UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2001
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to _____
Commission File Number: 0-27234
PHOTON DYNAMICS, INC.
(Exact name of registrant as specified in its charter)
California | 94-3007502 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
6325 San Ignacio Avenue San Jose, California | 95119 |
(Address of principal executive offices) | (zip code) |
(408) 226-9900
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý NOo
As of July 31, 2001, there were 12,920,225 shares outstanding of the Registrant’s Common Stock, no par value.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PHOTON DYNAMICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands) | June 30, 2001 | September 30, 2000 | ||||||
(Restated) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 9,734 | $ | 9,723 | ||||
Short-term investments | 92,092 | 93,003 | ||||||
Accounts receivable, net | 18,048 | 24,828 | ||||||
Inventories | 13,266 | 16,523 | ||||||
Other current assets | 1,907 | 2,510 | ||||||
Total current assets | 135,047 | 146,587 | ||||||
Land, property and equipment, net | 13,324 | 4,111 | ||||||
Other assets | 2,482 | 2,056 | ||||||
Total assets | $ | 150,853 | $ | 152,754 | ||||
| ||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 4,300 | $ | 6,622 | ||||
Other current liabilities | 9,977 | 12,039 | ||||||
Deferred revenue and customer deposits | 791 | 1,884 | ||||||
Total current liabilities | 15,068 | 20,545 | ||||||
Other liabilities | 383 | 409 | ||||||
Commitments and contingencies (See Note 9) | ||||||||
Shareholders’ equity: | ||||||||
Preferred stock, no par value | - | - | ||||||
Common stock, no par value | 160,806 | 159,723 | ||||||
Accumulated deficit | (25,306 | ) | (27,926 | ) | ||||
Accumulated other comprehensive income | (98 | ) | 3 | |||||
Total shareholders’ equity | 135,402 | 131,800 | ||||||
Total liabilities and shareholders’ equity | $ | 150,853 | $ | 152,754 | ||||
See accompanying notes to condensed consolidated financial statements.
PHOTON DYNAMICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended June 30, | Nine months ended June 30, | |||||||||||||
(in thousands, except per share data) | 2001 | 2000 | 2001 | 2000 | ||||||||||
(Restated) | (Restated) | |||||||||||||
Revenue | $ | 12,277 | $ | 25,288 | $ | 62,716 | $ | 68,381 | ||||||
Cost of revenue | 7,903 | 13,464 | 35,467 | 36,954 | ||||||||||
Gross margin | 4,374 | 11,824 | 27,249 | 31,427 | ||||||||||
Operating expenses: | ||||||||||||||
Research and development | 3,753 | 3,853 | 12,888 | 9,639 | ||||||||||
Selling, general and administrative | 3,896 | 4,356 | 13,271 | 12,228 | ||||||||||
Non-recurring acquisition charges | - | - | 2,325 | 860 | ||||||||||
Total operating expenses | 7,649 | 8,209 | 28,484 | 22,727 | ||||||||||
Income (loss) from operations | (3,275 | ) | 3,615 | (1,235 | ) | 8,700 | ||||||||
Interest income and other, net | 1,066 | 1,627 | 4,323 | 2,547 | ||||||||||
Income (loss) before income taxes | (2,209 | ) | 5,242 | 3,088 | 11,247 | |||||||||
Provision (benefit) for income taxes | (241 | ) | 1,000 | 468 | 2,120 | |||||||||
Net income (loss) | $ | (1,968 | ) | $ | 4,242 | $ | 2,620 | $ | 9,127 | |||||
Earnings (loss) per share: | ||||||||||||||
Basic | $ | (0.15 | ) | $ | 0.33 | $ | 0.20 | $ | 0.78 | |||||
Diluted | $ | (0.15 | ) | $ | 0.31 | $ | 0.19 | $ | 0.71 | |||||
Weighted average number of shares: | ||||||||||||||
Basic | 13,014 | 12,724 | 12,983 | 11,642 | ||||||||||
Diluted | 13,014 | 13,761 | 13,727 | 12,819 | ||||||||||
See accompanying notes to condensed consolidated financial statements.
PHOTON DYNAMICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended June 30, | |||||||||
(in thousands) | 2001 | 2000 | |||||||
(Restated) | |||||||||
Cash flows from operating activities: | |||||||||
Net income | $ | 2,620 | $ | 9,127 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||
Depreciation and amortization | 1,670 | 1,006 | |||||||
Loss on disposal of property and equipment | 6 | - | |||||||
Reversal of Canadian government liability | - | (264 | ) | ||||||
Stock compensation expense | 48 | 530 | |||||||
Unrealized gain on investments | - | (48 | ) | ||||||
Changes in assets and liabilities: | |||||||||
Accounts receivable, net | 6,780 | (7,218 | ) | ||||||
Inventories | 3,257 | (5,021 | ) | ||||||
Other current assets | 603 | 176 | |||||||
Other assets | (426 | ) | (289 | ) | |||||
Accounts payable | (2,322 | ) | 2,373 | ||||||
Other current liabilities | (2,062 | ) | 4,534 | ||||||
Deferred revenue and customer deposits | (1,093 | ) | (657 | ) | |||||
Net cash provided by operating activities | 9,081 | 4,249 | |||||||
Cash flows from investing activities: | |||||||||
Purchase of property and equipment | (10,889 | ) | (1,237 | ) | |||||
Purchase of short-term investments | (88,485 | ) | (40,423 | ) | |||||
Redemption of short-term investments | 89,504 | - | |||||||
Net cash used in investing activities | (9,870 | ) | (41,660 | ) | |||||
Cash flows from financing activities: | |||||||||
Issuance of common stock, net | 1,035 | 87,983 | |||||||
Proceeds from Canadian government grants | - | 286 | |||||||
Principle payments under bank loan | - | (629 | ) | ||||||
Principle payments under capital leases | (26 | ) | (6 | ) | |||||
Net cash provided by financing activities | 1,009 | 87,634 | |||||||
Effect of exchange rate changes on cash and cash equivalents | (209 | ) | (22 | ) | |||||
Net increase in cash and cash equivalents | 11 | 50,201 | |||||||
Cash and cash equivalents at beginning of period | 9,723 | 6,560 | |||||||
| |||||||||
Cash and cash equivalents at end of period | $ | 9,734 | $ | 56,761 | |||||
See accompanying notes to condensed consolidated financial statements.
