SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997 or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
NANOMETRICS INCORPORATED
(Exact name of registrant as specified in its charter)
California 94-2276314
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
310 DeGuigne Drive, Sunnyvale, California 94086
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (408) 746-1600
_________________________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
_________________________
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No
------- -------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 10, 1998: $25,504,534 based upon the last sales price
reported for such date. For purposes of this disclosure, shares of common
stock held by officers, directors or persons who hold more than 5% of the
outstanding shares of common stock of the Registrant have been excluded in that
such persons may be deemed to be "affiliates" as that term is defined under the
rules and regulations promulgated under the Securities Exchange Act of 1934, as
amended. This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
The number of shares outstanding of the Registrant's common stock as of
March 10, 1998 was 8,584,984.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Shareholders of the Company
for the year ended December 31, 1997 which will be filed with the Securities and
Exchange Commission no later than 120 days after December 31, 1997.
NANOMETRICS INCORPORATED
ANNUAL REPORT -- Form 10-K
TABLE OF CONTENTS
PAGE
----
Part I
Item 1. Business............................................ I-1
Item 2. Properties.......................................... I-15
Item 3. Legal Proceedings................................... I-15
Item 4. Submission of Matters to a Vote of Security Holders. I-17
Part II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters................................. II-1
Item 6. Selected Consolidated Financial Data................ II-1
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. II-3
Item 8. Financial Statements and Supplementary Data......... II-14
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................. II-32
Part III
Item 10. Directors and Executive Officers of the Registrant.. III-1
Item 11. Executive Compensation.............................. III-1
Item 12. Security Ownership of Certain Beneficial Owners
and Management...................................... III-1
Item 13. Certain Relationships and Related Transactions...... III-1
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K......................................... IV-1
Signatures........................................................ V-1
(ii)
PART I
BUSINESS
--------
Nanometrics Incorporated ("Nanometrics" or the "Company") is a leading
manufacturer of thin film measurement systems for the electronics industry. The
Company's primary customers are manufacturers of semiconductors, magnetic
recording heads and flat panel displays. Nanometrics' film measurement systems
use wide wavelength range, high sensitivity optics, proprietary computer
software and patented technology to measure thickness, uniformity and chemical
properties of films deposited on silicon and other substrates. The primary
application of these systems is to precisely monitor production processes
employed in the fabrication of integrated circuits, magnetic recording heads
used in disk drives and flat panel displays commonly used in laptop computers.
The Company has been selling measurement systems since 1977 and has an extensive
installed base of systems with customers worldwide, including Hitachi, IBM,
Motorola, Quantum and Texas Instruments.
The growth in the market for the Company's products is driven by the
increased use of thin film technology by manufacturers of electronic products
and by continued advances in thin film technology. Thin film technology is used
in the manufacture of numerous products including integrated circuits,
integrated fiber optics, conventional and advanced optics, magnetic recording
heads, high density optical and magnetic disks, glass flat panel displays,
sensors and lasers. These products benefit from the controlled electronic,
optical, magnetic and surface finish properties enabled by thin film technology.
The dramatic growth in the use of thin film technology has created significant
demand for the thin film measurement systems provided by the Company.
Companies that supply thin film deposition equipment to semiconductor
manufacturers continue to enhance their products to enable the fabrication of
more advanced semiconductors at reduced production costs per device. The next
generation of equipment, which is currently being introduced, will process
larger 300 mm (12 inch) wafers with geometries below 0.5 microns. In 1995, the
Company was awarded a contract by SEMATECH, a consortium of large U.S.
semiconductor manufacturers, to develop a 300 mm system for use by SEMATECH
members in the early evaluation of 300 mm process equipment. The Company
believes that it was the first to introduce a fully-automated product for thin
film measurement on 300 mm wafers that also complies with sub 0.5 micron design
rules. SELETE, a consortium of Japanese semiconductor manufacturers, purchased
one of the first systems in 1996 to test and evaluate 300 mm process equipment
and has recently ordered a second system. The Company has sold its advanced 300
mm measurement systems to several leading semiconductor equipment companies
including Applied Materials, Novellus and Tokyo Electron, which are using such
systems for the development and performance evaluation of advanced process
equipment.
The Company also sells fully automated systems for measuring films in
magnetic recording heads. In 1995, the Company shipped its first automated film
measurement system for use in flat panel display manufacturing. In 1997, the
Company sold a more fully automated flat panel display film measurement system
capable of measuring substrates up to 650 mm x 830 mm to Samsung in Korea.
I-1
INDUSTRY BACKGROUND
Manufacturers of semiconductors, magnetic recording heads and flat panel
displays use a variety of measurement systems to monitor and control key
dimensions and other physical properties during the manufacture of such
products. Some physical properties measured include film thickness, film
stress, line width, overlay, resistivity, step height, surface roughness and
chemical properties Film thickness and chemical property control is a critical
component of these manufacturing processes because deviations from thickness and
chemical property specifications of film layers could result in impaired
performance of the semiconductor, magnetic recording head or flat panel display.
Manufacturers rely upon accurate measurement systems to promptly detect and
minimize process deviations to increase production yields. With each new
generation of product, tighter tolerances increase the need for accurate film
thickness and chemical composition measurement. The two significant factors
affecting demand for thin film measurement systems are: (i) new construction or
refurbishment of manufacturing facilities, which, in turn, depends on the
current and anticipated market demand for semiconductors, disk drives and flat
panel displays and products that use such components and (ii) the increasing
complexity of the manufacturing process as a result of the demand for higher
performance semiconductors, magnetic recording heads and flat panel displays.
Thin film measurement systems are used at many points during the
fabrication process to monitor and precisely measure film thickness and
uniformity, as well as chemical properties in order to maximize the yield of
acceptable semiconductors, magnetic recording heads and flat panel displays.
Semiconductor Manufacturing Process. Semiconductors are fabricated by a
complex series of process steps on a wafer substrate made of silicon or other
semiconductor material. Each wafer typically goes through a series of 100 to
500 process steps in generally repetitive cycles. Three primary categories of
wafer film processing steps are deposition, photolithography and etch. During
deposition, layers of conductive or insulating films are deposited on each
wafer. Control of the uniformity and the thickness during deposition of these
films is important to the ultimate performance of the semiconductor circuit.
During photolithography, the wafer is precoated with photoresist, a light
sensitive film that must have an accurate thickness and uniformity. Individual
integrated circuit patterns are then optically projected onto the photoresist
after which it is developed, leaving open areas. During etch, certain areas of
the film underlying the photeresist are removed to leave the desired circuit
pattern. Most of these steps are typically repeated several times during the
fabrication process, with alternating layers of conducting and insulating films
being deposited each time to form a multitude of identical "dies" on each wafer.
These are final tested, separated into individual die and assembled into an
integrated circuit ready for use. Depending on the specific design of a given
integrated circuit, a variety of film types, film thickness (which can range
from less than 20 angstroms to greater than 25,000 angstroms) and a number of
layers can be used to achieve desired electronic performance characteristics.
Semiconductor circuits are becoming more complex, operating faster with
smaller feature sizes, and employing larger dies that contain more transistors
and that require increasing numbers of manufacturing process steps.
Manufacturers are adopting new processes and technologies that increase the
importance and utilization of thin film measurement systems. For example, to
achieve greater semiconductor device speed, manufacturers are utilizing thinner
films with different properties that require more frequent and accurate
measurement during the manufacturing process. As the number of layers increases,
manufacturers are also utilizing new manufacturing processes, such as
I-2
chemical mechanical polishing ("CMP"). Accordingly, semiconductor manufacturers
are seeking systems that can help the manufacturing process by measuring the
thickness of the layer being polished to determine precisely when the
appropriate film thickness has been achieved in the CMP process. Furthermore, as
manufacturers migrate to new production standards such as the 300 mm wafer and
higher levels of cleanliness and automation in the fabrication facility, they
require film measurement systems that can accommodate these new standards.
Semiconductor manufacturers demand film thickness measurement systems that meet
specifications for accuracy at a low cost of ownership. Cost of ownership is
estimated by cost per wafer inspected over a five-year period, which is
dependent upon system price, mean time between failure, throughput, operating
costs, footprint (space occupied in the fab), servicing and maintenance costs
and other factors.
Magnetic Recording Head Manufacturing Process. The magnetic recording
head manufacturing process is similar to the semiconductor fabrication process.
Magnetic recording heads are used to read and write data stored on hard disk
drives. The head is a critical component in the drive structure and determines
the data storage capacity. Multiple heads are manufactured on wafer-like pucks
of various sizes that are round or square and typically made of an aluminum
oxide-titanium carbide combination, 2 to 3 mm thick. The head structures are
then built up in a series of thin film depositions and patterning steps
involving mainly ultra-thin metals and dielectric films. The thickness of each
film in the stack must be measured and controlled to very tight tolerances for
optimum performance. Magnetic recording head manufacturers demand high
throughput film measurement systems that meet specifications for accuracy at a
low cost of ownership.
Flat Panel Display Manufacturing Process. Flat panel displays are
manufactured in clean rooms using processes that are similar to those used in
semiconductor manufacturing. Flat panel displays use thin film technology and
most displays are constructed on large glass substrates that range in size up to
650 mm x 830 mm. Future designs are expected to require panels as large as one
meter square. These manufacturing processes are monitored in part by thin film
measurement systems that measure the thickness and uniformity of various thin
films specific to flat panel displays. Manufacturers of flat panel displays
demand automated thin film measurement systems that handle large glass
substrates and place them in position for measurement of various films during
manufacturing.
PRODUCTS
- --------
Nanometrics has been a pioneer in the field of thin film measurement and
has been instrumental in the development of many innovations over the past 20
years. The Company's film measurement systems use wide wavelength range, high
sensitivity optics, proprietary computer software and patented technology to
measure thickness, uniformity and the chemical properties of films deposited on
silicon and other substrates. The primary technology used in the Company's
measurement systems is non-contact spectroscopic reflectometry. In addition,
some products offer simultaneous and complementary spectroscopic ellipsometry to
measure the thickness, uniformity and chemical properties of films on a variety
of substrates. The primary applications are in the semiconductor, magnetic
recording head and flat panel displays industries. The Company's products can
be divided into two groups: automated systems and table top systems. The
automated systems are employed in high volume production environments. The table
top systems are used mainly in low
I-3
volume production environments where automated sample handling and high
throughput are not required and where cost is a major consideration.
Automated Systems for Semiconductor Equipment Manufacturers
NANOSPEC 8300X SERIES
- -------------------------------------------------------------------------------------------------------
Model # Date of First Shipments List Price * Features
- -----------------------------------------------------------------------------------------------------------
8300X June 1996 $222K to $794K 200 mm and 300 mm wafers.
Wide range of film thickness
measurement.
Computerized maps
Full, automation, operator-free.
Low cost of ownership
- -----------------------------------------------------------------------------------------------------------
8300XSE September 1996 $366K to $889K Same as 8300X.
Spectoscopic ellipsometer.
- -----------------------------------------------------------------------------------------------------------
8300XSE-FOUP March 1998 $585K to $966K Same as 8300XSE.
FOUP mini-environment.
- -----------------------------------------------------------------------------------------------------------
* List prices vary from a base model with no options to a model with every
option available.
The 8300X Series of automated thin film measurement products are capable of
handling both 200 mm and 300 mm diameter wafers. These systems have been
developed over the last two years, funded in part by a contract from SEMATECH.
The 8300X is the basic system configuration, while the 8300XSE includes a fully
integrated spectroscopic ellipsometer which expands the measurement capabilities
of the basic product, especially in ultrathin and multiple film stack
measurement applications. The 8300XSE-FOUP (Front Opening Unified Pod) includes
a mini-environment that maintains wafers in an ultra-clean environment during
measurement and transfer between tools in the fabrication facilities and reduces
the cleanliness requirements of the fabrication facility, resulting in
substantial construction cost savings.
In 1995, the Company was awarded a contract by SEMATECH to develop a 300 mm
system for use by SEMATECH members in the early evaluation of 300 mm process
equipment. With the introduction of the 8300X in 1996, the Company believes
that it was the first to introduce a fully-automated product for thin film
measurement on 300 mm wafers that also complies with sub 0.5 micron design
rules. SELETE purchased one of the first systems in 1996 to test and evaluate
300 mm process equipment and has recently ordered a second system. In addition,
the 8300XSE received a Photonics Spectra Magazine Circle of Excellence Award as
one of the most technically innovative products in 1996.
I-4
NANOSPEC 8000 SERIES
- -------------------------------------------------------------------------------------------------------
Model # Date of First Shipment List Price * Features
- -------------------------------------------------------------------------------------------------------
8000 June 1995 $273K to $679K 75 mm to 200 mm wafers
Wide range of film thickness
measurements
Full automation, operator-free
Low cost of ownership
- -------------------------------------------------------------------------------------------------------
8000X September 1996 $301K to $715K Same as 8000
Measurement and stage enclosure
- -------------------------------------------------------------------------------------------------------
8000XSE December 1996 $444K to $809K Same as 8000X
Spectroscopic ellipsometer
- -------------------------------------------------------------------------------------------------------
8000XSE-SMIF April 1997 $499K to $875K Same as 8000XSE
SMIF mini-environment
- -------------------------------------------------------------------------------------------------------
* List prices vary from a base model with no options to a model with every
option available.
The 8000 Series consist of high throughput, high performance measurement
systems capable of handling wafers ranging in size from 75 mm to 200 mm. The
8000XSE incorporates a spectroscopic ellipsometer which expands the measurement
capabilities of this model over the basic 8000. The 8000XSE-SMIF includes a
SMIF (Standard Mechanical interface) mini-environment that offers fab
construction cost savings.
Both the 8300X Series and 8000 Series are used in the CMP process. These
systems are robust and offer computerized pattern recognition that accurately
and consistently measures data at a desired location, despite surface roughness
and scratches produced by the CMP process. In addition, the 8300X Series and
8000 Series are well suited for the precise measurements required by sub 0.5
micron geometries.
