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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-26824
TEGAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 68-0370244
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2201 SOUTH MCDOWELL BLVD.
PETALUMA, CALIFORNIA 94954
(Address of Principal Executive Offices)
TELEPHONE NUMBER (707) 763-5600
(Registrant's Telephone Number, Including Area Code)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange List. Yes [ ] No [X]
As of August 12, 2004 there were 46,557,672 shares of our common stock
outstanding.
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TEGAL CORPORATION AND SUBSIDIARIES
INDEX
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2004 and March 31, 2004................................... 3
Condensed Consolidated Statements of Operations -- for the three months ended June 30, 2004 and 2003........... 4
Condensed Consolidated Statements of Cash Flows -- for the three months ended June 30, 2004 and 2003........... 5
Notes to Condensed Consolidated Financial Statements........................................................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.................................................................................................. 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................................... 15
ITEM 4. CONTROLS AND PROCEDURES........................................................................................ 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................................................... 16
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS....................................................................... 16
ITEM 5. OTHER INFORMATION............................................................................................... 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................................................ 26
SIGNATURES................................................................................................................. 27
2
PART I -- FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TEGAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)
ASSETS
JUNE 30, MARCH 31,
2004 2004
----------- -----------
Current assets:
Cash and cash equivalents............................................................................. $ 4,657 $ 7,049
Accounts receivable, net of allowances for sales returns and doubtful accounts of $284 and $270 at
June 30, 2004 and March 31, 2004, respectively....................................................... 3,034 4,729
Inventories........................................................................................... 3,457 3,719
Prepaid expenses and other current assets............................................................. 568 905
----------- -----------
Total current assets............................................................................... 11,716 16,402
Property and equipment, net............................................................................. 3,895 4,039
Intangible assets, net.................................................................................. 2,064 1,190
Other assets............................................................................................ 928 1,027
----------- -----------
Total assets....................................................................................... $ 18,603 $ 22,658
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and bank lines of credit................................................................ $ 196 $ 2,450
2% Convertible debentures, net........................................................................ -- 74
Accounts payable...................................................................................... 1,768 1,645
Accrued product warranty.............................................................................. 312 366
Deferred revenue...................................................................................... 180 440
Accrued expenses and other current liabilities........................................................ 2,822 2,604
----------- -----------
Total current liabilities.......................................................................... 5,278 7,579
Long-term portion of capital lease obligations.......................................................... 23 26
Other long term obligations............................................................................. 86 98
----------- -----------
Total long term liabilities........................................................................ 109 124
----------- -----------
Total liabilities.................................................................................. 5,387 7,703
----------- -----------
Commitments and contingencies (Note 6) Stockholders' equity:
Preferred stock; $0.01 par value; 5,000,000 shares authorized; none issued and outstanding............ -- --
Common stock; $0.01 par value; 100,000,000 shares authorized; 44,183,297and36,583,850 shares issued
and outstanding at June 30, 2004 and March 31, 2004, respectively................................... 442 366
Additional paid-in capital............................................................................ 89,862 85,376
Accumulated other comprehensive income................................................................ 148 124
Accumulated deficit................................................................................... (77,236) (70,911)
------------ ------------
Total stockholders' equity......................................................................... 13,216 14,955
----------- -----------
Total liabilities and stockholders' equity......................................................... $ 18,603 $ 22,658
=========== ===========
See accompanying notes.
3
TEGAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
JUNE 30,
------------------------
2004 2003
-------- --------
Revenue:
Product .................................... $ 3,034 $ 3,542
Services ................................... 407 343
-------- --------
Total revenue ............................ 3,441 3,885
Cost of revenue:
Cost of product ............................ 2,177 2,492
Cost of services ........................... 464 356
-------- --------
Total cost of revenue .................... 2,641 2,848
-------- --------
Gross profit ............................. 800 1,037
-------- --------
Operating expenses:
Research and development ..................... 1,126 703
Sales and marketing .......................... 650 612
General and administrative ................... 1,601 1,036
In-process research and development .......... 1,653 --
-------- --------
Total operating expenses ................. 5,030 2,351
-------- --------
Operating loss ........................... (4,230) (1,314)
Other income (expense), net .................... (2,095) 60
-------- --------
Net loss ................................. $ (6,325) $ (1,254)
======== ========
Net loss per share, basic and diluted .......... $ (0.15) $ (0.08)
======== ========
Shares used in per share computations:
Basic ........................................ 41,812 16,092
Diluted ...................................... 41,812 16,092
See accompanying notes.
4
TEGAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
JUNE 30,
------------------
2004 2003
------- -------
Cash flows from operating activities:
Net loss ....................................................................................... $(6,325) $(1,254)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization ................................................................ 338 338
Allowance for doubtful accounts and sales return allowances .................................. 14 60
Non cash interest expense - accretion of debt discount and amortization of debt issuance costs 2,019 --
In-process research and development .......................................................... 1,653 --
Issuance of options for services rendered .................................................... 39 32
Changes in operating assets and liabilities:
Receivables ................................................................................ 1,727 (1,411)
Inventories ................................................................................ 269 905
Prepaid expenses and other assets .......................................................... 193 (166)
Accounts payable ........................................................................... 121 275
Accrued product warranty ................................................................... (58) (17)
Accrued expenses and other liabilities ..................................................... (152) 852
Deferred revenue ........................................................................... (260) 209
------- -------
Net cash used in operating activities .................................................... (422) (177)
------- -------
Cash flows from investing activities:
Purchases of property and equipment ......................................................... (20) (17)
------- -------
Net cash used in investing activities .................................................... (20) (17)
------- -------
Cash flows from financing activities:
Proceeds from the issuance of convertible debentures ........................................... -- 424
Proceeds from the issuance of common stock ..................................................... 335 --
Borrowings under lines of credit ............................................................... 43 178
Repayment of borrowings under lines of credit .................................................. (2,297) (92)
Payments on capital lease financing ............................................................ (5) (2)
------- -------
Net cash (used in) provided by financing activities ...................................... (1,924) 508
------- -------
Effect of exchange rates on cash and cash equivalents ............................................ (26) (64)
------- -------
Net decrease in cash and cash equivalents ........................................................ (2,392) 250
Cash and cash equivalents at beginning of period ................................................. 7,049 912
------- -------
Cash and cash equivalents at end of period ....................................................... $ 4,657 $ 1,162
======= =======
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING ACTIVITIES (IN THOUSANDS):
On May 28, 2004, Tegal purchased substantially all of the assets and
assumed certain liabilities of First Derivative Systems, Inc. ("FDSI") for
1,410,632 shares of common stock, $150 in debt forgiveness, approximately $50 in
assumed liabilities, and $158 in acquisition costs, pursuant to a purchase
agreement dated April 28, 2004. The purchase price was allocated as follows:
Fair value fixed assets acquired ................... $ 111
Non compete agreements ............................. 203
Patents ............................................ 733
In-process research and development ................ 1653
Debt forgiveness ................................... (150)
Assumed liabilities ................................ (50)
-------
$ 2,500
=======
See accompanying notes.
5
TEGAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
1. BASIS OF PRESENTATION:
In the opinion of management, the unaudited condensed consolidated interim
financial statements have been prepared on the same basis as the March 31, 2004
audited consolidated financial statements and include all adjustments,
consisting only of normal recurring adjustments, necessary to fairly state the
information set forth herein. The statements have been prepared in accordance
with the regulations of the Securities and Exchange Commission (the "SEC"), but
omit certain information and footnote disclosures necessary to present the
statements in accordance with generally accepted accounting principles. These
interim financial statements should be read in conjunction with the consolidated
financial statements and footnotes included in the Annual Report on Form 10-K of
Tegal Corporation (the "Company") for the fiscal year ended March 31, 2004. The
results of operations for the three months ended June 30, 2004 are not
necessarily indicative of results to be expected for the entire year.
The consolidated financial statements contemplate the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company incurred net losses of $6,325 and $1,254 for the periods ended June 30,
2004 and 2003, respectively, generated negative cash flows from operations of
$422 and $177 in these periods, and has a cash and cash equivalents balance of
$4,657 at June 30, 2004. Our past performance raised substantial doubt as to our
ability to continue as a going concern, and our independent registered public
accounting firm included a going concern uncertainty explanatory paragraph in
their report dated June 25, 2004, which is included in our Form 10-K for the
year ended March 31, 2004. Management believes that proceeds from the debenture
financing in fiscal year 2004 and additional funds which may be available to the
Company through the issuance of stock under the structured secondary financing
with Kingsbridge Capital, Ltd., will be adequate to fund operations through
fiscal year 2005, including the continued development of recently acquired
products. However, projected sales may not materialize and unforeseen costs may
be incurred. If the projected sales do not materialize, the Company will need to
reduce expenses further and raise additional capital through the issuance of
debt or equity securities. If additional funds are raised through the issuance
of preferred stock or debt, these securities could have rights, privileges or
preferences senior to those of common stock, and debt covenants could impose
restrictions on the Company's operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to the Company on acceptable terms, if at all. The consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or the amount or
classification of liabilities or any other adjustments that might be necessary
should the Company be unable to continue as a going concern.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of temporary cash investments
and accounts receivable. Substantially all of the Company's temporary
investments are invested in highly liquid money market funds. The Company's
accounts receivables are derived primarily from sales to customers located in
the U.S., Europe, and Asia. The Company performs ongoing credit evaluations of
its customers and generally requires no collateral. The Company maintains
reserves for potential credit losses. Write-offs during the periods presented
have been insignificant. As of June 30, 2004 two customers accounted for
approximately 38 percent of the accounts receivable balance. As of June 30, 2003
one customer accounted for approximately 49 percent of the accounts receivable
balance.
