1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 31, 1999 [ ] 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 0-26784 SPEEDFAM-IPEC, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Illinois 36-2421613 - ------------------------------- ----------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 305 North 54th Street, Chandler, Arizona 85226 - ---------------------------------------- ---------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (602) 705-2100 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---------- ---------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (October 11, 1999). Common Stock, no par value: 29,436,445 shares 2 SPEEDFAM-IPEC, INC. INDEX Page PART I FINANCIAL INFORMATION ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets August 31, 1999 and May 31, 1999.................................................2 Condensed Consolidated Statements of Operations Three Months Ended August 31, 1999 and 1998......................................3 Condensed Consolidated Statements of Cash Flows Three Months Ended August 31, 1999 and 1998......................................4 Notes to Condensed Consolidated Financial Statements.............................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................................10 Item 3. Quantitative and Qualitative Disclosures about Market Risk..........................18 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K....................................................19 SIGNATURE.....................................................................................................20 EXHIBIT INDEX Exhibit-27 Financial Data Schedule 3 PART I - FINANCIAL INFORMATION SPEEDFAM-IPEC, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (dollars in thousands) August 31, May 31, 1999 1999 ---------- --------- ASSETS Current assets: Cash and cash equivalents $ 67,701 $ 97,003 Short-term investments 65,126 50,020 Trade accounts receivable, net 78,543 76,808 Inventories 80,257 80,744 Other current assets 9,616 9,790 --------- --------- Total current assets 301,243 314,365 Investments in affiliates 25,342 25,360 Property, plant and equipment, net 85,776 88,997 Other assets 13,934 15,056 --------- --------- Total assets $ 426,295 $ 443,778 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,371 $ 1,275 Accounts payable and due to affiliates 23,730 25,101 Customer deposits 2,418 1,490 Accrued expenses 36,340 42,764 --------- --------- Total current liabilities 63,859 70,630 --------- --------- Long-term liabilities: Long-term debt 115,864 116,129 Other liabilities 9,729 10,269 --------- --------- Total long-term liabilities 125,593 126,398 --------- --------- Stockholders' equity: Common stock, no par value, 96,000 shares authorized, 29,418 and 29,392 shares issued and outstanding at August 31, 1999 and May 31, 1999, respectively 1 1 Additional paid-in capital 427,413 427,290 Retained earnings (191,274) (180,311) Accumulated comprehensive income (loss) 703 (230) --------- --------- Total stockholders' equity 236,843 246,750 --------- --------- Total liabilities and stockholders' equity $ 426,295 $ 443,778 ========= ========= See Accompanying Notes to Condensed Consolidated Financial Statements. 2 4 SPEEDFAM-IPEC, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended August 31, 1999 and 1998 (dollars and shares in thousands, except per share data) Three Months Ended August 31, ------------------------ 1999 1998 -------- -------- Revenue: Net sales $ 50,327 $ 64,984 Commissions from affiliate -- 585 -------- -------- Total revenue 50,327 65,569 Cost of sales 35,160 46,399 -------- -------- Gross margin 15,167 19,170 Research and development 12,890 15,511 Selling, general and administrative 12,260 15,278 -------- -------- Operating loss (9,983) (11,619) Other income (expense), net (88) 2,506 -------- -------- Loss from consolidated companies before income taxes (10,071) (9,113) Income tax benefit -- (1,096) -------- -------- Loss from consolidated companies (10,071) (8,017) Equity in net earnings (loss) of affiliates (892) 728 -------- -------- Net loss $(10,963) $ (7,289) Cumulative dividend on preferred stock -- (21) -------- -------- Net loss attributable to common stockholders $(10,963) $ (7,310) ======== ======== Net loss per share: Basic and diluted $ (0.37) $ (0.25) ======== ======== Weighted average number of shares: Basic and diluted 29,404 28,677 ======== ======== See Accompanying Notes to Condensed Consolidated Financial Statements. 3 5 SPEEDFAM-IPEC, INC. AND CONSOLIDATED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended August 31, 1999 and 1998 (dollars in thousands) Three Months Ended August 31, -------------------------- 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (10,963) $ (7,289) Adjustments to reconcile net loss to net cash used in operating activities: June 1998 IPEC net income -- (2,232) Equity in net earnings (loss) of affiliates 892 (728) Depreciation and amortization 4,523 4,389 Dividend from affiliate -- 521 Other (102) (385) Changes in assets and liabilities: (Increase) decrease in trade accounts receivable (1,587) 10,957 Decrease in inventories 697 1,041 (Increase) decrease in other current assets 175 (680) Decrease in accounts payable and due to affiliates (1,170) (13,206) Decrease in customer deposits and accrued expenses (7,348) (2,865) --------- --------- Net cash used in operating activities (14,883) (10,477) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of short-term investments (26,024) (11,158) Maturities of short-term investments 10,918 11,161 Proceeds from the sale of short-term investments -- 35,849 Proceeds from licensing technology and transfer of associated assets 2,335 -- Capital expenditures (2,233) (6,839) Other investing activities 603 (424) --------- --------- Net cash provided by (used in) investing activities (14,401) 28,589 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from exercise of stock options and employee stock plan purchases 123 1,328 Principal payments on long-term debt (169) (182) --------- --------- Net cash provided by (used in) financing activities (46) 1,146 --------- --------- Effects of foreign currency rate changes on cash 28 40 --------- --------- Net increase (decrease) in cash and cash equivalents (29,302) 19,298 Cash and cash equivalents at beginning of year 97,003 104,482 --------- --------- Cash and cash equivalents at August 31, 1999 and 1998 $ 67,701 $ 123,780 ========= ========= See Accompanying Notes to Condensed Consolidated Financial Statements. 4 6 SPEEDFAM-IPEC, INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (dollars and shares in thousands, except per share amounts) (1) BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by management without audit. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted, although management believes that the disclosures made are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended May 31, 1999, as filed with the Securities and Exchange Commission on August 30, 1999 as part of its Annual Report on Form 10-K. In the opinion of management the information furnished herein reflects all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of results for the interim periods presented. Results of operations for the three months ended August 31, 1999 are not necessarily indicative of results to be expected for the full fiscal year. (2) LOSS PER SHARE Basic loss per common share is based upon the weighted average number of common shares outstanding. Diluted loss per common share assumes the exercise of all options which are dilutive, whether exercisable or not. The dilutive effect of stock options is measured under the treasury stock method. Employee stock options outstanding during the three months ended August 31, 1999 and 1998 were not included in the computation of diluted loss per share because the effect would be antidilutive. (3) INVENTORIES The components of inventory were: August 31, May 31, 1999 1999 ---------- -------- Raw materials $ 49,335 $ 48,082 Work-in-process 19,893 23,428 Finished goods 11,029 9,234 -------- -------- $ 80,257 $ 80,744 ======== ======== (4) SHORT-TERM INVESTMENTS In August, 1998 the Company recorded a realized gain of $46 from the sale of tax exempt short-term investments, classified as held-to-maturity securities, with a carrying value of $35,803. The proceeds of $35,849 were re-invested. The Company sold investments originally intended to be held-to maturity to take advantage of more favorable rates of return available on taxable securities. The Company's short-term investments are now classified as available-for-sale. The short-term investments are recorded at fair market value and an unrealized loss of $252 is included as part of accumulated other comprehensive income (loss) within stockholders' equity at May 31 and August 31, 1999. 5 7 (5) INVESTMENTS IN AFFILIATES The Company owns a 50% interest in SpeedFam-IPEC Co., Ltd. The Company's equity interest in SpeedFam-IPEC Co., Ltd. was $21,587 and $21,764 at August 31, 1999 and at May 31, 1999, respectively, based on the balance sheet of SpeedFam-IPEC Co., Ltd. at July 31, 1999 and April 30, 1999, respectively. The remaining equity interest included in investments in affiliates relates to the Company's 50% ownership interest in Fujimi Corporation. Condensed consolidated financial statements of SpeedFam-IPEC Co., Ltd., which are consolidated on a fiscal year that ends April 30, are as follows: BALANCE SHEETS JULY 31, APRIL 30, 1999 1999 -------- --------- Assets Total current assets $ 85,945 $ 81,760 Property, plant and equipment, net 36,784 36,003 Other assets 11,746 10,759 -------- -------- Total assets $134,475 $128,522 ======== ======== Liabilities and Stockholders' Equity Total current liabilities $ 58,596 $ 57,789 Long-term debt 24,529 19,607 Other long-term liabilities 8,176 7,599 Stockholders' equity 43,174 43,527 -------- -------- Total liabilities and stockholders' equity $134,475 $128,522 ======== ======== 6 8 STATEMENTS OF OPERATIONS AND RETAINED EARNINGS Three Months Ended July 31, ------------------------ 1999 1998 -------- -------- Net sales $ 19,934 $ 39,623 Costs and operating expenses 23,310 37,765 -------- -------- Earnings (loss) before income taxes (3,376) 1,858 Income taxes 1,062 1,182 -------- -------- Net earnings (loss) before minority interest (2,314) 676 Minority interest (213) (232) -------- -------- Net earnings (loss) (2,101) 908 Beginning retained earnings 40,326 41,162 Dividends -- (1,042) -------- -------- Ending retained earnings $ 38,225 $ 41,028 ======== ======== The Company pays a commission to SpeedFam-IPEC Co., Ltd. on sales of equipment produced by the Company in the U. S. and exported to Pacific Rim customers through SpeedFam-IPEC Co., Ltd. As of August 31, 1999 the Company had accrued $785 of commission expense to SpeedFam-IPEC