Automated Systems for Magnetic Recording Head Manufacturers
NANOSPEC 8000S
- -------------------------------------------------------------------------------------------------------
Model # Date of first Shipment List Price Features
- -------------------------------------------------------------------------------------------------------
8000S December 1996 $300K to $809K Round or square pucks
Wide range of special film measurements
Computerized maps
Full automation, operator-free
Low cost of ownership
- -------------------------------------------------------------------------------------------------------
* List prices vary from a base model with no options to a model with every
option available.
I-5
The 8000S was designed to handle the round and square wafer-like pucks,
typically 2 to 3 mm thick, which are used in the magnetic recording head
industry. As in semiconductor manufacturing, magnetic recording head
manufacturing involves a variety of deposition and patterning steps, some with
requirements more stringent than those found in semiconductor manufacturing. In
particular, magnetic recording head manufacturers are required to deposit more
ultra-thin metal films than semiconductor manufacturers. Special proprietary
measurement software programs have been developed for the 8000S to satisfy the
production control requirements of the magnetic head industry.
Automated Systems for Flat Panel Display Manufacturers
NANOSPEC 5500/6500
- -------------------------------------------------------------------------------------------------------
Model # Date of First Shipment List Price * Features
- -------------------------------------------------------------------------------------------------------
5500 February 1995 $252K to $765K Up to 550 mm x 650 mm glass panel
substrates
Special measurement programs
Computerized maps
Full automation, operator-free
- -------------------------------------------------------------------------------------------------------
6500 September 1997 $420K to $980K Up to 650 mm x 830 mm glass panel
substrates
Special measurement programs
Computerized maps
Full automation, operator-free
Precise stage matrix and substrate
positioning
- -------------------------------------------------------------------------------------------------------
* List prices vary from a base model with no options to a model with every
option available.
The 5500 and 6500 systems were engineered and are manufactured by the
Company's subsidiary in Japan. The 5500 and 6500 are both fully automated and
can measure most optically transparent films used in the manufacture of flat
panel displays. The 5500 handles large glass substrates up to 550 mm x 650 mm.
This model is also capable of precisely measuring the thickness of virtually all
films used in the manufacture of flat panel displays at any site on the
substrate in a 20 micron spot and generating film thickness maps, which show
uniformity across the panel. The 6500 is an advanced version of the 5500, with
many proprietary software and hardware improvements, and is capable of handling
650 mm x 830 mm substrates.
I-6
Table Top Models for Semiconductor, Magnetic Recording Head, Flat Panel
Display Manufacturers and Other Thin Film Applications
NANOSPEC TABLE TOP MODELS
- -------------------------------------------------------------------------------------------------------
Model # Date of First List Price * Features
Shipment
- ------------------------------------------------------------------------------------------------------
2100 December 1993 $54K to $134K 75 mm to 200 mm substrates
Variety of measurement modes
Manual stage
- ------------------------------------------------------------------------------------------------------
3000 November 1995 $52K to $72K 75 mm to 200 mm substrates
Variety of measurement modes
Manual stage
- ------------------------------------------------------------------------------------------------------
4000 November 1992 $80K to $208K 75 mm to 200 mm substrates
Wide measurement range
Manual stage
Programmable software
- ------------------------------------------------------------------------------------------------------
4150 June 1994 $118K to $215K 75 mm to 200 mm substrates
Wide measurement range
Computerized maps
Programmable, motorized stage
Auto-focus
Programmable software
- ------------------------------------------------------------------------------------------------------
5000 April 1994 $100K to $130K 75 mm to 200 mm substrates
Wide measurement range
Manual stage
Programmable software
- ------------------------------------------------------------------------------------------------------
5100 May 1994 $130K to $252K 75 mm to 200 mm substrates
Wide measurement range
Computerized maps
Programmable, motorized stage
Auto-focus
Programmable software
- ------------------------------------------------------------------------------------------------------
6100 July 1996 $142K to $213K 75 mm to 200 mm substrates
Wide measurement range
Computerized maps
Programmable, motorized stage
Auto-focus
Programmable software
Faster measurement
- ------------------------------------------------------------------------------------------------------
* List prices vary from a base model with no options to a model with every
option available
The table top family of products provides a broad range of thin film
measurement solutions at a low entry price point to manufacturers of
semiconductors, magnetic recording heads, flat panel displays and other film
applications. The principal market for the Company's table top products is the
semiconductor industry, including device manufacturers and equipment materials
suppliers to this
I-7
industry. However, Nanometrics believes that a much broader market for these
systems exists, and the Company expects to sell additional systems as thin film
technology is used for new applications. With unique capabilities and several
available configurations, each model allows manufacturers to create custom
measurement programs used in developing new technology.
CUSTOMERS
Nanometrics sells its measurement systems worldwide to many of the major
semiconductor, magnetic recording head and flat panel display manufacturers, as
well as manufacturers of production equipment and materials for these
industries. In 1997 and 1996, approximately 80% of the Company's total net
revenues were derived from semiconductor applications, and approximately 20% of
the Company's total net revenues were derived from magnetic recording head and
flat panel display applications. Sales to one customer, Anam Electronics,
represented 11% of the Company's total net revenues in 1997. No single customer
represented 10% or more of the Company's total net revenues in 1996 and one
customer, Intertrade Scientific Inc., a distributor, represented approximately
10% of total net revenues in 1995.
The following is representative list of the Company's customers during 1996
and 1997.
Advanced Micro Devices, Inc. International Business Machines Corp. Samsung Group
Analog Devices, Inc. Intel Corporation SGS-Thomson Microelectronics
Anam Electronics IPEC Planar Seagate Technology
Applied Magnetics Corporation LG. Group Inc. Symbios Logic, Inc.
Applied Materials Inc. Lucent Technologies Texas Instrument Incorporated
Dallas Semiconductor Corp. Matsushita Electric Industrial Co. Ltd. Tokyo Electron, Ltd.
E.I. du Pont de Nemours & Co. Microchip Technology Inc. Toshiba Corporation
Ericsson Mitsubishi Corporation TSMC Ltd.
Telefonaktiebolaget LM Motorola, Inc. Vitesse Semiconductor Corp.
The Fairchild Corporation National Semiconductor Corp. Winbond Electronics Corp.
Fujitsu, Ltd. Nortel Communications
Hewlett-Packard Co. Novellus Systems, Inc.
Hitachi, Ltd. Quantum Corp.
Hyundai Motor Company Read-Rite
I-8
SALES AND MARKETING
The Company believes that a direct sales and support capability is
essential for developing and maintaining close customer relationships and for
rapidly responding to changing customer requirements. Nanometrics provides
direct sales support from its corporate office in California. In addition, the
Company has direct sales presence in Arizona, Oregon, Pennsylvania and Texas in
the United States, as well as South Korea, Taiwan and the United Kingdom. The
Company also uses sales representatives and distributors in Asia, Europe, and
the United States. Nanometrics intends to continue to develop its distribution
network by expanding its existing offices and opening new offices and forming
additional distribution relationships. The Company believes that growing its
international distribution network will enhance its competitive position. The
Company maintains a direct sales force of highly trained, technically
sophisticated sales engineers who are knowledgeable in the use of thin film
measurement systems in general and the features and advantages of the Company's
products in particular. In addition, the Company believes that its sales and
application engineers are skilled in working with customers to solve complex
measurement and process problems.
International sales, which includes sales by the Company's foreign
subsidiary in Japan, constituted approximately 60.3%, 52.5% and 64.1% of total
net revenues for 1997, 1996 and 1995, respectively. Direct exports of the
Company's film measurement systems to foreign customers and shipments to its
subsidiaries require general export licenses. See Note 10 of Notes to
Consolidated Financial Statements for information regarding total net revenues,
operating income (loss) and identifiable assets of the Company's foreign
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operation-Factors That May Affect Future Operating Results."
In order to raise market awareness of its products, the Company advertises
in trade publications, distributes promotional materials, publishes technical
articles, conducts marketing programs, issues press releases regarding new
products and participates in industry trade shows and conferences.
CUSTOMER SERVICE AND SUPPORT
The Company believes that customer service and technical support are
important competitive factors and are essential to building and maintaining
close, long-term relationships with its customers. The Company provides support
to its customers with site visits, telephonic technical support, direct training
programs and operating manuals and other technical support information. The
Company uses its demonstration equipment for training programs in addition to
sales and marketing. Nanometrics provides warranty and post-warranty service
from its corporate office in California. The Company also has service operations
based in Arizona, Massachusetts, Pennsylvania and Texas. Local service and spare
parts are provided in the United Kingdom by the Company's sales office in
Scotland and in the rest of Europe by distributors and sales representatives. In
Asia, service is provided by direct offices in Japan, Korea and Taiwan. The
Company's distributors and representatives provide service in other countries in
Asia.
I-9
Nanometrics provides a one year service warranty on parts and labor for
products. Revenues from post-warranty services (service revenue), including
sales of replacement parts, represented approximately 10.6%, 18.9%, and 20.4% of
total net revenues in 1997, 1996 and 1995, respectively.
BACKLOG
As of December 31, 1997, the Company's backlog was approximately $6.4
million. Backlog includes orders for products that the Company expects to ship
within 12 months. Orders from the Company's customers are subject to
cancellation or delay by the customer with minimal penalties. Historically,
order cancellations and order rescheduling have not been significant. However,
there can be no assurance that orders presently in backlog will not be canceled
or rescheduled. Since only a portion of the Company's revenues for any quarter
represent systems in backlog, the Company does not believe that backlog is a
meaningful or accurate indication of its future revenues and performance. See
"Risk factors-Dependence on Limited Systems Sales; Backlog."
COMPETITION
The market for film thickness measurement systems is subject to intense
competitive pressure and characterized by rapidly evolving technology. The
Company competes on a global basis with both larger and smaller companies in the
United States, Japan and Europe. The Company competes primarily with thin film
measurement products from KLA-Tencor Corporation, Therma-Wave Inc., Rudolph
Technologies, Dai Nippon Screen and Toray Industries. Many of the Company's
competitors have substantially greater financial, engineering, manufacturing and
marketing resources than the Company. Significant competitive factors include
technical capabilities, system performance (including automation and software
capability), ease of use, reliability, established customer bases, cost of
ownership, price and global customer service. The Company believes that it
competes favorably with respect to these factors but must continue to develop
and design new and improved products in order to maintain its competitive
position.
The Company expects its competitors to continue to improve the design and
performance of their current products and to introduce new products with
improved price and performance characteristics. For example, the Company
expects to face intense competition in the emerging market for 300 mm thin film
measurement systems. New product introductions and enhancements by the
Company's competitors could cause a significant decline in sales or loss of
market acceptance of the Company's systems or otherwise make the Company's
systems or technology obsolete or noncompetitive. There can be no assurance
that the Company will be able to compete successfully against current or future
competitors. Increased competitive pressure could lead to reduced demand
and lower prices for the Company's products, thereby materially adversely
affecting the Company's business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operation-Factors That May Affect Future Operating Results-Highly Competitive
Industry and Impact of Industry Consolidation."
I-10
MANUFACTURING
The Company manufactures its product in the United States and Japan by
combining proprietary measurement components and software produced in its
facility with components and subassemblies obtained from outside suppliers. The
Company tests all systems prior to shipment. Certain of the Company's products
includes system engineering and software development to meet specific customer
requirements. The Company's manufacturing operations do not require a major
investment in capital equipment.
The Company is relying increasingly on outside vendors to manufacture many
components and subassemblies. Certain components, subassemblies and services
necessary for the manufacture of the Company's systems are obtained from a sole
supplier or limited group of suppliers. For example, the Company relies on
Kensington Laboratories for much of the robotics incorporated in the Company's
automated systems. The Company does not maintain any long-term supply
agreements with Kensington Laboratories or any of its other suppliers. The
Company has entered into an agreement with J.A. Woollam Company for the purchase
of the spectroscopic ellipsometer component incorporated in the Company's
advanced measurement systems. The Company's reliance on a sole or limited group
of suppliers involves several risks, including a potential inability to obtain
an adequate supply of required components, reduced control of pricing and timely
delivery of components and subassemblies and suppliers' potential inability to
develop technologically advanced products to support the Company's growth and
development of new systems. Because manufacturing of certain of these
components and subassemblies involves extremely complex processes and requires
long lead times, there can be no assurances that delays or shortages caused by
suppliers will not occur in the future. The Company believes that alternative
sources could be obtained and qualified, if necessary, for most sole and limited
source parts. However, if the Company were forced to seek alternative sources
of supply or to manufacture such components or subassemblies internally; it may
be required to redesign its systems, which could prevent the Company from
shipping its systems to its customers on a timely basis. Certain of the
Company's suppliers have relatively limited financial resources. Any inability
to obtain adequate deliveries or any other circumstance that would restrict the
Company's ability to ship its products, could damage relationships with current
and prospective customers and could have a material adverse impact on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation-Factors That May Affect Future Operating Results-Sole or Limited
Sources of Supply; Reliance on Subcontractors; Complexity in Manufacturing
Process."
RESEARCH AND DEVELOPMENT
The Company's current research and development efforts are directed toward
enhancing existing products and developing and introducing new products to
maintain technological leadership and to meet current and evolving customer
needs. The Company is working to develop potential applications of new and
emerging technologies, including improved methods of thin film measurement.
These efforts are conducted at its facilities in California and also at its
Japanese subsidiary. The Company has an extensive base of proprietary
technology and expertise in areas such as spectrophotometry using its patented
absolute reflectivity, robust pattern recognition, and complex measurement
software algorithms. The Company also has extensive experience in systems
integration
I-11
engineering required to design compact, highly automated systems for advanced
clean room environments. The Company's process, engineering, marketing,
operations and management personnel have developed close collaborative
relationships with many of their customers' counterparts and have used these
relationships to identify market demands and target the Company's research and
development to meet those demands. Expenditures for research and development
during 1997, 1996 and 1995 were $3.0 million, $2.8 million and $2.6 million,
respectively, and represented 8.1%, 9.1% and 11.6% of total net revenues,
respectively.