During the quarter ended June 30, 2004 two customers accounted for 34
percent of total revenues. During the quarter ended June 30, 2003 one customer
accounted for 49 percent of total revenues.
6
2. INVENTORIES:
Inventories consisted of:
JUNE 30, MARCH 31,
2004 2004
-------- ---------
Raw materials .......................... $1,266 $1,563
Work in progress ....................... 1,370 1,147
Finished goods and spares .............. 821 1,009
------ ------
$3,457 $3,719
====== ======
3. PRODUCT WARRANTY:
The Company provides a warranty on all system sold, and the estimated
warranty liability is based on actual experience by system type. The warranty
obligation is affected by product failure rates, material usage rates, and the
efficiency by which the product failure is corrected. Should actual product
failure rates, material usage rates and labor efficiencies differ from
estimates, revisions to the estimated warranty liability may be required.
Warranty activity for the three-month period ended June 30, 2004 and 2003
was:
WARRANTY ACTIVITY WARRANTY ACTIVITY
FOR THE THREE FOR THE THREE
MONTHS ENDED MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Balance at the beginning of the period........................................... $ 366 $ 734
Additional warranty accruals for warranties issued during the period............. 133 120
Settlements made during the period............................................... (187) (103)
---------- ----------
Balance at the end of the period................................................. $ 312 $ 751
========= =========
Certain of the Company's sales contracts include provisions under which
customers would be indemnified by the Company in the event of a third-party
claim against the customer for intellectual property rights infringement related
to the Company's products. There are no limitations on the maximum potential
future payments under these guarantees. The Company has accrued no amounts in
relation to these provisions as no such claims have been made and the Company
believes it has valid, enforceable rights to the intellectual property embedded
in its products.
4. NET LOSS PER COMMON SHARE:
Basic earnings per share ("EPS") is calculated by dividing net income
(loss) for the period by the weighted average common shares outstanding for that
period. Diluted EPS takes into account the number of additional common shares
that would have been outstanding if the dilutive potential common shares
("common stock equivalents") had been issued.
Common stock equivalents for the three months ended June 30, 2004 and 2003
were 8,120,760 and 3,235,736, respectively, and have been excluded from shares
used in calculating diluted loss per share because their effect would be
antidilutive.
7
5. STOCK-BASED COMPENSATION:
The Company accounts for stock-based employee compensation under the
recognition and measurement principles of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and related
interpretations. Under APB No. 25, compensation cost is equal to the difference,
if any, on the date of grant between the fair value of the Company's stock and
the amount an employee must pay to acquire the stock. SFAS No. 123, Accounting
for Stock-based Compensation, established accounting and disclosure requirements
using a fair value based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value based method of accounting described
above, and has adopted the disclosure requirements of SFAS No. 123 and related
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure.
The following table illustrates the effect on net income (loss) and net
income (loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 to stock-based compensation (in thousands, except per
share data):
THREE MONTHS ENDED
JUNE 30,
2004 2003
------- -------
Net loss as reported ............................................ $(6,325) $(1,254)
Deduct: Total stock-based employee compensation expense ........ (358) (36)
determined under fair value method for all awards, net of tax
Proforma net loss ............................................... $(6,683) $(1,290)
======= =======
Basic net loss per share:
As reported ..................................................... (0.15) (0.08)
======= =======
Proforma ........................................................ (0.16) (0.08)
======= =======
The Company accounts for stock-based employee compensation arrangements in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, (APB No. 25) and related interpretations, and complies with
the disclosure provisions of SFAS No. 123, Accounting for Stock-based
Compensation and SFAS No. 148 Accounting for Stock-Based Compensation -
Transition and Disclosure. The disclosure provisions of SFAS No. 123 and SFAS
No. 148 require judgments by management as to the estimated lives of the
outstanding options. Management has based the estimated life of the options on
historical option exercise patterns. If the estimated life of the options
increases, the valuation of the options will increase as well.
During the quarter ending June 30, 2004, in connection with a review of
the Company's strategy and operations, it issued to certain consultants options
and warrants to purchase 58,333 shares of the Company's common stock to various
service providers for services rendered. The options and warrants were valued at
$72 using the Black-Scholes model with an exercise price at the market value on
the day of the grant. The life of the warrants is five years with an interest
rate of 5% and the volatility of 124%. A portion of these warrants were included
in other assets and will be amortized to expense over the service term for each
contract. Additionally the Company entered into a contract with certain
consultants for the Company to issue warrants on a monthly basis in lieu of cash
payments for the next two years, dependant upon the continuation of the contract
and the achievement of certain performance goals. These warrants will be valued
and expensed on a monthly basis upon issuance.
6. LINES OF CREDIT:
On January 19, 2004, the Company entered into a line of credit facility
with Silicon Valley Bank that will be available until January 19, 2005. The line
of credit has a maximum borrowing capacity of $3,500, bears interest at prime
plus 1.0% (5% as of June 30, 2004), is collateralized by substantially all of
the Company's domestic and Japanese assets, and is further limited by the
amounts of accounts receivable and inventories on the Company's consolidated
balance sheets. As of June 30, 2004, the Company had no amounts outstanding
under this domestic line of credit.
In addition, as of June 30, 2004, the Company's Japanese subsidiary had
$87 outstanding under its line of credit, which is collateralized by Japanese
customer promissory notes held by the Japanese subsidiary in advance of payment
on customers' accounts receivable. The Japanese line of credit bears interest at
Japanese prime (1.375% as of June 30, 2004) plus 1.0%, and has a total capacity
of 150 million yen (approximately $1,384 at exchange rates prevailing on June
30, 2004).
In addition, notes payable as of June 30, 2004 consisted of one
outstanding note to the California Trade and Commerce Agency for $109. The
unsecured note from the California Trade and Commerce Agency carries an annual
interest rate of 5.75% with monthly payments of approximately $4 per month.
Although the payment deadlines are being met, the note is currently in technical
default due to the merger of Sputtered Films and Tegal Corporation. The default
could result in the California Trade and Commerce Agency calling the note;
therefore, this note payable is classified as a current liability.
8
7. COMPREHENSIVE INCOME (LOSS):
The components of comprehensive loss for the three-month periods ended
June 30, 2004 and 2003 are as follows:
THREE MONTHS
ENDED
JUNE 30,
------------------
2004 2003
------- -------
Net loss .............................. $(6,325) $(1,254)
Foreign currency translation adjustment 24 (37)
------- -------
$(6,301) $(1,291)
======= =======
8. ACQUISITION:
On May 28, 2004, Tegal purchased substantially all of the assets and
assumed certain liabilities of First Derivative Systems, Inc. ("FDSI") for
1,410,632 shares of common stock valued at $2,342, $150 in debt forgiveness,
approximately $50 in assumed liabilities, and $158 in acquisition costs,
pursuant to a purchase agreement dated April 28, 2004.. All of the shares of
common stock are subject to a registration rights agreement in which the Company
has agreed to register the shares with the Securities and Exchange Commission
for resale. In addition, the Company entered into employment agreements with key
FDSI personnel. FDSI, a privately held development stage company based in
Goleta, CA, was founded in 1999 as a spin-off of Sputtered Films, Inc., which
itself was acquired by Tegal in August 2002. FDSI had developed a
high-throughput, low cost-of-ownership physical vapor deposition ("PVD") system
with highly differentiated technology for leading edge memory and logic device
production on 200 and 300 millimeter wafers. This transaction was accounted for
as a purchase of assets in accordance with EITF Issue No. 98-3, "Determining
whether a nonmonetary transaction involves receipt of productive assets or of a
business.
The following table represents the preliminary allocation of the purchase
price for FDSI. In estimating the fair value of assets acquired and liabilities
assumed management considered various factors, including an independent
appraisal.
Fair value fixed assets acquired .. $ 111
Non compete agreements ............ 203
Patents ........................... 733
In-process research and development 1653
Debt forgiveness .................. (150)
Assumed liabilities ............... (50)
-------
$ 2,500
=======
The assets will be amortized over a period of years shown on the following
table:
Fixed assets acquired...................... 3 to 5 years
Non compete agreements..................... 3 years
Patents.................................... 15 years
The fair value underlying the $1,653 assigned to acquired in-process
research and development ("IPR&D") in the FDSI acquisition was charged to the
Company's results of operations during the quarter ended June 30, 2004, and was
determined by identifying research projects in areas for which technological
feasibility had not been established and there was no alternative future use.
Projects in the IPR&D category are primarily certain design change improvements,
software integration and hardware modifications, which are estimated to cost
approximately $1 - $2 million, are approximately 50% complete, and will be
completed by December 31, 2005.
The IPR&D value of $1,653 was determined by an income approach where fair
value is the present value of projected free cash flows that will be generated
by the products incorporating the acquired technologies under development,
assuming they are successfully completed. The estimated net free cash flows
generated by the products over a seven-year period were discounted at a rate of
32% in relation to the stage of completion and the technical risks associated
with achieving technological feasibility. The net cash flows for such projects
were based on management's estimates of revenue, expenses and asset
requirements. Any delays or failures in the completion of these projects could
impact expected return on investment and future results of operations. In
addition, the Company's operating results would be adversely affected if the
value of other intangible assets acquired became impaired.
9
All of these projects have completion risks related to functionality,
architecture, performance, process technology, continued availability of key
technical personnel, product reliability and software integration. To the extent
that estimated completion dates are not met, the risk of competitors' product
introductions is greater and revenue opportunity may be permanently lost.