Co., Ltd. (6) DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments to offset exposure to market risks arising from changes in foreign exchange rates. Derivative financial instruments currently utilized by the Company include foreign currency forward contracts. The Company evaluates and monitors consolidated net exposures by currency and maturity, and external derivative financial instruments correlate with those net exposures in all material respects. Gains and losses on hedges of existing assets and liabilities are included in the carrying amounts of those assets or liabilities and are ultimately recognized in income when those carrying amounts are converted. Gains or losses related to hedges of firm commitments are deferred and included in the bases of the transactions when they are completed. Gains or losses on unhedged foreign currency transactions, if any, are included in income as part of cost of sales. Gains and losses on derivative financial instruments which protect the Company from exposure in a particular currency, but do not currently have a designated underlying transaction, are also included in income as part of cost of sales. If a hedged item matures, or is sold, extinguished, terminated, or is related to an anticipated transaction that is no longer likely to take place, the derivative financial instrument is closed and the related gain or loss is included in income as part of cost of sales. 7 9 (7) COMPREHENSIVE LOSS The Company's comprehensive loss was as follows: COMPREHENSIVE LOSS Three Months Ended August 31, ------------------------ 1999 1998 -------- -------- Net loss $(10,963) $ (7,310) Other comprehensive income (loss): Foreign currency translation adjustments 933 (1,813) -------- -------- Comprehensive loss $(10,030) $ (9,123) ======== ======== ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Unrealized Accumulated Other Foreign Currency Losses on Comprehensive Income Translation Securities (Loss) ----------- ----------- -------------------- Balance at May 31, 1999 $ 22 $(252) $(230) Three month period change 933 -- 933 ----- ----- ----- Balance at August 31, 1999 $ 955 $(252) $ 703 ===== ===== ===== (8) MERGER, INTEGRATION, AND RESTRUCTURING COSTS In connection with the merger of SpeedFam International, Inc. and Integrated Process Equipment Corp. in April 1999, the Company recorded various merger, integration and restructuring costs. Direct merger costs primarily consist of professional fees, such as investment banking, legal and accounting for services rendered through the date of the merger. The Company recorded integration and restructuring costs for lease terminations, the write-off of duplicative equipment previously used for demonstration purposes, the write-down of inventory and equipment related to product lines that will no longer be supported, and severance costs resulting from workforce reductions. The following table summarizes the components of the merger, integration, and restructuring costs: Three Months Activity ------------ Accrued at Cash Accrued at May 31, 1999 Expenditures August 31, 1999 ------------ ------------ --------------- Direct merger costs $ 3,600 $ 3,600 -- Lease termination costs 14,600 1,736 12,864 Discontinued product lines 100 -- 100 Severance costs 4,200 2,545 1,655 Other costs 500 15 485 ------- ------- ------- $23,000 $ 7,896 $15,104 ======= ======= ======= 8 10 (9) BUSINESS SEGMENT INFORMATION The Company classifies its products into three core business segments: (i) the CMP Group, which is comprised of the Company's development and production of chemical mechanical planarization systems; (ii) the Surface Technology Group, which is comprised of the development and production of high-throughput precision surface processing equipment used in thin film memory disk media and silicon wafer industries; and (iii) the Industrial Applications Group, which is comprised of the development and production of high-throughput precision surface processing equipment used in general industrial applications. Information concerning the Company's business segments in the three months ended August 31, 1999 and 1998 is as follows: 1999 1998 -------- -------- Revenue: Sales to unaffiliated customers: CMP Group ................................... $ 39,784 $ 50,880 Surface Technology Group .................... 7,694 10,575 Industrial Applications Group ............... 2,849 3,529 -------- -------- Total net sales to unaffiliated customers 50,327 64,984 -------- -------- Commissions from affiliate: Surface Technology Group .................... -- 485 Industrial Applications Group ............... -- 100 -------- -------- Total revenue ........................... $ 50,327 $ 65,569 ======== ======== Segment operating loss: CMP Group ................................... $ (5,339) $ (5,010) Surface Technology Group .................... (400) (1,951) Industrial Applications Group ............... 230 541 -------- -------- Total segment operating loss ............ (5,509) (6,420) General corporate income (expense), net ................... (4,303) (3,109) Interest income (expense), net ............................ (259) 416 -------- -------- Loss from consolidated companies before income taxes ...... $(10,071) $ (9,113) ======== ======== (10) RECLASSIFICATIONS Certain reclassifications have been made in the financial statements for the three months ended August 31, 1998 to conform to the fiscal 2000 presentation. 