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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended September 30, 2001
Commission File Number 0-27234
PHOTON DYNAMICS, INC.
(Exact name of registrant as specified in its charter)
California 94-3007502
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6325 San Ignacio Avenue
San Jose, CA 95119
(Address of principal executive offices, including zip code)
(408) 226-9900
(Issuer telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
(Title of Class)
Securities registered under Section 12(g) of the Act:
Common Stock, no par value per share
(Title of Class)
Indicate by check mark whether the issuer (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. |_|
As of November 26, 2001, the aggregate market value of the voting stock
held by non-affiliates of the registrant, computed by reference to the last sale
price of such stock as of such date on the Nasdaq National Market, was
$428,402,515. Shares of common stock held by each officer and director and by
each person who owned 5% or more of the outstanding common stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily conclusive.
As of November 26, 2001, there were 13,932,261 shares of the registrant's
common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2001
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A, not later than 120 days after the end of
the fiscal year covered by this Form 10-K, are incorporated by reference in Part
III hereof.
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PHOTON DYNAMICS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED SEPTEMBER 30, 2001
TABLE OF CONTENTS
Page
PART I ........................................................................1
Item 1. Business ..............................................................1
Item 2. Properties ...........................................................12
Item 3. Legal Proceedings ....................................................12
Item 4. Submission of Matters to a Vote of Security Holders ..................13
PART II ......................................................................14
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters ..................................................14
Item 6. Selected Financial Data ..............................................15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ..........27
Item 8. Financial Statements and Supplementary Data ..........................28
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS ............................29
CONSOLIDATED BALANCE SHEETS ..................................................31
CONSOLIDATED STATEMENTS OF OPERATIONS ........................................32
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ..............................33
CONSOLIDATED STATEMENTS OF CASH FLOWS ........................................34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...................................36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure .............................................56
PART III .....................................................................57
Item 10. Directors and Executive Officers of the Registrant ..................57
Item 11. Executive Compensation ..............................................57
Item 12. Security Ownership of Certain Beneficial Owners and Management ......57
Item 13. Certain Relationships and Related Transactions ......................57
PART IV ......................................................................57
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K .....57
Signatures ...................................................................61
i.
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of a number of
factors, risks and uncertainties, including the risk factors set forth under the
caption "Factors Affecting Operating Results" in Part II Item 7 of this Form
10-K and elsewhere in this Form 10-K. Generally, the words "anticipate",
"expect", "intend", "believe" and similar expressions identify forward-looking
statements. The information included in this Form 10-K is as of the filing date
with the Securities and Exchange Commission and future events or circumstances
could differ significantly from the forward-looking statements included here.
PART I
Item 1. Business
Introduction
Photon Dynamics, Inc. (the "Company") is a leading provider of yield
management solutions to the flat panel display ("FPD") industry. The acquisition
of CR Technology, Inc. ("CR Technology") in November 1999, Photon Dynamics
Canada Inc., formerly known as Image Processing Systems Inc. ("IPS") in December
2000 and Intelligent Reasoning Systems, Inc. ("IRSI") in July 2001 complemented
our core capabilities of data acquisition, image analysis and systems
engineering. As a result, we also offer yield management solutions for the
printed circuit board ("PCB") assembly and advanced semiconductor packaging
industries and the cathode ray tube ("CRT") display and CRT glass and auto glass
industries. Our test, repair and inspection systems are used by manufacturers to
collect data, analyze product quality and identify and repair product defects at
critical steps in the manufacturing process.
Photon Dynamics, Inc. is a California corporation incorporated on March 1,
1983.
Industry Background
Advancing technology and increasing demand for connectivity among
electronic devices have promoted the development and growing use of increasingly
sophisticated mobile electronic devices, such as notebook computers, cellular
phones, personal digital assistants and portable video games. Consequently,
manufacturers of mobile electronic devices are continually seeking ways to
increase the performance and quality as well as reduce the size, weight and
power requirements of the components incorporated into these devices such as
displays, electronic assemblies and semiconductors. For stationary devices,
including desktop computer monitors and televisions, consumers have increasingly
demanded higher resolution and performance as well as reduced footprint, power
consumption and heat emission. In response to these market demands, the desktop
monitor and television industries have increasingly adopted FPDs as an
alternative to traditional CRT technology.
PCB assembly and advanced semiconductor packaging and CRT display and
glass manufacturers are seeking to improve the quality and reduce the cost of
their products by improving manufacturing yields and throughput. To do so, they
are increasing the use of more advanced test, repair and inspection equipment
and other yield management technologies.
The Flat Panel Display Industry
Growth in the mobile electronic devices market has driven the demand for
FPDs, which offer many advantages over CRTs for mobile applications. FPDs offer
reduced size, weight, power consumption and heat emission and better picture
quality. In addition to their dominance of high performance portable
applications, FPDs offer similar advantages for stationary display applications
even though they are currently more expensive than CRTs with comparable viewing
areas. As a result, FPDs have emerged as the dominant display technology for
mobile electronic devices and have also made inroads into stationary display
markets such as the desktop monitor and television markets.
1.
The highest performance FPD available today is the active matrix liquid
crystal display ("AMLCD") which produces full color images and operates at much
faster refresh rates than earlier passive monochrome liquid crystal displays.
The color capability, resolution, speed and picture quality of AMLCDs currently
make these displays a preferred choice for high performance portable computer,
multimedia and other applications requiring the display of video and graphics.
The AMLCD Manufacturing Process
The manufacture of AMLCDs is an extremely complex process, which has been
developed and refined for different panel sizes and resolutions through research
and development, pre-production prototyping and commercial production.
Manufacturing an AMLCD involves a series of three principal phases. The first
phase is to fabricate an array of thin-film transistors on a glass substrate
through a process which is essentially the same as that used to create
electronic circuitry on a semiconductor device. In a high-quality color AMLCD,
each pixel, the smallest addressable dot on the display, is represented by three
transistors, one for each of the display's primary colors, red, green and blue.
The second phase, cell assembly, involves attaching a color filter to the
transistor-embedded substrate and injecting liquid crystal material between the
color filter and the transistor array. The color filter enables the display to
attain color capability by selectively filtering out the light emissions from
each multi-color pixel array to produce the desired color mix in the displayed
image. At the cell assembly phase, each individual pixel is created through the
combination of transistors and the color filter. The third phase in the process,
module assembly, involves packaging the display and attaching the electronics
that will allow the device to display the text, graphics and video images
directed by the computer or other electronic systems to the AMLCD. This step
also involves sealing the FPD and installing the electronics that connect the
FPD to other electronic devices such as a computer.
The ability of FPD manufacturers to improve yields of AMLCDs and other
FPDs depends, in large part, on their ability to test and inspect displays both
during and upon completion of the manufacturing process and to use test and
inspection data to refine the manufacturing process. Through test and
inspection, the FPD manufacturer seeks to identify defects at an early stage in
the process to permit repair or to avoid wasting costly materials on continued
manufacturing of a defective product. In addition, systematized test and
inspection provides qualitative feedback to the FPD manufacturer and enables it
to address yield problems and to optimize the manufacturing process.
PCB Assembly and Advanced Semiconductor Packaging Industry
Just as the growing demand for increasingly sophisticated mobile and
interconnected electronic devices is driving the market for new display
technologies, this demand has caused electronics manufacturers to seek to reduce
the size, power consumption and cost of the other components contained in these
devices. Additionally, as the functionality and sophistication of mobile
electronic devices have increased, so has the complexity of their electronic
components. These factors are driving the development of smaller, denser and
more complex PCBs, the backplanes upon which semiconductors and other electronic
components are attached and interconnected. These factors are also contributing
to the development of advanced semiconductor packaging technologies.
As semiconductors continue to shrink and become more complex, an
increasing number of wire connectors, or leads, must be attached to the
semiconductor package. Ball grid array ("BGA") semiconductor packaging
technology was developed to address the problems associated with greater lead
counts required for advanced semiconductors. Because the leads in BGA
semiconductor packages are located under the package and, therefore, are not
visible after the package has been affixed to a PCB, the inspection of these
solder joints requires the use of alternatives to visual inspection technologies
such as X-ray inspection or ultrasound technologies. Furthermore, as the number
of leads on semiconductor packages continues to increase, inspection technology
must become more sophisticated and precise.
At the same time, electronic device original equipment manufacturers are
increasing their focus on core competencies and outsourcing the manufacture of
many components incorporated into their products. This trend has resulted in the
rapid expansion of the contract manufacturing industry. Increased competition is
causing contract manufacturers to focus on reducing costs while differentiating
themselves through improved quality. One way in which contract manufacturers may
reduce manufacturing costs is through yield improvements and increased
throughput, which may be achieved through increased and more sophisticated
inspection. Contract manufacturers
2.
are moving towards 100% inspection standards and adopting new inspection
technologies as they seek to provide high quality products while reducing costs.
Also, the contract manufacturing industry is characterized by shorter product
life cycles, a greater variety of products manufactured in smaller lot sizes and
high employee turnover rate. These factors require contract manufacturers to
adopt a flexible approach to manufacturing with inspection equipment that is
intuitive, easy to use and easily configured.
CRT Display, CRT Glass and Auto Glass Industry
Each TV, computer monitor and CRT must be inspected, adjusted and aligned
to ensure that its picture is focused, has the specified size and color, and is
properly positioned on the screen. Historically, inspection and adjustment have
been performed manually, using hand-held instruments and special templates.
Manual inspections and adjustments are a time-consuming and error-prone part of
the CRT display manufacturing process and require skilled operators and
technicians.
The need for improved yield and quality has also increased in the glass
components used in the manufacture of televisions and computer monitors. The two
major glass components for inspection are "face plate panels" (the front of the
television or computer monitor tube) and "funnels" (the funnel - shaped glass
component behind the faceplate).
Increased consumer demand for higher quality in automobiles has resulted
in automobile manufacturers insisting on more stringent quality specifications
for automotive glass, in addition to reducing the acceptable parts per million
(ppm) defect rate. Currently, the primary method of inspection is by the human
eye. However, human inspection is inconsistent, expensive and unable to collect
precise data to trace cause of defects and correct the process.
FPD Products
Our FPD yield management products include test, repair and inspection
equipment. Our test and inspection equipment can identify and characterize
defects at early stages of the manufacturing process so that the panels may be
repaired before the next stage or, if necessary, discarded, minimizing the loss
of time and materials. Our test, repair and inspection systems use similar
software-based controls, processing and graphical user interfaces. Products can
be networked together so that defect data can be stored, analyzed and used
throughout the manufacturing process. Our highly reliable systems are also
compatible with a variety of material handling automation systems.
