997. Adoption of SFAS 131 will require disclosure by operating
segment of information such as profit and loss, assets and capital expenditures,
major customers and types of products from which revenue is derived.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," (SFAS 133), which is required to be adopted
in fiscal years beginning after June 15, 1999. The Statement permits early
adoption as of the beginning of any fiscal quarter after its issuance. The
Company is currently evaluating whether to adopt the new statement earlier than
is required. SFAS 133 will require the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through earnings. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in the fair value of the hedged assets, liabilities
or firm commitments through earnings, or recognized in other comprehensive
income until the hedged item is recognized in earnings. The ineffective portion
of a derivative's change in fair value will be immediately recognized in
earnings. Adoption of SFAS 133 is not expected to have a material impact on the
Company's financial condition or results of operations.
43
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.
Actual results inevitably will differ from those estimates and such
differences may be material to the financial statements.
Note 2
Acquisitions
In July 1997, the company, through a subsidiary, Fluence Technology, Inc.
(formerly known as Test Systems Strategies, Inc.), a Delaware corporation
("Fluence"), acquired certain assets and assumed certain liabilities from Summit
Design, Inc. and its wholly owned subsidiary, Test Systems Strategies, Inc., an
Oregon corporation, including the test development series software products
("TDS") and TSSI trademark of Test Systems Strategies, Inc, the Oregon
corporation (the "TSSI acquisition"). TDS includes tools designed to convert
gate-level simulation data from electronic design automation simulators to
programs that operate on targeted automatic test equipment ("ATE") for testing
integrated circuits characterized by the gate-level simulation data. TDS
facilitates simulation analysis, stimulus generation, simulation rules checking,
tester resource checking, ATE test program generation, and test program
conversion. The consolidated financial statements reflect the impact of TDS
operations subsequent to the acquisition date.
The purchase price of $7.3 million consisted of a cash payment of $7.0
million to Summit Design, Inc. and $300,000 for the assumption of liabilities.
Acquired assets and liabilities were recorded at their estimated fair market
value at the date of the acquisition. The aggregate purchase price, plus related
acquisition expenses, have been allocated to the assets and liabilities acquired
based on valuations. Amounts allocated to in-process research and development
("IPR&D") of approximately $6.0 million were written off at the acquisition
date, representing an estimated value (using risk-adjusted cash flows,
discounted at 35%) of development programs that had not yet reached
technological feasibility. Amounts allocated to developed technology, $1.0
million, and workforce in place, $0.3 million, are being amortized on a
straight-line basis over periods of six and three years, respectively.
The IPR&D associated with the TSSI acquisition related to the development
of a standard tester interface language ("STIL"). The STIL development project
is approximately 35% complete as of October 31, 1998. The significant
technological hurdles remaining to be addressed include: the ability to parse
mega-vector files and make them immediately available to the application program
interface; the ability to effectively process both batch and online input from
engineering design automation ("EDA") simulation tools, the development of
efficient algorithms for taking event data from EDA simulation tools and mapping
it into the limited resources of a given ATE system according to a standard set
of rules; and the development of additional STIL constructs which enable the use
of STIL as a design stimulus language, enable the use of STIL for representing
test patterns for embedded cores, representing the test program flow in STIL,
representing test methods in STIL and defining voltage and current levels
associated with STIL waveforms. The Company estimates that as of October 31,
1998, the remaining research and development work on the STIL project will take
approximately 13 engineering person years, at a cost of approximately $2.0
million and will be completed in fiscal 2000. The project has progressed more
slowly than originally projected due to lower than anticipated staffing. The
lower staffing levels were a result of the Company's actions to reduce expenses
during a period of reduced revenues and earnings. There can be no assurance that
the Company will be able to complete the development and successful marketing of
any STIL based products. A failure to successfully develop and market STIL based
products could have a material adverse effect on the Company's business,
financial condition or results of operations.
In August 1997, Fluence purchased from Zycad Corporation ("Zycad") and
one of its subsidiaries, Attest Software, Inc. certain assets, including the TDX
software product line ("TDX"). TDX consists of software products that facilitate
the development of ATE test programs to aid in ensuring the integrity of
integrated circuit designs prior to incurring the expense of wafer fabrication.
The purchase price consisted of a cash payment to Zycad of $2,250,000.
Acquired assets were recorded at their estimated fair market value at the date
44
of the acquisition. The aggregate purchase price, plus related acquisition
expenses, have been allocated to the assets acquired based on valuations.
Amounts allocated to developed technology, $2.0 million, workforce in place,
$0.1 million, and fixed assets, $0.1 million are being amortized on a
straight-line basis over periods of five, three and five years, respectively.
In June 1998, the Company purchased from Heuristics Physics Laboratories,
Inc. ("HPL") certain assets and assumed certain liabilities relating to its
memory self test business for $8.0 million in cash and the assumption of $0.2
million in liabilities. Additionally, the Company agreed to make payments to the
shareholder representatives of HPL in an amount equal to 10% of the Company's
net sales of products derived from the assets acquired from HPL's design for
test division for a period of two years following the acquisition. In connection
with the HPL acquisition, the Company recognized $2.0 million of acquired IPR&D.
The remaining $6.2 million has been capitalized, of which $5.3 million is for
purchased technology and other intangible assets which will be amortized ratably
over their estimated useful lives of five years.
The Company's management made certain assessments with respect to the
determination of all identifiable assets resulting from, or to be used in,
research and development activities as of the acquisition date. Each of these
activities was evaluated, by both interviews and data analysis, to determine its
state of development and related fair value. The Company's review indicated that
the IPR&D had not reached a state of technological feasibility and the
underlying technology had no alternative future use to the Company in other
research and development projects or otherwise. In the case of IPR&D, fair
values of the corresponding technologies were determined using an income
approach, which included a discounted future earnings methodology. Under this
methodology, the value of the in-process technology is comprised of the total
present value of the anticipated after-tax cash flows attributable to the
in-process project, discounted to net present value, taking into account the
uncertainty surrounding the successful development of the purchased IPR&D.