PHOTON DYNAMICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1— Basis of Presentation
In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements of Photon Dynamics, Inc. (“Photon Dynamics” or “the Company”) include all adjustments (consisting of normal recurring accruals) necessary for their fair presentation in accordance with generally accepted accounting principles. Preparing financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual amounts could differ materially from those amounts. The results for the nine-month period ended June 30, 2001 are not necessarily indicative of results to be expected for the entire year. This financial information should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2000.
On December 22, 2000, the Company acquired Image Processing Systems Inc. (“Image Processing Systems” or “IPS”). This transaction was accounted for as a pooling of interests. The consolidated financial statements for the three- and nine-month periods ended June 30, 2000 have been restated to include the financial position, results of operations and cash flows of IPS. Financial information for Photon Dynamics, Inc.’s fiscal years ended September 30, 2000 and 1999 have been combined with IPS’s financial information for the twelve months ended September 30, 2000 and the fiscal year ended March 31, 2000, respectively. Therefore, IPS’s results of operations for the six months ended March 31, 2000 have been included in both years. The results of operations for those six months are summarized as follows:
Six months ended March 31, (in thousands of U.S. dollars) | 2000 | ||
(Unaudited) | |||
Revenue | $ | 7,050 | |
Operating income | $ | 14 | |
Net income | $ | (15 | ) |
NOTE 2 – Inventories
Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. The components of inventories were as follows:
(in thousands) | June 30, 2001 | September 30, 2000 | ||||||
Inventories: | ||||||||
Raw materials | $ | 8,093 | $ | 9,025 | ||||
Work-in-process | 4,043 | 7,311 | ||||||
Finished goods | 1,130 | 187 | ||||||
Total | $ | 13,266 | $ | 16,523 | ||||
NOTE 3 – Other Current Liabilities
The components of other current liabilities were as follows:
(in thousands) | June 30, 2001 | September 30, 2000 | ||||||
Other current liabilities: | ||||||||
Warranty | $ | 3,113 | $ | 3,609 | ||||
Compensation | 2,247 | 3,540 | ||||||
Commissions | 1,166 | 1,463 | ||||||
Acquisition charges | 251 | 528 | ||||||
Income taxes | 871 | 284 | ||||||
Other accrued expenses | 2,329 | 2,615 | ||||||
Total | $ | 9,977 | $ | 12,039 | ||||
NOTE 4 – Comprehensive Income
The components of comprehensive income were as follows:
Three months ended June 30, | Nine months ended June 30, | ||||||||||||||
(in thousands) | 2001 | 2000 | 2001 | 2000 | |||||||||||
Net income (loss) | $ | (1,968 | ) | $ | 4,242 | $ | 2,620 | $ | 9,127 | ||||||
Other comprehensive income (loss): | |||||||||||||||
Change in unrealized gain on investments | 56 | (21 | ) | 108 | (48 | ) | |||||||||
Currency translation adjustments | 128 | (166 | ) | (209 | ) | (22 | ) | ||||||||
Other comprehensive income (loss) | 184 | (187 | ) | (101 | ) | (70 | ) | ||||||||
Total comprehensive income (loss) | $ | (1,784 | ) | $ | 4,055 | $ | 2,519 | $ | 9,057 | ||||||
NOTE 5 – Operations by Industry Segment
During the first quarter of fiscal 2001, the Company changed the structure of its internal organization following the IPS merger that became effective on the close of business December 22, 2000.
The Company conducts business in three operating segments: flat panel display (“FPD”) products, printed circuit board (“PCB”) assembly and advanced semiconductor packaging inspection products (collectively, “semiconductor inspection products”) and cathode ray tube (“CRT”) display and glass inspection products. The Company’s FPD products include test, repair and inspection equipment. The Company’s FPD test and inspection equipment identifies and characterizes defects at early stages of the manufacturing process so that the panels may be repaired before the next stage, or, if necessary, discarded, minimizing the loss of time and materials. The Company’s FPD products gather comprehensive data that enable FPD manufacturers to control and refine their manufacturing processes. The Company’s semiconductor inspection products enable PCB assembly and advanced semiconductor packaging manufacturers to detect and identify defects, thereby increasing yields and quality and reducing costs. The Company’s CRT display and glass inspection products allow CRT and glass manufacturers to detect and identify defects such as scratches, pits, bubbles, stones, inclusions and distortions, thereby increasing yields and quality and reducing costs.
Prior to the acquisition of Image Processing Systems in December 2000, the Company operated in the FPD and semiconductor inspection segments. The Company’s management has determined the operating segments based upon the manner in which the business is managed and operated. There are no significant intersegment sales or transfers, and the majority of the Company’s long-lived assets are located in the U.S. The Company’s principal customers are primarily Asian-based FPD and CRT manufacturers and North American-based PCB assembly and advanced semiconductor packaging manufacturers.