FPD Array Test Equipment. Our ArrayChecker test systems detect, locate,
quantify and characterize electrical, contamination and other defects in AMLCDs
after array fabrication. The systems use our proprietary non-contact Voltage
Imaging technology to provide a high-resolution voltage map of the entire
display and our proprietary image analysis software converts this voltage map
into complete pixel defect data. The ArrayChecker test systems determine whether
individual pixels or lines of pixels are functional and also find more subtle
defects such as variations in individual pixel voltage. These defect data files
are then used for repair and statistical process control. Our software driven
ArrayChecker test systems can be configured rapidly for testing different panel
sizes relative to traditional systems that require a different probe card for
each panel size.
Our next-generation ArrayChecker 3000 test system, which we began shipping
in the fourth quarter of fiscal 2001, is an enhanced version of our earlier
array test products with improved Voltage Imaging sensors, image processing
software, graphical user interface and materials transport features. These
enhancements substantially increase the throughput and reliability of our array
test systems to provide throughput rates that are similar to or higher than
traditional probe card based systems while accommodating the largest glass plate
sizes currently anticipated in the industry. At the same time, our ArrayChecker
3000 test system provides substantially improved defect detection, while
continuing to provide the superior functionality, flexibility and cost-efficient
features of our earlier array test systems.
FPD Repair Equipment. Our ArraySaver repair systems utilize our
proprietary PixeLaser technology and BeamBlender multiple wavelength laser
technology to repair defects in FPDs during and after array fabrication. Our
3.
systems can use defect data files downloaded from our array test systems or
other test and inspection systems to automatically position the panel for
repair, thereby eliminating the time spent by operators locating defects.
The ArraySaver system includes a high-precision stage and a user-friendly
graphical user interface allowing for high throughput and the capability to
repair all current panel sizes. Our fast high-precision stage fully automates
the precise positioning of the plate for each successive repair, thereby
substantially increasing throughput. Our graphical user interface and software
supports semi-automated setup of repair programs for common types of defects so
that repairs can be executed rapidly and accurately. These programs provide a
series of actions that the system automatically executes to repair the
particular defect type.
FPD Inspection Equipment. Our PanelMaster inspection systems use our
proprietary MuraLook image analysis algorithms and N-Aliasing technology to
inspect FPD panels for visual defects after cell assembly and also during and
after module assembly. The system uses a high-resolution camera and a computer
workstation to quantitatively measure visual characteristics such as contrast,
luminance and color balance and to precisely locate and characterize line,
cluster, pixel and blemish defects. Inspection data generated by the system is
displayed on a video monitor for immediate interpretation and can be stored or
sent to a repair system to effect repairs. Our inspection system offers
different levels of resolution, functionality and flexibility to suit customers'
needs. The system is available either as a stand-alone unit or as a modular unit
that can be integrated with manufacturers' material handling equipment.
PCB Assembly and Advanced Semiconductor Packaging Products
We also offer a broad line of X-ray and optical systems for
non-destructive inspection of PCB assemblies and advanced semiconductor
packaging. Customers use these systems to detect and identify defects on PCB
assemblies and within advanced semiconductor packaging. Both our X-ray and
optical inspection product lines are based on our proprietary image processing
technology and are integrated with a graphical user interface designed for ease
of use on the production line. Our user-friendly, flexible configuration
interface is a critical feature for many of our customers whose manufacturing
operations must cope with fast turnaround, short production runs and workforces
with limited skills and high turnover rates. These products use a common
Windows-based computing platform and can be networked together to provide
factory and enterprise-wide access to product defect data. We offer fully
automated systems for use in high volume production lines and also offer lower
cost systems for use off the production line.
X-ray Inspection Equipment. Our CRX X-ray inspection systems provide an
effective, non-destructive means of verifying hidden solder connections such as
under BGA packages. These systems also verify connections such as die
attachments and wire bonds inside semiconductor packaging. Customers use the
sharp, high magnification images provided by these CRX systems to analyze
failures that cannot be detected by optical means. We offer a variety of CRX
systems to meet customer requirements for handler size, resolution,
magnification, power, pricing and other factors. PCB assembly manufacturers use
our systems to inspect the hidden solder connections between PCBs and BGA
devices. Semiconductor manufacturers use our systems to inspect for features
within advanced semiconductor packaging, including die attach, wire bond and
flip chip solder bump connections.
Optical Inspection Equipment. Our optical inspection systems inspect PCB
assemblies for defects either before or after the soldering step in the
manufacturing process. Many of the defects detected by our systems cannot be
detected electrically. Our family of systems inspect for component presence,
correct component, orientation, polarity, skew, solder integrity and other
defects. Our systems feature integrated cameras and lighting heads which pass
over the surface of the PCB, selecting different magnifications depending on the
size of the components. The 6000 system inspects sizes up to 20 by 20 inches on
the production conveyor line and delivers the most comprehensive defect
detection available. The 4000 and 6500 systems inspect sizes up to 18 by 20
inches with the 4000 providing comprehensive component, lead and solder-level
defect detection and the 6500 providing value-added inspection at an economic
price. The 7500 inspects sizes up to 17 by 19 inches and provides
high-resolution color imagery and the fastest set-up time of our optical
inspection systems.
Combined X-ray and Automated Optical Inspection Systems. Our XRV combined
X-ray and automated optical inspection equipment reduces handling, speeds
throughput and saves floor space by simultaneously inspecting both visible and
hidden features of PCB assemblies.
4.
CRT Display, CRT Glass and Auto Glass Products
CRT Display Inspection Equipment. Our optical inspection systems inspect
CRT displays for defects after module assembly. The family of systems uses
high-resolution cameras and a computer workstation to quantitatively measure
visual characteristics such as contrast, luminance and color balance and to
precisely locate and characterize defects. The 9200 system performs inspection
and alignment without the need for operators. The 8200 system performs a
comprehensive set of production line inspection and alignment tasks. The 7200
system is modular and performs a more limited set of inspection and alignment
tasks and the 5200 system is a portable, hand held unit. Our systems can perform
the same inspections and adjustments more quickly and more accurately than
traditional manual methods and can automatically direct operators of our systems
(who require minimal training and no special computer skills) through the
inspection and alignment process, resulting in increased inspection accuracy,
improved speed of production lines and reduced costs and higher productivity in
manufacturing. Simple interactive graphics ensure that operators of our systems
do not pass products that do not meet required specifications. All results can
be recorded for management reporting, quality control analysis and product
traceability and can be fully integrated with a manufacturer's management
information system.
CRT Glass Inspection Equipment. Our optical inspection systems inspect
either curved or flat CRT glass panels in a variety of sizes early in the
manufacturing process. Our systems detect and measure most glass defects,
including scratches, pits, blisters, bubbles and stones. This fully-automated,
non-contact, high-speed inspection system delivers improved product quality,
reduced costs, increased productivity and data for process improvement. Our
inspection systems are used to replace human inspection in detecting scratches
and pits on the glass surface as well as bubbles and stones within the glass.
Auto Glass Inspection Equipment. Our optical inspection systems inspect
either flat or curved auto glass panels in a variety of different shapes and
sizes. Flat glass inspection typically occurs after the cut-grind-wash
operations and curved glass inspection occurs at the end of the production line
but prior to the expensive operation of laminating. Our system detects and
measures a wide variety of glass defects including scratches, pits, bubbles and
stones. This integrated, turnkey solution including a precision conveyor
provides a yield management solution to increase productivity and results in
data for process improvement. Our systems combine imaging devices, along with
advanced image analysis, to provide for the automated inspection of auto glass
with greater inspection accuracy, throughput and data collection than obtained
by traditional human inspection.
Customers
We sell our products to FPD manufacturers, semiconductor manufacturers,
PCB manufacturers, CRT display manufacturers and CRT and auto glass
manufacturers. Most of our FPD customers are located in Japan, Taiwan and Korea,
where FPD production is concentrated. The installed customer base for our FPD
products includes eight out of the ten leading FPD manufacturers. The majority
of our PCB assembly and advanced semiconductor packaging customers are located
in the U.S. The majority of our CRT display manufacturers are in Japan, Taiwan,
Korea and China. The majority of our CRT and auto glass manufacturers are in
Europe and the U.S.
We derive most of our revenue from a small number of customers, and we
expect this to continue. During fiscal 2001, sales to three unaffiliated
customers, Quanta Display Inc., LG Philips LCD Co., Ltd. and Ishikawajima-Harima
Heavy Industries Co., Ltd. ("IHI"), each of whom are customers of our FPD
products, accounted for 14%, 14% and 13% of revenue, respectively. Sales of our
FPD products represented $38.3 million, $64.2 million and $31.6 million, or 54%,
68% and 51% of revenue, in fiscal 2001, 2000 and 1999, respectively. Sales of
our PCB assembly and advanced semiconductor packaging products represented $18.1
million, $18.0 million and $13.9 million, or 25%, 19% and 22% of revenue, in
fiscal 2001, 2000 and 1999, respectively. Sales of our CRT display and glass
products represented $14.7 million, $12.5 million and $16.6 million, or 21%, 13%
and 27% of revenue, in fiscal 2001, 2000 and 1999, respectively. See Note 11 of
Notes to Consolidated Financial Statements included in "Item 8. Financial
Statements and Supplementary Data" for a description of revenues from external
customers, profit and loss and total assets of our three reportable segments
(FPD products, PCB assembly and advanced semiconductor packaging products, and
CRT display and glass inspection products) during the last three years, as well
as revenues from external customers attributable to geographic areas.
5.
Sales and Service
We sell our products for the FPD industry directly to our customers in
Korea and Taiwan, and through our value-added reseller Ishikawajima-Harima Heavy
Industries Co., Ltd. ("IHI") in Japan. We sell our products for the CRT display
and glass industries directly, except in Japan where we use a sales
representative. We sell our products for the PCB assembly and advanced
semiconductor packaging markets primarily through sales representatives. We
service our products worldwide directly, except in Japan, where IHI services our
FPD products.
We generally sell to our PCB assembly and advanced semiconductor packaging
customers on net-30 day terms. For our FPD, CRT display and glass product
customers our terms are typically 80% to 90% of payment due upon shipment with
the remaining amount due upon final acceptance. We typically provide a limited
warranty on our products for a period of one year. Our field service personnel
provide customers with repair and maintenance services. As of September 30,
2001, we had 82 sales and service personnel, who were located as follows: 50 in
Asia, 26 in North America and 6 in Europe.