The HPL acquired IPR&D consists of projects related to memory self test.
These projects are aimed at the development of products that can perform self
testing of on-chip memories, self testing of off-chip memories, automated memory
test vector generation, built-in memory repair analysis and built-in automated
memory circuit repair. The Company estimated that approximately 50% of the
research and development effort, based on complexity, had been completed at the
date of the acquisition. The significant work remaining on these projects was
estimated to take approximately 16 engineering person years, at a cost of
approximately $1.3 million and be completed in late fiscal 1999 or early fiscal
2000. As of October 31, 1998, the Company believed that the projections of time
and cost had not materially changed. As of the acquisition date, HPL was in the
alpha stage of development and required the resolution of certain memory self
test technological hurdles in order to complete the technology. The items
remaining to be addressed at the acquisition date included the following:
expansion of built-in self test (BIST) capability to address large (beyond
mega-bit) embedded memories used in the emerging system-on-a-chip market,
completion of third generation BIST, automation tools allowing the generation of
user-configurable test algorithms on the active load board of a test system,
completion of manufacturing oriented memory BIST architecture enabling parallel
test execution and full diagnostics for engineering debug and yield analysis,
and completion of the first built-in redundancy analyzer, software to direct
laser repair stations and embedded memory self repair.
There can be no assurance that these projects will achieve technological
feasibility or that the Company will be able to successfully market products
based on such technology. Should these in-process projects fail, the value of
the Company's investment in these incomplete technologies would be diminimous or
zero. A failure to successfully develop and market memory self test products
could have a material adverse affect on the Company's business, financial
condition or results of operations.
Note 3
Special Charges
In the third and fourth quarters of fiscal 1998, the Company recorded
special charges totaling $48.7 million, of which $28.4 million were classified
as cost of goods sold and the balance was classified as operating expenses.
These charges are the result of the Company's response to a major downturn in
the current and forecasted business outlook for the ATE and related
semiconductor and semiconductor equipment industries which took place during the
period. As a result of this industry downturn, the Company has downsized its
operations, including reducing headcount, reducing the volume of products being
produced and cancelling and delaying various projects, including facilities
expansions and certain research and development projects. The impact of this
downturn and these decisions is that significant amounts of the Company's
inventories, receivables, fixed assets, prepaid expenses, investments and
purchased technologies have been impaired and certain liabilities have been
incurred. As a result, the Company has written down the related assets to their
net realizable values and made provision for the estimated liabilities.
45
Of the $48.7 million in charges, approximately $28.4 million was charged
as cost of goods sold, of which approximately $26.7 million was related to
write-down of excess or obsolete inventories. The elements of the charges during
fiscal 1998 are as follows (in thousands):
Write-down of inventories to net realizable value
(including expected losses on supplier commitments) ....... $26,678
Write-down of excess fixed assets to fair value ................ 7,272
Write-down of purchased technology and investments to fair value 5,118
Write-off of prepaid and other current assets .................. 2,444
Excess facility costs .......................................... 2,641
Provision for uncollectible receivables ........................ 3,389
Employee termination benefits and accrued liabilities .......... 1,196
-------
$48,738
At October 31, 1998, approximately $4.8 million in accrued liabilities
related to special charges remained on the Company's balance sheet, primarily
the accrued loss on supplier commitments of $2.4 million and approximately $1.9
million for 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 fiscal 1998 were approximately
$700,000, relating primarily to excess facilities and to severance costs.
Note 4
Concentration of Risks
Credit Risk and Geographic Data
- -------------------------------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of investments in cash
equivalents, restricted cash, short-term and long-term investments and trade
receivables. The Company is exposed to credit risks in the event of default by
the financial institutions or customers to the extent of the amount recorded on
the balance sheet.
The Company and its subsidiaries operate in two industry segments: the
design, development, manufacture, sale and service of ATE used in the production
of semiconductors; and, as a result of acquisitions made in fiscal 1998 and
1997, the design, development, sale and service of software that assists in the
development of test programs used in ATE. Revenues from software were not
material to the Company's operations in fiscal 1998 and 1997.
The Company sells its products primarily to distributors and
semiconductor manufacturers located in the United States, Asia Pacific and
Europe. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company maintains reserves for
potential credit losses and such losses historically have been both immaterial
and within management's expectations.
Export sales, which are denominated in U.S. dollars and represent
substantially all of the Company's international sales, represent sales to the
Company's customers primarily throughout Asia Pacific and Europe. Sales by the
Company to customers in different geographic areas, expressed as a percentage of
revenue, for the periods ended were:
Year ended October 31, 1998 1997 1996
---- ---- ----
Domestic ... ................. 31% 30% 33%
Asia Pacific ................. 60 66 58
Europe ....................... 9 4 9
--- --- ---
Total sales 100% 100% 100%
=== === ===
46
One customer (a distributor) accounted for 34%, 30% and 25% of the
Company's net sales in fiscal 1998, 1997 and 1996, respectively. The Company's
major distributor sells product into Taiwan. This subjects a significant portion
of the Company's receivables and future revenues to the risks associated with
doing business in a foreign country, including political and economic
instability, currency exchange rate fluctuations and regulatory changes.
Disruption of business in Asia caused by the previously mentioned factors could
have a material impact on the Company's business, financial condition or results
of operations.
Other Risks
- -----------
The semiconductor industry has historically been cyclical and has
experienced downturns, which have had a material adverse effect on the
semiconductor industry's demand for ATE, including equipment manufactured and
marketed by the Company. Differences between the Company's forecast of market
demand for its products and actual demand could have a material effect on the
financial statements. In addition, the ATE industry is highly competitive, and
subject to rapid technological change. The Company has experienced and is
continuing to experience significant delays in the introduction of new products.
It is reasonably possible that events related to the above factors may occur in
the near term which would cause a change to the Company's estimate of the net
realizable value of receivables, inventories or other assets, and the adequacy
of costs accrued for warranty and other liabilities. Such changes have and could
continue to materially adversely affect the Company's business, financial
condition and results of operations.