The Company’s operating segments consisted of the following:
Three months ended June 30, | Nine months ended June 30, | ||||||||||||
(in thousands) | 2001 | 2000 | 2001 | 2000 | |||||||||
Net sales to external customers: | |||||||||||||
FPD products | $ | 6,508 | $ | 17,533 | $ | 36,511 | $ | 45,409 | |||||
Semiconductor inspection products | 3,440 | 4,553 | 14,023 | 12,720 | |||||||||
CRT display and glass inspection products | 2,329 | 3,202 | 12,182 | 10,252 | |||||||||
Consolidated net sales to external customers | $ | 12,277 | $ | 25,288 | $ | 62,716 | $ | 68,381 | |||||
Operating income (loss): | |||||||||||||
FPD products(1) | $ | (2,746 | ) | $ | 3,390 | $ | 1,132 | $ | 8,255 | ||||
Semiconductor inspection products(1) | (79 | ) | 554 | 763 | 1,619 | ||||||||
CRT display and glass inspection products(1) | (450 | ) | (329 | ) | (805 | ) | (314 | ) | |||||
Non-recurring acquisition charges | - | - | (2,325 | ) | (860 | ) | |||||||
Consolidated operating income (loss) | $ | (3,275 | ) | $ | 3,615 | $ | (1,235 | ) | $ | 8,700 | |||
(1) Excludes non-recurring acquisition charges.
NOTE 6 – Earnings Per Share
Basic earnings per share is calculated using the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed in the same manner and also gives effect to all dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of stock options issued to employees under employee stock option plans and of warrants. As the Company incurred a loss for the three months ended June 30, 2001, the effect of dilutive securities totaling approximately 837,000 weighted average shares from employee stock options and warrants has been excluded from the computation of diluted earnings per share as their effect is antidilutive.
Three months ended June 30, | Nine months ended June 30, | |||||||||||||
(in thousands, except per share data) | 2001 | 2000 | 2001 | 2000 | ||||||||||
Numerator: | ||||||||||||||
Net income (loss) for basic and diluted earnings per share: | $ | (1,968 | ) | $ | 4,242 | $ | 2,620 | $ | 9,127 | |||||
Denominator: | ||||||||||||||
Weighted average shares for basic earnings per share | 13,014 | 12,724 | 12,983 | 11,642 | ||||||||||
Effect of dilutive securities: | ||||||||||||||
Employee stock options | - | 1,030 | 737 | 1,091 | ||||||||||
Warrants | - | 7 | 7 | 86 | ||||||||||
Weighted average shares for diluted earnings per share | 13,014 | 13,761 | 13,727 | 12,819 | ||||||||||
Basic earnings (loss) per share | $ | (0.15 | ) | $ | 0.33 | $ | 0.20 | $ | 0.78 | |||||
Diluted earnings (loss) per share | $ | (0.15 | ) | $ | 0.31 | $ | 0.19 | $ | 0.71 | |||||
NOTE 7 – Non-Recurring Acquisition Charges
In December 2000, the Company acquired IPS in exchange for approximately 1,139,000 shares of its common stock with the acquisition accounted for as a pooling of interests. IPS shareholders received 0.0447 exchangeable shares for each common share of IPS held that can be exchanged into Photon Dynamics’ common stock on a one-for-one basis at any time within 5 years. The Company incurred $2.3 million in acquisition related charges primarily of legal, accounting and integration fees.
In November 1999, the Company acquired CR Technology, Inc. (“CR Technology”) in exchange for approximately 1,835,000 shares of its common stock with the acquisition accounted for as a pooling of interests. The Company incurred $860,000 in acquisition related charges primarily of legal, accounting and investment banking fees.
The following presents certain statement of operations data of the Company, IPS and CR Technology for the periods prior to the acquisition:
Year ended September 30, (in thousands) | 2000 | 1999 | 1998 | |||||||
Revenue: | ||||||||||
Photon Dynamics | $ | 64,221 | $ | 31,562 | $ | 22,420 | ||||
Image Processing Systems | 12,523 | 16,580 | 10,052 | |||||||
CR Technology | 18,013 | 13,869 | 8,550 | |||||||
Consolidated revenue | $ | 94,757 | $ | 62,011 | $ | 41,022 | ||||
Net income (loss): | ||||||||||
Photon Dynamics | $ | 12,909 | $ | 1,170 | $ | (1,465 | ) | |||
Image Processing Systems | (1,218 | ) | 845 | (3,450 | ) | |||||
CR Technology | 1,844 | 1,103 | 258 | |||||||
Consolidated net income (loss) | $ | 13,535 | $ | 3,118 | $ | (4,657 | ) | |||
NOTE 8 – Income Taxes
The provision for income taxes was a benefit of $241,000 and an expense of $468,000 for the three- and nine-month periods ended June 30, 2001 compared to expense of $1.0 million and $2.1 million for the same periods in the prior fiscal year. The effective tax rate was (11)% and 19% for the three-month periods ended June 30, 2001 and 2000, respectively. The effective tax rate was 9% and 18% excluding non-recurring acquisition expenses for the nine-month periods ended June 30, 2001 and 2000, respectively. The effective tax rate in all periods was lower than the statutory U.S. tax rate of 35% due to the utilization of net operating losses and credit carryforwards.
NOTE 9 – Commitments and Contingencies
The Company and certain of its directors and officers have been named as defendants in a lawsuit captioned Amtower v. Photon Dynamics, Inc. filed on April 30, 2001. The plaintiff in this action has purported to assert several causes of action arising out of the alleged misrepresentation and enforcement of the Company’s insider trading policy and is seeking damages of approximately $17.7 million. While the Company intends to vigorously contest this action, the Company cannot predict the outcome of this litigation. The Company believes that an adverse determination in this litigation would not have a material adverse effect on its financial condition or results of operation.