9. CONVERTIBLE DEBENTURE FINANCING:
On June 30, 2003, the Company signed definitive agreements with investors
to raise up to $7,165 in a private placement of convertible debt financing to be
completed in two tranches. The first tranche, which closed on June 30, 2003,
involved the sale of debentures in the principal amount of $929. The Company
received $424 in cash on June 30, 2003 and the remaining balance of $505 on July
1, 2003, which was recorded as an other receivable as of June 30, 2003. The
closing of the second tranche, which occurred on September 9, 2003 following
shareholder approval on September 8, 2003, resulted in the receipt of
approximately $6,236 in gross proceeds on September 10, 2003.
The Company was required to pay a cash fee of up to 6.65% of the gross
proceeds of the debentures to certain financial advisors upon the closing of the
second tranche. A fee of $448 was recorded as a debt issuance cost and was paid
in September 2003. The financial advisors also were granted warrants to purchase
1,756,127 shares of the Company's common stock at an exercise price of $0.35 per
share. These warrants were valued at $1,387 using the Black-Scholes option
pricing model with the following variables: stock fair value of $0.93, term of
five years, volatility of 95% and risk-free interest rate of 2.5%. During fiscal
year ended March 31, 2004, the financial advisors exercised warrants for
1,536,605 shares (plus 23,393 warrants remitted as payments for stock under a
cash-less exercise provision of the warrant agreement), leaving advisor warrants
for 196,129 shares unexercised at the end of the fiscal year. From April 1, 2004
through June 30, 2004, no additional advisor warrants had been exercised and
there remained 196,129 shares unexercised.
The debentures accrued interest at the rate of 2% per annum. Both the
principal and accrued interest thereon of these debentures were convertible at
the rate of $0.35 per share. The principal of the debentures converted into
20,471,428 shares of the Company's common stock. The closing prices of the
Company's common stock on June 30, 2003 and September 9, 2003, the closing dates
for the first and second tranches, were $0.55 and $1.49. Therefore, a beneficial
conversion feature existed which was accounted for under the provisions of EITF
00-27, Application of Issue 98-5 to Certain Convertible Instruments. A
beneficial feature also existed in connection with the conversion of the
interest on the debentures into shares of common stock.
As of June 30, 2004, debenture holders had converted all the debentures in
the principal amount of $7,165 into 20,471,428 shares of the Company's common
stock. Of the 3,542,436 shares that were registered for payment of interest
in-kind, 135,068 shares had been issued for such interest payments, and the
interest obligation to the debenture holders had been satisfied in full.
In addition, the debenture holders were granted warrants to purchase
4,094,209 shares of the Company's common stock at an exercise price of $0.50.
The warrants expire after eight years. The warrants were valued using the
Black-Scholes model with the following variables: fair value of common stock of
$0.35 for the first tranche debentures and $0.93 for the second tranche
debentures, volatility of 37% and risk-free interest rate of 2.5%. The debenture
holders had exercised warrants to purchase 2,239,832 shares (plus 168,695
warrants remitted as payments for stock under a cash-less exercise provision of
the warrant agreement) of the Company's common stock. As of June 30, 2004, there
remained unexercised warrants held by the debenture holders for 1,685,682 of the
Company's common stock.
The relative fair value of the warrants has been classified as equity with
the beneficial conversion feature because it meets all the equity classification
criteria of EITF 00-19, Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock.
The value of the beneficial conversion feature, warrants and debt issuance
costs were amortized as interest expense over the life of the debt using the
effective interest method. Related interest expense for the quarter ended June
30, 2004 amounted to $2,019. This amount is comprised of nominal interest,
amortization of beneficial conversion feature and amortization of debt issuance
costs.
10
The debt issuance costs associated with the debentures amounted to $2,369
and are comprised of $982 in cash issuance costs and $1,387 associated with
warrants issued to financial advisors. Approximately $603 of these costs were
allocable to the warrants and were therefore charged to equity. The remaining
balance of $1,766 was recorded as an asset and was amortized over the life of
the debt. As of June 30, 2004 the debentures had been fully converted, therefore
these costs have been fully expensed.
9. SUBSEQUENT EVENTS:
CHANGES IN THE COMPANY'S CERTIFYING ACCOUNTANT
On July 8, 2004, the Audit Committee of the Board of Directors of Tegal
Corporation (the "Company") dismissed PricewaterhouseCoopers LLP, the Company's
independent registered public accounting firm. The Company decided to change
accounting firms in order to reduce costs as part of the Company's ongoing
efforts to reduce operating expenses.
PricewaterhouseCoopers LLP reports on the consolidated financial
statements of the Company as of, and for the years ended, March 31, 2004 and
2003 contained no adverse opinion or disclaimer of opinion and were not
qualified or modified as to uncertainty, audit scope or accounting principle,
except for an explanatory paragraph included in each of such reports which
explanatory paragraph identified factors raising substantial doubt about the
Company's ability to continue as a going concern.
During the period from April 1, 2002 through July 8, 2004, there were no
disagreements with PricewaterhouseCoopers LLP on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of
PricewaterhouseCoopers LLP, would have caused PricewaterhouseCoopers LLP to make
reference thereto in its reports on the consolidated financial statements of the
Company as of and for the years ended March 31, 2004 and 2003.
On July 8, 2004, the Audit Committee of the Board of Directors of the
Company appointed Moss Adams LLP as its new independent registered public
accounting firm as of July 9, 2004.
During the two most recent fiscal years and through July 9, 2004, neither
the Company nor anyone on its behalf consulted Moss Adams LLP regarding either
the application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Company's consolidated financial statements, nor has Moss Adams LLP provided
to the Company a written report or oral advice regarding such principles or
audit opinion.
ISSUANCE OF COMMON STOCK TO KINGSBRIDGE CAPITAL LIMITED
Subsequent to June 30, 2004, the Company issued to Kingsbridge Capital,
Ltd. a total of 2,372,689 shares of its common stock in connection with the
Amended and Restated Common Stock Purchase Agreement dated as of May 19, 2004.
Gross proceeds from the sale of stock were $2,600.
ISSUANCE OF WARRANTS TO CONSULTANTS
On August 4, 2004, the Company issued warrants to purchase 240,000 shares
of common stock at $1.08 per share to consultants for services to be rendered
over a period of two years.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information herein contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995, which can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negative thereof or
other variations thereon or comparable terminology or which constitute projected
financial information. The forward-looking statements relate to the near-term
semiconductor capital equipment industry outlook, demand for our products, our
quarterly revenue and earnings prospects for the near-term future and other
matters contained herein. Such statements are based on current expectations and
beliefs and involve a number of uncertainties and risks that could cause the
actual results to differ materially from those projected. Such uncertainties and
risks include, but are not limited to, the cyclicality of the semiconductor
industry, impediments to customer acceptance, fluctuations in quarterly
operating results, competitive pricing pressures, the introduction of competitor
products having technological and/or pricing advantages, product volume and mix
and other risks detailed from time to time in our SEC reports. For further
information, refer to the business description and risk factors sections
included in our Form 10-K for the year ended March 31, 2004 and the risk factors
section included in this Form 10-Q (Part II, Item 5) as filed with the SEC.
The following summarizes our contractual obligations at June 30, 2004, and
the effect such obligations are expected to have on our liquidity and cash flows
in future periods (in thousands) excluding 2% convertible debentures which were
fully redeemed June 15, 2004:
Contractual obligations:
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------ ------ ------ ------ ------
Non-cancelable capital lease obligations . $ 34 $ 11 $ 22 $ 1 $ --
Non-cancelable operating lease obligations 5,369 902 2,010 1,892 565
Notes payable and bank lines of credit ... 196 196 -- -- --
------ ------ ------ ------ ------
Total contractual cash obligations ....... $5,599 $1,109 $2,032 $1,893 $ 565
====== ====== ====== ====== ======
Certain sales contracts of the Company include provisions under which
customers would be indemnified by the Company in the event of, among other
things, a third-party claim against the customer for intellectual property
rights infringement related to the Company's products. There are no limitations
on the maximum potential future payments under these guarantees. The Company has
accrued no amounts in relation to these provisions as no such claims have been
made and the Company believes it has valid, enforceable rights to the
intellectual property embedded in its products.
RESULTS OF OPERATIONS
Tegal designs, manufactures, markets and services plasma etch and
deposition systems that enable the production of integrated circuits ("ICs"),
memory and related microelectronics devices used in personal computers, wireless
voice and data telecommunications, contact-less transaction devices, radio
frequency identification devices ("RFID's"), smart cards, data storage and
micro-level actuators. Etching and deposition constitute two of the principal IC
and related device production process steps and each must be performed numerous
times in the production of such devices.
The following table sets forth certain financial items as a percentage of
revenue for the three-month period ended June 30, 2004 and 2003:
12
THREE MONTHS
ENDED
JUNE 30,
---------------
2004 2003
----- -----
Revenue:
Product revenue ............................. 88.2% 91.2%
Services revenue ............................ 11.8 8.8
----- -----
Total revenue ............................ 100.0 100.0
Cost of sales:
Cost of product ............................. 63.3 64.1
Cost of services ............................ 13.5 9.2
----- -----
Total cost of sales ...................... 76.8 73.3
----- -----
Gross profit ................................ 23.2 26.7
Operating expenses:
Research and development .................... 32.7 18.1
Sales and marketing ......................... 18.9 15.8
General and administrative .................. 46.5 26.8
In-process research and development ......... 48.0 --
----- -----
Total operating expenses ................. 146.1 60.7
----- -----
Operating loss ........................ (122.9) (34.0)
Other income (expense), net .................... (60.9) 1.5
----- -----
Net loss .............................. (183.8) (32.5)
===== =====
Product Revenue. Revenue for the three months ended June 30, 2004 was
$3,034, a decrease of $508 or 14.3% over the comparable period in 2003. The
decrease for the three months ended June 30, 2004 was principally due to the
sale of a used 6500 series system compared to the sale of a new system in the
prior period offset in part by the recognition of deferred revenue in the
current period. Revenue for the three months ended June 30, 2003 was $3,542, an
increase of $247 or 7.5% over the comparable period in 2002. The increase for
the three months ended June 30, 2003 was principally due to the sale of three
fewer 900 series systems offset by one more 6500 series systems over the same
period in the prior year.