In the FPD, CRT display and CRT glass and auto glass markets, our sales
and marketing strategy is to provide our customers with increased manufacturing
yields and throughput, improved quality and greater overall efficiency in their
manufacturing process. In the PCB assembly and advanced semiconductor packaging
industries, we focus on high-end applications where our high-resolution,
advanced image processing and optical inspection technologies and products
provide our customers with product quality assurance capabilities. Our sales and
marketing strategy is also to focus on the rapidly expanding contract
manufacturing industry. Operating on narrow margins, contract manufacturers
compete by reducing costs and improving quality, as well as promoting their
advanced capabilities. These customers require flexible systems that are easy to
set up and cost-efficient.
Research and Development
The market for integrated yield management systems is characterized by
rapid and continuous technological development and product innovation. We
believe that it is necessary to maintain our competitive position through
continued and timely development of new products and enhancements to existing
products. Accordingly, we devote a significant portion of our personnel and
financial resources to research and development. Our research and development
expenses, consisting primarily of personnel, consultants and prototype
materials, were $17.1 million, $14.2 million and $8.1 million, or 24%, 15% and
13% of revenue, in fiscal 2001, 2000 and 1999, respectively. We also maintain
close relationships with our customers, which helps us to remain responsive to
their product needs.
We are focusing our current research and development for the FPD market on
increasing the performance of our array test, repair and inspection systems. Our
current research and development for the PCB assembly and advanced semiconductor
packaging markets is focused on increasing the performance, reliability and
functionality of our inspection systems, expanding the application of our
inspection systems for use in related markets and developing new optical
inspection products. Our current research and development for the CRT display,
CRT glass and auto glass markets is focused on increasing the performance,
reliability and functionality of our inspection systems.
Manufacturing and Suppliers
We manufacture our products for the FPD industry in San Jose, California,
our PCB assembly and advanced semiconductor packaging products in Aliso Viejo,
California and our CRT display, CRT glass and auto glass products in Markham,
Ontario, Canada. Our manufacturing activities consist primarily of final
assembly and test of components and subassemblies, which are purchased from
third party vendors.
We obtain certain of the equipment for our systems from a single source or
a limited group of suppliers. For example, we currently obtain material handling
platforms, ultra high-resolution cameras and high-speed image processing systems
for our FPD products from single source suppliers. We also currently obtain
X-ray equipment for our PCB assembly and advanced semiconductor packaging
products from limited source suppliers. Although we seek to reduce dependence on
our single source and limited group suppliers, alternative sources of supply for
such equipment may not be available or may be available on unfavorable terms.
The partial or complete loss of a single
6.
source or limited group of suppliers or any delay in shipment from a single
source or limited group of suppliers could at least temporarily harm our results
of operations and damage customer relationships. Further, a significant increase
in the price of one or more of such equipment could harm our results of
operations. To date we have not experienced the loss of any single source or
limited group of suppliers or any delays in shipment.
We schedule production based upon customer purchase orders and anticipated
orders during the planning cycle. We generally expect to be able to accept a
customer order, build the required machinery and ship to the customer within 16
weeks for our FPD and CRT glass and auto glass products and within 8 weeks for
our CRT display, PCB assembly and advanced semiconductor packaging products. We
maintain quality control through inspection of components, in-process inspection
during equipment assembly and final inspection and operation of all manufactured
equipment prior to shipment. Although we assemble some components and final test
our systems under limited clean room conditions, most of our manufacturing
occurs in standard manufacturing space.
Under the terms of our relationship with IHI, we have retained the
exclusive right to manufacture some critical components based on technology not
shared with IHI and to sell these components to IHI at prices that are mutually
established from time to time. IHI has the right to manufacture, assemble and
sell array test systems incorporating these components. To date, we have
manufactured all array test systems sold by IHI. Furthermore, IHI has sold
products only in its capacity as our value-added reseller in Japan.
Patents and Other Proprietary Rights
We protect our proprietary technology through various methods such as:
o patents and patent applications;
o trademarks;
o non-disclosure agreements; and
o trade secrets
We have filed and obtained a number of patents in the United States and
abroad and have also jointly filed patent applications in Japan with IHI. We
intend to continue to pursue the legal protection of our technology through
intellectual property laws.
As of October 24, 2001, we have been issued 48 U.S. patents, of which 45
are active. The expiration dates of these patents range from 2006 to 2021. There
are 15 pending U.S. patent applications. We have been issued 24 active non-U.S.
patents and there are 55 pending non-U.S. patent applications. With only one
exception, each non-U.S. patent is directly related to a counterpart U.S.
patent.
These patents and applications are relevant to our product technologies
including:
o LCD panel testing
o LCD panel inspection
o LCD panel repair
o CRT and auto glass inspection
o CRT display inspection
o PCB assembly and advanced semiconductor packaging inspection
There can be no assurance that patents will be issued from any of our
pending applications or that any claims allowed from existing or pending patents
will be sufficiently broad to protect our technology. There can be no assurance
that any patents held by us will not be challenged, invalidated or circumvented
or that rights granted thereunder will provide us competitive advantages. In
addition, there can be no assurance that we will be able to protect our
technology or that competitors will not be able to independently develop similar
or functionally competitive technology. Any invalidation of our intellectual
property rights could harm our business.
7.
Backlog
Our backlog consists of orders for which we have accepted purchase orders
and assigned shipment dates within the next twelve months. All orders are
subject to delay or cancellation with limited or no penalty to the customer.
Because of possible changes in product delivery schedules and cancellation of
product orders, among other factors, our backlog may vary significantly and, at
any particular date, is not necessarily indicative of actual sales for any
succeeding period. Our backlogs as of September 30, 2001 and 2000 were $31.5
million and $52.7 million, respectively.
Competition
The worldwide market for integrated yield management systems is highly
competitive. We face substantial competition in each of our operating segments
from established companies, many of which have greater financial, engineering
and manufacturing resources and have larger service organization and
long-standing customer relationships with key existing and potential customers.
We may also face future competition from new market entrants from other overseas
and domestic sources or if IHI elects to begin competing with us.
In the FPD industry, our competitors include Micronics Japan Corporation
in array testing, NEC, NTN Corporation and Hoya Corporation in array repair and
several competitors in the cell and module inspection market. In the X-ray
inspection market, our competitors include Nicolet Imaging Systems, Agilent
Technologies Inc. and Fein Focus. In the optical inspection market, our
competitors include GSI Lumonics Inc., Hewlett-Packard Company and Omron USA,
Inc. In the CRT display and CRT glass and auto glass industries, most of the
competition comes from potential customers who have developed their own internal
inspection systems.
We expect our competitors to continue to improve the design and
performance of their products and to introduce new products with competitive
price and performance characteristics. Our customers may choose to develop
proprietary technology that may obviate or lessen their need to purchase our
products. Moreover, increased competitive pressure may necessitate price based
competition, which could harm our business, financial condition and results of
operations.
We believe that we can compete effectively with our competitors by
building on our substantial installed customer base, providing technologically
superior, competitively priced products and continuing to emphasize our
easy-to-use user interfaces and customer support. However, realizing and
maintaining such advantages will require a continued high level of investment by
us in engineering, research and development, marketing and customer service and
support. We may not have sufficient resources to continue to make such
investments. Even if sufficient funds are available, we may not be able to make
the technological advances necessary to maintain such competitive advantages.
Employees
As of September 30, 2001, we employed 324 persons. No employees are
represented by a labor union or covered by a collective bargaining agreement. We
consider our relationships with our employees to be good.
Business Combinations
In December 2000, we acquired Photon Dynamics Canada Inc., formerly known
as Image Processing Systems Inc. ("IPS") in exchange for approximately 1,139,000
shares of our common stock with the acquisition accounted for as a pooling of
interests. IPS shareholders received 0.0447 exchangeable shares for each common
share of IPS held that can be exchanged into our common stock on a one-for-one
basis at any time within 5 years. In addition, all outstanding IPS stock options
were converted at the common stock exchange ratio into options to purchase our
common stock. We incurred $2.3 million in acquisition related charges consisting
primarily of legal, accounting and integration fees.
In July 2001, we acquired Intelligent Reasoning Systems, Inc. ("IRSI").
IRSI is a designer and seller of automated optical inspection ("AOI") systems
based on its proprietary adaptive knowledge-based technology. In
8.
connection with the acquisition we issued 699,010 shares of our common stock,
valued at $19.8 million at closing, made payments of approximately $1.4 million
related to costs of the transaction, assumed a warrant, fair valued at $534,000,
which upon closing of the acquisition and pursuant to the terms therein, became
exercisable for 28,766 shares of our common stock and assumed $12.3 million in
liabilities. For further details regarding our business combinations, please see
Note 3 of Notes to Consolidated Financial Statements.
9.
Executive Officers of the Registrant
Name Age Position
---- --- --------
Vincent F. Sollitto 53 President, Chief Executive Officer and Director
Richard L. Dissly 57 Chief Financial Officer and Secretary
William K. Pratt 64 Chief Technical Officer
Bernard T. Clark 57 Vice President and President, Flat Panel Display
Division
Bruce P. Delmore 40 Vice President and President, Electronics
Division
Jon R. Hopper 40 Senior Vice President, Sales and Support
Organization
Kenneth Wawrew 52 Vice President, Business Development
Jeffrey A. Hawthorne 43 Vice President and President Image Processing
Systems Division
Steve Song 46 Vice President, Sales
Vincent F. Sollitto has been Chief Executive Officer since June 1996 and
has been a member of our board of directors since July 1996. From August 1993 to
1996, he was the General Manager of Business Unit Operations for Fujitsu
Microelectronics Inc., a semiconductor and electronics company. From April 1991
to August 1993, he was the Executive Vice President of Technical Operations at
Supercomputer Systems, Incorporated. Prior to joining Supercomputer Systems,
Incorporated, Mr. Sollitto spent twenty-one years in various management
positions at International Business Machines Corporation, an information
technology service company, including Director of Technology and Process. Mr.
Sollitto serves as a director of Irvine Sensors Corp., a compact packages
technology company, Applied Films Corporation, a thin film deposition equipment
company and Ultratech Stepper, Inc., a photolithography equipment company. Mr.
Sollitto holds a B.S. degree in Electrical Engineering from Tufts College.