The success of the Company in developing, introducing and selling new and
enhanced systems depends upon a variety of factors, including product
selections, timely and efficient completion of product design and development,
timely and efficient implementation of manufacturing and assembly process,
effective sales and marketing and product performance. Because new product
development commitments must be made well in advance of sales, new product
decisions must anticipate both the future demand for the products under
development and the equipment required to produce such products. If new products
have reliability or quality problems, reduced orders, higher manufacturing costs
and additional service warranty expense may result. There can be no assurance
that the Company will be successful in selecting, developing, manufacturing and
marketing new products or in enhancing and marketing existing products. If the
Company does not successfully introduce new products, the Company's business,
financial condition and results of operations will be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation-Factors That May Affect Future Operating Results-Rapid
Technological Change; Importance of Timely Product Introduction."
INTELLECTUAL PROPERTY
The Company's success depends in large part on the technical innovation of
its products. Nanometrics actively pursues a program of filing patent
applications to seek protection of technologically sensitive features of its
product. The Company holds a number of United States patents and additional
patents in Japan and Europe. The United States patents, issued during the
period 1981 to 1997, will expire from 1998 to 2014. While the Company attempts
to protect its intellectual property rights through patents, trademarks,
copyrights and non-disclosure agreements, it believes that its success will
depend to a greater degree upon innovation, technological expertise and its
ability to adapt its products to new technology. There can be no assurance that
the Company will be able to protect its technology or that competitors will not
be able to develop similar technology independently. In addition, the laws of
certain foreign countries may not protect the Company's intellectual property to
the same extent as do the laws of United States.
The validity of the Company's patents has not been adjudicated by any
court. Competitors may bring legal challenges to the validity of one or more of
these patents, or attempt to circumvent the patents. No assurance can be given
that the Company's patents will be sufficiently broad to protect the Company's
technology, nor that any existing or future patents will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
meaningful competitive advantages to the Company. Furthermore, there can be no
assurance that others will not independently develop similar products, duplicate
the Company's products, or if patents are issued to the Company, design around
such patents. The Company does not believe there is any infringement by its
products of any
I-12
patents or proprietary rights of others. However, there can be no assurance that
such infringements do not exist or will not occur in the future. As is typical
in the semiconductor industry, the Company has from time to time received, and
may in the future receive, communications alleging possible infringement of
patents or other intellectual property rights of others. The Company
investigates all such notices and responds as appropriate.
In 1997 the Company received a claim from another company that alleged that
the Company's sale of a measurement system with an ellipsometer violated such
party's patent and requested the Company discontinue marketing such products.
The Company reviewed the patent and advised such party that the Company believes
that there is prior art that would invalidate such patent. The Company has not
been contacted again by such party. In addition, some customers of the Company
have received notices of infringement from Technivision Corporation/the estate
of Jerome Lemelson alleging equipment used in the manufacture of semiconductor
products infringes their patents. A number of these customers have notified the
Company that they may seek indemnification from the Company for any damages and
expenses resulting from this matter. Certain of the Company's customers had
engaged in litigation with the late Mr. Lemelson involving a number of his
patents, and some of these cases have settled. Although the ultimate outcome of
these matters is not presently determinable, there can be no assurance that the
resolution of all such pending matters will not have a material adverse effect
on the Company's business, financial condition and result of operations. Based
on industry practice, the Company believes that in most cases it could obtain
any necessary licenses or other rights on commercially reasonable terms, but no
assurance can be given that licenses would be available or would be on
acceptable terms, that litigation would not ensue or that damages for any past
infringement would not be assessed. Litigation may be necessary in the future
to enforce patents issued to the Company, to protect trade secrets or know-how
owned by the Company, to defend the Company against claimed infringement of the
rights of others or to determine the scope and validity of the proprietary
rights of others. Any such litigation could result in substantial cost and
diversion of effort by the Company, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
Moreover, adverse determinations in such litigation could result in the
Company's loss of proprietary rights, subject the Company to significant
liabilities to third parties, require the Company to seek licenses from third
parties or prevent the Company from manufacturing or selling its products. The
failure to obtain necessary licenses or other rights or litigation arising out
of infringement claims could have material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation-Factors
That May Affect Future Operating Results-Uncertainty of Intellectual Property
Rights."
EMPLOYEES
At December 31, 1997, the Company employed 153 persons worldwide on a full-
time basis, including 28 in research and development, 30 in manufacturing and
manufacturing support, 78 in marketing, sales and field service and 17 in
general administration and finance. None of these employees is represented by a
union and the Company has never experienced a stoppage as a result of union
actions. Many of the Company's employees have specialized skills of value to
the Company. Nanometrics' future success will depend in large part upon its
ability to attract and retain highly
I-13
skilled, scientific, technical, managerial, financial and marketing personnel,
who are in great demand in the industry. Nanometrics considers its employee
relations to be good.
Executive Officers of the Registrant
- ------------------------------------
The executive officers of the Company are as follows:
Name Age Position with the Company
- ---- --- -------------------------
Vincent J. Coates 73 Chairman of the Board, Chief Executive Officer, Secretary
John Heaton 38 Director, President and Chief Operating Officer
Paul B. Nolan 43 Vice President and Chief Financial Officer
William N. Fate 35 Vice President and Director of International Sales
Roger Ingalls Jr. 35 Vice President and Director of North American Sales
William A. McGahan 31 Vice President and Director of Applications Engineering
Mr. Vincent Coates has been Chairman of the Board since the Company was
founded. He has also served as Chief Executive Officer and President from the
founding through July 1988 except for the period January 1986 through February
1987 when he served exclusively as Chief Executive Officer. He is currently the
Chief Executive Officer of the Company and was elected Secretary in February
1989.
Mr. Heaton joined the Company in September 1990 and in April 1994 he was
elected Vice President of Engineering and General Manager. In July 1995 he was
appointed to the Board of Directors. In May 1996 he was elected President and
Chief Operating Officer. Mr. Heaton served as Equipment Engineer at National
Semiconductor from 1978 to 1990 prior to joining the Company.
Mr. Nolan joined the Company in March 1989 and in March 1994 he was elected
Vice President and Chief Financial Officer. Mr. Nolan served as Senior
Financial Analyst at Harris Corporation prior to joining the Company.
Mr. Fate has been employed by Nanometrics since July 1993 and was elected
Vice President and Director of International Sales in October 1997. From July
1993 through July 1996, he served in various engineering and sales management
positions at the Company. Since July 1996 he has held the title of Director of
International Sales. Mr. Fate worked as an engineer at National Semiconductor
between 1983 and 1992.
Mr. Ingalls has been employed by Nanometrics since March 1995 and was
elected Vice President and Director of North American Sales in October 1997.
During his employment at Nanometrics, Mr. Ingalls has served as U.S. Sales and
Product Manager, and most recently Director
I-14
of North American Sales. Prior to joining Nanometrics he served as a sales
engineer for Nikon Inc. from March 1993 to March 1995.
Mr. McGahan, Ph.D. was elected Vice President and Director of Applications
Engineering in October 1997. He served as Applications Engineering Manager from
October 1996 to October 1997. Prior to that, Dr. McGahan served as Advanced
Metrology Development Manager from October 1995 to October 1996. From September
1987 to October 1995, Dr. McGahan served as an engineer for the J.A. Woollam
Co., Inc., a manufacturer of spectroscopic ellipsometers. Dr. McGahan has
published 46 papers relating to ellipsometry magneto-optics and thermal
characterization of materials.
Mr. Vincent Coates is the father of Mr. Norman Coates, a director of the
Company. There are no other family relationships among any of the executive
officers and directors of the Company. All directors hold office until the next
annual meeting of shareholders of the Company and until their successors have
been elected and qualified. Officers are elected by and serve at the discretion
of the Board of Directors.
ITEM 2. PROPERTIES
----------
The Company's principal manufacturing and administrative facility is
located in Sunnyvale, California in a leased building with approximately 35,000
square feet. The lease on this building began in May 1992 and was scheduled to
expire in April 1997, subject to a five-year renewal option. The Company
exercised this option in April 1997 and extended the lease through April 2002.
The Company also leases warehouse facilities in Sunnyvale. California and sales
and service offices in Texas and Scotland. Rent expense for the Company's
facilities was approximately $583,000 in 1997.
The Company, through its Japanese subsidiary, owns a 15,000 square foot
facility in Narita, Japan. This facility is utilized by the Company's Japanese
subsidiary for sales, service, engineering and manufacturing. The Company's
Japanese subsidiary also leases three sales offices.
ITEM 3. LEGAL PROCEEDINGS
-----------------
In 1997, the Company received a claim from another company that alleged the
Company's sale of a measurement system with an ellipsometer violated such
party's patent and requested the Company discontinue marketing such products.
The Company reviewed the patent and advised such party that the Company believes
that there is prior art that would invalidate such patent. The Company has not
been contacted again by such party. In addition, some customers of the Company
received notices of infringement from Technivision Corporation/the estate of
Jerome Lemelson alleging that equipment used in the manufacture of semiconductor
products infringes their patents. A number of these customers have notified the
Company that they may seek indemnification from the Company for any damages and
expenses resulting from this matter. Certain of the Company's customers have
engaged in litigation with the late Mr. Lemelson involving a number of his
patents and some of these cases have been settled. Although the ultimate outcome
of these matters is not presently determinable, there can
I-15
be no assurance that the resolution of all such pending matters will not have a
material adverse effect on the Company's business, financial condition or
results of operations. Based on industry practice, the Company believes that in
most cases it could obtain any necessary licenses or other rights on
commercially reasonable terms, but no assurance can be given that licenses would
be available or would be on acceptable terms, that litigation would not ensue or
that damages for any past infringement would not be assessed. Litigation may be
necessary in the future to enforce patents issued to the Company, to protect
trade secrets of know-how owned by the Company, to defend the Company against
claimed infringement of the right of others or to determine the scope and
validity of the proprietary rights of others. Any such litigation could result
in substantial cost and diversion of effort by the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, adverse determination in such litigation could
result in the Company's loss of proprietary rights, subject the Company to
significant liabilities to third parties, require the Company to seek licenses
from third parties or prevent the Company from manufacturing or selling its
products. The failure to obtain necessary licenses or other rights or litigation
arising out of infringement claims could have adverse material effect on the
Company's business, financial condition and results of operations.
I-16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1997.
I-17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
-----------------------------------------------------------------
MATTERS
-------
The Company's Common Stock is traded on The Nasdaq National Market under
the symbol "NANO". The following table sets forth, for the periods indicated,
the range of high and low sale prices as reported on the Nasdaq National Market.
January 2 and December 27 were the last trading days of the 1997 and 1996 fiscal
years.
1997 1996
-------------- --------------
Year ended December 31, High Low High Low
- ----------------------- ------ ------ ------ ------
First Quarter $ 7.75 $4.63 $8.63 $5.25
Second Quarter 7.38 4.63 7.19 4.88
Third Quarter 14.25 6.75 6.00 4.00
Fourth Quarter 13.38 7.69 6.13 4.19
As of March 10, 1998, there were approximately 136 shareholders of record
and approximately 2,000 beneficial shareholders. The last sale price reported
on the Nasdaq National Market on March 10, 1998 was $9.9375 per share.
The Company has never paid cash dividends. It is the present policy of the
Company's Board of Directors to retain earnings to finance expansion of the
Company's operations, and the Company does not expect to pay dividends in the
foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
------------------------------------
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Annual Report on Form 10-K. The balance
sheet information as of December 31, 1997 and 1996 and the statement operations
data set forth below for 1997, 1996, and 1995 are derived from the audited
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K. The balance sheet information as of December 31, 1995, 1994 and 1993
and the statement of operations data for 1994 and 1993 are derived from audited
consolidated financial statements of the Company not included herein.
II-1
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
(In thousands, except per share data)
Statement of Operations Data 1997 1996 1995 1994 1993
- ---------------------------- ---------- ----------- ------------- ------------ --------------
Net revenues:
Product sales............................ $32,767 $24,603 $18,117 $ 9,655 $13,126
Service.................................. 3,890 5,733 4,642 3,924 3,444
------- ------- ------- ------- -------
Total net revenues.................... 36,657 30,336 22,759 13,579 16,570
------- ------- ------- ------- -------
Cost and expenses:
Cost of product sales.................... 12,092 10,109 8,189 5,128 6,365
Cost of service.......................... 3,632 4,088 3,406 2,862 2,437
Research and development................. 2,986 2,754 2,631 2,405 2,177
Selling.................................. 6,050 4,696 3,712 2,946 3,465
General and administrative............... 2,765 2,476 2,180 2,469 1,910
------- ------- ------- ------- -------
Total costs and expenses.............. 27,525 24,123 20,118 15,810 16,354
------- ------- ------- ------- -------
Income (loss) from operations............... 9,132 6,213 2,641 (2,231) 216
------- ------- ------- ------- -------
Other income (expense):
Interest income......................... 535 390 302 93 129
Interest expense......................... (110) (92) (152) (49) (76)
Other, net............................... (175) 146 674 141 315
------- ------- ------- ------- -------
Total other income, net............... 250 444 824 185 368
------- ------- ------- ------- -------
Income (loss) before income taxes........... 9,382 6,657 3,465 (2,046) 584
Provision (benefit) for income taxes(1)..... 3,625 2,664 (812) 28 229
------- ------- ------- ------- -------
Net income (loss)........................... $ 5,757 $ 3,993 $ 4,277 $(2,074) $ 355
======= ======= ======= ======= =======
Net income per share:
Basic.................................... $0.69 $0.50 $0.56 $(0.28) $0.05
======= ======= ======= ======= =======
Diluted.................................. $0.65 $0.47 $0.52 $(0.28) $0.05
======= ======= ======= ======= =======
Shares used in per share computation:
Basic.................................... 8,325 8,047 7,604 7,304 7,016
======= ======= ======= ======= =======
Diluted.................................. 8,820 8,524 8,280 7,304 7,610
======= ======= ======= ======= =======
As of December 31
--------------------------------------------
(In thousands)
BALANCE SHEET DATA 1997 1996 1995 1994 1993
- ------------------ -------- -------- -------- -------- --------
Cash and equivalents and
short-term investments.............. $13,251 $ 8,382 $ 8,083 $ 2,628 $ 5,141
Working capital...................... 28,636 22,613 18,338 10,205 11,809
Total assets......................... 36,243 29,964 25,167 15,786 18,414
Debt Obligations, Net of
current portion..................... 2,568 3,296 3,528 421 578
Shareholders' equity................. 28,528 22,060 17,574 12,995 14,427
(1) Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes", and recognized the
cumulative effect of the adoption which increased the 1993 provision for income
taxes by $200,000.