Services Revenue. Revenue from service sales was $407 for the three month
period ended June 30, 2004, up from $343 for the three month period ended June
30, 2003, which we believe is a result of customers' increased use of our
systems resulting from increased production volume.
International sales as a percentage of our revenue were approximately 66%
and 82% for the three months ended June 30, 2004 and 2003, respectively. We
believe that international sales will continue to represent a significant
portion of our revenue.
Gross profit. Gross profit as a percentage of revenue (gross margin) was
23% and 27% for the three months ended June 30, 2004 and 2003, respectively. The
decrease in gross margin for the three months ended June 30, 2004, compared to
the same period in the prior year, was principally attributable the different
product mix in the current quarter which resulted in lower average selling
prices.
Research and development. Research and development expenses consist
primarily of salaries, prototype material and other costs associated with our
ongoing systems and process technology development, applications and field
process support efforts. Research and development expenses were $1,126 and $703
for the three months ended June 30, 2004 and 2003, respectively, representing
33% and 18% of revenue, respectively. The increase in research and development
spending resulted from new product development efforts related to the Company's
recent acquisitions.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions, trade show promotion and travel and living expenses
associated with those functions. Sales and marketing expenses were relatively
flat year over year at $650 and $612 for the three months ended June 30, 2004
and 2003, respectively, representing 19% and 16% of revenue, respectively.
General and administrative. General and administrative expenses consist
primarily of compensation for general management, accounting and finance, human
resources, information systems and investor relations functions and for legal,
consulting and accounting fees of the Company. General and administrative
expenses were $1,601 and $1,036 for the three months ended June 30, 2004 and
2003, respectively, representing 47% and 27% of revenue, respectively. The
increase in spending was primarily due to legal fees for the registration of
acquired patents and payments in cash and amortization of warrants to outside
consultants.
13
Other income (expense), net. Other expense, net consists principally of,
interest income, interest expense and gains and losses on foreign exchange. We
recorded net non-operating expense of $2,095 and a non-operating income of $60
during the three months ended June 30, 2004 and 2003, respectively. Interest
expense was $2,066 for the three months ended June 30, 2004 compared to interest
expense of $22 for the same period a year ago. The increase of interest expense
in the current quarter was primarily attributable to the accretion of the debt
discount and the amortization of the debt issuance costs related to the
debenture financing (see Note 9).
LIQUIDITY AND CAPITAL RESOURCES
For the three-month periods ended June 30, 2004 and 2003, we financed our
operations through the use of outstanding cash balances and borrowings against
our credit facilities in Japan, as well as our domestic line of credit.
Net cash used in operations was $422 during the three months ended June
30, 2004, due principally to a net loss of $6,325 offset by non cash expense
from depreciation and amortization, warrants issued for services rendered, and
non cash interest expense, and a non cash charge for acquired IPR&D related to
the FDSI acquisition. Additionally, the net loss is offset by a net decrease in
inventory and accounts receivable and an increase in accounts payable, offset by
a decrease of accrued liabilities and deferred revenue in prepaid expenses and
other assets.
Capital expenditures were negligible for the three months ended June 30,
2004.
Net cash used in financing activities totaled $1,924 for the three months
ended June 30, 2004 and was primarily related to the repayment of the domestic
line of credit and the partial repayment of the Japanese borrowing.
On January 19, 2004, the Company entered into a line of credit facility
with Silicon Valley Bank that will be available until January 19, 2005. The line
of credit has a maximum borrowing capacity of $3,500, bears interest at prime
plus 1.0% (5% as of June 30, 2004), is collateralized by substantially all of
the Company's domestic and Japanese assets, and is further limited by the
amounts of accounts receivable and inventories on the Company's consolidated
balance sheets. As of June 30, 2004, the Company had no amounts outstanding
under this domestic line of credit.
In addition, as of June 30, 2004, the Company's Japanese subsidiary had
$87 outstanding under its line of credit which is collateralized by Japanese
customer promissory notes held by such subsidiary in advance of payment on
customers' accounts receivable. The Japanese bank line bears interest at
Japanese prime (1.375% as of June 30, 2004) plus 1.0%, and has a total capacity
of 150 million yen (approximately $1,384 at exchange rates prevailing on June
30, 2004).
In addition, notes payable as of June 30, 2004 consisted of one
outstanding note to the California Trade and Commerce Agency for $109. The
unsecured note from the California Trade and Commerce Agency carries an annual
interest rate of 5.75% with monthly interest only payments of approximately $4
per month. Although the payment deadlines are being met, the note is currently
in technical default due to the merger of Sputtered Films and Tegal Corporation.
The default could result in the California Trade and Commerce Agency calling the
note, therefore, this note payable is classified as a current liability.
The consolidated financial statements contemplate the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company incurred net losses of $6,325 and $1,254 for the periods ended June 30,
2004 and 2003, respectively, generated negative cash flows from operations of
$422 and $177 in these periods, and has a cash and cash equivalents balance of
$4,657 at June 30, 2004. Our past performance raised substantial doubt as to our
ability to continue as a going concern, and our independent registered public
accounting firm included a going concern uncertainty explanatory paragraph in
their report dated June 25, 2004, which is included in our Form 10-K for the
year ended March 31, 2004. Management believes that proceeds from the debenture
financing in fiscal year 2004 and additional funds which may be available to the
Company through the issuance of stock under the structured secondary financing
with Kingsbridge Capital, Ltd., will be adequate to fund operations through
fiscal year 2005, including the continued development of recently acquired
products. However, projected sales may not materialize and unforeseen costs may
be incurred. If the projected sales do not materialize, the Company will need to
reduce expenses further and raise additional capital through the issuance of
debt or equity securities. If additional funds are raised through the issuance
of preferred stock or debt, these securities could have rights, privileges or
preferences senior to those of common stock, and debt covenants could impose
restrictions on the Company's operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to the Company on acceptable terms, if at all. The consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or the amount or
classification of liabilities or any other adjustments that might be necessary
should the Company be unable to continue as a going concern.
14
For more information on our capital resources, see "Risk Factors" in Part
II, Item 5.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash equivalents are principally comprised of money market accounts.
As of June 30, 2004, we had cash and cash equivalents of $4,657. These accounts
are subject to interest rate risk and may fall in value if market interest rates
increase. We attempt to limit this exposure by investing primarily in short-term
securities having a maturity of three months or less. Due to the nature of our
cash and cash equivalents, we have concluded that there is no material market
risk exposure.
We have foreign subsidiaries that operate and sell our products in various
global markets. As a result, our cash flow and earnings are exposed to
fluctuations in interest and foreign currency exchange rates. We attempt to
limit these exposures through the use of various hedge instruments, primarily
forward exchange contracts and currency option contracts (with maturities of
less than three months) to manage our exposure associated with firm commitments
and net asset and liability positions denominated in non-functional currencies.
There have been no material changes regarding market risk since the disclosures
made in our Form 10-K for the fiscal year ended March 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and, in reaching reasonable level of assurance
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
During the period from April 1, 2002 through June 30, 2004, there were no
reportable events, as that term is defined in Item 304(a)(1)(v) of Regulation
S-K, except for a reportable condition related to the Company's accounting for
its 2% Convertible Debentures Due 2011 (the "2% Convertible Debentures")
together with related debt issuance costs; and the expertise of the Company's
accounting personnel with respect to generally accepted accounting principles
related to complex financing and other transactions. In response to the
reportable condition, the Company restated its financial results and filed an
amended quarterly report on Form 10-Q/A for the quarter ended December 31, 2003
which corrected an error in the accounting for the 2% Convertible Debentures and
related debt issuance costs. The restatement reflected increased interest
expense, net loss, net loss per share, accumulated deficit and additional
paid-in capital as well as decreased current assets. The restatement did not
impact any reported revenue, operating expenses or operating loss.
Management believes that the reportable condition has been remediated. As
of June 15, 2004, all of the Company's 2% Convertible Debentures had been
converted into the Company's common stock. In addition, the Company expanded and
enhanced its accounting function to include sufficient knowledge of generally
accepted accounting principles related to complex financing and other
transactions by adding a new certified public accountant to the Company's
accounting staff on June 15, 2004.
As of June 30, 2004, as required by SEC Rule 13a-15(b), the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as of the end of
the quarter covered by this report. Based on the foregoing, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective at the reasonable assurance
level.
Other than that which has been disclosed above, there has been no change
in the Company's internal controls over financial reporting during the Company's
most recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the Company's internal controls over financial reporting.
15
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Sputtered Films, Inc. v. Advanced Modular Sputtering, et al., filed in Santa
Barbara County Superior Court.
Our subsidiary, Sputtered Films, Inc. ("SFI") filed an action against two
former employees, Sergey Mishin and Rose Stuart-Curran, and the company they
formed after leaving SFI, Advanced Modular Sputtering ("AMS"), alleging
misappropriation of trade secrets, violation of signed employee Secrecy
Agreements, unfair business practices and other claims arising out of AMS's
apparent possession and use of SFI's drawings and specifications for SFI's
Endeavor Sputtering System and the Series IV S-Gun. SFI believes that the tools
marketed by AMS result from unauthorized use of SFI's drawings, specifications
and other trade secret technology. The case was filed in December 2003. The
Court recently issued a stringent protective order regarding information
revealed during the litigation, and the parties are in the early stages of
discovery. A trial date is anticipated in mid 2005.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 30, 2003, the Company entered into agreements with investors to
raise up to $7,165 in a private placement to institutional and individual
investors of (i) an aggregate of $7,165 in principal amount of 2% convertible
debentures, convertible into common stock at $0.35 per share and (ii) warrants
to purchase 4,094,224 shares of common stock, exercisable at $0.50 per share.