9 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SEGMENTS The Company sells its products and services to three market segments: (1) semiconductor device manufacturers (CMP Group), (2) thin film memory disk media and silicon wafer manufacturers (Surface Technology Group), and (3) manufacturers of general industrial components (Industrial Applications Group). RESULTS OF OPERATIONS The following table sets forth certain consolidated statements of operations data for the periods indicated as a percentage of total revenue: Three Months Ended August 31, ------------------------------ 1999 1998 ------ ------ Revenue: Net sales 100.0% 99.1% Commissions from affiliate 0.0 0.9 ----- ----- Total revenue 100.0 100.0 Cost of sales 69.9 70.8 ----- ----- Gross margin 30.1 29.2 Research and development 25.6 23.6 Selling, general and administrative 24.3 23.3 ----- ----- Operating loss (19.8) (17.7) Other income (expense), net (0.2) 3.8 ----- ----- Loss from consolidated companies before income taxes (20.0) (13.9) Income tax benefit 0.0 1.7 ----- ----- Loss from consolidated companies (20.0) (12.2) Equity in net earnings (loss) of affiliates (1.8) 1.1 ----- ----- Net loss (21.8)% (11.1)% ===== ===== Net Sales. Net sales for the first quarter of fiscal 2000 were $50.3 million, down 22.6% from net sales of $65.0 million in the first quarter of fiscal 1999. Sales of CMP systems totaled $39.8 million, or 79.0% of net sales, down 21.8% from the $50.9 million, or 78.3% of net sales, of CMP system sales in the first quarter of fiscal 1999. Sales of CMP systems declined in fiscal 2000 from the prior year due to a worldwide slowdown in overall demand for semiconductor manufacturing equipment, which was caused by an over-capacity situation in the semiconductor device market worldwide. In addition, the Company has seen erosion in its market share of new sales due to increased competition in the sales of CMP systems to semiconductor manufacturers. 10 12 Sales of the Surface Technology Group in the first quarter of fiscal 2000 accounted for $7.7 million, or 15.3% of net sales, as compared to $10.6 million, or 16.3% of net sales in the first quarter of fiscal 1999. During the first quarter of fiscal 2000, thin film memory disk manufacturers continued to experience manufacturing over-capacity which in turn reduced capital spending. The thin film memory disk industry continues to feel "price per unit" pressures which in turn has forced a reduction in capital spending for equipment the Company supplies from its U.S. operations. The decline in sales from the Surface Technology Group was also due to continued slowdown in the silicon wafer market. This slowdown was due to the ongoing manufacturing over-capacity caused by various factors including die shrink, increased production efficiencies and Asian economic conditions. The Company expects the slowdown in these markets to continue for at least the next 12 months. Sales in the first quarter of fiscal 2000 of the Industrial Applications Group were $2.8 million, or 5.7% of net sales in the first quarter of fiscal 2000, compared to $3.5 million, or 5.4% of net sales in the first quarter of fiscal 1999. Commissions from Affiliate. No commissions from affiliate were recorded in the first quarter of fiscal 2000, compared to $585,000 recorded in the first quarter of fiscal 1999. The decrease was due to the continued slowdown in the thin film memory disk market, and silicon wafer markets. The Company believes that capital equipment spending will continue to be weak in the thin film memory and silicon wafer industries through the next 12 months in turn lowering commissions from affiliate compared to prior year periods. Gross Margin. In first quarter of fiscal 2000, gross margin was $15.2 million, or 30.1% of total revenue, compared to $19.2 million, or 29.2% of total revenue, in the first quarter of fiscal 1999. Gross margin dollars declined due to the decrease in total revenue in the first quarter of fiscal 2000 compared to the prior year period. The Company expects that the gross margin percentage will continue to increase compared to prior year quarters due to increased production efficiencies as a merged company. Research and Development. In the first quarter of fiscal 2000, research and development expense decreased to $12.9 million, or 25.6% of total revenue, compared to $15.5 million, or 23.6% of total revenue, in the first quarter of fiscal 1999. The decrease was due to management's efforts to realign the Company's research and development efforts around critical and key programs while eliminating duplicate projects. Selling, General and Administrative. In the first quarter of fiscal 2000, selling, general and administrative expense decreased to $12.3 million, or 24.3% of total revenue, from $15.3 million, or 23.3% of total revenue, in the first quarter of fiscal 1999. The dollar amount decrease in selling, general and administrative expense resulted primarily from management's efforts to reduce costs and eliminate functional duplications throughout the merged company. Other Income (Expense). Other income (expense) decreased to $88,000 of other expense in the first three months of fiscal 2000 from $2.5 million of other income in same period of fiscal 1999. In the first quarter of fiscal 1999, the Company recorded a gain arising from the collection of insurance proceeds for a CMP tool, which was destroyed in transit. The decrease in other income (expense) in the first three months of fiscal 2000 compared to the same period in fiscal 1999, was also due to the decrease in interest income caused by the decline in short-term investments. Provision for Income Taxes. At the end of fiscal 1999, as well as at the end of the first quarter of fiscal 2000, the Company established a valuation allowance for deferred tax assets generated by its operating losses. As a result, the effective tax rate for the first quarter of fiscal 2000 was zero. While the Company will reassess its tax situation each quarter, the Company expects that its effective tax rate will be zero at least throughout fiscal 2000. 