In addition, the Company relies on several suppliers and manufacturing
subcontractors to provide many of the key components and subassemblies used in
the Company's products. Some of these items are available from only one supplier
or a limited group of suppliers. Any disruption in the delivery of these items
could materially adversely affect the Company's business, financial condition
and results of operations.
Note 5
Credit Facilities
The Company has a $40,000,000 unsecured bank line of credit, with
interest at the bank's prime rate (8% at October 31, 1998) which expires July
23, 1999. This line supports the issuance of letters of credit and foreign
exchange contracts. At October 31, 1998, the Company had no borrowings
outstanding under this line of credit. Borrowings under the line of credit are
subject to the Company's ability to meet certain financial covenants including
profitability and leverage ratios and require the Company to obtain certain bank
approvals for the payment of dividends. The Company was not in compliance with
certain financial covenants at October 31, 1998, but it received waivers from
the banks and has subsequently renegotiated the applicable financial covenants
under the credit facility. There were no foreign exchange contracts outstanding
at October 31, 1998 or 1997.
Note 6
Lease Obligations and Other Commitments
The Company leases its facilities under operating leases that expire
periodically through 2014.
The approximate future minimum lease payments under operating leases for
facilities and equipment at October 31, 1998 are as follows (in thousands):
Lease Payments
--------------
1999 $ 5,145
2000 5,236
2001 4,900
2002 4,684
2003 3,636
Thereafter 23,874
------
$47,475
Rent expense was approximately $4,336,000, $4,147,000, and $4,132,000 for
the years ended October 31, 1998, 1997 and 1996, respectively.
The Company has an agreement with a distributor whereby the Company
issued a guaranty in favor of a bank with respect to certain obligations of the
47
distributor to the bank. Under this agreement, the distributor agreed to grant
to the Company a security interest to secure the obligations of the distributor
as a result of any payments by the Company pursuant to the guaranty. At October
31, 1998, the maximum allowable debt of the distributor subject to this
guaranty, $1,000,000, was outstanding.
Note 7
Convertible Subordinated Notes
In September 1997, the Company sold $115 million of 5 1/4% convertible
subordinated notes (the "Notes") due 2002 through a private placement. The Notes
are unsecured obligations of the Company and are subordinated to all present and
future senior indebtedness of the Company. The Notes do not provide for a
sinking fund and are redeemable at the option of the Company, in whole or in
part, at any time on or after September 20, 2000, at certain redemption prices.
Interest is payable semiannually on March 15 and September 15, commencing March
15, 1998. The Notes are convertible into common stock of the Company at an
initial conversion price of $69.15 per share. To date $6.1 million has been paid
in interest expense. Expenses of $3.3 million associated with the offering have
been deferred and included in other assets. Such expenses are being amortized to
interest expense over the term of the Notes. In November 1997, the Company filed
a Registration Statement with the Securities and Exchange Commission under Form
S-3 to permit public secondary trading of the Notes, and, upon conversion, the
underlying common stock. Such registration statement was declared effective in
December 1997. As of October 31, 1998, the fair value of the Notes based on
quotes from a major brokerage firm was approximately $74.4 million.
Note 8
Stockholders' Equity
Treasury Stock and Common Stock Repurchases
-------------------------------------------
During the year, the Company repurchased a total of 1.8 million shares of
its common stock at a cost of $32.8 million. Out of the total 1.8 million
shares, 500,000 were canceled and retired and the balance of 1.3 million shares
were put in treasury stock.
Stock Option Plans and Stock Purchase Plan
------------------------------------------
The Company grants options to employees and members of the Board of
Directors under the 1993 Stock Option Plan (the "1993 Plan"). The 1993 Plan is
divided into two separate components: (i) the Discretionary Option Grant Program
and (ii) the Automatic Option Grant Program. Options granted under the
Discretionary Option Grant Program will have an exercise price equal to 100% of
the fair market value of such shares on the date of grant, and a maximum term of
ten years, and are exercisable over a vesting period, generally four to five
years. Under the Automatic Option Grant Program, options are granted
automatically at periodic intervals to non-employee members of the Board at an
exercise price equal to 100% of the fair market value of the option shares on
the date of grant and a maximum term of ten years, and are exercisable over a
vesting period, generally four to five years. Under the Automatic Option Grant
Program, options are granted automatically at periodic intervals to non-employee
members of the Board at an exercise price equal to 100% of the fair market value
of the option shares on the date of grant and a maximum term of ten years.
On March 25, 1998, the stockholders approved an amendment to the
Company's 1993 Stock Option Plan that increased the number of shares of Common
Stock reserved for issuance thereunder by an additional 500,000 shares to a
total of 4,625,001 shares.
On March 25, 1998, the stockholders approved an amendment to the
Company's 1993 Stock Option Plan that implemented an automatic share increase
feature pursuant to which the number of shares available for issuance under the
1993 Stock Option Plan (the "1993 Plan") will automatically increase on the
first trading day of each fiscal year (the "First Trading Day"), beginning with
the 1999 fiscal year and continuing through the fiscal year 2003, by an amount
equal to two percent (2%) of the total number of shares outstanding on the last
trading day of the immediately preceding fiscal year. The 1993 Plan provides
that at the end of each First Trading Day the number of then outstanding options
under the Company's stock option plans shall not exceed fifteen percent (15%) of
the then outstanding voting shares of capital stock of the Company, together
with all then actually outstanding stock options under the Company's stock
option plans, together with all options in the reserve then available for future
grant under the Company's Stock Option Plans.