The first tranche of approximately $929 of the private placement was completed
on June 30, 2003 and the second tranche was completed on September 9, 2003
following shareholder approval. The proceeds were used for general corporate
purposes. This transaction was effected in reliance on Rule 506 of Regulation D
under the Securities Act.
On December 5, 2003, the Company closed a transaction in which it
purchased substantially all of the assets of Simplus Systems Corporation, a
Delaware corporation, in exchange for 1,499,994 shares of common stock. The
transaction was effected in reliance on Regulation D under the Securities Act.
On February 11, 2004, the Company signed a $25 million equity facility
with Kingsbridge Capital Limited ("Kingsbridge"). The arrangement will allow the
Company to sell shares of common stock to Kingsbridge at the Company's sole
discretion over a 24-month period on a "when and if needed" basis. Kingsbridge
is required under the terms of the arrangement to purchase stock following the
effectiveness of a registration statement. The price of the common shares issued
under the agreement is based on a discount to the volume-weighted average market
price during a specified drawdown period. The Company has no obligation to draw
down all or any portion of the commitment. The maximum amount of shares that may
be issued to Kingsbridge under the equity facility is 8,851,661. In connection
with the agreement, on February 11, 2004, the Company issued fully vested
warrants to Kingsbridge to purchase 300,000 shares of common stock at an
exercise price of $4.11 per share. The Company intends to use any proceeds from
such sale to Kingsbridge to finance acquisitions, including any product
development activity related to such acquisitions. This transaction was effected
in reliance on Regulation D under the Securities Act.
During the period March 16, 2004 through August 8, 2004, the Company
issued options and warrants to purchase 1,040,000 of common stock to various
consultants for services to be provided over a one-to-three year period, as well
as for the achievement of certain pre-determined goals and objectives. These
included: (i) on March 16, 2004, the issuance of options to purchase 50,000
shares of common stock at an exercise price of $1.87; (ii) on May 18, 2004, the
issuance of options and warrants to purchase 30,000 shares of common stock at an
exercise price of $1.32; (iii) on May 27, 2004, the issuance of warrants to
purchase common stock at $1.60 per share; (iv) on June 1, 2004, the issuance of
warrants to purchase 480,000 shares at $1.64 per share; and (v) on August 8,
2004, the issuance of warrants to purchase 240,000 shares of common stock at
$1.08 per share. The issuance of these securities was exempt from registration
under the Securities Act pursuant to Section 4(2) thereof.
On May 28, 2004, Tegal purchased substantially all of the assets of First
Derivative Systems, Inc. ("FDSI") for 1,410,632 shares of common stock and
approximately $200 in assumed liabilities, pursuant to a purchase agreement
dated April 28, 2004. All of the shares of common stock are subject to a
registration rights agreement in which the Company has agreed to register the
shares with the Securities and Exchange Commission for resale. This transaction
was effected in reliance on Regulation D.
16
ITEM 5. OTHER INFORMATION - CHANGES IN THE COMPANY'S CERTIFYING ACCOUNTANT
On July 8, 2004, the Audit Committee of the Board of Directors of Tegal
Corporation (the "Company") dismissed PricewaterhouseCoopers LLP, the Company's
independent registered public accounting firm. The Company decided to change
accounting firms in order to reduce costs as part of the Company's ongoing
efforts to reduce operating expenses.
PricewaterhouseCoopers LLP reports on the consolidated financial
statements of the Company as of, and for the years ended, March 31, 2004 and
2003 contained no adverse opinion or disclaimer of opinion and were not
qualified or modified as to uncertainty, audit scope or accounting principle,
except for an explanatory paragraph included in each of such reports which
explanatory paragraph identified factors raising substantial doubt about the
Company's ability to continue as a going concern.
During the period from April 1, 2002 through July 8, 2004, there were no
disagreements with PricewaterhouseCoopers LLP on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of
PricewaterhouseCoopers LLP, would have caused PricewaterhouseCoopers LLP to make
reference thereto in its reports on the consolidated financial statements of the
Company as of and for the years ended March 31, 2004 and 2003.
On July 8, 2004, the Audit Committee of the Board of Directors of the
Company appointed Moss Adams LLP as its new independent registered public
accounting firm as of July 9, 2004.
During the two most recent fiscal years and through July 9, 2004, neither
the Company nor anyone on its behalf consulted Moss Adams LLP regarding either
the application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Company's consolidated financial statements, nor has Moss Adams LLP provided
to the Company a written report or oral advice regarding such principles or
audit opinion.
RISK FACTORS
WE HAVE INCURRED OPERATING LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE;
OUR PLANS TO MAINTAIN AND INCREASE LIQUIDITY MAY NOT BE SUCCESSFUL; THE REPORT
OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM INCLUDES A GOING CONCERN
UNCERTAINTY EXPLANATORY PARAGRAPH; THE ACCOUNTING FOR THE 2% CONVERTIBLE
DEBENTURES RESULTED IN SIGNIFICANT EXPENSE AMOUNTS.
We incurred net losses of $6,325 and $1,254 for the periods ended June 30,
2004 and 2003, respectively, generated negative cash flows from operations of
$422 and $177 in these periods, and has a cash and cash equivalents balance of
$4,657 at June 30, 2004. Our past performance raised substantial doubt as to our
ability to continue as a going concern, and our independent registered public
accounting firm included a going concern uncertainty explanatory paragraph in
their report dated June 25, 2004, which is included in our Form 10-K for the
year ended March 31, 2004. Management believes that proceeds from the debenture
financing in fiscal year 2004 and additional funds which may be available to the
Company through the issuance of stock under the structured secondary financing
with Kingsbridge Capital, Ltd., will be adequate to fund operations through
fiscal year 2005, including the continued development of recently acquired
products. However, projected sales may not materialize and unforeseen costs may
be incurred. If the projected sales do not materialize, the Company will need to
reduce expenses further and raise additional capital through the issuance of
debt or equity securities. If additional funds are raised through the issuance
of preferred stock or debt, these securities could have rights, privileges or
preferences senior to those of common stock, and debt covenants could impose
restrictions on the Company's operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to the Company on acceptable terms, if at all. The consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or the amount or
classification of liabilities or any other adjustments that might be necessary
should the Company be unable to continue as a going concern.
THE EXERCISE OF OUTSTANDING WARRANTS, OPTIONS AND OTHER RIGHTS TO OBTAIN
ADDITIONAL SHARES WILL DILUTE THE VALUE OF THE SHARES.
As of June 30, 2004, there were debenture holder warrants exercisable for
approximately 1,685,682 shares and advisor warrants exercisable into 196,129
shares of our common stock. In addition, we have warrants outstanding from
previous offerings for approximately 2,378,840 shares of our common stock.
The exercise of these warrants and the issuance of the common stock will
result in dilution in the value of the shares of our outstanding common stock
and the voting power represented thereby. In addition, the exercise price of the
warrants may be lowered under the price adjustment provisions in the event of a
"dilutive issuance," that is, if we issue common stock at any time prior to
their maturity at a per share price below such conversion or exercise price,
either directly or in connection with the issuance of securities that are
convertible into, or exercisable for, shares of our common stock. A reduction in
the exercise price may result in the issuance of a significant number of
additional shares upon the exercise of the warrants.
17
The warrants do not establish a "floor" that would limit reductions in
such conversion price or exercise price. The downward adjustment of the exercise
price of these warrants could result in further dilution in the value of the
shares of our outstanding common stock and the voting power represented thereby.
SALES OF SUBSTANTIAL AMOUNTS OF OUR SHARES OF COMMON STOCK COULD CAUSE THE PRICE
OF OUR COMMON STOCK TO GO DOWN.
To the extent the holders of our convertible securities and warrants
convert or exercise such securities and then sell the shares of our common stock
they receive upon conversion or exercise, our stock price may decrease due to
the additional amount of shares available in the market. The subsequent sales of
these shares could encourage short sales by our stockholders and others which
could place further downward pressure on our stock price. Moreover, holders of
these convertible securities and warrants may hedge their positions in our
common stock by shorting our common stock, which could further adversely affect
our stock price. The effect of these activities on our stock price could
increase the number of shares issuable upon future conversions of our
convertible securities or exercises of our warrants.
We received stockholder approval to increase the number of authorized
shares of common stock to 100,000,000 shares. We may issue additional capital
stock, convertible securities and/or warrants to raise capital in the future. In
addition, to attract and retain key personnel, we may issue additional
securities, including stock options. All of the above could result in additional
dilution of the value of our common stock and the voting power represented
thereby. No prediction can be made as to the effect, if any, that future sales
of shares of our common stock, or the availability of shares for future sale,
will have on the market price of our common stock prevailing from time to time.
Sales of substantial amounts of shares of our common stock in the public market,
or the perception that such sales could occur, may adversely affect the market
price of our common stock and may make it more difficult for us to sell our
equity securities in the future at a time and price which we deem appropriate.
Public or private sales of substantial amounts of shares of our common stock by
persons or entities that have exercised options and/or warrants could adversely
affect the prevailing market price of the shares of our common stock.
THE SEMICONDUCTOR INDUSTRY IS CYCLICAL AND MAY EXPERIENCE PERIODIC DOWNTURNS
THAT MAY NEGATIVELY AFFECT CUSTOMER DEMAND FOR OUR PRODUCTS AND RESULT IN LOSSES
SUCH AS THOSE EXPERIENCED IN THE PAST.