11 13 Equity in Net Earnings of Affiliates. For the first quarter of fiscal 2000, equity in net earnings (loss) of affiliates decreased to a loss of $892,000 compared to $728,000 of net earnings in the first quarter of fiscal 1999. This decline was due to significantly decreased sales revenue of the Far East Joint Venture. Investments by manufacturers of both silicon wafer and thin film memory disks continue to be weak in fiscal 2000. The Company believes that the results of the Far East Joint Venture will be adversely affected in fiscal year 2000 by both a slowdown in demand for equipment sold into the thin film memory disk and silicon wafer markets, as well as the current financial difficulties facing several Asian economies. LIQUIDITY AND CAPITAL RESOURCES As of August 31, 1999, the Company had $132.8 million in cash, cash equivalents and short-term investments, compared to $147.0 million at May 31, 1999. The Company used $14.9 million of cash in operating activities during the first three months of fiscal 2000. Cash used in operations included the net loss of $11.0 million adjusted for non-cash items of $5.3 million, primarily representing depreciation and amortization expense. In addition, $8.5 million in cash was used to pay down accrued expenses and accounts payable, and $700,000 of cash was used to fund a net increase in certain current assets. The decrease in accrued expenses was primarily due to the payment of accrued liabilities for merger, integration and restructuring costs. The Company made capital expenditures of $2.2 million in the first quarter of fiscal 2000. The majority of the cash was used to fund additional building construction, software and equipment purchases. Cash of $2.3 million was provided from the licensing of certain technologies and transferring associated assets. Cash was also used to purchase short-term investments of $26.0 million, partially offset by proceeds of maturing investments totaling $10.9 million. The Company believes that its current cash, cash equivalents and short-term investments will be sufficient to meet the Company's cash needs during the next 12 months. SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" is effective for financial years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The Company is evaluating the new Statement's provisions and has not yet determined its impact. The Company will adopt SFAS No. 133 effective June 1, 2001. YEAR 2000 The Company is addressing the issues associated with the programming code in existing computer systems as the millennium (Year 2000) approaches. The Year 2000 problem is pervasive and complex as virtually every computer operation will be affected in some way. The Company is aware of and is addressing the potential computing difficulties that may be triggered by the Year 2000. The Company has commenced a Year 2000 date review and conversion project to address all the necessary changes, testing and implementation issues. The project encompasses three major areas of review: internal systems (hardware and software), supplier compliance and Company products. The Company has identified the changes required to its computer programs and hardware. The necessary modifications to the Company's centralized financial, manufacturing and operational information systems have been completed. To date, the Company's suppliers have been sent letters requesting information regarding their own Year 2000 plan, as well as requesting confirmation that the components supplied by these vendors are Year 2000 compliant. The Company has evaluated the vendor responses which have been received and concluded that the vendors which have responded 12 14 either are Year 2000 compliant or are proceeding with their own Year 2000 compliance programs. The Company will continue to follow-up with vendors with which the Company has a material relationship and who have not responded to obtain assurances that they expect to be Year 2000 compliant in time. Equipment and systems manufactured and supplied by the Company have been evaluated and determined to be free of any material problems that could be caused by the Year 2000 issue. Management estimates that the Company's remaining Year 2000 compliance expense will be immaterial. To date, the Company believes that Year 2000 problems related to its own internal systems and equipment and systems it sells will not have a material effect on the Company's business, financial condition and results of operations. However, there can be no assurance that the systems of other companies upon which the Company's systems and business rely will be timely converted or that any such failure to convert by another company would not have a material adverse effect on the Company's business, financial conditions or results of operations. To mitigate this risk, the Company is reviewing its vendor relationships