NOTE 10 – Derivative Instruments and Hedging Activities
On October 1, 2000, the Company adopted FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”). FAS 133, as amended, establishes methods for recording derivative financial instruments and hedging activities related to those instruments, as well as other hedging activities. The Company currently does not hold any derivative instruments and does not engage in hedging activities. Therefore, the adoption of FAS 133, as amended, has not had any impact on its consolidated financial position or results of operations.
NOTE 11 – Recently Issued Accounting Pronouncements
In June 2000, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial Statements (“SAB 101B”). SAB 101B amends Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB 101”), to defer the implementation date of SAB 101 for registrants until no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. SAB 101 summarizes certain views of the SEC in applying generally accepted accounting principles to revenue recognition in financial statements. The Company is required to adopt SAB 101 in the fourth quarter of its fiscal year ending September 30, 2001. Accordingly, any revenues reported prior to October 1, 2000 and revenue reported for the first three quarters of fiscal 2001 that do not meet SAB 101’s guidance will be deferred and recorded as revenue in whatever future periods SAB 101 guidance is met. Changes in the Company’s revenue recognition policy resulting from the interpretation and implementation of SAB 101 would not involve the restatement of prior fiscal year statements, but would, to the extent applicable, be reported as a change in accounting principle with a cumulative catch up adjustment as of October 1, 2000 in the fiscal year ending September 30, 2001, with the appropriate restatement of interim periods as required by FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. The Company’s reported results of operations for the 12 months ending September 30, 2001 will include a cumulative adjustment for all prior annual and interim periods as if SAB 101 had been adopted on October 1, 2000. While the Company believes that the adoption of SAB 101 will have an impact on its reported results of operations, it believes that SAB 101 will not affect the underlying strength or weakness of its business operations as measured by the dollar value of its product shipments and cash flows.
NOTE 12 – Subsequent Event
On July 17, 2001, the Company acquired Intelligent Reasoning Systems Inc. (“IRSI”), a privately-held company. IRSI manufactures in-line, advanced optical inspection equipment for the electronic manufacturing services and high-density interconnect markets. The Company acquired IRSI in exchange for approximately 636,000 shares of common stock. The transaction will be accounted for as a purchase, and the purchase price will be allocated to the estimated fair value of assets acquired and liabilities assumed based on management estimates.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The statements contained in this report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding our expectations, hopes, intentions, or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual results could differ materially from those in such forward-looking statements. Factors that could cause actual results to differ materially are those discussed under “Factors Affecting Operating Results” at the end of this Item 2. and elsewhere in this Form 10-Q.
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto in Item 1. above and with our audited financial statements and notes thereto for the year ended September 30, 2000 contained in our Annual Report on Form 10-K filed November 7, 2000.
Results of Operations
We are a leading global supplier of integrated yield management solutions for the display, electronics and glass markets. Our patented image acquisition and image processing technology, electro-optical design and systems engineering expertise are currently used for test and repair of FPDs; inspection of CRT display and automotive glass; and inspection of advanced semiconductors and printed wiring assembly packaging solutions. We develop systems that enable manufacturers to collect data from the production line, analyze it, and quickly diagnose and repair process-related defects. We focus specifically on delivering solutions that help manufacturers decrease material costs and improve throughput.
Revenue. Revenue for the three-month period ended June 30, 2001 was $12.3 million compared to $25.3 million for the same period in the prior fiscal year, representing a decrease of 51%. Sales of FPD products represented $6.5 million, or 53% of revenue, for the three-month period ended June 30, 2001 compared to $17.5 million, or 69% of revenue, for the same period in the prior fiscal year. Sales of semiconductor inspection products represented $3.5 million, or 28% of revenue, for the three-month period ended June 30, 2001 compared to $4.6 million, or 18% of revenue, for the same period in the prior fiscal year. Sales of CRT display and glass inspection products represented $2.3 million, or 19% of revenue, for the three-month period ended June 30, 2001 compared to $3.2 million, or 13% of revenue, for the same period in the prior fiscal year. The decrease in revenue across all market segments was attributable to the delayed capital spending plans by our customers due to the recent economic downturn.
Revenue for the first nine months of fiscal 2001 was $62.7 million compared to $68.4 million for the same period in the prior fiscal year, representing a decrease of 8%. Sales of FPD products represented $36.5 million, or 58% of revenue, for the first nine months of fiscal 2001 compared to $45.4 million, or 66% of revenue, for the same period in the prior fiscal year. This decrease in revenue was primarily attributable to the delayed capital spending plans by our FPD customers due to the recent economic downturn. Sales of semiconductor inspection products represented $14.0 million, or 22% of revenue, for the first nine months of fiscal 2001 compared to $12.7 million, or 19% of revenue, for the same period in the prior fiscal year. Sales of CRT display and glass inspection products represented $12.2 million, or 20% of revenue, for the first nine months of fiscal 2001 compared to $10.3 million, or 15% of revenue, for the same period in the prior fiscal year. The increase in revenue for these two market segments was primarily attributable to the number of units sold due to increased capital spending by CRT, PCB assembly and advanced semiconductor packaging manufacturers during the first three months of fiscal 2001.
Gross Margin. Gross margins were 36% for the three-month period ended June 30, 2001 compared to 47% for the same period in the prior fiscal year. Gross margins from FPD products decreased to 29% for the three-month period ended June 30, 2001 from 48% for the same period in the prior fiscal year. This decrease was attributable to decreased capacity utilization resulting from the lower production volume of FPD products. Gross margins from semiconductor inspection products decreased to 44% for the three-month period ended June 30, 2001 from 45% for the same period in the prior fiscal year. This decrease was attributable to increased customer support costs associated with the increase in the installed base of semiconductor inspection products. Gross margins from CRT display and glass inspection products were 41% for both three-month periods ended June 30, 2001 and 2000.