Our business depends upon the capital expenditures of semiconductor
manufacturers, which in turn depend on the current and anticipated market demand
for integrated circuits. The semiconductor industry is highly cyclical and
historically has experienced periodic downturns, which often have had a
detrimental effect on the semiconductor industry's demand for semiconductor
capital equipment, including etch and deposition systems manufactured by us.
During periods of a prolonged industry slow-down, we would have to initiate a
substantial cost containment program and complete a corporate-wide restructuring
to preserve our cash. However, the need for continued investment in research and
development, possible capital equipment requirements and extensive ongoing
customer service and support requirements worldwide will continue to limit our
ability to reduce expenses in response to the any downturn.
OUR COMPETITORS HAVE GREATER FINANCIAL RESOURCES AND GREATER NAME RECOGNITION
THAN WE DO AND THEREFORE MAY COMPETE MORE SUCCESSFULLY IN THE SEMICONDUCTOR
CAPITAL EQUIPMENT INDUSTRY THAN WE CAN.
We believe that to be competitive, we will require significant financial
resources in order to offer a broad range of systems, to maintain customer
service and support centers worldwide and to invest in research and development.
Many of our existing and potential competitors, including, among others, Applied
Materials, Inc., Lam Research Corporation, Novellus and Tokyo Electron Limited,
have substantially greater financial resources, more extensive engineering,
manufacturing, marketing and customer service and support capabilities, larger
installed bases of current generation etch, deposition and other production
equipment and broader process equipment offerings, as well as greater name
recognition than we do. We cannot assure you that we will be able to compete
successfully against these companies in the United States or worldwide.
IF WE FAIL TO MEET THE CONTINUED LISTING REQUIREMENTS OF THE NASDAQ STOCK
MARKET, OUR STOCK COULD BE DELISTED.
Our stock is currently listed on The Nasdaq SmallCap Market. The Nasdaq
Stock Market's Marketplace Rules impose certain minimum financial requirements
on us for the continued listing of our stock. One such requirement is the
minimum bid price on our stock of $1.00 per share. Beginning in 2002, there have
been periods of time during which we have been out of compliance with the $1.00
minimum bid requirements of The Nasdaq SmallCap Market.
18
On September 6, 2002, we received notification from Nasdaq that for the 30
days prior to the notice, the price of our common stock had closed below the
minimum $1.00 per share bid price requirement for continued inclusion under
Marketplace Rule 4450(a)(5) (the "Rule"), and were provided 90 calendar days, or
until December 5, 2002, to regain compliance. Our bid price did not close above
the minimum during that period. On December 6, 2002, we received notification
from Nasdaq that our securities would be delisted from The Nasdaq National
Market, the exchange on which our stock was listed prior to May 6, 2003, on
December 16, 2002 unless we either (i) applied to transfer our securities to The
Nasdaq SmallCap Market, in which case we would be afforded additional time to
come into compliance with the minimum $1.00 bid price requirement; or (ii)
appealed the Nasdaq staff's determination to the Nasdaq's Listing Qualifications
Panel (the "Panel"). On December 12, 2002 we requested an oral hearing before
the Panel and such hearing took place on January 16, 2003 in Washington, D.C.
Our appeal was based, among other things, on our intention to seek stockholder
approval for a reverse split of our outstanding common stock. On April 28, 2003
at a special meeting of our stockholders, our board of directors was granted the
authority to effect a reverse split of our common stock within a range of
two-for-one to fifteen-for-one. This authority was reaffirmed by our
stockholders at the Annual Meeting on September 8, 2003. The timing and ratio of
a reverse split, if any, is at the sole discretion of our board of directors,
but it must have been completed on or before December 2, 2003. On May 6, 2003,
we transferred the listing of our common stock to The Nasdaq SmallCap Market. In
connection with this transfer, and by additional notice, Nasdaq granted us an
extension until December 31, 2003, to regain compliance with the Rule's minimum
$1.00 per share bid price requirement for continued inclusion on The Nasdaq
SmallCap Market. On September 16, 2003, the bid price for our stock had closed
at $1.00 or above for ten consecutive days. On September 17, 2003, we received a
letter from Nasdaq confirming that Tegal had regained compliance with the
minimum bid price requirement and that the question of its continued listing on
The SmallCap Market was now closed.
If we are out of compliance in the future with Nasdaq listing
requirements, we may take actions in order to achieve compliance, which actions
may include a reverse split of our common stock, which would require stockholder
approval. If an initial delisting decision is made by the Nasdaq's staff, we may
appeal the decision as permitted by Nasdaq rules. If we are delisted and cannot
obtain listing on another major market or exchange, our stock's liquidity would
suffer, and we would likely experience reduced investor interest. Such factors
may result in a decrease in our stock's trading price. Delisting also may
restrict us from issuing additional securities or securing additional financing.
WE DEPEND ON SALES OF OUR ADVANCED PRODUCTS TO CUSTOMERS THAT MAY NOT FULLY
ADOPT OUR PRODUCT FOR PRODUCTION USE.
We have designed our advanced etch and deposition products for customer
applications in emerging new films, polysilicon and metal which we believe to be
the leading edge of critical applications for the production of advanced
semiconductor and other microelectronic devices. Revenues from the sale of our
advanced etch and deposition systems accounted for 40%, 25% and 36% of total
revenues in fiscal 2004, 2003 and 2002, respectively. Our advanced systems are
currently being used primarily for research and development activities or low
volume production. For our advanced systems to achieve full market adoption, our
customers must utilize these systems for volume production. There can be no
assurance that the market for devices incorporating emerging films, polysilicon
or metal will develop as quickly or to the degree we expect.
If our advanced systems do not achieve significant sales or volume
production due to a lack of full customer adoption, our business, financial
condition, results of operations and cash flows will be materially adversely
affected.
OUR POTENTIAL CUSTOMERS MAY NOT ADOPT OUR PRODUCTS BECAUSE OF THEIR SIGNIFICANT
COST OR BECAUSE OUR POTENTIAL CUSTOMERS ARE ALREADY USING A COMPETITOR'S TOOL.
A substantial investment is required to install and integrate capital
equipment into a semiconductor production line. Additionally, we believe that
once a device manufacturer has selected a particular vendor's capital equipment,
that manufacturer generally relies upon that vendor's equipment for that
specific production line application and, to the extent possible, subsequent
generations of that vendor's systems. Accordingly, it may be extremely difficult
to achieve significant sales to a particular customer once that customer has
selected another vendor's capital equipment unless there are compelling reasons
to do so, such as significant performance or cost advantages. Any failure to
gain access and achieve sales to new customers will adversely affect the
successful commercial adoption of our products and could have a detrimental
effect on us.
OUR QUARTERLY OPERATING RESULTS MAY CONTINUE TO FLUCTUATE.
19
Our revenue and operating results have fluctuated and are likely to
continue to fluctuate significantly from quarter to quarter, and there can be no
assurance as to future profitability.
Our 900 series etch systems typically sell for prices ranging between
$250,000 and $600,000, while prices of our 6500 series critical etch systems and
our Endeavor deposition system typically range between $1.8 million and $3.0
million. To the extent we are successful in selling our 6500 and Endeavor series
systems, the sale of a small number of these systems will probably account for a
substantial portion of revenue in future quarters, and a transaction for a
single system could have a substantial impact on revenue and gross margin for a
given quarter.
Other factors that could affect our quarterly operating results include:
o our timing of new systems and technology announcements and releases
and ability to transition between product versions;
o seasonal fluctuations in sales;
o changes in the mix of our revenues represented by our various
products and customers;
o adverse changes in the level of economic activity in the United
States or other major economies in which we do business;
o foreign currency exchange rate fluctuations;
o expenses related to, and the financial impact of, possible
acquisitions of other businesses; and
o changes in the timing of product orders due to unexpected delays in
the introduction of our customers' products, due to lifecycles of
our customers' products ending earlier than expected or due to
market acceptance of our customers' products.
BECAUSE TECHNOLOGY CHANGES RAPIDLY, WE MAY NOT BE ABLE TO INTRODUCE OUR PRODUCTS
IN A TIMELY ENOUGH FASHION.
The semiconductor manufacturing industry is subject to rapid technological
change and new system introductions and enhancements. We believe that our future
success depends on our ability to continue to enhance our existing systems and
their process capabilities, and to develop and manufacture in a timely manner
new systems with improved process capabilities. We may incur substantial
unanticipated costs to ensure product functionality and reliability early in our
products' life cycles. There can be no assurance that we will be successful in
the introduction and volume manufacture of new systems or that we will be able
to develop and introduce, in a timely manner, new systems or enhancements to our
existing systems and processes which satisfy customer needs or achieve market
adoption.
SOME OF OUR SALES CYCLES ARE LENGTHY, EXPOSING US TO THE RISKS OF INVENTORY
OBSOLESCENCE AND FLUCTUATIONS IN OPERATING RESULTS.
Sales of our systems depend, in significant part, upon the decision of a
prospective customer to add new manufacturing capacity or to expand existing
manufacturing capacity, both of which typically involve a significant capital
commitment. We often experience delays in finalizing system sales following
initial system qualification while the customer evaluates and receives approvals
for the purchase of our systems and completes a new or expanded facility. Due to
these and other factors, our systems typically have a lengthy sales cycle (often
12 to 18 months in the case of critical etch and deposition systems) during
which we may expend substantial funds and management effort. Lengthy sales
cycles subject us to a number of significant risks, including inventory
obsolescence and fluctuations in operating results over which we have little or
no control.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY OR OBTAIN LICENSES FOR
THIRD PARTIES' INTELLECTUAL PROPERTY AND THEREFORE WE MAY BE EXPOSED TO
LIABILITY FOR INFRINGEMENT OR THE RISK THAT OUR OPERATIONS MAY BE ADVERSELY
AFFECTED.