and building alternative sources of supply should the business operations of any one vendor be interrupted due to Year 2000 problems. CERTAIN FACTORS AFFECTING THE COMPANY'S BUSINESS The Company's business is subject to numerous risks, including those discussed below. If any of the events described in these risks occurs, the Company's business, financial condition and results of operations could be seriously harmed. The Company's growth depends on continued and increased acceptance of CMP among semiconductor manufacturers. While CMP is used by a number of advanced logic semiconductor manufacturers, CMP has been used to manufacture advanced memory devices only in the past 2 years. Continued and increased acceptance of CMP systems depends on many factors considered by potential customers, including the CMP product's - cost of ownership - throughput - process flexibility - performance, including reliability - customer support Failure to adequately meet potential customers' needs with respect to one or more of these factors will result in decreased acceptance of CMP and, therefore, the Company's CMP systems, which will in turn negatively impact the Company's profitability. The Company's Business is Highly Cyclical. The Company's business depends substantially on the capital expenditures of semiconductor manufacturers and, to a lesser extent, thin film memory disk and silicon wafer manufacturers. These industries are highly cyclical and have historically experienced periodic downturns, which often have a material adverse effect on the acquisition of capital equipment and other products used in the manufacturing process, including products offered by the Company. These downturns have in the past and are expected in the future to materially adversely affect the business and operating results of the Company. The semiconductor device industry has recently experienced a slowdown and the memory disk and silicon wafer industries are currently experiencing a slowdown. These events have negatively impacted the Company's results of operations. If the Company does not continue to integrate SpeedFam's and IPEC's technology and operations quickly and effectively, its operations may be adversely affected. The merger of SpeedFam and IPEC was consummated April 6, 1999. The company must continue to integrate all components of IPEC's former operations, including the following: 13 15 - - Sales and marketing operations, including international distribution channels. Combining international sales channels could result in significant expense or customer confusion. - - Product offerings, including marketing of products to the other's customers. - - Research and development programs. - - Manufacturing operations and philosophies. - - Field service support for CMP equipment. - - Management information and reporting systems. Since SpeedFam and IPEC used different management information systems, the Company may face difficulties obtaining timely and accurate information, data and reports to operate the company effectively until integration is completed. The Company cannot be certain that it can achieve integration of these components without adversely impacting operations. To the extent management focuses on integration, it may not be able to develop the business. The Company, and its predecessors, have had losses recently and the Company expects losses in the near future. In the first quarter of fiscal 2000, the Company recorded a net loss of $11.0 million. In fiscal 1999, the Company had a net loss of $139.9 million. This loss included $53.9 million of various merger, integration and restructuring costs. Direct merger costs primarily consist of professional fees, such as investment banking, legal and accounting for services rendered through the date of the merger. The Company recorded integration and restructuring costs for lease terminations, the write-off of duplicative equipment previously used for demonstration purposes, the writedown of inventory and equipment related to products lines that will no longer be supported, and severance costs resulting from workforce reductions. The Company attributes the additional loss to the slowdown in the industry combined with increasing investment in research and development. IPEC had net losses of $42.3 million in fiscal 1998 and $33.7 million in fiscal 1997. In fiscal 1998, IPEC incurred net charges of $25.9 million to increase the valuation allowance for its deferred tax assets and $10.6 million for an additional writedown of assets in connection with the closure of IPEC Clean, a subsidiary of IPEC. These losses, excluding the one time charges, are attributed mainly to the slowdown in the industry combined with increasing investment in research and development. The Company faces intense competition, including from companies with greater resources. Several companies currently market CMP systems that directly compete with the Company's 14 16 products, including Applied Materials, Inc. and Ebara Corporation. For several reasons, the Company may not compete effectively with competitors. These reasons include: - Some competitors may have greater financial resources than the Company. They also may have more extensive engineering, manufacturing, marketing and customer service and support capabilities. - Some competitors may supply a broader range of semiconductor capital equipment than the Company. As a result, these competitors may have better relationships