Gross margins were 43% for the nine-month period ended June 30, 2001 compared to 46% for the same period in the prior fiscal year. Gross margins from FPD products decreased to 45% for the first nine months of fiscal 2001 from 47% for the same period in the prior fiscal year. This decrease was attributable to decreased capacity utilization resulting from the lower production volume of FPD products during the three-month period ended June 30, 2001 which was offset by the mix of higher margin products sold during the first half of fiscal 2001 as compared to the same period in the prior fiscal year. Gross margins from semiconductor inspection products decreased to 44% for the first nine months of fiscal 2001 from 46% for the same period in the prior fiscal year. This decrease was attributable to increased customer support costs associated with the increase in the installed base of semiconductor inspection products. Gross margins from CRT display and glass inspection products decreased to 38% for the first nine months of fiscal 2001 from 42% for the same period in the prior fiscal year. This decrease was primarily attributable to an OEM shipment during the first three months of fiscal 2001 having a lower gross margin than typical product shipments. Overall gross margins will fluctuate on a quarterly basis due to production volume, product mix and other factors.
Research and Development. Research and development expenses were $3.8 million and $12.9 million for the three- and nine-month periods ended June 30, 2001, respectively, compared to $3.9 million and $9.6 million for the same periods in the prior fiscal year. As a percentage of revenue, research and development expenses were 31% and 21% for the three- and nine-month periods ended June 30, 2001, respectively, compared to 15% and 14% for the same periods in the prior fiscal year. The decrease in research and development expenses for the three-month period ended June 30, 2001 was primarily attributable to reduced incentive compensation expenses in the FPD and CRT display and glass segments as a result of the recent economic downturn. The increase in research and development expenses for the first nine months of fiscal 2001 was primarily the result of expenses for new FPD product development and enhancements to existing FPD products in addition to increased expenses related to new product development for semiconductor and CRT display and glass inspection products during the first half of fiscal 2001.
Selling, General and Administrative. Selling, general and administrative expenses were $3.9 million and $13.3 million for the three- and nine-month periods ended June 30, 2001, respectively, compared to $4.4 million and $12.2 million for the same periods in the prior fiscal year. As a percentage of revenue, selling, general and administrative expenses were 32% and 21% for the three- and nine-month periods ended June 30, 2001, respectively, compared to 17% and 18% for the same periods in the prior fiscal year. The decrease in selling, general and administrative expenses for the three-month period ended June 30, 2001 is primarily attributable to lower compensation related expenses and spending as a result of decreased sales of FPD products. The increase in selling, general and administrative expenses for the first nine months of fiscal 2001 was primarily attributable to higher selling expenses and to the investment in additional personnel to support the growth in semiconductor inspection products.
Non-Recurring Acquisition Charges. In December 2000, we acquired Image Processing Systems Inc. in exchange for approximately 1,139,000 shares of common stock. We accounted for the transaction as a pooling of interests and incurred $2.3 million in acquisition related charges consisting of legal, accounting and integration fees.
In November 1999, we acquired CR Technology, Inc. in exchange for approximately 1,835,000 shares of common stock. We accounted for the transaction as a pooling of interests and incurred $860,000 in acquisition related charges consisting of legal, accounting and investment banking fees.
Interest Income and Other, Net. Interest income and other, net was $1.1 million and $4.3 million for the three- and nine-month periods ended June 30, 2001, respectively, compared to $1.6 million and $2.5 million for the same periods in the prior fiscal year. The decrease for the three-month period ended June 30, 2001 was primarily attributable to decreased interest income as a result of lower interest rates on cash and investment balances offset in part by higher average cash and investment balances. The increase for the first nine months of fiscal 2001 was primarily attributable to interest income on higher average cash and investment balances as a result of the net proceeds from a public offering in February 2000 and cash flows from operations since that date.
Provision for Income Taxes. The effective tax rate for the three- and nine-month periods ended June 30, 2001 was (11)% and 15%, respectively, compared to an effective tax rate of 19% for both periods in the prior fiscal year. The effective tax rate in all periods was lower than the statutory rate due to the utilization of net operating losses and credit carryforwards.
Liquidity and Capital Resources
We have financed our growth primarily through a combination of cash flows from operations, public stock offerings, lines of credit and loans. Working capital was $120.0 million as of June 30, 2001 compared to $126.0 million as of September 30, 2000. A major component of working capital was $101.8 million of cash, cash equivalents and short-term investments as of June 30, 2001 compared to $102.7 million as of September 30, 2000.
Operating Activities. Cash provided by operating activities was $9.1 million for the nine-month period ended June 30, 2001 compared to $4.2 million for the same period in the prior fiscal year. The increase in cash provided by operating activities was primarily due to decreases in accounts receivable and inventories offset in part by decreases in accounts payable and other current liabilities.
Investing Activities. Cash used in investing activities was $9.9 million for the nine-month period ended June 30, 2001 compared to cash used in investing activities of $41.7 million for the same period in the prior fiscal year. The cash used during the nine-month period ended June 30, 2000 was primarily due to the investment of net proceeds from the Company’s public offering in February 2000. Capital expenditures were $10.9 million for the nine-month period ended June 30, 2001 compared to $1.2 million for the same period in the prior fiscal year. In March 2001, we purchased a new 22,000 square foot facility in San Jose, California for $6.0 million. The remaining capital expenditures during the nine-month period ended June 30, 2001 were primarily for internal test and repair equipment.