Richard L. Dissly has been Chief Financial Officer since November 1998. He
was appointed Secretary of the Company in October 1999. He was Chief Financial
Officer of Semaphore Communications, a network equipment provider, from January
1997 until October 1998 and Chief Financial Officer of CrossCheck Technology, an
electronics design automation company, from July 1992 until December 1996. He
currently serves on the board of directors of Nextest Systems, Inc.
Dr. William K. Pratt has been Chief Technical Officer since October 1996.
In 1993, Dr. Pratt founded Pixelsoft, Inc., an image processing software
development company, and served in various management and technical positions
until 1996. From 1988 through 1994, he was Director of Multimedia and Imaging
Technology at Sun Microsystems, Inc. Dr. Pratt holds five patents and is the
author of several books on image processing.
Bernard T. Clark has been Vice President and President, Flat Panel Display
Division since February 2001. From May 2000 to February 2001 he was Vice
President, Manufacturing and Field Operations. From 1995 until 2000, Mr. Clark
was the Director of Process and Product Assurance for IBM Storage Systems
Division, an information technology service company.
Bruce P. Delmore has been Vice President and President, Electronics
Division since August 2001. From August 1999 to August 2001 he was Vice
President of Marketing, Strategy and Business Development. He was President of
Strategos Group, a strategy consulting firm, from 1997 until 1999. From 1994
until 1997, Mr. Delmore held several executive positions including Director of
EDA and Strategic ASIC Development at Fujitsu Microelectronics, a semiconductor
and electronics company.
Jon R. Hopper has been Senior Vice President of Sales and Support
Organization since July 2001. From October 1998 to July 2001, Mr. Hopper was
Chief Executive Officer of Intelligent Reasoning Systems, Inc., a supplier of
capital equipment to the electronics manufacturing industry. From July 1997 to
October 1998, he served as Group Vice President for Electro Scientific
Industries ("ESI"), a supplier of capital equipment to the semiconductor and
electronics manufacturing industries. From January 1995 to July 1997, he served
as Chief Executive Officer of Dynamotion Corp. until Dynamotion was acquired by
ESI.
Kenneth Wawrew has been Vice President, Business Development since
November 2001. Mr. Wawrew joined the Company in December 2000 as Vice President
and President, Image Processing Division. From October 1995 to
10.
December 2000 he held various management positions at Photon Dynamics Canada
Inc., formerly known as Image Processing Systems ("IPS"), an optical inspection
company.
Jeffrey A. Hawthorne has been Vice President and President, Image
Processing Systems Division since November 2001. Mr. Hawthorne joined the
Company in 1991 and has held a series of other management positions including
Vice President, Development from September 1994 to November 2001.
Steve Song has been Vice President, Sales since August 1998. Mr. Song
joined the Company in April 1994 as the Korean Sales and Support Manager. He was
promoted to Director of Korean Operations in August 1995 and established the
Company's Korean subsidiary.
11.
Item 2. Properties
Our corporate headquarters are located in San Jose, California and consist
of a 52,000 square foot facility for FPD equipment manufacturing and operations.
We own an additional 22,000 square feet in San Jose, California for sales and
marketing and administration. We lease 19,700 square feet in Aliso Viejo,
California for PCB assembly and advanced semiconductor inspection equipment
manufacturing and operations. We lease 35,200 square feet in Austin, Texas for
PCB assembly and advanced semiconductor inspection equipment research and
development, sales, service and administration. We lease 50,000 square feet in
Markham, Ontario, Canada for CRT display, CRT glass and auto glass inspection
equipment manufacturing and operations. In addition, we lease office space for
our sales and service operations in Tokyo, Japan; Hsinchu, Taiwan; Seoul, Korea;
Surrey, England; Eindhoven, Netherlands and Beijing, China.
The table below summarizes information concerning our properties at
September 30, 2001:
Location Type Principal Use
-------- ---- -------------
San Jose, California....... Office, plant Corporate Headquarters, Research
and warehouse and Development, Manufacturing,
Sales and Marketing, Service and
Administration
San Jose, California....... Office Sales and Marketing and
Administration
Aliso Viejo, California.... Office, plant Research and Development,
and warehouse Manufacturing, Sales and Marketing,
Service and Administration
Austin, Texas.............. Office Research and Development, Sales,
Service and Administration
Markham, Ontario, Canada... Office, plant Research and Development,
and warehouse Manufacturing, Sales and Marketing,
Service and Administration
Tokyo, Japan............... Office Sales and Service
Hsinchu, Taiwan............ Office Sales and Service
Seoul, Korea............... Office Sales and Service
Surrey, England............ Office Sales and Service
Eindhoven, Netherlands..... Office Sales and Service
Beijing, China............. Office Sales and Service
Item 3. Legal Proceedings
We and certain of our directors and officers have been named as defendants
in a lawsuit captioned Amtower v. Photon Dynamics, Inc., No. CV797876, filed on
April 30, 2001 in the Superior Court of the State of California, County of Santa
Clara. The plaintiff in this action has purported to assert several causes of
action under state law arising out of the alleged misrepresentation and
enforcement of our insider trading policy and is seeking damages of
12.
approximately $17.7 million. While we intend to vigorously contest this action,
we cannot predict the outcome of this litigation. We believe that an adverse
determination in this litigation would not have a material adverse effect on our
financial condition or results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during the
quarter ended September 30, 2001.
13.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Common Stock Market Price
Our common stock commenced trading on the Nasdaq National Market on
November 15, 1995 under the symbol "PHTN." The closing price for our common
stock as reported by the Nasdaq National Market on September 28, 2001 was $23.15
per share. As of September 28, 2001, there were approximately 180 shareholders
of record of our common stock. The following table sets forth the high and low
sales prices of our common stock as traded on the Nasdaq National Market for the
periods indicated.
Fiscal 2001 Quarter ended December 31, 2000 March 31, 2001 June 30, 2001 September 30, 2001
- ------------------------- ----------------- -------------- ------------- ------------------
High $43.063 $27.625 $33.300 $39.970
Low $19.938 $16.875 $18.063 $22.010
Fiscal 2000 Quarter ended December 31, 1999 March 31, 2000 June 30, 2000 September 30, 2000
- ------------------------- ----------------- -------------- ------------- ------------------
High $43.250 $94.375 $78.375 $87.938
Low $20.125 $32.375 $43.750 $35.000
We have never declared or paid any cash dividends to our shareholders and
we have agreed not to pay cash dividends under our current bank line of credit.
We do not presently plan to pay cash dividends in the foreseeable future and
intend to retain any future earnings for reinvestment in our business.
In July 2001, we completed the acquisition of Intelligent Reasoning
Systems, Inc. ("IRSI"). IRSI is a designer and seller of automated optical
inspection ("AOI") systems based on its proprietary adaptive knowledge-based
technology. In connection with the acquisition, we issued 699,010 shares of our
common stock, valued at $19.8 million at closing, made payments of approximately
$1.4 million related to costs of the transaction, assumed a warrant, fair valued
at $534,000, which upon closing of the acquisition and pursuant to the terms
therein, became exercisable for 28,766 shares of our common stock and assumed
$12.3 million in liabilities. The shares were issued in reliance on Regulation D
promulgated under Section 4(2) of the Securities Act of 1933, in that the
recipients of the shares were accredited investors as defined in Regulation D,
and no general solicitation was made in connection with the transaction.
14.
Item 6. Selected Financial Data
The following selected consolidated financial data should be read in
conjunction with our Consolidated Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", which are included elsewhere in this report. The consolidated
statement of operations data for the years ended September 30, 2001, 2000 and
1999 and the consolidated balance sheet data as of September 30, 2001 and 2000
are derived from the consolidated financial statements included elsewhere in
this report. The consolidated statement of operations data for the years ended
September 30, 1998 and 1997 and the consolidated balance sheet data as of
September 30, 1999, 1998 and 1997 are derived from consolidated financial
statements not included in this report.
15.
Year ended September 30,
(in thousands, except per share data) 2001 2000 1999 1998 1997
- -------------------------------------------- --------- -------- -------- -------- --------
Statement of Operations Data:
Revenue .................................... $ 71,083 $ 94,757 $ 62,011 $ 41,061 $ 43,175
Income (loss) from operations .............. (11,522)(1) 12,554(2) 3,637 (4,843) (4,111)
Income (loss) before cumulative effect of
change in accounting principle .......... (6,567)(1) 13,535(2) 3,118 (4,617) (11,110)
Cumulative effect of change in accounting
principle ............................... (6,560)(3) -- -- -- --
Net income (loss) .......................... $ (13,127) $ 13,535(2) $ 3,118 $ (4,617) $(11,110)
Net income (loss) per share before
cumulative effect of change in accounting
principle:
Basic ...................................... $ (0.50)(1) $ 1.13(2) $ 0.31 $ (0.47) $ (1.18)
Diluted .................................... $ (0.50)(1) $ 1.04(2) $ 0.29 $ (0.47) $ (1.18)
Net income (loss) per share from cumulative
effect of change in accounting principle,
net of tax benefit:
Basic ...................................... $ (0.50) -- -- -- --
Diluted .................................... $ (0.50) -- -- -- --
Net income (loss) from operations per share:
Basic ...................................... $ (1.00)(1) $ 1.13(2) $ 0.31 $ (0.47) $ (1.18)
Diluted .................................... $ (1.00)(1) $ 1.04(2) $ 0.29 $ (0.47) $ (1.18)
Pro forma amounts with the change in
accounting principle related to revenue
recognition applied retroactively:
(unaudited)
Revenue .................................... $ 71,083 $ 91,722 (4) (4) (4)
Net income (loss) .......................... $ (6,567) $ 10,670 (4) (4) (4)
Net income (loss) per share:
Basic ...................................... $ (0.50) $ 0.89 (4) (4) (4)
Diluted .................................... $ (0.50) $ 0.82 (4) (4) (4)
Balance Sheet Data:
Cash, cash equivalents and short-term
investments ............................. $ 84,091 $102,726 $ 9,900 $ 7,503 $ 7,615
Working capital ............................ 99,707 126,042 25,179 13,028 20,710
Total assets ............................... 158,635 155,054 42,891 44,728 49,322
Shareholders' equity ....................... 143,308 131,800 29,335 21,755 30,532
(1) Includes non-recurring acquisition charges of $2.3 million and acquired
in-process research and development of $1.3 million in connection with the
acquisition of IRSI, as well as restructuring charges of $1.2 million and
amortization of intangibles of $239,000. Loss from operations, net loss,
basic and diluted loss per share would have been $6.4 million, $8.0
million, $ 0.61 and $ 0.61, respectively, excluding these charges.