48
A summary of the activity under all plans, excluding the Fluence Plan, as
defined below (in thousands, except per share amounts) is as follows:
Options Available Number of Price Weighted
for Grant Shares Per Average
(Authorized) Outstanding Share Exercise Price
-------------------- ----------- --------------- ---------------
Balance at October 31, 1995 ............. 652 1,041 $ 0.44 - $33.00 $13.46
Increase in authorized shares ........... 500 - - -
Options granted ......................... (1,107) 1,107 $12.75 - $29.00 $15.48
Options canceled ........................ 227 (227) $ 0.54 - $33.00 $23.48
Options exercised ....................... - (133) $ 0.52 - $16.50 $ 1.83
Options expired ......................... (8) - - -
-------------------- ----------- --------------- --------
Balance at October 31, 1996 ............. 264 1,788 $ 0.44 - $33.00 $14.29
Increase in authorized shares ........... 500 - - -
Options granted ......................... (408) 408 $19.00 - $29.50 $25.23
Options canceled ........................ 170 (170) $ 1.00 - $33.00 $19.11
Options exercised ....................... - (226) $ 0.44 - $33.00 $ 9.69
Options expired ......................... (2) - - -
-------------------- ----------- --------------- --------
Balance at October 31, 1997 ............. 524 1,800 $ 0.44 - $33.00 $16.90
Increase in authorized shares ........... 500 - - -
Options granted ......................... (699) 699 $14.50 - $29.50 $26.31
Options canceled ........................ 145 (145) $ 0.54 - $30.00 $19.47
Options exercised ....................... - (141) $ 0.44 - $23.12 $ 9.09
==================== =========== =============== ========
Balance at October 31, 1998 ............. 470 2,213 $ 0.44 - $33.00 $20.20
==================== =========== =============== ========
The Company has reserved for issuance approximately 2,683,000 shares of
common stock in connection with the stock option plans. At October 31, 1998,
approximately 907,000 shares were exercisable at an aggregate exercise price of
$15,515,000.
The following table summarizes information about options outstanding and
exercisable at October 31, 1998, excluding the Fluence Plan (in thousands except
per share amounts).
Options Outstanding Options Exercisable
Weighted-Avg. Weighted Options Weighted
Options Remaining Average Currently Average
Range of Outstanding at Contractual Life Exercise Exercisable at Exercise
Exercise Prices Oct. 31, 1998 (years) Price October 31, 1998 Price
- ------------------- --------------- ---------------- ---------- ----------------- -----------
$ 0.44 - $13.25 816,311 7.04 $11.69 489,020 $ 10.78
$14.17 - $26.25 568,895 8.24 $19.18 216,544 $ 19.64
$26.44 - $29.00 155,236 8.93 $27.49 37,026 $ 28.07
$29.50 - $33.00 672,726 8.70 $29.69 164,428 $ 30.11
=================== ============= ================ ========== ================= ===========
$ 0.44 - $33.00 2,213,168 7.99 $20.20 907,018 $ 17.11
=================== ============= ================ ========== ================= ===========
These options will expire, if not exercised, at specific dates from
February 1999 to August 2008.
In 1997, the Company's subsidiary, Fluence, adopted a 1997 Stock Option
Plan (the "Fluence Plan") under which incentive stock options to purchase
Fluence common stock could be granted to employees, non-employee members of the
Board or the non-employee members of the Board of Directors of any parent or
subsidiary, and consultants and other independent advisors who provide services
to Fluence (or any parent or subsidiary). Under the Fluence Plan, options to
purchase Fluence common stock can be granted at prices no less than 85% of their
fair value on the date of grant. Generally, options granted are immediately
49
exercisable and the resulting shares issued to employees under the Fluence Plan
are subject to certain repurchase rights by Fluence, at the discretion of
Fluence, upon the individual's cessation of service prior to vesting in the
shares at the original purchase price. As of October 31, 1998, 634,000 options
were granted at fair value to employees and are exercisable by employees at an
exercise price of $0.10 per share. These shares vest over a four-year period.
Activity under this plan (in thousands, except per share amounts) is as follows:
Options Outstanding
------------------------------
Options Available Number Weighted Average
For Grant of Shares Exercise Price
Balance at October 31, 1996 - - $ -
Initial shares authorized . 2,000 - -
Options granted ........... ( 851) 851 0.10
------ ------ -----
Balance at October 31, 1997 1,149 851 0.10
Grants .................... (195) 195 0.10
Cancellations ............. 410 (410) 0.10
Exercises ................. - (2) 0.10
====== ====== =====
Balance at October 31, 1998 1,364 634 $ 0.10
====== ====== =====
Fluence has reserved for issuance approximately 2,000,000 shares of
common stock in connection with the Fluence Plan.
The following table summarizes information about options outstanding
under the Fluence Plan at October 31, 1998 (option amounts are recorded in
thousands except per share amounts):
Options Outstanding Options Exercisable
Options Weighted
Options Weighted-Avg. Currently Average
Range of Outstanding Remaining Weighted-Avg. Exercisable at Exercise
Exercise Price at Oct. 31, 1998 Contractual Life Exercise Price October 31, 1998 Price
(years)
$0.10 634 9.07 $0.10 634 $0.10
These options will expire, if not exercised, at specific dates from
October 2007 to August 2008.
In 1994, the Company adopted the 1994 Employee Stock Purchase Plan, which
provides eligible employees with the opportunity to acquire shares of the
Company's common stock. The purchase price is 85% of the fair market value per
share of common stock on the date on which the purchase period begins or on the
date on which the purchase period ends, whichever is lower. Approximately
101,023, 114,940 and 89,000 shares were acquired pursuant to the plan in 1998,
1997 and 1996, respectively. At October 31, 1998, approximately 113,334 shares
were reserved for issuance under the plan.
The Company has elected to follow APB Opinion No. 25, "Accounting for
Stock Issued to Employees," in accounting for its employee stock options
because, as discussed below, the alternative fair value accounting provided for
under SFAS No. 123, "Accounting for Stock-Based Compensation," requires the use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB No. 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of the grant, no compensation expense is recognized in the Company's
financial statements.
Pro forma information regarding net income (loss) and net income (loss)
per share is required by SFAS No. 123. This information is required to be
determined as if the Company had accounted for its employee stock options
(including shares issued under the Employee Stock Purchase Plan, collectively
called "options") granted subsequent to October 31, 1995 under the fair value
method of SFAS No. 123.