Financing Activities. Cash provided by financing activities was $1.0 million for the nine-month period ended June 30, 2001 compared to $87.6 million for the same period in the prior fiscal year. The cash provided during the nine-month period ended June 30, 2000 was primarily attributable to a public offering of 2,000,000 shares of our common stock in which we sold approximately 1,321,000 shares for proceeds of approximately $68.0 million, net of issuance costs, in February 2000. In March 2000, we received additional proceeds of approximately $15.6 million as a result of the underwriters exercising their over-allotment option.
We have a borrowing capacity of $4.0 million available under a bank line of credit, secured by substantially all of our assets, that expires in March 2002. Our wholly-owned subsidiary, CR Technology, has an unsecured borrowing capacity of $1.5 million under a bank line of credit that expires in February 2003. Both credit facilities bear interest at the bank’s prime rate. Our wholly-owned subsidiary, IPS, has a borrowing capacity of $1.2 million available under a bank line of credit secured by substantially all of IPS’s assets and bearing interest at the Canadian prime rate plus 3 percent. At June 30, 2001, no amounts were outstanding under the lines of credit, and we were in compliance with all bank covenants.
We believe that existing liquid capital resources and funds generated from operations combined with the ability, if necessary, to borrow funds will be sufficient to meet our operating and capital requirements and obligations for at least the next twelve months. We believe that success in our industry requires substantial capital in order to maintain the flexibility to take advantage of opportunities as they may arise. We may, from time to time, invest in or acquire complementary businesses, products or technologies and may seek additional equity or debt financing to fund such activities. There can be no assurance that such funding will be available to us on commercially reasonable terms. The sale of additional equity or convertible debt could result in dilution to our shareholders.
Factors Affecting Operating Results
Fluctuations in Operating Results
We have experienced and expect to continue to experience significant fluctuations in our quarterly results. Our backlog at the beginning of each quarter does not necessarily determine actual sales for any succeeding period. A substantial percentage of our revenue is derived from the sale of a small number of yield management systems ranging in price from $250,000 to $1.5 million. Therefore, the timing of the sale of a single system could have a significant impact on our quarterly results. Moreover, customers may cancel or reschedule shipments, and production difficulties could delay shipments. Other factors that may influence our operating results in a particular quarter include:
• the downturn in capital spending by our customers as a result of the recent economic slowdown;
• the timing of the receipt of orders from major customers;
• product mix;
• competitive pricing pressures;
• condition of the financial markets and economic stability in Asia;
• the relative proportions of domestic and international sales;
• our ability to design, manufacture and introduce new products on a cost-effective and timely basis;
• the delay between incurring expenses to further develop marketing and service capabilities and the realization of
benefits from those improved capabilities;
• the introduction of new products by our competitors; and
• the adoption of SAB 101.
Customer Concentration
The FPD industry is extremely concentrated with a small number of manufacturers producing the majority of the world’s FPDs. Sales of FPD products represented 58% and 66% of our revenue for the nine-month period ended June 30, 2001 and fiscal 2000, respectively. Ishikawajima-Harima Heavy Industries Co., Ltd. (“IHI”) and Quanta, both of whom are customers of our FPD products, and LG Electronics and Samsung, both of whom are customers of our FPD and CRT display and glass inspection products, accounted for 55% of revenue for the nine-month period ended June 30, 2001. Hyundai and Unipac, both of whom are customers of our FPD products, and LG Electronics and Samsung, both of whom are customers of our FPD and CRT display and glass inspection products, accounted for 58% of revenue in fiscal 2000. If one or more of our major customers ceased or significantly curtailed their purchases, our results of operations would be harmed.
Flat Panel Display Industry Volatility
Our business depends in large part upon capital expenditures by FPD manufacturers, which in turn depend on the current and anticipated market demand for FPDs and products that use FPDs. The FPD industry is highly cyclical and has experienced periods of oversupply resulting in significantly reduced demand for capital equipment. There can be no assurance that the FPD industry will not experience further downturns or slowdowns in the future, which may harm our business and operating results. In addition, the need to invest in the engineering, research and development and marketing required to penetrate targeted foreign markets and maintain extensive service and support capabilities limits our ability to reduce expenses during such downturns.
International Operations
Sales to Japan, Taiwan, Korea and China accounted for 73% and 75% of our revenue for the nine-month period ended June 30, 2001 and fiscal 2000, respectively. We expect sales to these countries to continue to represent a significant percentage of revenue. A number of factors may harm our international sales and operations, including:
• imposition of governmental controls;
• fluctuations in the U.S. dollar, which could increase the foreign sales prices of our products in local currencies;
• export license requirements;
• restrictions on the export of technology;
• political instability;
• trade restrictions;
• changes in tariffs; and
• difficulties in staffing and managing international operations.
In 1998, many Asian countries experienced an economic recession that resulted in a decline in the purchasing power of our Asian customers. A future downturn in economic conditions in Asia could result in our customers failing to place new orders for our products. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as U.S. laws.
Key Suppliers
We obtain some of the components for our systems from a single source or a limited group of suppliers. For example, we currently obtain materials handling platforms, ultra high-resolution cameras and high-speed image processing systems for our FPD products from single source suppliers. We also currently obtain X-ray sources for our PCB assembly and advanced semiconductor packaging products from limited source suppliers. Although we seek to reduce dependence on our sole and limited source suppliers, alternative sources of supply for these components may not be available on favorable terms or at all. The loss of one or more sole or limited source suppliers could harm our results of operations and damage customer relationships. Furthermore, a significant increase in the price of one or more of these components could harm our results of operations.
Japanese Market and Competition
We believe that competing Japanese companies in the FPD industry have a competitive advantage in Japan because of the preference of some Japanese customers for local equipment suppliers. Historically, foreign companies have found it difficult to penetrate the Japanese market and often depend upon local sales channels to sell their products in Japan. Since June 1997, we have depended on IHI as our exclusive value-added reseller to sell our FPD products in Japan. For the nine-month period ended June 30, 2001 and fiscal 2000, 14% and 6% of our revenue came from sales to IHI, respectively. If IHI reduced the resources allocated to the customization, sale and support of our FPD products in Japan, our business would be harmed.