II-2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
OVERVIEW
Nanometrics is a leading manufacturer of thin film measurement systems for
the electronics industry. The Company's primary customers are manufacturers of
semiconductors, magnetic recording heads and flat panel displays. Nanometrics'
film measurement systems use wide wavelength range, high sensitivity optics,
proprietary computer software and patented technology to measure thickness,
uniformity and chemical properties of film deposited on silicon and other
substrates. The primary applications of these systems is to precisely monitor
production processes employed in the fabrication of integrated circuits,
magnetic recording heads used in disk drives and flat panel displays commonly
used in laptop computers. The Company has made several strategic changes in the
business over the past several years which have contributed to revenue growth
from $22.8 million in 1995 to $36.7 million in 1997 and positioned the Company
to further participate in these markets. Such changes include: (i) a shift to
direct sales from third-party representatives in Asia, the United Kingdom and
the United States, (ii) an increased emphasis on product development,
manufacturing and direct sales in Japan, (iii) a decision to outsource certain
system components such as robotics, enabling the Company to leverage its
technical resources, and (iv) the development of new products for the
semiconductor, magnetic recording head and flat panel display markets. In
addition, the Company has developed products that can be used for 300 mm wafers
and chemical mechanical polishing.
The Company's business is dependent upon the capital expenditures of
manufacturers of: (i) semiconductors, (ii) magnetic recording heads for the
read/write function on disk drives, and (iii) flat panel displays. The demand
by such manufacturers is, in turn, dependent on the current and future market
demand for (i) semiconductors and products utilizing semiconductors, (ii) disk
drives and computers that utilize disk drives, and (iii) flat panel displays for
use in laptop computers, pagers, cell phones, and a variety of other
applications where portability and low power consumption are important. The
increasing complexity of the manufacturing processes for semiconductors,
magnetic recording heads, and flat panel displays is also an important factor in
the demand for the Company's thin film measurement products. The Company
believes that its diversification through multiple industry applications of its
technology increases the total available market for its products and reduces, to
an extent, its exposure to the cyclicality of any individual industry segment.
For example, in fiscal 1996, a decline in sales to manufacturers of
semiconductors was offset by increased sales to manufacturers of magnetic
recording heads and flat panel displays.
The Company derives its revenues from product sales and service, which
includes sales of accessories and service of the installed base of products. In
1997, the Company derived 89.4% of its total net revenues from product sales and
10.6% of its total net revenues from services. Revenues from product sales and
replacement and spare parts are recognized at the time of shipment. Revenues
from service work are recognized when performed. See Note 1 of Notes to
Consolidated Financial Statements.
II-3
The Company derives a substantial portion of its revenues from the sale of
a relatively small number of systems. As a result, a small change in the number
of systems actually shipped may cause significant changes in revenues in any
particular quarter. The Company's backlog at the beginning of a quarter
typically does not include all sales required to achieve the Company's revenue
objective for that quarter. Moreover, all customer purchase orders are subject
to cancellation or rescheduling by the customer without penalties.
Consequently, the Company depends on shipping products in the same quarter that
the purchase order is received. The failure of the Company to receive
anticipated orders or delays in shipments may cause quarterly net revenues to
fall significantly short of the Company's objectives, which would adversely
affect the Company's operating results.
The Company believes that its quarterly and annual revenues, expenses and
operating results could vary significantly in the future and that period-to-
period comparisons should not be relied upon as indications of future
performance. There can be no assurance that the Company will grow in future
periods or that it will sustain its level of net revenues or its rate of revenue
growth on a quarterly or annual basis. The Company may, in some future quarter,
have operating results that will be below the expectations of stock market
analysts and investors. In such event, the price of the Company's Common Stock
would be materially adversely affected. See "Factors That May Affect Future
Operating Results-Significant Fluctuations in Operating Results."
RESULTS OF OPERATIONS
Total Net Revenues. Total net revenues increased 20.8% from $30.3 million
in 1996 to $36.7 million in 1997. Product sales increased by 33.2% from $24.6
million in 1996 to $32.8 million in 1997. The increase in product sales
resulted from stronger worldwide demand for and increased shipments of the
Company's products, especially its automated products. Service revenue
decreased 32.1% from $5.7 million in 1996 to $3.9 million in 1997. The decrease
in service revenue is primarily attributable to lower sales of parts, services
and accessories in Asia and the U.S. in 1997 due in part to increased
functionality and reliability of the Company's new products. Total net revenues
increased 33.3% from $22.8 million in 1995 to $30.3 million in 1996. The
increase in total net revenues resulted primarily from increased worldwide sales
of the Company's automated NanoSpec 8000 product family for the semiconductor
and magnetic recording head markets and of the automated Model 5500 flat panel
display measurement system particularly in Asia. International revenues, which
includes sales by the Company's foreign subsidiary in Japan, constituted
approximately 60.3%, 52.5% and 64.1% of total net revenues for 1997, 1996 and
1995, respectively. The Company's 1997 domestic revenues of $14.5 million
remained consistent with $14.4 million in 1996, while 1997 international
revenues increased 39.0% from $15.9 million in 1996 to $22.1 million in 1997.
In 1996, the Company experienced a 76.7% increase in domestic revenues from $8.2
million in 1995 to $14.4 million in 1996, while international revenues increased
9.0% from $14.6 million in 1995 to $15.9 million in 1996. The increases in
international revenue were partially offset by the impact of the strengthening
of the U.S. dollar against the Japanese yen on sales in Japan.
Gross Profit. The product gross profit margin increased from 58.9% in 1996
to 63.1% in 1997. The increase was caused primarily by higher sales volumes in
1997 resulting in lower per unit manufacturing costs. The service gross profit
margin decreased from 28.7% in 1996 to 6.6% in 1997. The decrease was primarily
attributable to the decline in the sales of accessories and upgrades while fixed
service costs increased to support the Company's growing installed base of
systems at customer locations in 1997. Product gross profit increased from 54.8%
in 1995 to 58.9% in 1996
II-4
primarily because of higher prices resulting from stronger demand for the
Company's products and a continued decline in fixed operating costs as a
percentage of revenues due to higher sales volume. Service gross profit
increased to 28.7% in 1996 from 26.6% in 1995 primarily as a result of
relatively higher margins on the increased sales of accessories in 1996.
Research and Development. Research and development expenses increased 8.4%
from $2.8 million in 1996 to $3.0 million in 1997 to support the continued
development of new products and product enhancements. Research and development
expenses increased by 4.7% from $2.6 million in 1995 to $2.8 million in 1996.
The Company is committed to the development of new and enhanced products and
believes that new product introductions are required for the Company to maintain
its competitive position. During 1997, research and development expenses
represented 8.1% of total net revenues, compared to 9.1% and 11.6% in 1996 and
1995, respectively.
Selling. Selling expenses increased 28.8% from $4.7 million in 1996 to
$6.1 million in 1997 primarily because of higher commission expenses resulting
from higher sales levels, the addition of sales and marketing staff and the
opening of an office in Scotland in 1997. Selling expenses increased by 26.5%
from $3.7 million in 1995 to $4.7 million in 1996 as a result of both higher
sales commission expenses from increased sales levels and the addition of sales
personnel in the U.S. and Asia. During 1997 selling expenses represented 16.5%
of total net revenues, compared to 15.5% and 16.3% in 1996 and 1995,
respectively.
General and Administrative. General and administrative expenses increased
11.7% from $2.5 million in 1996 to $2.8 million in 1997 as a result of higher
spending associated with the increase in total net revenues. General and
administrative expenses increased by 13.6% from $2.2 million in 1995 to $2.5
million in 1996 due primarily to the addition of a managing director and related
expenses in Japan. During 1997 general and administrative expenses represented
7.5% of total net revenues, compared to 8.2% and 9.6% in 1996 and 1995,
respectively.
Total Other Income, Net. Total other income, net decreased 43.7% from
$444,000 in 1996 to $250,000 in 1997 primarily due to higher royalty income and
exchange rate gains in the prior year. Total other income, net decreased by
46.1% from $824,000 in 1995 to $444,000 in 1996 as a result of more favorable
exchange rate results in 1995.
Income Taxes. The Company's effective income tax rate decreased from 40.0%
in 1996 to 38.6% in 1997 primarily due to an increased benefit from the
Company's foreign sales corporation. The effective income tax rates in 1997 and
1996 exceed the U.S. statutory rate due primarily to state income taxes
partially offset by realization of foreign sales corporation benefit. The
effective income tax rate in 1995 differed from the U.S. statutory rate because
the results for 1995 included a $2.3 million favorable income tax adjustment to
reverse the valuation allowance for certain deferred tax assets in accordance
with SFAS 109.
Income. The Company's income from operations was $9.1 million and net
income was $5.8 million or $0.65 per diluted share in 1997 compared to income
from operations of $6.2 million and net income of $4.0 million or $0.47 per
diluted share in 1996 and an income from operations of $2.6 million and net
income of $4.3 million or $0.52 per diluted share in 1995. In 1997, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No.128, "Earnings
Per Share", which requires a dual presentation of basic net income per share
("EPS") and diluted EPS. Basic EPS
II-5
is computed by dividing net income by the weighted average common shares
outstanding for the period. Diluted EPS reflects the potential dilution from
outstanding dilutive stock options and shares issuable under the employee stock
purchase plan and is unchanged from previously reported EPS. EPS for prior
periods have been restated to conform to SFAS 128. The impact of inflation on
the Company's results of operations has not been significant.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had working capital of $28.6 million
compared to $22.6 million at December 31, 1996. The current ratio at December
31, 1997 was 6.6 to 1. The Company believes working capital including cash and
equivalents and short-term investments of $13.3 million will be sufficient to
meet its needs at least through the next twelve months. Operating activities
during 1997 provided net cash of $4.2 million primarily from net income
partially offset by working capital requirements. Financing activities provided
cash of $590,000 from the sale of shares under the employee stock purchase and
option plans. Investing activities used cash of $3.1 million, primarily from
the purchase of short-term investments in the U.S.
During 1996, operating activities provided cash of $356,000 primarily from
net income partially offset by working capital requirements. Financing
activities provided cash of $358,000 primarily from the sale of shares under the
employee stock purchase and option plans. Investing activities used cash of $2.6
million, primarily from the purchase of short-term investments in the U.S.
During 1995, operating activities provided cash of $2.3 million primarily from
net income partially offset by working capital requirements. Financing
activities provided cash of $4.2 million primarily from: (i) a loan to the
Company's Japanese subsidiary of $4.7 million from a bank in Japan using the
Company's building and land in Japan as collateral and (ii) cash of $351,000
from the sales of shares under the Company's employee stock purchase and option
plans; partially offset by $822,000 of repayments of long-term debt. Investing
activities used cash of $4.1 million in 1995, primarily from the investment of
proceeds of the bank loan in short-term investments in the U.S.
The Company has evaluated and will continue to evaluate the acquisition of
products, technologies or businesses that are complementary to the Company's
business. These activities may result in product and business investments. For
example, as discussed in Note 12 of Notes to Consolidated Financial Statements,
in January 1998, the Company acquired from Optical Specialties, Inc. a license
to manufacture and sell, worldwide, a system used to measure the critical
dimensions and overlay registration errors observed in submicron lithography.
The Company may pay up to $2.85 million in royalties over 5 years if total
product sales are $75 million or greater. On March 30, 1998, the Company entered
into an agreement with Optical Specialties, Inc. to purchase the metrology
system product line and certain related assets. Under the agreement, the Company
is required to pay approximately $3.0 million in cash for all assets and
technology and assumes warranty and service obligations of the existing
installed base. The Company expects to fund these payments from its cash
equivalents, short-term investments and cash flows from operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which requires that an enterprise report, by
major components and as a single total, the change in net assets during the
period from nonowner sources; and SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information," which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas and major customers.
Adoption of these statements will not impact the Company's financial position,
results of operations or cash flows. Both statements are effective for the
Company in fiscal 1998.
II-6
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
This report contains statements that constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1993, as
amended (the "Securities Act"), and Section 21E if the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). The words "expect," "estimate,"
"anticipate," "predict," `believe," and similar expressions and variations
thereof are intended to identify forward-looking statements. Such statements
appear in a number of places in this report and include statements regarding the
intent, belief or current expectations of the Company with respect to, among
other things: (i) trends affecting the Company's financial condition or results
of operation; (ii) the Company's financing plans; and (iii) the Company's
business and growth strategies. Any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and actual
results may differ materially from those projected in the forward-looking
statements as a result of various factors. The accompanying information
contained in this report including without limitation, the information set forth
below under "Factors That May Affect Future Operating Results," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," identify important factors that could cause such differences. The
Company undertakes no obligation to publicly update or revise forward looking
statements made in this report to reflect events or circumstances after the date
of this report or to reflect the occurrence of unanticipated events.
The following risk factors should be considered by shareholders of and by
potential investors in the Company in evaluating the Company, its business,
financial condition and business prospects.
SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS. The Company's operating
results have fluctuated significantly in the past and may fluctuate
significantly in the future. The Company anticipates that the factors that may
affect its future operating results include the following: customer demand for
the Company's products, which is affected by factors including the cyclicality
of the semiconductor, magnetic recording head and flat panel display industries
served by the Company, patterns of capital spending by customers, technological
changes in the markets served by the Company and its customers, market
acceptance of products of both the Company and its customers, the timing,
cancellation or delay of customer orders and shipments, competition, including
competitive pressures on product prices and changes in pricing by the Company's
customers or suppliers, fluctuations in foreign currency exchange rates,
particularly the Japanese yen, the proportion of direct sales versus sales
through distributors and representatives, market acceptance of new and enhanced
versions of the Company's products, the timing of new product announcements and
releases of products by the Company or its competitors, including the Company's
ability to design, introduce and manufacture new products on a timely and cost
effective basis, the size and timing of acquisitions of businesses, products or
technologies and fluctuations in the availability and cost of components and
subassemblies. Gross margins may vary materially from quarter to quarter or
year to year, based on a number of factors, including the mix and average
selling prices of products sold and the absorption of fixed operating costs.