In calculating pro forma compensation, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model. The Black-Scholes option valuation model was developed for use in
50
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, the Black-Scholes model requires the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock-based awards to employees have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of its stock-based awards to its
employees. The fair value of each option grant is estimated assuming no expected
dividends and the following weighted-average assumptions:
1998 1997 1996
---- ---- ----
Expected life (years) ................. 3.03 3.35 3.19
Expected stock price volatility ....... 0.70 0.65 0.58
Risk-free interest rate ............... 4.28% 5.67% 5.64%
The grant date weighted-average fair value of options granted during the
year were $12.58, $25.23 and $15.48 for 1998, 1997 and 1996, respectively.
The pro forma net income (loss) and net income (loss) per share include
expense related to the Company's Employee Stock Purchase Plan. The fair value of
issuances under the Employee Stock Purchase Plan is estimated on the issuance
date using the Black-Scholes model assuming no expected dividends and the
following weighted-average assumptions for issuances made in 1998, 1997 and
1996:
1998 1997 1996
---- ---- ----
Expected life (years) ................ 0.50 0.50 0.50
Expected stock price volatility....... 0.82 0.65 0.58
Risk-free interest rate .............. 4.55% 5.67% 5.64%
The weighted-average fair value of purchase rights granted during the
year were $9.42, $7.49 and $6.82 for 1998, 1997 and 1996, respectively.
For pro forma purposes, the estimated fair value of the Company's
stock-based awards to its employees is amortized over the option's vesting
period and the Employee Stock Purchase Plan's six-month purchase period. The
Company's pro forma information is as follows (in thousands, except per share
amounts):
1998 1997 1996
---------- ---------- ----------
Net income (loss) as reported .................. $ (26,282) $ 10,693 $ 37,703
Pro forma net income (loss) .................... $ (30,725) $ 8,316 $ 36,547
Pro forma basic net income (loss) per share .... $ (1.43) $ 0.38 $ 1.70
Diluted net income (loss) per share as reported $ (1.22) $ 0.47 $ 1.72
Pro forma diluted net income (loss) per share .. $ (1.43) $ 0.37 $ 1.67
Because SFAS 123 is applicable only to options granted subsequent to
October 31, 1995, its pro forma effect will not be fully reflected until fiscal
2000.
Rights Plan
- -----------
On June 1, 1998, the Company adopted the Credence Systems Corporation
Stockholder Rights Plan (the "Rights Plan"). Pursuant to the Rights Plan, rights
were distributed as a dividend at the rate of one right for each of Credence
common stock, par value $0.001 per share ("Right") of the Company held by
stockholders of record as of the close of business on June 22, 1998. The Rights
will expire on June 22, 2008, unless redeemed or exchanged. Under the Rights
Plan, each Right initially will entitle the registered holder to buy one unit of
a share of preferred stock for $165.00. The Rights will become exercisable only
if a person or group (other than stockholders currently owning 15% of Credence
common stock) acquires beneficial ownership of 15% or more of Credence's common
stock, or commences a tender offer or exchange offer upon consummation of which
such person or group would beneficially own 15% or more of Credence's common
stock.
51
Note 9
Employee Benefit Plans
The Company maintains a 401(k) retirement savings plan for its full-time
domestic employees, which allows them to contribute up to 20% of their pre-tax
wages subject to IRS limits. The Company's only contribution to this plan was
$441,000 in fiscal 1997.
The Company maintains a profit sharing plan for those domestic employees
that are not otherwise eligible for incentive-based compensation. Contributions
to this plan are subject to the discretion of the Board of Directors. The
Company made contributions of $1,285,000, $476,000 and $3,721,000 in fiscal
1998, 1997 and 1996, respectively.
Note 10
Income Taxes
The tax provision consists of the following (in thousands):
Year Ended October 31, 1998 1997 1996
-------- -------- --------
Federal:
Current $ (3,786) $ 9,062 $ 16,317
Deferred (8,868) (3,059) 1,647
------- ------- -------
(12,654) 6,003 17,964
State:
Current (539) 1,818 2,358
Deferred (1,636) (373) 220
-------- -------- -------
(2,175) 1,445 2,578
Foreign:
Current 44 83 22
======== ======== =======
$(14,785) $ 7,531 $ 20,564
======== ======== =======
Pre-tax income (loss) from foreign operations was approximately $6,000 in
1998, $(206,000) in 1997 and $56,000 in 1996.
A reconciliation between the Company's effective tax rate (36% in 1998, 41%
in 1997 and 35% in 1996) and the U.S. statutory rate is as follows (in
thousands):
Year Ended October 31, 1998 1997 1996
---------- -------- ----------
Tax computed at statutory rate $(14,373) $6,380 $20,394
State income tax (net of federal benefit) (1,414) 935 1,687
Foreign sales corporation benefit -- (862) (1,626)
In-process research and development not currently benefited 466 1,264 -
Net operating loss carryforward benefit -- (141) (141)
Research and development credits (300) (370) -
Other items 836 325 250
========== ======== ==========
$(14,785) $7,531 $20,564
========== ======== ==========
At October 31, 1998, the Company has unused net operating loss and
research tax credit carryforwards for federal income tax purposes of
approximately $2,000,000 and $194,000, respectively, which expire in 2003
through 2005. Utilization of the net operating loss carryforwards at October 31,
1998 is limited to approximately $401,000 annually under the provisions of
Section 382 of the Internal Revenue Code of 1986, as amended.
Utilization of the credit carryforwards is similarly limited.
52
Significant components of the Company's deferred tax assets are as
follows (in thousands):
October 31, 1998 1997
-------- --------
Deferred tax assets:
Accounting for inventories ................ $ 8,277 $ 4,417
Allowance for doubtful accounts ........... 2,168 884
Accruals not currently deductible ........ 6,506 2,236
Net operating loss carryforwards .......... 703 703
Acquired technology ....................... 2,766 2,283
Research credit carryforwards ............. 194 194
-------- --------
Total deferred tax assets ........... 20,614 10,717
Valuation allowance for deferred tax assets (2,572) (2,106)
-------- --------
18,042 8,611
Deferred tax liability:
Tax over book depreciation ................ (166) (1,239)
-------- --------
Total deferred tax liability ........ (166) (1,239)
-------- --------
Net deferred tax assets ............. $ 17,876 $ 7,372
======== ========
The change in the valuation allowance was a net increase of $466,000 and
$1,209,000 in 1998 and 1997, respectively, and a net decrease of $140,000 in
1996.