In addition, IHI’s rights to continue as our exclusive value-added reseller in Japan are currently unresolved. IHI may have the right to market some or all of our FPD products in Japan on an exclusive basis, even as to us. If so, we may not be able to compete effectively in Japan. Although IHI must purchase some critical components from us, IHI may manufacture competing array test systems based on our technology. If this occurs, our business could be harmed.
We have granted IHI the non-exclusive right to manufacture and sell array test systems based on our technology, excluding technology incorporated into some critical components, in Korea, Taiwan and several other countries. Although IHI has never manufactured these products, nor sold these products in countries other than Japan, our business could be harmed if IHI manufactures and sells array test systems in competition with our own in these countries.
Competition
The FPD, CRT and PCB assembly and advanced semiconductor packaging industries are highly competitive. We face substantial competition from established competitors that have greater financial, engineering and manufacturing resources than we do and have larger service organizations and long-standing customer relationships. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price/performance characteristics. Competitive pressures may force price reductions that could harm our results of operations. Our customers may also develop technology and equipment that may reduce or eliminate their need to purchase our products. Although we believe we have certain technological and other advantages over our competitors, maintaining and capitalizing on these advantages will require us to continue maintaining a high level of investment in engineering, research and development, marketing and customer service support. There can be no assurance that we will have sufficient resources to continue to make these investments or that we will be able to make the technological advances necessary to maintain such competitive advantages.
New Products and Processes
We believe that our future success will depend in part upon our ability to continue to enhance our existing products and to develop and manufacture new products. For example, the size of FPD substrates and resolution of FPDs have changed frequently and may continue to change thus requiring us to redesign or reconfigure our FPD products. Similarly, as semiconductors, PCBs, semiconductor packaging and CRT display technologies have become more complex, our wholly owned subsidiaries, CR Technology and IPS, have been forced to continually redefine their product offerings. In addition, a substantial portion of our revenue is derived from sales of products based upon active matrix liquid crystal display (“AMLCD”) technology. An industry shift away from AMLCD technology to existing or new competing technologies could reduce the demand for our products and harm our business.
As a result, we expect to continue to make a significant investment in engineering, research and development. There can be no assurance that we will be successful in the introduction, marketing and cost effective manufacture of any of our new products; that we will be able to timely develop and introduce new products and enhance our existing products and processes to satisfy customer needs or achieve market acceptance; or that the new markets for which we are developing new products or expect to sell current products will develop sufficiently. To develop new products successfully, we depend on close relationships with our customers and the willingness of those customers to share information with us. The failure to develop products and introduce them successfully and in a timely manner could harm our competitive position and results of operations.
Key Employees
Our future success depends in part upon our ability to retain key personnel, particularly senior management and engineers. We also need to attract additional skilled personnel in all areas of our business to grow. There can be no assurance that we will be able to retain our existing personnel or attract additional qualified employees in the future. Other than Kenneth Wawrew, Vice President of Photon Dynamics and President, CRT Display and Glass Division, we generally do not have employment contracts with and do not maintain key person life insurance on any of our key employees.
Acquisitions
We have recently acquired Intelligent Reasoning Systems Inc. (“IRSI”), and we may pursue additional acquisitions of complementary product lines, technologies or businesses. Acquisitions may result in potentially dilutive issuances of equity securities, incurrence of debt and contingent liabilities and amortization expenses related to goodwill and other intangible assets, which could harm our profitability. In addition, current acquisitions such as IRSI or future acquisitions involve numerous risks, including the assumption of unknown liabilities, difficulties in the assimilation of the operations, technologies and products of the acquired company, the diversion of management’s attention from other business concerns, risks of entering markets in which we have no or limited direct prior experience, and the potential loss of key employees of the acquired company. There can be no assurance that we will be able to successfully integrate IRSI or accurately predict the effect of future acquisitions on our business or operating results.
Intellectual Property and Infringement
Our success depends in large part upon our intellectual property. While we attempt to protect our intellectual property through patents, copyrights and trade secrets, there can be no assurance that we will successfully protect our technology or that competitors will not be able to develop similar technology independently. No assurance can be given that the claims allowed on any patents held by us will be sufficiently broad to protect our technology. In addition, no assurance can be given that any patents issued to us will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to us. Litigation may be necessary in the future to enforce our patents and other intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Even if successful, litigation could be expensive and divert important management resources. If our intellectual property were not properly protected, our business could be harmed.
Regional Electric Shortages
Recently, California has been experiencing an electric power supply shortage that has resulted in the intermittent loss of power in some areas in the form of rolling blackouts. While we have not experienced any power failures to date, a blackout may affect our ability to manufacture products and meet scheduled deliveries. If blackouts were to interrupt our power supply, we would be temporarily unable to continue operations at some of our facilities. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could harm our business and results of operations.
Environmental Regulations
Some of our PCB assembly and advanced semiconductor packaging products are subject to regulation by the U.S. Food and Drug Administration, the California Department of Public Health and other agencies in each jurisdiction where these products are sold or used. Compliance with these regulations is time-consuming and expensive and may delay or even prevent sales in the U.S. or other jurisdictions. If we fail to comply with these regulations, we could face fines or penalties, and sales of our products could be prohibited. These fines, penalties and prohibitions could harm our business.
We are also subject to federal, state and local regulations related to the use, storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used in our manufacturing process. Failure to comply with current or future regulations could result in substantial fines being imposed on us, suspension of production, alteration of our manufacturing processes or cessation of operations. New environmental regulations could also require us to purchase expensive equipment or incur other significant expenses to ensure compliance. Unanticipated environmental compliance costs could harm our business.