(2) Includes non-recurring acquisition charges in connection with the
acquisition of Photon Dynamics Canada Inc., formerly known as Image
Processing Systems Inc. ("IPS") of $860,000. Income from operations, net
income, basic and diluted net income per share would have been $13.4
million, $14.4 million, $1.20 and $1.10, respectively, excluding these
charges.
(3) We recorded a non-cash charge of $6.6 million, net of tax, or $0.50 per
diluted share, to reflect the cumulative effect of an accounting change as
of October 1, 2000 related to the adoption of Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements ("SAB 101").
(4) Data is not determinable in sufficient detail to provide pro forma
information for this year.
16.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of a number of
factors, risks and uncertainties, including the risk factors set forth in this
discussion and elsewhere in this Form 10-K. Generally, the words "anticipate",
"expect", "intend", "believe" and similar expressions identify forward-looking
statements. The information included in this Form 10-K is as of the filing date
with the Securities and Exchange Commission and future events or circumstances
could differ significantly from the forward-looking statements included here.
The following discussion and analysis should be read in conjunction with
the Selected Financial Data and the Consolidated Financial Statements and
related Notes thereto of Photon Dynamics appearing elsewhere in this report.
Overview
We are a leading provider of yield management solutions to the flat panel
display ("FPD") industry and offer yield management solutions for the printed
circuit board ("PCB") assembly and advanced semiconductor packaging and CRT
display and CRT glass and auto glass industries. Our PCB products and advanced
semiconductor packaging inspection products are collectively referred to as our
"semiconductor inspection products". Our test, repair and inspection systems are
used by manufacturers to collect data, analyze product quality and identify and
repair product defects at critical steps in the manufacturing process.
In November 1999, we acquired CR Technology, Inc. This acquisition
complemented our core capabilities of data acquisition, image analysis and
systems engineering and enables us to broaden our product line to offer yield
management solutions to the PCB assembly and advanced semiconductor packaging
markets. Prior to the acquisition, we derived revenue primarily from sales of
FPD products to customers in Japan, Taiwan and Korea where FPD production is
concentrated.
In December 2000, we acquired Photon Dynamics Canada Inc., formerly known
as Image Processing Systems Inc. ("IPS"), a Canadian company. This acquisition
strengthened our ability to deliver market-leading yield management solutions to
the CRT display and glass industry and we expect significant synergies that will
benefit our customers.
In July 2001, we acquired Intelligent Reasoning Systems, Inc. ("IRSI"), a
privately held company. IRSI manufactures in-line, advanced optical inspection
equipment for the electronic manufacturing markets. This acquisition has further
expanded our product portfolio for the PCB assembly electronics market utilizing
patented knowledge based software.
We continue to derive the majority of our revenue from a small number of
customers in the FPD industry. Our top four customers, each of whom are
customers of our FPD products, accounted for 50% of our revenue in fiscal 2001.
We obtain revenue from the FPD industry through direct sales in Korea and Taiwan
and a value-added reseller in Japan. We obtain revenue from the CRT display and
glass industry through direct sales except in Japan where we use a sales
representative. We obtain revenue from the PCB assembly and advanced
semiconductor packaging industry primarily through sales representatives. Sales
of our FPD products represented $38.3 million, $64.2 million and $31.6 million,
or 54%, 68% and 51% of revenue, in fiscal 2001, 2000 and 1999, respectively.
Sales of our PCB assembly and advanced semiconductor packaging products
represented $18.1 million, $18.0 million and $13.9 million, or 25%, 19% and 22%
of revenue, in fiscal 2001, 2000 and 1999, respectively. Sales of our CRT
display and glass products represented $14.7 million, $12.5 million and $16.6
million, or 21%, 13% and 27% of revenue, in fiscal 2001, 2000 and 1999,
respectively.
The fiscal 2001 financial statements reflect our adoption of SAB 101,
discussed below in "Impact of Staff Accounting Bulletin Number 101 ("SAB 101")".
Without giving effect to SAB 101, revenue decreased 21% to $74.9 million in
fiscal 2001 from $94.8 million in fiscal 2000 and the net loss was $3.8 million
or $0.28 per share in fiscal 2001 compared to net income of $13.5 million or
$1.04 per share, as restated in fiscal 2000.
17.
Results of Operations
Fiscal Years Ended September 30, 2001, 2000 and 1999
The following table sets forth, for the periods indicated, the percentage
of revenue of certain items in our Consolidated Statement of Operations:
Year ended September 30, 2001 2000 1999
- ----------------------------------------------------------- -------- -------- --------
Revenue ................................................... 100.0% 100.0% 100.0%
Cost of revenue ........................................... 59.2 53.4 55.5
-------- -------- --------
Gross margin .............................................. 40.8 46.6 44.5
Operating expenses:
Research and development ............................... 24.1 15.0 13.1
Selling, general and administrative .................... 25.8 17.5 25.5
Non-recurring acquisition charges ...................... 3.2 0.9 --
Acquired in-process research and development ........... 1.9 -- --
Restructure charges .................................... 1.7 -- --
Amortization of intangibles ............................ 0.3 -- --
-------- -------- --------
Total operating expenses ............................ 57.0 33.4 38.6
Income (loss) from operations ............................. (16.2) 13.2 5.9
Interest income and other, net ............................ 7.0 4.5 0.2
-------- -------- --------
Income (loss) before income taxes and cumulative effect of
change in accounting principle ......................... (9.2) 17.7 6.1
Provision for income taxes ................................ -- 3.4 1.1
-------- -------- --------
Income (loss) before cumulative effect of change in
accounting principle ................................... (9.2) 14.3 5.0
Cumulative effect of change in accounting principle, net of
tax benefit ............................................ (9.3) -- --
-------- -------- --------
Net income (loss) ......................................... (18.5%) 14.3% 5.0%
======== ======== ========
Revenue. Revenue decreased 25% to $71.1 million in fiscal 2001 from $94.8
million in fiscal 2000. Revenue in fiscal 2000 increased 53% to $94.8 million
from $62.0 million in fiscal 1999. Sales of FPD products represented $38.3
million, $64.2 million and $31.6 million, or 54%, 68% and 51% of revenue, in
fiscal 2001, 2000 and 1999, respectively. The decrease in revenue in fiscal 2001
as compared to fiscal 2000 was due primarily to the general economic slowdown
resulting in reduced capital spending by FPD manufacturers and to a lesser
extent to the impact of the application of SAB 101 in fiscal 2001. The increase
in revenue in fiscal 2000 over fiscal 1999 was primarily attributable to
increased capital spending by FPD manufacturers as a result of improved economic
conditions in Asia and increased demand for flat panel displays. Sales of our
PCB assembly and advanced semiconductor inspection products represented $18.1
million, $18.0 million and $13.9 million, or 25%, 19% and 22% of revenue, in
fiscal 2001, 2000 and 1999, respectively. Revenue was unchanged in fiscal 2001
as compared to fiscal 2000 as reduced sales in X-ray systems due to competitive
pressures were offset by sales of next generation optical inspection systems.
The increase in revenue during fiscal 2000 as compared to fiscal 1999 was
attributable to increased sales of X-ray and optical inspection systems. Sales
of our CRT display and glass products represented $14.7 million, $12.5 million
and $16.6 million, or 21%, 13% and 27% of revenue, in fiscal 2001, 2000 and
1999, respectively. The increase in revenue in fiscal 2001 as compared to fiscal
2000 was related to increased sales of CRT display products. The decrease in
revenue in fiscal 2000 as compared to fiscal 1999 was due to the decline in the
growth of the CRT market.
18.
Gross Margin. Gross margin decreased to 41% in fiscal 2001 from 47% in
fiscal 2000 and 45% in fiscal 1999. The decrease in gross margin in fiscal 2001
as compared to fiscal 2000 is due to manufacturing inefficiencies resulting from
the decrease in revenues and lower manufacturing volumes. The increase in gross
margin in fiscal 2000 as compared to fiscal 1999 was primarily attributable to
increased capacity utilization resulting from higher production volume. Gross
margin from FPD products decreased to 41% in fiscal 2001 from 48% in fiscal 2000
and 42% in fiscal 1999. The change in gross margin was largely related to higher
capacity utilization in fiscal 2000 as compared to fiscal 2001 and fiscal 1999.
Gross margin from PCB assembly and advanced semiconductor inspection products
decreased to 41% in fiscal 2001 from 44% in fiscal 2000 and 47% in fiscal 1999.
The decrease in gross margin from semiconductor inspection products in fiscal
2001 and 2000 compared to fiscal 1999 was primarily due to competitive pricing
pressures on our X-ray inspection systems. Gross margin from CRT display and
glass products decreased to 40% in fiscal 2001 compared to 42% in fiscal 2000
and 47% in fiscal 1999. The decrease in gross margin from CRT display and glass
products in fiscal 2001 and fiscal 2000 compared to fiscal 1999 was primarily
due to a less favorable sales mix with increased sales of products with lower
gross margins.
Research and Development. Research and development expenses were $17.1
million, $14.2 million and $8.1 million, or 24%, 15% and 13% of revenue, in
fiscal 2001, 2000 and 1999, respectively. The increase in research and
development expenses in fiscal 2001 compared to fiscal 2000 was primarily
attributable to our investment in personnel, consultants and prototype materials
for the development of our ArrayChecker 3000 and ArraySaver-520 products. Also,
in fiscal 2001, we started work on our next generation cell and module
inspection system which increased research and development expenses by $571,000.
The increase in research and development expenses in fiscal 2000 compared to
fiscal 1999 was primarily attributable to our investment in personnel,
consultants and prototype materials for the development of our ArrayChecker 2000
and XRV Combo Inspection Systems that were introduced in the last half of fiscal
2000.
Selling, General and Administrative. Selling, general and administrative
expenses were $18.3 million, $16.5 million and $15.8 million, or 26%, 18% and
26% of revenue, in fiscal 2001, 2000 and 1999, respectively. The increase in
selling, general and administrative expenses in fiscal 2001 compared to fiscal
2000 was mainly attributable to increased labor and related expenses after the
acquisition of IRSI. The increase in selling, general and administrative
expenses in fiscal 2000 compared to fiscal 1999 was attributable to the
establishment of a Taiwan sales and customer support office, higher selling
related expenses associated with increases in orders and revenue and our
investment in additional personnel to expand our Asia customer support
capability.
Non-Recurring Acquisition and Other Charges. During the fourth quarter of
fiscal 2001 Photon Dynamics was restructured, which included a reduction in
force and a reorganization of our divisions. This resulted in restructuring
charges of $1.2 million for employee-related costs and other expenses which were
the result of several initiatives. First, as we completed the integration of
IRSI into our Electronics Division, efficiencies were realized in that business.