In addition, the Company's operating results for the quarter ended March
31, 1998, will be affected by a one-time charge relating to the acquisition of
in-process research and development from Optical Specialties, Inc. See
"Liquidity and Capital Resources".
The impact of the factors listed above and other factors on the Company's
revenues, financial condition and operating results in any future period cannot
be forecasted with any degree of certainty. Based upon these factors, the
Company believes that its quarterly and annual revenues, expenses and
II-7
operating results could vary significantly in the future and that period-to-
period comparisons should not be relied upon as indications of future
performance. There can be no assurance that the Company will grow in future
periods or that it will sustain its level of revenues or its rate of revenue
growth on a quarterly or annual basis. It is likely that, in some future
quarter, the Company's operating results will be below the expectations of stock
market analysts and investors. In such event, the price of the Company's Common
Stock would be materially adversely affected.
DEPENDENCE ON LIMITED NUMBER OF SYSTEMS SALES; BACKLOG. The Company
derives a substantial portion of its revenues from the sale of a relatively
small number of systems. As a result, a small change in the number of systems
actually shipped may cause significant changes in revenues in any particular
quarter. All customer purchase orders are subject to cancellation or delay by
the customers with minimal penalties. Moreover, the Company's backlog at the
beginning of a quarter typically does not include all sales required to achieve
the Company's revenue objective for that quarter. Consequently, the Company
depends to an extent on shipping products in the same quarter that the purchase
order is received. The failure of the Company to receive anticipated orders or
delays in shipments may cause quarterly net revenues to fall significantly short
of the Company's objectives, which would adversely affect the Company's
business, financial condition and results of operations.
CYCLICALITY OF CUSTOMER INDUSTRIES. Sales to customers in the
semiconductor industry represented approximately 80% of the Company's total net
revenues in 1997, and sales to customers in the magnetic recording head and flat
panel display industries represented approximately 20% of total net revenues in
1997. The Company's business will depend in large part upon the capital
equipment expenditures of semiconductor manufacturers, which in turn depends on
the current and anticipated market demand for integrated circuits and products
utilizing integrated circuits. In addition, the Company's business depends upon
the construction of new semiconductor fabrication facilities and improvements to
existing fabrication facilities to reduce unit costs or to respond to
technological innovation. The semiconductor industry has been cyclical in
nature and historically has experienced periodic downturns, most recently during
the second half of 1996. Such downturns are characterized by diminished product
demand, erosion of average selling prices and production over-capacity. During
downturns, manufacturers typically defer or cancel orders for equipment to
conserve cash and reduce expenses. There can be no assurance that the Company's
business, financial condition and results of operations will not be adversely
affected by future downturns in the semiconductor industry. During the downturn
in 1996, the Company offset declines in orders of its products from the
semiconductor industry with increased sales to manufacturers of magnetic
recording heads and flat panel displays; however, the Company may not be able to
do so in future industry downturns. In addition, the magnetic recording head
and flat panel display industries are subject to similar cyclical conditions
that could materially affect the market for the Company's products and the
Company's business, financial condition and results of operations. The Company
may also experience substantial period-to-period fluctuations in future
operating results due to such industry conditions or events occurring in the
general economy. Even during periods of reduced revenues, in order to remain
competitive the Company will be required to continue to invest in research and
development and to maintain extensive ongoing worldwide customer service and
support capability, which could have a material adverse impact on the Company's
business financial condition and results of operations during industry downturns
or other periods of reduced revenues.
LENGTHY SALES CYCLE; DIFFICULTIES IN DISPLACING ENTRENCHED COMPETITORS.
Sales of the Company's systems depend, in significant part, upon the decision of
prospective customers to increase their existing production capacity by building
and equipping new fabrication facilities or expanding existing facilities,
either of which typically involves a significant capital commitment. In
II-8
view of the significant investment involved in a system purchase, the Company
may experience delays in obtaining purchase orders while the customer plans for
such expansion, evaluates various thin film measurement systems of the Company
and its competitors and receive purchase approvals. Due to these and other
factors, the Company's systems typically have lengthy sales cycles during which
the Company may expend substantial funds and management effort. In addition,
lengthy sales cycles subject the Company to a number of significant risks,
including inventory obsolescence and fluctuations in operating results over
which the Company has little or no control. Customers often evaluate several
suppliers' systems before deciding on the type of thin film measurement system
to use. The Company believes that the customer generally relies upon that system
for the specific production line application and frequently will attempt to
consolidate its other thin film measurement system requirements with the same
supplier. Accordingly, the Company expects to experience difficulty in selling
to a particular customer for a significant period of time if that customer
already uses a competitor's thin film measurement system.
HIGHLY COMPETITIVE INDUSTRY. The market for thin film measurement systems
is subject to intense competitive pressure and characterized by rapidly evolving
technology. The Company competes on a global basis with both larger and smaller
companies in the United States, Japan and Europe. The Company competes
primarily with thin film measurement products from KLA-Tencor Corporation,
Therma-Wave Inc., Rudolph Technologies, Dai Nippon Screen and Toray Industries.
Many of the Company's competitors have substantially greater financial,
engineering, manufacturing and marketing resources than the Company.
The Company expects its competitors to continue to improve the design and
performance of their current products and to introduce new products with
improved price and performance characteristics. For example, the Company
expects to face intense competition in the emerging market for 300 mm thin film
measurement systems. New product introductions and enhancements by the
Company's competitors could cause a significant decline in sales or loss of
market acceptance of the Company's systems or otherwise make the Company's
systems or technology obsolete or noncompetitive. There can be no assurance
that Company will be able to compete successfully against current or future
competitors. Increased competitive pressure could lead to reduced demand and
lower prices for the Company's products, thereby materially adversely affecting
the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS; RECENT ECONOMIC TRENDS IN
ASIA. International revenues accounted for approximately 60.3% of the
Company's total net revenues for 1997. The Company anticipates that
international revenues will continue to account for a substantial portion of its
total net revenues in the foreseeable future. The Company's international
operations are subject to risks inherent in the conduct of international
business, including unexpected changes in regulatory requirements, exchange
rates, import or export requirements, tariffs and other barriers, political and
economic instability, limited intellectual property protection, difficulties in
collecting payments due from sales agents or customers, difficulties in managing
distributors or representatives, difficulties in staffing and managing foreign
subsidiary operations and potentially adverse tax consequences. Furthermore,
downturns in foreign capital markets could affect the Company's international
customers, which could have a material adverse effect on the Company's business,
financial condition and results of operations.
Recent economic trends, particularly in the Asia-Pacific marketplace, have
caused a heightened awareness of the impact of this portion of the world's
economy can have on the overall economy. As the Asia-Pacific market currently
represents almost one-third of the world's buying power and approximately 51.7%
of the Company's 1997 sales are to this region, changes in this area's economic
growth rate may impact suppliers of product in that market. While the actual
II-9
magnitude of the business at risk is unknown, it is likely that capital spending
in this market will decrease which could have a material adverse impact on the
Company's business, financial condition and results of operations. In addition,
the future performance of the Company will be dependent, in part, upon its
ability to continue to compete successfully in Asia, one of the largest markets
for the Company's products. The Company's ability to compete in this area in the
future is dependent upon the continuation of favorable trading relationships
between the region (especially Japan, Korea and Taiwan) and the United States
and the continuing ability of the Company to maintain satisfactory relationships
with customers and potential customers in the region. In addition, the Japanese
market, which is important to the Company's sales, has historically been
difficult for non-Japanese companies to penetrate. Although the Company has had
direct presence in Japan since 1985, there can be no assurance that the Company
will be able to maintain or improve its competitive position in Japan.
Approximately 27.5% of the Company's total net revenues for 1997, were
generated by the Company's Japanese subsidiary and are denominated in Japanese
yen. A significant fluctuation in the exchange rate between the yen and the
U.S. dollar could result in a significant gain or loss being recorded in the
Company's consolidated statement of income. A decline in the exchange rate of
the yen against the U.S. dollar would result in a decrease in consolidated
total net revenues and consolidated net income, whereas an increase in the
exchange rate of the yen against the U. S. dollar would result in an increase in
consolidated total net revenues and consolidated net income. Generally, a
change in the exchange rate would have a similar impact on the consolidated net
income associated with accounts due between the U.S. parent and the Japanese
subsidiary. The Company's international revenues in countries except Japan are
denominated in U.S. dollars and sales to customers may be affected by
fluctuations in exchange rates which could increase the sales price in local
currencies of the Company's products. Since the Company does not currently
engage in currency exchange rate hedging transactions, there can be no assurance
that fluctuations in currency exchange rates in the future will not have a
material adverse effect on the Company's business, financial condition and
results of operations.
RAPID TECHNOLOGICAL CHANGE; IMPORTANCE OF TIMELY PRODUCT INTRODUCTION. The
film measurement industry is subject to rapid technological change and new
product introductions and enhancements. The Company believes that a key factor
in its growth in the past three years has been the success of new product
introductions, including the Model 8000 and Model 5500 introduced in 1995. A
key factor in the Company's ability to achieve continued growth will be the
market success of recent new product introductions, including products for 300
mm wafers, chemical mechanical polishing and large flat panel displays. The
Company's ability to remain competitive will depend in part upon its ability to
respond to technological change and develop new and enhanced systems and
tointroduce these systems at competitive prices and in a timely and cost-
effective manner. New product introductions may contribute to fluctuations in
quarterly operating results, since customers may defer ordering product from the
Company's existing product line in anticipation of the introduction of the new
product or product enhancement. In addition, new product introductions or
enhancements of existing products by the Company's competitors could cause a
decline in sales or loss of market acceptance of the Company's existing products
or render the Company's current product offerings obsolete. The success of the
Company in developing, introducing and selling new and enhanced systems depends
upon a variety of factors, including product selections, timely and efficient
completion of product design and development, timely and efficient
implementation of manufacturing and assembly processes, effective sales and
marketing and product performance. Because new product development commitments
must be made well in advance of sales, new product decisions must anticipate
both the future demand for the products under development and the equipment
required to produce such products. If new products have reliability or quality
problems,
II-10
reduced orders, higher manufacturing costs and additional service and warranty
expenses may result. There can be no assurance that the Company will be
successful in selecting, developing, manufacturing and marketing new products or
in enhancing existing products. If the Company does not successfully introduce
new products, the Company's business financial condition and results of
operations will be materially adversely affected.
UNCERTAINTY OF INTELLECTUAL PROPERTY RIGHTS. The Company's future success
and competitive position depends in large part on the Company's ability to
obtain and maintain certain proprietary technology used in its systems. The
Company relies on a combination of patents, trademarks, copyrights, trade
secret laws and confidentiality procedures to protect its proprietary rights.
There can be no assurance that the Company will be able to protect its
technology or that competitors will not be able to develop similar technology
independently. In addition, the laws of certain foreign countries may not
protect the Company's intellectual property rights to the extent as do the laws
of the United States.
The validity of the Company's patents has not been adjudicated by any
court. Competitors may bring legal challenges to the validity of one or more of
these patents, or attempt to circumvent the patents. There can be no assurance
that Company's patents will be sufficiently broad to protect the Company's
technology, or that any existing or future patents will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
meaningful competitive advantages to the Company. Furthermore, there can be no
assurance that others will not independently develop similar products, duplicate
the Company's products, or if patents are issued to the Company, design around
such patents. The Company does not believe that its products infringe any
patents or proprietary rights of others. However, there can be no assurance
that such infringements do not exist or will not occur in the future. As is
typical in the high technology industry, the Company has from time to time
received, and may in the future receive, communications alleging possible
infringement of patents or other intellectual property rights of others. The
Company investigates all such notices and responds as appropriate
In 1997, the Company received a claim from another company that alleged the
Company's sale of a measurement system with an ellipsometer violated such
party's patent and requested the Company discontinue marketing such products.
The Company reviewed the patent and advised such party that the Company believes
that there is prior art that would invalidate such patent. The Company has not
been contacted again by such party. In addition, some customers of the Company
received notices of infringement from Technivision Corporation/the estate of
Jerome Lemelson alleging that equipment used in the manufacture of semiconductor
products infringes their patents. A number of these customers have notified the
Company that they may seek indemnification from the Company for any damages and
expenses resulting from this matter. Certain of the Company's customers have
engaged in litigation with the late Mr. Lemelson involving a number of his
patents and some of these cases have been settled. Although the ultimate
outcome of these matters is not presently determinable, there can be no
assurance that the resolution of all such pending matters will not have a
material adverse effect on the Company's business, financial condition or
results of operations. Based on industry practice, the Company believes that in
most cases it could obtain any necessary licenses or other rights on
commercially reasonable terms, but no assurance can be given that licenses would
be available or would be on acceptable terms, that litigation would not ensue or
that damages for any past infringement would not be assessed. Litigation may be
necessary in the future to enforce patents issued to the Company, to protect
trade secrets of know-how owned by the Company, to defend the Company against
claimed infringement of the right of others or to determine the scope and
validity of the proprietary rights of others. Any such litigation could result
in substantial cost and diversion of effort by the Company, which could have a
material adverse effect
II-11
on the Company's business, financial condition and results of operations.
Moreover, adverse determination in such litigation could result in the Company's
loss of proprietary rights, subject the Company to significant liabilities to
third parties, require the Company to seek licenses from third parties or
prevent the Company from manufacturing or selling its products. The failure to
obtain necessary licenses or other rights or litigation arising out of
infringement claims could have adverse material effect on the Company's
business, financial condition and results of operations.