Realization of a portion of the net deferred tax assets is dependent on the
Company's ability to generate approximately $30,000,000 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.
Note 11
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.
Note 12
Related Party Transactions
Bernard V. Vonderschmitt, a director of the Company, is the founder and
chairman of Xilinx, Inc. For the years ended October 31, 1998, 1997 and 1996,
the Company sold approximately $2,868,000, $1,356,000 and $7,887,000,
respectively, of products and services to Xilinx. The amounts receivable from
Xilinx were approximately $554,000 and $2,000 at October 31, 1998 and 1997,
respectively.
Dr. William G. Howard, a director of the Company, has been a director of
VLSI Technology, Inc. ("VLSI") since May 31, 1996. The Company's sales to VLSI
were approximately $2,011,000, $171,000 and $8,508,000 in fiscal 1998, 1997 and
1996, respectively. The amounts receivable from VLSI were approximately $568,000
and $166,000 at October 31, 1998 and 1997, respectively. Dr. Howard also serves
as a director of Ramtron International, Inc. ("Ramtron"). The Company's sales to
Ramtron were approximately $151,000, $6,000 and zero in fiscal 1998, 1997 and
1996, respectively. Amounts receivable from Ramtron were approximately $1,000
and zero at October 31, 1998 and 1997, respectively.
The Company sells products and services to Israeli Test House, Inc.
("ITH"), a company in which the Company has an investment. For the years ended
October 31, 1998, 1997 and 1996, sales to ITH totaled approximately $21,000,
$6,000 and $2,754,000, respectively. The amounts receivable from ITH were
approximately $345,000 and $324,000 at October 31, 1998 and 1997, respectively.
53
Note 13
Subsequent Event - Repricing (unaudited)
On November 5, 1998, the Compensation Committee of the Company's Board of
Directors approved a stock option repricing program pursuant to which employees
of the Company (excluding Board members and consultants) could elect to cancel
certain unexercised stock options in exchange for new stock options with an
exercise price of $17.19 per share equal to the closing price of the Company's
common stock on the Nasdaq National Market on December 14, 1998. Approximately
898,000 options were eligible for repricing, of which approximately 571,000 were
repriced. The vesting schedules and expiration dates of repriced stock options
were restarted at the new vesting commencement date of December 14, 1998.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
54
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT.
The information required by this item relating to the Company's directors
and nominees and disclosure relating to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is included under the captions "Election of
Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of
1934" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders and is incorporated herein by reference. The information required
by this item relating to the Company's executive officers and key employees is
included under the caption "Executive Officers and Key Employees" in Part I of
this Form 10-K Annual Report.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is included under the caption
"Executive Compensation and Related Information" in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is included under the caption
"Ownership of Securities" in the Company's Proxy Statement for the 1999 Annual
Meeting of Stockholders and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is included under the caption
"Certain Relationships and Related Transactions" in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of the Annual Report on Form 10-K:
1. Financial Statements. The following Consolidated Financial Statements
of Credence Systems Corporation are included in Item 8 of this Annual
Report on Form 10-K:
Page
Report of Ernst & Young LLP, Independent Auditors 35
Consolidated Balance Sheets --
October 31, 1998 and 1997 36
Consolidated Statements of Operations --
Years Ended October 31, 1998, 1997 and 1996 37
Consolidated Statements of Stockholders' Equity --
Years Ended October 31, 1998, 1997 and 1996 38
Consolidated Statements of Cash Flows --
Years Ended October 31, 1998, 1997 and 1996 39
Notes to Consolidated Financial Statements 40
2. Financial Statement Schedule. The following financial statement
schedule of Credence Systems Corporation, for the years ended October
31, 1998, 1997 and 1996, is filed as part of this Annual Report on
Form 10-K and should be read in conjunction with the Consolidated
Financial Statements of Credence Systems Corporation:
Page
Schedule II -- Valuation and Qualifying Accounts 59
Schedules other than the one listed above have been omitted since
they are either not required, are not applicable or the required
information is shown in the consolidated financial statements or
related notes.
3. Exhibits. See Exhibit Index on page 60.
(b) Reports on Form 8-K were filed during the last quarter of the fiscal year
covered by this Annual Report on Form 10-K. The Company filed a Current
Report on Form 8-K on August 20, 1998, reporting its financial results
for the third fiscal quarter ended July 31, 1998.
(c) See Exhibit Index on page 60.
(d) The following financial statement schedule of Credence Systems
Corporation, for the years ended October 31, 1998, 1997 and 1996, is
filed as part of this Annual Report on Form 10-K and should be read in
conjunction with the Consolidated Financial Statements of Credence
Systems Corporation:
Page
Schedule II -- Valuation and Qualifying Accounts 59
Schedules other than the one listed above have been omitted since they
are either not required, are not applicable or the required information
is shown in the consolidated financial statements or related notes.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on
January 29, 1999.
CREDENCE SYSTEMS CORPORATION
----------------------------------------------
(Registrant)
By: /s/ WILLIAM G. HOWARD, JR.
-------------------------------------------
Chairman of the Board of Directors
/s/ DENNIS P. WOLF
-------------------------------------------
Dennis P. Wolf
Executive Vice President, Chief Financial Officer and
Secretary (Principal Financial and Accounting Officer)
57
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Dennis P. Wolf and Jerry Bruce, and each
of them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and re-substitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Report on Form
10-K, and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ WILLIAM G. HOWARD, JR. Chairman of the January 28, 1999
- --------------------------- Board of Directors
William G. Howard, Jr.