Although we attempt to protect our intellectual property rights through
patents, copyrights, trade secrets and other measures, we may not be able to
protect our technology adequately and competitors may be able to develop similar
technology independently. Additionally, patent applications that we may file may
not be issued and foreign intellectual property laws may not protect our
intellectual property rights. There is also a risk that patents licensed by or
issued to us will be challenged, invalidated or circumvented and that the rights
granted thereunder will not provide competitive advantages to us. Furthermore,
others may independently develop similar systems, duplicate our systems or
design around the patents licensed by or issued to us.
20
Litigation could result in substantial cost and diversion of effort by us,
which by itself could have a detrimental effect on our financial condition,
operating results and cash flows. Further, adverse determinations in such
litigation could result in our loss of proprietary rights, subject us to
significant liabilities to third parties, require us to seek licenses from third
parties or prevent us from manufacturing or selling our systems. In addition,
licenses under third parties' intellectual property rights may not be available
on reasonable terms, if at all.
OUR CUSTOMERS ARE CONCENTRATED AND THEREFORE THE LOSS OF A SIGNIFICANT CUSTOMER
MAY HARM OUR BUSINESS.
Our top five customers accounted for 85%, 88% and 54% of our systems
revenues in fiscal 2004, 2003 and 2002, respectively. Three customers each
accounted for more than 10% of net systems sales in fiscal 2004. Although the
composition of the group comprising our largest customers may vary from year to
year, the loss of a significant customer or any reduction in orders by any
significant customer, including reductions due to market, economic or
competitive conditions in the semiconductor manufacturing industry, may have a
detrimental effect on our business, financial condition, results of operations
and cash flows. Our ability to increase our sales in the future will depend, in
part, upon our ability to obtain orders from new customers, as well as the
financial condition and success of our existing customers and the general
economy, which is largely beyond our ability to control.
WE ARE EXPOSED TO ADDITIONAL RISKS ASSOCIATED WITH INTERNATIONAL SALES AND
OPERATIONS.
International sales accounted for 67%, 66% and 67% of total revenue for
fiscal 2004, 2003 and 2002, respectively. International sales are subject to
certain risks, including the imposition of government controls, fluctuations in
the U.S. dollar (which could increase the sales price in local currencies of our
systems in foreign markets), changes in export license and other regulatory
requirements, tariffs and other market barriers, political and economic
instability, potential hostilities, restrictions on the export or import of
technology, difficulties in accounts receivable collection, difficulties in
managing representatives, difficulties in staffing and managing international
operations and potentially adverse tax consequences. There can be no assurance
that any of these factors will not have a detrimental effect on our operations,
financial results and cash flows.
We generally attempt to offset a portion of our U.S. dollar denominated
balance sheet exposures subject to foreign exchange rate remeasurement by
purchasing forward currency contracts for future delivery. There can be no
assurance that our future results of operations and cash flows will not be
adversely affected by foreign currency fluctuations. In addition, the laws of
certain countries in which our products are sold may not provide our products
and intellectual property rights with the same degree of protection as the laws
of the United States.
EVOLVING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC DISCLOSURE MAY RESULT IN
ADDITIONAL EXPENSES AND CONTINUING UNCERTAINTY.
Changing laws, regulations and standard relating to corporate governance
and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC
regulations and Nasdaq National Market rules are creating uncertainty for public
companies. We continually evaluate and monitor developments with respect to new
and proposed rules and cannot predict or estimate the amount of the additional
costs we may incur or the timing of such costs. These new or changed laws,
regulations and standards are subject to varying interpretations, in many cases
due to their lack of specificity, and as a result, their application in practice
may evolve over time as new guidance is provided by regulatory and governing
bodies. This could result in continuing uncertainty regarding compliance matters
and higher costs necessitated by ongoing revisions to disclosure and governance
practices. We are committed to maintaining high standards of corporate
governance and public disclosure. As a result, we have invested resources to
comply with evolving laws, regulations and standards, and this investment may
result in increased general and administrative expenses and a diversion of
management time and attention from revenue-generating activities to compliance
activities. If our efforts comply with new or changed laws, regulations and
standards differ from the activities intended by regulatory or governing bodies
due to ambiguities related to practice, regulatory authorities may initiate
legal proceedings against us and we may be harmed.
WE MUST INTEGRATE OUR ACQUISITIONS OF SIMPLUS SYSTEMS CORPORATION AND FIRST
DERIVATIVE SYSTEMS, INC., AND WE MAY NEED TO MAKE ADDITIONAL FUTURE ACQUISITIONS
TO REMAIN COMPETITIVE. THE PROCESS OF IDENTIFYING, ACQUIRING AND INTEGRATING
FUTURE ACQUISITIONS MAY CONSTRAIN VALUABLE MANAGEMENT RESOURCES, AND OUR FAILURE
TO EFFECTIVELY INTEGRATE FUTURE ACQUISITIONS MAY RESULT IN THE LOSS OF KEY
EMPLOYEES AND THE DILUTION OF STOCKHOLDER VALUE AND HAVE AN ADVERSE EFFECT ON
OUR OPERATING RESULTS.
On November 11, 2003, we acquired substantially all of the assets of
Simplus Systems Corporation, and on April 28, 2004, we acquired substantially
all of the assets of First Derivative Systems, Inc. We may in the future seek to
acquire or invest in additional businesses, products or technologies that we
believe could complement or expand our business, augment our market coverage,
enhance our technical capabilities or that may otherwise offer growth
opportunities. We may encounter problems with the assimilation of Simplus or
businesses, products or technologies acquired in the future including:
21
o difficulties in assimilation of acquired personnel, operations,
technologies or products;
o unanticipated costs associated with acquisitions;
o diversion of management's attention from other business concerns and
potential disruption of our ongoing business;
o adverse effects on our existing business relationships with our
customers;
o potential patent or trademark infringement from acquired
technologies;
o adverse effects on our current employees and the inability to retain
employees of acquired companies;
o use of substantial portions of our available cash as all or a
portion of the purchase price;
o dilution of our current stockholders due to the issuance of
additional securities as consideration for acquisitions; and
o inability to complete acquired research and development projects.
If we are unable to successfully integrate our acquired companies or to
create new or enhanced products and services, we may not achieve the anticipated
benefits from our acquisitions. If we fail to achieve the anticipated benefits
from the acquisitions, we may incur increased expenses and experience a
shortfall in our anticipated revenues and we may not obtain a satisfactory
return on our investment. In addition, if a significant number of employees of
acquired companies fail to remain employed with us, we may experience
difficulties in achieving the expected benefits of the acquisitions.
Completing any potential future acquisitions could cause significant
diversions of management time and resources. Financing for future acquisitions
may not be available on favorable terms, or at all. If we identify an
appropriate acquisition candidate for any of our businesses, we may not be able
to negotiate the terms of the acquisition successfully, finance the acquisition
or integrate the acquired business, products, technologies or employees into our
existing business and operations. Future acquisitions may not be well-received
by the investment community, which may cause our stock price to fall. We have
not entered into any agreements or understanding regarding any future
acquisitions and cannot ensure that we will be able to identify or complete any
acquisition in the future.
If we acquire businesses, new products or technologies in the future, we
may be required to amortize significant amounts of identifiable intangible
assets and we may record significant amounts of goodwill that will be subject to
annual testing for impairment. If we consummate one or more significant future
acquisitions in which the consideration consists of stock or other securities,
our existing stockholders' ownership could be significantly diluted. If we were
to proceed with one or more significant future acquisitions in which the
consideration included cash, we could be required to use a substantial portion
of our available cash.
OUR FINANCIAL PERFORMANCE MAY ADVERSELY AFFECT THE MORALE AND PERFORMANCE OF OUR
PERSONNEL AND OUR ABILITY TO HIRE NEW PERSONNEL.
Our common stock has declined in value below the exercise price of many
options granted to employees pursuant to our stock option plans. Thus, the
intended benefits of the stock options granted to our employees, the creation of
performance and retention incentives, may not be realized. As a result, we may
lose employees whom we would prefer to retain. As a result of these factors, our
remaining personnel may seek employment with larger, more established companies
or companies perceived as having less volatile stock prices.
PROVISIONS IN OUR AGREEMENTS, CHARTER DOCUMENTS, STOCKHOLDER RIGHTS PLAN AND
DELAWARE LAW MAY DETER TAKEOVER ATTEMPTS, WHICH COULD DECREASE THE VALUE OF YOUR
SHARES.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could make it more difficult for a third party to acquire us
without the consent of our board of directors. Our board of directors has the
right to issue preferred stock without stockholder approval, which could be used
to dilute the stock ownership of a potential hostile acquirer. Delaware law
imposes some restrictions on mergers and other business combinations between us
and any holder of 15% or more of our outstanding common stock. In addition, we
have adopted a stockholder rights plan that makes it more difficult for a third
party to acquire us without the approval of our board of directors. These
provisions apply even if the offer may be considered beneficial by some
stockholders.
22
OUR STOCK PRICE IS VOLATILE AND COULD RESULT IN A MATERIAL DECLINE IN THE VALUE
OF YOUR INVESTMENT IN TEGAL.
We believe that factors such as announcements of developments related to
our business, fluctuations in our operating results, sales of our common stock
into the marketplace, failure to meet or changes in analysts' expectations,
general conditions in the semiconductor industry or the worldwide economy,
announcements of technological innovations or new products or enhancements by us
or our competitors, developments in patents or other intellectual property
rights, developments in our relationships with our customers and suppliers,
natural disasters and outbreaks of hostilities could cause the price of our
common stock to fluctuate substantially. In addition, in recent years the stock
market in general, and the market for shares of small capitalization stocks in
particular, have experienced extreme price fluctuations, which have often been
unrelated to the operating performance of affected companies. There can be no
assurance that the market price of our common stock will not experience
significant fluctuations in the future, including fluctuations that are
unrelated to our performance.