SOLE OR LIMITED SOURCES OF SUPPLY; RELIANCE ON SUBCONTRACTORS; COMPLEXITY
IN MANUFACTURING PROCESSES. The Company is relying increasingly on outside
vendors to manufacture many components and subassemblies. Certain components,
subassemblies and services necessary for the manufacture of the Company's
systems are obtained from a sole supplier or limited group of suppliers. For
example, the Company relies on Kensington Laboratories for the robotics
incorporated in the Company's automated systems. The Company does not maintain
any long-term supply agreements with Kensington Laboratories or any of its
suppliers. The Company has entered into an agreement with J.A. Woollam Company
for the spectroscopic ellipsometer component incorporated in the Company's
advanced measurement systems. The Company's reliance on sole or a limited group
of suppliers involves several risks, including a potential inability to obtain
an adequate supply of required components, reduced control of pricing and timely
delivery of components and subassemblies and suppliers' potential inability to
develop technologically advanced products to support the Company's growth and
development of new systems. Because the manufacturing of certain of these
components and subassemblies involves extremely complex process and requires
long lead times, there can be no assurance that delays or shortages caused by
suppliers will not occur in the future. The Company believes that alternative
sources could be obtained and qualified, if necessary, for most sole and limited
source parts. However, if the Company were forced to seek alternative sources
of supply or to manufacture such components or subassemblies internally, it may
be required to redesign its systems, which could prevent the Company from
shipping its systems to its customers on a timely basis. Certain of the
Company's suppliers have relatively limited financial and other resources. Any
inability to obtain adequate deliveries or any other circumstance that would
restrict the Company's ability to ship its products, could damage relationships
with current and prospective customers and could have a material adverse impact
on the Company's business, financial condition and results of operations.
MANAGEMENT OF GROWTH. The Company's business is currently experiencing a
period of growth that has placed and is expected to continue to place a
significant strain on the Company's personnel and resources. The Company's
ability to manage future growth, if any, will depend on its ability to continue
to implement and improve operational, financial and management information and
controls systems on a timely basis, together with maintaining effective cost
controls. To support any future growth, the Company will need to hire more
engineering, manufacturing, sales, marketing, support and administrative
personnel, and expand customer service capabilities. Competition worldwide for
the necessary personnel in the Company's industry is intense. There can be no
assurance that the Company will be able to attract and retain the necessary
personnel or that it will be able to satisfy customer demand in a timely fashion
and satisfactorily support its customers and operations. In addition,
international growth will require the Company to expand its direct operations
worldwide and enhance its communications infrastructure. Expansion of
operations to various geographic areas with different business cultures could
further strain the Company's management systems. The inability of the Company's
management to manage growth effectively could have a material adverse effect on
the Company's business, financial condition and results of operations.
INFORMATION SYSTEMS AND THE YEAR 2000. The Company's information system
uses a two digit date code and, as a result, will not recognize the difference
between the years 2000 and 1900.
II-12
The Company has been informed by the vendor of the software that an upgrade is
available which will appropriately recognize Year 2000 date information. The
Company plans to license this upgrade and implement it by 1999. Management
believes that the cost for the license and the related internal and external
costs to implement the upgrade will not have a material adverse affect on the
Company's results of operations or cash flows.
Many of the Company's products incorporate systems which utilize personal
computers and related software to control certain functionality. The Company
believes that its current products, which all use current versions of personal
computer operating systems and software are compliant with the Year 2000. The
Company is currently assessing the extent to which its older products may
incorporate software which is not Year 2000 compliant and, based on the results
of that assessment, will determine what action, if any, is necessary.
Management believes that the cost of any such actions will not have a material
adverse affect on the Company's results of operations or cash flows.
DEPENDENCE UPON KEY EMPLOYEES. Because of the specialized nature of the
Company's business, the Company's future performance depends upon the continued
service of members of the Company's senior management and other key research and
development and sales and marketing personnel. The loss of any of such persons
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company does not have employment
contracts with any of its employees in the United States. The Company believes
that its future success will depend upon it continuing ability to identify,
attract, train and retain highly skilled managerial, technical, sales and
marketing personnel in key areas worldwide. Hiring for such personnel is highly
competitive. There can be no assurance that the Company will be able to
continue to attract, assimilate and retain the qualified personnel necessary for
the development of its business. The failure to recruit additional key
personnel in a timely manner, or the failure to retain new or current personnel,
would have a material adverse effect on the Company's business, financial
condition and results of operations.
IMPACT OF INDUSTRY CONSOLIDATION. The Company believes that the thin film
measurement system market is undergoing a period of consolidation which could
impact the Company's future success. A number of suppliers have been acquired
by larger equipment manufacturers. For example, KLA Corporation recently
acquired a competitor of the Company, Tencor Corporation, to form KLA-Tencor
Corporation. The Company believes that similar acquisitions and business
combinations involving competitors and potential competitors of the Company may
occur in the future. Such acquisitions could adversely impact the Company's
competitive position by enabling the Company's competitors and potential
competitors to expand their product offerings and provide direct customer
support worldwide, which could afford them an advantage in meeting customers'
needs, particularly with those customers that seek to consolidate their capital
equipment requirements with the same vendor. The greater resources, including
financial, marketing and support resources, of competitors engaged in these
acquisitions could permit them to accelerate the development and
commercialization of new competitive products and the marketing of existing
competitive products to their larger installed bases. Accordingly, such
business combinations and acquisitions by competitors and potential competitors
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company has in the past
considered consolidation with other companies and could consider such
consolidations in the future in order to enhance the Company's competitive
position or respond to competitive pressures.
II-13
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The financial statements filed herewith are listed in the index in Item
14.
II-14
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Nanometrics Incorporated:
We have audited the accompanying consolidated balance sheets of Nanometrics
Incorporated and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Nanometrics Incorporated and
subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
San Jose, California
February 13, 1998
(March 30, 1998 as to the last paragraph of Note 12)
II-15
NANOMETRICS INCORPORATED
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
- ----------------------------------------------------------------------------------------------------------------------
ASSETS 1997 1996
CURRENT ASSETS:
Cash and equivalents......................................................................... $3,656 $1,725
Short-term investments....................................................................... 9,595 6,657
Accounts receivable, net of allowances of $413 and $419
in 1997 and 1996, respectively............................................................. 10,225 11,100
Inventories.................................................................................. 7,138 5,078
Prepaid expenses and other................................................................... 1,075 882
Deferred income taxes........................................................................ 2,094 1,648
------- -------
Total current assets................................................................. 33,783 27,090
PROPERTY, PLANT AND EQUIPMENT, Net......................................................... 2,187 2,600
OTHER ASSETS.................................................................................. 273 274
------- -------
TOTAL.......................................................................................... $36,243 $29,964
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable............................................................................. $ 1,889 $ 1,563
Accrued payroll and related expenses......................................................... 596 533
Other current liabilities.................................................................... 1,493 763
Income taxes payable......................................................................... 565 1,271
Current portion of debt obligations.......................................................... 604 347
------- -------
Total current liabilities........................................................... 5,147 4,477
DEBT OBLIGATIONS, Net of current portion..................................................... 2,568 3,296
DEFERRED INCOME TAXES........................................................................ - 131
------- -------
Total liabilities................................................................... 7,715 7,904
------- -------
COMMITMENTS AND CONTINGENCIES (Note 7)
SHAREHOLDERS' EQUITY:
Common stock, no par value; 25,000,000 shares authorized;
8,521,484 and 8,258,061 outstanding in 1997 and 1996, respectively........................ 13,151 11,833
Retained earnings............................................................................ 16,144 10,387
Accumulated translation adjustment........................................................... (767) (160)
------- -------
Total shareholders' equity.......................................................... 28,528 22,060
------- -------
TOTAL.......................................................................................... $36,243 $29,964
======= =======
See notes to consolidated financial statements.
II-16
NANOMETRICS INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
NET REVENUES:
Product sales................................................................. $32,767 $24,603 $18,117
Service....................................................................... 3,890 5,733 4,642
------- ------- -------
Total net revenues.................................................... 36,657 30,336 22,759
------- ------- -------
COSTS AND EXPENSES:
Cost of product sales......................................................... 12,092 10,109 8,189
Cost of service............................................................... 3,632 4,088 3,406
Research and development...................................................... 2,986 2,754 2,631
Selling....................................................................... 6,050 4,696 3,712
General and administrative.................................................... 2,765 2,476 2,180
------- ------- -------
Total costs and expenses............................................... 27,525 24,123 20,118
------- ------- -------
INCOME FROM OPERATIONS........................................................ 9,132 6,213 2,641
------- ------- -------
OTHER INCOME (EXPENSE):
Interest income............................................................... 535 390 302
Interest expense.............................................................. (110) (92) (152)
Other, net.................................................................... (175) 146 674
------- ------- -------
Total other income, net............................................... 250 444 824
------- ------- -------
INCOME BEFORE INCOME TAXES................................................... 9,382 6,657 3,465
PROVISION (BENEFIT) FOR INCOME TAXES......................................... 3,625 2,664 (812)
------- ------- -------
NET INCOME..................................................................... $ 5,757 $ 3,993 $ 4,277
======= ======= =======
NET INCOME PER SHARE:
Basic......................................................................... $0.69 $0.50 $0.56
======= ======= =======
Diluted....................................................................... $0.65 $0.47 $0.52
======= ======= =======
SHARES USED IN PER SHARE COMPUTATION:
Basic......................................................................... 8,325 8,047 7,604
======= ======= =======
Diluted....................................................................... 8,820 8,524 8,280
======= ======= =======
See notes to consolidated financial statements.
II-17
NANOMETRICS INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
- ------------------------------------------------------------------------------------------------------------------------------
Common Stock Accumulated Total
-------------------------------- Retained Translation Shareholders'
Shares Amount Earnings Adjustment Equity
BALANCES, January 1, 1995...................... 7,370,978 $10,018 $ 2,117 $ 860 $12,995
Issuance of common stock under
employee stock purchase plan.................. 26,504 29 - - 29
Issuance of common stock under
stock option plan............................. 486,428 322 - - 322
Tax benefit of employee stock
transactions.................................. - 614 - - 614
Change in accumulated translation
adjustment.................................... - - - (663) (663)
Net income...................................... - - 4,277 - 4,277
--------- ------- -------- ------- -------
BALANCES, December 31, 1995.................... 7,883,910 10,983 6,394 197 17,574
Issuance of common stock under
employee stock purchase plan.................. 25,627 115 - - 115
Issuance of common stock under
stock option plan............................. 348,524 233 - - 233
Tax benefit of employee stock
transactions.................................. - 502 - - 502
Change in accumulated translation
adjustment.................................... - - - (357) (357)
Net income...................................... - - 3,993 - 3,993
--------- ------- ------------- ----------- -------
BALANCES, December 31, 1996.................... 8,258,061 11,833 10,387 (160) 22,060
Issuance of common stock under
employee stock purchase plan.................. 24,482 112 - - 112
Issuance of common stock under
stock option plan............................. 238,941 478 - - 478
Tax benefit of employee stock
transactions.................................. - 728 - - 728
Change in accumulated translation
adjustment.................................... - - - (607) (607)
Net income...................................... - - 5,757 - 5,757
--------- ------- ------------- ----------- -------
BALANCES, December 31, 1997.................... 8,521,484 $13,151 $16,144 $(767) $28,528
========= ======= ============= =========== =======
See notes to consolidated financial statements.
II-18
NANOMETRICS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
- --------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................................... $ 5,757 $ 3,993 $ 4,277
Reconciliation of net income to net cash provided by operating
activities:
Depreciation and amortization............................................... 213 309 318
Deferred income taxes....................................................... (588) 263 (1,826)
Changes in assets and liabilities:
Accounts receivable....................................................... 93 (4,031) (2,886)
Inventories............................................................... (2,322) (1,228) 766
Prepaid expenses and other................................................ (218) (458) (202)
Accounts payable, accrueds and other current liabilities.................. 1,251 111 782
Income taxes payable...................................................... 26 1,397 1,050
-------- -------- -------
Net cash provided by operating activities............................ 4,212 356 2,279
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments........................................... (18,152) (12,522) (8,786)
Sales/maturities of short-term investments.................................... 15,214 10,321 4,821
Purchases of property, plant and equipment.................................... (97) (270) (117)
Other assets.................................................................. (17) (128) (60)
-------- -------- -------
Net cash used in investing activities................................ (3,052) (2,599) (4,142)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt obligations.................................... 329 762 4,700
Repayments of debt obligations................................................ (329) (752) (822)
Sale of shares under employee stock purchase and option plans................. 590 348 351
-------- -------- -------
Net cash provided by financing activities............................ 590 358 4,229
-------- -------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH................................... 181 (15) (876)
-------- -------- -------
NET CHANGE IN CASH AND EQUIVALENTS......................................... 1,931 (1,900) 1,490
CASH AND EQUIVALENTS, Beginning of year....................................... 1,725 3,625 2,135
-------- -------- -------
CASH AND EQUIVALENTS, End of year............................................. $ 3,656 $ 1,725 $ 3,625
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest........................................................ $ 117 $ 118 $ 135
======== ======== =======
Cash paid for income taxes.................................................... $ 4,192 $ 715 $ 157
======== ======== =======
See notes to consolidated financial statements.
II-19
NANOMETRICS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS - Nanometrics Incorporated (the "Company") is a
leading manufacturer of thin film measurement and analysis systems. The
Company's primary customers are manufacturers of semiconductors, disk drives
and flat panel displays. These film measurement systems combine proprietary
computer software and patented optic technology to measure film thickness and
uniformity as well as chemical composition. The primary application of these
systems is to precisely monitor production processes employed in the
fabrication of integrated circuits, magnetic recording heads used in disk
drives and flat panel displays most commonly used in laptop computers.
BASIS OF PRESENTATION - The consolidated financial statements include the
Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
FISCAL YEAR - The Company uses a 52/53 week fiscal year ending on the
Saturday nearest to December 31. Accordingly, fiscal years 1997, 1996 and
1995 ended on January 3, 1998, December 28, 1996 and December 30, 1995, and
consisted of 53, 52 and 52 weeks, respectively. For purposes of the
consolidated financial statements, the year end is stated as December 31.
All references to years relate to fiscal years rather than calendar years.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Significant estimates include provisions for
doubtful accounts, warranty costs and net realizable value of inventory.
Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK - Financial instruments which potentially
subject the Company to concentrations of credit risk consist primarily of
cash and equivalents, short-term investments and accounts receivable. The
Company invests its cash and equivalents and short-term investments generally
in United States Treasury bills that are primarily held by one broker. The
Company performs ongoing credit evaluations of its customers and generally
does not require collateral for sales on credit. The Company also maintains
reserves for potential credit losses.
CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES - The Company participates in a
dynamic high technology industry and believes that changes in any of the
following areas could have a material adverse effect on the Company's
financial position, results of operations or cash flows: advances and trends
in new technologies and industry standards; competitive pressures in the form
of new products or price reductions on current products; changes in product
mix; changes in the overall demand for products and services offered by the
Company; changes in certain strategic partnerships or customer relationships;
litigation or claims against the Company based on intellectual property,
patent, product, regulatory or other factors (see Note 7); risks associated
with changes in domestic and international economic and/or political
II-20
conditions or regulations; availability of necessary product components;
risks associated with year 2000 compliance; and the Company's ability to
attract and retain employees necessary to support its growth.
Certain components used in the Company's products are purchased only from one
source. In particular, the Company currently purchases its robotics used in
its automated systems and its spectroscopic ellipsometer used in its advanced
measurement systems from separate single sources of supply. Any shortage or
interruption in the supply of any of the components used in the Company's
products, or the inability of the Company to procure these components from
alternate sources on acceptable terms, could have a material adverse effect
on the Company's business, financial condition and results of operations.
CASH AND EQUIVALENTS - Cash and equivalents include cash and highly liquid
debt instruments with original maturities of three months or less when
purchased.
SHORT-TERM INVESTMENTS - The Company's short-term investments consist of
United States Treasury bills with maturities at the date of acquisition of
more than three months. While the Company's intent is to hold such debt
securities to maturity, they are classified as available-for-sale because the
sale of such securities may be required prior to maturity. Available-for-
sale securities at December 31, 1997 are stated at cost which approximates
fair market value.
INVENTORIES - Inventories are stated at the lower of cost (first-in, first-
out) or market.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at
cost. Depreciation is computed using straight line and accelerated methods
over the estimated useful lives of the assets ranging from three to 45 years.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the lease term.
FAIR VALUE OF FINANCIAL INSTRUMENTS - Financial instruments include cash
equivalents, short-term investments, and debt obligations. Cash equivalents
are stated at fair market value based on quoted market prices. Short-term
investments are stated at cost which approximates fair market value. The
recorded carrying amount of the Company's debt obligations approximates fair
market value.
STOCK-BASED COMPENSATION - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees."
REVENUE RECOGNITION - Revenues from product sales are recognized at the time
of shipment. Revenues from service work is recognized when performed.
Revenue from service contracts is recognized ratably over the period of the
contract. The Company sells the majority of its products with a one-year
repair or replacement warranty and records a provision for estimated claims
at the time of sale.
FOREIGN CURRENCY - The functional currencies of the Company's foreign
subsidiaries are the local currencies. Accordingly, translation adjustments
for the subsidiaries have been included in shareholders' equity. Gains and
losses from transactions denominated in currencies other than the functional
currencies of the Company or its subsidiaries are included in other income
and expense and consist of a loss of $217,000 for 1997 and gains of $39,000
and $623,000 for 1996 and 1995, respectively.
INCOME TAXES -The Company accounts for income taxes under an asset and
liability approach for financial accounting and reporting of income taxes.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and tax
credit carryforwards.
II-21
NET INCOME PER SHARE - In 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share" and,
retroactively, restated net income per share ("EPS") for 1996 and 1995. SFAS
128 requires a dual presentation of basic and diluted EPS. Basic EPS excludes
dilution and is computed by dividing net income by the number of weighted
average common shares outstanding for the period. Diluted EPS reflects the
potential dilution from outstanding dilutive stock options (using the
treasury stock method) and shares issuable under the employee stock purchase
plan.
RECENTLY ISSUED ACCOUNTING STANDARDS - In June 1997, the Financial Accounting
Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which
requires that an enterprise report, by major components and as a single
total, the change in net assets during the period from nonowner sources; and
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas and major customers. Adoption of these statements
will not impact the Company's financial position, results of operations or
cash flows. Both statements are effective for the Company in fiscal 1998.
2. INVENTORIES
Inventories at December 31 consist of the following (in thousands):
1997 1996
Finished goods........................................... $2,934 $1,809
Work in process.......................................... 1,528 1,414
Raw materials and subassemblies.......................... 2,676 1,855
------ ------
$7,138 $5,078
====== ======
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 31 consist of the following (in
thousands):
1997 1996
Land.............................................................. $ 813 $ 908
Building.......................................................... 2,455 2,753
Machinery and equipment........................................... 1,243 1,510
Furniture and fixtures............................................ 404 281
Leasehold improvements............................................ 273 397
------- -------
5,188 5,849
Accumulated depreciation and amortization......................... (3,001) (3,249)
------- -------
$ 2,187 $ 2,600
======= =======
II-22
4. OTHER CURRENT LIABILITIES
Other current liabilities at December 31 consist of the following (in
thousands):
1997 1996
Commissions payable................................ $ 564 $ 269
Accrued warranty................................... 479 303
Other.............................................. 450 191
------ -----
$1,493 $ 763
====== =====
5. INCOME TAXES
Income (loss) before income taxes for the years ended December 31 consists of
the following (in thousands):
1997 1996 1995
Domestic............................... $9,644 $6,305 $1,964
Foreign................................ (262) 352 1,501
------ ------ ------
$9,382 $6,657 $3,465
====== ====== ======
The provision (benefit) for income taxes for the years ended December 31
consists of the following (in thousands):
1997 1996 1995
Current:
Federal................................................. $3,080 $1,583 $ 477
State................................................... 884 354 137
Foreign................................................. 181 304 461
------ ------ -------
4,145 2,241 1,075
------ ------ -------
Deferred:
Federal................................................. (574) 287 (1,302)
State................................................... 9 186 (557)
Foreign................................................. 45 (50) (28)
------ ------ -------
(520) 423 (1,887)
------ ------ -------
Provision (benefit) for income taxes...................... $3,625 $2,664 $ (812)
====== ====== =======
II-23
Significant components of the Company's net deferred tax asset (liability) at
December 31 are as follows (in thousands):
1997 1996
Deferred tax assets:
Reserves and accruals not currently deductible.................. $1,953 $1,466
Capitalized inventory costs..................................... 123 182
Tax credit carryforwards........................................ 31 -
------ ------
Total deferred tax assets......................................... 2,107 1,648
Deferred tax liabilities:
Depreciation.................................................... - (56)
Other........................................................... - (75)
------ ------
Total deferred tax liabilities.................................... - (131)
------ ------
Net deferred tax assets........................................... $2,107 $1,517
====== ======
At December 31, 1997, $13,000 of the net deferred tax assets are classified
as noncurrent (and included in other assets) and $2,094,000 is classified as
current.
Differences between income taxes computed by applying the statutory federal
income tax rate to income before income taxes and the provision (benefit) for
income taxes for the years ended December 31 consist of the following (in
thousands):
1997 1996 1995
Income taxes computed at 35% U.S. statutory rate......................... $3,284 $2,330 $ 1,213
State income taxes....................................................... 589 356 -
Foreign taxes higher than U.S. taxes..................................... - 60 225
Foreign sales corporation benefit........................................ (274) (205) (66)
Nondeductible expenses................................................... 94 87 84
Change in valuation allowance............................................ - - (2,339)
Other, net............................................................... (68) 36 71
------ ------ -------
Provision (benefit) for income taxes..................................... $3,625 $2,664 $ (812)
====== ====== =======
The reduction in the Company's valuation allowance in 1995 reflected the
Company's assessment that it was more likely than not that it would generate
sufficient taxable income to realize the tax benefits associated with its
deferred tax assets.
6. DEBT OBLIGATIONS
Debt obligations at December 31 consist of the following (in thousands):
1997 1996
1995 working capital bank loan..................................... $2,266 $2,949
1996 working capital bank loan..................................... 604 694
Other.............................................................. 302 -
------ ------
Total.............................................................. 3,172 3,643
Current portion of debt obligations................................ (604) (347)
------ ------
Debt obligations, net of current portion........................... $2,568 $3,296
====== ======
II-24
The 1995 working capital bank loan was obtained by the Company's Japanese
subsidiary. The loan is secured by receivables of the Japanese subsidiary
and is guaranteed by the parent, Nanometrics Incorporated. The loan is
denominated in Japanese yen ((Yen)300,000,000 at December 31, 1997) and bears
interest at 3.3% per annum. The loan is payable in quarterly installments
with unpaid principal and interest due May 2005.
The 1996 working capital bank loan was also obtained by the Company's
Japanese subsidiary and is secured by land and building. The loan is
denominated in Japanese yen ((Yen)80,000,000 at December 31, 1997) and bears
interest at 3.4% per annum. The loan is payable in quarterly installments
beginning May 1998 with unpaid principal and interest due May 2006.
Other represents unsecured borrowings by the Company's Japanese subsidiary
pursuant to an overdraft facility which bears interest at 1.925% per annum.
At December 31, 1997, (Yen)40,000,000 is outstanding under the facility.
At December 31, 1997, future annual maturities of debt obligations are as
follows (in thousands):
1998............................ $ 604
1999............................ 302
2000............................ 302
2001............................ 302
2002............................ 302
Thereafter...................... 1,360
------
$3,172
======
7. COMMITMENTS AND CONTINGENCIES
The Company leases manufacturing and administrative facilities and certain
equipment under noncancellable operating leases. The Company's current
primary facility lease expires in April 2002. Rent expense for 1997, 1996
and 1995, was approximately $583,000, $483,000 and $420,000, respectively.
Future minimum lease payments under the Company's operating leases for each
of the years ending December 31 are as follows (in thousands):
1998.............................. $ 653
1999.............................. 609
2000.............................. 617
2001.............................. 581
2002.............................. 191
------
$2,651
======
Pursuant to a 1985 agreement, as amended, if the Company's Chief Executive
Officer is required to relinquish his position for any reason, the Company
has agreed to continue his salary for a period of five years from such date.
The high technology industry is characterized by frequent claims and related
litigation regarding patent and other intellectual property rights. The
Company is a party to various claims, legal actions and complaints of this
nature. Although the ultimate outcome of these matters is not presently
determinable,
II-25
management believes that the resolution of all such pending matters will not
have a material adverse effect on the Company's financial position, results
of operations or cash flows.
8. SHAREHOLDERS' EQUITY
COMMON STOCK
The authorized capital stock of the Company consists of 25,000,000 common
shares, of which 22,500,000 shares have been designated "Common Stock" and
2,500,000 shares have been allocated to all other series of common shares,
collectively designated "Junior Common."
NET INCOME PER SHARE
The reconciliation of the share denominator used in the basic and diluted net
income per share computations for the years ended December 31 are as follows
(in thousands):
1997 1996 1995
Weighted average shares outstanding - shares used in
basic net income per share computation...................................... 8,325 8,047 7,604
Dilutive effect of common stock equivalents,
using the treasury stock method............................................. 495 477 676
----- ----- -----
Shares used in diluted net income per share computation....................... 8,820 8,524 8,280
===== ===== =====
During 1997, 1996 and 1995, the Company had common stock options outstanding
which could potentially dilute basic net income per share in the future, but
were excluded from the computation of diluted net income per share as the
common stock options' exercise prices were greater than the average market
price of the common shares for the period. At December 31, 1997, 5,000 such
common stock options with a weighted average exercise price of $10.88 per
share were excluded from the diluted net income per share computation.
STOCK OPTION PLANS
Under the 1991 Stock Option Plan (the "Option Plan"), as amended, the Company
may grant options to purchase up to 3,000,000 shares of common stock to
employees and consultants at prices not less than the fair market value at
date of grant for incentive stock options and not less than 50% of fair
market value for nonstatutory stock options. These options generally expire
five years from the date of grant and become exercisable ratably generally
over a period of three years as set forth in the stock option agreements.
Under the 1991 Directors' Stock Option Plan (the "Directors' Plan"),
nonemployee directors of the Company are automatically granted options to
purchase 10,000 shares of common stock, at the fair market value at the date
of grant, each year that such person remains a director of the Company.
Options granted under the Directors' Plan become exercisable ratably over a
period of three years and expire five years from the date of grant. The
total shares authorized under the Directors' Plan are 300,000.
II-26
Option activity under the plans is summarized as follows:
OUTSTANDING OPTIONS
----------------------------------------------------
WEIGHTED
SHARES NUMBER OF AVERAGE
AVAILABLE SHARES EXERCISE PRICE
Balances, January 1, 1995....................................... 941,500 1,283,700 $0.66
Exercised....................................................... - (486,428) 0.66
Granted (weighted average fair value of $3.20).................. (636,700) 636,700 4.76
Canceled........................................................ 122,500 (204,400) 0.73
--------- ---------
Balances, December 31, 1995 (372,312
exercisable at a weighted average price
of $0.63)..................................................... 427,300 1,229,572 2.77
Exercised....................................................... - (348,524) 0.67
Granted (weighted average fair value of $3.61).................. (308,500) 308,500 5.36
Canceled........................................................ 91,607 (91,607) 3.69
--------- ---------
Balances, December 31, 1996 (348,514
exercisable at a weighted average price
of $2.91)..................................................... 210,407 1,097,941 4.08
Additional shares reserved...................................... 1,500,000 - -
Exercised....................................................... - (238,941) 2.00
Granted (weighted average fair value of $5.17).................. (488,500) 488,500 9.33
Canceled........................................................ 14,139 (14,139) 4.46
--------- ---------
Balances, December 31, 1997..................................... 1,236,046 1,333,361 6.37
========= =========
Additional information regarding options outstanding as of December 31, 1997
is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
$ 0.56 - $ 0.75 92,507 2.1 $0.57 89,207 $0.57
$ 0.88 - $ 2.06 101,004 3.0 2.04 68,223 2.03
$ 4.31 - $10.88 1,139,850 4.1 7.23 345,837 5.74
--------- -------
$ 0.56 - $10.88 1,333,361 3.9 6.37 503,267 4.32
========= =======
EMPLOYEE STOCK PURCHASE PLAN
Under the 1986 Employee Stock Purchase Plan (the "Purchase Plan"), eligible
employees are allowed to have salary withholdings of up to 10% of their base
compensation to purchase shares of common stock at a price equal to 85% of
the lower of the market value of the stock at the beginning or end of each
six-month offering period, subject to an annual limitation. Shares issued
under the plan were 24,482, 25,627 and 26,504 in 1997, 1996 and 1995 at
weighted average prices of $4.58, $4.49 and $1.10, respectively.