Second, in connection with our restructuring, we believed that significant
savings would be achieved in the sales and service organization and related
expenses. Third, in our continuing strategy for controlling costs, we downsized
our capacity to current shipment levels. In November 1999, we acquired CR
Technology, Inc., in exchange for approximately 1,835,000 shares of our common
stock. This acquisition was accounted for as a pooling of interests. In
connection with this acquisition we incurred $860,000 in professional fees
consisting of legal, accounting and investment banking fees. In December 2000,
we acquired Photon Dynamics Canada Inc., formerly known as Image Processing
Systems Inc. ("IPS"), in exchange for approximately 1,139,000 shares of our
common stock. This acquisition was also accounted for as a pooling of interests.
We incurred $2.3 million in professional fees consisting of legal, accounting
and integration costs in connection with the acquisition of IPS. In July 2001,
we completed the acquisition of Intelligent Reasoning Systems, Inc. ("IRSI") in
which we issued 699,010 shares of our common stock, assumed a warrant, fair
valued at $534,000, which upon closing of the acquisition and pursuant to the
terms therein, became exercisable for 28,766 shares of our common stock and paid
approximately $13.8 million in cash ($8.1 million paid as of the date of the
acquisition and $5.7 million paid for assumed liabilities since the date of the
acquisition). The purchase price has been allocated in accordance with Statement
of Financial Accounting Standards No. 141 ("FAS 141") and the excess of the
purchase price over the fair value of the identifiable assets has been allocated
to goodwill, intangible assets and the in-process research and development in
the amount of $22.7 million, $4.7 million and $1.3 million respectively. The
identified intangible assets (other than goodwill) of $4.7 million are being
amortized over a three to five year period. We have recorded amortization of
intangibles of $239,000 for the year ended September 30, 2001.
Purchased In-Process Research and Development. Purchased in-process
research and development, or IPRD, of $1.3 million in fiscal 2001 represents the
write-off of in-process technology associated with our acquisition of
19.
IRSI. At the time of the acquisition, IRSI was in the process of developing an
intelligent optical inspection technology for their printed wire assembly
market. As this product had not reached technological feasibility at the
acquisition date all costs associated with its purchase must be written-off.
We used available information to calculate the amounts allocated to IPRD.
In calculating IPRD, we used established valuation techniques accepted in the
high-technology industry. These calculations gave consideration to relevant
market sizes and growth factors, expected industry trends, the anticipated
nature and timing of new product introductions by us and our competitors,
individual product sales cycles and the estimated lives of each of the products'
underlying technology. The value of the IPRD reflects the relative value and
contribution of the acquired research and development. We used a discount rate
of 25% to compute the net present value of the future cash flows for the purpose
of determining the value attributed to IPRD. We also gave consideration to the
IPRD's stage of completion.
We expect to continue the development of the technology and derivative
commercial products and believe that there is a reasonable chance of
successfully completing these development efforts. There is, however, risk
associated with the completion of the in-process projects, and there can be no
assurance that any project will achieve either technological or commercial
success.
Interest Income and Other, Net. Interest income and other, net consists
primarily of interest income and expense, foreign currency exchange gains and
losses and other miscellaneous income and expense. Interest income and other,
net was $5.0 million, $4.2 million and $154,000 in fiscal 2001, 2000 and 1999,
respectively. The increase in interest income and other, net in fiscal 2001 and
2000 compared to fiscal 1999 was primarily attributable to interest income
earned on higher cash and investment balances as a result of the net proceeds
from a public offering in February 2000.
Provision for Income Taxes. The fiscal 2001, 2000 and 1999 effective tax
rates were 0%, 19% and 18%, respectively. The effective tax rate in fiscal 2001,
2000 and 1999 is lower than the statutory rate due to the utilization of net
operating losses and tax credit carryforwards.
Impact of Staff Accounting Bulletin Number 101 ("SAB 101")
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, Revenue Recognition in Financials Statements
("SAB 101"). The SEC addressed several issues in SAB 101, including the timing
of revenue recognition for sales that involve contractual customer acceptance
provisions and installation of the product if these events occur after shipment
and transfer of title. Our previous revenue recognition policy was to recognize
revenue at the time the customer takes title to the product, generally at the
time of shipment. In October 2000, the SEC issued Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements -- Frequently Asked Questions
and Answers ("SAB FAQ"), which clarifies many of the implementation questions
surrounding SAB 101.
We derive revenue from the following sources: equipment sales and spare
part sales.
We changed our revenue recognition policy effective October 1, 2000 based
on guidance provided in SAB 101. We recognize revenue when persuasive evidence
of an arrangement exists, delivery has occurred or services have been rendered,
the selling price is fixed or determinable and collectibility is reasonably
assured.
Certain of our product sales in our FPD and CRT display and glass
inspection products segments are accounted for as multiple-element arrangements.
If we have met defined customer acceptance experience levels with the specific
type of equipment, we recognize revenue for a portion of the total contract
price due and billable upon shipment, with the remainder when it becomes due
(generally upon acceptance). All other product sales with the customer
acceptance provisions are recognized upon customer acceptance. Revenue from the
sale of our PCB assembly and advanced semiconductor inspection products is
generally recognized upon shipment, as such product sales are not subject to
customer acceptance holdbacks. Revenue from the sale of spare parts is
recognized upon shipment. The adoption of SAB 101 had no impact on the revenue
recognition policy for the sale of spare parts or PCB assembly and advanced
semiconductor inspection products.
20.
We have reported this change in accounting principle in accordance with
APB Opinion No. 20, Accounting Changes ("APB 20"), as a cumulative effect
adjustment. Because we are adopting SAB 101 in the fourth quarter, no cumulative
effect of the change is included in net income in the fourth quarter. Instead,
APB 20 requires that the change be made as of the beginning of the year and that
financial information for interim periods of fiscal 2001 reported prior to the
change, be restated by applying SAB 101 to those periods.
In accordance with guidance provided in SAB 101, we recorded a non-cash
charge of $6.6 million, or $0.50 per share in fiscal 2001, to reflect the
cumulative effect of the accounting change as of the beginning of fiscal 2001.
The decrease in net income before the cumulative effect of the accounting change
as a result of the adoption of SAB 101 amounted to $2.9 million or $0.22 per
diluted share for fiscal 2001.
The deferred revenue balance as of October 1, 2000 was $8.4 million. This
amount is comprised of final holdback amounts of 10-20% on equipment that was
shipped for which final installation and acceptance had not occurred as of
October 1, 2000. Of this amount, $3.5 million was recognized as revenue in
fiscal 2001. The pro forma amounts presented in the income statement were
calculated assuming the accounting change was retroactively applied to prior
periods.
Liquidity and Capital Resources
We have financed our growth primarily by a combination of cash flows from
operations, public stock offerings, lines of credit and loans. Working capital
was $99.7 million as of September 30, 2001 compared to $126.0 million as of
September 30, 2000. A major component of working capital is $84.1 million of
cash, cash equivalents and short-term investments as of September 30, 2001
compared to $102.7 million as of September 30, 2000.
Operating Activities. Cash used in operating activities was $4.9 million
in fiscal 2001, while cash provided by operating activities was $9.1 million and
$950,000 in fiscal 2000 and 1999, respectively. The decrease in cash provided by
operating activities in fiscal 2001 compared to fiscal 2000 was primarily due to
the loss from operations and the decrease in accounts payable and other current
liabilities. This was offset in part by a $15.0 million decrease in accounts
receivable due to reduced sales. The increase in cash provided by operating
activities in fiscal 2000 compared to fiscal 1999 was primarily due to increased
net income and increases in accounts payable and other current liabilities
offset in part by increases in accounts receivable and inventories.
Investing Activities. Cash provided by investing activities was $8.3
million in fiscal 2001, while cash used in investing activities was $94.6
million and $3.4 million in fiscal 2000 and 1999, respectively. The increase in
cash provided by investing activities in fiscal 2001 compared to fiscal 2000 was
mainly due to the liquidation of investments to fund the purchase of a new
building and the acquisition of IRSI. In July 2001 we completed the acquisition
of IRSI in which we issued shares of our common stock and paid approximately
$13.8 million in cash ($8.1 million paid as of the date of the acquisition and
$5.7 million paid for assumed liabilities since the date of the acquisition).
The decrease in cash provided by investing activities in fiscal 2000 compared to
fiscal 1999 primarily represented the investment of funds received from our
public common stock offering in February 2000. Capital expenditures were $9.2
million, $2.7 million and $1.0 million in fiscal 2001, 2000 and 1999,
respectively. The increase in capital expenditures in fiscal 2001 as compared to
fiscal 2000 was for the purchase of a new building and other equipment to
support our operations. The increase in capital expenditures in fiscal 2000 as
compared to fiscal 1999 was primarily for computers, equipment and leasehold
improvements to support our expansion.
Financing Activities. Cash provided by financing activities was $3.8
million, $88.7 million and $4.3 million in fiscal 2001, 2000 and 1999,
respectively. The increase in cash provided by financing activities in fiscal
2000 compared to fiscal 2001 and fiscal 1999 was mainly due to our public common
stock offering. In February 2000, we completed a public offering of 2,000,000
shares of our common stock. We sold approximately 1,321,000 shares of our common
stock, and approximately 679,000 shares were sold by one of our shareholders. We
received proceeds of approximately $68.0 million, net of issuance costs, from
the offering. In March 2000, we received additional proceeds of approximately
$15.6 million as a result of the underwriters exercising their over-allotment
option. Photon Dynamics Canada Inc., formerly known as Image Processing Systems
Inc. ("IPS"), completed a special warrant financing in December of 1999 and
received net proceeds of approximately $3.0 million. In
21.
addition, IPS received a repayable loan from the Canadian government of $209,000
in fiscal 1999 and $312,000 in fiscal 2000.
We have a borrowing capacity of $4.0 million available under a bank line
of credit that expires in March 2002. The line of credit is secured by
substantially all of our assets and contains certain financial and other
covenants. At September 30, 2001, no amounts were outstanding under the line of
credit.
We believe that existing liquid capital resources and funds generated from
operations combined with the ability, if necessary, to borrow funds will be
sufficient to meet our operating and capital requirements and obligations for at
least the next twelve months. We believe that success in our industry requires
substantial capital in order to maintain the flexibility to take advantage of
opportunities as they may arise. We may, from time to time, invest in or acquire
complementary businesses, products or technologies and may seek additional
equity or debt financing to fund such activities. There can be no assurance that
such funding will be available to us on commercially reasonable terms. The sale
of additional equity or convertible debt could result in dilution to our
shareholders.
Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No.144, Impairment of long-lived Assets ("FAS
144"). FAS 144 supercedes Statement of Financial Accounting Standards No.121,
Accounting for the Impairment of long-lived Assets and for long-lived Assets to
be disposed of ("FAS 121"). FAS 144 retains the requirements of FAS 121 to (a)
recognize an impairment loss only if the carrying amount of a long-lived asset
is not recoverable from its undiscounted cash flows and (b) measure an
impairment loss as the difference between the carrying amount and the fair value
of the asset. FAS 144 removes goodwill from its scope. FAS 144 is applicable to
financial statements issued for fiscal years beginning after December 15, 2001,
or for our fiscal year ended September 30, 2003. The adoption is not expected to
have any material adverse impact on our financial position or results of our
operations.
Factors Affecting Operating Results
Fluctuations in Operating Results
We have experienced and expect to continue to experience significant
fluctuations in our quarterly results. Our backlog at the beginning of each
quarter does not necessarily determine actual sales for any succeeding period. A
substantial percentage of our revenue is derived from the sale of a small number
of FPD yield management systems ranging in price from $400,000 to $1.5 million.
Therefore, the timing of the sale of a single system could have a significant
impact on our quarterly results. Moreover, customers may cancel or reschedule
shipments, and production difficulties could delay shipments. Other factors
which may influence our operating results in a particular quarter include:
o the timing of the receipt of orders from major customers;
o product mix;
o competitive pricing pressures;
o continued or worsened financial markets or economic instability in
Asia or the world in general;
o the relative proportions of domestic and international sales;
o our ability to design, manufacture and introduce new products on a
cost-effective and timely basis;
o the delay between expenses to further develop marketing and service
capabilities;
o the realization of benefits from those improved capabilities; and
22.
o the introduction of new products by our competitors.
Customer Concentration
The FPD industry is extremely concentrated with a small number of
manufacturers producing the majority of the world's FPDs. Sales of FPD products
represented 54%, 68% and 51% of revenue in fiscal 2001, 2000 and 1999,
respectively. LG Phillips LCD Co., Ltd., Samsung America, Inc., IHI and Quanta
Display Inc., each of whom are customers of our FPD products, collectively
accounted for 50% of revenue in fiscal 2001. Samsung America, Inc., LG Phillips
LCD Co., Ltd., Unipac Optoelectronics Corporation and Hyundai Electronics
Industries Co., LTD, each of whom are customers of our FPD products,
collectively accounted for 59% of revenue in fiscal 2000. IHI, Samsung America,
Inc. and LG Philips LCD Co. Ltd., each of whom are customers of our FPD
products, collectively accounted for 41% of revenue in fiscal 1999. If one or
more of our major customers ceased or significantly curtailed their purchases,
our results of operations would be harmed.
Flat Panel Display Industry Volatility
Our business depends in large part on capital expenditures by FPD
manufacturers, which in turn depend on the current and anticipated market demand
for FPDs and products that use FPDs. The FPD industry is highly cyclical and has
experienced periods of oversupply resulting in significantly reduced demand for
capital equipment. The FPD industry experienced a downturn in 1998 and 2001,
which led many FPD manufacturers to delay or cancel capital expenditures. More
recently, due to the deteriorating economic environment, FPD manufacturers have
decreased capital expenditures, resulting in steadily declining revenues over
the past four quarters. Our ability to increase our revenues in this market is
directly tied to existing economic conditions. There can be no assurance that
the FPD industry will not experience further downturns or slowdowns in the
future, which may harm our business and operating results. In addition, the need
to invest in the engineering, research and development and marketing required to
penetrate targeted foreign markets and maintain extensive service and support
capabilities limits our ability to reduce expenses during such downturns.
International Operations
Sales to countries other than the United States accounted for 79% of
revenue in fiscal 2001, 82% of revenue in fiscal 2000 and 78% of revenue in
fiscal 1999. We expect sales to these countries to continue to represent a
significant percentage of revenue. A number of factors may adversely affect our
international sales and operations, including:
o imposition of governmental controls;
o fluctuations in the U.S. dollar, which could increase the foreign
sales prices of our products in local currencies;
o export license requirements;
o restrictions on the export of technology;
o political instability;
o trade restrictions;
o changes in tariffs; and
o difficulties in staffing and managing international operations.
In 1998 and 2001, many Asian countries experienced an economic recession
that resulted in a decline in the purchasing power of our Asian customers. A
future downturn in economic conditions in Asia could result in our customers
failing to place new orders for our products. There can be no assurance that
such factors will not
23.
adversely impact our operations in the future. In addition, the laws of certain
foreign countries may not protect our intellectual property rights to the same
extent as U.S. laws.
Key Suppliers
We obtain certain of the equipment for our systems from a single source or
a limited group of suppliers. For example, we currently obtain materials
handling platforms, ultra high-resolution cameras and high-speed image
processing systems for our FPD products from single source suppliers, one of
which is experiencing financial difficulties and may cease operations, in which
case our ability to manufacture our FPD products would be significantly impaired
for a number of months. We also currently obtain X-ray equipment for our PCB
assembly and advanced semiconductor packaging products from limited source
suppliers. Although we seek to reduce dependence on our sole and limited source
suppliers, alternative sources of supply for such equipment may not be available
or may be available on unfavorable terms. The partial or complete loss of our
sole and limited source suppliers could at least temporarily harm our results of
operations and damage customer relationships. Further, a significant increase in
the price of one or more of such equipment could harm our results of operations.
Japanese Market and Competition
We believe that competing Japanese companies in the FPD industry have a
competitive advantage in Japan because of the preference of some Japanese
customers for local equipment suppliers. Historically, foreign companies have
found it difficult to penetrate the Japanese market and often depend upon local
sales channels to sell their products in Japan.
Since June 1997, we have depended on IHI as our exclusive value-added
reseller to sell our FPD products in Japan. We anticipate that this relationship
will continue in the future. In fiscal 2001, 2000 and 1999, 13%, 6% and 13% of
our revenue came from sales to IHI, respectively. If IHI reduced the resources
allocated to the development, systems construction, customization, sale and
support of our FPD products in Japan, our business would be harmed.
In addition, IHI's rights to continue as our exclusive value-added
reseller in Japan are currently unresolved. IHI may have the right to market
some or all of our products in Japan on an exclusive basis, even as to us. If
so, we may not be able to compete effectively in Japan. Although IHI must
purchase certain critical components from us, IHI may manufacture competing
array test systems based on our technology. If this occurs, our business could
be harmed.
We have granted IHI the non-exclusive right to manufacture and sell array
test systems based on our technology, excluding technology incorporated into
some critical components, in Korea, Taiwan and several other countries. Although
IHI has never manufactured these products, nor sold these products in countries
other than Japan, our business could be harmed if IHI manufactures and sells
array test systems in competition with our own in these countries.
Competition
The FPD, PCB assembly and advanced semiconductor packaging, CRT display
and CRT glass and auto glass industries are highly competitive. We face
substantial competition from established competitors that have greater
financial, engineering and manufacturing resources than us and have larger
service organizations and long-standing customer relationships. Our competitors
can be expected to continue to improve the design and performance of their
products and to introduce new products with competitive price/performance
characteristics. Competitive pressures may force price reductions that could
harm our results of operations. Our customers may also develop technology and
equipment which may reduce or eliminate their need to purchase our products.
Although we believe we have certain technological and other advantages over our
competitors, maintaining and capitalizing on these advantages will require us to
continue a high level of investment in engineering, research and development,
marketing and customer service support. There can be no assurance that we will
have sufficient resources to continue to make these investments or that we will
be able to make the technological advances necessary to maintain such
competitive advantages.
24.
New Products and Processes
We believe that our future success will depend in part upon our ability to
continue to enhance our existing products and to develop and manufacture new
products. For example, the size of FPD substrates and resolution of FPDs have
changed frequently and may continue to change requiring us to redesign or
reconfigure our FPD products. In addition, a substantial portion of our revenue
is derived from sales of products based upon active matrix liquid crystal
display ("AMLCD") technology. An industry shift away from AMLCD technology to
existing or new competing technologies could reduce the demand for our products
and harm our business.
Similarly, as semiconductors, PCBs and semiconductor packaging, CRT
display and glass technologies have become more complex, our wholly owned
subsidiaries, CR Technology, Inc., Intelligent Reasoning Systems, Inc. and
Photon Dynamics Canada Inc., formerly known as Image Processing Systems Inc.,
have been forced to continually redefine their product offerings.
As a result, we expect to continue to incur significant research and
development costs. There can be no assurance that we will be successful in the
introduction, marketing and cost effective manufacture of any of our new
products; that we will be able to timely develop and introduce new products and
enhance our existing products and processes to satisfy customer needs or achieve
market acceptance; or that the new markets for which we are developing new
products or expect to sell current products will develop sufficiently. To
develop new products successfully, we depend on close relationships with our
customers and the willingness of those customers to share information with us.
The failure to develop products and introduce them successfully and in a timely
manner could harm our competitive position and results of operations.
Key Employees
Our future success depends in part on our ability to retain key personnel,
particularly senior management and engineers. We also need to attract additional
skilled personnel in all areas of our business to grow. There can be no
assurance that we will be able to retain our existing personnel or attract
additional qualified employees in the future. Other than Kenneth Wawrew, Vice
President, Business Development, we generally do not have employment contracts
with our other key employees and do not maintain key person life insurance on
any of our employees.
Acquisitions
We may pursue acquisitions of complementary product lines, technologies or
businesses, such as the acquisition of CR Technology in November 1999, Photon
Dynamics Canada Inc., formerly known as Image Processing Systems Inc. in
December 2000 and Intelligent Reasoning Systems, Inc. in July 2001. Future
acquisitions may result in potentially dilutive issuances of equity securities,
incurrence of debt and contingent liabilities and amortization expenses related
to acquired intangible assets, which could harm our profitability. In addition,
current and future acquisitions involve numerous risks, including difficulties
in the assimilation of the operations, technologies and products of the acquired
company, the diversion of management's attention from other business concerns,
risks of entering markets in which we have no or limited direct prior experience
and the potential loss of key employees of the acquired company. There can be no
assurance as to the effect of future acquisitions on our business or operating
results.