/s/ DENNIS P. WOLF Executive Vice President, January 28, 1999
- --------------------------- Chief Financial Officer
Dennis P. Wolf andSecretary
/s/ HENK J. EVENHUIS Director January 28, 1999
- ---------------------------
Henk J. Evenhuis
/s/ JOS C. HENKENS Director January 28, 1999
- ---------------------------
Jos C. Henkens
/s/ BERNARD V. VONDERSCHMITT Director January 28, 1999
- ----------------------------
Bernard V. Vonderschmitt
58
Schedule II
CREDENCE SYSTEMS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
Balance at Charged to Balance at
Beginning Costs and End
Description of Year Expenses Write-offs of Year
Year ended October 31, 1998
Allowance for doubtful accounts $1,763 $4,325 $ 679 $5,409
Year ended October 31, 1997
Allowance for doubtful accounts $1,781 $ 762 $ 780 $1,763
Year ended October 31, 1996
Allowance for doubtful accounts $1,692 $ 270 $ 181 $1,781
59
EXHIBIT INDEX
Exhibit
Number
------
2.1(1) Agreement and Plan of Merger dated October 5, 1993 between
Credence Systems Corporation, a California Corporation, and the
Company.
2.2(1) Asset Purchase Agreement dated December 31, 1990 between
Tektronix, Inc. and the Company, including Amendment No. 1 to
the Asset Purchase Agreement dated December 31, 1990.
2.3(1) Technology Agreement between Tektronix, Inc. and the Company
dated December 31, 1990.
2.4(1) Letter Agreement between Tektronix, Inc. and the Company dated
September 30, 1992.
2.5(1) Amendment Agreement dated as of August 12,1993 between
Tektronix, Inc. and the Company.
2.6(1) 1990 Plan of Purchase Price Adjustment Recapitalization.
2.7(1) Letter Agreement between Tektronix, Inc. and the Company dated
August 11, 1993.
2.8(11) Agreement and Plan of Reorganization dated as of February 6,
1994 among the Registrant, Semiconductor Test Solutions, Inc.,
EPRO and the shareholders of EPRO listed therein.
2.9(18) Asset Purchase Agreement, dated as of May 19, 1997, among
Credence Systems Corporation, Test Systems Strategies, Inc., a
Delaware corporation and wholly-owned subsidiary of Credence
Systems Corporation, and Test Systems Strategies, Inc. an Oregon
Corporation and wholly-owned subsidiary of Summit Design, Inc.
2.10(26) Asset Purchase Agreement, dated as of August 20, 1997, among
Zycad Corporation, a Delaware Corporation, its wholly owned
subsidiary, Attest Software and Test Systems Strategies, Inc., a
Delaware Corporation and wholly owned subsidiary of the Company.
2.11(24) Asset Purchase Agreement, dated as of June 1, 1998, between
Credence Systems Corporation, a Delaware corporation and Yervant
David Lepejian and Lawrence Kraus, as authorized representatives
of all of the shareholders of Heuristics Physics Laboratories,
Inc., a California corporation.
3.1(14) Amended and Restated Certificate of Incorporation of the Company.
3.2(1) Bylaws of the Company.
4.1(1) Investor Rights Agreement dated October 15, 1989 by and among
the Company and the investors listed therein, including
Amendment Agreement to the Investor Rights Agreement dated June
15, 1990, Second Amendment Agreement to the Investor Rights
Agreement dated September 30, 1992 and the Third Amendment
Agreement to Investor Rights Agreement dated August 8, 1993.
4.2(4) Fourth Amendment Agreement to the Investor Rights Agreement
dated March 10, 1994.
4.3(19) Purchase Agreement between the Company and Smith Barney, Inc.
for purchase of $115,000,000 5 1/4%
Convertible Subordinated Notes due 2002, dated September 4,1997.
4.4(19) Indenture between the Company and State Street Bank and Trust
Company of California, N.A., as Trustee dated September 10,
1997.
4.5(19) Form of 5 1/4% Convertible Subordinated Note due 2002.
4.6(19) Registration Rights Agreement between the Company and Smith
Barney, Inc. dated as of September 4, 1997.
4.7(21) Form of Rights Agreement, dated as of June 2, 1998, by and
between the Company and BankBoston, N.A., as Rights Agent.
4.8(21) Form of Certificate of Designation for the Series A Junior
Participating Preferred Stock of the Company.
4.9(21) Form of Rights Certificate.
60
4.10(10) Fifth Amendment Agreement to the Investor Rights Agreement dated
May 26, 1995.
10.1(1) Form of Indemnification Agreement Between the Company and each
of its officers and directors
10.2(1) Underwriting Agreement dated October 28, 1993 by and among the
Company and the underwriters named therein.
10.3(4) Underwriting Agreement dated March 31, 1994 by and among the
Company and the underwriters named therein.
10.4(10) Underwriting Agreement dated June 14, 1995 by and among the
Company and the underwriters named therein.
10.5(1) Industrial Space Lease between Renco Investment Company and the
Company dated August 12, 1992 including the First Addendum dated
August 14, 1992, Option to renew Lease dated August 14, 1992,
First Amendment to Lease dated October 22, 1992 and Acceptance
Agreement dated November 25, 1992.
10.6(1) Indenture (lease agreement) between Pen Nom I Corporation and
the Company dated April 3, 1991, including the First Amendment
to Lease dated August 16, 1991, the Second Amendment to Lease
dated December 10, 1991, the Third Amendment to Lease dated
August 7, 1992, the Fourth Amendment to Lease dated October 13,
1992 and the Fifth Amendment to Lease dated November 15, 1993.
10.7(1) Master Equipment Lease Agreement between the Company and
Financing for Science and Industry, Inc. dated February 26,1993.
10.8(7) Leaseline Agreement between Comdisco and the Company dated
July 29, 1994.
10.9(2) Indemnification and Security Agreement between Credence Capital
Corporation and the Company dated October 28, 1994.
10.10(4) Stock Transfer Agreement by and among the Company, Richard Cann,
Rene Verhaegen and Credence Europa Limited dated as of February
28, 1994.
10.11(4) Secured Line of Credit Agreement between Credence Europa Limited
and the Company dated as of February 28, 1994.
10.12(9) Lease by and between the Company and The Mutual Life Insurance
Company of New York dated June 16, 1995.
10.13(13) First Amendment to Lease by and between the Company and The
Mutual Life Insurance Company of New York dated December 29,
1995.