II-27
The weighted average per share fair values of the 1997, 1996 and 1995 awards
were $4.41, $5.16 and $5.19, respectively. At December 31, 1997, 72,837
shares were reserved for future issuances under the Purchase Plan.
ADDITIONAL STOCK PLAN INFORMATION
As discussed in Note 1, the Company continues to account for its stock-based
awards using the intrinsic value method in accordance with APB No. 25,
"Accounting for Stock Issued to Employees" and its related interpretations.
Accordingly, no compensation expense has been recognized in the accompanying
consolidated financial statements for employee stock arrangements.
SFAS No. 123, "Accounting for Stock-Based Compensation" requires the
disclosure of pro forma net income and net income per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS
123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to
estimate the fair value of freely tradable, fully transferable options
without vesting restrictions, which significantly differ from the Company's
stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise, which
greatly affect the calculated values. The Company's fair value calculations
on stock-based awards under the 1991 Option Plan and the 1991 Directors' Plan
were made using the Black-Scholes option pricing model with the following
weighted average assumptions: expected life, three years from the date of
grant in 1997 and four years from the date of grant in 1996 and 1995; stock
volatility, 80% in 1997 and 90% in 1996 and 1995; risk free interest rate,
6.1% in 1997 and 6.0% in 1996 and 1995; and no dividends during the expected
term. The Company's calculations are based on a single option valuation
approach and forfeitures are recognized at a historical rate of 29% per year.
The Company's fair value calculations on stock-based awards under the
Purchase Plan were also made using the Black-Scholes option pricing model
with the following weighted average assumptions: expected life, six months in
1997, 1996 and 1995; stock volatility, 80% in 1997 and 90% in 1996 and 1995;
risk free interest rate, 5.5% in 1997, 5.6% in 1996 and 6.0% in 1995; and no
dividends during the expected term.
If the computed fair values of the 1997, 1996 and 1995 awards had been
amortized to expense over the vesting period of the awards, pro forma net
income and net income per share, basic and diluted, would have been as
follows in the years ended December 31 (in thousands except per share
amounts):
1997 1996 1995
Pro forma net income...................... $5,057 $3,576 $4,116
Pro forma net income per share:
Basic................................... $ 0.61 $ 0.44 $ 0.54
Diluted................................. $ 0.60 $ 0.43 $ 0.51
The impact of outstanding stock options and shares issuable under the
Purchase Plan granted prior to 1995 have been excluded from the pro forma
calculations; accordingly, the 1997, 1996 and 1995 pro forma adjustments are
not indicative of future period pro forma adjustments, when the calculation
will apply to all applicable stock-based compensation arrangements.
II-28
9. PROFIT-SHARING AND RETIREMENT AND BONUS PLANS
No contributions were made by the Company in 1997, 1996 and 1995 to the
Company's discretionary profit-sharing and retirement plan. The Company paid
$678,000, $523,000 and $188,000 in 1997, 1996 and 1995, respectively, under
formal discretionary cash bonus plans which cover all eligible employees.
10. MAJOR CUSTOMER AND GEOGRAPHIC INFORMATION
In 1997, sales to one customer accounted for approximately 11% of total
revenues. In 1996, no single customer accounted for 10% or more of total
revenues. In 1995, sales to a different customer than in 1997 represented
approximately 10% of total revenues. At December 31, 1997, one customer
accounted for 10% of accounts receivable. At December 31, 1996, no single
customer accounted for 10% or more of accounts receivable.
Transfers between geographic areas are recorded at amounts above cost with
profit intended to reflect the economic substance of the transaction.
Identifiable assets of geographic areas represent those assets used in the
Company's operations in each area. The following table summarizes selected
geographic financial information of the Company as of and for the years
ended December 31 (in thousands).
1997 1996 1995
Total net revenues:
United States.......................................... $26,477 $20,781 $13,876
Japan.................................................. 10,086 9,454 8,883
Korea.................................................. 90 101 -
Taiwan................................................. 4 - -
------- ------- -------
$36,657 $30,336 $22,759
======= ======= =======
Export sales:
Korea.................................................. $ 5,864 $ 4,062 $ 2,417
Europe................................................. 2,288 1,235 2,326
Other (primarily Asia)................................. 3,786 1,063 973
------- ------- -------
$11,938 $ 6,360 $ 5,716
======= ======= =======
Transfers between United States and Japan
eliminated in consolidation............................ $ 6,137 $ 4,118 $ 2,564
======= ======= =======
Operating income (loss):
United States.......................................... $ 8,751 $ 5,280 $ 741
Japan.................................................. 967 1,324 1,900
Korea.................................................. (465) (391) -
Taiwan................................................. (121) - -
------- ------- -------
$ 9,132 $ 6,213 $ 2,641
======= ======= =======
II-29
Identifiable assets:
United States.................................. $26,309 $20,805 $15,799
Japan.......................................... 9,726 9,040 9,368
Korea.......................................... 97 119 -
Taiwan......................................... 111 - -
------- ------- -------
$36,243 $29,964 $25,167
======= ======= =======
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth selected quarterly results of operations for
the years ended December 31, 1997 and 1996 (in thousands, except per share
amounts):
Quarters Ended
----------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
Total net revenues......................................... $8,259 $8,699 $9,416 $10,283
Gross profit............................................... 4,659 4,923 5,409 5,942
Income from operations..................................... 2,086 2,019 2,413 2,614
Net income................................................. 1,273 1,373 1,504 1,607
Net income per share:*
Basic.................................................... $ 0.15 $ 0.17 $ 0.18 $ 0.19
Diluted.................................................. $ 0.15 $ 0.16 $ 0.17 $ 0.18
Shares used in per share computation:
Basic.................................................... 8,260 8,282 8,327 8,431
Diluted.................................................. 8,673 8,665 9,002 8,940
Quarters Ended
----------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1996 1996 1996 1996
Total net revenues......................................... $7,068 $7,557 $7,739 $ 7,972
Gross profit............................................... 3,696 3,979 4,152 4,312
Income from operations..................................... 1,445 1,477 1,642 1,649
Net income................................................. 834 961 1,027 1,171
Net income per share:*
Basic.................................................... $ 0.11 $ 0.12 $ 0.13 $ 0.14
Diluted.................................................. $ 0.10 $ 0.11 $ 0.12 $ 0.14
Shares used in per share computation:
Basic.................................................... 7,917 8,043 8,071 8,156
Diluted.................................................. 8,551 8,583 8,514 8,448
* The sum of the quarterly basic and diluted net income per share amounts
will not necessarily equal the corresponding amounts for the entire fiscal
year in the accompanying consolidated statements of income.
II-30
12. SUBSEQUENT EVENTS
In January 1998, the Company acquired from Optical Specialties, Inc. ("OSI")
a license to manufacture and sell, worldwide, a metrology system used to
measure the critical dimensions and overlay registration errors observed in
submicron optical lithography. Under the agreement, the Company may pay up
to $2.85 million in royalty payments over five years if total product sales
are $75 million or greater.
On March 30, 1998, the Company entered into an agreement with OSI to
purchase the metrology system product line and certain related assets. Under
the agreement, the Company is required to pay approximately $3.0 million in
cash for all assets and technology and assume warranty and service
obligations of the existing installed base.
* * * * *
II-31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None
II-32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
The section entitled "Election of Directors" appearing in the Registrant's
proxy statement for the annual meeting of shareholders for the year ended
December 31, 1997, sets forth certain information with respect to the directors
of the Registrant and is incorporated herein by reference. Certain information
with respect to persons who are or may be deemed to be executive officers of the
Registrant is set forth under the caption "Business-Executive Officers of the
Registrant" in Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The section entitled "Executive Compensation" appearing in the Registrant's
proxy statement for the annual meeting of shareholders for the year ended
December 31, 1997, sets forth certain information with respect to the
compensation of management of the Registrant and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The section entitled "Election of Directors" appearing in the Registrant's
proxy statement for the annual meeting of shareholders for the year ended
December 31, 1997, sets forth certain information with respect to the ownership
of the Registrant's Common Stock and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The section entitled "Transactions with Management" appearing in the
Registrant's proxy statement for the annual meeting of shareholders for the year
ended December 31, 1997, sets forth certain information with respect to certain
business relationships and transactions between the Registrant and its directors
and officers and is incorporated herein by reference.
III-1
PART IV
ITEM 14. EXHIBITS FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
--------------------------------------------------------------
(a) The following documents are filed as part of this Report:
1. Financial Statements. The following Consolidated Financial Statements
--------------------
of Nanometrics Incorporated and Independent Auditors' Report are filed
as part of this Annual Report.
Independent Auditors' Report
Consolidated Balance Sheets, as of December 31, 1997 and 1996
For the years ended December 31, 1997, 1996 and 1995:
Consolidated Statements of Income
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Financial Statements Schedules. The following consolidated financial
------------------------------
statement schedules of Nanometrics Incorporated are filed as part of
this Report and should be read in conjunction with the Consolidated
Financial Statements of Nanometrics Incorporated.
Financial Statement Schedules for the years ended December 31, 1997, 1996
and 1995.
Schedule Page
-------- ----
II - Valuation and Qualifying Accounts .............. S-1
Schedules not filed herein are omitted because of the absence of
conditions under which they are required or because the information
called for is shown in the consolidated financial statements or notes
thereto.
(b) Reports on Form 8-K:
None
IV-1
3. Exhibits.
3.1(1) Restated and Amended Articles of Incorporation of Registrant filed July 7, 1982.
3.2(1) Certificate of Amendment of Articles of Incorporation filed January 31, 1983.
3.3(1) Certificate of Amendment of Articles of Incorporation filed July 28, 1983.
3.4(1) Certificate of Amendment of Certificate of Determination of Preferences of Series B Common Stock filed
September 13, 1983.
3.5(1) Certificate of Amendment of Articles of Incorporation filed September 13, 1983.
3.6 Certificate of Amendment of Articles of Incorporation filed December 3, 1984.
3.7 Certificate of Correction of Certificate of Amendment of Certificate of Determination of Preferences of
Series B Common Stock filed March 19, 1985.
3.8 Certificate of Amendment of Articles of Incorporation filed June 27, 1988.
3.9 Bylaws
4.1(1) Form of Common Stock Certificate
10.1 Form of Indemnification Agreement for Directors & Officers
10.2 1986 Employee Stock Purchase Plan, as amended through April 1997
10.3(2) 1991 Stock Option Plan, as amended through May 15, 1997
10.4(3) 1991 Director Option Plan
10.5(4) Amendment to and Restatement of Redemption Agreement dated March 4, 1993 between Vincent J. Coates and
Registrant
10.6 Consulting Agreement dated as of September 15, 1997 between the Registrant and Kanegi Nagai, as amended
10.7 Reverse Split Dollar Insurance Agreement and Collateral Assignment dated March 15, 1993 between the
Registrant and Vincent J. Coates
IV-2
10.8 Lease Agreement dated February 25, 1992 between PM-DE and the Registrant, first Addendum to Lease dated
February 22, 1992 and First Amendment to Lease dated April 24, 1997
10.9 Loan Agreement between Japan Development Bank and Nanometrics Japan kk.
10.10 Loan Agreement and Guarantee dated June 5, 1995 between Mitsubishi Bank, Limited and Nanometrics Japan Ltd.
21 Subsidiaries of Registrant
23 Independent Auditors' Consent and Report on Schedule
24 Power of Attorney (see page V-1).
27.1 Financial Data Schedule for the Year Ended December 31, 1997
27.2 Financial Data Schedule for the Years Ended December 31, 1995 and 1996 and for the Quarters Ended March 31,
June 30 and September 30, 1996
27.3 Financial Data Schedule for the Quarters Ended March 31, June 30 and September 30, 1997
1) Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (File No. 2-93949), which became effective November
28, 1984.
2) Incorporated by reference to Exhibit 4.1 filed with Registrant's
Registration Statement on Form S-8 (File No. 333-33583) filed on August 14,
1997.
3) Incorporated by reference to Exhibit 4.2 filed with Registrant's
Registration Statement on Form S-8 (file number 33-43913) filed on November
14, 1991.
4) Incorporated by reference to exhibit 10.10 filed with Registrant's Form 10-K
dated March 29, 1993
IV-3
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NANOMETRICS INCORPORATED
Date: April 1, 1998 By: /s/VINCENT J. COATES
--------------------------
Vincent J. Coates, Chairman
and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Vincent J. Coates, jointly and severally, his
attorneys-in-fact, each with full power of substitution, for him in any and all
capacities, to sign any amendments to this Report on Form 10-K, and to file the
same with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant in
the capacities and on the dates indicated:
Signature Title Date
- ---------------------- ------------------------------ -------------
/s/VINCENT J. COATES Chairman of the Board and April 1, 1998
- ----------------------
(Vincent J. Coates) Chief Executive Officer
(Principal Executive Officer)
/s/PAUL B. NOLAN Chief Financial Officer April 1, 1998
- ----------------------
(Paul B. Nolan) (Principal Accounting and
Financial Officer)
/s/JOHN D. HEATON Director, President and April 1, 1998
- ----------------------
(John D. Heaton) Chief Operating Officer
/s/NORMAN V. COATES Director April 1, 1998
- ----------------------
(Norman V. Coates)
/s/NATHANIEL BRENNER Director April 1, 1998
- ----------------------
(Nathaniel Brenner)
/s/KANEGI NAGAI Director April 1, 1998
- ----------------------
(Kanegi Nagai)
/s/CLIFFORD F. SMEDLEY Director April 1, 1998
- ----------------------
(Clifford F. Smedley)
V-1
SCHEDULE II
NANOMETRICS INCORPORATED
VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
Balance at Charged to Deductions- Balance
beginning costs and write-offs at end
Year Ended of period expenses of accounts of period
---------- ---------- ------------ ---------
December 31, 1997.. $419,000 $ 0 $(6,000) $413,000
========== ========== =========== =========
December 31, 1996.. $380,000 $ 39,000 $ 0 $419,000
========== ========== =========== =========
December 31, 1995.. $270,000 $110,000 $ 0 $380,000
========== ========== =========== =========
S-1