POTENTIAL DISRUPTION OF OUR SUPPLY OF MATERIALS REQUIRED TO BUILD OUR SYSTEMS
COULD HAVE A NEGATIVE EFFECT ON OUR OPERATIONS AND DAMAGE OUR CUSTOMER
RELATIONSHIPS.
Materials delays have not been significant in recent years. Nevertheless,
we procure certain components and sub-assemblies included in our systems from a
limited group of suppliers, and occasionally from a single source supplier. For
example, we depend on MECS Corporation, a robotic equipment supplier, as the
sole source for the robotic arm used in all of our 6500 series systems. We
currently have no existing supply contract with MECS Corporation, and we
currently purchase all robotic assemblies from MECS Corporation on a purchase
order basis. Disruption or termination of certain of these sources, including
our robotic sub-assembly source, could have an adverse effect on our operations
and damage our relationship with our customers.
ANY FAILURE BY US TO COMPLY WITH ENVIRONMENTAL REGULATIONS IMPOSED ON US COULD
SUBJECT US TO FUTURE LIABILITIES.
We are subject to a variety of governmental regulations related to the
use, storage, handling, discharge or disposal of toxic, volatile or otherwise
hazardous chemicals used in our manufacturing process. We believe that we are
currently in compliance in all material respects with these regulations and that
we have obtained all necessary environmental permits generally relating to the
discharge of hazardous wastes to conduct our business. Nevertheless, our failure
to comply with present or future regulations could result in additional or
corrective operating costs, suspension of production, alteration of our
manufacturing processes or cessation of our operations.
THE STRUCTURED SECONDARY OFFERING FACILITY WE ENTERED INTO IN FEBRUARY 2004 AND
AMENDED IN MAY 2004 MAY HAVE A DILUTIVE IMPACT ON OUR STOCKHOLDERS, AND THE
POTENTIAL UNAVAILABILITY OF THIS FACILITY WOULD NEGATIVELY IMPACT OUR FINANCING
ACTIVITIES.
On February 11, 2004, we entered into a structured secondary offering
facility (the "Structured Secondary") with Kingsbridge Capital Limited
("Kingsbridge"), which was amended on May 19, 2004. Under the terms of an
Amended and Restated Common Stock Purchase Agreement (the "Purchase Agreement")
entered into by the Company and Kingsbridge on May 19, 2004 with respect to the
Structured Secondary, we may, at our sole discretion, sell to Kingsbridge, and
Kingsbridge would be obligated to purchase, up to $25 million of shares of our
common stock, par value $0.01 per share. The price at which we may sell shares
of common stock under the Purchase Agreement is based on a discount to the
volume weighted average market price of the common stock for a specified number
of trading days following each of our respective elections to sell shares
thereunder. The lowest threshold price at which our stock may be sold is at the
sole discretion of the Company, but in no case may be lower than $1.00 per
share, and in the event the price of our common stock falls below this $1.00
threshold, the Structured Secondary will not be an available source of
financing. We may utilize the Structured Secondary through July 7, 2006 from
time to time in our sole discretion, subject to various conditions and terms
contained in the Purchase Agreement. Among the terms of the Purchase Agreement
is a "Material Adverse Effect" clause which permits Kingsbridge to terminate the
Structured Secondary if Kingsbridge determines that an event has occurred that
results in any effect on the business, operations, properties or financial
condition of the Company and its subsidiaries that is material and adverse to
the Company and such subsidiaries, taken as a whole, and/or any condition,
circumstance, or situation that would prohibit or otherwise interfere with our
ability to perform any of our obligations under the Purchase Agreement.
23
In connection with our entering into the Structured Secondary, we issued
to Kingsbridge a warrant (the "Warrant") to purchase 300,000 shares of common
stock at an exercise price of $4.11 per share. The Warrant will not be
exercisable until August 11, 2004, and will expire on August 11, 2009.
There are 9,151,661 shares of our common stock that are reserved for
issuance under the Structured Secondary with Kingsbridge, 300,000 of which are
issuable under the Warrant we granted to Kingsbridge. The issuance of shares
under the Structured Secondary and upon exercise of the Warrant will have a
dilutive impact on other stockholders and the issuance or even potential
issuance of such shares could have a negative effect on the market price of our
common stock. In addition, if we draw down the Structured Secondary, we will
issue shares to Kingsbridge at a discount of 10% of the daily volume weighted
average prices of our common stock during a specified period of trading days
after initiation of each respective draw down. Issuing shares at such a discount
will further dilute the interests of other stockholders.
To the extent that Kingsbridge sells shares of our common stock issued
under the Structured Secondary to third parties, our stock price may decrease
due to the additional selling pressure in the market. The perceived risk of
dilution from sales of stock to or by Kingsbridge may cause holders of our
common stock to sell their shares, or it may encourage short sales. This could
contribute to a decline in our stock price.
THE STRUCTURED SECONDARY IMPOSES CERTAIN LIMITATIONS ON OUR ABILITY TO ISSUE
EQUITY OR EQUITY-LINKED SECURITIES.
During the two-year term of the Structured Secondary, we may not engage in
certain equity or equity-linked financings without the prior written consent of
Kingsbridge, which consent will not be unreasonably withheld, conditioned or
delayed. However, we may engage in the following capital raising transactions
without Kingsbridge's consent: (1) establish stock option or award plans or
agreements (for directors, employees, consultants and/or advisors) and amend
such plans or agreements, including increasing the number of shares available
thereunder, (2) use equity securities to finance the acquisition of other
companies, equipment, technologies or lines of business, (3) issue shares of
common stock and/or preferred stock in connection with our option or award
plans, stock purchase plans, rights plans, warrants or options, (4) issue shares
of common stock and/or preferred stock in connection with the acquisition of
products, licenses, equipment or other assets and strategic partnerships or
joint ventures (the primary purpose of which is not to raise equity capital);
(5) issue shares of common and/or preferred stock to consultants and/or advisors
as consideration for services rendered, (6) issue and sell shares in an
underwritten public offering of common stock, and (7) issue shares of common
stock to Kingsbridge under any other agreement entered into between our company
and Kingsbridge.
In addition, we may not issue securities that are, or may become,
convertible or exchangeable into shares of common stock where the purchase,
conversion or exchange price for such common stock is determined using a
floating or otherwise adjustable discount to the market price of the common
stock (including pursuant to an equity line or other financing that is
substantially similar to an equity line with an investor other than Kingsbridge)
during the two-year term of our agreement with Kingsbridge.
WE MAY ISSUE ADDITIONAL SHARES AND DILUTE YOUR OWNERSHIP PERCENTAGE.
Certain events over which you have no control could result in the issuance
of additional shares of our common stock, which would dilute your ownership
percentage in our company. As of June 30, 2004, there were 44,183,297 shares of
our common stock issued and outstanding and there were 31,094 shares of common
stock reserved for issuance under our equity incentive and stock purchase plans.
In addition, as of June 30, 2004, there were outstanding options, warrants and
other rights to acquire up to approximately 12,115,046 [7,854,395 in equity
compensation plans and 4,260,651 in warrants] shares of common stock. We may
also issue additional shares of common stock or preferred stock:
o to raise additional funds for working capital, commercialization,
production and marketing activities;
o upon the exercise or conversion of additional outstanding options
and warrants; and
o in lieu of cash payment of dividends.
Moreover, although the issuance of our common stock under the Structured
Secondary will have no effect on the rights or privileges of existing holders of
common stock, the economic and voting interests of each stockholder will be
diluted as a result of such issuance. Although the number of shares of common
stock that stockholders presently own will not decrease, such shares will
represent a smaller percentage of our total shares that will be outstanding
after such events. If we satisfy the conditions that allow us to draw down the
entire $25 million available under the Structured Secondary, and we choose to do
so, then generally, as the market price
24
of our common stock decreases, the number of shares we will have to issue upon
each draw down on the Structured Secondary increases, to a maximum of 8,851,661
shares. Therefore drawing down upon the Structured Secondary when the price of
our common stock is decreasing will have an additional dilutive effect to your
ownership percentage and may result in additional downward pressure on the price
of our common stock.
25
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This Form 10-Q includes or incorporates by reference forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Forward-looking statements, which are based on
assumptions and describe our future plans, strategies and expectations, are
generally identifiable by the use of the words "anticipate," "believe,"
"estimate," "expect," "intend," "project," or similar expressions. These
forward-looking statements are subject to risks, uncertainties and assumptions
about us. Important factors that could cause actual results to differ materially
from the forward-looking statements we make in this Form 10-Q are set forth
under the caption "Risk Factors" and elsewhere in this prospectus and the
documents incorporated by reference in this Form 10-Q. If one or more of these
risks or uncertainties materialize, or if any underlying assumptions prove
incorrect, our actual results, performance or achievements may vary materially
from any future results, performance or achievements expressed or implied by
these forward-looking statements. All forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirely by
the cautionary statements in this paragraph.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Asset Acquisition Agreement by and between Tegal Corporation
and First Derivative Systems, Inc. dated as of April 28, 2004.
4.1 Registration Rights Agreement by and among Tegal Corporation,
First Derivative Systems, Inc. and Andy Clarke, as
representative of the stockholders and creditors of First
Derivative Systems, Inc., dated as of May 28, 2004.
31 Certifications of the Chief Executive Officer and Chief
Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certifications of the Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TEGAL CORPORATION
(Registrant)
/s/ THOMAS R. MIKA
--------------------------------------
Thomas R. Mika
Chief Financial Officer
Dated: August 16, 2004
27