with semiconductor manufacturers, including current and potential customers of the Company. - The Company expects competitors to continue to improve their existing technology and introduce new products. This could cause a decline in the Company's sales or lead to intensified pricebased competition. - Other capital equipment manufacturers not currently involved in the development of CMP systems may enter the market or develop technology that reduces the need for the Company's products. The Company may not develop products in time to meet changing technologies. Semiconductor manufacturing equipment and processes are subject to rapid technological changes and product obsolescence. Developing new products in the rapidly evolving industry in which the company operates involves a number of risks: - products may be introduced behind schedule or after customers have made buying decisions - products may not be accepted in the marketplace Competitive pressures require the Company to continue to enhance performance for finer geometrics in oxide and tungsten applications, while developing new process capabilities for emerging STI, copper and 300mm applications. The Company will also continue to develop with the Far East Joint Venture products and processes for thin film memory disk manufacturers and to enhance the plasma-assisted chemical etch processes. Product or process development problems could harm the Company's results of operations. The Company's products are complex, and from time to time have defects or bugs that are difficult and costly to fix. This can harm results of operations for the Company, in two ways: (1) The Company incurs substantial costs to ensure the functionality and reliability of products earlier in their life cycle. This can reduce orders, increase manufacturing costs, adversely impact working capital and increase service and warranty expenses. (2) The Company requires significant lead-times between product introduction and commercial shipment. As a result, the Company may have to write off inventory and other assets related to products and could lose customers and revenue. For example, in the second quarter of fiscal 1997, the Company incurred a $17.6 million pretax asset write-off for discontinuance of the Avanti 672 product development program. The Company's quarterly operating results will fluctuate for reasons not in its control. The Company's quarterly operating results will fluctuate due to a variety of factors, including: 15 17 - Industry demand for capital equipment, which depends on economic conditions in the semiconductor, memory disk and silicon wafer markets. - Timing, cancellation or delay of customer orders and shipments. The Company continues to derive a significant portion of revenue from the sale of a relatively small number of machines during a given quarter. Order and delivery delays and cancellations, even of one or two systems, may cause the company to miss quarterly revenue and profit expectations. - Unexpected costs associated with sales and service of the CMP tools and processes. - The quarterly operating results of the company's joint ventures, which are accounted for on the equity method. - Foreign currency exchange rates. Results of operations in any period are not an indication of future results. Fluctuations in the Company's operating results may also result in fluctuations in the Company's common stock price. Operating results may not meet the expectations of public market analysts or investors and the trading price of the common stock could decline. Orders in backlog may not result in future revenue if customers cancel or reschedule orders. The Company includes in backlog only those customer orders for which it has accepted purchase orders. Expected revenue may be lower if customers cancel or reschedule orders, which they can generally do without penalty. For example, the Company removed from its backlog orders of approximately $5.3 million in the fourth quarter of fiscal 1999, primarily due to reduced capacity requirements and increased funding constraints of certain customers. The Company Depends on key personnel. The Company's success is dependent upon its ability to attract and retain qualified management, technical, sales and support personnel. Competition for qualified personnel in the industry served by the Company, particularly in the Phoenix metropolitan area, is intense. SpeedFam and IPEC had in the past experienced difficulty in attracting qualified personnel. Also, other employers may offer lucrative compensation and benefit programs, including those with respect to stock options. The Company presently experiences the same difficulty and may continue to in the future. The Company depends on a small number of major customers. Currently, and for the foreseeable future, the Company expects that it will sell machines to a limited number of major customers. To date, the CMP process has been used primarily to fabricate advanced semiconductors, which accounts for only a portion of the overall semiconductor market. In fiscal 1999, Samsung and Intel accounted for 11.4% and 10.5%, respectively, of its total revenue. In fiscal 1998, Intel accounted for 19.4% of total revenue. The Company's success depends on international sales, particularly in Asia and Europe. International sales accounted for 38.1% of SpeedFam-IPEC's total revenue for fiscal 1999, 34.3% for fiscal year 1998 and 26.5% for fiscal year 1997. The Company expects