Common Stock Price Volatility
The market price of our common stock could fluctuate significantly in response to variations in quarterly operating results and other factors, such as:
• announcements of technological innovations or new products by us or by our competitors;
• government regulations;
• developments in patent or other property rights; and
• developments in our relationships with our customers.
In addition, the stock market has in recent years experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stock is traded. Broad market fluctuations, general economic condition and specific conditions in the FPD, CRT and PCB assembly and advanced semiconductor packaging industries may adversely affect the market price of our common stock.
Impact of Accounting Pronouncements
In June 2000, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial Statements (“SAB 101B”). SAB 101B amends Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB 101”), to defer the implementation date of SAB 101 for registrants until no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. SAB 101 summarizes certain views of the SEC in applying generally accepted accounting principles to revenue recognition in financial statements. We are required to adopt SAB 101 in the fourth quarter of our fiscal year ending September 30, 2001. Accordingly, any revenues reported prior to October 1, 2000 and revenue reported for the first three quarters of fiscal 2001 that do not meet SAB 101’s guidance will be deferred and recorded as revenue in whatever future periods SAB 101 guidance is met. Changes in our revenue recognition policy resulting from the interpretation and implementation of SAB 101 would not involve the restatement of prior fiscal year statements, but would, to the extent applicable, be reported as a change in accounting principle with a cumulative catch up adjustment as of October 1, 2000 in the fiscal year ending September 30, 2001, with the appropriate restatement of interim periods as required by FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Our reported results of operations for the 12 months ending September 30, 2001 will include a cumulative adjustment for all prior annual and interim periods as if SAB 101 had been adopted on October 1, 2000. While we believe that the adoption of SAB 101 will have an impact on our reported results of operations, we believe that SAB 101 will not affect the underlying strength or weakness of our business operations as measured by the dollar value of our product shipments and cash flows.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Rate Risk
As of June 30, 2001 the current foreign exchange exposure in all international operations is deemed to be immaterial. We believe the impact of a 10% change in exchange rates would not be material to our financial condition and results of operations. Accordingly, we do not use derivative financial investments to hedge our current foreign exchange exposure.
Market Risk
As of June 30, 2001, our exposure to market risk for changes in interest rates relates primarily to our short-term investment portfolio. We do not have derivative financial instruments in our portfolio. We believe that a sudden change in interest rates would not be material to the value of our short-term investment portfolio.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Photon Dynamics and certain of its directors and officers have been named as defendants in a lawsuit captioned Amtower v. Photon Dynamics, Inc., No. CV797876, filed on April 30, 2001 in the Superior Court of the State of California, County of Santa Clara. The plaintiff in this action has purported to assert several causes of action under state law arising out of the alleged misrepresentation and enforcement of the Company's insider trading policy and is seeking damages of approximately $17.7 million. While Photon Dynamics intends to vigorously contest this action, we cannot predict the outcome of this litigation. We believe that an adverse determination in this litigation would not have a material adverse effect on our financial condition or results of operation.
Item 2. Changes in Securities and Use of Proceeds
Effective July 16, 2001, we issued a total of 635,918 shares of our common stock to 53 preferred shareholders of Intelligent Reasoning Systems Inc. (“IRSI”) in connection with our acquisition of IRSI in a stock-for-stock merger. In addition, we issued a total of 63,092 shares to one former creditor of IRSI, who received these shares as consideration for the repayment of $1,688,242 of outstanding debt of IRSI. We also issued a warrant to purchase 28,766 shares of our common stock at an exercise price of $54.23 per share to one warrant holder of IRSI as a replacement warrant for an IRSI warrant assumed in the acquisition. The shares of common stock and warrant were issued in reliance upon Rule 506 of Regulation D under the Securities Act of 1933, as amended, in that all of the entities that received our common stock and warrant, with the exception of only two of the shareholders of IRSI, were “accredited investors” as defined in Regulation D.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number | Exhibit | |
4.1(1) | Restated Articles of Incorporation, as amended, of Registrant. | |
4.2(2) | Bylaws of Registrant. | |
4.3(3) | Certificate of Determination. | |
Key to Exhibits: | ||
(1) | Incorporated by reference to the exhibit so designated of Registrant's Registration Statement on Form SB-2 filed with the Securities and Exchange Commission ("SEC") on November 15, 1995. | |
(2) | Incorporated by reference to Exhibit 3.2 of Registrant's Form 10-KSB filed with the SEC on December 18, 1998. | |
(3) | Incorporated by reference to Exhibit 4.1 of Registrant’s Current Report on Form 8-K filed with the SEC on December 29, 2000. | |
(b) Form 8-K
None.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PHOTON DYNAMICS, INC. | |
By: /s/ RICHARD L. DISSLY | |
Richard L. Dissly | |
Chief Financial Officer and Secretary | |
Dated: August 10, 2001 |
EXHIBIT INDEX
Number | Exhibit |
4.1(1) | Restated Articles of Incorporation, as amended, of Registrant. |
4.2(2) | Bylaws of Registrant. |
4.3(3) | Certificate of Determination. |
Key to Exhibits: | |
(1) | Incorporated by reference to the exhibit so designated of Registrant's Registration Statement on Form SB-2 filed with the Securities and Exchange Commission ("SEC") on November 15, 1995. |
(2) | Incorporated by reference to Exhibit 3.2 of Registrant's Form 10-KSB filed with the SEC on December 18, 1998. |
(3) | Incorporated by reference to Exhibit 4.1 of Registrant’s Current Report on Form 8-K filed with the SEC on December 29, 2000. |