10.14(14) Loan and Security Agreement between the Company and Silicon
Valley Bank and Comerica Bank-California dated April 28, 1995,
as amended.
10.15(12) Domestic and International Master Agreement for Purchase of
Equipment and Product Support between the Company and Comdisco,
Inc., dated January 31, 1995.
10.16(13) Employment Agreement by and between the Company and
Elwood H. Spedden dated October 31, 1995.
10.17(14) Master Lease Purchase Agreement, Lease Purchase Closing Schedule
and Lease Purchase Addendum No. One between Metlife Capital
Corporation and the Company dated April 30, 1996.
10.18(15) Loan Agreement among Silicon Valley Bank, Bank of Hawaii and the
Company, dated July 26, 1996.
10.19(16) License Agreement between the Company and Kinetix Test Systems,
LLC, dated July 31, 1996.
61
10.20(16) Lease Agreement between Petula Associates, Ltd and Koll Portland
Associates, dba KBC - Tigard II and the Company dated
September 12, 1995.
10.21(16) Sixth Amendment to Lease by and between the Company and Pen Nom I
Corporation dated March 10, 1995.
10.22(18)* Software OEM License Agreement between the Company, Test Systems
Strategies, Inc. and Summit Design, Inc. dated May 19, 1997.
10.23(18) Joint Venture Agreement dated June 10, 1997, between the Company
and Innotech Corporation.
10.24(23) Lease Agreement between the Company and Bedford Property
Investors, Inc. dated December 10, 1997
10.25(24) Lease Agreement between the Company and Pacific Realty
Associates, L.P., dated April 10, 1998.
10.26(25) Amendment to Loan Agreement dated July 24, 1998 between the
Company, Silicon Valley Bank and Bank of Hawaii.
10.27(25) Non-Recourse Receivables Purchase Agreement dated May 1, 1998
between the Company and Silicon Valley Financial Services.
10.28 Employment offer letter, dated March 24, 1998, by and between
the Company and Dennis P. Wolf.
10.29 Letter Agreement, dated January 19, 1999, by and between the
Company and Dr. Wilmer R. Bottoms.
21.1 Subsidiaries of the Company.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (reference is made to page 58 of this report).
27.1 EDGAR Financial Data Schedule.
99.1(22) 1993 Stock Option Plan, as Amended and Restated through
February 13, 1998.
99.2(20) Form of Notice of Grant to be generally used in connection with
the 1993 Stock Option Plan.
99.3(20) Form of Stock Option Agreement to be generally used in
connection with the 1993 Stock Option Plan.
99.4(20) Addendum to the Stock Option Agreement (Special Tax Elections).
99.5(20) Addendum to the Stock Option Agreement (Limited Stock
Appreciation Rights).
99.6(20) Addendum to the Stock Option Agreement (Change in Control).
99.7(20) Addendum to the Stock Option Agreement (Financial Assistance).
99.8(20) Form of Notice of Grant of Stock Option (Non-Employee Director)
to be generally used in connection with the automatic option
grant program of the 1993 Stock Option Plan.
99.9(20) Form of Stock Option Agreement (Non-Employee Director) to be
generally used in connection with the automatic option grant
program of the 1993 Stock Option Plan.
99.10(17) Employee Stock Purchase Plan
99.11(8) Compensation Agreement between the Company and Jos C. Henkens,
dated November 5, 1993.
99.12(8) Compensation Agreement between the Company and Wilmer R. Bottoms,
dated November 5, 1993.
99.13(8) Compensation Agreement between the Company and Robert F. Kibble,
dated November 5, 1993.
99.14(8) Compensation Agreement between the Company and Bernard V.
Vonderschmitt, dated November 5, 1993.
62
99.15(8) Compensation Agreement between the Company and Henk J. Evenhuis,
dated November 4, 1993.
99.16(20) Form of Stock Purchase Agreement
99.17(20) Form of Enrollment/Change Form
- ---------------------
(1) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-1 (Registration No. 33-68438) as
amended.
(2) Incorporated by reference to an exhibit to the Company's 1994 Annual
Report on Form 10-K.
(3) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-8 (Registration No. 33-71856).
(4) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-1 (Registration No. 33-76264) as
amended.
(5) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-8 (Registration No. 33-76542).
(6) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended April 30, 1994.
(7) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended July 31, 1994.
(8) Management contract or compensatory plan filed pursuant to
Item 14(c).
(9) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended July 31, 1995.
(10) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-3 (Registration No. 33-92802), as
amended.
(11) Incorporated by reference to an exhibit to the Company's Current
Report on Form 8-K as filed with the Commission on March 29, 1995,
as amended on May 26, 1995.
(12) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended April 30, 1995.
(13) Incorporated by reference to an exhibit to the Company's 1995
Annual Report on Form 10-K (14) Incorporated by reference to an
exhibit to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 1996.
(15) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended July 31, 1996.
(16) Incorporated by reference to an exhibit to the Company's 1996
Annual Report on Form 10-K (17)Incorporated by reference to an
exhibit to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended April 30, 1997.
(18) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended July 31, 1997.
(19) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-3 (Registration No. 333-39387) as
amended.
63
(20) Exhibits 99.2 through 99.9 and Exhibit 99.16 and 99.17 are
incorporated herein by reference to identically numbered exhibits
included in the Company's Registration Statement on Form S-8 (File
No. 333-27499) declared effective with the Securities and Exchange
Commission on May 20, 1997.
(21) Incorporated by reference to an exhibit to the Company's Current
Report on Form 8-K as filed with the Commission on June 3, 1998.
(22) Incorporated by reference to an exhibit to the Company's
Registration Statement on Form S-8 (File No. 333-59051) as filed
with the Commission on July14, 1998.
(23) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended January 31,
1998.
(24) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended April 30, 1998.
(25) Incorporated by reference to an exhibit to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended July 31, 1998.
(26) Incorporated by reference to an exhibit to the Company's Annual
Report on Form 10-K for the year ended October 31, 1997.
* Confidential treatment has been granted for certain portions of
this exhibit.
64