Intellectual Property and Infringement
Our success depends in large part on our intellectual property. While we
attempt to protect our intellectual property through patents, copyrights and
trade secrets, there can be no assurance that we will successfully protect our
technology or that competitors will not be able to develop similar technology
independently. No assurance can be given that the claims allowed on any patents
held by us will be sufficiently broad to protect our technology. In addition, no
assurance can be given that any patents issued to us will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
competitive advantages to us. Litigation may be necessary in the future to
enforce our patents and other intellectual property rights, to protect our trade
secrets or to determine the validity and scope of the proprietary rights of
others. Even if successful, litigation could be expensive and divert important
management resources. If our intellectual property were not properly protected,
our business could be harmed.
25.
Regional Electric Shortages
Recently, California experienced an electric power supply shortage that
has resulted in the intermittent loss of power in some areas in the form of
rolling blackouts. While we have not experienced any power failures to date, a
blackout may affect our ability to manufacture products and meet scheduled
deliveries. If blackouts were to interrupt our power supply, we would be
temporarily unable to continue operations at some of our facilities. Any such
interruption in our ability to continue operations at our facilities could
damage our reputation, harm our ability to retain existing customers and to
obtain new customers and could result in lost revenue, any of which could harm
our business and results of operations.
Environmental Regulations
Some of our PCB assembly and advanced semiconductor packaging products are
subject to regulation by the U.S. Food and Drug Administration, the California
Department of Public Health and other agencies in each jurisdiction where these
products are sold or used. Compliance with these regulations is time-consuming
and expensive and may delay or even prevent sales in the United States or other
jurisdictions. If we fail to comply with these regulations, we could face fines
or penalties, and sales of our products could be prohibited. These fines,
penalties and prohibitions could harm our business.
We are also subject to federal, state and local regulations related to the
use, storage, discharge, handling, emission, generation, manufacture and
disposal of toxic or other hazardous substances used in our manufacturing
process. Failure to comply with current or future regulations could result in
substantial fines being imposed on us, suspension of production, alteration of
our manufacturing processes or cessation of operations. New environmental
regulations could also require us to purchase expensive equipment or incur other
significant expenses to ensure compliance. Unanticipated environmental
compliance costs could harm our business.
Common Stock Price Volatility
The market price of our common stock could fluctuate significantly in
response to variations in quarterly operating results and other factors, such
as:
o announcements of technological innovations or new products by us or
by our competitors;
o government regulations;
o developments in patent or other property rights; and
o developments in our relationships with our customers.
In addition, the stock market has in recent years experienced significant
price fluctuations. These fluctuations often have been unrelated to the
operating performance of the specific companies whose stock is traded. Broad
market fluctuations, general economic condition and specific conditions in the
FPD, CRT and glass and PCB assembly and advanced semiconductor packaging
industries may adversely affect the market price of our common stock.
26.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Rate Risk
The current foreign exchange exposure in all international operations is
immaterial. We believe the impact of a 10% change in exchange rates would not be
material to our financial condition and results of operations. Accordingly, we
do not use derivative financial investments to hedge our current foreign
exchange exposure.
Market Risk
Our exposure to market risk for changes in interest rates relates
primarily to our cash and cash equivalents and short-term investment portfolios.
We do not have derivative financial instruments in our portfolio. The following
table presents principal amounts and related weighted average interest rates by
year of maturity for the Company's cash and cash equivalents and short-term
investment portfolios:
There- Fair
(in thousands) 2001 2002 2003 2004 2005 after Total Value
- ---------------------------- -------- ------ ------ ------ ------ ------- ------- -------
Short-term investments:
Fixed rate securities ...... $67,455 -- -- -- -- -- $67,455 $67,563
Average interest rate ...... 3.64%
27.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Description Page
- -------------------------------------------------------------------------- ----
Report of Ernst & Young LLP, Independent Auditors ........................ 29
Report of Arthur Andersen LLP, Independent Public Accountants ............ 30
Consolidated Balance Sheets at September 30, 2001
and September 30, 2000 ................................................ 31
Consolidated Statements of Operations for the Years Ended
September 30, 2001, 2000 and 1999 ..................................... 32
Consolidated Statements of Shareholders' Equity .......................... 33
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2001, 2000 and 1999 ..................................... 34
Notes to Consolidated Financial Statements ............................... 36
28.
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Photon Dynamics, Inc.
We have audited the accompanying consolidated balance sheets of Photon
Dynamics, Inc. as of September 30, 2001 and 2000, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended September 30, 2001. Our audits also included the
financial statement schedule listed in the index at Item 14(a)(2). The
consolidated financial statements give retroactive effect to the acquisition by
Photon Dynamics, Inc. of Photon Dynamics Canada Inc., formerly known as Image
Processing Systems Inc. ("IPS"), on December 22, 2000, which has been accounted
for using the pooling of interests method as described in the notes to the
consolidated financial statements. These financial statements and schedule are
the responsibility of the management of Photon Dynamics, Inc. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits. We did not audit the financial statements of IPS as of September 30,
2000 and for the twelve month period then ended and as of March 31, 2000 and
1999 and for each of the two years in the period ended March 31, 2000, which
statements reflect total assets of $11.1 million and net loss of $1.5 million as
of September 30, 2000 and for the twelve month period then ended and total
assets of $11.2 million and $14.7 million and net income of $500,000 and net
loss of $7.0 million as of March 31, 2000 and March 31, 1999, respectively, and
for each of the years in the two years ended March 31, 2000, included in the
related 2000 and 1999 consolidated financial statements, respectively. Those
statements were audited by other auditors whose reports have been furnished to
us, and our opinion, insofar as it relates to data included for IPS, is based
solely on the reports of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Photon Dynamics, Inc. as of September 30,
2001 and 2000, and the consolidated results of its operations and its cash flows
for each of the three years in the period ended September 30, 2001, after giving
retroactive effect to the acquisition of IPS, as described in the notes to the
consolidated financial statements, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole presents fairly in all material respects the
information set forth therein.
As discussed in Note 1 to the consolidated financial statements, in fiscal
2001 the Company changed its method of accounting for revenue recognition in
accordance with guidance provided in SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements".
/s/ ERNST & YOUNG LLP
----------------------------------------
San Jose, California
October 19, 2001
29.
ARTHUR ANDERSEN LLP
AUDITORS' REPORT
To the Directors of
Photon Dynamics Canada Inc.,
We have audited the consolidated balance sheets of PHOTON DYNAMICS CANADA
INC. (formerly known as Image Processing Systems Inc.) as of September 30, 2000
and March 31, 2000 and the consolidated statements of operations, deficit and
cash flows for each of the twelve month periods ended September 30, 2000, March
31, 2000 and 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted
auditing standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance 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.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the Company as at September 30, 2000 and
March 31, 2000 and the results of its operations and its cash flows for each of
the twelve month periods ended September 30, 2000, March 31, 2000 and 1999 in
accordance with Canadian generally accepted accounting principles.
/s/ ARTHUR ANDERSEN, LLP
----------------------------------------
Mississauga, Canada
August 3, 2001
30.
PHOTON DYNAMICS, INC.
CONSOLIDATED BALANCE SHEETS
September 30,
(in thousands, except share data) 2001 2000
- ------------------------------------------------------------------- --------- ---------
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 16,528 $ 9,723
Short-term investments ...................................... 67,563 93,003
Accounts receivable, net of allowance of $1,897 and
$1,751 as of September 30, 2001 and 2000, respectively . 11,171 24,828
Inventories ................................................. 16,007 16,523
Other current assets ........................................ 3,406 4,810
--------- ---------
Total current assets ................................... 114,675 148,887
Land, property and equipment, net ................................. 14,046 4,111
Other assets ...................................................... 2,688 2,056
Intangible assets ................................................. 4,502 --
Goodwill .......................................................... 22,724 --
--------- ---------
Total assets ................................................ $ 158,635 $ 155,054
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................ $ 4,295 $ 6,622
Other current liabilities ................................... 8,361 14,339
Deferred revenue ............................................ 2,312 1,884
--------- ---------
Total current liabilities .............................. 14,968 22,845
Other liabilities ................................................. 359 409
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 5,000,000 shares authorized,
one and no shares issued and outstanding as of September
30, 2001 and 2000, respectively ........................ -- --
Common stock, no par value, 20,000,000 shares authorized,
13,884,354 and 12,959,095 shares issued and outstanding
as of September 30, 2001 and 2000, respectively ........ 184,500 159,723
Accumulated deficit ......................................... (41,698) (28,571)
Accumulated other comprehensive income ...................... 506 648
--------- ---------
Total shareholders' equity ............................. 143,308 131,800
--------- ---------
Total liabilities and shareholders' equity ............. $ 158,635 $ 155,054
========= =========
See accompanying notes to consolidated financial statements.
31.
PHOTON DYNAMICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
(in thousands, except per share data) 2001 2000 1999
- ------------------------------------------------------------- -------- ------- -------
Revenue ..................................................... $ 71,083 $94,757 $62,011
Cost of revenue ............................................. 42,053 50,624 34,391
-------- ------- -------
Gross margin ................................................ 29,030 44,133 27,620
Operating expenses:
Research and development ................................. 17,122 14,196 8,147
Selling, general and administrative ...................... 18,314 16,523 15,836
Non-recurring acquisition charges ........................ 2,325 860 --
Acquired in-process research and development ............. 1,323 -- --
Restructure charges ...................................... 1,229 -- --
Amortization of intangible assets ........................ 239 -- --
-------- ------- -------
Total operating expenses .............................. 40,552 31,579 23,983
-------- ------- -------
Income (loss) from operations ............................... (11,522) 12,554 3,637
Interest income and other, net .............................. 5,008 4,219 154
-------- ------- -------
Income (loss) before income taxes and cumulative effect of a
change in accounting principle ......................... (6,514) 16,773 3,791
Provision for income taxes .................................. 53 3,238 673
-------- ------- -------
Income (loss) before cumulative effect of a change in
accounting principle ................................... (6,567) 13,535 3,118
Cumulative effect of change in accounting principle, net of
tax benefit ............................................ (6,560) -- --
-------- ------- -------
Net income (loss) ........................................... $(13,127) $13,535 $ 3,118
======== ======= =======
Net income (loss) per share before cumulative effect of
change in accounting principle:
Basic ....................................................... $ (0.50) $ 1.13 $ 0.31
Diluted ..................................................... $ (0.50) $ 1.04 $ 0.29
Loss per share from cumulative effect of change in accounting
principle, net of tax benefit:
Basic ....................................................... $ (0.50) -- --