that international sales will continue to account for a significant portion of total revenue in future periods. International sales are subject to risks, including: - foreign exchange issues - political, economic and regulatory environment of the countries where customers are located - collectibility of accounts receivable - inadequate intellectual property protection Foreign exchange issues also affect the value of the Company's foreign subsidiaries and equity interest in its Far East joint venture. The Company does not manage this balance sheet risk through currency transactions known as hedging, which are designed to minimize this risk. The 16 18 Company does try to manage near term currency risks through hedging. However, efforts may not be enough to decrease the risks involved. If the Company is unable to protect its intellectual property, its business could suffer. The company's intellectual property portfolio is very important to its success. However, the Company may not be able to protect its technology because: - pending and new patent applications may not be approved in a timely manner or approved at all - third parties may try to challenge or invalidate existing patents and new patents - policing unauthorized use of intellectual property is difficult and expensive - the laws of some foreign countries do not protect intellectual property rights as much as U.S. laws - competitors may independently develop similar technology or design around intellectual property owned by the company Third parties may prevent the Company from selling products that allegedly infringe on those third parties' intellectual property rights. The Company cannot be certain that third parties will not in the future claim that its products infringe their intellectual property rights. Third parties may - bring claims of patent, copyright or trademark infringement - obtain patents or other intellectual property rights that limit the Company's ability to do business or require the Company to license or cross-license technology - Bring costly, time consuming lawsuits Third parties hold many patents relating to CMP machines and processes. The Company licenses the right to manufacture CMP machines employing an orbital motion in its Avant Gaard 676, 776 and 876 from a semiconductor manufacturer. The Company may Be subject To risks associated with acquisitions and dispositions. The Company continually evaluates strategic acquisitions of other businesses and dispositions of portions of its business that it determines are not complementary to its strategy. If the Company were to consummate an acquisition, the Company would be subject to a number of risks, including the following: - difficulty in assimilating the acquired operations and retaining acquired personnel; - limits on the Company's ability to retain acquired distribution channels and customers; - disruption of the Company's ongoing business; and - limits on the Company's ability to successfully incorporate acquired technology and rights into its service offerings and maintain uniform standards, controls, procedures and policies. Similarly, a disposition could absorb significant management time, distracting it from developing the business. The Company may not successfully overcome problems encountered in connection with potential acquisitions or dispositions. The Company may experience Year 2000 computer problems that harm its business. Certain computer systems may not correctly recognize dates when the year changes from 1999 to 2000. This could cause computers to either shut down or lead to incorrect calculations. The Company has reviewed their exposure to this problem, and does not believe it will incur significant expenses either to remedy the problem or as a result of the effect of the problem on business operations. However, Year 2000 issues may cause disruptions in the Company's business for the following reasons: - The Company cannot be certain that the measures taken are enough. Despite completed efforts, the company may incur significant expenses to remedy unforeseen problems or may suffer disruptions in its business. - Third parties with whom the Company has relationships may not successfully complete their Year 2000 remediation efforts. This could also result in disruptions in the company's business, which would harm its financial condition, results of operations and business prospects. For additional information regarding the status of Year 2000 issues, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations -Year 2000" 17 19 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. For financial market risks related to changes in interest rates and foreign currency exchange rates, refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Company's Annual Report on Form 10-K for the year ended May 31, 1999. 18 20 SPEEDFAM-IPEC, INC. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Exhibit - 27 Financial Data Schedule (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended August 31, 1999. 19 21 SPEEDFAM-IPEC, INC. SIGNATURE 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. SPEEDFAM-IPEC, INC. /s/ J. Michael Dodson ------------------------------------- Date: October 15, 1999 By J. Michael Dodson Treasurer and Chief Financial Officer (As Chief Accounting Officer and Duly Authorized Officer of SpeedFam-IPEC, Inc.) 20 22 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------ ----------- 27 Financial Data Schedule 21